Science Applications International Corp (SAIC) 2015 Q3 法說會逐字稿

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

Good morning, and thank you for joining us for SAIC's third-quarter FY15 earnings call. This morning 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 the 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 we specifically disclaim any obligation to do so.

It is now my pleasure to introduce Tony Moraco, our CEO.

Thank you, Paul, and good morning. SAIC's third-quarter results demonstrate continued performance in our markets and progress on delivering on our shareholder value creation proposition. Revenue of $993 million and operating margin of 6.3% resulted in diluted earnings per share of $0.77. After several quarters of revenue contraction, we are encouraged by the 2% revenue growth in our third quarter. Sustainment of our contract and past quarter portfolio, increased demand on our logistics and supply chain business, along with growth in a Navy C5 RSI, effort contributed to this growth. Third-quarter operating capital was strong at $82 million, a notable increase from the second quarter. John will provide additional details of the financial results in his remarks.

During the third quarter, we celebrated our one-year anniversary as an independent Company. A tremendous amount was accomplished during the year, not least of which is the continued excellent performance for our customers during a year of significant change and refinement of our matrix operating model. Thanks to all SAIC employees for their continued dedication. We are proud of your teamwork and more effective collaboration as we continue to build a pipeline of opportunities, for final offerings in the marketplace and execute our contracts.

With regard to the market environment, October began a critical government fiscal year which is the second year of the Bipartisan Budget Act of 2013. This will be a defining year to determine if sequestration will return in government FY16 or our elected officials will find common ground on a more thoughtful approach to our country's financial pressures. In this environment, our Federal government customers continue to develop new strategies and priorities that reduce budget levels. But even with contract scope and [funding] adjustments, we have not seen a decline in request for proposals. However, the pace of contract awards has not changed substantially and the award cycle continues to be elongated.

This quarter, SAIC had a large volume of task order renewals, but we did not see a significant increase of contract awards in September or acceleration in the face of procurement activity in October, the last month of our third quarter. Third-quarter activity translated for a book to bill of 1.0 and SAIC total contract backlog at the end of the quarter stood at $6.5 billion.

Total backlog is essentially unchanged from the second quarter; however, funded backlog is up 16% from the second quarter which is typical for the onset of the new government fiscal year. Our third-quarter win rates continue to be in line with our historical performance, and protests continue to be filed on most large announcements. As is our practice, awards that have been protested are not included in our backlog until the protest is adjudicated in our favor.

The value of our submitted proposals-winning award is $11 billion, down from about $12 billion at the end of the second quarter. This change is driven in large part by the award to FCIC of a few large IDIQ contracts such as the re-establishment to FCIC of a GSA IT Schedule 70 and the new OASIS contract vehicles. Although these IDIQ awards did not immediately impact bookings as we only book backlog when task orders are awarded on our IDIQ vehicles, these contract vehicles do provide great opportunity and access to a diverse customer set.

One year removed from separation, our market strategy remains intact as we are very well aligned with our customers' mission oriented requirements. The strategy to protect our base, expand with current customers and grow into market adjacencies is the underpinning of how we approach the market and make investment decisions. Our protect efforts are paramount to our stable revenue base and a launching point for which to leverage our existing capabilities across current and new customers. In this regard, we have made significant progress in our expand and growth strategies across the breadth of $11 billion of submitted proposals outstanding.

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

Thank you, Tony, and good morning, everyone. 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 for us and will decline over time as that work slate is completed. Our third-quarter revenues of $993 million represented 2% growth as compared to the third quarter of last year. After several quarters of revenue contraction, it is encouraging to deliver growth as our step change revenue contraction events discussed previously are largely behind us.

As I have previously communicated, our third-quarter revenue is typically our strongest of the year before experiencing reduction in revenue in the fourth quarter due to the holiday season. Historically, the holiday season has resulted in a decrease in revenue from our third quarter to fourth quarter of around 10%, and this is likely to be the case this year. In accordance with this seasonality, third-quarter revenues were up 6% from our second quarter, largely due to summer holidays and vacation time taken by our employees during the second quarter.

