Leidos Holdings Inc (LDOS) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen.

Thank you for standing by.

Welcome to the Second Quarter Fiscal Year 2013 Earnings Conference Call.

During today's presentation, all parties will be in a listen-only mode.

Following the presentation, the conference will be opened for questions.

(Operator Instructions)

This conference is being recorded today, Thursday, August 30, 2012.

I would now like to turn the conference over to Mr. Paul Levi, please go ahead, sir.

Thank you, Camille, and good afternoon.

I'd like to welcome you to our Second Quarter Fiscal 2013 Earnings Call.

Joining me today are John Jumper, our Chairman and CEO; Stu Shea, our COO; 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, the statements represent our views as of today.

We anticipate that subsequent events and developments will cause our views to change.

We may elect to update the forward-looking statements at some point in the future, but we specifically disclaim any obligation to do so.

I would now like to turn the call over to John Jumper, our Chairman and CEO.

Thank you, Paul, and good afternoon everyone.

During the call today, we'll start with a look at our quarterly performance, followed by a quick comment on market conditions, and then highlight the next step in our ongoing strategy execution.

Following that, our COO Stu Shea will amplify details about our performance in the future.

He will also cover our recent acquisition, the planned divestiture of our test and evaluation business, and will conclude with the business development results and progress in some of our growth areas.

Stu will be followed by our CFO Mark Sopp, who will go into details on the financial results.

Then we'll open the lines and take your questions.

As reflected in our earnings release today, our revenue performance reflects a strong market position, the disciplined execution of our strategy, and the dedicated efforts of 40,000 remarkable employees who share our pride in SAIC.

The fundamental strength of our core business and intensified efforts in business development have enabled us to grow in markets that are uncertain, and in many areas declining.

During the quarter, we were able to report revenue growth of 10%, of which 8% is internal growth.

While 8% revenue growth this quarter stands tall among our competitors, our market faces significant uncertainty, and we're being cautious on revenue expectations for the coming quarters, as Washington deals with the fiscal situation and the spectre of sequestration.

In the previous earnings call, we discussed the potential impacts of sequestration, and I commented that it's hard to imagine a situation where automatic triggers replace debate and compromise with regard to critical government programs.

Since that time, I've engaged senior government officials and industry partners to help make our government leaders aware of the profound consequences of automatic program cuts that could be well above 10%.

This was reinforced in a Congressional budget office report released on August 22 citing the possibility of a recession if Congress fails to avert a series of tax increases and budget cuts due in January 2013.

I do believe that the consequences are becoming better understood at senior levels of government, and I also believe that the Congress will take actions as late as the sequestration trigger for some months beyond the first of January 2013.

This of course only serves to extend the uncertainty that surrounds the entire issue, which may give pause for government procurement and funding, but it does, however, also buy time to replace the automatic sanctions with reasoned debate.

In our March and May earnings calls, we talked about the strategic review.

We've been having this under way with our Board of Directors for some time, as you know.

Our strategy has been unfolding over the past few years, with emphasized growth areas in intelligence, surveillance, and reconnaissance; energy, and health.

We particularly emphasized gaining more strength in commercial energy and health.

We now have a significant growing $1-billion presence in the energy, environment, and infrastructure space, all of which have a common thread in engineering.

As we go forward, we will refer to this business area as engineering.

Relative to our health business, we have been supporting the government in its electronic health records program for more than 20 years.

As you know, in the past few weeks we finalized the acquisition of maxIT Healthcare, previously the largest private independent health care IT consulting Company in North America.

MaxIT provides a comprehensive range of health care IT services and solutions, primarily to commercial hospital groups and other medical delivery organizations.

This addition of approximately 1,300 employees complements our earlier and very successful acquisition of Vitalize Consulting Solutions.

By itself, Vitalize has enjoyed double-digit growth, and our health business will be stronger with the addition of maxIT.

We see this as a strong growth market for the next five to 10 years, and has compelling synergies with the work we do on the government side.

SAIC is now one of the largest electronic health record implementation and optimization consulting firms in the country.

This is another step in executing our strategy.

In addition to adding critical mass in adjacent and commercial markets, we have also told you that more has to be done to allow our businesses to become more cost-effective and more competitive in their own space.

Over the past few years we have consolidated our organizational structure, introduced effective shared services and modernized enterprise IT systems in ways that have enabled more competitive pricing and more efficient business control processes.

More than a year ago we initiated major efforts to increase our bid and proposal activity as a way to offset market pressures, and we have built world-class capture and proposal teams as a result.

All of these efforts have been very successful, but the time has come to take the next steps on our journey to make our differentiators more evident to our customers and investors, and to go to the next level in eliminating the potential punishing effects of organizational conflicts of interest, or OCI.

One step in that direction is our decision to sell our operational test and evaluation business.

This business has annual revenue of approximately $75 million, and by its nature has faced increasing constraints due to possible OCI.

We are close to completing the sale of this business, and believe the buyer will be able to better capitalize on the business positioning, capabilities, subject-matter expertise, and client relationships without the potential OCI constraints that this business faces today.

We expect this to complete this transaction by the end of our third quarter.

