Note 1—Summary of Significant Accounting Policies:

Nature of Operations and Basis of Presentation

SAIC, Inc. is a provider of scientific, engineering, systems integration and technical services and solutions to all branches of the U.S. military, agencies of the U.S. Department of Defense, the intelligence community, the U.S. Department of Homeland Security and other U.S. Government civil agencies, state and local government agencies, foreign governments and customers in select commercial markets.

The condensed consolidated financial statements include the accounts of SAIC, Inc. and all majority-owned and 100%-owned subsidiaries (collectively referred to as the Company), including Science Applications International Corporation. All intercompany transactions and accounts have been eliminated in consolidation.

The accompanying financial information has been prepared by the Company pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (SEC). Certain disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 2010. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements, a s well as the reported amounts of revenues and expenses during the reporting periods. Estimates have been prepared by management on the basis of the most current and best available information at the time of estimation and actual results could differ from those estimates.

In the opinion of management, the financial information as of October 31, 2010 and for the three and nine months ended October 31, 2010 and 2009 reflects all adjustments, which consist of normal recurring adjustments, necessary for a fair presentation thereof. Operating results for the three and nine months ended October 31, 2010 are not necessarily indicative of the results that may be expected for the fiscal year ending January 31, 2011, or any future period.

Unless otherwise noted, references to years are for fiscal years ended January 31. For example, the fiscal year ending January 31, 2011 is referred to as "fiscal 2011" in these notes to condensed consolidated financial statements.

Discontinued Operations

The Company's results of discontinued operations for the three and nine months ended October 31, 2010 and 2009 relate primarily to the Company's former subsidiary Telcordia Technologies, Inc. (Telcordia). In March 2001, Telcordia instituted arbitration proceedings against a customer, Telkom South Africa, as a result of a contract dispute. Pursuant to the definitive stock purchase agreement for the fiscal 2006 sale of Telcordia, the Company was entitled to receive the net proceeds from any settlement after deduction for tax liabilities incurred by Telcordia. In July 2010, Telcordia and Telkom South Africa settled all claims related to these arbitration proceedings. Under the settlement, Telkom South Africa paid $80 million plus amounts for value added taxes (VAT). During the three months ended October 31, 2010, the Company and Telcordia executed an agreement which resolved matte rs related to the Telkom South Africa settlement and certain other contingencies related to the fiscal 2006 sale of Telcordia. The Company recorded after-tax gains of $18 million and $49 million in discontinued operations related to these actions during the three and nine months ended October 31, 2010, respectively.

Revenue Recognition Accounting Change

The Company's revenues are generated primarily from contracts with the U.S. Government, commercial customers, and various international, state and local governments or from subcontracts with other contractors engaged in work with such customers. The Company performs under various types of contracts, which include firm-fixed-price, time-and-materials, fixed-price-level-of-effort, cost-plus-fixed-fee, cost-plus-award-fee and cost-plus-incentive-fee contracts.

Accounting Change. Prior to February 1, 2010, the Company recognized revenues on cost-plus-fixed-fee, time-and-materials and fixed-price-level-of-effort contracts with the U.S. Government primarily based on contract costs incurred to date compared with total estimated costs at completion (cost-to-cost method), which is an input method of percentage-of-completion that relied heavily on management's estimates of contract revenues and contract costs at completion. Effective February 1, 2010, the Company changed its method of revenue recognition for cost-plus-fixed-fee, time-and-materials and fixed-price-level-of-effort contracts with the U.S. Government to the methods described below. Contract costs will continue to be expensed as incurred under these contracts.

 

Cost-plus-fixed-fee contracts—Revenue is recognized on the basis of partial performance as costs are incurred plus an estimate of applicable fees as the Company becomes contractually entitled to reimbursement of costs and the applicable fees pursuant to the guidance in Accounting Standards Codification (ASC) 912-605-25 Contractors-Federal Government—Recognition of Fees Under Cost-Plus-Fixed-Fee Contracts.

Time-and-materials contracts—Revenue is recognized using the percentage-of-completion method of accounting utilizing an output measure to measure progress toward completion based on the hours provided in performance under the contract multiplied by the negotiated contract billing rates, plus the negotiated contract billing rate of any allowable material and subcontract costs and out-of-pocket expenses.

Fixed-price-level-of-effort contracts—These contracts are substantially similar to time-and-materials contracts except they require a specified level of effort over a stated period of time. Accordingly, the Company recognizes revenue in a manner similar to time-and-materials contracts whereby the Company uses the percentage-of-completion method of accounting utilizing an output measure. The Company measures progress toward completion based on the hours provided in performance under the contract multiplied by the negotiated contract billing rates, plus the negotiated contract billing rate of any allowable material costs and out-of-pocket expenses.

