SAIC, Inc. F2Q10 (Qtr End 07/31/09) Earnings Call Transcript

Sep. 2.09 | About: Leidos Holdings, (LDOS)

SAIC, Inc. (SAI) F2Q10 Earnings Call September 2, 2009 5:00 PM ET

Executives

Stuart Davis - Senior Vice President for Investor Relations

Kenneth C. Dahlberg - Chairman of the Board, Chief Executive Officer

Mark W. Sopp - Chief Financial Officer, Executive Vice President

Analysts

William R. Loomis - Stifel, Nicolaus & Company

Jason A. Kupferberg - UBS

Laura J. Lederman - William Blair

Joseph B. Nadol III - JPMorgan

Cai von Rumohr - Cowen and Company

Tim Quillin – Stephens Inc.

Operator

Welcome to the second quarter fiscal year 2010 earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Stuart Davis, Senior Vice President for Investor Relations. Please proceed.

Stuart Davis

Thank you, Operator, and welcome everyone. Here on today’s call are Ken Dahlberg, our Chairman and CEO and Mark Sopp, our CFO. 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, the statements made 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 Ken.

Kenneth Dahlberg

Thanks, Stuart and good afternoon, everyone. As you can see from our press release for our second quarter it marked another quarter of steady, solid execution that I firmly believe has become our hallmark. We are navigating well in a relatively tough environment based on our good positioning and aggressive posture in the market. Mark will provide color on the financial details in a few minutes after I describe the market dynamics and our key business drivers.

We are reasonably optimistic about the prospects for passage of the government’s FY10 budget with only minimal periods of a continuing resolution. With other pressing topics such as the healthcare debate there is a lot on the Congress’ agendas when they return next week but the appropriations process seems to be on track and the mark ups are generally consistent with the President’s submission earlier this year.

Earlier this summer Congress passed the FY09 supplemental. Although the bill was somewhat delayed which pushed back some awards the funds are now flowing. That supplement supports our critical work in MRAP as well as intelligence, surveillance and reconnaissance.

Besides the overall level of spending, the two biggest potential market drivers are the evolving trends on organizational conflict of interest (OCI) and government in-sourcing. On the OCI matter, the DOD should issue guidance in response to the Weapons Systems Acquisition Reform Act shortly. Some customer organizations such as the National Reconnaissance Office are moving out aggressively to define their own OCI guidelines. We expect this will leave some companies who have significant businesses with these customers to divest work that creates conflicts with their strategic direction.

Most of our customers and competitors are taking a wait-and-see approach until the final DOD guidance is published. So it is still too early to tell the ultimate impact for the OCI issue. For the areas in doubt, we as a company are setting our businesses and preparing our approach. Depending on how the guidance is written there could be a substantial reshaping of the competitive landscape as most large contractors have a mix of development and advisory work with the intended firewalls and OCI mitigation plans.

In this case, we would expect to both acquire and divest businesses and participate on both the development and advisory side depending on the customer. The road ahead could be bumpy but ultimately we expect clearer OCI language to be a net positive for our company since we are platform independent, services and solution providers.

On the topic of in-sourcing, at the end of July Office of Management and Budget Director Orszag directed agencies to cut their contract spending by some 7% over the next two years. In a series of three memos, OMD directed agencies to accelerate in-sourcing of inherently governmental work to restore a proper balance between federal and contractor employees on government programs that rely heavily on contractors and to share contractor performance reviews with other agencies. Although the in-sourcing trend provides headwinds to the entire contractor base we believe there are some positives in the approach being articulated.

First, OMD is appropriately focused on the front end of the procurement process. Second, OMD calls on agencies to cut spending on cost based contracts by 10% in 2010. Transitioning cost reimbursement contracts to fixed price contracts once the needs and costs become clear should provide the right incentives for both government and contractors and could lead to better profitability if we can manage work efficiently. Third, the insistence on agency properly reporting and checking contractor past performance should reward contracts who perform best. Later this month OMD will issue further guidelines that define what is inherently governmental work, when it is appropriate to outsource work and when it is appropriate to use different kinds of contracts.

