Science Applications International Corporation
Q4 2014 Earnings Call Transcript

Published: 31 Mar 2015

[Operator:]

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 would like to turn the conference over to Paul Levi, Investor Relations. Please go ahead, sir.

[Paul Levi:]

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'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-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's now my pleasure to introduce our CEO, Tony Moraco.

[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 delivering 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 for fourth quarter revenues of $941 million resulted in the second straight quarter of year-over-year revenue growth and 6.3% operating margin. 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 in our strategy execution and most importantly performed well for our customers. We are carrying that momentum forward in the fiscal year 2016. From market standpoint, there have been no significant shifts in the environment, which is generally good news. Our federal customers are working with appropriated budget through September 30, the end of government fiscal year '15. There appears to be optimism as a result of the President’s budget recommendation for fiscal '16 and early feedback from Congressional Committee Deliberations. However, as also cautioned as demonstrated by our customers as pace of contract award does not change significantly and the sales cycle remain longer than historical terms. However, we continue to see demand for the capabilities that SAIC provides and new contract opportunities for us to pursue. Our protect, expand and growth strategy remains unchanged and we continue to execute that strategy. Similar to our third quarter, SAIC had a large volume of past quarter renewals and with our revenue profile coming largely IDIQ contracts, these renewals are vital in 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 workflow due to the holiday season and are well coming off of a usually higher third quarter. The value of our submitted proposals of winning awards is $12.7 billion up from about $11 billion at the end of the third quarter. This is largely due the resubmittal of the NASA human health and performance contract proposal. We anticipate HHPC contract decision this summer. Subject to the end of the quarter United States Marine Corps exercise a contract option for SAICs to continue into the next phase of Assault Amphibious Vehicle survivability upgrade program. After nearly a year long competitive down to [earth] process we were selected to continue with the next phase of this vital effort to support Marine Corps amphibious capability. Since last May we completed preliminary and critical design reviews and SAIC will now perform initial upgrade to 10 Assault Amphibious Vehicle prototypes. Following this additional option is exercised with the developmental testing and low rate initial production delivering 52 vehicles for operational test and evaluation to Marine Corps unit. 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 prime, applying our integration services capabilities and partnering with key subcontractors. To the capabilities demonstrated on previous vehicle upgrade programs with the Department of Defense, such as MRAP and AADC7 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 plan acquisition of Scitor Corporation. Announced at the beginning of this month we're on schedule to close the Scitor acquisition in May of this year. We are progressed on the financing or clearance under the Hart-Scott-Rodino Act and are excited by the shareholders value creation opportunity. Along with the Scitor management team I have visited several Scitor customers and intelligence community leaders in order to express my commitment to their critical national security missions. Our discussions with them, the reaction has been positive and our understanding of the vital role that Scitor plays and 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 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.

[John Hartley:]

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 cost 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 oppose to the full year. Fourth quarter revenues of $941 million reflect 1% 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 belief that we can achieve organic annual revenue growth in the low single-digits on average and overtime. 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 extension of the R&D tax credit retroactive to the beginning of the year and positively impacted EPS by about $0.03. Now on the cash and cash flows, in the fourth quarter we had cash flow from operations of $96 million and resulted in FY15 any 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’ve taken many actions designed to accelerate cash flow and I am very pleased with our cash collection performance. This leading performance it's the direct result of the focus we place on cash flow because 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 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 seized repurchasing stock in the open market in mid-December, under the existing share repurchase plan which continues to have 1.5 million available for repurchase. We intend to use as 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 30th. Our capital deployment actions in FY15 resulted in deployment of about 75% of our fiscal 2015 free cash flow, but if you include $150 million that we anticipate to utilize in the Scitor acquisition the percentage increases to about 130%. As mentioned on our March 2nd call to announce the signing of the Scitor acquisition agreement and based upon estimated pro forma historical results, we communicated our expectations and 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 expectations is to use future excess cash to pay down debt until we reach our previously communicated target debt level of between 2.5 and three 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.

[Tony Moraco:]

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 3rd 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. The continue dedication and pursuit our strategy and customer mission success have resulted in a successful year and positions us very well for fiscal '16. Operator, we’re now ready to take your questions.

[Operator:]

Thank you. [Operator Instructions]. We’ll take our first question from Jason Kupferberg with Jefferies.

