Science Applications International Corp (SAIC) 2015 Q4 法說會逐字稿

Good day and welcome to the SAIC fiscal year 2015 Q4 and year-end conference call. Today's conference is being recorded. At this time, I'd 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 fourth quarter and fiscal year-end 2015 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-K, to be filed soon, should be utilized in evaluating our results and outlook, along with the information provided on today's call.

Please note that 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 we specifically disclaim any obligation to do so. It is now my pleasure to introduce our CEO, Tony Moraco.

Thank you, Paul, and good morning. SAIC's fourth quarter and full fiscal year 2015 results reflect continued execution of our business strategy and delivery on our shareholder value creation proposition. Fiscal 2015 revenue of $3.8 billion and operating margin of 6.3% resulted in diluted earnings per share of $2.91.

John will cover the financial results in more detail but fourth quarter revenues of $941 million resulted in the second straight quarter of year-over-year revenue growth and 6.3% operating margins. We continued our strong cash flow performance with approximately $100 million of operating cash flows in the quarter and $277 million for fiscal year 2015.

Finishing our first full year as an independent Company, we made significant progress on our strategy execution and, most importantly, performed well for our customers. We are carrying that momentum forward into fiscal year 2016.

From a market standpoint, there have been no significant shifts in the environment, which is generally good news. Our federal customers are working with appropriated budgets through September 30, the end of government fiscal year 2015. There appears to be optimism as a result of the President's budget recommendation for fiscal 2016 and early feedback from Congressional committee deliberations.

However, there's also caution, as demonstrated by our customers, as the pace of contract awards has not changed significantly and the sales cycle remains longer than historical trends. However, we continue to see demand for the capabilities that SAIC provides and new contract opportunities for us to pursue. Our Protect, Expand and Grow Strategy remains unchanged and we continue to execute that strategy.

Similar to our third quarter, SAIC had a large volume of task order renewals and, with our revenue profile coming largely from ID/IQ contracts, these renewals are vital at protecting our base, providing opportunities to expand our services to these customers. Fourth quarter award activity translated to a book-to-bill of 0.7, which follows our historical pattern of lower fourth quarter awards.

SAIC total contract backlog at the end of the fourth quarter stood at $6.2 billion, of which funded backlog is $1.7 billion. Historically, our fourth quarter backlog is the lowest of the year, as we see customer awards slow due to the holiday season and a lull coming off of a usually higher third quarter.

The value of our submitted proposals awaiting awards is $12.7 billion, up from about $11 billion at the end of the third quarter. This is largely due to the resubmittal of the NASA Human Health and Performance Contract proposals. We anticipate an HHPC contract decision this summer.

Subject to the end of the quarter, the United States Marine Corps exercised a contract option for SAIC to continue into the next phase of the Assault Amphibious Vehicle Survivability Upgrade Program. After nearly a year-long competitive down-select process, we were selected to continue with the next phase of this vital effort to support Marine Corps amphibious capabilities.

Since last May, we completed preliminary and critical design reviews and SAIC will now perform initial upgrades to 10 assault amphibious vehicle prototypes. Following this, additional options, if exercised, will lead to developmental testing and low rate initial production, delivering 52 vehicles for operational test and evaluation to Marine Corps units. Total value of this contract, if all options are exercised, is $194 million over five years.

This important effort is another example of our strategy to expand work with current customers by leveraging our existing capabilities across our customer sets. In partnership with the Marine Corps, we leveraged our differentiated services model to provide a cost effective value proposition in direct competition with OEM primes, applying our integration services capabilities and partnering with key subcontractors.

Through the capabilities demonstrated on previous vehicle upgrade programs for the Department of Defense, such as MRAP and AAVC7, we were able to leverage our domain knowledge to the Marine Corps and help them ensure their war fighter safety and amphibious mission success.

Now I'd like to comment on our planned acquisition of Scitor Corporation. Announced at the beginning of this month, we are scheduled to close the Scitor acquisition in May of this year. We have progressed on the financing and received clearance under the Hart-Scott-Rodino Act and are excited by the shareholder value creation opportunity.