The revenue recognition change impacts contracts accounting for approximately two-thirds of the Company's revenues. The Company believes the change is to an alternative accounting principle that is preferable because it better reflects the economic substance and earnings process under these arrangements. This change was facilitated by the implementation of a new information technology system.

Although this change impacts contracts accounting for approximately two-thirds of the Company's revenues, the result of the accounting change was immaterial to the Company's consolidated financial position and results of operations for all periods presented because the resulting measurement of the progress toward completion under the two methods is not significantly different. Accordingly, the cumulative effect of the accounting change was recognized in the consolidated statement of income in the first quarter, rather than retrospectively applied to the prior period consolidated financial statements.

Revenue Recognition. Cost-plus-fixed-fee contracts—Revenue is recognized on cost-plus-fixed-fee contracts with the U.S. Government on the basis of partial performance equal to costs incurred plus an estimate of applicable fees earned as the Company becomes contractually entitled to reimbursement of costs and the applicable fees.

Time-and-materials contracts—Revenue is recognized on time-and-materials contracts with the U.S. Government using the percentage-of-completion method of accounting utilizing an output measure of progress. Revenue is recognized on time-and-materials contracts with non-U.S. Government customers using a proportional performance method. Under both of these methods, revenue is recognized based on the hours provided in performance under the contract multiplied by the negotiated contract billing rates, plus the negotiated contract billing rate of any allowable material and subcontract costs and out-of-pocket expenses.

Fixed-price-level-of-effort contracts (FP-LOE)—These contracts are substantially similar to time-and-materials contracts except they require a specified level of effort over a stated period of time. Accordingly, the Company recognizes revenue on FP-LOE contracts with the U.S. Government in a manner similar to time-and-materials contracts whereby the Company measures progress toward completion based on the hours provided in performance under the contract multiplied by the negotiated contract billing rates, plus the negotiated contract billing rate of any allowable material costs and out-of-pocket expenses.

Cost-plus-award-fee/cost-plus-incentive fee contracts—Revenues and fees on these contracts with the U.S. Government are primarily recognized using the percentage-of-completion method of accounting, most often based on the cost-to-cost method. The Company includes an estimate of the ultimate incentive or award fee to be received on the contract in the estimate of contract revenues for purposes of applying the percentage-of-completion method of accounting.

Firm-fixed-price contracts—Revenues and fees on these contracts that are system integration or engineering in nature are primarily recognized using the percentage-of-completion method of accounting utilizing the cost-to-cost method.

Revenues from services and maintenance contracts, notwithstanding contract type, are recognized over the term of the respective contracts as the services are performed and revenue is earned. Revenues from unit-priced contracts are recognized as transactions are processed based on objective measures of output. Revenues from the sale of manufactured products are recorded upon passage of title and risk of loss to the customer, which is generally upon delivery, provided that all other requirements for revenue recognition have been met.

 

The Company also uses the efforts-expended method of percentage-of-completion using measures such as labor dollars for measuring progress toward completion in situations in which this approach is more representative of the progress on the contract. For example, the efforts-expended method is utilized when there are significant amounts of materials or hardware procured for the contract that is not representative of progress on the contract. Additionally, the Company utilizes the units-of-delivery method under percentage-of-completion on contracts where separate units of output are produced. Under the units-of-delivery method, revenue is generally recognized when the units are delivered to the customer, provided that all other requirements for revenue recognition have been met.

The Company also evaluates its contracts for multiple elements, and when appropriate, separates the contracts into separate units of accounting for revenue recognition.

The Company provides for anticipated losses on contracts by recording an expense during the period in which the losses are determined. Amounts billed and collected but not yet recognized as revenues under certain types of contracts are deferred. Contract costs incurred for U.S. Government contracts, including indirect costs, are subject to audit and adjustment through negotiations between the Company and government representatives. The Company has agreed upon and settled indirect contract costs through fiscal 2004. Revenues on U.S. Government contracts have been recorded in amounts that are expected to be realized upon final settlement.

The Company's accounts receivable include unbilled receivables, which consist of costs and fees billable upon contract completion or the occurrence of a specified event, the majority of which is expected to be billed and collected within one year. Unbilled receivables are stated at estimated realizable value. Contract retentions are billed when the Company has negotiated final indirect rates with the U.S. Government and, once billed, are subject to audit and approval by government representatives. Consequently, the timing of collection of retention balances is outside the Company's control. Based on the Company's historical experience, the majority of retention balances are expected to be collected beyond one year.

