Science Applications' (SAIC) CEO Tony Moraco on Q1 2015 Results - Earnings Call Transcript

| About: Science Applications (SAIC)

Science Applications International Corporation (NYSE:SAIC)

Q1 2015 Results Earnings Conference Call

June 10, 2014 8:00 AM ET

Executives

Paul Levi - Investor Relations

Tony Moraco - Chief Executive Officer

John Hartley - Chief Financial Officer

Analysts

Edward Caso - Wells Fargo Securities

Cai von Rumohr - Cowen and Company

Chris Sands - JPMorgan

Amit Singh - Jefferies & Company

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the SAIC Fiscal Year 2015 First Quarter Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions)

This conference is being recorded today, Tuesday, June 10, 2014. I would now like to turn the conference over to Mr. Paul Levi. Please go ahead, sir.

Paul Levi

Good morning. And welcome to SAIC’s first quarter fiscal year 2015 earnings call. Presenting with me on the call today are Tony Moraco, our CEO; and John Hartley, our CFO.

This morning, we issued our earnings release detailing our quarterly results. Additionally, you will find presentation slides on our website. 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.

During this call, we will make forward-looking statements to assist you in understanding the company and our expectations about its future financial and operating performance. These statements are subject to a number of risks that could cause actual events to differ materially and 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 our quarterly report on Form 10-Q.

In addition, the statements represent our views as of today. We anticipate that subsequent events and developments will 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.

I will now turn the call over to our CEO, Tony Moraco.

Tony Moraco

Thank you, Paul, and good morning. SAIC’s results for the first quarter provide a solid foundation for the year. Revenue of $962 million and operating margin of 6.1% resulted in dilutive earnings per share of $0.69.

We are pleased with operating cash flow of $34 million in the first quarter, which have historically been a negative cash flow quarter. This increase is our confidence in the ability to execute our capital deployment strategy. John will discuss the details of the financial results later.

Since reporting our fiscal ’14 year end results, there has not been a significant change in the market environment. We have noticed the modest increase in procurement activities during our first quarter and believe this activity will continue to accelerate until the end of the current fiscal year.

Traditionally, our seasonal bookings profile begin with the first quarter of increase booking over the fourth quarter of the prior year and increases through the second and third quarters, with the third quarter being the highest of the year. All indications point toward a similar pattern in the current fiscal year.

We continue to see our customer’s obligate funds for shorter periods of time to maintain financial flexibility and accomplishing this by utilizing transporters on IDIQ contracts. Despite behavior impact of short-term bookings profile, but our contract phase is well situated to accommodate their actions as revenue comes predominantly from IDIQ vehicle.

SAIC’s total contract backlog at the end of the quarter stood at $6.6 billion, this translate to book-to-bill of $0.9 million, an increase from reported quarter of the prior year. Contributors to the quarterly bookings were the previously announced wins with the Army Human Resources Command provides full lifecycle IT support and the award of technical instructions on the AMCOM EXPRESS vehicle.

Additionally, we have notice the increase in procurement activity in the federal-civilian space. As agencies in the federal-civilian space with some of the earlier to adjusted budget pressures, these customers are now more confident and increase in their procurement activity, the program growth and new opportunities.

At the end of the first quarter of fiscal ’15 the value of our submitted proposal is $14.1 billion. After the close of the quarter, there has been activity on a few notable contract processes. We were awarded a five contract submission on DHS EAGLE II vehicle from which we and several others were initially excluded.

We are pleased to continue our work with Department of Homeland Security and protect our existing business with this important customer. The award was made to our former parent as the bid was submitted prior to separation, but this contract is included in the standard contract novation process that is underway.

You will also recall that NASA submitted a request of reconsideration of GAO’s previous decision now holding government protest of Human Health and Performance contract that was awarded to SAIC. GAO recently denied NASA’s request to return the procurement to them. NASA has now canceled the existing [NEDC] (ph) procurement previously awarded to us and has begun new procurement efforts for contract of (indiscernible) services for the recent issuance of a request for information.

We continue to execute our business strategy to take advantage of new opportunities awarded to us by virtue of our separation and SAIC’s more comparative operating structure. As such, we continue to pursue efforts, the in line of our strategy to protect our revenue base, expand revenue with the current customer and grow into adjacent market where appropriate.

We continue to see awards that demonstrate early successes of our strategy. In the expense category we won seven companies awarded the Joint Force Development Services IDIQ contract to provide training, education and exercise solutions and services and support of the Joint Staff J-7 Directorate, Combatant Commands, military services, U.S. government federal agencies and multinational partners. The multiple-award contract has a five-year period of performance and total potential value of more than $800 million for all awardees.

