Science Applications International Corp (SAIC) 2014 Q4 法說會逐字稿

And thank you for steady but will go to the SAIC FY14 fourth-quarter conference call.

(Operator Instructions)

This conference is being recorded today, Tuesday, April 8, 2014.

And I would now like to turn the conference over to Paul Levi. Please go ahead.

Thanks. Welcome to SAIC's fourth-quarter and fiscal year-end 2014 earnings call. Presenting with me on the call today are Tony Moraco, our CEO, and John Hartley, our CFO.

Today we issued our earnings release detailing our quarterly and year-end results. Additionally, you will find presentation slides on our website. Both of these documents, in addition to our form 10-K to be filed soon, should be utilized in evaluating our results and outlook, along with information provided on today's call.

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 the actual events to differ materially, and I refer you to our SEC filings for a discussion of these risks, including the risk factors section of our registration statement on our form 10 and the quarterly reports on our form 10-Q.

In addition, the statements represent our views as of today. We anticipate that subsequent events and developments will cause our views to change (technical difficulty) disclaim any obligation to do so.

I will now turn the call over to our CEO, Tony Moraco.

Thank you, Paul, and good afternoon. SAIC's financial results for FY14 were in line with our previous communications, and John will discuss the financial details later in the call. We operated the last quarter of FY14 as an independent, stand-alone company, filing a separation from our former parent, and I'm proud of the transformation of our operations, attributable to the focus of our leadership team and the dedication of all of our employees supporting our customers during a significant year of change.

I am also pleased with how well we have improved our competitiveness by reducing our cost structure. We are leveraging our newly implemented matrix operational model to provide more of our capabilities to all of our markets and customers.

Regarding the market environment, since our December call, the two-year federal budget deal was passed and is generally favorable to the environment during this time frame compared to full sequestration. We believe customers will have a more stable budget outlook to execute their missions, and are now able to prioritize their expenditures over a multi-year period, unlike what we have seen recently. However, fiscal challenges still remain for our customers, but these challenges may now be addressed by a more rational and deliberate approach.

We continue to see demand for the services and solutions that SAIC provides, and new contract opportunities that we can pursue. We also expect some improvement of our customers' contract award decisions as the government fiscal year progresses. To that point, we have noticed slight improvements in the pace of contract decisions so far in our first quarter.

Moving to our business development efforts, we continue to develop a quality pipeline of opportunities aligned with our strategy to protect our revenue base, expand revenues with current customers, and grow into adjacent markets where appropriate. At the end of FY14, the value of our submitted proposals awaiting decision totaled $14.8 billion, which represents an increase in buildup through the year, and a 26% increase from the end of our third quarter. SAIC finished FY14 with total contract backlog of $6.7 billion.

The fourth-quarter book to bill was only 0.3. While our fourth-quarter book to bill is historically a low bookings quarter, this was below our historical average.

There were three items that significantly impacted our book to bill in the quarter. First, our customer award decisions were light as a result of budget uncertainty -- the government shutdown leading up to the bipartisan budget act. However, [uncountered] decisions that were made, our win rate was at our historical average. Second, we had low bookings on our existing Army Aviation and Missile Command, or AMCOM, task order 32, caused by the delay of the [recompete] award and the existing Army task order [hit the funding sale].

And finally, and perhaps the most significant, was a much higher amount of de-bookings on existing programs than we previously experienced, which was approximately $200 million higher than our historical average. These de-bookings were associated with three specific contracts, with the majority of the de-bookings related to de-scoping of low-fee or non-fee [very] material pass-through or subcontract activity. So, while these de-bookings impacted our fourth-quarter book to bill, we do not see it will have a negative impact to our operating income.

Some of the de-bookings we experienced were indicative of the budget crunches that our customers are facing and their prioritization of their missions. Without these impacts, we would have delivered a quarterly book to bill in alignment with our historical average for the fourth quarter.

Looking past the end of the quarter, we have signs of increased award activity and several notable wins aligned to our protect, expand and grow strategy. In the protect category, we were successful in our recompete of our large AMCOM EXPRESS task order 32. Now known as task order 37, this very important win of an $836-million, three-year recompete allows us to continue to provide excellent support for the Army's most critical mission in the area of life cycle systems and software engineering support to provide world-class aviation and missile systems support for the joint warfighter. I would like to remind you that bookings are only recognized on the AMCOM EXPRESS task orders when funding is committed on technical instructions over time.

