SRA International Inc. (SRX)

F1Q09 Earnings Call

November 5, 2008 5:00 pm ET

Executives

Stanton Sloane – President, CEO

Steve Hughes – CFO, Executive Vice President, Operations

Barry Landew – Executive Vice President, Strategic Development

Analysts

William Loomis – Stifel Nicolaus

Timothy Quillin – Stephens Inc.

Michael Lewis – BB&T Capital Markets

Gautam Khanna – Cowan and Company

Joseph Vafi – Jefferies & Co.

Mathew Crews – Noble Financial

Jeff Houston – William Blair

Eric Olbeter – Pacific Crest

Jason Kupferburg – UBS

Presentation

Operator

I would like to welcome everyone to the SRA International fiscal year '09 Q1 earnings call. (Operator Instructions) I would now like to turn the conference over to Mr. Dave Keffer, Vice President of Investor Relations.

David Keffer

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

During this conference call we will make forward-looking statements to assist you in understanding the company and our expectations about its future financial and operating performance. These statements are subject to a number of risks that could cause actual events to differ materially and I refer you to our SEC filings for a discussion of these risks.

In addition, the statements made during this earnings call represent our views as of today. We anticipate that subsequent events and developments will cause our views to change. We may elect to update the forward-looking statements at some point in the future, but we specifically disclaim any obligation to do so.

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

Stanton Sloane

Good afternoon everyone. We appreciate your interest in SRA and look forward to providing an update on our first quarter results and fiscal year 2009 outlook. For the September quarter, revenue was $392 million a year over year increase of 8%. Operating income was $25.3 million and diluted earnings per share was $0.27.

In our core services business, our first quarter was highlighted by strong contract awards. We were awarded $805 million of contract orders with a mix of high quality labor services business that should help to improve our bottom line results. Organic revenue growth was 1% or about 8% excluding the AITS contract that ended this quarter.

On the product side, we experienced a few challenges in our Era business that affected our first quarter results and fiscal year 2009 forecast. As a reminder, Era develops, manufactures and sells flight tracking and surveillance solutions that address three core markets; one, air traffic management. This market accounts for about 55% of Era's revenue and is focused on the use of next generation technologies for aircraft tracking, surface surveillance and precision runway monitoring.

Two, airport operations. This market accounts for about 15% of Era's revenue and is focused on airport noise monitoring and revenue management. And three, military and security. This market accounts for approximately 30% of Era's revenue and is focused on tracking of aircraft, vehicles and sea borne vessels using advanced multi lateration technology.

In its military and security business, Era's experienced in delays in signing contract orders in two counties in Asia. These signings were anticipated last quarter but have slipped primarily because of the global economic situation, political unrest in one of those countries and a customer delay in the other.

The changes have had a significant effect on Era's forecast for the remainder of the year. As a result, we have reduced our fiscal year 2009 earnings guidance range by $0.13 to $0.18 primarily to account for the shift of Aero product orders. While this is clearly a significant change, it's important to note that the revenue and earnings forecast for our core services business are on track. Steve will cover these issues in detail in a few moments.

Our recent contract wins and hiring results give us confidence in our ability to accelerate growth and improve margins. Our diversified customer portfolio is serving us well across the government and we're seeing good traction in some of the high growth areas like cyber security and ERP systems.

On the product, a long term plan to differentiate our service offerings with hardware and software technologies remains intact. We continue to be enthusiastic about our technology, our market and opportunities and our growth prospects. While Era's experienced slippage in its order flow we continue to expect those orders to be filled. We've replaced members of its management team with experienced leaders who will help to ensure its success in the future.

Turning to the industry environment, we experienced strong demand at the end of the government's fiscal year 2008 which led to an increase in contract awards and funding in the quarter. President Bush signed an appropriations bill in late September that provides fiscal year '09 funding for Defense, Homeland Security, Veteran's Affairs and Military Construction.

The Defense and Homeland Security budgets are 5% to 6% above their fiscal year '08 levels. The bill also established a continuing resolution for Federal Civil Agencies through March which will continue fiscal year '09 funding at fiscal year '08 levels for most agencies.

Given the results of yesterday's elections, it appears likely that Congress and President Elect Obama will work together to pass civil appropriation bills by March with substantial increases in areas such as health, energy, infrastructure and environment. Over the longer term, the new administration is expected to favor additional growth in those budgets as well as continued investments in areas such as cyber security and homeland security. With more than half of our business in federal civilian agencies, our diversified customer portfolio positions us well for evolving government priorities.

It remains to be seen how the global economic slowdown in the $700 billion TARP program may affect federal spending but we look forward to helping our customers become more efficient by substituting capital for labor.

The government's demand for secure, inter-operatable systems continues to increase and we expect to continue relying upon trusted partners like SRA to deliver those capabilities.

