Leidos Holdings Inc (LDOS) 2011 Q2 法說會逐字稿

Good average.

My name is Alicia and I'll be your conference facilitator today.

Welcome to SAIC's second-quarter fiscal year 2011 earnings conference call.

At this time, all participants are in listen-only mode.

We will be conducting a question-and-answer session towards the end of the conference.

(Operator Instructions).

As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Paul Levi, Senior Vice President of Investor Relations.

Please proceed, sir.

Thank you, Alicia, and welcome, everyone.

Here on today's call are Walt Havenstein, our CEO, Mark Sopp, our CFO, and other members of our leadership team.

During this 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, these statements 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.

With that, I will turn the call over to Walt.

Thank you, Paul, and good afternoon, everyone.

During our second quarter, we continued to make sound progress in implementing our strategy by focusing on higher growth areas, in C4ISR, Cyber Security and logistics readiness and sustainment within the national security arena and help in energy markets.

As a result, we are expanding the volume of submitted proposals and increasing wins at double-digit growth rates compared with our performance a year ago.

For the call today, I'll briefly cover the market conditions and outlook and provide highlights of recent business activity.

Then Mark will provide a recap of our overall financial performance for the second quarter and outlook for the rest of the year.

I'll begin with our government solutions and services market update.

Despite flattening growth in the government solutions and services market, it is a very large market, and there remains several large and growing areas of opportunities for SAIC.

Much attention has lately been given to the implications of Secretary Gates' recent announcement that he intends to reform DOD spending practices in order to cut overhead costs and reinvest the savings in operations and modernization.

Let me make two points about the Secretary's announcement.

First, I'd like to say that we applaud and fully support his initiative.

We agree Pentagon dollars need to be more focused on acquiring affordable and rapidly deployable solutions which introduce more capable national security technologies, or modernizing existing platforms, which the country cannot afford to replace.

Second, allow me to also emphasize that Secretary Gates' efforts are indicative of the defense market environment that SAIC envisioned many months ago and with that foresight we set our strategy to emphasize solutions and services in a few large enduring markets that we believe will fare better than the broader government market itself.

To briefly reiterate our strategy, we are investing in and focusing on a select few higher growth areas within our core markets, where the Company can apply its distinctive competitive discriminators.

These higher growth areas are C4ISR, Cyber Security, and logistics readiness and sustainment within the national security arena, and the health and energy markets.

We remain bullish that growth in these areas will take place, despite overall reductions in contractor spending elsewhere.

SAIC can capture substantial new business in those areas, because we offer significant thought leadership, domain expertise and leading edge technologies, along with the ability to deliver large scale integrated solutions that include physical infrastructure.

Our performance will also benefit from our deep and wide-reaching customer affinity, combined with the agility of our entrepreneurial culture and organization.

These traits position us to take market share and achieve higher growth rates than would be possible in our core markets alone.

SAIC recently reorganized some operations to better execute our strategy.

We rationalized our operational structure to drive efficiency and generate resources for investment in the high growth areas we've identified.

Among these changes, we moved from four operating groups to three, and reoriented the Company's Cyber Security business to give it an enterprise-wide focus by making it report directly to me.

We also made strategy-based changes to our corporate leadership structure and personnel.

This reorganization is one step along our journey that in the future may include further changes to our organization to address strategic objectives or market requirements.

During our last earnings call, I shared a few examples of our noteworthy success and executing the strategy of our Cyber Security business area.

Customer restrictions prohibit us from sharing specifics with you, but I can say unequivocally that this strategy is hitting pay dirt.

So far this year we have won nearly $1 billion in contract awards and including ceiling on IDIQ contract awards with over $650 million in year-to-date bookings.

And the nature of these wins are centered in the most advanced technical areas within the intelligence community.

Our CloudShield capability continues to enable us to penetrate more deeply into a greater number of important DOD, commercial, intelligence community, and Department of Homeland Security Cyber Security programs.

Today, I'm happy to report that we are actively engaged in dozens of CloudShield related projects and pursuits across the Company.

These include new business pursuits in the Department of Defense, FAA, Patent and Trademark office, NASA, and health and international markets.

I'd next like to spend a few minutes addressing several of our accomplishments in delivering innovative solutions to our customers in several more of our chosen high growth areas.

I'll begin with C4ISR.

