<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
-----------------
FORM 10-Q
(MARK ONE)
/x/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED OCTOBER 31, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-12771
SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
------------------------------------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-3630868
------------------------------- -------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
10260 CAMPUS POINT DRIVE
SAN DIEGO, CALIFORNIA 92121
(619) 546-6000
-----------------------------------------------------------------
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES X NO
--- ---
As of November 30, 1998, the Registrant had 55,447,352 shares of Class A
common stock, $.01 par value per share, issued and outstanding, and 305,211
shares of Class B common stock, $.05 par value per share, issued and
outstanding.
<PAGE>
PART I
FINANCIAL INFORMATION
<PAGE>
ITEM 1. FINANCIAL STATEMENTS
SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(Unaudited, in thousands, except per-share amounts)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------------ -----------------------------------
OCTOBER 31, 1998 OCTOBER 31, 1997 OCTOBER 31, 1998 OCTOBER 31, 1997
---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Revenues $1,226,832 $714,408 $3,427,368 $2,039,896
---------- -------- ---------- ----------
Costs and expenses:
Cost of revenues 948,856 621,620 2,705,293 1,783,205
Selling, general and
administrative expenses 179,354 61,441 477,757 161,361
---------- -------- ---------- ----------
Operating income 98,622 31,347 244,318 95,330
Interest expense 8,588 1,688 23,314 4,541
Other (income) expense, net (9,479) (7,371) (14,996) (12,934)
Minority interest in income
of consolidated subsidiaries 3,924 1,952 10,052 4,647
---------- -------- ---------- ----------
Income before income taxes 95,589 35,078 225,948 99,076
Provision for income taxes 48,415 15,785 108,641 44,584
---------- -------- ---------- ----------
Net income $ 47,174 $ 19,293 $ 117,307 $ 54,492
---------- -------- ---------- ----------
---------- -------- ---------- ----------
Earnings per share:
Basic $ .84 $ .38 $ 2.11 $ 1.07
---------- -------- ---------- ----------
---------- -------- ---------- ----------
Diluted $ .77 $ .35 $ 1.95 $ 1.01
---------- -------- ---------- ----------
---------- -------- ---------- ----------
Common equivalent shares:
Basic 55,989 51,418 55,088 51,001
---------- -------- ---------- ----------
---------- -------- ---------- ----------
Diluted 60,834 54,760 59,609 54,195
---------- -------- ---------- ----------
---------- -------- ---------- ----------
</TABLE>
See accompanying notes to condensed consolidated financial statements.
I-2
<PAGE>
SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(in thousands, except per-share amounts)
<TABLE>
<CAPTION>
OCTOBER 31, 1998 JANUARY 31, 1998
---------------- ----------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . $ 274,660 $ 189,387
Restricted cash . . . . . . . . . . . . . . . . . . . . . . . . 15,773 25,344
Receivables . . . . . . . . . . . . . . . . . . . . . . . . . . 791,294 810,385
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . 13,049 12,471
Prepaid expenses and other current assets . . . . . . . . . . . 160,651 75,846
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . 87,998 62,367
----------- ----------
Total current assets . . . . . . . . . . . . . . . . . . . 1,343,425 1,175,800
Property and equipment (less accumulated depreciation
of $215,066 and $137,537 at October 31, 1998
and January 31, 1998, respectively) . . . . . . . . . . . . . . 284,261 288,282
Land and buildings (less accumulated depreciation of
$29,275 and $17,864 at October 31, 1998
and January 31, 1998, respectively) . . . . . . . . . . . . . . 187,429 195,534
Goodwill (less accumulated amortization of
$78,987 and $56,623 at October 31, 1998
and January 31, 1998, respectively) . . . . . . . . . . . . . . 91,466 106,757
Other intangible assets (less accumulated amortization of
$15,697 and $3,900 at October 31, 1998
and January 31, 1998, respectively) . . . . . . . . . . . . . . 80,969 103,520
Prepaid pension assets. . . . . . . . . . . . . . . . . . . . . . . 448,262 424,108
Other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . 131,596 121,233
----------- ----------
$2,567,408 $2,415,234
----------- ----------
----------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities. . . . . . . . . . . . $ 626,084 $ 748,031
Accrued payroll and employee benefits . . . . . . . . . . . . . 336,678 262,408
Income taxes payable. . . . . . . . . . . . . . . . . . . . . . 48,530 37,761
Notes payable and current portion of long-term debt . . . . . . 40,757 33,012
----------- ----------
Total current liabilities . . . . . . . . . . . . . . . . . 1,052,049 1,081,212
----------- ----------
Long-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . . 138,250 145,958
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . 86,252 111,941
Other long-term liabilities . . . . . . . . . . . . . . . . . . . . 299,460 313,677
Commitments and contingencies (Note G)
Minority interest in consolidated subsidiaries. . . . . . . . . . . 11,007 7,668
Stockholders' equity:
Common stock:
Class A, $.01 par value
Authorized: 100,000 shares
Issued and outstanding:
October 31, 1998 - 55,382 shares . . . . . . . . . . . . 554
January 31, 1998 - 51,931 shares. . . . . . . . . . . . . 519
Class B, $.05 par value
Authorized: 5,000 shares
Issued and outstanding:
October 31, 1998 - 305 shares. . . . . . . . . . . . . . 15
January 31, 1998 - 314 shares . . . . . . . . . . . . . . 16
Additional paid-in capital. . . . . . . . . . . . . . . . . . . 742,764 538,760
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . 268,874 237,588
Other stockholders' equity. . . . . . . . . . . . . . . . . . . (28,420) (14,983)
Accumulated other comprehensive income. . . . . . . . . . . . . (3,397) (7,122)
----------- ----------
Total stockholders' equity. . . . . . . . . . . . . . . . . 980,390 754,778
----------- ----------
$2,567,408 $2,415,234
----------- ----------
----------- ----------
</TABLE>
See accompanying notes to condensed consolidated financial statements.
