Science Applications International Corp (SAIC) 2016 Q3 法說會逐字稿

Good day, everyone, and welcome to the SAIC fiscal year 2016 Q3 conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Paul Levi, Investor Relations. Please go ahead, sir.

Good morning, and thank you for joining us for SAIC's third-quarter fiscal year 2016 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'll 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 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 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 our CEO, Tony Moraco.

Thank you, Paul and good morning. SAIC's third-quarter results demonstrate strong performance in the areas of cash flow, earnings per share, and contract award activity. The quarter revenues of over $1.1 billion reflect 14% total growth and internal revenue contraction of 2% for the third quarter, resulting in year-to-date internal growth of 0.3%. Third-quarter adjusted operating margin was 5.8%, and adjusted EBITDA was 7.3%, both excluding $1 million of acquisition- and integration-related costs. These results reflect our continued focus on the delivery of improved profit margins.

Adjusted diluted earnings per share were $0.73 in the quarter. Operating cash flow of $68 million was a return to more normative levels for the business, as compared to the first half of the year. With continued confidence in cash generation, we repurchased $18 million of our shares in the third quarter. John will provide detailed financial results in a moment. Let me provide an update on the performance of our recent Scitor acquisition.

The Scitor portfolio contributed $148 million to SAIC's revenue in the third quarter, reflecting year-over-year internal revenue contraction of $10 million, or 6%. Although we are disappointed in the quarterly revenue, we are addressing the revenue shortfall by expanding our [aria] initiatives, and by going to market together, we are addressing the competitive headwinds by adding $3 billion to our qualified pipeline, we're offering more of SAIC's capabilities to the intelligence community.

While we believe that Scitor's top line will continue to show slight contraction to flat for the next few quarters, the long-term outlook of mid-single-digit revenue growth in our intelligence portfolio is unchanged. We continue to be pleased with Scitor's EBITDA contribution in the quarter, which was in excess of 10%, with strong cash generation.

Turning to the broader federal market, our customers' fiscal environment has improved, as a result of a two-year budget deal and related appropriations working their way through the legislative process. This should facilitate our customers making award decisions with increased confidence, after a significant period of pent-up demand.

To that point, our third-quarter award activity of $1.4 billion translates to a book-to-bill of 1.2, with significant contract awards in all areas of our Protect, Expand and Grow strategy. Included in third-quarter bookings are notable wins such as the General Services Administration, Enterprise Operations contract, an extension of our largest task order on our AMCOM EXPRESS vehicle, and an increase in task order volume that replenishes work on previously won IDIQ vehicles.

With a successful win in the grow area, the General Service Administration selected SAIC to manage its IT infrastructure through a $549 million contract known as GSA Enterprise Operations, or GEO. Under this cost plus award fee task order, SAIC will provide a broad array of information technology services to support GSA's 11 regions and global operations.

As another takeaway win, we successfully differentiated our proposal while delivering a team of key personnel, who demonstrated their technical understanding of the GSA operating model, and staffing the program to appropriately meet the needs of GSA, without adding unnecessary cost or assuming excessive risk.

In the re-compete or Protect category, SAIC was awarded a $757 million task order to continue to support the United States Army, under the AMCOM EXPRESS vehicle. This systems and computer resources single-award task order extends the efforts conducted on our largest task order on the AMCOM EXPRESS BPA.

Strong customer affinity and demonstrated past performance excellence were the key elements of this award. As a reminder, we take AMCOM EXPRESS backlog credit as technical instructions are issued under this task order, which means bookings will occur over the life of this task order.

With the sales cycle ranging from about 12 to 24 months, we are beginning to see award adjudication from proposals submitted since the time of our separation. You'll recall that one of the reasons for our separation to an independent company was an increased market access, and investment in our end markets with the Expand and Grow strategies.

During the quarter, we were awarded a $200 million single-award IDIQ contract to expand our services to NASA. Under the Langley Information Technology Enhanced Services II, or LITES II contract, SAIC will provide a variety of IT support services to include science and engineering applications, and project management and support.

