Science Applications International Corporation (NYSE:SAIC) Q4 2024 Earnings Call Transcript

Science Applications International Corporation (NYSE:SAIC) Q4 2024 Earnings Call Transcript March 18, 2024

Science Applications International Corporation misses on earnings expectations. Reported EPS is $0.74 EPS, expectations were $1.44. Science Applications International Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Hello and welcome to the SAIC Fiscal Year 2024 Q4 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. [Operator Instructions] I will now turn the conference over to Joseph DeNardi, Senior Vice President, Investor Relations, Treasurer. Please go ahead.

Joseph DeNardi: Good morning. And thank you for joining SAIC’s fourth quarter fiscal year 2024 earnings call. My name is Joe DeNardi, Senior Vice President of Investor Relations and Treasurer. 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 fourth quarter of fiscal year 2024 that ended February 2, 2024. 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. My prepared remarks this morning will focus on a review of our fourth quarter and full-year results and an update on the implementation of our corporate strategy. Prabu will then discuss our results and outlook in more detail before we take your questions. I am proud of the financial performance we delivered in the quarter as our focus on providing value to customers and a favorable funding environment contributed to our strong revenue growth. For the full-year, we increased pro-forma revenue by over 7%, which highlights the potential of this business to deliver market level rates of profitable growth. While our margin rate and earnings per share were impacted primarily by higher incentive compensation accruals in the quarter, excluding this, we were able to increase EBITDA margins by 50 basis points over last year and free cash flow per share grew by 11%, indicating that our underlying execution remains very strong.

We continue to manage the business in fiscal year ‘25 to maximize EBITDA and free cash flow, while accelerating key investments in portfolio differentiators, market proven business development talent, and upskilling initiatives to drive growth and long-term shareholder value. Relative to the framework we provided last year at our 2023 Investor Day, we now expect fiscal year ‘25 adjusted EBITDA and free cash flow to be higher despite a roughly 20 bps incremental investment to drive profitable growth. We expect this investment to generate returns in fiscal year ‘26 with more meaningful impact in fiscal year ‘27 and beyond. Importantly, we will align incentives appropriately to drive these outcomes which I will discuss in more detail shortly.

Now, I will provide an update on the execution of our corporate strategy since we last spoke. As I discussed on our third quarter earnings call, the leadership team’s focus is on four strategic pivots related to our solutions portfolio, our go-to-market, our culture, and our brand. The ultimate goal of these four pivots is to create a more differentiated, more efficient, and more valuable SAIC in the future by becoming the premier mission systems integrator for the government market with a specific focus on five national imperatives. They are: undersea dominance, border of the future, citizen experience, all-domain warfighting, and next-generation space. All four pivots will contribute to our success in these areas, and we have made strong progress against each in recent months.

On brand, we recently hired a new Chief Communications Officer and SAIC’s first Chief Marketing Officer with a focus on ensuring that SAIC’s capabilities are known across our markets and our solutions are effectively packaged for success with our customers. On our portfolio pivot, we have completed the reorganization of our Innovation Factory under our new Chief Innovation Officer, with a focus on scaling and systematically deploying our technical differentiators in secure multi-cloud, digital engineering, operational AI, secure data analytics, and system of systems integration. To support this, we will be increasing our investment in the Innovation Factory in fiscal year ’25, while implementing new performance metrics to ensure we generate our targeted ROIC.

This is important because we have recognized a correlation between higher win probability and year-over-year growth in accounts that leverage our Innovation Factory solutions. Our new enterprise operating model outlines required contract delivery processes, bid rubrics, and performance metrics at the Account and Business Group levels to drive greater accountability and adherence to our strategy. Our expectation is that this investment will deliver increased value to our customer programs and our pipeline opportunities, resulting in sustained organic growth, increasing EBITDA and free cash flow in the coming years. On go-to-market, our focus to this point has been both organizational and operational. Organizationally, we centralized our business development and capture functions and reported them into a Senior Vice President, who directly reports to the Executive Leadership team.

