CACI International Inc (CACI) 2009 Q2 法說會逐字稿

Welcome to the CACI International second quarter fiscal year 2009 conference call. 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 question-and-answer portion of this call, we are only taking questions from the 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.

Thank you, Tamara. Good morning, ladies and gentlemen. I'm Dave Dragics, Senior Vice President of Investor Relations of CACI International. We are very pleased that you are able to participate with us today. Now, as is our practice on these calls, we are providing presentation slides. And during the presentation, we will also make every effort to keep all of you on the same page as we are.

Let's move to Slide Number 2. Before we begin our discussion this morning, I would like to make our customary, but important statement about regarding our written and oral disclosures, and commentary. There will be statements in this call that do not address historical facts, 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.

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 also described in the Company's Securities and Exchange Commission filings. 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 will include discussion of non-GAAP financial measures.

Now let's go to the next slide, please. And to open up our discussion this morning, here is Paul Cofoni, Chief Executive Officer of CACI International. Paul?

Thank you, Dave. Good morning, ladies and gentlemen. I'd like to personally welcome each and every one of you to our call this morning and we very much appreciate your interest in this company. With me today to discuss our results and answer your questions are Tom Mutryn, Chief Financial Officer, Bill Fairl, President of US Operations, Randy Fuerst, Chief Operating Officer for US Operations and by phone from the United Kingdom, Greg Bradford, Chief Executive of CACI Limited UK.

Let's go to Slide Number 4, please. At the midpoint of our fiscal year, I am extremely pleased with CACI's strong financial performance. We achieved a record quarterly revenue of $673 million in our fiscal 2009 second quarter. This second quarter is our fourth consecutive quarter of double-digit earnings per share growth. We've had six consecutive quarters of double-digit organic growth. This performance is consistent with our long-term financial goals of achieving at least 8% to 10% organic revenue growth and at least 15% net income growth annually.

Contract awards and contract funding orders were also up significantly from the fiscal 2008 second quarter. These positive results reflect the success of our strategic focus on the well-funded federal services market. Our growth strategy is to deliver mission critical support to defense intelligence, homeland security, and the improvement of government services. Our strategy to focus on solutions to defeat global terrorism through new technology, training and analysis, and intelligence, security services and cyber security is delivering profitable growth. Our intelligence revenue grew more than 35% over the same quarter last year and now represents 39% of our total business.

Slide Number 5, please. Our core markets continue to receive high priority mission critical funding. What differentiates CACI is that there is a steady long-term demand for our innovative and valuable solutions which are absolutely congruent with helping our clients defend our nation. Even now, with the global economic crisis, we see this clearly. Our mission, our client mission understanding has never been more valuable, and our client relationships have never been stronger.

The new administration is communicating its strategy for American global leadership. This includes integrating the soft power of diplomacy and socioeconomic with the hard power of military strength. Both are necessary to meet today's threats. They've [coined] this Smart Power; America needs to protect our homeland and promote global stability.

We are taking initiatives in advancing strategy and thought leadership in this area. We are hosting a series of symposia that bring together experts from government, industry and academia to deal with the global asymmetric threat. In October, we co-sponsored our second symposium on the role of soft power in defeating terrorism.

We will be publishing our white paper from this symposium soon and I invite you to read it and it will be posted on our website. We have scheduled our next symposium focused on the application of benefits of smart power for March 24th. We are convinced that our ideas and solutions in this area provide essential value to counter threats and promote global stability.

CACI's continued growth in our core business and expansion into new business areas is a result of our experience and innovative management team. In the second quarter, [Dal Azley], the FBI former Chief Information Officer joined us as Senior Vice President for Strategic Law Enforcement and National Security Programs. Dal brings us unique federal security and IT expertise. This includes twice being deployed to Afghanistan on behalf of a US intelligence agency to support military operations there on the ground. He also served eight years with the US Marines. At CACI, he will leverage this experience to help grow our name recognition and marketshare in the law enforcement and national security arena, and assist us in executing our strategy of integrating intelligence and security services.

Our fundamental strategy remains sound, despite the world economic crisis. However, as we said in our last earnings call, this crisis is impacting our UK business and our effective tax rate. We have taken immediate and aggressive corrective actions, including a new UK sales strategy and cost controls throughout the Corporation. These actions combined with the strong performance of our domestic business have helped to largely offset these impacts. Greg, Tom and Bill will provide more details on this.

Our core business has performed exceedingly well in the first half of fiscal 2009 and we believe funding for our key markets in defense, intelligence and homeland security will remain strong. We have a healthy balance sheet and cash flows, and remain prudent with our capital as part of a balanced and well-integrated financial strategy. We are winning more than our share of awards at the Tier 1 level and are are funding hiring and overall team performance is strong.

Tom will now provide his financial overview, followed by Greg Bradford and Bill Fairl who will provide more information on our operations. Tom?

Thank you, Paul. Good morning, everyone. Please turn to Slide Number 6.

