Science Applications International Corp (SAIC) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the SAIC fiscal year 2014 Q3 conference call. (Operator Instructions)

I would now like to turn the conference over to Paul Levi, Investor Relations. Please go ahead, sir.

Thank you and welcome to SAIC's third-quarter fiscal year 2014 earnings call. This is our first earnings call since our successful separation transaction in late September. With me today are Tony Moraco our CEO, John Hartley 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 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 our CEO, Tony Moraco.

Thank you, Paul, and good afternoon. Thank you for joining us on the call today.

Before I discuss our quarterly results I would like to take a moment to acknowledge what an important time the past month has been. We successfully completed the separation and became an independent publicly-traded company that probably carries the SAIC name. Although technically a new company, we have a tremendous legacy and are proud to move forward with the reputation of excellent contract performance earned over several decades.

To SAIC employees, let me congratulate and thank you for a job well done. The separation process was a tremendous amount of work with many changes over the last year and our employees handled a wide range of internal organizational and business model changes while continuing our most important work: customer-focused contract performance. Employee commitment enabled a smooth transition and unimpeded continuity of performance for our customers.

Third-quarter revenue was about $1 billion with operating income of $37 million. A few items impacted operating income, including $23 million of separation transaction and restructuring expenses, which, if excluded, we believe is a better measure of the profitability of the Company.

Diluted earnings per share were $0.44 and operating cash flow for the quarter was $10 million. John will discuss the financial results in more detail.

Our market environment continues to be shaped by budget challenges facing our customers. Sequestration is likely to continue in some form in this government fiscal year and we believe that our customers will continue to prioritize their mission needs against available fiscal budgets.

The government shutdown in October had a relatively minor impact on our third-quarter company results that we issued today with the federal civilian business area incurring the most disruption to contract efforts. However, it did affect a number of our employees as well as they were not able to work and created additional strain on performing for our customers.

I do believe that a government shutdown will not occur again based on our recent meetings with some of our elected officials when we shared the detrimental impact of not finding reasonable solutions to budget differences.

We continue our business development effort to increase and align our opportunity pipeline with our capabilities portfolio, while continuing to optimize the organization to maintain a competitive pricing position. Our value of submitted proposals of $10.2 billion demonstrates the breadth and depth of our pipeline. Our booked backlog stands at $7.3 billion and represents a book to bill of $1.4 billion for the third quarter.

During the quarter we had several notable wins that demonstrate our customers' continued confidence in our ability to perform. We were successful in winning a $224 million effort with the Federal Retirement Thrift Investment Board to provide a broad range of business process and IT services for this new customer. This is a great example of SAIC reaching out to provide its technical capabilities and solutions to a new customer.

We were awarded a $100 million prime contract by the Defense Threat Reduction Agency to provide integrated logistic services for worldwide cooperative threat reduction services. And, lastly, we were one of the awardees on a $900 million IDIQ vehicle issued by the Space and Naval Warfare Systems Center Atlantic to provide integrated cyber operations support services.

Looking across these three wins, it reflects early success in our Protect, Expand, Grow strategy as we have won business with some well-known current customers and brought our capabilities to bear with new customers.

During our investor day in September, we outlined the operating model that will be the underpinning of customer performance and business results. Our matrix organization of customer groups and service lines has been implemented and we have begun executing in this manner. Employee feedback has been tremendous with great optimism for expanded business opportunities in the future. Our customers are beginning to also expense the benefits of this model, which allows for more efficient resource allocations and increasing quality and reducing the cost of performance.

The matrix operational model is aligned with our business strategy and our Protect, Expand, Grow strategy is fueled by our organizational alignment to our customers and the services they demand. Business performance will be realized by our ability to protect our business base, expand business with current customers with existing mature capabilities, and grow in the selective adjacent markets.

In the interest of increasing shareholder value in these market conditions, we are dedicated to achieving relative revenue growth, improving operating income, and deploying capital in excessive of operating cash needs in the form of our recurring dividend, share repurchases, and selective M&A. It is our belief that through operational alignment, program execution, and prudent deployment of capital shareholder value will be created.

With that, let me turn it over to John.

Thank you, Tony. I would like to echo Tony's appreciation for the efforts involved in launching this great company. Our dedicated team has set us up quite well for future success as a stand-alone company.

Before I cover the financial results, I would like to call your attention to the supplemental earnings presentation on our website. Due to the completion of the separation during the quarter, our third-quarter results reflect two months as part of our former parent and one month as a stand-alone company. Additionally, in our financial results we reflect a minor amount of revenue and costs for work performed by former parent. In order to give you a clear picture of the Company's activities, my comments will exclude the revenues and costs performed by former parent.

