SRA International F3Q08 (Quarter End 3/31/2008) Earnings Call Transcript

SRA International, Inc. (SRX)

F3Q08 Earnings Call

May 6, 2008 5:00 pm ET

Executives

Dave Keffer – Vice President, Investor Relations

Stanton D. Sloane - President, Chief Executive Officer & Director

Stephen C. Hughes - Chief Financial Officer & Executive Vice President, Operations

Barry S. Landew - Executive Vice President, Strategic Development

Analysts

Bill Loomis – Stifel Nicolaus

Tim Quillin – Stephens, Inc.

Eric Olbeter – Pacific Crest

Edward Caso – Wachovia Capital Markets, LLC

Michael Lewis – BB&T Capital Markets

Joseph Vafi – Jeffries & Company, Inc.

Laura Lederman – William Blair

Tom Maher – Lord Abbett & Co.

Mark Jordan – Noble Financial

Timothy Quillin – Stephens, Inc.

Michael Lewis – BB&T Capital Markets

Presentation

Operator

Ladies and gentlemen thank you for standing by and welcome to the SRA International fiscal year 2008 third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator Instructions) I would now like to turn the conference over to Mr. David Keffer, Vice President of Investor Relations.

Dave Keffer

Welcome everyone. On the call today are Stan Sloane, our President and CEO; Steve Hughes, our CFO and Executive Vice President for Operations; and Barry Landew, our Executive Vice President for Strategic Development.

During this conference call, we will make forward-looking statements to assist you in understanding the company and our expectations about its future financial and operating performance. These statements are subject to a number of risks that could cause actual events to differ materially and I refer you to our SEC filings for a discussion of these risks. In addition the statements made during this earnings call represent our views as of today. We anticipate that subsequent events and developments will cause our views to change. We may elect to update the forward-looking statements at some point in the future, but we specifically disclaim any obligation to do so.

During this call we will also refer to non-GAAP financial measures. A reconciliation of any non-GAAP financial measures to the most directly comparable GAAP measures is available in the IR section of our website at www.SRA.com.

Stanton D. Sloane

Good afternoon everyone. We appreciate your interest in SRA and look forward to providing you an update on our results and business outlook.

For the March quarter revenue was $376 million a year-over-year increase of 18%. Operating income was $29.6 million an increase of 30%. Diluted earnings per share were $0.30 an increase of $0.04 year-over-year. Revenue was slightly below our guidance range primarily because of lower than expected direct materials volume. The more profitable and sustainable component, labor services revenue, increased by approximately 23% year-over-year and was ahead of plan. This mix change improved our operating margins and led to diluted earnings per share within our guidance range. In connection with the brief decline in our share price during the March quarter we elected to deploy a portion of our cash balance to repurchase shares of SRA stock. We used about $17 million of our $40 million authorization to execute these open market transactions. Steve will provide further details on our buy back activities in a moment.

As we’ve said many times in the past M&A remains our top priority for capital deployment. Last week we announced our intention to acquire Era Corporation a world leader in next generation surveillance and flight tracking solutions for the air traffic management, military, security and airport operations market. In a moment Barry will expand on this exciting opportunity which will give us leading edge technology differentiation in a fast growing area of the global market. But first I’d like to offer our perspective of the current industry environment and our recent business development results.

As you know the fiscal year 2008 appropriation bills were passed in December along with a portion of the annual Iraq Supplemental Funding. An additional increment of the Supplemental is expected to be passed in the next month or so improving our customers’ funding visibility and potentially leading to an increased flow of contract awards in the June and September quarters. However our addressable market is likely to soften again for several months next winter given the changes in Presidential Administration and agency leadership. In the long term our diversification among defense, civil and health customers as well as our international and commercial markets will enable us to position for fast growing segments under any Administration. We’re confident that our differentiated services and technologies will be valuable to the enduring missions of these customers helping them to achieve their objectives as efficiently as possible.

