Science Applications International Corp 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations and quantitative and qualitative disclosures about market risk should be read in conjunction with our unaudited condensed and consolidated financial statements and the related notes. It contains forward-looking statements (which may be identified by words such as those described in “Risk Factors—Forward-Looking Statement Risks” in Part I of the most recently filed Annual Report on Form 10-K), including statements regarding our intent, belief, or current expectations with respect to, among other things, trends affecting our financial condition or results of operations (including our financial targets discussed below under “Management of Operating Performance and Reporting” and “Liquidity and Capital Resources”); backlog; our industry; government budgets and spending; market opportunities; the impact of competition; and the impact of acquisitions and divestitures. 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. Risks, uncertainties and assumptions that could cause or contribute to these differences include those discussed below, in “Risk Factors” in Part II of this report and in Part I of the most recently filed Annual Report on Form 10-K. Due to such risks, uncertainties and assumptions, you are cautioned not to place undue reliance on such forward-looking statements, which speak only as of the date hereof. We do not undertake any obligation to update these factors or to publicly announce the results of any changes to our forward-looking statements due to future results or developments. We use the terms "SAIC," the “Company,” “we,” “us” and “our” to refer to Science Applications International Corporation and its consolidated subsidiaries. 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 2024 began on February 4, 2023 and ends on February 2, 2024, while fiscal 2023 began on January 29, 2022 and ended on February 3, 2023. Business Overview We are a leading technology integrator providing full life cycle services and solutions in the technical, engineering and enterprise information technology (IT) markets. We developed our brand by addressing our customers’ mission critical needs and solving their most complex problems for over 50 years. As one of the largest pure-play technology service providers to the U.S. government, we serve markets of significant scale and opportunity. Our primary customers are the departments and agencies of the U.S. government. We serve our customers through approximately 1,900 active contracts and task orders and employ approximately 24,000 individuals who are led by an experienced executive team of proven industry leaders. Our long history of serving the U.S. government has afforded us the ability to develop strong and longstanding relationships with some of the largest customers in the markets we serve. Substantially all of our revenues and tangible long-lived assets are generated and located in the United States. Economic Opportunities, Challenges, and Risks During the three and six months ended August 4, 2023, we generated 98% of our revenues from contracts with the U.S. government, including subcontracts on which we perform. Our business performance is affected by the overall level of U.S. government spending and the alignment of our offerings and capabilities with the budget priorities of the U.S. government. Appropriations measures passed in December 2022 provided full funding for the federal government through the end of government fiscal year (GFY) 2023. Delayed passage of appropriations for GFY 2024 funding could result in the U.S. government operating on one or more continuing resolutions and/or could potentially lead to a partial or full government shutdown. In January 2023, the Federal debt ceiling was reached and the U.S. Department of the Treasury was operating under "extraordinary measures." In June 2023, the President signed the Fiscal Responsibility Act of 2023 which suspends the Federal debt ceiling until January 1, 2025, postponing the threat of a federal government default. Adverse changes in fiscal and economic conditions could materially impact our business. Some changes that could have an adverse impact on our business include adverse regulations, the implementation of future spending reductions (including sequestration), delayed passage of appropriations bills resulting in temporary or full-year continuing resolutions, extreme inflationary increases adversely impacting fixed price contracts, and potential government shutdowns. -19- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION Spending packages, including the infrastructure bill, Inflation Reduction Act, and CHIPS and Science Act, as well as future potential spending packages, may provide additional opportunity in areas of SAIC focus such as digital modernization, cyber, microelectronics support, and climate resiliency. The U.S. government has increasingly relied on contracts that are subject to a competitive bidding process (including indefinite delivery, indefinite quantity (IDIQ), U.S. General Services Administration (GSA) schedules, and other multi-award contracts), which has resulted in greater competition and increased pricing pressure. Additionally, the U.S. government has put renewed emphasis on increasing the number