CACI International Inc (CACI) 2011 Q3 法說會逐字稿

Ladies and gentlemen thank you for standing by. Welcome to the CACI International third-quarter FY 2011 conference call. Today's call is being recorded. (Operator Instructions) At this time I would like to turn the conference call over to Dave Dragics, Senior Vice President of Investor Relations for CACI International. Please go ahead, sir.

Thanks Ally 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 are able to participate with us today. Now as is our practice on these calls we are providing presentation slides. And during our presentation we will 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 oral disclosures and commentary. And that 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 material than 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. 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. 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 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. Thank you for joining us today as we discuss the results of our third-quarter and first nine months. With me today are Tom Mutryn our Chief Financial Officer, Bill Fairl our President of US operations, Dan Allen, Chief Operating Officer of US Operations and Greg Bradford Chief Executive of CACI Limited in the UK. Slide 4 please.

CACI continued our record financial performance in the third-quarter of our fiscal year including record quarterly revenue, operating income, net income and diluted earnings per share. We exceeded our financial goal of mid to high single-digit organic revenue growth and delivered on our goal of double-digit earnings growth with an amazing 33.5% increase in earnings per share. These results demonstrate that despite budget pressures on our government clients, we continue to deliver record performance and build shareholder value. The most important factors that enable us to deliver these results are our positioning into high priority market areas that are critical to our nation. And our total commitment to operational excellence. Let's go to slide 5.

I'm also pleased to announce that we've added Dan Allen to our team as Chief Operating Officer of US Operations. Dan, who has extensive experience in the intelligence community -- technology community shares our vision to be the very best, and our focus on shareholder value operational excellence, innovation and superior customer service. I'd now like to invite Dan to share his perspectives on his new role, Dan?

Thank you Paul and good morning everyone. I'm very excited to join CACI and I appreciate the confidence that Paul and Bill have placed in me as the Chief Operating Officer. I've long held CACI in the highest regard for its strong focus on mission success and its rich culture based on integrity and mutual respect. All this positions CACI well in the market space as division of CACI future is filled with group opportunities. I look forward to bringing my experience in nationally critical market areas to build on CACI's exceptional track record. I'm also very proud to be part of what I believe to be a winning leadership team and look forward to working with this team to continue our positive forward momentum.

Thanks Dan and again welcome aboard. Dan will contribute strongly to our leadership in intelligence, cyber and C4ISR where we're helping our clients meet their most critical challenges. And he will also apply his broad experience in other markets spaces to expand our market share. Let's go to slide 6.

Our country continues to face persistent threats to national security. Which in turn are generating strong demand for CACI solutions. Our offerings include intelligent solutions and services that help prevent terrorist threats. Cyber solutions that safeguard networks and vital information and C4ISR solutions and services that leverage the effectiveness of the US forces.

Our most recent successes here and include a cyber related contract we won under the strategic services sourcing contract vehicle which calls for CACI to help the Army protect its networks. And Bill will have more details on this exciting win in just a few minutes. We are also focused on providing solutions for IT modernization and government transformation. Last week President Obama signed an executive order that urges federal agencies to make use of private-sector best practices to deliver services better, faster and at lower cost. This is exactly what CACI offers. Our solutions, help the federal agencies streamline operations and achieve higher levels of efficiency and productivity. Which is especially important during this time of budget constraints.

In this area, we recently won two awards for new business from the FBI and the Department of Justice to modernize information technology. Bill will also be providing more information on these wins. CACI operates in a large addressable market of approximately $400 billion per year. And we continue to see attractive opportunities to grow. Even as the government was operating under seven continuing resolutions from October 2010 to April of this year, CACI delivered record financial performance. As expected when the government operates under a continuing resolution, we experience a slowdown in awards and funding orders. But our pipeline remains strong, submitted proposals remain high, win rates are very good and operational execution is excellent.

We are raising our guidance for the full fiscal year in addition the Board of Directors has approved a new share repurchase program of up to an aggregate cost of $175 million. This underscores our continued confidence in our growth strategies. It's a key component of our balanced capital allocation strategy and will offset dilution. Now I'd like to turn the call over to Tom who'll provide more information on our financial results. Tom?

Thank you Paul and good morning everyone. Please turn to slide number 8. We are pleased with our strong third-quarter results. Revenue grew year-over-year by 16.5% with 14.3% organic growth. Easily achieving our stated goal. Our direct billable labor grew 13.2% with organic direct labor growing 9.6%. Our other direct costs were up 19.4%. Operating income was up 31% year-over-year proven by the strong growth in our various business units, increased direct labor and continued control of indirect cost. Our UK operation turned in a strong third-quarter as net income was up 37% over the same period last year. This performance was driven by increases in the commercial sector business. While our UK government business continues to be challenging because of UK budget reductions, we expect to see continued growth in our commercial activity. Slide 9 please.