This takeaway win was awarded to us through the combination of proposing [well respected] key personnel, as well as demonstrating a mission understanding superior to our competitors. After the end of the quarter, we were awarded two notable contracts that provide further momentum as we end SAIC's fiscal 2016 and begin fiscal 2017.

Successful in another Protect opportunity, the United States Department of Agriculture's risk management agency awarded SAIC a five-year $156 million task order, to provide full lifecycle information technology services. Under this effort, SAIC will provide IT services, to include program management, enterprise architecture, software development, IT operations and maintenance and end-user support.

Additionally, last week, we were one of the two down-select awardees for the United States Marine Corps Amphibious Combat Vehicle 1.1 competition. This is a new program for the Marine Corps, and SAIC will be under contract for the engineering, manufacturing and development phase.

This $122 million fixed price award is to produce 13 prototype amphibious vehicles, and is expected to be completed by September of 2017. If down-selected in the second phase, there are options for 60 low rate initial production vehicles, and 148 full rate production vehicles, that could bring the full value of this contract to over $1 billion.

At the end of the third quarter, SAIC's total contract backlog was $7.4 billion, of which $2.1 billion is funded, up slightly from last quarter due to the start of the government fiscal year. The estimated value of SAIC's submitted proposals awaiting awards is over $13 billion, or about 3 times our annual revenues.

Of the $13 billion of submitted proposals, it is split roughly in half, with about $6.5 billion in standard contract and task orders, and the balance an estimated SAIC value of future task orders on IDIQ vehicles. Furthermore, our opportunity for revenue growth is evidenced by the composition of about two-thirds of the submitted standard contracts in the Expand and Grow categories.

Before concluding my remarks, I'd like to congratulate the team on our recent significant recognition. SAIC was recognized by the military training technology publication for the 2015 top simulation and training company. This award recognizes SAIC as a company that has made many significant contributions on the military training and simulation industries, across a vast array of technologies and has allowed US airmen, marines, sailors, soldiers and Coast Guardsmen to train and rehearse for missions in theater, or to prepare for deployment while at home station. This year, SAIC was recognized for its solutions in serious games, human performance and cognitive training, evocative training, cloud-based simulations to support training, and workforce development.

Congratulations to the team for their hard work to ensure readiness of our war fighters. 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.

Our third-quarter revenues of approximately $1.1 billion represents 14% total growth and 2% internal revenue contraction, as compared to the third quarter of last fiscal year. The internal revenue contraction for the quarter is primarily due to reduced materials on our supply chain operations of $19 million, and the contraction in our intelligence portfolio of $10 million that Tony mentioned earlier.

Looking forward, I remind you that our fourth quarter is historically our lowest revenue volume quarter of the year, due to the holiday season, which we expect to occur in the current year, as well. Operating income of $64 million in the third quarter resulted in an operating margin of 5.7%, which was negatively impacted by $1 million of acquisition and integration cost that, if excluded, results in adjusted operating margin of 5.8%.

As communicated during our second-quarter call, we expect additional integration cost of approximately $5 million in the third and fourth quarters, as we complete the integration of Scitor's IT systems. This generally holds true, as we expect $3 million to $4 million of these IT-related costs in the fourth quarter.

In addition, as a result of further study of Scitor's facility needs, we have identified opportunities to further reduce cost through facility consolidation that will reduce annual operating expense by about $6 million. However, this will result in additional acquisition integration expense of approximately $10 million, and will be recognized over the next few quarters, depending on when we are able to complete these consolidation activities.

Continuing on third-quarter margins, we believe EBITDA is also an important metric to assess our profitability, as a result of the sizeable amount of intangible asset amortization expense resulting from our recent acquisitions. As communicated previously, following the acquisition of Scitor, we expect adjusted EBITDA to start in a range of around 7%, and we believe we can increase this by 10 to 20 basis points annually, on average and over time. We expect some additional improvements over the next couple of years, as a result of the cost synergies resulting from the Scitor acquisition.