Tony summarized the financial results, but let me provide some additional color. Revenues for the third quarter of $974 million were in line with our expectation and reflect an 18% contraction as compared to the prior-year quarter. This reduction is attributable to the $80 million impact of the ramp down of the DISN Global services program, $40 million from the completion and ramp down of IT and logistics programs related to the draw down in Afghanistan, and another $40 million from lower materials and subcontract work on Navy contract vehicles.

The remainder of the year-over-year decline was a driven by slower US government contract funding and awards resulting from government budget pressures.

Third-quarter operating profit was $37 million, or 3.8% of revenues. Profit was significantly impacted as a result of incurring the expected amount of separation expenses that are typical with a separation transaction of this nature. We do not expect to incur any additional separation or restructuring costs in the future for this transaction.

These separation and restructuring expenses were $23 million for the quarter and, if excluded, would have resulted in operating margin of 6.2%. Operating income was also adversely impacted by a few million due to the partial government shutdown. We do anticipate recovering a portion of this impact in the fourth quarter.

Net income for the third quarter of $22 million resulted in diluted earnings per share of $0.44. Our Q3 effective tax rate was 35%, which is generally in line with where we expect to finish the full fiscal year at about 36%. Our expected normative tax rate going forward is around 38% considering that the R&D tax credit has not yet been extended past December 31, 2013.

Now on to the balance sheet and cash flow statement. Days sales outstanding, or DSOs, were 67 days at the end of the quarter, which compares to our more normative level of DSOs of less than 60 days. DSOs were negatively impacted at quarter-end by payment delays caused by the government shutdown and anticipated billing delays resulting from a 10-day shutdown of our IT systems related to the Company's separation.

We expect a return to a more normative level of DSOs by fiscal year-end. As such, we ended the quarter with about $157 million cash, cash flow from operations for the quarter was only $10 million, and free cash flow was slightly less after incurring $8 million of capital expenditures related to infrastructure required to operate as a stand-alone company. After we complete this required infrastructure, our normative level of capital expenditures is expected to be less than $20 million annually.

During the quarter a few notable capital deployment items occurred. First, we initiated and paid a quarterly cash dividend on October 30. We also announced today our next quarterly dividend of $0.28 per share payable on January 30 to shareholders of record on January 15, which is a consistent amount as our last quarterly dividend.

Finally, as previously announced, our Board of Directors authorized a stock repurchase program under which the Company may repurchase up to 5 million shares of the Company's common stock. No repurchases were made during the third quarter, but as we stated in September, our intention is to deploy capital in excess of our target average cash balance to maximize shareholder return.

Let me now turn to fiscal year guidance for our fiscal year ending January 31, 2014. The Company, while part of the former parent, provided fiscal year 2014 forward guidance prior to completion of the separation transaction. Based on our financial results through the third quarter and the outlook for the remainder of the fiscal year 2014, our expectations for the Company's revenues and cash flows is unchanged from prior guidance.

The Company is updating the prior guidance for diluted earnings per share to apply a higher effective tax rate and a higher effective share count than was assumed prior to the separation. The former parent's effective tax rate of 31% was used in the prior guidance and our guidance is based on the Company's estimated tax rate of 36% for this fiscal year. That means our guidance for fiscal year 2014 is revenues in the range of $3.85 billion to $4.1 billion, diluted earnings per share in the range of $2.13 to $2.33, and cash flow from operations above $125 million.

Consistent with what we stated at our investor day in September, our view of future operating results remains unchanged. We anticipate coming out of the separation with revenues of about $4 billion annually with low single-digit annual revenue growth potential, with additional contraction in early FY15 as we see the final impact of the FY14 revenue reduction items I discussed earlier come through in the year-over-year results.

We intend to drive revenue through protecting our existing contract base, selling more of SAIC's capabilities to customers who know us well, and growing with customers that we previously underserved because of organizational conflict of interest or a lack of investment. Also, we continue to expect operating margins to be in the low 6% range.

Improving our operating income is a high priority for the Company and will be achieved over the next three to five years through a combination of optimizing our indirect cost structure, expanding our value-added labor base, leveraging our scale by bidding higher contract fees, and, finally, executing well for our customers so we realize the fee that we have bid. And finally, of course, continue to drive strong cash flow from operations.