In the first quarter, we won $805 million of business for book to bill ratio of 2.1 and we expanded our backlog by $300 million. About half of the overall total for the quarter, including three of the four largest wins, represents new work for SRA. September 30 backlog totaled $4.2 billion for an increase of 3.5% year over year. Funded backlog currently stands at $840 million, up 11% year over year.

I'd now like to highlight a few key contracts we won in the September quarter. First, SRA was awarded a blanket purchase agreement from the Small Business Administration to replace and modernize its loan management and accounting system. This single award BPA has a $250 million ceiling over 10 years.

The first three task orders have been awarded with a total of $26 million. This contract represents a significant milestone in the expansion of our ERP practice. Together with the web based supply chain management contract for the Department of Agriculture, and the civilian personnel management system contract for the Defense Department, it gives us a large scale government ERP implementation at HR supply chain and now financial management.

Next, the Federal Aviation Administration awarded SRA a five year $56 million contract to support the cyber security management center. This win continues the rapid growth of the company's cyber security and information assurance business addressing an area of critical need across our customer set.

We launched a cyber security campaign in fiscal year '08 to expand upon our existing capabilities in this area, which accounts for over $100 million of annual revenue. In the first quarter, we won over $200 million of new cyber security business. We have an additional $100 million in pending bids and we're positioning for an additional $1 billion of upcoming opportunity.

Third, also in the field of information operations, we won a five year $49 million contract to continue our support for the Air Force Research Lab. This work involves classified technology and behavioral science services to improve the effectiveness of Air Force personnel.

Fourth, the State Department awarded SRA a three year $35 million contract to operate and enhance the world wide refugee admissions processing system. This program, for which we unseated a long term incumbent, reflects continued expansion in our State Department business where our revenue has grown from zero to more than $30 million per year since 2006.

Fifth, we were awarded a five year $29 million contract by the U.S. Army that combines and extends two of our business process modernization programs. Both portions of the contract involve leading edge system automation and management.

In September we were also awarded the enterprise management services contract for the Drug Enforcement Administration, the nearly $80 million contract that had been protested by losing incumbent contractor when we won it in February 2008. Our award was protested again and we expect the government to issue a new ruling in the next few months.

The other contract for which we are awaiting protest resolution is the $77 million Federal Energy Regulatory Commission contract that we won in May. These programs together have the potential to generate about $30 million in annual revenue for SRA but protests continue to delay their starts.

Our total pipeline now stands at $25.9 billion, up 20% year over year but down slightly from the June quarter because of the heavy contract award activity in September. We currently have about $1.6 billion in pending bids.

In terms of re-competes, the only contracts over 1% of revenue to be re-competed between now and June are the GAO infrastructure support program which should be awarded this quarter and our IT outsourcing contract for FDIC which is expected to be awarded in the spring or early summer.

As we announced yesterday, we were recently awarded the $56 million contract to continue our work for the Pentagon Force Protection Agency which had been another re-compete.

Having won several new jobs late in the September quarter, we began to see acceleration in employment growth in the last two months. Excluding the acquisitions and divestiture, head count increased by 38 in the first quarter. We anticipate an improvement from that level in the December and March quarters also which should lead to better growth in our labor services revenue. Our voluntary attrition rate was 18% in the first quarter and we finished the quarter with 6,689 employees.

Stephen Hughes

I'd like to start by giving you a detailed explanation of our Q1 results and the reasons for the reduction in our annual earnings guidance.

For the first quarter, revenue was $392 million up 8% year over year. Organic growth was about 1% given the sharp decline in revenue with the loss of the AITS re-compete. Our first quarter operating margin of 6.5% and earnings per share of $0.27 were below our expectations.

I'll now walk you through the Q1 issues and provide a detailed bridge to our new earnings guidance. To start, our plan anticipated diluted earnings per share of $0.29. We had several operating items that showed that lowered EPS in the first quarter.

First, Constella Futures operating income was $1 million lower than anticipated for the two months preceding divestiture. Given the divestiture, this will not reoccur. Second, [Aras] operating profit was $700,000 lower than expected because of slippage in new orders and milestone acceptance delays. Third, SRA's proprietary license sales were $800,000 below the recent run rate.

Historically, the revenue from our software sales to National Security and Law Enforcement community have been around $1.5 million per quarter, but it was lower in Q1 as these sales can be lumpy.

There's also these three items; first quarter operating income was $2.5 million lower than anticipated reducing our earnings per share by about $0.03. We had a non recurring gain on the sale of Constella Futures which added $0.02 and a non cash in process research and development charge related to the Era acquisition accounting for $0.01.

Taxes are about $400,000 higher than forecast.

In summary, our plan anticipated diluted earnings per share of $0.29. The combination of the Constella Futures divestiture and its lower operating results added $0.01 net to the EPS which would take it to $0.30 from $0.29. The Era acquisition and operations subtracted $0.02 which then would take it to $0.28 and the lower license sales and the higher taxes subtracted another $0.01 for a net of $0.27 per share.