For the third quarter, EBITDA as a percentage of revenues was 7.2%. And after adjusting for the $1 million of acquisition-related costs, adjusted EBITDA was 7.3%. These results reflect strong overall contract performance across the portfolio. Looking forward, we have historically experienced a meaningful reduction in profitability in the fourth quarter, caused by the normal seasonal reduction in revenue, which I mentioned earlier, and we expect that to occur in the current year, as well.

Net income for the third quarter was $34 million, and diluted earnings per share was $0.72 for the quarter. Net income and earnings per share were favorably impacted by a lower tax rate of about 32%, increasing earnings per share by about $0.06. This reduction in tax expense for the quarter was primarily the result of our completion of an in-depth review of our expenditures that qualify for the manufacturers' tax deduction and the federal research tax credit for prior fiscal years.

Going forward, we expect to return to a more normative tax rate of about 38%. Additionally, third-quarter EPS was negatively impacted by $0.01, as a result of the acquisition integration cost. Excluding these acquisition costs results in adjusted diluted earnings per share of $0.73 for the quarter.

In the area of cash flow, SAIC delivered on its strong cash flow value proposition by generating operating cash flow of $68 million, and free cash flow of $63 million. Our days sales outstanding at the end of the quarter decreased from the second quarter by 1 day, to 54 days. Consistent with my second-quarter remarks, these results include our internal investment of working capital of about $20 million, in support of our important Marine Corps assault amphibious vehicle contract, which is progressing on schedule.

As a reminder, this fixed-price contract calls for scheduled milestone payments, as certain contract deliverables are met. Based on the contract schedule, the working capital investment is expected to grow to a total of $30 million by the end of the fiscal year, and should normalize in the first half of fiscal year 2017. Even with this investment, our third-quarter cash flow demonstrates the strong cash flow value proposition of SAIC, and we continue to expect fiscal 2016 full-year cash flow from operations approaching $200 million.

With this level of cash generation, SAIC's current free cash flow yield is attractive and, along with our capital deployment intention, is at the heart of our value proposition. We ended the third quarter with a cash balance of $184 million, which is above our minimum operating cash balance target of $150 million. Our total debt is now approximately $1.1 billion, equating to a leverage ratio of about 3.5 times pro forma debt to adjusted EBITDA.

Since the announcement of the Scitor acquisition in March, we have communicated that we intend to deploy excess cash by honoring our recurring dividend of approximately $55 million annually, meeting our required debt obligation, estimated to be $43 million in the fourth quarter of FY16, and about $60 million in FY17, and deploying the excess cash for shareholder value creation. This level of debt repayment is expected to result in reaching a leverage ratio below 3 times debt to adjusted EBITDA by the end of FY17.

We have executed on this strategy this quarter by paying dividends of $13 million, making debt payments of $13 million, and repurchasing $18 million of our stock, for about 430,000 shares. Under our credit facility, we are currently restricted to share repurchases of $50 million per fiscal year, until a certain leverage ratio is reached, which we expect to occur in the second half of FY17, at which time, the capital deployment restrictions generally will not limit the Company from repurchasing shares at that leverage ratio.

Finally, our long-term financial targets remain unchanged, and can be found in the supplemental presentation to this call on our Investor Relations website.

Operator, we are now ready to take questions.

Thank you.

(Operator Instructions)

Our first question will come from Jason Kupferberg, Jefferies.

Hi guys, this is Amit Singh for Jason. Just to start off on, the material volume on supply chain contracts. They were down year over year, and it seems like fourth quarter is going to be, again, seasonally a low quarter. How should we think about this volume level next year, when we are looking at next year versus this year? Should we see an increase more in line with your overall revenue growth?

Are you referring specifically to the supply chain activity?

Yes.

The supply chain activity will be down year over year. There was one re-compete PVMRO contract that we were not successful in, and so that has ramped down in the second half of this year. And so the supply chain on the PVMRO will be down about $50 million year over year.