I-3
<PAGE>
SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited, in thousands)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
----------------------------------------
OCTOBER 31, 1998 OCTOBER 31, 1997
---------------- ----------------
<S> <C> <C>
Cash flows from operating activities:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 117,307 $ 54,492
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization . . . . . . . . . . . . . . . . . 124,798 36,884
Non-cash compensation . . . . . . . . . . . . . . . . . . . . . 50,686 27,214
Other non-cash items . . . . . . . . . . . . . . . . . . . . . 13,383 (879)
Income tax benefit from employee stock transactions . . . . . . 25,026 12,678
Increase (decrease) in cash, excluding effects of
acquisitions, resulting from changes in:
Receivables . . . . . . . . . . . . . . . . . . . . . . . . . 38,274 6,164
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . (564) 6,406
Prepaid expenses and other current assets . . . . . . . . . . (22,844) (5,763)
Progress payments . . . . . . . . . . . . . . . . . . . . . . (8,502) (4,041)
Deferred income taxes . . . . . . . . . . . . . . . . . . . . (52,039) (23,424)
Other assets . . . . . . . . . . . . . . . . . . . . . . . . (35,758) (3,304)
Accounts payable and accrued liabilities . . . . . . . . . . (125,467) 11,038
Accrued payroll and employee benefits . . . . . . . . . . . . 76,827 81,351
Income taxes payable . . . . . . . . . . . . . . . . . . . . 13,088 (3,464)
Other long-term liabilities . . . . . . . . . . . . . . . . . 2,353 2,063
--------- ---------
216,568 197,415
--------- ---------
Cash flows from investing activities:
Expenditures for property and equipment . . . . . . . . . . . . . (47,698) (27,931)
Expenditures for land and buildings . . . . . . . . . . . . . . . (1,509) (16,489)
Acquisitions of certain business assets, net of cash acquired . . (500) (785)
Purchases of debt and equity securities available for sale . . . (67,688)
Purchases of debt securities held to maturity . . . . . . . . . . (6,000)
Proceeds from sales of certain business assets . . . . . . . . . 864 50,174
Proceeds from disposal of property and equipment . . . . . . . . 581 5,124
Investments in unconsolidated affiliates . . . . . . . . . . . . (2,851)
--------- ---------
(124,801) 10,093
--------- ---------
Cash flows from financing activities:
Proceeds from notes payable and issuance of long-term debt . . . 14,372 1,816
Payments of notes payable and long-term debt . . . . . . . . . . (25,879) (16,667)
Principal payments on capital lease obligations . . . . . . . . . (20,892) (1,072)
Net proceeds from issuance of subsidiary common stock . . . . . . 5,116 63,528
Dividends paid to minority interest . . . . . . . . . . . . . . . (7,096)
Sales of common stock . . . . . . . . . . . . . . . . . . . . . . 118,534 49,363
Repurchases of common stock . . . . . . . . . . . . . . . . . . . (88,213) (60,970)
--------- ---------
(4,058) 35,998
--------- ---------
Effect of exchange rate changes on cash . . . . . . . . . . . . . (2,436) (375)
--------- ---------
Increase in cash and cash equivalents . . . . . . . . . . . . . . 85,273 243,131
Cash and cash equivalents at beginning of period . . . . . . . . 189,387 45,279
--------- ---------
Cash and cash equivalents at end of period . . . . . . . . . . . $ 274,660 $288,410
--------- ---------
--------- ---------
Supplemental schedule of non-cash investing and financing activities:
Repurchases of common stock upon exercise of stock options . . . $ 18,553 $ 15,949
--------- ---------
--------- ---------
Capital lease obligations for property and equipment . . . . . . $ 36,555 $ 23,507
--------- ---------
--------- ---------
Fair value of assets acquired in acquisitions of certain
business assets . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,487 $ 643
Cash paid in the acquisitions of certain business assets . . . . (912) (625)
--------- ---------
Liabilities assumed in acquisitions of certain business assets. . $ 575 $ 18
--------- ---------
--------- ---------
</TABLE>
I-4
<PAGE>
SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - BASIS OF PRESENTATION:
The accompanying financial information has been prepared in accordance with
the instructions to Form 10-Q and therefore does not necessarily include all
information and footnotes necessary for a fair presentation of financial
position, results of operations and cash flows in conformity with generally
accepted accounting principles. The preparation of financial statements, in
conformity with generally accepted accounting principles, requires management
to make estimates and assumptions that affect the reported amounts of assets
and liabilities and the disclosure of contingencies at the date of the
financial statements as well as the reported amounts of revenues and expenses
during the reporting period. Estimates have been prepared on the basis of the
most current and best available information and actual results could differ
from those estimates.
