Science Applications International Corp annual report, FY2015

Science Applications International Corporation (SAIC) — Form 10-K

Reporting period: Fiscal year ended January 30, 2015 (fiscal 2015). Although the request refers to 2014 Q4, this filing reports the full fiscal year and includes unaudited fourth-quarter results. SAIC, a U.S. government technical, engineering and IT services provider, had operated as an independent public company since its September 2013 spin-off from Leidos.

Financial performance and position

Metric	Fiscal 2015	Prior comparable period
Total revenue	$3.885 billion	$4.121 billion; down 6%
Operating income	$240 million	$183 million
Operating margin	6.3%	4.6%
Net income	$141 million	$113 million
Diluted EPS	$2.91	$2.27
Operating cash flow	$277 million	$183 million

• Revenue included $50 million of work performed by former Parent, recorded at cost; revenue excluding that work was $3.835 billion, down 5% from $4.017 billion.
• Cash and cash equivalents were $301 million, versus $254 million. Total debt was $489 million, including $32 million current and $457 million long-term; the $200 million revolving facility was undrawn. The company reported compliance with its credit covenants.
• Operating cash flow increased 51%, attributed to higher net income, $29 million utilization of prepaid income taxes, and stronger customer collections. Investing cash outflow was $22 million; financing cash outflow was $208 million, including dividends, repurchases and debt principal payments.
• Total backlog was $6.172 billion, down from $6.651 billion; funded backlog was $1.659 billion and negotiated unfunded backlog $4.513 billion. Net bookings were an estimated $3.4 billion, versus $3.0 billion.
• Fiscal 2015 quarterly revenue was $977 million, $952 million, $1.004 billion and $952 million; fourth-quarter operating income was $59 million and net income $36 million.

Material changes and management commentary

• The revenue decline moderated from the prior year. Lower revenue reflected the DGS recompete loss, reduced in-theater logistics activity, lower DoD subcontract and materials revenue, and completion of an Army Reserve and National Guard program. New awards and higher supply-chain materials volume partly offset the decreases.
• Operating income and margin improved as separation and restructuring charges fell to zero from $58 million, and contract execution produced net favorable estimate changes. Net favorable contract estimate adjustments contributed $11 million to operating income in fiscal 2015, compared with net unfavorable adjustments of $4 million in fiscal 2014.
• Revenue mix shifted toward employee labor: labor-related revenue was 45% of total, subcontractor revenue 32%, and materials revenue 23%. Contract revenue mix was 37% cost-reimbursement, 29% time-and-materials and 34% firm-fixed-price.
• Management’s stated long-term financial targets were low-single-digit organic revenue growth, annual operating-margin expansion of 10–20 basis points, deployment of capital exceeding operating needs, and leverage appropriate to investment needs and cash generation. These are targets, not a fiscal 2016 forecast.

Outlook, risks, contingencies and unusual items

• SAIC agreed in March 2015 to acquire Scitor, a provider primarily to the intelligence community, for $790 million, subject to adjustment and closing conditions. The expected funding included approximately $670 million of additional secured debt and cash on hand. Closing was expected in the second quarter of fiscal 2016.
• The amended credit agreement provides for the acquisition financing and makes existing facilities secured upon closing. It imposes leverage tests, mandatory excess-cash-flow prepayments and restrictions affecting dividends, repurchases and other actions. Post-closing senior secured leverage limits were set at 4.00-to-1.00 through July 31, 2016 and 3.75-to-1.00 thereafter.
• Business is highly concentrated in government: 97% of fiscal 2015 revenue came from the U.S. government, including 28% from the Army and 20% from the Navy. Budget reductions, sequestration, shutdowns, funding delays, contract protests, competition and contract cancellations could reduce awards and revenue.
• Government contract audits and reviews may result in cost disallowances, refunds, penalties or contracting restrictions. SAIC recorded a $17 million liability for estimated customer refunds related to indirect-cost audits and compliance; audits for fiscal 2008 and later had not been completed. Outcomes remain uncertain.
• SAIC committed to follow obligations under the former Parent’s Army administrative agreement, including retaining an independent monitor and maintaining a contractor responsibility program. The agreement was expected to continue through August 2017, subject to possible earlier termination. The former Parent’s CityTime deferred prosecution agreement expired March 14, 2015, and the court disposed of the charge against former Parent on March 16, 2015.
• SAIC disclosed ongoing legal proceedings and routine investigations but stated that management did not expect the identified claims and lawsuits, based on then-current information, to have a material adverse effect. A BCTM program fee agreement in principle had not yet been formalized; the related receivable was approximately $2 million.
• Other material risks include cybersecurity and sensitive-data breaches, difficulty recruiting cleared personnel, fixed-price cost overruns, uncertain realization of unfunded backlog, and the integration and financing risks of the Scitor transaction. The company reported effective disclosure controls and effective internal control over financial reporting; the auditor issued unqualified opinions.

Important facts for investors to verify

• Progress and final terms of the Scitor acquisition, financing, leverage, covenant headroom and integration costs.
• Whether backlog converts to funded task orders and revenue, particularly protested awards and the HITS procurement, and whether bookings remain sufficient to offset contract run-off.
• Final outcomes of government audits, including the basis and adequacy of the $17 million reserve and any cost adjustments shared with former Parent.
• Revenue, margin and cash-flow trends as government budget pressures and contract mix evolve; assess the contribution and sustainability of favorable contract estimate changes.
• Ability to sustain dividends and repurchases under post-acquisition credit restrictions and cash requirements.
• Completion of remaining contract novations and continuing compliance-monitor obligations tied to the former Parent’s administrative agreement.