And how should we think about this for next year, next fiscal year?

That's what I'm referring to. That's next fiscal year is down $50 million from this year.

Okay. And then on your overall revenues, I think in the last quarter, you had broadly spoken about expecting largely flattish revenue growth in fiscal 2016, both for your non-Scitor and Scitor revenue. Is that expectation still hold?

Relatively flat. It still holds for this fiscal year. We do, as I said, see a fairly meaningful drop-off in revenue in the fourth quarter. Last year wasn't quite as bad, because we did, at year end, see a surge of supply chain materials come in, of about additional $40 million to $50 million. That muted a little bit of the decrease. But the holiday season does have a seasonal impact to our revenue, so it tends to come down. So we'll probably see a little bit of contraction in the fourth quarter from the year-ago quarter, primarily driven by that surge, last year, in supply chain materials.

Okay, great. And just last one on Scitor. You broadly mentioned, over the next few quarters, we should see a year-over-year decline. But again, as you are looking at next year, and provide a little bit more color on what the next few quarters mean? On a yearly basis, next year, should we start seeing an improvement in that revenue? And when should we expect -- I think before acquisition, Scitor was growing, I guess, mid-single digits. When should we expect that type of growth? (multiple speakers)

This is Tony. I think we'll see, as I said, over the few quarters, as a year-over-year comparison, some of that contraction that was similar in some of our other markets, in [feds] and in defense over the recent years with maybe it was around slight reductions in the re-competes, as the government look at their budgets. Increasing competition to get better pricing, as well as some shifts in the contract portfolios to small business set-asides that eliminate some of our subcontractor revenues.

So we're well positioned in our prime locations. We'll have some modest headwinds that, I think, represent that contraction over these quarters. And in turn, we're building a quality pipeline under our Protect, Expand, Grow strategy, to continue to sell additional services that Scitor did not have, but using their market access that we gained when we acquired them.

Thank you very much.

Thank you.

The next question will come from Cai von Rumohr with Cowen and Company.

Yes, thank you, and good quarter, guys.

Thank you.

So could you give us a little bit more color on why Scitor volume is light and maybe what their book-to-bill was in the third quarter?

As I just mentioned, Cai, the pressures we saw, I think, would be, they're not concentrated in any one area. It's similar to what we saw in the other market segments in this space. We look at the timing, the -- when we looked at the acquisition through due diligence, the recent quarters, I think, are consistent with that $600 million portfolio. We don't expect that to drop off substantially.

It's really year over year. And that year-over-year comparison does reflect some of the acquisition strategies, where we saw some small business set-asides, and some contracts pulled apart, where we did lose some of that subcontractor revenue stream. But confident that we'll continue to close those gaps, and as importantly, manage the margins and the earnings generation and cash that's come out of that portfolio, as we continue to grow in that market space.

As far as Cai, as far as the book-to-bill goes, the Scitor alone book-to-bill was lower than the total for the Company. But Scitor's book-to-bill is going to be a little more volatile, because of the few number of contracts they have compared to SAIC's overall contract portfolio that utilized a lot of IDIQ contracts that get task orders, and have a lot of task order churn. Scitor is more standard contracts, and they are two and three to five years in length. And so they -- it's a little more volatile for Scitor stand-alones.

Terrific. And then -- so you'd mentioned -- and thank you for highlighting the takeaway wins. Were there any other takeaway wins that you haven't mentioned we should think about? And could you mention any re-compete losses? You mentioned the one, materials, but were there any others we should think about?

I think we highlighted the fundamental takeaways, the task order churn continues. We talked about the replenishment as the fiscal year crosses over, we'll perhaps see some additional movement there. No real losses of any substance in the quarter that diminish that, on the book-to-bill side.

Got it. And Scitor, is there any opportunity that, as a result of the Paris attacks, that we could see expanded spending that would benefit Scitor? Or is that not on the horizon, at this point?

