Leidos Holdings Inc (LDOS) 2007 Q4 法說會逐字稿

Good afternoon.

At this time I would like to welcome everyone to the SAIC fourth 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 session.

At this time I would like to introduce Stuart Davis, Senior Vice President for Investor and Employee/Owner Relations.

Thank you.

Mr.

Davis, you may begin your conference.

Thank you, Lamont, and welcome, everyone, to our fourth quarter FY '07 earnings conference call.

Here today are Ken Dahlberg, our Chairman and CEO, and Mark Sopp, our CFO.

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 discussions 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 the forward-looking statements at some point in the future but we specifically disclaim any obligation to do so.

Ken.

Thank you, Stuart, and good afternoon, everyone.

Our fourth quarter was a strong finish to a milestone year for our company.

We exceeded our guidance for revenue, earnings per share and cash flow.

We have had solid momentum as we begin our fiscal year 2008.

Mark Sopp will guide you through the numbers in a moment but first let me address the major developments in our markets and our company.

Investors have expressed concern about our market since several competitors lowered their growth expectations as a result of factors, such as the diversion of defense O&M dollars to fund the warfighter, continuing resolution in civil agencies, and increased contract award protest activity.

To some extent, these factors affect us all.

But none of them are new.

In fact they've all been part of a landscape for more than a year.

This is still in my opinion a large and growing market and, I believe filled with opportunity for SAIC.

Since our last call, President Bush submitted a $716 billion budget request for next year that showed strong growth in our core markets.

His request includes a $481 billion base budget and wartime supplementals of $142 billion for FY '08 and $93 billion for FY '07.

Congress has taken up the '07 supplemental bill and both the House and Senate have approved versions that meet the President's request, but add $20 billion in emergency domestic spending and set a timetable for troop withdrawals.

We expect Congress to pass a reconciled version over the next few weeks when it is back in session.

President Bush then will likely veto the bill and Congress will not be able to override the veto which would mean that the earliest that the supplemental could be approved is early to mid-May.

The Pentagon is already moving funds from future quarter procurement and O&M accounts to help pay for wartime operations to offset this expected slip in the supplemental.

We see the delay in the supplemental to only be temporary and we are encouraged that the President has requested full year funding for the war in '08.

Also the House and Senate budget resolutions which set the macro guidelines for the approps bills fully support the president's requested funding for the full three years.

Really the contentious issue is Iraq, not the overall defense spending.

Looking ahead, there will continue to be fairly slow growth in the overall services market and many demands simply will not be met, because of the level of national debt and the critical needs in national and Homeland Security.

Companies will differentiate themselves by their relative positioning in the faster growing areas.

Their capability and reputation and their ability to deliver services at a competitive price will be the discriminators.

Beyond the overall level of spending there are two trends of bear watching.

First included in the House version of the '07 supplemental bill is language that moves the government away from cost-plus contracting.

It is unclear whether this clause will remain but it is clear that the new Congress wants more contractors' skin in the game which we believe is good for the profitability of contractors like ourselves, who can execute well and manage risk.

Second, there is a DoD mandate that lead systems integrators for major systems cannot have any direct financial interest in the development or construction of the system.

Our recent five-year $250 million award to manage the development of the next-generation navigational satellites AKA GPS is evidence of this very favorable trend for us.

It marks a clear break from the usual reliance on platform primes to provide the essential management oversight.

And I think our past performance, our scale and platform independence makes us well positioned for this market.

In the area of new business, new business bookings showed a strong pickup in the fourth quarter, totaling some $2.7 billion, representing a book to bill ratio of 1.3.

As a result, backlog now is over $15.1 billion of which $4 billion, $4.8 billion is funded.

Given our strict definitions of bookings in which no value is assigned unless we have a signed contract for a price statement of work, we again are well positioned for accelerating growth in fiscal year 2008.

You can read our press release for more description on a lot of the awards but I want to call out two that merit special attention.

First is our win in NATO, the active layer theater ballistic missile defense contract, which was a great win for us on many fronts.

Not only was it highly strategic, this $95 million win meant that we beat Boeing, Lockheed Martin and Northrop Grumman on the very tough systems engineering and integration job.

Kudos to our entire team.

To prevail on this entire competition, we needed to bring together our best and brightest from several business units, and people throughout the Company have taken notice of the benefits of collaboration.

Furthermore the win establishes a real presence for us overseas.

And we look to expand our government business to selected foreign customers.

The second that I want to bring to your attention is the area of cargo and container inspection systems.

We recently received several new orders and made some technical breakthroughs in product development.

Our mobile detection units and our high energy systems place us in the forefront of this expanding market.

And we believe we are now supporting five of the six demonstration sites under the secure freight initiative.

We are well positioned to support the demand should Congress mandate 100% inspection of cargo coming into our country.

In addition to these two noteworthy accomplishments, we have won several ID/IQ contracts that are not included in the bookings total.

These include contracts that secure our business space with important legacy customers, such as the program and integration support for the Army's Chemical Materials Agency, and the joint test and evaluation contract for the DoD JT&E program office.