The big step and the big news for all of us today is to announce that the SAIC Board of Directors has unanimously approved a plan recommended by the Management team to pursue a separation of SAIC into two independent publicly traded companies.

We intended for the separation to take place in the form of a tax-free spinoff to SAIC shareholders of 100% of the shares of a newly formed Company focused on government technical services and enterprise information technology.

The separation is expected to occur next year, subject to the final approval of the Board and certain other conditions.

This planned separation will result in two companies that Stu and Mark will more fully describe in a few minutes.

As time goes on, you'll see that our acquisition activities and the plan we are announcing today are consistent parts of the same theme, to add strength and mass to the most promising growth areas on the solution side, and to leverage our decades of science and engineering expertise in both government and commercial businesses.

It was also become clear that the power of our government technical services and enterprise IT business, when free from the complications of avoiding OCI, will be even more competitive and able to expand into spaces previously denied.

We are convinced that we are creating two businesses with unleashed potential and the ability to grow, even in depressed market conditions and to the enduring benefit of our customers, our employees, and our shareholders.

Finally, let me say that the Board and its leadership team are excited to be into this -- to have transitioned into the execution phase of our strategy.

We plan to see this come to a completion by the end of next year.

With all that on the table, let me turn it over to Mr. 24/7, our COO, Stu Shea.

Thanks, John.

As you can see from John's introduction, we have a number of important topics to cover today, not the least of which is our strong performance in the face of difficult market conditions.

Frankly, it's a testament to the strong disciplined planning that we've done over the past two years to prepare for these tougher times.

We have worked methodically to tighten our strategic focus, increase our investments and differentiated capabilities, significantly increase our R&D and B&P investments, deploy our capital for a number of key acquisitions, and deliver to our shareholders a track record of performance.

As we position SAIC for the future, we will continue deliberately shape our portfolio along strategic lines.

The divestiture of our operational test and evaluation business, as well as the continued expansion of our help offering, are both solid examples of that focus going forward; but clearly our decision to separate SAIC into two companies is a significant step in taking our strategy to the next level.

The entire Management team is excited and committed to this change to be more focused and better aligned with our markets, with the needs of our end customers, with the interests of our investors, and with the growth opportunities for our employees.

Let me offer some observations about what this means.

First, the separation provides greater portfolio clarity for our investors, and allows the market to gain greater insight into the performance of our diversified businesses.

Clarity into our financial performance in each market we serve is important to our investors.

Second, separation enables us to unlock substantial shareholder value by removing organizational conflicts of interest that have prevented our pursuit of new business in both the services and the solutions markets.

Third, by managing these two distinct businesses differently going forward, it enables significant operational efficiencies, produces more cost-competitive offerings, and unlocks the potential for increased revenue and margin performance.

Finally, we see this as a positive enabler for our employees as it will provide them with additional career opportunities at SAIC made possible by an enhanced market position due to growth.

As John mentioned earlier, this separation well result in two differentiated businesses.

One will be a government technical service and enterprise IT Company built around a leaner, more cost-efficient cost structure.

As one of the largest pure-play government services companies in the market, it will compete in a broad market space, leveraging deep mission knowledge and customer relationships in a more competitive and agile organizational structure.

Moreover, it will be free of potential organizational conflicts of interest restrictions caused by its current relationship with other SAIC business pursuits, specifically those involved in developing ISR solutions and products for the Department of Defense and the intelligence agencies.

In the past, we've had to carefully navigate these conflicts.

Eliminating them reduces the Management burden and the need for mitigation.

As we begin to plan for the separation, we've already identified over 150 new business opportunities, totaling almost $25 billion between now and fiscal year 2016 solely in the Department of Defense that we were not able to previously bid on under the current SAIC structure due to OCI.

This includes systems engineering and technical assistance, or SETA efforts, cost and financial analysis, program office support, and logistics and supply chain opportunities; likewise, we'll be able to expand our offerings to the intelligence community and civil agencies for all of the efforts just mentioned.

Estimated pro forma 2013 fiscal year revenue for the future technical services Company is $4 billion.

The second Company created in the separation will have a solutions focus, delivering science and technology solutions in three high growth markets that reflect high-priority, long-term global needs -- that is national security, engineering, and health.

These three markets operate in complex, data-rich environments, and are foundational for securing the future.

These markets contribute to the future of our families, our communities, and our world.

We believe we have a unique opportunity for horizontally integrating across these markets our experience in developing mission-critical systems, applying robust cyber security defense, and offering solutions for synergies in big-data analytics.

Moreover, the elimination of OCI with SAIC's technical services business will allow us to have unimpeded access to an estimated 700 new contracts under 78 major DOD ISR programs, totaling $37 billion annually of new business opportunities that are not available to us today.

This includes science and technology opportunities in both major defense acquisition programs, and programs of record in multiple C4 ISR regimes, specifically maritime ISR, US Navy airborne programs, battle-space awareness, maritime domain awareness, electronic warfare, and missile warning programs, as well as logistics readiness and sustainment growth across a range of both US and international customers, just to name a few.

SAIC's ISR systems in theatre have had a profound impact on the war fighter over the past few years, so eliminating these OCI roadblocks allows us to expand and extend our contribution to our national security posture.