of small business prime set-aside contracts that further reduce the addressable market in some areas. Despite the budget and competitive pressures affecting the industry, we believe we are well-positioned to protect and expand existing customer relationships and benefit from opportunities that we have not previously pursued. Our scale, size, and prime contractor leadership position are expected to help differentiate us from our competitors, especially on large contract opportunities. We believe our long-term, trusted customer relationships and deep technical expertise provide us with the sophistication to handle highly complex, mission-critical contracts. Our value proposition is found in the proven ability to serve as a trusted adviser to our customers. In doing so, we leverage our expertise and scale to help them execute their mission. We succeed as a business based on the solutions we deliver, our past performance, and our ability to compete on price. Our solutions are inspired through innovation based on adoption of best practices and technology integration of the best capabilities available. Our past performance was achieved by employees dedicated to supporting our customers' most challenging missions. Our current cost structure and ongoing efforts to reduce costs by strategic sourcing and developing repeatable offerings sold "as a service" and as managed services in a more commercial business model are expected to allow us to compete effectively on price in an evolving environment. We believe that our ability to be competitive in the future will continue to be driven by our reputation for successful program execution, competitive cost structure, development of new pricing and business models, and efficiencies in assigning the right people, at the right time, in support of our contracts. Management of Operating Performance and Reporting Our business and program management process is directed by professionals focused on serving our customers by providing high quality services in achieving program requirements. These professionals carefully monitor contract margin performance by constantly evaluating contract risks and opportunities. Throughout each contract's life cycle, program managers review performance and update contract performance estimates to reflect their understanding of the best information available. We evaluate our results of operations by considering the drivers causing changes in revenues, operating income and operating cash flows. Given that revenues fluctuate on our contract portfolio over time due to contract awards and completions, changes in customer requirements, and increases or decreases in ordering volume of materials, we evaluate significant trends and fluctuations resulting from these factors. Whether performed by our employees or by our subcontractors, we primarily provide services and, as a result, our cost of revenues are predominantly variable. We also analyze our cost mix (labor, subcontractor and materials) in order to understand operating margin because programs with a higher proportion of SAIC labor are generally more profitable. Changes in cost of revenues as a percentage of revenues other than from revenue volume or cost mix are normally driven by fluctuations in shared or corporate costs, or cumulative revenue adjustments due to changes in estimates. Changes in operating cash flows are described with regard to changes in cash generated through the providing of services, significant drivers of fluctuations in assets or liabilities and the impacts of changes in timing of cash receipts or disbursements. -20- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION Results of Operations The primary financial performance measures we use to manage our business and monitor results of operations are revenues, operating income, and cash flows from operating activities. The following table summarizes our results of operations: Three Months Ended Six Months Ended August 4, 2023 Percent change July 29, 2022 August 4, 2023 Percent change July 29, 2022 (dollars in millions) Revenues $ 1,784 (3 %) $ 1,831 $ 3,812 — % $ 3,827 Cost of revenues 1,568 (3 %) 1,612 3,361 (1 %) 3,382 As a percentage of revenues 87.9 % 88.0 % 88.2 % 88.4 % Selling, general and administrative expenses 88 (5 %) 93 172 (7 %) 185 Acquisition and integration costs 1 — % 1 1 (90 %) 10 Other operating income (235) 100 % — (241) 100 % — Operating income 362 190 % 125 519 108 % 250 As a percentage of revenues 20.3 % 6.8 % 13.6 % 6.5 % Net income attributable to common stockholders $ 247 238 % $ 73 $ 345 136 % $ 146 Net cash provided by operating activities $ 150 6 % $ 141 $ 232 (10 %) $ 259 Revenues. Revenues decreased $47 million for the three months ended August 4, 2023 as compared to the same period in the prior year primarily due to the sale of the Supply Chain Business ($149 million) and the deconsolidation of FSA ($34 million) (see Note 4 for additional information), and contract completions, partially offset by ramp up on existing and new contracts. Adjusting for the impact of the divestiture of the Supply Chain Business and the deconsolidation of FSA, revenues grew 8.3%. Revenues decreased $15 million for the six months ended August 4, 2023 as compared to the same period in the prior year primarily due to the sale of the Supply Chain