Science Applications International Corporation (SAIC) — Form 10-Q Summary
Reporting period: First quarter of fiscal 2019, the three months ended May 4, 2018. Comparisons are with the three months ended May 5, 2017 unless otherwise noted. SAIC provides technical, engineering and enterprise IT services, primarily to the U.S. government, and reports as one segment.
Financial results and liquidity
| Metric | Q1 FY2019 | Q1 FY2018 |
|---|---|---|
| Revenue | $1.175 billion | $1.103 billion |
| Operating income / margin | $66 million / 5.6% | $63 million / 5.7% |
| Net income | $49 million | $49 million |
| Diluted EPS | $1.13 | $1.08 |
| Operating cash flow | $88 million | $88 million |
| EBITDA / EBITDA margin (non-GAAP) | $76 million / 6.5% | $73 million / 6.6% |
- Revenue rose 6.5%, while operating income increased 5%. Net income was unchanged; higher operating income was offset by a lower tax deduction for stock-based compensation. The effective tax rate was 10.3%, versus 5.9%.
- Cost of revenue was 91.4% of revenue, versus 91.3%; SG&A was $35 million, versus $33 million. Higher supply-chain materials content contributed to lower operating and EBITDA margins.
- Operating cash flow was flat year over year. Investing activities used $6 million, mainly for capital expenditures; financing activities used $74 million, including $14 million of dividends and $53 million for stock repurchases or equity-award tax withholding. Cash, cash equivalents and restricted cash increased $8 million to $160 million.
- At May 4, cash and cash equivalents were $152 million; current assets were $930 million and current liabilities $695 million. Debt was $1.016 billion net of issuance costs, including $45 million current. The $200 million revolving facility had no borrowings. SAIC reported compliance with its credit-facility covenants.
Business trends and material changes
- Revenue growth reflected $47 million from new contracts, primarily supporting NASA and the Environmental Protection Agency, and $64 million of increased supply-chain orders; these gains were partly offset by $39 million from completed contracts and other portfolio declines.
- Cost mix shifted toward supply-chain materials, which rose to 16% of cost of revenue from 12%; labor-related costs fell to 46% from 48%. Management noted that programs with more SAIC labor are generally more profitable.
- Net bookings were approximately $1.0 billion, compared with $1.3 billion in the prior-year quarter. Backlog was $10.043 billion, versus $10.227 billion at February 2, 2018, comprising $1.898 billion funded and $8.145 billion negotiated unfunded.
- Remaining performance obligations were $0.9 billion; SAIC expected to recognize approximately 75% within 12 months and 90% within 24 months. These obligations exclude certain short-duration, as-invoiced and variable-consideration contracts.
- SAIC adopted ASC 606 on February 3, 2018 using the modified retrospective method. Adoption increased opening retained earnings by $3 million. For this quarter, reported revenue was $10 million lower and operating income $1 million lower than under the prior accounting guidance; prior-year figures were not restated.
Outlook, risks and unusual items
- Management’s long-term targets, expected on average over time, are low-single-digit annual revenue growth, annual EBITDA margin expansion of 10–20 basis points, and returning capital in excess of operating needs. These are targets, not quarter-specific guidance.
- Management cited increased federal discretionary spending for government fiscal years 2018 and 2019 as an opportunity, while noting uncertainty beyond that period, potential future spending reductions, shutdowns and debt-ceiling issues. More competitive bidding and pricing pressure are ongoing challenges. More than 95% of fiscal 2018 revenue came from U.S. government contracts.
- SAIC had committed to approximately $36 million of long-lead materials for the Marine Corps Assault Amphibious Vehicle low-rate initial production phase, which had not yet been fully awarded. Management believed the award probable, but warned costs might not be fully recoverable if it is not awarded.
- Government contract audits remain open for fiscal 2012 and subsequent years. SAIC recorded a $42 million liability for estimated potential customer refunds from contract-cost audits; adverse audit findings beyond reserves could affect results. Outstanding letters of credit were $12 million and surety bonds $17 million.
- Management stated that disclosure controls were not effective at May 4, 2018 because of a material weakness concerning controls and training for contracts with multiple customer funding sources. Remediation was underway, with completion expected in the second quarter of fiscal 2019.
- Other notable items: aggregate contract estimate changes reduced operating income by $5 million in the quarter; SAIC received a $6 million Scitor escrow distribution, recorded as a reduction in SG&A. The company said ordinary-course legal proceedings were not expected to have a material adverse effect.
Important facts for investors to verify
- Progress and effectiveness of remediation of the material weakness, including whether the expected completion timing is met.
- Federal budget, contract awards and renewals, competitive pricing, and conversion of negotiated unfunded backlog into funded work.
- Results of open government audits and whether the $42 million reserve is sufficient.
- Award status and recoverability of the approximately $36 million Marine Corps materials commitment.
- Revenue and margin comparability following ASC 606 adoption, given the disclosed impact on current-quarter results.
- Debt repayment, interest-rate exposure, cash generation and capital returns, including dividends and repurchases.