Science Applications International Corp 10-Q

Item 1. Financial Statements SCIENCE APPLICATIONS INTERNATIONAL CORPORATION CONDENSED AND CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) Three Months Ended Nine Months Ended October 28, 2022 October 29, 2021 October 28, 2022 October 29, 2021 (in millions, except per share amounts) Revenues $ 1,909 $ 1,898 $ 5,736 $ 5,612 Cost of revenues 1,688 1,685 5,070 4,950 Selling, general and administrative expenses 87 87 272 252 Acquisition and integration costs 1 12 11 36 Other operating income — — — ( 3 ) Operating income 133 114 383 377 Interest expense 30 26 87 79 Other (income) expense, net 3 — 6 ( 3 ) Income before income taxes 100 88 290 301 Provision for income taxes ( 20 ) ( 17 ) ( 62 ) ( 66 ) Net income 80 71 228 235 Net income attributable to non-controlling interest — — 2 1 Net income attributable to common stockholders $ 80 $ 71 $ 226 $ 234 Earnings per share: Basic $ 1.45 $ 1.24 $ 4.06 $ 4.05 Diluted $ 1.45 $ 1.22 $ 4.04 $ 4.01 See accompanying notes to condensed and consolidated financial statements. -1- Table of Conten ts SCIENCE APPLICATIONS INTERNATIONAL CORPORATION CONDENSED AND CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) Three Months Ended Nine Months Ended October 28, 2022 October 29, 2021 October 28, 2022 October 29, 2021 (in millions) Net income $ 80 $ 71 $ 228 $ 235 Other comprehensive income, net of tax: Net unrealized gain on derivative instruments 29 17 63 32 Total other comprehensive income, net of tax 29 17 63 32 Comprehensive income $ 109 $ 88 $ 291 $ 267 Comprehensive income attributable to non-controlling interest — — 2 1 Comprehensive income attributable to common stockholders $ 109 $ 88 $ 289 $ 266 See accompanying notes to condensed and consolidated financial statements. -2- Table of Conten ts SCIENCE APPLICATIONS INTERNATIONAL CORPORATION CONDENSED AND CONSOLIDATED BALANCE SHEETS (UNAUDITED) October 28, 2022 January 28, 2022 (in millions) ASSETS Current assets: Cash and cash equivalents $ 53 $ 106 Receivables, net 1,059 1,015 Inventory, prepaid expenses and other current assets 135 142 Total current assets 1,247 1,263 Goodwill 2,911 2,913 Intangible assets, net 1,040 1,132 Property, plant, and equipment (net of accumulated depreciation of $ 194 million and $ 182 million at October 28, 2022 and January 28, 2022, respectively) 95 100 Operating lease right of use assets 166 209 Other assets 169 129 Total assets $ 5,628 $ 5,746 LIABILITIES AND EQUITY Current liabilities: Accounts payable and accrued liabilities $ 819 $ 840 Accrued payroll and employee benefits 396 364 Long-term debt, current portion 15 148 Total current liabilities 1,230 1,352 Long-term debt, net of current portion 2,358 2,370 Operating lease liabilities 155 192 Deferred income taxes — 43 Other long-term liabilities 189 160 Commitments and contingencies (Note 11) Equity: Common stock, $ 0.0001 par value, 1 billion shares authorized, 55 million and 56 million shares issued and outstanding as of October 28, 2022 and January 28, 2022, respectively — — Additional paid-in capital 679 838 Retained earnings 981 818 Accumulated other comprehensive income (loss) 26 ( 37 ) Total common stockholders' equity 1,686 1,619 Non-controlling interest 10 10 Total stockholders' equity 1,696 1,629 Total liabilities and stockholders' equity $ 5,628 $ 5,746 See accompanying notes to condensed and consolidated financial statements. -3- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION CONDENSED AND CONSOLIDATED STATEMENTS OF EQUITY (UNAUDITED) Shares of common stock Additional paid-in capital Retained earnings Accumulated other comprehensive income (loss) Non-controlling interest Total (in millions) Balance at July 29, 2022 55 $ 723 $ 923 $ ( 3 ) $ 10 $ 1,653 Net income — — 80 — — 80 Issuances of stock — 5 — — — 5 Other comprehensive income, net of tax — — — 29 — 29 Cash dividends of $ 0.37 per share — — ( 22 ) — — ( 22 ) Stock-based compensation — 11 — — — 11 Repurchases of stock — ( 60 ) — — — ( 60 ) Distributions to non-controlling interest — — — — — — Balance at October 28, 2022 55 $ 679 $ 981 $ 26 $ 10 $ 1,696 Balance at January 28, 2022 56 $ 838 $ 818 $ ( 37 ) $ 10 $ 1,629 Net income — — 226 — 2 228 Issuances of stock 1 13 — — — 13 Other comprehensive income, net of tax — — — 63 — 63 Cash dividends of $ 1.11 per share — — ( 63 ) — — ( 63 ) Stock-based compensation — 19 — — — 19 Repurchases of stock ( 2 ) ( 191 ) — — — ( 191 ) Distributions to non-controlling interest — — — — ( 2 ) ( 2 ) Balance at October 28, 2022 55 $ 679 $ 981 $ 26 $ 10 $ 1,696 Balance at July 30, 2021 58 $ 945 $ 747 $ ( 74 ) $ 10 $ 1,628 Net income — — 71 — — 71 Issuances of stock 1 4 — — — 4 Other comprehensive income, net of tax — — — 17 — 17 Cash dividends of $ 0.37 per share — — ( 22 ) — — ( 22 ) Stock-based compensation — 11 — — — 11 Repurchases of stock ( 2 ) ( 64 ) — — — ( 64 ) Distributions to non-controlling interest — — — — — — Balance at October 29, 2021 57 $ 896 $ 796 $ ( 57 ) $ 10 $ 1,645 Balance at January 29, 2021 58 $ 1,004 $ 627 $ ( 89 ) $ 10 $ 1,552 Net income — — 234 — 1 235 Issuances of stock 1 12 — — — 12 Other comprehensive income, net of tax — — — 32 — 32 Cash dividends of $ 1.11 per share — — ( 65 ) — — ( 65 ) Stock-based compensation — 21 — — — 21 Repurchases of stock ( 2 ) ( 141 ) — — — ( 141 ) Distributions to non-controlling interest — — — — ( 1 ) ( 1 ) Balance at October 29, 2021 57 $ 896 $ 796 $ ( 57 ) $ 10 $ 1,645 See accompanying notes to condensed and consolidated financial statements. -4- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION CONDENSED AND CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Nine Months Ended October 28, 2022 October 29, 2021 (in millions) Cash flows from operating activities: Net income $ 228 $ 235 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 118 123 Amortization of off-market customer contracts ( 12 ) ( 30 ) Amortization of debt issuance costs 8 6 Deferred income taxes ( 29 ) 41 Stock-based compensation expense 35 35 Gain on divestitures — ( 2 ) Impairment of assets — 10 