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Executives

Lawrence Delaney, Jr. - Investor Relations Counsel

Philip O. Nolan - Chairman of the Board, President, Chief Executive Officer

Brian J. Clark - Chief Financial Officer, Corporate Treasurer

Analysts

William R. Loomis - Stifel, Nicolaus & Co.

Edward S. Caso - Wachovia Securities

Tim Quillin - Stephens, Inc.

Brian Gesuale - Raymond James & Associates

Cai von Rumohr – Cowen and Company

Michael Lewis – BB&T Capital Markets

Stefan Mykytiuk – Pike Place Capital

Brian Kinstlinger – Sidoti & Company

[Brian Kowalchek – Pantera Capital Management]

Erik R. Olbeter – Pacific Crest Securities

Tim Quillin - Stephens, Inc.

Stanley, Inc. (SXE) F2Q09 Earnings Call October 30, 2008 5:00 PM ET

Operator

Welcome to the second quarter fiscal year 2009 Stanley, Inc. earnings conference call. My name is Jerri and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of today’s 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 conference, Mr. Larry Delaney, Investor Relations Counsel.

Lawrence Delaney, Jr.

Thanks for joining us for Stanley’s fiscal second quarter 2009 conference call. Here today are Stanley’s Chairman, President and CEO Phil Nolan and Executive Vice President and Chief Financial Officer Brian Clark. Phil will begin with an overview of the company’s second quarter operating results. Brian will then go through the financial results and issue guidance for Stanley’s fiscal third quarter 2009 and update full year fiscal 2009 guidance. We’ll then take your questions.

Before we get started I’d like to remind our listeners that our comments today will contain forward-looking statements and information based on management’s current expectations. Such forward-looking statements are subject to certain risks, uncertainties and assumptions. Information about risks that could affect the company’s financial results is available in the Risk Factors section of Stanley’s Form 10K for the fiscal year ended March 31, 2008 and the other reports the company files with the SEC.

In addition, today’s cal will include discussions of certain non-GAAP financial measures including EBITDA and organic revenue growth. Tables reconciling our non-GAAP financial measures are available in our earnings press release available under the Investor Relations section of the company’s website at www.stanleyassociates.com.

With that I’ll turn the call over to Phil Nolan.

Philip O. Nolan

I’d like to thank all of you for joining us this evening. Stanley posted another quarter of strong revenue growth and even greater margin improvement. Second quarter fiscal 2009 revenue came in at $190 [inaudible] guidance we issued on our last earnings call. Net income for the quarter was $8.7 million versus $6.3 million a year ago which equals diluted earnings per share of $0.37 up from $0.27 for Q2 of last year. Q2 EPS exceeded the high end of our guidance by $0.04.

Bookings for the second quarter were $213.1 million equating to a Q2 book-to-bill of 1.1 to 1 which was a bit higher than we told you to expect. We can also report that the third quarter has started out strong with over $250 million in bookings thus far. We are awaiting customer approval to make public announcements on a number of these awards so I won’t be able to discuss any specifics with you, but we are pleased to have that kind of momentum at the beginning of the quarter.

Our contract backlog at September 26 was approximately $2.1 billion up 4% sequentially over Q1 and more than 53% year-over-year. Our qualified pipeline currently exceeds $4.1 billion following a very successful period of new business awards for Stanley. As of today we have nearly $290 million in proposals submitted and we expect to submit another 19 proposals of $190 million or more in the next six to nine months.

It has been just over 100 days since we announced the closing of our acquisition of Oberon Associates. I can report t hat the integration process is proceeding at pace and that we expect them to be essentially fully integrated by the end of our fiscal year. We’ve been pleased with the contribution this acquisition has made to our overall performance thus far and have already made good progress in recognizing business development synergies from the combined companies.

During the quarter we announced the award of a $45 million systems integrator task order under our previously announced INSCOM Futures ID/IQ contract. Under this task order we will assist the INSCOM Futures Directorate in managing and coordinating a cohesive effort to focus technology development and insertion into the INSCOM mission. This is truly mission critical work and we’re proud to count it as a growing business area.

We also saw additional plus ups to this vehicle as well as strong intelligence operations and training activity at Fort Huachuca during the last quarter. We have talked frequently in the past about our passport services, USCIS and army equipment RESET as important growth drivers so I’d like to update you on each of these individually.

As we projected last quarter passport services revenues were down both sequentially and year-over-year. In Q2 we worked closely with the state department to put additional infrastructure in place to handle the projected increase in passport demand that we believe will come with the June 2009 land and sea provisions of the Western Hemisphere travel initiative.

The department state is in the process of opening a larger national passport center in Portsmouth, New Hampshire and building another passport adjudication facility that will join our recently opened book and production facility in Tucson, Arizona. Also, the department has announced plans to add additional gateway agencies which are essentially storefront facilities designed to service walk-in traffic.

These enhancements coupled with increased Stanley hiring will help meet the growth in passport demand we expect to see after the beginning of the year.

