Science Applications International Corporation (NYSE:SAIC) Q3 2024 Earnings Call Transcript

Science Applications International Corporation (NYSE:SAIC) Q3 2024 Earnings Call Transcript December 4, 2023

Science Applications International Corporation beats earnings expectations. Reported EPS is $1.74, expectations were $1.66.

Operator: Good morning. My name is Krista, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the SAIC Fiscal Year 2024 Third Quarter Earnings Conference Call [Operator Instructions]. I would now like to turn the conference over to Joe DeNardi, Vice President of Investor Relations. Joe, you may begin.

Joe DeNardi: Good morning. And thank you for joining SAIC’s third quarter fiscal year 2024 earnings call. My name is Joe DeNardi, Vice President of Investor Relations and Strategic Ventures, and joining me today to discuss our business and financial results are Toni Townes-Whitley, our Chief Executive Officer; and Prabu Natarajan, our Chief Financial Officer. Today, we will discuss our results for the third quarter of fiscal year 2024 that ended August 4, 2023. Earlier this morning, we issued our earnings release, which can be found at investors.saic.com where you will also find supplemental financial presentation slides to be utilized in conjunction with today’s call and a copy of management’s prepared remarks. These documents, in addition to our Form 10-Q to be filed later today, should be utilized in evaluating our results and outlook along with 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. 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. In addition, we will discuss non-GAAP financial measures and other metrics, which we believe provide useful information for investors. And both our press release and supplemental financial presentation slides include reconciliations to the most comparable GAAP measures.

The non-GAAP measures should be considered in addition to and not a substitute for financial measures in accordance with GAAP. It is now my pleasure to introduce our CEO, Toni Townes-Whitley.

Toni Townes-Whitley: Thank you, Joe, and good morning to everyone on our call. I want to start by thanking my colleagues at SAIC for the warm welcome I’ve received over the past several months and for their level of engagement and enthusiasm towards creating the very best future we can for SAIC. In particular, I want to express my appreciation to Nazzic. The strength of our culture, our commitment to inclusivity and the focus on our customers’ missions are true differentiators for our company and they exist in large part because of Nazzic’s efforts in recent years. And as I’ve already discussed with many of you, SAIC’s progress during her tenure has set the table for this leadership team to do exceptional things for our employees, customers and shareholders.

I’ve spent much of my time since becoming CEO, listening and learning and then forming and testing certain hypotheses to solidify a growth strategy for the company going forward. While this process will continue, I want to share some early observations related to four strategic pivots our leadership team is focused on, specifically our solutions portfolio, our go-to-market, our culture and our brand. Since my announcement as CEO, I’ve come to understand the value of SAIC’s brand. Over the past five months, I’ve received congratulatory phone calls from senior government, military and business leaders as well as SAIC alumni, many characterized SAIC as a national asset, and informed me of the company’s deep legacy of tackling complex, large scale national security challenges.

As the threats and opportunities for our country have evolved over the decades and will continue to, we at SAIC must ensure that our customers appreciate the breadth of our capabilities so that we can capitalize on the value of our brand. On culture, we will operationalize an enterprise-first mindset while driving a stronger sense of entrepreneurial execution. While we’re still finalizing how best to implement our plan, I would expect it to include additional changes to the design and execution of our incentive compensation model to further a culture of accountability and align our objectives with shareholder value. On innovation and solutions, I believe the capital light business model we have committed to is the right one. However, this increases the importance to SAIC of differentiating itself in the market with the best solutions, solving for where our customers are today and where they will be in the future.

We must ensure that our portfolio is mission relevant, scalable, differentiated and aligned with our strategy to drive sustainable organic growth in our key markets. This view drove the decision to hire Lauren Knausenberger as SAIC’s first Chief Innovation Officer, where Lauren will be responsible for operating our innovation factories, managing our technology roadmap and ensuring that the investments we make maximize differentiation and long term value. Lauren joins SAIC from the United States Air Force where she served as the Department CIO. This role combined with prior commercial and private equity experience makes Lauren a true triple threat and I am thrilled to have her on our team. In my first month as CEO, I have been impressed by the degree to which our innovation factories differentiate SAIC in the market as evidenced by specific customer feedback on competitive procurements in recent years.

