SCIENCE APPLICATIONS INTERNATIONAL CORP - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q


(Mark One) ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 31, 2002


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 0-12771

Science Applications International Corporation

(Exact name of registrant as specified in its charter)


Delaware		95-3630868
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

10260 Campus Point Drive
San Diego, California 92121
(858) 826-6000
(Address, including zip code, and telephone number,
including area code, of Registrant’s principal executive offices)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No

As of November 30, 2002, the Registrant had 185,263,624 shares of Class A common stock, $.01 par value per share, issued and outstanding, and 243,374 shares of Class B common stock, $.05 par value per share, issued and outstanding.

TABLE OF CONTENTS


PART I
	FINANCIAL INFORMATION
	Item 1. Financial Statements
	Condensed Consolidated Statements of Income
	Condensed Consolidated Balance Sheets
	Condensed Consolidated Statements of Cash Flows
SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
	Notes to Condensed Consolidated Financial Statements
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
	Item 4. Controls and Procedures
PART II OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 2. Changes in Securities
	Item 3. Defaults Upon Senior Securities
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 5. Other Information
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURE
CERTIFICATION
EXHIBIT 99.1
EXHIBIT 99.2

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
Condensed Consolidated Statements of Income
(Unaudited, in thousands, except per share amounts)


					Three months ended						Nine months ended

					October 31, 2002			October 31, 2001			October 31, 2002			October 31, 2001

Revenues					$	1,594,449		$	1,554,570		$	4,535,880		$	4,525,961
Costs and expenses:
		Cost of revenues				1,287,421			1,245,131			3,681,160			3,622,906
		Selling, general and administrative expenses				147,597			176,625			452,276			589,528
Goodwill impairment												9,007
Gain on sale of business units, net						(1,516	)					(4,899	)		(6,922	)

Operating income						160,947			132,814			398,336			320,449

Non-operating income (expense):
		Net (loss) gain on marketable
				securities and other investments,
				including impairment losses		(8,476	)		70,481			(134,134	)		(78,858	)
		Interest income				11,652			11,192			28,565			43,120
		Interest expense				(18,189	)		(3,954	)		(32,039	)		(14,080	)
		Other income (expense), net				26			(105	)		6,144			2,681
		Minority interest in income of consolidated subsidiaries				(4,726	)		(4,346	)		(14,007	)		(11,285	)

Income before income taxes						141,234			206,082			252,865			262,027
Provision for income taxes						49,395			67,389			87,238			85,683

Income before cumulative effect of accounting change						91,839			138,693			165,627			176,344
Cumulative effect of accounting change, net of tax															711

Net income					$	91,839		$	138,693		$	165,627		$	177,055

Earnings per share:
	Basic, before and after cumulative
			effect of accounting change, net of tax		$	.48		$	.66		$	.83		$	.81
	Diluted, before and after cumulative effect of accounting change, net of tax				$	.46		$	.62		$	.80		$	.76
Common equivalent shares:
		Basic				192,616			210,735			198,916			217,711

		Diluted				198,373			223,766			207,045			231,544

See accompanying notes to condensed consolidated financial statements.

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
Condensed Consolidated Balance Sheets
(Unaudited, in thousands)


					October 31, 2002			January 31, 2002

ASSETS
Current assets:
	Cash and cash equivalents				$	1,128,199		$	480,004
	Restricted cash					10,217			4,845
	Short-term investments in marketable securities					1,086,258			708,945
	Receivables, net					1,136,596			1,238,789
	Prepaid expenses and other current assets					76,035			97,559
	Deferred income taxes					55,508			56,192

			Total current assets			3,492,813			2,586,334
Property, plant and equipment (less accumulated depreciation of $655,626 and
	$605,566 at October 31, 2002 and January 31, 2002, respectively)					490,526			555,340
Intangible assets						28,394			35,068
Goodwill						145,623			149,513
Long-term investments in marketable securities						16,660			815,548
Prepaid pension assets						562,677			546,137
Other assets						170,833			259,749

					$	4,907,526		$	4,947,689

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Accounts payable and accrued liabilities				$	772,389		$	1,068,220
	Accrued payroll and employee benefits					395,613			384,548
	Income taxes payable					372,559			220,869
	Notes payable and current portion of long-term debt					37,677			37,294

			Total current liabilities			1,578,238			1,710,931
Long-term debt, net of current portion						910,186			123,472
Deferred income taxes						21,570			254,216
Other long-term liabilities						293,336			302,115
Minority interest in consolidated subsidiaries						35,622			33,202
Stockholders’ equity:
	Common stock:
		Class A, $.01 par value, 1,000,000 shares authorized; issued and outstanding:
				185,588 shares and 199,291 shares at October 31, 2002 and January 31, 2002,
				respectively		1,856			1,993
		Class B, $.05 par value, 5,000 shares authorized; issued and outstanding:
				243 shares and 267 shares at October 31, 2002 and January 31, 2002, respectively		12			13
		Additional paid-in capital				1,694,906			1,550,716
		Retained earnings				458,708			956,042
		Other stockholders’ equity				(80,204	)		(56,309	)
		Accumulated other comprehensive (loss) income				(6,704	)		71,298

			Total stockholders’ equity			2,068,574			2,523,753

					$	4,907,526		$	4,947,689

See accompanying notes to condensed consolidated financial statements.

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
Condensed Consolidated Statements of Cash Flows
(Unaudited, in thousands)


					Nine months ended

					October 31, 2002			October 31, 2001

Cash flows from operating activities:
	Net income				$	165,627		$	177,055
	Adjustments to reconcile net income to net cash provided by
		operating activities:
			Depreciation and amortization			108,213			135,372
			Non-cash compensation			87,725			72,452
			Loss (gain) on derivative instruments			47,626			(44,158	)
			Impairment losses on marketable securities			105,392			106,366
			Goodwill impairment			9,007
			(Gain) loss on sale of marketable securities and other investments			(18,884	)		16,650
			Gain on sale of business units, net			(4,899	)		(6,922	)
			Minority interest in income of consolidated subsidiaries			14,007			11,285
			Other			(331	)		4,401
			Non-cash restructuring charge			7,188			43,862
			Pension curtailment gain						(10,077	)
			Increase (decrease) in cash, excluding effects of acquisitions
				and divestitures, resulting from changes in:
				Receivables		63,978			185,242
				Prepaid expenses and other current assets		10,072			(96	)
				Progress payments		(109	)		(2,803	)
				Deferred income taxes		(185,052	)		(106,334	)
				Other assets		(27,683	)		(35,722	)
				Accounts payable and accrued liabilities		(258,024	)		(465,330	)
				Accrued payroll and employee benefits		24,290			5,504
				Income taxes payable		255,985			110,535
				Other long-term liabilities		12,701			14,579

						416,829			211,861

Cash flows from investing activities:
	Expenditures for property, plant and equipment					(32,286	)		(76,112	)
	Acquisitions of business units, net of cash acquired					(2,275	)		(13,675	)
	Purchases of debt and equity securities available-for-sale					(714,494	)		(37,668	)
	Proceeds from sale of marketable securities and other investments					981,094			452,918
	Investments in affiliates					(11,210	)		(49,116	)
	Other					105			9,368

						220,934			285,715

Cash flows from financing activities:
	Proceeds from notes payable and issuance of long-term debt					791,212			862
	Payment on settlement of treasury lock contracts					(8,157	)
	Payments of notes payable and long-term debt								(928	)
	Principal payments on capital lease obligations					(18,329	)		(21,329	)
	Dividends paid to minority interest stockholders					(7,802	)		(6,634	)
	Net proceeds from subsidiary issuance of stock					444			16,518
	Sales of common stock					21,784			24,888
	Repurchases of common stock					(755,135	)		(823,561	)

						24,017			(810,184	)

Effect of exchange rate changes on cash						(13,585	)		(5,136	)

Increase (decrease) in cash and cash equivalents						648,195			(317,744	)
Cash and cash equivalents at beginning of period						480,004			644,492

Cash and cash equivalents at end of period					$	1,128,199		$	326,748

Supplemental schedule of non-cash investing and financing activities:
	Common stock exchanged upon exercise of stock options				$	71,342		$	55,608

	Capital lease obligations for property and equipment				$	7,724		$	25,007

	Fair value of assets acquired in acquisitions				$	3,167		$	18,734
	Cash paid in acquisitions					(2,275	)		(13,675	)

	Liabilities assumed in acquisitions				$	892		$	5,059

See accompanying notes to condensed consolidated financial statements.

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION

Notes to Condensed Consolidated Financial Statements
(Unaudited)

Note A — Basis of Presentation:

The accompanying financial information has been prepared in accordance with the instructions to Form 10-Q and therefore does not necessarily include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America. The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, 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 as well as the reported amounts of revenues and expenses during the reporting period. Estimates have been prepared on the basis of the most current and best available information and actual results could differ from those estimates.

Certain amounts from the three and nine months ended October 31, 2001 have been reclassified in the condensed consolidated financial statements to conform to the presentation for the three and nine months ended October 31, 2002.

In the opinion of management, the unaudited financial information as of October 31, 2002 and for the three and nine months ended October 31, 2002 and 2001 reflect all adjustments, which include only normal recurring adjustments, necessary for a fair presentation thereof. Operating results for the three and nine months ended October 31, 2002 are not necessarily indicative of the results that may be expected for the fiscal year ending January 31, 2003. For further information, refer to the consolidated financial statements and footnotes included in the Company’s 2002 Annual Report on Form 10-K.