Certain amounts from the three and nine months ended October 31, 1997 have
been reclassified in the condensed consolidated financial statements to
conform to the presentation of the three and nine months ended October 31,
1998.
In the opinion of management, the unaudited financial information for the
three and nine months ended October 31, 1998 and 1997 reflect all adjustments
(which include only normal, recurring adjustments) necessary for a fair
presentation thereof. Operating results for the three and nine months ended
October 31, 1998 are not necessarily indicative of the results that may be
expected for the fiscal year ending January 31, 1999. For further
information, refer to the consolidated financial statements and footnotes
included in the Company's 1998 Annual Report on Form 10-K.
NOTE B - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS:
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position (SOP) 98-1 "Accounting for Costs of Computer Software
Developed or Obtained for Internal Use," which defines the characteristics of
internal-use software and provides guidance on when and what types of costs
should be capitalized and when they should be expensed as incurred. The
Company will adopt SOP 98-1 effective for the fiscal year beginning February
1, 1999. Upon adoption, the Company will be required to capitalize certain
types of costs on a prospective basis that were expensed as incurred under
current accounting practice. The Company does not expect the adoption of SOP
98-1 to have a material impact to its consolidated financial position or
results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133 "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and
reporting standards for derivative instruments and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those
instruments at fair value. SFAS No. 133 also requires that changes in the
derivative instrument's fair value be recognized currently in results of
operations unless specific hedge accounting criteria are met. The Company
will adopt SFAS No. 133 for the first quarter ending April 30, 2000. The
Company has not determined what impact, if any, the adoption of SFAS No. 133
will have on the Company's consolidated financial position or results of
operations.
NOTE C - RESTRICTED CASH:
The Company's majority-owned subsidiary, Network Solutions, Inc. ("NSI") had
an agreement with the National Science Foundation ("NSF") which required NSI
to set aside 30% of the cash collections from domain name registrations to be
reinvested for the enhancement of the intellectual infrastructure of the
Internet. Effective April 1,1998, the NSF amended the agreement to eliminate
this requirement and reduce domain name registration fees. In September
1998, NSI disbursed a portion of its restricted cash to the NSF at the NSF's
direction. The Company also has a contract to provide support services to the
National Cancer Institute's Frederick Cancer Research and Development Center
("Center"). As part of the contract, the Company is responsible for paying
for materials, equipment and other direct costs of the Center through the use
of a restricted cash account which is pre-funded by the U.S. Government.
NOTE D - RECEIVABLES:
Unbilled accounts receivable include $24,725,000 of costs incurred on
projects for which the Company has been requested by the customer to begin
work under a new contract, or extend work under an existing contract, but for
which formal contracts or contract modifications have not been executed at
October 31, 1998.
I-5
<PAGE>
NOTE E - COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS:
<TABLE>
<CAPTION>
OCTOBER 31, 1998
----------------
(IN THOUSANDS)
<S> <C>
Inventories:
Contracts-in-process $ 6,874
Raw materials 6,175
--------
$ 13,049
--------
--------
Prepaid expenses and other current assets:
Prepaid expenses $ 31,200
Short-term investments 107,876
Other 21,575
--------
$160,651
--------
--------
</TABLE>
NOTE F - NOTES PAYABLE:
The Company has a five-year unsecured reducing revolving credit facility of
$700,000,000 with a group of banks which allow borrowings until August 2002.