In our core services business our revenue earnings were on track with our plan for the year. Factoring out AITS, organic growth would have been 8%. While our bid, proposal, investment and lead picking were high in Q1, these are expected seasonal factors. Given that we won over $800 million of business in the quarter and increased our head count, we should start to see acceleration in labor services business as the year progresses.

As we anticipated, the mix between cost of services and SG&A expenses changed this quarter. Era and ICS have lower cost of services and higher SG&A. With this and lower re-billable revenue gross margin was higher at 26.6%. SG&A rose to 18.1% of our revenue given the increases noted, namely higher SG&A from Era and ICS, futures costs and business development investments.

Stock based compensation was $2.6 million in Q1, about on track with our forecast for the remained of '09. Interest expense was about $1 million for the quarter. Interest expense will increase somewhat in Q2 given the higher interest rates. The effective tax rate in Q1 was 41.3%.

Now for forward guidance; we are reaffirming the Sept' 8 revenue guidance and reducing earnings guidance for fiscal year 2009. We continue to expect total revenue of $1.54 billion to $1.6 billion with Era contributing less and the core business making up the difference.

At its midpoint, this range implies total growth of 4% and organic growth of 2.5%. Adjusting for the A3 re-compete loss and lower re-billable revenue, core organic growth would be about 10%.

On the earnings side, our fiscal year '09 guidance is now $1.12 to $1.22 per share, down $0.13 at the high end and $0.18 at the low end compared with our prior guidance. The prior guidance was $1.30 to $1.35. The first quarter results accounted for $0.02 of the reduced earnings guidance.

Now I'd like to walk through the 2Q to Q4 earnings guidance update starting with the core services business and moving to SRA proprietary software sales and finally to our forecasts for Era.

First, our core services business plan for fiscal year '09 is essentially unchanged. We should see substantial organic growth and earnings per share in the second half of fiscal year '09. We expect that the increased bid and proposal investment for the first quarter will continue to bear fruit in the form of contract awards and labor services revenue.

To achieve our labor services plan, we need to increase head count by 100 in quarter two, 150 in quarter three and 100 in quarter four. Hiring results for the first month of Q2 support this outlook as does business demand. For the year, labor services revenue should grow in the double digits.

Second, we scaled back our fiscal year '09 proprietary software license sales estimate, reducing earnings by $0.01 at the low end of guidance, given uncertainty in the state and local government markets. We've begun to build our software product sales staff this year and will expand that further as we go forward.

For proprietary software sales, we need to book about $3 million per quarter in quarters two, three and four to achieve our plan. Our early second quarter results and future lead lists suggest that we are well positioned to achieve this growth in sales.

We have been investing the technical refreshment of several of our software products and have added business development resources to accelerate our license sales. Both initiatives are progressing well and we look forward to improvement as the year progresses. Quarter two to date software license sales are approximately $2 million or approaching $2 million.

Third, and most important, we're reducing our fiscal year '09 earnings forecast range for Era by $0.11 to $0.15. This is primarily the result of the slippage of two international government orders in Era's military security business. We're actively engages with Era to achieve success with these customers and to bolster the pipeline with other new accounts but we feel it's prudent to remove these contracts so Era's forecast at the low end of our new guidance range.

At the high end, we've assumed that the orders slip one quarter to the right. At the low end, we've assumed that they slipped into fiscal year 2010. Given the global political and economic situation, we've chosen this more conservative route until these orders are signed and funded.

In the air traffic management business, Era experienced first quarter delays on three contracts due to some software integration issues. All are now in the final acceptance process, but we need to resolve the software issues in order to complete the projects. These issues contributed somewhat to our reduced outlook as well.

In summary, we reduced our earnings guidance range by a total of $0.13 to $0.18. First quarter results account for $0.02, lower SRA proprietary license sales account for $0.01 at the low end and the Era business accounts for the remaining $0.11 to $0.15.

The high end of our new guidance includes revenue of $55 million. On a GAAP basis, net loss after all deal costs and interest expense would be $6 million and would dilute earnings per share by $0.11. On a cash basis, dilution would be $0.07.

The low end of guidance includes air revenue of $45 million or $10 million lower than the high end and would dilute EPS by about $0.15 on a GAAP basis. On a cash basis, dilution would be $0.11.

Now turning to the balance sheet, we finished the quarter with about $93 million of cash and $150 million of long term debt for a net debt position of $57 million. Our accounts receivable balance was $360 million. We had approximately $1.1 billion of total assets and shareholders equity of $688 million.

Now on to the statement cash flows, Q1 operating cash flows were $14 million or .9 times net income. Day sales outstanding were about 79 in the September quarter up 3 days from the third quarter as Era has a longer collection cycle. Core DSO's declined to 76 days in the September quarter. Capital expenditures were about $4 million in Q1.