Note B — Recently Issued Accounting Pronouncement:

In June 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 146, “Accounting for Costs Associated With Exit or Disposal Activities,” which nullifies previous financial accounting guidance in Emerging Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring),” and is effective for exit or disposal activities initiated after December 31, 2002. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be measured initially at fair value and recognized when the liability is incurred rather than the date a company makes a commitment to an exit plan, which was the guidance under EITF No. 94-3. The Company does not expect adoption of SFAS No. 146 to have a material impact on the Company’s consolidated financial position or results of operations.

Note C — Business Segment Information:

The following summarizes interim business segment information:


		Three months ended October 31						Nine months ended October 31

		2002			2001			2002			2001

					(in thousands)
Revenues:
	Regulated	$	1,143,694		$	1,022,846		$	3,196,965		$	2,893,380
	Non-Regulated Telecommunications		289,837			346,538			838,379			1,103,411
	Non-Regulated Other		172,084			200,071			514,030			564,790
	Corporate		(11,166	)		(14,885	)		(13,494	)		(35,620	)

Total reportable segment revenues		$	1,594,449		$	1,554,570		$	4,535,880		$	4,525,961

Segment operating income (loss):
	Regulated	$	92,678		$	83,633		$	248,060		$	194,785
	Non-Regulated Telecommunications		61,937			48,702			161,276			112,753
	Non-Regulated Other		12,738			12,533			34,726			38,721
	Corporate		(12,705	)		(13,461	)		(50,131	)		(35,539	)

Total reportable segment operating income		$	154,648		$	131,407		$	393,931		$	310,720

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements — (continued)
(Unaudited)

The following is a summary of depreciation and amortization included in the calculation of reportable segment operating income:


		Three months ended October 31				Nine months ended October 31

		2002		2001		2002		2001

				(in thousands)
Depreciation and amortization:
	Regulated	$	5,356	$	9,985	$	15,846	$	27,817
	Non-Regulated Telecommunications		15,621		20,208		47,877		63,340
	Non-Regulated Other		13,062		12,018		39,080		38,371
	Corporate		1,831		1,987		5,361		5,787

Total reportable segment depreciation and amortization		$	35,870	$	44,198	$	108,164	$	135,315

The following reconciles total reportable segment operating income to the Company’s consolidated operating income:


		Three months ended October 31						Nine months ended October 31

		2002			2001			2002			2001

					(in thousands)
Total reportable segment operating income		$	154,648		$	131,407		$	393,931		$	310,720
	Investment activities		(1,586	)		(2,244	)		(4,983	)		(6,326	)
	Goodwill impairment								(9,007	)
	Gain on sale of business units, net		1,516						4,899			6,922
	Equity in loss (income) of unconsolidated affiliates		1,643			(695	)		(511	)		(2,152	)
	Minority interest in income of consolidated subsidiaries		4,726			4,346			14,007			11,285

Total consolidated operating income		$	160,947		$	132,814		$	398,336		$	320,449

Consolidated depreciation and amortization of $35,887,000 and $44,217,000 for the three months ended October 31, 2002 and 2001, respectively, includes $17,000 and $19,000 on investment activities for the same periods. For the nine months ended October 31, 2002 and 2001, consolidated depreciation and amortization of $108,213,000 and $135,372,000, respectively, includes $49,000 and $57,000 on investment activities for the same periods. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” effective February 1, 2002, the Company ceased amortizing goodwill as further described in Note G.

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements — (continued)
(Unaudited)

Note D — Short-term and Long-term Investments in Marketable Securities:

Included in the condensed consolidated balance sheet captions “Short-term investments in marketable securities” and “Long-term investments in marketable securities” are derivative instruments and available-for-sale marketable securities. The cost basis, gross unrealized gains, gross unrealized losses and fair market value of available-for-sale marketable securities and derivative instruments are as follows:


		Short-term			Long-term
		investments in			investments in
		marketable securities			marketable securities			Total

					(in thousands)
At October 31, 2002
	Marketable securities:
	Cost basis	$	1,082,318		$	9,533		$	1,091,851
	Unrealized gains		4,063			7,859			11,922
	Unrealized losses		(123	)		(732	)		(855	)

	Fair market value	$	1,086,258		$	16,660		$	1,102,918

At January 31, 2002
	Marketable securities:
	Cost basis	$	697,466		$	674,004		$	1,371,470
	Unrealized gains		3,291			96,330			99,621
	Unrealized losses		(28,612	)		(141,440	)		(170,052	)

			672,145			628,894			1,301,039
	Derivative instruments (Note F)		36,800			186,654			223,454

	Fair market value	$	708,945		$	815,548		$	1,524,493

As of January 31, 2002, the Company was hedging the equity price risk of certain available-for-sale marketable securities using equity collars. As more fully described in Note F, during the three months ended October 31, 2002, the Company liquidated all of its remaining shares in VeriSign, Inc. (“VeriSign”) and Amdocs Limited (“Amdocs”) and the equity collars that hedged those shares. As a result, there are no derivative instruments included in short-term investments in marketable securities and long-term investments in marketable securities at October 31, 2002.

Gross realized gains and losses from sales of marketable securities are included in “Net (loss) gain on marketable securities and other investments, including impairment losses” and are as follows:


	Three months ended October 31						Nine months ended October 31

	2002			2001			2002			2001

				(in thousands)
Gross realized gains	$	15,961		$	546		$	26,983		$	10,654
Gross realized losses		(134	)		(1,738	)		(11,239	)		(49,750	)

	$	15,827		$	(1,192	)	$	15,744		$	(39,096	)

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements — (continued)
(Unaudited)

Note E — Receivables:

Receivables include $31,105,000 of costs incurred on projects for which the Company has been requested by the customer to begin work under a new contract, or extend work under an existing contract, but for which formal contracts or contract modifications have not been executed at October 31, 2002.

Note F — Derivative Financial Instruments:

The Company is exposed to certain market risks which are inherent in certain transactions entered into in the normal course of business. They include sales contracts denominated in foreign currencies, investments in equity securities and exposure to changing interest rates. The Company has a risk management policy (“Policy”) in place which is used to assess and manage cash flow and fair value exposures. The Policy permits the use of derivative instruments and other natural hedges with certain restrictions and appropriate authorization. The Company presently uses derivative instruments to manage exposures to foreign currency and interest rate risks and uses natural hedges to minimize exposure for net investments in foreign subsidiaries. The Company does not hold derivative instruments for trading or speculative purposes.

Equity Securities Price Risk

The Company’s portfolio of publicly-traded equity securities is subject to market price risk and there may be instances where the Company will use derivative instruments to manage this risk of potential loss in fair value resulting from decreases in market prices. The Company had equity collars in place to mitigate the risk of significant price fluctuations of certain of its marketable equity securities. The equity collars were designated as fair value hedges of the underlying publicly-traded equity securities and, therefore, the changes in fair value of the derivative instruments and the hedged items attributable to the hedged risk were recorded in the condensed consolidated statements of income. During the three months ended October 31, 2002, the remaining VeriSign and Amdocs shares and the equity collars that hedged those shares were liquidated for gross proceeds of $570,594,000, and a net gain before income taxes of $15,229,000 was recognized. In April 2002, one of the equity collars on certain shares of the Company’s investment in Amdocs matured, which resulted in gross proceeds of $60,810,000 from the sale of the underlying Amdocs shares (Note M). At October 31, 2002, the Company no longer holds equity collars or has investments in shares of VeriSign or Amdocs.

Prior to the liquidation of the equity collars, a net loss before income taxes of $44,438,000 for the ineffective portion of changes in the fair value of the collars was recorded in earnings (Note M) during the nine months ended October 31, 2002 compared to a net gain before income taxes of $45,230,000 for the same period in the prior year. A gain before income taxes of $93,555,000 was recognized for the three months ended October 31, 2001 for the net changes in the fair value of the equity collars and the underlying equity securities. At January 31, 2002, the fair value of the equity collars of $36,800,000 and $186,654,000 was included in short-term and long-term investments in marketable securities, respectively.

Interest Rate Risk

As described in Note I, the Company issued $800,000,000 of fixed rate debt on June 28, 2002. In anticipation of this debt issuance, in June 2002, the Company entered into a series of treasury lock contracts to economically lock in the effective borrowing rate on portions of the anticipated debt issuance. Due to declines in interest rates from the dates of entering into the treasury lock contracts to the date of the debt issuance, the Company was required to pay $8,157,000 to settle the treasury lock contracts upon the debt issuance. Since the treasury lock contracts were designated as cash flow hedges that were fully effective, the net of tax loss of $4,852,000 was recorded as a component of accumulated other comprehensive income in stockholders’ equity and is being amortized to interest expense over the terms of the related debt.

The forward starting interest rate swap agreements, as described in the Company’s 2002 Annual Report on Form 10-K, are fully effective and net of tax losses of $2,555,000 and $5,361,000 for the three and nine months ended October 31, 2002, respectively, were recorded as a component of accumulated other comprehensive income in stockholders’ equity. The fair value of the interest rate swap agreements of $8,938,000 and $75,000 has been reflected in other long-term liabilities as of October 31, 2002 and other assets as of January 31, 2002, respectively.

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements — (continued)
(Unaudited)

Foreign Currency Risk and Other Derivatives

For the three and nine months ended October 31, 2002, the Company recognized losses before income taxes of $624,000 and $3,188,000, respectively, related to the change in fair value of warrants that are deemed derivative instruments and not designated as hedging instruments, compared to losses of $1,226,000 and $1,072,000 for the three and nine months ended October 31, 2001, respectively. Fair value of $388,000 and $3,466,000 as of October 31, 2002 and January 31, 2002, respectively, was reflected in other assets.

