Business context and reporting period
Science Applications International Corporation (SAIC) filed this unaudited Form 10-Q for the quarter and six months ended August 4, 2017, the second quarter of fiscal 2018. SAIC provides technical, engineering and enterprise IT services, primarily to U.S. government customers; more than 95% of fiscal 2017 revenue came from U.S. government contracts. Following management reporting changes, the company reports one operating and reportable segment.
Key financial metrics
| Metric | Three months ended Aug. 4, 2017 | Six months ended Aug. 4, 2017 |
|---|---|---|
| Revenue | $1.078 billion | $2.181 billion |
| Operating income / margin | $59 million / 5.5% | $122 million / 5.6% |
| Net income | $36 million | $85 million |
| Diluted EPS | $0.80 | $1.88 |
| Operating cash flow | Cash used of $35 million | Cash provided of $53 million |
Six-month capital expenditures were $7 million. Cash, cash equivalents and restricted cash totaled $148 million at quarter-end ($140 million unrestricted cash). Debt was $1.064 billion net of issuance costs, including $58 million current; $25 million borrowed on the revolver shortly before quarter-end was repaid August 18. The $200 million revolving facility had $175 million available at August 4, and SAIC reported compliance with its debt covenants. The company declared and paid $0.31 per share in quarterly dividends.
Material changes versus prior comparable periods
- Revenue declined 2% in the quarter and 6% for the six months year over year. The six-month comparison included an estimated $88 million from an extra week in the prior-year period; adjusted internal revenue contracted 1.4% for the quarter and 1.6% for the six months.
- Operating margin fell from 6.4% to 5.5% for the quarter and from 5.9% to 5.6% for the six months. Management cited less favorable contract-estimate adjustments, lower supply-chain contract profitability, and higher severance or facility costs. Six-month unfavorable estimate changes were associated in part with U.S. Marine Corps platform-program testing and mission requirements.
- Net income was down $1 million for the quarter but up $15 million for the six months. Lower taxes contributed materially: adoption of share-based compensation accounting produced tax benefits of $4 million for the quarter and $20 million for the six months. Six-month effective tax rate was 15.8%, versus 36.4% a year earlier.
- Six-month operating cash flow decreased $5 million to $53 million. Reduced customer collections were a key headwind, including a government payment-system issue that delayed $45 million; the filing also cites lower collections overall. Quarter operating cash flow was negative $35 million versus positive $23 million a year earlier.
- Total backlog rose to $9.241 billion from $8.020 billion at fiscal year-end, mostly from large awards. Funded backlog was $1.805 billion; negotiated unfunded backlog was $7.436 billion.
Outlook, risks, contingencies and unusual items
Management’s long-term financial targets, expected on average over time, are low-single-digit annual internal revenue growth, annual margin expansion of 10–20 basis points, and returning capital in excess of operating needs. These are targets, not a specific quarterly or full-year forecast. Management expects to fund working capital and other needs with cash, future operating cash flows and, if needed, revolving-credit borrowings; it believes resources are adequate for short- and long-term needs, while noting financing availability depends on market and company factors.
- Government budget changes, shutdowns, sequestration, debt-ceiling issues, competitive bidding and pricing pressure could affect results. Government customers may modify or cancel contracts; much of backlog, especially unfunded amounts and future IDIQ task orders, is not assured revenue.
- SAIC committed to approximately $50 million of long-lead materials for an anticipated Marine Corps Assault Amphibious Vehicle low-rate initial production phase before award. A subsequent partial award reduced the commitment for the not-yet-awarded portion to approximately $30 million. Failure to receive the remaining award could impair profitability.
- Government audits of indirect costs remained open for fiscal 2012 and later years. SAIC recorded a $39 million liability for estimated customer refunds or adjustments. Audit outcomes could exceed reserves and adversely affect profitability. Management said routine legal claims were not expected to have a material adverse effect.
- The Department of Defense accepted the final termination proposal for the BCTM program in July 2017; approximately $2 million remained receivable, with administrative closeout expected in the second half of fiscal 2018.
- Contract estimate changes increased operating income by $1 million in the quarter but reduced it by $4 million for the six months; the prior-year comparable changes increased operating income by $7 million and $13 million, respectively.
- SAIC is preparing for revenue-recognition standard adoption in fiscal 2019 and has not determined its impact. It adopted new share-based compensation rules in fiscal 2018, affecting tax expense and cash-flow presentation.
Important facts for investors to verify
- Whether delayed government collections normalize and improve operating cash flow and receivables.
- Whether margins recover as contract cost estimates, Marine Corps program costs and supply-chain contract profitability develop.
- How much of the large unfunded backlog converts to funded task orders and revenue, and the pace of backlog execution.
- Whether SAIC receives the remaining Marine Corps production award and can recover its approximately $30 million residual materials commitment.
- Potential outcomes of government audits relative to the $39 million reserve, and compliance with debt covenants and leverage limits.
- The extent to which earnings growth depends on share-based compensation tax benefits rather than operating performance.