As I mentioned earlier, one of SAIC's strategic discriminators is our ability to merge leading edge technologies into integrated solutions for our customers.

Last month, SAIC completed the development, environmental testing, calibration and delivery of a commercially hosted infrared payload known as CHIRP, wide field of view sensor.

This sensor is to be installed on a SES World Skies communications satellite currently in production.

This commercial satellite with this sensor on-board is scheduled to be launched next year.

The sensor assembly features a telescope that can view a quarter of the Earth from geosynchronous orbit.

This Pace-qualified payload was developed and built by SAIC with technology that enables our Air Force customer to field the required capability in a rapid response fashion, and with lower risk.

All told, the sensor was developed in less than two years and exceeds the capability of similar sensors by a wide margin.

It will be used to test the potential for using staring infrared sensors for a range of overhead persistent infrared missions.

Additionally, the ongoing success of this program is proof of concept that a variety of operational military missions can be served by special purpose payloads hosted on commercial spacecraft.

Also within C4ISR and contributing to our improved business development results in Q2 has been an uptick in our wins in our intelligence business.

This includes an award of a four year task order from a government agency that has a potential value of $429 million if all options are exercised.

We also won two large multiple IDIQ contracts, one from the Defense Intelligence Agency to provide IT services to support combatant commanders and service intelligence agencies and the other from the National Geospatial Intelligence Agency to provide research and innovative system solutions for emerging critical geospatial intelligence requirements.

Another growth area I'd like to highlight is logistics readiness and sustainment.

SAIC has numerous logistics capabilities and a distinguished record of supporting our customers in this area.

We expect significant growth in this area as a budget-constrained defense department chooses to repair and modernize rather than replace its large inventory of now war-weary equipment.

SAIC recently won a key defense logistic agency contract for two new customers, the Aniston and Red River Army depots, by displacing a larger long-term incumbent.

Our Company will provide supply chain management of industrial hardware and parts required for the repair of military vehicles for the Army, Navy, Air Force and Marine Corps.

Our role will run the gamut from collaborative demand forecasting to parts acquisition, storage, delivery and inventory management, to quality assurance, data management, field based customer support and order processing and fulfillment, all using SAIC's proprietary integrated logistics tool set.

We take great pride in this opportunity, because logistics is at the heart of the support for the war fighter and frankly, we're very good at it.

Another higher growth area is energy.

A recent example of our success in this area is our win in the second quarter of a contract to support the Smart Grid initiative undertaken by the City of Lakeland, Florida.

SAIC is helping Lakeland to install infrastructure that will create an enhanced power grid with higher reliability and more dependable energy delivery capabilities, improved operational efficiency, minimize energy prices and give consumers more control over their energy bills.

The enhanced system will operate through 124,000 residential electric meters and 5,000 home area network devices.

The build-out of Smart Grid systems throughout the country represents a large and growing market for SAIC, and one we are well positioned to support with our expertise in energy management, transmission and distribution engineering, command and control network systems, cyber security solutions and relationships with large energy and utility customers.

Within the last week we also secured a new contract in the renewable energy market.

Under this agreement with US Geothermal, Inc., a leading renewable energy company, SAIC will provide design and build service for a geothermal plant in northwest Nevada.

Regarding our overall business developed results, bookings totaled $2.7 billion in the second quarter, with a book-to-bill of 1.0.

On a year-to-date basis, bookings are up 21% over the first half of last fiscal year, and the book-to-bill is 1.1.

We ended Q2 with $16 billion in total backlog, funded backlog increased by $200 million to $5.8 billion during the quarter.

Our year-to-date total dollar win rate on definitive delivery contracts, is running at a healthy pace of 65%.

Year-to-date submittals for definitive delivery contracts are up $3.3 billion or 32%, compared with the same period a year ago, reflecting our more aggressive business development objectives.

We began the second quarter with $17.3 billion in outstanding submittals for defined delivery and IDIQ contracts combined.

During the second quarter, we added $10.4 billion in new submittals and received decisions on $8.9 billion, leaving us with $18.8 billion in submitted proposals awaiting decision at the end of the quarter.

Up $1.5 billion from last quarter, and up 45% compared with a year ago.

Over 50% of the $8.8 billion is for non-IDIQ opportunities.

This level of proposals awaiting decision exceeds the comparable amount at Q2 in last year by nearly $6 billion which we believe provides SAIC with substantial opportunities for additional bookings during the remainder of fiscal year 2011.