The estimated pro forma revenue for FY 2013 for the future solutions-focused Company is $7 billion.

Now it's our intent that these two new companies will have capital structures, liquidity credit ratings, and guiding principles that are all customized to meet the operational needs of each Company, while always maintaining a strong focus on shareholder value creation and returns.

We're not prepared at this time to talk specifically about many of the topics that will clearly be on your minds regarding leadership decisions, organizational construct, headquarter locations, et cetera, but we intend to do so during the coming months.

In a little bit Mark Sopp will, however, provide some additional details on the capital structures and some of our guiding principles in his remarks; but before he does that, I want to take some time to offer two examples of recent successes in our health and ISR markets, both of which are the result of long-term planning and investment.

In these, each act is critical building blocks in our future structure.

As John mentioned earlier, we recently completed the acquisition of maxIT shortly after the end of the quarter.

MaxIT and our earlier acquisition of Vitalize Consulting Solutions are solid examples of our strategy in action.

For the past three years, we've continued to expand our focus on health.

The acquisition of maxIT is another critical step in that plan.

A combination of maxIT and Vitalize Consulting Solutions makes SAIC one of the nation's largest commercial consulting practices in electronic health records, or HER, implementation and optimization.

From a strategic perspective, we view the electronic health record as a foundational element that can be leveraged for the improvement of health care quality while reducing cost.

The execution of our strategy thus far has enabled us to solidify a leadership position in EHR-related services, and sets the stage for future waves of growth in systems interoperability, advanced analytics, as well as clinical health sciences and business integration.

These additional growth avenues will also depend on the data flowing through the HER, and the business processes and workflows that encapsulate them.

Leveraging health data is key in the evolution towards value-based health care in the United States.

We see a similar pattern of potential data leverage emerging in the Canadian health care market as well.

The work that we've been doing for the Saskatchewan Health Services positions us well for further expansion in the Canadian health market.

Although Canadian health care is a publicly funded and provincially administered system, the drive towards improved quality achieved in an economical way remains unchanged.

We are not only excited about the potential synergies of our commercial health activities with our government work, as John has mentioned earlier, but also continuing to extend our health business to the rest of North America and beyond.

Changing to the ISR market.

SAIC continues to expand its presence in airborne ISR development, with several critical operational successes in theatre.

The recent award of DARPA's anti-submarine warfare continuous-trail, unmanned vessel, or ACTUV, development contract, now positions SAIC as a leading-edge maritime ISR system provider, with unique capabilities for the operational needs of tomorrow.

As we've opined for several years now, the evolving maritime threat in the western Pacific, and the decrease in US Navy manned surface vessels underpins the criticality of autonomous maritime systems such as ACTUV.

Under a contract awarded by DARPA for approximately $58 million, SAIC was selected as the only Phase II system development winner, despite stiff competition.

In this landmark program, we will build and deliver to DARPA a 132-foot fully autonomous maritime system that tracks quiet diesel electric submarines for long durations by combining multiple sensor types, advanced sensor fusion, automated perception, and mission execution.

Our wave-piercing trimaran design reflects the results of deep technology development, and modeling and analysis that validated the suitability of our Phase I platform concept for the broader mission requirements.

SAIC collaborated across industries and academia to bring together a team of leading innovators in autonomy and sensor fusion and a chip design, construction and propulsion including NASA's Jet Propulsion Lab, Carnegie Mellon University, and Oregon Ironworks.

With the ACTUV program, SAIC is well-positioned to shape the future of unmanned anti-submarine systems and sensors, and be a leader in unmanned naval systems for the nation.

Moving now to our business development results.

Net bookings totaled $2.2 billion in the second quarter and produced a net booked-to-bill ratio of 0.8.

We ended the quarter with $16.7 billion in total backlog, $5.5 billion of which is funded.

Compared with Q2 a year ago, this represents a 6% decrease in total backlog, but a 5% increase in funded backlog.

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

From the start of Q2 through today, we have won 13 opportunities valued at more than $100 million each.

Added to the seven wins of this size that we achieved in Q1, this brings our year-to-date total of $100-million-plus wins to 20.

These larger programs continue to be the fuel for our growth.

We've continued to earn outstanding win rate on new business opportunities, achieving over 60% of total-dollar value win rate on opportunities this fiscal year.

This consistently high win rate is the result of a solid track record of strong program performance and execution, as well as targeted investments in technology, capture, and proposal development.

Finally our submitted proposals awaiting decision continues to grow.

We currently have $36.8 billion in submitted bids awaiting award, and that includes $23.1 billion in IDIQ bids, and $13.7 billion in definite-delivery bids.

This is $7.6 billion, or 26% higher than Q2 a year ago.

This reflects our added emphasis on bidding on more opportunities in areas where we can offer best-value solutions to our customers.

Coupled with our strong win rate, we expect that this will produce growth opportunities when these procurements are ultimately decided.

Let me pass the call now over to Mark Sopp, who will cover our financial performance for the quarter, as well as a few more details on the separation.

Great, thank you, Stu.

8% internal growth was the primary financial highlight for the second quarter.

The major drivers of that performance were scope increases and new contract ramp-ups on several large programs within our defense solutions and our intelligence and cyber security operating segments.