The foreign currency forward exchange contracts that are designated in cash flow hedging relationships, as described in the Company’s 2002 Annual Report on Form 10-K, were fully effective. Net of tax losses of $87,000 and $66,000 for the three and nine months ended October 31, 2002, respectively, were recorded as a component of accumulated other comprehensive income in stockholders’ equity, compared to net of tax gains of $275,000 and $803,000 for the three and nine months ended October 31, 2001, respectively. As of October 31, 2002, the fair value of the foreign currency forward exchange contracts of $366,000 and $558,000 was reflected in other current assets and other assets, respectively. The fair value of the foreign currency forward exchange contracts as of January 31, 2002, was reflected in other current assets and other assets in the amounts of $518,000 and $1,001,000, respectively.

Note G — Goodwill and Intangible Assets:

Effective February 1, 2002, the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” which changed the accounting for goodwill such that the amortization of goodwill ceased. Instead of amortization, the carrying value of goodwill is tested for impairment on an annual basis or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit, which includes the allocated goodwill, below its carrying value. Intangible assets with indefinite lives are no longer amortized in accordance with SFAS No. 142. The Company does not have any intangible assets with indefinite lives. Intangible assets with finite lives continue to be amortized over their useful lives and are evaluated for impairment whenever events or changes in circumstances indicate that their carrying value may not be recoverable under SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets.”

As previously disclosed in the Company’s 2002 Annual Report on Form 10-K, effective February 1, 2002, the Company completed its implementation of SFAS No. 142 and reclassified one intangible asset for assembled workforce of $1,513,000 to goodwill and determined that it would not have a transitional goodwill impairment charge. The goodwill impairment test consisted of assigning goodwill and intangible assets to individual reporting units, estimating the fair values of each of the reporting units by discounting estimated future cash flows and comparing those estimated fair values with the carrying values, which includes the allocated goodwill.

The changes in the carrying amount of goodwill by segment for the nine months ended October 31, 2002 are as follows:


				Non-Regulated		Non-Regulated
	Regulated			Telecommunications		Other		Total

				(in thousands)
January 31, 2002	$	78,555		$	52,502	$	18,456	$	149,513
Foreign currency translation					159		1,665		1,824
Reclassification of assembled workforce intangible asset		1,513							1,513
Acquisitions		1,780							1,780
Impairments		(9,007	)						(9,007	)

October 31, 2002	$	72,841		$	52,661	$	20,121	$	145,623

The Company acquired certain assets of two companies during the nine months ended October 31, 2002 for total cash consideration of $2,275,000, resulting in additional goodwill of $1,780,000. The Company acquired three intangible assets totaling $314,000 during the nine months ended October 31, 2002.

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements — (continued)
(Unaudited)

As a result of the loss of certain significant contracts and proposals related to two reporting units, the Company determined during the nine months ended October 31, 2002 that the goodwill assigned to those reporting units had become impaired. Accordingly, the Company recorded goodwill impairment charges totaling $9,007,000. The impairment charges represent the excess of the carrying amount of the reporting units’ goodwill over the implied fair value of their goodwill. The implied fair value of goodwill is derived from estimating the fair value of the reporting unit based on a discounted cash flow model using revenue and profit forecasts for the next five years.

Intangible assets consist of the following:


		October 31, 2002						January 31, 2002

		Gross						Gross
		carrying		Accumulated				carrying		Accumulated
		value		amortization		Net		value		amortization		Net

						(in thousands)
Amortized intangible assets:
	Software and technology	$	60,984	$	41,137	$	19,847	$	80,980	$	57,271	$	23,709
	Patents		12,163		4,018		8,145		12,163		3,413		8,750
	Customer contracts		4,628		4,424		204		4,484		3,500		984
	Other		444		246		198		6,845		6,733		112
	Assembled workforce								2,300		787		1,513

Total intangible assets		$	78,219	$	49,825	$	28,394	$	106,772	$	71,704	$	35,068

Software and technology with a gross carrying value of $20,000,000 and other intangible assets with a gross carrying value of $6,570,000 became fully amortized at January 31, 2002 and, therefore, are no longer reflected in the gross carrying value at October 31, 2002. Amortization expense related to amortizable intangible assets was $1,698,000 and $5,481,000 for the three and nine months ended October 31, 2002, respectively, compared to $2,190,000 and $8,138,000 for the three and nine months ended October 31, 2001, respectively. Based solely on the intangible assets as of October 31, 2002, the estimated annual amortization expense of intangible assets for the years ending January 31 is as follows. Actual amortization expense to be reported in future periods could differ from these estimates as a result of acquisitions, divestitures, and other relevant factors.


Year ending January 31

(in thousands)
2003	$	7,066
2004		4,908
2005		4,757
2006		4,754
2007		4,749
Thereafter		7,641

	$	33,875

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements — (continued)
(Unaudited)

The following unaudited pro forma information presents net income and earnings per share as if the Company adopted SFAS No. 142 effective February 1, 2001 and, accordingly, did not amortize goodwill and the assembled workforce intangible asset during the fiscal year ended January 31, 2002.


	Three months ended October 31, 2001						Nine months ended October 31, 2001

			Earnings per share						Earnings per share

	Net income		Basic		Diluted		Net income		Basic		Diluted

			(in thousands, except per share amounts)
Income before cumulative effect of accounting change, as reported	$	138,693	$	.66	$	.62	$	176,344	$	.81	$	.76
Amortization of goodwill, net of tax		3,845		.02		.02		12,811		.06		.06

Pro forma income before cumulative effect of accounting change		142,538		.68		.64		189,155		.87		.82
Cumulative effect of accounting change, net of tax								711

Pro forma net income	$	142,538	$	.68	$	.64	$	189,866	$	.87	$	.82

As previously disclosed in the Company’s 2002 Annual Report on Form 10-K, the cumulative effect of accounting change of $711,000 referred to in the table above relates to the Company’s adoption of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” in the prior fiscal year.

Note H — Revolving Credit Facilities:

On July 31, 2002, the Company entered into two new revolving credit facilities (“credit facilities”) totaling $750,000,000 with a group of financial institutions that provide for (i) a five-year revolving credit facility of up to $500,000,000 and (ii) a 364-day revolving credit facility of up to $250,000,000. These credit facilities replaced the Company’s previous revolving credit facility that terminated on July 30, 2002. Borrowings under the new facilities are unsecured and bear interest at a rate determined, at the Company’s option, based on either LIBOR plus a margin or a defined base rate. The Company pays a facility fee on the total commitment amount and a fee if utilization exceeds 50% of the total commitment amount. As of October 31, 2002, the Company was in compliance with all financial covenants under the new credit facilities, including, for example, maintaining a minimum interest coverage ratio. There were no balances outstanding under the previous credit facility when it terminated and there were no balances outstanding under the new facilities as of October 31, 2002. The entire $750,000,000 was available at October 31, 2002.

Note I — Notes Payable and Long-Term Debt:

On June 28, 2002, the Company completed a private offering of $550,000,000 of 10-year senior unsecured notes (“10-year notes”) and $250,000,000 of 30-year senior unsecured notes (“30-year notes”). The 10-year notes are due on October 1, 2012 and pay interest at 6.25% on a semi-annual basis beginning January 1, 2003. The 30-year notes are due on October 1, 2032 and pay interest at 7.125% on a semi-annual basis beginning January 1, 2003. The Company amortizes the note discounts, issuance costs and the loss on the treasury lock contracts (Note F) to interest expense which results in an effective interest rate of 6.5% for the 10-year notes and 7.43% for the 30-year notes. During the three months ended October 31, 2002, the Company completed an exchange of substantially all the private notes for new notes registered with the Securities and Exchange Commission. These new registered notes are identical in terms to the notes issued on June 28, 2002.

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements — (continued)
(Unaudited)

Note J — Comprehensive Income (Loss):

Comprehensive income (loss), which combines net income, unrealized gains and losses on the Company’s available-for-sale securities, derivative instruments and foreign currency translation adjustments, consists of the following:


		Three months ended October 31						Nine months ended October 31

		2002			2001			2002			2001

					(in thousands)
Net income		$	91,839		$	138,693		$	165,627		$	177,055
Other comprehensive loss, net of tax:
	Unrealized loss on marketable securities		(694	)		(260,340	)		(277,870	)		(405,755	)
	Reclassification of net realized (loss) gain on marketable securities		(9,452	)		80,965			206,844			198,516
	Unrealized (loss) gain on derivatives		(2,642	)		275			(10,279	)		803
	Reclassification of net realized gain (loss) on derivatives		31			(153	)		(33	)		(580	)
	Foreign currency translation adjustments		45			1,292			3,336			411
	SFAS No. 133 implementation											443

			(12,712	)		(177,961	)		(78,002	)		(206,162	)

Total comprehensive income (loss)		$	79,127		$	(39,268	)	$	87,625		$	(29,107	)

Note K — Earnings Per Share (EPS):

A summary of the elements included in the computation of basic and diluted EPS is as follows:


		Three months ended October 31				Nine months ended October 31

		2002		2001		2002		2001

		(in thousands, except per share amounts)
BASIC EPS:
Net income		$	91,839	$	138,693	$	165,627	$	177,055

Weighted average shares			192,616		210,735		198,916		217,711

Basic EPS		$	.48	$	.66	$	.83	$	.81

DILUTED EPS:
Net income		$	91,839	$	138,693	$	165,627	$	177,055

Weighted average shares			192,616		210,735		198,916		217,711
Effect of:
	Stock options		5,535		12,572		7,744		13,439
	Other stock awards		222		459		385		394

Weighted average shares, as adjusted			198,373		223,766		207,045		231,544

Diluted EPS		$	.46	$	.62	$	.80	$	.76

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements — (continued)
(Unaudited)

Options to purchase 22,061,000 shares of common stock at prices ranging from $28.90 to $33.06 per share were outstanding during the three months ended October 31, 2002 but were not included in the computation of diluted EPS at October 31, 2002 because the effect of such options would be antidilutive. Such options expire at various dates through October 2007.

