SCIENCE APPLICATIONS INTERNATIONAL CORPORATION 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 consolidated financial statements and the related notes included in this Form 10-K, as well as Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Form 10-K for the year endedFebruary 1, 2019 , which provides additional information on comparisons of fiscal 2019 and 2018. 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 this report), including statements regarding our intent, belief, or current expectations with respect to, among other things, trends affecting our financial condition or results of operations; backlog; our industry; government budgets and spending; market opportunities; the impact of competition; and the impact of the Engility and Unisys Federal 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 and elsewhere in this report, particularly in "Risk Factors" in Part I of this report. 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 toScience Applications International Corporation and its consolidated subsidiaries. The Company utilizes a 52/53 week fiscal year ending on the Friday closest toJanuary 31 , with fiscal quarters typically consisting of 13 weeks. Fiscal 2018 began onFebruary 4, 2017 and ended onFebruary 2, 2018 , fiscal 2019 began onFebruary 3, 2018 and ended onFebruary 1, 2019 , and fiscal 2020 began onFebruary 2, 2019 and ended onJanuary 31, 2020 . 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 technical service providers to theU.S. government, we serve markets of significant scale and opportunity. Our primary customers are the departments and agencies of theU.S. government. We serve our customers through approximately 1,800 active contracts and task orders and employ more than 24,000 individuals who are led by an experienced executive team of proven industry leaders. Our long history of serving theU.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 inthe United States . Economic Opportunities, Challenges and Risks In fiscal 2020, we generated greater than 95% of our revenues from contracts with theU.S. government, including subcontracts on which we perform. Our business performance is affected by the overall level ofU.S. government spending and the alignment of our offerings and capabilities with the budget priorities of theU.S. government. Appropriations measures passed inDecember 2019 provide full funding for the federal government through the end of government fiscal year (GFY) 2020. These bills are funded at increased levels for defense and non-defense spending based on theAugust 2019 Bipartisan Budget Act agreement that raises the Budget Control Act spending caps enacted inAugust 2011 and suspends the Federal debt ceiling untilJuly 31, 2021 . Adverse changes in fiscal and economic conditions could materially affect our business. Some changes that could have an adverse impact on our business include the implementation of future spending reductions (including sequestration) and government shutdowns. TheU.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. We expect that a majority of the business that we seek in the foreseeable future will be awarded through a competitive bidding process. 22
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Despite the budget and competitive pressures impacting 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 contracts. We believe our long-term, trusted customer relationships and deep technical expertise provide us with the sophistication to handle highly complex mission-critical contracts. SAIC's 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, inspired through innovation, are based on best practices and technology transfer. Our past performance was achieved by employee dedication and customer focus. Our current cost structure, as well as our ongoing efforts to reduce costs by strategic sourcing and developing repeatable offerings, is 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 of successful program execution, competitive cost structure and efficiencies in assigning the right people, at the right time, in support of our contracts. OnJanuary 14, 2019 , we completed the acquisition ofEngility Holdings, Inc. (collectively with its consolidated subsidiaries, "Engility"). The acquisition of Engility accelerates the execution of our long-term strategy to be the premier technology integrator in the government services market and deliver sustained profitable growth. The acquisition of Engility strengthens the execution of our long-term strategy by: (1) combining two leading government service providers with highly complementary capabilities, customers, and cultures (2) accelerating both companies long-term strategies, creating sub-segment scale in strategic business areas of national interest and (3) enhance shareholder value through improved cash flow and margin profile driven by cost synergies and increased growth from greater customer access with more competitive and differentiated solutions. OnMarch 13, 2020 , we completed the acquisition of Unisys Federal, an operating unit within Unisys Corporation. The acquisition of Unisys Federal, in alignment with our long-term strategy, positions SAIC as a leading government services technology integrator in digital transformation. The acquisition of Unisys Federal: (1) enhances SAIC's capabilities in government priority areas, including IT modernization, cloud migration, managed services, and development, security and operations (2) expands SAIC's portfolio of intellectual property and technology-driven offerings that enable government-tailored, commercial-based solutions (3) increases SAIC's access to current and new customers with a strong pipeline of new business opportunities and (4) is highly accretive across all key financial