Year-over-year net income for CACI increased 36%. The effective tax rate of 34.7% for the quarter reflecting gains we realized in our executive deferred compensation plan, was similar to the third-quarter tax rate from last year. This tax rate was lower than guidance which added $0.05 to third-quarter earnings per share. We are now assuming a 37.0% effective tax rate for the full year which is based on an assumption of no net deferred compensation plan gains to losses for the remainder of our fiscal year. During the quarter we benefited from a $2.6 million decrease in our earnout rebated liability which equates to $0.05 per share. Next slide please number 10.

Our cash position at the end of the quarter with $98 million reflecting a strong operating cash flow for the quarter of $78 million. Quarter ended, DSO was at 54 days, five days better than the same time last year and at record low. Our free cash flow which is operating cash flow less capital spending was $222 million for the 12 month period ended March 31, 2001 or about $7.14 per diluted share. This translates to a free cash flow yield per share of 11.9% at a $60 share price. We also report results after eliminating certain non-cash charges depreciation, amortization, stock compensation and non-cash interest expense.

For the quarter our diluted adjusted earnings per share were $1.61. Materially greater than our GAAP earnings per share of $1.16 and 22% higher than last year. Our balance sheet remains strong. Our quarter leveraged net debt was at $311 million and our net debt to trailing EBITDA leverage ratio was at a comfortable 1.1 times. Slide 11 please.

We are increasing the FY '11 earnings guidance ranges we provided last quarter due primarily to the strong third-quarter results. We now expect earnings per share to be in the range of $4.15 to $4.30. We continue to expect that our full operating margin will be at least 6.4%. We expect diluted share count for the full year to be 31.3 million with the diluted share count in the fourth quarter at 32.1 million shares driven by the impact of the convertible debt and equity-based compensation. We expect operating cash flow in 2011 to be at least $195 million. With that let me turn the call over to Bill Fairl. Bill?

Thanks Tom and welcome to everyone on the call. This morning I will address highlights from operations during our third-quarter and first nine months of fiscal year '11. Let's go to slide 12 please. Our funded backlog at the end of the quarter was $1.94 billion, that's 3.6% higher than it was at the end of the third-quarter of fiscal year '10. Contract funding orders in the third-quarter were $749 million and for the first nine months of fiscal '11 they were $2.7 billion. That's a 7.7% increase over the first nine months of fiscal year '10.

The strength of our funded backlog and the funding orders we received are major factors in our ability to deliver record performance this fiscal year. Contract awards for the third-quarter were $274 million. A lower level than usual as a result of two factors. First, the prolonged, government fiscal year '11 budget process and second most importantly, a very low level of re-compete activity for CACI this year.

Now regarding our re-competes, I really want to emphasize that the low level of CACI re-compete activity is generally the result of delays in the procurement process and not due to program cancellations. So, stretching out the procurement process, programs are still viable still continuing on. So, in other words, our base of business remains very strong. We are seeing contract extensions and bridge contracts as a result of delays in the procurement process.

As you heard me say on previous calls we take a longer view on contract funding orders and awards since quarter-to-quarter variations really are the norm in our business. Contract awards over the first nine months of fiscal '11 were a very solid $2.1 billion. That's a 22.2% increase over the first nine months of fiscal year '10. Through the third-quarter of fiscal '11, over 70% of our contract awards have been for new business. That's a big number. That's all new business won this year. Great for growth prospects in the future there. This nine month figure of $2.2 billion does not include $450 million Department of Homeland Security Task award that we announced in our second fiscal quarter that's because the protest of this award was sustained this past March.

Let's go to slide 13 please. I'd like to give you a little color on some of our major third-quarter fiscal year '11 contract awards. One of our most important awards was the FBI's Information Technology Supplies and Support Services or ITSSS contract. This ID/IQ contract has an eight year period of performance and a ceiling value of $30 billion, making it the largest contract ever awarded by the FBI. This represents new work for CACI.

Because it's a new ID/IQ award for us we did not included it in our backlog. We take a very conservative approach to that. Under this contract we will be competing for task orders to provide IT services in such areas as cyber security, biometrics, secure communications and counter terrorism, along with more traditional systems engineering, software development, and systems operations and maintenance. We have an outstanding record of success in reducing costs, maintaining security and improving efficiency in IT infrastructured environments. So, we are excited about our opportunities here.

Closely aligned with this award is the contract we won with the Department of Justice which is as you know, the FBI's parent agency. Here we won a prime position to support DOJ's Information Technology Support Services 4 or what we call ITSS 4 contract. This ID/IQ award has a ceiling value of $1.1 billion in a period of performance of six and a half years. ITSS 4 spans all of DOJ's IT infrastructure and administrative support systems and positions us to help DOJ standardize and consolidate data and information sharing. This also represents new work for CACI.

I may also point out that both the FBI and DOJ contracts show that in the era of federal top line budgetary pressure the need for modernization and transformation solutions that can drive efficiencies and save money is strong and growing. We believe that the value we can add on both of these awards is a differentiator for CACI and continues to make some very attractive partners at federal agencies that have to reduce cost, improve efficiencies and increase tax payer value. We also continue to win key awards under our strategic services sourcing or what we call S3 contract vehicle with the US Army. Including a new award in the cyber arena.