This included increased demand from our Army customer down in Huntsville for a systems and software development program that's called AMCOM; the ongoing ramp-up of both the Vanguard contract with the Department of State, and the expanded US military tires logistics contract; and increases in several mission-critical ISR and cyber [SIGIN] programs, providing advanced technologies and life-saving solutions to our war fighters.

In addition, internal growth continues to be strong in our commercial health area focused on electronic health records.

While our five strategic growth areas -- cyber, ISR, engineering, health and logistics -- collectively produced 10% of internal growth, it is important to note that our C4 business area within the defense solutions group posted double-digit internal growth, as well.

This underscores what John said earlier -- our strategy to be more aggressive in business development, particularly on large programs, would provide new sources of growth despite the head winds in the government market.

Further, we've been more aggressive partnering with small business, and are finding this a positive discriminator in today's procurement dynamic.

Our revenue performance in the first half of the year, our large pipeline of outstanding bids, and our acquisition of maxIT are foundations for our increased revenue guidance for the year, which I'll touch on later on.

Operating margin was 6.7% in the second quarter.

That's significantly down from Q2 of last year, which was 8.1%.

Part of this reduction pertains to performance; part pertains to issues surrounding government funding; and a significant amount from discretionary costs we've undertaken to benefit the Company in the long term.

I do want to spend a few moments and walk through this area in some detail.

On the performance side, we had $5 million in net project write-downs in the health, energy, and civil solutions segment, primarily driven by three different engineering and construction projects that are in various stages of commissioning and completion.

These projects have encountered schedule delays and associated cost increases, attributable largely to subcontractor and equipment performance, which we are confident we have now remediated.

Conversely, this segment had about $7 million of net write-ups in Q2 of last year.

These items eroded year-over-year operating margins by 40 basis points on a consolidated level, and 170 basis points for the health, energy, and civil solutions segment.

Relating to the government funding environment, we took a $6-million charge in the second quarter related to the contract termination negotiations between Boeing and the Army for the BCTM program, where work wound up about nine months ago.

This reflects our updated best estimate of contract profitability for the latter stages of the program, where Boeing and SAIC were working under a non-definitized contract.

This charge was taken in our defense solutions segment, and eroded consolidated operating margin by roughly 20 basis points in the second quarter, and segment operating margin by roughly 50 basis points.

The third category, and most significantly, we had some charges related to improving performance in the longer term.

First, as part of completing our corporate move to northern Virginia, we incurred $9 million in expenses, primarily related to retention and severance.

Second, we also incurred about $2 million in consulting costs related to our strategic review and our work toward today's separation announcement.

These two items, the corporate move and the consulting costs, were reported in the corporate segment.

Finally, we incurred $3.5 million in costs in the health, energy, and civil solutions segment for leased exit costs stemming from the consolidation of production facilities for our Reveal and VACIS product lines.

Those three discretionary items eroded consolidated operating margin by 50 basis points in the second quarter.

Taking all three categories, operating margin was adversely affected by over a full percentage point in the second quarter, the absence of which would have placed us in our normative range of 7.5% to 8% of sales.

Moving on to the non-operating area, we had some favorable developments which partially offset the effect of the items I just mentioned.

We resolved a long-outstanding legal matter related to our sale of DS&S several years ago, releasing $4 million of pre-tax deferred contingent gain on that transaction.

On the tax side, our effective tax rate was about two points less in Q2 of this year versus last year, in part from the tax-deductible portion of our dividend, and also a couple of fairly minor favorable adjustments.

Our normative tax rate, reflecting the benefit of the dividend, but absent any benefit of the research tax credit, is 37.5%.

Earnings per share from continuing operations was $0.32 for the second quarter.

That was consistent with our overall plan for the year.

On the cash flow and the balance sheet side, operating cash flow for the second quarter came in at a strong $200 million, reflecting a seven-day sequential improvement in day sales outstanding, which finished the quarter at 63 days.

The DSO improvement stemmed from a good payment rhythm from the government, but also and significantly, process improvements associated with the centralizing of billing and collection functions in our three operating groups.

We finished Q2 with about $750 million of cash on hand, and that's after we paid off $550 million of debt as planned in July.

All of our remaining $1.3 billion of debt is long- term, with the nearest maturity in year 2020.

That wraps up my comments on the second quarter financial performance, and now I want to finish up with guidance and also comments on the capital structure perspectives regarding today's separation announcement.

As our release states today, we are bumping up our revenue guidance for fiscal 2013 based on solid results in the first half and considering the recently announced acquisition of maxIT.

Fiscal 2013 revenues are now expected to be between $10.9 billion and $11.4 billion.

Our outlook for Q3 and Q4 is appropriately conservative.

Our guidance reflects an estimated reduced pace for the MRAP JLI program, and also the DISA GSM programs in the second half; also, overall caution on new and incremental revenue sources, given the stressed federal budget environment.

On the EPS side, guidance remains unchanged at $1.26 to $1.36 for the year, which reflects amortization and integration cost related to maxIT, and new expenses related to the separation process we've been discussing here.

Cash flow from operations guidance is also unchanged at $150 million or higher for the year.

Now with respect to the separation plans that we are announcing today, we will be evaluating the details on how the two companies will be capitalized over the coming months leading up to the separation date next year.

