Science Applications International Corporation

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

Science Applications International Corporation is a technology integrator primarily serving the U.S. government with a focus on national security and IT modernization.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: SAIC is a technology integrator, not a product maker, meaning they do not develop and sell their own tech. Their services include systems integration, engineering, and enterprise IT solutions. The Company operates in two segments: Defense and Intelligence and Civilian.

Defense and Intelligence: This segment provides a diverse portfolio of national security solutions to defense and intelligence agencies of the U.S. government. This entails areas such as AI/ML, mission support, and training and simulation.
Civilian: This segment helps the civilian sector with IT modernization, digital transformation, and cloud solutions, focusing on providing technological solutions to local and state governments and agencies, and also delivering citizen services.

Revenue Distribution: 98% of SAIC’s revenue is directly from the U.S. government, including both prime contracts and subcontracts. A small portion (2%) of its revenue comes from international clients. Of the U.S. revenue, around 50% comes from the Department of Defense (DOD), and the rest comes from various other US government entities and contracts.

This concentration of revenue on the US government makes SAIC’s revenue streams very dependent on government priorities and spending.

Industry Trends and Competitive Landscape: SAIC operates in the technology and federal contracting space. Some key dynamics are:

The need for ongoing modernization and digital transformation in the government as well as a shift in national security priorities.
A highly competitive market with established players like Lockheed, Raytheon, and Leidos, which are large, established competitors with scale, resources, and deep knowledge. They often use their own products and tech.
The rise of new entrants and smaller firms, often specializing in particular areas, which increases competition for government contracts.
A preference for large-scale integrated solutions rather than more traditional “a la carte” solutions.
A shift toward the cloud as the central infrastructure for government operations and related services.
Increased focus on AI/ML and cybersecurity to defend government assets and ensure resilience against attacks.
A demand for specialized expertise in various technical niches, which are difficult for companies to have.
Emphasis on improving efficiency in government procurements and streamlining processes.

What Makes SAIC Different: Although SAIC is a big company, it doesn’t directly produce tech/products for its operations. The company’s differentiated skills are in system engineering, integrating new technologies and solutions across domains and their deep government expertise to deliver end-to-end solutions. SAIC focuses on understanding customer requirements and provides tailored solutions, which gives them an advantage. The company claims it is more of a partner than a seller and focuses on long-term value creation and recurring revenues.

Margins: SAIC’s operating margins are relatively narrow. As per the last report they are about 7.4%, with an average revenue growth rate at around 7-8% per year. This means the company relies on maintaining tight cost control and operational efficiencies to create an attractive ROIC. In this line of work, a lot of contracts have fixed margins or a pre-defined cost-plus basis, which limits the potential for large profit margins from the same contracts. Competition and the US government’s contracting strategies also limit higher profits.

Moat Rating: 2/5 SAIC’s moat is classified as narrow. Their moat stems from the following: * Switching Costs: High integration with a variety of government systems and operations, makes it costly and complex for the government to switch to a new supplier. This includes specialized expertise and integration with mission-critical assets. These switching costs increase customer stickiness. * However, a more aggressive government may decide to use different suppliers to have more competition in bids, even if that costs a bit more, which will reduce the moat. * Customer Relationships: SAIC’s long-standing relationships with US Government agencies provide some stability and predictability to its revenue base, and it’s seen as a reliable partner to those clients.

Reputation for Success: Since the company has a long record of delivering services, its reputation within the contracting market has been very strong. However, these moats are not wide, because the company does not have a competitive moat from products or technology itself; the competition also is very strong within this sector. And since most of the revenue is highly concentrated in a single entity (the US government), a change in US government spending or priorities can hurt the company’s moat.

Risks to Moat and Business Resilience * Dependence on Government Spending: A decline in government budgets, changing government priorities, or an alteration in procurement rules could hurt SAIC’s revenues and profitability significantly. * Competition: Intense competition from larger competitors and niche specialists could pressure margins and profitability. A company that does not maintain long term relationships and improve operations may fail to deliver enough value. * Technological Changes: Since SAIC integrates technology and not develop its own, it’s crucial for SAIC to stay on the cutting edge and make sure its solutions don’t become obsolete too quickly. Failure to adopt new technology could mean clients might choose other more up-to-date providers. * Contract Termination and Delays: The government often has the right to terminate existing contracts for convenience, and such termination could create problems and uncertainty in the revenue. Any sort of contract delays will result in missed opportunities and less money in the balance sheets. * Economic Slowdown: Since the company’s earnings are sensitive to overall economic health, periods of downturn could harm the company due to budgetary restrictions and project cancellations. * Increased Oversight: A government investigation could lead to significant costs and may damage the company’s reputation, potentially affecting future contracts as well. * Loss of Key Personnel: The company’s continued success depends on its ability to retain and recruit skilled professionals and engineers. Loss of these people may cause problems in the implementation of solutions and projects. * Cyber and Data Security: If the company faces data breaches, leaks, or cyber attacks, it will suffer loss of reputation, customers and financial damages.

Supply chain disruption: Since SAIC deals with a ton of different entities and many different projects across the nation, they are prone to supply chain issues and disruption.

Financials * Financial Performance: The last quarterly report showed revenues of $1.9 billion, up 4% YOY, and diluted EPS from continuing operations of $1.80, compared to $1.13 last year. This growth was partly due to a new government infrastructure and modernization program as well as higher government spending. The company also reported having a healthy pipeline of contracts. * The management stated the organic revenue growth is expected to range between -0.5% to 1.5% in fiscal 2025. This may be due to increased competition and slowing economic growth.

Debt Levels and Liquidity: SAIC has long term debt worth around 2.2 billion, which is roughly about 20% of total capital. They have a decent amount of cash and assets on hand, which provides liquidity. They also have a credit facility of $1.1 Billion that they can tap into if needed for operations. They are expecting to de-leverage in the coming years.
Returns to Shareholders: SAIC also has a share buyback program and continues to pay a quarterly dividend. For investors with a focus on returning capital, this adds to the attraction.
Future Outlook: The management is optimistic for 2025, due to the various modernization projects and new contracts. They expect to have a steady margin and consistent revenue generation.

Understandability: 2/5 The business is quite complicated and difficult to understand because of the following factors.

Government Contracts: Understanding what each contract details and how it is structured (including the revenue model, type of work, etc) is very difficult to understand for a lay investor. * Complex Service Model: SAIC doesn’t sell products but offers solutions that require specialized skills and experience with government operations, making it very complicated to comprehend how they are generating revenue. * Financial statements: The financial statements are very complicated and do not offer a good perspective of what’s happening under the hood. * Ever-Changing Landscape: With a focus on defense and technology, there’s always the chance that government priorities and spending may shift, or technology and software can render some company solutions obsolete, making it hard to accurately predict future revenue streams and sustainability.

Balance Sheet Health: 3 / 5 The company has a reasonable balance sheet, but it isn’t without its risks and vulnerabilities. * Debt: With a debt to equity ratio of 0.9, the company is highly leveraged. The company also has considerable debt repayment obligations over the next few years.

Cash: The company also has around 100 million in cash, which gives them some room to maneuver in case operations get affected.
Intangibles: The company also has a good number of intangibles that they got from acquisitions, which will need to be amortized over time. * Limited flexibility: Due to the long-term nature of the business and its contracts, the company has limited flexibility to make big changes in a short span of time and needs proper capital allocation to have consistent long-term growth.