Leidos Holdings Inc (LDOS) 2008 Q2 法說會逐字稿

Good afternoon. My name is Deketria, and I will be your conference operator today. At this time, I would like to welcome everyone to the SAIC second quarter fiscal year 2008 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 for our analyst group. At this time, I would like to introduce our speaker for today's call, Stuart Davis, Senior Vice President for Investor Relations. Thank you. Mr. Davis, you may begin your conference.

Thank you, Deketria, and welcome, everyone, to our second quarter FY '08 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 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 the forward-looking statements at some point in the future, but we specifically disclaim any obligation to do so. Ken?

Thank you, Stuart. Good afternoon, everyone. The second quarter was a strong one for our Company. Revenue, operating margin, earnings per share and cash flow were well ahead of plan, and we are on track to meet our FY 2008 guidance, laid out last December. We are successfully navigating the course that we chartered on the IPO: Accelerating organic growth, improving operating margin, and deploying capital on accretive acquisitions and share repurchases when it makes good financial sense.

Now I'll address the major developments in our market and our Company. On our last conference call, we indicated that the government would likely start the new fiscal year with a continuing resolution in place, and nothing has happened since to change our view. Iraq is even more contentious, and we continue to create discord and we will continue to create discord and unpredictability. The mid-September testimony of General Petraeus and the administration, as well as other independent reports will re-energize the debate and impact the funding cycle. We again think the most likely scenario is an omnibus continuing resolution covering most, if not all of the appropriation bills. Because government fiscal year 2007 spending is fairly robust, a two to three month continuing resolution should not present much of a problem to our business. The key issue will continue to be the timing and level of the war time supplemental funding. We see it as likely that we will begin the government fiscal year with supplemental funding in place, but for only part of the year, perhaps as part of a continuing resolution. As such, we may experience some tightening of funds as DOD managers hold back on core programs, similar to what we have seen over the last several years. The particulars of the appropriation strategy will become a lot clearer over the next several weeks as the Iraq situation is fully debated.

We appear to be in a much stronger position in terms of Congressional backing for our Future Combat Systems, since our last call. The House Armed Services Committee trimmed $867 million from the President's budget. But the House Appropriations Committee added back $400 million. So the program would only be down about $100 million from last year under a continuing resolution, and could be up once the new budget is approved, as the Senate has even a stronger position. Moreover, we're seeing the Army leadership fully behind the program, and they've indicated that they intend to fully fund the program if there is an appropriations cut.

Now turning to business development, we've had significant new business orders in the quarter. Although many of the contracts we won are indefinite delivery indefinite quantity contracts which again, I want to remind everybody, does not add to the backlog until funded task orders are received. We booked about $1.9 billion for the quarter, for a book-to-bill ratio of 0.9. The Immigration and Customs Enforcement award cited in our press release was a particularly rewarding win, because it's a take-over of an existing contract from a competitor, meaning that it will quickly ramp up with an annual run rate of about $30 million. We continue to solidify our strong position at DHS. We experienced a sequential decrease in backlog of about $400 million. As of the end of July, total backlog was $14.1 billion, of which $4.5 billion was funded. This marks the second straight quarter that backlog has declined, but we believe the business base is actually stronger than before because of the success in winning the single award IDIQ contracts.

In the first half of the year we won many single award IDIQs, including several that will be significant revenue drivers. As an example, we expect to receive about $1.5 billion in revenue under the POL Chem win alone, none of which is in the second quarter bookings or backlog. Remember again, I reiterate, we do not have to compete for these task orders under single award IDIQs. So if the customer has a funded requirement within the scope of the contract, the work will generally come to us.

Another indicator of the strength of our business is revenue visibility. We now have about 80% of our second half revenue in backlog, which is consistent with our historical experience, looking two quarters ahead. Of the remaining 20%, the portion that is expected to come from single award IDIQs is significant. So we will have to compete for a relatively small portion of our forward revenue. That said, we continue to see great opportunities ahead. Even after the POL Chem award, our submitted proposals awaiting adjudication at the end of the quarter was over $15 billion, including 19 opportunities north of $100 million. Our proposal tanks are full. We expect to submit another 30 proposals greater than $100 million by the end of October. Included in this bunch is the low rate production and initial spin out stage of Future Combat Systems, where the Army has informed Congress that they plan to extend Boeing and SAIC as lead systems integrators through this phase.