A word or two about the share buy back; as we noted on our last earnings call, we bought $6 million with best rated stock in July, completing our previous $40 million authorization. Later in the quarter, we repurchased about $15 million worth of stock.

Now I'd like to update you on a few other key metrics; first, contract business mix. As a percentage of Q1 revenue, time and materials business was 41%, cost plus business was 37% and fixed priced business was 22%.

Next, national security contracts accounted for 50% of our Q1 revenue, civil government 32% and health 18%. Within this breakdown, U.S. government customers accounted for 93% of our revenue, commercial customers 4% and international governments the remaining 3%.

The core services business generated about 96% of our Q1 revenue and product sales about 4%. We were the prime contractor for 86% of our revenue in the quarter.

A brief comment on the credit crisis, as [inaudible] our products business has been affected by the global economic and liquidity crisis. Two of our primary international government customers are experiencing political instability and various economic challenges.

Closer to home, SRA's balance sheet is very strong with low leverage and good liquidity. Our debt to EBITDA ratio is 1.1. Factoring out the cash, our net debt to EBITDA ratio is .5 to 1. At the end of September we had about $93 million in cash on hand and $150 million drawn from our $285 million line of credit, thus we have $135 million of additional borrowing capacity remaining under our existing revolver.

We expect fiscal year '09 cash flow from operations to be in the $80 million to $90 million range. Capital expenditures are estimated at $20 million with free cash therefore in the $60 million to $70 million range.

Stanton Sloane

I'd like to take a moment to reiterate our enthusiasm for the positioning of our business in the current market environment, the progress we've made on the core services business development front, the number of large contract opportunities we'll be pursuing over the next few quarters.

While we're disappointed with our performance in Q1, we remain convinced that a suite of leading technology products will benefit our core business in the future. We are now ready to take your questions. To make sure we get to as many people as possible, please restrict yourself to one question.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from William Loomis – Stifel Nicolaus.

William Loomis – Stifel Nicolaus

On the Era business, I guess I'm not sure why the revenue reductions are having such a big impact on EPS. If we looked Era and assumed originally $65 million of revenues for this year and a generous 10% net margin of $6 million net income contribution, why are these so called temporary delays creating such a huge impact on EPS and loss in the Era business?

Stephen Hughes

Let me reset where we were. We'll start with Era plan levels because we didn't really give quarterly guidance. In our September guidance we had Era revenues of $70 million. I believe we told you on the call we'd have at least $65 million, so those two numbers are consistent.

So if we assume that these orders that were mentioned on the call slipped one quarter, we take $15 million as a revenue base and the Era revenue would be $55 million. If you look at the gross margin effect on that that's about $7 million of gross margin. Because of the situation, we decided to adopt a generally more conservative gross margin and reduce that gross margin six or seven points which had about a $4 million effect.

Going from $70 million of revenue to $55 million of revenue basically took $11 million added to the operating income level plus the deal costs and the IPR, the in process research and development costs of $2 million in total, so the net of that is $7 million from volume, $4 million from the change in rate on gross margin and $2 million for deal costs is about $0.13 which is about $13 million.

If then you say, if the low end would happen, well revenues would go from, remember they were at $70 million in the plan to $55 million with the one quarter slip, and then if we assume that those orders slip all the way to the right into 2010, fiscal year 2010, that takes another $9 million out of revenue, at a little bit lower gross margin, about $4 million out of gross margin and the overall reduction in the gross margin as I mentioned a moment ago, about $1 million.

The net of that is about another $5 million or $0.05. So the $13 million slip from the one quarter slip plus the $5 million for the two quarter slip gives you $18 million or about $0.18. We would expect those orders to come at some point in time, but given the uncertainty of the economic situation, the liquidity crisis, and political instability, we feel like it makes sense to factor the worst case into the low end of the guidance and then in another case at the high end.

William Loomis – Stifel Nicolaus

As far as other orders that may flip, what have you done, obviously you say you replaced some management and I assume you've done a detailed customer review. What the risk for the remaining portfolio?

Stanton Sloane

We don't believe the rest of the portfolio is at risk.

William Loomis – Stifel Nicolaus

Is the nature of those different than these two sales?

Stanton Sloane

On the military side of the system, other than these two orders, everything is under contract but they tend to be smaller jobs. On the air traffic control and the airport operations side, the portfolio is looking pretty good, or the orders pipeline, I don't see any issues, certainly not like this.

Stephen Hughes

If you look at the performance in Q1, Era did about $10.5 million for the time that we had them, and to get to the low end of the guidance, you need to book another $35 million of revenue. The 12 to 18 month backlog number is about $35 million, the 12 to 18 month burn rate.

Firm orders right now total $20 million and pretty good orders in the pipeline are about $10 million so from that perspective then at the low end we seem to have it covered.

Operator

Your next question comes from Timothy Quillin – Stephens Inc.