In addition, we are increasing investment in fiscal year ‘25 in our business development teams to upgrade talent where appropriate. Operationally, we have implemented a new enterprise model to leverage our Innovation Factory investments and further standardize our business development and delivery functions across the company. In practice, we expect the result of these efforts to be earlier and more consistent engagement with our customers along the procurement lifecycle, allocating business development dollars disproportionately to our high growth markets, and driving accountability to ensure that pipeline identified is pipeline qualified and bid. On culture, I have spent much of my time over the last several months meeting with senior government customers and our employees.

The strength of SAIC’s commitment to our customer is evident across the enterprise and provides a valuable base off which we can build. Consistent with the investments we are making in our Innovation Factory and business development functions, our pivot around culture will align with positioning SAIC to deliver profitable, differentiated growth over the long-term. We will focus on adopting a one enterprise mindset to encourage the sharing of best practices and talent and cross-functional coordination to bring the best of SAIC to our customers. We will aspire to accelerate our growth — taking ownership of outcomes, driving accountability for results and providing differentiated rewards for outsized achievement. Relative to our incentive design, we recently recommended to our Board of Directors that we increase the relative share of PSUs to RSUs in our equity compensation to encourage our senior leaders to drive our portfolio towards more sustainable and profitable growth vectors.

We have additionally broadened the use of Total Shareholder Return as a metric to ensure we are incenting results that meet or exceed the performance of our peer group. As I started with, the driving force behind these pivots is to position SAIC to maximize profitable, organic growth in the future. We have continued to see a lower than targeted recompete win rate in recent years impacting our BTB. While we have been able to offset this with good new business capture and capitalizing on our large backlog with continued on-contract growth, it’s important that we improve our retention of existing work. While our efforts to standardize best practices across the Enterprise will improve our overall business development and capture functions, we are specifically focused on improving two outcomes: first, retaining our current business by improving our recompete win rate and second increasing our yearly bid rate with more strategic bid selection to drive higher book-to-bill over 1.0. For our current programs, we are implementing new process and rigor in driving innovation and value progression to additional as-a-service offerings.

We are expanding the scope of our customer satisfaction process to gain broader and more objective feedback throughout program delivery. Our improved enterprise processes will allow us to monitor, inform, and influence our bid selections to ensure our portfolio remains on strategy and in our growth vectors. Given the longer procurement cycle inherent in our business, we expect to realize the full impact of our efforts to impact business development results over the next 12 to 18 months. While Prabu will discuss our updated guidance in greater detail, our expectation for FY25 proforma revenue growth is approximately 2.5%. This is notably off of a higher base than previously contemplated and it assumes a still healthy, but more normalized funding environment.

We expect to deliver EBITDA of approximately $690 million with free cash flow per share of approximately $10, which excludes any potential benefit from changes to Section 174 legislation. We are off to a strong start, and I am encouraged by the enthusiasm and cohesion I see across my new leadership team. We have momentum building off three peak performance quarters — the best financial results SAIC has delivered over the last decade. I look forward to seeing many of you in New York on April 11 for our 2024 Investor Day. We plan to provide updated multiyear financial targets, greater detail into our growth strategy, including a showcase of technical differentiators from our Innovation Factory. I’ll now turn the call over to Prabu to discuss our financial results and improved outlook.

Prabu Natarajan: Thank you, Toni, and good morning to everyone on the call. My remarks will focus on our financial results in the quarter and updated guidance. We reported strong fiscal fourth quarter results with revenue of $1.74 billion, an increase of nearly 8% on a pro-forma basis, revenue growth in the quarter was driven by ramp-up on new and existing programs, the timing of certain materials revenue and favorable labor and funding trends which helped offset expected headwinds from program transitions. Adjusted EBITDA margin in the quarter was 7.3%, it was impacted by higher incentive compensation accrual given our strong financial performance. For the year, higher incentive compensation accruals impacted margins by approximately 30 basis points with the 9.3% margin adjusting for this in line with our guidance and reflecting continued strong program performance.

Adjusted diluted earnings per share of $1.43 was in line with expectations. Full-year adjusted diluted earnings per share of $7.88 was ahead of prior guidance when adjusting for the aforementioned incentive compensation accrual, which reduced EPS by $0.34 due to our stronger performance in the fourth quarter and a lower tax rate. Free cash flow adjusted for transaction fees and other costs related to the sale of our supply-chain business was $119 million in the quarter and $486 million for the year as we continue to see good momentum in maintaining our industry-leading rate of cash conversion. As Toni indicated, we delivered an 11% increase in free cash flow per share in FY ’24, representing our third straight year of double-digit pro forma cash flow improvement.

