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

Terrific. Welcome you to the third day of the Cowen A&D Conference. We're delighted to have with us for this meeting, SAIC. And from SAIC, we have Nazzic Keene, the CEO; and Prabu Natarajan, CFO. And I don't know, I guess Shane is not on. But anyway, welcome Nazzic, welcome, Prabu. Glad to have you with us.

So to start, you've had very strong bookings this -- in calendar '20. And your LTM book-to-bill at the end of the third quarter was a sector high 2.0, and that was up from 1.2 at year-end fiscal '20 or calendar '19. So to what do you attribute the fact that you seem to have picked up your game in terms of bookings capture?

Thank you, Cai. And it's a pleasure to be here again. I wish I could be with you all in person, maybe next year. But we'll make the best of this media. And just thrilled to welcome Prabu to our team, and I know you'll get a chance to hear from him as well over the course of these next few minutes. So as you noted, Cai, we have been very proud of our book-to-bill this past year. It has really attributed to several things. There's no one dimension. It's been something we've been focused on. So internally, we've been continuing to look at best practices, ensure we have great talent and really strengthen our internal operations around sales and business development. We've also done some work these last couple of years on really refining our strategy and being very focused on what we go after, the customers that we serve, the missions that we support and the investments that also go with that focus. And then, of course, our 2 most recent acquisitions have allowed us greater customer access in some areas that gave us some market access to be able to sell our solutions as well as an expanded solution set, in particular, in modernization -- IT modernization with the Unisys -- recent Unisys Federal acquisition. So all of that comes together, and you layer that on top of what SAIC is known for, that is exceptional customer performance and mission delivery, and those have really been the catalyst for the success that we've seen in our bookings. Now we all know and you know this that bookings and book-to-bills are lumpy. So we're very proud of where we sit today. We've got great momentum coming out of our last fiscal year, going into our next, and we just look to continue in every fashion that we can, strengthening our abilities and bringing forth these great combination of what's driven our success. The good news is much of our wins have been a combination of both recompetes, which protects our backlog as well as some nice new contracts. And they're all relatively long-term contracts; 5, 6, 7 years. So we're in a good position as we go into this next fiscal year.

I was going to start asking you about specific contract or 2, but you mentioned you refined your strategy. Maybe what are the couple of things that you changed from where you were to where you are that you think helped contribute to your success?

Great question. So as you know, it's a journey. What we did the last couple of years is really look at a couple of things. Certainly, we always look to where we believe. Our customers were are to be focusing their investment, their time, the most critical things in whether it's nation's priorities or the mission priorities. And so it's a combination of looking forward and ensuring that we have solutions and wherewithal to be able to deliver those things as well as building on contracts that we have and being able to expand where it makes sense. And so in some cases, we've actually narrowed our focus. So a great example, as you know, you lived with us during the focus and the investments that we were making in platform -- the platform-related missions, and we've elected to take a different view of that particular part of our strategy with a stronger emphasis on modernization, whether it's IT modernization, digital transformation, digital engineering, and of course, a very strong position in the space market. So we look to stay focused in those areas that we believe will be long-term organic growth.

So one of your big successes has been winning 2 of the Ford AMCOM EXPRESS recompetes. I think investors always ask about it. When did the next 2 -- when do you expect those decisions and give us some sense in terms of roughly how large they might be?

Yes. Very, very proud of the team for securing the first 2. That's -- it's a competitive environment out there. But the work that we do for our customer, the critical nature of the missions we support and the incredibly talented team, just really proud of the team being able to deliver the first 2. Now, as you mentioned, we have 2 more to go. And we expect those sometime in the next 4 to 6 to 8 weeks, somewhere in the March time frame is what we're understanding to be the case. And so far, they've executed and stayed relatively close to schedule. So that would be our expectation, sometime by the end of March. I'm not going to share a lot of color on the size. They're bigger than a breadbox. And -- just for competitive reasons. But they're important to us. One is significantly larger than the other, but both are very important to our recompete structure.

So speaking of recompetes, give us some color on your recompete risk for this year. I understand you have only 15% of revenues are up for recompete. What are the largest ones maybe in those recompetes?

Yes, you're exactly right. We have about 15% of our annual revenues up for recompete. We secured a lot of the recompetes this last year. So we do get to go into a position that's a little bit lower than our normal 20%, 25%. That allows us to focus additional resources on new business, which is a great place to be. You're correct. We have about 2. There are several of them, obviously, at different scale. But the 2 largest are one of the NASA programs that's being called AEGIS and a contract in our supply chain portfolio called PVMRO. Both of them, they're about $50 million to $60 million a year. And so it's meaningful, significant but don't have undue risk to the overall portfolio for next year.

Terrific. So Prabu, to get you into the mix. So you come from Northrop. You're very familiar with this kind of business area, you were the CFO. And you were one of the large primes that decided to exit this business. What impact do you see, the trend for large primes to exit the business? What do you think that means for the industry dynamics?