I think in a broader sense, our positions with Scitor and Intel, and the broader defense sector that I think collectively, with the global activities, anything related to national security interest for the country, we will be responsive to. I think it's a little early to reflect any direct correlation. But we will see, I think, further support, based on the rhetoric that's going on in the global community. And we're positioned with our customers to manage those surges.

Whether, again, it's through some of the supply chain, logistics and positionings for forward deployments, the operational. We don't have in-country exposure as much, but we do, on occasion, do access those, as the customers utilize the contract vehicles that we have at our disposal. So I think we'll see some discontinued efforts, but it's really not getting any safer, so we expect that we'll see some potential impacts.

Thank you. And the last one, you'd mentioned spending $10 million of additional acquisition integration expenses, to save $6 million. That seems like a high number to spend to save $6 million. And could you tell us, of the $10 million, how much of that is recoverable under cost-plus contracts? And how much of the $6 million in cost savings would you retain?

Right, so that is $6 million annually, so those are long-term leases. Costs are made up of breakup fees, some vacant facilities, and also some assumed losses on subleases. So that's a complete run rate. Our cost reimbursable portion is about 50% of our business, when you break it down. And so the other 50% would stay with us, and then would churn out over time. That expense is -- it may hit as early as the fourth quarter, and run through the second quarter as we complete those consolidation activities. But it may all slide into FY17, as well.

Thank you very much.

Thank you, Cai.

And the next question comes from Jon Raviv with Citi.

Hey, good morning, guys. To beat a dead horse, just on Scitor, a couple more follow-ups there. Multi-part. What do you have to do to bring that business back to growth? You talked about some hiring processes. Could you lay out more of a game plan there, in terms of what you have to do? Because it has clearly been a disappointment, it seems. And then also, on Scitor, would it be fair to characterize the sales pressure there being on the lower margin subcontract sales such that, should we still expect to see $60 million of cash flow benefiting next year?

Let me touch on that. I think the growth side with Scitor, very consistent with what we've been doing over the years. You've got a market that is making budget adjustments. We've represented in the past that, throughout this budget constraint, I would probably put in the order of Fed/Civ, defense and IC, on a time basis of their moving to the budget realities.

There's still high demand in all of those segments, given what's going on. And our return to growth, if you will, in Scitor is around shaping that portfolio, resolving any of the small business set aside, and replenishing the revenue stream that's a result of some of those acquisitions. We haven't lost anything substantial in any of the markets. Our award fees are still as high as they were, and our confidence in the margins is very, very strong on the earnings side. So I don't really expect any pressures on the margin side.

I think we have more levers in our control to manage those, even with higher price competition, in the sensitivity side. But we're well positioned to compete in that space. There are still very high barriers to entry. So confident in the sustainment of the re-competes, have to offset any revenue contraction that's part of those re-competes, just from a customer-budget perspective, and then we'll continue to expand our ability to sell the broader capabilities of SAIC. The most prominent would be along our Enterprise IT portfolio, where we have strong past performance that, in the past, Scitor has not really sold IT-type services.

So we see the growth being driven, in part, there but also based on the subject matter expertise in the core areas that they've served the country over the last 30 years.

And I'll touch on the subcontract content in that reducing. We do have fairly substantial margins on Scitor's subcontract revenue. Not as high as our direct labor, but still fairly high, much higher than the SAIC average subcontract profit. So that being said, we still would expect in the range of $50 million to $60 million of free cash flow coming from Scitor on a normalized basis. And that includes the utilization of the tax asset that we acquired in the acquisition.

John, can you specify what Scitor is adding this year, in terms of free cash flow, including the AIT cost?

I'm sorry, including the what cost?

Any of the -- what is Scitor adding in cash flow this year versus what is it costing to integrate this year? And how should that slip into next year? Just trying to figure out what -- heading into next year, what the comp should be?

Right. I think if you see, if you just look at the acquisition and integration cost line, you can see what the drag is from that. It's certainly providing more cash flow than that drag is. But on a normalized basis, ignoring the intangible -- or I'm sorry, the integration and acquisition cost, it's running at that $50 million to $60 million annually, with ebbs and flows, just based on working capital.