Moving on to USCIS. In Q2 we completed negotiations and signed a collective bargaining agreement with the union in Southern California. We consider the CBA to be a favorable resolution to the workforce issues in Laguna Niguel for all the parties involved and have formally notified our government customer. We expect that the labor rate schedule in the CBA will replace the wage determinations in our initial contract.

Lastly, our army equipment RESET work showed solid growth both sequentially and year-over-year. We continue to see ramp up in the work coming out of the field logistics readiness centers or FLRCs in Kentucky as well as in other regional hubs where we support the army’s equipment RESET mission. We continue to target a large number of RESET related opportunities. In the next 12 months we expect to submit a number of proposals on these efforts.

A few of these bids are in a related area, army retrograde. As background, retrograde is the process of moving equipment and material from a deployed theater to a RESET program or to another theater of operations as a force multiplier to replenish degraded unit stocks or to preposition for future contingencies. The army material command, a long-time Stanley customer, is the army’s executive agent for retrograde. We view both RESET and retrograde as promising growth drivers for Stanley going forward.

As you are aware, we have been back and forth on our projections of RESET RFP and award gates as they continue to move to the right. But an important takeaway here is that based on our current growth trajectory and new contract awards, we are confident in our FY09 projections without any RESET awards. New RESET work awarded to us before the end of this fiscal year would represent upside to our current guidance.

Next I’d like to take a step back to discuss two broader initiatives underway at Stanley.

First, we are keenly focused on taking market share as a means of meeting our growth objectives and we are continuing to target procurements where we see incumbent vulnerabilities. In fact of the $213.1 million of new work we booked in Q2 and the $200 million+ we booked thus far in Q3, approximately half of that has come by taking work from incumbents. We believe this will continue to be an important avenue for our growth going forward.

Second, we are adding more business development resources to further execute on our growing pipeline. Our pipeline is already well stocked with promising RESET opportunities and other numerous prospects in existing accounts. With Stanley’s considerable growth we have additional resources to reinvest in our business and with the integration of Oberon additional capabilities we can market. We see near-term opportunities in the intelligence and cyber security arenas and we fully expect to capitalize on Stanley’s growing capabilities in these areas. We also expect to turn our sites toward expanding the civilian side of our business.

Finally before I turn the call over to Brian, I’d like to share a few thoughts on some of the macro issues affecting our space. I’m not in a position to predict which party will control Congress or the White House nor will I project what that party might do at the contracting level once in power. The truth is nobody knows.

But what we do know is that the bulk of what Stanley does as a company, our key growth drivers, are in truly mission essential areas vital to the business of government. If you take passport services, immigration, RESET, intelligence operations, biometrics, cyber security, C4ISR, these are all areas that will grow or require modernization and sustainment regardless of which party holds power. These business areas coupled with the demographic demands for increased outsourcing within the federal IT workforce make Stanley particularly well positioned to benefit as the next administration unfolds.

With that I’ll turn the call over to Brian to walk you through the numbers.

Brian J. Clark

I’m pleased to report that Stanley posted outstanding financial results for our fiscal second quarter ended September 26, 2008. Revenues exceeded street consensus and near the high end of the guidance we issued last quarter while EPS exceeded both consensus and the high end of the guidance by $0.04. Additionally, our cash performance yielded record cash flows from operations and resulted in free cash flow conversion of 2.7 times net income for the quarter.

Second quarter revenue was $191.1 million up 27% from $150.2 million in the second quarter of fiscal 2008. Revenue growth for the second quarter, 17% of which was organic, came from expanded support to the Department of Homeland Security and continued to ramp up an expansion supporting the US Army’s global equipment RESET mission as well as from the acquisition of Oberon Associates.

For the September quarter DOD contracts made up 71% of total revenue while federal civilian contracts comprised 29%. The DOD share increased by 3% year-over-year and 8% sequentially. As we projected last quarter the sequential increase was largely the result of revenues coming from our acquisition of Oberon.

Contracts in which Stanley acted as the prime contractor accounted for approximately 68% of revenue for the quarter down from 78% last quarter primarily as a result of the addition of Oberon’s largely subcontracted work. We expect that Oberon’s recent prime contract wins coupled with Stanley’s continued organic growth will migrate Stanley towards a larger share of prime contract work in the coming quarters.

Our passport services contract accounted for 11% of total revenue in the second quarter of fiscal 2009 down from 16% last quarter due to lower processing volumes as expected, growth in other areas of the business and the acquisition of Oberon. As Phil mentioned, we expect passport services revenues will be at reduced levels in Q3 before picking up again in the fourth quarter as the next phase of the Western Hemisphere travel initiative comes into play.

Revenues earned under task orders on our corporate production contract aggregated to 10% of total revenue in the quarter and were driven primarily by integration and installation of C4ISR systems for the United States Navy and Marine Corp.