Note L — Gain on Sale of Business Unites, Net:

During the three and nine months ended October 31, 2002, gains before income taxes of $1,516,000 and $4,899,000, respectively, were recognized due to the settlement of contingent liabilities related to business units that were sold in prior years. During the nine months ended October 31, 2001, the Company recognized net gains before income taxes of $6,922,000 from the sale of two business units, one of which was sold for a loss before income taxes of $3,030,000. The Company did not sell any business units during the three months ended October 31, 2001.

Note M — Net (Loss) Gain on Marketable Securities and Other Investments, including Impairment Losses:

Net (loss) gain on marketable securities and other investments, including impairment losses, consists of the following:


	Three months ended October 31						Nine months ended October 31

	2002			2001			2002			2001

				(in thousands)
Impairment losses	$	(24,502	)	$	(21,669	)	$	(105,392	)	$	(106,366	)
Net (loss) gain on derivative instruments		(624	)		92,329			(47,626	)		44,158
Net gain (loss) on sale of investments		16,650			(179	)		18,884			(37,758	)
Amdocs and Solect transaction											21,108

	$	(8,476	)	$	70,481		$	(134,134	)	$	(78,858	)

The Company recognized impairment losses before income taxes of $24,502,000 and $105,392,000 during the three and nine months ended October 31, 2002, respectively, on certain marketable and private equity securities due to declines in fair market value which were deemed to be other-than-temporary. Of the total impairment losses, $546,000 and $19,725,000 were impairments related to our publicly-traded equity securities for the three and nine months ended October 31, 2002, respectively, and $23,956,000 and $85,667,000 were impairments related to our private equity securities for the three and nine months ended October 31, 2002, respectively.

During the three and nine months ended October 31, 2002, the Company recognized an aggregate net loss before income taxes of $624,000 and $47,626,000, respectively, from changes in fair value of its derivative instruments as described in Note F compared to aggregate net gains before income taxes of $92,329,000 and $44,158,000 for the three and nine months ended October 31, 2001, respectively.

During the three months ended October 31, 2002, the Company recognized a net gain before income taxes of $16,650,000 from the sale of certain investments. The primary component of the net gain for the three months ended October 31, 2002 was related to the liquidation of all the Company’s remaining shares and related equity collars in VeriSign and Amdocs in August 2002 for gross proceeds of $570,594,000 and a net gain before income taxes of $15,229,000. During the nine months ended October 31, 2002, the Company also recognized a gain before income taxes of $8,756,000 from the sale of Amdocs shares that were hedged by an equity collar (Note F), a loss before income taxes of $9,618,000 on the sale of VeriSign shares that were not hedged by an equity collar, and a net gain before income taxes of $3,096,000 from other sale transactions of certain investments. During the three and nine months ended October 31, 2001, the Company recognized a net loss before income taxes of $179,000 and $37,758,000, respectively, on the sale of certain marketable securities and other investments. The largest component of the net loss for the nine months ended October 31, 2001 is attributable to the sale of VeriSign shares which resulted in a loss before income taxes of $48,012,000.

During the nine months ended October 31, 2001, the Company recognized a gain before income taxes of $21,108,000 related to its former investment in Solect Technology Group (“Solect”) which was acquired by Amdocs in the same period of the prior year. Under the terms of the initial exchange agreement with Amdocs, a certain number of Amdocs shares were put into an escrow account and were

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements — (continued)
(Unaudited)

to be released upon meeting certain contingent conditions. These conditions were met during the six months ended July 31, 2001 and the shares were released from escrow resulting in the additional gain.

Note N — Restructuring Costs:

In response to the continuing decline in the telecommunications market, the Company’s Telcordia subsidiary continued to have involuntary workforce reductions to realign its staffing levels to the reduction in market demand. During the three and nine months ended October 31, 2002, the Company recorded a total restructuring charge of $3,631,000 and $7,889,000, respectively. The restructuring charge consisted of workforce reduction costs for special termination pension benefits and extension of medical benefits. The special termination benefits of $3,354,000 and $7,188,000 for the three and nine months ended October 31, 2002, respectively, have been funded through Telcordia’s surplus pension assets and will be allocated to the participants’ pension accounts as appropriate. The special termination benefits will be paid from the pension trust as plan obligations and represent a non-cash charge to the Company. As of January 31, 2002, accrued other severance benefits and facilities costs were $7,465,000. During the nine months ended October 31, 2002, the Company incurred an additional $701,000 of other severance benefits and paid out benefits of $6,651,000 resulting in accrued severance benefits and facilities costs of $1,515,000 as of October 31, 2002. For the three and nine months ended October 31, 2001, Telcordia recorded a restructuring charge of $25,967,000 and $62,725,000, respectively.

Note O — Commitments and Contingencies:

The Company’s Telcordia subsidiary filed a Demand for Arbitration with the International Chamber of Commerce in Paris, France initiating arbitration and seeking damages of approximately $130,000,000 from Telkom South Africa related to a contract dispute. The dispute involves a contract executed on June 24, 1999, pursuant to which Telcordia would provide a Service Activation and Assurance System. The value of Telcordia’s portion of the contracted work was $208,000,000. Telcordia performed the contract for over 18 months and delivered multiple software releases to Telkom South Africa. On January 12, 2001, Telcordia notified Telkom South Africa that Telkom South Africa had breached the contract for, among other things, taking and using Telcordia software without paying for it, improperly refusing to accept software deliveries, failing to cooperate in defining future software releases, and failing to make other payments due under the contract. On February 2, 2001, Telkom South Africa responded by denying Telcordia’s claims and asserting various breaches on the part of Telcordia. The parties were unable to negotiate a mutually acceptable resolution of the dispute. On March 6, 2001, Telcordia initiated arbitration proceedings in accordance with the terms of the contract. On May 22, 2001, Telkom South Africa filed with the International Chamber of Commerce its Answer to Telcordia’s Demand for Arbitration and its Counterclaims against Telcordia.

Telkom South Africa contends in its Counterclaims that Telcordia breached the contract for, among other things, failing to provide deliverables compliant with the requirements of the contract at the times provided in the contract. Telkom South Africa also contends that Telcordia misrepresented its capabilities and the benefits that Telkom South Africa would receive under the contract. Telkom South Africa seeks substantial damages from Telcordia, including repayment of approximately $97,000,000 previously paid to Telcordia under the contract and the excess costs of reprocuring a replacement system, estimated by Telkom South Africa to be $234,000,000. Telkom South Africa’s Counterclaim contains additional claims which have not been quantified by Telkom South Africa. The parties have engaged in substantial discovery. On April 11, 2002, Telkom South Africa filed an amended Answer and Counterclaim. Telcordia disputes Telkom South Africa’s contentions and intends to vigorously defend against these claims while pursuing its own claims in the arbitration.

The arbitration hearing to determine the merit of both parties’ substantive claims commenced in May 2002 in Johannesburg, South Africa with witness testimony. Upon completion of witness testimony, Telcordia and Telkom South Africa submitted briefs as requested by the arbitrator. Oral closing arguments were presented in London, England on July 30 and 31, 2002. At the close of the hearing, the arbitrator indicated his intention to issue a decision within four weeks.

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION
Notes to Condensed Consolidated Financial Statements — (continued)
(Unaudited)

South Africa’s letter by reaffirming his intention to declare the proceedings closed and rule on the issues raised in this stage of the arbitration, but posing additional questions to Telkom South Africa regarding its request for a judicial referral. Telkom South Africa filed an application with the South African High Court on August 30, 2002 requesting that the High Court direct the arbitrator to refer all issues of contract interpretation to the High Court (the “Section 20 application”). In a Partial Award dated as of September 27, 2002, the arbitrator dismissed the counterclaims of Telkom South Africa and found that Telkom South Africa repudiated the contract by refusing to take delivery of the December 2000 software release, which complied in all material respects with the contractual specification. In the Partial Award, the arbitrator indicated that Telcordia’s financial claims for debt, damages, extras and costs would be addressed in additional proceedings and that the parties should file written submissions on these issues. In a separate letter dated as of September 27, 2002, the arbitrator expressed his opinion that, in accordance with existing South African law, the High Court should not consider Telkom South Africa’s Section 20 application. While Telkom South Africa has not withdrawn the Section 20 application, Telcordia believes it is now moot under South African law, given that the Arbitrator has issued an award.

On October 9, 2002, Telcordia filed a Petition to Confirm the Arbitral Award in the U.S. District Court for the District of Columbia. On November 5, 2002, Telkom South Africa filed a Notice of Motion with the South African High Court, requesting that the High Court set aside the Arbitrator’s Partial Award, dismiss the Arbitrator and the International Court of Arbitration, and submit the dispute to a new arbitration panel. The Notice of Motion and supporting affidavit allege that the Arbitrator committed gross irregularities and misconduct, exceeded his powers and manifested bias or partiality against Telkom South Africa. On November 21, 2002, the Arbitrator submitted a Memorandum to the South African High Court responding to the allegations against him, and re-affirming the basis of the Partial Award. Although Telcordia believes Telkom’s Notice of Motion is without merit and constitutes an abuse of process, no assurance can be given that the High Court will not consider Telkom South Africa’s application, or provide all or some portion of the relief requested.

Due to the complex nature of the legal and factual issues involved and the uncertainty of litigation in general, the outcome of the arbitration is not presently determinable. As of October 31, 2002, the total amount of receivables under the contract, net of deferred revenue, was not significant.

The Company is also involved in various investigations, claims and lawsuits arising in the normal conduct of its business, none of which, in the opinion of the Company’s management, will have a material adverse effect on its consolidated financial position, results of operations, cash flows or ability to conduct business.

