Leidos Holdings Inc (LDOS) 2007 Q3 法說會逐字稿

Good afternoon. My name is Jason, and I will be your conference facilitator today. At this time I would like to welcome everyone to the SAIC third quarter fiscal year 2007 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer period. I would now like to introduce Stuart Davis, Senior Vice President for investor and employee owner relations. Sir, please go ahead.

Thank you, Jason, and welcome everyone to our third quarter fiscal year '07 earnings conference call, our first call with analysts and investors as a public company. Ken Dahlberg our Chairman and CEO will introduce the company, discuss the government services marketplace and provide updates on our business strategy and execution. Mark Sopp, our CFO will provide details of the quarter and forward guidance. During this conference call we will make forward-looking statements to assist you in understanding the company and our expectations about its future financial and operating performance. These statements are subject to a number of risks that could cause actual events to differ materially, and I refer you to our SEC filings for a discussion of these risks.

In addition the statements made during this earnings call represent our views as of today. We anticipate that subsequent events and developments will cause our views to change. We may elect to update forward-looking statements at some point in the future but we specifically disclaim any obligation to do so.

Thank you, Stuart, and good afternoon ladies and gentlemen. I welcome the opportunity to discuss our third-quarter results as we begin our experience as a public traded company. As most of you know, we are quite unique with respect to our IPO as we've been in the business for 37 plus years with over $8 billion in revenues and 43,000 plus employees. That said, the management team and I are excited about our future as we see opportunity for top line and bottom line growth. I will provide a little color on our third quarter, and then Mark will go into more detail and provide guidance for year-end and next year.

For the quarter revenue was $2.1 billion, an increase of 6% compared to the quarter one year ago. About 3 percentage points of the growth was organic. We generated $212 million of cash flows from continuing operations, up 55% compared to the year ago quarter. And new business bookings for the quarter totaled $2.1 billion. All in all I would say it was a solid quarter for our company.

Now let's turn to the federal services market in which we operate. At more than $200 billion in annual spending the addressable federal service market offers solid opportunities. That said, overall growth rates are slowing down from what they have been over the last several years. We see that overall market growing at a compounded annual growth rate of 3% to 5%. Our focus on our nation's priorities in defense and federal government transformation, intelligence and security, homeland defense and a fast-growing outsource market of logistics and product support should yield us additional top line growth. With the ongoing on-time passage of the defense and home and security appropriation bills and the $70 billion supplemental, the funding environment is significantly better than last year at this time when we still had no base or supplemental budgets approved.

Last Friday Congress extended the continuing resolution for the remaining 11 appropriations until February 15th. These bills may be passed in a large omnibus package or we may see a year-long continuing resolution. Although the lack of a budget for Fed civil departments and agencies offers some challenges, spending continues at last year's level, and our work funded by these appropriations is less than 18% of our year-to-date revenue.

Now recently there has been three significant changes in our market space. First the Democratic Party has assumed control of Congress. We expect Congress to move fairly slowly on the big issues, such as the war in Iraq. We also expect more congressional oversight and hearings on those issues. Second, Secretary of Defense elect Gates should be sworn in next Monday. We expect that his less confrontational style should improve relations with both the military and with Congress.

Third, we believe that the Iraq Study Group findings brings additional pressure to hasten the withdrawal of troops from Iraq. We have limited exposure to direct spending on Iraq and Afghanistan. In new business the third quarter showed a pickup in award activity as we are setting the stage for accelerating growth in our fiscal year 2008. To give you a sense of the type of businesses we are winning I want to highlight just a few of our wins this quarter.

First, we received a two-year, cost-plus award fee contract from the Department of Homeland Security's domestic nuclear detection office to design, develop, test and deliver a prototype next generation high-energy radiographic inspection system known as Cargo Advanced Automated Radiography System or CAARS. Under this contract we will deliver the prototype unit to automatically detect radiological and nuclear materials, such as highly enriched uranium or weapons grade plutonium even when shielded by other materials. If this prototype is successful we will have the opportunity to field operational systems under this contract with a potential to receive up to $450 million in revenue.

We also believe port security has strong bipartisan support in Congress and as such we expect to receive additional ISIS system awards. Second, we received a four-year $45 million firm-fixed price contract with a 330th aircraft sustainment wing at Robins Air Force Base for depo inspection repair aircraft mod and logistics support that will enable them to deliver five C-130E aircraft to Poland's Air Force. The logistics and product support business is growing very rapidly, and we are believe we are well positioned for equipment reset and similar opportunities.