Further demonstration of our ability to grow into adjacent markets is award of a Marine Corps contract, engineer, design and test upgrades to the Legacy Assault Amphibious Vehicle Personnel Carrier Variant Platform program.

SAIC is one of two awardees for this multiple award, firm fixed price contract to support the Marine Corps Program Executive Office - Land Systems that have an additional value of $16 million to execute preliminary and critical design reviews by carriers option proposed by vehicle build and testing followed by low rate initial production. If all options are exercised, total contract value over five-year could reach over $190 million.

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

John Hartley

Thank you, Tony. Consistent with my remarks on prior calls, in order to provide a better view into SAIC's operating results, my comments will exclude the minor amount of revenues and cost performed by our former parent.

Our first quarter revenues of $962 million were much as expected except for a $25 million negative effect from delays in funding on our recently awarded AMCOM EXPRESS passport. This represents a year-over-year revenue decline of 13% for the quarter.

I mentioned during our April call that we anticipate in the first quarter of fiscal ’15 would results in a double-digit revenue decline, based on pre-spin event, which was the case and we expect year-over-year revenue stability in the second half of fiscal ’15. At that point we expect to be aligned with our long-term revenue target of low single-digit revenue growth on average and overtime.

First quarter revenues were up 3% from the sequential prior quarter. This was largely due to the heavier amount of holidays and vacation time that we typically seen in our fourth quarter.

To give you a sense of our normative quarterly revenue profile, our first quarter is usually one of our more productive revenue quarter with the second quarter softening somewhat due to the Memorial Holiday and July 4th holiday and a surrounding of fully vacation season. The third quarter then usually rebound due to fewer holidays and associated vacation time with softening occurring then in the fourth quarter due to the holiday season.

Moving to profitability, we had first quarter operating income of $59 million resulting in operating margin of 6.1%. These results include about $1 million of severance expense or a negative 10 basis points impact to operating margin as we continue to optimize our operating model.

Now that we are fully executing in our major operating structures, we have enhanced visibility into our operation, which provides more improved enterprise level decision making. While first quarter operating margin is consistent with what we have previously communicated, there remains opportunities for improvement.

Optimizing our operating margin continues to be the area of focus and we are being discipline in implementing our initiative to show steady improvement in this operating metric overtime.

We are committed to enhancing profitability with the objective of 10 to 20 basis points of average annual improvement overtime until we reach a level more reflective of the markets where we operate.

Net income for the fourth quarter was $34 million, which resulted in dilutive earnings per share of $0.69 for the quarter. Our expected forward tax rate continues to be in the 38% range.

Let me now turn to the balance sheet and cash flow, our day sales outstanding or DSOs were 56 days at the end of the quarter, which is a three-day improvement from the prior quarter.

We continue to place great emphasis on our cash flow optimization program. As a result of this strong cash flow performance, we ended the third quarter with $237 billion of cash and our cash flow from operations of $34 million in the quarter.

This performance compares well to historical trends in the first quarter where we have experienced negative cash flow from operations due to our annual bonus cycle and the timing of payroll which also occurred this year and was overcome by strong cash collection.

Capital expenditures for the quarter were $7 million, slightly higher than our normative level as we had same additional infrastructure spend associated with the transfer of the transition services previously performed by our former parent. We continue to expect more normative capital expenditures of about $20 million annually.

We have made progress on our contract innovation process for SAIC from our former parent required as a result of its separation. Our current expectation is that process will be completed during summer timeframe but I would like to remind you that the process is likely to result in a temporary negative impact on operating cash flows as customers complete the administrative actions necessary to move the contract payable and payment mechanism from our former parent to our company.

We believe this disruption will be fairly minor and temporary until we expect it will not influence our capital deployment decision later in the year. Capital deployment continues to be a priority in SAIC value proposition. Consistent with our commitment of saying what you do and doing what you say, we continue to deploy capital to increase shareholder value.

This morning we announced the approval of our current cash dividend of $0.28 per share payable on July 30. In addition, we continue to repurchase shares with our cash in excess of operating views.

During the quarter, we repurchased approximately 685,000, shares deploying $26 million of capital and we have repurchased approximately 2% of our outstanding shares since we baked in repurchasing our shares in December of last year.

We expect to deploy capital through share repurchases with our excess cash after prior return of ample deployment opportunities such as business acquisition or internal capital investment. At this point, we have a relatively high return threshold to potential acquisition in targets we need to offer a compelling pull through of our technical capabilities in currently underserved government customer.