Other new contracting vehicles expand our footprints such as the Navy's E2 C2 -- EC2 ATS -- that's a mouthful -- the Army's ITES-2 system and the Department of Veterans Affairs Vista contract.

In other developments, we have reached an agreement with the Greek government on contract modifications for the security system originally developed for the 2004 Olympics.

This resolution is positive for all parties.

Greece will have a state-of-the-art security system and our Company will not have to bear the risks and costs of a protracted arbitration process with the Greek government.

On the acquisition front, we have completed the acquisition of AETC, and Applied Marine Technology Inc.

or AMTI for a total cost of $252 million in the fourth quarter.

AMTI is by far the larger of the two deals, bringing us key customer relationships in the special warfare and Intel communities and new capabilities in rapid prototyping.

Both acquisitions are progressing well, integrating into our businesses, and I must say our pipeline of acquisition candidates is still very robust.

Finally we have taken steps to reduce our stock option overhang.

We recently distributed our bonuses for our FY '07 and cut our option grants more than in half replacing their value with restricted shares on a three options for one share basis.

You will remember on the IPO roadshow we said it would take us two years to put the right program in place but we did it in one year and we are now done.

So far, the reaction from our employees has been positive.

We now have an incentive comp program that has matched the levels in our Company -- primarily cash for our staff, restricted shares for mid-level managers, and options for our executive management team.

Mark Sopp, our CFO, will now provide detailed results and color for the quarter and the outlook for FY '08.

Mark.

Thanks, Ken.

As Ken indicated just a moment ago, we indeed had a strong fourth quarter on all major fronts.

Revenues, profits, cash flow and bookings -- the four pillars in measuring our financial performance -- each compared favorably to our expectations.

I will cover the fourth quarter and the full year results for fiscal '07 upfront.

And then I will move on to our forward outlook at the end.

Revenue for the quarter reached $2.15 billion.

That represented a 10% year-over-year growth on a total basis and 7% on an internal growth basis.

We are particularly pleased to more than double the 3% internal growth rate that we had for the first three quarters through balanced revenue growth across virtually all of our business areas in the fourth quarter.

The lower growth in the earlier quarters of fiscal '07 were primarily due to funding delays from many of our government customers and also an insufficient new business pipeline as we entered the year.

With on-time passage of both the government fiscal '07 defense budget and the first supplemental, you might recall we expressed confidence during our IPO in October that the funding environment would improve toward the end of the year.

We also reengineered our business development functions starting about 12 months ago and, indeed, invested more discretionary dollars to improve the quantity and quality of our new business pipeline over the course of the year.

That confidence was validated.

Our stronger performance in the fourth quarter was primarily attributable to the improved DoD funding environment but also to new contract wins in recent months.

In addition to growth in labor based revenues over the prior year, we did see somewhat of a spike in material purchases in the fourth quarter, mostly in the logistics and systems integration business areas, which we believe is a combination of both pent up demand if you will from previous periods, and to some degree an acceleration from what we otherwise expected in Q1 fiscal '08.

As I mentioned, we also believe that our new business development and internal research and development efforts are paying off with both new and recompete wins during the period.

In the fourth quarter, incremental revenues were generated under our new NATO contract, several intelligence contracts, and orders and delivery of cargo and container inspection systems that Ken mentioned a moment ago.

Importantly as well, we won all major recompetes during the fourth quarter and also so far in Q1 of fiscal '08.

Moving onto profitability, operating income was $144 million for the fourth quarter.

That represented about 6.7% of revenues.

As I stated in our last earnings conference call we had expected lower operating margins in the second half of fiscal '07, due to timing of discretionary expenses.

While this held true we had higher profitability than expected in the fourth quarter due to strong overall contract fee and indirect rate management performance.

Our operating margin for the year was 7.1% of revenue.

That is up from the prior year of 6.3%.

While we improved margins year-over-year as targeted, we invested more discretionary dollars in fiscal '07 to refuel revenue growth opportunities and also to position the business for long-term growth.

Indicative of this, during fiscal '07 we increased spending in business development, IR&D internal research and development, and IT infrastructure by over 19% compared to fiscal '06.

Diluted earnings per share from continuing operations for the quarter were $0.20.

That is $0.02 to $0.04 above our implied guidance range for the quarter of $0.16 to $0.18.

The increase is driven by stronger revenue, stronger operating profit and slightly better than expected results in our non-operating items and in our tax rate.

Our diluted share count was on target at 420 million for the fourth quarter although we did execute share repurchases during the quarter.

I will discuss that more in a moment.

For the year diluted earnings per share from continuing operations were $1.01.

With respect to cash flow, we continued effective management of working capital through the fourth quarter, generating cash flow from operations of about $200 million in the fourth quarter and just over $700 million for the full year.

DSOs were 69 days for the fourth quarter of the fiscal year '07.

That is one day better than last year.