Okay, thanks. And then on some of the recent wins, I was wondering if you could just be more -- specify a bit more on the growth trends heading into next year, especially in light of the AMCOM expiration? Obviously, that -- you had one large win for a big slug of that. How should we expect AMCOM to impact next year?

Right now, with the AMCOM re-compete, if you will, the recent award, does basically protect the FY17 revenues, as we see it. The acquisition strategies of the Army will evolve. We're working closely with them. We reported earlier that a different scope of work, ASCR-8 SRC, moved to the OASIS IDIQ vehicle, is one example of following that work. So we're confident that the acquisition cycles really won't have a major impact on FY17, particularly given the recent award. So AMCOM is pretty stable, going forward.

So you're still thinking about that as about a $600 million to $700 million business? Or how should we think about AMCOM?

Yes, we do.

Okay. And then last for me, just on free cash flow. I think you guys had previously talked about roughly a $240 million normalized free cash flow generation rate. What are the moving pieces this year, that shouldn't repeat next year, that will help us get to that number? And on a related note, is there any working capital build associated with the ACV win?

Right, so the $240 million, on an ongoing basis, is still a reasonable estimate, and that's on average over time. The things that won't repeat from this year, obviously, is the build in the AAV, which is about $30 million. As we approach year end, that will be the working capital investment as of the end of the [fourth] quarter. Also, there's an additional quarter of Scitor that will be included in next year that was not included this year, since we acquired them at the beginning of the second quarter.

So as you look forward, $240 million is, on average and over time, a pretty good way to think about it. I can tell you that, by virtue of the fact that we have a 53-week fiscal year next year, there is one extra payroll in next year. And so that has a drag, on a normalized basis, very temporary in nature, of about $25 million for that extra week, because of that payroll. As far as ACV, ACV has a fairly similar cash flow, or working capital buildup, as the AAV.

So as the AAV comes down and normalizes in the first half of FY17, ACV will be growing, over that same time frame, getting up to about $30 million by the end of the fiscal year, if everything stays on schedule. And again, that's assuming no protest. Won't be a huge drag on this year, although we'll have some buildup in working capital, but it's not significant like AAV.

So when just thinking about moving from this year, operating cash flow approaching $200 million, aside from the additional Scitor quarter next year, it seems like not a lot has changed, because the AAV release is offset by the ACV build. Is that the right way to think about it?

That is right, but it's neutralized, right? So while we had the build this year, there is no total build next year.

Understood. All right, thanks.

We'll go next to William Loomis with Stifel.

Good morning. Just one more quick one on Scitor. Any -- can you talk about turnover at the business since you acquired it? Is there any material executive changes, or changes in business development, or anything like that so far this year?

Bill, the retention at the senior levels is all intact. We've, I think, done a good job to make sure that we protect our customer access. The staff are doing a great job to service the customers. We are seeing a slightly higher attrition rate, compared to historical levels, a year ago, pre-acquisition. But I think that's, again, in line with the small company/large company transition.

We've got a very effective hiring mechanism, continue to take advantage of, to make sure the customer contracts are staffed appropriately. But I think at this point, it's in line, slightly higher than we would have expected, perhaps, than historical levels. But we're managing through that workforce challenge.

Okay, and then just one on the AAV. Is this the TERREX vehicle that you're going forward with?

I'm sorry, could you ask that question again?

Yes. On the AAV contract, is this the TERREX vehicle that you're going forward with on that program, on the prototype?

TERREX is on ACV, the combat vehicle that was recently awarded and down-selected.

Okay. What -- can you talk about just the risk of the program? I know it's fixed price. What -- how much work is being done by yourself on the build, versus subcontractors?

