Science Applications International Corporation — Q3 FY2015 Form 10-Q
Reporting period: Third quarter ended October 31, 2014; comparisons are with the quarter ended November 1, 2013. Nine-month comparisons cover the corresponding year-to-date periods. Amounts are in millions except per-share data. SAIC provides technical, engineering and enterprise IT services, primarily to the U.S. government; it reports one aggregated segment. The prior-year comparison includes pre-spin-off combined results and former-parent activity, which may not be directly comparable to standalone results.
Financial performance and liquidity
| Metric | Q3 FY2015 | Q3 FY2014 | Nine months FY2015 | Nine months FY2014 |
|---|---|---|---|---|
| Total revenue | $1,004 | $1,007 | $2,933 | $3,180 |
| Operating income | $63 | $37 | $181 | $127 |
| Operating margin | 6.3% | 3.8% | 6.3% | 4.1% |
| Net income | $37 | $22 | $105 | $80 |
| Diluted EPS | $0.77 | $0.44 | $2.15 | $1.60 |
| Operating cash flow | $82 | $10 | $181 | $58 |
Q3 revenue excluding $11 million of work performed by the former parent was $993 million, up 2% from $974 million. Nine-month revenue excluding former-parent work was $2,894 million, down 6% from $3,086 million. Management’s non-GAAP operating margin excluding separation and restructuring costs was 6.3% versus 6.2% for Q3, and 6.3% versus 6.0% year to date. No separation or restructuring expenses were recorded in FY2015; the prior-year periods included $23 million and $57 million, respectively. Nine-month results also included $2 million of severance expense. Favorable contract-estimate changes added $4 million to Q3 operating income and $9 million year to date.
Nine-month investing cash flow was negative $15 million, including $15 million of capital expenditures; financing cash flow was negative $166 million. Cash was $254 million at October 31, 2014, unchanged from January 31. Total debt and capital lease obligations were $495 million ($29 million current), versus $502 million at January 31; cash less debt implies net debt of about $241 million. The term loan’s stated/effective rate was 1.94%, and interest-rate swaps hedge its floating-rate exposure. A $200 million revolving credit facility was undrawn; the company reported compliance with credit covenants. Current assets were $965 million and current liabilities $586 million (current ratio about 1.65). These balance-sheet figures are point-in-time values.
Dividends were $0.28 per share for the quarter and $0.84 per share year to date. The company repurchased approximately 3 million shares year to date; equity records show $120 million of repurchases, and cash flows show $123 million for repurchases and shares withheld for taxes. Funded backlog was $2.036 billion and negotiated unfunded backlog $4.426 billion, totaling $6.462 billion, down from $6.651 billion at January 31. Net bookings were approximately $1.0 billion for Q3 and $2.7 billion for nine months.
Material changes and management commentary
- Q3 total revenue was essentially flat, while nine-month revenue declined 8%. Q3 growth in supply-chain materials and recently awarded programs was largely offset by the loss of the DISN Global Solutions (DGS) program, lower logistics activity from in-theater force drawdown, and DoD funding delays.
- Nine-month revenue declined primarily due to the DGS program loss ($97 million), lower logistics activity ($55 million), completion of an Army Reserve and National Guard program ($44 million), and lower DoD materials and subcontract revenue ($42 million); growth on previously awarded contracts partly offset these declines ($79 million).
- Operating income rose, chiefly because prior-year separation and restructuring charges did not recur. Nine-month operating income also benefited from favorable contract estimates, partly offset by lower revenue volume.
- Nine-month operating cash flow improved by $123 million year over year. Management cited prior-year government-shutdown collection delays, separation-related billing interruptions and separation costs, as well as higher net income and use of prepaid income taxes.
- Management said government budget pressure, defense-spending reductions, shutdowns, sequestration and competitive bidding may pressure demand and pricing. It also cited the company’s customer relationships, technical capabilities and cost structure as competitive strengths. No quantitative earnings or revenue guidance was provided.
Risks, contingencies and unusual items
- More than 90% of FY2014 revenue came from U.S. government contracts and about 70% from DoD contracts. Scope reductions, cancellations, funding delays and intense competition could affect results.
- Spin-off-related bid protests pose a specific risk. A competitor’s protest led GAO to sustain a challenge to a NASA award valued at approximately $1.8 billion; NASA terminated the contract and is conducting a new solicitation in which SAIC expects to compete. The company also reported other protests and reliance on contract vehicles whose access arrangements were transitioning after September 30, 2014.
- Government audits and reviews may result in cost disallowances, penalties or suspension/debarment. SAIC recorded a $20 million liability for estimated customer refunds relating to contract-cost audits and compliance matters. The filing describes an allocation with the former parent for certain unknown pre-separation and corporate contingent losses exceeding a $50 million aggregate threshold.
- A BCTM program terminated by DoD remains subject to an agreement in principle with the prime contractor and DoD, but no formal contract modification had been received; the related receivable was approximately $2 million.
- Routine legal claims were not expected by management to materially affect financial position, operations or cash flow. SAIC stated it had no liability for uncertain tax positions, while noting tax authorities could assess additional amounts. Its independent monitor and contractor-responsibility obligations related to former-parent matters continue.
- Contract-estimate revisions, customer funding and cancellation decisions, backlog conversion, and the effect of separation-related costs remain important uncertainties. The filing also notes adoption of the new revenue-recognition standard was not yet assessed.
Investor verification priorities
- Track funded backlog conversion, new awards/bookings, and the revenue impact of the DGS loss, contract completions, funding delays and transition away from former-parent contract vehicles.
- Monitor the NASA re-solicitation and other spin-off-related bid protests, plus completion of contract novations.
- Assess whether cash generation remains strong after working-capital movements, capital spending, dividends and repurchases; verify debt repayment and covenant headroom.
- Review outcomes of government contract audits and the adequacy of the $20 million refund reserve, as well as any developments on the BCTM contract modification.
- Distinguish underlying operating performance from the benefit of nonrecurring prior-year separation costs and favorable contract-estimate changes.