[Jason Kupferberg:]

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 to look at the metric more on a trailing 12 month basis to trying to adjust to that seasonality and actually on that basis look like your book-to-bill ticked up a little bit this quarter as compared to where it was 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 '16, 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 sale cycle. So how does that kind of net out at the end of the day, I mean should we be looking for a similar book-to-bill in '16 as in '15?

[Tony Moraco:]

Jason, I think it's going to be very similar, I mean we still target that 1.0, it has its cycles. But we saw the seasonal aspects as you mentioned. The 1.0 in the aggregate looking at each of the various customer groups, so we're confident that we continued to sell through the past quarters on the large IDIQ contracts. The pent up demand on submit was still out there for some of the larger non IDIQ 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 of years, we've had that new normal in bottom and looking to '16 FY -- government FY16 and '17 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 in the services that we deliver. So I wouldn’t expect much change but we still have around that 1.0 up or down just with quarter of fluctuations.

[John Hartley:]

And Jason I will point out that the FY14 Q4 book-to-bill of 0.3 we believe was episodically low. So I wouldn’t use that for comparison for any forward years.

[Jason Kupferberg:]

And then just a question of Scitor, I know you guys said that it should be accretive to adjust the EPS in year one. 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.

[John Hartley:]

Well we gave the historical run rate to the pro forma activity of the Scitor acquisition; you can see that in the March 02 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 our FY16 would lead to. We expect their margins that you would have seen in the pro forma trailing 12 months to hold consistent generally, expect for the transaction cost 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 forma once you put on that mid single-digit growth to the activity that we had on the pro forma. We'll go into much more detail on that in June but hopefully that’s enough to get you buy for now.

[Jason Kupferberg:]

And just last question from me on cash flow in FY15, I think you did quite a bit better than your typical annual target. So if we think about the prospects for fiscal '16 and 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 to fiscal '16? So can you do still do something in the neighborhood of 200 million of operating cash in fiscal '16 even with some of these working capital movements?

[Tony Moraco:]

It will be tough to hit 200 but we’re certainly going to push for it, we don’t expect to be far off that number.

[Operator:]

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

[Cai von Rumohr:]

Could you maybe update us I guess you had on the [hit] contract where you are there and the NASA Health?

[Tony Moraco:]

We have to resubmit it human health and performance contract back in the late January, February conference. We still expect that decision to be made sometime in this summer. So they did hold to their original schedule on the proposal track so that is in and we expect that to look forward. On [hit] that’s still back at correct with actions of the agency the core and we do again expect to get some decision prior to next three to four months hard to predict on that. But we're in that prior couple of months but that’s we can tell you as far time both are in and are going through consideration for our customers.

[Cai von Rumohr:]

On Scitor, rather you have some tax benefits. If you're free cash flow in area of 200 million presumably how much would Scitor add to that on an annual basis? Can you give us any help there?

[Tony Moraco:]

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 at least the 20 million levels for the next seven years.

[Cai von Rumohr:]

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

[Tony Moraco:]

Coincidently 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 its within -- if we’re ready within a week’s time out 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.

[Cai von Rumohr:]

And last one, you’ve still got some local Afghanistan business, could you comment how big was it last year and with the decision to come and delay withdrawal of troops what you see directionally for 2016?

[Tony Moraco:]

So the majority of what we see is in the supply chain area that’s about in the $80 million like year range, it certainly and it ebbs and flows, depending on what's going on because we've had things like Ebola and stuff like that, that have delivered to that. In '15, we had about 100 million in total, it will slightly be lower in '16, we expect about 90 million. Again the vast majority of it over 60 million coming from our supply chain with tires and [cap] and then we have a little bit under war-fighter and little bit under income express. But we don’t expect that to cause any step changes.

[Operator:]

We’ll go next to Jon Raviv with Citi.

[Jon Raviv:]

Tony, you mentioned that customers seem to have adjusted; I was wondering if you could comment on how you think the environment is 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?