Borrowings bear interest at the Company's option at various rates, based on
the base rate, bid rate or on margins over the CD rate or LIBOR. There were
no balances outstanding under the facility at October 31, 1998 and the entire
$700,000,000 was available.
NOTE G - COMMITMENTS AND CONTINGENCIES:
The Company is involved in various investigations, claims and lawsuits
arising in the normal conduct of its business, none of which, in the opinion
of the Company's management, will have a material adverse effect on its
consolidated financial position, results of operations, cash flows or its
ability to conduct business.
NOTE H - COMPREHENSIVE INCOME:
Effective February 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income," which establishes standards for reporting and
displaying comprehensive income and its components in the annual financial
statements with the same prominence as other annual financial statements.
For interim periods, only a total for comprehensive income shall be reported
in the condensed financial statements. SFAS No. 130 requires unrealized
gains or losses on the Company's available-for-sale securities and foreign
currency translation adjustments to be included in other comprehensive
income. Prior year financial statements have been reclassified to conform to
the requirements of SFAS No. 130. Comprehensive income as defined by SFAS
No. 130 consisted of the following:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
OCTOBER 31 OCTOBER 31
----------------------------- --------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Net income $47,174 $19,293 $117,307 $54,492
Other comprehensive income, net of tax:
Unrealized gain (loss) on securities, net of
reclassification adjustment (859) 5,130
Foreign currency translation adjustments (307) (92) (1,405) 204
------- ------- -------- -------
(1,166) (92) 3,725 204
------- ------- -------- -------
$46,008 $19,201 $121,032 $54,696
------- ------- -------- -------
------- ------- -------- -------
</TABLE>
I-6
<PAGE>
NOTE I - EARNINGS PER SHARE (EPS):
A summary of the elements included in the computation of basic and diluted
EPS is as follows (in thousands, except per-share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
OCTOBER 31 OCTOBER 31
-------------------------------- ------------------------------
1998 1997 1998 1997
----------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
BASIC EPS:
----------
Net income $47,174 $19,293 $117,307 $54,492
Effect of:
Subsidiary preferred stock dividends (351) -- (1,039) --
------- ------- -------- -------
Net income available to common
stockholders, as adjusted $46,823 $19,293 $116,268 $54,492
------- ------- -------- -------
Weighted average shares 55,989 51,418 55,088 51,001
------- ------- -------- -------
Basic EPS $ .84 $ .38 $ 2.11 $ 1.07
------- ------- -------- -------
------- ------- -------- -------
DILUTED EPS:
------------
Net income $47,174 $19,293 $117,307 $54,492
Effect of:
Subsidiary preferred stock dividends (351) -- (1,039) --
Majority-owned subsidiary's
dilutive securities (91) -- (292) --
------- ------- -------- -------
Net income available to common
stockholders, as adjusted $46,732 $19,293 $115,976 $54,492
------- ------- -------- -------
Weighted average shares 55,989 51,418 55,088 51,001
Effect of:
Stock options 4,750 3,293 4,425 3,192
Other stock awards 95 49 96 2
------- ------- -------- -------
Weighted average shares, as adjusted 60,834 54,760 59,609 54,195
------- ------- -------- -------
Diluted EPS $ .77 $ .35 $ 1.95 $ 1.01
------- ------- -------- -------
------- ------- -------- -------
</TABLE>
I-7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Revenues for the three and nine months ended October 31, 1998 increased 72%
and 68%, respectively, compared to the same periods of the prior year,
primarily driven by the Company's commercial business. Of the total
increase, 51% and 48% of the increase for the three and nine months ended
October 31, 1998, respectively, were directly attributable to Bellcore, a
subsidiary which was acquired on November 14, 1997, Network Solutions, Inc.
("NSI"), a majority-owned subsidiary, and INTESA, a joint venture. The
remaining increase in revenues of 21% and 20% for the same periods,
respectively, was attributable to internal growth in the traditional business
areas which continued to shift toward lower cost service type contracts.
This trend reflects the increasingly competitive business environment in the
Company's traditional business areas, as well as the Company's increased
success in the engineering and field services market, which typically involve
lower cost contracts.
Revenues on the Company's contracts are generated from the efforts of its
technical staff as well as the pass through of costs for material and
subcontract efforts, which primarily occur on large, multi-year system
integration type contracts. At October 31, 1998, the Company had
approximately 32,100 full-time employees compared to approximately 23,200 at
October 31, 1997. Material and subcontract ("M&S") revenues were $235 million
and $645 million for the three and nine months ended October 31, 1998,
respectively, compared to $168 million and $489 million for the same periods
of the prior year. As a percentage of total revenues, M&S revenues have
decreased to 19% for the three and nine months ended October 31, 1998
compared to 24% for the same periods of the prior year.