EBITDA for the second quarter of fiscal 2009 was $18.9 million up 42% from $13.4 million for the second quarter of last year. EBITDA margin was 9.9% for Q2 reflecting 100 basis points of margin improvement or over 8.9% from the second quarter of last year and up 50 basis points sequentially from 9.4% last quarter. EBITDA margin improved year-over-year due primarily to a greater proportion of more profitable time and materials contracts as opposed to cost plus fee contracts and the contribution coming from Oberon.

These gains were offset partially by additional FAS 123 our stock compensation expense related to equity grants made in the first quarter of fiscal 2009 and Oberon having a higher G&A as a percentage of revenues.

We continued to see a significant shift in contract mix during Q2. In the September quarter time and materials contracts accounted for 55% of revenues up from 47% in Q1 and up from 35% last year. Cost plus fee contracts accounted for 30% of revenues in Q2 down from 33% in Q1 and down from 49% last year. Fixed price contracts were 15% of revenues in the quarter down 5% sequentially and essentially unchanged year-over-year. We expect this mix to trend more towards T&M and fixed price contracts over the next few quarters based on expected growth in existing programs as well as the relative mix in our pipeline of new opportunities.

GAAP operating income was $16.3 million up 41% from $11.6 million in the same quarter of last fiscal year. Operating margin was 8.6% versus 7.7% in the second quarter of fiscal 2008. The increases in operating income and margin resulted primarily from the factors improving EBITDA I just discussed offset slightly by depreciation and amortization representing a higher percentage of revenues as the amortization of purchased intangibles related to Oberon come into play.

Net interest expense for the second quarter was $1.8 million versus $1.1 million for the second quarter of last year. The increase in net interest expenses year-over-year was the result of higher average outstanding borrowings on our amended senior credit facility after the Oberon acquisition offset slightly by an overall lower weighted average borrowing rate.

Net income for the quarter increased 38% to $8.7 million from $6.3 million a year ago. The increase in net income year-over-year is attributable to the factors affecting operating income offset by higher year-over-year interest expense as well as a slightly higher effective income tax rate.

Diluted earnings per share was $0.37 in the second quarter of fiscal 2009 compared with $0.27 in the year ago quarter exceeding the high end of our guidance by $0.04.

Day sales outstanding or DSO was 80 days for this quarter down from 83 days last quarter. The decrease in DSOs was attributable to higher cash collections during the quarter and the favorable timing of receipts from a key customer with a new payment processing system offset by higher average receivable balances during the quarter. We continue to expect DSO to fluctuate throughout the year and ultimately settle into the high 70s.

Cash flow from operations for the first six months of fiscal 2009 was $33.2 million. Cash generated by operations resulted primarily from increased net income and receivables collections in the second quarter. Operating cash flow came in at approximately 2 times net income for the first six months of fiscal 2009.

Cap ex for the six months was $5.1 million resulting in free cash flow of $28.2 million or 1.7 times net income. As a reminder, cap ex for the first six months of fiscal 2009 was higher than normal principally due to the build-outs of two new facilities in the first quarter needed to support expanding operations. We expect the cap ex will be approximately 1% of revenues for full fiscal 2009.

As previously announced in July, we exercised and closed on an additional $69 million of available credit through a partial exercise of the accordion feature associated with our senior revolving credit facility. This additional availability was used in part to fund the acquisition of Oberon and to provide additional funding for future working capital and other needs. Strong free cash flow enabled us to reduce debt on Stanley’s revolver to its current balance of just over $152 million and report cash on hand of $13.5 million.

Due to the significant increase in LIBOR rates caused by the recent turmoil in the credit markets, in mid-October we converted our LIBOR based borrowing on our revolver to base rate borrowing to take advantage of lower rates. Under our credit facility we have the option of borrowing at the LIBOR rate plus the applicable margin, currently 1.375%, or at the prime rate plus the applicable margin, currently 0.375%.

The LIBOR rate is set at the beginning of each month while the base rate adjusts whenever there’s a change in the prime rate. The 50 basis point drop in the prime rate in October prompted us to change to the base rate option for the month of October. As our leverage has continued to decrease, the applicable margins for LIBOR and base rate borrowings will drop to 1.25% and 0.25% respectively starting in November. Due to the recent drop in LIBOR rates over the past two weeks, for the month of November we have elected to convert back to LIBOR based borrowings and will continue to evaluate on a monthly basis going forward.

Finally, to date we have hedged approximately $18 million of our term loan indebtedness to fixed rate debt during interest of 5.28%.

Now moving on to guidance. For the third quarter of fiscal 2009 we expect revenues to be in the range of $195 million to $202 million and diluted earnings per share of $0.35 to $0.37 on a weighted average diluted share count of 23.8 million to 23.9 million shares. For the full fiscal 2009 year we now expect revenues to be in the range of $765 million to $780 million raising the midpoint of top line guidance from $767.5 million to $772.5 million. We now expect diluted earnings per share of $1.44 to $1.48 which moves the midpoint up $0.12 from $1.34 to $1.46 on a weighted average diluted share count of 23.8 million to 23.9 million shares.

