Science Applications International Corporation — Q2 FY2017 Form 10-Q
Business context and reporting period. SAIC provides technical, engineering and enterprise IT services, primarily to the U.S. government. The quarter ended August 5, 2016; the six-month period is compared with the six months ended July 31, 2015. Each second quarter comprised 13 weeks, but FY2017’s first quarter had an additional week, affecting six-month comparisons. More than 95% of FY2016 revenue came from U.S. government contracts and more than 60% from the Department of Defense.
Financial performance
Amounts are in U.S. dollars; financial statement amounts are in millions except per-share data.
| Metric | Three months ended Aug. 5, 2016 | Prior-year quarter | Six months ended Aug. 5, 2016 | Prior-year six months |
|---|---|---|---|---|
| Revenue | $1,095 | $1,099 | $2,310 | $2,108 |
| Operating income | $70 | $52 | $136 | $109 |
| Operating margin | 6.4% | 4.7% | 5.9% | 5.2% |
| Net income | $37 | $22 | $70 | $55 |
| Diluted EPS | $0.81 | $0.46 | $1.52 | $1.15 |
| Operating cash flow | $23 | $21 | $58 | $50 |
- Six-month revenue rose 10%, substantially reflecting Scitor revenue and the extra fiscal week; excluding Scitor’s prior-year pre-acquisition revenue, former-parent work and the extra week, internal revenue contracted 1.1%. The comparable quarter’s internal revenue grew 0.4%.
- Quarterly operating margin excluding acquisition and integration costs was 6.7%, versus 5.8%; six-month margin on that basis was 6.3%, versus 5.9%. Quarterly adjusted EBITDA margin was 7.8%, versus 7.5%; six-month adjusted EBITDA margin was 7.4%, versus 7.0%.
- Six-month diluted EPS increased to $1.52 from $1.15. The effective tax rate was 36.4%, compared with 40.3%, primarily reflecting prior-year nondeductible acquisition costs and current-year tax deductions and credits.
- Cash and equivalents were $115 at quarter-end, down from $195 at January 29, 2016. Current assets were $914 and current liabilities $681. Six-month cash flows were $58 from operations, $5 used in investing and $133 used in financing; financing outflows included $88 of stock repurchases and withholding-related share purchases, $27 of dividends and $26 of debt principal payments.
- Debt totaled $1,061 principal ($1,045 net of issuance costs), including $61 current. The $200 revolving facility was undrawn; the company reported compliance with its credit covenants. Debt principal declined from $1,087 at fiscal year-end.
Material changes and operating developments
- Quarterly revenue was nearly flat: new programs contributed $64, offset by lower supply-chain materials volume, reduced Assault Amphibious Vehicle activity and other program declines. Six-month revenue growth also reflected $88 from the extra week and $110 from newly awarded programs; supply-chain materials revenue fell $59 year over year.
- Quarterly operating income improved primarily from lower SG&A and acquisition/integration costs. Six-month improvement also reflected Scitor, the extra week and more favorable contract estimate changes.
- Backlog increased to $7.471 billion from $7.198 billion at January 29, 2016, comprising $2.011 billion funded and $5.460 billion negotiated unfunded. Net bookings were estimated at $1.3 billion for the quarter and $2.6 billion for six months. The EAST 2 award was included after a protest was resolved in SAIC’s favor.
- In an August 23, 2016 post-quarter amendment, SAIC extended the Term Loan A and revolving facility maturities to August 2021, shifted $132 million of Term Loan B principal to Term Loan A, reduced interest margins, reset Term Loan A amortization and eliminated scheduled quarterly Term Loan B principal payments.
Outlook, risks and contingencies
- Management’s long-term targets are low-single-digit internal revenue growth, annual margin expansion of 10–20 basis points, and returning capital in excess of operating needs. These are targets, not specific near-term guidance; the filing gives no clear numerical full-year revenue or earnings forecast.
- Management expects to fund working capital and capital needs with cash, operating cash flow and, if needed, revolving borrowings. Its target average minimum cash balance is $150 million; excess cash may go to dividends, repurchases, debt repayment or acquisitions, subject to restrictions.
- Government spending and budget decisions, especially defense spending, competitive bidding and pricing pressure, contract awards and cancellations, and execution of long-term contracts are material risks. SAIC also cited delays in awards and work shifting to small-business set-asides as factors weighing on legacy Scitor revenue.
- Scitor’s intelligence-community/Air Force reporting unit had only about 4% ($30 million) fair-value headroom over carrying value in the FY2016 annual goodwill test. Continued underperformance or a higher cost of capital could trigger impairment testing and possibly a charge.
- Government audits of indirect costs remained open for fiscal 2011 and later years. SAIC recorded a $36 million liability for estimated potential customer refunds; adverse audit or compliance findings could lead to additional refunds, penalties or other consequences. The filing also identifies a $2 million BCTM program receivable while a formal contract modification remained outstanding, and $8 million in letters of credit and $18 million in surety bonds.
- Management said routine legal matters were not expected to have a material adverse effect. It reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether reported growth and margins persist after adjusting for Scitor, the extra fiscal week, contract mix and cumulative contract-estimate changes; estimate revisions added $13 million to six-month operating income.
- Scitor’s revenue and operating performance, and whether its limited goodwill headroom warrants an interim impairment test.
- Cash conversion, liquidity and compliance with debt covenants after the amendment, including the effect of reduced cash and continued capital returns.
- Backlog conversion and funding, particularly negotiated unfunded backlog and the timing of government awards and task orders.
- Outcomes of government audits, the adequacy of the $36 million reserve, and resolution of the BCTM receivable.