metrics. See "Risk Factors" in Part I of this report for additional discussion of our industry and regulatory environment. Impacts of the COVID-19 Pandemic We are monitoring 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. Due to the nature of our business, we have seen minimal impacts to our operations at this time and have developed contingency plans should the disruptions increase. We cannot predict the impact of the COVID-19 pandemic, however the longer the duration of the event, the more likely it is that it could have an adverse effect on our business, financial position, results of operations and/or cash flows. See "Risk Factors" in Part I of this report for additional discussion of the risks associated with the COVID-19 pandemic. Management of Operating Performance and Reporting Our business and program management process is directed by professional managers focused on satisfying 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. Through 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. 23
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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:
Year Ended
January 31, 2020 Percent change February 1, 2019 Percent change February 2, 2018
(dollars in millions)
Revenues $ 6,379 37 % $ 4,659 5 % $ 4,454
Cost of revenues 5,673 35 % 4,195 4 % 4,043
As a percentage of revenues 88.9 % 90.0 % 90.8 %
Selling, general and administrative
expenses 288 82 % 158 2 % 155
Acquisition and integration costs 48 (44 )% 86 100 % -
Operating income 370 68 % 220 (14 )% 256
As a percentage of revenues 5.8 % 4.7 % 5.7 %
Net income attributable to common
stockholders $ 226 65 % $ 137 (23 )% $ 179
Cash flows provided by operating
activities $ 458 149 % $ 184 (15 )% $ 217
Revenues. Revenues increased $1,720 million from fiscal 2019 to fiscal 2020
primarily due to the acquisition of Engility. Adjusting for the impact of
acquired revenues, revenues contracted 1.4% due to the completion of certain
contracts, including contracts with the U.S. Marine Corps , and the effect of
acquisition related dis-synergies. These decreases were partially offset by net
increases in program volume.
Cost of Revenues. Cost of revenues increased $1,478 million from fiscal 2019 to
fiscal 2020 primarily due to the acquisition of Engility. Cost of revenues as a
percentage of revenues decreased from 90.0% in fiscal 2019 to 88.9% in fiscal
2020, primarily driven by a more profitable cost mix through higher labor
content and acquisition related cost synergies.
Selling, General and Administrative Expenses. SG&A increased $130 million from
fiscal 2019 to fiscal 2020 primarily due to the acquisition of Engility and
related intangible asset amortization ($70 million ) and higher business
development costs, partially offset by acquisition related cost synergies.
Operating Income. Operating income as a percentage of revenues increased to 5.8%
for fiscal 2020, compared to 4.7% for fiscal 2019, primarily due to lower
acquisition and integration costs, a more profitable labor mix and cost
synergies, partially offset by increased intangible asset amortization.
Net Income Attributable to Common Stockholders. Net income attributable to
common stockholders increased $89 million from fiscal 2019 to fiscal 2020
primarily due to higher operating income, partially offset by higher interest
expense.
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Cash Flows Provided by Operating Activities. Cash flows provided by operating activities were$458 million for fiscal 2020 which represented an increase of$274 million from fiscal 2019 primarily due to cash provided from the operating activities of Engility, customer collections recouped from theU.S. federal government partial shutdown that occurred in the fourth quarter of fiscal 2019, and lower payments for acquisition and integration costs. These increases were partially offset by higher interest payments in the current year as a result of additional borrowings related to the acquisition near the end of fiscal 2019. 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 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 expense, interest income, provision for income taxes, and depreciation and amortization. Adjusted EBITDA is calculated by taking EBITDA and excluding restructuring costs, and acquisition and integration costs. Integration costs excluded are costs to integrate acquired companies and include the costs of strategic consulting services, facility consolidation and employee severance. The acquisition and integration costs relate to the Company's significant acquisitions of Engility and Unisys Federal. We began excluding restructuring costs in the third quarter of fiscal 2018 as a result of the restructuring described in Note 5 to the Consolidated Financial Statements. Adjusted EBITDA is a performance measure that excludes costs that we do not consider to be indicative of our ongoing operating performance. 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 is calculated as follows:
Year Ended
January 31, 2020
(in millions)
Net income $ 229 $ 137 $ 179
Interest expense 90 53 44
Interest income (4 ) (3 ) (1 )
Provision for income taxes 57 33 35
Depreciation and amortization 131 47 44
EBITDA 503 267 301
EBITDA as a percentage of revenues 7.9 % 5.7 % 6.8 %
Acquisition and integration costs 48 86 -
Restructuring costs - - 13
Depreciation included in restructuring costs and
acquisition and integration costs (5 ) - (1 )
Recovery of acquisition and integration costs(1) (8 ) - -
Adjusted EBITDA $ 538 $ 353 $ 313
Adjusted EBITDA as a percentage of revenues 8.4 % 7.6 % 7.0 %
(1) Adjustment to reflect the portion of acquisition and integration costs
recovered through the Company's indirect rates in accordance with Cost
Accounting Standards.