In the third quarter we received $503 million of contract awards over 2.9 times the volume we won in the same quarter last year. Our total contract backlog stands at $3.9 billion an increase of 11% year-over-year. Funded portion of our backlog is $785 million up 17% year-over-year. These metrics demonstrate that we’ve made progress on the business development front but given the contract protest environment and continuing delays in RFPs and award decisions we need to maintain this momentum in order to capitalize revenue growth. Before elaborating on these factors I’d like to highlight a few of the key contracts we won in the March quarter.

Our largest award was a five year $108 million task order to deliver program and systems support for the Defense Department’s Joint Tactical Radio System or JTRS. For consolidation of work previously performed separately by SRA and several competitors this win represents the second significant expansion of our San Diego business in the last six months. Next we won a five year $78 million contract to help the Drug Enforcement Administration transform its IT infrastructure. This order has been protested by the incumbent contractor and the government is expected to rule on the protest later this month. Third, the company was awarded a five year $48 million contract to provide enterprise wide systems engineering services for the Defense Manpower Data Center, a valuable SRA customer for more than 20 years. This contract involves database design and development, web services, data analysis and identity management solutions. Fourth, the Food and Drug Administration awarded SRA a five year $27 million contract to develop a common reporting system for all adverse events and problems related to FDA regulated products. Known as the FDA Adverse Event Reporting System, or FAERS, the program represents a highly visible mission critical capability for FDA.

SRA’s health practice, strengthened by the Constella acquisition offered FDA a valuable combination of domain expertise and IT capability and we intend to apply the same model to future health opportunities. Fifth, the company won a two and a half year $24 million re-compete to deliver network support services to the Office of Personnel Management. Under this contract SRA will continue to design, manage and upgrade OPM’s network infrastructure. We were also awarded prime positions on several multiple award IDIQ vehicles in the March quarter. As always we dot include any value for IDIQ in GWAC vehicle wins in our award totals or backlog but they do provide significant opportunity for future growth.

The largest multiple award vehicle SRA won in the quarter was the five year $478 million program management support services two contract for the Army Program Executive Office Enterprise Information Systems or PEOEIS. Several unsuccessful bidders have since protested the award decision and task order activity will not begin until the protests have been resolved. SRA was also awarded a prime contract on the seven year $200 million Software Engineering and Specialized scientific support or SES3 BPA for the Environmental Protection Agency. SRA has already won two task orders under this vehicle with a total combined value of $32 million and both represent new work for the company.

A few days ago the Defense Information Systems Agency announced that SRA was one of the awardees of its $12 million Encore 2 contract which was originally awarded SRA and other companies in January 07 and subsequently protested by several unsuccessful bidders. We look forward to the opportunity to compete for task orders to implement Net-Centric IT Systems across the Defense Department. As of March 31^st we had $1.4 billion in pending bids and another $1.4 billion of proposals currently under development. The total pipeline stands at $23.8 billion up about 49% year-over-year. Given the macro level budget dynamics the next two quarters will be particularly important for us to bid and win a large volume of new business. The pipeline has expanded rapidly over the last year particularly in areas such as cyber security, ERP software implementation, an IT infrastructure consolidation. With this growing set of opportunities many of which are slated for award this summer or fall we are currently devoting a great deal of energy to the bid and proposal process.

Last quarter we mentioned that we were awaiting the results of three significant re-compete bids, the largest the National Guard’s AITS contract represents about 5% of revenue and earnings. The customer revised the RFP in March and requested new proposals. We submitted modified costs and technical proposals in late April and we anticipate an award decision later this month. The other two re-competes were both consolidations of SRA contracts with work being done by other contractors. As I mentioned we won the JTRS support contract in March quarter for $108 million. We recently learned that we were not successful in the third bid an Intelligence contract that was awarded to one of the other incumbents. Due to the high demand for SRA services across the Intel community we have been able to retain and redeploy all those employees to other programs.