As Paul indicated, we are very pleased with our second quarter results. Our revenue grew year-over-year by 16.4%, driven by strong organic growth of 13.5% in acquisition-related revenue from the Dragon and Athena transactions. Our direct billable labor grew by 13.8%, driven by both our hiring activities and our acquisitions. Our other direct costs were up 23.4% as we continued to provide valuable services to our customers using a variety of subcontractors. This work helps our clients, solidifies our relationships, adds to our bottom line, and prudently leads to direct labor growth.

Let go to the next slide, Number 7. Second quarter operating income was up 18.1% year-over-year. The growth in our direct labor and ODCs, our continued control of indirect costs and lower expense as acquisition amortization tails off, all contributed to the strong operating income growth. Net interest expense fell by 9% as we realized the benefit of lower interest expense on our floating rate debt. Pretax income was up an impressive 23.9%.

Please turn to Slide Number 8. Our net income for the quarter was $22.1 million, an 15.1% increase from the second quarter of last year, despite a material increase in our effective tax rate. For the quarter, the effective tax rate was 43.5%, driven by continued declines in the asset values of the investments in our executive deferred compensation program. We are currently assuming a full-year effective tax rate of 42.5%, based on assumption that we will not experience further losses in planned assets in the back half of the year. Let me add that the losses in the deferred compensation plan are not impacting our cash flow or the cash taxes we are currently paying.

Diluted earnings per share for the quarter were $0.73, up 15.9% year-over-year; the fourth successive quarter of double-digit earnings per share growth. We are gratified to see continued progress toward our longer term goal of at least 15% annual EPS growth. Next slide, please.

Our cash position at the end of the quarter was $105 million. Our operation used $1 million in cash during the quarter. The growth in our business requires more working capital and we continue to experience normal fluctuations in cash. Day sales outstanding at the end of December were 64 days and continue to be industry-leading.

Our businesses generate strong dependable cash flows. We bill the government promptly and accurately. The government pays on time and our capital needs are minimal. As such, we expect operating cash flow to be consistent with our initial guidance of about $130 million. Our trailing 12-month operating cash flow per share was $5.31, equivalent to a 12.3% cash flow yield at our current stock price.

Next Slide Number 10, please. Our financial fundamentals remain strong. Our quarter end net debt was at $553 million, with our net debt to trailing EBITDA leverage ratio at a comfortable 2.4 times. We have two major debt instruments outstanding. Our $334 million institutional loan matures in May 2011 and is priced at the lower of prime or LIBOR plus 150. Currently, our weighted interest is 3%.

In addition in May of 2007, we issued a $300 million of seven-year convertible notes with a 2 1/8% coupon. With this attractively priced debt in place, I am happy to say, we have no near term financing issues and we have more than adequate liquidity with $100 million of cash, plus $240 million of unused revolver capacity.

Next slide, please. Based on activity since our last call, we continue a review of our operations and expectations for the remainder of the year, we are increasing our revenue guidance $2.65 billion to $2.75 billion due to our strong growth in OBCs. The higher effective tax rate is resulting in a decline of about $0.17 per share for the full year. The weakening of the UK pound is costing about $0.05, and the UK recession impact on our operations there is costing about $0.05.

Because of these headwinds, we have reduced the top end of our earnings guidance and we now expect earnings per share to be between $2.90 and $3.05. We are pleased that the strength of the US operations, cost control activities and new UK sales strategies are expected to offset most of these headwinds. That we are able to keep the bottom end of the EPS guidance in tact and only lower the top end, is a testament to the strength of our core US business.

The next slide, Number 12 has a good amount of detail on accounting for convertible debt. Let me summarize this issue without getting into all the specifics. Beginning July 1, we are will adopt new accounting standards, governing the accounting for convertible debt instruments. This rule requires us to impute a noncash interest charge associated with our convertible debt and it requires retrospective application.

As such, we will be recasting our financial results for the prior period, beginning with the first quarter of our fiscal year '10 -- 2010. To give you an idea of the impact, if this standard was in place during our second quarter, our interest expense would have been $2.4 million higher than reported and our pro forma net income would have been $1.3 million less. Let me underscore that this is a noncash expense. Cash flows are unchanged.

To minimize computing regarding 2010 estimates in comparison with our current year numbers, we encourage you to refrain from incorporating the new accounting into your estimates until we provide our initial full year '10 guidance. With that, let me turn the call over to Greg Bradford. Greg?

Thank you, Tom. Good morning, everyone. Although it is afternoon here in London. I would like to give you an update on our UK operation and what we are doing to address the impacts of the global recession on our business over here.

Let's move to Slide Number 13, please. Our UK subsidiary reported revenue of $18.1 million for the quarter, a 21% decrease from last year's second quarter. This decrease was the result of a 23% fall in the value of the pound from the second quarter of last year. Our net income margin was 6.1%, compared to 6.6% for the second quarter of last year.

Our UK operation performance in the second quarter and year-to-date has been adversely impacted by the substantial fall in the value of the pound and the UK recession. We took a number of management actions during the quarter to increase sales activity and reduce costs to mitigate the impact of the recession. These actions enabled us to successfully generate a net income margin in the second quarter close to what we achieved in quarter two of last year. The UK recession is expected to worsen and so we implemented additional measures, mostly cost savings, at the end of the second quarter to offset any further impact on our business going forward.