Net bookings of $1.4 billion resulted in a book-to-bill of approximately 0.8 in the quarter and roughly 0.9 on a trailing 12-month basis. Subsequent to the close of the quarter, we were awarded several new bookings, including a $444 million contract with the U.S. Space Force. We remain encouraged by a healthy and growing pipeline of opportunities in the coming years and expect proposal submission volume to increase by at least 25% in FY ’25, consistent with the strategic focus to improve our overall process, including the quality and volume of our submissions. Our pipeline has a healthy mix of larger needle-moving opportunities and strategic pursuits in areas such as ABMS, CJADC2 and Data Analytics and Operational AI, which will leverage our enterprise solutions.

As Toni mentioned, our long-term focus is on building a more differentiated pipeline and capture a greater share of markets, which value differentiated and more profitable outcome-based work. I’ll now discuss our updated guidance for fiscal years 2025 and 2026. We are increasing our fiscal year ’25 revenue guidance to a range of $7.35 billion to $7.5 billion, which represents pro-forma organic growth of approximately 2.5% at the midpoint. This outlook assumes a more typical outlay environment than we saw in FY ’24 and incorporates our expectation for an approximately 4% to 5% headwind from contract transitions spread ratably over the course of the year. Consistent with our comments on the last earnings call, we expect roughly flat to low-single-digit organic growth in the first-half with higher growth rates in the second-half of FY ’25 as we ramp on the strength of our new business wins and see more funding clarity for our customers.

We expect FY ’25 adjusted EBITDA of approximately $690 million at the midpoint of our guidance, as increased revenue and underlying margin improvement are partially offset by an approximately 20 basis points investment predominantly in our Innovation Factory in business development function as Toni discussed. FY ’25 adjusted earnings per share is expected in a range of $8 to $8.20 and assumes an effective tax rate of approximately 23% and further benefits from our share repurchase program. I would note that every 1% of our tax rate impacts earnings per share by approximately $0.10. We are increasing guidance for fiscal year ’25 free cash flow by $10 million to a range of $490 million to $510 million with increased earnings and working capital efficiency, helping to offset higher cash taxes and cash outlays related to FY ’24 incentive compensation.

We expect to deliver approximately $10 and free cash flow per share in FY ’25 and approximately $11 in free cash flow per share in FY ’26. Our outlook for free cash flow does not assume any favorable change related to Section 174 legislation. Should this occur, we would expect the recovery of approximately $125 million from FY ‘23 in FY ‘24 payments already made and our fiscal years ‘25 to ‘27 free cash flow should improve by approximately $45 million, $20 million and $5 million, respectively. Please note that if Section 174 change is enacted our FY ‘25 effective tax rate could be higher than our guidance of approximately 23%. In fiscal year 2024, we deployed $357 million to repurchase $3.3 million in shares, reducing our weighted average share count by a bit over 4% year-over-year.

Over the past three years, we’ve repurchased over 8 million shares, representing about 15% of our total outstanding shares at prices, representing a substantial discount to our intrinsic value. We accomplished this while reaching our target net debt over EBITDA, leverage of approximately 3.0. As reflected on slide 11, our solid cash generation gives us options for additional value creation. For fiscal years 2025 and ’26 at this time. We expect to allocate approximately $600 million to $650 million in total to our repurchase program, while reducing leverage to roughly 2.5 times and remain opportunistic given ongoing budgetary or market dislocations in an uncertain election year. Our perspective on the M&A market is largely unchanged as we prioritize capability-focused acquisitions that can differentiate our portfolio and accelerate the execution of our long-term strategic roadmap.

We believe our bias towards organic initiatives with a discerning eye towards M&A is the correct posture for our long-term shareholders. Lastly, I want to thank our treasury team for their outstanding work in managing the seven-year extension of our Term Loan B, which strengthens our maturity profile and provides us with an improved rate compared to our prior term Loan B. The transaction represented the tightest seven-year loan pricing on a non-investment grade-rated facility in over two years. More importantly, it has generated additional flexibility with respect to our near-term debt maturities and has positioned us to take advantage of potentially lower interest rates in the future. I am proud of the financial performance we delivered in FY ’24 and I’m confident that we can sustain our ability to deliver value for shareholders over the long-term.