Our focus on winning larger opportunities continues to yield good results.

As of the end of the quarter, we had won 12 opportunities that valued at more than $100 million, and had over 200, $100 million plus opportunities in our pipeline.

In summary, our business development performance for the first half of fiscal year 2011 was significantly improved over the first half of fiscal year 2010.

This performance reflects our efforts to capitalize on the many outstanding, competitive discriminators we possess at SAIC.

With regard to acquisitions, SAIC did not close on any new deals during the second quarter.

However, in August, just at the beginning of our third quarter, SAIC announced and closed the acquisition of Reveal Imaging Technologies, Incorporated, a leading threat detection products and services company, headquartered in Bedford, Massachusetts.

Reveal Imaging enables SAIC to support the efforts of the Transportation Security Administration, and other customers in the airport and transportation safety industries, as a supplier of explosive detection systems and automated threat detection technologies that assist in inspecting checked baggage for explosives.

Reveal Imaging's innovative explosion detection and baggage scanning systems offer customers sophisticated computed tomography imaging technology.

The acquisition provides our Company with an opportunity to apply our domain expertise in signal processing and operations and maintenance support to Reveal's worldwide clientele.

Reveal Imaging's bagging scanning system enhance SAIC's Homeland Security solution portfolio, adding to our existing capabilities which include a successful [backus] passenger and cargo inspection systems.

This enhanced offering will enable SAIC to better serve customers including Customs agencies, the military and other security organizations.

With that, I'd like to thank you for joining us today, and I will now turn the call over to Mark Sopp.

Great.

Thank you, Walt.

There were a number of dynamics in our financial results for the second quarter, including favorable resolutions on an intellectual property matter and a litigation matter, which improved our overall results.

Revenues fell a little short of our expectations in the quarter but as Walt just mentioned, bookings continue to be good which lays the foundation for improved revenue growth during the second half of the year and beyond.

Our Q2 operating margins and earnings per share from continuing operations rose significantly.

A large portion of which was due to the receipt of royalty income from our previously announced intellectual property agreement with VirnetX.

Earnings per share also benefited from additional share repurchases made in the second quarter.

We also received a large favorable settlement in our former subsidiary's case against Telkom South Africa, which generated a large cash gain in Discontinued Operations during Q2.

Working capital metrics were good with operating and free cash flow running over $100 million as expected.

That's a quick snapshot.

Now I'll cover the major areas in greater detail.

Total revenue growth in Q2 was up 2% with internal revenues contracting about 1%.

We had growth in a number of areas, most significantly in ground vehicle systems integration and logistics support, systems engineering solutions for the Navy, intelligence, surveillance and reconnaissance system solutions for a variety of national security customers, and Cyber Security programs.

However, as expected, these growth areas were offset by programs that contracted year-over-year.

The most significant reductions were in materials requested under a supply chain prime vendor contract, the descoping of the Brigade Combat Team modernization program, formerly FCS, a reduction in revenues from our NASA Unites program, which was restructured last year, and the expiration of the Scottish Power IT contract.

As anticipated, revenue growth from new contract starts continues to lag behind what we have seen recently, in our view attributable to the ongoing delays in procurement decisions across the intelligence and defense sectors.

As Walt mentioned, bookings were $2.7 billion for the quarter, and are $5.9 billion year-to-date, up 21% over the same period last year.

Our year-to-date book-to-bill of 1.1 is generally on track with where we want it to be to achieve this year's growth expectation.

The continued growth in submitted proposals awaiting decision, now well above $18 billion, reflects our ongoing investment to improve our long-term revenue growth prospects in our large addressable market, coupled with the slower pace of procurement decisions we continue to see.

For profitability, we reported an operating margin of 9.8% for the quarter, bolstered by the royalty receipt, which was virtually all profit.

Excluding this item, operating margin was 7.9% for the quarter, right on track with our expectations.

Program performance was strong throughout, with good award fee scores and profit rates on fixed price contracts.

We also incurred about $3 million in severance costs this quarter, related to additional down-sizing in our commercial IT business, and the ongoing streamlining of various G&A functions across the Company.

Taxes and nonoperating items in continuing operations were noneventful.

We continued to deploy excess cash towards share repurchases in the second quarter, buying back about $150 million in stock, representing about 9 million shares.