On the recruiting and retention front, we increased our total headcount by about 40 employees in the March quarter billable headcount grew slightly faster but was still below our plan. The labor market remains very tight particularly in the Washington area and for employees with skills in information assurance and other high growth disciplines. In spite of these challenges we don’t expect supply constraints to stand in the way of long term revenue growth.

Barry S. Landew

Over the last year we’ve broadened the aperture of our M&A program to identify more businesses with hardware and software product offerings, international market experience, mission systems focus. Our five year strategic plan calls for rapid growth and increasing margins as we differentiate ourselves through a proprietary mix of products and services and build upon our legacy of strong relationships across the US government and related markets. With these objectives in mind, I’m excited to talk about our pending acquisition of Era Corporation which we announced last week.

Headquartered in Reston, Virginia the company specializes in leading edge technology solutions for the air traffic management, airport operations, Defense and Homeland Security markets. With air traffic expected to more than double by 2025 Era’s next generation products represent a valuable extension of traditional ground based radar systems. Era is a world leader in multilateration and automatic dependent surveillance broadcast, commonly known as ADSB. By increasing the speed and accuracy of surveillance data these technologies improved the safety and efficiency of commercial flight traffic both in the air and on the ground. Using the same core technologies Era’s products also enhance the surveillance capabilities of military and security organizations around the world. Era has already completed over 130 implementations for government and commercial customers in more than 30 countries and its cost structure will cover the research and development required to maintain and enhance its leading product suite.

The company is growing rapidly with over 300 employees, 38 patents and offices on four continents. In its first year with SRA we expect Era to generate more than $65 million of revenue and to be accretive to both GAAP and cash earnings per share. Upon the completion of the deal we will have a suite of valuable technology offerings and expanded global footprint and the necessary scales to integrate Era’s products into large scale systems as a prime contractor. The transaction should close before the end of our fiscal year pending completion of the standard Hart-Scott-Rodino waiting period.

We’re also continuing to evaluate a number of other strong M&A prospects and won’t hesitate to act upon them even in the near term if the right opportunity presents itself.

Stephen C. Hughes

Good afternoon everyone. Revenue for the third quarter grew 18% year-over-year. Labor services revenue or revenue less rebillables grew about 23%. Labor services revenue grew 5% sequentially while rebillables declined by $17 million. As we have discussed on each of our earnings calls this year we’ve decided to minimize low margin rebillable revenue as we seek to increase return on sales. This is introduced to some revenue volatility in the short term as we approach a base line rebillable level. While labor services grew nicely in the third quarter it could have been higher if not for the combination of bid protest slow downs and a reduced level of effort on the AITS contracts which is currently in re-compete.

As labor services content as grown operating margins have increased. Operating income for the quarter was $29.6 million up 30% year-over-year. The Q3 operating margin was 7.9% 70 basis points better than last year given the richer revenue mix and strong contract execution. Consistent with these improvements our gross margin for the quarter was 26.4% its highest level since June 2004. SG&A was 16.9% of revenue given increased spending in marketing and sales and acquisition integration costs. Stock based compensation expense was $2.4 million in the third quarter slightly below the run rate going forward. Our effective tax rate was 39.5%. Net income for the quarter was $18 million and diluted earnings per share were $0.30. Diluted EPS increased by $0.04 or 15% year-over-year.

Turning to the balance sheet, as of March 31^st we had about $137 million in cash and $80 million of debt. Accounts receivable were $341 million down from $345 million last quarter. We had approximately $1 billion of total assets and shareholders’ equity of $687 million. Now the statement of cash flows. Q3 operating cash flows were $20 million and days sales outstanding were 79. Both metrics were affected by the integration of Constella and [inaudible] collection into our financial system. This is nearly complete and we expect DSOs and cash flows to improve in the June quarter.

In addition two customers had implemented new payment systems resulting in temporary collection delays. Looking forward we continue to expect our operating cash flow to be lose to the level of operating income for the long term. We have instituted a lean six sigma approach to the invoicing and collection process which should yield efficiencies and improve our future cash flows. Capital expenditures were about $100,000 in Q3.