At the new midpoint of our annual guidance we have approximately 98% of our forecasted revenues coming from existing contract backlog, 1% coming from recompete contracts and 1% from identified new business opportunities. As Phil noted, any revenues derived from army equipment RESET awards for the remainder of fiscal 2009 would be additive to our current revenue projections.

On last quarter’s call we said we expected EBITDA margins to show 40 to 50 basis points of improvement for full fiscal 2009 and we guided to an improvement of 20 to 30 basis points in operating margins. We now expect to yield EBITDA margin improvement of 50 to 60 basis points and operating margin improvement of 30 to 40 basis points for full fiscal 2009 over fiscal 2008. The difference in basis point growth between EBITDA margins and operating margins is due to the amortization of purchased intangibles related to the acquisition of Oberon.

The primary reason for the year-over-year margin improvement will be as a result of a higher mix coming from more profitable T&M and fixed price contracts and the continued realization of efficiencies in our general and administrative infrastructure.

Finally based on equity grants of stock options and restricted stock in the first two quarters of fiscal 2009 as well as the two prior fiscal years, we have included approximately $1.7 million in the third quarter and approximately $6.3 million for the full fiscal year for FAS 123R equity based expenses. Included in earnings per share for the third quarter and full fiscal 2009 are FAS 123R expenses of $0.04 and $0.16 respectively. Earnings guidance for fiscal 2009 also includes the impact of the amortization of purchased intangibles of approximately $5.6 million related to Oberon and our acquisitions completed in prior years.

With that I’ll turn the call back over to Phil.

Philip O. Nolan

Before we open up for Q&A, let me just say that we’re really excited about the margin and earnings improvement that we’re adding to Stanley’s organic revenue growth story in fiscal 2009. We’ve been telling you since our IPO that we thought achieving 10% in EBITDA margin was achievable in the three to five year timeframe. That we’re on track to possibly reach that particular goal early says a lot about the culture here at Stanley and the great execution of our team.

That’s all we’ve got for you here tonight but we’d be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from William R. Loomis - Stifel, Nicolaus & Co..

William R. Loomis - Stifel, Nicolaus & Co.

Looking at the margins, clearly they’re better than expected. You mentioned Oberon adding to margins even with the intangible amortization and also a shift to T&M. Is Oberon the shift to T&M or are there other programs that are also shifting in that direction?

Brian J. Clark

It’s both. As you know substantially all of Oberon’s work is T&M so that was a big part of the needle movement that happened in the quarter but also remember we’ve got the passport services contract, our largest contract converted from cost plus to T&M. That was actually our biggest mover year-over-year. And then we’ve just got a general shift in some of our other work and new contract awards are coming out that way. Those are going to be your two biggest pieces; passport and Oberon.

William E. Loomis

What was the revenue for Oberon in the current quarter?

Brian J. Clark

A little bit better than what we got it to before. We said about 22 to 23 and it came in just a little bit above that.

William E. Loomis

Are you giving the breakout for the USCIS and the passport? You already gave core production at 10% but can you give the breakout for the other two?

Brian J. Clark

Yes. Passport was 11% for the quarter and CIS we don’t break that out. That’s less than 10%.

Operator

Our next question comes from Edward S. Caso - Wachovia Securities.

Edward S. Caso - Wachovia Securities

You went really fast on the margin improvement. Was that operating margin improvement is now expected to do what?

Brian J. Clark

30 to 40 basis points over where we came in last year.

Edward S. Caso - Wachovia Securities

And that’s basically all better than expected shift in the mix or is there any different view on the amortization or the interest expense?

Brian J. Clark

It’s both. Interest expense obviously doesn’t come into play here but in terms of EBITDA a lot of it’s coming from the shift in contract mix and just better performance coming off of contracts overall as well as continuing to get better realization of efficiencies out of our G&A structure. On the operating margin side, the lift there is a result of that but also as I talked about last quarter I had put out some guidance or at least what we initially estimated in terms of what the amortization of intangibles was going to be for Oberon. Since that time we completed our independent valuation purchase study and those valuations came in a little bit lower so the amortization is less than we had anticipated originally.

Edward S. Caso - Wachovia Securities

The tax rate, do we run it out at 40.2% at this point?

Brian J. Clark

Yes. That’s what you should use for the remainder of the year. We may have some true ups in Q3. As I think you know and most companies in the third quarter when you file final tax returns you usually have some true ups. If you look back at our third quarters over time you see some variation there. But that’s what you should use for modeling purposes for now.

Edward S. Caso - Wachovia Securities

Implied organic growth rate both in the next two quarters and for the full fiscal year?

Brian J. Clark

For the next quarter it’s 35% overall and about 20% organic. Then for the full year we’re looking at about 28% overall and 18% of that organic and that’s using the midpoint of the guidance ranges I’ve given.

Operator

Our next question comes from Tim Quillin - Stephens, Inc..

Tim Quillin - Stephens, Inc.

I think your guidance had been $85 million in revenue from Oberon. Is that still accurate or are you expecting to be above that plan?