We see some evidence of in-sourcing pressures across our federal government business base but there are certainly no clear trends as yet either by customer or by type of work. We will continue to monitor this trend and expect that the September memo may provide some urgency. To date in-sourcing is relatively minor to our overall picture. In fact our voluntary attrition rate is a scant 9.3%. We have lost about 200 people to the government, a few more than in the second quarter of last year, compared to about 1,700 new hires in the quarter.

Now let me move onto the business development. Bookings in the second quarter were $2.3 billion for a book to bill ratio of 0.8 which is lower than both our first quarter this year and our second quarter last year. We ended the quarter with $16.3 billion in total backlog and $5.6 billion in funded backlog.

Compared to the end of the second quarter fiscal year 2009 our total backlog actually increased 2%. Our current book to bill ratio and backlog growth numbers reflect the impact of what I believe are three main factors; The booking pause that is the normal part of the start of a new administration; a lengthening of the federal procurement decision cycle due to all the added scrutiny on potential contractor conflicts of interest and as importantly more reviews to protect against protest; finally, a reluctance among our commercial clients to commit to new design build contracts.

I think the most significant of these factors is award delays arising from the start of the new administration. To date the administration as filled less than half of the senior policy making jobs requiring Senate confirmation. So many of these key posts remain vacant or are occupied by temporary stand ins who often have limited power over the direction of pending procurement activities. We do expect though as the administration gets more of its key people in place the current bookings pause will moderate leading to an upturn in our bookings and backlog.

At the same time, the backlog of pending federal contract decisions is building and substantial federal monies must either be spent or forfeited. The obligation of the federal stimulus funds must also be accelerated very soon in order to achieve their intended purpose. For all these reasons we believe our bookings and backlog will improve in Q3 and Q4 and expect to meet a book to bill target of nominally 1.1 to 1.2 for the year.

We have reasons to be optimistic about Q3 and Q4. We are achieving noteworthy win rates on both re-competes and new business and we have a mountain of submitted proposals awaiting decision. We have won all of our $50 million plus re-compete opportunities so far this year and have achieved a stellar 96% total dollar win rate on all re-compete business. We have also won about a 60% total dollar win rate in all new business we sought to capture.

As of early August our submitted but undecided proposals for standard contract and task order bookings totaled a whopping $8.5 billion compared with $5.1 billion at the end of the first quarter. By the way this excludes bid outstanding on IDIQ contracts where the trend is very similar. We believe we should have some near-term bookings with the second extension of our NASA UnitEs contracts and the communication engineering effort for the MRAP all-terrain vehicles for SPAWAR.

We continue to see benefit from our one SAIC approach to winning larger opportunities. We won six opportunities valued at more than $100 million each in the second quarter. We now have a robust 166 $100 million plus opportunities in our pipeline compared to 137 a year ago. Moreover, 70 of those 166 large opportunities have an expected award date within the next two quarters.

While Q3 is still young we have already scored wins on five $100 million plus opportunities along with ten more wins valued at $50 million plus. The stimulus package continues to present large opportunities for our company. Despite getting off to a slow start, stimulus related opportunities are finally beginning to move through the federal acquisition cycle. We expect to win $100 million in stimulus awards by the end of this fiscal year with the potential for far more next year. The key areas of opportunity for our company includes smart grid, energy efficiency, infrastructure, homeland security, health and environmental.

We are also expanding our opportunity pipeline and capture opportunities in several market areas that have especially promising growth potential. You have heard me talk about them before; energy, cyber and health. We have established strategic campaigns around these areas and are investing heavily in them. Combined, we have built an opportunity pipeline in this high growth market that exceeds $11 billion.

Since our last call the Acquisition Decision Memorandum on Future Combat Systems came out and it was essentially in line with our views expressed on the last call but we took a hard look at FCS as part of review of backlog which drives our bookings. Because we have conservatively hedged the forward outlook for some time now the FCS backlog remained unchanged at about $1 billion. Essentially the portion of the lost man ground vehicle component that was not hedged was offset by growth in the programs that our customers already approved. Again, we still believe it is likely we will participate in at least first spin outs of new capability packages in the Brigade Combat teams which would be a future contract award for us.

