SAIC feels no rush to pull trigger for scale

SAIC executives explain to Wall Street why they feel comfortable with the company's trajectory and current size in a consolidating government services market.

Like other government services contractors, Science Applications International Corp. is looking around for potential acquisition opportunities in a consolidating market that is creating fewer and larger players as General Dynamics proceeds on closing its acquisition of CSRA.

But the criteria SAIC uses for its mergers-and-acquisition filters is unchanged based on comments Thursday by company executives in their fourth quarter and year-end earnings call with investors.

"We're always looking for opportunities to expand our market leadership in the form of larger-scale positions with certain accounts or certain domains, expanding our differentiation and capabilities at this point going forward," CEO Tony Moraco told analysts.

"The M&A filters are still very consistent with what we were talking about in the past on market access and capability development, and we'll apply that in key areas and best position for the market as we see some optimism going forward for the next couple of years."

The government services market is due to have a pair of nearly $10 billion-revenue players: a Leidos now past its integration with the former Lockheed Martin IT business, plus a soon-to-be larger General Dynamics IT services business that will include CSRA after that deal closes.

But SAIC at $4.5 billion in fiscal year 2018 sales -- 2.5 percent higher than the prior period -- remains comfortable at its current size, Moraco said, even as others are looking to add scale quickly as a means to position themselves for expected growth in defense and IT modernization spending among other areas.

As scale grows, so does the ability to spread costs out over a larger base and be more competitive for larger contracts of longer durations, as Leidos argued when it merged with the Lockheed IT business.

Moraco said SAIC's size already gives it comfort with "the resources at our disposal, economies of scale on costs over that diversified base (and) opportunities in this market with an optimistic view of improvements given the budget field," Moraco said.

Although that comfort evidently did not prevent SAIC from making a cash-and-stock offer for CSRA, as sources have told Washington Technology and analysts have speculated.

SAIC is holding to its outlook of low single-digit growth in the new fiscal year that started Feb. 1 and its Ingenuity 2025 strategy focused in part on IT modernization, readiness, engineering and platform integration that includes military ground vehicles.

Moraco expressed optimism to analysts that an improving budget environment in light of the two-year framework agreement struck earlier this year bodes well for both SAIC and the government services market as a whole but it will take time for added funds to flow through agencies.

"The expectation is that the customers are going to work hard to commit that, preferably against our already-submitted pipeline and the large IDIQ presence that we have," Moraco said. "Task orders are another convenient mechanism to put money on contracts faster. But, I do think that as we think about our (fiscal year) 2019, we'll see a modest increase that will convert from award to revenue toward the tail end of the year."

That means SAIC is expecting its growth to accelerate next calendar year -- or its 2020 fiscal year -- as contracts move through the procurement cycles leading up to award.

With that understanding, SAIC is watching to see where the additional funds go and how they move through those procurement cycles, Moraco said. But one key indicator shows SAIC is poised to see some continued revenue growth for its new fiscal year.

As SAIC's earnings release points out, they recorded a 1.5 book-to-bill ratio for the full fiscal year to show the company adds contracts to the backlog faster than it is drawn down from to recognize revenue. And SAIC expects that "to be the leading indicator of the progression of customer decisions under the new budget environment," Moraco said.

SAIC could also get off to a good start for first quarter bookings if it holds onto an almost $700 million task order to support the Army that was won late last year and subsequently protested. That was a recompete of work previously performed under the AMCOM Express contract vehicle SAIC was the prime for. The company already has won two of three major recompetes of work that fell under AMCOM Express.

Another trend in the favor of SAIC and its peers is a move by agencies to more best-value contracting for large IT jobs versus the low-price, technically acceptable method that previously dominated the market as services budgets shrunk, Moraco said.

Confidence in its organic growth trajectory does not mean SAIC will stop looking for potential acquisition targets, however. SAIC's market access filter includes the public sector health market and customers in the intelligence community, Moraco said.

"It's 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 and market segments that we bring to bear," Chief Operating Officer Nazzic Keene said on the call.

Prior to the 2013 split of what is now SAIC and Leidos, that almost $10 billion-revenue company then known as SAIC had a large health business in both the public sector and commercial markets.

The split saw much of that book of business go to Leidos, who is the prime contractor on the Defense Department's $4.3 billion electronic health record modernization job awarded in 2015. Leidos is also watching for a similar EHR modernization contract to be signed between the Veterans Affairs Department and Cerner, who is Leidos' partner for the DOD program.

SAIC has seen some "great success over the course of last year or so" with organic growth in the federal health care market however, Keene said.

The company won positions on a pair of contract vehicles during the fourth quarter in a $207 million IT services blanket purchase agreement at the Health and Hman Services Department and a similar $214 million BPA with the National Heart, Lung and Blood Institute.

That HHS vehicle also brought with it a potential 54-month, $74 million task order for service desk and deskside support services among other work areas.

SAIC also saw the intelligence community business go to Leidos in the split but re-entered that market with the acquisition of Scitor in 2015. That deal also gave the "new" SAIC a presence with the Air Force.

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