A key component of our business strategy over the last five years has been to grow our government business. Today, approximately 32% of the UK business is government. This area of our business has been largely unaffected by the recession which we believe will continue to be the case in the future.

To further our strategy, we acquired a small government software contract last week which we expect will generate $3.5 million revenue per year and be accretive. We will of course continue to keep a watchful eye on the UK economy. And we will take swift and appropriate action where necessary to sustain our business and maintain our profitability. Our greatest asset in achieving this is our UK management team. I have been at the helm of the UK business since the mid 1980s, and the members of my top management team are well-seasoned business managers with many years of experience at CACI.

While every economic crisis is different, we successfully managed our UK operation through the recession in the early 1990s and the lessons learned from that experience are proving valuable this time around. We know what is expected of us, and we know what to do. With that, I would like to turn it over to Bill Fairl for an overview of our US operations. Bill?

Thanks, Greg. And let me add my welcome to everyone on the call. This morning, I will address second quarter highlights from US operations. And if you could, let's go to Slide 14.

Our contract fundings orders for the quarter increased to $538 million. That's a growth of 21% or more than $92 million over the second quarter of fiscal '08. Our funded backlog through the first half of fiscal '09 was $1.53 billion. Now at this point, I call your attention to our contract awards for the second quarter. During the quarter, we received contract awards of $886 million. That's a dramatic increase of $442 million or nearly 100% more than the second quarter of fiscal '08. 100% more.

I would like to take a moment now to briefly discuss some major second quarter contract awards and announcements. Our largest single award for the quarter was Genesis 3, a prime contract with a $452 million ceiling to continue providing mission support services to the US Army intelligence and security command. CACI's role here is to provide complete support for systems for electronic warfare, security, quick reaction capability and prototyping. We also received additional classified contract awards with an approximate value of $114 million to support the intelligence community.

We received $96 million in S-3 awards during our second quarter and through December, we have been awarded more than $1.6 billion in S-3 cash flows We announced the opening of the CACI research and development labs, what we call Cradle, on the US Army's Aberdeen proving grounds in Maryland. With this innovative new high-tech facility, CACI continues our ongoing support for army operations transitioning to Aberdeen from Ft. Monmouth, New Jersey as mandated by the defense-based realignment and closure commission.

The Cradle provides tools and resources to support the seemless and uninterrupted transition of these operations. We also announced an agreement with Oracle during the second quarter. Per this agreement, Oracle and CACI will jointly develop a contract life cycle management solution to help federal organizations manage procurement contracts in compliance with federal regulations.

Slide Number 15, please. Growth in the Intel portion of our portfolio was strong again, as we were up 35% quarter-over-quarter. Our intelligence business was approximately 39% of our revenue in the quarter.

Our Athena and Dragon acquisitions contributed to this impressive growth. And just to give you a little historical perspective here; between our fiscal years '05 and '08, CACI's intelligence revenue grew from 25% of our total revenue or about $414 million per year to 34% of our revenue or almost $834 million a year in fiscal '08. Year-to-date, our Intel revenue represents 38% of our total business or almost $503 million of the $1.33 billion in revenue we have reported for our first two quarters. Pretty impressive.

Let's move to the next slide, please. Our proposal activity continues at a high level. At the end of our second quarter, we had more than $4.2 billion in submitted proposals under evaluation, both new and [recompete]. We expect nearly all of them to be awarded by the end of our fiscal year. During our third and fourth quarters, we anticipate submitting more than $5 billion in additional proposals.

During our recent conference calls, I have discussed our progress in hiring. This morning, I'm delighted to report that our trend of outstanding hiring results continued during our second quarter, as we added over 240 net new hires. Many with security clearances of top secret or above. Today, approximately 35% of our workforce has a top secret or above security clearance. Overall, we now have more than 8400 cleared employees. That's 8,400 cleared employees.

In summary, our strong contract awards, contract funding orders and funded backlog, coupled with our success in hiring, give us continuing positive momentum for the second half of fiscal '09. Our team is focused on maintaining our momentum through the remainder of this fiscal year and beyond. Paul, that concludes my remarks.

Thanks, Bill. And thank you, Greg and Tom for your comments. Let's turn to the last slide, please.

I would like to conclude our call today by summarizing CACI's business strengths. We believe CACI's double-digit earnings per share and organic growth for the second quarter and the first half of fiscal 2009, validates our growth strategy. This strategy is to position ourselves in the government's growth areas in defense, intelligence, homeland security and the improvement of government services where our services are in high demand. Our clients are expected to continue to spend in support of their critical missions.

The strength of our US operations, combined with our ongoing cost control initiatives, should largely offset impacts we are experiencing in our UK business and increase our effective tax rate. We believe our core business is resilient to the current economic crisis. The government services market remains robust and CACI is a leader in this market. We have an outstanding and experienced leadership team, implementing a sound strategic plan in a robust federal services market.

Our employees are committed to our vision of being the best in our industry. CACI is a market leader, value-added business partner, and a great place to work. We are delivering on our commitments of building lasting trust and enhancing shareholder value. With than, Tamara, we can open up the lines for questions.