Operating income of $63 million in the third quarter resulted in operating margin of 6.3%. This demonstrated our continued commitment to improve operating margins through our focused initiative that cover both cost and program execution improvements. Net income for the third quarter was $37 million, and diluted earnings per share was $0.77 for the quarter. Our income tax rate for the quarter was a little over 37%, which is generally in line with our forward expectations.

Moving to cash and cash flows, the third quarter ended with a cash balance of $254 million and cash flow from operations of $82 million. This represented a significant improvement from our previous quarter's cash flow primarily due to strong cash collections. Our days sales outstanding were 57 days at the end of the third quarter, which is improvement from the second quarter of four days, or about $40 million of additional cash flows.

During the September call, I discussed the impact on our DSOs and cash flows in the second quarter caused by contract novation activities from our former parent which was the primary reason for the quarter-to-quarter improvement. We have largely completed these activities and are now on a more normative cash collection cadence. Capital expenditures for the quarter were $5 million, in line with our long-term expectation and about $20 million, annually.

Consistent with my previous communications, we continued our cash deployment activities during the quarter. We repurchased 1 million of our shares in deploying $50 million. This brings our fiscal year to date share repurchases to 2.7 million shares, for $114 million, and we have repurchased 6% of our shares, or 3.1 million shares, for $127 million since the initiation of our repurchase program in December of 2013. Additionally today, we announced the approval of our quarterly cash dividend of $0.28 per share payable on January 30. These actions collectively have resulted in deployment of 93% of our year-to-date free cash flow through the third quarter.

Since separation, we have been operating with a target average minimum cash balance of $200 million. One year following separation, we are more comfortable with our operating cash needs, and we are adjusting our target average minimum cash balance to $150 million. We intend to deploy excess cash through dividends, share repurchases or some combination of the two absent other capital deployment opportunities with expected higher returns. In addition, given the strength and flexibility of our balance sheet, we anticipate that we will increase our financial leverage over time to further support our capital deployment strategy.

Before I turn the call over for questions, I would like to reiterate our 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 expected 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)

Jason Kupferberg with Jefferies.

Nice to see the top line back here in positive territory. If we look at the quarter-over-quarter commentary for January, not surprising given the seasonality, but it would imply -- it looks like we go back negative again here year over year in Q4, yet you are reiterating the longer-term outlook to be in low single-digit range. Can you help us understand how you see the trajectory going into FY16?

It sounds like, at a minimum, there's been some stabilization in the end markets, which is good to see. But still some open questions regarding the future of sequestration, for example. So, how would you encourage us to think about, roughly, a next 12 months sort of trajectory on the organic growth side?

Sure, this is John Hartley. I appreciate the questions, Jason.

Looking at the fourth quarter -- realize that we did have a bit of a surge in the third quarter. Locked back down -- should be in the normative range of about 10%. You would see a little bit of decline if that was the case. That doesn't mean that we couldn't reach flattish if we did indeed exceed what we were expecting.

Looking into next year, with sequestration looming and the other budget headwinds that we are facing, we certainly think that our results will not be inconsistent with our long-term financial targets. Maybe a little more in the flattish range, but may also reach low-single digit. We don't expect any big step changes. I'd say we have fairly good visibility into our next 12 months' worth of revenue, as we have much of it in backlog and the rest of it identified with very little, if any, unidentified. So, that gives us confidence that we'll be in line with the long-term financial expectations.

Jason, this is Tony. Good morning. To John's points, I think, in the market, as the customers are going through their strategic planning, I think we are seeing a little more clarity on what they may begin to invest in. I think our contract vehicles are very well aligned to take advantage of that through the past quarter volume; a lot of which we saw [has been indicative] in Q3. So, based on the task orders and a constant approach on the pipeline for the contract awards into next year, all of which have been submitted, frankly, really just staying aligned on what the customers' fundamental needs are, addressing their award decisions, and then transition the program, so that's when we can convert them to revenue.