In addition to evolving our business base through normal business wins, we took deliberate steps to rebalance our portfolio. First, we restructured the AMSEC joint venture along customer and product lines. We kept the Aviation Combat Systems and Strike Force Integration Services business and Northrop Grumman received the shipyard maintenance business, which we see as a slower growth and not consistent with our focus on higher end technology and engineering. We will continue to test whether all of our businesses match our strategic direction, but do not anticipate any more major transactions. Second, we acquired Benham, an engineering and life cycle technology implementation firm, with specialized expertise in energy management, industrial manufacturing, alternative fuels, process engineering, and advanced visualization and communication systems. Benham's expertise in energy project design, implementation and monitoring, combined with our core capabilities in engineering consulting, research and development and risk management, creates a wonderful end-to-end solution for the energy market. Looking beyond Benham, we expect to complete another small acquisition within the next month, and our M&A pipeline outlook remains positive. We have not seen consistent evidence that private company valuations are coming down, but we do expect to continue to deploy approximately $300 million or more each year in acquisitions, and remain ready for a large acquisition, should it come along.

Finally, I wanted to talk about the management changes in the team since the last call. In the last three months, we've named new heads of business development and human resources, and today I announced our Chief Operating Officer. All three promotions were from within, because our internal candidates were superior to those from the outside. We are harvesting the fruits of our comprehensive talent management review and succession planning programs that identify high potential employees and provides them with training and rotational assignments that prepare them for leadership roles. First, Greg Henson now runs our Corporate Business Development function, after leading that function at a business unit level and then group level at SAIC. Greg has substantial experience in both business development and line management. He's building on the good works of Paul Sullivan with an emphasis on further deploying CRM, improving the business development business process across the Company, and positioning the Company for larger system integration and engineering contracts.

Second, Brian Keenan now runs Corporate Human Resources, a strategic position given the importance of recruiting the people we need for growth and retaining the people we need to perform flawlessly for our customers. Brian's been with SAIC for seven years, and he knows the importance of our culture and our enduring values, so he will bring a fresh approach to our human capital challenges. Third, we named Larry Prior our new Chief Operating Officer effective October 1st. As President of SAIC's Intelligence, Security and Technology Group, Larry's hallmark is his intense focus on business fundamentals and on execution of his passion around customers' missions. I look forward to Larry's help in driving top line and bottom line growth. We plan to name Larry's successor as Intelligence, Security and Technology Group President from among several capable internal candidates before Larry assumes his new role. I feel we have the right leadership team in place to drive growth for this Company in the future. With that, I'll turn it over to Mark for the financial picture.

Thank you, Ken. On the financial front, we indeed had a strong second quarter with significant improvements in internal revenue growth and in operating margins. Our team is executing our fiscal '08 business plan with good discipline and success. With dedicated efforts by our employees across the Company, a partial list of accomplishments this quarter includes winning all key recompetes and several important new contracts, increasing our internal research and development spend for the second consecutive quarter, focusing on longer term technology differentiators in advanced weapons, Homeland Security and information technology applications, delivering results from our margin improvement initiative, including execution of cost control, strong program performance and improved indirect rate management leading to higher profitability on a number of cost plus contracts from the recovery of prior year cost overruns, something the Company hasn't done very effectively in the past, strong execution of strategic transactions, including excellent progress toward resolving our Greek contract, favorable developments on the Telkom South Africa legal dispute, the successful AMSEC reorganization transaction, and preparing for the close of the Benham acquisition which occurred just after the quarter end, and finally, achieving a record low days sales outstanding metric of 64 days at the end of the quarter.

I'll start with more detail on the quarter's results, and then I'll talk about our outlook for the rest of the year at the end. Before I do that, as our earnings release describes, our second quarter numbers exclude the results from the portion of AMSEC that went to Northrop Grumman in the reorganization that we announced in June. That portion is accounted for in Discontinued Operations, and prior period results have been restated accordingly in our earnings release and in our second quarter 10-Q which will be filed either today or tomorrow. In terms of the top line, we generated internal revenue growth of 8% in the quarter. That's our best performance in a few years. Growth from acquisitions added another 3%, for a total organic -- or sorry, total revenue growth metric of 11%. We generated all of our revenue growth from a variety of sources within our government segment, while year-over-year revenues in our commercial segment were essentially flat.

Growth came from strong performance and some expansion of several existing programs, along with the start of several new systems integration contracts. The most significant ramp-ups were our GPS contract with the Air Force, our NATO Missile Defense contract and Navy systems integration work coming from our SeaPort-e contract vehicle. As we expected, we also had strong internal revenue growth from cargo inspection system deliveries to Homeland Security and military customers. Finally, we recognized some revenue on the maintenance and service portion of our Greek contract in the quarter, following receipt of payment from the customer.