Earnings per share from continuing operations rose 35%, driven by the growth in net income, coupled with the reduced share count from repurchases.

Operating cash flow was about $110 million.

Receivables management was good with days sales outstanding, DSO, running at 65 days at the quarter end, compared to 64 days in Q2 of last year.

The strong results in cash earnings indeed bolstered by the royalty income was more than offset by payments of income taxes and interest which were particularly concentrated in the quarter.

Cash flows from operating and Discontinued Operations exceeded capital expenditures and the $150 million of cash repurchases made, driving our ending cash balance up about $40 million over Q1, to over $600 million.

Maybe now I will share a little more color on the royalty payment we received and also on the Telkom South Africa settlement.

We are of course pleased that these matters yielded substantial cash receipts for the Company in the quarter.

The nature of both of these items have been discussed and disclosed in previous public settings, including our public filings.

First, we received a $56 million royalty payment in conjunction with the royalty rights we obtained when we transferred patents that we developed in previous years to VirnetiX.

VirnetiX subsequently settled litigation against Microsoft regarding these patents and paid SAIC the royalties due us from the settlement proceeds.

The royalty payment received was appropriately recorded in revenues and continuing operations.

There was about $2.5 million in costs of revenues to meet obligations to the original customer for whom we developed some of the patents.

Other potential infringement cases involving these patents are being pursued by VirnetX, from which we are entitled to receive additional royalties, if successful.

The Telkom South Africa settlement related to a long-standing litigation matter between Telkom and our former Telcordia subsidiary.

We recorded a net gain of about $30 million in discontinued operations in Q2, reflecting an $80 million settlement payment made to us, less the obligations we expect to have to pay related to this transaction, primarily being taxes.

That covers Q2 results.

Now let me move on to forward expectations.

Back in March when we updated fiscal 2011 guidance, we advised that revenue growth in the first half of fiscal 2011 would be flat and that bookings coming in during Q1 and Q2 would need to drive growth in the back half of the year to hit our guided internal revenue growth range of 3% to 6%.

While our internal revenue growth performance has been slightly below flat we have produced a healthy level of bookings through the first half to fuel stronger growth in the two quarters to come.

With the year-to-date book-to-bill of 1.1, substantially improved contract capacity under IDIQ contracts, and continued growth in outstanding contract submittals, now at $18.8 billion as we mentioned a few times, we do have the necessary elements to produce strong second half internal growth and achieve our 3% to 6% internal growth expectation for the year.

While that is our expectation, the market conditions we face, particularly on the government side, have introduced more risk in predicting short-term outcomes.

These risks include ongoing delays in the adjudication of outstanding bids, slow starts on new contracts including funding delays, contract ceiling limitations, and also program terminations or reductions, all of which have contributed to offsetting growth in recent quarters.

We previously guided operating margin improvement of 10 to 20 basis points, and earnings per share from Continuing Operations growth of 8% to 14% for the year.

This guidance has consistently excluded and still excludes the impact of special charges related to the termination of the Scottish Power contract.

Those charges have been delayed due to transition issues with the new contractor, but we do still expect them to be $20 million to $30 million pretax, and are now expected to be concentrated in the second half of this fiscal year.

Excluding the impact of Scottish Power special charges, fiscal 2011 operating margins are expected to improve 20 to 40 basis points over last year.

For earnings per share from continuing operations, our revenue growth, our operating margin outlook, and shares repurchased to date are expected to drive EPS growth of 14% to 18% over the last fiscal year.

Operating cash flows are tracking consistent with our model of projected income plus depreciation and amortization and plus or minus any special items.

We expect days working capital to be consistent with last year, which implies and assumes days sales outstanding metrics of about 70 days.

Capital expenditures are expected to track less than 1% of total revenues, consistent with prior years.

Taking this into account, free cash flow is expected to again well outpace net income.

In summary, we remain focused on delivering growth in earnings and free cash flow per share by executing the strategy that Walt has articulated.

This strategy involves positioning ourselves for long-term revenue and profitability growth through investments in market discriminators and select acquisitions which can be leveraged across our strong market entry points.

When we have built excess cash positions, we have consistently returned cash to shareholders in the form of share repurchases.

With this, our outlook for this fiscal year contemplates we'll again deliver year-over-year EPS growth in the mid-teens range, with free cash flow per share continuing to outpace earnings per share.

