Science Applications International Corporation — Q2 FY2016 Form 10-Q
Reporting period: Three and six months ended July 31, 2015; comparative periods ended August 1, 2014. Figures are unaudited and in millions, except per-share data. SAIC provides technical, engineering and enterprise IT services primarily to the U.S. government and reports as one segment.
Business context and material developments
- SAIC acquired Scitor Holdings on May 4, 2015, expanding its access to intelligence-community customers and adding approximately 1,500 employees. The $764 million purchase consideration, net of cash acquired, was funded with cash and increased borrowings.
- Scitor contributed $147 million of revenue and $2 million of net income after acquisition through July 31. Preliminary purchase accounting recorded $481 million of goodwill and $255 million of intangible assets; valuations and review of Scitor’s government accounting practices remained incomplete.
- More than 90% of FY2015 revenue came from U.S. government contracts and more than 70% from DoD contracts, including subcontracts. The filing identifies government budget and procurement decisions, competitive bidding and pricing pressure as business risks.
Financial performance
| Metric | Three months ended July 31, 2015 | Three months ended August 1, 2014 | Six months ended July 31, 2015 | Six months ended August 1, 2014 |
|---|---|---|---|---|
| Total revenue, including former-Parent work | $1,099 | $952 | $2,108 | $1,929 |
| Operating income | $52 | $59 | $109 | $118 |
| Operating margin | 4.8% | 6.3% | 5.2% | 6.2% |
| Operating margin excluding acquisition and integration costs | 5.9% | 6.3% | 5.9% | 6.2% |
| Interest expense | $13 | $4 | $17 | $9 |
| Net income | $22 | $34 | $55 | $68 |
| Diluted EPS | $0.46 | $0.70 | $1.15 | $1.38 |
| Cash from operating activities | $21 | $65 | $50 | $99 |
- Reported revenue grew 15% in the quarter and 9% for the half. Excluding acquired Scitor revenue from the comparison, internal revenue contracted 0.5% in the quarter and grew 1.5% for the half.
- Operating income fell 12% in the quarter and 8% for the half. Acquisition and integration costs were $12 million and $15 million, respectively. Higher SG&A also included $11 million of acquired-intangible amortization in each period.
- Net income declined 35% in the quarter and 19% for the half, reflecting lower operating income and $9 million of increased interest expense associated with acquisition financing. Effective tax rates were 43.4% for the quarter and 40.3% for the half, versus 37.3% and 37.6% in the comparable periods; the filing attributes the increase primarily to nondeductible Scitor transaction costs and lower permanent tax benefits.
- Operating cash flow for the half fell $49 million, primarily due to changes in prepaid taxes ($36 million) and acquisition/integration cost payments ($15 million), as well as increased days sales outstanding from customer collection delays and milestone timing. Capital expenditures were $6 million for the half.
Balance sheet, debt and liquidity
- At July 31, 2015, cash and equivalents were $163 million, current assets $951 million and current liabilities $683 million. Total assets were $2.158 billion and equity was $384 million.
- Debt principal was $1.143 billion ($1.124 billion net of unamortized issuance costs), compared with $489 million principal at January 30, 2015. The balance-sheet carrying amount was $71 million current and $1.053 billion long term. The company had a $200 million revolving facility with no draws.
- Six-month investing cash outflow was $787 million, including $764 million paid for the Scitor acquisition, net of cash acquired. Financing cash inflow was $599 million, including $670 million of borrowing proceeds. Cash declined $138 million from the fiscal-year start.
- Debt is variable-rate, with interest-rate swaps covering $825 million of notional debt. The company reported covenant compliance at July 31 and stated that a hypothetical 50-basis-point interest-rate change would not materially affect results or cash flows. The credit agreement requires a senior secured leverage ratio no greater than 4.00:1.00 through July 31, 2016 and 3.75:1.00 thereafter; actual leverage is not stated here.
Outlook, risks and contingencies
- Management’s long-term targets are low-single-digit internal revenue growth, annual operating-margin expansion of 10–20 basis points, and returning capital in excess of operating needs. These are targets, not specific quarterly or full-year guidance; the filing provides no clear numerical FY2016 forecast.
- Management expects to maintain an average minimum cash balance of $150 million and says cash, future operating cash flow and bank financing should provide adequate resources for short- and long-term needs. It cautions that future financing availability and terms depend on credit ratings, markets and economic conditions.
- Backlog was $7.142 billion at July 31 ($1.932 billion funded; $5.210 billion negotiated unfunded), including approximately $1 billion acquired with Scitor. After accounting for acquired backlog, total backlog was described as relatively unchanged from fiscal year-end. Government contracts may be reduced or canceled, and backlog excludes anticipated IDIQ task orders until awarded.
- Government audits and reviews could result in cost disallowances, penalties, fines or suspension/debarment. SAIC recorded a $23 million liability for estimated customer refunds related to potential indirect-cost and cost-accounting adjustments. Management said ordinary-course claims and lawsuits were not expected to have a material adverse effect. The BCTM program’s formal contract modification remained outstanding; approximately $2 million was receivable.
- Operating lease commitments were $199 million. The company also reported $8 million of letters of credit and $11 million of surety-bond obligations. The filing states that disclosure controls were effective and that no material risk-factor changes were reported.
Important facts for investors to verify
- Progress on final Scitor purchase accounting, including intangible valuations and any liabilities identified through the government-accounting review.
- Whether Scitor integration delivers the anticipated customer access and growth while containing integration costs and acquired-intangible amortization.
- Customer collections, days sales outstanding and operating cash-flow recovery after the reported delays and prepaid-tax impacts.
- Debt repayment, leverage-covenant headroom, variable-rate exposure and the effect of required excess-cash-flow prepayments.
- Backlog conversion and contract awards amid government budget constraints, competitive bidding, audits and potential contract cancellations.