Now transitioning from internal growth drivers to our acquisitions I am pleased we were able to close two deals since the last call in areas that we see as very attractive. The larger deal, R.W. Beck Group, builds out our Energy’s Homeland Security offerings. This core business which is a little over $100 million in annual revenues serves utilities, government entities, financial institutions and other commercial customers in the energy, water, waste water and solid waste industries and provides a tremendous capability in the energy grid technology capital program management and water and waste management.

R.W. Beck also contains an emergency management business that provides all hazard mitigation preparedness, recovery and reconstruction services for state and local government agencies nationwide. Not only does this unit round out our Homeland Security offering, it provides us a new sales channel into the state and local customer arena. This piece of business is highly variable based on the level of disaster activity.

The second acquisition which was small but well known in the testing and certification market which we think is critical for growing demand for cyber tools is called Atlan. Atlan provides federal information processing standard validations to accredit graphic software and hardware. We think it is a key acquisition.

We also continued dialogue with several candidate companies in order to leverage our strong balance sheet. We see energy, health and cyber as critical areas and will entertain acquisitions and divestitures driven by OCI concerns I talked about earlier.

Finally, short after the last call the Department of Justice joined a Qui Tam lawsuit claiming that SAIC and a small subcontractor met with senior officials within the government to exhort the competitive process and direct work to our company. Although some of the headlines reported a $3.2 billion figure we booked about $115 million on this contract. Also there were no concerns raised about the quality of our work and in fact we were awarded a follow-on contract with a new government review board.

I encourage all to read the source materials. When we first became aware of the concerns on the original contract we did our internal due diligence and also had an outside legal review. In addition, after the Department of Justice joined the lawsuit we engaged an independent legal review by another law firm. Based on what we know to date we continue to believe the government’s legal claims lack merit. Unfortunately it could be years before this matter is resolved. Also, as with any litigation matter many factors including the results of pre-trial discovery and pre-trial motions can affect the ultimate outcome of this case. Now these types of cases and their resolution are critically important to me and our company because we are committed to maintaining the highest ethical standards which our reputation is built upon.

With that I will turn it over to Mark for the financial details. Mark?

Mark Sopp

Thanks Ken. Second quarter results were in line with our expectations with balanced performance in revenue growth, strong operating margin improvement and generation of cash flows. As today’s earning release indicates, compared to the second quarter of last fiscal year internal revenue growth totaled 7%. Operating margins grew 60 basis points and operating cash flow decreased about $120 million.

Now I will get into some color on those results. Revenue growth was particularly strong in our Defense Logistics area and our Traditional Defense Solutions area. Our largest single contributor to growth was the continued ramp up of our PolCam logistics contract which is now running at an annualized rate of around $150 million.

Revenues under our Future Combat Systems (NASDAQ:FCS) contract held stronger than expected due to a delay in the partial termination associated with the Manned Ground Vehicle effort and heavy material buys on continuing parts of the program. We saw continued strong internal growth in other systems engineering, integration and IT programs in the Defense community and benefited from the ramp up of recent cyber awards in the intelligence area and the IT integration work we are doing for the U.S. Central Command.

In addition, we are now seeing more growth in IT infrastructure work for the Department of Homeland Security and more work in our Military Health Technology Services area. Despite these growth areas, as expected our aggregate internal growth rate came off the double digit pace we have seen in recent quarters. The there were three primary contributors to the slower growth pace.

First, our MRAP communications integration contract slowed in the second quarter as deliveries on that program were completed. We expect to avoid further erosion in growth on that operation by new work integrating electronics gear on the new MATVs, the all-terrain MRAPs.

Second, we have seen a buildup in outstanding proposals as award decisions have pushed to the right as Ken mentioned earlier. This inhibited growth on expected new starts. This is particularly affecting our intelligence business area where an unusually high number of awards have been delayed, some pushing to the right as many as 18 months. Despite that condition, our proposal centers are extremely busy and bid and proposal costs are substantially higher and our new business pipeline is healthy; all factors that should increase new work in future quarters as long as the government’s procurement decisions get back on track.