Along with the Scitor management team, I have visited several sites with customers and intelligence community leaders in order to express my commitment to their critical national security missions. In our discussions with them, the reactions have been positive, and our understanding of the vital role that Scitor plays in the security of this nation has been reinforced.

During these visits, customers have expressed their appreciation for the high-caliber technical talent of Scitor employees. I look forward to close -- to the closing scheduled for May and officially welcome the employees of Scitor to the SAIC family. 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 scope is completed. Also, I will primarily focus on SAIC's performance for the fourth quarter as opposed to the full year.

Fourth quarter revenues of $941 million reflects 1% growth as compared to the fourth quarter of last year. This is our second straight quarter of year-over-year revenue growth and is in line with our beliefs that we can achieve organic annual revenue growth in the low single digits on average and over time. As I have previously communicated, our fourth quarter revenue is typically the lowest of the year and as anticipated, decreased by about 5% from the third quarter due to the holiday season.

Operating income of $59 million in the fourth quarter resulted in an operating margin of 6.3%. This operating margin is in line with recent performance and is encouraging, given the lower fourth quarter revenues due to the holidays.

Net income for the fourth quarter was $36 million, and diluted earnings per share was $0.75, representing an increase of 14% from the fourth quarter of last year. Our income tax rate for the quarter was about 35%, which benefited from the federal government's extension of the R&D tax credits, retroactive to the beginning of the year and positively impacted EPS by about $0.03.

Now on to cash and cash flows. In the fourth quarter, we had cash flow from operations of $96 million, and resulted in an FY2015 ending cash balance of $301 million. Cash flow from operations for the year were $277 million.

Our days sales outstanding stood at 52 days at the end of the fourth quarter, which is an improvement from our third quarter of five days, contributing about $50 million of additional cash flow. We have taken many actions designed to accelerate cash flow and I am very pleased with our cash collection performance.

This leading performance is the direct result of the focus we place on cash flow because of its importance to shareholder value. However, we do expect our DSOs to return to a more normative level in the mid-50 day range. Capital expenditures for the quarter were $7 million, slightly above our normative quarterly amount, but generally in line with our long-term expectation of about $20 million annually.

Moving on to capital deployment. We continued our capital deployment activities during the first half of the fourth quarter through share repurchases at about the same daily pace we had in previous quarters. Accordingly, we repurchased 455,000 of our shares by deploying about $25 million.

This brings our fiscal year 2015 share repurchases to 3.2 million shares for about $140 million and we have repurchased 7% of our shares, or 3.5 million shares for $150 million, since the initiation of our repurchase program in December of 2013. We ceased repurchasing stock in the open market in mid-December under the existing share repurchase plan, which continues to have 1.5 million shares available for repurchase.

We intend to use this accumulated excess cash on hand of $150 million as one of the funding sources for the Scitor acquisition when it closes in early May. Additionally, today, we announced the approval of our quarterly cash dividend of $0.28 per share, payable on April 30. Our capital deployment actions in FY2015 resulted in deployment of about 75% of our fiscal 2015 free cash flow. But if you include the $150 million that we anticipate to utilize in the Scitor acquisition, the percentage increases to about 130%.

As mentioned on our March 2 call to announce the signing of the Scitor acquisition agreement, and based upon estimated pro forma historical results, we communicated our expectation to have a debt to EBITDA level of approximately 3.6 for the combined Company. While we fully expect to continue our quarterly dividend at its current level, our expectation is to use future excess cash to pay down debt until we reach our previously communicated target debt level of between 2.5 and 3 times EBITDA.

At that point, we expect to continue our disciplined capital deployment program, evaluating options of share repurchases, dividends, M&A, and additional debt repayment. I would like to reiterate that our long-term financial targets remain substantially unchanged and I will provide any modest updates following the close of the Scitor acquisition. Tony, back over to you for concluding remarks.

Thanks, John. Our proxy statement will be distributed soon to shareholders and I would like to announce that our Annual Shareholder Meeting will take place on June 3 at our McLean, Virginia offices and I encourage shareholders to attend this event.

Concluding our first full year as an independent Company, I would like to thank the SAIC team for a job well done. Your continued dedication and pursuit of our strategy and customer mission success have resulted in a successful year and position us very well for fiscal 2016. Operator, we're now ready to take your questions.