Business ($149 million), the deconsolidation of FSA ($71 million), and contract completions, partially offset by ramp up on existing and new contracts. Adjusting for the impact of the divestiture of the Supply Chain Business and the deconsolidation of FSA, revenues grew 5.7%. Cost of Revenues. Cost of revenues decreased $44 million for the three months ended August 4, 2023 as compared to the same period in the prior year primarily due to the sale of the Supply Chain Business ($138 million) and the deconsolidation of FSA ($32 million), partially offset by ramp up on new and existing contracts. Cost of revenues decreased $21 million for the six months ended August 4, 2023 as compared to the same period in the prior year primarily due to the sale of the Supply Chain business ($138 million) and the deconsolidation of FSA ($65 million), partially offset by ramp up on new and existing contracts. Selling, General and Administrative Expenses (SG&A). SG&A decreased $5 million and $13 million for the three and six months ended August 4, 2023, respectively, as compared to the same periods in the prior year primarily due to lower indirect costs and intangible asset amortization. Operating Income. Operating income as a percentage of revenues for the three months ended August 4, 2023 increased from the comparable prior year period primarily due to the gain recognized from the sale of the Supply Chain Business, improved profitability across our contract portfolio, and lower indirect costs. Operating income as a percentage of revenues increased for the six months ended August 4, 2023 from the comparable prior year period primarily due to a $233 million gain recognized from the sale of the Supply Chain Business, a $7 million gain recognized from the deconsolidation of FSA, improved profitability across our contract portfolio, and lower indirect costs. -21- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION Net Cash Provided by Operating Activities. Net cash provided by operating activities decreased $27 million for the six months ended August 4, 2023 as compared to the prior year primarily due to higher cash provided by the MARPA Facility in the prior year and higher tax payments in the current year, partially offset by other changes in working capital. Non-GAAP Measures Earnings before interest, taxes, depreciation and amortization (EBITDA) and adjusted EBITDA are non-GAAP financial measures. While we believe that these non-GAAP financial measures are useful for management and investors in evaluating our financial information, they should be considered as supplemental in nature and not as a substitute for financial information prepared in accordance with GAAP. Reconciliations, definitions, and how we believe these measures are useful to management and investors are provided below. Other companies may define similar measures differently. EBITDA and Adjusted EBITDA. The performance measure EBITDA is calculated by taking net income and excluding interest and loss on sale of receivables, provision for income taxes, and depreciation and amortization. Adjusted EBITDA is a performance measure that excludes the impact of non-recurring transactions that we do not consider to be indicative of our ongoing performance. Adjusted EBITDA is calculated by taking EBITDA and excluding acquisition and integration costs, impairments, restructuring costs, and any other material non-recurring items. Integration costs are costs to integrate acquired companies including costs of strategic consulting services, facility consolidation and employee related costs such as retention and severance costs. The acquisition and integration costs relate to the Company's acquisitions. We believe that EBITDA and adjusted EBITDA provide management and investors with useful information in assessing trends in our ongoing operating performance and may provide greater visibility in understanding the long-term financial performance of the Company. EBITDA and adjusted EBITDA for the periods presented were calculated as follows: Three Months Ended Six Months Ended August 4, 2023 July 29, 2022 August 4, 2023 July 29, 2022 (dollars in millions) Net income $ 247 $ 74 $ 345 $ 148 Interest expense and loss on sale of receivables 35 31 71 59 Interest income (4) — (5) — Provision for income taxes 88 21 113 42 Depreciation and amortization 36 40 72 81 EBITDA 402 166 596 330 EBITDA as a percentage of revenues 22.5 % 9.1 % 15.6 % 8.6 % Acquisition and integration costs 1 1 1 10 Restructuring and impairment costs 5 2 6 2 Recovery of acquisition and integration costs and restructuring and impairment costs (1) — (3) — (3) Gain on divestitures, net of transaction costs (234) — (240) — Adjusted EBITDA $ 174 $ 166 $ 363 $ 339 Adjusted EBITDA as a percentage of revenues 9.8 % 9.1 % 9.5 % 8.9 % (1) Adjustment reflects the portion of acquisition and integration costs and restructuring and impairment costs recovered through the Company's indirect rates in accordance with U.S. government Cost Accounting Standards. Adjusted EBITDA as a percentage of revenues for the three and six months ended August 4, 2023 increased to 9.8% from 9.1% and increased to 9.5% from 8.9% for the same periods in the prior year, respectively, primarily due to improved profitability across our contract portfolio and lower indirect