Increase (decrease) resulting from changes in operating assets and liabilities, net of the effect of acquisitions: Receivables ( 44 ) ( 123 ) Inventory, prepaid expenses and other current assets 7 28 Other assets 5 ( 8 ) Accounts payable and accrued liabilities ( 21 ) 47 Accrued payroll and employee benefits 32 45 Income taxes payable 59 — Operating lease assets and liabilities, net ( 1 ) 4 Other long-term liabilities 2 4 Net cash provided by operating activities 387 415 Cash flows from investing activities: Expenditures for property, plant, and equipment ( 18 ) ( 27 ) Purchases of marketable securities ( 5 ) ( 5 ) Sales of marketable securities 3 4 Cash paid for acquisitions, net of cash acquired — ( 247 ) Proceeds from divestitures — 8 Other ( 3 ) ( 5 ) Net cash used in investing activities ( 23 ) ( 272 ) Cash flows from financing activities: Dividend payments to stockholders ( 63 ) ( 65 ) Principal payments on borrowings ( 780 ) ( 84 ) Issuances of stock 12 12 Stock repurchased and retired or withheld for taxes on equity awards ( 208 ) ( 154 ) Proceeds from borrowings 630 116 Debt issuance costs ( 6 ) — Distributions to non-controlling interest ( 2 ) ( 1 ) Net cash used in financing activities ( 417 ) ( 176 ) Net decrease in cash, cash equivalents and restricted cash ( 53 ) ( 33 ) Cash, cash equivalents and restricted cash at beginning of period 115 190 Cash, cash equivalents and restricted cash at end of period $ 62 $ 157 See accompanying notes to condensed and consolidated financial statements. -5- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION NOTES TO CONDENSED AND CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 1— Business Overview and Summary of Significant Accounting Policies: Overview Science Applications International Corporation (collectively, with its consolidated subsidiaries, the “Company”) is a leading provider of technical, engineering and enterprise information technology (IT) services primarily to the U.S. government. The Company provides these services for large, complex projects with a targeted emphasis on higher-end, differentiated technology services and solutions that accelerate and transform secure and resilient digital environments through system development, modernization, integration, and sustainment to drive enterprise and mission outcomes. The Company is organized as a matrix comprised of two customer facing operating sectors supported by an enterprise solutions and operations organization. The Company's operating sectors are aggregated into one reportable segment for financial reporting purposes. Each of the Company’s two customer facing operating sectors is focused on providing both (1) growth and technology accelerating solutions and (2) core IT service offerings to one or more agencies of the U.S. federal government. Growth and technology accelerating solutions include the delivery of secure cloud modernization, outcome based enterprise IT as-a-service, and the integration, production and modernization of defense systems. Core IT services include systems engineering, the operation and maintenance of existing IT systems and networks, and logistics and supply chain solutions. During the second quarter of fiscal 2022, the Company completed the acquisition of Halfaker and Associates, LLC (Halfaker), a mission focused, pure-play health IT company, growing the Company's digital transformation portfolio. Additionally, the Company acquired Koverse, a software company that provides a data management platform enabling artificial intelligence and machine learning on complex sensitive data. Principles of Consolidation and Basis of Presentation The accompanying financial information has been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission for interim reporting purposes. References to “financial statements” refer to the condensed and consolidated financial statements of the Company, which include the statements of income and comprehensive income, balance sheets, statements of equity and statements of cash flows. These financial statements were prepared in accordance with U.S. generally accepted accounting principles (GAAP). All intercompany transactions and account balances within the Company have been eliminated. The financial statements are unaudited, but in the opinion of management include all adjustments, which consist of normal recurring adjustments, necessary for a fair presentation thereof. The results reported in these financial statements are not necessarily indicative of results that may be expected for the entire year and should be read in conjunction with the information contained in the Company’s Annual Report on Form 10-K for the year ended January 28, 2022. Non-controlling Interest. The Company holds a 50.1 % majority interest in Forfeiture Support Associates J.V. (FSA). The results of operations of FSA are included in the Company's condensed and consolidated statements of income and comprehensive income and statements of cash flows. The non-controlling interest reported on the condensed and consolidated balance sheets represents the portion of FSA's equity that is attributable to the non-controlling interest. Use of Estimates The preparation of the financial statements in conformity with GAAP 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 periods. Significant estimates inherent in the preparation of the financial statements may include, but are not limited to estimated profitability of long-term contracts, income taxes, fair value measurements, fair value of goodwill and other intangible assets, pension and defined benefit plan obligations, and contingencies. Estimates have been prepared by management on the basis of the most current and best available information at the time of estimation and actual results could differ from those estimates. -6- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION NOTES TO CONDENSED AND CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Reporting Periods The Company utilizes a 52/53 week fiscal year ending on the Friday closest to January 31, with fiscal