Leidos Holdings Inc (LDOS) 2012 Q3 法說會逐字稿

Good afternoon.

My name is Stacy and I will be your conference facilitator for today.

Welcome to SAIC's third-quarter fiscal year 2012 earnings conference call.

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

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

(Operator Instructions).

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

I would now like to turn the presentation over to your host for today's call to Mr.

Paul Levi, Senior Vice President of Investor Relations.

Please proceed.

Thank you, Stacy, and good afternoon.

I would like to welcome you to our third-quarter fiscal year 2012 earnings conference call.

Joining me today are Walt Havenstein, our CEO, and Mark Sopp, our CFO, and other members of our leadership team.

During this call, we will make forward-looking statements to assist you in understanding the Company and our expectations about its future financial and operating performance.

These statements are subject to a number of risks that could cause actual events to differ materially and I refer you to our SEC filings for a discussion of these risks.

In addition, statements represent our views as of today.

We anticipate that subsequent events and developments could 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.

I would like to turn the call over to Walt Havenstein, our CEO.

Thank you, Paul, and good afternoon, everyone.

For the call today I'll cover market conditions, speak to the ongoing CityTime investigation, highlight recent business development results, review acquisitions and share several special recognitions.

Then, Mark will provide financial details.

And then, we will take your questions.

While uncertainty in the markets continued to present challenges to our financial performance this quarter, I am encouraged by our business development results, including our increasing pipeline of new opportunities, record level of submitted proposals awaiting decision, the increasing number of large wins, uptick in awards and targeted strategic growth areas, and improvement in book to bill performance.

I am also very proud of our employees who continue to deliver outstanding value to our customers.

One of the great strengths of SAIC is our culture of focusing on customer success.

Our culture is one of strong customer affinity for more than 40 years at an unparalleled understanding of customer mission.

The overall federal government acquisition process continues to be negatively impacted by the uncertainty caused by the government budget situation.

As a result, revenues remained flat in the quarter.

Looking ahead, our expectation for the year are for revenues to meet the outlook we shared with you during this last quarter's earnings call.

I would next like to update you on CityTime, the workforce management system that is currently being used by more than 65 New York City municipal agencies.

As we have disclosed previously, the US Attorney's office is conducting a criminal investigation relating to the CityTime program.

Two former SAIC employees along with other contractors on this program have been charged with conspiring to defraud the City of New York for their own profit by taking kickbacks and increasing the cost for the program.

The two former SAIC employees have also been charged with defrauding SAIC by depriving it of their honest services.

One of these former SAIC employees has pleaded guilty to multiple charges, including taking millions of dollars in kickbacks from an SAIC subcontractor.

The Company is continuing to cooperate with the US Attorney's investigations but cannot predict its outcome.

After a comprehensive review of the CityTime program, including a review of management performance, a group President, a deputy group President and a business general manager responsible for management and oversight of the CityTime program were removed and are no longer with the Company.

The Company is not aware of any evidence that these individuals had any personal involvement in the CityTime fraud.

In addition to taking these personnel actions, the Company engaged an outside law firm to assist Company leadership in conducting a comprehensive review of key policies and practices and to recommend enhancement to strengthen the Company's culture of ethics, accountability, and compliance.

As a result of this systemic review, the implementation of process improvements and control enhancements by the Company is now underway.

In addition, a special committee of the Board of Directors that is overseeing the Company's response to CityTime has engaged an independent company, Guidepost Solutions, and specifically its Chairman, Art Schwartz, to undertake its own review that monitor the efforts the Company is making in response to this matter.

Based on developments related to the CityTime matter, since our last quarterly filing, the Company now estimates that its loss relating to the CityTime program will be at least $232 million.

Accordingly, we have taken a loss provision for that amount this quarter.

An updated description of the CityTime matter will be included in the 10-Q which we'll file this week.

Turning to market conditions, while there's been a large volume of rhetoric and speculation regarding the federal budgeting process, the overall government solutions and services market outlook remains unchanged since we spoke with you last.

Our customers are being told to do more with less or, at a minimum, to hold the line.

As a result, we expect spending to be flat at best for the next couple of years with low single digits spending declines in the following out years.

We continue to believe there will be areas of nominal growth such as Intelligence, Surveillance and Reconnaissance, Cybersecurity, Logistics, Readiness and Sustainment, Energy and Health IT.

We have and will continue to invest in these areas to provide our customers with the solutions they require.

Moving on to our business development results, bookings totaled $3.8 billion in the third quarter and produced a net book to bill ratio of 1.3.