As Stan mentioned earlier we made use of our $40 million share repurchase authorization in the March quarter. We bought back a total of 754,000 shares over a span of several weeks deploying a total of $17.3 million in cash. Given the Era acquisition and our general preference to use capital for M&A we have no specific plans regarding future repurchases but will continue to evaluate our options over time.

Before discussing forward guidance I’d like to update you on a few other key metrics. First, contract and business mix, as a percentage of Q3 revenue time and materials business was 42%, cost plus was 39% and fixed price was 19%. Cost plus revenue was lower than last quarter and fixed price higher primarily because of lower direct materials content in several costs plus contracts. Next, national security contracts accounted for 53% of our Q3 revenue, we sold the government 28% and health 19%. We were the prime contractor for 87% of our revenue in the quarter. On the people side direct reutilization was about 79.5% in Q3. Voluntary attrition was 16.3%. We finished the quarter with 6,442 employees an increase of more than 1,200 over the last year.

Looking forward we are updating our guidance for the fourth quarter and fiscal year 2008. This guidance reflects our expectation of reduced low margin rebillable revenue and higher labor services content. It does not include any effect from our pending acquisition of Era. In the June quarter we expect revenue of $370 million to $390 million and diluted EPS of $0.31 to $0.33. This implies revenue growth of about 16% to midpoint with an operating margin in the 8.25% range again reflecting a richer mix of labors, services business in the fourth quarter a year ago. For fiscal year 2008 we expect revenue of $1.492 billion to $1.512 billion and diluted EPS of $1.23 to $1.25. At the midpoint this would represent year-over-year revenue growth of 18%. The improving business mix has enable us to raise the low end of the full year EPS guidance range by $0.01 from last quarter. The year-over-year EPS growth at midpoint would be 18% excluding the non-recurring $0.04 Mantas gain in fiscal year 2007.

Although we’re eager to accelerate organic growth we’re pleased at their progress and the strengthening of labor services component. Our remaining rebillable revenue stream consists primarily of subcontractor services on long term contracts as well as occasional third party hardware and software buys that are an integrated component of certain services engagements. Going forward we’re focusing our marketing and sales resources on building a more profitable labor services and proprietary products business.

Stanton D. Sloane

It’s been just over a year now since I arrived at SRA and I’m pleased to say that we’re making progress in nearly every aspect of the company. When the Era transaction is completed we will have made two acquisitions of industry leaders in strategically valuable market segments. We’ve augmented our management team with several experienced leaders, we’ve invested heavily in the business development function and still managed to improve operating margins by about 70 basis points year-over-year. We’ve won several significant contracts in the last few quarters but we need to convert these wins into revenue growth in order to fund further investment and provide additional opportunities for our employees. I look forward to updating you on our progress in each of these areas as we continue to execute our strategic plan.

We’re now ready to take your questions. To ensure that we can get to as many people as possible please restrict yourselves to one question. Now Heather will explain to you how you can ask your questions.

Question-And-Answer Session

Operator

(Operator Instructions) We will pause for just a moment to compile the Q&A roster. Our first question comes from Bill Loomis – Stifel Nicolaus.

Bill Loomis – Stifel Nicolaus

One thing on the backlog, the backlog was up year-over-year but flat sequentially but you won more than your revenue. Was there anything that came out of backlog? And then my second question quickly on the intelligence contract that you lost, you said you had the people redeployed. Does that mean no impact to revenue?

Stephen C. Hughes

On the first question every quarter there’s some amount of backlog that is de-obligated by customers for various reasons and that’s an explanation to why backlog is flat from Q2 to Q3.

