By Calvin Biesecker
SAIC [SAI] on Tuesday lowered its organic revenue and earnings expectations for the year amid uncertainty in the government contracting environment including delays in the contracting cycle, and the company’s new chief outlined a strategy that deemphasizes some what core services market in favor directing more resources to specific high growth areas.
The contracting cycle is being delayed on the front end as new business opportunities are emerging more slowly than expected and on the back end as contract awards decisions are drift, Walt Havenstein, SAIC’s CEO, said during the company’s fourth quarter earnings call on Tuesday evening. This is true across various Defense Department segments SAIC does business with, including the intelligence community where $1 billion of expected bookings were pushed out of the fourth quarter into the company’s fiscal year 2011, he said.
As a result of the delays, SAIC’s overall bookings in the quarter were short of expectations, Havenstein said.
In addition to contracting delays, expectations of increased government oversight of contractors along with an “anti-contractor undercurrent” remain, Havenstein said. Rules on organizational and personnel conflicts of interest are expected soon as well as a new definition on what is inherently governmental work, he said.
Against these uncertainties, what is less uncertain is that there will be downward pressure on federal discretionary spending, including defense spending, from both the Obama administration and Congress, Havenstein said. While there is proposed modest growth in the FY ’11 defense budget, this is mostly for DoD’s “must pay bills” such as the troop surge in Afghanistan, he said.
“We expect only nominal growth in our markets,” Havenstein said.
Havenstein divided SAIC’s roughly $11 billion in annual sales into two equal business areas, its core services market and high growth markets.
The market outlook for the core services business is flat to modestly declining, Havenstein said. This is a large market where the company has a relatively small share so there is room to capture additional business, he said.
“But industry can no longer rely on a rising tide to lift all boats,” he said.
Within the high growth market SAIC plays in specific areas, which have the potential for up to 15 percent annual growth, Havenstein said. In the national security arena these are C4ISR, logistics and cyber security, he said. Cyber security is particularly important because it is a “differentiator and or enabler” across all of the company’s market areas, he added.
In the broader federal civil space, these high growth areas include energy and health care, he added.
After several months of review, SAIC has developed a new strategy that is “centered on organic growth,” with the focus on high performance across the company, deploying resources to higher growth areas, pursuing acquisitions that fit into these growth areas, and generating strong cash flow to increase shareholder value, Havenstein said.
Acquisitions could be large or small but the key will be providing “differentiating capabilities or expanding market access,” Havenstein said. Going forward SAIC will have to do better in creating “revenue synergies” between its acquisition targets and existing businesses, which will require better integration and focus, he said.
J.P. Morgan aerospace and defense analyst Joseph Nadol said in a note to clients that SAIC’s new strategy “makes sense and [we] will be looking for evidence that it can grow faster than peers.” However, Nadol said this hasn’t happened yet although he believes the company’s new forecast is realistic given the challenging market environment.
SAIC’s revised outlook calls for organic growth between 3 and 6 percent, down from 6 to 9 percent, which had also been its long-term goal. There is no long-term growth goal for now, Havenstein said. Sales due to previous acquisitions are expected to add between $150 million to $200 million in revenues in FY ’11.
Earnings per share (EPS) guidance for FY ’11 is between 8 and 14 percent growth, down from 11 to 18 percent growth. While operating margins are expected to increase slightly, fewer bookings combined with increased investment in research and development will eat into the originally planned profit growth. The higher internal R&D spending will be in the area of cyber security, Havenstein said.
For the fourth quarter, SAIC’s net income was $123 million (31 cents) EPS, a nearly 3 percent gain from the $120 million (29 cents EPS) posted a year ago. Earnings were a penny below analysts’ expectations. Operating margins fell have a percent to 7.8 percent due to higher bid and proposal expenses and an impairment charge related to an acquisition last year.
Sales in the quarter rose 7 percent to $2.7 billion from $2.5 billion, with 4 percent of the gain organic.
For the year, net income was $497 million ($1.24 EPS), up 10 percent from $452 million ($1.09 EPS) a year ago. Sales increased 8 percent to $10.9 billion from $10.7 billion, with organic growth 6 percent of the gain. Free cash flow for the year was a strong $560 million. Backlog at the end of FY ’10 was $15.6 billion with $5.3 billion funded, down 7 and 6 percent respectively compared to a year ago.