Business context and reporting period
Science Applications International Corporation (SAIC) provides technical, engineering, and enterprise IT services, primarily to U.S. government customers. This unaudited Form 10-Q covers the 13 weeks ended May 5, 2017 (fiscal 2018 first quarter); the comparable quarter ended May 6, 2016 had 14 weeks. More than 95% of fiscal 2017 revenue came from U.S. government contracts.
Key financial metrics
| Metric | Quarter ended May 5, 2017 | Comparable prior period |
|---|---|---|
| Revenue | $1.103 billion | $1.215 billion |
| Operating income / margin | $63 million / 5.7% | $66 million / 5.4% |
| Net income | $49 million | $33 million |
| Diluted EPS | $1.08 | $0.71 |
| Operating cash flow | $88 million | $35 million |
| Capital expenditures | $4 million | $4 million |
| Cash and cash equivalents at period end | $207 million | $210 million at February 3, 2017 |
| Debt at period end | $1.051 billion principal; $1.038 billion net of issuance costs | $1.060 billion principal; $1.047 billion net at February 3, 2017 |
Current assets were $917 million and current liabilities $647 million. The company had a $200 million undrawn revolving credit facility and reported compliance with its credit-facility covenants. Cash, cash equivalents, and restricted cash totaled $214 million at May 5, 2017.
Material changes versus the prior comparable period
- Reported revenue declined 9%. The prior-year quarter included an additional week, estimated by SAIC to account for $88 million of revenue. After adjustments for that week and former-parent revenue, internal revenue contracted 1.8%, or $20 million, primarily from contract losses and government budget and funding constraints.
- Operating income fell 5%, but operating margin rose to 5.7% from 5.4%, as lower SG&A more than offset higher contract estimate charges. Cost of revenue was 91.3% of revenue, compared with 90.4%.
- Net income increased mainly because adoption of share-based payment accounting rules produced a $16 million tax benefit. The effective tax rate was 5.9%, versus 36.6% a year earlier; this benefit is not a measure of underlying operating growth.
- Operating cash flow increased by $53 million, reflecting, among other factors, the prior-year extra payroll week, the current-year $16 million excess tax benefit, and prior-year working-capital investment.
- Backlog was $8.196 billion, up from $8.020 billion at February 3, 2017; funded backlog was $1.790 billion and negotiated unfunded backlog $6.406 billion. Net bookings were an estimated $1.3 billion, the same as in the prior-year quarter.
Outlook, commentary, risks, and unusual items
Management’s long-term targets are low-single-digit annual internal revenue growth, 10–20 basis points of annual margin expansion, and return of capital exceeding operating needs. These are long-term targets, not quarterly guidance. SAIC said it expects to fund operations and commitments with cash, operating cash flow, and, if needed, its revolving facility; it believes its resources are adequate for short- and long-term needs.
Management cited U.S. government spending priorities, budget pressures, competitive bidding, and pricing pressure as important business factors. Government customers may change scope or cancel contracts. Contract estimate changes reduced operating income by $5 million ($0.10 per diluted share) in the quarter, compared with a $6 million increase ($0.08 per diluted share) in the prior-year quarter; current-period unfavorable estimates were driven largely by costs to meet testing and mission requirements on U.S. Marine Corps platform integration programs.
SAIC reported $39 million in reserves for potential customer refunds from contract-cost audits and Cost Accounting Standards matters. DCAA indirect-cost audits remain open for fiscal 2011 and later years; adverse findings could result in cost disallowances, penalties, or other consequences. The company expects acceptance of its final termination proposal for the BCTM program in the second half of fiscal 2018 and reported an approximately $2 million receivable on that contract. Management said ordinary-course legal proceedings were not expected to have a material adverse effect. Other disclosed commitments included $9 million of letters of credit and $17 million of surety bonds.
Other notable items included a $7 million gain from reversal of a facility vacancy reserve and $65 million of cash used for share repurchases or shares withheld for taxes on equity awards. The board declared a $0.31-per-share dividend payable July 28, 2017. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether revenue and backlog convert into funded work, given the reported contract losses and government funding constraints.
- Whether contract cost estimates, particularly on Marine Corps programs, stabilize or lead to further margin changes.
- How much of the quarter’s net-income and cash-flow improvement reflects the nonrecurring $16 million share-based compensation tax benefit.
- Outcomes of open indirect-cost audits, the $39 million refund reserve, and the BCTM termination settlement.
- Debt reduction, covenant headroom, and capital returns relative to cash generation and the company’s $150 million target minimum cash balance.