And then last, we were the sole winner of a five-year $250 million IDIQ contract known as the Geospatial Research, Integration, Development and Support or GRIDS contract. Under this contract we will provide engineering services and geospatial support to the U.S. Army's engineering research and development center. In total, new business bookings for the quarter was at $2.1 billion. This total excludes ceiling values on IDIQ awards and single award vehicles like GRIDS where we have no competition going forward and we expect to receive the total value of the contract. Included in the total are $1.6 billion in awards from the intelligence, defense and homeland security customers.

In connection with the company's review of backlog at the end of the quarter, we lowered unfunded backlog by $1.6 billion as explained in our press release. This change in backlog has not diminished our revenues forecast. More than 55% of our planned revenue for fiscal year '08 is in our current backlog, and another 35% is from follow-on's or recompetes. All of the remaining work that we need to win to meet our '08 projections has been identified. Moreover, the dollar amount of proposals submitted but awaiting award determination is still significant at more than $10 billion.

Now a few updates about our business portfolio. This past quarter we deployed $114 million to complete three acquisitions. Applied Ordnance Technology, Varec and bd Systems. Applied Ordnance Technology brings us capability and customers primarily in ordinance and weapons systems engineering and design. Varec brings us expertise in measurement, control and automation systems for both oil and gas industry, and also both government and commercial. bd Systems gives us more capability and a greater footprint in aerospace engineering with strong positions at Northern Command and at the Space and Missile System Center. On all, we welcome all 520 employees from these fine companies into SAIC.

In addition, after the close of the quarter we closed on AETC, which brings expertise in remote sensing technology. We also expect to close Applied Marine Technology Inc. in the immediate future, which provides a broad range of services, products and expertise to the special warfare, military, law-enforcement and intelligence communities.

During the quarter the Company sold its majority-owned subsidiary, ANX for $27 million. There is still some working capital and other adjustments that need to be considered so we've recorded a preliminary tax gain, pre-tax gain of $19 million. ANX was a communications provider facilitating e-business for primarily the automotive industry. This business was outside of our target markets and not part of our go forward strategy. And that is why we divested.

Now Mark Sopp, our CFO will discuss detailed results for the quarter and provide forward guidance.

Thank you, Ken, and good afternoon everyone. We have sustained steady growth in our core business over a long period of time and we are pleased to continue that record through our third quarter of fiscal year '07 which ended on October 31st. As Ken mentioned revenue for the quarter reached $2.1 billion a record for the company and representing year-over-year growth of 6% with internal revenue growth of just over 3%. The growth contributed by acquisitions, the other 3%, is primarily from our acquisition of Geo centers in October of last year which continues to perform well. Our internal growth so far this year has been driven by delivering technical solutions and operational support to the intelligence community and in the homeland security markets. In addition we've seen solid growth in providing professional services to government and commercial customers in the energy, public health and environmental sciences markets.

In intelligence community we believe our expertise is well-established in all the key agencies and in forward deployed operations. With greater collaboration and recent strategic acquisitions we intend to gain access to new intelligence markets to cross-sell the breadth of SAIC's capabilities on future larger procurements in this space. In homeland security we are providing an array of solutions ranging from weapons of mass destruction detection, protection and response to IT engineering and operations for various Department of Homeland Security agencies.

In the energy markets we have generated strong growth in IT optimization and outsourcing for large oil and gas and utilities customers worldwide. Internal growth in these areas has ranged from 5% to just over 10% this year. This internal growth was offset by flat year-over-year revenues in our contract resource and development business, and internal revenue declines in professional services to certain Armed Forces customers, particularly areas of SETA support, that is systems engineering and technical assistance and training.

Finally, our logistics business despite having a large new opportunity pipeline today, is off on revenues as well due to a large recompete loss early in the year and funding and procurement delays throughout the year. With respect to profitability, operating income was $144 million for the third quarter or 6.7% of revenues. As expected, operating income for the third quarter as a percentage of revenue was higher this year over last year due to losses we have incurred on our Greek contract in last year's third quarter. Sequentially from Q1 and Q2 of this fiscal year operating margin percentage this quarter was comparatively lower; again as expected as we are intentionally investing more proportional discretionary dollars in the second half of this year in internal research and development, business development and internal information systems to position our business for growth for next year and beyond.

