Science Applications International Corp
NASDAQ:SAIC
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Science Applications International Corp
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Good day. And welcome to the SAIC Fiscal Year 2018 Fourth Quarter and Year End Conference Call. Today’s conference is being recorded.
At this time, I would like to turn the conference over to Shane Canestra, SAIC’s Director of Investor Relations. Please go ahead, sir.
Good morning. My name is Shane Canestra, SAIC’s Director of Investor Relations and thank you joining our fourth quarter and full fiscal year 2018 earnings call. Joining me today to discuss our business and financial results are Tony Moraco, SAIC’s Chief Executive Officer; Nazzic Keene, our Chief Operating Officer; Charlie Mathis, our Chief Financial Officer; and other members of our management team.
This morning, we issued our earnings release, which can be found at investors.saic.com where you’ll also find supplemental financial presentation slides to be utilized in conjunction with today’s call. Both of these documents, in addition to our Form 10-K to be filed soon, 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 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.
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.
It is now my pleasure to introduce our CEO, Tony Moraco.
Thank you, Shane, and good morning. SAIC’s fourth quarter results reflect the fundamental execution of our business strategy to position the company for sustain profitable growth. I am pleased with SAIC’s revenue growth in the fourth quarter and margin improvements in the last half of fiscal year 2018.
Nazzic and Charlie provide details on the operational and financial results, but let me provide you with a few highlights of our fourth quarter and our assessment of today’s market environment.
Fourth quarter internal revenue grew by 10.3% as compared to the prior year quarter, primarily due to new business contracts with NASA and Environmental Protection Agency won earlier in the fiscal year and increased volume in our supply chain and U.S. Army portfolios.
Full fiscal year 2018 internal revenue growth was 2.5% in line with our long-term financial targets. I am proud of the revenue growth in the fourth quarter and the full fiscal year that they both have the highest amounts with the respective timeframe since our spin in 2013. SAIC performed well with regards to the fourth quarter profitability, which is typically a lower margin quarter due to holidays and surrounding employee vacation time.
Fourth quarter adjusted EBITDA margins after adjusting for restructuring costs were 7.4%, with full fiscal year margins of 7%. As we have previously reported, fiscal year ‘18 contains several portfolio challenges to margins in the early part of the year, but we took responsible actions that will mitigate these challenges and improve profitability by year end.
Throughout fiscal year 2018, SAIC executed business development activities in alignment with our long-term market strategy, Ingenuity 2025 and positions the company well for sustained profitable growth.
With the fourth quarter book-to-bill of 0.5 and what is typically a seasonably low booking quarter, SAIC produced a full fiscal year book-to-bill ratio of 1.5, de-risking several large protect or recompete customer contracts, while winning several expand and grow opportunities that enable future revenue growth.
We continue to be encouraged by the demand signals from our customer base, with a strong pipeline of contract opportunities and $15 billion of submitted proposal value, an amount consistent with the end of the third quarter.
Turning to the market environment, we now have federal government fiscal year 2018 budget appropriations and a two-year budget agreement that also adjusted budget caps for the following fiscal year.
These actions provide our customers with more budget certainty to execute their mission priorities and plan for the future, With increases to both defense and better than expected federal civilian budgets, SAIC’s balance and diversified portfolio is well-positioned to help a broad array of customers.
Our customers are looking to companies such as SAIC to help infuse technologies to replace aging infrastructure and provide innovative solutions to meet ever increasing challenges. In several areas particularly our defense and national security portfolios, our customers are placing an increasing priority on accelerating the delivery of mission capabilities.
With strategic intent to maintain and in some areas regain our technological superiority our military forces are investing in areas such as modernization and readiness, looking to deploy capabilities faster through innovative and mature existing technologies. The desire to adopt existing technologies and thus reduce the time to deploy aligns well with two tenants of our long-term market strategy.
First, our emphasis on our repeatable solutions helps our customers accelerate the fielding of mission critical capabilities, but also allows them to do so with the confidence of deploying proven solutions. With an increasing focus by our customers to modernize their infrastructure, SAIC provides an effective channel to implement commercially available technologies.
Secondly, SAIC’s approach to platform integration directly aligns with our customer’s desire to adopt non-developmental items as a critical part of their acquisition strategy. As evidenced by our platform integration strategy, we are responding to our customer’s desire to innovate faster through integrating existing hardware and technologies from broad global supplier base to provide a complete system solution and a reduced timeframe.
Our focus on many mission areas that we expect will benefit from customer budget increases give us confidence in the low single-digit internal revenue growth and our long-term outlook. SAIC’s broad customer market access and a range of solutions for training and simulation, military modernization and readiness, and IT modernization and cybersecurity enhance the possibility to outperform should there be an increased pace of contract decisions and enactment of acquisition reforms.
We also expect to achieve our margin improvement and cash flow goals as realized the benefits of our restructuring efforts, mitigate conversions to costs reimbursable type contracts and balance our investments for growth.
