Business context and reporting period
Science Applications International Corporation (SAIC) filed this unaudited Form 10-Q for the quarter ended November 2, 2018, the third quarter of fiscal 2019. SAIC provides technical, engineering and enterprise IT services, primarily to the U.S. government, and reports as one segment. More than 95% of fiscal 2018 revenue came from U.S. government contracts.
Financial results and position
Amounts are in millions except per-share data. Third-quarter and nine-month results are compared with the corresponding 2017 periods.
| Metric | Quarter | Nine months |
|---|---|---|
| Revenue | $1,177; +2.8% | $3,467; +4.2% |
| Operating income | $73; +1% | $213; +10% |
| Operating margin | 6.2%, versus 6.3% | 6.1%, versus 5.8% |
| Net income | $48; versus $43 | $146; versus $128 |
| Diluted EPS | $1.11; versus $0.98 | $3.37; versus $2.86 |
| Adjusted EBITDA margin | 8.3%, versus 7.4% | 7.4%, versus 6.9% |
Cost of revenue was 89.0% of quarterly revenue versus 90.5% a year earlier, and 90.1% for the nine months versus 90.9%. Adjusted EBITDA is a company-defined non-GAAP measure.
Nine-month operating cash flow was $162, up from $133; capital expenditures were $24, and net cash used in investing activities was $23. Financing activities used $89, including $40 of dividends and $56 of share repurchases and tax-withholding-related stock activity. Cash and cash equivalents were $193 at quarter-end, plus $9 of restricted cash. Current assets were $1,072 and current liabilities $682.
Debt had a net carrying value of $1,037, including $11 current and $1,026 long-term, compared with $1,024 at fiscal year-end. The company refinanced its debt in October; the new Term Loan B carries a 4.05% stated rate and matures in 2025. No revolving credit balance was outstanding, and SAIC reported compliance with its debt covenants.
Material changes and notable items
- Revenue growth reflected new awards and higher supply-chain orders, partly offset by completed contracts and other portfolio declines. Nine-month growth included new NASA, EPA, and state and local work.
- SAIC recorded a $25 inventory provision related to long-lead materials for the Marine Corps Assault Amphibious Vehicle program, terminated for convenience in October. SAIC was negotiating recovery of termination costs; the filing does not establish the final recoverable amount.
- Changes in contract estimates increased operating income by $19 in the quarter and $16 year to date. Revenue recognized for prior-period performance obligations added $4 in the quarter and $7 year to date.
- Net income benefited from a lower effective tax rate: 17.7% for the quarter and 17.4% year to date, compared with 30.7% and 21.5%. The company said the decline reflected the lower federal rate and tax credits, among other factors.
- SAIC adopted ASC 606 using the modified retrospective method, adding $3 to opening retained earnings. Adoption affected reported revenue and costs; year-to-date revenue was $10 lower than it would have been under the prior accounting guidance.
- Backlog was $10.445 billion, including $2.394 billion funded, versus total backlog of $10.227 billion at fiscal year-end. Net bookings were an estimated $1.2 billion for the quarter and $3.7 billion year to date. Separately, disclosed remaining performance obligations were $1.1 billion; this measure excludes certain contracts and consideration.
Outlook, risks and contingencies
Management’s long-term targets are low-single-digit annual revenue growth, adjusted EBITDA margin expansion of 10–20 basis points annually, and return of capital exceeding operating needs. These are targets, not specific fiscal 2019 guidance. SAIC expected to recognize approximately 65% of disclosed remaining performance obligations over the next 12 months and 85% over the next 24 months.
SAIC agreed to acquire Engility in a stock transaction at an exchange ratio of 0.450 SAIC shares per Engility share. Estimated transaction value was $2.1 billion, including Engility net debt. The merger was subject to shareholder and other customary approvals and was expected to close in fiscal 2019’s fourth quarter. SAIC expected to assume approximately $900 million of Engility debt and arranged acquisition financing. The filing highlights risks of failure to close, integration challenges, transaction costs, possible customer or employee disruption, and the fixed exchange ratio.
Other risks include reliance on federal spending and competitive bidding, possible government budget cuts or shutdowns, contract execution and cost-estimation uncertainty, and government audits. SAIC recorded a $43 liability for potential contract-cost audit adjustments; fiscal 2014 and subsequent indirect-cost audits remained open. It also disclosed $12 of letters of credit and $18 of surety bonds. Management said routine legal proceedings were not expected to have a material adverse effect. Disclosure controls were reported effective, with no material change in internal control.
Important facts for investors to verify
- Whether the Engility transaction closed on the expected terms, and its eventual financing, integration costs and realized benefits.
- How much of the $25 AAV-related inventory provision SAIC ultimately recovers from the customer or other sources.
- Whether favorable contract-estimate adjustments recur and whether contract performance sustains the reported margin improvement.
- Cash conversion and working-capital trends, including receivables growth and funding needs for platform integration programs.
- Final outcomes of government audits, tax accounting reviews, and other disclosed contingencies.
- Backlog conversion, since some backlog is unfunded and government customers may change or cancel contract work.