SAIC Earnings Call Insights: Programs Review and Acquisitions Outlook

SAIC, Inc. (NYSE:SAI) recently reported its second quarter earnings and discussed the following topics in its earnings conference call.

Programs Review

Cai von Rumohr – Cowen and Company: Could you give us a little more color on the specific problems on the four problem programs? Secondly, you mentioned you’re going to be a little pickier, but you know, (take) price development with new customers particularly foreign, and state and local are kind of like for many analyst a red flag. How many other contracts of that sort still are in your backlog?

K. Stuart Shea – COO: Cai, this is Stu, good morning. We have a very rigorous process, a review of all of our programs and we have a watchlist that we pay particular attention to. Of the 9,000 contracts that we have within the Company today, we have about 25 programs that are on that white – on that watchlist and all four of the contracts that we noted in our call just a moment ago, were on that watchlist. But based upon our Q2 testing, our customer interaction, and scheduled requirements, we really determined that our two foreign contracts needed to be redesigned and we had to increase our cost and resourcing to meet schedules for the other two contracts. So we adjusted the EAC’s accordingly. These types of estimates at completion or estimates to complete are a standard process in any quarter and there is a lots of ups and downs. They just all happened that have happened at the same time, because of technical or customer milestones in Q2, which bore out new information. So we feel pretty confident in the overall process of review, but we did use the opportunity to do a deep dive on a much of a contract baseline this quarter to take a look and see whether or not we had any other issues. Right now, we don’t see any that confront us with the same level of concern that we have than any other ones.

Cai von Rumohr – Cowen and Company: Then you had mentioned that going forward, you’re going to be a little bit more, I guess, picky about looking at what you do? Are you going to continue to take fixed price development contracts with state and local and foreign customers? Or are you going to basically have a policy where you kind of stick to customers you know a little better?

K. Stuart Shea – COO: Well, let’s see. The first answer is, we do a lot of fixed price work and we do a lot of fixed price development and solutions work. So we’re going to continue that and we’ll continue with the customer sets, but I think it’s – when you cross the particular type of contract and the particular customer, this was a little bit out of the ordinary. We also had folks that were working on these contracts that weren’t necessarily the best in the Company to focus on them. So, it was kind of the perfect storm of the contract, the nature of the customer, the nature of deliverable, the timing of it and we had an opportunity to fix it, so we did. We’re going to keep focusing on many of the same because we’ll do a lot of business in future SAIC and state, local business. We’ll continue to pursue our foreign customers in Leidos and to new SAIC and we’re just going to be a lot more attentive to the nature of the delivery, the nature the requirements and how we go about staffing the programs.

Cai von Rumohr – Cowen and Company: Just one last one, you had had a cost target of $350 million. What is your cost target, saving target today? How much more do you have to go to get there and how does that split between the two new businesses?

K. Stuart Shea – COO: Again, Cai, we completed our cost cuts at $350 million, split approximately $200 million for Leidos and $150 million new SAIC. I think we’re on track for that full $350 million program cut. Those cuts far exceed any dyssynergy costs that we have related to splitting the two companies, which is nominally $50 million to $60 million on a full year basis. What our plan going forward is to really have a – and we’ve already started this, a continued improvement process. We expect there will be more cost changes to come. Post-separation both Leidos and new SAIC will have active programs. It’ll be a little bit different between the two companies to address this, and the cost reductions that we’ve seen in FY’14 have considerably lowered our FY’14 wrap rates and they’ll have greater impact in FY’15 and beyond on a full year basis. So, as you know, the FY’14 is kind of a transitional year and you’ll see more evidence of the impact in FY’15 and beyond. We’re going to talk more about that at the Investor Conference on the 11th.

Acquisitions Outlook

Edward Caso – Wells Fargo: You mentioned the potential for ongoing divestitures. I was curious if you could also talk about your intent on the acquisition side of the equation as many believe that we’re going to be consolidating here the next few years. Within that context, can you offer any sense of what leverage limits you’d be happy with, with the two companies?

John P. Jumper – President and Chief Executive Officer: Let me address the – this is John Jumper. Let me address the M&A plans. We’ll be hearing more about this at the Investor Conference of M&A and capital deployment as we come up to the 11th, but I think broadly speaking on M&A, we can say that we will be much more focused on predictable profit streams and returning capital to our shareholders with M&A. As always, we’re going to try and maintain a balance, but I think the balance is going to favor taking better advantage of not building up bunch of cash on the balance sheet and returning that to the shareholder. These are decisions that the Board of Directors make every quarter, and I think we’ll continue to look at it that way.

Mark W. Sopp – EVP and CFO: Ed, this is Mark, I’ll comment on the leverage ratios going forward. As the two companies exit this transition period and embark on separate track, they will have the leverage ratios in the 1.5x to 2x range, each of them. As previously stated and as originally designed, that would generally be where we would intend to operate for the most part going forward. We would be willing to level up to closer toward three in both companies should the right compelling opportunities arise, but it’s very important on the Leidos side, we maintain an investment-grade rating to make sure the credit markets are available to us, as we said that’s less important on the new SAIC side, but we still want to operate the capital structures, as John said, with less excess cash, number one, but a fairly conservative leverage ratio in the 1.5 to 2.5 sort of arena…

Edward Caso – Wells Fargo: Could you talk a little bit about where you think the September, the government’s fourth quarter will come in as far as award activity is concerned, relative to the fourth quarter a year ago?

John P. Jumper – President and Chief Executive Officer: Let me start off, this is John. I think that, if there is one word to describe the situation we are in right now, it’s confused. I have a hard time and I think my colleagues in the industry have a hard time even defining what the baseline is right now. The spending patterns are erratic. I think there is great caution among the contracting officers out there that we do business with day-in and day-out, which is our best indication of volatility. So, I think to try and be predictive about fourth quarter or an end of year even for the government, where you normally see a flush, trying to be predictive about that is extremely difficult and I think it would be dangerous for anyone to try and define in any way what’s going to happen.

Edward Caso – Wells Fargo: My last question, Mr. Kendall that came out in the last few days and mentioned that they had done things to sort of get through government 13 and that their harder decisions to come, how would you interpret that as far as the flow of funding to the government services sector in general?

John P. Jumper – President and Chief Executive Officer: Frank Kendall I think has been an outstanding spokesman for not only for the Pentagon and for government spending but for the rest of us in industry. I think what Frank was referring to are some of the things we talked about earlier. We’ve seen a pronounced 10% reduction in intelligence budgets. You’ve heard some of the agency leadership talking about that here just in the recent – in recent weeks, yet the level of activity out there in the big world is anything, but a level that would indicate a reduction in intelligence activity. So, I think that there is some conflict here between what we’re seeing out there in the world and the demands that we see being fairly well sustained on things like intelligence. Having said that, I do believe that the government is looking for a continued efficiencies and I think that we will see as Frank said a decrease in spending, delay decisions and I think this all adds to the confusion I was talking about earlier.