Brian J. Clark

That’s still what we expect.

Tim Quillin - Stephens, Inc.

Should we think about going up to the $30 million range with the full quarter of revenue in 3Q versus the $24 million that you did in Q2?

Brian J. Clark

That’s right.

Tim Quillin - Stephens, Inc.

That accounts for a lot of the quarter-to-quarter growth that you’re assuming, I guess you already alluded to this that 98% of your forecast is in backlog so it seems like a very conservative number. But is there any reason to think that anything else would be down? Will passport be even lower than it was in 2Q?

Brian J. Clark

We think it’s going to be probably at or maybe slightly below for the third quarter before it picks up again in the fourth quarter.

Tim Quillin - Stephens, Inc.

In terms of the margins, I think also if you plug in the same EBITDA margin that you had in 2Q for the next couple quarters, you end up I think with a little better margin improvement than 50 to 60 basis points, maybe more like 70 basis points. Do you expect margins to be a little bit lower for the remaining two quarters?

Brian J. Clark

They could be. I think we’ve got to factor in some of the newer contract wins we had. I think one of the ones you’re aware of that we’ve announced is the INSCOM Futures work. That’s a cost plus fee vehicle so we’re going to add them. I’m just giving you that as an example. It’s not going to move the whole needle but obviously margins will be lower than what Oberon has generated in the past and what they’ve generated this past quarter for us. We have some things like that that’ll bring it down a little bit. This quarter came in as you know a little bit better than we had expected so I think if we see more room down the road, we’ll pick it up. But that’s where we feel we’ll come in for the year right now.

Tim Quillin - Stephens, Inc.

I think you said $5.6 million in intangibles amortization. Is that just Oberon or is that all intangibles amortization?

Brian J. Clark

That’s all intangibles amortization.

Tim Quillin - Stephens, Inc.

What is depreciation?

Brian J. Clark

For what period?

Tim Quillin - Stephens, Inc.

I presume the $5.6 million is for the year for fiscal ’09. Is that right?

Brian J. Clark

Yes. $5.6 million is for the full fiscal year and that is just amortization of purchased intangibles related to both Oberon and prior acquisitions. If you included I’ll call it normal depreciation, just normal fixed asset leasehold depreciation, that’s about $4.2 million for the year.

Tim Quillin - Stephens, Inc.

So total depreciation and amortization of about $10 million.

Brian J. Clark

That’s correct.

Tim Quillin - Stephens, Inc.

In interest expense, it’s just a complicated world right now but that was a complicated explanation of the interest rates that you’re paying. Can you help us forecast what that means in terms of interest expense?

Brian J. Clark

Sure. What I was alluding to is we want to lock in on LIBOR based borrowing for the month of November using today’s drop in the LIBOR rates. So we’ll be at 2.85% one month LIBOR plus the spread which will be 1.25% on top of that. You’ll have an incremental rate of 4.10% for the month of November.

Tim Quillin - Stephens, Inc.

Is there different pieces at different rates? You mentioned a different interest rate I think on a separate line?

Brian J. Clark

What I was mentioning is that on our term loans we’ve got half of that hedged and the term loan sits just above $36 million. That’s why I said approximately $18 million of that is hedged and that’s at a fixed rate of 5.28%.

Tim Quillin - Stephens, Inc.

Do you have a status update on the PEO [Stry Acida] recompete?

Brian J. Clark

Before we move on to that, I want to hopefully help eliminate any confusion. One of the things as you know with the credit facility you’ve got prepaid bank fees and things like that that get amortized into interest expense. So for the benefit of everybody on the call here, let me just help everyone out by providing what we’re estimating for the interest expense for the quarter. I’d tell you between $2.4 million and $2.5 million is what you should expect to see in interest expense for the quarter all-in. That would include the actual rates that we pay plus amortization of bank fees and those other noncash items that get amortized interest expense over time.

Philip O. Nolan

To answer your [PEO Stry] question, that proposal has been submitted. We expect that there’s probably a fair amount of competition on that and we don’t really expect to hear anything until after the first of the year.

Operator

Our next question comes from Brian Gesuale - Raymond James & Associates.

Brian Gesuale - Raymond James & Associates

Phil, given the strong set of bookings as well as the strong revenue growth, it seemed like one piece of the puzzle that was still a little bit slow was some of the RESET work. Despite the strength you’ve had, are we starting to see some of these bids outstanding really hit some of that RESET work and are we going to see that logjam start to flow through here through the end of the year and early next year?

Philip O. Nolan

We sure hope so. The RESET stuff has been a little bit of a frustration just in terms of seeing that work come out. As you well know this is ongoing work so there’s obviously already contracts and task orders in place on this and most of these things are recompetes so they’re able to keep them going by extending them and trying to increase the ceiling on them a little bit. But there’s still a logjam down there in that contracting shop. I haven’t been very good in predicting what’s going to happen on that so I think I should probably stop trying. But we know there’s a bunch of them stacked up and we’re really hoping that after the first of the year we’re going to see that flowing pretty good.