We deployed about $250 million in cash in the fourth quarter to complete the two acquisitions that Ken mentioned and also an additional $67 million in cash to repurchase roughly 3.5 million shares of common stock, which we did either on the open market or through privately negotiated transactions.

These repurchase transactions were largely in the month of January, therefore, the effect on the average diluted share count for the year was minimal.

With the strong cash flow in the fourth quarter coupled with the investments I mentioned, we ended fiscal year '07 with about $1.1 billion of cash on hand which approximately offsets our total debt of $1.2 billion.

That debt is comprised of long-term notes and at year end, we had no outstanding debt from the $750 million credit facility that we had put in place last June.

Let me shift gears for a moment and provide a little more color on the positive developments with the Greek contract, and also a quick update on our legal matter concerning our former subsidiary Telcordia and its dispute with Telcom South Africa.

You may recall on our December conference call that South Africa's constitutional court had denied Telcom's appeal of the reinstatement of an arbitration finding in favor of Telcordia and thus the second base of the arbitration has now begun to determine damages payable to Telcordia.

Telcordia's claim is in excess of $200 million and the hearing on this matter is now scheduled for September.

Under the Telcordia sale agreement, we SAIC will receive the net proceeds from any settlement or arbitration award.

We do not have any receivables on the books for this matter and plan to account for this anticipated award when received.

As for the Greek contract, the contract modification that Ken referenced has several key elements.

First, a much more specific and objective set of technical requirements for the remaining work, which is planned to be done before the end of calendar 2008.

That is essentially fiscal '09 for us.

Acceptance -- second point -- acceptance for two-thirds of the subsystems within 70 days of signing the modification at a maximum price reduction of $10 million.

Third point, reduction of the outstanding bonds commensurate with the value of these accepted subsystems.

Fourth point, payment of $33 million U.S.

in roughly 30 days for work we have previously performed.

Finally, a final payment for completion of the system development phase of $48 million U.S.

at the acceptance of the remainder of the system.

There was no accounting effect related to the Greek contract modification in our fiscal 2007 year end results.

For now, we will continue to recognize revenue in excess of the cash -- pardon.

For now, we will continue to not recognize revenue in excess of the cash received until more clarity on the ultimate outcome of this issue can be obtained.

Given that the $33 million payment milestone should occur before our next earnings release, we expect to provide a more complete status on our next conference call as well as anticipated P&L and cash effects of this modification.

Now let me handle our outlook for fiscal '08.

That year started of course on February 1, 2007.

Four months ago we provided fiscal '08 revenue guidance of $8.7 to $9 billion.

This implied a growth rate of 5 to 8.5% over fiscal '07 actual revenues.

The associated diluted earnings per share guidance from continuing operations was $0.83 to $0.88.

This guidance included an estimated improvement in our operating margins of 20 to 30 basis points.

With solid performance in revenue growth and bookings in the fourth quarter we just discussed, coupled with a healthy new business pipeline, our confidence level of the meeting this guidance has increased.

Going into fiscal '08, our funded backlog as Ken mentioned is $4.8 billion.

This represents over six months of forward revenues, certainly good business level visibility well into the year.

Given the fairly high volumes of materials and product shipments that we just had in the fourth quarter of '07, coupled with our historical seasonality, we expect a modest decline in revenue sequentially in the first quarter with growth throughout the remainder of fiscal '08.

In addition to our healthy backlog coming into the fiscal year, we have $13 billion in bids currently outstanding and 81 new business opportunities in our pipeline with a potential value in excess of $100 million each.

So in summary we are coming off a strong quarter and are off to a good start in fiscal year '08.

Whether we have a great year will largely be determined by our win rates on bids outstanding and also the timing of the Supplemental Bill being debated on Capitol Hill.

If these Supplemental passes in June or before, our confidence in meeting our business objectives for fiscal '08 would remain high and we would expect to be toward the high side of our guidance.

If on the other hand the Supplemental was delayed into the summer or beyond, funds could once again be diverted from domestic defense programs and we would generally expect to be toward the low side of our guidance.

With respect to the share count, while we did make roughly 2 million of unplanned repurchases in the fourth quarter the repurchases are not significant enough to change guidance at this point.

For these reasons we believe the guidance previously set is our most prudent range at this time.

Finally, our guidance for cash flow from operations remains unchanged at $450 million or more for fiscal '08.

This is down quite a bit from the $700 million we achieved in fiscal '07 but our expected true cash management performance is not as different as this spread suggests.

About $50 million of the difference is from our plan to use more cash than equity for our compensation programs.

Another $50 million is directly related to expected revenue growth in '08 and an initial investment in inventory for a new logistics and product support contract.

The remaining difference pertains to timing variations for taxes between years, a change in the accounting presentation related to the adoption of FAS 123R, and some amount of conservatism built into the forecast.

That completes my discussion and guidance.

On a final but very important note you'll see in our Form 10-K to be filed tomorrow that we have made our first SOX 404 compliance attestation, together with an unqualified opinion from our independent auditors.

This is certainly a substantial effort for the Company and of, note, we accomplished this objective when year in advance of our requirement to do so.

