**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**(Mark One)**

| **o**      | ** ** | **ANNUAL REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                       |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | **For the fiscal year ended  December 31, 2005**                                                                                                                                                                                      |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                    |
| ** ** | ** ** | **For the transition period from                  to                    ** |

 

**Commission File Number**

**000-50080**

**SIInternational, Inc.**

(Exact Name of Registrantas Specified in Its Charter)

| **Delaware**                                  |   | **52-2127278**       |
|-----------------------------------------------|--------|----------------------|
| (State of Other  Jurisdiction of              |   | (I.R.S. Employer     |
| Incorporation or  Organization)               |   | Identification  No.) |
| **12012 Sunset Hills Road, Reston, Virginia** |   | **20190-5869**       |
| (Address of  Principal Executive Offices)     |   | (Zip Code)           |

 

Registrant’s TelephoneNumber, Including Area Code: **(703) 234-7000**

Securities to be registeredpursuant to Section 12(b) of the Act:

|      | **Title  of Each Class** | ** ** |   |  | **Name  of Each Exchange on Which Registered** | ** ** |
|------|--------------------------|------------|--------|--|------------------------------------------------|------------|
| None |                     | None       |

 

Securities to be registered pursuant to Section 12(g) ofthe Act:

**Common Stock, $0.01 parvalue per share**

(Title of Class)

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes o No x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act.  Yes o No x

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15 (d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and large acceleratedfiler” in Rule 12b-2 of the Exchange Act. (Check one):

| Large accelerated filer  o |   | Accelerated filer  x |   | Non-accelerated filer  o |
|--------------------------------------|--------|--------------------------------|--------|------------------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Act). Yes o No x

The aggregate market valueof SI International, Inc. Common Stock held by non-affiliates of theregistrant as of June 25, 2005 was $288,381,811.

As of March 1, 2006,there were 11,426,232 shares of SI International, Inc. Common Stock, $0.01par value per share, outstanding.

**DOCUMENTSINCORPORATED BY REFERENCE**

Certainportions of the registrant’s annual report to stockholders for the fiscal yearended December 31, 2005 will be incorporated by reference into Part IIand III of this Form 10-K. Certain portions of the definitive proxystatement to be used in connection with SI International, Inc.’s annualmeeting of stockholders, which is expected to be filed not later than120 days after the registrant’s fiscal year ended December 31, 2005,will be incorporated by reference into Part III of this Form 10-K.

 

 

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**SI INTERNATIONAL, INC.**

**FORM 10-K**

|                   | ** ** | ** **                                                                                                            | ** ** | **Page** | ** ** |
|-------------------|------------|-----------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| **PART I**   |       |                                                                                                                  |
| ITEM 1            |       | Business                                                                                                              |       |     | 3          |   |   |
| ITEM 1A           |       | Risk  Factors.                                                                                                        |       |     | 18         |   |   |
| ITEM  1B          |       | Unresolved Staff  Comments                                                                                            |       |     |       |   |   |
| ITEM 2            |       | Properties                                                                                                            |       |     | 32         |   |   |
| ITEM  3           |       | Legal  Proceedings                                                                                                    |       |     | 32         |   |   |
| ITEM 4            |       | Submission Of Matters To a Vote of Security Holders                                                                   |       |     | 33         |   |   |
| **PART II**  |       |                                                                                                                  |
| ITEM 5            |       | Market for the Company’s Common Equity and Related  Stockholder Matters and Issuer Purchase of Equity Securities |       |     | 34         |   |   |
| ITEM 6            |       | Selected Financials Data                                                                                              |       |     | 35         |   |   |
| ITEM 7            |       | Management’s Discussion and Analysis of Financial  Condition and  Results of Operations                          |       |     | 37         |   |   |
| ITEM 7A           |       | Quantitative and Qualitative Disclosures about Market  Risk                                                           |       |     | 49         |   |   |
| ITEM 8            |       | Financial Statements and Supplementary Data                                                                           |       |     | 49         |   |   |
| ITEM 9            |       | Changes in and Disagreements With Accountants on  Accounting and  Financial Disclosure                                |       |     | 50         |   |   |
| ITEM 9A           |       | Controls and Procedures                                                                                               |       |     | 50         |   |   |
| ITEM  9B          |       | Other  Information                                                                                                    |       |     | 52         |   |   |
| **PART III** |       |                                                                                                                  |
| ITEM  10          |       | Directors and  Executive Officers of the Company                                                                      |       |     |       |   |   |
| ITEM  11          |       | Executive  Compensation                                                                                               |       |     |       |   |   |
| ITEM  12          |       | Security  Ownership of Certain Beneficial Owners and Management and  Related Stockholder Matters                      |       |     |       |   |   |
| ITEM  13          |       | Certain  Relationships and Related Transactions                                                                       |       |     |       |   |   |
| ITEM  14          |       | Principal  Accountant Fees and Services                                                                               |       |     |       |   |   |
| **PART IV**  |       |                                                                                                                  |
| ITEM 15           |       | Exhibits and Financial Statement Schedules                                                                            |       |     | 53         |   |   |
|              |       | Signatures                                                                                                            |       |     | 54         |   |   |