Lawrence Delaney, Jr.

Operator we’ll take the next question please.

Philip O. Nolan

Cai you were up next, are you on the call?

Cai von Rumohr – Cowen and Company

Could you tell us what your funded backlog was at the end of the quarter and how much the Oberon total backlog was at the end of the quarter?

Brian J. Clark

The funded backlog was $355 million. I don’t know that we have Oberon’s broken out. I’d tell you probably about $130 million, $140 million.

Cai von Rumohr – Cowen and Company

So really if we back out Oberon your backlog was flat to down? That’s the way it looks. It’s okay, I mean you basically have a good enough backlog. Now, if we kind of look at what you’ve announced, you announced this $45 million from INSCOM, you announced this $30 million at Fort Huachuca, I guess SAIC announced $37 million for the bat and you get about a quarter of that so it looks like you’ve gotten $84 million of bookings on Oberon, is that in line with your expectations or is that disappointing?

Philip O. Nolan

No, I’d say that was pretty much in line with what we expected. I’d say it’s not disappointing I’d say it was pretty good.

Cai von Rumohr – Cowen and Company

Did you expect it actually to be that good? That looks pretty good just as an outsider. Was that in line with expectations or maybe a little better?

Philip O. Nolan

I’d say we were pleasantly surprised.

Cai von Rumohr – Cowen and Company

I mean given you beat within the quarter in terms of where Oberon’s volume was and you’ve got this pretty substantial bookings so far is there a reasonable chance that we might have upside to the $85 million number they’ve got?

Philip O. Nolan

We still think the $85 is pretty solid guy. Some of the stuff in terms of coming in here and saying that we’re pleasantly surprised in the quarter was a little bit more related to timing than actually thinking they got stuff that we weren’t expecting them to get.

Cai von Rumohr – Cowen and Company

You had mentioned kind of the INSCOM work is going to be a little bit lower margin. Because they’re margin is already a fair amount above yours is the INSCOM business kind of in line with your margin or are they likely as this business builds to see a fairly significant down tick in their profitability?

Brian J. Clark

Well to the extent it continues to – you know the task orders are cost plus or are going to be some sort of cost award then you would expect they’d be a little bit lower than what they’ve been doing and what we’ve been doing as a company overall. But, we think we’ve got that fairly well factored in right now.

Cai von Rumohr – Cowen and Company

Sometimes these things go pretty quickly but what is your qualify pipeline at this point? What are your bids outstanding going in to the next quarter, going in to the current quarter? And, it sounds like with a $250 you’ve gotten so far you’ve been doing very well. Is that just timing or were you winning more things than you expected to win? A couple of question there.

Philip O. Nolan

Well, we expect to win a lot Cai. So I guess I could just say it’s a good start to the quarter. We have some things that are happening a little bit quicker. As we sit right now the qualified pipeline sits at $4.1 billion, that’s a little bit up over the last time we did so that means a little bit better pipeline even though we’ve taken some things out of action with getting the rewards and where we sit right now I think I said in the prepared remarks we said roughly $300 million, maybe a little bit less than $300 million in proposals that are currently submitted that we’re waiting to hear on.

Cai von Rumohr – Cowen and Company

Is that after the $250 you won or going in to the quarter?

Philip O. Nolan

No, that’s after.

Cai von Rumohr – Cowen and Company

That’s after, so it was really $550 plus going in to the quarter?

Philip O. Nolan

Yes, that’s right.

Cai von Rumohr – Cowen and Company

Just if you could comment on [inaudible] how many folks have you hired excluding Oberon in the quarter? And, kind of what you’re seeing is it easier or more difficult to hire, just what that looks like?

Philip O. Nolan

I’d say we haven’t seen a whole lot of difference Cai. Our voluntary attrition has stayed pretty steady. I think we told you 14% over the last several quarters and we’re still hanging right in there. If you look at net hires, roughly 227 over the quarter so a good number.

Operator

Your next question comes from Michael Lewis – BB&T Capital Markets.

Michael Lewis – BB&T Capital Markets

Phil, I was wondering if I could follow up on Cai’s question about the bats program that was awarded SAI last week. Did I hear him correctly that you’ll be getting about a quarter of that contract?

Philip O. Nolan

That’s what Cai says.

Michael Lewis – BB&T Capital Markets

Okay, what about you?

Philip O. Nolan

Yes, that’s probably a pretty good number.

Michael Lewis – BB&T Capital Markets

Then, not to beat a dead horse on RESET and I understand it’s been difficult at the contracting office but the last time we kind of talked about this I think you said you had about half a dozen RESET related opportunities kind of in the bid pipeline, has that number increased? And if so, how many do you currently have out there right now?

Philip O. Nolan

No, that’s about right there. I think we said on the call we’ve got about $100 million plus bids that we’re looking at in kind of the nine month time frame. I’d tell you roughly that roughly a third of those are what I’d attribute to RESETs so that number is pretty cognoscente. Right now I think I expect that will go up but those are the ones that are in the time frame that we’re looking at in that six to nine months.