Timothy Quillin – Stephens Inc.

Era was the first acquisition to really focus on this product strategy, integrated technology and solutions strategy. One might wonder if this is making sense. How would you defend that for us?

Stanton Sloane

I still believe that that's the right strategy. I think we're just a little nervous with the global situation which is kind of new news since we started this. I don't see anything fundamentally different here. The issue is timing, but we want to be conservative given that.

Timothy Quillin – Stephens Inc.

Can you just help us understand the quarterly progression of revenue and earnings? I know you don't give quarterly guidance, but any help there would be great.

Stephen Hughes

Were you referring to the Era business or just in general?

Timothy Quillin – Stephens Inc.

In general.

Stephen Hughes

You know that we book about $392 million in the first quarter. We also divested of Constella Futures and that's going to have probably about a $12 million effect so you would expect some reduction from that level in Q2.

You know that in Q3 and Q4 we have a big pick up from Ires and a higher utilization because Q2 is a very high leave taking quarter and we have high bid and proposal activity in quarter one of course, but you expect the $392 million in Q2 to probably drop off a bit given the divestiture and you'd expect it to pick back up in Q3 roughly at the Q1 level because of the growth in labor services and then to accelerate a bit from there.

A part of this as you know, is that we have decided to avoid low margin re-billable revenue so we've pulled this year compared to last year, $35 million, $45 million of re-billable revenue out of it.

Timothy Quillin – Stephens Inc.

You're buying back stock, presumably after your last conference call and toward the end of the quarter so when did you find out about the delays here at Era? It seems like you didn't see this coming until very late. Is that fair? Is that part of the management changes?

Stanton Sloane

Our investor conference was September 9. The world is radically different from then from a political and economic standpoint. On the 14th I think we had one of the investment banks went under, on the 15th we had a whole line of investment bank acquired by a growing commercial bank. We had Fanny and Freddy after that. So there's been a lot of changes, which change your outlook.

Had those things not happened, my guess is that our forecast would be a bit better than it is now.

Stephen Hughes

We've made some changes. Some of those were anticipated. We had a detailed review on this business last week and just to be frank with you, I just feel like I want to be much more conservative given what's going on in the world.

There's nothing that's fundamentally changed with the business. In other words we haven't lost any contracts. There hasn't been any change in the follow on counties. The two contracts we're talking about that are follow on contracts. There hasn't been any fundamental change other than the world's a different place and I think we have to be more conservative in our outlook.

Timothy Quillin – Stephens Inc.

Did those orders slip because of funding issues? I know the world changed there mid September but was it funding issues that they experienced, credit issues?

Stanton Sloane

No. There's two issues; one is as I said both of these are follow on orders. In one case the follow on contract cannot be signed until the system completes site acceptance testing in country. The system was delayed in shipping because the customer couldn't get vessel space to ship the system. So therefore, we were off schedule to get final acceptance and get the follow on contract.

That's the only issue on that contract.

The other one is not a funding or any other issue other than the customer is just slower in getting the follow on contract in place than was anticipated in the plan.

Operator

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

Michael Lewis – BB&T Capital Markets

With regard to Era, and I understand this was done back in April, but as part of the due diligence process, my expectation would have been that a part of the business would have been factored in much lower if it was a higher risk type situation based on the commentary that these two problem areas were not under contract, and they were not in the back log at that time, can you help us understand the thought process of incorporating that into, how you factored that into the guidance and what the expectation was at that time?

Stanton Sloane

We signed this deal in April, closed it in July. In the course of due diligence, we reviewed the two contacts we're talking about and everything appeared to be on track to us. Subsequent to that, the shipping delay was encountered. That was absolutely unforeseen. Nobody thought there would be a delay in getting the system on boat. And the other one really is just a result of changing political scenario and priorities in the customer shop and them getting their process under way.

Those things are absolutely not know or foreseen when we did the due diligence, and I don't think could have been. We thought we had a reasonable projection around the numbers, but those two things tend to be fairly large and we just can't, they're significant. So if we're going to take more conservative position on those, it's going to have this effect.

Michael Lewis – BB&T Capital Markets

I'm not sure if you've run this type of calculation but if I look at the new guidance, the $112 million to $122 million, and I look backwards at the $124 million that we hit in fiscal '08, if we were to look at it on an apples to apples basis, reducing last year by the contribution that you had in AITS, what is the implied growth here, or is there any growth at all from '08 to '09 taking out that AITS? Basically what I'm trying to do is isolate in on the specific EPS end margin impact related to Era.

Stephen Hughes

First on the revenue side, if you factor out AITS and the revenue growth would be about 700 basis points higher, about 8%. The second part of your question has to do with the earnings growth in the core business. I guess if you pro forma everything out of it, and I'd have to give this pro forma details off line if it's helpful, for the Constella's Futures transaction divestiture and for Era and everything, what you'd have would be roughly a 4% change in total revenue and about a 2.5%, 3% change in operating income.

