Science Applications International Corporation — Q1 FY2017 Form 10-Q
Reporting period: The quarter ended May 6, 2016. SAIC provides technical, engineering, and enterprise IT services, primarily to U.S. government customers, and reports as one segment. This quarter comprised 14 weeks versus 13 weeks in the prior-year quarter; the extra week contributed an estimated $88 million of revenue.
Financial performance
| Metric | Q1 FY2017 | Prior-year quarter |
|---|---|---|
| Revenue | $1.215 billion | $1.009 billion |
| Operating income / margin | $66 million / 5.4% | $57 million / 5.6% |
| Operating margin excluding acquisition and integration costs | 6.0% | 5.9% |
| Net income | $33 million | $33 million |
| Diluted EPS | $0.71 | $0.69 |
| Operating cash flow | $35 million | $29 million |
| Adjusted EBITDA, a non-GAAP measure | $86 million; 7.1% of revenue | $65 million; 6.4% of revenue |
- Revenue rose 20% as reported, mainly from the Scitor acquisition and the extra week. On SAIC’s adjusted basis, internal revenue contracted $36 million, or 3.1%.
- Gross profit was $117 million (revenue less cost of revenues of $1.098 billion); cost of revenues was $923 million in the prior-year quarter. The filing does not present gross margin as a stated metric.
- Interest expense rose to $14 million from $4 million, largely reflecting borrowing for Scitor. Income before taxes was $52 million versus $53 million; the effective tax rate was 36.6% versus 38.0%.
- Cash from operations was partly offset by $73 million of financing outflows, including $14 million in dividends, $15 million of debt principal payments, and $47 million of share repurchases or shares withheld for taxes. Cash declined $41 million to $154 million.
Balance sheet and capital
- At May 6, 2016, total assets were $2.134 billion, current assets $974 million, and current liabilities $730 million.
- Debt was $1.072 billion principal, or $1.056 billion net of unamortized issuance costs; $57 million was current. Debt principal was down from $1.087 billion at January 29, 2016.
- The company had a $200 million revolving facility with no outstanding draws. It reported compliance with credit-facility covenants. Its stated target is an average minimum cash balance of $150 million.
- Quarterly dividend was $0.31 per share, up from $0.28. The board declared another $0.31 dividend payable July 29, 2016.
Changes, outlook, and risks
- Revenue growth also reflected $42 million from newly awarded programs; these were partly offset by a $41 million reduction in supply-chain volume following a contract loss. Management cited delayed awards and work transitioning to small-business set-aside contracts as factors in legacy Scitor revenue contraction.
- Management’s long-term targets are low-single-digit internal revenue growth, annual margin expansion of 10–20 basis points, and return of capital above operating needs. These are targets, not specific quarterly guidance. Backlog was $7.235 billion, including $2.096 billion funded; net bookings were an estimated $1.3 billion for the quarter.
- Scitor contributed a higher proportion of labor-related and cost-reimbursement work. Management said favorable contract mix and contract-estimate revisions supported profitability. Changes in contract estimates increased operating income by $6 million, or $0.08 per diluted share, versus $1 million, or $0.01 per diluted share, a year earlier.
- Government spending and procurement decisions are key risks: over 95% of fiscal 2016 revenue came from U.S. government contracts and over 60% from DoD contracts. Management also cited competition, pricing pressure, budget reductions, shutdowns, and debt-ceiling issues.
- Government audits remain open for fiscal 2011 and later years. SAIC recorded a $35 million liability for estimated customer refunds tied to contract-cost audits and compliance matters; adverse audit findings beyond reserves could affect results. Routine legal matters were not expected by management to have a material adverse effect.
- Scitor’s new reporting unit had only about 4% ($30 million) of fair-value headroom over carrying value in the latest impairment test. Continued underperformance could trigger an interim goodwill test. Scitor’s historical business contracted in the quarter.
- Unusual and other items: Q1 included $7 million of Scitor integration costs, mainly lease-exit and related costs, and $2 million of executive severance expense. The filing also reports a CFO departure arrangement: CFO John Hartley was to remain in a consulting role through October 7, 2016, with a $1.287 million severance payment subject to the agreement’s conditions.
- The company said there were no material changes in risk factors or market-risk disclosures, and disclosure controls were effective as of May 6, 2016.
Important facts for investors to verify
- How much of reported revenue and adjusted EBITDA growth is sustainable after separating Scitor, the extra week, and contract-estimate effects.
- Whether the legacy Scitor business stabilizes and whether its goodwill headroom remains adequate.
- Outcomes of open government audits and whether the $35 million reserve adequately covers potential adjustments.
- Cash conversion and working-capital needs, including the effect of contract investments and the company’s capital-return plans on cash and leverage.
- Whether backlog converts to funded work and revenue, given unfunded awards, task-order renewals, protests, and government cancellation rights.