Before I conclude my remarks, let me reiterate our commitment to ensuring transparency with our investors and growing shareholder value. I am a firm believer in saying what you do and doing what you say. It is a fairly simple principle, but we have a great amount of conviction to execute in that regard. Our future actions should clearly demonstrate our commitment to achieving our objectives.

With that I will turn it back over to Tony.

Thank you, John. As I look forward to the next few months, I am confident of a productive fiscal year 2014 close and momentum into fiscal 2015. I wish you and your family's best wishes for the holiday season. And with that we will now take your questions.

(Operator Instructions) Joe Nadol.

Good afternoon, guys. It is actually Chris Sands on for Joe. Couple questions about contracts; could you please update us on the status of the AMCOM Express Task Order 32 competition?

Sure, Chris, this is Tony. The AMCOM contract is still being executed under the current contract vehicle and the upcoming recompete is yet out for actual formal proposal, so we are still waiting that to be released by the customers.

(multiple speakers) Okay, but no specific expectation for when that could happen?

No, we haven't had any specific dates. We have been saying it is relatively soon in the process. We would expect it to happen, again, fairly near term.

And does the extension run to a specific date?

I think it runs -- currently runs through the end of February of next year.

Then, this one may be more challenging to answer, but any insight into EAGLE and what happened there?

Well, there has been a lot of press on the EAGLE contract. We have officially submitted a protest to GAO based on a debrief that we received shortly after Thanksgiving, so we have yet to get a response from that. But with the rest of the industry being attentive to what the customer's intentions were, trying to understand that and put forward what we think is a best case probability sustain our service delivery of that important customer. So wait and see how that plays out with the customer sets.

And do you get the sense that it was primarily based on price?

Price was a factor, as it has been in a lot of the other industries, but I think there is a number of factors that played into the award process and that is what we are trying to evaluate.

Okay, and then one for John. Can you just remind us what that minimum cash balance is above what you have returned to shareholders?

Sure, Chris. Right now we think it is around $200 million. Once we get comfortable with our operating cadence, we may bring that down over time.

Okay, and then one more. The official guidance does that include the revenue performed by parent?

No, it is not.

Okay, and so same with the long-term, low 6% margin target?

That is correct.

Okay, great. Thanks, guys.

Edward Caso.

I was wondering if you could opine a little bit on the budget process going on in Washington, if you think the current effort will actually pass here or whether we will just kick into a continuing resolution.

Not sure about the CR, but from what we have been reading and what you have been looking in the press as well, I think the sequestration debate, if we do in fact get relief the next two years, as evident at least by the most recent discussions, that that is actually a favorable element. We have been lobbying with others on the removal of sequestration in the near term as a means for budget reductions.

It takes a little bit of pressure off the services components; their ability to drive their maintenance and training programs, for instance. Areas that we also support. So I think that is one element that it provides a little more rational budget decisions and prioritization by the armed services and other agencies.

I think also with -- if we get to, in fact, a flat budget and some numbers relative to federal budgets across the board, both in defense and non-defense, just in and of itself should create some clarity in the contract community that they can at least work off of a funding line that allows them to perhaps release the pent-up demand and submits that are out there. So we are hopeful that the sequestration allows them to make more robust decisions and prioritization.

And, secondly, that the contract offices themselves have a little more confidence in releasing the contracts that have been sitting on their desks for quite a long period of time with more than 12 to 18 months sales cycle that we have all been living with.

Does the deal ease up some of the line item cuts across the board, line item cuts? Does it give the DOD more flexibility or not?

It appears that it would, that the across-the-board cuts would be lessened in quantity, so scale may be down. So, again, there may be some across the board but it appears there is at least efforts underfoot to allow much more specific targeted funding changes so that they can take a broader view on where their priorities lie.

During the split process you provided information about direct labor subcontracting materials as an effort to help us understand your forward margin outlook. Are you going to make that information available for us to track?

Yes, this is John Hartley. You will see that in our 10-Q that will be filed, hopefully, shortly after the earnings call. So that is a big initiative for us, we are starting to see some early movement in that percentage as a component of total labor once you remove the materials. And that is top of mind for our management team.

Great, thank you.

Jason Kupferberg.

Hi, this is Amit Singh for Jason; just wanted to delve a little bit more into margins. So during an analyst day you had said that you had started around 6.2% and then over the next two to five years go up to mid-7%. Now you guys have already printed, ex separation expenses, margins of 6.2%.

So I was trying to under -- if there is any change in your guidance and when do you expect to reach that mid-7% target? And also while you talk about it, if you can give us a little bit more color on where do you expect, let's say, SG&A to be, because right now if you remove the separation rate expenses it is around 2.3%? Is that a normalized level?