SAIC is confident in our ability to achieve sustained profitable growth through organically driven efforts, as well as the potential for M&A transactions in a consolidated market. Overall, the current market environment aligns very well to our long-term strategy, so we can achieve our financial targets and continue to provide long-term shareholder value creation.
Nazzic over to you for discussion of our business operations.
Thank you, Tony. Contract award activity in the fourth quarter led to bookings of $610 million, which translates to a book-to-bill of 0.5 for the quarter. For the full year, SAIC delivered a book-to-bill ratio of 1.5, a strong leading indicator of revenue growth, as we look to fiscal year ‘19 and beyond.
Fourth quarter bookings included the recompete or protect win of $57 million for continued support of our U.S. Navy SPAWAR customer to provide command, control and situational awareness services.
Also contributing to bookings this quarter was a growth contract award extending our services to new customers through the award of a Blanket Purchase Agreement for the Department of Health and Human Services. Under this BPA, we were awarded a $74 million task order to support IT operations services, including service desk and desk side support, infrastructure and data center operations.
I am very excited with this award as it’s a great proof point of our strategy coming to fruition since we have consistently communicated our desire to grow into the public health market either organically or through strategic M&A, various other awards and contract modifications across the portfolio make up the balance of this quarter’s bookings.
During our December call, I mentioned that a significant task order from our AMCOM customer was being recompeted and was under evaluation. Commonly referred to as Task Order 33 we were re-awarded this work during the quarter, but it was subsequently protested by a competitor. We expect resolution soon on this Task Order valued at over $700 million and should be included in our first quarter bookings if resolved in our favor.
At the end of the fourth quarter, SAIC’s total contract backlog stood at approximately $10.2 billion, a 28% increase from the fourth quarter of last year. Funded contract backlog was $2 billion. The estimated value of SAIC submitted proposals awaiting award at the end of the fourth quarter was approximately $15 billion, unchanged from the third quarter.
With an improving market outlook and as we continue to invest in the future of SAIC, it is encouraging to see strong demand for the services and solutions we offer. We will continue to utilize a disciplined approach to our investment spend as we pursue a strong pipeline of business opportunities.
Now before turning the call over to Charlie, I would like to give you a brief update on the completion of our restructuring efforts. As discussed last quarter, we reviewed our operating model and cost structure to improve profitability and better align to our long-term strategy Ingenuity 2025.
We took actions to achieve our objectives and provide for long-term shareholder value creation. These actions included a voluntary retirement incentive packages to certain senior managers. We also consolidated five customer facing organizations into three groups and six capability focused service lines into three market segments. I am pleased to report that these actions along with others were completed during the fourth quarter and we have entered fiscal year ‘19 with the benefits of these restructuring efforts.
We have achieved our previously communicated goal of reducing our annual operating costs by $20 million. After adjusting for our cost plus contract mix, this provides for approximately $11 million of benefit to invest in growth initiatives and improve profitability.
While Charlie will provide you with the fourth quarter and full fiscal year ‘18 financial impacts of these actions, we begin fiscal year 2019 with a more competitive operating structure poised to offer differentiated solutions to our diverse customer base and enable long-term shareholder value creation.
Charlie, over to you for our financial results.
Thank you, Nazzic, and good morning, everyone. During my remarks I will primarily focus on SAIC’s fourth quarter performance with references to full year results in specific areas.
Our fourth quarter revenues of over $1.1 billion reflect internal growth of 10.3% as compared to the fourth quarter of last fiscal year. Revenue growth was driven by new business contracts with NASA and the Environmental Protection Agency and increased volume in our supply chain and U.S. Army portfolios.
For the full year, internal revenue grew 2.5% year-over-year. Fourth quarter adjusted EBITDA was $83 million, a $12 million increase from the prior year, driven by revenue growth in lower SG&A cost related to our cost reduction initiatives.
These increases were offset by net unfavorable changes in contract estimates on a number of programs including increased cost and reserves on our platform integration programs supporting the United States Marine Corps.
Adjusted EBITDA margin equated to 7.4% as a percentage of revenues after adjusting for the expected $10 million of restructuring cost. The expected restructuring costs were in line with our previous communications and were mainly related to severance and facility exit cost. The total full year restructuring cost of $13 million was as expected and completed in the fourth quarter. We did not expect any further restructuring costs going forward.
Net income for the fourth quarter was $51 million and diluted earnings per share was $1.16 for the quarter inclusive of the fourth quarter restructuring cost of $10 million, which negatively impacted earnings by $0.22.
Net income was positively impacted by $70 million due to recently enacted tax reform and the associated reevaluations of net deferred tax liabilities which increased EPS by $0.39 per share.
Our fourth quarter effective tax rate was effectively zero and our full year effective rate was approximately 17%, significantly lower than our previous expectation of 23% to 25% due to recently enacted tax reform.