Operator

Your next question comes from Gautam Khanna – Cowan and Company.

Gautam Khanna – Cowan and Company

Can you please explain the product that didn't make it on the ship in time? How is that more than a one quarter slip? It's not like it's going to be delayed for a full year. Were you expecting it to be recognized in the fourth quarter if it had gone on time?

Stanton Sloane

No, it has to do with the follow on order. The revenue recognition profile is really associated with follow on order. The signing of the order was delayed. That moves the revenue recognition farther to the right.

Gautam Khanna – Cowan and Company

That's the one that was on the boat?

Stanton Sloane

Yes.

Gautam Khanna – Cowan and Company

You mentioned this credit crisis issue, but can you really point to any specifics as to how the macro deterioration affected these two shipments or was that just thrown in there.

Stephen Hughes

The orders we're anticipating that they delayed, they slipped to the right, so what I was trying to say was that the situation politically in those countries, economically in those countries cause us to look at that and say, "Oh, if the government has funding or economic challenges, there is a chance." That a part of the risk analysis of whether those orders happen or not.

So again, we're anticipating that slower order flow and the world situation is coloring the way we look at things. We're just not as optimistic as we were in the past.

Gautam Khanna – Cowan and Company

When did you actually expect this to happen? Was it early September? And then the crisis hit in mid September. Could you take us through the chronology, because I'm questioning whether it's a failure of due diligence and forecasting or whether it's a true failure of the macros?

Stanton Sloane

Our belief was that both of these orders would be signed in the November/December time frame. We're not to that December time frame yet, but again, looking at the situation, we said, "Well, there's a chance given what's going on politically and economically that those will not get signed in December." So we moved into March.

Actually then, we'll look at that move and we say, "That's a significant change, we've got to look at another case and stress the model." It's not tied to Lehman Brothers but the world events have changed our perspective on how we think orders flow and how we look at guidance. We thought we have to tell people that.

Gautam Khanna – Cowan and Company

The back log you mentioned Era has currently, how much of it, could you just walk through how much of it is firm for this year's deliveries, your fiscal year? Was it $20 million in revenue recognition by June 30?

Stanton Sloane

The remaining revenue, two-thirds of it is signed and the rest is in pipeline and we expect to be signed.

Gautam Khanna – Cowan and Company

Do any of the things that 'expect to be signed' are any of those to similarly challenged customers?

Stanton Sloane

No.

Gautam Khanna – Cowan and Company

Who are they to?

Stanton Sloane

The balance of it is mostly air traffic related either to government operators in air traffic agencies, or in some cases to airports.

Gautam Khanna – Cowan and Company

Was there any currency impact on any of these guidance reductions?

Stephen Hughes

No. That's a comprehensive income effect.

Gautam Khanna – Cowan and Company

Was there any part of the guidance that was reduced, are core services weakening at all relative to your prior expectations?

Stanton Sloane

No. The core services revenue is higher. The earnings is the same at the high end and we basically reduced it $0.01 at the low end if the software license sales don't materialize as rapidly as we think they will. But we're ahead of schedule in Q2 on the licensing.

Gautam Khanna – Cowan and Company

When you looked at Era's books originally, were they guiding to $70 million of sales?

Stanton Sloane

Our initial plan actually was a bit of a haircut off their plan so on your point about diligence, we diligence, both those contracts that are being discussed here in quite a bit of depth, and we came up with a plan that was somewhat more conservative actually than their projection. But the status of those orders has changed obviously since September when we gave guidance initially.

Operator

Your next question comes from Joseph Vafi – Jefferies & Co.

Joseph Vafi – Jefferies & Co.

You did say that you were changing the margin contribution assumptions on some of the Era products. I was wondering where that ultimate catch up then is supposed to true up the overall margin assumptions based on bringing them down now.

Stephen Hughes

We reduced those margins 70 basis points. The reason for that is our view of the world and my guess at this point is that we would not see that return to its normal level until next fiscal year, at least that's the way we've dialed in the guidance.

Joseph Vafi – Jefferies & Co.

So it's just kind of a general margin assumption based on volumes then? I don't think you're lowering your price or anything like that.

Stephen Hughes

That's correct. It's just a more conservative take on it given that we're anticipating because of the various conditions we've talked about; those orders are going to slip to the right. We basically want to get to a level where we have very high confidence that the orders will support our guidance.

Joseph Vafi – Jefferies & Co.

Is any of that business, is that accounted for under, what's the revenue rack on the...

Stephen Hughes

Generally a percentage of completion.

Joseph Vafi – Jefferies & Co.

On the software business that you did mention, is there margin variability there based on volume as well or is it kind of straight line?

Stephen Hughes

We've kind of straight lined it in the guidance. We said basically $3 million per quarter. If that number turns out to be $4 million a quarter, a lot of that falls to the bottom line.