(Operator Instructions). We will pause for just a moment to give everyone an opportunity to signal. We will take our first question from Bill Loomis with Stifel Nicolaus.

Thank you. Good quarter. Good morning.

Thank you. Morning, Bill.

Morning. Just one thing on the gross margin, I know you've had higher ODCs, but you have had them for awhile. Why does the gross margin hit a low in the quarter -- all-time low? Yet your direct labor was up 14% so almost as high as your total revenue growth. What is the component that is is going on with the gross margin and where do we see that going over to next year?

Do you want to take that?

I will. Two components of gross margin obviously, direct labor margins and ODC margins. In the quarter, we continue to see strong ODC performance. Everything else being equal, that's going to depress gross margins -- as gross margins, as ODCs grow. That is one of the major drivers of the gross margin. It was down year-over-year and that was the major attributing factor to it.

The other factor that is occurring within direct labor and within ODCs, there is a variety of components. At any point in time, CACI has over 2,000 task orders. Not all direct labor is created equal. Not all ODCs are created equal. As certain projects grow, as certain projects contract, we will see mixes within the direct labor margin category or the ODC margin category as well. A lot of moving pieces going on simultaneously and the net results of those moving pieces is the gross margin that we reported.

We will take our next question from Michael Lewis with BB&T Capital Markets.

Good morning. Thank you for taking my call. Paul, can we get a status on the ETOS recompete? Do you have any new information there?

Yes. That recompete I believe, Bill, is due in March.

We are can currently thinking March, Paul.

And of course, we are feeling very confident we have --

Yes.

Been there a very long time. We have won successive recompetes. Our performance is strong and the client relationship is outstanding. We are confident, not cocky but confident.

Was that two previous recompetes that you won on that or three?

Michael, this is Bill Fairl. That relationship goes back many, many years, 20 years, 25 years in various contract forms -- before the client actually moved up to Fort Mammoth out here in Virginia. There has been a whole series of recompetes here. To Paul's point, our success comes not from low price bids, but instead from a really solid, solid client relationship and best value deliveries to over a whole series of recompete wins.

We will take our next question from Brian Gesuale with Raymond James.

Hey guys. Excellent quarter.

Thank you. Thank you.

Thank you.

Good morning, Brian.

Wanted to talk to you a little bit about direct labor, it looks like it grew really nicely in the quarter. On some of this new business that you have won which has been impressive, how does that fit into that overall goal of having the 60/40 split direct versus indirect? Maybe on the 14% direct labor number growth that you gave, is that all organic or how should we look at that?

Brian, this is Bill Fairl. I will start with that. We have got -- as Tom mentioned, we have got 2,000 -- approximately 2,000 active task orders at any given time. Some of the growth in direct labor or actually a lot of it comes from those ongoing 2000 task orders, many of which go back many years in time. The initiative you are referring to about our new business wins, going out and focusing on those opportunities that give us at least 60% CACI labor content. That is slowly over time delivering more labor content to us. But if you use the analogy or metaphor of an aircraft turning here, it takes a long time to do that.

At the same time, as Tom mentioned, we have had outstanding growth in ODCs. Direct labor has been growing fantastically. Good news, ODC has been growing even faster. We like that because we get real value. We earn money on it. It builds client relationships. And also, it frequently leads to new direct labor work downstream.

The whole thing is good there. It just changes the mix there while ODCs are growing faster. Tom, do you want to add anything to that?

You covered the question.

We will take our next question from Jason Kupferberg with UBS.

Morning, guys.

Morning Jason.

Want to touch on the operating margins briefly. With the ODCs going up, and we have been assuming your operating margin for the full fiscal year would come in around the low end of the 6.7% to 7.0% range was where you left off on the guidance. Is that a pretty reasonable working assumption, just given the ODC trends?

It is. Let me take a step back and address the margin question -- we've just had a few questions on margin. As we have said, our focus is on delivering value to our shareholder. First and foremost, we believe that driving a 15% plus year-over-year growth in net income and earnings per share will drive significant shareholder value.

At the same time, we believe that delivering strong organic growth -- 10% will provide value to our shareholders. Quite candidly, our next priority is to improve our margins, our gross margin, our operating margin, our net margin. In other words, we do want to make sure that every incremental dollar we produce is more profitable -- one way to look at margin. But like many things, it is easier said than done.

Complicated issues due to two broad mix issues. One is the ODC versus direct labor mix, both ODCs and direct labor are good. We have seen over the last several quarters, higher growth in ODC, positive through bottom line. Good for a number of strategic and operational regions, but it does serve to reduce margin.

And as we said, we also have mix within our ODC categories and mixes within our direct labor. With that said, we are focused on increasing the margin of ODC, getting higher mark-ups, increasing our direct labor taking time to do that. In our cost control initiatives, economies of scale, tight controls will help our operating margins as well. A long winded answer to your question -- bottom line, we initially guided operating margin of 6.7% to 7% for the year. Right now, we think we will either be at the low end of the range or slightly outside of the range, given the strong growth in ODCs. That is where we are thinking mark will come out for the full year.

Next from Mark Jordan with Noble Financial.