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Critical Accounting Policies

Our discussion and analysis of financial condition and results of operations are based upon our consolidated condensed financial statements, which are prepared in accordance with generally accepted accounting principles (“GAAP”). The preparation of these financial statements in accordance 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 as well as the reported amounts of revenues and expenses during the reporting period. Management evaluates these estimates and assumptions on an on-going basis, including those relating to allowances for doubtful accounts, inventories, fair value and impairment of investments, fair value and impairment of intangible assets and goodwill, income taxes, warranty obligations, restructuring charges, estimated profitability of long-term contracts, pensions and other postretirement benefits, contingencies and litigation. Our estimates and assumptions have been prepared on the basis of the most current available information. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates under different assumptions and conditions.

We have several critical accounting policies, which were discussed in the 2002 Annual Report on Form 10-K, that are both important to the portrayal 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 complex and difficult have to do with making estimates about the effect of matters that are inherently uncertain. During the nine months ended October 31, 2002, we have not adopted any new accounting policies that are considered critical accounting policies nor have there been any significant changes related to our critical accounting policies that would have a material impact to our consolidated financial position, results of operations, cash flows or our ability to conduct business. There may be changes to assumptions used in one of our critical accounting policies as described below.

Pension and other postretirement benefit plans — Due to the continued poor performance of the equity markets, we have experienced declines in the fair value of our pension assets at Telcordia and at Calanais, our foreign subsidiary in Scotland. Further, in conjunction with management’s annual update of the assumptions used in the actuarial valuations that are performed on the Plans’ measurement dates, which are December 31 for Telcordia and January 31 for Calanais, it is expected that the discount rate used to value the future pension obligation and the expected return on plan assets may change. If the discount rate is lowered, assuming no other changes in assumptions or factors, the amount of the pension obligation will increase. If, on a plan-by-plan basis, the fair value of the pension assets is less than the accumulated pension benefit obligation at each Plan’s measurement date, we will be required to recognize an additional minimum pension liability and a noncash after tax reduction to stockholders’ equity. A decrease to the expected return on plan assets, along with other actuarial assumption changes and other factors, may result in recording higher pension expense in the next fiscal year beginning February 1, 2003.

Recently Issued Accounting Pronouncement

In June 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 146, “Accounting for Costs Associated With Exit or Disposal Activities,” which nullifies previous financial accounting guidance in Emerging Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring),” and is effective for exit or disposal activities initiated after December 31, 2002. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be measured initially at fair value and recognized when the liability is incurred rather than the date a company makes a commitment to an exit plan, which was the guidance under EITF No. 94-3. We do not expect adoption of SFAS No. 146 to have a material impact on our consolidated financial position or results of operations.

Results of Operations

Our revenues for the three and nine months ended October 31, 2002 increased 3% and 0.2%, respectively, over the same periods of the prior year. Although we experienced growth from our U.S. Government customers, revenues from our telecommunications commercial customers decreased as the telecommunications industry continued its decline, and revenues from our non-telecommunications commercial customers decreased due to challenging economic conditions facing our customers.

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION

Regulated segment revenues as a percentage of consolidated revenues were 72% and 70% for the three and nine months ended October 31, 2002, respectively, compared to 66% and 64% for the same periods of the prior year. On an absolute basis, Regulated segment revenues increased 12% and 10% for the three and nine months ended October 31, 2002, respectively, over the same periods of the prior year as a result of growth in our traditional business areas with departments and agencies of the U.S. Government. Since we derive a substantial portion of our revenues from the U.S. Government as either a prime contractor or subcontractor, our revenues could be adversely impacted by a reduction in the overall level of U.S. Government spending and by changes in its spending priorities from year to year. Obtaining U.S. Government contracts remains a highly competitive process. We have seen our growth in revenues with the U.S. Government continue to shift toward service type contracts which are competitively priced utilizing lower cost structures. This shift reflects the increasingly competitive business environment in our traditional business areas, as well as our increased success in the engineering and field services markets, which typically involve these lower cost service type contracts.

Non-Regulated Telecommunications segment revenues as a percentage of consolidated revenues were 18% for the three and nine months ended October 31, 2002 compared to 22% and 24% for the same periods of the prior year, respectively. On an absolute basis, such revenues decreased 16% and 24% for the three and nine months ended October 31, 2002, respectively, over the same periods of the prior year. The decrease in revenues as a percentage of consolidated revenues and on an absolute basis is attributable to the continuing downturn in the global telecommunications market that began last year and its effects on our subsidiary, Telcordia. Telcordia historically has derived a majority of its revenues from the Regional Bell Operating Companies (“RBOCs”). As a result of the changes and continuing decline in the marketplace, Telcordia’s customers, particularly the RBOCs, continue to reduce their contract spending and place pressure on Telcordia for reduced pricing and less favorable terms on existing and future contracts. Telcordia continues to seek opportunities for growth but on a more focused basis. However, loss of business from the RBOCs or other commercial customers as the global telecommunications market continues to decline could further reduce revenues and have an adverse impact on our business.

Non-Regulated Other segment revenues as a percentage of consolidated revenues were 11% for the three and nine months ended October 31, 2002 compared to 13% for the same periods of the prior year. On an absolute basis, such revenues decreased 14% and 9% for the three and nine months ended October 31, 2002, respectively, over the same periods of the prior year. We experienced high growth in our commercial IT outsourcing business throughout the prior fiscal year. This year, our commercial IT outsourcing customers, largely in the energy industry, are experiencing a challenging economic environment which is causing them to reduce contract spending. For the three and nine months ended October 31, 2002, revenues from our INTESA joint venture, of which we own 60%, decreased. INTESA represented 4% of consolidated revenues for the three and nine months ended October 31, 2002 and 3% and 2% of total reportable segment operating income for the three and nine months ended October 31, 2002, respectively. INTESA derives substantially all of its revenues from PDVSA, which is not only INTESA’s primary customer, but also our joint venture partner that owns 40% of INTESA. The basic term of the outsourcing contract INTESA had with PDVSA expired on June 30, 2002, and the parties are operating under a six-month agreement to allow for ongoing service delivery through December 31, 2002. No further discussions regarding an extension of the contract have occurred and no such extension may occur. In addition, we continue to have negotiations in regard to PDVSA’s request to purchase our ownership interest in INTESA. Therefore, our role in the future ownership and operation of INTESA is highly uncertain. The political and economic environment in Venezuela is very unstable and we are uncertain what impact, if any, this may have on INTESA’s business or the resolution of our joint venture ownership.

Revenues on our contracts in the three reportable segments are generated from the efforts of our technical staff as well as the pass through of costs for material and subcontract efforts, which primarily occur on large, multi-year system integration type contracts. At October 31, 2002, we had approximately 37,900 full-time employees compared to approximately 38,700 at October 31, 2001. Material and subcontract (“M&S”) revenues were $417 million and $1,106 million for the three and nine months ended October 31, 2002, respectively, compared to $358 million and $1,007 million for the same periods of the prior year. As a percentage of total revenues, M&S revenues were 26% and 24% for the three and nine months ended October 31, 2002, respectively, compared to 23% and 22% for the same periods of the prior year. The contract types we enter into with our customers can impact our revenues and segment operating income. The percentage of our revenues attributable to the higher risk, firm fixed-price (“FFP”) contracts decreased to 26% for the nine months ended October 31, 2002 from 29% for the same period of the prior year. We assume greater performance risk on FFP contracts and our failure to accurately estimate the ultimate costs or to control costs during performance of the work may result in reduced profits or losses. Fixed-price level-of-effort and time-and-materials type contracts represented 32% of revenues for the nine months ended October 31, 2002 and 2001, while cost reimbursement contracts were 37% and 33% for the same periods, respectively. Target cost and fee with risk sharing contracts were 5% and 6% for the nine months ended October 31, 2002 and 2001, respectively.

Cost of revenues as a percentage of revenues increased slightly to 80.7% and 81.2% for the three and nine months ended October 31,

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION

2002, respectively, compared to 80.1% and 80.0% for the same periods of the prior year. The increase is primarily attributable to changes in relative revenues among our three business segments. Our revenues from our commercial customers have more of their associated costs in selling, general and administrative (“SG&A”) as opposed to cost of revenues. Therefore, the lower revenues in our Non-Regulated Telecommunications segment for the three and nine months ended October 31, 2002 caused the overall cost of revenues to increase as a percentage of revenues. Regulated segment cost of revenues as a percentage of its revenues were 87.0% and 86.9% for the three and nine months ended October 31, 2002, respectively, compared to 86.7% and 87.6% for the same periods of the prior year. The increase for the three months ended October 31, 2002 is primarily attributable to certain FFP contract losses. Non-Regulated Telecommunications cost of revenues as a percentage of its revenues were 55.2% and 57.4% for the three and nine months ended October 31, 2002, respectively, compared to 58.8% and 59.3% for the same periods of the prior year and decreased primarily as a result of the restructuring and cost control efforts that began at Telcordia in the prior year. Non-Regulated Other segment cost of revenues as a percentage of its revenues were 76.9% and 78.1% for the three and nine months ended October 31, 2002, respectively, compared to 78.8% and 79.2% for the same periods of the prior year and decreased primarily due to improved operating performance.

