Paul Levi - IR Tony Moraco - CEO John Hartley - EVP and CFO

Edward Caso - Wells Fargo Securities Cai von Rumohr - Cowen & Company Jon Raviv - Citi Amit Singh - Jefferies William Loomis - Stifel

Good day and welcome to the SAIC Fiscal Year 2016 Q1 Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Paul Levi, Investor Relations. Please go ahead, sir.

Good morning. And thank you for joining us for SAIC’s first quarter fiscal year 2016 earnings call. This morning we issued our earnings release and joining me today to discuss our business and financial results are Tony Moraco, our CEO; and John Hartley, our CFO. Today’s call is being webcast at www.investors.saic.com where you'll also find the earnings release and supplemental financial presentation slides to be utilized in conjunction with today’s call. Both of these documents, in addition to our Form 10-Q to be filed soon, should be utilized in evaluating our results and outlook along with the information provided on today's call. Please note we may make forward-looking statements on today’s call that are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from statements made on this call. I refer you to our SEC filings for a discussion of these risks, including the Risk Factors section of our Annual Report on Form 10-K and quarterly reports on Form 10-Q. In addition, the statements represent our views as of today and subsequent events may cause our views to change. We may elect to update the forward-looking statements at some point in the future, but we specifically disclaim any obligation to do so. It's now my pleasure to introduce our CEO, Tony Moraco.

Thank you, Paul, and good morning. In the first quarter of fiscal year 2016, we delivered on our business strategy and shareholder value creation proposition. First quarter revenue of $998 million represents 4% internal revenue growth, adjusted operating margin of 6.0% after excluding acquisition and integration related cost and diluted earnings per share of $0.69. We continue our strong cash flow performance for approximately $29 million of operating cash flows. And we are beginning fiscal year 2016 with a great deal of momentum. Working from appropriate budget in government fiscal year 2015 continues to provide some stability for our customers. We've noticed the modest increase in order activity as demonstrated by the increased amount of bookings this quarter. And as we've communicated in the past, it is difficult to attribute one quarter of activity as representative of the larger market environment. Although early congressional actions and commentary on the government fiscal year 2016 budget reflects some willingness to continue that stability. Our customers remain guarded with their resources. However, we continue to have confidence in our go to market strategy and continue to see demand for the capabilities that SAIC provides. We are off to a good start in fiscal year 2016 from business development perspective with continued execution of our protect, expand and grow strategy. First quarter award activity of just over $1 billion translated to book to bill of 1.0 which is above our historical norm for first quarter contract award. Notable bookings include the Protect wards of NAVC's fleet forces deployment training contract and extension of our work supporting Toyota Motor, North America as well as the expand award of the next phase of the . Marine Corps Assault Amphibious and Vehicles contracts. In the quarter, we are also successful on a few notable IDIQ vehicle award but do not contribute to the booking immediately but position the company well for future task order basement efforts. For the protect category, we were successful on our recompete of the Prime Vendor Maintenance Repair and Operation or PVMRO, Southwest region work for the defense logistics agency as part of our supply chain management portfolio. This $165 million win under the C40 vehicle allows us to continue our efforts to add value of the customers look to reduce total maintenance and repair cost to the military services. Additionally, under the expand category, we were awarded a $425 million single award IDIQ contract by the Federal Aviation Administration, provide a wide range of train services to FAA air traffic controllers. Under the scope of the contract, SAIC will provide support services to the FAA academy and air traffic control facilities to help the FAA fulfill controller training requirement. This is a great example of new business secured by leveraging our training and simulation capabilities to an existing customer. SAIC total contract backlog at the end of the first quarter stood at $6.2 billion of which funded backlog is $1.8 billion. The estimated value of our submitted proposal awaiting award is $13.3 billion, up from $12.7 billion at the end of the fourth quarter. As you can see even with the quarter of significant contract awards, we continue to expand our business opportunities and increase our proposals of waiting award decisions. Before I turn over to John, let me give you an update on the acquisition of Scitor which we closed on May 4 at the beginning of our second quarter. We've been very busy with integration planning that began shortly after we announced the acquisition in March. Those activities are now being executed in order to ensure an orderly transition into SAIC. Along with several members of the senior management team of both companies, I visited several Scitor locations to meet Scitor employees and customers. A level of talent of Scitor employees validated by their customers only reinforces our conviction that we've joined forces with an outstanding company. As a joint team, we will identify areas to leverage each other's offerings into the expanded market access made available through the acquisition. Due to expected increase of cash flow generation from Scitor, I'm pleased to announce that SAIC has increased our quarterly dividend by about 11% to $0.31 a share. This increase reflects our commitment to continue disciplined capital deployment for shareholder value creation. John, over to you to discuss our financial results.