Looking at profitability, operating income was $173 million for the quarter, or 7.8% of revenues. The results here were favorably affected by consistent execution at the program level, controlled spending and some fruits from our margin improvement campaign. Also, the increase in high margin cargo inspection system deliveries contributed about 20 basis points of margin growth over last quarter's performance. Despite those deliveries this quarter, we have generated a growing backlog of orders for future shipment, which should continue to favorably affect margins as these systems roll out in the quarters ahead. There is also a healthy pipeline of new opportunities in this area for continued growth over the long haul.

Margins recovered from the first quarter in our commercial business as well, although its 7.5% operating margin lagged behind our government segment operating margin of about 8.1%. We have made cost reductions in our commercial area in light of lower service revenues in the UK, and that is mostly tied to our ongoing contract renegotiations with Scottish Power, where we've lost some project work. We've also made management changes in our UK business area to more aggressively pursue new work, but also to continually align our cost structure with business levels. Finally, we are able to deliver these strong operating margin results despite taking an $8 million charge for the information security incident where customer sensitive data was potentially compromised. This cost includes notification of individuals or families potentially affected, and the associated call center operations to assist those persons in understanding and taking appropriate actions related to the incident. At the present time we are not aware of circumstances that would require the Company to incur further material costs associated with this incident. But this is certainly not an assurance at this time. The $8 million charge eroded operating margin by about 40 basis points.

In the non-operating area, we incurred a $5 million pretax charge for impairments and losses on investments held in our venture capital portfolio. This portfolio started a number of years ago, and our current strategy is to harvest positions within the portfolio that show upside potential and prune positions that are not developing favorably. The portfolio has a carrying balance of about $33 million as of the end of the second quarter.

For the tax provision, our effective rate was just about 38% for Q2. That's lower than our normative rate of 40% due to reversal of a reserve we had for a tax contingency upon the expiration of its associated statute of limitations. Diluted earnings per share from Continuing Operations were $0.24 for the second quarter, primarily reflecting improvement in our operating margins on increased revenue volume. Our diluted share count for the quarter was 418 million. As mentioned in the earnings release today, we had a gain on the reorganization of an AMSEC, which was the driver in recording $0.07 of earnings per share from Discontinued Operations. Cash flow from Continuing Operations was a strong $260 million for the quarter, fueled by improved profitability and a significant reduction in our days sales outstanding metric that I mentioned up front, going from 73 days in the first quarter this year, to 64 days here at the end of Q2. This reduction reflects successful efforts by our business units across the Company in aggressively managing receivables, but also coupled with a healthy funding environment that we have today in the federal space.

We used almost $80 million in cash during the quarter for share repurchases via open market repurchases and buy backs from employees from our stock compensation programs. Roughly 4 million shares were purchased under these programs in the quarter. With operating cash flow significantly exceeding uses of cash in repurchases and other investments, we increased our cash balance by almost $200 million in the quarter, to just over $1.1 billion at quarter end. This cash is invested in low risk, highly liquid short term money market funds, with some of this being used just after the quarter to fund the Benham acquisition. As a final note in this area, we extended our existing credit facility for an additional year during the quarter with identical terms and pricing from the original agreement that we made in June of last year. This transaction preceded the advent of the credit market disruptions that we saw in July and continue to see.

With that, let me cover our outlook for the rest of the year. Just cutting to the chase, we are confirming our original and existing guidance for fiscal '08, which reflects stronger performance from our government business, offset to some extent by the removal of the portion of AMSEC that went to Northrop Grumman. The AMSEC and Benham transactions were meaningful in size and have meaningful impacts on the year, so let me cover how we expect those will affect our year-end results. Compared to our original and existing guidance, the AMSEC reorganization will remove about $225 million to $250 million of revenues from our results for the full year. It will have a negligible effect on operating margin and earnings per share from Continuing Operations, but will adversely affect operating cash flow by about $15 million.

Benham, which again closed right at the beginning of the third quarter, should add approximately $75 million to $100 million of revenues for the rest of the year. It's expected to dilute operating margin by about 5 basis points in our full year results as a result of intangible amortization and other transaction-related costs. It should have a negligible effect on earnings per share and will adversely affect operating cash flow by about $5 million to $10 million. Netting these two together, the transactions should remove about $125 million to $150 million of revenues, 5 basis points of operating margin, and about $20 million to $25 million of operating cash flow for the full year results.

As I said up front, the year is progressing very well for us, so with improved internal revenue growth, excellent progress and winning recompetes and new contracts for future growth and real traction in our margin improvement program. Given our operating momentum, we believe we will make up the aggregate revenue, margin, and cash flow lost from the combined AMSEC and Benham transactions with strong results from the rest of our business. Indicatively, our trending through the second quarter supports internal growth of 5% to 6% for the year, and operating margins generally consistent with our goal of 20 to 30 basis points of improvement over last year. Combined with our year-to-date share repurchases of roughly 9 million shares, this translates to earnings per share trending toward the upper range of the guidance.