Progress on our strategy to expand this current customers was evident in the award of a $221-million task order with the Army's Human Resources command for full lifecycle information technology support. Though this Army command has been an important customer of SAIC for decades, we were the incumbent on a portion of this work. We were successful in expanding our contract scope to provide system maintenance, enhancement and development support vital to managing their personnel. This is a great example of our ability to expand our relationships and contract revenues with current customers.

With regard to the growth category, we have been qualified opportunities before the spend. In the fourth quarter, we submitted over $200 million in proposals to customers we had not pursued in the past. Although it will take some time to convert submits to revenue, SAIC was awarded a relatively small Air Force contract that gives us on trade to develop and deliver, change management, and communication services as the Air Force integrates many separate financial management systems into one integrated system. This three-year, $5-million win with the Air Force illustrates our newly expanded reach into previously underserved customers.

During the fourth quarter, a long-standing protest for a $70-million Navy contract to provide Naval Surface Warfare Center, Crane [air] electronic warfare engineering support, was resolved in our favor. We are still awaiting the government's decision on two other major programs under protest. The DHS EAGLE II contract is still in a re-evaluation process by the customer, and the NASA HSBC contract award is under reconsideration by the GAO on behalf of NASA's award of the contract to SAIC but protested by the incumbent.

I would like to take a moment to talk about our new operating model. Just a bit over a year ago, we designed, and have now fully implemented, our new major structure that is focused in two dimensions: the customer safety groups that manage the contract portfolios and the service line that aggregate our technical capabilities. This efficient and effective organization is critical to fully leverage our strong customer mission understanding and our tremendous technical capabilities of our workforce. We are now operating on five customer groups following integration of our Defence Logistics Agency portfolio with a DOD agencies and commands group.

We continue to align our resources and eight service lines to deliver services and solutions across a full lifecycle of engineering services and enterprise IT disciplines. We believe that the implementation of a matrix organization is compelling to the government services space. This model will result in a more collaborative organization and one that is more competitive that can drive improved operating margins. One example is our ability to optimize our proposed solutions to increase our [uptake in] labor content, reduce dependencies on subcontractors who result in higher contract fees.

We continue to put our words into action with regards to capital deployment as well. Capital deployment in excess of our minimum operating cash level, the foundational tenet of SAIC, and during the fourth quarter we took another step in returning shareholder value.

In addition to our recurring cash dividend payable on April 30, we initiated a share repurchase program. At the beginning of mid-December and through the end of January, we repurchased approximately 363,000 shares, deploying $12.5 million of capital. Absent higher return on capital deployment opportunities, we expect to continue buying back shares with our cash in excess of our operating needs.

I will now turn it over to our CFO, John Hartley, to discuss our financial results.

Thank you, Tony. In order to provide a better view into SAIC's operating results, my comments on this call will exclude the minor amount of revenues and cost performed by our former parent, and will be primarily focused on SAIC's performance for the fourth quarter as opposed to the full year, as it reflects SAIC's first full quarter as an independent company.

Our revenues for the fourth quarter were $931 million, and we ended FY14 with just over $4 billion in revenue, which aligned with our guidance. As expected, this represented a year-over-year revenue decline for the whole year of 14%, and was driven principally by the rampdowns of the DBS program and also by the completion and rampdown of IT and logistics programs related to the drawdown in Afghanistan, the completion of a program to provide technical support to the Army, and lower materials and subcontract work on Navy contract vehicles.

While on the subject of year-over-year revenue decline, as we have communicated previously, we expect the first quarter of FY15 will result in a double-digit year-over-year revenue decline, then reach improved stability in revenue as we exit from the year-over-year revenue decline towards the second half of FY15.

Moving on to operating income, we had fourth-quarter operating income of $56 million, representing 6% of revenue. After several quarters of significant separation expense impact, this was largely behind us in the fourth quarter, with only $1 million of separation costs, or 10 basis points impact to operating margins for the quarter. We believe that our fourth-quarter profitability is representative of the current state of our Business, but there is significant room for improvement in this area. Optimizing our operating margin is a key area of focus for us, and we have various levers available to show steady improvement in this operating metric over time. We are committed to enhancing profitability, with the objective of 10 to 20 basis points of average annual improvement until we reach a level more reflective of the markets where we operate.