Good morning, gentlemen. I would like to talk a little bit about the concept of cash earnings versus reported GAAP, as GAAP is becoming more and more complex. Specifically, if you look at the fiscal '09 outlook -- if we had adopted SP-14-1, you would be looking at a base of say 280 or less. But then looking at the amortization of purchase intangibles which this year I believe is at about $32.1 million or $1.05 a share, you add back the $0.20 from 14-1, you are looking at a $4.05 number which would be up say, 45% from what will be the recap '09 when you adopt 14-1.

In addition, going into the new year, I believe you will have to use 141-R which is the immediate write-off of any deal expense which will add more noncash variability to profit. Do you believe at some point in time, you might also start to report a cash EPS-type number which would add back these noncash charges, as it would be instructive to your shareholder base that this is more reflective of what you are earning versus the GAAP numbers?

Yes, those are very good observations. We have certainly about thought about that quite a bit. In my prepared remarks I mentioned that our operating cash flow per share was equivalent to $5.31 per share, equivalent to a 13% cash flow yield. We are very much focused on cash and we recognize that some of the current accounting is noncash base. You mentioned the convertible. You mentioned the amortization. We also have significant noncash stock compensation expense.

Some of the higher effective tax rates we are seeing are noncash. We will take that under advisement and we want to provide that type of insight into our investors. I encourage all of you on the call to do your own calculations as well. That's a very good way to look at both CACI and other companies on a cash basis.

We will take our next question from Tim Quillin with Stephens.

Good morning. Nice quarter.

Thank you.

Thank you, Tim.

Tom, in terms of cash flows, I think both last year and this year, it is going to be back half weighted. What is the comfort or confidence level that the timing of collection receivables will be such that you will achieve that $130 million operating cash flow target?

We went back over the last several years and looked at cash flow the first half of the year versus the back half of the year. Typically, we are stronger in the back half of the year. We have a good amount of confidence that the back half of the year will come in quite strong.

Year-to-date, our cash from operations is essentially flat. We have a significant positive cash flow to come up with in the back half to get to those particular numbers. All in all, we are comfortable that we will get that money. We bill the government; the government pays. CACI generally is a very strong cash flow generating machine. The reality though is there are always random fluctuations in cash flow. We look at cash coming in the door every day, every week, every month.

It is somewhat of a sawtooth, choppy graph if you look at it on a day-to-day basis. Often times, one of these situations we face is where does the quarter end versus that sawtooth, choppy pattern that will impact our GAAP reported, cash flow from operations. The long question, bottom line we are very comfortable we will continue to generate very solid, dependable cash flow. That being said, there is some choppiness to it.

Sure. On the tax rate, I know it is a little complicated. I don't want to get too deep into it. But in terms of how we think about fiscal '10, do asset values stabilize as the tax rate go down or do asset values have to increase before the tax rate goes down?

Asset values stabilize. In fiscal '10, if you assume that the plant assets are generally flat, there's no precipitous losses, we are back to a normal tax rate. Let's say 39%.

We will take our next question from Dhruv Chopra with Morgan Stanley.

Nice work, gentlemen, on the quarter.

Thank you. Good morning.

I have a couple of questions. Over the past year and a half, you have seen pretty solid growth in cost reimbursable contracts. How should we think about that going forward and what impact is this makeshift having on the margins?

Okay. This is Bill Fairl. I will start on that. Actually, most of the shift for us for -- to cost plus occurred, I think three to four years ago. The last couple of years, it has stabilized a little bit. Going forward here, there seems to be a bias -- easier said than done, but maybe moving more towards fixed price contracts. That's still very much under debate inside the government if you will.

With that in mind, I would just offer an observation that we are spending a fair amount of time training our managers -- our project managers on the proper management of fixed price contracts. We have a very deliberate process around here for risk management and getting those projects delivered on time within budget. We're really good at. We think there's going be more movement toward fixed price contracts. There will be more requirements so we are getting ahead of that if you will. And fixed price contracts managed properly can be very profitable. It can be a good thing.

To your question about cost plus contracts. When you think about three types of projects -- fixed price contracts, managed very properly. Time and materials contracts and then cost plus. In terms of profitability, cost plus is at the bottom of that totem pole if you will -- somewhere around between 5% and 8% if you will. Or there can be some variations depending on it, depending on if you have [war fee] contracts on that or not. But we generally think about 5% to 8% on the cost plus contracts.

We will take our next question from Joe Nadol with JP Morgan.

It is Seth for Joe this morning. A quick question on taxes. For the year as a whole -- to the 42.5% guidance, it looks like the tax rate in the second half would have to be fairly high -- a lot higher than the tax rate in the first quarter and then the normal tax rate. I thought you said you were assuming no more loss in the deferred comp plans so just wondering how that shakes out.

Yes. Seth, here is it work. That any quadrant we new need to come up with an effective tax rate which is based on our best estimates for the full year. For the first quarter, we had a 41% tax rate. Our second quarter was approximately 43.5% which brought us year-to-date close to the 42.5% tax rate. Right now with no further gains or loss in the deferred compensation assets, we would book an effective tax rate in our third and fourth quarter of 42.5%.