SG&A is comprised of general and administrative, bid and proposal and independent research and development expenses. SG&A expenses as a percentage of revenues were 9.3% and 10.0% for the three and nine months ended October 31, 2002, respectively, compared to 11.4% and 13.0% for the same periods of the prior year. SG&A as a percentage of revenues in the Regulated segment was 5.0% and 5.3% for the three and nine months ended October 31, 2002, respectively, compared to 5.3% and 5.7% for the same periods of the prior year and decreased due to continued economies of scale and close monitoring of our SG&A costs. SG&A as a percentage of revenues in the Non-Regulated Telecommunications segment was 25.0% and 25.4% for the three and nine months ended October 31, 2002, respectively, compared to 27.2% and 31.3% for the same periods of the prior year. The decrease is a result of the restructuring and cost control efforts that began at Telcordia in the prior year in response to the downturn in the telecommunications industry. SG&A as a percentage of revenues in the Non-Regulated Other segment was 13.2% and 13.7% for the three and nine months ended October 31, 2002, respectively, compared to 14.5% and 13.5% for the same periods of the prior year and decreased during the three months ended October 31, 2002 primarily due to reduced marketing costs.

Consolidated segment operating income, as defined in our 2002 Annual Report on Form 10-K, as a percentage of consolidated revenues was 9.7% and 8.7% for the three and nine months ended October 31, 2002, respectively, compared to 8.5% and 6.9% for the same periods of the prior year. Regulated segment operating income as a percentage of its revenues was 8.1% and 7.8% for the three and nine months ended October 31, 2002, respectively, compared to 8.2% and 6.7% for the same periods of the prior year and decreased for the three months ended October 31, 2002 due to FFP contract losses and increased for the nine months ended October 31, 2002 primarily due to improved operating performance and overall lower FFP contract losses in the first half of this year than the same period of the prior year.

Our Non-Regulated Telecommunications segment operating income as a percentage of its revenues increased to 21.4% and 19.2% for the three and nine months ended October 31, 2002, respectively, from 14.1% and 10.2% for the same periods of the prior year, primarily due to an overall decrease in cost of revenues and SG&A expenses as a result of the restructuring and cost control efforts that began in the prior year. While segment operating income increased, in response to the continuing decline in the telecommunications market, Telcordia continued to have involuntary workforce reductions to realign its staffing levels to the reduction in market demand. During the three and nine months ended October 31, 2002, the Company recorded a total restructuring charge of $4 million and $8 million, respectively. The restructuring charge consisted of workforce reduction costs for special termination pension benefits and extension of medical benefits. The special termination benefits of $3 million and $7 million for the three and nine months ended October 31, 2002, respectively, have been funded through Telcordia’s surplus pension assets and will be allocated to the participants’ pension accounts as appropriate. The special termination benefits will be paid from the pension trust as plan obligations and represent a non-cash charge to us. As of January 31, 2002, accrued other severance benefits and facilities costs were $7 million. During the nine months ended October 31, 2002, the Company incurred an additional $1 million of other severance benefits and paid out benefits of $7 million resulting in accrued severance benefits and facilities costs of $1 million as of October 31, 2002. Telcordia recorded a restructuring charge $26 million and $63 million for the three and nine months ended October 31, 2001, respectively.

Our Non-Regulated Other segment operating income as a percentage of its revenues was 7.4% and 6.8% for the three and nine months ended October 31, 2002, respectively, compared to 6.3% and 6.9% for the same periods of the prior year and increased for the three months ended October 31, 2002 primarily due to lower SG&A costs and improved operating performance. For the nine months ended

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October 31, 2002, Non-Regulated Other segment operating performance decreased primarily as a result of higher SG&A costs as a percentage of revenues during the first half of the year as these costs were not decreasing in relation to the revenue decline from our commercial IT outsourcing contracts.

Interest income was $12 million and $29 million for the three and nine months ended October 31, 2002, respectively, compared to $11 million and $43 million for the same periods of the prior year. The increase for the three months ended October 31, 2002 was primarily due to increase in average cash balance from the proceeds of the June 2002 debt issuance as well as the liquidation of all of our remaining shares in VeriSign and Amdocs and related equity collars. The decrease for the nine months ended October 31, 2002 was primarily due to lower interest rates.

Interest expense of $18 million and $32 million for the three and nine months ended October 31, 2002, respectively, increased from $4 million and $14 million for the same periods of the prior year, primarily due to interest on $800 million of unsecured notes issued in June 2002 as further described in Note I of the condensed consolidated financial statements. In addition, interest expense also reflects interest on our outstanding public debt securities that were issued in January 1998, a building mortgage, deferred compensation arrangements, capital lease obligations and notes payable.

Minority interest in income of consolidated subsidiaries was $5 million and $14 million for the three and nine months ended October 31, 2002, respectively, compared to $4 million and $11 million for the same periods of the prior year and increased primarily from our joint ventures, AMSEC LLC and INTESA.

The provision for income taxes as a percentage of income before income taxes was 35.0% and 34.5% for the three and nine months ended October 31, 2002, respectively, compared to 32.7% for the same periods of the prior year. The higher effective tax rate was primarily related to a lower amount of charitable contributions of appreciated property and slightly higher state and foreign taxes.

Goodwill Impairment

SFAS No. 142, “Goodwill and Other Intangible Assets,” changed the accounting for goodwill. Under SFAS No. 142, the amortization of goodwill ceases and instead goodwill is evaluated for impairment on an annual basis or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit, which includes the goodwill, below its carrying value. During the three months ended October 31, 2002, we did not have any impairment of goodwill. However, one of our equity method investees had an impairment of its goodwill, of which we recognized our proportionate share of the impairment of $3 million in other income (expense), net. During the nine months ended October 31, 2002, as a result of the loss of certain significant contracts and proposals related to two reporting units, we determined that goodwill assigned to those reporting units had become impaired. Accordingly, we recorded goodwill impairment charges of $9 million. The impairment charges represent the excess of the reporting units’ goodwill over the implied fair value of their goodwill. The implied fair value of goodwill is derived from estimating the fair value of the reporting unit based on a discounted cash flow model using revenue and profit forecasts for the next five years.

Gain on Sale of Business Units, Net

Gains or losses related to sales of a business unit or operating asset that generated revenue or whose operating results were included in our condensed consolidated financial statements are recorded as “Gain on sale of business units, net” and are part of operating income. During the three and nine months ended October 31, 2002, we recognized gains before income taxes of $2 million and $5 million due to the settlement of contingent liabilities related to business units that were sold in prior years. For the nine months ended October 31, 2001, we recognized net gains before income taxes from the sale of two business units.

Net (Loss) Gain on Marketable Securities and Other Investments, including Impairment Losses

Gains or losses related to transactions from our investments that are accounted for as marketable equity or debt securities, as cost method investments or as equity method investments are recorded as “Net (loss) gain on marketable securities and other investments, including impairment losses” and are part of non-operating income or expense. Impairment losses on marketable securities and other investments from declines in fair market values that are deemed to be other-than-temporary are also recorded in this financial statement line item.

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION

In accordance with our policy to assess whether an impairment loss on our marketable and private equity securities has occurred due to declines in fair market value, we determined that declines in the fair market value below the carrying value of certain of our marketable and private equity securities had occurred and were deemed to be other-than-temporary in nature. We, therefore, recorded impairment losses totaling $25 million and $105 million for the three and nine months ended October 31, 2002, respectively. Of the total impairment losses, $546 thousand and $20 million were impairments related to our publicly-traded equity securities for the three and nine months ended October 31, 2002, respectively, and $24 million and $85 million were impairments related to our private equity securities for the three and nine months ended October 31, 2002, respectively. Taking into account these impairments as of October 31, 2002 and the liquidation of all of our remaining shares and related equity collars in VeriSign and Amdocs, as described below, we hold $17 million of publicly-traded debt and equity securities and $109 million of private equity securities. In the prior year, we recorded impairment losses of $22 million and $106 million for the three and nine months ended October 31, 2001, respectively.

Our portfolio of publicly-traded equity securities is subject to market risk and there may be instances where we will use derivative instruments to manage the risk of potential loss in fair value resulting from decreases in market prices. We had equity collars in place to mitigate the risk of significant price fluctuations of certain of our marketable equity securities. We also have warrants to purchase equity securities of certain private and publicly-held companies that can be net settled. These warrants are considered derivative instruments and not designated as hedging instruments. For the three and nine months ended October 31, 2002, we recognized net losses before income taxes of $624 thousand and $48 million, respectively, related to the equity collars and the related underlying equity securities and the warrants that can be net settled, compared to a net gain before income taxes of $92 million and $44 million for the same periods of the prior year. During the three months ended October 31, 2002, all of our remaining VeriSign and Amdocs shares and the equity collars that hedged those shares were liquidated for gross proceeds of $571 million, and a net gain before income taxes of $15 million was recognized. We no longer hold equity collars or investments in VeriSign and Amdocs as a result of these transactions.

During the three months ended October 31, 2002, we recognized a net gain before income taxes of $17 million from the sale of certain investments with the primary component being the gain before income taxes of $15 million on the liquidation of all our remaining VeriSign and Amdocs shares and related equity collars. During the nine months ended October 31, 2002, we also recognized an additional gain before income taxes of $9 million from the sale of Amdocs shares that were hedged by an equity collar (Note M), a loss before income taxes of $10 million on the sale of VeriSign shares that were not hedged by an equity collar, and a net gain before income taxes of $3 million from sales of other certain investments. During the three and nine months ended October 31, 2001, we recognized a net loss before income taxes of $179 thousand and $38 million, respectively, on the sale of certain marketable securities and other investments, primarily from the sale of VeriSign shares.

During the nine months ended October 31, 2001, we recognized a gain before income taxes of $21 million related to our former investment in Solect which was acquired by Amdocs in the same period of the prior year. Under the terms of the initial exchange agreement, a certain number of Amdocs shares were put into an escrow account and were to be released upon meeting certain contingent conditions. These conditions were met during the six months ended July 31, 2001 and the shares were released from escrow resulting in the additional gain.

Liquidity and Capital Resources

Cash and cash equivalents and short-term investments in marketable securities totaled $2.2 billion and $1.2 billion at October 31, 2002 and January 31, 2002, respectively, and increased primarily from the liquidation of all of our remaining shares and related equity collars in VeriSign and Amdocs as previously described and our debt issuance described below.