Stanton D. Sloane

On the second part, Bill, we have open positions for all of the folks that were affected on that loss. Clearly we prefer to win things than lose things. So I don’t want to misrepresent them as we’re always disappointed when we lose a contract. But the thing that’s disappointing about that loss is that it would have provided some additional growth that we won’t be able to count on in that contract. So when you said to impact to revenue I think the answer is yes because we would have had some growth that would have come with that contract. I think our guidance is consistent with what we see and we expect to put all those folks on revenue generating work pretty quickly.

Operator

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

Tim Quillin – Stephens, Inc.

In terms of bookings I think year to date you’ve announced $1.7 billion in new business. What percent of that is new or expanded work and at this point do you feel like you have enough coming into backlog to drive an acceleration of growth as you look into fiscal 09?

Barry S. Landew

There’s a significant amount of new work in that $1.7 billion, Tim. It’s basically work we won in the whole four quarters last year. We feel like to drive the kind of growth we’re looking at we need to win the amount of business we’ve been winning and to increase that going forward.

Stanton D. Sloane

Let me add a little bit of color to that as you would say. The pipeline, if you analyze our pipeline I feel pretty good about it. If you look at the amount of work that’s in adjudication, if you look at the value of the work that is currently in the proposal development stage and look at the rate that we’re growing backlog, all of those leading indicators look pretty good to me. The uncertainty I think that I see has to do with the election and the new appointees and those kinds of things and also there’s still a little bit of uncertainty around the Supplemental which is not a direct impact on us but if doesn’t get passed then of course it has the effect of eventually affecting other kinds of spending. So that’s the concerns but I think the pipeline we have today looks pretty robust.

Operator

Our next question comes from Eric Olbeter – Pacific Crest.

Eric Olbeter – Pacific Crest

Question on SG&A, I think we’re up about $4 million sequentially. Steve you mentioned some acquisition related integration costs. Can you break that down between those costs that are one time and the costs related to extra BD spending? What should we assume going moving forward?

Stephen C. Hughes

I guess there’s a couple things here, Eric, as we’ve said before we’re going to increase our spending on marketing, sales and B&P and so for example if you look at what we spent on B&P in 07 it was about 1% of revenue. We’re on a path that gets us to spending about 2% of revenue on B&P and we’re about halfway there between that 1% and 2% ratio for this year, fiscal year 08. We’ve also invested more in marketing and sales. I’d say in the quarter rough estimate maybe $1 million would have to do with systems integration, with professional services, with bringing Constella up on our billing systems and those kinds of things. And that would be more than one time type of thing. Whereas on the B&P and the marketing and sales we would expect to continue to drive more resources into that bucket.

Stanton D. Sloane

Eric, one thing to keep in mind we intend to pay for that by driving efficiency in other parts of the business not by reducing margins.

Operator

Our next question comes from Edward Caso – Wachovia Capital Markets, LLC.

Edward Caso – Wachovia Capital Markets, LLC

Can you repeat what the headcount numbers were?

Stephen C. Hughes

The ending headcount was 6,442.

Operator

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

Michael Lewis – BB&T Capital Markets

I was wondering, Stan, if you could talk a little bit about the strategy looking forward, say that’s two to three years, what do you think your internal plan would look like with regard to product contribution as a percent of the total portfolio and also with regard to your international exposure versus the domestic business?

Stanton D. Sloane

In the two to three year timeframe I don’t think, let me stated it a little different. I have it in my head that in the five year timeframe that products would be about 25% to 30% of our business mix. That’s a step function more than a linear function depending on the size of the acquisitions that we make, but I think that’s kind of a notional mix. Figure 20%, 30% in the three to five year timeframe. International will become an increasing portion of the portfolio but as a percentage of our overall business I don’t think it’s going to be the dominant part of the business clearly not in the next few years. Our principal customer will remain the US government. We will seek to increase our international presence but I don’t think it’s going to substantially change the percentage mix of revenue source.

Michael Lewis – BB&T Capital Markets

Stan, would by calculation be correct to see about 5% to 7% of the business right now in international related revenue?