Sure, let me go into that. So we still do believe that over the next three to five years we can get to that more normative operating margin level, and that is the 7% to 7.5% range. We do have a large component, I will remind you, of DLA business, which is largely supply chain and has a significant component of materials, and so therefore that does draw the operating margin down.

So if you pull that out that moves us on our labor side by 60 to 80 basis points and that can provide for us a better comparison to our competitors. But we think if we can move 20 basis points per year or so over that three to five years -- and some of the operating improvement initiatives that we have and levers available to us take a little longer to get to. Some are shorter-term in nature, but we will be doing all of those so that after three to five years we are looking in the 7% range.

Okay. And SG&A at mid-2% is that the right way to think of it going forward?

Yes, mid to low 2% is where we would be.

Okay, and just quickly on the operating cash flow. For the quarter, obviously, it was down but you maintained your guidance. And I believe in the quarter it was down because there was some delays in payments from the government. So are you expecting to catch up to it in the last quarter or the original guidance had a little bit of leeway in it anyway to start with?

We probably won't recover completely, but we expect to recover the majority of it. So we -- as you can tell with our guidance, we do expect to turn the DSOs around fairly significantly. But we think it will leak a little bit into FY15 by a few days is what we are currently anticipating.

All right, thank you very much.

Bill Loomis.

What is the war-related work that you have now as a total percent of revenue?

Sure. So in FY14 we have about $150 million in overseas contingency operation. That is primarily supply chain, which would be our POLCHEM contract as well as our tires contract, some tactical vehicle integration work, and then also you would see certainly the force protection work as well.

Going into 2015 that is probably going to come down to about $100 million of OCO, again primarily force protection and supply chain. Supply chain should follow the op tempo of the military and we will just move somewhere else if it moves out of OCO, so we don't expect that to be impacted significantly. But the force protection could be impacted a little more.

So on the supply chain, if we look at the DLA work you are doing overall that it will just shift someplace else so those revenues won't go down after we pull out of Afghanistan? Did I interpret you right?

We don't think it will go down significantly. There has got to be a certain op tempo. They have been putting off a lot of training that does require supply chain activity as well, so the readiness and sustainment is going to, we believe, going to have to come back. So we think we have largely leveled off in the supply chain.

On the DISN contract loss, what are the comparisons that we have coming up on that over the next couple quarters?

I'm sorry, could you --?

On the DISN contract that cost you -- when you were comparing year over year was $80 million lower. What are the comps that we are looking at on that in the next couple quarters? How long it is going to be a drag?

Yes, it will drag for about two more quarters and so that is why you will see contraction in -- you will continue to see the fourth quarter of large contraction in Q1 of FY15. And then we will largely trough at that point and maybe even see some growth in H2.

So a large -- another large contraction in the fourth quarter? And then did you say another large one in the first quarter and then it is minimal after that or even a growth?

Yes, the first quarter will also have a large decline as well, as you would expect. That is the fourth quarter of double-digit decline and whether it is double digit or not is yet to be seen. But that is the fourth consecutive quarter and from that we will have flattened out and, again, may even see some growth later in H2 of FY15.

And how would you see growth if Lockheed has that?

Oh, I'm sorry, I'm sorry. I was just referring to the enterprise as a whole. The DSG work that is still leaking through, it will be less than $10 million to $15 million for Q1 -- Q4 and Q1. I am sorry, I was misunderstanding your question.

Okay. So you will compare against less than $10 million to $15 million in Q4 and in Q1, and then pretty much nothing in the next two, right?

That's right.

That's right.

Okay. And the other headwinds, lower material and sub work on Navy, what was going on there?

Just that is the Navy's way of implementing some of the budget pressures, so we don't think it is completely lost in its entirety. Also, some of the vehicles we have they have been more hesitant to run some of the materials through. Tony, do you have anything to add to that?

I would say that the Navy has probably been, of the armed services, one that has probably held those monies more so than the others, and so from a portfolio basis we saw probably a larger variance in the Navy accounts.

Okay, great, thank you.

Thank you. I would like to turn the call back over to Paul Levi for closing remarks.

Thank you very much. I would like to thank you all for your interest in SAIC and participating in the call today. I wish everybody a safe and happy holiday season. Good evening.

Ladies and gentlemen, this concludes the SAIC fiscal year 2014 Q3 conference call. Thank you for using ACT conferencing, you may now disconnect.