quarters typically consisting of 13 weeks. Fiscal 2023 began on January 29, 2022 and ends on February 3, 2023, while fiscal 2022 began on January 30, 2021 and ended on January 28, 2022. Operating Cycle The Company’s operating cycle may be greater than one year and is measured by the average time intervening between the inception and the completion of contracts. Derivative Instruments Designated as Cash Flow Hedges Derivative instruments are recorded on the condensed and consolidated balance sheets at fair value. Unrealized gains and losses on derivatives designated as cash flow hedges are reported in other comprehensive income (loss) and reclassified to earnings in a manner that matches the timing of the earnings impact of the hedged transactions. The Company’s fixed interest rate swaps are considered over-the-counter derivatives, and fair value is calculated using a standard pricing model for interest rate swaps with contractual terms for maturities, amortization and interest rates. Level 2, or market observable inputs (such as yield and credit curves), are used within the standard pricing models in order to determine fair value. The fair value is an estimate of the amount that the Company would pay or receive as of a measurement date if the agreements were transferred to a third party. See Note 8 for further discussion on the Company’s derivative instruments designated as cash flow hedges. Marketable Securities Investments in marketable securities consist of equity securities, which are recorded at fair value using observable inputs such as quoted prices in active markets (Level 1). As of October 28, 2022 and January 28, 2022, the fair value of our investments totaled $ 26 million and $ 28 million, respectively, and are included in other assets on the condensed and consolidated balance sheets. The Company's investments are primarily held in a custodial account, which includes investments to fund our deferred compensation plan liabilities. Cash, Cash Equivalents and Restricted Cash The following table provides a reconciliation of cash, cash equivalents and restricted cash to amounts reported within the condensed and consolidated balance sheets for the periods presented: October 28, 2022 January 28, 2022 (in millions) Cash and cash equivalents $ 53 $ 106 Restricted cash included in inventory, prepaid expenses and other current assets 5 5 Restricted cash included in other assets 4 4 Cash, cash equivalents and restricted cash $ 62 $ 115 Acquisition and Integration Costs Acquisition-related costs that are not part of the purchase price consideration are generally expensed as incurred, except for certain costs that are deferred in connection with the issuance of debt. These costs typically include transaction-related costs, such as finder’s fees, legal, accounting, and other professional costs. Integration-related costs represent costs directly related to combining the Company and its acquired businesses. Integration-related costs typically include strategic consulting services, facility consolidations, employee-related costs, such as retention and severance, costs to integrate information technology infrastructure, enterprise planning systems, processes, and other non-recurring integration-related costs. Acquisition and integration costs are presented together as acquisition and integration costs on the condensed and consolidated statements of income. -7- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION NOTES TO CONDENSED AND CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) The amounts recognized in acquisition and integration costs on the condensed and consolidated statements of income are as follows: Three Months Ended Nine Months Ended October 28, 2022 October 29, 2021 October 28, 2022 October 29, 2021 (in millions) Acquisition (1) $ ( 1 ) $ — $ ( 2 ) $ 3 Integration (2) 2 12 13 33 Total acquisition and integration costs $ 1 $ 12 $ 11 $ 36 (1) Acquisition expenses for the three and nine months ended October 28, 2022 reflects amounts recognized to reduce the fair value of the Koverse earnout liability. Acquisition expenses for the nine months ended October 29, 2021 are related to the acquisitions of Halfaker and Koverse. See Note 4 for additional information related to the acquisitions. (2) Integration expenses for the nine months ended October 29, 2021 include $ 10 million for the impairment of assets. Restructuring During the three and nine months ended October 28, 2022, the Company incurred $ 5 million and $ 7 million, respectively, of restructuring costs related to the consolidation of certain facilities and other costs associated with the optimization of business processes. These costs are presented within selling, general and administrative expenses in the condensed and consolidated statements of income. Accounting Standards Updates In September 2022, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2022-04, Liabilities—Supplier Finance Programs (Subtopic 405-50) , which requires annual and interim disclosures for entities that use supplier finance programs in connection with the purchase of goods and services. The new standard does not affect the recognition, measurement or financial statement presentation of supplier finance program obligations. These amendments are effective for fiscal years beginning after December 15, 2022, except for the requirement to provide rollforward information, which is effective for fiscal years beginning after December 15, 2023. Early adoption is permitted. The Company does not expect the adoption of this standard to have a material impact on its consolidated financial statements. In October 2021, the FASB issued ASU No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers , which requires contract assets and contract liabilities acquired in a business combination to be recognized and measured at the acquisition date in accordance with Topic 606 as if the acquirer had originated the contracts. The standard is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, and must be applied prospectively. Early adoption is