It's a broad team. We're obviously working off of that existing platform. I don't think the risk is necessarily going to change substantially. We've done a lot of work up front, as the market has generally, to put forward a fairly strong system that's operational. And so I do think that we're seeing system integration upgrades, and surely enhancements off of the previous platform. But I think in our case, it is not a new build from scratch. And we'll leverage our prior experiences in AAV and the like, and the expertise that we have, to mitigate any of the risks that are going to be part of the program, working with the customer.

Any big new components you've got to be tested the hybrids, the drive system, or anything like that, that could provide unusual risk?

No, not that I'm aware of, as far as major subsystems are pretty much intact. That was part of the acquisition strategy from the Marine Corps, to ensure that they had a more operational system than our research and development platform. So I'm pretty confident that we have a fairly high maturity level on our major subsystems.

And at least in the early part, say the next 18 months, do you expect that program, other than the working capital build, to -- what type of margins do you expect? Above average, below average, red line type margins?

They will be above average, from our historical trends on the portfolio we've had.

Okay, great, thank you.

Thank you.

The next question comes from Edward Caso with Wells Fargo.

Hey, good morning. This is actually Tyler Scott on for Ed. Thank you for taking my question. First, I was just hoping, John, you could level set us on what exactly the acquisition integration expenses are going to be? I know you had mentioned $5 million next quarter, but is that all-in, including this new $10 million fee that you mentioned?

It is not. So we expect about $3 million to $4 million of IT integration cost, as we complete our IT integration next quarter. The -- in addition to that, there's upwards of about $10 million of facility consolidation, that will be additive to that additional $3 million to $4 million, that you'll see in the fourth quarter. That can happen over the next three quarters.

We're working to accelerate that as much as we can, to get it behind us. So we may see about half of that or so hit in the fourth quarter, or it may slide to Q1. So we'll be working with our Board, and coming to a final conclusion on that. So you should see that $10 million hit over the next three quarters.

Thank you for that. And then just any comments on award activity in F Q4 so far? Have you guys seen any uptick or change in client behavior since the bipartisan budget act was signed?

We noted the -- (multiple speakers).

Of 2015, I'm sorry.

Yes, we noted the two [probably] major ones since the quarter has closed, was ACV and the RMA re-competes. So those are probably the most substantial. I think, with the budget deal, expectations are that there is a slightly higher confidence to maybe award some of this submitted proposal portfolio that's hanging out there. And my take is that, with a two-year deal, and the ability for some higher confidence, that they will invest in some of those larger programs, with single award contracts that have been hanging there, where they haven't been maybe fully committed.

So we have seen the task orders pretty steady. They are running their day-to-day operations. But perhaps we will see development programs or upgrade, whether it be on IT or on the mission side, maybe realized as we move past the holidays and into 2016 calendar.

Okay, that's great. And then maybe just on the awards, I don't know, has there been any material change in the pricing environment, use of LPTA, or anything around that?

No, the pricing competition, I think, is [bobbed] as it has been. Everyone has been reacted to the general market, so I don't see any additional pricing pressures. I think we would represent that perhaps there's a little backing off of explicit LPTA, as -- and with a more emphasis on best value.

The differential on price is still pretty narrow, but at least we're seeing some awards that are not solely the lowest bidder. Partly, I think that's attributable to the fact that the customers got what they paid for when they went low a few years ago. We've seen some instances of earlier re-competes, three years instead of five, when they haven't been getting the services that they actually require to conduct their missions.

Great, thank you very much.

The next question will come from Brian Ruttenbur with BB&T Capital Markets.

Yes, a lot of my questions have been answered, but got two little housekeeping. The headcount on Scitor, now and when you acquired them? So that's number one. And then number two, I want to understand the flexibility on your debt repayment. What percentage of your free cash flow will have to go to debt repayment, in order for you to hit the 3 times debt-to-EBITDA number by the end of fiscal 2017?

I'll address the headcount, and John can give you a sense on the debt side. The portfolio within Scitor involves about 1,500 people. We've seen just a modest net reduction in that headcount, and again we backfill. So I'd say that we have slightly higher than historical attrition. The hiring strategies are in place. They're back-filled to serve the customers. So it's a very modest net headcount reduction.

