Science Applications International Corp (SAIC) 2015 Q2 法說會逐字稿

Good day, and welcome to the SAIC FY15 Q2 conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Paul Levi with Investor Relations. Please go ahead, Sir.

Good afternoon, and thank you for joining us for SAIC's second quarter FY15 earnings call. This afternoon, we issued our earnings release. And joining me today to discuss our business and financial results are Tony Moraco, our CEO, and John Hartley, our CFO.

Today's call is being webcast at investors.SAIC.com, where you will also find the earnings release and supplemental financial presentation slides to be utilized in conjunction with today's call. [Both of] these documents, in addition to our form 10-Q to be filed soon, should be utilized in evaluating our results and outlook, along with information provided on today's call.

Please note we may make forward-looking statements on today's call that are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from statements made on this call. 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 quarterly reports on form 10-Q.

In addition, the statements represent our views as of today, and subsequent events may cause our views to change. We may elect to update the forward-looking statements at some point in the future, but were explicitly disclaim any obligation to do so. It is now my pleasure to introduce our CEO, Tony Moraco.

Thank you, Paul, and good afternoon. SAIC's second-quarter results reflect continued progress in the execution of our business and shareholder value creation strategy. Revenue of $939 million, and operating margin of 6.3%, resulted in diluted earnings per share of $0.70. Operating cash flow for the second quarter of $65 million was impacted, as expected, by the previously discussed contract novation activities. John will discuss the details of the financial results in a few minutes.

Since our last earnings call in early June, there has not been a significant change in the market environment. Our customers continue to be guarded with their resources and award dollars, in shorter cycles and reduced amounts. There have been a few larger, longer-term awards issued, but many continue to be quickly protested, and thus delays transition, or in some cases, causes customers to restart the entire procurement process. Several customers have reacted to the protest environment, I think in a much more deliberate and elongated RFP development, their selection process, in an attempt to protest-proof their decisions, which also contributes to delays in awards.

It is unclear whether government's FY14 year-end award activity [with SORRIC], given the current procurement environment and the likelihood that the government will start the FY15 under a continuing resolution. Award activity in Q2, translated to a book to bill of 0.9, and the total contract backlog at the end of the quarter stood at $6.5 billion. As is our practice, awards that have been protested are not included in our backlog until the protest is adjudicated in our favor.

At the end of the second quarter of FY15, the value of our submitted proposals is about $12 billion. This is down from about $14 billion of the end of the first quarter. This is driven in large part by the award to SAIC of a few large IDIQ contracts, and the restart of procurement activity of a NASA HHP fee contract that was removed from our submitted proposal backlog.

We continue to develop a pipeline of quality opportunities aligned with our strategy to protect our revenue base, expand revenues of current customers, and grow into adjacent markets where appropriate. Along with a substantially reduced OCI obstruction following the spend, our optimized operating structure has enabled us to take current capabilities to new customers. We have many examples of contracts we have bid that we previously did not have the opportunity or focus to pursue.

During last quarter's call, I mentioned the award of a prime contract position on the DHS EAGLE II vehicle after the end of the first quarter. This award allows us to sustain our DHS revenue base, a prime example of our efforts in the protect category.

During the second quarter, we were awarded a prime position on a GSA vehicle, named one acquisition solution for integrated services, or OASIS. The awarded positions in all seven pools available on this contract, which afford us the ability to provide a diverse set of capabilities to a wide range of federal customers. This multiple award government-wide IDIQ vehicle includes program management, management consulting, logistics, engineering, scientific and financial services, for a five-year period, with one five-year option.

Finally, I am pleased to let you know that the contract novation agreement was signed by our government customer in July. They have received approval to transfer the contracts, and are executing the administrative actions on individual contracts.

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

Thank you Tony, and good afternoon. Consistent with my remarks in prior calls, my comments today will exclude the minor amount of revenues and costs performed by our former parent, which generate no profit and are expected to decline over time as that work scope is completed. Second-quarter revenues of $939 million were in line with our expectations, and resulted in a 7% contraction that's compared to the second quarter of last year. This contraction is also in line with the comments I made on our last quarter's call, where I spoke of the quarterly revenue profile for this year.