Combined with the book to bill ratio we achieved in the first two quarters, we have produced a solid year-to-date book to bill ratio of 1.2, which reflects the strength of our strategy in people.

We ended the quarter with $18 billion in total backlog.

$6.3 billion was funded up nearly $1 billion or 19% from the second quarter.

And as compared with the third quarter of fiscal 2011, total backlog increased by 16%.

I am very encouraged that we have achieved a 63% total dollar win rate on business opportunity pursued and awarded through the third quarter.

Our high win rate is attributable to strong program execution and well-targeted investments in business development.

This win rate is consistent with last year's, reflecting positive results of these targeted investments considering the increased amount of bids submitted and increasing competition.

Additionally, submitted proposals awaiting decision continued to increase and now stand at a new peak of $30.6 billion, consisting of $21.7 billion in IDIQ bids and $8.9 billion in definite delivery bids.

This is $7.6 billion higher than Q3 a year ago which we expect will produce growth when these procurements are decided.

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

We won 13 opportunities valued at more than $100 million in the third quarter of FY 2012.

When added to the 18 opportunities of this size we won in the first half of the year this represents a 55% increase compared with the first three quarters of last year.

Recently we won four additional large programs following the end of the third quarter, which brings the total of greater than $100 million wins for the fiscal year to 35 compared to 26 for all of last year, a record for us.

There were many significant awards this quarter.

Let me take a moment to highlight two of these wins, each of which has expected value at SAIC of greater than $100 million.

These are just two examples of SAIC's continuing to bring the best solution at the best value to our customer.

First, SAIC was awarded the tire successor initiative contract by the Defense Logistics Agency.

This competitively one single award IDIQ has an estimated value of $1.1 billion over seven years.

Under this contract, SAIC will provide end-to-end wide chain management for all US military land vehicle and aircraft tires.

Previously, SAIC had been a subcontractor to Michelin for only land vehicle tires.

With this win, SAIC has significantly enhanced its position as a leading logistics contractor for the Defense Logistics Agency.

Also during the third quarter, SAIC was awarded two task order contracts totaling nearly $600 million for ongoing sustainment of mine resistant ambush protected or MRAP vehicles in both Kuwait and Afghanistan.

Like the tire successor initiative contract, this win on the MRAP joint logistics integrator contract demonstrates the kind of progress SAIC is making toward realizing the exceptional results we've targeted in our strategic growth area of logistics, readiness and sustainment.

I would now like to take a few moments to highlight an exciting development in SAIC's approach for driving growth in Cybersecurity.

Namely, our recently announced strategic partnering alliance with McAfee, the world's largest dedicated security technology company.

This strategic alliance will enable SAIC and McAfee to offer a new combination of Cybersecurity solutions to meet the sophisticated threats faced by large complex enterprises around the world.

Cyber threats are outpacing the traditional hardware-based defense and depth models by an alarming margin at a time when critical data more commonly moves beyond the enterprise network to mobile endpoints.

McAfee technology, combined with SAIC's solution-based deployment approach and our CloudShield CS 4000 security solution, will offer advanced security across the network by using reprogrammable hardware platforms that intelligently adapt to anticipate, protect, remediate cyber threats and sophisticated network infrastructure.

This more agile capability allows enterprises to select virtualized services and applications, based on their unique threats and desired security posture, an alternative approach that is long overdue.

Corporate leaders and governments understand Cybersecurity is an enterprise risk that continues to evolve.

And [our] companies need solutions that can adapt to this changing environment.

The same is true of enterprises who must adapt to protect national security, financial institutions that must ensure robust capabilities in order to guard billions of dollars in transactions; the health industry which is moving toward digital health records; energy companies adapting smartgrid technology and telecommunications companies that must ensure quality of service while also shielding millions of customers from fraudulent activities.

The coupling of McAfee's industry-leading security products with SAIC's CloudShield security products provides both companies with greatly expanded access to new markets and overall stronger combined solutions.

Moving on to acquisitions.

We completed in the quarter the acquisition of Vitalized Consulting Services, a leading provider of clinical business and information technology services for health enterprises.

The deal enables SAIC to expand in a commercial health provider market and leverage its information integration and data analytics expertise with BCS's healthcare IT and clinical workforce optimization capabilities to further grow its commercial and federal health markets converge.

Approximately 600 BCS employees joined SAIC.

Before I turn the discussion over to Mark I want to share several special recognitions.

The first accomplishment I would like to recognize is the successful launch of SAIC's commercially hosted infrared payload or CHIRP sensor into space.

The CHIRP sensor was integrated onto a commercial telecommunications satellite, the first time a national security payload has been hosted on a commercial satellite.