Revenues by contract type indicate that the percentage of the Company's
revenues attributable to higher risk, firm fixed-price ("FFP") contracts
increased to 41% for the nine months ended October 31, 1998 from 28% for same
period of the prior year. The increase in revenues from FFP contracts is
primarily driven by Bellcore. As of the year ended January 31, 1998,
revenues from FFP contracts were 32% and only included Bellcore revenues for
the period from November 14, 1997 to January 31, 1998. In addition, growth
in other non-U.S. Government revenues contributed to the increase in revenues
from FFP contracts. The Company's non-U.S. Government customers typically do
not contract on a cost-reimbursement basis. The Company assumes greater
performance risk on FFP contracts and the failure to accurately estimate
ultimate cost or to control costs during performance of the work may result
in reduced profits or losses. Fixed-price level-of-effort and
time-and-materials type contracts increased slightly to 21% of revenues for
the nine months ended October 31, 1998 from 18% for the same period in the
prior year, while cost reimbursement contracts were 38% and 54% for the same
periods, respectively.
The cost of revenues as a percentage of revenues decreased to 77.3% and 78.9%
for the three and nine months ended October 31, 1998, respectively, compared
to 87.0% and 87.4% for the same periods of the prior year, respectively. The
decrease reflects the growth in commercial revenues from Bellcore, INTESA and
NSI, which have more of their associated costs in selling, general and
administrative costs ("SG&A") as opposed to cost of revenues.
SG&A expenses as a percentage of revenues for the three and nine months ended
October 31, 1998 increased to 14.6% and 13.9%, respectively, compared to 8.6%
and 7.9% for the same periods of the prior year. SG&A is comprised of
general and administrative ("G&A"), bid and proposal ("B&P") and independent
research and development ("IR&D") expenses. G&A, B&P and IR&D increased as a
percentage of revenues for the three and nine months ended October 31, 1998
compared to the same periods of the prior year due to growth in commercial
revenues which have more of their associated costs in SG&A as opposed to cost
of revenues. While the level of B&P activity and costs have historically
fluctuated depending on the availability of bidding opportunities and
resources, B&P costs have increased in relation to revenues for the three and
nine months ended October 31, 1998. IR&D costs have also historically
fluctuated depending on the stage of development for various hardware and
software systems and have also increased in relation to revenues for the
three and nine months ended October 31, 1998. G&A costs as a percentage of
revenues were 6.5% and 6.8% for the three and nine months ended October 31,
1998, respectively, compared to 6.0%
I-8
<PAGE>
and 5.7% for the same periods of the prior year. The increase in G&A costs
represents the combination of growth in commercial business, increased
amortization costs of goodwill and intangible assets associated with the
Bellcore acquisition and losses from the impairment of goodwill. For the
three and nine months ended October 31, 1998, certain events and
circumstances indicated that the recovery of certain goodwill was unlikely.
For the three and nine months ended October 31, 1998, the Company reduced
goodwill by $3.9 million and $13.1 million, respectively, to its estimated
recoverable value as determined by the excess of carrying amount over the
estimated fair value.
Interest expense for the three and nine months ended October 31, 1998 and
1997 primarily relates to interest on a building mortgage, deferred
compensation arrangements, capital lease obligations and notes payable. The
increase in interest expense is primarily driven by an increase in deferred
compensation balances, capital lease obligations and public debt securities.
Other income, net of other expense, was $9 million and $15 million for the
three and nine months ended October 31, 1998, respectively, compared to $7
million and $13 million for the same periods of the prior year. The primary
components of other income, net of other expense, for the nine months ended
October 31, 1998 are interest income of $13 million, gain on sale of business
assets of $4 million and an other-than temporary loss on an equity security
of $3 million.
The provision for income taxes as a percentage of income before income taxes
was 50.7% and 48.1% for the three and nine months ended October 31, 1998,
respectively, compared to 45% for the same periods of the prior year. The
Company increased its tax provision for the three months ended October 31,
1998 as it reassesses certain tax positions related to the Company's on-going
appeals process with the IRS for fiscal years 1988 through 1993. The higher
effective tax rate for the nine months ended October 31, 1998 also includes a
greater amount of non-deductible goodwill amortization.
The Company is involved in various investigations, claims and lawsuits
arising in the normal conduct of its business, none of which, in the opinion
of the Company's management, will have a material adverse effect on its
consolidated financial position, results of operations or its ability to
conduct business.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of liquidity continue to be funds provided by
operations and the five-year revolving credit facility. At October 31, 1998
and 1997, there were no borrowings outstanding under the credit facility and
cash, cash equivalents and short-term investments were $383 million and $288
million, respectively.