With a strong portfolio of contracts and orders in hand, the main issue concerning our performance toward the end of the fiscal year will be the health of the funding environment from the U.S. government which is of course, where we derive most of our revenues. If the supplemental passes on time and has a sufficient funding level, we believe we will be on our way to a very good and balanced financial performance for the year. If however, the supplemental passage is not timely, we would expect funding problems with existing programs and new starts as we have seen before, and that would adversely affect our ability to continue to grow internally as our current momentum suggests. It is certainly too hard at this time to predict the probability and magnitude of this as we sit here today, which is why we reasoned, despite our favorable trends, it's prudent to stick to our existing guidance at this time. With that, I'll turn it back over to Ken to conclude the call and then on to Q&A.

Thank you, Mark. Finally, before turning to your questions, I want to address the Company's major misstep in the quarter - the security failure in the handling of the customer data which placed the personal information of uniformed service members, family members and others at risk of potential compromise. Even though it appears that no personal information was actually compromised, I view this incident as completely unacceptable, and a clear failure to live up to the high level of performance that our customers have expected and demand from us. However, I am proud of the way the Company stepped up to take the responsibility for the error, and to mitigate the damages for the service members and their families. We have taken appropriate personnel actions, and I want to make sure that it is clear to all of our customers, our shareholders and our employees, that noncompliance weth Company policies of this behavior will not be tolerated at SAIC. With that, DEketria, we are ready to take questions.

(OPERATOR INSTRUCTIONS) James Kissane, Bear Stearns.

Mark, it seems like there were a few one-time items in the quarter, both positive and negative. Can you kind of rattle those off, and maybe give us the net impact in the quarter?

Sure, Jim. The reported operating margin was 7.8%. The biggest pickup, if you will, which I wouldn't necessarily call a nonrecurring item, is the pickup from cost overruns by better managing indirect rates. That was about $12 million. We also, of course, offset that by what Ken was just talking about, the security incident. That was $8 million going the other way. We did have significant shipment activity in our cargo inspection deliveries. And we also have a bullish view on that going forward. But if you take a look at those things, you could get to a normalized operating income of about 7.4%, versus the 7.8% we reported.

Because I thought you mentioned something about the Greek contract, as well.

The Greek contract, we recognized revenues, but no profit. That actually diluted margins by a little bit. About $20 million of revenue, again, with an equal number of cost of revenues.

Okay. And then the revenue -- the net revenue impact from the AMSEC restructuring in the quarter? Because I mean looked like your revenues were very strong when you take into account that part of AMSEC was gone.

Yes, it's $50 million, $60 million per quarter from the AMSEC piece that we no longer have.

Okay. And Ken, can you give us a little more color on the rationale for the creation of the new Chief Operating Officer position?

Well, the rationale, we've been out looking for a Chief Operating Officer for the last year-and-a-half, Jim. A Company of this size, I think we really need someone that's focused on a daily basis on driving efficiencies, improving margins, improving top line growth. And the Board and I have been on an active search for the last year-and-a-half, as I mentioned, to find one. We feel really comfortable with Larry. We can be giving him ever increasing responsibility in the years that he's been with the Company. And when we stepped back a few months ago, we said, this is the guy for the job. And so I'm pleased that he's joining us in this position, and look forward to him really working in a full-time basis in driving overhead costs down and improving margin and building a top line growth.

So the progress towards your long-term margin targets, kind of tracking your expectations?

Yes.

Great. Thank you.

Jason Kupferberg, UBS.

Just looking at the second half of the year, first, Mark, just wanted to clarify the comment you made near the end around the 20 to 30 basis points of year-over-year improvement. Was that for fiscal second half '08 versus fiscal second half '07, or full fiscal year '08 versus full fiscal year '07?

It's full fiscal '08 versus full fiscal '07.

Okay. That's helpful. And so if we look at the back half of the year, I mean the upper end of your EPS guidance range I guess would imply a quarterly EPS run rate of about $0.23 a quarter, which is a little lower than what you just printed. And based on the items you just went through, I guess there's a little bit of one-timish kind of stuff. You also had a lower tax rate. Is it a combination of some of that nonrecurring stuff that makes the EPS run rate maybe tick down a little bit? Or is there just some conservatism baked in there, as well?

You're on the right track, Jason. We expect the tax rate to creep up again in Q3, Q4. We expect the share count to creep up as it normally would, assuming no repurchases, which is our constant assumption as we look forward. Benham will have a drag on earnings as we bring that in. And we also don't have the nonrecurring items, if you will, in the quarter. But also we are hedging a little bit on funding risk in the fourth quarter with the uncertainties that exist with the Defense budget, and the supplemental in particular.

