Business context and reporting period
Science Applications International Corporation (SAIC) filed this unaudited Form 10-Q for the quarter ended August 3, 2018, the second quarter of fiscal 2019. SAIC provides technical, engineering and enterprise IT services, primarily to U.S. government customers; it reports one aggregated segment. More than 95% of fiscal 2018 revenue came from U.S. government contracts.
Financial performance
| Metric | Three months ended Aug. 3, 2018 | Six months ended Aug. 3, 2018 | Prior comparable period |
|---|---|---|---|
| Revenue | $1.115 billion; up 3.4% | $2.290 billion; up 5.0% | $1.078 billion and $2.181 billion |
| Operating income | $74 million; up 25% | $140 million; up 15% | $59 million and $122 million |
| Operating margin | 6.6%, versus 5.5% | 6.1%, versus 5.6% | Prior comparable quarter and half-year |
| Net income | $49 million; up 36% | $98 million; up 15% | $36 million and $85 million |
| Diluted EPS | $1.13, versus $0.80 | $2.26, versus $1.88 | Prior comparable quarter and half-year |
| Adjusted EBITDA margin | 7.5%, versus 6.7% | 7.0%, versus 6.6% | Non-GAAP measure |
For the six months, operating cash flow was $76 million, compared with $53 million; investing cash outflow was $17 million, including $18 million of capital expenditures, and financing cash outflow was $97 million. Cash, cash equivalents and restricted cash totaled $114 million at period-end, including $8 million restricted cash; balance-sheet cash and cash equivalents were $106 million. Current assets were $926 million and current liabilities $662 million.
Debt had a net carrying value of $1.008 billion ($1.018 billion principal); $49 million was current. The $200 million revolving facility had no borrowings outstanding. SAIC reported compliance with credit covenants. It declared and paid $0.31 per share in the quarter and $0.62 for the half-year.
Material changes versus prior periods
- Revenue growth reflected higher supply-chain orders and new contracts, particularly supporting NASA and other federal civilian agencies; contract completions and other portfolio declines partly offset growth.
- Margins improved, which management attributed to better contract performance, efficiencies from the fiscal 2018 restructuring, and the absence of prior-year restructuring expense. Six-month operating income also benefited from lower net unfavorable contract-estimate changes.
- Six-month operating cash flow increased primarily because of higher customer collections, partly offset by working-capital investment in platform integration programs. Share repurchases and tax-related share withholding were lower than in the prior-year period.
- At August 3, backlog was $10.454 billion, versus $10.227 billion at February 2; funded backlog was $2.099 billion. Six-month net bookings were approximately $2.5 billion. Remaining performance obligations were $1.0 billion, with about 70% expected to be recognized within 12 months.
Outlook, commentary, risks and unusual items
- Management’s long-term financial targets are low-single-digit annual revenue growth, 10–20 basis points of annual adjusted EBITDA margin expansion, and return of capital exceeding operating needs. These are targets over time, not quarter-specific guidance.
- On September 9, 2018, SAIC agreed to acquire Engility in a stock-for-stock transaction at 0.450 SAIC shares per Engility share. The estimated transaction value was $2.5 billion, including Engility net debt. A committed $1.05 billion seven-year secured term loan is intended to refinance Engility debt. Closing was expected in fiscal Q4 2019 and remained subject to shareholder and regulatory approvals.
- On August 27, 2018, the Marine Corps issued a 90-day stop-work order on portions of the Assault Amphibious Vehicle low-rate initial production program. SAIC had approximately $42 million in purchase commitments for a portion not yet awarded and had paid $6 million. If work is not resumed or awarded as planned, some costs may not be recoverable and profitability could be materially affected.
- Government budget uncertainty, competitive bidding and pricing pressure are key business risks. Government audits of indirect costs remained open for fiscal 2012 and later years; SAIC recorded a $43 million liability for potential customer refunds. The filing also describes routine legal matters and government reviews, which management did not expect to materially adversely affect results based on information then available.
- SAIC adopted ASC 606 on February 3, 2018, using the modified retrospective method, increasing opening retained earnings by $3 million. Adoption reduced reported six-month revenue by $12 million versus prior guidance, with no net effect on operating income; the quarter’s reported operating income was $1 million higher than under prior guidance. Management said Tax Act accounting remained provisional in specified areas.
- Management said disclosure controls were effective at quarter-end and that it had remediated a previously identified material weakness involving controls for contracts with multiple customer funding sources.
Most important facts for investors to verify
- Whether the AAV stop-work order was lifted, the affected production was awarded, and SAIC recovered costs tied to its vendor commitments.
- Engility merger approval and closing status, financing availability, integration costs, and realization of expected benefits.
- Future contract performance, margin sustainability, bookings and backlog conversion, particularly amid government budget and competitive pressures.
- Cash conversion and working-capital requirements, alongside debt repayment, capital deployment and covenant compliance.
- Outcomes of government contract audits and any changes in the $43 million refund reserve or other contingencies.