Michael Lewis – BB&T Capital Markets

Phil, are all the RESET opportunities north of $100 million each?

Philip O. Nolan

No. Those are just the number that we have that are over $100 million. We have a number of them, probably just as many of them that are under $100 million, kind of in the $50 million to $60 million range.

Michael Lewis – BB&T Capital Markets

Then just a final question for Brian, free cash flow has been quite strong. Are you anticipating that you’ll be able to have a free cash flow yield of one times net income by the end of this year Brian?

Brian J. Clark

I think for the full year it will probably be for now I’d tell you to use probably about 90% of that.

Michael Lewis – BB&T Capital Markets

Would you anticipate about the same level next year as well? Do you have any idea on a range?

Brian J. Clark

I think I’d probably stick it somewhere .7, .8 times net income similar to what we had started out this year with.

Operator

Our next question comes from the line of Stefan Mykytiuk – Pike Place Capital.

Stefan Mykytiuk – Pike Place Capital

It wasn’t one of my questions but I want to make sure I understand your last answer Brian. You’re saying free cash flow will only be 90% of net income for this year?

Brian J. Clark

Yes.

Stefan Mykytiuk – Pike Place Capital

The gross margin, I know you were talking a lot about EBTIDA margins and EBIT margins, the gross margin increase on a sequential basis, I’m assuming that’s bringing in Oberon and the contract mix?

Brian J. Clark

That’s correct.

Stefan Mykytiuk – Pike Place Capital

Then in terms of the passport, the ramp that you expect coming in January, does the economy have any sort of impact on that in terms of people planning vacations and stuff? Or, because this is kind of the land piece you think this is more just people who are crossing the border on a more regular basis for work or other stuff?

Philip O. Nolan

We thought about that, I guess if it was the year deadline we’d be a little bit more concerned about it. We think as we look at the land requirement that’s much more commerce related than it is people going on vacation related. We talked about that with the State Department, they kind of feel the same way, that’s why they’re planning for this ramp up.

Stefan Mykytiuk – Pike Place Capital

Phil, I always ask this question, I think we heard yesterday from a couple of your competitors that the private market multiples are still quite high and seemingly more out of whack with what’s going on in the public markets. Is that your view?

Philip O. Nolan

At this point in time that’s probably true but I would not be surprised to see them come down a bit. Also, from the standpoint that I think a lot of us are going to be looking at those [inaudible] and looking at the financial markets and what we can borrow at and saying that we’re not going to go as high on some of these things with the rates where they are right now. But, at this point of time, yes that’s still a little bit out of whack in terms of the valuations.

Operator

Your next question comes from the line of Brian Kinstlinger – Sidoti & Company.

Brian Kinstlinger – Sidoti & Company

I was curious is there a difference in the economics between you guys processing a passport versus a card because they cost different and maybe the consumer will look in this kind of economy to go the cheaper route and I’m just curious how that, if at all, would affect profitability?

Philip O. Nolan

I wouldn’t go think that profitability is going to be impacted by that Brian. I mean, there is a little bit of difference in terms of the processing but most of the steps that we have to go through to do a card and a passport are the same right down to the final step which is actually the printing of the book or the card. So, the cards can be done a little bit more in a batch than the passports can but we don’t really expect much of an impact on that and really what we’ve seen so far we haven’t seen much of a difference in passport volume as opposed to card volume.

Brian Kinstlinger – Sidoti & Company

When does the New Hampshire office, I think you mentioned that you’re building out. When did that open, did you say?

Philip O. Nolan

It’s hasn’t opened yet. That’s in process right now. That should be, I would imagine, in the next few months that will be opened. There’s already a national passport center in Portsmouth New Hampshire and what they’re doing is moving to a new location where they can expand their footprint.

Brian Kinstlinger – Sidoti & Company

Is there enough capacity at that point to handle it or does the government have to order more printers? I remember a long time ago they were slow to order printers so where does that stand to meet the demand?

Philip O. Nolan

I think from a capacity standpoint and the number of shifts that we can work that we’re pretty well positioned to handle a pretty good surge. I can’t say it’s a limitless surge but I think capacity in terms of facilities and printers and people, we’re in good shape on that. We expect to have to ramp up and staff, that’s what’s left to be done when we see the demand coming.

Brian Kinstlinger – Sidoti & Company

The last question I had, are there any army RESET proposals that were outstanding at the end of the quarter that you’ve already submitted a proposal in the third quarter here?

Philip O. Nolan

No.

Operator

Your next question comes from the line of [Brian Kowalchek – Pantera Capital Management].

[Brian Kowalchek – Pantera Capital Management]

Just one quick one, I realize you hadn’t submitted any proposals yet on the RESET side, is it realistic to expect some awards this fiscal year or is that a next fiscal year event?