The CHIRP sensor uses an electro-optical telescope to persistently view a quarter of the earth from geosynchronous orbit.

Its wide field of view infrared sensor is used to sense bright spots on the surface of the earth that aid in the early morning of missile launches and to support other military missions.

The sensor is remotely commanded and monitored from the SAIC developed CHIRP Mission Analysis Center or CMAC in Seal Beach, California.

This program is an example of how the government can achieve significant savings by taking advantage of commercially hosted payloads based upon a more agile development environment.

And allows us to plan and implement space missions on shorter schedules compared to the time it takes to procure an entire satellite.

In as short as 24 months.

CHIRP was successfully powered on on October 23rd, and is currently undergoing [more] orbit testing.

First successful collections occurred on October 24th as recently reported in Aviation Week and Space Technology, the Air Force is impressed with the results so far.

Second, I am happy to recognize that in November (technical difficulty) from SAIC won NASA's prestigious Space Flight Awareness Award for our design in building a high technology fiber-acoustic test facility that will support development of NASA's new Orion space system.

Third, and also in Cybersecurity SAIC founded the Maryland Cybersecurity Challenge and Conference in October.

The 312 Challengers split in 52 teams across professionals, colleges, and high schools.

Maryland Governor Martin O'Malley helped launch the event and three weeks ago, NSA Director General Keith Alexander, and University of Maryland and Baltimore County President Freeman Hrabowski recognized the awardees at a dinner in their honor on November 18.

Fourth, I would like to recognize that SAIC is a proud founding partner and continuing supporter of Cyber Patriot, the nation's largest and fastest-growing high school cybersecurity challenge competition which is building the next generation of cybersecurity professionals.

This year's competition got underway in October with over 1,000 teams, representing all 50 states and will conclude in March 2012.

Fifth, I am glad to recognize that SAIC has been ranked one of the top 100 military employers by G.I.

Jobs magazine, in recognition of our long-term commitment to hiring former military members and our progressive policies for Reserve and Guard members called to active duty.

SAIC presently employs over 8,000 former military members, including over 2,300 disabled veterans.

Finally, I would like to point out that SAIC was recognized again this year on Newsweek's annual green rankings, rising to 44 among the greenest 500 companies in the United States, up from 192 last year.

SAIC recently announced its goal to reduce operational greenhouse emissions 25% by 2020, reinforcing its commitment to sustainable business practices and other corporate responsibility initiative.

Also, I'd like to update you on the CEO succession process.

The Board of Directors has established a special committee to identify and assess both internal and external candidates for the CEO position.

Their work is well underway with the expectation that a new CEO will be in place not later than my planned retirement date of June 15th, 2012.

You should note that since my retirement announcement and through my last day at SAIC, I continue to remain fully engaged and committed to executing my role as CEO ensuring we focus on creating enduring shareholder value.

In closing, I would like to emphasize once again that SAIC prides itself on its history of ethics and integrity.

While some aspects of our third-quarter performance were overshadowed by CityTime we performed well in new business development and cash flow while continuing to provide strong execution on programs of national significance, demonstrating the underlying strength of SAIC and its employees.

Mark will now cover the financial details for the third quarter of fiscal 2012.

Thank you, Walt.

As mentioned in today's release, our results for the third quarter were pretty much as expected before considering the effects of the loss provision concerning CityTime.

The CityTime loss provision was recorded as a $52 million reduction to revenue and $180 million charge [to] SG&A expense, aggregating to a $[230] million pretax loss.

We reflected a large portion of the charge to SG&A as nondeductible for tax purposes which is why the effective tax rate was well above normal for the quarter.

Consequently, the loss provision had a material impact in the financial results for the third quarter, and for the full fiscal year 2012 expected results.

We have provided a pro forma set of statements in today's earnings release to show our results with and without this item.

As Walt discussed, total revenues were flat in the quarter comprised of 2% growth from acquisitions offset by 2% internal revenue contraction.

All of the internal revenue contraction was attributable to a $52 million revenue reduction related to the CityTime loss provision.

We continue to generate growth in select areas of the business that are more attractive in today's market.

However, that growth is offset by wind-downs of a few larger programs completed earlier this year and broader contractions, primarily in certain defense and federal civilian areas.

Overall, the five parts of the business we call our strategic growth areas -- Cyber, ISR, Energy, Logistics, Readiness and Sustainment and Health -- rose internally in revenues 6% over last year, with ISR and Cyber being the most significant favorable drivers.

We recorded an operating loss of $17 million for the quarter, driven by the $232 million pretax CityTime loss provision.