permitted. The Company adopted the requirements of ASU 2021-08 on a prospective basis effective the first day of fiscal 2023. Note 2— Earnings Per Share, Share Repurchases and Dividends: Earnings Per Share (EPS) Basic EPS is computed by dividing net income attributable to common stockholders by the basic weighted-average number of shares outstanding. Diluted EPS is computed similarly to basic EPS, except the weighted-average number of shares outstanding is increased to include the dilutive effect of outstanding stock options and other stock-based awards. -8- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION NOTES TO CONDENSED AND CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) The following table provides a reconciliation of the weighted-average number of shares outstanding used to compute basic and diluted EPS for the periods presented: Three Months Ended Nine Months Ended October 28, 2022 October 29, 2021 October 28, 2022 October 29, 2021 (in millions) Basic weighted-average number of shares outstanding 55.0 57.5 55.6 57.8 Dilutive common share equivalents - stock options and other stock-based awards 0.5 0.5 0.4 0.6 Diluted weighted-average number of shares outstanding 55.5 58.0 56.0 58.4 Antidilutive stock awards excluded from the weighted-average number of shares outstanding used to compute diluted EPS for the three and nine months ended October 28, 2022 and October 29, 2021 were immaterial . Share Repurchases The Company may repurchase shares in accordance with established repurchase plans. The Company retires its common stock upon repurchase with the excess over par value allocated to additional paid-in capital. The Company has not made any material purchases of common stock other than in connection with established share repurchase plans. In June 2022, the number of shares of our common stock that may be repurchased under our existing repurchase plan was increased by 8.0 million shares, bringing the total authorized shares to be repurchased under the plan to approximately 24.4 million shares. As of October 28, 2022, we have repurchased approximately 16.5 million shares of common stock under the program. Dividends The Company declared and paid a quarterly dividend of $ 0.37 per share of its common stock during the three months ended October 28, 2022. Subsequent to the end of the quarter, on November 29, 2022, the Company's Board of Directors declared a quarterly dividend of $ 0.37 per share of the Company's common stock payable on January 27, 2023 to stockholders of record on January 13, 2023. Note 3— Revenues: Changes in Estimates on Contracts Changes in estimates of revenues, cost of revenues or profits related to performance obligations satisfied over time are recognized in operating income in the period in which such changes are made for the inception-to-date effect of the changes. Changes in these estimates can occur routinely over the performance period for a variety of reasons, which include: changes in scope; changes in cost estimates due to unanticipated cost growth or reassessments of risks impacting costs; changes in the estimated transaction price, such as variable amounts for incentive or award fees; and performance being better or worse than previously estimated. Many of the Company's contracts recognize revenue on performance obligations using a cost input measure (cost-to-cost), which requires estimates of total costs at completion. In cases when total expected costs exceed total estimated revenues for a performance obligation, the Company recognizes the total estimated loss in the quarter identified. Total estimated losses are inclusive of any unexercised options that are probable of award, only if they increase the amount of the loss. -9- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION NOTES TO CONDENSED AND CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Aggregate net changes in estimates on contracts accounted for using the cost-to-cost method of accounting were recognized in operating income as follows: Three Months Ended Nine Months Ended October 28, 2022 October 29, 2021 October 28, 2022 October 29, 2021 (in millions, except per share amounts) Net (unfavorable) favorable adjustments $ ( 6 ) $ — $ 4 $ 9 Net (unfavorable) favorable adjustments, after tax ( 5 ) — 3 7 Diluted EPS impact $ ( 0.09 ) $ — $ 0.05 $ 0.12 Revenues were $ 2 million lower and $ 7 million higher for the three and nine months ended October 28, 2022, respectively, and $ 1 million and $ 21 million higher for the three and nine months ended October 29, 2021, respectively, due to net revenue recognized from performance obligations satisfied in prior periods. Disaggregation of Revenues The Company's revenues are generated primarily from long-term contracts with the U.S. government including subcontracts with other contractors engaged in work for the U.S. government. The Company disaggregates revenues by customer, contract-type and prime versus subcontractor to the federal government. Disaggregated revenues by customer were as follows: Three Months Ended Nine Months Ended October 28, 2022 October 29, 2021 October 28, 2022 October 29, 2021 (in millions) Department of Defense $ 969 $ 920 $ 2,799 $ 2,740 Other federal government agencies 903 940 2,827 2,762 Commercial, state and local 37 38 110 110 Total $ 1,909 $ 1,898 $ 5,736 $ 5,612 Disaggregated revenues by contract-type were as follows: Three Months Ended Nine Months Ended October 28, 2022 October 29, 2021 October 28, 2022 October 29, 2021 (in millions) Cost reimbursement $ 1,071 $ 1,045 $ 3,201 $ 3,028 Time and materials (T&M) 363 363 1,077 1,139 Firm-fixed price (FFP) 475 490 1,458 1,445 Total $ 1,909 $ 1,898 $ 5,736 $ 5,612 -10- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION NOTES TO CONDENSED AND CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Disaggregated revenues by prime versus subcontractor were as follows: Three Months Ended Nine Months Ended October 28, 2022 October 29, 2021 October 28, 2022 October 29, 2021 (in millions) Prime contractor to federal government $ 1,725 $ 1,722 $ 5,212 $ 5,069 Subcontractor to federal government 147 138 414 433 Other 37 38 110 110 Total $ 1,909 $ 1,898 $ 5,736 $ 5,612 Contract Balances Contract balances for the periods presented were as follows: Balance Sheet line item October 28, 2022 January 28, 2022 (in millions) Billed and billable receivables, net (1) Receivables, net $ 580 $ 615 Contract assets - unbillable receivables Receivables, net 479 400 Contract assets - contract retentions Other assets 16 17 Contract liabilities - current Accounts payable and accrued liabilities 35 55 Contract liabilities - non-current Other long-term liabilities $ 5 $ 9 (1) Net of allowance of $ 3 million and $ 4 million as of October 28, 2022 and January 28, 2022, respectively. During the three and nine months ended October 28, 2022, the Company recognized revenues of $ 4 million and $ 39 million, respectively, relating to amounts that were included in the opening balance of contract liabilities as of January 28, 2022. During the three and nine months ended October 29, 2021, the Company recognized revenues of $ 8 million and $ 72 million, respectively, relating to amounts that were included in the opening balance of contract liabilities as of January 29, 2021. Remaining Performance Obligations As of October 28, 2022, the Company had $ 5.0 billion of remaining performance obligations. Remaining performance obligations exclude any variable consideration that is allocated entirely to unsatisfied performance obligations on our supply chain contracts. The Company expects to recognize revenue on approximately 85 % of the remaining performance obligations over the next 12 months and approximately 95 % over the next 24 months, with the remaining recognized thereafter. Lessor Revenue The Company leases IT equipment and hardware to its customers. All of the Company’s lessor arrangements are operating leases. Operating lease revenue is recognized on a straight-line basis over the term of the lease. Operating lease income is reported as revenue on the condensed and consolidated statements of income. During the nine months ended October 28, 2022, the Company recognized revenue of $ 23 million from the exercise of purchase options under certain lessor arrangements. Operating lease income was immaterial for the three and nine months ended October 28, 2022 and $ 3 million and $ 14 million for the three and nine months ended October 29, 2021, respectively. -11- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION NOTES TO CONDENSED AND CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 4— Acquisitions: Halfaker On July 2, 2021, the Company completed the acquisition of Halfaker, a mission focused, pure-play health IT company for a purchase price of $ 228 million, net of $ 3 million cash acquired. The Company funded the transaction from increased borrowings and cash on hand. During the first quarter of fiscal 2023, the Company made fair value adjustments decreasing goodwill and increasing customer relationships intangible assets by $ 2 million. The Company has completed the determination of fair values of the acquired assets and liabilities assumed. The allocation of the purchase price resulted in goodwill of $ 104 million and intangible assets of $ 114 million, both of which are deductible for income tax purposes. The recognized goodwill is primarily associated with future customer relationships and an acquired assembled work force. The intangible assets consist of customer relationships of $ 97 million and backlog of $ 17 million that will be amortized over a period of nine years and one year , respectively. The Company made additional cash payments of $ 21 million in March 2022 associated with certain change in control provisions that are recognized as post-combination expense. Koverse On May 3, 2021, the Company acquired Koverse, a software company that provides a data management platform enabling artificial intelligence and machine learning on complex sensitive data, for a purchase price of $ 30 million, net of $ 2 million cash acquired. The purchase price included $ 3 million of contingent consideration, representing the acquisition date fair value recognized for up to $ 27 million gross of potential future earnout payments based on the achievement of certain revenue targets over the next four years. The Company has completed the allocation of the purchase price which resulted in goodwill of $ 21 million and intangible assets of $ 10 million, which are both not deductible for income tax purposes. The goodwill is primarily associated with intellectual capital, future customer relationships, and an acquired assembled work force. The intangible assets, which primarily consist of developed technology, are being amortized over a weighted-average period of seven years . As of October 28, 2022, the Company has recognized $ 11 million of the additional $ 13 million of post-combination compensation expense associated with certain employee retention agreements. Unisys Federal During the second quarters of fiscal 2023 and 2022, the Company accelerated the amortization for certain off-market customer contracts as a result of a change in their expected contractual terms. The accelerations resulted in additional amortization of $ 4 million and $ 6 million for the three and nine months ended October 28, 2022, respectively, and $ 9 million and $ 17 million for the three and nine months ended October 29, 2021, respectively. As of October 28, 2022, the remaining unamortized balance of the provision for certain off-market customer contracts is $ 7 million and is expected to be amortized by the end of fiscal 2024. Note 5— Goodwill and Intangible Assets: Goodwill Goodwill had a carrying value of $ 2,911 million and $ 2,913 million as of October 28, 2022 and January 28, 2022, respectively. There were no impairments of goodwill during the periods presented. -12- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION NOTES TO CONDENSED AND CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Intangible Assets Intangible assets, all of which