Given our strong cash flow performance to date and cash flow expectations for the rest of the year, this presents an opportunity to increase the pace of repurchases for the remainder of the year in order to meet our stated capital deployment objectives. Also we continue to evaluate whether the debt level ratio for a company with SAIC strong and predictable cash flow should be increased. If we conclude that our debt level ratio should be increased, we would expect to increase the amount of capital deployed by the company.

With that, I will turn the call back over to Tony.

Tony Moraco

Thanks John. I would like to thank all our SAIC employees for a great start in fiscal year ‘15. Last week, we held our first annual stockholder meetings at which we all of our directors were re-elected and all of their proposals passed consistent with our Board’s recommendation.

At the stockholder’s meeting, I communicated that after a year of transformation of fiscal ‘14, this year is dedicated to optimization of the enterprise. The solid base on which to start, managed organization to take full advantage of the numerous opportunities that lies before us.

Operator, we’re now ready to take questions.

Question-and-Answer Session

Operator

Thank you, gentlemen. (Operator Instructions) Our first question is from the line of Edward Caso with Wells Fargo Securities. Please go ahead.

Edward Caso - Wells Fargo Securities

Hi. Good morning. Congratulations on a solid quarter. I believe your top five clients are about 40% of revenue. Could you talk about each one of those and what the trends are with them?

Tony Moraco

Thanks. I think right now if there’s a churn line we’ve seen is fairly consistent with our past performance. The army represents our largest single account of our client. The AMCOM EXPRESS vehicle we’ve have been talking about is an important aspect of that in the recent task order of 37 is an important aspect of our supported Huntsville effect on arsenal.

Right now, across the board, whether it be AMCOM, DLA, National Account, the State Department, Central Command aspect of our DHS and Navy account and across that profile as mentioned in my remarks, the IDIQ activity and our portfolio alignment, I think is very, very sound. The deliveries and the customers intend to move moneys across the task orders. The contract vehicles have broadened in scope and we think we’re well positioned to align to what they’re going to prioritize going forward utilizing the various scope of work under those task orders.

So no major changes in trends from what we’ve seen in the past. We are seeing some of the federal civilian agencies commit dollars maybe little bit more confidently than the DoD. Our recent conversations with the Defense Department, I think they are still trying to assess their short and long-term priorities as they try and lay out this year’s budget, next year’s with still some anticipation of possible sequestration out beyond ‘16 as we’ve seen in the rhetoric on the Hill.

Edward Caso - Wells Fargo Securities

Now in the civilian clients you said DHS and NASA, is that primarily your civilian clients or are there others?

Tony Moraco

Those are -- the largest were DHS, NASA. We’re seeing task order activities move through particularly on a DHS site. So that’s been helpful. So those were the two largest within the space that we faced today. There are few others but they are at smaller scale.

Edward Caso - Wells Fargo Securities

You had a pretty good book-to-bill in a generally soft quarter. Were there any deep bookings as well within that number?

John Hartley

Every quarter there are deep bookings. We had more of a normal level of deep bookings this year. Deep bookings come from a number of areas. Often times they just result in the fact that all of the funding wasn’t used under the period of performance and therefore in essence falls off. But we are back to more than normative level after we saw the spike in Q4.

Edward Caso - Wells Fargo Securities

Could you remind us of your guidance on cash flow both debt and CapEx? Thank you.

John Hartley

Cash flow for the year for our operating cash flow, we don’t have guidance on it. But our target is approaching $200 million in operating cash flow per year on average and our CapEx at a normative level is $20 million or less…

Edward Caso - Wells Fargo Securities

Great. Thank you.

John Hartley

Thank you.

Operator

Our next question is from the line of Cai von Rumohr with Cowen and Company. Please go ahead.

Cai von Rumohr - Cowen and Company

Yes. Thanks so much. And let me echo great quarter. So you talked of the seasonal downtick and you do have one fewer working day in the second quarter, but maybe give us some help if you have that $25 million delay on AMCOM EXPRESS. Now that that’s kind of in the fold and J7 I gather is new work. Could we see a relatively modest falloff in the second quarter?

Tony Moraco

It won’t be an extreme falloff. I can’t give you an order of magnitude, but we look at effective days. We try to estimate the amount of holiday and vacations. Obviously we know holidays. Vacations, we have to estimate. We have about 4 less effective days in Q2 versus Q1, because of the spring break holidays and vacations that people take. So we look at that. That will more than offset the downtick on AMCOM. So we will see a decline, I wouldn’t say it would be significant, but it would be definitely down from Q1.