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Adjusted EBITDA as a percentage of revenues increased to 8.4% for fiscal 2020, compared to 7.6% for fiscal 2019, driven by a more profitable cost mix, cost synergies related to the acquisition and higher net profit write-ups. 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
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 taskorders expected to be awarded under IDIQ, GSA Schedules or other master
agreement contract vehicles.
We expect to recognize revenue from a substantial portion of our funded backlog within the next twelve months. However, theU.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: January 31, 2020 February 1, 2019 (in millions) Funded backlog $ 2,569 $ 2,753 Negotiated unfunded backlog 12,748 11,048 Total backlog $ 15,317 $ 13,801
We had net bookings worth an estimated
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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
revenue, see "Business-Contract Types" in Part I of this report. The following
table summarizes revenues by contract type as a percentage of revenues for the
periods presented:
Year Ended
January 31, 2020 February 1, 2019 February 2, 2018
Cost reimbursement 57 % 50 % 45 %
Time and materials (T&M) 20 % 23 % 27 %
Firm-fixed price (FFP) 23 % 27 % 28 %
Total 100 % 100 % 100 %
Our contract mix reflects an increase in cost reimbursement type contracts due
to the acquisition of Engility, which historically had a higher proportion of
cost reimbursement type contracts, and a change in contract type on a
significant contract supporting the Department of Defense .
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 changes in cost mix for the periods presented:
Year Ended
January February February
31, 2020 1, 2019 2, 2018
(as a % of total cost of revenues)
Labor-related cost of revenues 54 % 48 % 47 %
Subcontractor-related cost of revenues 29 % 30 % 33 %
Supply chain materials-related cost of revenues 11 % 15 % 13 %
Other materials-related cost of revenues 6 % 7 % 7 %
Cost of revenues mix for fiscal 2020 reflects an increase in labor-related content primarily due to the acquisition of Engility, which historically had a higher proportion of such costs.
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$400 million Revolving Credit Facility and$300 million receivable factoring 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 cash 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. Upon the acquisition of Engility, we drew$1.1 billion on our committed five-year senior secured term loan facility, see Note 11 to the Consolidated Financial Statements. The proceeds were used to repay Engility's existing credit facility and outstanding notes. In addition, the Revolving Credit Facility increased by an additional$200 million upon the successful completion of the acquisition. Upon the acquisition of Unisys Federal, we drew$0.6 billion on our incremental senior secured Term Loan B Facility dueMarch 2027 and issued$400 million of Senior Notes due 2028. In addition, inFebruary 2020 we sold$200 27
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million of accounts receivable under our receivable factoring facility. See Note 18 to the Consolidated Financial Statements. The proceeds were used for the purchase of Unisys Federal. 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 fund our short-term liquidity and long-term capital needs. Borrowings under our Term Loan Facilities, our receivable factoring facility and, if used in the future, our Revolving Credit Facility incur interest at a variable rate. In accordance with our risk management objectives, we hold fixed interest rate swap agreements to hedge the variability in interest payment cash flows on a substantial portion of our outstanding variable rate debt. These instruments are accounted for as cash flow hedges. Under the swap agreements, we pay the fixed rate and the counterparties to the agreement pay a floating interest rate. Our Credit Facility contains customary terms and conditions including financial covenants and covenants restricting the Company's ability to merge or consolidate with another entity or undertake other fundamental changes, enter into property sale and leaseback transactions, and incur liens. The Company's dividends and share repurchases may be limited under certain leverage ratios, and we may be required to make an annual debt prepayment based on our cash flows from operating activities. See Note 11 of the notes to the consolidated financial statements contained within this report for a more complete understanding of our Credit Facility. We currently maintain credit ratings from majorU.S. rating agencies. Failure to maintain acceptable ratings could have an adverse effect on the Company's future cost of capital and any significant increase in the level of our borrowings could negatively impact these ratings. During fiscal 2020 we repurchased approximately 2.2 million shares of our common stock for$177 million from the open market in connection with our existing share repurchase program. Since the program's inception in December of 2013, we have repurchased 11.8 million shares for$716 million . Historical Cash Flow Trends The following table summarizes our cash flows:
Year Ended
January 31, 2020
(in millions)
Net cash provided by operating activities $ 458 $ 184 $ 217
Net cash used in investing activities (47 ) (1,028 ) (22 )
Net cash (used in) provided by financing activities (455 ) 938 (261 )
Total (decrease) increase in cash, cash equivalents and restricted cash
$ (44 ) $ 94 $ (66 )
Cash Provided by Operating Activities. Refer to "Results of Operations" above
for a discussion of the changes in cash provided by operating activities between
fiscal 2020 and fiscal 2019.