So with that I'll turn it back over to Ken to wrap it up

Thank you Mark.

Before we start the Q&A I wanted to offer just a final few reflections on the terrific year we just completed.

As I said to many of you before with a dispute on the Greek Olympics contract and our IPO, our Company became too focused internally and we took our eyes off of growing the business and keeping the pipeline vibrant.

Those events are now behind us.

Over the past year we have reinvigorated our business development function and invested in building a pipeline of opportunities.

And we are now starting to get traction in terms of collaborating as a company on the large wins that are just basically key to achieving our growth range.

We are creating a virtuous cycle of collaboration.

The more we demonstrate the benefits of collaboration, the more people are inspired to collaborate, driving even more success.

It's also encouraging that the project execution remains strong in the Company.

We should note that we've had no major problem contracts since the Greek contract.

We have managed to accomplish all of these things while still preserving the spirit of innovation that is truly the heart and soul of the Company.

In fact last month, Gartner recognized SAIC as one of a small handful of companies with a sustainable culture of innovation.

And even with the tough macro environment I believe we are well positioned to drive shareholder value in fiscal year '08, through accelerating organic growth, improving operating margins and wisely deploying our capital.

Lamont, with that, we are now ready to take questions.

(OPERATOR INSTRUCTIONS) Joseph Vafi of Jefferies.

-- and solid results here on this quarter.

I was wondering maybe if we could drill down a little bit into, Mark, some of your comments here on guidance up-and-down in '08 relative to the supplemental.

And are there specific programs we should be potentially focused on, that might have more sensitivity to the delay in the Supplemental, relative to your results?

You are referring to the developments on Capitol Hill and what might trigger either early passage or what might trigger (MULTIPLE SPEAKERS)?

Is that the nature of your question?

Yes.

I think what I was implying, Mark, was looking at the low end to the high end of your guidance range and some of your comments around it if the Supplemental passed on time or not.

Which programs would be more sensitive relative to your portfolio of contracts to delay and Supplemental or not?

As you know we have a pretty high degree of revenues derived from ID/IQ contracts.

Those that pertain to services and those that are more in the commodity arena, IT in particular, I think might be subject to diversion, if you will, which is what we experienced very much in fiscal (technical difficulty) parts of fiscal '07.

So that part we would be concerned about.

We wouldn't be as concerned with some of the single award, installation-oriented vehicles as well as a lot of our intelligence and Homeland Security work due to the priority of those missions.

But, again, into the Navy and the Army and Air Force service arena under ID/IQs would be most susceptible in our view.

And to add to that, Joe, I mean you recall in the year past, most of the service directorates really took a look at some of these service delivery task orders and viewed them as necessary but not mandatory at that particular time.

So they used discretion and delayed several.

So I would not see it going away, but I would see it maybe shifting until the Supplemental got resolved.

All right.

That's helpful.

Then on the margin outlook, obviously a pretty good quarter here and some of your comments, Mark, were talking about some of the things we have been looking for relative to stronger fees coming from some of the subcontractor work and the like.

If we -- would you say the Company is kind of ahead of where you thought you would be on some of these margin endeavors here at this point, as we look into '08?

Joe, I think we are ahead on our dilution program that Ken mentioned, which does in fact have a margin impact.

But, otherwise, I think we are pretty much on schedule with our management of indirect costs.

As you recall we are investing quite a bit in IT infrastructure and we are on pace there.

So, we are not ahead nor behind but right on track in that regard.

All right.

Thank you very much.

Jason Kupferberg with UBS.

Thanks and good afternoon.

Just wanted to pick up on the margin point and maybe hone in on the SG&A line a bit.

Specifically in absolute dollars the number was actually down quarter-over-quarter; and as you pointed out, Mark, that was a bit better than you guys expected.

Wanted to get a sense of these sustainability here, given that you do have some necessary investments in business development and IT infrastructure.

Are there other offsets behind the scenes that you guys have been able to execute on, to drive overall operating margins upside via the SG&A line because gross margin if anything was a little light because of the materials pass-throughs?

That's correct.

The precision of the location in the income statement is not perfect in this business, as you recall.

So you have business development and IT and things like that, not necessarily in the same place from company to company.

But we are seeing increased investment as I said in business development, infrastructure, IR&D, and IT.

And that actually hit both lines for us.

Some amount hits cost of sales and the other amount hits SG&A.

So I don't want to bog you too much in those details, but we generally would expect continued economies of scale on the SG&A line for the next foreseeable couple of years.

And to what number I won't make so precise but we do see that decreasing in general, although I wouldn't focus on it quarter to quarter too much but general trends year-over-year should work in our favor.

We actually had success in reducing legal expenses in recent quarters and that's helping the SG&A line quite a bit as well.

Plus I think overall, we are continuing to look to make the organization lean and agile.

And our focus is to be as competitive as we know we must be and I think the organization is really starting to step up as we have grown our groups to be quite larger than we started three years ago.

And my goodness we went from 72 business units down to some 22.