We have, when you think about the billable direct side, we have, as we looked at cost synergies, taken a look at the broader. So you have got to rationalize, a little bit, that the net headcount should be down slightly, as we link cost synergies. But on the billable side, it's modest down, as we try and make sure that we're serving the customers.

And on the debt repayment side, we'll see about $40 million or so, in the fourth quarter, of debt repayment. That includes the mandatory repayment, plus we have an excess cash flow repayment requirement, as defined in the agreement. So that makes up the remainder of it. So we'll see $40 million to $45 million in the fourth quarter. Next year, we'll see $60 million in required debt repayments. Those required debt repayments should get us to a book level of debt-to-EBITDA by the end of FY17, or a little bit below.

On the bank -- or the debt-to-bank EBITDA, which is a little more forgiving, because you get to add back stock comp, we expect to hit that about halfway through the middle of the year. And that's when our repurchase restrictions would be removed. And we generally wouldn't be restricted from repurchasing shares, as long as we stay at that leverage ratio.

Okay, thank you very much.

The next question comes from Michael French, Drexel Hamilton.

Good morning, gentlemen. Congratulations on the strong results.

Thank you.

First question I have is on bid-and-proposal activity. Has the two-year budget deal, or any other factor, altered your approach to that area?

I'd say, on the bid and proposal overall, the demand signals are still there. The volume has been pretty steady over the recent years. Our attention on leveraging the operating model in the matrix of the isolation of the customer-facing groups, I think, has allowed us to build a higher quality pipeline. So although the volume is probably just as high, which I believe we have a -- probably a stronger probability to win portfolio than maybe we did a couple of years ago.

So I think it's a focus on each customer, making sure that our bids are aligned to our capabilities and our strong past performance. And I think that's what we're seeing in some of the recent award activities. But generally, the flow is about the same. We're exploiting the IDIQs that we have, we have got great market access across the board. So we're just continuing to prioritize. And there are still probably more opportunities out there than we can actually service. So we're being really selective, so that we can sustain the business and serve the customers.

Okay, very good. And following up on a point about the probability of winning and competition overall. So CSRA is out there now, and obviously, they've combined two companies. And they're not shy about pointing to you, and others in the space, and saying, we're bigger than them, and this is about scale. And since we're the biggest, we're the best position. That's out of their mouths. And since they haven't been shy about talking about this, I figured it's fair to give you a chance to react to what they are saying.

Our position right now is that our diversified portfolio, at over $4 billion, gives us adequate scale. I think the diversification across the federal civilian, defense and intel segments is very strong. And further, one differentiator is that we carry a much broader mission subject matter expertise orientation, with our customers, than strictly an enterprise IT portfolio. So we serve it on both sides of that. So I think that that's our opportunity to serve customers on a broader basis than maybe some of our competitors.

Right. And on your point about the mission expertise, will the Marine Corps' amphib, will this in any way help you go after or create other opportunities whether it's new platforms, or integrating systems on platforms? Because it seems to be a nice showcase, if you will.

Yes, definitely. So the combination of AAV and ACV do give us further credibility in past performance in our hardware integration activities, in this case centered on ground tactical vehicles, so there are other platforms and other services, such as the Army, that obviously have large fleets that do need sustainment and modernization. That all fits that portfolio. I would believe that some of that same capability could be extended to the other services, perhaps, if we think about avionics and other areas within the defense sector.

So we do believe that it does create a very strong platform; it's a differentiated business model, and how we're partnering with the customer on a very cost effective basis. So we're very confident that we can continue to use the Expand-and-Grow strategy off of those key programs.

Very well, thank you.

(Operator Instructions)

And it appears there are no further questions at this time. Mr. Levi, I'd like to turn the conference back to you for any additional or closing remarks.

Operator, thank you very much. I'd like to thank you all for your interest in SAIC, and participating in the call today. Have a good day. That concludes our call for today.

Thank you, and that does conclude today's conference. Thank you for your participation.