There are some aspects, however, that we can share today.

First, SAIC today has low capital intensity, and generally has stable, predictable, and strong free-cash flows.

Both companies should share these same favorable attributes after separation.

Stemming from that, our current plan is to continue the recently announced regular dividend in the aggregate across the two companies.

The precise allocation between the two will be determined later on.

With respect to the cash deployment strategy after dividends, the solutions-focused business will be delivering science and technology solutions in three global, high-growth markets, spanning both government and commercial clients and national security, engineering, and in the health domains.

This growth-oriented Company is likely to conduct meaningful M&A, and thus will require a capital structure which provides attractively priced investment capital.

Fire power and low cost of capital are important design criteria here, and we are committed to maintaining an investment-grade credit rating for this business.

The business that will be focused on government technical services and enterprise IT will at least initially have a more limited M&A strategy.

Having significant investment capital is of lesser relative importance here.

With that in mind, and as is customarily the case, we do plan to raise the debt capital in conjunction with the spin-off transaction.

Our preliminary plan would be to raise $500 million to $700 million of debt on the services business just prior to the spin, with the major it of those proceeds being retained by the solutions business.

This would put the services business debt-to-EBITDA ratio in the 2x to 3x range.

This will balance out the debt between the two companies, leaving both in strong financial condition and with appropriate capital structures.

As Stu mentioned, but worthy of repeating, we have deployed experienced teams that will engage in organizational design and business process re-engineering activities as a fundamental part of this overall process.

Both the solutions and service companies will be designed to be more cost-effective, more price-competitive, agile, and more focused in their marketplace for greater success and improved financial performance.

That's the real exciting part of the next chapter for SAIC.

With that, I'll hand it back over to John.

Thank you, Mark.

First, I realize we've used more time than usual with the expanded content of today's call.

Thank you for the extra time to process today's announcement.

We look forward to answering your questions today and are committed to providing open and timely communications to you throughout this process.

With this announcement, we plan to enhance our overall investment community outreach, so the new SAIC story can be better understood.

We've also filed a briefing with the SEC that covers the major points of our planned separation, which we hope you'll find useful.

Second, for the record I'd like to mention that SAIC paid a $0.12 per share dividend on the 30th of March, 2012, and that our Board of Directors will meet next on September 14 to address the next quarterly dividend payment.

Finally, please allow me to acknowledge the diligence of our Board of Directors, who have vigorously engaged and challenged the leadership team, and devoted many additional hours of deliberation and council to help our team arrive at these necessary but complex decisions about SAIC's future.

I'll speak for both Stu and myself in thanking the leadership team for a work ethic that only comes with true selfless devotion to the task at hand.

There are too many to mention, but starting with my own wingman Stu, our leaders have been the models of diligence and professionalism.

I'd like to assure everyone on this call that the leadership team is fully aware of the task that lies before us in executing the planned separation.

We will execute that task with the greatest respect for our customers, our employees, our shareholders, and our investors.

What will emerge are two powerful companies of significant scale.

Our new groups and business units will be able to leverage existing market power and they will be more recognizable from the outside.

Our line leaders and proposal teams, already feeling the margin pressures and bare-knuckles re-competes, will operate in cost-conscience organizations all unconstrained by potential conflicts.

In our growth markets, we will design organizations to leverage our ample technical skills in ways that embrace our customers' growing concern about cyber security in government and commercial markets, even as we help define the next level of information security and performance in the cyber world.

Thank you all very much, and now I'm going to turn it back over to Paul to answer your questions.

Thank you, John.

Camille, we'd like to begin with the questions.

(Operator Instructions)

Mike Lewis, Lazard Capital Markets.

Good afternoon.

Actually, it's Mike Smith in for Mike Lewis.

How are you guys doing today?

Good, Mike.

Excellent.

Just a couple quick ones.

On the two separate businesses, thanks for providing the pro forma revenue, but do you have a pro forma operating income for 2013?

Mike, Mark Sopp here.

We will provide that later on when we get down the road.

We've got a lot of design ahead of us.

The team's going to be very focused on cost efficiency, and so it's just premature until we get farther down the road to provide that, but we will be very transparent in those expectations at the right time.

Okay, great.

Secondly on GSN, from my understanding it's still in under protest.

I think you guys submitted a couple protests on that particular program, but how was that factored into the guidance at this point?

We have eliminated revenue from that program in our guidance as a cautionary measure, but we're certainly hopeful that we get a better outcome.

Okay, and if I understand it right, you guys are still collecting revenue under the program right now, or is there a stop work?

We are still collecting revenue today, correct.

Okay, great, thank you.

Jason Kupferberg, Jefferies & Company.

Thanks, guys, congrats on the announcement.

I just wanted to ask a follow-up on one of the prior questions.

Just coming back to the margins, I understand it's premature to give us target margin for the individual two new companies, but in aggregate should we still be thinking about the collective margin structure being in the 7.5% to 8% range, or do you see it being higher because of some of the cost efficiencies that I think you talked about in your prepared remarks?

Directionally, would the combined margins be higher or more similar to what SAI looks like today?

Great question.