Before moving on to our financial results, let me discuss two items related to our Annual 10-K filing that is expected to be filed this evening. First, SAIC management identified that we had recognized some revenues in excess of the contractual authorized amounts on a specific program primarily in fiscal year 2017.
Therefore, in our 10-K you will see that we have elected to revise fiscal year 2017, which results in a reduction of net income by $5 million. Although this amount is immaterial to our overall 2017 results, we revised fiscal 2017 to provide greater transparency and comparability of the periods presented. We believe that there is no further financial exposure.
We will also be disclosing a material weakness in our internal controls related to the revenue recognized in excess of contractually authorized amounts. Upon discovery by SAIC management and subsequent review of the issue, we identified the root causes and believe that the issue is contained to one of our contracts. We have enacted a remediation plan with a number of actions already implemented with others to be completed in the first quarter. It is our intent for the material weakness to be remediated in the first half of fiscal year 2019.
Now let me turn back to the financial results. Fourth quarter operating cash flow and free cash flow were $84 million and $77 million respectively. This performance resulted in $195 million of free cash flow for the year, lower than the expectation we delivered in our December call.
The shortfall occurred due to unexpected delays in our supply chain business and the $30 million shortfall in cash receipt was received in the first two business days following year-end. We ended the fourth quarter with days sales outstanding at 54 days, an improvement of three days from the end of the third quarter continuing our best-in-class performance.
Despite the free cash flow shortfall, the fiscal year ended with a cash balance of $144 million, in line with our average operating cash balance target of $150 million. We begin fiscal year 2019 with a strong cash balance to continue our consistent capital allocation strategy.
During the fourth quarter, we deployed $58 million of capital, consisting of $36 million of planned share repurchases representing about 478,000 shares, $14 million in cash dividends and $8 million of term loan debt repayment.
For full fiscal year ‘18, we deployed $229 million to our shareholders, consisting of $150 million of planned share repurchases, reducing our share count by over two million shares or approximately 4%. $54 million of dividends and $25 million of debt repayment rounded out our capital deployment for the fiscal year.
Net debt at the end of the fiscal year stands at approximately $1 billion and our net debt to trailing 12-month EBITDA leverage ratio is less than three times.
Now turning to our forward outlook for fiscal year ‘19. We are committed to our long-term financial targets, and they remain unchanged, on average and over time we expect low-single digit internal revenue growth, and remain confident in our long-term profitability improvement target a 10 basis points to 20 basis points annually.
With regards to fiscal year ‘19 specifically, we expect revenue and margin improvement as measured by the EBITDA margin to be in line with these long-term targets and consistent with our previously communicated outlook on margin improvement.
We still believe the second half normalized margin baseline is around the 7.2% range, and then we can increase margins 10 basis points to 20 basis points consistent with our previous communication and long term financial targets.
In addition, we expect margins to be higher in the second half of fiscal ‘19 than in the first half. We expect a full year of active tax rate of between 23% and 25%, an increase from fiscal ‘18 due to substantially lower expected tax benefits on and stock-based compensation offset by the new federal corporate rate enacted by tax reform.
For fiscal year ‘19, we expect free cash flow of approximately of $250 million. The partial recovery of the fourth quarter delayed payments and our supply chain business and the permanent favorable impacts of tax reform positively impacts the fiscal year ‘19 cash flow outlook by about $40 million from our targeted free cash flow of $240 million.
However, we expect temporary increases in our working capital and capital expenditures to offset the increased cash flow by $30 million this fiscal year. The investment in additional working capital is necessary to support new programs such as our newly awarded Virginia Information Technology agency contract and the timing of the expenditures related to our platform integration business.
Also we plan on increasing capital expenditures to support our internal infrastructure by $10 million to approximately $30 million, both of these investments are necessary to sustain our long-term profitable growth and strategic initiatives.
Our capital deployment strategy remains consistent with the intent to continue distributing excess cash to our shareholders through dividends, share repurchases and strategic M&A should it arise. I am pleased to announce that the Board of Directors has approved our next quarterly dividend at $0.31 per share and will be payable to shareholders on April 27.
Tony, back to you for concluding remarks.
Thanks Charlie. I would like to announce that our Annual Shareholder Meeting will take place on June 6. Similar to last year, we’ll be conducting a virtual shareholder meeting whereby shareholders will participate online. Instructions on how to participate virtually will be included with the proxy voting ballot, as well as on our investor website.
With an improving market environment and the investments we have made to enable sustained profitable growth, we are well positioned for a successful fiscal year 2019 and with a leading position on the competitive markets we serve, SAIC continues to offer compelling shareholder value creation opportunity.
Operator, we are now ready to take your questions.
Thank you. [Operator Instructions] We will take our first question from Jon Raviv from Citi. Please go ahead.
Hey. Good morning, guys. Thanks for taking the questions as always.
Good morning.