This is the $41 million, three year task order we won to support information assurance and cryptographic programs for the Army's Communications Electronics Research Development and Engineering Center. Here our services and solutions will help fulfill the Army's critical objective of safeguarding networks from security vulnerabilities as systems are built and integrated into battlefield communications. This work will be important to our future growth and will expand our capabilities in developing innovative mobile applications to enhance war fighter communications.

Now, on the re-compete front I'm pleased to report that we won our five year $2.5 billion operations, planning, training and resource support services are what we call OPTARS 2 contract vehicle with the US Army Forces Command. We are excited about this award because on the original OPTARS contract CACI won the most task orders and had the largest revenue stream of any contractor. On OPTARS 2 we expect to continue with this outstanding record of service with solutions for mobilization and deployment planning that we believe will be vital to future Army operations.

Our intelligence business continued its very strong growth during the quarter. It was up 37% over the third-quarter of fiscal year '10 and represented almost 47% of our business for the quarter. Year-to-date, our intelligence business has increased by more than 27% and now represents a little over 44%. 44% of CACI's total business.

Let's go to slide 14 please. Turning now to our opportunity pipeline, I'm pleased to tell you it remains very strong. In fact it grew significantly over the past quarter. Specifically, at the end of our third-quarter, we had approximately $6.1 billion in submitted proposals under evaluation. $6.1 billion in submitted proposals and more than half of those are for new business. As you may recall at the end of our second-quarter we had approximately $4.1 billion in submitted proposals under evaluation. In other words, the value of our submitted proposals grew by $2 billion during our third-quarter.

Now, in addition to this large bow wave of submitted proposals we expect to submit more than $8.5 billion of new proposals during the next two quarters. And again, more than half of these are going to be for new business. We are especially targeting new business in our strategic focus areas of defense, intelligence, homeland security, and IT modernization and government transformation. Which also includes healthcare IT. As it has throughout the year, as Paul mentioned earlier, our win rate is excellent.

Now, in the area of hiring, our numbers are again solid and reflect our continued ability to grow. During the third-quarter we added approximately 100 net new hires. In summary, as we near the end of our fiscal year '11 which is shaping up to be another year of record performance, we are very confident in our long-term outlook. Our growth strategy continues to deliver the record performance we envision. We are in markets that are mission-critical and that we believe will continue to be well-funded. We have the ID/IQ vehicles in place to help the government meet its top priorities and as the DOJ, FBI and OPTARS awards show, we continue to win new contract vehicles that position us for further growth. And Paul, that concludes my remarks.

Well done Bill, thank you very much. And thank you, Tom. Dan, again, welcome aboard. Let's go to slide 15 please.

CACI has achieved another record performance in our fiscal 2011 third-quarter. And we expect fiscal '11 to be another record year. All indicators point to CACI's continued growth and achievement now and into the future. We operate in a very large market with considerable growth opportunities. This is especially true of our areas of strategic focus. And in our specific target markets including C4ISR, cyber, and intelligence in general. Our sustained strong operational and financial performance in all of these areas position us to grow in 2011 and '12 and beyond. At this time, I also want to thank all of our CACI employees for their many contributions to our success. They are intensely focused on innovating to create new value for our customers and to deliver service excellence in all they do. Because of their unwavering support for our Company and our customers, we have been able to deliver on our financial goals and build shareholder value. With that Ally, we can open the call up for questions now.

(Operator Instructions) Our first question comes from Michael Lewis of Lazard Capital; please go ahead.

Good morning, thank you so much. Bill, can we talk about S3 for a second? With BRAC ending in September, are there any implications to the contracts growth outlook posted at the finishing up on the BRAC effort?

Yes, Mike, the BRAC task is -- our BRAC task is ending. That is one of over 40 active task orders we have at any given time. I won't go into all the details, but the organization up there has just let it be known to their contract holders that they are planning on issuing a very large basket of S3 task orders that are going to go out for bid this spring here. And we have an outstanding win rate on those task orders that we bid. In fact, it's just a little shy of 75%. So lots and lots of opportunity there, Mike.

Okay, thank you for that color. Also, Tom, if I could just ask you about the DSOs; we're at these historical low levels. Really have to applaud you guys on the level that we are seeing. But is this the new normal for the firm?

Yes. We believe having -- thank you, Mike, we have been seeing some quarter-over-quarter improvement in DSOs. And it appears that we are reaching a level which hopefully is sustainable. We do caution that DSO is often driven by activity in the last few days of a particular quarter. There could be a couple of successive strong days of cash collection, there are a couple days of relatively weak cash collection. But we expect to have DSO below 60 days for the foreseeable future.

Our next question comes from Brian Gesuale of Raymond James.

Nice job on the quarter, and wanted to commend you for increasing the share buyback. Paul, I wanted to talk a little bit about headcount. I think you ended your last fiscal year at just over 13,000 folks. You added about 500 in a couple of acquisitions late last year. You're now at 13,700, I think. Can you just talk about how you have to increase, what your view is in terms of increasing that net add of personnel?

Okay, I will let Bill take a crack at that.