There are certain economies of scale that we are getting all the way through the organization.

That color is useful and switch gears for a second.

Maybe any comments you guys can make on the overall federal IT funding and spending environment since the end of your January quarter.

Obviously there have been a lot of concerns out there as you guys alluded to.

So it's been -- call it 2 1/2 months or so since your first quarter, your first fiscal quarter started.

Any appreciable change in the case of funding that you are seeing?

Because your funding backlog was up significantly quarter-over-quarter in the January quarter.

Well, it certainly hasn't slowed down.

We have had one heck of a quarter in proposal activity.

All across the line, I mean, from the VA to DHS to DoD to the Intel communities and we're, as Mark said we are winning all of our recompetes, at least through this current quarter.

So we are cautiously optimistic the wild card is Supplemental; and getting that resolved sooner than later will be healthy for our entire industry base.

Sounds good.

Thanks.

Edward Caso with Wachovia.

In the past, you have talked about your investments you've made in the area of IED defeat.

I was wondering if you could give us an update there?

That's a good question.

We in fact held a review towards the end of last year on a lot of our key Research and Development programs, Ed.

In particular in the Counter IED we feel we have got three to four breakthrough innovation concepts -- I can't really describe them in detail on the phone -- that we now are interacting with our government counterparts to secure funding so that we can take these from concept to proof of design and that train is now starting to roll.

It was noteworthy that in the new budget there was a significant increase in the President's request for counter IED.

So we absolutely see this as an opportunity for our Company and I want to do it, because of the loss of lives but there's a business aspect as well.

Is there a -- can you give us a sense whether you believe you and maybe some of the other Tier 1 providers are gaining market share?

Or are you gaining market share versus the other Tier 1 providers in a what's generally more hostile environment?

Tough to call.

I mean you know, first preserve our base.

So we are winning our recompetes.

I think we ended last year with well over 95% win rates on our recompetes on the total.

So we are doing fine there.

I like our wins in NATO.

If you want to call that taking away market share.

You wouldn't have naturally thought we would be a contender and active layer theater ballistic missile expense and GPS.

So we are stepping up to the plate.

Look at the $81+, $100+ million plus opportunities that I guarantee two or three years ago, a company wouldn't even be pursuing.

So if that is taking away market share I guess you're right.

We intend to do that and to swing the bat.

Two quick ones for Mark.

In the guidance, tax rate assumption and are you assuming any share repurchases?

Good question, Ed.

The tax rate assumption is 40% for fiscal '08 and we are not assuming share repurchases.

That is our consistent assumption from the last guidance so as we make them, we will report them and advise of any effects to guidance but not do so in advance.

Jim Kissane with Bear Stearns.

Can you talk a little bit more about the acquisition pipeline, maybe the valuations out there given that the public comps have come under a lot of pressure in the past year?

Thanks.

There's -- it's varying degrees.

We've really stepped up of last couple of years to look at somewhat larger acquisitions, $200, $300 million in revenues and I -- we still find these deals to be not dilutive, even maybe mildly accretive in the first year.

So we are not overpaying.

In fact if anything I think some of the frothiness is starting to come out of the system.

And we tend to be much better when they are private companies because our cultures match up.

I typically don't like to get into auctions because I just won't overpay.

But it is an active robust pipeline.

Because I mean, you were pretty quiet during the quarter.

There were no new announced deals.

Is that just a timing issue?

Well, in the fourth quarter, we announced two deals.

You know, I can't ever tell the timing of these.

It is never going to be linear, I can guarantee that.

Got you.

And Mark, can you talk about the sustainability of the 7% organic growth because it sounded like materials revenue bumped it up a little bit in the quarter?

Can you maybe quantify that?

Materials did bump it up in parts of the revenue, but in other parts it diluted it.

So it really was pretty much as expected except with better indirect rate management and a little bit of lift from the -- from some product sales, but we are comfortable in our guidance at 20 to 30 basis points going forward, with a number of initiatives under way that I think we've all articulated in the past.

Any time our revenue is ahead of plan, there are economies of scale derived from there and so we are still bullish on the numbers we had provided.

Can you give us a split between labor-related and M&S revenue for fiscal '07?

Yes.

Well, if we could be more precise labor was for the year 64% and M&S 36 (technical difficulties) indicate tomorrow.

And we -- labor is up a little bit in the prior year so that is a good direction for us.

Don't see any major swings in that in the forward year.

Great.

Thanks, Mark.

Bill Loomis with Stifel Nicolaus.

Just going back to Jim's question on the organic revenue growth of 7%.

You mentioned a couple of times significant materials pass-throughs.

Was that -- could that have accounted for 1 percentage point, 2, 3 percentage points?

Can you just give us a magnitude?

The run rate on materials for some of our bigger contracts was approximately $50 million more than the third quarter.

And these are contracts mostly as I said in the logistics and Homeland Security areas and as I said, I think some of that was picked up from the funding delays earlier in the year.

But also some of it just came in faster than we had expected.

That's a magnitude so call that 1.5 percentage points or something like that.