On the free cash flow, can you just help us parse through some of the thoughts around where you see this over a long-term, I think you used to talk about $240 million. It sounds like tax rate worth of 10. So should $250 million on new base? And then also to what extent is this CapEx and working capital investments, is it structurally higher forever or is it kind of like just one-time thing this year to support some of the initiatives you have going on?
Yes. Thanks, Jonathan. So we expect $250 million of free cash flow. So we have $20 million favorable -- permanent favorable impact from Tax Reform. So our new annualized target is now $260 million. So in addition to the partial recovery as the delayed payments of $20 million this is offset by increased CapEx of $10 million and that’s really a one year event in order to improve our infrastructure, we don’t see that continuing and we will be back into the $20 million range for CapEx on an annual basis and then there’s timing on the working capital related to platform integration and the new beta programs of about $20 million, which is also a more annualized one-time event.
Got it. And then just some bigger picture question on the idea of scale in this spacing, it’s getting without worth getting a lot of play in the enterprise IT environment. How are you competing against the larger providers, what’s your perspective on some consolidation we’ve seen? And then I guess related to that inside, trying to lump on another question about how do you weigh big or small deals, how do you look valuation, how much – what is the appropriate leverage for business like this, do you have seen a competitor who want to do high 4s or 5s and any of and all thoughts around that, that would great?
So, just to your last point, we’re so very pretty comfortable with the leverage around 3.0, it’s a good operating model for us. It’s just a capital structure rollout. Surely, I can go above that the market is still favorable to get access to capital that we need. With that’s generally an operating level that we’re comfortable with, cash generation to do go-to-market, to draw that back down to that 3.0 range pretty quickly.
On a broader sense of scale, it’s still very comfortable $4.5 billion as far as the size of the company, the resources, our disposal, economies of scale on cost over that diversified base. Opportunities in this market with an optimistic view of improvements given the budget deal and apply ‘18 and ‘19 government dollars on both defense and non-defense. And the demand for enterprise IT modernization monetization, I think, we’re well aligned to take advantage of that, but due to our capabilities and market access at the appropriate levels.
As far as the consolidation always looking for opportunities to expand in our market leadership in the form of larger scale positions, with certain accounts or certain domains, expanding our differentiation capabilities at this point going forward.
So very conformable we’re at, the market growth [inaudible] rather still very consistent what we’ve talked about in the past on market access and capability development. And we’ll apply that in few key areas and as position for the market as we see some optimism for the next couple of years.
All right. Thanks. I’ll hop back in the queue.
Thanks.
We will now take our next question from Greg Conrad from Jefferies. Please go ahead.
Good morning. Just…
Good morning.
… in terms of you think about the savings, the $11 million of savings that you expect from restructuring in ‘19, you got kind of 20 basis points of improvement just from that. Is there an offset to that or when we think about ‘19, should we expect maybe margin expansion above that longer term target?
Yeah. This is Charlie. So let me go back to the margin outlook and give you a little more color around that. So a simple way to look at is to take the full year 2018 results of 7% as a baseline and our outlook would be 20 basis points to 40 basis points increase from that result there. That would include the restructuring savings, which is about 20 basis points. That would also include an increase in the performance of our platform integration year-over-year, we’ve got 20 basis points and this is offset by additional costs in SG&A.
Thank you. And then when you think about that opportunity, $15 billion pipeline, it seems like budgets are moving in the right direction. As we move through fiscal year ‘19, would you expect to exit the year at the higher number and is there any way to quantify the types of win rates that you’re targeting?
This is Nazzic. Hi. So we have very strong win rates and we look at our portfolio against the protect expand and grow that, I am sure you’re familiar with. First and foremost, protecting the business that we have and then looking for expansion and grow opportunities into new customers and expanding our service offerings into existing customers.
And so we do absolutely apply the lands that you’ve heard about previously in our strategy and looking for opportunities to drive more fixed price work, more profitable work to marry into the current portfolio as it sits today.
As we look forward into the new budgets and get continue to get clarity on how those dollars will get spent and allocated, and go through the procurement cycle, we’re staying very close to that and the areas that are being reinforced from our customers are areas that are very core to our business strategy. So we do have general optimism on the pipeline development, as well as being able to close and prosecute that pipeline.
Thank you.
We will now take our next question from Lucy Guo from Cowen & Co. Please go ahead.
Good morning, everyone. Wanted to follow up on this question of industry consolidations in the sense, I am wondering if there are any customers or capability that you can potentially compete better on if you had more scale double your size or anything in between, where you are now?
Yeah. Sure, Lucy. This is Tony. There’s a line to the strategy we’ve talked about in the past on the market access side, look for opportunities, to take advantage of expansion and intelligence community, public sector health, still high demand on both health IT, IT infrastructure services across that whole market area.
On the capability side, I think, we’re very well aligned, but can also improve our portfolio on training and simulation capabilities that links with the simulation, data analytics, skill sets that really are tied to modernization and readiness, particularly on the defense side.