Operating income, excluding the loss provision, was $215 million or 7.5% of revenue.

Within that, we also took a $19 million impairment asset charge related to certain technologies from our CloudShield acquisition made in 2010.

That accounted for about 70 basis points of operating margin.

Margin, excluding both the CityTime loss provision and the impairment charge, exceeded 8% in the third quarter, a level consistent with profitability in the first and second quarter.

Within that, it's important to note we concurrently and significantly increased research and development investments all year, which we believe will offer margin enhancement opportunities in future years.

Diluted earnings per share from continuing operations resulted in a loss of $0.27 per share this quarter with the CityTime loss provision having a $0.62 per share impact.

Ex CityTime earnings per share was $0.35.

Operating cash flow for the third quarter came in at $423 million, bringing year-to-date operating cash flow to well above $600 million.

Much of this stemmed from a three-day sequential improvement in days sales outstanding during the quarter, which finished in 71 days.

In the areas of capital deployment, we acquired about 3 million shares in the beginning of the quarter under our ongoing and completed the Vitalized Consulting acquisition, together totaling about $240 million in funds used in the period.

Now let me cover our operating results for our four segments.

Revenues for the Defense Solutions segment decreased by 8% in the third quarter compared with last year.

More than half of the revenue decline was when the revenue portion of our loss provision related to CityTime, the effects of which were entirely reflected in this segment -- the Defense Solutions segment.

The remainder of the revenue contraction was from the wind down of a US Army brigade combat team modernization contract, BCTM, which ended in the third quarter and other reduced activity on an infrastructure support services program.

Offsetting these declines we continue to ramp up on our Department of State Vanguard Enterprise Network IT program, and continue to drive growth on our Anaconda Systems and Software Maintenance program for the US Army.

We also experienced solid growth in our logistics business, driven by material resources in additional work by combat vehicle integration and maintenance activities.

The Defense Solution segment had an operating loss of $133 million, reflecting the CityTime loss provision.

Excluding CityTime the segment had operating income of $99 million or 8.5% of revenues.

Revenue from our Health, Energy and Civil Solutions segment increased 6% during the third quarter compared to a year ago, driven mainly by revenue from the acquisition of Vitalized Consulting.

Internal revenues grew 1% which reflects increases in several areas.

Delivery of nonintrusive inspection systems, design build activities related to geothermal power plant construction, healthcare, IT consultant services, and increased disaster recovery support services.

These were offset by declines in various federal civilian programs including those supporting NASA.

Operating margin for the Health, Energy, and Civil Solutions segment improved to 10.6% in the third quarter, reflecting increased deliveries of nonintrusive inspection systems and higher healthcare IT consulting services that's primarily from the Vitalized acquisition.

Both of those have higher profitability relative to other business areas in the segment.

The Intelligence and Cybersecurity Solutions segment total and internal revenues increased 5% compared with last year.

This increase was primarily driven by increased activity on our airborne surveillance programs, increased materials deliveries under an existing processing exploitation and dissemination contract, and increased cybersecurity program activity as well.

These increases were partially offset by a decline in activity on a variety of programs, particularly with DoD customers in the areas of intelligence analysis and maritime ISR.

Operating margin for the Intelligence Cybersecurity Solutions segment was 5.6%, down significantly from previous quarters.

The decline in operating margin was entirely driven by the $19 million impairment charge on the purchased intangibles related to CloudShield and also increased investment in R&D and bid and proposal expenses.

This was partially offset by revenue growth and in presales increase sales of higher margin proprietary products in the ISR arena.

The impairment charge was primarily associated with lower-than-expected sales of certain CloudShield products.

We however remain optimistic and committed to the future prospects of CloudShield.

In particular, the recently completed next generation deep packet inspection technology, embodied in the CS 4000 system are the foundation of that competence.

We believe our recently announced strategic partnering alliance with McAfee is a catalyst for increased sales across both commercial clients and our installed government business space.

The Corporate and Other segment had unallocated corporate costs of $16 million in the quarter, arising from recurring costs like stock options and other unallowable expenses.

That covers my remarks on the third quarter.

I'll now finish up with our forward guidance for the remainder of fiscal 2012.

That, of course, ends on January 31, 2012.

As you'll see in our third-quarter 10-Q filing, we have fully disclosed the risks associated with the CityTime contract.

While there's risk of possible additional losses, fiscal 2012 guidance does not include any charges beyond the $232 million CityTime loss provision we took here in the third quarter.

Also, given the difficulty of determining the timing of any payments with respect to the CityTime data, our cash flow guidance excludes any payment assumption this fiscal year.

