Science Applications International Corp (SAIC) 2015 Q1 法說會逐字稿

Good day, ladies and gentlemen and thank you for standing by. Welcome to the SAIC FY15 first-quarter conference call.

(Operator Instructions)

This conference is being recorded today, Tuesday, June 10, 2014. I would now like to turn the conference over to Mr. Paul Levi. Please go ahead, sir.

Good morning and welcome to SAIC's first-quarter FY15 earnings call. Presenting with me on the call today are Tony Moraco, our CEO, and John Hartley, our CFO.

This morning, we issued our earnings list detailing our quarterly results. Additionally you will find presentation slides on our website. Both of these documents, in addition to our Form 10-Q to be filed soon, are to be utilized in evaluating our results and outlook, along with information provided by 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 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 annual report on Form 10-K and our 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. 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'll now turn the call over to our CEO, Tony Moraco.

Thank you, Paul. And good morning. SAIC's results for the first quarter provide a solid foundation for the year.

Revenue of $962 million and operating margin of 6.1% resulted in diluted earnings per share of $0.69. We are pleased with operating cash flow of $34 million in the first quarter, which has historically been a negative cash flow quarter. This increases our confidence in the ability to execute our capital deployment strategy. John will discuss the details of the financial results later.

As reported in our FY14 year-end results there's not been a significant change in the market environment. We have noticed a modest increase in procurement activity during our first quarter. I believe this activity will continue to accelerate through the end of the government's fiscal year.

Traditionally, our seasonal bookings profile begins with a first quarter of increased bookings over the fourth quarter of the prior year, and increases through the second and third quarters, with the third quarter being the highest of the year. All indications point towards a similar pattern in the current fiscal year.

We continue to see our customers obligate funds for shorter periods of time to maintain financial flexibility. And our customers are accomplishing this by utilizing task orders on IDIQ contracts. This buying behavior impacts the short-term bookings profile, but our contract base is well situated to accommodate their actions, as the revenues come predominantly from IDIQ vehicles.

SAIC's total contract backlog at the end of the quarter stood at $6.6 billion. This translated to a book to bill of 0.9, an increase from the fourth quarter of the prior year. Contributors to the quarterly bookings were the previously announced win with the Army Human Resources Command to provide full lifecycle IT support, and the award of technical instructions on the AMCOM EXPRESS [vehicles].

Additionally, we have noticed an increase in procurement activity in the federal civilian space. As agencies in the federal civilian space were some of the earliest to adjust from budget pressures, these customers are now more confident and are increasing their procurement activities through program growth and new opportunities.

At the end of the first quarter of FY15 the value of our submitted proposals was $14.1 billion. After the close of the quarter there has been activity on a few notable contract process. We were awarded a prime contract position on a DHS EAGLE II vehicle from which we and several others were initially excluded.

We are pleased to continue our work for the Department of Homeland Security, and protect our existing business with this important customer. The award was made to our former parent, as the bid was submitted prior to separation. But this contract is included in the standard contract novation process that is underway.

You'll also recall that NASA submitted a request for reconsideration of GAO's previous decision upholding the incumbent's process of a Human Health and Performance contract that was awarded to SAIC. The GAO recently denied NASA's request and returned the procurement to them. NASA has now canceled the existing HHPC procurement previously awarded to us and has begun new procurement efforts for a contract with similar scope and services for the recent issuance of a request for information.

We continue to execute our business strategies to take advantage of new opportunities awarded to us by virtue of our separation and SAIC's more competitive operating structure. As such, we continue to pursue efforts aligned with our strategy to protect our revenue base, expand revenues with current customers, and grow into adjacent markets where appropriate. We continue to see awards that demonstrate early successes of our strategies.

In the expand category, we were one of seven companies awarded the Joint Force Development Services IDIQ contract to provide training, education and exercise solutions and services in support of the Joint Staff J-7 Directorate Combatant Commands, military services, US government federal agencies, and multinational partners. The multi-award contract is a five-year period of performance and a total potential value of more than $800 million for all award agencies.