Okay. That's understandable. And just on the employee retention front, kind of a two-part question. First, if you can give us a voluntary turnover number for the quarter, and also just talk bigger picture, around employee retention strategies. Obviously, all the lockups will expire as of the one year anniversary of the IPO next month. Do you guys have any concerns there? Or are you making any adjustments to employee retention approach to try and make sure that that doesn't become an issue going forward?

Well, we always keep our eye focused on retaining employees and as we mentioned on prior calls, we really have focused a lot on this. We established a task force almost nine months ago that came up with some good ideas which we have implemented. It's basically common sense, touching the folks more, interacting with them, communicating with them. We have recently re-energized the redeployment of people as they come off of existing programs. And that has been very, very successful. We've been able to redeploy literally hundreds of folks. Our voluntary turnover rate is actually doing quite well. It's in the low 14%, which is not bad for a company in our space, especially in the hot markets in Washington. We just recently completed a Gallup survey, which is, again, focused on what are the concerns and issues of our employees, and we aim to develop action plans around those results. And again, heavy emphasis on retaining our employees.

And just one last one. Lower DSOs sustainable, Mark, in your view?

It's possible, Jason. We had a couple of good things, and some of that, I would say is a little bit of catch-up of some lingering issues that the team really focused on and cleaned up at the end of the second quarter. So we expect to be sub-70, but I wouldn't necessarily count on 64. So I think a safe range to assume for us is 65 to 69, thereabouts.

Okay, thanks, guys.

Laura Lederman, William Blair.

Nice to see such a solid quarter. Can you talk a little bit more about when you say if the supplemental passes on time, what you consider on time, and also thoughts on a CR civil for the full year and any timing of the CR on the DOD budget? So just a little bit more granular detail on your expectation for timing.

You really broke up a bit. I think you were asking the timing of the supplemental?

Yes, when you say on time, what do you mean and also -- ?

We mean in the October timeframe that the supplemental would be passed. And my comments were -- I think with the upcoming administration change, it's probably unlikely that it would be a supplemental for the entire fiscal year. Your bet is as good as ours. We think it might last a few months until the Iraq debate gets resolved and so on. As far as I thought you were asking about the continuing resolution?

Yes, on the civil side and also any expectation for any at all on the DOD -- ?

I think we said we expect the CR on all the appropriation bills. It's just jump ball right now in Congress and -- .

For the full year? In other words, what's your current expectation on how long those will last?

I don't know. You want to start a poll?

We should. We should start a little betting pool on that. It would be fun.

I wouldn't venture to guess.

And a little small question, which is the churn, you mentioned was 14% on voluntary. What about the involuntary, what's that been running at? So we can get a total churn number.

The involuntary is like 4% to 5%.

Okay. One final question, which is if you look at the breach that happened, any feedback on that from the government, any commentary from the user organization, just any thoughts? I thought you handled it beautifully by putting out your release and everything that you did, a lot of companies would have just hidden it. But just any feedback you've gotten on it.

Well certainly, the customer was disappointed, as we were. Having said that, they appreciated how quickly we reacted and stepped up to it, and wanted all the assurances that we were doing all that we could to protect any and all sensitive data in all the contracts. And that's why we're doing a very, very thoughtful review of all our contracts involving sensitive data. So far, as we said, we don't see any ID thefts as a result of this particular potential effect, but you don't know. So we're cautiously optimistic. But again, it was a failure on Company policy and one that I regret that the employees did not adhere to it. I take full responsibility for it.

Thank you.

Bill Loomis, Stifel Nicolaus.

Good quarter. Mark, when you talked about the $12 million from the lower indirect costs or cost recoveries and then separately, the improved fees, how much of that are we going to see again in the third quarter and the fourth quarter? Or were those -- or should we think of those as one-time in nature, or is that recurring, that's going to stay in the operating margin as a positive impact?

That's a tough question to answer. We still have some work to do on recovering some of the overruns from the prior year. We could have a couple more million dollars leak in over the rest of the year. And profitability will also depend significantly on how we manage rates for the rest of the year. And if we have underruns, we always provide for reserves on those for cost reimbursable underruns, and we pay back the government as we have always done. And that adversely affects profitability. On the other hand, if we have overruns, then we have to consider if it's recoverable and go pursue it, as we did in the second quarter. So it's really hard to predict that. Second part of your question again, Bill, was?

The improved fees, I'm not sure if there was award fees that you were mentioning or some other type of fees on programs?