I will now turn the call over to the operator to begin Q&A.

Operator: [Operator Instructions] Your first question comes from the line of Seth Seifman with JPMorgan. Your line is open.

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Q&A Session

Seth Seifman: Hey, thanks very much, and good morning.

Prabu Natarajan: Good morning, Seth.

Seth Seifman: I guess a couple of questions, maybe on the investments that you’re making. I guess you guys have talked a lot over time about having kind of a capital-light business model. I know this is CapEx, sorry, this is R&D or other investments that you’re making. It’s not CapEx. But can you talk about kind of the investments that you’re making and how we think about that as being different? Are these are investments in people that you’re making in hiring people or are in developing new technologies, how do we think about what these, these investments are?

Toni Townes-Whitley: Hey, good morning Seth, it’s Toni. Let me start off with that and Prabu will add some color. So we have three flavors of investment that we’re making in the business. First, around our Innovation Factory. We’ve mentioned that we’ve got some differentiators across our enterprise, particularly around AI, our secure data, our digital engineering. The investments we’re making are primarily in people, but also tools and some capabilities that we are looking to expand to ensure that those differentiators when systematically deployed across all our programs can be integrated into our customer environments. So we’ve been able to identify these, we’re making roughly $15 million in investments in this space around the differentiators that we’re going to add more color to on Investor Day to give some demos on how those are actually deployed in the customer environment.

Second, areas in our business development, obviously, we have been focused heavily on not only our ability to bid, higher-volume bidding but also high-quality strategic bid capability for our pipeline as well as our recompete our ability to retain the current business that we have. And we have challenges in both of those areas. So we are investing in upgrading talent in key areas and we’re making a significant investment in business development, what we call capture and solution architecting, which is all around ensuring that we create more value for our customers in existing programs and that we can bid in a systematic, standardized way with higher talent and greater talent in certain areas. And then the third investment is around upskilling, and that’s our ability to deliver our capabilities at our customer sites with individuals that have to evolve with the talent and the expectation that our customers have in terms of the solutions that we’re implementing.

So those are the three fundamental investments that we’re making in the business. And we expect over the next 12 to 18 months that those investments will shore up our bid capability, our win rates, our recompete rates, and overall our customer satisfaction. Prabhu, anything else you’d like to add?

Prabu Natarajan: Thank you, Toni. Good morning, Seth. Appreciate the question. I’m going to zoom out a little bit and a really big picture, Seth, we’re investing about 20 basis points of margin. That’s the $15 million that Toni referred to. We have a chart in our earnings package that shows that operationally, we’re poised to deliver mid-9 margins, 9.5% consistent with the guidance that we previously provided, and the $15 million that Toni refers to effectively brings the midpoint of the new guide down to about 9.3%, which is what we’re communicating this morning. I think you picked up on something else that I think is really important to emphasize. This is operating expense primarily. We are not expecting our capital light model to change fundamentally as a result of these investments.

We are committed to remaining capital light. And I think just as important as making the investment is to ensure that we’re generating an adequate return on the investment. And therefore we are laser focused on delivering good ROIC on the investments we are making right now. And as Toni said, we’re 18 to 24 months out, but we are dialed into ensuring that we are delivering an appropriate return for the investments we’re making. Hopefully that was responsive.

Seth Seifman: Yes, I know, absolutely, absolutely. And then, as a follow-up, maybe, if you could talk a little bit, I mean, I assume the answer is yes, but if you could maybe tell us a little bit about why. I assume increasing bid rate, I assume you feel like you can both increase the bid rate, but also the things that you want to be focused on in terms of priority areas and value added solutions is — it means that I would think you want to be somewhat discriminating about what you bid on. And so the idea of being discriminating and bidding in higher value areas with also increasing the bid rate, how you kind of square that circle.

Toni Townes-Whitley: You’re going to start that and…

Prabu Natarajan: Yes, I’ll take that one first, Seth. Look, I think we’re taking a longer term view of the pipeline to ensure that the pipeline reflects the priority areas we’ve got out there. As you probably observed, we’re holding our top line multi-year guide at the 2% to 4% range, recognizing that we are not chasing calories, but we’re chasing vitamins. Our incentive comp is focused on delivering more EBITDA from the business, as well as generating cash out of the EBITDA we’re delivering. And therefore, I think of this as the right kind of top line for the business that will differentiate this portfolio. And one of the benefits of having a more differentiated portfolio downstream is that you actually improve your incumbency win rates.