Contract type mix was unchanged sequentially in the second quarter but shifted more towards fixed price from the last year’s second quarter into growth in our fixed price logistics business. Labor mix came in at 57% of revenues, down from 61% in the year-ago quarter. This trend reflects strong subcontractor and materials activity under our fast growing logistics business, the materials on the FCS program and overall higher mix of larger systems integration contracts across the intelligence and defense communities.

Operating margins improved to 8% up 60 basis points over last year’s second quarter. This is a nice progression towards our full year goal particularly considering the heavier volume of higher margin security product shipments scheduled in the second half of the year.

Consistent with the last few quarters we had excellent contract execution with good fee performance and efficient absorption of SG&A costs which ran at 5.8% of revenues. That said, within the SG&A expense category bid and proposal costs and internal research and development costs together were up almost 20% year-over-year reflecting our ongoing commitment to fueling long-term growth.

Also contributing nicely to profitability improvement was our commercial business where margins exceeded 10% on a leaner cost structure and higher margin project IT revenues. They also benefited from a reduction in litigation costs compared to last year which contributed about 15 basis points of year-over-year margin improvement.

Interest income was negligible as we remain invested in government insured securities or treasuries where yields are near zero. The tax rate was consistent with just above 38%, favorable compared to last year’s Q2 rate of 40%. Last year’s rate was higher than normal due to the nondeductibility of litigation costs experienced in the second quarter.

We bought back about 30 million shares of stock for roughly $50 million bringing down Q2’s average fully diluted share count to 388 million shares. Earnings per share from continuing operations totaled $0.41, up a healthy 19% over the prior year.

Moving on to cash flow and liquidity, we had a strong quarter on billings and collections yielding a day sales outstanding metric of 64 days. Despite the strong DSO we compare unfavorably to the year-ago quarter’s operating cash flows as we had an extra payroll cycle on this year’s Q2. The timing difference impact was about $150 million. The reverse of this happened as you might recall in the first quarter of this year. Accordingly, on a year-to-date basis the number of payroll periods is the same this year versus last year and as you can see the operating cash flow in this year’s first half are more comparable but improved over last year’s first half.

Ending cash totaled about $950 million and our credit statistics continue to improve. We are continuing to de-lever the business. The cash balances remained fairly static all year reflecting solid free cash flow generation of about $250 million coupled with deployment of that cash towards share repurchases.

Before moving on to guidance I want to call your attention to the enhanced disclosure we will be making in this quarter’s form 10Q regarding our government contract auditor, the Defense Contract Audit Agency. We are seeing, as many other contractors are, more rigorous audits and the standards to which we are held are being interpreted more strictly. We are certainly dedicated to fully meeting all regulatory and compliance requirements but investors should understand that our cost of compliance is increasing and the risk of having adverse findings has increased.

On that note I will quickly cover our outlook for the rest of this fiscal year. Year-to-date internal revenue growth year-to-date is currently 9%. Our submitted bids outstanding value has grown with delayed decisions. We hope that corrects and fuels second half new starts. We will also continue to ramp up in the second half our PolCam, the SENCOM IT contract and the larger cyber contracts that we won over the past year.

Offsetting those growth drivers we should see the reduced scope of the FCS contract take effect in the second half. Another challenge to internal growth would be the recent acquisition of R.W. Beck which we completed just at the start of our third quarter. Ken mentioned earlier that part of this business has quite variable revenues. As excited as we are about the capabilities and prospects the acquisition brings to us we expect the Beck Group to have a materially lower revenue in the last half of our fiscal year post-acquisition compared to their same period the prior year. This was due to a very busy hurricane season last year which drove unusually high revenues in Beck’s disaster recovery business. We do not expect currently that to be repeated this year at least so far.

As we include the revenues of acquired companies for prior year periods in our baseline to calculate internal growth, Beck’s expected lower revenues of this year will adversely impact this metric. Specifically, we expect about $90 million less in revenue for the rest of our fiscal year compared to Beck’s results over the same period last year. While we expect our core internal revenue growth rate to be within our targeted 6-9% range for the back half of the year, the addition of Beck could adversely affect the enterprise internal growth rate by as much as three percentage points in the third quarter and a projected one percentage point for our full fiscal year.