Thank you, Tony and good morning everyone. Consistent with my remarks in prior calls, my comments today will exclude the minor amount of revenues and cost performed by our former parent. First quarter revenues of $998 million reflect 4% internal growth as compared to the first quarter of last year. This is our third straight quarter of year-over-year revenue growth and is in line with our belief that we can achieve annual internal revenue growth in the low single-digits on average and overtime. First quarter revenue growth was largely due to increased DoD material and subcontract revenues on new find contract award and increased material volume on supply chain contract. Operating income of $57 million in the first quarter resulted in an operating margin of 5.7%, and was negatively impacted by $3 million of Scitor acquisition cost. So that if excluded would have resulted in adjusted operating margin of 6%. We do expect a heavier amount of acquisition and integration related cost to be reported in the second quarter and estimate that these costs will total approximately $50 million for the first half of fiscal 2016. We do not expect any significant acquisition and integration cost thereafter. Net income for the first quarter was $33 million and diluted earnings per share were $0.69 for the quarter. However, the first quarter acquisition cost negatively impacted earnings per share by approximately $0.04.Our income tax rate for the quarter was in line with our normative rate of about 38%. Moving on to cash and cash flows, in the first quarter we had cash flow from operations of $29 million and had an ending cash balance of $295 million. Subsequent to the end of the quarter, we utilized $157 million of cash on hand to partially fund Scitor acquisition and as previously communicated we entered into new credit agreement to fund the remaining $670 million of purchase price and related transaction costs. After the execution of this new credit agreement, our total debt is approximately $1.2 billion equating to a leverage ratio of about 3.6x debt to adjusted EBITDA and carries in overall interest rate of just under 5%. Our day sales outstanding were 51 days at the end of the first quarter which is an improvement from the fourth quarter by one day contributing about $10 million of additional cash flows. I continued to be pleased with our cash flow performance and attribute it to our cash flow acceleration effort and dedication of our team on one of our tenet for shareholder value creation. While we continue to strive keep DSO at or below our current level, as I conveyed last quarter, we expect DSO to return to a more normative level in the mid 50 day range. Capital expenditure for the quarter was only $1 million which is relatively light for our business, but we continue the expectation of about 0.5% of revenue annually. In the area of capital deployment, today we announced an increase of $0.03 per share in our recurring quarterly dividend for about an 11% increase over the previous amount. In light of the additional annual $50 million to $60 million of free cash flow expected from the Scitor acquisition, our Board of Directors took this action to further shareholder value creation. This quarterly cash dividend of $0.31 per share is payable on July 30 to shareholder of record on July 15. Let me conclude my remarks by giving few an update on our long-term financial target. Our previously communicated targets remain largely intact and are relatively unaffected as a result of the acquisition of Scitor. However, let me address each of our communicated targets which we expect to achieve on average and overtime. First, we continue to expect low single digit annual internal revenue growth. We expect to be added intelligence community portfolio which represents approximately 11% of our annual revenue to grow in a mid single digit and this solidifies our confident in achieving our revenue target on a consolidated basis. Second, we remain committed to 10 to 20 basis points of annual profitability improvement again on average and overtime. We are still working through the purchase price accounting process but assuming that approximately 30% of the Scitor purchase prices will be allocated to intangible, this would result in about $25 million of annual amortization. Considering that and inclusive of Scitor we believe that adjusted operating margin of our acquisition costs would start in the 6% range and adjusted EBITDA would be in the 7% range considering Scitor's EBITDA above 9%. These are the starting point for the 10 to 20 basis points of improvement in both op margin and EBITDA will increase in corresponding manners. Third, we intend to continue the return of capital and excess of operating need in our minimum average cash balance is unchanged at $150 million. We remain committed to all recurring quarterly dividend and anticipate using excess cash for the next 12 to 18 months to repay debt until a more optimal debt to EBITDA level is achieved. This brings me to leverage which is the fourth and final target. We've communicated that we desired to operate with leverage appropriate for SAIC investment requirement and cash generating characteristics. This remains unchanged and we currently believe our optimal leverage ratio is between 2.5x and 3x debt to adjusted EBITDA which subsequent to the acquisition stands at about 3.6x. We anticipate we will have additional capital deployment flexibility after the recurring dividend and debt repayment and will look at other capital deployment actions to maximize shareholder value creation with these excess cash flows. Tony, back over to you for concluding remarks.