We do believe our normative margins today are indeed in that 7.5% to 8% range before non-recurring expenses that I described in my remarks, as an example.

Some of those will continue, but in terms of the pure business, that's the baseline today, and we will have to see what the market forces dictate in the shorter term, but we will be designing to be maximizing financial performance.

We will be endeavoring to improve that number, given the portfolio positions we have.

That's the challenge to the team.

Okay, and just your thoughts as we head into the last month of the government fiscal year here.

What are you thinking in terms of potential for budget flush?

Would it be something on the order of kind of a normal intensity of spend here, or not, just given some of the macro uncertainties?

Yes, Jason, this is Stu.

We're seeing a steady increase in the award decisions each period, and the beginning of Q3 was particularly strong in terms of those awards.

When we start looking at our bookings performance, we're seeing an up-tick in that towards the end of Q2 and beginning to accelerate as well into Q3.

When you translate that into a strong Q3 booked-to-bill, we see Q3 being very strong.

It's still expected on a year-to-year basis to be at 1.0 or better, so that really is not really as much of a flush as more of a decision-making process on the part of the government.

Just to clarify that, the 1.0 plus, is that what you're now thinking for full-year fiscal 2013?

I know you're running about 0.8 through the first half of the year, and I think you had been targeting something a little north of 1.0, maybe 1.1 plus.

Is it more likely to be the lower end of that range, just given where you are year-to-date?

Yes, it is at 0.8 now, and we're looking to see it get to year-end at 1.0 and above; and how much above depends on how the pace of awards continues towards the end of the fiscal year, including the impact of sequestration.

But the booked-to-bill, it should be noted, it doesn't account for IDIQ programs, and our IDIQ programs are about $5 billion year-to-date.

That's a growth of almost 50% over last year.

Many of those IDIQs are single-award IDIQs, which also contributes to our performance.

When you couple that with roughly 50 non-IDIQ programs that we have in the pipeline that we expect to be decided this year in excess of $100 million, recognizing the slow historical nature of some of those awards, that's why we're remaining bullish on the 1.0 and the booked-to-bill.

Makes sense.

Okay, thanks guys.

Cai von Rumohr, Cowen & Co.

Yes, thank you.

Your technical service is about $4 billion.

Could you give us an approximate breakdown of where that -- what percent of the $4 billion comes from defense, what comes from the health and civil, and what comes, if any, from intel?

I think -- hi, this is Mark Sopp.

Ballpark, I think the contribution from the defense solutions group toward that $4 billion is roughly 75%, and the remaining 25% exclusively from the health, engineering, and civil solutions segment.

Okay, terrific.

Then you made the comment that the solutions business will do lots of M&A, I think that was the word you said, and you have an engineering component.

Given that you had a write-off on your engineering project in the first quarter; last year you had a write-off on the engineering project; and now here in the second quarter, we have another engineering project; do you -- are you looking to do more acquisitions there?

There is this rumor out there of SKM.

Is that an area of where you're looking to expand, and maybe flesh out the idea of lots of M&A?

Well I said -- I didn't say lots of M&A.

Yes, I don't know about lots of.

It will continue its course, if you will, as we have been on.

We'll need to be structured in order to support meaningful M&A going forward in the solutions business.

We did have some performance issues, as I directly stated in the engineering area, and we are working hard to remediate them.

I would consider them growing pains, but we're also introducing some very interesting new technology on those projects, and these sort of things happen; but that has not dampened our positive view toward this space.

We believe we are a capable provider and will continue to be one and we will continue to look for M&A opportunities in that space.

The last one -- by my numbers, by the time you do the spin excluding additional M&A, you'll have about $1 billion of cash.

Any thoughts about increasing the share buy-back?

Our standard philosophy on that remains, Cai.

If you do the math on the existing cash balance plus what will be departing the treasury in the third quarter to pay for maxIT, we will not have excess cash for the short-term -- i.e., the rest of this fiscal year, above $500 million -- we'll finish around $500 million for this fiscal year.

Our philosophy remains that if we have excess cash above that level, and if we don't have M&A properties that are foreseeably ahead of us, then we have in the past, and will continue to consider buy-backs.

I don't see that in the immediate short term, given our cash balance projected for the rest of this year, but that does remain a viable option as a deployment of our cash, yes.

Thank you very much.

Glenn Fodor, Morgan Stanley.

Hi, good evening.

Thanks for taking my question.

Can you give us some order of -- on this whole concept of the OCI -- can you give us the magnitude, order of magnitude, on what impact the total revenue growth you think may have your whole business would have incurred because of this OCI?

Is it a percent, 2% drag to revenue growth?

Secondly, is there something about your business lineup that may have given you more OCI-related pressures versus say your competitors?

George, this is Stu.

I think the basis of our OCI in the past has been -- we didn't have hard OCI issues that we had to contend with, but we had lots of churn in the system because of our desire to navigate through them, so there was a lot of transactional reviews of growth.

In many cases, we just walked away from business lines because we couldn't pursue them, and that's really reflected in the size of the market expansion that we see after the separation.

I don't know if I can attribute a percentage increase that we would have gone to, but as we look at the future of the split, we really expect growth to be higher than it would be if we didn't do the separation.