were finite-lived, consisted of the following: October 28, 2022 January 28, 2022 Gross carrying value Accumulated amortization Net carrying value Gross carrying value Accumulated amortization Net carrying value (in millions) Customer relationships $ 1,467 $ ( 435 ) $ 1,032 $ 1,467 $ ( 351 ) $ 1,116 Backlog — — — 17 ( 10 ) 7 Developed technology 10 ( 2 ) 8 10 ( 2 ) 8 Trade name 1 ( 1 ) — 1 — 1 Total intangible assets $ 1,478 $ ( 438 ) $ 1,040 $ 1,495 $ ( 363 ) $ 1,132 Amortization expense related to intangible assets was $ 29 million and $ 94 million for the three and nine months ended October 28, 2022, respectively, and $ 33 million and $ 94 million for the three and nine months ended October 29, 2021, respectively. There were no intangible asset impairment losses during the periods presented. As of October 28, 2022, the estimated future annual amortization expense related to intangible assets is as follows: Fiscal Year (in millions) Remainder of 2023 $ 31 2024 115 2025 115 2026 115 2027 115 Thereafter 549 Total $ 1,040 Actual amortization expense in future periods could differ from these estimates as a result of future acquisitions, divestitures, impairments, and other factors. Note 6— Income Taxes: The Company's effective income tax rate was 20.3 % and 21.3 % for the three and nine months ended October 28, 2022, respectively, and 19.4 % and 22.0 % for the three and nine months ended October 29, 2021, respectively. The Company’s effective tax rate was higher for the three months ended October 28, 2022 compared to the prior year period primarily due to a lower deduction for foreign-derived intangible income. The Company’s effective tax rate was lower for the nine months ended October 28, 2022 compared to the prior year period primarily due to tax benefits recorded in fiscal 2023 from the completion of prior year tax return planning efforts including foreign-derived intangible income studies. Tax rates for the three and nine months ended October 28, 2022 were lower than the combined federal and state statutory rates due to excess tax benefits related to employee stock-based compensation, research and development tax credits, a deduction for foreign-derived intangible income, and other permanent book tax differences. As of January 28, 2022, the net deferred tax liability balance was $ 43 million and is presented as deferred income taxes on the condensed and consolidated balance sheets. As of October 28, 2022, the net deferred tax asset balance is $ 3 million, which is presented in other assets on the condensed and consolidated balance sheets and is due to capitalization of certain research and development expenses required under the Tax Cuts and Jobs Act of 2017. -13- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION NOTES TO CONDENSED AND CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 7— Debt Obligations: The Company’s long-term debt as of the dates presented was as follows: October 28, 2022 January 28, 2022 Stated interest rate Effective interest rate Principal Unamortized debt issuance costs Net Principal Unamortized debt issuance costs Net (in millions) Term Loan A Facility due June 2027 4.38 % 4.50 % $ 1,230 $ ( 5 ) $ 1,225 $ — $ — $ — Term Loan A Facility due October 2023 — % — % — — — 785 ( 5 ) 780 Term Loan A2 Facility due October 2023 — % — % — — — 100 — 100 Term Loan B Facility due October 2025 5.01 % 5.22 % 488 ( 3 ) 485 983 ( 7 ) 976 Term Loan B2 Facility due March 2027 5.01 % 5.44 % 272 ( 4 ) 268 272 ( 5 ) 267 Senior Notes due April 2028 4.88 % 5.11 % 400 ( 5 ) 395 400 ( 5 ) 395 Total long-term debt $ 2,390 $ ( 17 ) $ 2,373 $ 2,540 $ ( 22 ) $ 2,518 Less current portion 15 — 15 148 — 148 Total long-term debt, net of current portion $ 2,375 $ ( 17 ) $ 2,358 $ 2,392 $ ( 22 ) $ 2,370 As of October 28, 2022, the Company has a $ 3.0 billion secured credit facility (the Credit Facility) consisting of a Term Loan A Facility due June 2027, a Term Loan B Facility due October 2025, a Term Loan B2 Facility due March 2027 (together, the Term Loan Facilities), and a $ 1.0 billion Revolving Credit Facility due June 2027. During the quarter, the Company made a $ 90 million voluntary principal prepayment on the Term Loan B Facility due October 2025. During the nine months ended October 28, 2022, the Company borrowed and repaid $ 200 million under the Revolving Credit Facility. There was no balance outstanding on the Revolving Credit Facility as of October 28, 2022. As of October 28, 2022, the Company was in compliance with the covenants under its Credit Facility. On June 30, 2022, the Company executed the Fifth Amendment to the Third Amended and Restated Credit Agreement (Fifth Amendment), which established, among other things, a $ 1,230 million senior secured term loan credit facility (Term Loan A Facility due June 2027) and increased the Revolving Credit Facility commitment from $ 400 million to $ 1,000 million. The entire Term Loan A Facility due June 2027 was immediately borrowed by the Company and the proceeds were used to pay in full the outstanding principal balances under the Term Loan A Facility due October 2023 and Term Loan A2 Facility due October 2023 and to prepay $ 400 million of principal on the Term Loan B Facility due October 2025. For the three months ended July 29, 2022, the Company wrote off deferred debt issuance costs of $ 3 million associated with the Term Loan B Facility due October 2025 voluntary principal prepayments which was recognized in interest expense. Borrowings under the Term Loan A Facility due June 2027 amortize quarterly beginning on October 31, 2023 at 1.250 % of the original borrowed amount thereunder, with such quarterly amortization increasing to 1.875 % on October 31, 2024 and to 2.500 % on October 31, 2025. The Term Loan A Facility due June 2027 may be prepaid at any time without penalty and is subject to the same mandatory prepayments, including from excess cash flow, as the Company’s existing term loans under the Credit Facility. As a result of the Fifth Amendment, the maturity date for the Revolving Credit Facility