So, to John's point, I think it's pretty steady. I think the mix to date will benefit our long term, and we will just address the [contract of work here] as they come out through each quarter.

As we think through those next 12-month comments a little bit, and try and translate that into book to bill -- we like to look at that metric on a trailing 12-month basis, just given there's some natural lumpiness quarter to quarter. On that LTM basis, I think the metric has maybe slipped a little bit to around 0.8 or so, though on the quarter itself I think you were right around 1. What I'm trying to get a sense of is: As you think about doing maybe flattish plus organic revenue growth in your FY16, do you need a book to bill of around 1? Or can you kind of run where you are about now on an LTM basis?

We can run where we're at. I think we've seen and messaged before that the sheer numbers themselves keep you close to that 0.9 to 1 based on the shorter revenue booking per task order. I think we've shown that Q3 is indicative of -- we can rule out of the past quarter refresh and stay close to that number. And any opportunity to win the full up contract awards is how we calculate that -- those bookings -- really will create some additional upside on the book-to-bill metric, itself.

We continue to submit large proposals, and a couple a quarter really gets you above that on a normative range. So, one, with some change on those contract awards gets you north of that. But comfortable with a 0.9, plus or minus, as we look at task order volumes alone.

Okay. That's very helpful. Thank you, guys.

Edward Caso with Wells Fargo.

Can you talk a little bit about the acquisition environment within the context of the competitive landscape, particularly now with the announced task acquisition? Thank you.

Sure, Ed, good morning. I think the market generally has been talking about the need for some level of consolidation, given the run-ups over the last 10 to 12 years, that there's a lot of properties, a lot of companies all jockeying for similar work, given the budget environment. And on the competitive landscape, I think we will see consolidations over the next two years. Properties will try and assess where they've got growth opportunities; and absent growth, look to the acquisition markets.

On a competitive basis, I think most of the market's taken out a lot of the cost in the infrastructure, as we've all been adjusting to the new budget norms, the price pressures. The cost side, I think, is pretty well normalized at this point, and folks are still tweaking their margin opportunities, their pipelines and portfolios.

So, you still may see some divestiture and some focus going forward in some areas. You might see some of the former companies themselves consolidate to really try and get to a point of scale. We do think that $4 billion -- that that does give us a lot of scale and leverage to manage the rates with less volatility to be able to continue to pursue the work, whether it's new contract awards or task orders.

Each company, as they go through that consolidation, will have to address what cost synergies they can realize -- what market synergies on the revenue side. But I don't think the competitive landscape, as a whole, will change dramatically. You may see slightly few bidders, and you may see some new entrants in some markets based on those consolidations. But in the macro, I don't think you'll see significant change in the competitive landscape based on price pressures and capabilities that people are going to market with.

Some of your -- some of the other publicly traded companies have highlighted the difference between solutions focus and services focus, and I believe you guys are pretty much services focused. But they also, in that context, talk about severe price pressure within the services side. The first part of my question is: Are you staying services focused; and second, are you seeing continued price pressure? Thanks.

I'd say, as we really designed the Company portfolios in the spin, the intent is to stay on the services side, from a business model perspective. But we've traditionally continued to deliver technology integration solutions. It's not just a resume shootout, it is a total solution, whether it's an integrated tactical vehicle, whether it's integrated network architectures across the board leveraging some of our strategic partners.

To be clear, it's still about providing the capability of solution for that customer need, than just staff augmentation, which we tend to stay away from. But in that model, we think on the services side, it does give us system engineering and requirements and planning proximity to the leadership, to be able to be better aligned and then take advantage of the contract vehicles that we have. I like being on the services side at this time, so we can help the customers navigate their own priorities, and do it in such a way that we can manage the risk and the transition to that next-generation capability, whatever it is.