Brian, we did -- there's one important part of the calculation you need to keep in mind here, which is we had a task under our Army First contract where we were the prime on that. And we had a large number of people on that. And then for the re-complete on that we went into a joint venture with another company. Those personnel that were employed by us transferred into the joint venture, and that was done around this time last year, maybe a little later, the summer of last year. So that's several hundred people that moved, say from being CACI employees into the joint venture employee. So, when you incorporate that calculus into it, our net headcount growth was actually much higher -- our organic as opposed to the acquired.

So, you put your finger on it though, that is the key driver for us. As we have said on many occasions, growing our net headcount is really what drives our bottom-line results. We've had a program around here of margin improvement, which includes things like investing our B&P dollars in bids that are going to deliver more CACI labor.

I think maybe you have heard me talk in the past, just had a question from Mike there on the S3 vehicle. We look at all of our S3 and test business together, call it our C4ISR business. That's getting up near a run rate of about $900 million a year, just a little shy of that. Our direct labor in there is growing twice as fast. Actually more than twice as fast, as we're already seeing. So we are seeing real significant margin improvement in that S3 test basket of business, if you will. So, we've got a lot of new hires out of that, and that remains a focus area for us.

So Paul?

That's great; I think that sums it up.

That's great color. Just one follow-up. Direct labor, your growth actually was super in the quarter, in the mid-teen levels. But still trails the pass-through growth. If we look at that, and if you look at your backlog and some of that S3 commentary, Bill, when does that normalize where direct labor -- when would you expect it to normalize where direct labor begins to exceed the pass-through stuff?

Well, Brian, my crystal ball is in the shop today. But what I will tell you is our focus as I said over the long-term is investing our B&P dollars in those activities that are going to drive more CACI labor growth. Our planning assumption, and I believe it is going to happen is, you will see that begin to normalize. I believe there will be at some point some drop-off in some demand for some of the ODCs. And then couple that with our investments in high labor-content bids, we are going to see that trend. But in the meantime, as my colleague Tom Mutryn would say, we make money on all of those ODCs, and they lead to future direct labor growth for CACI. So -- .

I would just add, Brian, a comment that Bill calls them ODCs, you use that phrase of task driven. There's a subtle difference. In a pass-through, people of an image of not adding value to whatever it is that we are acquiring on behalf of our clients. The vast majority of what we are talking about is subcontractor labor. Where we are actually selecting subcontractors to perform important roles on our overall task orders and vehicles. And we are managing the work ethics of those subcontractors, and in many cases integrating their services and products into the final solution. And we get lower margin on that work, for obvious reasons because the client doesn't want to pay profit on labor twice. But the vast majority is labor-related work.

Our next question comes from Bill Loomis of Stifel Nicolaus.

Hi, thank you, just a couple things. First, you have excellent amount of bids outstanding and pipeline. But we hear, when you look at the overall DOD spending numbers and so forth, it's a very low growth environment. So when you look through your pipeline and bids outstanding, can you just characterize that? I mean, it appears, it almost has to be almost all market share gains versus competitors, but I'd like to hear your comments on that, and when you look through the pipeline.

And then second, related to that is the pricing. We have heard from Ash Carter and others at the DOD that they are trying to push down pricing. One of your competitors announced last night their biggest contract got shift from time and materials to cost-plus at the Army at much lower margins. So how do you see those 2, if the pipeline is mostly incumbency work, and you're seeing a lot of pricing pressure, how do you see that impacting your business over the next couple of quarters? And then, more importantly over the next 2 years?

Okay, I will let Bill Fairl address the bulk of your question, but I wanted to give a little preface if I could. Which is to say that while it's true that the federal budget and the Department of Defense top line budget is not growing at the same rate as our business is growing or we expect it to grow, we are outpacing that. But if you go look at, before we talk about pipeline, if we go look at recent wins, and look at the characterization of those. They are not take-aways, not all take-aways. So like that VLER work that we won with the Veterans Administration was to take an existing set of systems and data around healthcare records for veterans and to build an integrated healthcare record system for the veterans administration. That is really new work and a new thrust of government.

Similarly, if you look at the VIPS job that we won, was all about improving the efficiency of recruiting activities by virtualizing recruiting, and that is all new work, not somebody's incumbency. If you look at the work, the biometric work we won, the ICOPs work, that is all new work associated with force protection activity. And so I will let Bill pick up and talk about the pipeline going forward, but I do want to comment that in that big addressable $400 billion market space, the amount of turn that happens every year in terms of reprioritization or things ending and new starts getting created, there is ample opportunity for new work that is not somebody's incumbency. And the facts are that our recent history demonstrates that we are picking up a good share of that work.

Yes, Paul, I will pick up from there. So on the pipeline, Bill, your question actually had a key word in it, which is when you are talking about overall. At the very macro level, slow growth if any in the federal spending. We don't operate at that overall level; we are down here in these very targeted areas as we mentioned national security, intelligence, transformation efficiency in government. That is where these opportunities are that Paul is talking about.