Stanton D. Sloane

Yes, but you have to, when you say international, most of the international work we have today is in fact with the US government even though the work is done internationally. So it’s like when you talk about military sales would you categorize FMS sales as international or would you characterize them as government? Most of our work is still with the US government even though it may be done internationally.

Operator

Our next question comes from Joseph Vafi – Jeffries & Company, Inc.

Joseph Vafi – Jeffries & Company, Inc.

I was wondering if we could talk about Era for a second, what the historical growth profile has been and the margin profile and then finally how the company fares versus the base services business in its cash flow profile?

Stanton D. Sloane

Everybody wants to comment so let me start with just a couple of high level thoughts and I’ll let Steve and Barry jump in. Our interest in Era is because it is a high growth company and our anticipation is that that’s going to continue otherwise clearly we wouldn’t have been interested. It’s in an area of the market where we see particular opportunities for synergy. In other words, our ability to be a prime contractor and integrator to include the mission systems which is something that we have told you over the last year that was a principal focus for us to move closer to the mission. When you put that together now the thoughts of an Era that provides a lot of opportunity in my view to be a prime integrating contractor which we think will even further accelerate the growth.

We won’t comment on past numbers or acquisition costs or any of that. There’s a few reasons for that. One, is obviously that the deal is not closed and at this point we’d be reluctant to talk about too many things until the deal is closed. But with that, Barry, Steve, you guys want to comment?

Stephen C. Hughes

Joe, I would just add in addition to high growth we obviously see and are confident of margins that are higher than the labor services margins you typically see in our industry. We’re confident of double digit margins.

Operator

Our next question comes from Laura Lederman – William Blair.

Laura Lederman – William Blair

Just a few quick questions, one can you give us a little bit more color on some of the delays you expect in the new Administration? Would that be on the path, the actual budgets or more on getting task orders to flow and how long you think that’ll last? And also on the same lines, the Supplemental, what do you think of the odds that it gets delayed? Two, five, ten, 20, big, small? And separately on a totally different line, can you talk a little bit about the organic growth rate and what that is for Q4 and also for full year 08?

Stanton D. Sloane

I’ll start then I’ll pass the hard questions off to someone else. On the Administration it’s nothing specific, it’s just the general concerns that you’d have when you change Administration and you have periods where you don’t have appointees in place and agencies are typically reluctant to start new things until the new people. It’s just the standard worry beads, nothing beyond that. On the Supplemental I was actually encouraged by the progress made in the House recently in that it appears that the issues of tying domestic spending things to the Supplement have been mitigated to some degree so that’s encouraging. We’ll see what happens in the Senate next week. If that moves forward then I think that’s a great sign and I think the vector on that appears to be good. I’m encouraged by that but until it’s passed it’s not passed. We have to keep our eye on that. Steve, do you want to?

Stephen C. Hughes

On the growth picture Laura, I think on the last couple of calls and today as well we talked about eliminating low margin resulting revenue. We’ve done that and the effect of that is that it basically gives us flat growth or no growth in Q4 organically and about 3% fiscal year 08 compared to fiscal year 07. Obviously, if we hadn’t elected not to take on this re-billable work we’d have had about $30 million more of revenue. When you look at it on the total company basis the things that we’re really focused on is labor services growth which is revenue minus our re-billables and we’d see that labor services growth growing probably 23% to 24% fiscal year 08 over fiscal year 07 and that’s really what’s driving the margin increase.

Stanton D. Sloane

Let me add a little more color because I don’t want to dodge a tough question. Clearly, we would like better organic growth. We made a conscious decision to eliminate or not pursue some pass through revenue that really had no margin in it. My view of the world is we’re in business to make money not to recover costs and so when you divert resources of the company to pursue work that has no margin there’s a huge opportunity cost associated with that. I will assume responsibility for making that decision and I wouldn’t change that decision tomorrow and I won’t as long as I am here because I don’t think it’s the right thing for the long term position of the company to pursue low margin work. So, our focus is going to be not on quarter-to-quarter economics of business mix, it’s going to be what’s the best interest long term of the shareholders. So, there’s a couple of conspiring events if you want to talk about organic growth. One is clearly the decision to avoid the low margin pass through work. The other is there’s been protests on jobs and things have moved to the right and it’s just a confluence of those events. My view of the world is our pipeline is good, all the leading indicators are good and I don’t see anything that I’m concerned about and I want to focus on the long term and not the quarter-to-quarter so that’s the way we’re going to keep going.