 

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**BUSINESSINFORMATION**

Throughoutthis document, we occasionally distinguish between SI International, Inc.,as a company separate from its subsidiaries, and SI International, Inc.,as a company combined with its subsidiaries.In order to clarify which entity we are referring to in various discussions, weuse the terms“SI International, Inc.” and “SI International” to refer to SIInternational, Inc. without its subsidiaries. All other references,including “SI,” “the Company,” “we” and “us” refer to SI International and itssubsidiaries.

*Some of the statementsunder Item 1. “Business,” Item 7. “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations,” and elsewhere in this Form 10K constitute forward looking statements. These statements involve known andunknown risks, uncertainties, and other factors that may cause our actualresults, levels of activity, performance or achievements to be materiallydifferent from any future results, levels of activity, performance or achievementsexpressed or implied by such forward looking statements. In some cases, you canidentify these statements by forward looking words such as “anticipate,” “believe,”“could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “should,” “will,”and “would” or similar words. You should read statements that contain thesewords carefully because they discuss our future expectations, containprojections of our future results of operations or of our financial position,or state other forward looking information. We believe that it is important tocommunicate our future expectations to our investors. However, there may beevents in the future that we are not able to predict accurately or control. Thefactors listed in the section captioned Item 1A. “Risk Factors,” as well as anycautionary language in this Form 10 K, provide examples of risks,uncertainties, and events that may cause our actual results to differmaterially from the expectations we describe in our forward looking statements.*

*Although we believethat the expectations reflected in the forward looking statements arereasonable, we cannot guarantee future results, levels of activity, performanceor achievements. You should not place undue reliance on these forward lookingstatements, which apply only as of the date of this Form 10 K. Subsequentevents and developments may cause our views to change. However, while we mayelect to update these forward looking statements at some point in the future,we specifically disclaim any obligation to do so.*

**PART I**

**Item 1. Business**   SIInternational, Inc. was organized as a Delaware corporation under the nameof “SI International, Incorporated” on October 14, 1998. SI International conductsoperations both in its own name and through subsidiaries, each of which islocated in the U.S. but some of which have international operations.

**Recent Events**

*Zen Acquisition.*   OnFebruary 27, 2006, we closed the acquisition of Zen Technology, Inc, or Zen, aVirginia corporation, pursuant to a Stock Purchase Agreement dated February 8,2006 (the “Zen Agreement”).  Zenis a provider of critical IT services, specializing in managed networkservices, information assurance, software development and systems engineering,database and systems administration and IT consulting to various U.S.Government agencies.  Zen’s largestclients include the Missile Defense Agency (MDA), Department of Defense’sWashington Headquarters Services (WHS), Federal Communications Commission(FCC), the Pension Benefit Guaranty Corporation (PBGC), and the Federal TradeCommission (FTC).  As a result of ouracquisition of Zen, we gained approximately 275 employees, of whichapproximately 50% hold security clearances. The acquisition of Zen provides additional scale with existing customersas well as diversification with new government customers.  