costs. -22- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION Other Key Performance Measures In addition to the financial measures described above, we believe that bookings and backlog are useful measures for management and investors to evaluate our potential future revenues. We also consider measures such as contract types and cost of revenues mix to be useful for management and investors to evaluate our operating income and performance. Net Bookings and Backlog. Net bookings represent the estimated amount of revenues to be earned in the future from funded and negotiated unfunded contract awards that were received during the period, net of adjustments to estimates on previously awarded contracts. We calculate net bookings as the period’s ending backlog plus the period’s revenues less the prior period’s ending backlog and initial backlog obtained through acquisitions. Backlog represents the estimated amount of future revenues to be recognized under negotiated contracts as work is performed. We do not include in backlog estimates of revenues to be derived from IDIQ contracts, but rather record backlog and bookings when task orders are awarded on these contracts. Given that much of our revenue is derived from IDIQ contract task orders that renew annually, bookings on these contracts tend to refresh annually as the task orders are renewed. Additionally, we do not include in backlog contract awards that are under protest until the protest is resolved in our favor. We segregate our backlog into two categories as follows: • Funded Backlog. Funded backlog for contracts with government agencies primarily represents estimated amounts of revenue to be earned in the future from contracts for which funding is appropriated less revenues previously recognized on these contracts. It does not include the unfunded portion of contracts in which funding is incrementally appropriated or authorized on a quarterly or annual basis by the U.S. government and other customers even though the contract may call for performance over a number of years. Funded backlog for contracts with non-government customers represents the estimated value on contracts, which may cover multiple future years, under which we are obligated to perform, less revenues previously recognized on these contracts. • Negotiated Unfunded Backlog. Negotiated unfunded backlog represents estimated amounts of revenue to be earned in the future from negotiated contracts for which funding has not been appropriated or otherwise authorized and from unexercised priced contract options. Negotiated unfunded backlog does not include any estimate of future potential task orders expected to be awarded under IDIQ, GSA Schedules or other master agreement contract vehicles, with the exception of certain IDIQ contracts where task orders are not competitively awarded and separately priced but instead are used as a funding mechanism, and where there is a basis for estimating future revenues and funding on future anticipated task orders. We expect to recognize revenue from a substantial portion of our funded backlog within the next twelve months. However, the U.S. government can adjust the scope of services of or cancel contracts at any time. Similarly, certain contracts with commercial customers include provisions that allow the customer to cancel prior to contract completion. Most of our contracts have cancellation terms that would permit us to recover all or a portion of our incurred costs and fees (contract profit) for work performed. The estimated value of our total backlog as of the dates presented was: August 4, 2023 February 3, 2023 (in millions) Funded backlog $ 3,716 $ 3,554 Negotiated unfunded backlog 18,808 20,248 Total backlog $ 22,524 $ 23,802 We had net bookings worth an estimated $0.7 billion and $2.7 billion during the three and six months ended August 4, 2023. -23- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION Contract Types. Our earnings and profitability may vary materially depending on changes in the proportionate amount of revenues derived from each type of contract. For a discussion of the types of contracts under which we generate revenues, see “Contract Types” in Part I of the most recently filed Annual Report on Form 10-K. The following table summarizes revenues by contract type as a percentage of revenues for the periods presented: Six Months Ended August 4, 2023 July 29, 2022 Cost reimbursement 58 % 56 % Time and materials (T&M) 19 % 18 % Firm-fixed price (FFP) 23 % 26 % Total 100 % 100 % The change in contract mix for the six months ended August 4, 2023 reflects a decrease in firm-fixed price type contracts due to the divestiture of the Supply Chain Business which historically had a higher proportion of these contracts. Cost of Revenues Mix. We generate revenues by providing a customized mix of services to our customers. The profit generated from our service contracts is affected by the proportion of cost of revenues incurred from the efforts of our employees (which we refer to below as labor-related cost of revenues), the efforts of our subcontractors and the cost of materials used in the performance of our service obligations under our contracts. Contracts performed with a higher proportion of SAIC labor are generally more profitable. The following table presents cost mix for the periods