Further demonstration of our ability to grow into adjacent markets is the award of a Marine Corps contract to engineer, design and test upgrades to the legacy Assault Amphibious Vehicle Personnel Carrier Variance Platform Program. SAIC is one of two awardees for this multiple award, firm fixed-price contract to support the Marine Corps Program Executive Office Land System that has an initial value of $16 million to execute preliminary and critical design reviews, but carries options for prototype vehicle build and testing followed by a lower rate of initial production. If all options are exercised the total contract value over five years could reach over $190 million.

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

Thank you, Tony. Consistent with my remarks on prior calls, in order to provide a better view into SAIC's operating results my comments will exclude the minor amounts of revenues and costs performed by our former parent.

Our first-quarter revenues of $962 million were much as expected except for a $25 million negative effect from delays in funding on our recently awarded AMCOM EXPRESS passport. This represents a year-over-year revenue decline of 13% for the quarter.

I mentioned during our April call that we anticipated the first quarter of FY15 would result in a double-digit revenue decline based on pre-spin events, which was the case. And we expect year-over-year revenue stability in the second half of FY15. At that point we expect to be aligned with our long-term revenue target of low single-digit revenue growth, on average and over time.

First-quarter revenues were up 3% from the sequential prior quarter. This was largely due to the heavier amount of holidays and vacation time that we typically see in our fourth quarter. To give you a sense of our normative quarterly revenue profile, our first quarter is usually one of our more productive revenue quarters, with the second quarter softening somewhat due to the Memorial holiday and the July 4 holiday, and the surrounding employee vacation season. The third quarter then usually rebounds due to fewer holidays and associated vacation time, with softening occurring again in the fourth quarter due to the holiday season.

Moving to profitability, we had first-quarter operating income of $59 million resulting in operating margin of 6.1%. These results include about $1 million of severance expense, or a negative 10 basis point impact to operating margin as we continue to optimize our operating model.

Now that we are fully executing in our matrix operating structure we have enhanced visibility into our operations which provides for improved enterprise-level decision-making. While first-quarter operating margin is consistent with what we've previously communicated, there remained opportunities for improvement. Optimizing our operating margin continues to be a key area of focus, and we are being disciplined in implementing our initiatives 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 over time until we reach a level more reflective of the markets where we operate. Net income for the fourth quarter was $34 million which resulted in diluted earnings per share of $0.69 for the quarter. Our expected forward tax rate continues to be in the 38% range.

Let me now turn to the balance sheet and cash flow. Our days sales outstanding, or DSOs, were 56 days at the end of the quarter, which is a 3-day improvement from the prior quarter. We continue to place great emphasis on our cash flow optimization program.

As a result of this strong cash flow performance, we ended the first quarter with $237 million of cash and cash flow from operations of $34 million in the quarter. This performance compares well to historical trends in the first quarter where we have experienced negative cash flow from operations due to our annual bonus cycle and the timing of payroll, which also occurred this year but was overcome by strong cash collection.

Capital expenditures for the quarter were $7 million, which is slightly higher than our normative level as we had some additional infrastructure spend associated with the transfer of the transition services previously performed by our former parent. We continue to expect more normative capital expenditures of about $20 million annually.

We have made progress on our contract novation process to SAIC from our former parent, required as a result of the separation. Our current expectation is that the process will be completed during the summer timeframe. But I would like to remind you that the process is likely to result in a temporary negative impact on operating cash flows as customers complete the administrative actions necessary to move the contract vehicle and payment mechanism from our former parent to our Company. We believe this disruption will be fairly minor and temporary, so we expect it will not influence our capital deployment decisions later in the year.

Capital deployment continues to be a priority in SAIC's value proposition. Consistent with our commitments of saying what you do and doing what you say, we continue to deploy capital to increase shareholder value. This morning we announced the approval of a recurring cash dividend of $0.28 per share payable on July 30.