I am confident that under Lauren’s leadership, SAIC can further develop our portfolio of solutions and increase pull through of these differentiators across our business lines. On go-to-market, I see opportunities across the lifespan of business development and capture from early stage shaping through leveraging of our factory differentiators to premium proposal submission and impactful customer program execution. In order to prioritize the quality and pace at which we execute these opportunities, we will be establishing a new enterprise business development function, responsible for standardizing and optimizing our go-to-market strategy across our sectors. This function will be centralized and report into our new EVP of Enterprise Operations, Tim Torito, who previously led the creation of the Microsoft federal entity and their business development and capture organization.

Tim will be responsible for instituting enterprise guardrails to drive greater rigor in our sales and delivery processes in conjunction with our sector leaders. Given the audience, I will provide my initial perspective on what all of this means for our financial strategy and performance in the coming years. I believe the framework that was provided at our April Investor Day is appropriate and one that I support. However, as Prabu has mentioned previously, our internal aspiration is to do better. We, as a leadership team, are aligned with the goal to establish a new normal for SAIC’s sustainable organic growth rate above the 2% to 4% framework we provided in April, while delivering increased earnings and free cash flow. We will share more detail as to how and when we get there at our 2024 Investor Day, but it will be a multi-horizon approach with an initial focus on enterprise wide mechanisms and processes to drive improved business development and capture execution, as well as an increased focus on quantifying, targeting and prosecuting on contract growth.

Finally, on my view of M&A, it is my belief that in order to be an effective acquirer and create true long term shareholder value, a company must have a proven track record of maximizing organic growth from its own portfolio. As we demonstrate success against this goal going forward, our capital deployment philosophy remains open to additional M&A and with a healthy skepticism towards larger transactions and a focus on shoring up our solutions portfolio with new technology as well as maximizing long term returns. I am incredibly excited to be a part of the SAIC leadership team, and I take great pride in the opportunity to lead such a storied company. I now turn the call over to Prabu to discuss our financial results and updated outlook.

Prabu Natarajan: Thank you, and welcome, Toni, and good morning to everyone on the call. Let me start by saying how excited we all are to have you leading the team. Your vision for SAIC, your experience and strong leadership skills will no doubt contribute to a stronger SAIC for all our stakeholders. Now on to a review of our performance and increased guidance. We reported strong fiscal third quarter results with revenue of $1.90 billion, an increase of nearly 11% when excluding FSA and supply chain revenue from the prior year. Revenue growth in the quarter was driven primarily by the ramp-up of work on new and existing programs, improved labor productivity and favorable timing of material sales. I am very proud of the focus our team has shown in recent quarters to deliver value to our customers and exceed the commitments made to our investors.

Adjusted EBITDA margin in the quarter was 9.4%, an increase of 50 basis points year-over-year driven by strong program performance, the impact of our previously discussed portfolio actions and cost efficiency initiatives. Adjusted diluted earnings per share of $2.27 represents an increase of 19% year-over-year, driven primarily by the strong operating performance in the quarter, a lower tax rate and a roughly 4% decline in our diluted weighted average share count. Free cash flow adjusted for transaction fees and other costs related to the sale of our supply chain business was $148 million in the quarter and $367 million year-to-date as we continue to see good traction on our working capital improvement efforts. Net bookings of $2.5 billion resulted in a book-to-bill of 1.3x in the quarter and roughly 1x on a trailing 12 month basis.

I’ll now discuss our updated guidance for fiscal year 2024 and increased financial targets for fiscal year 2025 and 2026. We are increasing our FY24 revenue guidance at the midpoint by roughly 2% to a range of $7.325 billion to $7.35 billion, which represents pro forma organic growth of approximately 6%. This increase reflects our stronger operating performance in fiscal third quarter and captures pressures related to previously discussed contract transitions and the potential for a short lived, but disruptive government funding environment. We’re also increasing our FY25 and FY26 targets for revenue to reflect favorable recent momentum while factoring in some degree of risk that budgetary disruptions and our year-to-date outperformance in FY24 may create more challenging year-over-year comparisons in FY25.