That's helpful.

And then on the year '08 revenue guidance, what assumptions are in the revenue in terms of organic growth and acquisitions that haven't been done yet, if any?

There is no contribution of acquisitions not yet announced.

So it's all organic growth going forward in the '08 guidance.

Okay.

And on the gross margin obviously some offset with the higher materials but you also mentioned better fees and indirects.

As we look to the mix between the SG&A which was lower than we expected in the quarter and gross margin, how should we think of this going forward, SG&A continuing at -- it was down in absolute dollars?

Should we continue that or just was the fourth quarter a little bit lower than we should think about on SG&A than going forward?

Generally you should expect a lesser mix of products in a given quarter than we had in the fourth quarter but again some of that was at high margin and some of it was at no margin and I don't really -- I can't really parse that out right now in terms of its net impact to the gross margin.

But I think, in general, the 6% range on SG&A is a reasonable number going forward for '08.

Okay.

And then on the -- you said some better contract fees, were these true-ups as contracts came to an end or was it kind of an ongoing in that the contracts you have won have better fees going forward?

As Ken mentioned, there were no blowups if you will on programs.

So we didn't get hit with any write-downs of any magnitude.

So we had a pretty quiet quarter on that front.

And we had excellent fee, if you will, on our proprietary product revenues, cargo inspections, most prominently.

So that's -- .

I think the entire team are now focused on a whole basket of margin improvement initiatives, not the least of which is getting better fee rates on new contracts.

So I think we are at the early stages of a lot of that happening.

But we are seeing better fees and as we reported before as we moved up into more of the system engineering integration opportunities as a prime, we are afforded higher fee rates.

Thank you.

This is a trend that will continue over time, not just an instance.

Laura Lederman with William Blair.

A few questions.

One, can you talk a little bit about the hiring environments with (inaudible).

You are breaking up, Laura.

Could you -- ?

Sure.

Can you hear me better now?

With the better growth rate coming a little bit better can you talk about the ability to hire and what you are seeing out there?

Are you meeting your goals for hiring?

And also, separately, what you think the odds are that the language in the Supplemental to move from cost was away from cost-plus stays and a totally (MULTIPLE SPEAKERS) both of those and then I will follow up.

So the first question is what's the hiring environment like and what's our needs?

I think our needs for the year are some net of 700 folks.

And so from a gross top-level, that is not a big deal for us.

We really are a hiring machine.

The issue, of course, is retention and controlling the voluntary attrition.

We have seen a good trending down.

Again modest, but the trending down in our fourth quarter and good sustainability here in our first quarter.

Obviously, the D.C.

Metroplex area is a hot area.

And if you are a cleared polygraph Intel specialist, you command a lot of activity.

So we are doing our best to find ways to keep as well as to hire these kind of folks.

I think the employee ownership model where stock is held deep and broad within the Company is a unique attribute of us and we have attracted a lot of people.

Our best recruiters are our people by the way.

So we feel pretty good about the hiring environment but we are not naive.

We have got to stay competitive from a benefits and salary, but I like the position we are at.

You were mentioning about some of the language in the bills moving out of cost plus.

I think that's what you were saying.

Do you view that as a benefit?

No not a benefit of how likely it is (MULTIPLE SPEAKERS) to remain in (MULTIPLE SPEAKERS).

That's a jump ball.

I don't know.

I really can't say.

I believe you will see more performance-based contracting where they do want more risk presumed, assumed by the contractor and as long as it's not a silly risk like we are never going to go into fixed price development programs, but those kinds of things where we can -- we know we have opportunities to understand risk and how to mitigate it.

And along with that, we can get additional fee.

I think you're going see a lot of our industry applaud that as long as it doesn't get silly.

Two final, real quick questions.

One is the timing of the really big deal like the $500 million plus so [are] they likely to happen more than six months, the year (technical difficulties) sort of a feel for the (technical difficulties) not just $100 million plus but the really big one?

The timing of the $500 million plus acquisition pipeline.

No, no, no.

The big deal winning, in other words the results of the (MULTIPLE SPEAKERS)

I'm sorry.

You are breaking up Laura so we are having a hard time on that.

We have got one that is very near term.

We bid on a DLA outsourcing for POLCHEM that, help me guys, it's the end of April or around that time frame.

It's days.

Days away.

Then the rest of them are throughout the year and more likely in our FY '09 than in our FY '08.

Final question, from a very high level, what do you see the long-term growth rate in your business as, just going up 35,000 feet away from this year's growth, next year's growth but just long-term sustainable growth for the market?

Well as we said in the roadshow, we have not really changed.

We feel organically we can grow in the range of 6 to 9%.

We are clawing our way up that ladder.

We are going to be at 5+ growing and the reason is because we are focused on the higher growth markets in the broader services space, Intel, Homeland Defense, logistics transformation, so I think our strategy is right and the proof will be where we're going to be next couple three years.

Ferat Ongoren with Citigroup.

Could you just tell me what percent of your guidance is independent on new contract wins or recompetes?