In addition, we continue to repurchase shares with our cash in excess of operating needs. During the quarter we repurchased approximately 685,000 shares, deploying $26 million of capital. And we have repurchased approximately 2% of our outstanding shares since we began repurchasing our shares in December of last year.

We expect to deploy capital through share repurchases with our excess cash after higher-return capital deployment opportunities such as business acquisitions or internal capital investments. At this point we have a relatively high recurring threshold for potential acquisitions, and targets would need to offer a compelling pull-through of our technical capabilities to currently underserved government customers.

Given our strong cash flow performance to date and cash flow expectations for the rest of the year, this presents an opportunity to increase the pace of repurchases for the remainder of the year in order to meet our stated capital deployment objectives. Also, we continue to evaluate whether the debt level ratio for a company with SAIC's stronger and predictable cash flow should be increased. If we conclude that our debt level ratio should be increased we would expect to increase the amount of capital deployed by the Company.

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

Thanks, John. I would like to thank all SAIC employees for a great start to FY15. Last week we held our first annual stockholder meeting at which all of our directors were re-elected and all of their proposals passed, consistent with our Board's recommendation. At the stockholders' meeting I communicated that after a year of transformation in FY14 this year is dedicated to optimization of the enterprise. With a solid base on which to start, we'll manage the organization to take full advantage of the numerous opportunities that lie before us.

Operator, we are now ready to take questions.

(Operator Instructions)

Edward Caso, Wells Fargo Securities.

Good morning. Congratulations on a solid quarter. I believe your top five clients are about 40% of revenue. Could you talk about each one of those and what the trends are with them?

Sure, thanks. I think right now the trend line we've seen is fairly consistent with past performance. The Army represents our largest single account or client. The AMCOM EXPRESS vehicle that we have been talking about is an important aspect of that. And the recent Task Order 37 is an important aspect of our supported Huntsville at Redstone Arsenal.

Right now across the board, whether it be AMCOM, DLA, our NASA accounts, the State Department, Central Command, aspects of our DHS and Navy accounts, across that profile, as I mentioned in my remarks, the IDIQ activity and our portfolio alignment I think is very sound, our deliveries and the customers' intent to move monies across the task orders. The contract vehicles have broadened in scope. And we think we're well-positioned to align to what they're going to prioritize going forward, utilizing the various scope of work under those task orders.

So, no major changes in trends from what we've seen in the past. We are seeing some of the federal civilian agencies commit dollars maybe a bit more confidently than the DoD. Our recent conversations with the Defense Department, I think they are still trying to assess their short- and long-term priorities as they try and lay out this year's budget, next year's, with still some anticipation of possible sequestration out beyond 2016 as we've seen in the rhetoric on the Hill.

Now, in the civilian clients, is that DHS and NASA? Is that primarily your civilian clients or are there others?

Those are the largest, with DHS, NASA. We're seeing task order activities move through, particularly on the DHS side. So, that's been helpful. But those are the two largest within the space that we face today. There's a few others, but they're at smaller scale.

You had a pretty good book to bill in a generally soft quarter. Were there any debookings, as well, within that number?

Every quarter there are debookings. We had more of a normal level of debookings this year. Debookings come from a number of areas. Oftentimes it just results in the fact that all of the funding wasn't used under the period of performance and therefore it, in essence, falls off. But we were back to more of a normative level after we saw the spike in Q4.

Could you remind us of your guidance on cash flow, both that and CapEx? Thank you.

Sure. Cash flow for the year for our operating cash flow, we don't have guidance on it but our target is approaching $200 million in operating cash flow per year on average. And our CapEx on a normative level is $20 million or less.

Great, thank you.

Cai von Rumohr, Cowen and Company.

Yes, thanks so much. And let me echo, great quarter. You talked of the seasonal downtick. And you do have one fewer working day in the second quarter. But maybe give us some help. If you have that $25 million delay on AMCOM EXPRESS, now that that's in the fold -- and J-7, I gather, is new work -- could we see a relatively modest falloff in the second quarter?