Net income for the fourth quarter was $33 million, which resulted in diluted earnings per share of $0.66 for the quarter, or $2.27 for the year. Our tax rate for the quarter was 36.5%, slightly below our expected normative tax rate going forward of around 38%. This considers that the R&D tax credit expired at the end of calendar 2013, and has not yet been extended.

I will now move on to the balance sheet and cash flow statement. Our days sales outstanding, or DSOs, were 59 days at the end of the quarter, which is an eight-day improvement over the prior quarter. You will recall that our Q3 DSOs were significantly impacted by the government shutdown and the planned 10-day shutdown of our IT systems related to the separation. We are very pleased to report that we have fully recovered from these adverse effects and are in a more normative DSO range.

Accordingly, we ended the year with $254 million of cash. Our cash flow from operations was $125 million for the quarter and $183 million for the year, well in excess of our guidance of $125 million for the full year.

We also had fourth-quarter capital expenditures of $6 million, which is in line with our normative level of approximately $20 million on an annual basis. Important to our operating cash flow in the coming quarters is our pending contract novation due to the separation. Disruption in this largely government-led process could have a temporary negative impact on operating cash flow, but we do not expect this will have an ongoing impact.

Regarding SAIC's capitalization, we are in active dialogue with our Board of Directors regarding our leverage ratio. Over time, we plan to move toward a capital structure more appropriate for a business of SAIC's steady and substantial cash flow by increasing our debt level over time. We believe that our cash generation and balanced sheet flexibility allows us to simultaneously invest in growth, return capital to shareholders, and pursue selective acquisitions when compelling opportunities present themselves.

Additionally, for now, we view $200 million as our average minimum cash level for operating purposes, but this will likely come down as we get more comfortable with our financial operations and working capital requirements.

Moving on to our long-term financial targets, at our Investor Day in September and subsequent investor conferences, we provided long-term financial targets for our Company. Those targets, which we expect to achieve on average and over time, remain unchanged. First, low single-digit organic revenue growth; second, operating margin expansion of 10 to 20 basis points annually; third, return of capital in excess of operating needs, absent higher return capital deployment opportunities; and fourth, financial leverage appropriate for a company with SAIC's investment requirements and cash-generating characteristics.

Going forward, given the longer-term targets that I just reiterated, our commitment to providing transparency into our quarterly results, the greater market and offering alignment of the Company post-separation, we do not believe there is added benefit to providing annual estimates of revenue, EPS, and cash flow as was initiated while we were part of our former parent. We expect to comment on our long-term targets and update them in our quarterly process, should our views change in the future.

Our policy on disclosure of long-term targets instead of annual estimates of financial metrics should in no way suggest that we have reduced visibility into our future performance. Rather, this reflects the desire of management and the Board to align investor expectations more closely with our own, and is reflective of how we intend to manage the Business. I would like to reiterate that the Board, Tony and I are fully committed to providing appropriate business and financial transparency to help our investors in making informed investment decisions about SAIC.

With that, I will turn the call back over to Tony.

Thanks, John. We recently announced that France Cordova left our Board of Directors to take on a critical role for our country as the Director of the National Science Foundation. I would like to thank France for many years of service and participation in the separation process as one of the initial Board members that were -- of our independent Company. We wish her well as she serves our country in this challenging and important role.

Our proxy statement will be distributed soon to shareholders, but I would like to announce that our annual shareholder meeting will take place on June 4 at our McLean, Virginia, offices. I encourage all shareholders to attend this event.

I very much look forward to FY15. The leadership team and I remain resolute in our primary objectives of sustaining revenues, improving operating margins and further optimizing our operating structure while we effectively deploy our capital.

Before taking your questions, I would like to thank all SAIC employees for their continued dedication and focus on performance during a year of dramatic change. Your efforts have resulted in a very successful year of transition, and positioned SAIC for success in FY15.

Operator, we are now ready to take questions.

Thank you, sir.

(Operator Instructions)

Cai von Rumohr, Cowen and Company

Yes, thanks so much. So Tony, the $200 million of debooking -- approximately when that might have hit in FY15?

Cai, that will be spread across the rest of the year. Based on what we saw, those come through across all of the contract vehicles, so that will be spread across the rest of FY15.

And also I would point out that these are multi-year contracts, so it is actually spread over a number of years, so the impact to FY15 is nowhere near $200 million.