Thanks, John. Last week we held our annual stockholder meeting and all three proposals outlined our proxy statements were overwhelmingly approved by our stockholders. Thanks to all who participated in the process. I'd like to once again welcome Scitor employees to the company and convey my appreciation to all SAIC employees for your dedication to our customers. Operator, we are no ready to take your questions.

[Operator Instructions] We will go first to Edward Caso with Wells Fargo Securities.

Hi, good morning. Just checking a couple of numbers here. Can you repeat what your target margins were? You mentioned two different ones.

Yes. So we believe once you consider the amortization which we are trying to still figure out exactly what the intangible valuation will be, we maybe a little conservative in that regard but we have to see-- is obviously doesn't affect cash flow. But we believe we would be starting in op margin if indeed that $25 million on intangible amortization a year is correct. That would start and about 6% op margin range. It would also mean we be in about 7% EBITDA, adjusted EBITDA range once adding in Scitor's 9 plus percent EBITDA to our call it 6.7% EBITDA that you see last year. So since it is only 11% of the portfolio it moves it up but only by those 30 basis points.

The second clarification is that the Scitor cost you said -- did you say $50 million in the first half or $50 million in the second quarter?

$50 million for the first half so that would be about $12 million for the second quarter once you subtract the three out.

And my last question is on the pace of pricing pressure commoditization in your various markets mostly DoD versus civil. Can you give us some sense where you are continuing to see pressure and where -- maybe where you are not? Thanks.

Sure, Ed. This is Tony. Yes, I think the pricing pressure is continued to be somewhat stable over the last year or two. The DoD I think collectively we've seen industry moves their indirect rate structures down to the very competitive range has been passed on to the customers. So I think that we've also seen a bit of the LPTA low price technically acceptable behaviors. I probably comment back from where they maxed out say year or two ago, I believe that the customers in some cases have actually realized the negative impact of buying too low or mission and service delivery. So I think the pricing pressures will continue, characterize as distinct competitive that the customers behavior are at a new budget norm I think they've all been rational about getting to their new budget numbers. We will see how the future plays out with the next government budget. CR is probably likely continuing resolution, sequestration probably in some fashion but in collectively we will see this continuation where we've been, maybe a bit of hesitation in government Q1 as they reconcile 2016 budget for them. But overall I think our business collectively will continue as we've done solid submits going forward. We've plenty in the pipeline anticipating contract reward and as the price pressure will this be pretty static as they've been. Feds have been very similar. They are out in front on the cost basis but we aren't seen any major swings in pricing behaviors nor we've seen any major swings in margins affiliated with the contracts and contract fees as a part of the change.

And maybe I can stick one more in and updated on the NASA contract?

Still in customer evaluation, expect a decision as they have messaged sometime this summer, over the next couple of months, that's all we know at this time.

We will go next to Cai von Rumohr with Cowen.