Joseph Vafi – Jefferies & Co.

The majority of customers there, that's state and local, or are those customers there, is the funding for that business, are you aware if that's coming from state generated funds or is that federally funded?

Stanton Sloane

You're talking about the software license sales now?

Joseph Vafi – Jefferies & Co.

Yes.

Stanton Sloane

There's three customers for that. There's state and local authorities, police departments, law enforcement, homeland security at the state level. Then there's federal customers. In many cases, the state and local customers pay for the software through grants that come from the federal government, in a lot of cases homeland security.

We don't see any particular issues there. Right now it's looking pretty good in the second quarter, but there's no kind of big software license chunk that's dependent on a particular state grant. But that business tends to be a lot of very small sales and so it doesn't have these kind of big swing digital issues there like the military products have.

Joseph Vafi – Jefferies & Co.

On the core business and services, it sounds like you might have actually guided up a little bit. If that were the only business in place at this point, from your other comparables this quarter, has seen a little bit of budget flush flow through from the end of the government's fiscal year. Just maybe some commentary on how you saw the quarter in terms of contract activity and how your pipeline stands at this point after a pretty good bookings quarter here in September.

Stanton Sloane

The new business picture I think is a pretty good one. Steve talked about backlog that looks good. I'll just give you another statistic which is, if you look at our pipeline, we have I think it was $100 million non IDIQ. In other words, a single award programs in pursuit, in the pipeline. That's a pretty good statistic for us so I'm pretty encouraged by the outlook there. I think we're off to a good start in the second quarter. So I think that's pretty favorable.

Operator

Your next question comes from Mathew Crews – Noble Financial

Mathew Crews – Noble Financial

Given the troubles here with the Era acquisition, what do you have in the pipeline now? What do you see in the market? Do you have things queued up? Can you just give a general description on the current side of things?

Stanton Sloane

We continue to look for opportunities. The market valuations haven't come down yet so we've had to pass on a lot of things, and we've elected to pass on a lot of things because we didn't think they were a good fit for us.

Obviously given the global situation, if we were going to look at anything in terms of M&A, we'd be very careful about things that are likely to be impacted by that. At the moment we don't have anything in the pipeline that's what I would describe as an international kind of play.

We have a variety of things. We continue to look for things that are important to us; we'll continue to pursue them.

Barry Landew

We don't think timing delays on two orders at Era should fundamentally change our view on the value of acquisitions, so we're continuing to look at acquisitions. We still hope to do more. The pipeline of acquisitions has shifted a little bit. There's going to be more that are traditional kinds of labor based services, but we're still committed to a balanced growth profile of organic growth and acquisitive growth and we don't think the timing issues here should really profoundly change that strategy.

Mathew Crews – Noble Financial

Given the technology at Era and interface and control systems, if you were staying on the product side, are you looking for similar type products to build on and build a portfolio that you can sell off, or is there a specific strategy there?

Stanton Sloane

Our strategy on the products and technologies has not changed and it was and continues to be looking for things that principally sell to governments that are in what I would broadly describe as the C4SR suite, and use that as a way to move ourselves up the integration chain. In other words, we're not going to buy products just for the sake of selling products.

In fact, I don't even want to use the word products. I call them solutions. We're looking for solutions where we can integrate the higher level of the system by virtue of having domain expertise in some particular value added technology point of view that provides a competitive advantage.

That was the original strategy, it remains the strategy and just the hard part is finding companies that fit that at reasonable values. But when we find them, we're certainly going to look hard at them.

Operator

Your next question comes from Jeff Houston – William Blair.

Jeff Houston – William Blair

You mentioned that your product strategy remains in place, so should we still expect products to reach 20% of revenue in five years, or should that be pushed out maybe a few years?

Stanton Sloane

I hope so. It depends a lot on what opportunities come up in the M&A arena how close to that we can get. I'd like to see a bigger portion of it.

Jeff Houston – William Blair

Is your contract win rate still in the 55% to 60% range and how does that really vary by the different business groups?

Stanton Sloane

It's I think about 55%. On a prime basis, obviously we're going to win more contracts. So if you just look at the prime contract wins that would be closer to 60% to 70% range. We've seen an uptick in win rates lately which again, is pretty encouraging.

Jeff Houston – William Blair

How does that vary by the different business groups?

Stanton Sloane

It's not significantly different across the groups.

Operator

Your next question comes from Eric Olbeter – Pacific Crest.

Eric Olbeter – Pacific Crest

On SG&A, you really see a significant pop up here in the quarter. Can you tell us what our expectation should be for the rest of 2009?

Stephen Hughes

First, I think we reported SG&A rate of about 15.9% for fiscal year '08. Think of it as being about 19% for '09, roughly basis points. Let me walk you through it. As I mentioned in my comments before, Era has a different mix of cost. They have lower cost of services and higher SG&A, so Era adds about 80 bits of that. That takes the 15.9% in '08 to about 16.7%.