Our second-quarter revenues were down 2% from the sequential prior quarter. This is largely due to the Memorial Day and Fourth of July holidays, and summer vacation time taken by our employees. We continue to expect third-quarter revenues to rebound slightly from the second quarter, with fourth-quarter revenues again softening due to the holiday season.

Operating income of $59 million in the second quarter resulted in operating margin of 6.3%. We are encouraged by this performance, as it is indicative of early success from our focus on margin improvement. We remain committed to enhancing profitability, with the objective of 10 to 20 basis points of average annual margin improvement over time, until we reach a level more normative of the markets where we operate.

Net income for the second quarter was $34 million, which resulted in diluted earnings per share of $0.70 for the quarter. Our tax rate for the quarter of about 38% is aligned with our go-forward expectations.

Moving to the balance sheet and cash flows, our days sales outstanding were 61 days at the end of the quarter, which is an increase from the first quarter by five days. This increase was primarily due to the timing of the contract novation activities from our former parent that Tony referenced earlier. As you will recall, I discussed this potential impact in last quarter's call, as customers complete the administrative actions necessary to move the contract vehicles and payment mechanisms from our former parent to our Company.

This temporary disruption of about $30 million peaked at quarter end, and has largely returned to normal as of today. Despite this event, we end the first quarter with $247 million of cash, and our cash flow from operations was $65 million for the quarter. We continue to place emphasis on our cash flow optimization programs. Capital expenditures for the quarter were $3 million, in line with our long-term expectation of less than $20 million annually.

And finally, in the capital deployment arena, we announced today the approval of a recurring cash dividend of $0.28 per share, payable on October 30. Additionally, consistent with our desire to deploy cash in excess of operating needs, we have increased our share repurchase activity during the quarter. We ended our first six months of our repurchase program in mid-June, and deployed about $50 million over that period.

Then, during our open trading window opportunity in mid-June, we began deploying cash for share repurchases at about twice the previous pace. This approach resulted in share repurchases of approximately 920,000 shares, and deployment of about $39 million in the second quarter. Since the initiation of our share repurchase program in December, and through the end of the second quarter, we have repurchased approximately 2 million shares, for a total of $77 million.

Before I turn the call over for questions, I would like to reiterate the long-term financial targets that we expect to accomplish on average and over time. 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 finally, financial leverage appropriate for a Company with SAIC's investment requirements and cash generating characteristics.

Operator, we are now ready to take questions.

(Operator Instructions)

Cai von Rumohr, Cowen and Company.

Good quarter. You mentioned that you had some delays. Could you give us a little more color on the impact it had in the quarter, in terms of subcontractor and material revenues, and on profitability?

Thanks, Cai. Yes, the delays have been pretty consistent with the prior quarters. It was not a big shift in either the subcontract or materials flow. As we all expected, with the last quarter and the government side, we would expect some of that material pickup. Haven't seen that as of yet; we still have a couple of weeks to go.

But overall, the value add that we talked about in the new submit in the past quarters, is increasing slightly, as compared to the subcontractor mix. But overall, I'd say that we've got a pretty consistent mix between the value add with sub and the materials. The contract delays, again, nothing unusual. Just really tied to the overall procurement process that we see unfold the last year or two.

Okay, thank you. And maybe you sound somewhat cautious. Do you expect -- I assume you expect some kind of launch or pickup in the current calendar quarter. Is that the case, or is it still very slow?

Cai, it's possible, but I would say that we're this far into it, with only a few weeks to go. We have not seen the award decision [add] any material volume in the last couple of weeks, and we would expect, again, some lift as we get the final commitments. The sense, perhaps, is that the customers continue to be pragmatic about their contract award decisions, may stretch that out over multiple quarters.

We are seeing the shorter cycles, that reduced amounts continue. And [hence], I think we've seen this constant slightly below one book to bills, as work that is recurring, yet [spun it] on these shorter cycle times. But maybe we'll see it, but I'd say collectively, it's not likely to be dramatic from the last year or two.