Cash Used in Investing Activities. Cash used in investing activities decreased
in fiscal 2020 compared to the prior year period primarily due to cash paid for
the acquisition of Engility in the prior year, partially offset by purchases of
marketable securities.
Cash Used In/Provided by Financing Activities. Cash used in financing activities
increased in fiscal 2020 compared to the prior year period primarily due to
proceeds from borrowings in the prior year, higher share repurchases and an
increase in dividend payments to stockholders.
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Off-Balance Sheet Arrangements For an understanding of our obligations relating to surety bonds, see Note 16 of the notes to the consolidated financial statements contained within this report. Contractual Obligations The following table summarizes, as ofJanuary 31, 2020 , our obligations to make future payments pursuant to certain contracts or arrangements and provides an estimate of the fiscal years in which these obligations are expected to be satisfied: Payments Due by Fiscal Year 2026 - Total 2021 2022-2023 2024-2025 Thereafter (in millions) Contractual obligations: Long-term debt including current portion(1)$ 1,941 $ 70 $ 215 $ 672 $ 984 Interest payments on long-term debt(2) 270 62 107 77 24 Operating lease obligations 235 41 84 53 57 Estimated purchase obligations(3) 94 59 19 7 9 Other long-term liabilities(4) 84 17 49 3 15
Total contractual obligations
(1) The amounts presented are based on an anticipated loan repayment schedule.
However, we may be required to make certain mandatory prepayments based on
our level of cash flow generation and we also have the option to prepay loan
principal amounts at any time.
(2) Amounts include an estimate of future variable interest payments on the Term
Loan Facilities based on scheduled outstanding principal amounts, current
applicable margin and projected 1-month LIBOR as of
amounts presented in this table exclude the effects of interest rate swaps
used to hedge against changes in 1-month LIBOR.
(3) Includes estimated obligations to transfer funds under legally enforceable
agreements for fixed or minimum amounts or quantities of goods or services
at fixed or minimum prices. Excludes purchase orders for services or
products to be delivered pursuant to
have full recourse under normal contract termination clauses.
(4) Other long-term liabilities primarily consist of liabilities associated with
deferred compensation plan obligations, liabilities for unrecognized tax
benefits, and expected contributions to fund defined benefit plans for
fiscal 2021. Deferred compensation plan obligations have been allocated to
fiscal years based on participants' payment elections on retirement and
estimated retirement ages, but is subject to acceleration on participants'
termination of employment prior to retirement. Liabilities for unrecognized
tax benefits are allocated to the fiscal years in which the statute of
limitations is currently expected to expire. Expected contributions to fund
defined benefit plans after fiscal 2021 are not estimable at this time.