Yes, thank you very much. So first could you give us some color on the $2 million negative VAC in the quarter?

You'll need to be a little more specific, you mean just the $2 million loss that we recognized on the contract?

Yes. Yes.

That just on a fixed price contract. It is more of a development type contract with the army and it is just we were having some trouble, it is only about $3 million contract so it is not a huge contract, we don't expect that to continue to leak on us. So we think we are in a good spot but it is something that we had to accrue for and correct for.

Okay. And then to follow up on Ed's line of questioning. Maybe give us first the status of where we are on the army hit contract and secondly on the FAA award, what's the expected ramp on that?

Yes, Cai, it is Tony. Good morning. Army hit also is in customer evaluation. We have a GAAO this mid to pre award process that was the recent round of the reconsideration but the proposals are in. The Corps of Engineers are evaluating that and again we expect a determination subsequent award over the next couple of months to June- July timeframe is what they message. So we are anxiously waiting that. On the FAA front, it is an IDIQ single award; we did get an initial contract award to start the transition activities. It runs probably this year in the $20 million range as it gears up through H2, there are second half of year, that run rate probably in the $70 million to $80 million range when it is a full up and running as the subsequent task orders get awarded through this transition period. So that would be the run rate if you will in FY17 for future.

Okay. And then just a clarification. Does your operating margin guidance of 6% also still assume that core SAIC is achieving 10 to 20 basis points of margin improvement?

Yes. It does. On average it is flattish to slightly up is what we believe but yes we are continuing to strive to achieve that 10 to 20 basis points.

We will go next to Jon Raviv with Citi.

Hi, good morning, guys. Thanks for taking the question. Question about leverage and long-term guidance or long-term target of being in line with investment requirements. What would cause you to move away from that 2.5x to 3x and how much more leverage perhaps could you take on if you saw a compelling investment case out there especially as other properties seem to be coming to the market?

Sure. And this is John Hartley. As you can see going to 3.6x certainly was very comfortable for us with very favorable interest rate. So that was really not a stretch for us. We could push that even a little more. We wanted to be disciplined and paying down that debt but we won't hesitate to taking a right back up if the right opportunity comes along. But again we are not an acquisition machine, we will be selective, it will be strategic acquisitions when we decide to do them. And they will fit, they will fill market gap that we believe that it is pass through the market and better investment to buy away into those markets versus investing internally.

Understood. And on book-to-bill, in your mind what's driving one time? Is it underlying market or is it more SAIC specific or SAIC excellence on the protect, expand, grow? And how should we think about that going forward in light of I think a target that you suggested for the year of one time. So you still expect a strong fiscal 3Q so that's an upside to that one time for the year?

This is Tony. I think the one time is a good parameter based on the budget environment and the decisions. I think we've had a good result in sustaining to submit penning award profile and that's above the $30 billion range. So those year or two in the queue already plus their continuation of its budget, we think the realization of the protect, expand and grow where we emphasize protecting our incumbent positions but on the expand side in particular I think posting acceleration and leverage have been able to submit as prime on such bit like FAA where the service line and customers who comes together to deliver a broader services to customers we know. I think it is a fundamental part of the strategy and great confidence in our ability to seek our competitive award. I believe the competitive rates are still in line, don't see that moving off the normative range. So I think we are in a good spot with the submits, would expect to book-to-bill again to hover around that 1.0, recall we are still a fairly large, very large IDIQ portfolio to the past quarter, our churn is there that replenished on a recurring basis. But we still have a number of very large single award or contract award non IDIQ awards in the pipeline. And that gives us confidence it is cyclical and subject to these awards as we just talk about things like HHPC and hits programs such as those will have an impact on quarterly basis. But overall on average I think 1.0 is practical to look forward, I am very proud of the quarter-to-quarter growth, top line given our industry perspective we feel that we are in a strong position in a positive to flat where the others are seeing much more contraction in the market place.