So we spend a fair amount of money on B&P, and we spend a lot of time. I think we have a really disciplined process in looking at specific bids that we're getting into here and making good solid bid decisions. This process has been around here a long time. Next year is going to be CACI's 50th year of business. So we know how to do this. That leads to a very high win rate.

So our business has always been a mix of what I would call greenfield opportunities. That's those new things Paul was talking about, and yes, some targeted take-aways from other contractors that aren't performing well. But I will tell you, we do that, we look at a take-away not with an idea, well, we're just going to drive our price to the bottom of the cellar, we are going to deliver our best value proposal so that we can get in there and perform. And win that thing when it comes up for re-compete next time. So, it's all about best value there.

So, I would say the mix, Bill, long answer to your first question, it is not dramatically changed for us. It's a pipeline, very strong, I gave you the numbers, which you have noted there. It's a mix, as it has been as long as I have been here of new greenfield opportunities and selected take-aways from other folks as well.

Regarding the pricing issue, which I think was the second part of your question. We had a big movement here at CACI quite a few years ago when our Navy customer moved virtually all of their business office schedules onto seaport. So that movement from T&M to cost-plus-type contracts occurred for us a few years ago. Recently the Army has gotten on that same sort of theme if you will. So in terms of the S3 contract, the new awards that are coming out are either cost-plus or some sort of fixed-price instrument as opposed to T&M.

I'll go back to what I said before, because we're putting such a focus on increasing our direct labor content, and again, it is growing twice or more than twice as fast in that $900 million bucket of C4ISR business as the ODCs; our margin is improving very significantly just as a result of that mix change there. We are very good at fixed-price contract management around here; we have a couple hundred of them at any given time. That's the most profitable type of instrument we have, and it's because we do a great job. We don't get into bad deals and we are good managers and our customers are happy. So I think I'm going on a while here but -- .

Very good, Bill.

Our next question comes from Joe Nadol of JPMorgan. Please go ahead.

Morning, guys, it's actually [Seth] on the line this morning for Joe. A question for you, Paul, last year in the -- I know it's early for guidance for FY '12, but last year in the Q3 press release you noted that looking out to next year you still saw the potential for mid to high single-digit organic revenue growth. And this year you talked about increases in shareholder value in the years to come, and we have this large repurchase program relative to what you've done in the past. To what extent do you still see that mid to high single-digit organic growth as kind of the target going forward, and to what extent is the overall budget situation imperiling that and you're looking to drive EPS growth in other ways?

Well, we still see mid to high single digits as doable. And again, I think it is mostly related to the fact that we operate in such a large $400 billion a year market. And we are less than 1% market share of that when you think about our revenue. And so the amount of reprioritization that goes on every year inside of that provides ample opportunities. It's a function more of how well we are developing the pipeline, finding those right things to have large complex problems that are important to our clients. And where we can bring innovative value-added solutions creatively in our proposals and white papers and discussions. And so we see, I think the short way of saying it is we do see our abilities continue to be at the mid to high single digits.

And the buyback is really a function of just having a balanced corporate capital allocation strategy. We have ample capacity in our financial structure here to be able to both pursue our M&A program, which is a vital part of our growth strategy, and we have had activity recently and you should expect we continue to have activity in the M&A program, but there's also capacity here for doing share repurchase. And so we've decided, the Board has decided to authorize this repurchase as a way of demonstrating that we have confidence in our ability to grow going forward. And that we want to make sure that we are returning value back to the shareholders. And that will likely result in us acquiring some shares here.

Great, thanks very much. If I could just follow up. Tom, and I apologize if you mentioned this earlier, but can you just talk briefly about the benefit related to the earn-out in the quarter, and maybe what acquisition that was related to, and if you got the earn-out because that business didn't hit a target?

Seth, as you know, a few of our recent acquisitions were structured such that a portion of the purchase consideration is dependent upon post-acquisition performance. This is not a typical, in the world of M&A. The accounting rules require that a long-term payable was created based on the expected repurchase consideration. Each quarter we review the current forecast and true-up that payable to make sure that is going to be reflective of what we expect. It turns out that the performance of kind of 1 or 2 of the acquisitions in the earn-out period was not as robust as we originally thought. And hence, we reduced that earn-out consideration liability.

I will add that the acquisitions are still quite solid, performing well, accretive, positive cash flows. The earn-outs our doing what they were intended to do; if the Company falls short of the projections, we pay less. And the economics still work quite nicely for us. I'd just assume not talk about the specific acquisitions that this is related to.

Our next question comes from Cai von Rumohr of Cowen and Company.

Thank you. A follow-up. If you didn't have the $2.6 million adjustment in the liability, what would the size of the earn-out had been approximately?

I'm sorry, you were cutting out near the end, Cai.

If you did not have the liability reduction of $2.6 million, what would the size of the earn-out charge have been in the quarter?

It would have been essentially nothing.

Okay.

Basically what we do is we establish that liability at times zero and we true it up. It is the net true up. Now there is another complicating factor, whereby when we establish the true-up we need to assume a certain interest rate and provide an ongoing quarterly charge associated with the interest rate related accretion of the earn-out. But that is relatively de minimus.