This includes the hiring of more business development professionals, targeted technical solutions development, such as our counter improvised explosive device defeat initiative and expenses to modernize our internal business development, financial and planning systems. We acknowledge that our operating margins lag behind our peers, and we believe we can improve our margins towards our peer group over the next few years. We have launched a comprehensive initiative to improve margins which includes improving fees on materials and subcontractors, generating economies of scale through cost containment, collaborating on larger procurements more effectively and other measures. We believe we can increase operating margins by 20 to 30 basis points per year for the next few years as a result of these initiatives.

Non operating income totaled $11 million for the third quarter with higher interest income from higher interest rates and the impact of cash received in the initial public offering in October. Interest income will be reduced significantly in the fourth quarter and in fiscal '08 as we pay the $2.45 billion special dividend in November as planned and to a lesser extent due to our planned cash acquisition of Applied Marine Technology in December.

Our effective tax rate was higher than normal in the third quarter due to nondeductibility of a portion of the special dividend that was considered as compensation and which was in excess of IRS deductible limits. We expect to go back to a normative rate in the fourth quarter.

Diluted earnings per share from continuing operations were $0.26. Our diluted share count was $347 million for the third quarter, down from the prior year due to repurchases of stock over the last 12 months but up sequentially from the second quarter due to the IPO in October.

As Ken mentioned we sold our subsidiary ANX in the third quarter for roughly $27 million, recording an after-tax gain in discontinued operations of approximately $7 million. While this business had strong profitability and the sale had an immediate diluted effect to earnings we believe this move was in the best interest of our shareholders in the long-term.

Now turning to the balance sheet. There were significant balance sheet changes this quarter resulting from the IPO and the special dividend. For the IPO we sold a total of 86.25 million shares with net proceeds of approximately $1.24 billion. The exercise of the over allotment in the IPO was the full 15% or 11.25 million shares. The proceeds from the IPO were the primary driver in the increase in this quarter's cash, cash equivalents and marketable securities from the beginning of the year and also from last quarter. As of the end of the third quarter of fiscal year 2007 we had $3.6 billion of cash and cash equivalents on hand; networking capital of $1.4 billion and long-term notes outstanding of $1.2 billion. As of the end of the quarter we were in compliance with all of our debt covenants.

The special dividend amounting to roughly $2.45 billion was declared in October and recorded as a current dividend payable as of the end of the third quarter. This was paid as scheduled in November and accordingly our cash and cash equivalents were reduced by that amount in our fourth quarter. With over $1 billion in cash on hand currently and additional debt capacity our balance sheet remains strong and enables us to continue to pursue strategic acquisitions and other growth initiatives.

Now on to cash flows. We continue to generate strong cash flow from operations this quarter totaling over $200 million for Q3. Cash flow from operations year-to-date exceeds $500 million. Management of working capital has remained strong throughout this fiscal year with days sales outstanding at 66 days at the end of the quarter. We are certainly pleased with our teams' strong performance in this regard in managing receivables throughout the year. Capital expenditures were roughly $35 million in the third quarter, a little higher than our normal rate due to a concentration of software and hardware purchases for internal use and new and expanded facility expenditures this quarter. Overall capital expenditures should remain at roughly 1% of annual revenues.

Finally we will use roughly $145 million year-to-date for the acquisitions that Ken discussed earlier which have an aggregate trailing 12 months revenue of roughly $130 million. In our earnings release today we also announced the authorization of a stock repurchase program. This program which has a ceiling of 40 million shares is intended to be part of our overall strategy with respect to capital allocation. We intend to pursue various opportunities to maximize shareholder value including continued acquisitions and possibly share repurchases in either the open market and/or through privately negotiated transactions for this purpose. Whether we make repurchases under this program will depend on a variety of factors including the price of our stock, market conditions, our performance and outlook, relative priorities for the use of capital available and other factors. We will report any repurchases made under this program and as appropriate in our quarterly public filings.

Now I am going to spend some time looking forward both in terms of strategy and specific guidance. On the IPO Roadshow we laid out our target operating model for cash deployment strategy over the next three years. Three to five years, I should say. Based on our view of the marketplace, we are targeting average organic revenue growth in the 6% to 9% range over the next three to five year period. We expect to stick to our core markets centered on government funding that continue to grow our commercial services business both domestically and internationally in the energy utilities and life sciences markets. We have revamped our business development team and increased discretionary business development in research and development funding with these goals in mind.

I mentioned earlier our margin improvement initiative where we are targeting moderate improvements to our profitability over time to reach our optimal level, yet planning to continue to have adequate discretionary funds to continue to grow the business and invest in our people. We intend to use our cash to fund internal growth and its intended working capital needs to pursue strategic acquisitions and engage in capital structure transactions to maximize shareholder value.