And that is my last one is relatively high level. But how important from your perspective is scale in your business perhaps as it pertains to driving direct labor rates or being better at capturing. And from your perspective is a $4.5 billion, $4.6 billion business rate scale in this order, is that really not the right way to think about it?

No. I think scale is very important. I've talked to lot of the folks in the market, and scale affords us the opportunity to have a level set on our indirect rate, industry collectively I think is got to their new normal on rate structures so we are seeing that I think realized in the fee and profitability performance as the new rates are being work through contracts. The scale afford is kind of dampens any volatility of your rate structure but there is no cost on those larger base, I think at this level it gives us diversity within the collective federal contracting space. And having billion dollar portfolios in some of the key market in the army, navy that too also they add scale on their own right. And so those businesses can operate with the right level of resources to build a pipeline and execute effectively. And it drives that capture and so I think they had scaled themselves, provide good optics on decision making to sustain revenues that we've seen and the collectively as an enterprise of $4.5 billion we can make the trade at the enterprise level, we continued investment in staff, investment in pipeline, develop this particular solutions and use their collective scale on a rate basis to provide a balance of investment and profitability and cash flows. I think those that $1 billion or less or up $2 billion are seeking scale, I think you will continue to see businesses trying to line a portfolio accordingly.

Understood. And I am sorry it is my very last one. Just on cash flow. I realized 1Q is typically soft. What grows cash flow going forward excluding Scitor just in light of what seemed like a relatively low run rate in the quarter?

Our run rate in the quarter, you are saying with light compared to what we be for the year?

Yes. I mean actually on the last call I think we've talked a little bit about perhaps $200 million for the year at Scitor, apologies if I am pulling that number out of thin air.

No, no, you are not. So our first quarter is normally our softest cash flow quarter, that's when we pay our cash bonus. That's when we have an extra payroll. So every other quarter has an extra payroll and it is sort 7 versus 6. We would have planned normally for Q1 to be cash flow negative on the operating side to the tune of $20 million to $30 million. And so coming in at nearly $30 million of positive cash flow, we exceeded our expectations by pushing $50 million.

We will go next to Jason Kupferberg with Jefferies.

Hi, guys. This is Amit Singh for Jason Kupferberg. So just want to start off with fiscal 2016. You guys have previously spoken about expecting slightly positive organic revenue growth in fiscal 2016. Now this quarter you guys grew around 4% year-over-year internally and then last three quarters you guys have witness increase in tier volume on supply chain contract and then book-to-bill has been strong and the overall market seems to be, if not increasing it is pretty stable. So is mid single digit organic revenue growth in fiscal 2016 more of a better way to look at your revenue this year.

So I would say that is achievable. It is a flattish to perhaps slightly up year for us. We will see supply chain, we expect to be coming down so that will provide some headwind that we need to overcome, but we are hopeful that contracts like FAA and hopefully some of these protests coming out will help us get back so that we are flat to slightly up. Scitor bring them on certainly helps that low single digit which will have them on for three quarters. So we do and we still believe that low single digit is achievable for this whole fiscal year and that we accelerated some supply chain revenue that will fall off later in the year in the first quarter.

All right, great. And then just staying on Scitor, can you guys provide a little bit more information on its contribution to your top line and EPS in fiscal 2016?

Sure. I think we disclosed in our announcement back in March that they were in the 600 plus range on revenue like we said they are growing slightly faster than we are. So you can extrapolate that so that's about you know it turns into about 600 plus to our top line. And did you ask about the bottom line?

Yes. Thank you.

Yes. And they run a much higher EBITDA than we do which you would expect for the type of work they are providing much higher value add versus being a pure prime in a number of cases and so they do run north of 9% EBITDA compared to our mid 6% to high 6% EBITDA.

All right, perfect. And just one last one. You talked about contribution to free cash flow of $50 million - $60 million from Scitor. But on your organic free cash flow, I mean even though 1Q was strong I believe you are expecting your DSOs to increase from 51 to mid 50s during the year. So is $200 million plus organic operating cash flow for fiscal 2016 still the right target or is there an update there?