Because it is less gladiatorial in that part of the market. And candidly, that’s why I think we’re trying to get the equation calibrated between improving growth rates, which I think is a must, but also making sure that we’re delivering good value for the top line. Toni?

Toni Townes-Whitley: No, I think that’s exactly on point where Prabu is. And acknowledging that we spent some time putting a strategy together to identify specific growth vectors. So when we talk about bid rate, we want to make sure that we talk about strategic bid selection, because that’s also, as Prabu has talked about, correlated with our ability to win a recompete, it’s also about bidding the right work the first time, work that is in fact differentiating that we bring value from the first day of a contract that is let. And so we are looking at, and we quite frankly, historically our bid rate, our bid volume has dropped over the last couple of years. We want to return back to a higher bid volume and not do that at the expense of a win rate. So we’re doing both at the same time and that will be why the investments we’re making now we believe will pay off over the next 12 to 18 months.

Seth Seifman: Great. Thank you very much.

Prabu Natarajan: Great. Thank you.

Toni Townes-Whitley: Thank you, Seth.

Seth Seifman: Sure.

Operator: Your next question comes from the line of Jason Gursky with Citi. Your line is open.

Jason Gursky: Yes. Good morning, everybody. Thanks for taking the question.

Prabu Natarajan: Good morning, Jason.

Jason Gursky: Toni, I was wondering if you could just — and Prabu as well, chime in if you’ve got some thoughts as well, just the postmortems that you’ve done on the recompete losses and what has driven those losses? Have you seen a kind of a common theme? Just trying to understand that this is a pricing issue? Do we have performance issues? Just generally speaking from a broad, [Indiscernible] broke perspective? What’s the lesson learned here?

Toni Townes-Whitley: Yes, look, there are probably about three areas that we have learned going across the various losses. Specifically, and it’s tied to our investments, we want to make sure that we differentiate on our technical proposals when we submit in our solutions and the differentiated offerings that we have. And so we know that we have gotten feedback at times that our technical volumes, our proposals have not been evaluated as positively. And so one area that we have got to make sure is that our solution differentiation is not only clear, but also well presented in the proposals and is systematically part of all things that we bid across our factory. The second area in terms of is making sure that our processes are standard across.

And that means that how we run bid and capture has to be a systematic standardized in the DNA, no compromise approach at the enterprise level, which is why I centralized and put under one, one human, quite frankly, and with direct reporting into the executive team, how we run those with the appropriate forward metrics, not only backward looking, for the appropriate forward-looking performance metrics to really look at the health of our pipeline and understand. Look, I think the last piece is, as we’ve heard, we’ve expanded our understanding of our feedback throughout a program. When we’re delivering a program, you think of a recompete, you win the recompete day one of delivering a contract. And we’ve got to make sure our listening mechanisms are in place across multiple customer sets that we deliver to.

That’s generally not one set of customers. And so we are expanding that to make sure that we’re getting the feedback throughout and that we are training our teams on the ground to add value in every aspect of the contract delivery. Value into as-a-service offerings, value into integrated solutions, increasing capabilities that we’re adding all throughout the contract. That is how you ensure that you are not only the provider for the current business, but that you are the provider for the future business. So we’ve learned in those three areas, and that’s where we’re placing some bets and having some mitigations. Prabu, any other thoughts there?

Prabu Natarajan: That was great, Toni. Jason, here’s the only thing I would add, if you looked at our new business win rates, they are higher than we would expect them to be and the thing that animates that higher win rate is how much more differentiated we are when we are bidding new work. And some of that is natural in an organization with a ton of excitement around new business captures. I think it’s the — how do we replicate that performance across the recompete spectrum. I think that is sort of where we have to have less of an opt-in culture around best practices. We are making a number of changes to bid thresholds, expectations for profit, expectations for differentiation, while we are executing and while we are delivering programs and we do sincerely believe that all of those things will result in higher recompete win rates over time, but recognize that we are doing some really good things on the new business front.