Importantly, the Beck valuation and acquisition purchase price was based on the lower revenue level that this year’s expectation is projected to be. Combining all those factors including the effect from the Beck acquisition we are still comfortable with achieving our enterprise targeted internal growth goal of 6-9% this fiscal year. Obviously we are just making it a bit more interesting this year.

Our operating margins are tracking to our plan as the drivers for profitability are occurring pretty much as expected. Heavier security product shipments especially in the fourth quarter should sustain margins of around 8% plus for the second half yielding full year growth of 20-30 basis points over last year. Our projected revenue growth, operating margin growth and diluted share count and not a lot of volatility in a non-operating and tax areas yields a growth and projected diluted EPS from continuing operations to be within our annual growth goal of 11-18% over last year.

We expect our two recent acquisitions to be EPS neutral. Thus at this point, all three of our guidance metrics; internal revenue growth, operating margin improvement and earnings per share growth are on track to achieve our stated long-term financial goals for the fiscal year.

Finally, our operating cash flow model of taking the result of projected net income plus depreciation and amortization is also tracking well for this year. Funding risk does increase this time of year reflecting the risk of the timely passage of appropriation bills for the new government fiscal year starting October 1st. As Ken mentioned we think we are in pretty good shape in this regard. We also maintain there is risk of billing and/or collection disruption from our more rigorous regulatory audit but so far we have managed well through that challenge.

In sum, our P&L outlook is consistent with what we have set out to do this year. Our balance sheet remains strong. Our cash flow is visible and we expect to continue to deploy cash on sensible acquisitions and stock repurchases as opportunities are created and/or presented.

With that I will turn it back to Ken for concluding remarks.

Kenneth Dahlberg

Thank you Mark. Before turning to your questions I just wanted to say how pleased I am that we have found the right leader to succeed me. This will be my last call and I look forward to transitioning to the Chairman role when CEO Walt Havenstein joins the team on September 21. I am sure you are all looking forward to meeting Walt whose first exposure to the street will be at our annual Institutional Investor Conference set for the 13th and 14th of October at our offices in Maclean. The feedback from past events has been universally positive and this event promises to be even better.

The conference will follow the same basic schedule as past years. On Tuesday afternoon we will have a technical demonstration of some of our main products and solutions followed by dinner with the senior management team. On Wednesday morning we will have management presentations with a special focus on our capability, positioning and strategy in the energy market. Now we all recognize the full event requires a substantial time commitment on all your parts but the two theme session is especially rewarding. The demos showcase our technical discriminators and most of our senior team will attend the dinner. If you are at all interested in attending this year’s conference just give Stuart a call or send him an email.

With that, operator, we are ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of William R. Loomis - Stifel, Nicolaus & Company.

William R. Loomis - Stifel, Nicolaus & Company

You are talking about future combat starting to decline in the second half and then you have the headwind with RW Beck optics hurting organic growth by 3% and you are keeping the metric in place. Can you quantify what kind of drop off, in terms of revenues what was FCS revenue in the quarter and have you seen that progressing over the next few quarters? It seems like it was less of a hit than I would have thought or you are winning more business or ramping up more than I anticipated as well.

Kenneth Dahlberg

We like the latter.

Mark Sopp

The FCS did hold much stronger through the second quarter. Revenues were in the $80 million range to give you a sense of that. We project once the full effect of the reduction in scope takes effect we are on a pace of roughly $250 million per year, down from roughly $300 million per year today and there is some variability quarter-to-quarter based on [inaudible] order of magnitude. That is really consistent with what we said in our last call.

William R. Loomis - Stifel, Nicolaus & Company

How complete are the negotiations with the Army? How confident are you in that $250 million number?

Kenneth Dahlberg

We certainly I think are confident about it for this year and into next year yet negotiations are just getting under way. We did receive that acquisition decision memorandum and we are fully cooperative with Boeing as well as ourselves as we attempt to restructure the contract or create a new contract it is still on a TBD condition.

William R. Loomis - Stifel, Nicolaus & Company

This assumes no role in the restructured Manned Ground Vehicle?