The price pressures -- I think we've seen that reality over the last few years. Again, I don't think it's going to be another step function in price pressures. We've seen, in fact, a little bit of pull-back on just straight, low-priced, technically acceptable decisions. I think some of our customers have felt they got what they paid for, and wasn't quite satisfactory. I think we're seeing some rationalization with the technical staff being engaged with the acquisition community. I think, although price will still be a predominant evaluation criteria, I think we're trying to see a little bit of a balance as they try and be smart about how they spend their money.

Thank you.

(Operator Instructions)

Joe Nadol with JPMorgan.

It's actually Chris on for Joe. Going back to M&A, can you shed some light on any particular areas where you may be focused, whether it's customers or capabilities?

Sure, Chris. This is Tony again. Our approach on M&A, which we think we still have access through the balance sheet and the leverage position -- then you got the flexibility -- we wanted to make sure that we have the organic focus, and we continue to have that and we will sustain that organic growth. But I think it can be complemented by some M&A activity.

So, I'd put it maybe in four categories of how we think about it, maybe in not necessarily priority order, but market access is predominant in our ability, with the eight service lines we have, to be able to create and get access to additional markets, and break that down to specific customer accounts and fundamentally contract vehicles that we don't have today, a year after the spin. We'll look at technical capabilities that complement our own across our full lifecycle to ensure that we continue to do what we do. And per the previous question, aligned along a services business model than out chasing product technologies, which we love to tap some intellectual property, but it doesn't have to be out on a productization limb, if you will.

And then look at the compliance environment, to ensure, given what's going on with [ECMA, DTA] the Federal regs, that the compliance elements fit our own behaviors and bars that we set, and then look at the culture aspects. From a fit of the integration, we'd expect to move forward with the matrix itself as a differentiator for us. And so, we would look to a cultural environment that would be adaptive to that, so we can take full advantage of that.

With those characteristics, there's a number of properties that would be out there. We've talked in the past about places we've underserved in places like the Air Force, the intelligence community, the health sector, public health in particular, as areas where it may be interesting and more timely to get to market through M&A. But, again, the focus is still on the organic side.

Excellent, thanks. That's helpful. John, one for you: With Q4 sales being down, do you think you'll be able to hold margin in the low-6% range where it's been? Or could there be some pressure there?

There certainly could be some pressure on the lower volume. We do still expect to stand by what we had communicated at the 10 to 20 basis points year over year, coming off a 6% year -- couldn't go much below 6% and still stay in that range.

Okay. Fair enough. And then last one: Is there any update on the program that was formerly NASA's human health and performance?

Yes. The proposal itself has been issued. We continue in our capture activities and strategies. But the proposal is out, and the government's requested to submit sometime in the late January time frame.

Great. Thanks, guys.

Cai von Rumohr with Cowen and Company.

Yes, thanks so much. Your worst of sales looked like it's a little under 1 -- 0.96 -- but your months of funded backlog are up. And, Tony, I think you alluded to the fact that the average duration of a task order has been coming down. Can you give us any color or quantification, like where it is today versus a couple of months ago?

Cai, it's probably similar on a monthly basis -- probably comparative to maybe two years ago, when you could get a full option year funded on the IDIQ task orders. It's more traditional and typical now for it to be three to six months of funding coming in.

Unfortunately, it's created additional transactional churn on the customer side. But it gives them a little more flexibility on the commitment of those funds. It's nothing substantially changed, say, in the last year, but it is different, and we've seen that consistent task order pressures over the last year or so.

Okay. And then, you mentioned a couple of contracts in your press release. Could you comment which of those are new work, and which of those may be -- because you only booked the task order -- have potential for growth next year?

Well, I'd say that OASIS is the only formal new contract vehicle that we've recently been awarded; again, the task order is still there. We have reestablished the schedule 70, although we have been using the previous schedule under our separation agreement.

Overall, and with the DLA awards that sustain our activities there, it's important that we carry those contracts forward -- [complete readiness] and the prime vendor program. This quarter, I'd say it is still characteristic of market access -- contract vehicles that we will see and exploit. We've reported in the past, additional ones, the DHS EAGLE, for example, where that's in transition, and we start moving things to EAGLE II.