was extended to, and the maturity date of the Term Loan A Facility due June 2027 is, the earlier of June 30, 2027 or 91 days prior to the earliest term loan “B” facility maturity date (subject to acceleration in certain circumstances). The Term Loan A Facility due June 2027 is secured by substantially all of the assets of the Company and the Company’s wholly owned domestic subsidiaries, and is guaranteed by each of the Company’s wholly owned domestic subsidiaries. The Term Loan A Facility due June 2027 is subject to the same covenants and events of default as the Company’s existing term loans under the Credit Facility. -14- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION NOTES TO CONDENSED AND CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Effective with the Fifth Amendment, all interest rates under the Credit Facility transitioned from LIBOR to Term Secured Overnight Financing Rate (Term SOFR) plus 0.10 % for US dollar denominated loans, Sterling Overnight Index Average (SONIA) for UK pound sterling denominated loans, and Euro Interbank Offered Rate (EURIBOR) for Euro denominated loans. The applicable interest rate margins under the Term Loan A Facility due June 2027 and the Revolving Credit Facility were reduced to a range from 0.75 % to 1.75 % per annum for Term SOFR, SONIA and EURIBOR loans, and from 0 % to 0.75 % per annum for base rate loans, in each case based on the Company’s leverage ratio. Commitment fees for undrawn amounts under the Revolving Credit Facility were also reduced to a range of 0.125 % to 0.25 % per annum based on the Company’s leverage ratio. During the nine months ended October 28, 2022, the Company incurred $ 8 million of debt issuance costs associated with the Fifth Amendment, of which $ 2 million was recognized in interest expense, with the remaining $ 6 million deferred and amortized to interest expense through the maturity date of the facility utilizing the effective interest rate method. As of October 28, 2022 and January 28, 2022, the carrying value of the Company’s outstanding debt obligations approximated its fair value. The fair value of long-term debt is calculated using Level 2 inputs, based on interest rates available for debt with terms and maturities similar to the Company’s Term Loan Facilities and Senior Notes. Maturities of long-term debt as of October 28, 2022 are: Fiscal Year Total (in millions) Remainder of 2023 $ — 2024 31 2025 77 2026 596 2027 123 Thereafter 1,563 Total principal payments $ 2,390 Note 8— Derivative Instruments Designated as Cash Flow Hedges: The Company’s derivative instruments designated as cash flow hedges consist of: Fair Value of Asset (Liability) (1) at Notional Amount at October 28, 2022 Pay Fixed Rate Receive Variable Rate Settlement and Termination October 28, 2022 January 28, 2022 (in millions) (in millions) Interest rate swaps #1 $ 685 2.96 % Term SOFR Monthly through October 31, 2025 $ 23 $ ( 39 ) Interest rate swaps #2 525 2.36 % Term SOFR Monthly through October 31, 2023 11 ( 12 ) Total $ 1,210 $ 34 $ ( 51 ) (1) The fair value of the fixed interest rate swap asset is included in other assets on the condensed and consolidated balance sheets. The fair value of the fixed interest rate swap liability is included in accounts payable and accrued liabilities on the condensed and consolidated balance sheets. The Company is party to fixed interest rate swap instruments that are designated and accounted for as cash flow hedges to manage risks associated with interest rate fluctuations on a portion of the Company’s floating rate debt. The counterparties to all swap agreements are financial institutions. -15- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION NOTES TO CONDENSED AND CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) On June 30, 2022 and in conjunction with the Fifth Amendment, the Company transitioned the variable rate on its interest rate swaps from 1-month LIBOR to 1-month Term SOFR. Effective with the transition, the Company will pay fixed rates of 2.96 % and 2.36 % on the group of interest rate swaps maturing on October 31, 2025 and October 31, 2023, respectively. The Company elected to apply the optional expedient in ASC 848 in connection with transitioning its interest rate swaps from LIBOR to Term SOFR that enabled it to consider the new swaps a continuation of the existing contracts. As a result, the transition did not have an impact on the Company’s hedge accounting or a material impact to the Company’s financial statements. See Note 9 for the unrealized change in fair values on cash flow hedges recognized in other comprehensive income (loss) and the amounts reclassified from accumulated other comprehensive income (loss) into earnings for the current and comparative periods presented. The Company estimates that it will reclassify $ 22 million of unrealized gains from accumulated other comprehensive income into earnings in the twelve months following October 28, 2022. -16- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION NOTES TO CONDENSED AND CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 9— Changes in Accumulated Other Comprehensive Income (Loss) by Component: The following table presents the changes in accumulated other comprehensive income (loss) attributable to the Company’s fixed interest rate swap cash flow hedges that are discussed in Note 8 and the Company's defined benefit plans. Unrealized Gains (Losses) on Fixed Interest Rate Swap Cash Flow Hedges (1) Defined Benefit Obligation Adjustment Total (in millions) Three months ended October 28, 2022 Balance at July 29, 2022 $ ( 4 ) $ 1 $ ( 3 ) Other comprehensive income before reclassifications 38 — 38 Amounts reclassified from accumulated other comprehensive loss 1 — 1 Income tax impact ( 10 ) — ( 10 ) Net other comprehensive income 29 — 29 Balance at October 28, 2022 $ 25 $ 1 $ 26 Three months ended October 29, 2021 Balance at July 30, 2021 $ ( 71 ) $ ( 3 ) $ ( 74 ) Other comprehensive income before reclassifications 13 — 13 Amounts reclassified from accumulated other comprehensive