Okay. And then the last one, other of your peers have noted continuing tough pricing, resulting in lower margins on re-competing and on take-away wins. Is that something are you -- that you're seeing? Because that seems to run in conflict to your plan to have margins trend upward by 20 basis points.

I would say that the price pressures are still there, but the emphasis on price and the total competition, and the solutioning, ability to compete with all the components of the price is on labor, the rates and the margins. We're comfortable that we can control the amount of margins selected. So I'd say collectively, the price sensitivity is having some impact on top line, as we see customers pull back scope, if you take a 10% reduction in the total contract value. But as we manage the cost structure, we feel we can still manage the margins at the levels that you talk and prove and full commit to that 10 to 20 basin points improvement over time, part of that contract mix.

Jason Kupferberg, Jefferies.

This is Amit sitting for Jason. Just wanted to come back on the budget [flush] expectations for this year. How are you expecting [when is close] this year to be, especially compared to last year? And then if you can tie that with -- it seems like the year-over-year comparisons for revenue for the second half seemed slightly easier. So should we expect that there's a chance that we could see modest year-over-year revenue growth in second half?

I would say that there may be modest, just a transition, as we look at the revenue streams. We saw the single-digit contraction from year over year. We're seeing that flattening occur in the revenue stream going forward. Feel pretty comfortable that that will move through the system.

On the overall pipeline, and award activity and the outlook, again, most of it aligned on that book to bill. Very little of it will have a direct impact on near-term revenues. But as we see, and move into next fiscal year, those awards will be, obviously, much more important. But overall, I think it has been a fairly consistent approach. And I don't see any dramatic change over the year-end activity that we saw last year or the year before.

All right, great. And just coming back on margins. Your long term target is 10 to 20 basis point year-over-year improvement. But during the year, your 6.2%, this operating margin of 6.2% this quarter, they were 6.1% last quarter. So what -- do you expect similar trend to continue? And then, if that's the case with 2015 operating margin, would year-over-year improve more than the 10 to 20 basis points?

We came off of normalized. After removing separation cost, we came off of FY14 at about 6%, and we expect to grow the 10 to 20 basis points off of that FY14. So that would put you into the 6.1% to 6.2% range. It is going to ebb and flow as we go throughout the year, depending on volume and other items that occur. But we expect to be in that range for this fiscal year.

All right, great. And just one last one. For operating cash flow, do you expect in FY15 -- I know you had previously said that $200 million per year is your target. Do you expect to reach that target this year?

If we are able to continue to deploy our capital the way we see it, we could approach that target towards the end of the year. We would also look to lower that average minimum cash need down by about $50 million, as we get more and more comfortable with our cash flows being a separate company. So we're trying to get down to that level. We've got plans in place, or we've got ways to do that. So you'll see that in the coming quarters, as we try to get closer to that $200 million, and then have that available $50 million in addition, to deploy as well into FY16.

All right. Perfect.

Bill Loomis, Stifel.

Just looking at the book to bill in the quarter, it was 0.9, which is pretty good for this quarter and better than last year's, I think, 0.7. And your first-quarter results were a lot better than the year ago. But yet you sound like you're somewhat disappointed on the level of contract award activity. Why is not a 0.9 book to bill so far this year a good thing? Why is it -- why are you still saying the award activities seems to be below your expectations?

No, we are definitely proud of the 0.9 this quarter. But in the context of trying to drive this to get to an occasional quarter of north of 1.0, we're just tying to watch those trends. But we're very confident in the submits. Do everything in on our power to just improve the quality of that pipeline. I don't see any dramatic shift in our competitive win rates. So we'll win our fair share, happy about the 0.9 compared with the last year. But really not being overly optimistic that we're going to blow through that 1.0.

But there are -- make a point of, there are some very large deals that have been won and protested, that in and of themselves could drive it 0.2, 0.3, just on their own. So we're going to float around that 0.9. We will hit some deals that will push us over the top in the coming quarters. But that's how I'd characterize the book to bill, based on award decisions process right now.