Operating activities continued to generate cash for the nine months ended
October 31, 1998. The Company actively monitors receivables with emphasis
placed on collection activities and the negotiation of more favorable payment
terms.
Cash spent on investing activities was $125 million for the nine months
ended October 31, 1998 compared to a source of cash of $10 million for the
same period of the prior year. The increase in spending on investing
activities for the nine months ended October 31, 1998 is primarily
attributable to the purchases of debt and equity securities by NSI. For the
same period in the prior year, cash was primarily generated from the sale of
net assets of the SAIT business unit, while cash was used for the purchase
of land and buildings.
The Company spent $4 million on financing activities for the nine months
ended October 31, 1998 compared to a source of cash of $36 million for the
same period of the prior year. The increase in spending for the nine months
ended October 31, 1998 is primarily attributable to repurchases of common
stock and payments on capital lease obligations. The source of cash for the
nine months ended October 31, 1997 was primarily attributable to proceeds
from the sale of a minority interest in the Company's subsidiary NSI.
The Company's cash flows from operations plus borrowing capacity are expected
to provide sufficient funds for the Company's operations, common stock
repurchases, capital expenditures and future long-term debt
I-9
<PAGE>
requirements. In addition, acquisitions and equity investments in the future
are expected to be financed from operations and borrowing capacity as well as
with the issuance of Company common stock.
FORWARD-LOOKING INFORMATION
The foregoing discussion in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" contains forward-looking
statements, including statements regarding the intent, belief or current
expectations of the Company and its officers with respect to, among other
things, trends affecting the Company's financial condition or results of
operation and the impact of competition. Such statements are not guarantees
of future performance and involve risks and uncertainties, and actual results
may differ materially from those in the forward-looking statements as a
result of various factors. Some of these factors include, but are not
limited to the risk factors set forth in the Company's 1998 Annual Report on
Form 10-K. Due to such uncertainties and risks, readers are cautioned not to
place undue reliance on such forward-looking statements, which speak only as
of the date hereof.
YEAR 2000
THE STATEMENTS IN THE FOLLOWING SECTION CONSTITUTE "YEAR 2000 READINESS
DISCLOSURE" WITHIN THE MEANING OF THE YEAR 2000 INFORMATION AND READINESS
DISCLOSURE ACT.
YEAR 2000 PLAN - In 1996, the Company initiated a program to prepare the
Company's centralized internal computer systems and applications for the Year
2000. The program has evolved into a risk-based plan designed to minimize
risk to the Company's consolidated financial position, results of operations,
cash flows and its ability to conduct business. The Company has established
a Corporate Year 2000 Committee, which reports to an executive management
team and the Board of Directors, to oversee, monitor and coordinate the
Company-wide Year 2000 effort. The plan focuses on information technology
("IT") systems, non-IT systems, critical service suppliers and vendors
("business partners"), and the Company's services and products.
IT SYSTEMS - The Company has established a six-phase program intended to
ensure that its IT systems are Year 2000 compliant. IT systems include
internally developed software, software obtained from third parties,
databases, mainframe computers, servers, and network and related hardware.
Phases one, two and three of the program, which have been substantially
completed, consist of planning the project, increasing internal awareness of
Year 2000 issues, and developing and assessing an inventory of IT systems for
Year 2000 issues. Phases four, five and six consist of renovating and testing
impacted IT systems and implementing the appropriate solutions for these
problems. These phases are expected to be completed by March 1999. The
Company plans to complete the remediation of its critical internal systems,
including its internal core financial accounting systems, by the beginning of
the Company's fiscal year 2000 that begins on February 1, 1999. The Company
has also implemented a Company-wide program to test and, if necessary,
replace computer desktops, laptops and internal communications network
equipment and associated software. In addition, the Company's subsidiaries
that do not use the core financial accounting systems of the Company are
testing and remediating their internal systems for Year 2000 issues. As of
this date, no matters have come to the attention of management that would
indicate that these subsidiaries will not meet their plan to be Year 2000
compliant.
NON-IT SYSTEMS - The Company has inventoried and assessed its non-IT
systems in Company-owned or controlled facilities that may contain embedded
technology, such as those found in elevators, telephone systems and security
and access systems. Company-owned or controlled sites are typically the
largest sites and although they represent only 6% of the Company's facilities
in number, these sites serve 45% of the Company's workforce. Systems
identified as having Year 2000 issues are being remediated or replaced and
are scheduled to be Year 2000 compliant by February 1999. The Company has
engaged in communications with its lessors and customers regarding Year 2000
issues with non-IT systems in leased or customer facilities and has provided
its lessors with Year 2000 awareness information regarding embedded systems.