Thank you. (Operator Instructions) We'll take our first question from Jason Kupferberg with Jefferies.

Good morning, guys. How are you?

Great.

Thanks, good morning.

Good. Good. Just wanted to start with a question on book-to-bill. I know you have some seasonality impact always in the January quarter. We tend the to look at the metric more on a trailing 12-month basis to try and adjust for that seasonality. And actually on that basis, it looked like your book-to-bill ticked up a little bit this quarter as compared to where it was on a trailing 12-month basis last quarter.

So wanted to get a sense from you guys in terms of how you're thinking about potential book-to-bill expectations for full year fiscal 2016. It sounds like from an overall market standpoint, things haven't gotten worse, though they haven't necessarily gotten much better either just in terms of sales cycle. So how does that kind of net out at the end of the day? Should we be looking for a similar book-to-bill in 2016 as in 2015?

Yes, Jason, I think it's going to be very similar. We still target that 1.0 as it cycles. But we saw the seasonal aspect that you mentioned, the 1.0 in the aggregate, looking at each of the various customer groups, we're confident that we continue to sell through the task orders on the large ID/IQ contracts.

The pent-up demand on the submits are still out there for some of the larger non-ID/IQ deals. So you'll get a little bit of that fluctuation quarter to quarter but very comfortable with the prospects that are in the pipeline right now. As you mentioned, we think that the customer budgets have stabilized over the last couple years.

We're kind of at that new normal in the bottom and looking to 2016, FY -- government FY2016 and 2017 to kind of get back on that track. So I think our customers have adjusted and I believe that we're well-aligned to the demands that they still put forward on the services side on what they continue to contract for, and the services that we delivered. So I wouldn't expect much change but we still have around that 1.0, up or down, just with the quarter fluctuation.

Jason, I will point out that the FY2014 Q4 book-to-bill of 0.3, we believe, was episodically low. So I wouldn't use that for comparison for any forward years.

Okay. That's all helpful. And then just a question on Scitor. I know you guys said that it should be accretive to adjusted EPS in year one, but what else can you tell us just in terms of annualized revenue contribution and sort of sizing that EPS accretion? Not sure how modest you're expecting that to be. I understand you haven't quite closed it yet but any general thoughts there would be helpful for modeling purposes.

Well, we gave the historical run rate for the pro forma activity of the Scitor acquisition. You can see that in the March 2 presentation. And also it does have adjusted EBITDA of higher than what we run.

But if you look at it, they're adding about, we said about $600 million on a historical basis. They're growing at, we believe, about a mid-single digit run rate. So you can think of that for what FY -- our FY2016 would lead to. We expect their margins that you would have seen in the pro forma trailing 12 months to hold consistent generally, except for the transaction costs that we'll have.

And then also the intangible amortization that we're in the process of determining that amount. So the adjusted non-GAAP should very much follow those pro formas once you put on that mid-single digit growth to the activity that we had on the pro formas. We'll go into much more detail on that in June, but hopefully that's enough to get you by for now.

It is. It is. And then just last question from me on cash flow. In FY2015, it looks like you did quite a bit better than your typical annual target. So if we think about the prospects for fiscal 2016, I guess just kind of putting Scitor on the side for now, were there timing benefits? It sounds like you're expecting DSO to go back up to the mid-50s, I guess, as we go through fiscal 2016. So can you still do something in the neighborhood of $200 million of operating cash in fiscal 2016 even with some of these working capital movements?

It will be tough to hit $200 million but we're certainly going to push for it. We don't expect to be far off that number.

Okay. Very good. Thanks for the comments.

Yes, absolutely.

We'll go next to Cai von Rumohr with Cowen & Company.

Thank you very much. Could you maybe update us -- I guess you had on the HITS contract, where you are there and the NASA Health?

Sure. Good morning, Cai. It's Tony. We had resubmitted the Human Health and Performance Contracts back in the late January, February time frame. We still expect that decision to be made sometime this summer. They did hold to their original schedule on the proposal track. So that is in and we expect that to move forward.

On HITS, that's still back at corrective action at the agency at the core and we do, again, expect to get some decision over probably the next maybe three to four months. It's hard to predict on that but we're in that, probably a couple months. But that's the best we can tell you as far as timing, both are in and going through consideration for the customers.

Okay, and then on Scitor, I mean, I gather you have some tax benefits. If your free cash flow is in the area of $200 million, presumably how much would Scitor add to that on an annual basis? Can you give us any help there?

We think on a normal annual run rate, it should provide $50 million to $60 million when you take into account the $20 million of additional cash flow from the tax asset amortization and that lasts, at least the $20 million level, for the next seven years.

Got it. Okay. And then if you've passed Hart-Scott-Rodino and I guess the financing's pretty close to in-place, how come it takes until May? Is the plan to -- sometimes people close like at the last day of the quarter or the first day of the new quarter. Can you tell us a little bit more about that?

Coincidentally, it is the first day of our second quarter, so when we put the plan together and put all the financing activities together, it looked like things were culminating around that date. And so that's how we've laid up all the communications with our rating agencies and then our Term Loan B activities and we just think that's how long it's going to take. And so if it's within, if we're ready within a week's time of that, we will probably just wait until the first day of the quarter, just to ease the disruption to the financial statement reporting and the like.

Terrific. And last one. You've still got some (inaudible) Afghanistan business. Could you comment how big was it last year and with the decision to kind of delay withdrawal of troops, what you see directionally for 2016?

The majority of what we see is in the supply chain area. That's about in the $80 million a year range. It's certainly -- and it ebbs and flows, depending on what's going on because we've had things like Ebola and stuff like that, that has delivered to that.

In 2015, we had about $100 million in total. It will slightly be lower in 2016. We expect about $90 million. Again, the vast majority of it, over $60 million coming from our supply chain with tires and pull-cab. And then we have a little bit under Warfighter and a little bit under AMCOM EXPRESS. We don't expect that to cause any step changes.

Terrific. Thank you very much.

Thank you, Cai.

We'll go next to Jon Raviv with Citi.

Hi. Good morning, guys. Thanks for taking the questions. Tony, you mentioned that customers seem to have adjusted. I was wondering if you could comment on how you think the environment's going to trend over the next few months, given the gulf we still have between budget proposals and sequester caps and whatnot and how you think those debates are going to sort themselves out.

I think that with the budget cap baselines, the President's budget, the Republicans' position on national security and defense, I think, again, we've seen the bottom of the general cycle. We do expect there will be some activity around sequestration relief to a degree.

I don't think anybody's expecting a full repeal on sequestration but they're working around it relative to the legislation. I do think that the customers have already self-selected down to the appropriate levels. Most that I've talked to are planning on that DCA level with some upside based on how the budget and the mark-ups actually play out.

So really don't see huge fluctuations. It will be pockets probably on the sequestration relief side. You may see a fluctuation, plus or minus, 5% is kind of how I'd see at individual account levels. But I think they're going to be much more selective, make the broader program decisions.

And as it reflects on our business, we're still seeing fairly high demand for the technical expertise that the customer continues to seek across the portfolio and diversification portfolio helps in meeting both their IT program upgrades but also the system engineering and the mission capabilities.

So I think we're still going to be fairly stable. And as we've mentioned before, kind of get back into this normative from really FY2016 -- government FY2016 and beyond. We've been saying 2017 to 2020. It looks like we're reaching a stable platform on budgets right now, so we're well-positioned for that, so (inaudible).

Okay. Great. And then how could you -- you guys point to new programs ramping up helping your sales number and certainly you're outperforming. How do you characterize the new business, the new programs? Is it mostly brand-new business? Is it expansion of current work? Is it pure take-aways from large OEMs and pure competitors? How would you characterize that?

It's still very competitive environment. It's a mix of what you described. We have, I think, been more focused with this operating model with the customers, customer groups able to focus pipeline decisions around where we're best aligned, increase of probability of win. We've seen our competitive win rates hold. It's a combination of selling through the large ID/IQ platforms that we have to secure the task order volume.

I think in terms of securing the work on the protect side, but within those vehicles, we are looking to expand our services using those vehicles that we have in place. Separate from that, like with AAV, we do think that our maturing capabilities through the service line, we can leverage our past performance and again, sell mature capabilities to customers we know, but customers maybe we haven't delivered that specific service to.

So more on the expand side as far as that market opportunity. We are still focused on the growth side, the emphasis this year, obviously, will be on the intelligence community and leveraging the Scitor acquisition. So we're looking to align to the portfolio that Scitor has created and then complement that with what we need going forward to grow that, that particular market segment.

Thanks. I'll hop back in the queue.

(Operator Instructions) We'll take our next question from Edward Caso with Wells Fargo.

Hey, good morning. I was wondering if you could talk a little bit about pricing. What we hear is that there may be some flexibility in the non-commodity end of the market? So maybe you could help us. One, is that right? And two, can you differentiate your revenue between sort of value-add and commodity? Thanks.

Sure. We spend most of the time on the value-add services, very little on the commodity side relative to perhaps even supply chain being the exception but that's a slightly different business model. But on the straight surfaces, it's still very much on the higher end technical service capabilities and that's both on the mission engineering side as well as on the enterprise IT.

So we tend to try and stay in the higher value-add architectures, application development and migration through the systems. And I think the technology integration asset portfolio also allows us to deliver an end state solution.

Relative to the flexibility, we are looking to position more on the fixed price side where we have capabilities. There's a number of programs, like the AAV where we can model our program capabilities and promote a fixed price model for the government. Most of the ID/IQs offer flexibility and use cost reimbursable or fixed price.

We're starting to see perhaps some hybrids, where we can be more cost effective, take on the fixed price work. (Inaudible) where we can manage the risk, it's mature systems and capabilities that we have. But then at the same time, there's appropriate levels of the cost reimbursable and when we use those at the customer side.

So the flexibility does exist. I would not say it's necessarily growing but we are also seeing, although very price competitive, that the slight pullback on the formal low price technically acceptable, fewer, let's say formal LPTA. I think the government had a taste of that and realized that there is still a value proposition and a best value solution. So we've been trying to influence that on the procurement decisions that they're undertaking today.

John, could you talk about direct labor versus ODCs? In the press release, there's several comments about notable material pass-throughs, so if you could maybe give us growth rates in the quarter and the year for direct labor versus ODC?

Yes. A lot of what we did see in this quarter was surge in materials. Our labor remains fairly constant as a run rate, considering the holidays while we see a dip in labor a little more than we do in materials. Just as an example, our supply chain material, where we saw the largest increase, averaged about 16% for the year, but in Q4, it ran about 17% for the fourth quarter.

So that 1% to 1.5% tick-up in the fourth quarter associated with that. But we did maintain our percentage of our labor compared to subcontractor's labor, that mix for the year ended at 58% our labor, 42% subcontract and we ended the fourth quarter just -- the fourth quarter by itself, standalone were those same numbers, 58/42.

So we'll always take those revenue pass-throughs, especially when they're on supply chain, because of the fixed cost gets spread over a larger base, that becomes more profitable for us relatively than having a lower base on that material. So it is still good profit generating revenue, but the majority of the surge we saw, that 1%, was in the materials area.

John, you mentioned that the long-term guidance was substantially unchanged. Was that a before Scitor comment and if that's what it is, give us some body language on what part of the model the outlook may be different?

It really is a -- it is a with kind of leaning towards with Scitor comment and what will change is, more or less, the starting point for where our operating margin will be. We've said 10 to 20 basis points of margin improvement per year on average over time, starting in the low 6%.

We have to re-evaluate where that new starting point is going to be once we bring on Scitor. On a GAAP basis, we do not yet know that number because of the purchase price allocation and intangible valuation we're going through at this point but we will update those in June so we have a good picture.

But all in all, we think those same items, the low single digit revenue growth, the 10 to 20 basis points of improvement, the return of capital in excess of what we said is about $150 million we need on average and then maintaining our financial leverage at an appropriate level for SAIC's cash generating characteristics.

Last question. Clarification. In your bookings, do you count wins that are still under protest?

We do not.

Thank you.

Thanks, Ed.

(Operator Instructions) That concludes today's question-and-answer session. Mr. Levi, at this time, I'll turn the conference back to you for any additional or closing remarks.

Thank you very much. I'd like to thank you all for your participation and interest today and we look forward to speaking to you again in the future. This concludes today's call.

This concludes today's conference. Thank you for your participation.