Pursuantto the terms of the Zen Agreement we acquired all of the outstanding capitalstock of Zen for $60 million in cash, of which we are withholding $6 million for 15 months in order to securepost-closing indemnity obligations of the sellers.  The purchase price is subject to a two-wayadjustment based upon whether the working capital of Zen as of the closing datewas above or below the target working capital specified in the Zen Agreement.Each of the parties to the Zen Agreement has made customary representations andwarranties and agreed to certain indemnification obligations. The transactionwas 

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funded through cash-on-hand, a subordinated Seller’sNote in the amount of $6 million, and borrowing from our newly amended creditfacility, which is described below. We expect the acquisition to be accretiveto earnings. Zen’s trailing twelve months revenue ended November 30, 2005, wasapproximately $38 million (unaudited).

*Amendment to CreditFacility.*   On February 27, 2006,contemporaneously with our closing the acquisition of Zen, we entered into aFirst Amendment to the Amended and Restated Credit Agreement, or FirstAmendment, with a syndicate of lenders, including Wachovia Bank, NationalAssociation, a national banking association, which acted as administrativeagent for the lenders.

TheFirst Amendment amended the terms and conditions of the Amended and Restated CreditAgreement entered into on February 9, 2005, or the Credit Agreement, by (i)establishing a new term loan in the principal amount of approximately $129.3million, which replaced the then existing term loan under the Credit Agreement,(ii) reducing both the base rate margin and the LIBOR margin on the termfacility, (iii) increasing the leverage ratio for the financial covenants and(iv) amending certain restrictive covenants. The principal balance of the new term loan is to be repaid in quarterlyinstallments commencing March 31, 2006, with the balance due upon theexpiration of the Credit Agreement, as amended, or the Amended Credit Agreement,on February 9, 2011.  If an event ofdefault occurs and is continuing, we may be required immediately to repay allamounts outstanding under the Amended Credit Agreement. 

Thefunds borrowed under the new term loan were used to (i) refinance the approximately$99.3 million in principal outstanding under the then existing term loan underthe Credit Agreement and to pay any and all fees and expenses related thereto;(ii) to finance the acquisition of Zen and pay any and all fees and expensesrelated thereto; and (iii) to provide for working capital expenditures, andother general corporate uses.  

The borrowingcapacity under the Amended Credit Agreement totals approximately $189.3 millionand is comprised of a $60 million five-year revolving credit facility and approximately$129.3 million term loan facility. Additionally, a $75 million uncommitted incremental term loan facilitywill be available upon our request at any time for up to two years from thedate of the Credit Agreement from one or more of the lenders.

*NVC Contract Award.*   OnJanuary 31, 2006, in a recompetition for our expiring National VisaCenter, or NVC, contract, we were awarded the successor contract for the NVCcontract by the Department of State. Under the contract, we anticipateperforming over 20 million immigrant visa transactions each year at the NVC inPortsmouth, New Hampshire and at the Kentucky Consular Center in Williamsburg,Kentucky. The prime contract has a one-year base period and four one-yearoptions with an announced value of approximately $84 million, inclusive of theoptions.

*Acceleration of Vesting of Stock Options.*   OnDecember 13, 2005, our Board of Directors approved the accelerated vestingof unvested stock options previously awarded to employees, officers anddirectors as of December 7, 2005 in light of new accounting regulationsthat were to come into effect January 1, 2006. Based on the Statement ofFinancial Accounting Standards No. 123R, “Share-Based Payment” (SFAS123R), the Board took the action to accelerate the unvested stock with thebelief that it is in the best interest of stockholders, as it will reduce theCompany’s reported compensation expense in future periods.

**Overview**

Weare a provider of mission critical information technology and network solutionsprimarily to the Federal Government. Our business is guided by our experiencedteam of eight executive officers and over twenty-five other corporate officerswho manage and are responsible for successfully growing our business. As of theend of fiscal year 2005, we employed over 4,000 employees. Approximately 85% ofour employees hold Federal Government security clearances or have passedNational Agency Checks. Approximately 15% of our employees hold Top Secretsecurity clearances. A significant portion of our 

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employees who hold Top Secret security clearances alsohold Sensitive Compartmental Information clearances, which permit us to bid onhighly classified projects.