Finally, we are continuing to provide guidance on a GAAP basis consistent with past practice which includes the impact of CityTime.

However, given the nature and magnitude of this item, we provided guidance on a pro forma basis without CityTime to show expected results of more normalized business activities.

Given that our fiscal 2012 GAAP guidance for revenue and cash flow are unchanged from last quarter, whereas earnings per share is reduced $0.60 for the full-year effect of the CityTime loss provision taken this quarter, that is the only change to fiscal 2012 guidance at this time.

Accordingly, we expect full-year fiscal 2012 revenues to come in between $10.6 billion and $11 billion and operating cash flow at $600 million or above.

GAAP diluted earnings per share from continuing operations is being adjusted $0.60 downward to $0.70 to $0.80 per share full-year guidance.

Guidance for EPS on a pro forma basis which excludes CityTime remains at the same $1.30 to $1.40 range we provided in our last Q2 earnings call.

As for fiscal 2013, we have historically provided initial guidance at this point in time during our third-quarter earnings release.

Going forward, we are changing our cadence to initiate guidance for our next new fiscal year to our fourth-quarter earnings release where we will have the benefit of having completed the previous fiscal year and will provide more time to evaluate developments in the federal budget cycle.

Accordingly, we are not providing fiscal 2013 guidance today but will plan to do so in March.

To summarize my remarks, we had some special nonrecurring charges this quarter which will likely capture the headlines.

However, performance across our broader business base showed both improvement and strength.

Excluding the two special items, CityTime and the impairment, internal revenue growth was flat quarter over quarter, reversing course from contraction in the first half of the year.

On that same basis, operating profits have stayed above 8% all year while we have increased IR&D investments by well over 50% year over year.

This reflects our view that building capabilities and differentiated technologies will be increasingly important in this market.

We improved day sales outstanding by three days during the third quarter, and have delivered almost $600 million in free cash flow so far this year.

Finally, our focus on strategic growth areas and larger contracts has yielded record wins in the $100 million plus category and a new peak in the value of bids outstanding as Walt mentioned earlier.

These are the performance metrics that better reflect the commitment and focus of the people of SAIC, which will continue to be the basis of our confidence and sound financial execution going forward.

With that I'll now turn it back to Walt.

Thanks, Mark.

I would like to conclude by thanking the more than 41,000 employees who remain focused and dedicated to solving our customers' and country's most difficult problems.

Their dedication and commitment provides the foundation for growing our enterprise.

With that, we'll turn it over for questions.

Stacy, we are now ready to take questions.

(Operator Instructions).

Edward Caso, Wells Fargo.

Hi.

It's actually Rick Huskilson on for Ed.

Thanks for taking my question.

Just the first question, nice job on the bookings in the quarter.

I was wondering if you could talk about the pace of bookings and client decision-making.

Once we started the government's new fiscal year if you see a change between this fiscal versus F Q4 of last year?

Well, we saw certainly the end of Q4 of the government's last fiscal year some optics right at the end.

And that continued a bit apace.

But we saw just like we'd expect to see at the beginning of this fiscal year, which represented two periods of our fiscal Q3, a little slowing of the pace, more normal to what we saw last year.

And if you recall, we were disappointed in the pace of award decisions at the latter half of the government's fiscal year.

And frankly, that was the basis for our reduced guidance going into the balance of our fiscal year.

But I would say the pace is pretty much normalized to where we saw it during the end of -- in the end of the last two quarters of the government fiscal year.

Okay, thanks, and then just real quick, I was wondering if you could give some thoughts on the super committee.

And now that they have come back and said they're not going to find the savings, did -- first did clients see an impact or did you see an impact to your clients on decision-making?

And has there been a change they came out and said we're not going to find the savings?

I think first of all, in the context of their inability to reach a decision on the -- with regard to that committee, although it's disappointing, frankly I don't think it's having a damaging impact to our business simply because the pace is based upon the FY 2012 continued resolution and that is, frankly, what we expected to see for this quarter.

And I think I'm reasonably bullish that they'll actually get to an omnibus before the end of this quarter.

And as we kind of said two quarters ago, we thought by the end of this calendar year we would see things normalized within the government and I think, frankly, that is regardless of the results of the super committee.

Thanks and just to clarify an omnibus are we talking about the government's fiscal quarter or your fiscal quarter?

Talking about the government's omnibus for the balance of government fiscal 2012.

So you think a decision could happen as early by the end of December on the omnibus or by the end of January?

Yes, they have to either do that or come up with some continued resolution.

I think if they can get some of the policy issues resolved I think there's a fairly good chance they will come up with an omnibus bill for the balance of the budgets for FY 2012.