That's a fundamental belief that we have.

When you look at the fact that the solutions Company has access to $37 billion annually of addressable market, and the services with maybe $5 billion annually, our revenue assumptions reflect the capture of a very small amount of that market share from the expansion.

When we think about incremental annual revenue, it's close to $1 billion by the time ramp-up is completed, nominally number of years from now.

That's really because in post-separation, it takes a little bit of time for us to begin to capture the proposals and get them in place.

When you think about the allocation of that growth between the solutions and the services Company, we see still a meaningful amount of that to accrue to the services side as well, maybe 25%, but most of it going in the solutions side.

That's great.

That really helps out, thank you.

The second question, if I may.

You had solid organic growth in defense solutions.

Can you just remind us how much of this business line is in your strategic growth areas like surveillance and reconnaissance, et cetera?

There's about a third of that business is logistics readiness and sustainment area, which is one of the strategic growth areas.

There's a part of our -- what we call cyber area -- a good half of our cyber area are contracts that provide that sort of solution set that's in the defense solutions group.

That gives you a rough idea of the size.

Thanks a lot.

I really appreciate it.

Robert Spingarn, Credit Suisse.

A couple questions.

First congratulations on your path forward.

Thank you.

Could you characterize -- I don't know, General Jumper if this is for you or maybe for Stu, but could you characterize who you see as your peer companies in each of the two businesses going forward?

I'm sure there are --

Well, I'm not sure I'm going to acknowledge that there is, but let me--

Many that would claim (laughing).

You know what I mean.

Yes, I think if you look at the services segment, you would think of Booz Allen, CACI, VSI, TASC, [CYTUR], ManTech, et cetera.

When you look at the solutions side, it's a broader mix because of the three lines of business.

Think on the C4 ISR side, you have the Northrup, General Dynamics, Lockheed, Boeing, L3, et cetera.

In the health area you have CSD, Accenture.

In the engineering side, you'd have Black and Peach, Jacobs, Hatch, AECOM, and others, so it's a little different spin between them.

Okay, thank you for that.

Mark, I don't mean to revisit a question that's been asked earlier a couple different ways, but given that you've been able to divvy up the Company on the revenue side, why wouldn't you have a general sense of how the margins differ between the two?

Why couldn't you disclose that here?

I do have a general sense in today's business, but I don't want to limit our thinking as we design going forward.

As you would expect, given all the remarks we've made heretofore the solutions business piece, with more products and higher technology areas, does have higher margins relative to the services business; but we believe that when we are engaged in our redesigning efforts, then we want to think openly and free the teams up to do something different.

Again, we'd like -- prefer to provide more color on that down the road when we have developed those thoughts to a greater degree.

We also have a different allocation of commercial businesses between the two sides.

At various stages of development, so there's 20% of the solutions business, pro forma today, is commercial.

That's pretty substantial.

Part of that, a significant part of that is growing very significantly.

We have some products businesses and solutions that are in various stages of their life cycle, some very early, some more mature and that has a pretty significant impact on profitability today.

As we get closer to the spin, we'll have a greater clarity on where those product margins are heading at that time, which will greatly inform, I think, the solutions margins.

Okay, and then just quickly if I could ask just another one on guidance, and you may have mentioned this earlier, but to what extent is your guidance, or how much absorption did you have to do here with regard to the amortization and the separation costs you mentioned earlier?

What does that cost?

How much of the revenue increase is the acquisition, is max IT?

Let me start with the latter question.

The revenue piece is greater than $100 million, but less than $200 million --

Okay.

Even though we bumped up the range by $200 million, as you saw.

On the margin front, there's about $10 million of new amortization expense related to maxIT that we have to absorb and operating margins in the second half, and with respect to expenses, we have about $5 million more to go on the corporate relocation for the rest of this year, and we have roughly $20 million, we expect, in terms of the expenses-related separation process.

Those are incremental expenses that we will need to absorb in the second half, and are implicit in our EPS guidance.

Lastly, Stu, on bookings -- thank you, Mark.

On bookings, how much of your third-quarter bookings strength will be derived from DOD trying to deploy un-obligated funds from prior years?

I understand those get lost.

I don't know if it's in October or January, but they're subject to sequester.

Yes, a lot of it is.

I don't know the number -- a significant percentage.

In other words we're going to get the fiscal 2012 flush, along with some funding?

Do you have access to funding from prior years?

It's relatively small in the scheme of things.

Okay, thank you very much.

Timothy McHugh, William Blair & Company.

Yes, thanks.

First, I want to ask the max IT and the general, the commercial health business, is that going with the services or the solutions side of the split?

That goes with the solutions side.

Okay.

Can you give, if you can't talk about the margins, can you talk at all, or are you willing to talk at all, about the growth rates of the two businesses, if we look back at the last year?

The current year do you mean, Tim?

Yes, that's fine.

Whatever time horizon you're willing to share.

Well, I'll provide it by strategic growth area, if I could.

A number of our strategic growth areas are running between 5% and 10%, as we said all along.

One or two of them are south of that for various reasons, including some singular contract reductions.

The core area has contracted all year, and that's single-digit contraction, but nonetheless contraction.

I think the solutions business is -- they kind of balance each other out, when you think about it.