Thanks for having us, Cai. Good morning, everybody. First of all, I have to say I'm really incredibly honored to join SAIC. Really after a careful consideration, I would say it was clear to me that this provided an opportunity to join what I truly believe is a best-in-class government services company and a top-notch management team. As you correctly point out, for some of the primes, I underline some. Services has not been a core strategic focus, and I think you've seen that in recent years through a variety of different transactions. I think what you've also probably seen is that the demand for these assets remained high. There is certainly a thirst in the market for these assets. My sense is consolidation will continue. We're likely to see fewer bigger deals in the near term. And from time to time, you're likely to see more small deals. And I think that trend is going to continue. But it's certainly an exciting time in the industry with some of the consolidation happening. And we tend to think about some of these as sort of accretive to the way we think about executing our portfolio. And there is that dynamic environment that will provide some opportunities for the folks that are here, the incumbents that are settled in their roles, and I think we're looking forward to the next 12, 24 months here.

So you mentioned you think there's going to be more consolidation. I mean, certainly having lived through the large primes consolidation. I once did a chart, I think, there when you had, like, 60 companies went down to 5. It was sort of what it was. But we seem to be along a comparable path here. I mean, you mentioned smaller deals we have, low interest rates. As you look forward, is that a plus for the folks who are there or how should we think about that? Because technology is also moving pretty quickly.

Yes. I'd say on balance, it's a plus. I think the view that the team is taking is it's really important to build differentiation in the portfolio over time. And people tend to think about stroke -- cycle businesses and it's true that the contracts turn in 12 months or more, but the reality is this is a business that is focused on building differentiation over time. So I do think it offers a little bit of an advantage for the folks that are there, have a strategy mapped out, have a pipeline that's aligned with the strategy and know how to go execute it. But it is also going to bring, I think, some level of uncertainty in the way business gets delivered to the customer, whether it's directly to the customer or via a business model change. I think it's going to bring some element of dynamism, I think, to the conversation and I think we're really excited about what's going on. And as I said, demand has remained high for these assets. Investors see valuated, especially in a low interest rate environment. And I think we're thrilled about the prospects for continued success in the area.

So for either one of you, do you think fiscal '22 under a Biden administration will offer a rich bidding environment as '21 did? Why or why not?

So the early days are relatively unchanged, and it's still very early days. So -- but at this juncture, the demand for what we do, the demand for the services we provide is very, very robust. There's always more opportunities than we have resources to pursue. And the governments have appropriated their budgets for this fiscal year and they're moving out. So we feel very good about the position we're in going into this fiscal year. And then we'll continue to navigate as does everybody else as the Biden administration takes hold and starts outlining the priorities. It's a very large addressable market. And as you know, it's a very long sales cycle. So if we begin to see shifts, one direction or the other or we see something ebb and flow. We've got a very diverse portfolio, and we serve basically all aspects of the federal government. And we can pivot or shift as required or as necessary. But at this juncture, the early days are very consistent with what we've seen.

Got it. So one of the things they clearly focus on health care, but he's also asked for $9 billion to kind of update federal IT networks. And I think among some, there's the thinking that there's probably more money in the intel budget to sort of address the cyber hack that we just saw. What do you think those -- I mean, do you see opportunities in those apparent initiatives?

So certainly, in the conversation around cyber, on modernization, on IT modernization or network modernization, all those come together in some form or fashion. We absolutely see opportunity. We see that's -- that really is a critical priority of our federal government across the board. The cyber attacks certainly make us all aware of how important it is to ensure that we've got modernized systems. And then also with the impact of COVID, as we saw last year, the need for people to work from home, work remotely from home, work securely from home also was a call to action on modernization. So we believe there's clearly an opportunity there for us over the course of the next many years. As it relates to the intel community, I would tend to agree. We believe that, that is an opportunity that could get greater focus and greater attention, and we're exceptionally well positioned across the Intelligence Community as we are with space, as an example, where we believe there'll be sustained focus. So I think all of those, Cai, are areas that, again, speaking to our diversification to our strategy that give us a strong position as we look forward. As it relates to health, we do have a small portfolio serving public sector health. But that is an area where -- and I've mentioned this in the past, where we look to drive growth organically or inorganically. But we do believe that's probably an area as well that's going to get incremental spend and an area for us to strengthen our presence at some point.

So that's maybe a launching pad to go back to the strategy question. You mentioned narrowing the focus. I mean -- and going after areas where you're differentiated. So health is one. Any other areas you would increase? And you mentioned kind of deemphasizing platforms a little bit. What about supply chain that looks like a relatively low-margin area? Are there any areas you will put less focus on going forward?

Well, one of the things that Prabu is driving for us and giving us a fresh set of eyes is looking at our portfolio, helping us -- as with any strategy review, helping us understand where are those opportunities of growth that I touched on. And then potentially, what are the opportunities that are -- that have less growth opportunity, either due to market saturation or just by our choice. And so that's the work that we're doing today. We did a small divestiture last year of some international business for that reason. And so we'll continue to look for opportunities to strengthen our portfolio, remain focused on what we believe will be in our long-term best interest. Supply chain, as an example, is a good business for us. It's relatively low risk. It was, obviously, impacted by the COVID situation. It generates strong cash. So it's an important part of our portfolio, certainly of size and scale. So there's no immediate drive to go do anything. But we do -- even internally, as we do organic investments and decide where to put our precious dollars, we look at our portfolio in a different form or fashion. Prabu, do you want to add any color to that?