It's pretty much consistent with what's been going on in the past. And as I mentioned earlier, there's still a substantial amount of non-IDIQ submits that the customer groups, under Nazzic Keene, have been really addressing in our ability to go to market faster, supported by Doug Wagoner's services lines on our offerings.

Okay, great. And then, going back to Jason's question about your low single-digit revenue growth target, and then if, in fact, there hasn't been a change over the past year in terms of duration of task orders, what will it take to get you to a couple percent revenue growth next year, or up?

I think what we will see is continuing to sell through the IDIQ vehicles that we have. We are working hard to expand our channel with some of our strategic partners. As we go to market as a technology integrator, one of the strategic components that we've invested some time in this past year are some of the technology channels, the capabilities that we need. And then, turn around and partner with them on some of the market access that they may have through their sales force.

I think it's a combination of: take advantage of the strategic partners on the technology side, sell through on the IDIQs, working with those broad teams that we have. And continue to introduce new services to those same customers that maybe we didn't historically provide. And then continue to address the pipeline opportunities on the non-IDIQs, of which we have many opportunities to take the market share, and provide the solutions that we need. It's in those three dimensions that I'm still confident that we can sustain the revenue base, and then to John's point, over time, build up on that single-digit organic growth.

Cai, just to add to what Tony is saying, on the book to bill, as it relates to low single-digit revenue growth, if you think about what Tony is saying as far as the funding on task orders being three to six months, which can be new work on those task orders, they don't necessarily have to be just re-competes. But if you think of those, and then you also realize we have a large book of standard contract awards that we are working off that backlog -- think about our Department of State and our NASA mix; very big amounts that were burning a couple, $300 million worth of backlog each year, and those only get replaced every 10 years.

So, we can run at a 0.9 to a 1.0, and still grow in the low-single digits. You certainly wouldn't want to do that for years and years in a row, and we also like to see those big 10-year awards come through in our favor. But that's kind of a way to think about the book to bill in the short term.

That's very helpful. And then, Tony, your background with the Air Force -- I think the Air Force was one of your key targets, given the relaxation or the avoidance of OCI restrictions that you had when you were part of SAIC. How are you doing in terms of penetrating the Air Force?

Cai, we have really submitted bids against the Air Force requirement set -- have been, I think, pretty practical on where we can offer solutions and technologies that we've performed well. As you know in this market, the past performance weighs heavy. Our ability to translate what we've done for other customers, to the Air Force -- we've got a good, quality pipeline. We've submitted bids there, as well as in other areas, like the Navy post-OCI environment.

I'm very confident that we've looked at what we can do on both the enterprise IT side, as well as on the mission engineering side. We have a lot of work in avionics, test equipment, so really still full lifecycles of what we do. And we are just being really practical on which ones make the most sense, as we are smart about how we spend our BMP money and maintain a quality pipeline with a high probability to win. We are not going to chase anything that's out there but those that align best for us.

That's great. Last one for John: Last year, your op margin in the fourth quarter was higher than the third quarter, despite the revenues having the seasonal downtick. This quarter, you had a pretty good gross margin. Should we really expect the margin to be down in the fourth quarter versus the third? Or could it be stable, just slightly higher, as it was last year?

In looking at last year, Cai, you have to keep in mind, and maybe you did, the separation costs that were heavy in the third quarter, not as heavy in the fourth. We were dealing with --

I'm excluding them. I'm doing it before them. It was [6.1%] versus [6%].

Okay, great. It's going to be in that range. As with any government contractor, a lot of things true up at the end of the year, so you have all of your rates truing up, you have all of your fringe benefits truing up. So, there's a little bit of perturbation, up or down, as a result of those items truing up. I don't think it's going to fall off dramatically; I wasn't saying that at all. It should just be in a -- generally a smooth range. I don't expect any big ups or downs.

Thank you very much.

And that concludes the question-and-answer session. I would now like to turn the conference 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 today's call. Have a good day.

And that concludes today's conference. We thank you for your participation.