We've discarded or voided re-billable revenues to a significant degree and if you normalize that for '08 to '09 that would add basically 70 more basis points. It takes the 16.7% to 17.4%. I think we called out in the script too that we were spending more on software license sales marketing, another 40 which takes you to 17.8%.

Then on the marketing and sales and V&P side, we were talking about 60 basis points or so because we're talking about a lot more business development expenses. Finally, to scale up to business, we've been investing in infrastructure in a variety of places which would be 60 to 80 basis points which takes you to about 19%. That's the annual analysis.

Eric Olbeter – Pacific Crest

One of the things that you had talked about in terms of plans for the company was trying to fund business development out of existing costs to the infrastructure. Now it sounds like you're doing more infrastructure and business costs being not being recouped somewhere else. Is that true? Is that what we should expect moving forward?

Stanton Sloane

No, those costs were making trade offs within the business. What you're seeing is higher SG&A in part because of lower re-billable revenues and lower cost of services. We are not spending out of the core services business to drive that. We are trying to trade those costs off.

Obviously at some level, some of it does affect the bottom line, depending on how much of the business is cost type and pricing T&M and how you forecast your rates. What our objective is is not to take that out of the profit line.

Operator

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

Michael Lewis – BB&T Capital Markets

With regard to some prior expectations that you offered analysts in the past has been revenues typically weighted more heavily on the back end and a 48/52 split first half to second half, and then EPS is 45 to 55. I'm running some basic numbers here. Let me run this by you. I want to see if you'll basically approve this.

I'm seeing about 44% first half, 56% in the second half. Is it 40/60 on EPS? Should we model?

Stephen Hughes

On the earnings per share side, what you would expect to see is 44% to 45% in the first half and the remainder, 55% to 56% in the second half. In terms of the revenue profile, we did about $392 million in the first half. There's a little more revenue in the first half than earnings per share. We expect because of the things we talked about before, so call it roughly 49% to 50% in the first half, and maybe 52% in the second half, deduct the divestitures and the acquisitions and stuff that kind of confuse that.

But I think the bottom line point here is expect about 44% to 45% earnings per share in the first half with an increase in the second half given the divestiture costs are gone, given that services revenue is higher the third and fourth quarters, and the other things we talked about.

Michael Lewis – BB&T Capital Markets

With regard to Era, I can't recall, was there an earn out associated with Era and if so, what was the amount, and do you think based on what's happening now that that will be payable later?

Stanton Sloane

There is no earn out between Era and us, but I believe Era acquired a very small company that has a small, we're not going forward, would not be material.

Operator

Your next question comes from Jason Kupferburg – UBS.

Jason Kupferburg – UBS

I think last call if I'm not mistaken you set a fiscal '09 bookings of $2.3 to $2.6 billion and at the time everyone thought the whole government would be under a CR for quite awhile. Now obviously we got a pretty good chunk of the budget approved on time, so is this still the right bookings range or could you do better given the strong start to the year?

Stanton Sloane

We can always hope to do better, but we still think that's the right range.

Stephen Hughes

The low end, the $2.3 billion, we've won $800 billion in the first quarter. That leaves $1.5 billion over three quarters and so far Q2 is coming along fairly nicely so $500 million per quarter is the kind of range we'd need and that seems to be doable for us.

Jason Kupferburg – UBS

Any change in the near term M&A aspirations just given a lot of companies behaving more conservatively with regard to balance sheets and these types of credit markets?

Stanton Sloane

Everybody, I think us included is looking at the economic situation thinking about that. I would just tell you it hasn't fundamentally altered our plans but we'll continue to look at it. We have a pretty solid balance sheet so I don't feel like we have any issues there. But we're going to be a little bit conservative.

Jason Kupferburg – UBS

I believe FDIC is a fairly large customer of yours. Obviously they've had a lot more on their plate the last few months since they've gotten involved in the whole financial crisis. Has that had any kind of impact either way on the work that you're doing over there?

Stanton Sloane

I think it's been a very favorable situation for us. Let me set the financial argument aside. FDIC has had a huge work load dumped on them. You know what's going on as well as everybody. We've been very instrumental in helping them work through that, and I think that's probably one of the better, one of the best partnerships we have in the government space right now because of the crisis.

So we'll continue to support them. Ultimately that reflects itself in good customer relationships and good past performance, and those things clearly are material to winning future business.

Jason Kupferburg – UBS

A bid comes up later this year, is that right?

Stanton Sloane

Yes.

Operator

There are no further questions. I would now like to turn the call back over to Mr. Dave Keffer for any closing remarks.

Dave Keffer

We'd like to thank everyone for joining us this afternoon and you're welcome to contact us at any time with follow up questions. So that concludes today's call.

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