They weren't that significant in the quarter. We actually had some ups and some downs. But by and large, we had some net adjustments up of a couple, $2 million, $3 million in the quarter on all of our contracts collectively. We do EACs on all of them, and that was the effect. So it wasn't huge. Sometimes we have a couple million go the other way, and hard to predict. But we feel confident that we're executing better program to program as a result of the training and the improved disciplines we put in place.

I think, Bill, we're just starting to see the benefits of our rollout of our margin improvement initiatives and the discipline to live within our rates. And when we do have rate creep, we are going to go back to the government on cost-plus contracts to see if we can recover. Which heretofore, the Company never did. So I applaud Mark and his team for doing that.

And then a final question on the single award IDIQs. Taking out the Chem POL award and looking at the others that you've won this year, I know you don't include them in backlog. But is there any way you can kind of throw a number out there, if you did include them in backlog and had a reasonable value, not necessarily the ceiling value, but a reasonable value what those might total?

Bill, we don't want to disclose a number that we don't put as part of our formal disclosure, so we're not going to do a pro forma book-to-bill. But there are hundreds of millions of revenues besides POL Chem on various contracts that we expect to earn that we have won this year. And again, it just makes the existing book-to-bill and bookings numbers not as indicative on future revenue potential than it used to be, given the weighting of business going to the IDIQ and for us, particularly, the single award IDIQ area.

Mark, help me. Isn't our revenue almost 60% IDIQ?

Our revenue from IDIQs exceed 60%. So very significant.

Very significant, right.

Okay. Thank you.

Ferat Ongoren - Citigroup.

Mark, a quick one for you to begin with. The guidance, do we still issue [430 million] shares?

I'm sorry, I -- we couldn't hear you.

The guidance, does it still issue for 430 million shares?

Well you might have noticed we didn't put guidance number in the earnings release. And the reason for that is when we did the IPO with the option activity and changing conditions, we thought it was advisable to put that out there to help investors understand. Now that we have recorded a few quarters, we don't think that's necessary going forward. So we started off with an assumption of 430, and within that, an assumption that we would not make repurchases. We have since made about 9 million of repurchases. And so looking at our going forward scenario, again, not assuming further repurchases from here, 420 is more indicative of where we are. And again, absent significant activity going forward, that's where we intend to stay, and we'd creep up a little bit with our equity comp programs.

And you'll see that in the Q as we release it.

Okay. So I mean, if I look at the share count, I mean, that's giving you $0.02 to $0.03 benefit if you remained around where we are, or maybe slightly higher, and this quarter was pretty good. I mean, why won't you at least increase the bottom of the guidance somewhat higher?

I mentioned with an earlier call, I think, from Jim or Jason, that there are some profitability headwinds in the second half of the year, share count, tax rate, risk in funding, Benham, et cetera. So we certainly consider that and -- .

And we're being cautious with the supplemental and the CR uncertainties.

And is it fair to assume that you're primarily concerned about Q4, not so much about Q3, given -- ?

That would be the one that would be most affected by the funding concern, certainly.

And if you kind of look at Q3 historically in the past three years, Q3 was 4% better than Q2, sequentially. I mean this year we have some gives and takes with these acquisitions and AMSEC. Should we assume kind of a flattish third quarter, looking at the data you're looking at now?

You were breaking up, but I think it's safe to say our momentum is good for the third quarter. The funding environment is good. The contract wins are good. And the main concern of course, even though things are going well for us, is the funding environment tied to the fourth quarter.

Okay. And Ken, could you comment on the pricing environment?

Our win rates have been really, really high. Pricing sensitivity, I think continues in those things that are more commodities. The kind of business that we're in, which is more the high end noble work continues to -- we continue to discriminate ourselves with some of our technology offerings and capabilities. So I'm not saying it's easy, but that's why we're continuing to drive overhead expenses down, to keep our wrap rates competitive. But so far, we're doing well.

Okay. Thank you very much. Good numbers.

Joe Nadol, JPMorgan.

First question is I just want to clarify one more thing on the sales guidance. The organic growth of 5% to 6%, does that include a continuing resolution or does that include a budget passing?

It assumes that we will have a supplemental in place, or at least not adversarial funding conditions in the fourth quarter. But we also assume that we will be in a CR for the rest of our fiscal year, essentially.

Okay. Okay. And then on the margin, you give a normalized number that was below. And it just seems like the better cost containment that you showed -- or the better recovery, I guess, or lack of non-recovery you showed in the quarter, that should be the kind of thing that's sustainable. That's what you've been working towards. So is it fair to say you just want to see a couple quarters of that before you get a little more enthusiastic about bumping up the margin guidance?