Philip O. Nolan

Well, if [inaudible] gets broken and they come out these are fairly quick reaction types of proposals under the first contract so we can come out and literally have on the order of two weeks to respond and they can come back with a reward within two weeks also. So, it’s a pretty quick turn when it actually starts happening. So yes, it’s reasonable to expect that there could be something by the end of the year. But, as we said in our remarks we’re not planning on it at this point.

[Brian Kowalchek – Pantera Capital Management]

The turnaround time in terms of the proposal submission and award is rapid however, is there a lead time or build up in terms of when you potentially begin to recognize revenue? Is there a long cycle and ramp up or if you were so fortunate to actually get an award this year would you be able to recognize any revenue under that this year?

Philip O. Nolan

Yes, if you were able to get that, and our year still has five months to go, we could get some revenue on that, you could see some ramp on that and you’ve got to look at these things – I mean we kind of look at it being from anywhere from three to six months to being steady state but you start recognizing revenue on it almost immediately. It’s just a question of how much revenue you recognize.

Operator

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

Erik R. Olbeter – Pacific Crest Securities

Very quickly you mentioned Phil that you were actually going to increase some of the bidding proposal machine at the firm. Can you tell us what you’re really planning to do and maybe how should we think about that in terms of SG&A?

Philip O. Nolan

Well, from an SG&A standpoint I don’t really think – you know as the company is growing here I don’t think you’re going to see that much of an impact on that. When we talk about that we’re talking about people who work in our business development account management process so we’ve got more people to help work the pipeline for us.

Erik R. Olbeter – Pacific Crest Securities

So as a percentage of revenue you just sort of see it as staying flat? Is that kind of how we should think about it, just taking it from other task and putting it here or just as sort of as the firm grows just putting in people?

Philip O. Nolan

Yes.

Operator

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

Cai von Rumohr – Cowen and Company

Just two follow ons, could you kind of clarify the quarterly pattern of passport? It looks like it was $28 million in the first quarter, now it’s like $22 million, it’s going to be down in December and then it spikes up in the fourth quarter so you get to a little over $100 or you’re up some for the year? Is that the way it works? And, why do we have this kind of exaggerated decline now and then huge spike in the fourth quarter? It was much more even last year.

Philip O. Nolan

Yes it was. If you look at last year that was really working through the tremendous backlog that was built up with the air requirement coming in so that kept everybody employed in a pretty steady volume of work coming in there. That’s dropped off now and we just haven’t seen the volume. In the past, many years ago we use to see just kind of seasonal fluctuation but it’s been a while. I don’t know that I would attribute it to anything in particular right now. We just know that it’s a little bit down coming in to it. It’s still quite a bit higher than the steady state numbers we were seeing before the air border crossing requirement went in to effect.

Cai von Rumohr – Cowen and Company

But, do you still expect it to be – I mean, you did about $99 million last year, we’re going to be slightly over $100, is that a realistic guess for this year?

Philip O. Nolan

I think overall for the year it’s probably going to be fairly flat year-over-year.

Cai von Rumohr – Cowen and Company

Then no one asked about the corporate production contract. Last year that thing just bounced around like a rubber ball every quarter so is that relatively level? $18 million a quarter, is that holding fairly steady or what’s happening there?

Philip O. Nolan

Yes. It’s holding fairly steady. We are seeing some good growth in that but it’s been a little bit more predictable for us. Like you said it bounced around for us last year and as soon as I tell you it’s steady and predictable over the last couple quarter something will fall on our head here and change that. So far it’s been behaving.

Cal von Rumohr - Cowen & Co.

Is it relatively stable or is it growing?

Philip O. Nolan

It’s growing a little bit.

Operator

Our next question comes from Tim Quillin - Stephens, Inc.

Tim Quillin - Stephens, Inc.

I just wanted to extend a little further on the passport business. Presumably we’re going to get a spike up in your March quarter and probably continued spike or surge in the June quarter. Should we be thinking about a drop off back to more sustainable levels after that? Is that something you’re factoring in as kind of sequential decline, something we should think about in your fiscal 10?

Philip O. Nolan

I don’t think you’ll see a decline in fiscal 10. I expect if it happens I think it would be a fairly steady climb in fiscal 10 because really if things happen the way we think they would happen we’d be preparing after the first of the year for this to come on so that means we’d start the staffing exercise and we’d really end up with most of the work after the deadline approaches. I think for FY10 it’s going to stay at elevated levels if it performs the way we think it’s going to. If it’s going to start coming back at all based on our previous experience that would be probably midway through 11.

Tim Quillin - Stephens, Inc.

That’s way too far down the road.

Operator

This concludes the question and answer portion of your conference. Now we will turn the call over to Mr. Nolan for closing remarks.

Philip O. Nolan

Thanks everybody for joining us tonight. If you have any questions that didn’t get answered, we’d be happy to follow up with you. Please go through Larry Delaney, our Investor Relations Counsel, and one of us will be happy to get back to you. Thanks again. Goodnight everyone.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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Source: Stanley, Inc. F2Q09 (Qtr End 9/26/08) Earnings Call Transcript
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