Laura Lederman – William Blair

Two final quick follow up questions, one is can you talk about the acquisition pipeline, how pricing is looking in the market? And, also what re-competes are up for Q4 and next year as well.

Stanton D. Sloane

On the acquisition pipeline again, I’ll make comment and Barry can jump in here if he wants. I think we’ve got a really good pipeline. We have some things that I would call very exciting and for us exciting means that we see synergy, we see growth, expansion in to new markets. We’re really not in to buying more of the same, we’re trying to do things that are going to provide more rapid growth for us so we continue to work those. The pricing for the top quality companies that we would be interested in, they come at a premium and that’s always the trick to make a business deal that we think is reasonable but there are no bargains. The kind of properties that we’re interested don’t come at bargain prices.

Stephen C. Hughes

Laura, if I could just add to that. Pricing is at lofty levels and I think it’s going to stay that way. There’s more competition than ever before for high quality companies and frankly there’s a diminishing supply of high quality companies in the traditional IT services sector. There are more when you broaden the [inaudible] to adjacent markets as Stan mentioned but given kind of supply in our marketplace and what’s happening with companies that rely on set aside, contracts with the SBA ruling with those being in less favor right now it just increases the premium on companies with a full and open portfolio. I think pricing is going to stay high and I think not just for SRA but frankly for many of our peers it’s about finding good companies for a strategic fit and not for near term financial returns.

Barry S. Landew

On the [inaudible] for contracts that were in the fourth quarter there’s just a few of them, the big one obviously is the AITS re-compete. There are a couple of other contracts that are not of that scale, one at EPA and one at the Army.

Laura Lederman – William Blair

Up for next year?

Barry S. Landew

For the next 12 months there are a few more but again I don’t think they’re the scale of the AITS.

Operator

Our next question comes from the line of Tom Maher – Lord Abbett & Co.

Tom Maher – Lord Abbett & Co.

Sure, it makes sense to not bid on some of the pass through business but I was just kind of curious in terms of how neatly can you do that in the sense of is there business that is sort of part and parcel of it and therefore to carve it out is difficult?

Stanton D. Sloane

The way I would say it Tom is we don’t want to pursue low margin pass through work as an end in itself. Clearly, we have customers and contracts where we do that as part of a broader relationship where it’s important to our customers and we obviously will continue to do that. But, if we’re just going to pursue contracts or task orders that are simply pass through low margin work, that doesn’t make sense to me so those are the kinds of things we’re trying to purge if you will.

Stephen C. Hughes

And we’ve actually turned down some business that’s come to us that we really didn’t even have to pursue because it was low margin in nature.

Tom Maher – Lord Abbett & Co.

So in terms of looking at the changes in the guidance I think you guys had described it as substantially sort of reliant or dependent on these kinds of businesses. Was there anything else that was sort of big enough to categorize it that might have become less certain looking forward?

Stephen C. Hughes

There were certain [inaudible] protests that took place that slowed down the revenue and those kinds of delays and that would have been a part of it as well.

Tom Maher – Lord Abbett & Co.

The other discussions about the administration changes, etc. was sort of the statement of the obvious risks or concerns around those kinds of events?

Stanton D. Sloane

Yes, like I said nothing particular I just always worry about those periods.

Operator

Our next question comes from the line of Mark Jordan – Noble Financial.

Mark Jordan – Noble Financial

First of all you had mentioned that Era has double digit margin potential. Is that currently operating at that rate or is that in the future? Secondly, could you detail the scope of work that’s done in Czechoslovakia, it’s mentioned, is there R&D and production there? And, does that Czech content have any issues for purchasing at DOD?