So our alignment to getting the market faster on channels, repeatable products and technologies and expanding in a couple of different federal segments along with readiness alignment on training and analytics are really aligned to where we’re thinking about consolidation opportunities. So we can get to market faster and not be solely dependent on organic market opportunities through the pipeline development that Nazzic just talked about.
Can you talk maybe specifically on potential for more wrap rate optimization which is on the cost side of things between where your carriers now versus having more to go?
I think with, as I mentioned, at the $4.5 billion within enterprise, I think, we’re realizing effective and efficient economies of scale that pertains to our wrap rates or the indirect rate structure on our investment portfolio that’s we believe – we think we fully served appropriately given the pipeline development again is one example.
But I really don’t see that intent on scale to drive a wrap rate reduction. It’s more around alignment and increased capacity to compete in certain market segments, increased the volume of either capability development or increase our ability to submit a larger number of large scale programs, so that you can get further diversified the market access. So we see it in more forms of growth and capabilities in markets than we would approach any scale as it relates to our wrap rate or impact on actual pricing of strategies.
Good. Good to know. Thank you. One last question just want to follow up on the margin pluses and minuses, are there any onetime items that we should be aware of and also maybe if you can just describe contract mix change and recomplete coming up here whether that has any affect?
So I’ll address the one-time. So we did have $4 million of net contract write-downs in the quarter with the primary driver being in our platform programs. And on the other hand we had a favorable under-runs in our SG&A in an indirects primarily related to fringe benefits like health insurance that are very hard to predict and very volatile. So that was also a very favorable impact in the quarter.
And I can touch quickly on the recompete question. We actually are going into this year in a little better position as it relates to recompetes, last year with a very heavy recompete year. This year is more normative, if not slightly better than normal. We’ve got a couple of key recompetes that probably drive have a significant impact on a year, one I touched on a few minutes ago, which is the Task Order 33 that is significant recompete and we’re just waiting on a conclusion of that.
The second thing is, as I mentioned on the last call, is our [tires] program and that’s in the process of being recompete as well. Although, there is strong indication and it’s highly likely that that could get pushed later in the year, so we would have minimal impact for this year as it relates to revenue.
And can you also talk about your one-time items and as you see the – except the changes in AMCOM portfolio, how that may affect the margin outlook for FY ‘19?
The – I am trying to understand the question. So that the transition of some of the AMCOM work from the legacy T&M construct to the cost plus construct?
Exactly.
Yeah. So, yeah, IT certainly is that transition that is taking place and we certainly see some – a little bit of softness for the margins there, but nothing that’s overly significant.
Got you. Thank you.
Thank you, Lucy.
We will now take our next question from Edward Caso from Wells Fargo. Please go ahead.
Hi. Good morning. I was interested given the rather large increase in funding and the budget deal that was just got a few weeks back, why you haven’t sort of shifted up your long-term view? I understand that it’s really more of a calendar ‘19 impact by the time all of the contracting work gets done, but I didn’t sense from your commentary that you’re more positive on the outlook than say a year ago?
Hi, Ed. This is Tony. That’s a good question. I do think that we are positioned today, as you mentioned, still a little bit of a wait and see of the budget deal that just signed, the monies will flow into this current quarter. The expectation of the customer is going to work hard. Hopefully commit that preferably against already submitted pipeline and the large IDIQ presence that we have task orders or another convenient mechanism to put money on contract faster.
But I do think that as we think about this our FY 2019 that we will see perhaps a modest increase that will convert from work to revenue toward the tail end of the year. That does give us confidence in our ability to outperform FY ‘18 results, both topline and bottomline as we think about that.
So much more optimistic and confidence that we can exceed and outperform. Last year a lot of good momentum. The amount of last year on book-to-bill, to your point, would expect to see further improvements into next fiscal year as we see the – hopefully the government budgets reconcile, maybe get lucky on a shorter CR scenario for government ‘19.
But as you think that the larger increase year-over-year will be in our FY ‘20 or government ‘19. So to your point 2019 representation is little accurate. But we are much more optimistic given a two year deal that we are going to perform prior year targets.
Can you talk a little bit about your hiring and retention efforts, so we continue to hear other providers saying that they could have had more revenue if they had more people particularly on the cleared side, sort of what steps you’re taking to sort of address the pipeline of people needed?
Sure. The workforce challenge is still good principally in that cleared workforce. We’ve been collectively in industry talking to our customers about the impacted mission looking for opportunity to increase reciprocity, so we can move to currently clear staffed between customers and contracts to meet mission needs plus an element but also trying to reinforce the ability to increase the workforce by simplifying the pipeline of getting clear to new talent in new markets and new technologies through the federal system so that we can get a month’s contract.
So it is a bit of a headwind. It’s across industry, nothing unique to SAIC. But alternatively if we think about workforce optimization, I think, the customers are beginning to be a little more open to a remote workforce and really put an emphasis on the technology development, not so much the geographic location of where that staff is in our opening of the Cookeville Technology Integration Center last year is another means to better workforce, to get the right talent at the right levels and still be able to serve our customers.