Commitments and Contingencies We are subject to a number of reviews, investigations, claims, lawsuits and other uncertainties related to our business. For a discussion of these items, see Note 16 of the notes to the consolidated financial statements contained within this report. Critical Accounting Policies Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which are prepared in accordance withU.S. generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingencies, as well as the reported amounts of revenues, expenses, gains and losses during the reporting periods. Management evaluates these estimates and assumptions on an ongoing basis. Our estimates and assumptions have been prepared on the basis of the most current reasonably available information and, in some cases, are our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Estimates and assumptions may change in the future as more current information is available. 29
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Management believes that our critical accounting policies are those that are both material to the presentation of our financial condition and results of operations and require management's most difficult, subjective and complex judgments. Typically, the circumstances that make these judgments difficult, subjective and complex have to do with making estimates about the effect of matters that are inherently uncertain. These policies are described below. Revenue Recognition. We generate our revenues primarily from long-term contracts in which we provide technical, engineering and enterprise IT services directly for theU.S. government and as a subcontractor with other contractors engaged in work for theU.S. government. We evaluate the nature of the contract and the services provided when determining the accounting method utilized for each contract. We recognize a significant portion of our revenues using a cost input measure of progress that requires us to rely on the skill and expertise of our engineers, program managers and business management professionals in the many areas of cost estimation. These estimates of costs can span several years and take into account many factors including the availability, productivity and cost of labor, potential delays in our performance and the level of future indirect cost allocations. We provide for anticipated losses on long-term production type contracts and service contracts with theU.S. government by recording an expense for the total expected contract loss during the period when the loss is determined. Contract costs incurred forU.S. government contracts (including allocated indirect costs) are subject to audit and adjustment through negotiations with government representatives. Revenues onU.S. government contracts have been recorded in amounts that are expected to be realized on final settlement. Many of our contracts include forms of variable consideration such as reimbursable costs, award and incentive fees, usage-based pricing, service-level penalties, performance bonuses, and other provisions that can either increase or decrease the transaction price. Variable amounts generally are determined upon our achievement of certain performance metrics, program milestones or cost targets and may be based upon customer discretion. At contract inception, we estimate the transaction price and may include variable consideration in the transaction price only to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. When developing these estimates, we consider the customer, contract terms, the complexity of the work and related risks, the extent of customer discretion, historical experience and the potential of a significant reversal of revenue. 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 routinely occur 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. 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. Aggregate changes in contract estimates increased operating income by$22 million for fiscal 2020, increased operating income by$17 million for fiscal 2019 and decreased operating income by$3 million for fiscal 2018. For additional information related to changes in estimates on contracts, including gross favorable and unfavorable adjustments as well as the impact to earnings per share, see Note 3 of the notes to the consolidated financial statements contained within this report. Business Combinations. We record all tangible and intangible assets acquired and liabilities assumed in a business combination at fair value as of the acquisition date, which is determined using a cost, market or income approach. The excess amount of the aggregated purchase consideration paid over the fair value of the net of assets acquired and liabilities assumed is recorded as goodwill. Acquisition date fair value represents the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as measured on the acquisition date. The valuations are based on information that existed as of the acquisition date. During the measurement period that shall not exceed one year from the acquisition date, we may adjust provisional amounts recorded for assets acquired and liabilities assumed to reflect new information that we have subsequently obtained regarding facts and circumstances that existed as of the acquisition date. 30
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Acquisition-related costs that are not part of the purchase price consideration are 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, and legal, accounting and other professional costs.Goodwill and Intangible Assets.Goodwill is recorded as the difference between the aggregate consideration paid for an acquisition and the fair value of the net tangible and intangible assets acquired and liabilities assumed.Goodwill is not amortized, but rather tested for potential impairment annually at the beginning of the fourth quarter, or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The goodwill impairment test is performed at the reporting unit level. The Company estimates and compares the fair value of each reporting unit to its respective carrying value including goodwill. If the fair value is less than the carrying value, the amount of impairment expense is equal to the difference between the reporting unit's fair value and the reporting unit's carrying value. Determining the fair value of each reporting unit involves judgment and the use of estimates and assumptions. We estimate the fair value of our reporting units using either a market approach, income approach, or a combination of both. For our annual impairment analysis, we reconcile the aggregate fair value of all of our reporting units to our market capitalization as of the measurement date. Under the income approach, we estimate the fair value of a reporting unit using a multi-year discounted