Great.

Thank you very much for taking my questions.

Cai von Rumohr with Cowen and Company.

Yes.

Thank you very much.

You know, you gave us a number of the loss of at least [$230 million] on the CityTime contract.

Could you maybe give us will some clue in terms of what is in the 10-Q and I know that Mayor Bloomberg has asked for $600-odd million but kind of how did you come to these numbers?

And you know, how should we think about what is the upside left on those?

Cai, I know you appreciate the difficulty we have in describing it in any more detail, frankly, beyond what we just discussed with you today given that the US Attorney investigation is an ongoing investigation and we still have areas to resolve.

So, frankly I think it would be inappropriate for us to give you any more color on that at this point.

I wish we could but it just would be inappropriate.

Okay and then just the second one.

I know you didn't provide guidance for next year but L-3 today provided guidance for their services business to be down 19% next year, and Lockheed at a recent conference talked about their services business being down next year.

Can you give us any general color in terms of is there any chance of a flat year or is it more likely to be down and L3 talked about the OCO as a particular area of weakness.

What are you seeing in your Iraq- and Afghanistan-related work?

Cai, I think first of all we won't give guidance up or down right now for the next fiscal year, simply because I still think there is some priority shifting that is ongoing for the balance of fiscal 2012.

I think the best indicator we have is our win rate and our increasing backlog and, frankly, the fact that we have such a large number of proposals that are in the submit stage awaiting award.

So and I think that's all I would like to say about it but I'm bullish on the performance we have seen in the third quarter as an indicator of what next year should look like.

Okay.

And just the last one, you had mentioned that there was some slowdown early in this government fiscal year.

You know you are about halfway through your quarter.

Can you give us any color in terms of have bookings been slow for you so far in the fourth quarter or any kind of just general color at all?

Thanks.

Yes, I think what we thought we saw in the last few weeks of September an uptick in orders which represented the first part of our Q3.

And then, we saw the first couple of periods -- the next couple of periods of our Q3 which represented the first month and a half or so of the current fiscal year return to the normalcy we saw during the early parts of the summer and late spring.

So, I would say the normalcy we saw for most of 2000 -- or 2012 is pretty much continuing.

We are seeing more RFPs right now and in some of our areas like Cybersecurity and we are, most recently, we have seen at least in our case a couple of nice hundred million dollar wins in the last few weeks.

So I think it will be more comparable to what we saw in our second quarter as opposed to the end of our third quarter.

Thanks so much.

Does that help?

Yes, that's great.

Thanks.

George Price, BB&T Capital Markets.

Hi, thanks for taking my questions.

First, Mark, just on gross margin, just looking at it if I'm looking at it right kind of below what I expected down materially year over year.

What was the drivers for that was there anything one time there?

Or just if you could give a little color?

I don't spend a lot of time looking at gross margin to be honest with you, George.

We look at profit rates and I was pretty careful to separate out the nonrecurring items.

So in my book, we have had strong profitability.

Other than the special items all year we have had strong award fee scores, we did have quite a bit of material shipments in the third quarter from our non-intrusive inspection business but we also had some pass throughs as well that might have some impact on what you're looking at.

We had one material order for $30 million alone that was no fee, for example.

So, that said, I think we've had pretty consistent profitability to include the gross margin coupled with the pretty efficient absorption of our SG&A all year and strong performance on the fixed price in award fee areas to keep us above that 8% that I referred to.

Okay, fair enough.

Second question is notwithstanding some of the press about how people are going about trying to possibly make changes in the budget control legislation that is out there, how is SAIC or -- well, are you and how are you planning for the potential impact of sequestration?

I would tell you that I don't know that we think about it strictly as a result of sequestration.

We do and have been planning for the last couple of years that the budgets will flatten and tip in the 2012 and 2013 timeframe.

And that's exactly what's happening.

And the way we have dealt with that is we have put more and more emphasis, especially on our investments on areas within our markets that we believe will be enduring and offer higher growth opportunities than the market as a whole and those are the ones we covered earlier.

Those are within national security, ISR, Logistics, Readiness and Sustainment, Cybersecurity and then our Health IT business and our Energy business.

And I think that's how we are dealing with the inevitable budget reductions.

And that's very consistent with what we've said for the last 24 months.

And frankly I think were starting to see that pay off.

The additional IRD we've used this year and [B&P] we've used this year and the allocation of our SG&A has been focused on those higher potentially higher growth areas and we believe those growth areas, notwithstanding the budget downturn, will continue to have an enduring nature.

And so, that's how we are dealing with -- from a strategic standpoint, dealing with the inevitable downturn in the budget.

