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Rating Action:

MOODY'S CONFIRMS SCIENCE APPLICATIONS INTERNATIONAL CORP. SR. DEBT RATINGS AT A3

19 Jun 2002
MOODY'S CONFIRMS SCIENCE APPLICATIONS INTERNATIONAL CORP. SR. DEBT RATINGS AT A3

Approximately US$1.5 Billion of Debt Securities Affected.

New York, June 19, 2002 -- Moody's confirmed the A3 senior unsecured rating of Science Applications International Corporation (SAIC), and assigned an A3 rating to its proposed $750 million senior unsecured debt offering announced yesterday. The outlook is stable.

Ratings confirmed include:

Senior Unsecured Bank Credit Facility A3

Senior Unsecured A3

The confirmation reflects increasing business growth opportunities within SAIC's regulated government division (64% of fiscal year 2002 revenue, 48% of operating profit); stability provided by recurring revenue from long-term contracts; strong internal and external liquidity; and free cash flow (cash flow from operating activities less capital expenditures). The rating is tempered by weakness within its Non-Regulated Telecommunications division (24% of fiscal year 2002 revenue, 40% of operating profit), by concern about cost overruns on several firm fixed price contracts, and by a stock system that more recently has created overhang for SAIC to buy back shares at relatively significant levels. The company's stock system is a critical incentive tool for its employees who, along with former employees, own 100% of the company.

In Moody's view, SAIC's strong position in the federal government sector, evidenced by its 62% contract win rate for fiscal year 2002 (ended January 31, 2002), will continue to contribute to revenue and cash flow growth within its Regulated division. In addition, Moody's expects SAIC will benefit from the U.S. government's increased defense spending posture, whose opportunities should offset the slowdown in the company's Non-Regulated Telecommunication (Telcordia Technologies, Inc.) division. Moody's believes the Regulated division's long term government contracts provide a predictable annuity revenue stream overall, though Moody's believes that the company will continue to be challenged by fixed price contracts (about 30% of revenue), given uncertainties inherent to stipulating long term services for a fixed price. Nevertheless, Moody's rating incorporates the expectation of growth in profitability in the government segment.

Moody's expects that the Non-Regulated Telecommunications division will continue to suffer revenue declines from contract deferral and reduced spending, given the weak condition of the telecommunications industry, but that it will continue to achieve profitability, benefiting from cost savings which resulted from its 2002 restructuring, as well as its track record of selling essential management and administrative software. This division has historically been comprised of the company's Telcordia subsidiary and Moody's notes that Telcordia's offerings include both cost cutting and revenue generating solutions. The company remains heavily exposed to Regional Bell Operating Companies (65% of Telcordia revenue in fiscal year 2002). Should Telecordia experience a substantial decline in profitability or generate losses, the rating could come under pressure.

Moody's notes that SAIC currently has in excess of $1.5 billion of liquid cash and investments, and after the offering will have over $2.0 billion, which includes collared investments in Amdocs and Verisign. The company's existing reducing revolving credit facility of $519 million expires in August 2002. Moody's expects the company to achieve $750 million of external liquidity in tandem with the current offering, consisting of a $500 million multi-year revolving credit facility and a $250 million, 364 day revolving credit facility. While SAIC may increase its acquisition and investment activity, Moody's does not expect substantial uses of cash in the near-term and thus cash balances should remain high and the credit facility undrawn.

SAIC consistently generates cash flow from operating activities (as defined by GAAP) in excess of capital expenditures, and capital expenditures are less than 3% of revenues, lower than many of its IT services peers. Moody's believes capital expenditures may increase slightly as SAIC attempts to increase the portion of revenue it derives from outsourcing, but will remain modest relative to the industry.

Share repurchases of company stock will likely continue to be a significant use of cash, because company stock is an integral aspect of compensation in SAIC's employee ownership structure (all shares are held by current or former employees) and there is no public market for SAIC's shares. Moody's notes that the high share repurchase activity of fiscal year 2002 was an aberration resulting in part from the excess cash SAIC accumulated from liquidation of various holdings in its venture capital fund. With the exception of Amdocs and Verisign, Moody's does not expect any other large sales of investments. A critical element of maintaining its current rating level is that SAIC moderates its share buybacks to be within the amount of free cash flow it generates, and that it does not borrow to buyback shares.

SAIC has historically demonstrated considerable financial discipline around acquisitions, and has a fairly solid record of selecting and integrating acquisitions. Moody's expects future acquisitions to cluster in the $10 to $50 million range, and believes a single acquisition exceeding $100 million to be unlikely. Moody's anticipates that SAIC will use the proceeds of the offering primarily to finance future acquisitions over the next several years and that these acquisitions will remain within the company's historic acquisition discipline.

Science Applications International Corporation, with headquarters in San Diego, California, is an employee-owned research and engineering company providing information technology and systems integration services to governments and commercial customers.

New York
Robert Konefal
Managing Director
Corporate Finance
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
John D. Moore
Asst Vice President - Analyst
Corporate Finance
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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