Contract claims are unanticipated additional costs incurred but not provided for in the executed contract price that the Company seeks to recover from the customer. Such costs are expensed as incurred. Additional revenue related to contract claims is recognized when the amounts are awarded by the customer.

In certain situations, primarily where the Company is not the primary obligor on certain elements of a contract such as the provision of administrative oversight and/or management of government-owned facilities or logistical support services related to other vendors' products, the Company recognizes as revenue the net management fee associated with the services and excludes from its income statement the gross sales and costs associated with the facility or other vendors' products.

Selling, General and Administrative Expenses

The Company classifies indirect costs incurred within or allocated to its Government segment as overhead (included in cost of revenues) and general and administrative expenses in the same manner as such costs are defined in the Company's disclosure statements under U.S. Government Cost Accounting Standards. Effective with the beginning of fiscal 2011, the Company updated its disclosure statements with the Defense Contract Management Agency, resulting in certain costs being classified differently either as overhead or as general and administrative expenses on a prospective basis. This change has caused a net increase in reported cost of revenues and a net decrease in reported selling, general and administrative expenses in fiscal 2011 as compared to fiscal 2010; however, total operating costs were not affected by this change.

Supplementary Cash Flow Information

Supplementary cash flow information, including non-cash investing and financing activities, for the periods noted was as follows:

 

		Nine Months Ended October 31
		2010				2009
		(in millions)
Stock exchanged upon exercise of stock options		$	32			$	81
Stock issued for settlement of accrued employee benefits		$	4			$	3
Decrease in accrued stock repurchases		$	(24	)		$	—
Fair value of assets acquired in acquisitions		$	445			$	198
Less: cash paid in acquisitions, net of cash acquired of $10 million in fiscal 2011 and $7 million in fiscal 2010			(358	)			(157	)
Liabilities assumed in acquisitions		$	87			$	41
Cash paid for interest		$	35			$	35
Cash paid for income taxes		$	246			$	185

 

Accounting Standards Updates Issued But Not Yet Adopted

In October 2009, the Financial Accounting Standards Board (FASB) issued an update to "Revenue Recognition—Multiple-Deliverable Revenue Arrangements." This update removes the objective-and-reliable-evidence-of-fair-value criterion from the separation criteria used to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting, replaces references to "fair value" with "selling price" to distinguish from the fair value measurements required under the "Fair Value Measurements and Disclosures" guidance, provides a hierarchy that entities must use to estimate the selling price, eliminates the use of the residual method for allocation, and expands the ongoing disclosure requirements. This update is effective for the Company beginning February 1, 2011 and can be applied prospectively or retrospectivel y. The Company is currently evaluating the effect that adoption of this update will have, if any, on the Company's consolidated financial position and results of operations when it is adopted.

In October 2009, the FASB issued an update to "Software—Multiple-Deliverable Revenue Arrangements." This update amends the existing accounting model for revenue arrangements that include both tangible products and software elements. Tangible products containing software components and nonsoftware components that function together to deliver the tangible product's essential functionality are excluded from the scope of software revenue guidance. In addition, this update provides guidance on how a vendor should allocate consideration to deliverables in an arrangement that includes both tangible products and software and enhances the disclosure requirements related to these arrangements. This update is effective for arrangements entered into or materially modified by the Company after January 31, 2011 and can be applied prospectively or retrospectively. The Com pany is currently evaluating the effect that adoption of this update will have, if any, on the Company's consolidated financial position and results of operations when it is adopted.

Other new accounting standards and updates issued but not effective until after October 31, 2010, are not expected to have a significant effect on the Company's consolidated financial position or results of operations.

Note 2—Earnings Per Share (EPS):

In calculating EPS using the two-class method, the Company is required to allocate a portion of its earnings to its unvested stock awards containing nonforfeitable rights to dividends or dividend equivalents. Basic EPS is computed by dividing income less earnings allocable to unvested stock awards by the basic weighted average number of shares outstanding. Diluted EPS is computed similar to basic EPS, except the weighted average number of shares outstanding is increased to include the dilutive effect of outstanding stock options and other stock-based awards.