Finally we are addressing our stock option overhang issue carefully. We are considering a combination of means to do this, the short-term effects of which are included in our fiscal '08 guidance. With that given this is our first issuance of guidance let me lay out our overall approach. After a fairly rigorous process of business plan reviews with our line operations we established a base case financial plan. This includes identification of all sources of projected revenue, including revenue from funded backlog, unfunded backlog, recompetes, add-ons and new business opportunities in our pipeline. Potential upside and downside revenues and profits are identified for each business unit. Management then applies judgment against this plan including high-end and low-end estimates based on the specific business plan information and external conditions and risks.

We are providing a range in revenue and EPS guidance estimates to consider the inherent risk in predicting future results. Events which can lead to either the high-end, low-end or outside the range altogether include higher and lower-than-expected contract win rates, higher or lower than expected direct labor hires, favorable and unfavorable cost variances, favorable or unfavorable market conditions and numerous other factors including that the following assumptions with respect to the forward guidance being issued today. As we believe the closing of the Applied Marine Technology's acquisition will occur this month our forward guidance includes our estimates of its performance over the guidance period. The guidance does not include any estimates from any unannounced acquisitions.

Secondly, for guidance purposes we are assuming no stock repurchases are made under the newly authorized stock repurchase program. We expect that any repurchases are made under this program they will be accretive to earnings per share. Our current fiscal year 2007 ends in about 1.5 months on January 31, 2007. For fiscal '07 we expect total revenues to be in the $8.15 billion to $8.25 billion range and diluted earnings per share from continuing operations in the $0.96 to $0.98 range. The new point of this guidance reflects an internal revenue growth rate of roughly 2.5% for the year and the GAAP operating margin improvement of approximately 50 basis points over fiscal year '06. Our projected diluted share count for fiscal '07 is 365 million shares. Finally for cash flow from continuing operations we expect to equal or exceed $550 million for the year.

For fiscal 2008 which starts on February 1, 2007 our revenue guidance us $8.7 billion to $9 billion. Revenue at the midpoint of this guidance reflects an internal growth rate of approximately 5% over fiscal 2007. As stated before we are targeting 20 to 30 basis points of improvement in operating margins in fiscal '08 as well. Our diluted earnings per share from continuing operations is $0.83 to $0.88 for fiscal '08 on a projected diluted share count of 430 million shares. The share count number again assumes no buybacks under the repurchase program, but does include issuances of shares for equity based compensation and additional common stock equivalents associated with some assumed price appreciation during the period.

We expect moderate progression of sequential revenues and profitability during the course of the new fiscal year associated with incremental revenues on new contract wins. As Ken stated earlier, we have all revenue sources identified in fiscal '08 and either backlogged today or in specific target opportunities in our pipeline that we intend to pursue. That concludes my prepared remarks; I will turn it back over to Ken to wrap it up.

Thank you, Mark. Before turning to your questions I want to offer a few reflections on the initial public offering. Throughout our history we've kept a low profile focused only on our reputation with our customers. So it is quite a change to be out on the road talking about the company and its accomplishments and prospects with potential investors. The success of our initial public offering was truly a tribute to the hard work and innovation of our 43,000 employees. For 36 plus years the company operated a business model that created a legacy of innovation and entrepreneurial growth that we believe is unmatched in our industry. To reach the next level of growth the company is in the midst of change. We have increased our operating margins but we still have more to do. We have significantly improved cash collection. We are making the company more collaborative, more efficient and more disciplined with the tools and training to scale to larger programs and a much higher revenue base. Our entire company is committed to executing the strategy that we presented to our new shareholders on our IPO Roadshow. That is accelerating organic growth, expanding operating margins and making strategic acquisitions. I will now turn it back to Stuart Davis.

We are now ready to take your questions. To ensure that we can get to as many people as possible please restrict yourselves to one question and if needed one follow-up question. Now Jason will explain how you can phone in your questions.

(OPERATOR INSTRUCTIONS) Laura Lederman, William Blair.

Congratulations on your first quarter as a public company. Just a few quick questions, one, can you talk about the pricing environment on the new contracts and what you're seeing out there? And number two, can you talk about turnover and number of employees hired and your ability to hire the people that you need? And the final question is acquisitions; would you make large ones as well as the type of small ones that you made so far? Thank you.