At the same time, we have continued to take cost out of our infrastructure and -- starting with our project alignment activities several years ago and that continues.

So becoming more cost-efficient, targeting our investments to the potentially higher growth areas within the declining budget is exactly how we are approaching that condition.

Okay.

A couple of quick housekeeping [items] for Mark.

Mark, if [you] missed it I apologize but did you give, could you give the VCS revenue in the quarter and what was the share count for the EPS excluding the charges?

Well, the share count is unchanged by the charges and (multiple speakers).

It's right on the face of the income statement if I'm understanding your question, George, the 329?

The shares -- .

I thought there might have been some exclusions, given that it was a loss.

I can circle back (multiple speakers).

That's miniscule so to clarify that.

That's tiny, okay.

And with respect to Vitalize, I'll just say this, that on a full-year basis it's north of $100 million and so it's between $100 million and $200 million and that's about all I want to say.

One quarter's, I think, a little too much in this context.

Okay, all right, fair enough.

Thanks.

Jason Kupferberg.

Jefferies & Company.

Thanks, hey guys.

Mark, I was hoping you could clarify some of the comments you made around the cash component on CityTime.

Obviously we know the size of the charge to the P&L but I think you mentioned the cash flow guidance does not assume any outflows related to CityTime.

Can you just clarify how we should potentially think about cast cash versus non-cash components here and what will openly dictate the amount of cash outflow?

And are you in effect saying that, there will be some amount of cash outflow in Q4 but you just can't quantify it?

Wanted to make sure we have that framed properly.

The bulk of the provision we took would represent our best estimate of the resolution at this time.

But as Walt said, this is an ongoing matter.

And there could be changes to that as we hopefully reach a resolution.

There is some outstanding receivable that would be baked in to the process so it doesn't exactly agree to the provision in our books.

But for orders of magnitude, the provision is a reasonable proxy of the cash flow, other than the receivable we have which is $40 million.

And what we are saying in the guidance is, while it is certainly possible that a resolution happens this fiscal year, we would not call that likely and that the -- so the resolution and eventual payments and cash outflows would be next fiscal year.

And so, as a result of that we decided not to put it in this year's cash flow guidance.

But we were clear to state that assumption just in case a faster resolution does occur.

Okay, okay.

That makes sense.

And can you guys just talk a little bit about the primary criteria that the Board is looking for in the context of the CEO search?

And by the way, Walt, congrats on your retirement.

Well, they certainly have to be articulate.

No, I think it probably would be inappropriate for me to talk about the specifics of the search that, frankly, is at the discretion of the Board.

Okay, okay.

I understand.

And then just, finally, I know you talked a little bit about Vitalize as far as near-term.

But on a full run rate basis in fiscal 2013, how should we be thinking about the revenue run rate because, Mark, I think you said $100 million to $200 million but I wasn't clear.

Is that an annualized number?

Yes, that would be an annualized number.

I gave you a pretty wide range but I will tell you that the business is performing very well and is growing well into double digits and we expect that to continue.

Okay, sorry.

Just one quick one.

Vanguard, do you still expect that to get the full run rate in Q2 of fiscal 2013?

Yes, we still expect that to happen.

Okay, terrific.

Thanks, guys.

Bill Loomis.

Stifel Nicolaus.

Just focusing on the Intelligence and Cyber group.

If I look sequentially, it looks like they didn't have as much awards as some of the other areas.

Why do you think that is?

It's clearly one of your fastest-growing segment, it is your fastest-growing segment.

Why didn't we see more actual award activity in the last quarter?

What do you think -- do you think that changes here in the January quarter?

Well, if you remember we had some very, very strong bookings at the end of last year and the beginning of this year that funded -- that has been funding and will continue to fund the growth within the cyber space.

And so the cyberspace was slow in this quarter, simply because they had such a big second quarter as did ISR.

I [shouldn't] say cyber had a big end of last year and early beginning of this year.

ISR had a big second quarter and so that is really the difference.

And yes, we've seen a significant uptick in proposal activity in the third -- in our third quarter and now going into our fourth quarter.

So we expect that to normalize with the rest of the business.

Okay and then on the two contracts, the DLA tire contract and then the JLA contract, just first on the DLA contract, it's a $1.1 billion value.

What is the revenue run rate going to be versus the prior and then also now that you are prime how does that impact the margin outlook?

That's a good question.

We expect to see a run rate over that seven years of nominally $100 million a year.

And the margin will be a little lower, all right?

And that is --.

That is how we did it and that is what we expect but it is a magnificent contract for us and I think will be generating EPS for us for a long time to come.