On June 28, 2002, we raised $790 million, which is net of underwriters’ commissions and reflects an interest discount on the notes, by completing a private offering of $550 million of 10-year senior unsecured notes (“10-year notes”) and $250 million of 30-year senior unsecured notes (“30-year notes”). The 10-year notes are due on July 1, 2012 and pay interest at 6.25% on a semi-annual basis beginning January 1, 2003. The 30-year notes are due on July 1, 2032 and pay interest at 7.125% on a semi-annual basis beginning January 1, 2003. We expect to use the proceeds for general corporate purposes, including, without limitation, future acquisitions, expansion of our outsourcing business, stock repurchases and capital expenditures. Per the terms of the private offering, on August 30, 2002, the Company filed a registration statement with the Securities and Exchange Commission (“SEC”) relating to an offer to exchange any and all of the notes for new notes that are substantially identical to the notes issued on June 28, 2002, except that the new notes have been registered pursuant to an effective registration statement under the Securities Act. The exchange of the notes has been completed and substantially all of the private notes were exchanged.

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION

On July 31, 2002, we entered into two new revolving credit facilities (“credit facilities”) totaling $750 million with a group of financial institutions that provide for (i) a five-year revolving credit facility of up to $500 million and (ii) a 364-day revolving credit facility of up to $250 million. These credit facilities replaced our previous revolving credit facility that terminated on July 30, 2002. Borrowings under the new credit facilities are unsecured and bear interest at a rate determined, at our option, based on either LIBOR plus a margin or a defined base rate. We pay a facility fee on the total commitment amount and a fee if utilization exceeds 50% of the total commitment amount. As of October 31, 2002, we were in compliance with all financial covenants under the new credit facilities.

At October 31, 2002, there were no borrowings outstanding under the new facilities and no borrowings were outstanding under the previous credit facility at January 31, 2002. Our primary sources of liquidity are funds provided by operations, funds from the sale of our remaining shares in VeriSign and Amdocs, and the funds raised by the debt offering and our new credit facilities, of which the entire $750 million was available for borrowing.

Cash flows generated from operating activities were $417 million for the nine months ended October 31, 2002 compared to $212 million for the same period of the prior year. Net cash provided by operating activities for the nine months ended October 31, 2002 consisted primarily of net income of $166 million increased for non-cash items of $379 million, offset by $128 million used in working capital and other activities compared to net income of $177 million increased for non-cash items of $329 million, offset by $294 million used in working capital and other activities for the same period of the prior year. The increase in cash generated from operating activities in the nine months ended October 31, 2002 was primarily attributable to lower estimated tax payments and lower use of cash for working capital and other activities compared to the same period of the prior year.

Our investing activities generated cash of $221 million for the nine months ended October 31, 2002 compared to $286 million for the same period of the prior year. During the nine months ended October 31, 2002, we decreased our capital expenditures and the level of investments in private companies and generated less cash from our transactions in short-term marketable securities compared to the same period of the prior year.

We generated $24 million in cash from financing activities for the nine months ended October 31, 2002 compared to a use of $810 million for the same period of the prior year. The primary source of the cash generated during the nine months ended October 31, 2002, was the net proceeds of $790 million from the private debt offering, and the primary use of cash was for repurchases of our common stock. In the nine months ended October 31, 2002, we repurchased $106 million and $81 million of common stock from employees upon their termination and other stock transactions, respectively, compared to $162 million and $77 million in the same period of the prior year. We also repurchased $159 million of our common stock from our 401(k) and retirement and profit sharing plans (collectively referred to as “the Plans”) in the nine months ended October 31, 2002 compared to $263 million in the same period of the prior year. Although we have no obligation to make stock purchases during a quarterly stock trade, we purchased stock in recent quarterly stock trades in which more shares were offered for sale by stockholders than the aggregate number of shares sought to be purchased by authorized buyers. We repurchased $409 million of common stock during our quarterly trades in the nine months ended October 31, 2002 compared to $322 million for the same period of the prior year. In summary, for the nine months ended October 31, 2002, total repurchases of our common stock were $755 million compared to $824 million for the same period of the prior year.

As previously discussed in the 2002 Annual Report on Form 10-K, there is no public market for our Class A common stock and a limited market is maintained by our wholly-owned broker-dealer subsidiary, Bull, Inc., which permits existing stockholders to offer for sale shares of Class A common stock only on predetermined days which we call a “trade date”. Generally, there are four trade dates each year, however, a scheduled trade date could be postponed or cancelled. In fact, the trade originally scheduled for July 26, 2002 was postponed to August 16, 2002 in order to modify the stock price set by the board of directors on July 12, 2002 as it no longer represented a fair market value. All sales in the limited market are made at the prevailing price of the Class A common stock determined by the board of directors or its stock policy committee pursuant to the valuation process described on page 17 of our 2002 Annual Report on Form 10-K. If the number of shares offered for sale by stockholders exceeds the number of shares sought to be purchased by authorized buyers in any trade, our stockholders who requested to sell stock may not be able to sell all such stock in that trade. Although we are currently authorized, we are not obligated to purchase shares of stock in the limited market on any trade date. If the increasing trend of trade imbalance continues, we cannot assure you that we will continue to purchase such excess shares in the future. Accordingly, if we elect not to participate in a trade or otherwise limit our participation in a trade, our stockholders may be unable to sell all the shares they desire to sell.

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION

As previously discussed in the 2002 Annual Report on Form 10-K, Federal legislation has been proposed that, if adopted, would impose new requirements and restrictions on certain types of retirement plans which could impact our stock system and liquidity. If legislation of this nature were adopted, it would be likely that purchases of our stock by our retirement plans would decrease and sales increase, which would likely result in increased repurchases of our common stock. As of October 31, 2002, because of the uncertainty surrounding if, when, and in what final form such legislation may be enacted, we are unable to determine the impact this legislation might have on our retirement plans, the operation of our limited market and our liquidity and cash needs.

We expect our existing cash, cash equivalents, short-term investments in marketable securities, cash flows from operations and borrowing capacity to provide sufficient funds for our operations and capital expenditures. In addition, we expect to finance acquisitions and equity investments in the future with cash from operations and our borrowing capacity.

Commitments and Contingencies

Our Telcordia subsidiary filed a Demand for Arbitration with the International Chamber of Commerce in Paris, France initiating arbitration and seeking damages of approximately $130 million from Telkom South Africa related to a contract dispute. The dispute involves a contract executed on June 24, 1999, pursuant to which Telcordia would provide a Service Activation and Assurance System. The value of Telcordia’s portion of the contracted work was $208 million. Telcordia performed the contract for over 18 months and delivered multiple software releases to Telkom South Africa. On January 12, 2001, Telcordia notified Telkom South Africa that Telkom South Africa had breached the contract for, among other things, taking and using Telcordia software without paying for it, improperly refusing to accept software deliveries, failing to cooperate in defining future software releases, and failing to make other payments due under the contract. On February 2, 2001, Telkom South Africa responded by denying Telcordia’s claims and asserting various breaches on the part of Telcordia. The parties were unable to negotiate a mutually acceptable resolution of the dispute. On March 6, 2001, Telcordia initiated arbitration proceedings in accordance with the terms of the contract. On May 22, 2001, Telkom South Africa filed with the International Chamber of Commerce its Answer to Telcordia’s Demand for Arbitration and its Counterclaims against Telcordia.

Telkom South Africa contends in its Counterclaims that Telcordia breached the contract for, among other things, failing to provide deliverables compliant with the requirements of the contract at the times provided in the contract. Telkom South Africa also contends that Telcordia misrepresented its capabilities and the benefits that Telkom South Africa would receive under the contract. Telkom South Africa seeks substantial damages from Telcordia, including repayment of approximately $97 million previously paid to Telcordia under the contract and the excess costs of reprocuring a replacement system, estimated by Telkom South Africa to be $234 million. Telkom South Africa’s Counterclaim contains additional claims which have not been quantified by Telkom South Africa. The parties have engaged in substantial discovery. On April 11, 2002, Telkom South Africa filed an amended Answer and Counterclaim. Telcordia disputes Telkom South Africa’s contentions and intends to vigorously defend against these claims while pursuing its own claims in the arbitration.

Telkom South Africa submitted a letter dated August 16, 2002 to the arbitrator indicating that it believed the issue of the interpretation of the contract under the laws of South Africa should be made by the South African High Court rather than an arbitrator. The letter also indicated that if the arbitrator did not refer that issue to the High Court for decision, Telkom South Africa would file an application with the South African High Court requesting that it decide the issue. In a letter dated August 27, 2002, the arbitrator responded to Telkom South Africa’s letter by reaffirming his intention to declare the proceedings closed and rule on the issues raised in this stage of the arbitration, but posing additional questions to Telkom South Africa regarding its request for a judicial referral. Telkom South Africa filed an application with the South African High Court on August 30, 2002 requesting that the High Court direct the arbitrator to refer all issues of contract interpretation to the High Court (the “Section 20 application”). In a Partial Award dated as of September 27, 2002, the arbitrator dismissed the counterclaims of Telkom South Africa and found that Telkom South Africa repudiated the contract by refusing to take delivery of the December 2000 software release, which complied in all material respects with the contractual specification. In the Partial Award, the arbitrator indicated that Telcordia’s financial claims for debt, damages, extras and costs would be addressed in additional proceedings and that the parties should file written submissions on these issues. In a separate letter dated as of September 27, 2002, the arbitrator expressed his opinion that, in accordance with existing South African law, the High Court should

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION

not consider Telkom South Africa’s Section 20 application. While Telkom South Africa has not withdrawn the Section 20 application, Telcordia believes it is now moot under South African law, given that the Arbitrator has issued an award.