You've got to give your -- tip your hat to the defense solutions group for very strong year-to-date performance, driven by growth in programs like tires and Vanguard and others.

Some will taper off in the second half, and we've baked that in, like the joint logistics integration contract.

There's a mixed performance this year because there are significant singular contracts that move the needle one way or the other.

What we'd really like to do is get down the road and evaluate recent developments, including sequestration as we get closer to the spin, provide you a better view forward of revenue expectations at that time.

But there isn't one that's growing just substantially better than the other one -- solutions versus the services?

They are not dramatically different, sitting here today.

Okay, and then just one last question on -- do you have any sense, I guess, of the extra overhead, if you will, because now you'll have two separate companies, there will be some additional overhead.

I imagine that will be offset by just trying to be more efficient, but if we try and think through the math of the additional corporate overhead you'll have to have for the second business, just trying to get a sense of how much additional efficiency then you'll need to offset that?

Our going-in position that if you think of it as one plus one has to equal a lot less than two.

We're not looking to have additional, we're looking to see a net reduction in the combination or the creation of the two independent entities.

Okay.

We're going for -- the real focus of the overhead structure -- and it gets down to the construct about the organizational structure or the nature of the processes, the way we're designing the two companies -- is to have an overhead structure right-sized for the kind of business that they're in.

Not just taking SAIC and replicating it in two different places, but to create an efficient agile organizational construct with the appropriate structure for the business and markets they support.

Okay, thanks.

George Price, BB&T Capital Markets.

Hi, thanks very much.

Number of my questions have been answered, but still had a couple more.

First, I'm assuming that all the product revenue's going to go with solutions.

I just wanted to confirm that, and if you can just kind of talk about I guess what that assumption would be as a percentage of the solutions business?

The answer is correct.

It does go into solutions business.

In terms of proprietary products, the part of the $7 billion solutions business would still be less than 10% for proprietary products, but obviously a greater portion than today.

It will move the needle more in that business, but still between 5% and 10% would be the proprietary revenues within the solutions group.

Is that, I guess is that a -- just thinking about product specifically, or all product-related services?

Services would be on top of that.

Okay.

We're trying to digest the question here, just give us a second.

Well I guess I was just trying to get a better feel for how much of that size for that new business would be really being driven by the product, even just beyond the product itself?

Well for example, the number I provided of 5% to 10% would include, for example, the maintenance revenue stream we get on the VACIS product line, that part of that business, with similar profit profile, I may add.

We consider that one and the same.

With respect to pure services contracts that deal with supporting platforms, then that's a very different matter, and that will largely be in the services business, with the exception of those services that are supporting platforms in the intelligence market, which would be in the solutions business.

Maybe that's where you're heading, but does that help clarify your question?

Yes.

That did.

Second question is, I know you talked about going through the end of the government fiscal year in terms of what you're expecting for award flow.

Any thoughts, I guess, in how you see things shaping up for the first quarter of GFY13, your fourth fiscal quarter, given everything that's going on?

Well that gets to the sort of strategic budget issue that I don't think anybody is able to predict, but we're in a continuing resolution.

We have the whole mystery of sequestration still before us, and all the dynamics, sort of the end of the year -- it all piles up, I think, just to contribute to an atmosphere of uncertainty.

We got continuing resolution through the 31st of March, and that means that when the Congress comes back at the end of September, they've got to start dealing with the next fiscal year budget.

How they're going to reconcile that with FY13 and how they're going to do the pro forma spread of the sequestration through a fiscal year that has already got part of it in the continuing resolution is all sort of unknown right now, and contributes to a bit of uncertainty.

What we can report, though, is what we've observed.

It's what Stu said.

The slight acceleration in our government business, government revenue here in the end of the second quarter, and continuing into the third quarter.

We just don't know what that's going to mean with regard to how this all ends up, with regard to flush, with regard to the caution of contracting officers toward the end of the year.

This thing -- these things all add to the uncertainty.

Okay, last quick question.

When can we expect more specific information on the two businesses -- historicals, more detail on your go-forward expectations and so forth to kind of fill in the blanks that people have asked about?

Do you have a particular timeline or manner in which you expect to disclose that?

Well, we do promise to keep you all informed.

That's the main thing.

As we go forward we have a few things that are on our plate early on -- naming the companies, leadership of the companies, et cetera.

Mark has undertaken significant efforts on the financial side to try and wrestle to the ground how we're going to do the capital structure, et cetera.

These things, as we progress and as we have things that we can tell you that we are certain of, or more or less certain of, we will be revealing these things as we go forward.

I think we're going to work as quickly and as methodically as we can, but the one thing that we have as a precursor to all those decisions is not letting go of the existing performance.

We're very focused on execution today, and so that remains a kind of a pre-eminent position for us.

Okay.

Great, thank you for taking my questions.

Thank you.

That does conclude the question-and-answer session.

I would now like to turn the call back over to Mr. Levi for closing remarks.

I'd like to thank everyone on the call for your interest in SAIC, and we look forward to speaking to you in the future.

Have a good evening.

Ladies and gentlemen, this concludes the Second Quarter Fiscal Year 2013 Earnings Conference Call.

You may now disconnect.

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