Cai von Rumohr - Cowen and Company

Got it. And you mentioned cash flow of $200 million minus $20 million so that’s like a $180 million. Is that the right number? I thought you had a slightly lower cash flow number, maybe I am wrong.

John Hartley

We said over time we expect our operating cash flow to approach $200 million CapEx of $20 million. We won’t be approaching that level this year if everything stays stable, and we’ve seen very strong cash flow performance both last year and this year. So our DSOs are near record lows, which is a lot of focus that we put on it and we continue to focus on to accelerate that cash flow.

Cai von Rumohr - Cowen and Company

What does it take to get to that kind of -- excuse me what does it take to get to that kind of number because you already had a great 56 days, can you get better? And you had mentioned about the novation impact, will that back up to 60 temporarily or maybe give us some help there?

Tony Moraco

That novation impact should be completely through by year end. We are hoping most of it is through by Q2. That’s probably the only time you will see a short-term effect of the Q2 boundary. Our cash flow, again if you just look at our net income and you add back the stock compensation, you start to approach the $180 million, $190 million worth of cash flow from operations. And so if we’re able to improve and continue to improve on our days working capital, that’s how we are able to stay at that level. So we are hopeful, again, we probably won’t reach $20 million this year, but we are hopeful we will be approaching it in operating cash flow. Now realize that a significant amount of that while not committed, we intend to subject to Board approval deploy through the form of dividends. So after that, there is less what we would call free cash flow for other choices on capital deployment.

Cai von Rumohr - Cowen and Company

Now, I guess the last question is with the sort of novation impact in the second quarter, how should we think about the cash deployment for share repurchase consistent over the years or likely to be opportunistic and fluctuate and how does that sort of pair off versus potential for special dividend?

Tony Moraco

At this point, we haven’t adopted an opportunistic approach that doesn’t prevent us from doing so in the future. We are not letting the Q2 perturbation in cash flow affect our capital deployment decisions, because we fully expect it to be minimal and temporary in nature. So as I said in my commentary, we have the opportunity to deploy, to accelerate the amount of capital we are deploying on share repurchases if -- in order to meet our stated capital deployment goal, which is the deploying all cash in excess of minimal operating needs, which right now we pegged at $200 million.

Cai von Rumohr - Cowen and Company

Terrific. Thank you.

Tony Moraco

Thank you, Cai.

Operator

Our next question is from the line of Joe Nadol with JPMorgan. Please go ahead.

Chris Sands - JPMorgan

Hi. Good morning, guys. It’s Chris Sands on for Joe. I was hoping if you could give us a quick update on the effort to improve the direct labor mix, maybe tell us where it was in the quarter and if you have a goal for the year?

Tony Moraco

Sure. So we are seeing a positive trend in our direct labor. Quarter-over-quarter you are going to see perturbations that are caused by a number of events. As an example, we ran direct labor very high that you will see in our Q of about 59% compared to 41% of subcontract that after you remove the material components. That is higher than it was 49% versus 41% which is higher than what we have been running, but trending upward and there wasn’t uplift because of the fact that the majority of the impact of the $25 million on AMCOM EXPRESS that we saw delay in Q1 was subcontract component. So that right now is a little higher than what our trend is, our run rate, but we are seeing 2 to 3 point improvements each year is what our expectation would be which would help us get to that 10 to 15 basis points that we want to get from that lever.

Chris Sands - JPMorgan

And so you are on track for that 2 to 3 point improvement, thus far this year?

Tony Moraco

It appears so.

Chris Sands - JPMorgan

Okay. And then I was curious if the scope of the work you’re expecting for the EAGLE II is any different from the previous contract or do you expect any material change in the revenue?

Tony Moraco

Right now we are not seeing a significant shift in the scope. We will see how the customer migrates from EAGLE I to EAGLE II, but there is very strong alignments from those two vehicles. So we do not expect any major changes going forward.

Chris Sands - JPMorgan

Okay. And then finally, is there a timing expectation for the successor contract to the NASA human health and performance.

Tony Moraco

It’s going to be up to the customer. The RFI came out with responses already in. We’ll anticipate a request for proposal and see what that looks like and go forward from that. So no exact timeline on the outcome, so we expect that process to continue on a normal customer baseline.

Chris Sands - JPMorgan

Okay, great. Thanks, guys.

Tony Moraco

Thank you.