Okay, on the pricing environment going forward, it is a highly competitive market. Again as we mentioned on the Roadshow, we believe that what will discriminate us from a lot of our competitors is the innovation and technology discriminators that we bring to bear in our marketplace. Having said that, we continue to look for ways to become a leaner, more efficient enterprise.

Employees, new employees turnover, the marketplace is red hot in certain areas. Certainly when you go to DC metroplex area it is highly competitive. We believe again we offer some unique opportunities with the deep ownership of stock available to our employees. The freedom and entrepreneurism to really run businesses on their own really creates I think a great environment for attracting new employees and retaining our own.

Acquisitions, certainly we have the firepower to step up and do larger acquisitions as they become available. We continue to have a list of companies that we are interested in, and that is about as far as I can say.

Jason Kupferberg, UBS.

Let me add to congratulations on the IPO as well. I wanted to start with a question of maybe for Mark on fiscal '08 operating cash flow looks to be down about $100 million year-over-year. And I think you're talking in the press release a little bit about some of the pieces there, can you just maybe quantify some of these moving parts so that we can understand what goes into the forecast there?

Sure, Jason. The first part is real easy, about $35 million or so is strictly due to accounting wherein under the previous accounting rules we had roughly that amount in cash flow from operations, we are now required to put that in the financing section related to FAS 123(R). The second mostly pertains to our response to our overhang issue and while not fully approved, our strategy is to in select areas substitute cash compensation for equity compensation, and that does have an adverse effect to cash flow from operations. But that is what we feel is appropriate to address our overhang matter on a timely basis. Those are the really two big chunks there.

And just a follow-up can you talk about the future combat system program a little bit as far as what the outlook might be there for the fiscal '08 budget? I think there have been some news reports of possible budget cuts there just because of the size and visibility of the program; obviously we've got some new political leadership in Congress as well. What do you guys expecting there and maybe what have you baked into your plan for FCS on a year-over-year basis in '08 versus '07?

Jason, I'll take that one. It certainly is the Army's highest profile program, so it will continue to get a lot of scrutiny. We basically have ramped up over the last several years and now are relatively flat. FY '07 had a modest budget cut that we had already baked into our revenue forecast of 10%, and the '08 outlook looks strong. However, we are certainly cautious and in our plan we are assuming a modest cut in FCS.

James Kissane, Bear Stearns.

Just a quick question, the margins came in somewhat better than we were expecting in the quarter. Did you push out some of the investment spending that you had planned for the quarter?

That is a good question and is a fairly complicated response. But let me give it a shot here. We did have a little built-in proposal expense shift to the right, if you will, and we spent a little bit less particularly on the Alliant bid, so that was a little bit of savings, if you will. We did have higher revenue, and with that fee which improved operating income in the quarter, but the biggest chunk is actually related once again to accounting and FAS 123(R). Recall that we had planned a $10 to $12 million expense for the dividend compensation. That did occur as planned. But when we did make the special dividend payment that caused the modification of all of our outstanding stock awards for purposes of applying FAS 123(R), and with expert consultation from the gurus in that area we determined that we need to forecast the forfeitures of vesting shares and take benefit of that estimate now as opposed to actually when they occur over time. And that was a pickup of about $7 to $8 million in operating income for Q3. We will see that slowly reverse and hit us as those forfeitures actually occur and we true that up in the forward period, not necessarily immediately but over a long period of time. So those pieces together were the contributors to higher operating income versus what you might have expected.

One follow-up on the margins. Can you give us a little insight in terms of the margin profile on some of the recent acquisitions. Including, I guess Applied Marine Technology?

Well, be careful with that one. The Applied Marine Technology's margins are better than our average margins. However, with the first 1, 1.5 years of heavier amortization of purchased intangibles that pretty much goes away. We will not finalize of course what those numbers will be but we are expecting them to pretty much wipe out the profitability of that acquisition in year one and maybe leaking into year two. The other ones are quite small, and their profitability rates are very similar to our averages.

Joseph Vafi, Jefferies & Co.

Good afternoon. A question on the new business signings here in the quarter. Some of the peer companies out there that I would consider your peer companies were posting pretty strong new bookings numbers, book-to-bill, kind of well over one and kind of riding some of the coattails of the spending bills being passed and kind of saw you're bookings of come in right around 1.0 to 1 to 1 ratio, basically. And maybe just some color from you on how you see the new business signings environment for you in the quarter and how you might see it moving forward to kind of get to those growth rates you're talking about for fiscal '08.