So working clearances, work in geographic positions to really take a broad view. But, overall, I think, we’re well-positioned, attractive as an employer of choice for the technical talent that we need. So we’re always monitoring that, but a lot of the people are asset and does drive revenue to some degree.
As we think about the ability to solution more and outcome based, we’re probably moving hopefully to an environment where we’re less dependent dollar-for-dollar on the labor, but it through the total of lack of integrated solution as we’re well-positioned to be a channel for a lot of those technologies and complement that with our talent, people and resources.
If I could sneak in another quick one, the MPVs vehicle program, sort of another adjustment here to the cost structure. What’s the comfort that we’ve sort of found bottom here as far as the cost side of the equation where we might not see more program write-downs?
Yeah. This is Nazzic. I’ll touch on that and certainly, Charlie, can chime in as well. So as we went into this last quarter, we’re entering into the limited rate production phase of the AAV program. And so as we go into production, get more clarity and visibility on the cost to complete the production phase, it does give us higher confidence that we have our hands around the material and the labor required to execute.
So we’ve done some thorough work, have very strong bids from our supplier in a fixed price manner and so at this juncture, we feel confident that we have a good understanding of what it’s going to take for this phase and appropriately took those costs in Q4. Charlie, anything you want to add?
I would just say, part of this was, as Nazzic said, we reevaluated scheduled material cost to complete it. We increased the reserves for fiscal year ‘19 in anticipation of things that can possibly go wrong as we get to this critical time point. So we feel very comfortable with the program and where we’re going it’s – all these platform integration programs offer great opportunity for us and in the future, so we’re moving along with some great people working on this and great leadership down in Charleston.
Thank you.
Thanks, Ed.
We will now take our next question from Tobey Sommer from SunTrust. Please go ahead.
Thanks. Question about your – the platform business. Is the success that you’ve had over the last few years changing the way that potential future bids come together? Are you getting approached by partners that are kind of bringing ideas to you about things to bid on? I am just curious how that success is kind of change the way you may look at future opportunities? Thanks.
Sure. Thanks, Tobey. This is Nazzic. So, I think, and short answer is, yes, and let me provide a little bit of color. So as we have put up this business and formulated this business over the course of the last few years, we certainly are seeing some interest from our government customers as they look to – be able to drive their readiness in a faster manner and so we are seeing some great interest not only from suppliers and customers, and we are seeing increasing pipeline opportunity as we look forward over the course of the next few years.
I know you touched on this in an earlier question, but I’d like to ask it again. The internal growth that company has for a long-term target. You were right in the thick of it and the reported fiscal year and exited that year with a book-to-bill that could suggest a faster rate of future growth. And we have a better spending environment. How do we think about the influence of spending growth on the companies medium term prospects for internal growth?
Again I think the spending growth expectations are high. The conversion and execution of contract decision awards is still a bit premature. We’ve got - try to temper the optimism even to the last year of what we’ve talked about as far as opportunities and the reality of how things move through the system. We have seen improvements as you saw on book-to-bill.
We expect that probably the leading indicator of the progression of customer decisions under the new budget environment. So perhaps watch for that in the mid-term cycles to see how that converts, given the cycle we look about end of this current fiscal year, perhaps it will be that acceleration.
So there is optimism that the back half of the year could see further growth as we would transition in new programs. But as I said, I think that we’re very optimistic about our ability to outperform in that low single-digit to use that last year as the baseline of that 2.5% that still low single-digit will get carried away to go to high single-digits, but outperformed last year and in context of the last few years, it’d be great to see a sustained positive organic growth within SAIC and across the industry and I’ll expect that to happen. And it’ll just be based on the customer decision process.
But our portfolio with contract vehicles, we think positions us very well to take full advantage of the improved budget environment and our ability to convert submitted proposals into contract awards and subsequently revenue.
So it will take a little time probably next quarter the industry as a whole, it would be great to provide some color on how fast the government has been able to react to a budget environment because it does have to slow down through the program operations and contract officials to get actual money on contract.
With respect to the duration of contracts in the book-to-bill as well as the pipeline, are there any material changes to that that would inform us on kind of how to view the connection between book-to-bill and future organic growth?
I would just say that, you know, earlier on, we saw some lengthening of the contracts you know, typically five years and some of these were being extended up to seven years, but I would say it’s not changed dramatically over the course for the last years.
I think most of them fall between three years to five years.
We do see - just to provide a little more color, we do see - continued use of bridges when the time comes and contracts, organization or the customer hasn’t fully finalized their next strategy. So when you’re in the company’s position that’s obviously a great thing. If you’re looking to compete for the work then it’s just a long gauge step process.
[Operator Instructions] We will now take our next question from Krishna Sinha from Vertical Research Partners. Please go ahead.