Before I turn it back to Walt, we have announced dates for our annual institutional investor and analyst conference which will be held at our McLean, Virginia headquarters on October 12 and 13.

We certainly encourage institutional investors and analysts to reach out to our Investor Relations office, now headed by Paul Levi, if you have an interest in attending, which we certainly hope you do.

With that, I'll turn it back over to Walt.

Thanks, Mark.

Before we turn to your questions, I have only a few points I want to reemphasize.

I'm encouraged by our program performance, i.e., delivering on our commitments to our customers, our new business results and of course as always, our free cash flow and earnings per share growth.

We remain watchful of the changing government contract environment, to include the budgets.

I remain enthusiastic about our Company and I'm fully confident in our ability to succeed in this challenging environment.

Thank you.

Alicia, we are now ready to take questions.

(Operator Instructions).

Your first question comes from the line of Tim Quillin from Stephens.

Please proceed.

Good afternoon.

In terms of the royalty impact, am I doing the math right, in coming up with about a $0.09 impact and I guess the follow-on to that would be it looks like if I do the math on your EPS growth guidance that you're raising EPS guidance by something more like $0.05 to $0.07 versus $0.09.

Maybe if you could talk about that a little bit.

Thanks.

Okay.

Hi, Tim.

It's Mark.

First, the royalty impact was indeed $0.09 for the quarter, so you were right on that measure.

With respect to the full year, it really isn't quite that precise.

We received the royalty amount back in early July and in conjunction with that we have re-evaluated and made changes to our spending profile across the business for the rest of the year, in light of receiving the royalty, which certainly was a nice boost to have.

So with that, we factored that into the full year guidance.

Clearly, the full year amount benefits substantially from the royalty amount, but it's not appropriate to necessarily reduce the entire royalty amount from your calculations to derive a result without it, because we did modify our plans as I described, to take benefit of that in some cases, accelerating some investments that we had planned in the out-years to this year, to try to accelerate the growth coming from those investments.

You're talking about the investments specifically in that relationship with VirnetX?

No, I'm talking about investments in IR&D, in various overhead projects we have and in business development, primarily.

Okay.

And just one other question is how you're thinking about the start of the government fiscal year 2011 and the potential for CR and how that factors into guidance?

Thanks.

Yes, I think we -- I think it's generally recognized, that we'll be operating under a continuing resolution beginning in October.

Don't know whether it will be a short continuing resolution or a longer one.

I suspect some of that will depend upon the results in November.

And we're prepared to operate and our forecasts and guidance reflects that assumption.

Thank you.

Your next question comes from the line of Jason Kupferberg.

Please proceed.

Just wanted to delve a little bit on the last question around the margins for this year and the intersection of some of these different items.

I guess what you guys are basically saying is that yes, on an apples-to-apples basis, your margin and EPS growth guidance are coming down but they wouldn't have been coming down if you hadn't received this royalty payment, and therefore made some accelerated internal investment decisions.

Is that what you're saying?

Not precisely, Jason.

We, again, modified our investment spending in light of the royalty, which kind of changed the playing field for the year.

It's really pretty straightforward in that respect.

Okay.

I mean, I guess I'm just -- I just want to make sure I have the math right, that this was about 50 basis points of margin expansion for the year, the $56 million, net of a little bit of cost.

So if you guys had previously been talking about improving margins 10 to 20 bips and now you're talking about margins going up, what, 20 to 40, I think.

Yes.

You got 50 basis points of lift from the royalty, that's -- I guess that I'm -- I just want to make sure that the math is right there?

That's true, but we have modified our spending from what we were otherwise planning to -- which has impacted margins adversely but for good reasons, excluding the royalty piece.

But again, that was made with full knowledge of the benefit of the royalty and the type of results we wanted to produce for the year.

But at the same time, be able to invest more for the long haul.

We thought that was a good way to balance the benefit of the royalty amount to fuel our long-term growth.

Okay.

Okay.

So there's no other adverse developments in the business as far as pricing or anything else like that that's -- this is kind of voluntary margin compression if you will because you have the opportunity to make these investments?

That's generally correct.

Okay.

Would that then set us up theoretically for a really nice year-over-year margin increase in fiscal 2012 if you pulled some of those investments forward into fiscal 2011?

We'll see.