Well we're enthusiastic about our progress, I'll say that. But when it comes down to guidance, we do tend to be cautious. I would say that. And again, the -- while there was indeed upside to the 7.4, I said if things go well for us, there is the effect of Benham which would bring us down a little bit, and the other things we mentioned with respect to funding.

We're pleased with where we're at, though.

On the book-to-bill and your IDIQ point, that you're not getting much in -- you're getting less and less in the way of future -- of bookings for future revenues. You still get the task orders in the quarter. So that would contribute to the bookings in your book-to-bill. At what point do you expect that to get back above one?

You're absolutely right that over the long haul we need to be at least at one or above to grow the business. And it's hard to predict when that will occur. You know, the non-IDIQs are choppy and they can really move the needle a lot in the book-to-bill ratio. So we don't predict when, but we just know we have a healthy pipeline and good ptocess to continue, hopefully, our growth going forward and accelerate it further.

We have experienced, by the way, quite a few wins that had then been protested, which caused us not to get the revenue that we predicted as soon. For example, POL Chem. And there is numerous others that have now converted. So a lot of it has also been just a delay because of the protests that have occurred.

Okay. One final one on that note, Ken. Could you maybe walk through for the back half of the fiscal year what you see as maybe the top three or four targets, from a bookings standpoint, that are competitive?

Well, we just have a lot in our pipeline. So there's not one or two that are of any more consequence than the other. I'm just pleased that we're really stepping up now and bidding $100 million or greater opportunities. We could probably give you more color on that at our analyst day in October.

Okay. We'll look for that. Thank you.

Cai von Rumohr, Cowen and Company.

Good quarter, guys.

Thank you, Cai.

Direct labor, what percent of it -- what percent was it of the revenue mix in the second quarter, and what are we looking for in the second half?

It was about 60% in the second quarter, Cai.

Uh huh.

And the second half, we really have no reason to believe that it will be materially different.

60%. So that's really lower. I thought we were looking for about 65%. Is that not correct or -- that's essentially where it had been running, 65. I thought you were looking for 63. So that's essentially lower than expected.

Well, we have won a lot of systems integration contracts that involve lots of materials and subs, and those have ramped up well. The cargo inspection is pretty much all materials. And we love that. And so that's notching us up, as well. So it's not in our view adversely affecting us. We certainly aim to internalize as much as we can, and our labor numbers have been improving with headcount additions.

And our collaboration initiative is just starting to take off where we would do more internal work as opposed to the subbing to others, Cai. And I think the number is actually is like 61%. So we're moving it up, but not as dramatically as you had forecasted.

Okay. Okay. No, it does look like it notched up very slightly. And then SG&A was up $10 million from the first quarter. What drove it up? And should it be relatively flat in the second half? Because I know you had some kind of weird -- a little -- some movements that were a little unexpected in the second half of last year.

It was -- most of that -- half of that increase was B&P, the other half was mostly some of our initiatives, like Deltek, I would say. There were no other surprises. IRAD was essentially flat. It was up a little bit from the first quarter. And in terms of those trends, I think that B&P and IRAD will stay near the same level as the second quarter. And G&A will probably flatten, but I don't want to be too precise on that. Some of those parts are hard to predict.

So essentially we're talking 139 plus or minus a little bit in the second half -- I mean in the third and fourth quarter. Essentially that's what you seem to be saying. Is that what I'm -- am I reading this correctly? More like where it was in the second quarter. Maybe up a little bit, but nothing -- .

You should expect it to go up a little bit, but nothing dramatic.

Okay. And then if I look at your contracts, I mean, you just had this enormous surge in August. I mean, we had Alliant, ICE, DSC,EPA, NASA, Unites, CAAS III, MRO. I mean, really just looking at the numbers and some of the numbers associated with them, while they're mostly IDIQs, they're really fairly substantial. Have you had any tasking on any of those?

Well, the answer is yes. We have had some tasking. Most of the time, it does take a little while to get the engine going, Cai. But you're absolutely right. We believe we're well-positioned with winning those large, especially single IDIQ awards. Now the momentum has to get moving for the Company.

I recall on the last quarter, you mentioned POL Chem at that point, you won it, but it was still under protest. And it seems like it was resolved relatively quickly in contrast to F3 and all the other large ones that people had. So what should the run rate on POL Chem? I believe you said at one point it would get to like $200 million rough annualized run rate about a year from now. What kind of annualized run rate could it be at in the fourth quarter?

I think we said it was about a $1.5 billion estimate over a ten year period. So you do you the math. It's more like about $150 million or so run rate after it ramps up.

Okay. But when should it hit that rate? I mean, does it have a fairly steep ramp, because you presumably started in the -- ?

