Science Applications International Corp quarterly report, Q2 FY2020

Business context and reporting period

Science Applications International Corporation (SAIC) provides technical, engineering and IT services primarily to the U.S. government. This Form 10-Q covers the quarter and six months ended August 2, 2019, the second quarter of fiscal 2020. Comparisons are to the periods ended August 3, 2018. The January 2019 Engility acquisition materially increased SAIC’s scale and affects year-over-year comparisons.

Financial performance and liquidity

Quarterly revenue growth was primarily acquisition-related; excluding acquired revenue, revenue was consistent with the prior-year quarter. For the six-month period, revenue excluding acquired revenue declined 1.4%, reflecting prior-year humanitarian-relief materials and acquisition-related dis-synergies. Six-month net income and operating cash flow were $113 million and $273 million, respectively, before the $1 million non-controlling interest allocation.

Cost of revenues was 88.4% of revenue for the quarter and 88.6% for six months, versus 90.0% and 90.7% in the comparable periods. GAAP operating margin was lower year over year, partly due to Engility-related amortization and integration costs. Adjusted EBITDA margin, a non-GAAP measure, was 8.4% for both the quarter and six months, versus 7.5% and 7.0%, respectively.

At August 2, cash and cash equivalents were $179 million, with $9 million restricted cash. Total debt was $2.060 billion principal ($2.038 billion net carrying value); $151 million was classified current, including $100 million outstanding on the revolver. The $400 million revolving facility had $300 million available. SAIC reported compliance with debt covenants and repaid $50 million on the revolver after quarter-end. Operating cash flow improved from $76 million to $273 million for the six-month comparison. Investing activities used $37 million and financing activities used $294 million, including debt prepayments, dividends and share repurchases.

Backlog was $13.922 billion, including $2.593 billion funded. Remaining performance obligations were $4.2 billion; SAIC expected to recognize about 80% within 12 months and 90% within 24 months. The company paid $0.74 per share in dividends during the six months and repurchased $195 million of stock, including shares withheld for taxes on equity awards.

Material changes versus prior comparable periods

• Engility drove most of the reported revenue increase and added debt, intangible-asset amortization and integration costs.
• Net income attributable to common stockholders rose 16% for the quarter and 14% for six months, while diluted EPS fell to $0.96 from $1.13 and to $1.88 from $2.26, respectively. The filing’s weighted-average share counts reflect the Engility stock issuance.
• Six-month operating cash flow increased by $197 million, attributed to Engility operations, strong customer collections and collections following the prior-year federal shutdown.
• Interest-rate swap fair-value liabilities increased to $83 million from $24 million at February 1, 2019; six-month other comprehensive loss was $45 million, largely reflecting derivative changes.
• SAIC adopted the new lease standard, recognizing $184 million of operating lease right-of-use assets and $198 million of lease liabilities at quarter-end; adoption had no material income-statement or cash-flow impact.

Outlook, commentary, risks and unusual items

The filing provides no specific numerical earnings or revenue guidance. Management cited opportunities from increased federal spending caps but noted that fiscal 2020 appropriations had not passed; continuing resolutions and a potential shutdown remained possible. SAIC said it expected to fund operations and capital needs with cash, operating cash flow and, if needed, its revolver.

Key risks include dependence on U.S. government spending, competitive bidding and pricing pressure, contract execution and cost-estimate changes, and government audits. DCAA indirect-cost audits remained open for fiscal 2011 and later; SAIC recorded a $68 million liability for estimated potential customer refunds. The company was negotiating recovery of costs following termination for convenience of its Marine Corps Assault Amphibious Vehicle program. Management did not expect ordinary-course legal matters to have a material adverse effect.

Contract estimate changes increased operating income by $4 million for the quarter and $12 million for six months in fiscal 2020. Acquisition and integration costs were $8 million and $18 million, respectively. The purchase-price allocation for Engility remained preliminary and could change, including goodwill adjustments. Management reported disclosure controls effective and no material changes in internal control during the quarter.

Important facts for investors to verify

• How much future growth and margin improvement is organic versus attributable to Engility, and whether expected synergies are being realized.
• The effect of federal appropriations, continuing resolutions or a shutdown on contract awards, funding and collections.
• Progress on Engility purchase accounting, integration costs and any changes to acquired assets, liabilities or goodwill.
• Outcomes of open government audits and the adequacy of the $68 million estimated refund liability; status of the AAV termination cost recovery.
• Debt repayment pace, interest-rate exposure and cash needs, including the impact of share repurchases and dividends.