We haven't put together our plan for fiscal 2012 and so we'll evaluate the developments between now and December and we plan to discuss fiscal 2012 at that time.

Okay.

That's helpful.

And just the last one from me.

As we head into the last month of the government fiscal year here, what are you guys kind of expecting in terms of quote, unquote, budget flush, in terms of both funding activity and contract award decisions?

I mean, will there be less of a traditional flush this year just because of some of the macro challenges around procurement decision delays or will that traditional fiscal year end dynamic of that spending flurry that we typically see, do you expect that to prevail this year?

Jason, from what I am seeing, there is expected to be some year end flush but it remains that the decisions on specific tasks remain longer and more difficult and challenged and so for that reason, we would expect slightly less than what we've seen in historical years, because of really the length in procurement cycle applying to even a small short turnaround purchases.

Okay.

Understood.

Thanks very much for the color, guys.

Thank you.

Your next question comes from the line of Cai von Rumohr from Cowen and Company.

Yes, thank you very much.

So Mark, what percent of revenues were direct labor and in that calculation, if you could tell us where you're counting the royalties.

Are the royalties included in M&S?

When you see the filing, Cai, you'll see that 56% of the revenues in the quarter were from labor and 44, what we call materials and subcontractors.

And the 44 is historically high because, you're right, the royalty payment was recorded in this case as in the M&S category, so it spiked that number.

Outside of that, there were no major changes in the overall mix of our labor to M&S, in recent quarters.

That would look like your direct labor billings are down some $40 million, $45 million from the April quarter; is that correct?

Don't have that handy.

We'll work on that one, Cai.

If it's 56%, that's, it's like $15.65 versus $16.09.

It would -- I just want to understand, was there some other sequential slowing?

Because usually I guess you have one fewer day per quarter -- in the quarter so that's--?

One fewer day so that's pretty significant.

You're right, it is about $30 million to $40 million quarter to quarter sequential effect and you can rack that up as the one day difference, plus the specific contract reductions that I mentioned in my remarks such as DCTM, Day Combat Team Modernization and the others.

Got it.

And then of your outstanding bids, ATA refresh my memory, I guess I missed.

What is -- of that is non-IDIQ and how much of that are non-IDIQ bids awaiting decision in the next six months?

The non-IDIQ piece is roughly $10 billion of that, Cai, and roughly high $8 billion, $9 billion is the IDIQ piece.

And then what do you expect your tax rate to be for the year now and separately, how much did you pay, approximately, for Reveal?

The tax rate for the full year, Cai, is about 37.5%.

And the Reveal transaction was notionally $200 million.

And then so the tax rate, it looks like it goes up, what, close to 39% in the second half; is that correct?

We had some discrete favorable items in Q1 and Q2.

So you're seeing that balance out to a notional rate absent the discrete items of 38.5%.

But the discrete items brought it down and we are continuing to assume we will not see a benefit of the R&D tax credit this year.

Hopefully that will be something that develops later on in our favor.

But we did take that out of the equation for now.

But you took that out.

And how much would that be?

It's between a 0.5 point and 1 full point, so 70, 80 basis points.

Excellent.

Thank you very much.

Thank you.

Your next question comes from the line of Bill Loomis from Stifel Nicolaus.

Hi.

Thank you.

Just looking at the second half revenue, the third and fourth quarter revenues, so we're looking going from negative 1% internal growth to, by my calculations, upper high single digits.

I know Mark, you've talked about there's more uncertainty in projecting but obviously we're already into the third quarter here.

How confident are you that you can have such a quick turn in growth based on what you've won, and is that mostly based on what you've won as opposed to what you will win in September and October?

There's a few pieces.

First of all, as I think we've mentioned before, the comparables, i.e.

last year's second half is a much easier bogey to overcome than this year's first half.

So we actually get lift in the growth rate because the second half of last year was relatively weak to the first.

That's more of a mathematical effect.

We are indeed counting on some recent wins.

Walt mentioned several.

So there's a ramp-up activity from those that are of high confidence in terms of predictability.

We also have some specific material activity that we have good visibility on in terms of request and ship date.

So that's part of the equation.

And we have almost $19 billion of outstanding submittals and we are indeed counting on some of that to come through at historical win rates, if you will, and get started.

So those things give us confidence that we have the capacity to fuel the growth here in the second half.