Kenneth Dahlberg

The manned ground vehicle won’t be part of the restructured or new contract. It will be a separate contract that the Army is working diligently on right now.

William R. Loomis - Stifel, Nicolaus & Company

Do you plan to participate or bid on that or bid on portions of that or team on portions of that as well?

Kenneth Dahlberg

It is doubtful we would participate in the manned ground vehicle effort.

Operator

The next question comes from the line of Jason A. Kupferberg – UBS.

Jason A. Kupferberg - UBS

I wanted to start with a question on the margins here. I know you are reiterating the 20-30 bips of year-over-year improvement but half way through the year you are up I think about 50 basis points and that implies kind of flattish year-over-year performance in the back half. I know you have the [VACA] sales teed up to accelerate in the second half probably similarly as you did last year. Are there other factors here that would leave margins just flat year-over-year in the second half and kind of flattish with where they are in the second quarter especially since the product sales are picking up or is there just a little bit of conservatism there given we are going into a new fiscal year and some of those factors?

Mark Sopp

We are doing well in the first half this year versus the first half of last year for all the reasons we have articulated on both calls. The margins in the second half of the year are fairly consistent year-over-year and there was similar effect of the improvement in margins the second half versus the first half for the security products business. We are expecting a tiny bit of dilution in the margins from the acquisitions. That always happens with the purchased intangibles getting started. We also expect heavier [BMT] in the second half of this fiscal year compared to the second half last fiscal year.

Kenneth Dahlberg

We have always said we built our strong logistics business as that revenue climbs that is not as high a profitability as the products business. So blended we do believe we are on a 20-30 basis point improvement year-over-year.

Jason A. Kupferberg - UBS

Just to circle back on the lawsuit that the Department of Justice jumped in on as you highlighted, how should investors think about potential worst case scenarios here understanding that legal situations are very hard to handicap but everyone always wants to get a sense of just what the downside risk is here understanding that from your perspective the case seems to be without merit.

Kenneth Dahlberg

I think it is too early for us to make any kind of predictions. As we progress if we can garner more information we can provide more color on that. At this point our internal review and due diligence believe the case has no merit. Having said that the process has to unfold.

Jason A. Kupferberg - UBS

Can you update us on the expected growth in net savings from project alignment and from the Deltech implementation in fiscal 2011 and have either either of these initiatives been disrupted at all by the COO departure you had back in June?

Mark Sopp

The projects continue on schedule as planned. There is no disruption from the departure of the COO. The aggregate cost structure savings annualized for project alignment is $100 million. We have been consistent with that and we think we are tracking with that. We actually think there is some up side to that. We are doing well on those initiatives. I don’t think we get the full effect of that in fiscal 2011 but we get a good chunk of it. Those activities will continue into fiscal 2012. By and large we will be done at some point in that year.

Operator

The next question comes from the line of Laura J. Lederman - William Blair.

Laura J. Lederman - William Blair

Could you talk a little bit about how much of the business conceptually would be at risk from in-sourcing? I’m not sure how to view that and can’t get my head around it from let’s say a 3 year and 5 year perspective. Can you also talk a little bit about the stimulus and what positives you are seeing there as well? My final question, acquisition pricing where is that trending versus let’s say a year ago?

Kenneth Dahlberg

As I stated in my earlier comments I think we are getting our arms around a customer by customer what side of the business we want to be on and what do we currently have. It would be premature for us to talk about that until we see what the DOD’s interpretation of the Reform Act. Be advised we are being prepared. We will be ready to react once that guidance comes out. As I said we could be an acquirer or a divestiture depending on what side of the business we want to be on; advisory or development.

Stimulus, we are now starting to see and we have been bidding very actively mainly in the energy arena through DOE and other agencies. Energy efficiency type contracts that we expect I think I said in my opening comments to get roughly $100 million in awards by the end of the year. I think the administration has metrics on every agency as to how much of the stimulus money they are responsible for, where is that in the pipeline. Is it ordered for RFP’s etc? We are just starting to see more of a pent up amount of activity in that area and that is why our expectation is next year we could have significantly more stimulus related awards.

Acquisitions, I think you meant by that are people now becoming more realistic about what their businesses are worth? Is that correct?

