Science Applications International Corporation (SAIC) — Q2 FY2014 Form 10-Q
Reporting period: Quarter ended August 2, 2013; comparisons are with the quarter and six months ended July 31, 2012. The statements cover the technical, engineering and enterprise IT services business as a combined, pre-separation entity, not a standalone company. Parent Leidos completed the tax-free spin-off on September 27, 2013.
Financial performance
| Metric | Three months ended Aug. 2, 2013 | Prior-year quarter | Six months ended Aug. 2, 2013 | Prior-year six months |
|---|---|---|---|---|
| Total revenue | $1,034 million | $1,231 million | $2,173 million | $2,413 million |
| Operating income | $38 million | $62 million | $90 million | $147 million |
| Operating margin | 3.7% | 5.0% | 4.1% | 6.1% |
| Net income | $25 million | $38 million | $58 million | $94 million |
| Pro forma diluted EPS | $0.51 | $0.79 | $1.21 | $1.94 |
| Operating cash flow | Not stated for the quarter | $48 million | $149 million |
Six-month capital expenditures were $2 million, versus $5 million. Cash at August 2 was $2 million. Current assets were $808 million and current liabilities $599 million. Receivables were $710 million. The balance sheet showed $3 million of capital lease obligations and notes payable in total; Parent’s senior debt was not allocated to this pre-separation business.
Material changes and operating drivers
- Revenue declined 16% in the quarter and 10% for the six-month period. Management cited the DGS program ramp-down, completion of an Afghanistan network operations program, fewer working days in the quarter, and slower federal contracting amid sequestration. DGS revenue fell by $85 million in the quarter and $143 million for six months.
- Operating income fell 39% in both comparison periods. Separation and restructuring expenses were $18 million in the quarter and $34 million for six months, compared with $4 million in each prior-year period. Other six-month pressures included lower DGS profit and $6 million of net unfavorable contract-estimate changes.
- Contract-estimate changes reduced operating income by $4 million in the quarter and $8 million for six months, versus reductions of $5 million and $2 million in the comparable periods.
- Operating cash flow declined by $101 million year over year for six months. Management attributed the decrease primarily to slower collection of receivables after the federal accelerated-payment initiative ended and payment of severance accruals.
- Backlog was $6.873 billion at August 2, down about $891 million from January 31: funded backlog was $1.664 billion and negotiated unfunded backlog $5.209 billion. Net bookings were about $0.8 billion for the quarter and $1.3 billion for six months, below the prior-year $0.9 billion and $1.6 billion, respectively.
Liquidity, debt, outlook and risks
- Before separation, cash was managed centrally by Parent and most cash was not assigned to the business; reported cash therefore does not represent standalone cash generation or liquidity. Management expected operating cash flows and bank financing to meet needs, while noting standalone forecasting limitations.
- A $700 million credit agreement provided a $500 million five-year term facility and a $200 million five-year revolver. After the reporting date, SAIC drew $500 million on September 26, 2013; $295 million funded a cash distribution to Parent. The revolver became available September 30 and had no borrowings reported. A fixed-rate swap was entered into to hedge the term loan’s LIBOR exposure. Credit covenants include maximum leverage of 3.25:1 and minimum interest coverage of 3.50:1.
- No specific revenue or earnings guidance was provided. Management described federal budget reductions, sequestration, competitive bidding and pricing pressure as significant industry challenges, while citing customer relationships, technical expertise and its cost structure as competitive strengths.
- Federal government shutdown and budget uncertainty were highlighted as risks to contract work, awards, revenue and cash collection. Fiscal 2013 revenue was approximately 95% from U.S. Government work and 73% from DoD work. Management warned that sequestration, a prolonged shutdown or debt-ceiling disruption could delay, reduce or cancel funding.
- The company recorded a $14 million liability for estimated potential refunds arising from incomplete government indirect-cost audits and reviews. Outcomes could require adjustments beyond recorded estimates. The filing also discusses Parent’s CityTime deferred prosecution agreement and Army administrative agreement; SAIC stated it would comply with applicable obligations after separation.
- A terminated Army modernization program had generated approximately $480 million in recognized revenue through August 2; a formal contract modification following an agreement in principle was still pending. Management said other routine claims and lawsuits were not expected to have a material adverse effect.
Important facts for investors to verify
- Whether revenue, margins and bookings stabilize as the DGS transition and federal budget pressures continue.
- Actual post-spin-off cash conversion, receivable collections and liquidity needs, distinct from the Parent-managed historical cash flows.
- Term-loan pricing and hedge terms, covenant headroom, and use of the remaining $200 million revolver.
- Results of government contract-cost and business-system reviews, including any effect on the recorded $14 million liability or billing rates.
- Resolution of the Army program modification, and performance and cancellation risk embedded in funded and unfunded backlog.
- Costs of operating independently: historical results include Parent allocations that may not equal standalone costs. The filing text does not provide a clear standalone earnings baseline.