Joseph, as we mentioned on the Roadshow, we had the perfect storm with several of our large programs winding down or flattening GIG-BE, winding down FCS, flattening. And we did not rejuvenate the pipeline with opportunities of that size. So we committed $40 million of additional discretion this year in both R&D and business development to rejuvenate the pipeline. And believe me, it is starting to pay off. We've got recent wins of J63, the DHS EAGLE contract, the NATO Active Layered Ballistic Missile Defense program, so the pipeline we see is really starting to expand at least for our company. And as we mentioned, we still have about $10 billion of proposals outstanding awaiting adjudication. So there is -- gives us hope that we are reenergizing the organic growth engine of the company.

That's helpful, and then maybe just a quick follow-up on the revenue line on the commercial business kind of where it came in and growth that you might have seen in the quarter there on the commercial business.

That is a little misleading, Joseph. Included in the commercial segment are shipments of some of our scanning systems to commercial customers, and we had an episodically large Q3 last year, which did not reoccur this year. But when we talk about the commercial business, i.e. energy, utilities, pharma, consulting and outsourcing, its growth rate is significantly above what you see in the segment numbers there, more like 9% or so.

Bill Loomis, Stifel Nicolaus.

Thank you. Mark, can you just confirm that the gain from the ANX sale was in the discontinued ops? And then just a follow-up on your other large contract, NASA UNITeS, how they delayed in their budget over the next year if we get a one-year resolution might impact that program.

I will let Ken tackle the second one, but with respect to the gain on ANX, pre-tax gain was large. After-tax gain wasn't so large, about $7 million. It is in discontinued operations. The reason for the very high tax rate is it had a negative tax basis for very complicated reasons, so it has an unusually large tax rate applied to it. But it is in discontinued.

As far as NASA UNITeS, that program we won several years ago. We were now up to the appropriate staffing and funding level, so a CR in that space we don't see as impacting us at all.

Alex Hamilton, Benchmark Company.

Quick question. During the quarter or actually just recently a little bit after the close of the quarter, you got a favorable court ruling in terms of your South African liabilities. Can you potentially put a box around that help us quantify potentially what that could need?

We won't speculate on the outcome as far as dollar value, but I can tell you we feel pretty confident that we are going to get some cash proceeds as the South African Supreme Court unanimously overturned the ruling of the lower court. So the amount of damages will be determined by the arbitrator, and I like the fact that as the clock is ticking damages awarded earn interest at a 15.5% rate from the date of the breach. So there is potentially a significant amount of money but I wouldn't venture to tell you what our guess would be. Though we have a pool.

Edward Caso, Wachovia.

My first question -- I have two questions -- first question revolves around the change and the recertification rules of small-business, whether that impacts any of your existing small acquisitions that you've made or what you're seeing as far as pricing in the market or any impact it might have on your acquisition plan.

Certainly up to date, we see no impact on that new legislation. Certainly going forward those companies frankly will be less attractive since a lot of their contracts will go South if acquired. So it's an interesting conundrum, I think, that a lot of the industry will be facing going forward.

My second question is for Mark. Given that the share count pops up in the fourth quarter tends to lead to funny EPS numbers when you back in. Maybe you can just help us out and back into what the fourth quarter EPS number would be.

The share count -- I'll give you the share count we expect in the fourth quarter should be right around 420, 421. And I would prefer to not get into detailed modeling questions on the call so we can deal with that later.

Cai von Rumohr, Cowen & Company.

A follow-up on the cash flow. You had mentioned that you are going to have the switch next year to cash from equity and substituting cash for equity. Can you tell us how much is that impact going to be next year and how much out of this year's cash flow is really non-cash comp, i.e. equity comp that is in your cash flow?

Next year's, Cai, is roughly $50 million of substitution of cash comp for equity based on our projected change in compensation programs not yet finalized. We have -- back to the earlier question we have about $25 million of negative cash flow from operations with respect to quarter-over-quarter Q4 growth next year with DWC being constant. So I failed to mention that third component earlier. With respect to non-cash comp in this year's numbers, somewhere in the range of $150 million. So we are substituting some of it, but not all of it when we look at our current projection of next year and how we change comp structure.

And kind of a question on the orders. You had mentioned that you got $10 billion of outstanding bids outstanding, but that number was 11.5 at the end of July. So it is down. How much of that is non IDIQ? What do you expect to see our impact to be? I mean it doesn't impact NASA UNITeS but do you have other new programs that might impact? And how much of that $10 billion would you expect to kind of be awarded over the next six months?