Stanton D. Sloane

On the margin side our expectation is the first year with our company will be well in to double digits so I’ll let it go at that. On the Czech Republic, engineering and hardware design and integration and test is done in the Czech Republic, Pardubice which is not far from Prague. They have two operations in the US, one in Virginia, one in Texas where analytical work is done, some software work, some other things, corporate functions, those types of things. I don’t see any issues with Czech Republic, relations are good there, the product suite is a mix of air traffic control and some passive military electronic systems and I just don’t foresee any issues. I can perhaps, if you have something more specific, I can answer it but we’ve talked about that with a variety of folks. I’ve been to see the Czech Ambassador so I don’t see any issues.

Operator

Our next question comes from the line of Timothy Quillin – Stephens, Inc.

Timothy Quillin – Stephens, Inc.

With regards to [CR2] which you don’t plan to rebid, is some of the reduction that we’re seeing right now in re-billables related to existing work under that contract that you’re starting to walk away from? And, how much of that business is remaining that will go away over time?

Stanton D. Sloane

The answer is yes and I’ll let Steve give you the numbers there.

Stephen C. Hughes

In general Tim, for the company in total we would have had probably $30 million more business, not just for renewing that contract but for the low margin re-billables if we had taken it. The way I look at it going forward is we’re probably pretty close to the operating level. I would expect that our labor services component would be probably maybe in the 65% range. Now, we have subcontractors and ODCs at maybe 25% and then the main 10% being between out-of-pocket expenses and pass through type stuff. This quarter that total was about 9% and it’s down significantly, that’s the lowest level of pass through we’ve had in the last three years.

Barry S. Landew

Tim, on the second part of your question about potential for deterioration of SRA work under [CR2], I don’t expect that’s going to happen. We actually had some recent wins under [CR2] for SRA related work at respectable margins and going forward we expect to be on a winning team to keep doing the kind of work that SRA wants to do with returns that are commensurate with that work. What we don’t want is to pick up re-billable work under that contract which as you know is constrained by no fee under that contract. So, I don’t think it effects SRA related tasking at all.

Timothy Quillin – Stephens, Inc.

If I could just squeeze in one more question, a couple of contracts have been a drag on growth over the past couple of years, or customers, specifically USAID and National Guard, can you just give us an update in terms of where you are with those customers? Are you at a stable rate? Do you see growth for those customers? Just a little update there.

Barry S. Landew

AITS contract, that’s up for re-compete Tim and typically the level of effort drops off a bit as re-compete approaches. In terms of USAID I think we would see that as being stable with some upside.

Timothy Quillin – Stephens, Inc.

And Guard, not the other part of?

Barry S. Landew

Guard has really never been an issue. We won our re-compete at Guard at basically the same levels as running before. So Guard Net which is now [EOS] is not an issue. It’s just AITS which during this re-compete phase is obviously running at a lower level than kind of steady state.

Operator

Our next question comes from the line of Michael Lewis – BB&T Capital Markets.

Michael Lewis – BB&T Capital Markets

Just a quick follow up, Steve you had addressed a question earlier with regard to pass through contribution, you said something about $30 million in revenue. Is that $30 million in revenue in the fourth quarter that you’ve pulled out?

Stephen C. Hughes

No, for the year.

Michael Lewis – BB&T Capital Markets

Now, with regard to the fourth quarter what’s the delta on the pass through that you have pretty much walked away from?

Stephen C. Hughes

We expect it to be below Q3 level.

Operator

At this time we have reached the end of the allotted time for questions. Mr. Keffer are there any closing remarks?

Dave Keffer

We’d like to thank everyone for joining us this afternoon. You’re all more than welcome to contact us anytime with follow up questions. That concludes today’s call.

Operator

Thank you. This concludes the SRA International fiscal year 2008 third quarter earnings conference call. You may now disconnect.

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