Operator

(Operator Instructions) Our next question is from the line of Jason Kupferberg with Jefferies & Company. Please go ahead.

Amit Singh - Jefferies & Company

Hi. This is Amit Singh for Jason Kupferberg. Just wanted to quickly talk about your operating margin this quarter. You mentioned that you got the operating income benefited from some favorable changes in contract profit estimates. So it would be helpful if you could quantify the benefit for this quarter. And also if this is a trend, do you believe that you could -- your year-end margins could actually do better than 10 to 20 basis point year-over-year improvement, considering that after you remove the $1 million severance expense for this quarter you’re already at 20 basis point improvement?

John Hartley

Sure. Let me address that. So first, the comment in our earnings release and elsewhere that we benefited from net positive change, means you’re coming off of net write-down in the prior year quarter, compared to slight net write-up in this quarter. So by order of magnitude you’ll see in our 10-Q that we had about $3 million in write-down -- I’m sorry $4 million in write-down in the FY’14 Q1 and $3 million positive in Q1 of FY’15.

The write-downs were those episodic items of the Red programs we had. I would say a $3 million write-up net in any given quarter is certainly not unusual. I wouldn’t necessarily say if the trend, but we have seen strong [fee] (ph) performance as we have optimized and rationalized our cost structure. So there is always a chance the write-ups will occur that will give a short-term lift, but again, we’re looking more at steady improvements over time and on average versus any episodic quarter or year.

Amit Singh - Jefferies & Company

All right. Perfect. And have you guys identified any other costs takeout opportunities, I believe, since the time of the split you’ve already -- you are pursuing some costs takeout efforts, but has there be any additional opportunity that you have found?

John Hartley

The actions we took in the first quarter that resulted in the million dollars of severance results in somewhere north of $5 million in labor cost savings per year for the remainder of the year and then that will be in perpetuity. We also have looked at our non-labor cost and we have identified some areas for savings there. But those are savings, quite frankly we are expecting to bring in and that to stay aligned with what our commitment if the customer are returning some of that savings to them through our more competitive cost structure.

Amit Singh - Jefferies & Company

Okay. And just lastly on your organic revenue growth guidance, after fiscal 2Q which could have some negative impact, like going forward now that you are starting to -- you are seeing an improvement in the procurement environment. And overall, your revenue base over the last few years has obviously enough for you and for the competitors have shrunk. So now looking into third quarter, fourth quarter and going-forward, is it safe to assume that you’ll starting seeing these low single-digit year-over-year growth, considering easier comps?

John Hartley

I wouldn’t say it would be out of the question. It kind of looks flattish at this point but again, there is a number of things that are in play that could improve that especially the encouraging science we’ve seen from some of our customers. But certainly, as now the question that we wouldn’t expect to see any real reduction to that point either.

Amit Singh - Jefferies & Company

All right. Perfect. Thank you very much.

John Hartley

Thank you.

Operator

Our next question is a follow-up question from the line of Edward Caso with Wells Fargo Securities. Please go ahead.

Edward Caso - Wells Fargo Securities

Hi, thanks. Could you talk a little bit about the pace of OCO spending and how your -- where you stand with Afghanistan and your expectations for that run-off?

John Hartley

Good. So in FY ‘15, for what we consider true OCO exposure, we have about $50 million. It’s a lot of the forward operating basis and the likes that we look at that will come down overtime obviously. The rest of the activity we have there is more supply chain business, which is another $50 million. We do believe that and follow the true tone and so we don’t feel that that’s going to be a headwind to it.

Edward Caso - Wells Fargo Securities

And our sense is that your pace of share repurchase in the quarter was a little bit lower than we thought it would be. Was -- are you sort of easing in at the repurchase program or I know you mentioned you expected that to accelerate but did you sort of hold back in this past quarter?

John Hartley

I didn’t say we held back in this quarter. We took a little longer view and looked at a six-month period and decided how do we want to get started in the market. We’re approaching to end of that six-month period and so we’re going to have to make a decision on what to do forward.

Edward Caso - Wells Fargo Securities

Great. Thank you.

John Hartley

Thank you.

Operator

Mr. Levi, there are no further questions at this time. Please continue with any closing remarks.

Paul Levi

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. Bye now.

Operator

Ladies and gentlemen if you’d like to listen to a replay of today's conference, please dial 1-800-406-7325 or 1-303-590-3030 and answer the access code 4679946 followed by a pound sign. This concludes the SAIC fiscal year 2015 first quarter conference call. Thank you for your participation. You may now disconnect.

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