We are maintaining our adjusted EBITDA margin guidance for FY24 in a range of 9.3% to 9.4%. However, if our stronger than expected financial performance continues through the remainder of the year, we could see higher incentive compensation accruals in our fiscal fourth quarter, which may result in full year margins at or slightly below the low end of our guidance range. As I have discussed with many of you, aligning our incentive compensation structure with increasing shareholder value has been an important part of our strategy to drive change. Adjusting for these potential costs, we expect our full year EBITDA margin to be within our guidance range for the year. Rewarding strong performance with increasing pay is an important part of our philosophy, and I believe our results year-to-date reflect this.

Rest assured that our Board and executive leadership team is focused on raising the bar going forward so that incentive compensation plays an important role in the evolution of our strategy, which Toni discussed. Notwithstanding this potential for Q4 margin pressure, we continue to expect margins in the mid-9% range in FY25. We are increasing FY24 adjusted EPS guidance to a range of $7.70 to $7.90, driven mainly by improved operating results, lower interest expense and a lower planned effective tax rate. We are maintaining our free cash flow guidance of $460 million to $480 million and the strength of our earnings growth and the robustness of our cash collections provides us with increased confidence in our path to at least $11 per share in FY26.

Importantly, as we’ve communicated, our plan to increase free cash flow per share by approximately 10% annually for the next three years assumes that the company’s cash taxes, excluding Section 174 payments, increase from approximately 0 in FY23 to approximately $100 million in FY26. Notwithstanding this planned increase in cash taxes, we continue to expect double digit free cash flow per share growth in the coming years, driven by strong earnings growth, continued rigor in managing working capital and prudent capital deployment, focused on our share repurchase program and M&A posture informed by capability based tuck-ins. We are encouraged by the strong financial results we’ve delivered in recent quarters. Our updated FY26 targets for revenue and adjusted EBITDA are already 2% higher and adjusted EPS 5% higher than the original targets provided at Investor Day eight months ago, and position us well to create additional value for our shareholders.

With that, I’ll now turn the call back over to Toni.

Toni Townes-Whitley: Thank you, Prabu. Before we begin Q&A, I want to reemphasize how excited I am to be leading SAIC, a company whose combination of mission knowledge, domain expertise and legacy of problem solving is a remarkable national asset. As I mentioned, the table has been set and my focus going forward will be accelerating our growth through strategic pivots in four areas. Our solutions portfolio, go-to-market, culture and brand. Each pivot has the potential to create significant value for our shareholders, customers and employees. Collectively, if well executed, these pivots will position SAIC as a market leader in every dimension. Consistent with our focus on a culture of transparency and accountability, I look forward to sharing updates on key milestones as we progress in the coming quarters and years. Now let’s open the call for Q&A.

See also 25 Most Powerful Countries in the World by Military and Oil and Gas Production by State: Top 15.

Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Jason Gursky from Citi.

Jason Gursky: Let’s see here [Multiple Speakers] a bigger picture question to start. So I’m just kind of curious what you saw coming in here at the outset that gives you confidence in a higher growth outlook for the company, maybe starting with the customer set and the demand signals that you’re seeing, and how you think you’re going to — what you’re seeing and kind of what pockets you’re seeing the demand signals coming in that align well with the solutions that you have and the technology that you have? I just want to get a sense of where you initially saw some of the opportunities here that are giving you some confidence in leaning forward on the growth?

Toni Townes-Whitley: I came in with a hypothesis around four strategic areas, which I mentioned in my prepared comments there. The hypothesis was around our solutions portfolio, our go-to-market strategy, our culture and our brand. And I’ve been testing whether there have been opportunities to accelerate shift or change in any or all of those areas. And let me give you an example in terms of our solutions portfolio where what I’ve learned over the first 60 days here. I have four questions coming in around whether our portfolio was at enterprise scale, whether it was innovative, differentiated and mission relevant, whether in our portfolio, we would be able to evolve our solutions to greater profitability and value for our customers and then finally, were those solutions and differentiators systematically deployed across our various sectors.

Here’s what I’ve learned. I’ve learned that the portfolio is majority at enterprise scale, we have a few gaps to close, that’s been very promising. Recent investments have been made in digital engineering, secure data analytics, operational AI, multilevel security, different forms of technology differentiation combined with the way we deliver in an open systems architecture with various approaches have yielded differentiation and mission relevant integrated solutions. And what’s been most promising is that our customers have cited these solutions in many of our recent bids and recompete efforts. While we understand, I think, the profitability of our solutions within our portfolio, we do have to improve on value creation processes within once we’ve gotten into a contract with the customer, do we know how to increase value, both on the profitability side for our company as well as for the customer itself, and whether our differentiators are systematically deployed across our enterprise, which we still have some room to grow there.