So when you say organic you mean ex Scitor

Ex Scitor, yes.

Yes. So this year we were and again when we talked $200 million of op income it is on average and overtime, we greatly exceeded that last year because of our DSO. If our DSO slipped back we would probably organically be just a little north of $200 million. But again we are going to try very hard to keep the DSOs where they are if we are able to. So certainly north of $200 million with Scitor in including also don't forget the transaction and integration cost that will be coming out above $200 million with three quarters of Scitor is certainly achievable.

We will go next to William Loomis with Stifel.

Hi, good morning. You talked about the margin -- I mean the supply chain work having higher material subcontract work and pulling work ahead but when I look at the gross margin and the adjusted operating margin, it didn't show a decline really from a year ago about the same. What was the nature of that? Was it just -- is it the rest of your business that much more profitable or why didn't we see the lower margins with those higher material.

Yes. What we see in the supply chain is when you have incremental materials coming through those tend to be profitable. If you look at the whole portfolio it brings down the total but each incremental makes all of it more profitable. So it is definitely volume driven and so the more volume the more you can spread your fixed cost over. So you won't necessarily see a supply chain really grew fast. You won't see pulled down the margins overall.

Okay. And what's in terms of the supply chain coming down and revenues this year? What was -- what's the rational for that? I mean when you are looking at what the customers are doing is there some change in the business other than the pulling in the first quarter on some of the material?

It is really just try to the op tempo of what get delivered in theater, what's going on in operations. Based on really just the demand signal coming from customers so trans logistics agencies, principal cost that drives through just a buying habits and could be tied to the training activities locally could be tied to deployment that weren’t anticipated. We saw some of that surge in Q4 as we looked at some of the [Ebola] and other services. So there is some incremental changes but overall I think we are kind of this new norm and that $0.5 billion range of where we are seeing can steady flow. The market itself in that area continues to be on a commodity driven basis in some cases. And we are trying to also avoid some of those businesses through reverse auction or others that drive those margins even further down. So we are trying to stay balanced in providing a value proposition it is there. But overall it is fairly steady driven in part by op tempo of the supply side for the group DLA services.

Yes, just one clarification as well on that. That does provide us additional visibility. The PVMRO that you heard we just won the Southwest region, all of those region I think it is 6 or 7 are out for recompete. We have lost at least one of those, so that will provide some downward pressure as we go through these reverse auction, some people are buying into this, we don't think we ultimately make money at it but that's their choice. And so that does provide some headwinds that we are going to have to fill and we are going to try to fill them at SAIC overall with our system integration type contracts that are coming on with FAAV and others.

Okay. And then just staying along the recompete line. What are some of the other major recompete over the next 12 to 18 months both you and Scitor?

Well, good news is there aren't too many at a large scale. There are few if any at our top 15, 20 this year that are up for recompete. We are in constant recompete on the flow of task orders inside the contract vehicles. But I don't think there are any substantial recompete in 2016, FY16 that will have an effect on this year's results. We will see how it plays out next year there is a couple. Next year with NASA and a few others but none that are material in this current year that we are -- that either out there or pending except for summer supply chain work that John just mentioned on some of the recompete well in through the system.

And that Scitor also?

Scitor is pretty stable, no major recompete; their largest contracts have still a couple of years of period of performance on them. So we don't see any particular pressures near term on large on contracts to recompete on the Scitor side.

Okay. And then just one final one, I saw your extension on the Toyota contract. Any -- I mean do you have any other efforts? I know you have that one but any other efforts on to commercial side?

No, non material right now. You know that's recompete of our portfolio position that we had. It facilitates some of our IT managed services portfolio. It is very diverse portfolio in our help desk and systems are security operations, network operations type services so no there is no substantial pursuit in the commercial arena.

At this time, we'll turn the conference back over to today's speakers.

Thank you very much. I'd like to thank you all for your interest in SAIC and participating in today's call. Have a good day.

This does conclude today's conference. Thank you for your participation.