On the -- your big IDIQ's, like recent ones, OASIS, EAGLE II, have you seen task order flow on these new ones yet?

I'm not sure on not having seen anything on the DHS, nothing on OASIS coming through. The vehicles, there are other alternatives in place today, and it generally takes some time for task orders and customers to transition those efforts. So they are in place, and the migrations will be fairly natural, as we finish off current vehicles and move on to those new ones.

And what about -- have you seen the steady ramp up in some of the other contracts you've won? Like the Army human resources contract? The federal thrift investment four contract? Have those ramped up per your expectations over the last several quarters?

Yes, they have. Great kudos to the team on the transition activities up front, HR on the staffing side. But I'd say that those programs are at their run rates. We're still responsive on some surge activities on some vehicles, as well. So there's still some capacity, and I'm very proud of the team's performance on this program as we go forward. So high confidence on those, and they are at run rates that we'd expected.

So you're not seeing the customers holding back on funding on awarded contracts that are generally seem to be ramping up as expected? Or are you seeing some hold-back on some programs?

They are still being conservative in [what] they do, but given the vehicles that they own, they still have the work to do. And their comfort increases based on their priorities, and then the monies get committed. So pretty natural process. But in place, the customers are using their vehicles. But the ways that we have talked about do creep, due to the new contract awards, as you've heard us talk about.

Any change in tone on how your customers are talking about their comfort level on funding environment? Or anything that you can shed light on?

As I said, I think they're being conservative. They know they had a two-year window. We're coming up on the end of that first window, with the threat of sequestration out in 2016. How that sequestration manifests itself is yet to be seen, but it is a legitimate threat in their eyes, at least the ones I've talked to. But I think they all understand the new budget baselines that they need to get to to avoid sequestration.

And I think you're seeing all the customers prioritize and rationalize their commitments to be on the trend line, based on their department or agency requirement. So it will trend out, but I would say they are being practical but conservative. I see that as a [limited] budget environment undertaking actions accordingly.

Okay, great.

Edward Caso, Wells Fargo.

Solid quarter. Great. Just to be really clear, do you expect your clients to spend to their 2014 -- the government 2014 budgets?

Yes, I would expect that they do, but it's not a guarantee that they will. Some may still be adjusting to the multi-year view to try and ramp to a 2015 number. I don't think we're going to see any (inaudible) but they could sack their in-place of their 2014 to get into 2015. We're still expectations that CR will be -- at least the first round will be fairly short. But I think that (inaudible) focused on the new baseline budgets that they're headed towards. And then you are just seeing the requirements, the budget allocations, and the subsequent [pocket] (inaudible).

I guess I'm -- what I'm trying to figure out is the first -- although there was almost no activity in the December quarter, or the government's first quarter. Very slow in the March quarter. So to spend the number, you have to really spend a lot of money here at the back end of the year. Yet I'm hearing, in general, that things are just moving along at pace in prior years. So shouldn't there be a very noticeable surge in spend here, to reach that -- those government 2014 appropriated levels?

Yes, I think there should be, but we haven't seen that volume. The submit volumes are there, but frankly the award decisions are still very slow across the entire industry. And I think you have seen that reflected. So we would expect it. And my only speculation would be, you look at 2014 and 2015 together, and you budget environment and baselines are trying to drive through. We may just be seeing the outcome of some of that slowdown, as they reduce their overall (technical difficulty).

Yes, the ISIS chatter lately, are you seeing any change in your client behavior, as we start to ramp up our activities against this terrorist group?

With the customers, they're looking globally at all the different threats, the deployment opportunities. I'd say there are a number of contingency plans underway, trying to assess, think in terms of supply chain logistics. Where are the assets today? And how might they be deployed across the globe? And how the government may surge in those areas. But there -- we haven't seen any direct task order or specific tasking to serve that activity at this time. But a lot of contingency plans are underway, just in case.

Last question. Can you remind us about your OCO exposure?