But we, as I said, are dependent on an ongoing healthy funding environment which would be the case for continuing resolution and hopefully a strong adjudication of those outstanding awards.

And what's on -- for [Gates'] modernization, where does that stand right now in terms of what your expectations are in the guidance?

I understand those negotiations are continuing through the end.

That's right.

Those negotiations are continuing through the end of the year.

Maybe more appropriate is whether -- is the continuation of BCTM and its support by the Army.

If you look at the limited user tests that are under way, all right, based upon the demonstration test done over the last quarter, there's a much higher confidence that that's going to be successful and that will continue to advance BCTM.

Certainly, the Army is very bullish and I think even at this point OSD is very bullish and, frankly, we expect to start fielding first brigade set this year.

Okay.

And Mark, given some numbers on BCM in the past what are you thinking about now through fiscal 2011 for the year?

No change to that from any recent developments.

So back to earlier remarks, fiscal 2010 was notionally $350 million and this fiscal year is notionally $275 million, down about 20%.

Okay.

Thank you.

Thanks, Bill.

Your next question comes from the line of Joe Nadol from JPMorgan.

Please proceed.

Thanks.

Good afternoon.

Mark, I just wanted to dig back into the margins just to make sure I understand exactly what's going on.

So your guidance, ex the 50 bips from the royalty receipt, the guidance is down 30 to 40 basis points from last quarter.

Is all of that due to higher investment spending in B&T and IR&D or is there anything else in there?

Joe, that math is not correct.

Okay.

If hypothetically you took out the royalty amount, then your margin impact year-over-year would be roughly flat from last year.

All other things being equal.

And part of that is due to the fact that we have accelerated some investments in light of receiving the royalty.

So having not received a royalty payment, we might have modified that investment outlook and cranked out a better result.

But -- so we don't look at it that way.

We look at it as during the year good things happen, bad things happen, and we do our best to achieve investments made for the long term, coupled with the financial commitments that we make to ourselves, the Board, and our shareholders.

So I think deriving a 30 to 40 reduction is not correct.

30 to 40 reduction from your prior guidance.

So you were 8.0 last year.

You've said up 10 to 20 last quarter.

Now you're saying up 20 to 40, but you got a 50 basis point benefit.

So my down 30 to 40 is not relative -- is not relative to last year, it was relative to your prior guidance from three months ago.

I understand.

We were indeed 10 to 20.

I'll check.

I'm not sure we got a straight 50 from the VirnetX on a full year basis.

Well, I mean, it's 56 divided by $11 billion, so that's -- I'm not trying to split hairs here.

I'm just trying to understand.

Because 30 to 40 basis points is my math, I think it's accurate, that's a pretty big change.

Is there any color you can give on where you're investing?

Is it more B&P, is it more IR&D?

Is this something that's going to run off?

Does this change your two to three year margin profile, in that it's kind of a one-timer and goes away?

Or is this that the Company is going to be spending more money?

Any more color you can give.

The margin impact is about 46, 47 basis points, to be precise.

As I said, we're investing in areas that I mentioned.

The cost to do business these days has risen in the business development area, in light of our view of the need to expand our pipeline, which we think will pay dividends.

Nothing further to add.

Okay.

Maybe we can follow up at the investor conference on that one because, I mean, that would be nice to get more color.

You bet.

Thanks.

You bet.

Your next question comes from the line of Mike Lewis from BB&T Capital Markets.

Good afternoon, Walt.

Good afternoon, Mark.

It's actually Mike Smith in for Mike Lewis.

A quick question regarding a recent commentary by Gates.

Just curious as to SAIC's exposure to JFCom, BTA, the J6, and what impact the directives could have potentially on SAI's business.

Well, if you look broadly at his comments, they're going to have not just impacts on those activities, but if you look explicitly at those, we do about $50 million a year with those explicit organizations.

We believe -- first of all, let me just say, we're kind of in round one or the first inning of a nine-inning game.

All right?

There are things that Secretary Gates wants to do.

There are things that Congress says are good, some things, they say they don't agree with.

We have to see how that all plays out.

But if you looked at those items you just mentioned, Mike, there's about $50 million a year that we do in revenue with those particular agencies.

We believe that some of that work will in fact, if Secretary Gates' intent holds, will go away.

We think some of that work will shift to other commands and other agencies, because some of that work has to continue to get done regardless.