That makes sense. Just a quick follow-up. I wonder if you can talk in a little more detail about what you're expecting from the UK business for the remainder of the year? It seemed like the margins held up fairly well this quarter. I know there's a -- translation losses ahead. But just in terms of where the margins might go and what that contribution might be.

Greg, do you want to take that one?

I can take that. Our forecast for quarters three and four are that we should be able to maintain the same level of profitability as we have achieved in quarter two. The margin percentages may vary depending on the mix of revenue. Our government services business is actually growing, but it produces a smaller margin than our commercial software product business. The absolute profit that we feel we can continue to generate the next two quarters -- again the percents may change. Hopefully that answers your question.

We'll take our next questions from Brian Kinstlinger with Sidoti and Company.

Good morning, Brian.

How are you?

Good.

First question I have is as we've talked about the cash flows historically, what are your expectations for the year, Tom?

I'm sorry. You broke up near the end. Can you repeat that?

Let me pull up the phone. We talked about cash flows looking backward. Can we talk about what we expect the free cash flow target to be this year? I don't know if you mentioned that.

I did. We are expecting cash flow from operations for the full year to be about $130 million consistent with our initial estimates. We generate approximately $10 million of capital spending on a typical year so the free cash flow target would be --.

$120 million.

$120 million. Thank you.

I am just curious then -- you are more and more profitable each of the last two years. What is the difference that it has caused free cash within it -- if that comes in like that to drop in each of the last two years?

Two thing that are occurring. One is our -- our collection organization had been doing a spectacular job of reducing our DSO. Our DSO has dropped from the low 70s to the low 60s so just very admirable work by that organization.

The second factor is we are growing, and growing companies use working capital. That is -- it is a use of cash. But I think first and foremost, it's a very strong collection activity we have.

We will take our next question from Erik Olbeter with Pacific Crest Securities.

Good morning, guys. Congratulations from me as well.

Thank you,.

Thank you, Eric.

Real quickly, it looks like the market for the -- in the fourth quarter was expected to take a pause as we went through new transition-- new audit programs, new programs not coming online. You guys really showed a lot of resilience, particularly in contract awards. Can you talk in a little bit more detail -- what particular customers you are seeing that from. What particular areas of business core competencies you're seeing strengthen?

I will start. This is Paul. I am sure Bill might want to add something. I think the resilience lies in the fact we are focused -- our market is focused at the largest most complex problems that our clients face. We are getting that kind of continuous funding from defense, Intel, homeland security.

There is obviously the big problems of the nation, once you get past the global economic crisis that we are experiencing. The next thing right below that is of course security and the threat of terrorism around the world. That continues to be a steady funding from the clients that are involved in that fight which of course spans a good part of government. We expect going forward the that spectrum of involvement from the US federal government in the war on terrorism will broaden. Today, it is more focused on defense and intelligence, but we expect other agencies of government to increasingly participation in what Secretary Clinton called smart power which is that provision of targeting socioeconomic development and diplomacy -- and trouble spots that will likely breeding grounds for terrorism.

This is the big problem -- securities problem for the nation and the [citizenry]. We are heavily committed to that focus there -- invested there. Nearly 40% of our people are specializing in an area of intelligence alone. If you add in the other dimensions I mentioned -- the homeland security and other agencies that is will get involved in the smart power contribution. Probably 80% of what we do is in this area. That is pretty independent of the even the world global economic situation because security has to come first.

We will take our next question from Ed Caso with Wachovia.

Good morning. Two quick ones. Given your strong free cash flow, $120 million this year, I don't think you did any repurchase activity in the quarter. But do you have interest in restarting your repurchase effort? Any cost reductions -- control focused in the US or was it all in the UK?

Okay. I will start and Tom might want the to add. This is Paul. First of all on stock repurchase, we did do some, not in this current quarter, in the prior quarter we did some.

Before that, we did some in fiscal '07 as part of the convertible as well. I think that was close to $50 million at that time and then $20 million in the first quarter of fiscal '09. We are always evaluating that from time to time. We continue to evaluate that. However given the tightness in the markets for access to capital, that would be a more difficult decision for us right now. Tom talked a little bit in the script and I expect he will want to use this as an opportunity to expand on those comments. But our strategy for preserving capital and going forward, I would say that that is always a consideration for us. Tom, did you want to add?

Yes, I will. I think everyone on this call hopefully will agree that we are in a new environment. The world is significantly different than it was six, ten, twelve months ago. Capital markets, quite candidly, are in disarray, the cost of capital much higher, and capital is scarce. As a result of that, we have adjusted our strategy.

We are responding to a new environment. The sound strategy right now is to limit the amount of capital we will deploy until there is more clarity and stability in the marketplace. That goes to both share repurchase and acquisitions. That said, we expect acquisition values to come down. There maybe some very attractive opportunities in the next six to 12 months. Given the disarray in the market, the prudent course of action is for us to respond to the new environment and take a pause.

There was a second part to your question?