Ferat, going into the year it was roughly 10%.

Our plan was in new business, go find if you will.

And about 35% was a combination of follow-ons on ID/IQs because you have to remember our backlog definition.

Any time you want a new task order on an existing ID/IQ that's a new award effectively; and that, coupled with recompetes, is in a 35% category of our total revenue.

So it's -- well, that really answers your question.

So 35% of follow-ons and recompetes about 10% of new business and we've already won some of the awards in that new business category.

Ken mentioned GPS.

That was certainly one of them.

(indiscernible) 6, 7% maybe new business?

That's probably a good -- .

That's probably close.

Backlog now is north of 60% which is good.

Then a question on the margin side.

I mean if you basically drove in and the IT expenses the Greek expense last year, option expense this year said all in all, the margin has come down some this quarter.

It was down last quarter.

Should we expect to see the margin going up in the first quarter?

Be careful with quarter to quarter.

We did have a flip-flop in timing of discretionary expenses between fiscal '06 and fiscal '07.

And so we look at the full year.

I think it is appropriate to look at the full year and on that basis we were indeed up by the 20 or 30 basis points from '06 to '07, when you factor out the items you mentioned.

And we expect to continue that pace.

Some then we expect first quarter of year-over-year margin improvement looking into fiscal '08.

It will depend on the timing of discretionary.

We certainly endeavor to have a flatter spend pattern in that category but it is dependent on B&P and IRAD investments and stuff like that.

So I would encourage you not to look at any one quarter; but hopefully through the first half we will be able to show some improvement over the first half of last year.

We are committed to move our margins 20 to 30 basis points.

We said that and we are consistently going to do that.

And then if you could -- revenue drivers, I mean, what is your expectation for the intelligence business to grow this year.

And the same question for DoD overall and federal civil.

I know some of it will depend on the performance on the Supplemental but if you can give a ballpark estimate.

It's hard to give a ballpark estimate.

I mean, my goodness, they are under continuing resolution in civil space.

I think when you look at the President's budget, reaffirmed by what the House and Senate proposed, you are going to see that there's solid growth, double digit in intelligence, Homeland Defense is really now starting to pick up.

I can't tell you how many proposals we now have ongoing.

I mean that agency is really started to get some traction in releasing RFPs.

While the logistics business does not show huge growth -- in fact, it is modest to flat -- because of all of the outsourcing that is going to occur if we are able to pick up this POLCHEM job, we got the Michelin tire job, you are going to see dramatic growth from our Company standpoint in that logistics space.

Then, a final one maybe for Mark.

What was the change in internally funded IR&D fiscal '07 versus fiscal '06?

And what is your expectation for fiscal '08 directionally?

We (multiple speakers) almost doubled the IR&D spending '06 to '07.

So we are up to call it $30 million range right now in IR&D for the year.

And I think that we will continue to invest more.

I won't provide a precise number but I expect an increase.

For a science and technology company, we have to invest in discriminating technologies.

Tim Quillin of Stephens Inc.

Good afternoon.

Mark, I appreciate that color regarding the year-to-year delta in your cash flow from operations assumptions.

Can you just walk through a little more of the detail in your assumptions this year in terms of D&A stock comp, any other non-cash items in there?

Working capital changes?

And if you could touch on CapEx plans for the year?

Thank you.

Let me start with the latter.

CapEx, we expect to continue right at about 1% of revenue.

So call it $80 million range.

In terms of major elements, I will walk you from the $700 to the $450.

I think I covered that.

Your question was stock comp and what else, Tim?

D&A and then changes in working capital.

We are looking -- I will give you round numbers.

I don't want to get too precise on the call here but D&A is right around $80 million as well.

Coincident with the CapEx number.

Working capital outflows are $75 to $100 and the non-cash stock is somewhere around $100.

That's helpful.

Thank you.

Julie Santoriello with Morgan Stanley.

Ken, wondering if you can share with us some of your thoughts on the Supplemental and just the likelihood of it passing before June?

I realize that there's a lot of politics going on that are certainly hard to handicap, but what do you see as the risk that the Supplemental does slip past June?

I think the risk is the OSD doesn't have enough funds to really handle all the programs.

I mean, this is going to become a real pressure play probably sooner than later.

Look, they are going to fund the war.

I believe cooler heads will prevail and after the President vetoes the current bill, they will come to some resolve.

Boy, June -- that's a long way away so I, right now today, knowing what I know I would high handicap that it would happen.

Then, just related to that, are you concerned at all that the debate can move to the fiscal '08 budget approval progress within Congress?

So if or when the Supplemental is passed, there's a debate that it shifts to the pretty large defense budget that the administration has put out there.

I mean the last couple of years we've seen it signed on time.

Do you think that this year is shaping up to the another on time approval for the Defense budget or could it be a little bit more contentious this year?

I think it will be a little more contentious, but I still believe that they will proceed to do that without a CR.

I mean, after all this is also coming up to a 2008 election and I don't know either side of the aisle wants to say that they are not supporting defense.