Got it. How big it might it be?

We do not see it having a significant impact based on the type of revenue that we had on what we are expecting for FY15. It is more in the out years that we see it having a drag.

Terrific. And then just comment maybe if you could on some of the margin issues in the fourth quarter. The gross margin looked pretty good there at 8.5%. Did it have any award fees or catch-ups? The SG&A, a little higher than I had guessed. What's the run rate going forward? And I assume that's the last separation expense. Thanks.

I think the profitability, Cai, was in line with what we expected as we came out of the spin. You saw the light separation costs that were part of that. The contract performance delivering fees in the normative range of what we would expect, so I think to your point we didn't anything unusual coming out of Q4 on the margin side.

Terrific. Thank you very much.

Jason Kupferberg, Jefferies and Company.

Hi. This is Amit Singh for Jason. Just wanted to come again on the overall discretionary spending or the budget -- the government spending environment. Have you actually, since the signing of the budget deal, if you could add a little bit more -- have you actually started seeing a pickup in the contracting and awarding activity? I am just trying to tie this with recent comments from some of your peers who seemed to indicate that maybe the pickup just never happened and that they were more pessimistic than you, if I would put it that way.

I think what we're seeing coming out of the budget deal, the reassessment by the customers of what they're spend profiles are going to look like, building on a prioritization that they had looked at over the last year. I think like our peers, we have not seen a lot of activity in the contract awards decision in those first two month as we looked at January/February.

We are seeing pickups in certain customer sets. We commented on the AMCOM EXPRESS deal, and those efforts continue. But generally, I think we would be in line with overall expectations that it would be the end of this calendar year, end of government year that you'd start seeing any additional contract awards at the levels that we saw in 2013.

All right. Great. And then you reiterated your long-term margin guidance but since last few quarters have you identified any additional cost takeout opportunities?

First, I want to make it clear that we're not providing guidance. We have long-term targets. We continue to look at cost takeout activities so that, one, we meet our commitments to our customers and stay on our rates. Also monitoring our direct labor base closely, but we'll continue to optimize the organization through FY15 and this year of optimization, so there certainly will be some additional reductions in costs. Whether that's labor or non-labor we're still analyzing but we'll be making those throughout the year.

Thank you very much.

Joe Nadol, JPMorgan.

Hi. Good afternoon, guys. This is actually Chris Sands on for Joe. John, you mentioned that there could be a temporary disruption to cash flow this year from the contract innovation issue. Can you quantify how big that might be for us?

It is difficult to quantify because it would depend on how long it progressed. We are in a very awkward situation where there is a name change to our former parent and at the same time, we need a novation to occur over to us. Again, it is largely government led.

We don't project that there's going to be a significant impact. We think it will recover quickly. We haven't seen a large impact to date. We don't expect there to be a huge perturbation in Q1 and we would certainly be expecting to be back on target in Q2. Of course we will update you in Q1 if that turns any more bleak. I just wanted to make all of you aware of that situation.

So it's not something that would stretch out into 2016 and then disrupt cash flow for the whole year?

Absolutely not. We certainly won't go past the first half of the year, or the first three quarters, it is our belief.

And then it sticking with cash flow, you started the share repurchase this quarter. You are now $50 million above your target balance and you said you're comfortable with leverage going even higher. Should we expect repurchase activity to increase from this level going forward, or how should we think about that?

Well, what I will say is we anticipate deploying the capital in a consistent manner of what is in excess of our operating needs. You've picked up on the fact that we ended the year in excess of our operating needs. We also have the ability to move up the leverage, so that may very well indicate an acceleration or an increase in the amount of share repurchases we do in the future that would be required based on what you saw through the end of the year to deploy our available capital, and that is, of course, absent higher return capital deployment opportunities.

So just consistently expect, again, if we don't have those higher return capital deployment activities to deploy the excess capital that we have available to us. Right now, share buyback is what we would intend to do.

Got you. And then on a few of the discrete revenue items, can you just remind us how much of a headwind [Dicin] will be this year and then maybe how much Afghanistan will be? What it was in FY14 and what you expected FY15?

I'm sorry. Are you asking how much headwind that is for FY15 on a year over year?

Yes, for both Dicin and Afghanistan.