The scope of the Company's involvement varies depending upon access to the
facility and the extent of cooperation received from the lessors and
customers. The Company cannot control Year 2000 compliance in leased and
customer facilities and must depend upon the cooperation of these third
parties.
I-10
<PAGE>
BUSINESS PARTNER AND CUSTOMER YEAR 2000 IMPACTS - The Company's
operations are dependent to varying degrees on the Year 2000 compliance of
its business partners. Its significant business partners include, but are not
limited to, the Company's suppliers and subcontractors, utility companies,
banking partners, payroll processing vendor, insurance and benefit providers,
the retirement plans' fund managers and trustees, and property management
firms. In 1997, the Company initiated communications with its business
partners to determine their Year 2000 readiness and the extent to which the
Company is vulnerable to their failure to be Year 2000 compliant. To date,
the Company has not received responses from all contacted business partners.
Although it has inquired of most of its business partners, this effort has
not been completed. However, based on responses to date, the Company is not
aware of any material exposure to Year 2000 problems attributable to its
business partners. The Company continues to actively pursue responses in
order to assess its own state of readiness and develop any appropriate
contingency plans. The ability of the Company's business partners to be Year
2000 compliant is beyond the Company's control. Accordingly, the Company can
give no assurances that its business partners and other third parties will be
Year 2000 compliant or that the systems of such third parties will be
compatible with the Company's systems. Failure of such third party systems to
be compliant or compatible could have a material adverse effect on the
Company's results of operations and ability to do business.
The Company is substantially dependent upon the effectiveness of its
customers' systems, principally those of the U.S. Government, for the
administration of contracts and payment of the Company's invoices. The
Company is in the process of contacting its major U.S. Government payment
offices to understand the current status of their Year 2000 issues and
remediation efforts. Although there could be a number of impacts, a primary
concern is delays in contract payments if the Company's customers were to
experience Year 2000 problems. This could require a temporary increase in
working capital to fund operations. Although the Company has substantial
borrowing capacity available under its current revolving credit facilities
which expire in August 2002, the Company will further evaluate the potential
cash flow impact of a delay in contract payments and determine if additional
steps are necessary to ensure that sufficient contingency financing is
available.
IMPACT ON INTERNATIONAL OPERATIONS - As of January 31, 1998, 11% of
consolidated revenues was derived from the Company's international
operations, primarily in Venezuela and the United Kingdom. Foreign countries
and businesses located within those countries may not be applying adequate
resources to address the Year 2000 issue. To the extent that foreign
countries and businesses are not Year 2000 compliant, the Company's
international operations may be adversely affected.
PRODUCTS AND SERVICES - The Company's Bellcore subsidiary derives
significant revenues from the sale of telecommunication products. Bellcore
has established an assessment, remediation and testing program for its
proprietary software products that it expects to complete in early 1999. The
Company has also implemented an on-going program to assess its exposure, if
any, with respect to its other products and services. To date, no matters
concerning the Company's products and services have come to the attention of
the Company's management that would have a material adverse effect on its
consolidated financial position, results of operations, cash flows or its
ability to conduct business.
YEAR 2000 REMEDIATION COSTS - The Company is currently developing
formalized procedures for tracking and reporting costs associated with
remediating internal IT and non-IT systems. To date, the Company estimates it
has spent approximately $5-$8 million on this remediation and expects to
spend an additional $5-$11 million to complete this effort. All costs,
except long-lived assets, are expensed as incurred. These costs include the
cost of system replacements, hardware, software, internal labor and outside
consulting and programming services.
RISKS OF YEAR 2000 ISSUES - While the Company expects to resolve Year
2000 issues within its control without material adverse impact on results of
operations, cash flows or its ability to conduct business, there can be no
assurances as to the ultimate success of the program. Uncertainties exist as
to the Company's ability to detect and successfully resolve all Year 2000
problems. Uncertainties also exist concerning the preparedness and readiness
of the Company's business partners to avoid Year 2000 related service and
delivery interruptions. The "most reasonably likely worst case scenario for
the Company" could include interruption of the Company's business, lost or
delayed revenues, Company, vendor or subcontractor non-performance and
delays, potential litigation with
I-11
<PAGE>
customers, suppliers or vendors with respect to Year 2000 compliance of
products and services, performance problems with administrative and financial
accounting systems, service problems with the payroll vendor and utilities in
Company-owned and leased facilities, interruptions of subcontract services
and products from vendors who are an integral component of the Company's
performance on contracts, increases in general and administrative costs until
the problems are resolved, slow payments by customers, and higher interest
expense. In addition, customers of the Company may direct significant
resources to addressing their own Year 2000 issues which could result in
reductions or delays in purchases of the Company's services and products.