Okay. And then a question for Bill. You mentioned, and you have this pretty dramatic uptick in bids awaiting decision by $2 billion. Although, they are not a whole lot higher than they were at December of 2000 -- I guess 6 quarters ago. How fast, A, have you seen that the government is really starting to let task orders, so far since the CR, and how quickly do you feel that the government is basically going to be able to plow through this stuff?

Okay, Cai, it's a little difficult for me to hear, but I think you were asking, have we seen a pick up since the CR was resolved. And really that's only been like 3 or 4 weeks now. Our experience is it probably takes 6 weeks to 2 months for that to really flow through the system in terms of funding orders, and then funding orders first actually. And then contract awards are sometimes a bit even further downstream from that. So the short answer is I haven't seen any real big pick up in contract awards yet as a result of the CR being put to rest there.

As far as when these awards will be made, and this $6.1 billion bow wave of submitted proposals we have, Cai, again, I've always been reluctant to predict any particular time period because as we know things just get extended out and then you get into the protest things which is part of our business reality around here. The good news is we have plenty of backlog on both funded and contract side. And in pretty good shape. Our programs are not being canceled, the awards are still there, they are going to come out someday. And we still have plenty of opportunities.

Our next question comes from Josh Sullivan of Gleacher and Company. Please go ahead.

Thanks for taking my questions. Most of my questions actually have been answered. I guess I'll just do a follow-up on S3. Can you help us understand the scope of S3? I know you had mentioned that there was a cyber-related award in the quarter? Just trying to get an idea if the definition of the vehicle is expanding?

Josh, it is Bill Fairl. This contract has a $20 billion -- it's a task order contract with 7 contract holders and $20 billion in ceiling on it. It has an extremely broad scope. Our work tends to focus around what we call C4ISR command control communications, computers, intelligence, surveillance and reconnaissance. And it will be about rapid prototyping of new systems there to react to different threat environments. It will be about training, software development, you name it.

The point is, this is a very, very broad large scope $20 billion contract vehicle. We'll have, as I mentioned earlier, we'll have 40, 50 task orders active at any given time. Over the period we have had this thing, we have had almost 70 different clients on this come out and mostly out of the Army. But think about Army signal intelligence, communications, electronics, things like that. All aspects of that; very, very broad.

The last 2 notable wins, we mentioned 1 this morning. We have cyber-related space, and the 1 last quarter we mentioned was in biometrics. So those are 2 recent examples. But as Bill points out, it's a very broad spectrum scope vehicle.

Great. So then as far as the total Company, what do you guys consider your cyber breakdown?

The percentage of our business that is cyber? That's a difficult percentage factor to give because cyber is embedded in so many of our contracts as part of what we do. So for any systems integration job we undertake, there is an element of the work that is cyber to make sure the networks and the data are protected. There are some contracts such as the one we just won in S3, that is, the heart of it is cyber. That's a little different. Getting our hands around the exact percentage is difficult.

Dan, did you have any comment? Dan is an expert in cyber here, so we will let him chip in. Go ahead, Dan.

I will just add that as we look to the future, the scope of the programs that Paul mentioned, the component of cyber that part of it is going to grow. And we see significant opportunities there for us with some of the work that we are doing in our core corporate company competencies to develop world class capabilities and deliver those as this scope expands. So we see this as a big opportunity for the Company.

Our next question comes from Tim Quillin of Stephens, Inc. Please go ahead.

Nice results in the quarter. Nice direct labor growth. Your contract awards, I think 6 of the past 7 quarters have been below revenue, but yet you did have this nice growth in DL. Is there a time that you need to see a pick up in contract awards in order for that mid to high single-digit growth to be realistic in fiscal '12?

Tim, it is Bill Fairl. We currently have about, almost 2 years of backlog right now at our current revenue run rate. I mentioned the submitted proposals, if you will, so we are very pleased with how the machine is working here. We bid these things because we expect these programs to be awarded at some point. We are very confident that we have sufficient funding and contract award backlog today to fuel our growth going forward.

An interesting sort of aspect of the 2 sets of numbers you just mentioned is the ratio revenue to contract awards, that's top line. And as you know about our book of business, our bottom line is driven primarily by our direct labor growth. So there's plenty of room in there, in fact I was asked a question earlier about when I saw maybe the mix between, of what we call ODCs and direct labor coming more into sort of a balanced sort of thing. There's plenty, plenty of room inside our current contract backlog for quite a while to continue to grow our labor at these very strong rates, which is really what delivers our bottom line results.

In the meantime, as I mentioned, we have $6.1 billion in submitted proposals at the end of third quarter. We are going to submit another $8.5 billion over the next 6 months. Those programs are not being canceled, they are going to get awarded at sometime, I just can't tell you exactly which quarter that is going to be. And our win rates stay high. To me that says growth here. Where there's [spy], there is lumpiness in contract awards totals. As Cai mentioned earlier, the CR did have an impact on new business awards there. Over the long run, these proposals will get awarded, our win rate will stay high. We will keep investing our B&P dollars in the right things, and that will continue to fuel our growth.