It won't be an extreme fall off. I can give you an order of magnitude. When we look at effective days, we try to estimate the amount of holidays and vacations. Obviously we know holidays. Vacations we have to estimate.

We have about four less effective days in Q2 versus Q1 because of the spring break holidays and vacations that people take. So, we look at that. That will more than offset the downtick on AMCOM. So, we will see a decline. I wouldn't say it would be significant but it would be definitely down from Q1.

Got it. And you had mentioned cash flow of $200 million, minus $20 million. So that's like $180 million. Is that the right number? I thought you had a slightly lower cash flow number. Maybe I'm wrong.

We said over time we expect our operating cash flow to approach $200 million, CapEx of $20 million. We'll be approaching that level this year, if everything stays stable. We've seen very strong cash flow performance both last year and this year. So, our DSOs are near record lows, which is a lot of focus that we put on it, and we'll continue to focus on accelerating that cash flow.

What does it take to get to that kind of number? Because you're already at a great 56 days. Can you get better? And you'd mentioned about the novation impact. Will that back up to 60 temporarily? Maybe give us some help there?

That novation impact should be completely through by year end. We're hoping most of it is through by Q2. It's probably the only time you'll see a short-term effect, is at the Q2 boundary. Our cash flow, again, if you just look at our net income and you add back the stock compensation, you start to approach the $180 million, $190 million worth of cash flow from operations.

So, if we're able to improve and continue to improve on our days working capital, that's how we're able to stay at that level. So, we're hopeful. Again, we probably won't reach $200 million this year but we're hopeful we'll be approaching it in operating cash flow. Now, realize that a significant amount of that, while not committed, we intend to, subject to Board approval, deploy through the form of dividends. So, after that, there's less what we would call free cash flow for other choices on capital deployment.

The last question is, with the novation impact in the second quarter, how should we think about the cash deployment for share repurchase? Consistent over the years? Or likely to be opportunistic and fluctuate? And how does that pair off versus potential for a special dividend?

At this point we haven't adopted an opportunistic approach. That doesn't prevent us from doing so in the future. We're not letting the Q2 perturbation in cash flow affect our capital deployment decisions because we fully expect it to be minimal and temporary in nature. So, as I said in my commentary, we have the opportunity to deploy, to accelerate the amount of capital we're deploying on share repurchases in order to meet our stated capital deployment goal, which is deploying all cash in excess of minimal operating needs, which right now we've pegged at $200 million.

Terrific, thank you.

Joe Nadol, JPMorgan.

Good morning, guys. This is actually Chris Sands on for Joe. I was hoping you could give us a quick update on the effort to improve the direct labor mix. And maybe tell us where it was in the quarter and if you have a goal for the year.

Sure. We are seeing a positive trending in our direct labor. Quarter over quarter you're going to see perturbation to that, that are caused by a number of events. As an example, we ran direct labor very high, that you'll see in our Q, of about 59% compared to 41% of subcontract. That's after you remove the material component.

That is higher than -- it was 49% versus 41%, which is higher than what we have been running, but trending upward. And there was an uplift because of the fact that the majority of the impact of the $25 million on AMCOM EXPRESS that we saw a delay in in Q1 was subcontract component. So that right now is a little higher than what our trend is, our run rate. But we are seeing a 2- to 3-point improvement each year, is what our expectation would be, which would help us get to that 10 to 15 basis points that we want to get from that lever.

And so you're on track for that 2- to 3-point improvement thus far this year?

It appears so.

Okay. And then was curious if the scope of the work you're expecting from Eagle II is any different from the previous contract. Are you expecting any material change in the revenue?

Right now we're not seeing a significant shift in the scope. We'll see how the customer migrates from Eagle I to Eagle II, but there's very strong alignment from those two vehicles. So, we do not expect any major changes going forward.

Okay. And then, finally, is there a timing expectation for the successor contract to the NASA Human Health and Performance?

It's going to be up to the customer. The RFI came out with responses already in. We'll anticipate a request for proposal and see what that looks like and go forward from there. So, no exact time line on the outcome but we expect that process to continue on a normal customer base line.