It had to do with the cost reduction efforts, are they impacting both the US and UK. As we see some of the headwinds associated with the tax rates in the UK, we are also looking at our indirect expenses in the US and we continue to have a very tight control in our expenses in incremental hiring, traveling, discretionary types of activities. I think all in all, we have been doing a very good job of controlling our expense, both here in the US which is the majority of our business as well as the UK.

We acted -- as a corporation, we acted across the whole spectrum if indirect spending, both in the US and UK with our management actions to partially offset the effect that Tom talked about, regarding the effective tax rate as well as the UK exchange rate as well as [impression] of the sales in the UK. It was a comprehensive corporate activity.

We will take our next question from Laura Lederman, William Blair.

Yes. Thank you for taking the question and my kudos on the quarter as well. Following up on your last question on the desire to hold capital and acquisitions, does that mean if you acquire something, it is likely to be small, not the mega acquisitions you have talked about strategically in the past? And also if you can talk a little bit about the new UK sales strategy and a little bit of components on that. Thank you.

The first part of this is we continue to stay very active in the area of mergers and acquisitions. We're looking at all size opportunities. However, given the realities that Tom talked about, at least for the near term, yes, we are focused more at the smaller niche, strong technology capability or strong advanced in a new client area from smaller organizations right now. That is something we evaluate continuously as we go through. We don't know how long our visibility about the liquidity in the capital markets -- how long our visibility will be limited. As soon as we have greater visibility, we are likely to reopen to some larger opportunities as well. Second part about UK sales. UK sales strategy, Greg, do you want to comment on that?

I can. It is focused primarily on our commercial software products business which has been hit by the recession and which does generate high margins. What we primarily do in the UK is we have software products and services that help commercial organizations expand. For example a retail organization wants to open up new branches, we tell them the locations in the UK where they can achieve the highest sales potential. The problem with the recession is that the retailers aren't opening up new branches.

In fact, they're actually contracting. But we can take our same products and services and had help them decide which branches they should consider closing or merging, based on the sales potential and not just go by the sales of those branches. We are pushing that quite hard. We are also -- all companies in the UK, and US as well, are attempting to reduce costs as much as they can. There are outsourcing opportunities for us where we can take over marketing functions or customer databases and provide that service to them at a lower cost than they can provide themselves.

We are pushing that sales initiative hard as well. Those are two examples. We are achieving some success though these are long sales cycles and we think this will be instrumental in us maintaining our profitability going forward.

Thank you.

We will take our next question from Chris Donaghey with SunTrust Robinson Humphrey.

Nice quarter, guys. Obviously this very early on, but just looking at the stimulus package and the well documented limitations of the federal acquisition workforce, what level of involvement do you see yourselves playing in this area or just the government services sector as a whole? Then as a quick follow up, Tom, could you give us the mix of direct labor over the past -- the trend in direct labor mix over the past couple of quarters, including the second quarter? Thanks.

I will start with the first part. That is a very good question. We have been examining that same question here ever since the concept of a stimulus package first emerged on the national scene. We continue to explore what role -- how we might help in some way.

I think you put your finger on one of the key areas that the whole concept -- whether the money is being distributed directly to the states or whether there are federal programs, the same issue, we believe will emerge which is the ability of the federal government to administer a program like this. All the way from selecting projects that deserve funding to program management oversight and control, this is a very, very large amount of money which will have real implications in terms of control against waste, fraud and abuse. I think Congress is very, very -- our interactions with various Congress members tell us that they're very focused on this language of that sort will be in the stimulus package bill. There is one area where we think we might be able to have a strong expertise in the areas of acquisition management services and also in program management -- and oversight type of work.

Also, as you might imagine, all of that being new will require technology. Technology to track, control, manage information systems to overseeing the allocation of funds, the progress of projects, the tracking of reviews of projects and corrective actions against slippages in schedule -- all of that from a program management standpoint will require managed information systems. There's also secondarily, several agencies of government, including the Department of Defense -- I think the Department of State, several other agencies that will be direct recipients of the funds from the stimulus package.

The stimulus package calls for nearly one-quarter of a million new government employment jobs, one-quarter of a million new jobs, federal workers. That will have impacts across the board in terms of technology support, et cetera. We continue to look at this. This is a good question. There are many more questions than answers in this area. Obviously, companies that are positioned more in the infrastructure project area will benefit the most from this. But we think there will be a role for us.

To follow up on the question on the direct labor mix, the statistics I will give you will be our direct labor as a percentage of our direct costs. Third quarter '08, 42.3%. Fourth quarter of '08, 41.4%. First quarter of '09, 41%. Second quarter '09, 39.4%.

We will take our next question from Alex Hamilton, Jesup & Lamont.

Good morning.

Morning.

Most of my questions have been answered. I think you guys highlighted something that is very important and it is speaks to your strategy. I would like to know if you can talk about the future for it. You talked about your Intel revenue being 38%/39% of revenue and that is certainly impressive as it's grown from about 26% in '05. How do you look at that in the next or two? Where do that to be? Do you think most of it is going to come organically or is that where you are going to probably focus acquisitions?

Thanks. I will start. Bill, will want to add I'm sure something.