No, that was really good, Nazzic. I think the best way to characterize it is pick the tool and prioritize it depending on what's best for our shareholders. It is currently an area -- is it inherently an area we want to be in? Can we drive differentiation in the area? And can we protect our incumbency? Those things are critical in the choices we make, and our cost-plus business model allows us to move investment dollars through the portfolio. But we have to make sure that the work we bring is margin accretive to the portfolio as it stands today. I think we just take a longer-term lens to it and be thoughtful in the investment choices we make and the decisions we make as a result.

So Nazzic, you mentioned health care and sort of any other areas you could mention in terms of areas where you would like to maybe expand your capability or presence?

Well, as we look at the future, there's -- health care is certainly an area where, again, through either organic or inorganic means, we believe that we can play a bigger role. In some of the enabling technologies, AI, as an example, would be something that AI is -- does span so much of our portfolio but will span so much of what happens in the future. So that would be an example of a technology-type play, solution-oriented play that could strengthen our capabilities. Again, we have a practice today. It's a strong practice but sometimes you can do something either by greater internal investment or through M&A that really accelerates the position. So those are a couple of examples where one is for market access, the other is for solution access. But it really is an acquisition for us. To Prabu's point, we look to accelerate our existing strategy as well as to drive shareholder value, and we've been pretty disciplined, as you know, in how we think about that.

Absolutely. So your adjusted EBITDA margins have been improving. Do you see further upside over the next couple of years? And what will it take to get there? And is that the way to look at your business? Because, obviously, supply chain, low-capital investment required, but margin dilutive. How should we think about that whole issue?

Yes, good question, Cai. I'd say, clearly, with respect to FY '21, where we ended the year or with respect to our FY '22 guidance, we'll obviously be clearer and more prescriptive in our guidance call towards the end of March. Here is probably what I'd leave you with qualitatively. We do take a longer-term view on operating margin rates. And as I mentioned previously, we need to fund the investments that are critical to our long-term success, our management incentives. And I think I truly believe that incentives for the team have to be aligned in ways that are accretive to shareholder value. And so we are working through the process of ensuring that there's greater alignment of those metrics to the things that drive long-term opportunity. And I would say, in the near term on margin rates, more specifically to your question, given the preponderance of the cost-plus work in the portfolio, I would say near term, the opportunities will be in the continued execution. As Nazzic correctly pointed out, we have a proud legacy of executing well on programs. I would say, near term, the opportunities will be in ensuring that we continue to perform and that we generate the accretion necessary on a margin rate perspective, so we continue to deliver value that way. Over the longer term, I'd say this is a harder puzzle, but I think the preface that I mentioned, which is take the long-term view, make the investments in the right area, cost-plus model affords us the flexibility to be selective in the things that we go after. And I think, importantly, for work that is part of the portfolio but that may be viewed as somewhat less accretive than other work we have, I would just probably leave you with the comment that we're going to be thoughtful about the choices we make, about our bid strategy as long as we want to execute at higher margin rates. But we've got to do it thoughtfully, methodically and make sure that we bring something to the table that doesn't exist today. And so to me, that element of differentiation is critically important. And the pandemic has obviously had an impact on the revenue base for the company, about $250 million, as we mentioned on the Q3 call. There was also about a $35 million impact to our adjusted EBITDA as a result of the pandemic. And at this point, I will caution you that we are continuing to live in the pandemic right now. And while we are all comfortable, we're doing some things that we were perhaps interested to do in March of last year. The reality is we're in the middle of a pandemic, and so we just have to be cautious about the things we do, programs we take on, how we execute and ultimately ensuring that we continue to deliver additional value to our shareholders.

And if raising the issue of being in the pandemic, others have mentioned that there's some -- there have been some short-term margin benefits, lower travel, which we talked about before the meeting, lower travel, lower medical expenses, in some cases, lower paid time off. But I mean, others are mentioning that that's been a benefit, but in some cases, PTO buyback programs. Can you give us any color kind of going forward? How should we think about that, the totality of COVID given that there are some -- there have been some margin benefits?

Yes. I think, Cai, you're right. I think we have seen some margin benefit in -- from some of the factors you mentioned, paid time off, clearly people just working because they're home. [ Flip being ], if you think about group insurance costs, not just for us, for a number of companies, people aren't seeing doctors as often as they used to prior to the pandemic. I think the big question as we launch into '22 is, are these ephemeral? Are people going to learn how to do these things differently if we continue to live in a pandemic? And obviously, we run incredible number of models internally to model out what people do with their choices around health care or travel time and vacation time. And I would say there was a little bit of a tailwind in FY '21 on margin rates as it related to lower costs. And I suspect we'll see a little bit of that in '22. But clearly, I think it's going to depend on the next turn of this pandemic. And obviously, we'll say a little more about this on our March guidance call.