cash flow model that involves assumptions about projected future revenue growth, operating margins, income tax rates, capital expenditures, discount rate and terminal value. The discount rate is an estimate of the cost of capital that a market participant would expect for the respective reporting unit. The terminal value represents the present value in the last year of the projection period of all subsequent cash flows into perpetuity. Under the market approach, we estimate the fair value of a reporting unit based on multiples of earnings derived from observable market data of comparable public companies. We evaluate companies within our industry that have operations with observable and comparable economic characteristics and are similar in nature, scope and size to the reporting unit being compared. We analyze historical acquisitions in our industry to estimate a control premium that we incorporate into the fair value estimate of a reporting unit under the market approach. During the fourth quarter of fiscal 2020, we completed our annual goodwill impairment testing and determined that each reporting unit's fair value significantly exceeded its carrying value. In addition, determining the carrying value of each reporting unit requires judgment and involves the assignment of assets and liabilities to the reporting units based on a systematic and rational allocation methodology. Certain assets and liabilities may be specifically identified and assigned to a reporting unit based on the information contained within our financial systems; whereas, other assets and liabilities may be allocated using measurable relationships or other basis for allocation. Intangible assets with finite lives are amortized using the method that best reflects how their economic benefits are utilized or, if a pattern of economic benefits cannot be reliably determined, on a straight-line basis over their estimated useful lives. Intangible assets with finite lives are assessed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Income Taxes. Our income tax expense, deferred tax assets and liabilities, and liabilities for unrecognized tax benefits reflect our best estimate of current and future taxes to be paid and includes judgments related to matters for which ultimate resolution may not become known until the final resolution of an examination by taxing authorities or the statute of limitations lapses. We record net deferred tax assets to the extent we believe these assets will more likely than not be realized. In making this determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent operating results. If we were to determine that we would be able to realize our deferred income tax assets in the future in excess of their net recorded amount or would no longer be able to realize our deferred income tax assets in the future as currently recorded, we would make an adjustment to the valuation allowance which would either decrease or increase, respectively, the provision for income taxes. 31
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We also recognize liabilities for uncertainty in income taxes when it is more likely than not that a tax position will not be sustained on examination and settlement with various taxing authorities. Liabilities for any uncertainty in income taxes are measured based on our estimate of the largest amount of benefit that is greater than 50% likely of being realized on ultimate settlement. The Company recognized a tax benefit of$11 million for research and development credits as the result of a project we completed during the fourth quarter of FY20 to improve the method by which we identify expenditures that qualify for the research and development tax credit. We recognized$6 million in research and development credits related to fiscal year 2016 through fiscal year 2019 and$5 million related to the fiscal year 2020 tax year from the study. While we expect this method to provide continued benefits in fiscal 2021, we expect our effective tax rate to increase in relation to fiscal 2020 due to the research and development credits in fiscal year 2021 being limited to a single tax year. For additional information concerning the research and development tax credit, see Note 10 of the notes to the consolidated financial statements contained within this report. Recently Issued But Not Yet Adopted Accounting Pronouncements For information on recently issued but not yet adopted accounting pronouncements, see Note 1 of the notes to the consolidated financial statements contained within this report. Effects of Inflation For any of the most recent three fiscal years endedJanuary 31, 2020 , inflation has not had a significant impact on revenues or costs. Most of our contracts are paid inU.S. dollars and our cost to perform on these contracts are generally paid inU.S. dollars, so inflation risk is generally limited to that which is related to theU.S. dollar. Approximately 57% of our revenues for fiscal 2020 were derived from cost-reimbursement type contracts, which have limited inflation risk because our contracts generally entail the provision of labor on a reimbursable basis, and, when materials are acquired, they provide for billing to the customer during the period in which the materials were received. Bids for longer-term FFP and T&M contracts typically include sufficient provisions for labor and other cost escalations to cover anticipated cost increases over the period of performance. As a result, if we were to experience significant levels of inflation, our revenues and costs for cost-type contracts would generally both increase commensurate with inflation and operating income as a percentage of total revenues would not be significantly affected. Operating income as a percentage of total revenues would not be significantly affected for longer-term FFP and T&M contracts to the extent that bid contract cost escalations are sufficient to cover heightened inflation levels. Item 7A. Quantitative and Qualitative Disclosures About Market Risk We are exposed to certain market risks in the normal course of business. The following information about our market sensitive financial instruments contains forward-looking statements. Foreign Currency Risk Since the substantial majority of our business is conducted inU.S. dollars, a 10% change in any foreign currency exchange rates would not have a material impact to our financial condition or results of operations. Interest Rate Risk Debt obligations. Our financial risk management objective is to reduce variability in earnings from changes in interest rates, which we may manage through operational means or the use of financial instruments, such as interest rate swaps. We have approximately$1.9 billion of variable rate debt. The fair value of our outstanding long-term debt obligations approximates its carrying value. In connection with the issuances of our variable rate Term Loan A and Term Loan B Facilities, we entered into fixed interest rate swap agreements, effectively converting a substantial portion of our variable rate debt to fixed rate debt in order to mitigate our exposure to fluctuations in interest rates. We regularly evaluate our outstanding debt and swap agreements to meet our risk management objective. A hypothetical 50 basis points (bps) change to interest rates would not materially change our results of operations or cash flows. For additional information related to our debt and interest rate swap agreements, see Note 11 and Note 12, respectively, of the notes to the consolidated financial statements contained in this report. 32