And so our estimate, around that -- those specifics, is about $20 million potential impact to SAIC.

Okay.

And just kind of another one, just more qualitative than that, I guess, but with the recent Intel acquisition of McAfee and SAI being a systems integrator I'd like to get maybe your thoughts on what you think about hardware providers potentially embedding defensive IA software.

Is that a long-term issue for you or your IA or cyber business or anything like that?

That's a good question.

And the acquisition of McAfee was very, very interesting to us for a variety of reasons.

I think it frankly represents from my perspective opportunity and it's consistent with our belief that what you just described is going to happen, and that one of the partners that they'll be looking to, to bridge between the dot-IC, dot-mil, dot-gov to the dot-com world is SAIC.

Okay.

Great.

Thanks a lot, guys.

Your next question comes from the line of Erik Olbeter from Pacific Crest.

Please proceed.

Yes, hi, guys, and thanks for all of the color.

Just one quick question, share buyback, Mark, how much more do you have left in the tank for this year?

What has the Board approved?

Precisely, it's not very much, but when we meet each quarter we look at what's left in the $40 million authorization and if required, we will replenish it, which is done as necessary.

So precisely, I think we have $7 million left of the $40 million but that can easily be replenished if the Board so chooses in our quarterly meetings.

Okay.

Great.

Thanks.

All my other questions are answered.

Your next question comes from the line of James Friedman from Susquehanna Financial Group.

Hi.

Thanks for taking my question.

One that I don't think has been asked yet, you did reference it briefly in the prepared comments, but was otherwise a strong quarter.

I just wanted to ask about the commercial segment, where the revenue declined by our calculation by 22%.

I was just wondering, is there potentially a reclassification in there or is there something else that's driving the market?

Is SAI maybe focusing more on the government segment?

If you could share some color on the commercial segment, that would be helpful.

Sure.

First of all, there were no reclassifications but the greatest impact was the loss of the Scottish Power contract, which had a revenue run rate of $40 million to $50 million, and that left the revenue base in the early part of the year, so you're seeing the full year impact of that plus an overall soft commercial market which has affected new wins there pretty significantly.

Okay.

And is there any stability contemplated in your forward guidance?

It seems like there would be.

Well, we certainly have a pretty predictable business there, notwithstanding Scottish Power coming out.

We are predicting a continued soft market in that area.

We've taken cost out to be more predictable on the profitability side.

Okay.

Thanks, Mark.

Your next question comes from the line of Ed Caso from Wells Fargo.

Please proceed.

Great.

Thanks.

Walt, can you update us on the latest goings on with organizational conflicts of interest, inherently governmental and in-sourcing, and what's your latest understanding of the drafts and where the various agencies are headed?

Yes, I think a little more clarity has occurred since we last spoke.

I told you last spring, my estimate would be that from the time the guidance actually came out last spring, it would be 18 to 24 months before that fully settled down and that's still where it is.

Now, there are certain agencies that have kind of declared explicitly or at least implied it in their behavior, and we're reacting to that.

Right now from an overall practical point of view, even though things are starting to get a little more clear, it probably doesn't change our strategic thoughts today.

Mark, was there any expense at all from Scottish Power in the quarter?

Ed, there was not.

And just really to be clear on the tax rate, what rate should we assume in F Q3 and F Q4?

Got 38.5% for the second half, each quarter, Ed, which again is consistent with our notional tax rate I said earlier, absent discrete items.

And finally, just some math on Reveal.

Sort of revenue run rate and how much would show up this year.

$25 million to $50 million for half of the year.

Thank you.

Your next question comes from the line of Tim McHugh from William Blair.

Please proceed.

Most of my questions have been answered.

The one last financial one I would ask, is the repurchases, any color on when during the quarter those were done or ending kind of share count so we can get a sense for the second half of the year.

Generally speaking, they were made in the earlier parts of the quarter.

You'll see that when we file the Q, lay it out by month.

Okay.

Thanks.

You're welcome.

Ladies and gentlemen, this concludes the question and answer portion of the call.

I will now turn the call back over to Paul Levi for closing remarks.

Thank you, Alicia.

On behalf of the SAIC team, we want to thank everybody on the call today for their participation and interest in the Company.

That concludes our call.

Ladies and gentlemen, this concludes the presentation.

Thank you for your participation in today's conference.

You may now disconnect.

Have a great day.