SCIENCE APPLICATIONS INTERNATIONAL CORP Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)
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. 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. Dueto 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
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, 2022and ends on February 3, 2023, while fiscal 2022 began on January 30, 2021and ended on January 28, 2022.
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 26,000 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 by or owned by entities located in the United States.
Economic opportunities, challenges and risks
During the three months ended
April 29, 2022, we generated approximately 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 March 2022provided full funding for the federal government through the end of government fiscal year 2022. In October 2021, the Federal debt ceiling was increased by $480 billionand in December 2021was further increased by $2.5 trillionwhich is expected to allow the U.S.government to operate into 2023. It is unlikely but possible these measures could expire without extension and lead to a partial or full government shutdown. Adverse changes in fiscal and economic conditions could materially impact our business. Some changes that could have an adverse impact on our business include 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, inability to increase or suspend the Federal debt ceiling, and potential government shutdowns.
Spending sets, including the infrastructure bill and potential future spending sets, may provide additional opportunities in SAIC’s areas of focus such as broadband, cybersecurity and climate resilience.
SCIENCE APPLICATIONS INTERNATIONAL CORPORATIONThe 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. 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. 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. On July 2, 2021, we completed the acquisition of Halfaker and Associates, LLC(Halfaker). The acquisition of Halfaker, in alignment with our long-term strategy, grows the Company's digital transformation portfolio while expanding its ability to support the government's healthcare mission.
Impacts of the COVID-19 pandemic
We are continuing to monitor the ongoing outbreak of the coronavirus disease 2019 ("COVID-19") and we continue to work with our stakeholders to assess further possible implications to our business, supply chain and customers, and to take actions in an effort to mitigate adverse consequences. The CARES Act allowed for the deferral of certain payroll tax payments through
December 31, 2020and we deferred total payments of approximately $103 million. The first installment of these deferred payroll taxes was paid during the third quarter of fiscal 2022 (approximately $51 million) with the remaining amounts due in the fourth quarter of fiscal 2023. In September 2021, the President issued an executive order which requires all federal employees and contractors to be fully vaccinated by January 18, 2022, unless an employee is legally entitled to an accommodation. In December 2021, a federal district judge issued an order, which temporarily enjoined the federal contractor vaccine mandate. We had taken steps to comply with the vaccine mandate across our workforce until it was enjoined. We are continuing to monitor the impact that the enforcement of this executive order will have on our workforce and operations, but at this point the impact has not been material. We have not experienced a significant impact to our liquidity or access to capital as a result of the COVID-19 pandemic. While we continue to navigate the impacts of the COVID-19 pandemic, COVID-19 did not have as significant an impact on revenues and operating income as compared to the prior year. The full extent of the impact of COVID-19 on our business and our operational and financial performance will depend on future developments, including the duration and spread of the pandemic, all of which are uncertain and cannot be predicted.
Operational performance management and reporting
Our business and program management process is directed by professional managers focused on serving our customers by providing high quality services in achieving program requirements. These managers 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. For performance obligations satisfied over time, updates to estimates are recognized on inception-to-date activity, during the period of adjustment, resulting in either a favorable or unfavorable impact to operating income. -19-
SCIENCE APPLICATIONS INTERNATIONAL CORPORATION 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 in these terms. 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 or materials) in order to understand operating margin because programs with a higher proportion of SAIC labor are generally more profitable. Changes in costs of revenues as a percentage of revenue 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 delivery of services, significant drivers of fluctuations in assets or liabilities and the impacts of changes in timing of cash receipts or disbursements. 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 April 29, Percent April 30, 2022 change 2021 (dollars in millions) Revenues
$ 1,9966 % $ 1,878Cost of revenues 1,770 7 % 1,661 As a percentage of revenues 88.7 % 88.4 % Selling, general and administrative expenses 92 15 % 80 Acquisition and integration costs 9 (10 %) 10 Other operating income - (100 %) (3) Operating income 125 (4 %) 130 As a percentage of revenues 6.3 % 6.9 % Net income attributable to common stockholders $ 73(10 %) $ 81Net cash provided by operating activities $ 118(38 %) $ 189Revenues. Revenues increased $118 millionfor the three months ended April 29, 2022as compared to the same period in the prior year primarily due to ramp up on new and existing contracts and the acquisition of Halfaker (approximately $42 million), partially offset by contract completions. Adjusting for the impact of acquired revenues and divested revenues, revenues grew 3.9% primarily due to ramp up on new and existing contracts. Cost of Revenues. Cost of revenues increased $109 millionfor the three months ended April 29, 2022as compared to the same period in the prior year primarily due to ramp up on new and existing contracts and the acquisition of Halfaker. Selling, General and Administrative Expenses. SG&A increased $12 millionfor the three months ended April 29, 2022as compared to the same period in the prior year primarily due to higher indirect expenses and the acquisition of Halfaker. Operating Income. Operating income as a percentage of revenues for the three months ended April 29, 2022decreased from the comparable prior year period primarily due to higher indirect costs in the current year period and higher benefit from net favorable settlement of prior indirect rate years in the prior year period, partially offset by improved profitability across our contract portfolio. -20-
SCIENCE APPLICATIONS INTERNATIONAL CORPORATIONNet Cash Provided by Operating Activities. Net cash provided by operating activities was $118 millionfor the three months ended April 29, 2022, a decrease of $71 millioncompared to the prior year, primarily due to lower net earnings, cash payments during the quarter associated with certain change in control provisions related to the acquisition of Halfaker, and timing of customer collections and vendor disbursements.