Of the 10 to 11 of the outstanding proposals, Cai, it is a little over half is not IDIQ, and the rest is IDIQ. So call it 6 and 4.5 or something like that.

And I think the period of adjudication ranges from next month to the next five to six months.

And the last one, could you just confirm there have been some reports that the price on AMTI was between $250 and $300 million which would seem high for a company with $100 million of sales. Is that an accurate estimate?

We don't disclose the prices of individual transactions. But it is in the intelligence space and the multiple on that business is higher than looking at our average acquisition prices over history.

And also has higher growth potential than others.

That's right.

Okay, thank you.

Ferat Ongoren, Citigroup.

Good afternoon. My first question is on the guidance and probably for Mark. I am looking at annual guidance here and I take out first nine months, it seems like sequentially the net income will come down pretty sharply in the fourth quarter, although revenues will be either flat or slightly down. Will you tell us what is going on in the fourth quarter in terms of the operating margin and the line items?

First, our fourth quarter has typically been at or slightly below the third quarter historically. So we have some of that seasonality if you will. Also with respect to earnings just broadly, the removal of ANX is about -- well it is a fairly profitable business and that is about $0.01 to our fiscal '07 earnings per share reduction. In addition, the larger IPO, both the original size plus the greenshoe is about $0.02 diluted. I'm going to repeat that, about $0.02 diluted for the full year, and then finally, I mentioned earlier the pickup we had on FAS 123(R) in the third quarter offsets that by about $0.01, so those three things together is about $0.02 off of what we expected sitting here say a month ago.

I see. Okay.

And you know, for the plan we developed a point estimate plan that has upside and downside. We like to have $0.01 here on the upside and on the downside to deal with a variety of unknowns, including time sold, foreign exchange, we have some currency exposure with respect to Athens and things like that. Snow in Washington D.C. -- so we like to have a little flexibility in a forecast period like this.

And then a question for Ken. Except for JD all of the IT services of larger defense companies have pretty strong growth, most of them in the teens. Do you see them creating a pricing pressure in the market especially against the smaller guys?

As we said on the Roadshow I really believe we are an inflection point where size does matter, and I like where we are positioned with respect to some of the companies that I built in my prior employment. So I think over time we're going to see more bundling of procurements. It requires a lot more investment dollars; a lot more human resources, companies that have scale have a better opportunity to win their fair share.

So you essentially see some pricing competition but being larger you will be able to deal with that basically?

Yes but I also like that we are at $8 billion in revenue, not one billion or two.

And then a quick one on the turnover rate, could you update us on the voluntary turnover rate?

I don't have the exact percentages, but it is trending down. We are doing a much better job -- winning is a real invigorator for people to want to stay. We are doing a lot more training of our people; we are putting a lot more tools and processes in place to make their jobs easier, more rewarding. So we like the fact that the turnover rate is slowly migrating down. But again in the hot market areas there is going to be naturally more churn than others.

And then a final quick follow-up to Cai's question on the AMTI acquisition. I assume you're going to see the cash outlays in the fourth quarter results, right?

That is correct.

Thank you very much.

Jamie Friedman, Susquehanna.

Thank you. Most of my questions have been answered, but Mark I was wondering if you could repeat what some of the assumptions are mechanically surrounding the 20 to 30 basis point operating margin improvement next fiscal year.

The first piece I would say is economies of scale fairly broadly. And we are working hard on containing cost at the corporate level while growing revenue $400 to $500 million next year, whatever the range implies. So that is a significant piece. Second, we are where it makes sense combining in specialized cases some of our operating units, which we is somewhat of an economies of scale argument. We are putting in-place different incentives this year across the board that more accentuate margin improvement, and also specifically to negotiate better fees on materials and subs which is a big number for us. We have improved our metrics in this arena and are tracking in our overall awareness and training. So those are the big pieces, and those don't happen overnight. So that's why we think we will make some progress next year and the year after that as we migrate toward what we think is normative.

Thank you very much.

Julie Santoriello, Morgan Stanley.

Mark, can you give us a little bit more background in the change in the backlog definition what the rationale is for that? And if we were to look at your bookings numbers say this quarter compared to the prior quarter or the prior year, the numbers are look down obviously tough to compare year-over-year but also down sequentially. And I am wondering if this change in definition has impacted bookings as well?

We did not change our definition. That is the first point. The change or the adjustment in beginning backlog, if you will, was the result of implementing a new system which gave us greater visibility as to the categorization of our 9000 plus active contracts. And in that process we identified where there was incorrect application of our definition. Our definition as you know is perhaps more conservative than some of the others as we don't ascribe backlog value to unfunded IDIQ contracts or nontask orders, if you will.