We think that the funding stream for intelligence will continue to be vibrant. This is the first line of defense tactically against global terrorism -- is the ability to have information timely and exchange it with the right resources that can predict and pre-empt terrorist activity. It is not theory. It is practice. It is going on all over the world today. It is the best single tool we have in the near term to defeat or hold at bay the terrorist threats.

In the long term, smart power is the bigger answer, more comprehensive answer because it attacks the underlying conditions that cause terrorism to breathe. That will be a big growth area. We see cyber terrorism and cyber crime as a big, big area going forward. These are the focus areas. Taken together, and then of course the normal homeland security activities -- taken all together, that is a well-funded and will continue to receive strong funding. It is the condition that as long as it can continue to be effective, this is the first place the nation should invest in the short term. In the long term, the first investment needs to be in smart power. In the short term, the first investment for security has to be in the area of intelligence to gather the information necessary to pre-empt -- Bill, do you want to add?

I will just add a little specific to that. We show through good efforts of our Chief Operating Officer, Randy Fuerst and the head of our corporate business development, we have moved to this account structure over the last couple of years. We currently define about 30 major account for the Company. Among other things, we look at what our forward pipeline is for each one of those accounts. The biggest account we have right now -- with about $8 billion in future opportunities in it, is the Army's communications electronics activity, if you will. That gives you an indication, lots and lots of opportunity there.

Specifically, if you think about what is being talked about in government -- the idea of bringing folks out of Iraq, but putting folks and capability and focus on Afghanistan and one of the major challenges there is the whole ISR problem; intelligence, surveillance and [recongence]. A big factor is turning the tide in Iraq among other political sorts of things that has happened. When you move to Afghanistan -- completely different country, completely different topography, people don't live in cities there. They live out in little villages. No roads or anything. ISR is going to play a big roll there, but it is a new ISR requirement.

Our customer -- the Army side, also the -- that's their mission. We are there to support them. We have the contract vehicles already -- S3 and others. We are there. Task orders are rolling into us. Lots and lots of opportunity there.

And to take it -- very good, Bill. To take that piece of your question that dealt with the acquisition strategy, the priorities are clearly in the area of niche technologies that make a difference and counter terrorism and intelligence is a big part.

Cyber and smart power which is got to do more with diplomacy and socioeconomic development. These are the areas we have on the top of our priority stack currently. Also logistics is going to continue to be a very important thing as we see this fight that we're engaged in -- fourth generation fights we're engaged in today, widely dispersed around the globe, the logistic trains aptitude is a resource since they're fighting -- are long and they have to be maintained. Logistics will continue to be an important area as well.

We'll take a follow-up question from Mark Jordan, Noble Financial.

thank you. again, i'd like to talk a little bit about your m&a plans. clearly, with the changing in rules, it seems like your deals are going to become more costly from an amortization standpoint, both the write-off deal costs and also an [upward bias] on what you have to amortize. secondly, it seems the company would (inaudible) over that you do -- a wave of acquisitions to some extent will probably chance the profile of this Company towards the intelligence side. Given those two trends, do you think the desire to make acquisitions moving forward and the need to do them are less now that they were say, two years ago?

I'd say we're in a temporary period where that's true, but Ii don't view that as a long-term effect. Our strategy has consistently been to grow the Company through a combination of organic which of course is the most efficient way to grow for the Company, and acquisition growth. Now the acquisition growth is aimed -- the whole strategy of acquisition growth is about new things. It's about being able to have access to clients -- new technologies that are important.

That is all correlated to our ability to track or trend the future -- to be able to predict a bit of what is going to be important a year from now, two years or three years. It's not about [opening up], it's about what -- where is the requirement going. Where is the shifting importance of the requirement set upon clients. Or in some cases, even new clients who are the clients that we should be -- that we have the ability to help more.

The acquisition program is more a function of -- has been throughout our history of our -- acquisitions have been about access to new technology to support growth, access to new clients to support growth. Always focused on the shifting requirement of the client set. We're in a period now where necessarily because of the uncertainty of the availability about capital going forward that we have to step back -- wait for the expectations and sellers to intersect with reality which is starting to occur. And also, we've proven in terms of preserving our cash so that when we need to we can either repay the debt or refinance the debt we have. That we have cash available to give us the leverage as an alternative or choice between paying the debt down in cash versus refinancing -- we're not at the mercy of the financial institutions.

We have necessarily pulled back, but we're continuing to be active in the market. This could change. All of this could change in the next three to six months, as you know. Acquisition activities from the period -- from the time you start looking at a company until the time you close, six months, nine months. It can last a year. We are continuing to have an active program. This is for -- brought it down a bit so that we can be conservative with cash preservation.

We have no further questions at this time. I'd like to turn the conference over to Mr. Paul Cofoni for any additional or closing remarks.

Thank you, Tamara. And thank all of you who participated this morning on the call. We certainly appreciate your interest. It's important to us -- your interest of course is important to us as investors, advisors, and potential investors. We know that some of you may have additional questions, and as always, are team will be available to respond -- this call. Perhaps in about 20 minutes. That concludes our second quarter and first half fiscal year 2009 earnings conference call. Thank you all very much.

Ladies and gentlemen, that does conclude today's conference. We appreciate your participation. You may disconnect at this time.