All right.

Okay.

Thanks for that.

Just one quick one for Mark.

On the SG&A expenses -- I know this was covered a lot and nice decline in dollar terms in the quarter.

I recall in the fiscal third quarter, I think there was -- you also had a much lower than expected number.

And I think you talked about part of that was being a deferral in some bid and proposal costs and that should catch up in the fourth quarter.

Did that indeed happen or is there any change going on in the bid and proposal expenses?

We are actually getting more efficient in our proposal generation.

We've got two world-class proposal centers.

One East Coast and West Coast and when we look in there the volume of activity is not decreasing.

It is increasing.

But, frankly, we are becoming more efficient and because of the quicker turnarounds on some of these task orders -- I mean, you can't spend a lot of B&P.

So our activity's going up but our actual expense has gone down.

It actually went up during the year about 3% or so but in terms of the timing of the quarters you're right.

It did go down.

Now the larger single up awards I would expect we would spend a little more B&P so look for that probably over time to -- frankly, we are looking for more efficiency in the smaller contracts so that we can bid the larger ones with the same amount of B&P that we forecasted.

Cai von Rumohr with Cowen

Thank you very much and good quarter.

SG&A was down $7 million from the third quarter and as Julie said, you kind of expected to spend some more money.

And yet your outstanding bids are up to $13 billion like $3 billion from the third quarter, so it looks like there was a fair amount of activity.

First, kind of discretionary spending I'd classified IR&D bid and proposal down in the fourth quarter from the third or was the decline sequentially -- decline in other items like legal expenses?

Well you are right on that last part.

Legal did go down quite a bit in the fourth quarter --

Thank God.

That was nothing but a good news story there.

In terms of IR&D, was kind of flat as well as B&P was down a little bit from the third quarter.

Not a huge amount but a little bit, and the rest is just timing of corporate expenses.

And some of those can move around a little bit.

But those are the big movers.

Then I think you said you would expect this SG&A level to continue at about 6% in '08.

Is that correct?

That's the right ballpark.

Right.

But if that happens, so you get all of your 30 bips is in SG&A, right, if you do 20 to 30?

So you are essentially telling us that gross margins are going to be flat to up -- flat to down a little bit.

That's what the math implies.

Is that correct?

I'm rounding a little bit here, Cai, so it's not exactly flat.

It's -- at 6% flat our SG&A is a tick above that if you will.

6.2, 6.3 for the year.

So bear in mind that difference.

We are not expecting a major shift in gross margins year-over-year.

No, no, I mean, you said so what you are saying -- because you said it would continue at the 6% which would say it would be down 30%.

What I'm trying to get at is of the 20 to 30 bips how much of your target is SG&A and how much of it is gross margins?

I think in the earlier years of our margin improvement program the bulk of the margin improvement is on the SG&A line.

(MULTIPLE SPEAKERS) Go ahead.

Then your M&S was 36% in '07.

Where do you expect it to be in '08?

It is hard to predict because some of the M is passed through of course.

But, what we'd like to see is more of our proprietary products add a greater mix which would increase that metric, but some of it -- so much of it is unpredictable in terms of pass-through.

Yes.

Our recommendation is pretty much what it was this year.

Correct.

And it will, over time, trend down as we prime more opportunities and collaborate more inside the Company.

But your M&S was really lower in '07 than it was in '06.

So I guess what I'm getting at, you know, you've given us a revenue estimate and you must have some assumption -- is it likely that M&S would be flat as a percent of sales in '08 in your assumption.

Or is it likely to be -- (indiscernible) jump a little bit?

Remember, from '06 to '07 we had a large contract GigBE during '06 which had a huge M component so that distorts that equation a little bit.

But, again, we are projecting flat for '08 on this mix.

Maybe a percent or two maximum in either direction.

Of your $13 billion of outstanding bids which by the way, very nice -- increase sequentially.

How much of that is ID/IQ?

How much of the $13 billion is ID/IQ?

(MULTIPLE SPEAKERS).

You gave us -- of the 11.5 you had at midyear was -- 4.9 was ID/IQ.

Approximately how much of that is ID/IQ?

I don't think we -- we'd have to get back to you on that.

We will have Stuart follow up.

Then I guess the last one, I think at midyear you said of the 11.5 you expected decisions of close to 11 in the second half.

Of that $13 billion how much approximately would you expect to occur in the first half to get those decisions (inaudible)?

We prefer to get back to you on that.

There's specific opportunities that are spread across the map here.

Some are bigger than others, of course.

So it will require a little digging up.

Then of course we win them and they are protested.

So we have to just give you a little bit more color on that.

That's terrific and thanks a lot and good quarter.

Lamont, I think that is all the time we have.

That's all the time we have for today's session.

So I just want to thank everybody for joining the call.

I will be around and Mark will be around and perhaps others, if you have some follow-up questions that didn't get answered.

But I appreciate your joining today's call.

This includes today's SAIC fourth quarter fiscal year 2007 earnings conference call.

You may now disconnect.