Hopefully, I don’t beat this growth question to death here, but I just want to come out from a little different angle. Some of your peers are guiding towards you know mid-single digit growth or even higher than that. I know during the defense budget downturn this was primarily like a market share environment where you had to take from somebody else in order to grow. To what extent have we exited that like are there a lot of contracts that are new to the world that the government is pushing through the pipeline that you guys can win.
So is the pie getting bigger with this budget deals, and you know, the budget growth that we’re seeing? Or are you still having to take away from other competitors in order to grow your top-line? And if you could just kind of quantify if you’re saying you know low to low-single digit growth, maybe a slightly higher than that in the medium term depending on the budget dollars flow. Like how much of that of your growth will be - you taking market share from competitors and how much will just be coming naturally from the budget?
So this is Nazzic. I’ll try to answer a couple of these things and certainly Tony can add some color. For the most part, what we’re seeing today in the submitted pipeline as well as the near-term pipeline is exactly what you referenced and that’s the same pie just shifting in some cases or recompeting.
So we’re not saying to-date a lot of new work, but we are optimistic as you’ve heard that with the new budget deal that does free up our customers to invest in what is new solutions, new technologies, new initiatives, new programs and assuming that that is the case, which is what we expect then the other part of your question does hold true and that is as we go into later this year into next year then hopefully the direction would be in addition to the takeaway work that there would be some new work as well. And so that is what drives the optimism as we look at later this year and into next year from the overall budget standpoint.
I am going to just add like I believe I think that’s spot on in the - as we saw and talked in past about some of the pressures on our organic growth have been on the recompete, the existing contracts and as the customers had to adjust to a more budget environment, the existing work declines, existing scope of work.
So I think as the balance between the increased budgets in part return IT modernization for example back to a level that perhaps we saw three or four years ago where they’ve been in more of an operation and sustainment mode, the upside is around on existing contracts, increase scope to accelerate modernization things that may have weight in enterprise systems, datacenters, architectures, migration of the cloud.
So I think there is still a lot of work and lot of it’s this budget dollars will move through existing contracts. So on this point there will be some specific areas where it would be some new contracts perhaps, but I think that’s minority of the portfolio that we’ll see. A lot of it will be expanding the existing scope on contract that wield today. And hence for future growth is still a bit more in the takeaway as you try and shape in our - to expand and grow of serving our customers.
I think in terms of that as we see the budgets kind of come back to a better base line and takeaway will still be pretty prevalent on the growth side overall. And on the overall numbers as I said, outperforming last year you come in a still lower single digits, you look about the scale but I think maybe closer to mid, low to mid, but I would not see expectations above that midpoint given the scale that we see and the amount of money that moves through that baseline.
And then just as a follow up. Who’s sort of losing in this market share environment? I mean you guys if you guys are growing most of your peers are growing, that implies if the pie is not really getting that much bigger that you’re taking share from other people. So who are the losers that are really kind of like just eroding their market share by not being competitive either on costs or what have you?
I think the losers will be evidenced as the market plays out. It’s hard to predict. I think we all see optimism in our ability to continue to expand the scope of our work, on existing contracts. So I think that is a basis some of the optimism of growth that we haven’t seen, so that’s a little bit more conservative, but the contacts, the takeaways, I think the market dynamics will still continue to play out. Not likely to see a huge shift, but still very strong incumbent capture percentages. So the population of the takeaways and percentages are still relatively small.
So I think the growth optimism amongst our peers in large part beyond the existing contracts. And so there aren’t as many losers in that sense, but I do think that the way to see how the market plays out and we all believe that we can effectively compete.
And as seen in the last three or four years we can outperform on the revenue side whether we’re filling gaps or are now on a positive momentum, so we’re again optimistic that we’ll get our fair share on our growth side relative to our peers.
We will now take our next question from Josh Sullivan from Seaport Global. Please go ahead.
Just in regard to the Ingenuity 2025, now that you’ve completed the restructuring efforts here, what are the other near-term steps might we look for in that plan?
I think part of the intent on the growth is still around alignment of key technologies and looking at outcome-based solutions. I think within the domain we talked about on training, model-based system engineering, readiness, IT modernization, I think we see opportunity to be able to continue to leverage commercial technologies to be a channel that government driving grow through the 2025 elements of our business to really get market share in specific segments that we think we’ve got a good position.
We continue to focus on pipeline development on the expand and grow sides, so we can expand capabilities, as well as seek adjacencies with new customers. But overall, our ability to increase and align the outcome based acquisition styles with maybe improvements in other service, I’ll provide opportunities to kind of shift the opportunity set on our strategy to deliver more effective solutions that are differentiated but again to support growth in both revenues and in margins.
And I think you mentioned in the comments, public health was a target just kind of related to that. What opportunities are out there and why are you well-positioned to take advantage of those opportunities at this point?