presented: Three Months Ended Six Months Ended August 4, 2023 July 29, 2022 August 4, 2023 July 29, 2022 (as a % of total cost of revenues) Labor-related cost of revenues 56 % 53 % 54 % 54 % Subcontractor-related cost of revenues 32 % 30 % 30 % 29 % Supply chain materials-related cost of revenues — % 7 % 4 % 7 % Other materials-related cost of revenues 12 % 10 % 12 % 10 % Total 100 % 100 % 100 % 100 % The change in cost of revenues mix for the three and six months ended August 4, 2023 reflects a decrease in supply chain materials-related costs due to the divestiture of the Supply Chain Business. Liquidity and Capital Resources As a services provider, our business generally requires minimal infrastructure investment. We expect to fund our ongoing working capital, commitments and any other discretionary investments with cash on hand, future operating cash flows and, if needed, borrowings under our $1.0 billion Revolving Credit Facility and $300 million MARPA Facility. We anticipate that our future cash needs will be for working capital, capital expenditures, and contractual and other commitments. We consider various financial measures when we develop and update our capital deployment strategy, which include evaluating cash provided by operating activities, free cash flow and financial leverage. When our cash generation enables us to exceed our target average minimum cash balance, we intend to deploy excess cash through dividends, share repurchases, debt prepayments or strategic acquisitions. -24- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION Our ability to fund these needs will depend, in part, on our ability to generate cash in the future, which depends on our future financial results. Our future results are subject to general economic, financial, competitive, legislative and regulatory factors that may be outside of our direct control. Although we believe that the financing arrangements in place will permit us to finance our operations on acceptable terms and conditions for at least the next year, our future access to, and the availability of financing on acceptable terms and conditions will be impacted by many factors (including our credit rating, capital market liquidity and overall economic conditions). Therefore, we cannot ensure that such financing will be available to us on acceptable terms or that such financing will be available at all. Nevertheless, we believe that our existing cash on hand, generation of future operating cash flows, and access to bank financing and capital markets will provide adequate resources to meet our short-term liquidity and long-term capital needs. Beginning in fiscal 2023, the Tax Cuts and Jobs Act of 2017 requires the capitalization of research and development costs for tax purposes and requires taxpayers to amortize such expenditures over five years. We estimate that our income taxes payable for fiscal 2024 will increase by approximately $76 million as a result of this provision, offset by a corresponding deferred tax asset. The actual impact will depend on the amount of research and development costs incurred by the Company, whether the U.S. Congress modifies, or repeals this provision and whether new guidance and interpretive rules are issued by the U.S. Treasury, among other factors. Historical Cash Flow Trends The following table summarizes our cash flows: Six Months Ended August 4, 2023 July 29, 2022 (in millions) Net cash provided by operating activities $ 232 $ 259 Net cash provided by (used in) investing activities 334 (17) Net cash used in financing activities (323) (249) Net increase (decrease) in cash, cash equivalents and restricted cash $ 243 $ (7) Net Cash Provided by Operating Activities. Refer to “Results of Operations” above for a discussion of the changes in cash provided by operating activities between the six months ended August 4, 2023 and the comparable prior year period. Net Cash Provided by (Used in) Investing Activities. Cash provided by investing activities for the six months ended August 4, 2023 was $334 million compared to cash used in investing activities of $17 million in the prior year period. This change is primarily due to the $355 million of cash proceeds for the sale of the Supply Chain Business (see Note 4 to the condensed and consolidated financial statements). Net Cash Used in Financing Activities. Cash used in financing activities for the six months ended August 4, 2023 increased compared to the prior year period due to higher share repurchases and higher term loan principal payments compared to the prior year period. Critical Accounting Policies and Estimates There have been no changes to our critical accounting policies and estimates during the six months ended August 4, 2023 from those disclosed in our most recently filed Annual Report on Form 10-K. Recently Issued But Not Yet Adopted Accounting Pronouncements For information on recently issued but not yet adopted accounting pronouncements, see Note 1 to the condensed and consolidated financial statements contained within this report. Item 3. Quantitative and Qualitative Disclosures About Market Risk There have been no material changes to our market risks from those discussed in our most recently filed Annual Report on Form 10-K. -25- Table of Contents SCIENCE APPLICATIONS INTERNATIONAL CORPORATION