Okay, great. Thanks, guys.

(Operator Instructions)

Jason Kupferberg, Jefferies & Co.

Hi, this is Amit Singh for Jason Kupferberg. I just wanted to quickly talk about your operating margin this quarter. You mentioned that the operating income benefited from some favorable changes in contract profit estimates. So it would be helpful if you could quantify the benefit for this quarter. And also, if this is a trend, do you believe that your year-end margins could actually do better than 10 to 20 basis points year over year improvement considering that, after you remove the $1 million severance expense this quarter, you're already at 20 basis point improvement?

Sure, let me address that. First, the comments in our earnings release and elsewhere that we benefited from a net positive change means we are coming off a net write-down in the prior-year quarter compared to slight net write-up in this quarter. So, by order of magnitude you'll see in our 10-Q that we had about $4 million in write-downs in the FY14 Q1 and $3 million positive in Q1 of FY15.

The write-downs were those episodic items of the Red programs we had. I would say a $3 million write-up, net, in any given quarter is certainly not unusual. I wouldn't necessarily say it's a trend but we have seen strong fee performance as we have optimized and rationalized our cost structure. So, there's always a chance write-ups will occur that will give a short-term lift. But, again, we're looking more at steady improvement over time and on average versus any episodic quarter or year.

All right, perfect. And have you guys identified any other cost takeout opportunities? I believe since the time of the split you are pursuing some cost takeout efforts but has there been any additional opportunity that you have found?

The actions we took in the first quarter that resulted in $1 million of severance result in somewhere north of $5 million in labor cost savings per year for the remainder of the year. And then that will be in perpetuity. We also have looked at our non-labor costs and we have identified some areas for savings there. But those were savings, quite frankly, we were expecting to bring in, and that's to stay aligned with what our commitment is to the customer of returning some of that savings to them through our more competitive cost structure.

And just lastly, on your organic revenue growth guidance, after fiscal 2Q which could have some negative impact, going forward now that you are seeing an improvement in the procurement environment, and overall your revenue base over the last few years is obviously -- for you and for the competitors -- have shrunk. So, now, looking into third quarter, fourth quarter and going forward, is it safe to assume that we'll start seeing this low single-digit year-over-year growth considering easier comps?

I wouldn't say it would be out of the question. It looks flattish at this point. But, again, there's a number of things that are in play that could improve that, especially the encouraging signs we've seen from some of our customers. So it certainly isn't out of the question but we wouldn't expect to see any real reductions at that point either.

Perfect, thank you very much.

Edward Caso, Wells Fargo Securities.

Hi, thanks. Could you talk a little bit about the pace of OCO spending and where you stand with Afghanistan and your expectations for that runoff?

Sure. In FY15, for what we consider true OCO exposure, we have about $50 million. It's a lot of forward operating bases and the like that we work at. That will come down over time, obviously. The rest of the activity we have there is more supply chain business, which is another $50 million. We do believe that will follow the troops home and so we don't feel that that's going to be a headwind to us.

And our sense is that your pace of share repurchase in the quarter was a little bit lower than what we thought it would be. Are you easing into the repurchase program? I know you mentioned you expected it to accelerate but did you hold back in this past quarter?

I wouldn't say we held back in this quarter. We took a little longer view and looked at a six-month period and decided how did we want to get started in the market. We're approaching the end of that six-month period and so we're going to have to make a decision on what to do forward.

Great, thank you.

Mr. Levi, there are no further questions at this time. Please continue with any closing remarks.

Thank you very much. We would like to thank you all for your interest in SAIC and participating in the call today. Have a good day. Bye, now.

Ladies and gentlemen, if you'd like to listen to a replay of today's conference please dial 1-800-406-7325 or 1-303-590-3030 and enter the access code 467-9946 followed by the pound sign. This concludes the SAIC FY15 first-quarter conference call. Thank you for your participation. You may now disconnect.