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Derivatives. As ofJanuary 31, 2020 , the fair value of our fixed interest rate swaps was$92 million (liability). Under the swap agreements, we pay a fixed rate and the counterparties to the agreements pay a floating interest rate based on 1-month LIBOR. A hypothetical 50 bps change in the 1-month LIBOR curve would change the fair value of the fixed interest rate swaps up to$29 million . Since the interest rate swaps are accounted for as cash flow hedges, the change in fair value is reported as a component of equity (accumulated other comprehensive income or loss). We do not hold or issue derivative financial instruments for trading or speculative purposes. For additional information related to calculating the fair value of our interest rate swaps, see Note 12 of the consolidated financial statements included in this report. Cash equivalents. A 10% unfavorable interest rate movement for interest earned on our cash and cash equivalents would not materially impact the value of our cash holdings and would have a negligible impact on interest income at current market interest rates. Inflation Risk We have generally been able to anticipate increases in costs when pricing our contracts. Bids for longer-term FFP contracts typically include labor and other cost escalations in amounts that historically have been sufficient to cover cost increases over the period of contract performance. Item 8. Financial Statements and Supplementary Data See our consolidated financial statements attached hereto and listed on the index found on page F-1 of this report. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure No information is required in response to this item. Item 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our management, with the participation of our principal executive officer (our Chief Executive Officer) and principal financial officer (our Chief Financial Officer), has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as ofJanuary 31, 2020 , and our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of theSEC . These disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our principal executive officer and our principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Changes in Internal Control Over Financial Reporting There have been no changes in our internal control over financial reporting during the fourth quarter of fiscal 2020 that materially affected, or are likely to materially affect, our internal control over financial reporting. Management's Report On Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. 33
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Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, completely, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of the financial statements in accordance with GAAP; (iii) provide reasonable assurance that our receipts and expenditures are made only in accordance with the authorization of our management and directors; and (iv) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the consolidated financial statements. Internal control over financial reporting includes the controls themselves, monitoring and internal auditing practices and actions taken to correct deficiencies as identified. Our management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our internal control over financial reporting as ofJanuary 31, 2020 based on the framework established in the 2013 Internal Control - Integrated Framework issued by theCommittee of Sponsoring Organizations of theTreadway Commission . Our management has assessed in its evaluation the effectiveness of our internal control over financial reporting as ofJanuary 31, 2020 and has concluded that our internal control over financial reporting was effective.Ernst & Young LLP , an independent registered public accounting firm, audited our consolidated financial statements included in this report and our internal control over financial reporting, and the firm's report on our internal control over financial reporting are set forth below this report. Although our management, including the Chief Executive Officer and the Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting, because of inherent limitations, our management does not expect that our internal controls over financial reporting will prevent or detect all errors and all fraud. Also, projections of any evaluation of effectiveness in such assessment to future periods are subject to the risk that controls may be inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. 34
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders ofScience Applications International Corporation Opinion on Internal Control Over Financial Reporting We have auditedScience Applications International Corporation's internal control over financial reporting as ofJanuary 31, 2020 , based on criteria established in Internal Control - Integrated Framework issued by theCommittee of Sponsoring Organizations of theTreadway Commission (2013 framework) (the COSO criteria). In our opinion,Science Applications International Corporation (the Company) maintained, in all material respects, effective internal control over financial reporting as ofJanuary 31, 2020 , based on the COSO criteria. We also have audited, in accordance with the standards of thePublic Company Accounting Oversight Board (United States ) (PCAOB), the consolidated balance sheets of the Company as ofJanuary 31, 2020 andFebruary 1, 2019 , the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the two years in the period endedJanuary 31, 2020 , and the related notes and our report datedMarch 26, 2020 expressed an unqualified opinion thereon. Basis for Opinion The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with theU.S. federal securities laws and the applicable rules and regulations of theSecurities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/Ernst & Young LLP Tysons, VirginiaMarch 26, 2020 35
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