Any -- can you share with us just trying to get the relative magnitude between the prior one and what the new one is going to deliver in terms of operating income contributions.

Is it going to be higher in terms of operating income dollars, actual dollars not margin?

Yes, yes.

When you compare it to just the sub work we were doing under Michelin.

Okay and then on the JLA contract, how does the revenue run rates change there and what is the outlook over the next year with the MRAP type work in the theater.

It's going to go up but, frankly, I don't have it on the tip of my fingers the exact amount that it will -- percentagewise -- but it will go up.

it will go up slightly.

I'll tell you this past period, this last month was the highest in-country content of SAIC employees in the AOR since the action began in Afghanistan.

And notwithstanding the flatlining in some cases declining of OCO funding, the nature of the things that we do we are doing, we expect to see continue for the foreseeable future.

And actually growth from what you just said, right?

Yes.

In a couple of areas we will see it grow.

You know, we are not doing base maintenance over there.

Michael Lewis.

Lazard Capital Markets.

Thank you.

Walt, just to follow up on Bill's question.

There is a large countermine contract that will be awarded here in the next few months and with regard to your bid on that, how important do you think it is with regard to your logistics expertise in winning a position on that contract?

Mike, I'm not going to talk about a future competitive contract, all right?

Frankly, I'm not even sure we have a position, established position on our bidding on that contract yet so I will just -- I'll tell you if and when we win it.

(multiple speakers).

That's fair.

That's fair.

If I could just shift gears to Mark for a second.

Mark, can you help me understands the costs of the litigation and the consultants you have hired.

Now is that already incorporated into the reserve you have taken or is that an additional cost to the P&L?

Can you help me understand how that works through?

Sure, you cannot reserve for cost of that nature.

Lawyers, consultants, etc.

So you expense those as they are incurred Southern that they are not part of our loss provision.

However, our guidance does reflect our estimate of our ongoing legal costs and other costs related to this matter.

So we have covered that base.

Can you define what that expectation is on the costs?

If it is significant, we will talk about it in the context of our fiscal 2013 discussion but in the context of our overall SG&A it is still nonsignificant today.

And again, it is fully covered in the guidance and not impactful to our overall results.

Okay.

And then, just one final question, can you remind me of the duration of how you define your funded backlog?

Is it a 12-month period?

Nine months, 15 months?

Can you help me out here real quickly?

It is whatever the funding period is from the contracting officer.

So it can be a year.

It can be more.

Generally it's not (multiple speakers).

Okay, well, then what's the average duration of your funded backlog right now?

Well, I would say it is notionally somewhere between four and six months.

Eric Olbeter.

Pacific Crest Securities.

Hey guys.

Thanks for taking my question.

Really quickly, Mark, if I back out the $232 million CityTime charge it appears that SG&A came down pretty dramatically both year-over-year and quarter-over-quarter.

Can you tell us was there anything else in there we should be thinking about that or is that sort of really sort of normalizing around $100 million now?

Well, I will say that the R&D expenses are going up pretty significantly year-over-year as I mentioned up 50% this year over last year.

So that is climbing and that is fully in the SG&A, but we have offset it to a significant degree in other G&A-related costs.

You will want to make sure you redo the revenue numbers for CityTime as well, when you are doing your calculations because there weren't any other major SG&A hits or credits in the quarter that I can think of other than ongoing increases in R&D and reductions in G&A pursuant to our various initiatives in place.

Okay.

That's helpful, I will look at the numbers again.

And for the fourth quarter and I know there's a lot of moving parts that from looking into DC and budgets and trying to figure out the omnibus passes.

The guidance for the full year has a pretty big window there of around $400 million.

Can you give us a sense of sort of what brings you closer to the bottom end of that guidance and what brings you close to the top end of revenue?

We don't want to give point estimates within the range but, actually, based on the experience we are seeing in the market and the comments Walt made earlier, the historical projection we've had in the past or historical distribution of revenues from Q3 to Q4, that general pattern we expect to be the case.

So, we expect Q4 will be a downtick from Q3 by some measure that's in part due to a lesser number of productive workdays and holidays.

But on the other hand, we have as Walt said we've got some good opening backlog and some good momentum in some areas ramping up.

So, expect a downtick but not too different than historical trends.

And at this time I would like to turn the presentation back over to Mr.

Levi for closing remarks.

Thank you, Stacy.

On behalf of the SAIC team, I want to thank you on the call, everyone on the call, for their participation and interest in the Company.

Have a good evening.

This concludes our call.

Ladies and gentlemen you may now disconnect and have a great day.