Paul do you want to -- ?

I think you hit it right on the head there, Bill. I think we are positioned well in the marketplace. And therefore, high-priority, high-demand areas, and therefore those submitted proposals of $6 billion that Bill refers to, submitted proposals under consideration. Those are very highly likely to be awarded, and a question of when is always the thing, we don't know the exact timing. If you consult history, we've seen them sort of move more rapidly through the system toward the end of the government's fiscal year. And maybe our first quarter and second quarter is when we tend to see the bigger rush of awards come through. But that's just looking at history. And it's impossible for us to accurately predict it. The important thing is for robust pipeline, the high volume of submitted proposals, the lack of cancellations in that inventory and the high-demand areas that we are bidding.

Our excellent win rate.

And the win rate is very high.

That's fair. In terms of your earnings guidance for the year now, it's a relatively high range, I guess for a fourth quarter. Is the low end of that range a realistic possibility? Thanks.

Yes, we use that range, especially the lower limit, as kind of a -- we do a lot of sensitivity analysis and we're careful about picking the low end to make sure that we have a very low probability of falling out of the low end of the range. And so we aim for the middle of the fairway, as Tom likes to say, we aim for the middle of the fairway. This guidance has the fairway being a little wider, sometimes you get a narrow fairway, sometimes you get a little wider fairway. But we are aiming for the middle. And the high, the most likely outcome is towards the middle of the range here. A very low probability of falling below the lower limit.

(Operator Instructions) Our next question comes from Tobey Sommer of SunTrust; please go ahead.

Thanks. I was wondering if you could give us a sense for what sort of growth you're seeing in sort of more dedicated cyber contracts, as opposed to the exposure that you have in many of your networking contracts? Thanks.

I will start out, Tobey, this Bill Fairl, and then I'll ask Dan to share some of his thoughts on it in perspective. From our standpoint, there's a couple of them out there that are specifically targeted around cyber, and some of those tend to be IDIQ contracts as well that have sort of a cyber scope to them. The vast majority of our work, this embedded notion that Paul talked about earlier where cyber comes along with everything else. This S3 win we had for $41 million, a bit of an exception to that. That's specifically cyber-ish, if you will. But everything else, even the biometrics awards, they have a cyber aspect to them, but you can't tell that from name, they are embedded in it. Every customer wants a couple of pounds of cyber in all the work they do these days. There are a few of them out there that we've targeted and are bidding that are specifically cyber. But generally it is this embedded nature.

And Dan, any perspective from your point of view?

Yes, I would like to add that the cyber marketplace has had some difficulty over the last couple of years having some structure. So seeing the cyber capabilities that are inside current programs has been difficult. But we are beginning to see more competitions that are more pure cyber plays. And the S3 example is one of them. And I believe as you go through the next 2 years, you will see more of those opportunities around the lines of being in compliance with the new FSMO roles and so forth. So, that's part of the space that we are targeting. And I think that you'll see more of that as we talk in the future.

So numerically is it some multiple above your organic growth rate, or is it just fractionally kind of above that?

Is what?

The rate of the cyber market opportunity?

The cyber market opportunity, I think Dan pointed out pretty well. There are 2 major national things, 1 has happened and 1 may happen. One was placement of the head of the cyber command, within the oversight or jurisdiction of NSA. And obviously we don't talk much about what goes on there, nor do they. But there is a high concentration, as you would expect in that agency of pure cyber activity. Our strategy is to grow into that space, and Dan is working on helping us with specific opportunities near term, intermediate term to penetrate more into that space. We already have a quite nice presence there, and feel like we have a good chance of increasing there.

The other big thing that can happen nationally is a national strategy for cyber, which hasn't really emerged. There has been a lot of discussion and even at the congressional level a lot of proposed legislation. There is some prospect that the Department of Homeland Security may have a bigger role, let's say outside of the classified environment for architecture, standards, sort of buttoning up or protecting, defending more the total national critical infrastructure for cyber. And that could spawn new requirements that would be more pure cyber content. But right now it is the fact that most agencies are sort of on their own defining what their needs are in cyber, closing gaps, and using existing contract vehicles that they already have for IT services to achieve that increased hardening activity.

Our next question is a follow-up from Michael Lewis of Lazard Capital. Please go ahead.

Thank you for the follow-up. Bill, I was wondering if you could talk about the timing of tasks bidding out on SSS, and also what your expected scope increase on OPTARSS? Thank you.

Okay, on SSS, Mike, we don't have as much visibility on the FBI SSS right now. I would tell you that on the other one, the DOJ ITSS 4, we see a couple of dozen task orders lined up and ready to come out there, and we have our eye on those. So, still working the FBI SSS, to define the task order pipeline on that. The DOJ ITSS 4 contract looks like a very strong pipeline there of task orders.

And you can remind me what the second -- ?

OPTARSS.