We are also involved in various investigations, claims and lawsuits arising in the normal conduct of our business, none of which, in our opinion, will have a material adverse effect on our consolidated financial position, results of operations, cash flows or our ability to conduct business.

Forward-looking Information

The foregoing discussion in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the following discussion in “Quantitative and Qualitative Disclosures About Market Risk” should be read in conjunction with the consolidated condensed financial statements and contains forward-looking statements, including statements regarding our intent, belief or current expectations with respect to, among other things, trends affecting our financial condition or results of operations and the impact of competition. 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. Some of these factors include, but are not limited to the following factors: (i) competitive pressures; (ii) changes in the demand for our commercial information technology outsourcing, consulting and systems integration services; (iii) our ability to consummate strategic acquisitions and alliances; (iv) our ability to profitably bid and perform FFP contracts; (v) the level of common stock repurchases made by us, and (vi) the risk factors set forth in our 2002 Annual Report on Form 10-K. Due to such uncertainties and risks, you are warned not to place undue reliance on such forward-looking statements, which speak only as of the date hereof. We are not undertaking any obligation to update these factors or to publicly announce the results of any changes to our forward-looking statements due to future events or developments.

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to certain market risks which are inherent in our financial instruments arising from transactions entered into in the normal course of business. Our current market risk exposures are primarily in the interest rate, foreign currency and equity price areas. The following information about our market sensitive financial instruments contains forward-looking statements. For further information, refer to Item 7A and the consolidated financial statements and footnotes included in the Company’s 2002 Annual Report on Form 10-K and Note F in the Notes to Condensed Consolidated Financial Statements in Item 1 of this Form 10-Q for a discussion of our derivative instruments and hedging activities.

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our cash equivalents, investment portfolio, short-term and long-term receivables, interest rate swaps and long-term debt obligations. As noted in Note I of the notes to condensed consolidated financial statements, in June 2002, we issued $550 million of 6.25% 10-year fixed rate debt and $250 million of 7.125% 30-year fixed rate debt. As described in Note F of the notes to condensed consolidated financial statements, in anticipation of this debt issuance, we also entered into a series of treasury lock contracts to economically lock in the effective borrowing rate on portions of the anticipated debt issuance. Due to declines in interest rates from the dates of entering into the treasury lock contracts to the date of the debt issuance, we were required to pay $8 million to settle the treasury lock contracts upon the debt issuance. Proceeds from the debt issuance and the VeriSign and Amdocs transactions, described below in the discussion of equity price risks, contributed to higher amounts of cash equivalents and managed portfolio investments that are subject to interest rate risk at October 31, 2002. Interest rates at October 31, 2002 decreased from January 31, 2002. If rates stay at current levels, proceeds from maturities of fixed income securities may be reinvested at lower interest rates.

Foreign Currency Risk

Although the majority of our transactions are denominated in U.S. dollars, some transactions are based in various foreign currencies. Our objective in managing our exposure to foreign currency rate fluctuations is to mitigate adverse fluctuations in earnings and cash flows associated with foreign currency exchange rate fluctuations. Our policy allows us to actively manage cash flows, anticipated transactions and firm commitments through the use of natural hedges and forward foreign exchange contracts.

We assess the risk of loss in fair values from the impact of hypothetical changes in foreign currency exchange rates on market sensitive instruments by performing sensitivity analysis. The market values for forward foreign exchange contracts were estimated using spot rates in effect on October 31, 2002. The differences that result from comparing hypothetical foreign exchange rates and actual spot rates as of October 31, 2002 are the hypothetical gains and losses associated with foreign currency risk.

A 10% adverse movement in levels of foreign currency exchange rates related to the U.S. dollar as of October 31, 2002, with all other variables held constant, would result in a decrease in the fair values of the forward foreign exchange contracts of approximately $1 million.

Equity Price Risk

We are exposed to equity price risks on our strategic investments in publicly-traded equity securities, which are primarily in the high-technology market. We used equity collars to mitigate the risk of significant price fluctuations of our investments in VeriSign and Amdocs. Equity collars are derivative instrument transactions where we lock in a ceiling and floor price for the underlying equity security to minimize our risk of loss since we locked in a floor price. These derivative instruments were designated as fair value hedges of the underlying publicly-traded equity securities and, therefore, the changes in the fair value of the derivative and the hedged item attributable to the hedged risk were recognized in earnings. During the three months ended October 31, 2002, our remaining shares in VeriSign and Amdocs and the equity collars that hedged those shares were liquidated for proceeds of $571 million and, a net gain before income taxes of $15 million was recognized. As a result of these transactions, we no longer have market exposure related to VeriSign or Amdocs.

At October 31, 2002, the quoted fair value of our publicly-traded equity securities was approximately $13 million, a decrease of $674 million from January 31, 2002. The decrease was primarily driven by the sale of all our remaining shares in VeriSign and Amdocs

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during the three months ended October 31, 2002. Based on our position at October 31, 2002, a 10% decrease in market prices, with all other variables held constant, would result in a decrease in fair value of our publicly-traded equity securities of approximately $1 million.

Item 4. Controls and Procedures

(a) Evaluation of disclosure controls and procedures. Within the 90 days prior to the date of filing this Quarterly Report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of management, including J. Robert Beyster (Chief Executive Officer) and Thomas E. Darcy (Chief Financial Officer), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, J. Robert Beyster and Thomas E. Darcy concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in our periodic SEC filings.

(b) Changes in internal controls. There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls. There were no significant deficiencies or material weaknesses and, therefore, no corrective actions were required.

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION

PART II
OTHER INFORMATION

Item 1. Legal Proceedings

Telkom South Africa contends in its Counterclaims that Telcordia breached the contract for, among other things, failing to provide deliverables compliant with the requirements of the contract at the times provided in the contract. Telkom South Africa also contends that Telcordia misrepresented its capabilities and the benefits that Telkom South Africa would receive under the contract. Telkom South Africa seeks substantial damages from Telcordia, including repayment of approximately $97 million previously paid to Telcordia under the contract and the excess costs of reprocuring a replacement system, estimated by Telkom South Africa to be $234 million. Telkom South Africa’s Counterclaim contains additional claims which have not been quantified by Telkom South Africa. The parties have engaged in substantial discovery. On April 11, 2002, Telkom South Africa filed an amended Answer and Counterclaim. Telcordia disputes Telkom South Africa’s contentions and intends to vigorously defend against these claims while pursuing its own claims in the arbitration.

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submitted a Memorandum to the South African High Court responding to the allegations against him, and re-affirming the basis of the Partial Award. Although Telcordia believes Telkom’s Notice of Motion is without merit and constitutes an abuse of process, no assurance can be given that the High Court will not consider Telkom South Africa’s application, or provide all or some portion of the relief requested.

Item 2. Changes in Securities

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

99.1 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer)

99.2 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial Officer)

(b) Reports on Form 8-K

During the fiscal quarter for which this report is filed, we filed the following reports on Form 8-K:

(i) Form 8-K filed October 16, 2002, Item 5, Other Events.

(ii) Form 8-K filed October 2, 2002, Item 5, Other Events and Regulation FD Disclosure.

(iii) Form 8-K filed September 16, 2002, Item 7, Financial Statements and Exhibits and Item 9, Regulation FD Disclosure.

(iv) Form 8-K filed August 19, 2002, Item 5, Other Events and Regulation FD Disclosure.

(v) Form 8-K filed August 15, 2002, Item 5, Other Events and Regulation FD Disclosure and Item 7, Financial Statements and Exhibits.

(vi) Form 8-K filed August 7, 2002, Item 5, Other Events and Regulation FD Disclosure and Item 7, Financial Statements and Exhibits.

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		SCIENCE APPLICATIONS INTERNATIONAL CORPORATION

Date: December 13, 2002		/s/ Thomas E. Darcy Executive Vice President and Chief Financial Officer and as a duly authorized officer

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION

CERTIFICATION

I, J. Robert Beyster, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Science Applications International Corporation;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.


Date: December 13, 2002		/s/ J. Robert Beyster Chief Executive Officer

SCIENCE APPLICATIONS INTERNATIONAL CORPORATION

CERTIFICATION

I, Thomas E. Darcy, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Science Applications International Corporation;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and


Date: December 13, 2002		/s/ Thomas E. Darcy Chief Financial Officer

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(a)		Evaluation of disclosure controls and procedures. Within the 90 days prior to the date of filing this Quarterly Report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of management, including J. Robert Beyster (Chief Executive Officer) and Thomas E. Darcy (Chief Financial Officer), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, J. Robert Beyster and Thomas E. Darcy concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in our periodic SEC filings.

(b)		Changes in internal controls. There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls. There were no significant deficiencies or material weaknesses and, therefore, no corrective actions were required.

	99.1		Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer)

	99.2		Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial Officer)

(b)		Reports on Form 8-K

		During the fiscal quarter for which this report is filed, we filed the following reports on Form 8-K:

	(i)		Form 8-K filed October 16, 2002, Item 5, Other Events.

	(ii)		Form 8-K filed October 2, 2002, Item 5, Other Events and Regulation FD Disclosure.

	(iii)		Form 8-K filed September 16, 2002, Item 7, Financial Statements and Exhibits and Item 9, Regulation FD Disclosure.

	(iv)		Form 8-K filed August 19, 2002, Item 5, Other Events and Regulation FD Disclosure.

	(v)		Form 8-K filed August 15, 2002, Item 5, Other Events and Regulation FD Disclosure and Item 7, Financial Statements and Exhibits.

	(vi)		Form 8-K filed August 7, 2002, Item 5, Other Events and Regulation FD Disclosure and Item 7, Financial Statements and Exhibits.