Laura J. Lederman - William Blair

Yes.

Kenneth Dahlberg

I think it is spotty. Certainly we feel like we got a fair deal with Atlan and RW Beck and we continue to pursue vigorously to leverage our balance sheet when we believe we have deals that are strategic as well as neutral or positive as far as earnings per share. The trend I think is getting a little better but it is a little early.

Operator

The next question comes from the line of Joseph B. Nadol III – JPMorgan.

Joseph B. Nadol III - JPMorgan

My first question is I want to flesh out in your introductory comments some of the deals you spoke about. The real reason you attributed it to was slow nomination for confirmation for some of the major positions. Is there any reason to believe the outlook for that is going to change enough in the second half where you are going to see some of these contracts come through or do you think other factors are going to help clear the [inaudible] here a little bit?

Kenneth Dahlberg

I think it is going to be a combination. I think clearly the administration is doing their best going through the vetting process. It doesn’t help when Congress is out but the activity should pick up again and frankly the healthcare debate is taking a bit more front and center of Congress’ time as with regard to concerning candidates. I do think there will be some more momentum there because the administration does have to fill those vacant slots.

The other thing is there could be potentially some expiring monies. I don’t think there is any agency that doesn’t want to commit to funds that if they don’t would expire by the end of the fiscal year. In all categories we have begun seeing that early in Q3. The log jam seems to be breaking and we are seeing more adjudications of these contracts.

Joseph B. Nadol III - JPMorgan

Is it fair to say that the next couple of months, in other words the remainder of this quarter, is sort of the make or break of the log jam breaking up in order to achieve your long-term organic growth expectations for next fiscal year?

Mark Sopp

I think it is very important so we will evaluate our success on that front in our next conference call and that will be baked into our forward view. Clearly the end of the government fiscal here we are expecting decisions to be made in the third quarter. We could handle it if it leaks into the fourth quarter as long as the budgets are in place and recover from there and still have our hard target attainable in the next fiscal year. A lot will be decided in these next forward six months for sure.

Stuart Davis

Remember in the last two years we have had book to bill in Q3 in the kind of 1.5 to 1.6 range and we would certainly expect that kind of behavior again.

Kenneth Dahlberg

That is why we have been saying that seasonally Q3 is one of our largest book to bill quarters.

Joseph B. Nadol III - JPMorgan

On the OCI front some of the new rules are getting interpreted and some of the customers are starting to put down the rules as to how they are interpreting the new law on conflicts of interest and there are rumblings that some businesses, at least one potentially coming for sale. What are your thoughts on what kind of opportunities there might be as the landscape shifts here for SAIC?

Kenneth Dahlberg

As I think I said in my remarks overall I think it is a positive for our company once it gets sorted out because we are not a big iron provider. We are a platform independent but we do cover the gamut from seeded to solutions provider. Depending on the customer, our strategy and the market size and the guidelines come back you have to be either fish or fowl we decide what side of that fence we want to go on and prosecute.

Joseph B. Nadol III - JPMorgan

Where I am going is you have been waiting for the strategic acquisition opportunity for a few years and you have done a lot of smaller ones. You haven’t done the bigger ones. Do you think this might be the opportunity that is the catalyst that finally drives an opportunity into your lap?

Kenneth Dahlberg

It could be one of them. The other is they were just too damned expensive.

Joseph B. Nadol III - JPMorgan

Right but if supply increases presumably pricing would take a hit as well?

Kenneth Dahlberg

That is if you are normal.

Joseph B. Nadol III - JPMorgan

Mark, you gave FCS numbers and I’m just wondering on MRAP you mentioned a pick up in the MATV. I’m just wondering if you could quantify what you did in the quarter on MRAP all-in and then what you are looking at for the back half of the year.

Mark Sopp

What I said was that the MAP would help or prevent further erosion of the decrease we are seeing in our original MRAP communications integration contract. I think we have said in previous discussions that our peak revenue under the original program was in the neighborhood of $40 million and going forward under just the MATV program should we win that it is in the order of $20-30 million at its best as far as we can tell now. So roughly a halving of the pace on an apples-to-apples basis, one program versus the other.