Our broad set of contract vehicles gives us extensivereach and enables us to deliver a full range of our services and solutions tothe Federal Government. The strength of our service offerings and informationtechnology expertise allows us to maintain substantial relationships withclients, some of whom have been clients of ours, or of one of our acquiredbusinesses, for over 20 years. In fiscal 2005 and fiscal 2004, we derivedapproximately 75% and 81%, respectively, of our revenue from contracts on whichwe acted as prime contractor. Acting as a prime contractor provides us withstronger client relationships, as well as the visibility and access to new workthat are not available when acting as a subcontractor. Our total backlog as of December 31,2005 was approximately $854 million, of which approximately$191 million was funded. See “—Backlog” for a discussion of how wecalculate backlog.

**The Federal Government technology services market**

Theongoing transformation of the Federal Government’s information systems andcommunication networks is creating an increase in its demand for informationtechnology, or IT, services. According to INPUT, an independent market researchfirm, the federal market demand for vendor-furnished information systems andservices is projected to increase by $19.6 billion from $59.2 billion ingovernment fiscal 2005 to $78.8 billion in government fiscal 2010, a compoundannual growth rate of approximately 5.9%. In addition, the addressable ITspending, which is the amount that is contracted out, for the U.S. Air Force,our single largest client in terms of revenue for each of the last fourcompleted fiscal years, is projected by INPUT to grow from $4.8 billion ingovernment fiscal 2005 to $7.0 billion in government fiscal 2010, representinga compounded annual growth rate of 7.8%. The Department of Homeland Securityaddressable portion of the IT budget is projected by INPUT to grow from $4.5billion in government fiscal 2005 to $6.4 billion in government fiscal 2010,representing a compounded annual growth rate of 7.6%. Spending for federal ITrequested by the U.S. Office of Management and Budget (OMB) in governmentfiscal 2006 shows an increase of 9.0% over the government fiscal 2005 request,according to INPUT.

Weexpect that the Federal Government’s need for the types of IT services that weprovide will continue to grow in the foreseeable future, as a result of thehigh priority placed by the federal government on the transformation of its ITprograms. INPUT forecasts that the percentage of IT spending that is contractedout by the federal government will reach a high of 86% of total IT spending ingovernment fiscal 2010. According to INPUT, the government fiscal 2006 ITbudget request of 7% over the enacted government fiscal 2005 budget, at a timewhen the request for overall federal spending was nearly flat, demonstrated theimportance the administration places on IT as an integral part of federalbusiness processes.

We believe the following industry trends will alsocontinue to drive the Federal Government technology services market:

·                    *Continued focus on mission-criticalinitiatives.*   Sincethe events of September 11, 2001, the Federal Government has made the transformationof its IT infrastructure a major priority. According to INPUT, the FederalGovernment IT services “commercial” segment, which is comprised of outsourcing,professional services, systems integration and processing services, isprojected to grow from $25.1 billion in government fiscal 2005 to $34.1 billionin government fiscal 2010, representing a projected compounded annual growthrate of 6.1%. According to INPUT, growth in the commercial segment for the U.S.Air Force is projected to rise from $1.7 billion in government fiscal 2005 to$2.6 billion in government fiscal year 2010, a compounded annual growth rate of8.9%.

·                    *Increased Federal Governmentreliance on outsourcing.*   Accordingto INPUT, outsourcing through the use of outside providers to provide FederalGovernment services is projected to grow from $12.3 billion in governmentfiscal 2005 to $17 billion in government fiscal 2010, representing a projectedcompounded annual growth rate of 6.9%.

