LDOS

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended October 31, 2006, for SAIC, Inc. (formerly Science Applications International Corporation). The filing reflects a significant corporate restructuring: on October 16, 2006, the company completed a reorganization merger to become a publicly traded entity. On October 13, 2006, SAIC, Inc. completed an Initial Public Offering (IPO) of 86.25 million shares of common stock at $15 per share, raising net proceeds of $1.244 billion. Prior to the IPO, a special dividend of $2.45 billion was declared and paid in November 2006. The company provides scientific, engineering, and technical services primarily to U.S. government agencies.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Consolidated revenues increased 6% year-over-year for both the three and nine-month periods, driven by 6% growth in the Government segment (93% of total revenue) and 6% growth in the Commercial segment for the nine-month period.
• Profitability: Operating income increased 36% for the quarter and 23% for the nine-month period. This improvement was primarily due to reduced losses on the Greek contract compared to the prior year and increased operating income in the Government segment.
• Discontinued Operations: Net income for the nine months ended October 31, 2006, decreased 60% compared to the prior year ($307 million vs. $773 million). This decline is largely attributable to the absence of the $869 million gain on the sale of Telcordia Technologies, Inc., which occurred in the prior year's nine-month period.
• Liquidity: Cash and cash equivalents increased significantly to $3.636 billion from $1.010 billion at the start of the fiscal year, reflecting IPO proceeds and the liquidation of marketable securities to fund the special dividend.

Guidance, Outlook, Risks, and Unusual Items

• Unusual Items - Greek Contract: The company continues to face significant uncertainty regarding a firm-fixed-price contract with the Greek government for the 2004 Olympic security system. As of October 31, 2006, the company has recorded $123 million in total losses on this contract. Arbitration proceedings were initiated in April 2006 seeking damages in excess of $76 million. The company has $244 million in standby letters of credit outstanding that could be called by the customer.
• Unusual Items - Discontinued Operations: The company sold ANXeBusiness Corp. (ANX) in October 2006, recording a preliminary gain of $19 million. Results for ANX and Telcordia are classified as discontinued operations.
• Stock-Based Compensation: The adoption of SFAS No. 123(R) resulted in increased stock-based compensation expense of $7 million for the quarter and $43 million for the nine months ended October 31, 2006, compared to $16 million and $31 million in the prior year periods, respectively.
• Outlook: Management expects to recognize a substantial portion of its $14.4 billion negotiated backlog within the next 12 months. However, the company notes that U.S. government spending priorities and budgetary constraints could impact future revenue growth.
• Risks: Key risks include the outcome of the Greek contract arbitration, potential calling of performance bonds, reliance on U.S. government contracts (89% of revenue), and the impact of the Pension Protection Act of 2006 allowing retirement plan participants to sell shares, potentially affecting stock price.

Investor Verification Checklist

• Greek Contract Exposure: Verify the status of the arbitration proceedings and the potential for additional losses beyond the recorded $123 million, including the risk of the customer calling the $244 million in standby letters of credit.
• Discontinued Operations Impact: Confirm that the significant drop in nine-month net income is solely due to the one-time gain on the Telcordia sale in the prior year and does not reflect a deterioration in core continuing operations.
• Capital Structure: Review the implications of the dual-class stock structure (Class A preferred vs. Common) and the upcoming conversion of restricted shares held in retirement plans beginning January 1, 2007.
• Backlog Realization: Assess the funded vs. unfunded backlog ($4.0 billion funded vs. $10.4 billion unfunded) and the risks associated with unfunded government contract options.
• Debt Covenants: Confirm continued compliance with the financial covenants of the $750 million revolving credit facility, specifically the debt-to-EBITDA and interest coverage ratios.