Joseph B. Nadol III - JPMorgan

That is something you are still waiting on here?

Mark Sopp

We have not had an official notification of any award on MATV at this time.

Kenneth Dahlberg

Having said that, this whole MRAP effort that started with getting those protected vehicles in the hands of our soldiers has really built a tremendous clout for our company and platform integration and especially quick react capabilities. So we are taking those kinds of tenets and hopefully trying to find ways where we can expand knowing the kind of capabilities that we have built.

Operator

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

Cai von Rumohr - Cowen and Company

A quick question to maybe clarify you talked about 6-9% organic growth in the second half. Refresh my memory, that is including acquisitions pro formed for last year or excluding acquisitions?

Mark Sopp

Good question. What I was trying to articulate was we would have 6-9% of our core business before the acquisitions in the second half. The new acquisition, Beck in particular, would dilute that by the numbers I shared but that all said, on a full year basis we still expect to achieve our target 6-9% range all-in.

Cai von Rumohr - Cowen and Company

If you are 6-9% before the acquisition whether the acquisitions are up or down year-over-year they are not in the prior year results. So what you are telling us is the reported revenue growth is likely to be better than 6-9% in the second half. Is that correct?

Mark Sopp

I’m not sure I follow. What I would ask you to do is the last page of our release shows the calculation of internal growth. When you see how we reflect newly made acquisitions into our base period you would see how the effect of a decreasing revenue scenario would occur when you acquire a company that came off of a hot year and were expecting to lower going forward how it would reverse the effect of our internal revenue growth rate this year. I wanted to clarify that our core business still is performing strongly in the second half at 6-9% with some dilution from the acquisition but still on pace for the year as we said.

Kenneth Dahlberg

But the total revenue growth would be higher with the [FY].

Cai von Rumohr - Cowen and Company

Your tax rate was lower again in this quarter. I think your guidance last time I remember was something like 38.8%. What do you expect the tax rate to be for the year this year?

Mark Sopp

We expect it to be 38% flat to 38.5%.

Cai von Rumohr - Cowen and Company

Taking your comments on direct labor, it looks like direct labor was relatively flat sequentially in the second quarter from the first. Normally that is up. Is that reflective of the delay in new starts?

Mark Sopp

Absolutely.

Cai von Rumohr - Cowen and Company

Are you seeing, I assume by what you are saying, you are starting to see the pick up so what kind of direct labor ratio should we expect in the second half?

Mark Sopp

We expect improvement but I don’t want to quantify that number. The materials and subs are more volatile over a shorter period of time. We do expect improvement on labor as the new wins come in and as Ken said we have had a nice pace out of the gate here in the quarter which will drive labor growth.

Operator

The next question comes from the line of Tim Quillin – Stephens Inc.

Tim Quillin – Stephens Inc.

I just have three detailed questions. On the FCS contract I understand you expect it to go on a quarterly basis from $80 million to let’s say $62.5 million. How should we expect the timing of that quarterly progression? In other words when would we see that quarterly drop off?

Mark Sopp

We expect to see it during the course of the third and fourth quarters.

Tim Quillin – Stephens Inc.

Just throughout that period and getting to that…

Mark Sopp

Some in the third, more in the fourth.

Kenneth Dahlberg

A real run rate probably in the fourth quarter.

Tim Quillin – Stephens Inc.

You talked about the comparisons on RW Beck but what is the revenue contribution you expect from that acquisition as well as what is the revenue contribution you expect from Atlan?

Mark Sopp

Atlan is not significant at all. The Beck acquisition is on the order of $100 million annually on the lower base of hurricane activity which is implicit in this year’s projection.

Tim Quillin – Stephens Inc.

Lastly, you may have mentioned this somewhere along the line, I think you mentioned the margins in commercial were about 10%. What was the revenue level on the commercial business?

Mark Sopp

About $120 million.

Operator

There are no further questions at this time. I would like to turn the call back over to management for closing remarks.

Stuart Davis

Thank you. As there are no more questions I guess that will conclude the call. If any of you do have interest in attending the conference as Ken mentioned just give me a shout. With that, again I would like to thank you for your participation.

Operator

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

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