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Webelieve that the Federal Government is increasingly turning to the IT industryto execute support processes and functions that were traditionally performed byFederal Government employees. INPUT expects that Department of Defense (DoD)budgets will continue to grow over the next several governmental fiscal yearsand anticipates that each of the defense agencies will move toward outsourcingmore of the information technology functions that are not core to thewar-fighting mission. Business process outsourcing, or BPO, is a relationshipin which a contractor is responsible for performing an entire businessoperations function, including the information systems outsourcing thatsupports it. INPUT projects that Federal Government BPO spending will grow from$555 million in government fiscal 2005 to $857 million in government fiscal in2010, which represents a compounded annual growth rate of 9.1%. In addition,during this same period, INPUT projects a compounded annual growth rate for BPOspending by defense agencies of 8.3%. According to INPUT, the size of theFederal Government workforce, which includes only civilian employees andnon-uniform military personnel in federal civilian agencies and the DoD,decreased by 1.1 million workers during the period 1990 through 2000,representing a 22% decline.

We believe that homeland security will have thegreatest impact on three specific segments of the Federal Government IT market:information security, communications and knowledge management. We believe thatthe rapid pace of technological innovations and the Federal Government’sincreasing reliance on complex IT infrastructure, combined with a decline inthe size of the Federal Government workforce, as described above, make itincreasingly difficult for many governmental agencies to operate and upgradetheir IT systems. We expect that several trends will contribute to the FederalGovernment’s increased use of service providers to fulfill a larger portion ofits iIT responsibilities, and we believe that we will continue to gain newengagements to the extent that the Federal Government increases its reliance onoutsourcing for its IT needs. These trends include:

·                    *The aging of the FederalGovernment’s workforce.*   Accordingto INPUT, the government has estimated that more than 45% of federal IT workerswill be eligible for retirement by 2008, and the average age of FederalGovernment employees increased from 42 years of age in 1990 to 47 years of agein 2005. In April 2001, the GAO concluded in a report that the FederalGovernment’s human capital challenges are adversely affecting the ability ofmany agencies to carry out their missions.

·                    *Increased Federal Governmentemphasis on competitive sourcing.*   Thecurrent administration has made competitive sourcing a major initiative of itsmanagement agenda. According to the President’s Management Agenda, which wasissued in 2001 and for which progress reports continue to be issued, includingmost recently during 2003, nearly half of all Federal Government employeesperform tasks that are available in the commercial marketplace. To the extentthat the size of the Federal Government workforce decreases, we believe thatthe Federal Government will have an increased need for entities that offer thetechnical skills, familiarity with government processes and procedures andskilled personnel that are necessary to meet the diverse IT requirements of thevarious Federal Government agencies.

***Increasedspending on homeland security and intelligence.***

Inthe wake of the terrorist attacks on September 11, 2001, there has been anincreased emphasis on homeland security, intelligence and national defense,including protecting critical infrastructure. According to INPUT, the totaladdressable IT budget for the Department of Homeland Security is projected togrow from $4.5 billion in government fiscal 2005 to $6.4 billion in governmentfiscal 2010, representing a compound annual growth rate of 7.6%.

Although the total amount to be spent for intelligenceapplications is classified, based on available information, INPUT hasforecasted that the addressable Federal Government IT spending in theintelligence community may be as much as $7.8 billion in government fiscal 2005.We believe that there will continue to be increases in spending on federalintelligence activities, which are expected to represent significant additionalopportunities for us.

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***Increasedsimplicity of procurement.***

Through changes that began with the FederalAcquisition Streamlining Act of 1994, or FASA 94, the federal government hasdeveloped a variety of accelerated contracting methods. Federal governmentalagencies have increasingly been able to rely on multiple contracting vehiclesto procure needed services in an expedient manner. According to INPUT, theaverage time to procure products and services was approximately 100 days ingovernment fiscal 2004 as compared to 278 days in government fiscal 1995.

**OurCore Strengths**

We strategically built our business to respond specificallyto the federal IT marketplace. We believe that our core strengths position usto respond to the long-term trends and changing demands of our market.

**OurExperienced Management Team**

On July 15,2005, our Board of Directors approved a CEO succession plan, pursuant to whichthe Board appointed S. Bradford Antle, formerly our President and ChiefOperating Officer, to be the next President and Chief Executive Officer (CEO)succeeding Ray J. Oleson, and to serve on our Board of Directors.Mr. Antle assumed these positions effective September 24, 2005.Mr. Antle, who joined us in 1999, brings more than 25 years of managementexperience in our industry to his new position. In addition to his new role asCEO and member of the Board, Mr. Antle retained the position of President.Ray Oleson continues to serve as Executive Chairman of the Board.