Well, the next couple quarters we're estimating $10 million to $11 million a quarter, and it will start picking up in our next fiscal year. So probably by the end of our FY '09 we'll be at our run rate of 150 or -- yes, okay. After -- that's what I said. At the end of FY '09, we ought to be at a run rate of $150 million.

And the last one, you mentioned that your guidance does not assume any more share buyback, but in fact you did buy back shares. You've said that that's something that you do plan to do. How should we think about what it's going to actually be? Like if you do another acquisition you may not buy as much? But I mean, you've done it so consistently, I would have to assume you're going to continue to do it. Is that an unfair assumption?

I don't think we said we expect to continue, Cai. We meet every quarter, with -- well, amongst the management team and the Board and we look at the entire landscape, and make decisions then and carry those decisions going forward. And quite honestly, we have not developed our strategy for the rest of the year, as we have some meetings ahead. And -- .

Right. But I mean, if I just look at your cash flow was better than expected, and you've been buying at an average of 4 million to 5 million shares, every then, the fourth straight quarter in a row where you've bought at that pace. So I assume, unless you have more acquisitions, given you have more cash, but you know not unreasonable to think that you might actually buy it, something like that.

Well, it's not unreasonable. It also depends on stock price.

Got it. Got it. Okay. Thank you very much.

Greg Wowkun, Banc of America Securities.

Just in 1Q '08, you saw a spike in attrition rates in your commercial business that you partially service from India. How were your attrition rates inIndia in fiscal Q2, and how much success have you had in rehiring staff in that region?

We don't have the answer to that. It was higher. It's been normalized now. We're doing okay. But we did have a blip that our management jumped on, and that frankly, was part of the reason why we took such a significant write-down on our Scottish Power contract. Because we were going to transition quite a bit of work to India, and we didn't have enough workers. That has now been rectified.

As a follow-up, are there any plans to use these employees to do some back office work potentially for SAIC, and is that part of your plan to increase margins by 20 to 30 basis points annually?

We are seriously looking at that. In fact, we're doing some of our support work in India today. It's not tremendously significant, but we are leveraging that capability to some extent. But it is not the key component to our 20 to 30 basis point margin improvement program. You could say it's part of our overall initiative to improve profits where we're looking at a number of places, but it's not assumed as a key component in that specific goal.

Great. Thank you.

Julie Santoriello, Morgan Stanley.

A follow-up question on the supplemental, and the issues around that budget approval process and what is in your guidance. I understand the importance of timing and something being signed in October. What about just the importance of the dollars that actually are signed? I don't know how the debate might unfold. But is it possible that there is a smaller amount of dollars over a smaller amount of time that could be either positive or negative for you?

Yes.

Is there a range you could give us or in terms of -- anything that's been stated publicly that we can look toward?

I really couldn't, Julie. But again, remember, for us in the supplemental, the funding of the war, while the big primes it's about recapitalization and the like, and MRAPS, for us it's down range, intelligence, perhaps a little bit more of our security products in theater. So it's not a huge number for us. But one that we still count on. I'm sorry, I can't give you any more color than that.

Okay. And just from a big picture standpoint, lots going on in the political environment and lots of talk about strategy ahead of the presidential elections. If we do see a troop pullout sometime next year, how do you see that impacting SAIC? Are there positives in terms of more funds being unlocked to go to IT initiatives? Or are there negatives in terms of certain programs perhaps getting cancelled or -- ?

You probably won't believe this, but it's probably the opposite. I worry most if more troops pull out, there may be more contractors required in theater to do some of the intel work. So I don't see it as a big, big impact on our Company.

Okay, thank you.

(OPERATOR INSTRUCTIONS) James Friedman, Susquehanna.

I just had one question with regard to VACIS or cargo inspection. Could you give us some estimate of what that may constitute now in terms of a percentage of revenue? Is it basis points? Is it hundreds of basis points? Because I was kind of surprised that although it's an exciting initiative, it could have such a significant impact on the gross margins, Mark, as you had described.

Revenue-wise, it represents hundreds of millions of dollars of our top line. But it is a highly profitable part of our business. I'm not going to tell you the details. But it does have an impact on the rest of the business that's running at 8% to 12%. So when we have a lot of sales in that area, we do get a nice pop in our margins.

Operator, do we have another question?

We have no further questions in the queue.

Okay. I appreciate you all taking the time to join the call. Before signing off, I did want to mention, Ken did allude to it, that we are hosting our first institutional investor conference, coming up at our McLean facility this October 8th and 9th. Space is limited for this event, but we do still have a few slots available. If you are interested in attending, please shoot me an e-mail at Stuart.Davis@SAIC.com. And I want to, again, thank you all for participating for today's call.

This concludes today's presentation. You may disconnect at this time.