CONTINGENCY PLANS - The Company is currently developing contingency
plans for IT and non-IT systems, focusing on the Company's internal systems
and its dependence on its business partners. The contingency plans are under
development and the Company has not yet established a date for their
completion. The Company intends to establish a timetable for completion of
the contingency plans by January 31, 1999. Due to the potentially far
reaching consequences of the Year 2000 problem and the speculative nature of
contingency planning, it is uncertain whether the Company's contingency plans
once developed will adequately address the impacts of Year 2000 problems on
the Company's operations.
YEAR 2000 FORWARD LOOKING STATEMENTS - The foregoing statements as to
costs, dates, intent, belief and current expectations of the Company or its
officers with respect to Year 2000 issues are forward looking and are made in
reliance on the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. Such statements are based on the Company's best
estimates and expectations given the information available at the date hereof
and may be updated as additional information becomes available. In addition,
such statements are not guarantees of future results or outcomes and involve
risks and uncertainties, and actual results may differ materially from those
in the forward-looking statements as a result of various factors. Some of
these factors, include, but are not limited to, the Company's ability to
identify and address all Year 2000 issues associated with its IT and non-IT
systems; the representations, preparedness and readiness of the Company's
business partners; unanticipated expenses or delays on the part of the
Company or its customers, service providers, suppliers and vendors, and the
ability of the Company to develop and execute a comprehensive contingency
plan to cover the "most reasonably likely worst case" scenario. Due to such
uncertainties and risks surrounding Year 2000 issues, the Company's
assessment of the Year 2000 issue, including the costs of the program and
timing of completion are based on management's best estimates and input from
customers, service providers, suppliers and vendors. These estimates were
derived using numerous assumptions about future events, including continued
availability of certain resources, third party modification plans and other
factors. However, the Company cautions that it is impossible to predict the
impact of certain factors that are not within the control of the Company and
there can be no assurances that these estimates will be achieved and actual
results could differ materially from those anticipated.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
I-12
<PAGE>
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is involved in various investigations, claims and lawsuits
arising in the normal conduct of its business, none of which, in the opinion
of the Company's management, will have a material adverse effect on its
consolidated financial position, results of operations or its ability to
conduct business.
ITEM 2. CHANGES IN SECURITIES
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - See Exhibit Index.
(b) Reports on Form 8-K.
During the fiscal quarter for which this report is filed, the
following report on Form 8-K was filed by the Registrant:
(i) Form 8-K filed October 14, 1998, Item 5, Other Events.
(ii) Form 8-K filed November 23, 1998, Item 4, Changes in Registrant's
Certifying Accountant.
II-1
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SCIENCE APPLICATIONS
INTERNATIONAL CORPORATION
Date: December 15, 1998 /s/ W. A. Roper
--------------------------------
Senior Vice President and
Chief Financial Officer and
as a duly authorized officer
II-2
<PAGE>
Exhibit Index
Science Applications International Corporation
Fiscal Quarter Ended October 31, 1998
<TABLE>
<CAPTION>
Exhibit Sequential
No. Description of Exhibits Page No.
------- ----------------------- ---------
<S> <C> <C>
27 Financial Data Schedule
</TABLE>
II-4
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEET AND RELATED CONDENSED CONSOLIDATED
STATEMENTS OF INCOME AND CASH FLOWS FOR THE NINE MONTHS ENDED OCTOBER 31, 1998
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-31-1999
<PERIOD-START> FEB-01-1998
<PERIOD-END> OCT-31-1998
<CASH> 290,433
<SECURITIES> 107,876
<RECEIVABLES> 791,294
<ALLOWANCES> 30,197
<INVENTORY> 13,049
<CURRENT-ASSETS> 1,343,425
<PP&E> 716,031
<DEPRECIATION> 244,341
<TOTAL-ASSETS> 2,567,408
<CURRENT-LIABILITIES> 1,052,049
<BONDS> 138,250
0
0
<COMMON> 569
<OTHER-SE> 979,821
<TOTAL-LIABILITY-AND-EQUITY> 2,567,408
<SALES> 0
<TOTAL-REVENUES> 3,427,368
<CGS> 0
<TOTAL-COSTS> 2,705,293
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 23,314
<INCOME-PRETAX> 225,948
<INCOME-TAX> 108,641
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 117,307
<EPS-PRIMARY> 2.11
<EPS-DILUTED> 1.95
</TABLE>