A reconciliation of the income used to compute basic and diluted EPS for the periods noted was as follows:

 

		Three Months Ended October 31								Nine Months Ended October 31
		2010				2009				2010				2009
		(in millions)
Income from continuing operations, as reported		$	154			$	135			$	437			$	377
Less: allocation of undistributed earnings to unvested stock awards			(5	)			(4	)			(14	)			(12	)
Income from continuing operations, for computing EPS		$	149			$	131			$	423			$	365
Net income, as reported		$	172			$	135			$	486			$	374
Less: allocation of undistributed earnings to unvested stock awards			(6	)			(4	)			(15	)			(12	)
Net income, for computing EPS		$	166			$	131			$	471			$	362

A reconciliation of the weighted average number of shares outstanding used to compute basic and diluted EPS for the periods noted was as follows:

 

		Three Months Ended October 31								Nine Months Ended October 31
		2010				2009				2010				2009
		(in millions)
Basic weighted average number of shares outstanding			359				384				366				387
Dilutive common share equivalents—stock options			1				4				2				4
Diluted weighted average number of shares outstanding			360				388				368				391

 

Basic and diluted EPS for the periods noted was as follows:

 

		Three Months Ended October 31								Nine Months Ended October 31
		2010				2009				2010				2009
Basic:
Income from continuing operations		$	.42			$	.34			$	1.16			$	.94
Income from discontinued operations			.04				—				.13				—
		$	.46			$	.34			$	1.29			$	.94
Diluted:
Income from continuing operations		$	.41			$	.34			$	1.15			$	.93
Income from discontinued operations			.05				—				.13				—
		$	.46			$	.34			$	1.28			$	.93

The following stock-based awards were excluded from the weighted average number of shares outstanding used to compute basic and diluted EPS for the periods noted:

 

		Three Months Ended October 31								Nine Months Ended October 31
		2010				2009				2010				2009
		(in millions)
Antidilutive stock options excluded			20				11				20				11
Performance-based stock awards excluded			1				1				1				1
Weighted average number of unvested stock awards outstanding excluded			13				13				12				13

 

Note 3—Stock-Based Compensation:

Total Stock-Based Compensation. Total stock-based compensation expense for the periods noted was as follows:

 

		Three Months Ended October 31								Nine Months Ended October 31
		2010				2009				2010				2009
		(in millions)
Stock options		$	5			$	8			$	16			$	24
Vesting stock awards			21				20				58				54
Performance-based stock awards			1				1				4				2
Total stock-based compensation expense		$	27			$	29			$	78			$	80

Stock Options. Stock options granted during the nine months ended October 31, 2010 and 2009 have a term of five years and a vesting period of four years, except for stock options granted to the Company's outside directors, which have a vesting period of one year. The fair value of stock options granted during the periods noted was determined using the following weighted average assumptions:

 

		Nine Months Ended October 31
		2010				2009
Expected term (in years)			3.8				3.9
Expected volatility			25.1	%			30.6	%
Risk-free interest rate			2.1	%			1.5	%
Dividend yield			0	%			0	%

The weighted average grant-date fair value of stock options granted during the nine months ended October 31, 2010 and 2009 using the Black-Scholes option-pricing model was $3.96 and $4.79, respectively.

 

 

Stock option activity for the nine months ended October 31, 2010 was as follows:

 

		Shares of stock under stock options				Weighted average exercise price				Weighted average remaining contractual term				Aggregate intrinsic value
		(in millions)								(in years)				(in millions)
Outstanding at January 31, 2010			31.6			$	16.26				2.0			$	66
Options granted			5.3				17.44
Options forfeited or expired			(1.7	)			16.07
Options exercised			(6.8	)			13.90								32
Outstanding at October 31, 2010			28.4				17.05				2.2				8
Exercisable at October 31, 2010			14.7				16.12				1.1				8

Vesting Stock Awards. Vesting stock award activity for the nine months ended October 31, 2010 was as follows:

 

		Shares of stock under stock awards				Weighted average grant- date fair value
		(in millions)
Unvested at January 31, 2010			12.1			$	18.60
Awards granted			4.4				17.41
Awards forfeited			(0.9	)			18.13
Awards vested			(3.5	)			19.14
Unvested at October 31, 2010			12.1				18.05

The fair value of vesting stock awards that vested during the nine months ended October 31, 2010 and 2009 was $62 million and $53 million, respectively.

Performance-Based Stock Awards. Performance-based stock award activity for the nine months ended October 31, 2010 was as follows:

 

		Expected number of shares of stock to be issued under performance- based stock awards				Weighted average grant- date fair value
		(in millions)
Outstanding at January 31, 2010			0.6			$	18.35
Awards granted			0.6				17.45
Awards forfeited			(0.1	)			18.12
Outstanding at October 31, 2010			1.1				17.89

Increases or decreases in the expected number of shares to be issued may occur due to changes in the expected level of achievement of the performance goals over the life of the awards. As of October 31, 2010, there have been no vesting events for performance-based stock awards.