Yes. So you can expect the year over year to decline double digits in the first quarter. As I've said, that's our fourth double-digit decline in the fourth quarter. But we do anticipate that we'll start to hit a steady state. If you look at our revenues for Q3 and Q4, when adjusting for seasonality, which is minor, we do think those are indicative of a more normative run rate trend for looking into FY15 and projecting our performance.

Great. Thanks.

Q3 and Q4 of FY14.

Right. Understood.

Thanks, Chris.

Edward Caso, Wells Fargo Securities.

Hi. Can you talk a little bit about the NASA contract, and is it still in the protest? Is it still with the GAO? And any sense on timing?

Yes. The NASA deal is still under reconsideration by the GAO, based on the actions that NASA took as part of the protest process. They had 100-day clock that went forward from last quarter so we would suggest that by the end of April, that clock expires. No guarantees, but they typically hold to that date. What we would see for GAO's response back to NASA and then based on that outcome, NASA would have to make formal decisions and we're awaiting those as well.

Can you talk a little bit about the impact of Afghanistan activities? Several companies have talked about the level of activity, especially with pass-throughs being lower than anticipated and that seems to be a common theme of the last few quarters. Is it running below your expectations, given the election uncertainty, and probably a rising probability that the military will be completely out of Afghanistan by year end?

Sure. I'll answer that. This is John Hartley. We don't have a lot of OCO exposure in Afghanistan remaining. In fact we -- it's about $50 million in FY15, give or take. And so we don't expect -- we expect that to come to fruition as we do some of the wind down. There could be some slight under-run but that is kind of what our exposure is.

Okay. And if you could talk a little bit about how the senior management is compensated. Obviously, you provided us a very squishy scorecard here to guide you -- to score you on. I'm curious to see how your senior management scorecard works with the Board.

This is Tony. The set of plans aligned around these targets. An emphasis on operating margins is more weighted then revenue and cash flow, but those are the three dimensions that we measure, short-term and long-term, post separation.

We've also instituted a performance share plan that also aligns to those same similar measures, with, again, emphasis on operating income and cash flows. So we think it's very well aligned to the shareholders interest. We have full Board support on that and I would expect to deliver on those plans.

Great. Thank you.

Cai von Rumohr, Cowen & Company

Yes. So first question is, normally your first quarter is cash flow negative and you've mentioned that contract -- potential contract novation issue. If you kind of run normal negative, you could be down toward the $200 million. Would it be fair to assume that you might be a little bit more cautious on cash deployment opportunities early in the year until you are through those two issues?

You are likely to see that, although we project our cash flow out so that we don't mind dipping below $200 million. That's what we would consider an average. We always have the revolver available to us. So we want to deploy capital on a consistent basis, so we do project quite far forward in making the decision on what to deploy.

You're likely to see Q1 operating cash flows to be negative as we've seen in the past, because that's when we pay some of our bonuses and other things that occur. But that won't really dissuade us from looking a little longer term on how much to share repurchase. But it may not accelerate significantly in Q1.

Okay. And then you'd mentioned, I guess, that on AMCOM EXPRESS, you only book the task orders and then you had this Army HR health contract. So how much would the bookings you've gotten so far from those be in the quarter, just so we can kind of gauge where you are starting off in the quarter?

Yes. So the healthcare one is a booking. It's a task order. We do book task orders for every other contract except AMCOM EXPRESS. When you look at AMCOM EXPRESS, when they issue a task order, it really is an IDIQ vehicle, because other customers come and issue what they call technical instructions and that's truly the tasking audit. And so AMCOM comes in as funding-is-committed, but the Army one will be booked in the first quarter.

Okay. And then, your SG&A was $23 million in the quarter. I've been looking for somewhat less. How should we think about your SG&A run rate as you go through the year?

Yes. We think we've hit back to our more normative level of SG&A. Again, it aligns with the way we disclose our -- in our disclosure statement to the government, so it includes certain items. You could expect it to be in the neighborhood of between 2% and 3% for FY15, is where you could expect us to be trending.

Terrific. Thank you very much.

Thank you. And I'd like to turn the conference back over to management for any closing remarks. Please go ahead.

Thank you very much. I'd like to thank you all for your interest in SAIC and for participating in the call today. We wish you all a good evening.

Thank you. Ladies and gentlemen, this does conclude our conference for today. If you would like to listen to a replay of today's call, please dial 303-590-3030 or 1-800-406-7325 with access code 4670471. Thank you for your participation. You may now disconnect.