So as we look at the portfolio that we hold in the market segments that we serve, we see the opportunity to expand a lot of the work that we do in two or three key areas. So certainly the IT portfolio training as Tony mentioned. So there are several offerings that we can bring to bear in the public sector healthcare market.
And so, that’s the market that we’ve under-served post spin that portfolio stayed with our previous parent. Then, we have the opportunity to grow into that space. And so we’ve had some great success over the course of the last year, so doing that organically.
And as Tony mentioned, it’s also a filter as we look for potential M&A. It’s just a significant share of the market that we don’t have significant scale in today and it is one that we believe we can easily penetrate with the offerings of market segments that we bring it there.
We will now take our next question from Brian Ruttenbur from Drexel Hamilton. Please go ahead.
And just along the lines of the rising budget, can you talk about the competitive environment, you hit on that a little bit, but as you see things in the future, do you see margins rising again overall for the entire industry? Is there going to be winners and losers in here they’re going to get squeezed out?
Over the last seven years it’s been brutal in this industry where there’s been shrinking budget, shrinking margin, we’re starting to recovery. And I will just want to hear some of your commentary for the industry and yourself what you see in terms of recovery with these budgets going forward, not necessarily fiscal 2019 but beyond.
But in sales environment’s so very robust with no attractive market, no several contracting community at all levels, there are still a lot of opportunity as you state. It’s been challenged given a budget environment since 2013, so we’re seeing a little bit more optimism in the budget profile we’ve talked about.
We’ve seen over the last two years a move to more of what we’d call it the best value decision making and moving away from an LTE low priced, technically acceptable when price was the only driver three years ago just because of the budgets were so constrained, just squeezing out folks.
So now there is I think more opportunity to blend technology advancements, modernization, bringing in innovative technologies in perhaps a different style as a service perhaps, look at best value opportunities. So I think the market improvements are there. I think industry has been pretty responsive to understand and keep pace with customer requirements and with the pipelines that have been submitted including of the customer even in budget environments never really pulled back on the request for proposals and I think you see in industry there are $15 billion of submitted proposal waiting award, the demands have been there, and now I think with the budget environments, we’re really optimistic that they’ll be able to actually execute those decisions on that pipeline.
And so I don’t think we have to beef up. The proposal activity is really trying to work with our customers to get execution on what they’ve already asked for and now with the dollars in place on a longer term basis, we should be able to move forward.
And relative to winners and losers, I think we’ve seen the ability to maintain a diverse portfolio, capabilities in market channels through customer and contract vehicles is very important. It’s tough to get those in a new sense, so we’ve been able to sustain that over the last four years. So we’ve definitely been on the winning side of that equation, we’ll continue to be as a competitive through our solutions, our presence with our customers and diversity of our past performance.
You see us invest in areas such as the platform programs to really seek new market channels and very optimistic about our alignment on as a technology integrator today to get more capabilities in the market faster, which is again very much aligned where customers’ needs permission to the fields in a much shorter period of time.
So well-positioned, we’ll see how the market shakes out. But the competitive landscape, we don’t see it changing dramatically relative to the dynamics on competition, but more so hopefully an increased volume.
We will now take our next question from Jon Raviv from Citi. Please go ahead.
Charlie, can you just quantify the baseline for margin growth in FY ‘19, and I thought it would be the - you’re going to grow 10 to 20 off of this fiscal second half run rate…
Yes, Jonathan. Two ways to look at it. One was what we’ve talked about previously was looking at the second half run rate which again we normalize at 7.2% looking for 10 basis points to 20 basis points off of that.
However, a simpler way to look at it is to take the full-year 2018 results which came in at 7% margins as the baseline. And we would look to grow 20 to 40 basis points increase from that. And again that’s related to 20 to 40 basis points increase that are related to the restructuring savings, the increased performance and platform integration offset by increases in SG&A costs.
And then just on that, if you just give us a sense and I’ll get in the queue later. In light of the ceiling, just a sense of your perspective on the material weakness exactly what it is and what gives you confidence that it is contained to that one item that you tagged with?
Yes. So, one of the things that’s very important about this is something that SAIC management identified. As we were getting late in the fourth quarter and for the end of the year, we identified that there had been revenue recognized in excess of authorized amounts on a specific program. And we did a lot of investigation into this to make sure that we understood it all, that we had a fence around it and that there was no further financial exposure.
However, due to the timing of this coming in late of the year, we were not able to remediate the material weakness and be able to test it and to ensure that the effective controls were in place, so that’s why we elected to have a material weakness which again we believe will be remediated and the first half and again it’s just being able to go back and test and verify that the controls are effective in the first half of the year.
As there are no further questions in the queue, that will conclude today’s question-and-answer session. I will now turn the call back to your host for any additional or closing remarks.
Thank you very much for your participation in SAIC’s fourth quarter and full fiscal year 2018 earnings call. This concludes the call and we thank you for your continued interest in SAIC.
That would conclude today’s conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.