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 may be useful 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 costs 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 costs. 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 of Halfaker and Koverse in fiscal 2022 and Unisys Federal in fiscal 2021. 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 April 29, April 30, 2022 2021 (in millions) Net income
$ 74 $ 82Interest expense and loss on sale of receivables 28 28 Provision for income taxes 21 23 Depreciation and amortization 41 42 EBITDA 164 175 EBITDA as a percentage of revenues 8.2 % 9.3 % Acquisition and integration costs 9 10 Depreciation included in acquisition and integration costs - (1) Adjusted EBITDA $ 173 $ 184Adjusted EBITDA as a percentage of revenues 8.7 % 9.8 % Adjusted EBITDA as a percentage of revenues for the three months ended April 29, 2022decreased to 8.7% from 9.8% for the same period in the prior year primarily due to higher indirect costs in the current year period and higher benefit from net favorable settlement of prior indirect rate years in the prior year period, partially offset by improved profitability across our contract portfolio.
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. -21-
SCIENCE APPLICATIONS INTERNATIONAL CORPORATIONNet 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 separate 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 arrears. Negotiated unfunded backlog represents the estimated amounts of revenue to be earned from negotiated contracts for which funding has not been allocated or otherwise authorized and unexercised priced contract options. The Negotiated Unfunded Backlog does not include any estimates of potential future task orders expected to be awarded under IDIQ, GSA Appendices, or other Master Agreement contractual vehicles.
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 at the dates presented was:
April 29, January 28, 2022 2022 (in millions) Funded backlog
$ 3,218 $ 3,491Negotiated unfunded backlog 20,894 20,601 Total backlog $ 24,112 $ 24,092
We had net reservations of an estimated value
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: Three Months Ended April 29, April 30, 2022 2021 Cost reimbursement 55 % 53 % Time and materials (T&M) 19 % 22 % Firm-fixed price (FFP) 26 % 25 % Total 100 % 100 % 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 April 29, April 30, 2022 2021 (as a % of total cost of revenues) Labor-related cost of revenues 54 % 54 % Subcontractor-related cost of revenues 29 % 29 % Supply chain materials-related cost of revenues 7 % 8 % Other materials-related cost of revenues 10 % 9 % Total 100 % 100 %
Breakdown of cost of revenue for the three months ended
Cash 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
$400 millionRevolving Credit Facility and $300 millionMARPA 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. -23-
SCIENCE APPLICATIONS INTERNATIONAL CORPORATIONOur 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, which can then be amortized over five years. Congresshas proposed tax legislation to delay the effective date of this change to 2026, but it is uncertain whether the proposed legislation will ultimately be enacted into law. If the current effective date and current legislation remains in place, the Company's initial assessment is that our cash flows from operations in fiscal 2023 will decrease by a minimum of $90 million, but our net deferred tax assets will increase by a similar amount.
Historical cash flow trends
The following table summarizes our cash flows:
Three months completed
April 29, April 30, 2022 2021 (in millions) Net cash provided by operating activities
$ 118 $ 189Net cash used in investing activities (6) (4) Net cash used in financing activities (162) (95)
(decrease) net increase in cash, cash equivalents and restricted cash $
Net cash from operating activities. Refer to the “Operating Results” section above for an analysis of the changes in cash provided by operating activities between the three months ended.
Net Cash Usedin Investing Activities. Cash used in investing activities for the three months ended April 29, 2022increased compared to the prior year period primarily due to proceeds from divestitures in the prior year period, partially offset by lower capital expenditures for property, plant, and equipment. Net Cash Usedin Financing Activities. Cash used in financing activities for the three months ended April 29, 2022increased compared to the prior year period as a result of higher term loan principal payments in the current year period and higher share repurchases.
Critical accounting policies
There have been no changes to our critical accounting policies during the three months ended
Accounting pronouncements recently issued but not yet adopted
For more information on accounting pronouncements recently published but not yet adopted, see note 1 of the notes to the summary and consolidated financial statements contained in this report.
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