But overall, I’ve been super pleased to find out the resiliency, the robustness of our portfolio and the fact that our customers are now able to identify our differentiators in our bid activity.

Prabu Natarajan: If I can maybe add to the question on growth rates. Look, at Investor Day earlier this year, we shared that the 2% to 4% that we put out there that our internal aspirations are higher. And I think we are demonstrating rather convincingly this year, especially Q2 and Q3 that structurally that we can grow this business at clips that are consistently above that, let’s call it, mid-single digit growth rate. So to me, I think I think our increased confidence is primarily faith in the team that we are actually capable of delivering these growth rates. And we are committing to driving a little bit harder on growth and that’s what you’re hearing in our prepared remarks.

Jason Gursky: And then just a quick follow-up on the balance sheet. Toni, I’d love to just get your initial thoughts on the balance sheet itself and how willing you’re going to be to use it to drive growth? You mentioned M&A in some of your prepared remarks and just curious what your general philosophy is around the balance sheet and leverage metrics?

Toni Townes-Whitley: Listen, I have tried to make it very clear that my perspective, particularly on M&A is that organizations that can show a track record of organic growth with their own portfolio tend to do better over time in terms of being able to identify targets and do successful inorganic activity. And so when I look at the history of SAIC and the various acquisitions it’s done, we are going to be focused in the short term on tightening all forms of our internal processes, making sure our portfolio is fully at enterprise scale and capable with whatever investments are needed to get there, and that would be our priority for the short term. We are open to and we’ll always be open to excellent M&A but a little more skeptical on the large scale at this point more towards our portfolio needs, differentiation, focused on our growth vectors and making sure we’re fully aware of our integration capacity.

So that’s where we are for the short term as we look forward, very focused on organic growth over the next 12 to 24 months.

Operator: Your next question comes from the line of Bert Subin from Stifel.

Bert Subin: So back in April, when you hosted your Investor Day, you highlighted an expectation for $7.60 to $7.80 in earnings next year. You’re already pacing ahead of that range this year and raised your expectation for FY25. It seems partly on better below the line items but also improvement to EBITDA. With your book-to-bill at 0.9 times over the last 12 months, what happens from here to keep the earnings trajectory you’ve been seeing going?

Toni Townes-Whitley: Well, look, we’ve been focused significantly on our book-to-bill, mostly in the context of our business development capture function. As you heard me announce during the prepared comments, we are centralizing that function to an enterprise [BD] capability to make sure that we’re driving more rigor, a standardized process and we get back to the win rates, if you will, recompete and new business win rates that we have had historically. And that’s one of the first organizational structural changes I’ve made to drive, again, more rigor, increase the velocity and volume and quality of our bids and enhance our program execution in that direction. So that’s going to be a specific focus. Look, as we look forward, our expectation is that our growth rate moderates next year based on our view of the market and some elevated headwinds from, as you know, the major recompete losses we’ve discussed previously.

So we’ve got a continued ramp on recent contract wins, which is moving us in the right direction but will not fully offset some of the revenue impact of the recompete losses that materialize in H1 of next year. But even with that said, the combination of the ramp of our current work that we’ve been winning as well as our focus on our business development and capture function with a centralized capability, we feel confident and fairly bullish about our ability to grow next year.

Prabu Natarajan: And Bert, maybe as a follow-up to that on the specific EBITDA and EPS questions from Investor Day, look, we’re performing really well on top line. I think we are demonstrating that we can convert top line into good quality EBITDA, and our conversion rate from EBITDA to cash is best-in-class, I think. And therefore, we are demonstrating we can convert nearly every dollar of EBITDA into a dollar of cash. When you put those three things together in a single year, you get the sort of compelling operating performance that we have delivered this year. Now fast forward, what does this look like next year? I think we’re going to be going back to basics, Q1 of next year and say, here’s what the revenue and EBITDA rhythm looks like for a year or inside of a year within a quarter, and then we have to make sure that we are delivering just as effectively next year as we are delivering this year.