Additionally,to further support our growth during 2006 and beyond, our eight business unitsare now incorporated into the Strategic Programs Group, the IT Solutions Group,and the Mission Services Group. Each of these Business Groups is headed by anExecutive Vice President, who reports to Mr. Antle.

HarryGatanas is the Executive Vice President of the Strategic Programs Group, wherehe oversees a significant portion of our business with the DoD and theIntelligence community. Mr. Gatanas is a retired U.S. Army general withover 30 years of experience in the military and intelligence community,including serving as Commanding General of the U.S. Army White Sands MissileRange.

MarylynnStowers is the Executive Vice President of the IT Solutions Group. She overseesa significant portion of business that addresses federal IT modernization.Ms. Stowers has more than 24 years of experience providing IT services tothe Federal Government, such as Department of Homeland Security, Department ofState, Department of Treasury, Internal Revenue Service, and the Intelligencecommunity.

Mike Becraft is the Executive Vice President of theMission Services Group. He is responsible for a major portion of work with theDeparment of Homeland Security, Department of State, and U.S. Army. Mr. Becrafthas more than 37 years of Federal civilian government and military experience. Hejoined us in 2003 as Senior Vice President of Homeland Security.

**OurCorporate Culture**

Ourcorporate culture is based on respect for clients, personnel, business partnersand management. We view our commitment to this culture of respect as acornerstone of our company. We believe that our culture helps us build therelationships necessary to gain an in-depth understanding of our clients’needs, business practices and information technology and network systems. Inaddition, we believe our culture is a factor in helping our employee turnoverrate remain low compared to other companies in our industry, helping us tomaintain client domain knowledge and provide consistent service to our clients.Further, we believe that our commitment to respect, combined with quality ofperformance, is an important factor in retaining clients and winning newreferrals.

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**Focuson Information Technology Services**

We deliver a fullspectrum of IT services and solutions that address challenges common to manyFederal Government agencies and commercial companies. Our capabilities positionus to capitalize on the Federal Government’s increasing demand for IT services.We integrate our technical areas of expertise into comprehensive solutionscovering IT applications, systems engineering, network and telecommunicationsengineering and outsourcing. Our focus on end-to-end information technologysolutions allows us to leverage our knowledge and experience to provide bestpractices across many Federal Government agencies and industries. Our key focusareas are:

·       *Federal IT Modernization*.   Wedefine federal IT modernization to include designing, building anddeploying solutions that enable our clients to replace legacy applications anddatabases and allow effective information sharing across agencies. We believewe have a proven track record of delivering true end-to-end solutions in thisfocus area that encompass application and software development, systemsengineering, network solutions, and information security and performancesupport.

·       *Defense Transformation*.   We define defense transformation toinclude development of solutions intended to enable the U.S. military tosuccessfully adapt to the requirements of net-centric warfare through our deepcapabilities in space systems engineering, enterprise and operationalarchitecture, command and control, logistics, and military satellitecommunications. In the area of space systems modernization, we are supportingclients such as Air Force Space Command, NORAD, Northern Command and U.S.Strategic Command.

·       *Homeland Defense*.   We define homeland defense as defense ofthe U.S. homeland, and includes the development of large scalereplicated databases, secure optical calls processing and identificationsystems, managing records, and processing visas. We are working in this focus areato provide advanced information technology to assist in meeting this challengefor clients that include Department of Homeland Security, Department of State,Northern Command, Department of Energy, and Department of Agriculture.

·       *Mission-Critical Outsourcing*.   We definemission-critical outsourcing as assisting the Federal Government with shortagesof personnel, including for the purpose of permitting re-assignment to higherpriority government assignments, increasing operational efficiency, andimproving the overall quality of service. We provide services in this focusarea to both civilian agencies and the DoD.

Our skilled employees usetheir advanced technological training and extensive experience to implement ourstate-of-the-practice solutions. As of the end of fiscal year 2005, we employedover 4,000 employees, many of whom possess security clearances and NationalAgency Checks that allow us to bid on and perform classified work for theFederal Government.