OPTARSS, yes, right. OPTARSS, that's interesting. This is sort of like a case study of what happens when these procurements really get drug out for a long time. We included in our awards total for this quarter about $50 million because that is the tasking that we sort of currently have on the existing OPTARSS 1. We had a lot more tasking on that. But what happened was, as OPTARSS 1 dragged on and they couldn't get OPTARSS 2 awarded because they were struggling with their procurement strategy, clients, because they still wanted to get to us and wanted long periods of performance move to other contract vehicles that we had.

So our revenue run rate on the OPTARSS came down because the work moved to other places because OPTARSS 2 couldn't get in place. We still kept the work, in fact, we grew but on different contract vehicles. That is one of the great things about our strategy to get as many of these multiple award IDIQ contracts as you possibly can, because it gives your clients flexibility in a situation like that.

So I expect we are going to see some of that work flow back into our OPTARSS vehicle, and then we are a much bigger company now than we were when we had OPTARSS 1. Gosh, we are more than twice as big as we were when we first won that contract. At one point we were up to about $60 million, $70 million a year on that contract. So, that's a good goal for us for our team, I'm not making any predictions but we're going to set the bar high because we think we can do well on OPTARSS 2.

Okay, that's helpful. Thank you so much.

Our next question comes from Robert Spingarn of Credit Suisse; please go ahead.

Can you talk about the component of your sales backlog and pipeline frankly that's in theater, just refresh us on that?

Okay, we have approximately 550 of our people that are in theater, most of them are doing technology support work. And we've seen some shift between Iraq and Afghanistan, and we expect some shift from Afghanistan to other Middle East countries in the region. And that's on a percentage basis, around by headcount percentage, around 4%.

It's really minor.

It's minor, yes. And a lot of the work we do of course, back here is in support of activity to both protect the war fighter and also technologies that serve to protect the war fighter and help to target the adversary, et cetera. So, a lot of the work we do back here relates to conflict elsewhere. But those activities tend to be applicable around the globe to other needs around the globe.

We see the focus of course, right now is on Afghanistan and Iraq, but really the threat of global terrorism is a global -- it is global, it is a high threat and it is persistent, remains that way. We of course, have Iran and North Korea out there as sort of wild card maverick country nation states. China represents a large peer type threat to our security. There is instability in the Middle East and parts of Africa as we have seen, all seen in Libya, Egypt, Syria, Yemen and other places. All of these are directly -- those threats are all directly correlated to many of our activities that are done here in the states.

Cyber, we spent a good time here this morning talking about cyber, cyber incursion is it to our critical and national infrastructure is increasing dramatically. And if you think about our growth strategy as it relates to all of these areas of threat, our strategy is to develop capabilities and solutions to address these high-priority threats. And our offerings in C4ISR and intelligence and security services, cyber, and information management really are enablers to our nation's missions -- of national security missions to defeat those threats. So we talk about people that are based in that part of the world, but really the thrust of our activity is national security here domestically and globally, and dealing with all of the various threats that exist.

Understanding that, you did bring up a very interesting point, which is there is some level of domestic activity in your business that is associated with the activity in Southwest Asia and Iraq and Afghanistan. Recognizing what you just said that most of your business continues regardless of the war stance, what piece of the US or domestic business is dependent on this level of operation in Iraq and Afghanistan?

Well, I think it is a very small piece. Periodically we reevaluate that, and it tends to come in at 5% or less of our business being directly correlated to the -- .

I've got a little interesting wrinkle here, Paul, which is sort of -- we are talking about the correlation here between our business and troop levels in Southwest Asia. There's another reverse sort of thing, inverse correlation. So as troop levels came down in Iraq, we got a big plus up in some task orders to bring some new C4ISR equipment in, get it up and running, and maintain it there. So it's this idea of less boots on the ground, more technology, more C4ISR to make sure there is no more white space, if you will. I think you're going to see that be a real practice around the world here that -- this idea of no more white space. So troop levels come down, technology comes in to increase the C4ISR aspects of things.

That's a really important point, Bill.

(Operator Instructions) Our next question is a follow-up from Joe Nadol of JPMorgan. Please go ahead.

A quick follow-up. Tom, I think you noted that the margin guidance is going to be 6.4% or higher, and definitely could be higher, but just the 6.4% itself would imply a pretty low fourth quarter, and fourth quarter is typically kind of strong seasonally. Wondering if there is anything we should be aware of about Q4 margins that might make this year different than previous years?

No, Joe, you shouldn't notice anything different. We stuck with our margin guidance throughout the year, stressing that we expect it to be at least 6.4%, which is a year-over-year improvement. Year to date, our margin was 6.6% fourth quarter, third-quarter margin 6.8%. So I would just view that as a lower bound.

Okay, great, thanks.

I'm showing no further questions at this time, and I would like to turn the call back over to Mr. Paul Cofoni for any closing remarks.

Okay, thank you so much, Ally, for your help today on the call. And I'd like to thank everyone who dialed in or logged on to the webcast for your participation today. We really value your interest in our Company and your excellent questions. We know many of you may have some follow-up questions. And of course, Tom Mutryn and Dave Dragics will be available right after we finish here to take any additional questions you may have. So this concludes our call today, thank you all, and have a great day.

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