[Tony Moraco:]

I think that with the budget cap baseline, President’s budget, the Republicans' position on national security defense. I think again we’ve seen the bottom of the general cycle. We do expect there will be some activity around sequestration at least to a degree, I don’t think anybody is expecting a full appeal on sequestration but they are working around it relative to legislation. Few things that the customers have already self selected down to the appropriate level most that I’ve talked to are planning on that DCA level with some upside based on how the budget and the markups actually play out. So really don’t see huge fluctuations, it will be pocket probably on the sequestration release side. You may see a fluctuation plus or minus 5%, cannot 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 or the technical expertise that our customers continue to seek across the portfolio and diversification portfolio helps in meeting both their IT program upgrade but also the system engineering and the mission capability. So we'll soon be fairly stable, as we've messaged before, I kind of get back into this normative from FY16 -- government FY16 and beyond we’ve been saying '17 to '20, it looks like we’re reaching a stable platform on budgets right now. So we’re well positioned for those correct changes.

[Jon Raviv:]

And then how could you guys point to new programs ramping up hoping the sell numbers and certainly you're not performing. How do you characterize the new business and new programs and then mostly, brand new business and expansion of current work is it pure takeaways from large OEMs and pure competitors, how would you characterize that?

[Tony Moraco:]

It's still very competitive environment, it's a mix of what you describe. We have I think been more focused with this operating model with the customers -- customer group able to focus pipeline decisions around really best aligned increase our probability or win between our competitive win rate as a whole. So combination of selling through the large IDIQ platforms that we have to secure the task order volume, I think in terms of securing the work on protect side, but within those vehicles we are looking to expand our services, are using those vehicles that we have in place, separate from that like with [AIZ], we do think that our maturing capabilities to the service line we can leverage our past performance and again sell mature capabilities to customers we know, but customers think we haven’t delivered that with the service too. So more on the expense 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 a line to the portfolio that Scitor has created and then complement that with what we need going forward to grow that that particular market segment.

[Operator:]

[Operator Instructions]. We’ll take our next question from Edward Caso with Wells Fargo.

[Edward Caso:]

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 if one is right and two can you differentiate your revenue between sort of value add and commodity?

[Tony Moraco:]

So we spend most of the time on the value add services very little on the commodity side relative to perhaps even supply chain being an exception. But that is totally different business model but on the straight services 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 via systems. And I think the technology integration asset with portfolio also have 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 is a number of programs and like [AIZ] where we can model our program capability and promote a fixed price model for the government mostly IDIQs offer flexibility to use cost reimbursable or fixed price and we're starting to see perhaps some hybrids where we can be more cost effective take on the fixed price work. And where we can manage the risk its mature system and capability that we have but at the same time appropriate levels of the cost reimbursable and while we use those to the customer side. So the flexibility does exist human health is significantly growing. But we are also seeing although very price competitive that the slight pull back on the formal low price technically acceptable few or let's say formal LPTA and the government had to taste of that and realized that there is still a value proposition and best value solutions. So we're trying to influence that on the procurement decision that they're undertaking today.

[Edward Caso:]

John could you talk about direct labor versus ODCs in the press release there is several comments about notable material pasture. So if you could maybe give us growth rates in the quarter and the year for direct labor versus ODC.

[John Hartley:]

Yes lot of what we did see in this quarter was surge and material, our labor remained fairly constant as a run rate considering the holidays while we see a dip in labor a little more than we do in materials. That's 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 you had that 1% and 1.5% pick up in the fourth quarter associated with that. Although we did maintain our percentage of our labor compared to sub-contractors labor that mix for the year ended at 58% our labor 42% sub-contract. And we ended the fourth quarter by itself standalone with the same numbers 58, 42. So we'll always take those revenue pass through especially when they're on supply chain because of the fixed cost gets spread over a large base that becomes more profitable for us relatively than having a lower base on that material. So it is still good profit generating revenue of its majority of the surge we saw that 1% was in the material area.

[Edward Caso:]

John you mentioned that the long-term guidance was substantially unchanged. Was that before Scitor comment and if that’s what it is? Give us some body language on what part of the model the outlook maybe different.

[John Hartley:]

Yes it really is above; it is a width -- kind of leaning towards with Scitor comment. And what we've changed is more or less the starting point so where our operating margin will be. We said 10 basis points to 20 basis points of margin improvement per year on average overtime starting in the low 6%. We have to reevaluate 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 to low single-digit revenue growth -- the 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 in appropriate level for SAICs cash generating characteristics.

[Edward Caso:]

Last question clarification, in your bookings do you count wins that are still under protest?

[John Hartley:]

We do not.

[Operator:]

[Operator Instruction]. 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.

[Paul Levi:]

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.

[Operator:]

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