So the adjustment was cleaning that up, if you will, and then there were some cases where we did not adequately adjust our unfunded backlog to the estimated value we expect. And then finally there was one case where we had the announcement of an early recompete and so we had to remove the backlog associated with its original period of performance. In that case we expect to bid on that job and win, and in the first case where we had categorized some future revenue in the option category as opposed to the IDIQ category, that took it out of backlog but the reality is we expect -- that was 800 million of the number -- we expect about $1.6 billion of revenue under those contracts over their life. But because of the definition and our adherence to that we had to move it into the other bucket which is not considered backlog under our definition. So that is probably very confusing. I apologize for that, but we did not change our definition, we just found some issues there that we wanted to clean up promptly.

Okay, and that difference in the categorization would not have impacted bookings?

It did not impact bookings. I think Ken earlier addressed the bookings level for the quarter, and importantly the change the backlog adjustment does not impact as Ken mentioned in his remarks, our forecast, our composition of revenue next year with respect to what is coming from backlog from bookings, etc.

Okay. If I can just get a couple of housekeeping items. Have you discussed or can you discuss in terms of trend how the win rate was in the quarter and a part of the strategy is to bid on more deals and larger deals and believe with that strategy you are comfortable with a lower win rate. You have been at industry highs there. Can you talk about how that has trended?

Actually we don't have that statistic here. I continue to say even on the Roadshow that I'd like to see us expand our aperture and bid more opportunities and as such we would expect the win rates to drop below the historic norms. Probably have to go get that information, Julie. I just don't have it. It is probably getting closer to 60% whereas our win rates traditionally have been in the 70, and I still like it at 60.

And just any update on the Greek contract and the potential arbitration there?

Again, as we mentioned at the Roadshow, we are continuing to work a parallel path of working towards a modification of a contract with a Greek customer, and we also filed with the ICC in our arbitration claim. We have really gained some ground in the modification side of the strategy, and we are right now pausing because I don't know if you have been reading the newspapers, but there is a potential bribery scandal with Siemens Munich which could impact Siemens Greece, which is a principal subcontractor to us on the Greek Olympics program. So we are looking and doing due diligence to make sure that we are addressing any allegations around that issue. So that if we can clear that we are hopeful that we can get to a contract mod in the next couple months. And if not, we will go and continue the arbitration path. So progress is being made, but it is a slow slog in Greece.

Okay. Thank you.

Robert Dezego, Banc of America Securities.

Good evening, guys. Just had a quick question in your release you said certain amounts of the special dividend were not tax-deductible. So I guess my question is are you still awaiting a decision from the IRS on a tax treatment for this dividend, or has that been resolved and that's it? Because I know you talked about a potential $350 million benefit from the IRS tax treatment on this.

The nondeductibility which impacted the tax rate is a separate issue then the decision we are waiting for from the IRS. So that is just a fact, and that is a onetime item, if you will, in the tax rate as I alluded to in my remarks. We are still awaiting a decision from the IRS on how recipients of the dividend will be taxed and how that affects our relative deductibility of their treatment. We don't have an answer. We did not bake in any tax benefits if we get a favorable decision from them in our forward guidance whatsoever, so anything would be an upside. And we are awaiting a decision; if we don't have one by March 30, as we committed to we will abandon that request, and we will not receive the tax benefits from the company's perspective.

And one last final follow-up, so what would you kind of model in as your tax rate going forward on a more normalized basis?

30% is our normative tax rate going forward and that is the number that is baked into the '08 guidance.

Thank you very much.

Jason, we have time for one last question.

Saba Hekmat, New York Life Investment Management.

Thank you, just a quick question. I was wondering if you could remind us of your long-term leverage target and whether we should expect a change in the company's capital structure now that it is public.

With leverage I am assuming you're referring to debt to EBITDA. Right now we are right around 1.5, and we are investment-grade credit, as you know. We would like to stay investment-grade credit, but we are able and willing with the right investment opportunities to lever up to some degree. Our covenants allow us to go up to three times; we would like to stay below three times, but certainly want and have the firepower, as Ken mentioned, to increase our leverage somewhat to go after larger acquisitions if they make sense.

By investment-grade do you mean within the single A category or would you be willing to take the company down to the triple B category?

I said I would like to stay investment-grade.

Thank you very much.

Thank you.

Jason, that concludes our session. I want to thank you all for joining today's call.