Science Applications International Corporation (SAIC) Earnings Call Transcript & Summary

All right. Great. This is Gavin Parsons with Goldman Sachs. And we have SAIC. Glad to have Charlie Mathis, CFO; and Shane Canestra with us. How are you guys?

Great, Gavin. Thank you.

We're okay, Gavin. Thanks for having us.

Yes, absolutely. We're just going to dive right into Q&A. Audience members, if you have any questions, you can submit them via the webcast or you can send me an e-mail at [email protected]. So guys, maybe getting right into kind of the most topical subject right now. Obviously, COVID-19. I think you guys reported probably a peak uncertainty in the end of March. Can you maybe give us an update on how that's progressed over the last 1.5 months? How much of your workforce is as a -- is impacted? And kind of what the impact has been relative to what you were expecting then?

Yes. I would just say, Gavin, that what we said back on the March call that we've seen minimal impact on the business from the COVID-19 pandemic, was based on the model, our operating model or business model that hasn't changed. So therefore, you'd assume that what we're seeing hasn't changed either. So we're very fortunate to be in the industry that we're in and with a flexible workforce, employees that are able to continue to work in locations, to work from home or alternate work schedules. So we're quite fortunate to be in the position that we are -- we did hit this and talk about this at the peak, as you said. But our business model hasn't changed. And therefore, you should assume that what we were seeing hasn't changed either.

Okay. So then safe to assume that the 3% to 6% organic target that you gave, obviously, that wasn't the firm guidance, but you would maybe factored in some cushion from COVID-19, that's still the right range to think about for this year?

Yes. So that was the pre-COVID for -- we guided to the COVID, and that's what we'd described it as. We had not factored any of those numbers to what the COVID impact would be. As we said, we believe it will be minimal. We will have some impact. You've seen our peers who have reported recently their impacts were somewhat in similar lines or various different contracts and customers, but not a huge difference in the makeup and kind of what they've reported and what we would expect, I guess, going forward. So not a huge impact, but there will be some impact to us. And those were not contemplated in that 3% to 6% range.

Got it. Is it possible to give us some quantification as to how much of your workforce is affected?

Yes. It's -- again, most of the workforce that is impacted is on the national security side, those area -- those people who are not able to go to work and [indiscernible] type areas, and now most of that is covered by the CARES Act of the DoD directives. And the biggest challenge there is the fee, the recoverability of the fee on those employees. So that's kind of the most direct impact, the other less direct or just slowing down purchases and materials, OPTEMPO in our supply chain business just because DoD OPTEMPO is just not that robust or hasn't been over the last couple of months. Those type of impacts that we've seen. But again, none of this is, I would say, material on our results. We've been very fortunate.

Got it. Well, then maybe on that 2% to 6% target, can you help us bridge from kind of the negative organic growth rate this year to maybe the midpoint of that range? What the key contributors are? And size those? And any headwinds that you still have to overcome?

Yes. Okay. So -- yes, the -- one of the biggest headwinds contributing to that 1.5% was the revenue dissynergies that was just associated with the Engility acquisition. Those items that we've gone over a number of times related to the cost-plus nature of the contracts. When the cost comes down, the revenue comes down, prime sub impacts and that. It was about $120 million per year of headwind that doesn't exist in FY '21. So you have to start from that baseline. And then we're very fortunate to have a number of very large new business wins that finally came out of protest going into FY '21. EDIS contract with the Air Force. The Cloud One contract that was also with the Air Force. And then the FSG-80, all that contributed about $250 million, $300 million of annual run rate revenue. That's all new business, so incrementally higher from that standpoint. And then the headwinds risk we had was large recompetes that were out there. One of them was the FSA contract that we inherited from Engility. That was around $120 million, $130 million a year. We're fortunate enough to win that contract and we announced that on the earnings call back in March. So that took that recompete off the table. And then as you know, the AMCOM win that we had just a couple of weeks ago, $2.9 billion contract award that really removed any of our AMCOM recompete risk in this fiscal year. And I think that was the largest ever contract award SAIC has been awarded since certainly the spin. So we're very, very pleased about the outcome of that. And therefore, most of the recompete risk that would potentially be a headwind to that 3% to 6% revenue growth, is somewhat taken off the table with those recompete wins. And then the headwind that we have is the COVID. What's COVID-related? How do we navigate that? What's the impact on the revenue? How long does it last in order to be able to achieve those numbers? That's kind of the bridge and where we get to these numbers.

That's helpful. What's your remaining recompete rate for the rest of the year now that you've more closed in?

All right. So now Shane, you have to help me there. Because it seems like most of the large ones we have won been successful or I don't know, if there's something out in the fall time frame or something, Shane, out there?

Yes. Let me -- yes, I can cover that. So as we've kind of been talking about, the AMCOM portfolio of task orders is going through a series of recompetes. Now you may have seen recently that we won the first one, which was absolutely fantastic, but there's a few more to go. But we got the big one initially. So the rest of the AMCOM portfolio will be competed, awarded somewhere in the fall through next spring, kind of as a series of task orders going through that time frame. So that's the biggest risk for the remainder of this year. But again, we got that first one that gives us a lot of confidence. The second largest, putting AMCOM aside, the second largest recompete we had this year was our FAA controller training contract. And you saw that we recently announced that we have resecured that contract. So that takes that risk off the table. And then after that, it drops off significantly to a smaller amount of contracts. So we have significantly derisked the portfolio in terms of recompetes so far this year.

Got it. And you made the comment that the revenue growth acceleration would be a little bit more back-half weighted. Can you give us an idea of, obviously, now COVID impact will be more near term in the first half of the year? Can you give us an idea of what sort of book-to-bill you would need to maintain in the first half? Or if that acceleration is really just executing on work that you've already won?

Yes. It's really just about the ramp-up of those new business wins that we talked about, was driving the back-end growth. We felt that EDIS, Cloud One, FSG-80, those -- it would take a couple of quarters in order to get to kind of the peak revenue that we would expect. And that really hasn't changed EDIS, Cloud One, all progressing as planned. As I mentioned, a little bit of OPTEMPO issues on the supply chain, FSG-80 not so material. But just that -- not that much travel, and not that much deployments. And I think that's taking place right now. It's having a little bit of impact on our supply chain type of business.

Got it. And then Shane mentioned some of the other outstanding AMCOM contracts, not the recompetes, but other opportunities. Can you size what the potential takeaway work is that you could add to your AMCOM portfolio?

Yes. Well, we do about $600 million a year in AMCOM work. We've done this for a number of years. The $2.9 billion contract award was over a 5-year period. And so you see that there's a lot of revenue if we hit that full kind of sealing value per year. And that only included about a $300 million, a battlefield, and then included new work from other sources. So that's the good news on that, is that, we feel we're in pretty good shape. However, we still have to win the other part of the AMCOM business that we had in order for this to be incrementally upside, of which there's a number of additional AMCOM task orders that will be decided over the next few months. Now some of those have slipped just because of the complexities of the proposal process. We were very fortunate in the first one and that the oral presentations, the demos and all that, which required 50, 75 people in a room to demonstrate the capabilities happened in January, February. So that it can make that -- those decisions. Whereas now, they're looking at different methodologies, some remotely and other ways of which may slow those awards down somewhat a few months or so out, kind of what could come out of that. So that's kind of where we stand in AMCOM. And I can't emphasize enough how important it was for us to win this first one. And the largest one. And we felt very confident in that. I think whenever I talk to investors, I relayed how confident I felt we were just because of the nature of the work. The thousands of software engineers working on battlefield systems, networks and coding, very difficult to change out that and process of continuity and the vital mission work that these guys perform and provide for intonation and services. So there's others that will -- also, they're very valuable out there, and we feel like we're in good position to win this. These as well. But certainly, on the first one, I'm very pleased to have that one turned out. And the timing of that being awarded. The process of that being the first one out of the gate that we have this one behind us. And we can focus on these going forward. So the other ones have slipped a little bit in just the proposals because, again, what was going to be 5 demos, 5 orals have turned out to something different. And they're working through all that, where time lines have slipped a little bit on those.

Is that a dynamic you're seeing across your portfolio where there's been some COVID-19 disruption to your time lines of awards?

I guess it varies because I can go back and look at just the recent win that we had on this TADS contract with the Air Force that was a new business award that we just announced last week. So fortunately, there was no impact on that one. I think it just depends. It's all very specific to kind of contracts and terms and the nature of the work and where they are in the process and making the selection and how well they can do it or feel. So I -- it's hard for me just to say, broad general stroke that's impacting the selection process and are making awards. Because we haven't seen that other than just -- as I mentioned on the AMCOM, that selection process, I believe, has been delayed a few weeks. So I don't know.

Yes, that's helpful. Go ahead.

Yes. Go ahead, Shane.

I just thought I'd just add, and Charlie is right. It kind of is agency by agency and how they're dealing with disruptions, et cetera. But my sense is that a lot of awards you're seeing now are -- we're probably fairly mature or long in the process of the evaluation and have been pushed below the goal line, so to speak. So the ones that were submitted in March and -- or around that time frame or probably going through the process a little slower, such as Charlie mentioned on our next AMCOM task order. So the government continues to procure. They're doing the work and getting contracts, et cetera, just little slower. And notionally speaking, yes, maybe they're at like 80% throttle than what they were before, just due to the work from home, dealing with other contractual issues that you're dealing with on their current contracts because of COVID-19. Contracting officers are distracted by that. So -- but the government continues to operate and do business.

That's helpful. Continuing on that TADS contract, is that a -- that's a Unisys Federal award for, I think, $600 million from the Air Force, is that right?

Yes, that's correct. Yes.

Can you give us a little bit more color just on what you'll be doing there? And if that's something that you had anticipated, kind of -- or Unisys gave confidence and your comments. So then I think you saw Unisys growing potentially double digits for the foreseeable future?

Yes. So there were a number of contracts that new business that they were going after and we use that in the due diligence. And we felt very confident that they would win a portion of those in order to meet that deal piece as a double-digit growth for the next couple of years going forward. So that's basically -- this win was, therefore, somewhat anticipated, maybe not this one. We're lucky, it was this one. Because this was the largest of those that they were going after. And so if any of them, we're happy they won this one, very high margins. And there's still a protest period that's out there. But very, very pleased that the -- what the team did. What they're bringing to the Air Force and their weather enterprise capabilities, and the fact we're able to displace an incumbent, had it been there for many, many years. Just, again, shows the capabilities and that what we bought from Unisys Federal is holding up. So I could say, we're very, very happy and pleased by this. And this certainly builds tremendous confidence in the deal thesis that we laid out when we acquired them.

So a big one for Unisys. There've been a couple for Engility, and I think we've submitted a stand-alone Engility. Obviously, that acquisition completed almost 1.5 years ago now. So can you talk a little bit about how much you've submitted as kind of joint Engility, SAIC? How long it takes for that process to kind of go through to submit the RFP protest and then final award? And then kind of how you're progressing on integrating some of the joint bids of SAIC and Engility? And when those will come through?

Yes. So that's -- we don't even track it like that now, Gavin. I mean it's all fully integrated. They're fully integrated into our National Security's segment. I couldn't tell you what's Engility and what's SAIC. It's a completely integrated team effort. I know that the submittals, the win rates have been very, very high. We've been very pleased by that portfolio, particularly on the space and the -- on the Intel portfolio. They've been very successful there. And they continue to look for areas to grow and grow that business. They have enormous capabilities there. I know the cements are up in that area, but I couldn't tell you -- split it up or and be separated. It's all -- at least from my level, what I see, it's all very much an integrated team.

Makes sense. Shifting to margins. You gave the high 8% to 9% target for this year. Obviously, that was pre-COVID. How much impact is there potentially to that from COVID? You mentioned the lost -- meaning that obviously couldn't have more drop-through. Is that still a range that you can achieve this year?

Yes. So again, I just go back to bridging to prior year, we ended at 8.4. We were looking to get another 20 to 30 basis points margin improvement from the Engility cost synergy pickup -- that we had planned. And then we were going to get another 20 to 30 basis points from Unisys Federal acquisition and assuming the 9 months that we own them -- or the period of time that we own them there. So yes, we felt comfortable with that margin profile prior to COVID. And again, we will have some impact on the COVID, where particularly at national security or other agencies or customers of which that we have billable people. But they're not able to get on the site. And therefore, not able to charge a fee to them, although they do cover the cost. So that's -- again, we don't see it being significant. There will be some -- but I think those margins hopefully would still stay in that range there that we talked about.

Great. And then over the longer term -- go ahead.

No, I was just going to say that on our June 4 call, we'll certainly give more guidance and as for how we see the year progressing.

Got it. Over the longer term for margins? I mean should we expect that the core SAIC margin can expand? Or should most of the longer-term expansion be driven by mix up of whether it'd be Unisys Federal, higher-margin wins like you mentioned and further accretive M&A?

Yes. I think it's really the focus -- that Nazzic laid out is for us strategically where we want to position ourselves in that higher end business, more the IT modernization, more solutions-based. So we're going after the higher-margin type of contracts as the top priority. So I think it's really the mix that you will see in the future. And again, Gavin, I'm thinking in the future, maybe 10 to 20 basis points per year margin increase would be tremendous achievement if we could do that going forward, that would be something that we would, I think, target and look to try to achieve with a more favorable mix in the portfolio.

Makes sense. With that mix, obviously, it's a ongoing transition and you're pivoting there, both organically and through M&A. But I mean, is there a target that you're thinking about or how much of the business do you want to mix towards that digital transformation? I'm sure, obviously, you'd love to have all of it get there, but is that something that you anticipate accelerating further through M&A? Or is that now pretty well positioned organically?

Yes. I think we're pretty well positioned organically. And I could say that one of this -- as a strength that we have now is this very diverse portfolio that was brought largely or somewhat augmented by the acquisitions that we have. So the -- having a diverse portfolio of Civilian, Intel, DoD, well balanced is something we look to achieve. We think that positions us well in the government budgeting environments going forward. And also with a slight nudge tilt to the higher margin. I mean work there would again translate into what we could see as 10 basis points, 20 basis points improvement in margins. So I think we're pretty well positioned. And you get down to the detail level, which contracts we're going after. And what our capabilities are now on the higher solutions. So we think we're in pretty good shape. I mean we got a lot of good things in the pipeline that are coming there. So feel pretty confident.

Okay. And then moving to free cash flow. The step-up to $550 million in guidance next year, you guys are run rating at $200 million, $250 million for a couple of years, a few years ago. EBITDA growth has seemingly the majority of that expansion. But can you size us how much you're anticipating as working capital contribution? And NOL contribution in the $550 million next year?

Yes. So of the $550 million next year, it's pretty minimal impact as far as the working capital. I think we're looking maybe for 1 day DSO improvement. So most of this is related to the free cash flow and a very capital-light business model. Unisys Federal generated a lot of free cash flow. They were very disciplined and careful with the amount of cash that they spend. So we're very happy to inherit a company, and has a similar capital-light model. And we're so focused on cash and cash generation and focus -- that's helpful. Engility was in a similar situation. So it's really the combination of those as well as we do get additional tax assets that come over with the Engility acquisition. That will contribute somewhat to the cash flow, but it's not overly substantial there. So it's really the combination of the acquisitions, the cost synergies the higher margin that but leads to that expansion in cash flow. Now. I would say, Gavin that you do know, since we're talking about cash flow that in the CARES Act, there is this provision that allows companies to defer employer payroll tax deferrals for a year or more. And I think most of our peers have talked about that or it's known that, that's out there. That would all be additional upside to anything that we've talked about here. But that is something you should obviously be aware of, as I'm sure you are. And I know it's a timing issue, but it certainly favorable -- it will be favorable impact for us in this year.

Right. And then with all that cash generation, you obviously delever pretty quickly. So I mean, where do you think you'll be at the end of this year or end of next year? And what leverage level you need to get to before you start thinking about something other than debt paydown?

Yes. I would say, we've looked at getting back in 2 years to that optimal capital structure. We talked about a 2.5x to 3x net leverage. And with this provision in the CARES Act, it will certainly accelerate us delevering, either on a net basis or building up cash on the balance sheet. As previously talked, I think we'll give more guidance and color on that on our June call. But we need to -- our priority is to delever and delever quickly. Before we would look for any other capital allocations, whether it be share repurchases or additional M&A that is our top priority. And until we get into a more comfortable range, it's all focused on reducing and paying down debt.

Got it. And maybe just going back to a much higher level, Charlie. Given all the governments are doing to provide COVID relief, obviously, creating a fairly large deficit. So I mean, longer term, what are your expectations here for both DoD and perhaps some spending, and whether or not they'll have to trim the government budget or areas that you're in to try to help balance that over the medium term?

Yes. We have a lot of discussion of the longer term, the strategic impact of this. Certainly with our Board and Nazzic, and strategic focus. So we're aware of this. We're positioning the company to be in a position of strength, financial strength, strategically sound and in the right areas of those budgets that would perhaps not come under as much pressure as other areas. So we're certainly aware of something where there would be more budget pressures in the coming years. And I don't know if that's 1 year or 2 years, 5 years down the road. I think a lot of it has to do with Presidential elections and 2016's elections and whether deficits do matter to people or not. So at some point, you think that would happen, just the timing of when that pressure would be, it's hard to tell. And so we're just began trying position the company strategically and financially to be in the strongest position that we can be in case something like that does happen. And I think we're in -- I can only say that I'm thrilled where we are as a company, the industry that we're in. How we're able to continue to navigate COVID. And it's just an amazing achievement. These new wins that we've gotten recently. It really feels like the momentum that we had anticipated in our BD efforts is gaining a lot of strength. And we're getting on a role as far as contract wins and new business and recompetes, maintaining those. So we feel like we're in very good shape and we'll continue to get stronger as we go forward.

That's great. Maybe I'll leave it there with one final question, I'll throw back a little bit. Are you still working on the Polaris DAGOR? Is that still an opportunity?

I'm sorry, what -- that was right now?

Yes, that's the Infantry Squad Vehicle.

Yes, yes, yes. We are. Yes, we are still working on that with Polaris. And I know that we -- there's been a number of engineering notes that have come out that we've responded to. And I don't remember when the selection of that is, Shane, do you remember where we are...?

If I recall correctly -- yes, the down-select between the 2 competitors, I think, is scheduled for the mid- to late summer, I believe.

Yes. That's what I was thinking. It was somewhere in that time frame. So yes, there are certain things, and we -- that, on that vehicle side as the Infantry Squad Vehicle, there's an ARV vehicle out there. That's -- I know that we're working on as well. It's Kind of the next generation. We're not looking to do anything even close to what we were doing with AAV or ACV platforms, where we're actually going to manufacture and build these. But we are looking to use engineering capabilities combined with others who have those manufacturing capabilities to be successful. So it's a different business model, but selectively we are going after some of those programs that we think we can be successful on.

Got it. Great. Well, thank you both so much. Really appreciate your time.

Great. Thanks, Gavin, for having us and hope to see you sometime soon. Stay safe, everyone. Okay.

Yes. Thank you very much.