Yes, the OCO, we started at about $100 million last year. It's moved down closer to $50 million this year. And as we look to those monies, we may see that maybe bounce around plus or minus $10 million or so, as we look for support in different fields. That's all I have today.

Great.

Joe Nadol, JPMorgan.

First question is just on the revenue mix. Could you provide specifically what we will see in your Q on -- when you file it, on direct labor-related revenue? What percentage of your revenue was that?

Sure. So you'll see that our direct labor, our labor-related revenue, will be about at 45%, compared to about 33% the subcontract-related and 22% for materials. If you just take the materials out, that shows a consistent run of about 58% of just -- of the percentage of our labor and subcontract-related labor, which is consistent with the prior quarter, which is also up from the FY14 rates. So we are seeing some progress in moving to our organic labor, and we put a lot of emphasis on that. Again, it takes time to move the needle, but we're seeing a trend in the right direction, and it's a little ahead of our expectations at this point.

What's the key to really moving the needle? Is it internal training on how to approach contracting? Is it just the timing of contracts? Certain types of contracts rolling off? What are you seeing as the biggest obstacles to really pushing that agenda?

Yes, I would say the training is largely complete. In our bid reviews, we've largely put in our expectations of the amount of SAIC labor that should be in the bid. We've developed who our strategic partners are going to be, so that we are very explicit now in our bid reviews, on what we are going to partner for versus what capabilities we will provide. And so I say that's largely in place. The biggest hurdle to that is just the elongated award cycle of 12 to 18 months.

If we look out at our submitted proposals under evaluation, we see that our submitted award are in excess by a fair amount of our current portfolio. So that means we're bidding in the right direction. Of course, we have to win those in order to move that, but that's going to be the case regardless. But we do see that on the horizon, that it's headed in the right direction. The other thing is, as we approach task order by task order, as those are renewed, or as we evaluate our current contract portfolio, we have limited capability to switch from a subcontract labor to SAIC labor. But we have seen a number of successes in that area, as well.

Okay. And then, the NASA human health situation, any update on what's happening there?

The procurement is back in what they say is a traditional cycle, with [total] activities in the government, [teaming] discussions within the private sector, and preparing for our resubmit, based on that procurement play (inaudible) and that restart.

Okay. So timing this would seem to be certainly something -- I guess, hard to say precisely, given what has happened, but certainly is being (multiple speakers) next year?

It is underway, the RFP and (inaudible) activities are underway, but it is hard to say what the timing will be on final submit. And then obviously, the award activities have really been up in the air. We are on track with motivation moving forward, but hard to quantify that [on] schedule.

Okay. And then just one more. You mentioned that, as usual, you keep protested but awarded contracts out of your backlog. I was just wondering if you could cite how large that number would be right now? And how that compares to the last few quarters? Has it been going up?

The backlog, on the protest side, we've got big deals. There aren't a huge number of protests, but the ones that we've been involved with are at a fairly large scale, in (inaudible) HHPC and some of the other more recent ones. So they are material, and they do move the backlog number and the book to bill that we mentioned earlier. But overall, we just treat those as an extension of that procurement process. I do feel confident in the protest activities that, for those that are strategic and at scale, that at least on the first round, we come out and -- as an award winner. And just work through and support the customers, do whatever corrective actions they are trying to undertake.

Okay. And I have, actually, just one more. OASIS, is there a way of -- since it's multiple award, is there a way of quantifying the opportunity? Or at least giving us a sense for what you think might be the competitive landscape there? Particularly since, as you mentioned, there are other contract vehicles that it will essentially compete with?

Yes, it is kind of hard to say how that -- again, very tough to quantify now, based on how those customers will migrate to that vehicle. It will take time. I would probably give it a couple quarters, begin to realize which customers find it most advantageous. And then folks will be able to align their pipeline, and give you maybe a little more clarity on the nature of the work, and the customers that will use OASIS on a more regular basis. But I can't give you a number now.

Okay. Understood.

And that does conclude our question-and-answer session at this time. And I would like to turn the call back over to Paul Levi for any additional or closing remarks.

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

And once again, that does conclude our conference for today. Thank you for your participation.