loss 9 — 9 Income tax impact ( 5 ) — ( 5 ) Net other comprehensive income 17 — 17 Balance at October 29, 2021 $ ( 54 ) $ ( 3 ) $ ( 57 ) Nine months ended October 28, 2022 Balance at January 28, 2022 $ ( 38 ) $ 1 $ ( 37 ) Other comprehensive income before reclassifications 72 — 72 Amounts reclassified from accumulated other comprehensive loss 13 — 13 Income tax impact ( 22 ) — ( 22 ) Net other comprehensive income 63 — 63 Balance at October 28, 2022 $ 25 $ 1 $ 26 Nine months ended October 29, 2021 Balance at January 29, 2021 $ ( 86 ) $ ( 3 ) $ ( 89 ) Other comprehensive income before reclassifications 17 — 17 Amounts reclassified from accumulated other comprehensive loss 26 — 26 Income tax impact ( 11 ) — ( 11 ) Net other comprehensive income 32 — 32 Balance at October 29, 2021 $ ( 54 ) $ ( 3 ) $ ( 57 ) (1) The amount reclassified from accumulated other comprehensive income (loss) is included in interest expense. -17- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION NOTES TO CONDENSED AND CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 10— Sales of Receivables: The Company has a Master Accounts Receivable Purchase Agreement (MARPA Facility) with MUFG Bank, Ltd. (the Purchaser) for the sale of up to a maximum amount of $ 300 million of certain designated eligible receivables with the U.S. government. Effective March 31, 2022, the Company amended the MARPA Facility to transition the purchase discount rate defined within the facility agreement from using LIBOR to Term SOFR. The amendment did not have a material impact on the Company's financial statements. During the nine months ended October 28, 2022 and October 29, 2021, the Company incurred purchase discount fees of $ 4 million and $ 2 million, respectively, which are presented in Other (income) expense, net on the condensed and consolidated statements of income. MARPA Facility activity consisted of the following: Nine Months Ended October 28, 2022 October 29, 2021 (in millions) Beginning balance $ 200 $ 185 Sale of receivables 2,776 2,484 Cash collections ( 2,716 ) ( 2,469 ) Outstanding balance sold to Purchaser (1) 260 200 Cash collected, not remitted to Purchaser (2) ( 15 ) ( 31 ) Remaining sold receivables $ 245 $ 169 (1) For the nine months ended October 28, 2022 and October 29, 2021, the Company recorded a net increase to cash flows from operating activities of $ 60 million and $ 15 million, respectively, from sold receivables. (2) Primarily represents the cash collected on behalf of but not yet remitted to the Purchaser as of October 28, 2022 and October 29, 2021. This balance is included in accounts payable and accrued liabilities on the condensed and consolidated balance sheets. Note 11— Legal Proceedings and Other Commitments and Contingencies: Legal Proceedings The Company is involved in various claims and lawsuits arising in the normal conduct of its business, none of which the Company’s management believes, based on current information, is expected to have a material adverse effect on the Company’s financial position, results of operations or cash flows. AAV Termination for Convenience On August 27, 2018, the Company received a stop-work order from the United States Marine Corps on the Assault Amphibious Vehicle (AAV) contract and on October 3, 2018 the program was terminated for convenience by the customer. The Company is continuing to negotiate with the Marine Corps to recover costs associated with the termination. -18- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION NOTES TO CONDENSED AND CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Government Investigations, Audits and Reviews The Company is routinely subject to investigations and reviews relating to compliance with various laws and regulations with respect, in particular, to its role as a contractor to federal, state and local government customers and in connection with performing services in countries outside of the United States. U.S. government agencies, including the Defense Contract Audit Agency (DCAA), the Defense Contract Management Agency and others, routinely audit and review a contractor’s performance on government contracts, indirect rates and pricing practices, and compliance with applicable contracting and procurement laws, regulations and standards. They also review the adequacy of the contractor’s compliance with government standards for its business systems. Adverse findings in these investigations, audits, or reviews can lead to criminal, civil or administrative proceedings, and the Company could face disallowance of previously billed costs, penalties, fines, compensatory damages and suspension or debarment from doing business with governmental agencies. Due to the Company’s reliance on government contracts, adverse findings could also have a material impact on the Company’s business, including its financial position, results of operations and cash flows. The indirect cost audits by the DCAA of the Company’s business remain open for certain prior years and the current year. Although the Company has recorded contract revenues based on an estimate of costs that the Company believes will be approved on final audit, the Company does not know the outcome of any ongoing or future audits. If future completed audit adjustments exceed the Company’s reserves for potential adjustments, the Company’s profitability could be materially adversely affected. As of October 28, 2022, the Company believes it has adequately reserved for estimated net amounts to be refunded to customers for potential adjustments for indirect cost audits and compliance with U.S. government Cost Accounting Standards. Letters of Credit and Surety Bonds The Company has outstanding obligations relating to letters of credit of $ 9 million as of October 28, 2022, principally related to guarantees on insurance policies. The Company also has outstanding obligations relating to surety bonds of $ 19 million, principally related to performance and payment bonds on the Company’s contracts. -19- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION