Science Applications International Corp (SAIC) 2016 Q1 法說會逐字稿

Good day and welcome to the SAIC FY16 Q1 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. Thank you for joining us for SAIC's first-quarter FY16 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's now my pleasure to introduce our CEO, Tony Moraco.

Thank you, Paul, and good morning. In the first quarter of FY16, we delivered on our business strategy and shareholder value creation proposition. First-quarter revenues of $998 million represents 4% internal revenue growth, adjusted operating margin of 6% after excluding acquisition- and integration-related costs, and diluted earnings per share of $0.69. We continue our strong cash flow performance with approximately $29 million of operating cash flows and we are beginning FY16 with a great deal of momentum.

Working from appropriate budgets in government FY15 continues to provide some stability for our customers. We have noticed a modest increase in award activity, as demonstrated by an increased amount of bookings this quarter, but as we have communicated in the past, it is difficult to attribute one quarter of activity as representative of the larger market environment.

Although early Congressional actions and commentary on the government's FY16 budget reflect some willingness to continue that stability, our customers remain guarded with their resources. However, we continue to have confidence in our go-to-market strategy and continue to see demand for the capabilities that SAIC provides.

We're off to a good start in FY16 from a business development perspective, with continued execution of our Protect, Expand, and Grow strategy. First-quarter award activity of just over $1 billion translates to a book-to-bill of 1, which is above our historical norm for first-quarter contract awards. Notable bookings include the Protect awards of NAVC's fleet forces deployment training contract, an extension of our work supporting Toyota Motor North America, as well as the Expand award of the next phase of the Marine Corps Assault Amphibious Vehicle contract.

In the quarter, we were also successful on a few notable IDIQ vehicle awards that do not contribute to bookings immediately but position the Company well for future task-order based efforts. Part of the Protect category, we were successful in our recompete of the prime vendor maintenance, repair, and operations, or PVMRO, southwest region work for the Defense Logistics Agency as part of our supply chain management portfolio. This $165 million win under the [C4E] vehicle allows us to continue our efforts to add value as our customers look to reduce total maintenance and repair costs to the military services.

Additionally, under the Expand category, we were awarded a $425 million single award IDIQ contract by the Federal Aviation Administration to provide a wide range of training services to FAA air traffic controllers. Under the scope of the contract, SAIC will provide support services to FAA Academy and Air Traffic Control Facilities to help the FAA fulfill controller training requirements. This is great example of new business secured by leveraging our training and simulation capabilities to an existing customer.

SAIC total contract backlog at the end of the first quarter stood at $6.2 billion, of which funded backlog is $1.8 billion. The estimated value of our submitted proposals awaiting award is $13.3 billion, up from $12.7 billion at the end of the fourth quarter. As you can see, even with a quarter of significant contract awards, we continue to expand our business opportunities and increase our proposals awaiting award decisions.

Before I turn it over to John, let me give you an update on the acquisition of Scitor, which we closed on May 4, the beginning of our second quarter. We have been very busy with integration planning that began shortly after we announced acquisition in March. Those activities are now being executed in order to ensure an orderly transition into SAIC.

Along with several members of the senior Management team of both companies, I have visited several Scitor locations to meet Scitor employees and customers. The level of talent of Scitor employees, validated by their customers, only reinforced our conviction that we have joined forces with an outstanding company. As a joint team, we will identify areas to leverage each other's offerings into the expanded market access made available through the acquisition.

Due to the expected increase of cash flow generation from Scitor, I am pleased to announce that SAIC has increased our quarterly dividend by about 11% to $0.31 a share. This increase reflects our commitment to continued disciplined capital deployment for shareholder value creation. John, over to you, 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. First-quarter revenues of $998 million reflects 4% internal growth as compared to the first quarter of last year.

This is our third straight quarter of year-over-year revenue growth and is in line with our belief that we can achieve annual internal revenue growth in the low single-digits on average and over time. First-quarter revenue growth was largely due to increased DoD material and subcontract revenues on new prime contract awards and increased material volume on supply chain contracts.

Operating income of $57 million in the first quarter resulted in operating margin of 5.7%, and was negatively impacted by $3 million of Scitor acquisition costs, that if excluded, would have resulted in adjusted operating margin of 6%. We do expect a heavier amount of acquisition- and integration-related cost to be reported in the second quarter and estimate that these costs will total approximately $15 million for the first half of FY16. We do not expect any significant acquisition and integration costs thereafter.

Net income for the first quarter was $33 million, and diluted earnings per share was $0.69 for the quarter. However, the first-quarter acquisition cost negatively impacted earnings per share by approximately $0.04. Our income tax rate for the quarter was in line with our normative rate of about 38%.

Moving on to cash and cash flows, in the first quarter, we had cash flow from operations of $29 million and had an ending cash balance of $295 million. Subsequent to the end of the quarter, we utilized $157 million of cash on hand to partially fund the Scitor acquisition, and as previously communicated, we entered into new credit agreements to fund the remaining $670 million of purchase price and related transaction cost. After the execution of these new credit agreements, our total debt is approximately $1.2 billion, equating to a leverage ratio of about 3.6 times debt-to-adjusted EBITDA, and carries an overall interest rate of just under 5%.

Our days sales outstanding were 51 days at the end of the first quarter, which is an improvement from the fourth quarter by one day, contributing about $10 million of additional cash flows. I continue to be pleased with our cash flow performance and attribute it to our cash flow acceleration effort and dedication of our team on one of our tenets of shareholder value creation. While we continue to strive to keep DSOs at or below our current level, as I conveyed last quarter, we expect DSOs to return to a more normative level in the mid-50-day range.

Capital expenditures for the quarter were only $1 million, which is relatively light for our business, but we continue the expectation of about a 0.5% percent of revenue annually. In the area of capital deployment, today we announced increase of $0.03 per share to our recurring quarterly dividend, or about an 11% increase over the previous amount.

In light of the additional annual $50 million to $60 million of free cash flow expected from the Scitor acquisition, our Board of Directors took this action to further shareholder value creation. This quarterly cash dividend of $0.31 per share is payable on July 30 to shareholders of record on July 15.

Let me conclude my remarks by giving you an update on our long-term financial targets. Our previously communicated targets remain largely intact and are relatively unaffected as a result of the acquisition of Scitor. However, let me address each of our communicated targets, which we expect to achieve on average and over time.

First we continue to expect low single-digit annual internal revenue growth. We expect that the added intelligence community portfolio, which represents approximately 11% of our annual revenues, to grow in the mid-single-digits, and this solidifies our confidence in achieving our revenue target on a consolidated basis.

Second, we remain committed to 10 to 20 basis points of annual profitability improvement, again, on average and over time. We are still working through the purchase price accounting process, but assuming that approximately 30% of the Scitor purchase price will be allocated to intangibles, this would result in about $25 million of annual amortization.

Considering that, and inclusive of Scitor, we believe that adjusted operating margins before acquisition cost would start in the 6% range and adjusted EBITDA would be in the 7% range, considering Scitor's EBITDA above 9%. These are the starting points for the 10 to 20 basis points of improvement and both op margin and EBITDA will increase in corresponding manners.

Third, we intend to continue the return of capital in excess of operating needs, and our minimum average cash balance is unchanged at $150 million. We remain committed to our recurring quarterly dividend and anticipate using excess cash for the next 12 to 18 months to repay debt until a more optimal debt-to-EBITDA level is achieved.

This brings me to leverage, which is the fourth and final target. We have communicated that we desire to operate with leverage appropriate for SAIC's investment requirements and cash generating characteristics. This remains unchanged and we currently believe our optimal leverage ratio is between 2.5 and 3 times debt-to-adjusted EBITDA, which subsequent to the acquisition, stands at about 3.6 times.

We anticipate we will have additional capital deployment flexibility after the recurring dividend and debt repayments, and will look at other capital deployment actions to maximize shareholder value creation with these excess cash flows. Tony, back over to you for concluding remarks.

Thanks, John. Last week, we held our annual stockholder meeting and all three proposals outlined in our proxy statement were overwhelmingly approved by our stockholders. Thanks to all who participated in the process. I would like to once again welcome Scitor employees to the Company and convey my appreciation to all SAIC employees for your dedication to our customers. Operator, we are now ready to take your questions.

(Operator Instructions)

We'll go first to Edward Caso with Wells Fargo Securities.

Hi. Good morning. Just checking a couple of numbers here. Can you repeat what your target margins were? You mentioned two different ones?

Yes, we believe once you consider the amortization, which we are trying to still figure out exactly what the intangible valuation will be, we may be a little conservative in that regard but we'll have to see, it obviously doesn't affect cash flow. But we believe we would be starting an op margin, if indeed that $25 million of intangible amortization a year is correct, that would start us in about the 6% op margin range.

It would also mean we would be in about the 7% adjusted EBITDA range, once adding in Scitor's 9%-plus EBITDA to our, call it, 6.7% EBITDA that you will see last year. So since it's only 11% of the portfolio, it moves it up, but only by those 30 basis points.

The second clarification is the Scitor costs, did you say $15 million in the first half or $15 million in the second quarter?

$15 million for the first half so that would be about $12 million for second quarter once you subtract the $3 million out.

My last question is on the pace of pricing pressure or commoditization in your various markets, mostly DoD versus civil. Can you give us some sense where you are continuing to see pressure and maybe where you're not? Thanks.

Sure, Ed. This is Tony. The pricing pressures have continued to be somewhat stable over the last year or two. The DoD, collectively we have seen industry move their indirect rate structures down to the very competitive range that's being passed on to the customers. We have also seen a bit of the LPTA, the low price technically acceptable behaviors, probably coming back from where they were maxed out, say, a year or two ago.

I believe that the customers in some cases have actually realized negative impact of buying too low for [mission] and service delivery. The pricing pressures will continue, characterize those as just staying competitive. The customers' behaviors are at a new budget norm. They have been rational about getting to their budget numbers.

We'll see how the future plays out with the next government budget. CR is probably likely, continuing resolution, sequestration probably in some fashion. Collectively, we will see this continuation of where we have been, maybe a bit of hesitation in government Q1 as they reconcile the 2016 budgets for them.

But overall, I think our business, collectively, will continue as we've done. Solid submits, going forward. We have plenty in the pipeline anticipating contract awards. The price pressures will just be pretty static as they have been.

Fed/civ has been very similar. They were out in front on the cost basis, but we aren't seeing any major swings in pricing behaviors nor are we seeing major swings in margins affiliated with the contracts and contract fees as a part of the change.

Maybe I can sneak one more in, an update on the NASA contract?

Still in customer evaluation. Expect a decision, as they've messaged, sometime this summer, over the next couple months, but that's all we know at this time.

Thank you.

You're welcome. Thanks, Ed.

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

Yes, thank you very much. First, could you give us some color on the $2 million negative EAC in the quarter?

You will need to be a little more specific. Do you mean just the $2 million loss that we recognized on the contract?

Yes, yes, yes?

That's just on a fixed price contract. It is more of a development type contract with the Army, and it's just we were having some trouble. It's only about a $3 million contract, so it's not a huge contract.

We don't expect that to continue to leak on us. So we think we are in a good spot, but it is something that we had to accrue for and correct for.

Okay. Then to follow up on Ed's line of questioning, maybe give us first the status of where we are on the Army HITS contract? And secondly, on the FAA award, what's the expected ramp on that?

Cai, it's Tony. Good morning. Army HITS also is in customer evaluation. We have had the GAO dismiss the pre-award protest that was the recent round of the reconsideration, but the proposals are in. The Corps of Engineers is evaluating that, and again, we expect a determination and subsequent award over the next couple months, the June/July time frame is what they've messaged, so we are anxiously awaiting that.

On the FAA front, it is an IDIQ single award. We did get an initial contract award to start the transition activities. It runs probably this year in the $20 million range, as it gears up through H2, through our second half of our year, with run rates probably in the $70 million to $80 million range when it is full up and running as the subsequent task orders get awarded through this transition period. That would be the run rate, if you will, in our FY17 for futures.

Okay. Then just a clarification. Does your operating margin guidance of 6% also still assume that core SAIC is achieving 10 to 20 basis points of margin improvement?

Yes it does. On average it is flattish to slightly up is what we believe, but yes, we are continuing to strive to achieve that 10 to 20 basis points.

Okay, thank you.

Thank you, Cai.

We'll go next to Jon Raviv with Citi.

Good morning, guys. Thanks for taking the question. The question about leverage and long-term guidance or long-term target of being in line with investment requirements, what would cause you to move away from that 2.5 to 3 times? How much more leverage, perhaps, could you take on if you saw a compelling investment case out there, especially as other properties seem to be coming to the market?

This is John Hartley. As you can see, going to 3.6 times certainly was very comfortable for us with very favorable interest rates, so that was really not a stretch for us. We could push that even a little more. We want to be disciplined in paying down that debt but we won't hesitate to taking it right back up if the right opportunity comes along.

But again, we are not an acquisition machine. We'll be selective. They will be strategic acquisitions when we decide do them and they will fill market gaps that we believe it is faster to market and better investment to buy our way into those markets versus investing internally.

Understood. And on book-to-bill, in your mind, what's driving 1 times? Is it underlying market or is it more SAIC specifics or SAIC excellence on the Protect, Expand, Grow, and how should we think about that going forward, in light of a target that you suggested for the year of 1 times? Should we still expect a strong fiscal 3Q, so perhaps an upside to that 1 times for the year?

This is Tony. The 1 times is a good barometer, based on the budget environments and the decisions. We have had a good result in sustaining the submit pending award profile in that $12 billion to $13 billion range. So those are a year to two in the Q already, plus the continuation of it.

But I do think the realization of Protect, Expand, Grow, where we emphasize protecting our incumbent positions, but on the Expand side in particular, seeing the post-spin acceleration and leverage, have been able to submit as prime on such bids like FAA, where the service lines and customer groups come together to deliver broader services to customers we know. It is a fundamental part of the strategy and creates confidence in our ability to seek our competitive awards.

I believe the Fed rates are still in line. Don't see that moving off of the normative range. So we are in a good spot with the submits. Would expect the book-to-bills, again to hover around that 1. Recall, we still have a very large IDIQ portfolio for the task order. Churn is there. That's replenished on a recurring basis.

But we still have a number of very large single award or contract award non-IDIQ awards in the pipeline. That gives us confidence it is cyclical and has been subject to these awards, as we just talked about, things like HHPC and HITS, programs such as those will have an impact on quarterly basis.

But overall, on average, 1 is practical to look forward. I am very proud of the quarter-to-quarter growth top line. Given the industry's perspective, we feel that we are in a strong position, in a positive to flat, whereas others are seeing much more contraction in the marketplace.

Then my last one is relatively high level, but how important from your perspective, is scale in your business, perhaps as it pertains to driving direct labor rates or being better at capturing? From your perspective, is a $4.5 billion, $4.6 billion business the right scale in this world or is that really not the right way to think about it?

Scale is very important. Talk to a lot of the folks in the market. Scale affords us the opportunity to have a level set on our indirect rates. Industry collectively has gotten to their new normal on rate structures so we are seeing that realized in the fee and profitability performance as the new rates are being worked through contracts.

But scale affords -- it dampens any volatility of your rate structure by spreading those costs on those larger base. At this level, it gives us diversity within the collective Federal contracting space. Having $1 billion portfolios in some of the key markets in the Army/Navy/Fed/Civ, also they're at scale in their own right, and so those businesses can operate with the right level of resources to build their pipeline and execute effectively and that drives that capture.

So they at scale themselves provide good optics on decision-making to sustain the revenues that we have seen. And then, collectively, as an Enterprise at $4.5 billion, we can make trades at the Enterprise level to continue to invest in the staff, invest in the pipeline, develop particular solutions, and use the collective scale on a rate basis to provide a balance of investment and profitability and cash flows. That $1 billion or less, or up to $2 billion, are seeking scale. You will continue to see businesses trying to align their portfolios accordingly.

Understood. Then sorry, just my very last one. Just on cash flow, I realize 1Q is typically soft, but what grows cash flow going forward, excluding Scitor, just in light of what seemed like a relatively low run rate in the quarter?

Our run rate in the quarter, you are saying, was light compared to what we would be for the year?

Yes. On the last call, we've talked a little bit about perhaps $200 million for the year ex-Scitor? Apologies if I am pulling that number out of thin air?

No, no, no, you are not. Our first quarter is normally our softest cash flow quarter. That's when we pay our cash bonus, that's when we have an extra payroll, so every other quarter has an extra payroll in it. That's seven verses six. W

e would have planned normally for Q1 to be cash flow negative on the operating side to the tune of $20 million to $30 million and so coming in at nearly $30 million of positive cash flow, we exceeded our expectations by pushing $50 million.

Great. Thank you very much.

We'll go next to Jason Kupferberg with Jefferies.

Hi guys. This is Amit Singh for Jason Kupferberg. Just want to start with FY16. You guys have previously spoken about expecting slightly positive organic revenue growth in FY16, and at this quarter, you guys grew around 4% year-over-year internally, and then last three quarters, you guys have witnessed increased material volume and supply chain contract and then book-to-bill has been strong and the overall market seems to be if not increasing, it's pretty stable. So is mid-single-digit organic revenue growth in FY16 more of a better way to look at your revenues this year?

I would say that is achievable. It is a flattish to perhaps slightly up year for us. We will see supply chain, we expect, to be coming down, so that will provide some headwinds that we need to overcome, but we are hopeful that contracts like FAA and hopefully some of these protests coming out will help us get back so that we are flat to slightly up.

Scitor, bringing them on, certainly helps that low single-digit, which we'll have them on for three quarters. We do -- we still believe that low single-digits is achievable for this whole fiscal year and that we accelerated some supply chain revenues that will fall off later in the year in the first quarter.

All right. Great. Then just staying on Scitor, can you guys provide a little bit more information on its contribution to your top line and EPS in FY16?

Sure. We disclosed in our announcement back in March that they were in the $600 million-plus range on revenue. Like we said, they are growing slightly faster than we are, so you can extrapolate that. So that's about, it turns into about $600 million-plus to the top line. Did you ask about the bottom line?

Yes. Thank you.

They run a much higher EBITDA than we do, which you would expect for the type of work they're providing, much higher value-add versus being a pure prime in a number of cases. And so they do run north of 9% EBITDA compared to our mid-6% to high-6% EBITDA.

All right. Perfect. Then just one last one. You talked about contribution to free cash flow of $50 million to $60 million from Scitor, but on your organic free cash flow, even though 1Q was strong, I believe you are expecting your DSOs to increase from 51 to mid 50s during the year. So is $200 million plus organic operating cash flow for FY16 still the right target or is there an update to that?

So when you say organic, you mean ex-Scitor?

Ex-Scitor, yes?

This year, we were -- and again, when we talk $200 million of op income, it is on average and over time. We greatly exceeded that last year because of our DSOs. If our DSOs slipped back, we would probably organically be just a little north of $200 million, but again, we are going to try very hard to keep the DSOs where they are if we are able to.

So certainly north of $200 million with Scitor, and including also don't forget the transaction and integration costs that will be coming out. Above $200 million with three quarters of is certainly achievable.

All right. Perfect. Thank you very much.

Thank you.

We'll go next to William Loomis with Stifel.

Hi. Good morning. You have talked about the supply chain work having higher material and subcontract work and pulling work ahead, but when I look at the gross margin and the adjusted operating margin, it didn't show a decline really from a year ago, about the same. What was the nature of that? Was it just -- did the rest of your business that much more profitable or why didn't we see the lower margins with those higher materials?

What we see in the supply chain is when you have incremental materials coming through, those tend to be profitable. If you look at the whole portfolio, it brings down the total, but each incremental makes all of it more profitable, so it is definitely volume-driven. And as there's the more volume, the more you can spread your fixed costs over. You won't necessarily see if supply chain really grew fast, you won't see it pull down the margins overall.

Okay. And in terms of supply chain coming down in revenues this year, what's the rationale for that? When you are looking at what the customers are doing, is there some change in the business other than the pull-in, in the first quarter on some of the materials?

It's really just tied to the op tempo of what gets delivered in theater, what's going on in [CONUS] operations, based on really just the demand signal coming from the customers. So in terms of logistics agency at principle cost from the drives through, it's just the buying habits and could be tied to the training activities. Locally, it could be tied to deployment that weren't anticipated.

We saw some of that surge in Q4, as we looked at some of the ebola and other services. So there are some incremental changes, but overall, we are in this new norm in that $0.5 billion range of where we are seeing steady flow.

The market itself in that area continues to be on a commodity driven basis in some cases and we are trying to also avoid some of those businesses through reverse auction or others that drive those margins even further down. We are trying to stay balanced in providing a value proposition that's there, but overall, it is fairly steady driven in part by op tempo of the supply side for good BLA services.

Just one clarification, as well, on that, that does provide us additional visibility. The PVMRO that you heard we just won the southwest region, all of those regions, I think it is six or seven, are up for recompete. We have lost at least one of those, so that will provide some downward pressure.

That's, as we go through these reverse auctions, some people are buying into these. We don't think they'll ultimately make money at it, but that's their choice. So that does provide some headwinds that we are going to have to fill and we are going to try to fill them at SAIC overall with our system integration type contracts that are coming on with FAA, AAV, and others.

Okay. Then just staying along the recompete line, what are some of the other major recompetes over the next 12 to 18 months, both you and Scitor?

The good news is that there aren't too many at the large scale. I'd say, there are very few, if any, in our top 15, 20 this year that are up for recompete. We are in a constant recompete on the flow of task orders inside the contract vehicles, but I don't think there are any substantial recompetes in FY16 that will have an effect on this year's results.

We'll see how it plays outs next year. There's a couple next year with NASA and a few others, but none that are material in this current year that are either out there or pending, except for some of the supply chain work that John just mentioned on some of those recompetes flowing through the system.

And Scitor, also?

Scitor is fairly stable. No major recompetes. Their largest contracts have still a couple of years of periods of performance on them, so we don't see any particular pressures near term on large prime contracts through recompetes on the [sector side either].

Okay. Then just one final one. I saw your extension on the Toyota contract. Do you have any other efforts? I know you have had that one but any other efforts on the commercial side?

No, none material right now. Again, that was recompete of a portfolio position that we had. It facilitates some of our IT managed services portfolio. It's a fairly diverse portfolio in our help desk and security operations network, operations services, so no, there is no substantial pursuits in the commercial arena.

Okay. Great. Thank you.

You're welcome.

At this time, we'll turn the conference back over to today's speakers.

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.

This does conclude today's conference. Thank you for your participation.