**Knowledgeof Federal Government Contracting and Federal Agencies**

We believe that ourin-depth knowledge of Federal Government contracting and the governmentalagencies we serve and their procurement processes allows us to provide bettersolutions for our clients’ needs. Our experienced team of executive officersand senior managers brings to us their many years of experience and extensivecontacts in the industry. They provide us with an understanding of our clients’needs and procedures, as well as valuable mission-specific information.We believe that the insight provided by our officers and managers allows us todesign solutions that are responsive to our clients’ mission-criticalneeds.

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**SuccessfulIntegration of Acquired Businesses**

We believe that a criticalcomponent of our success is our ability to identify, acquire and integratecompanies that build or expand our suite of services to serve our clients’needs more effectively. Members of our management team have substantialexperience acquiring and successfully integrating acquired entities. We believethat this experience provides a basis for our disciplined approach toidentifying acquisition candidates and integrating acquired companies. Byintegrating corporate infrastructures such as marketing and sales, accounting,human resources and internal networks, we can save the expense of redundantfunctions. In addition, by integrating operations, we establish acorporate-wide mission which can reduce internal competition and promote thecross-selling of newly augmented skill sets to increase our client base.

Within the 15-monthperiod from January 1999 through March 2000, we identified, acquiredand integrated four federal IT companies with aggregate revenues ofapproximately $105 million, measured for the 12 months prior to theirrespective acquisition dates. In January, 2004, we acquired MatcomInternational Corporation, or Matcom; in December 2004, we acquired BridgeTechnology Corporation, or Bridge; in February 2005, we acquiredShenandoah Electronic Intelligence, Inc., or SEI. We successfullyintegrated each of these acquisitions into our organization; and, we built andexpanded our services and solutions capabilities and our client relationships.We applied our disciplined acquisition processes to integrate the acquiredcompanies and successfully grew these businesses. On February 27, 2006, weacquired Zen, and we have commenced the integration process as we have donewith our previous acquisitions.

**Our Growth Strategy**

We have implementedthe following strategies in order to reach our goal of becoming a leadingprovider of information technology and network solutions to our clients:

·       *Maintain and expand our existing client relationships.*   Wemaintain relationships with our existing clients by adhering to our culture ofrespect and providing quality performance. We believe this helps us winrenewals of our engagements. In addition, we use our knowledge of our clients’needs to identify additional opportunities and cross-sell new services to them.

·       *Leverage our existing client base to win new clients.*   Webelieve satisfied clients are one of our most effective marketing tools. SinceFASA 94 went into effect, client referrals have become a crucial component ofexpedited procurement processes and are key to our winning new contracts. Sincewe focus on technology infrastructure improvement, we are able to transfer ourskills readily from client to client. We plan to continue building a network ofclients and leveraging these relationships to gain access to new clients. Wehave launched a Major Programs initiative through which we intend to competefor large contracts over longer procurement periods. We believe that favorableclient referrals are strategically important to our winning theseopportunities.

·       *Pursue strategic acquisitions.*   We plan to continueutilizing our disciplined methodology to identify, evaluate and integratestrategic acquisitions. We have acquired and successfully integrated sevenbusinesses since 1999 and we are in the process of integrating our eighthacquisition, Zen, which we acquired in February 2006. This acquisition haspositioned us with strategically important technical skills in important clientareas.

·       *Business Capabilities and Sales Integration*.   Ourbusiness units are now incorporated into the Strategic Programs Group, the ITSolutions Group, and the Mission Services Group. Under our new managementstructure (see above Our Experienced Management Team for more information aboutour management), these three business groups will be better able to presentintegrated solutions through the cross-marketing and delivery of our business capabilitiesto new and existing customers.

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**Our Areas of Practice**

We provide IT andnetwork solutions in the following eight practice areas to supplement ourclients needs in Defense Transformation, Homeland Defense, Mission CriticalOutsourcing and Federal IT Modernization.

·       *Program Management & Acquisition Support***–** The program management and acquisition support practiceassists clients with initiating, assembling, executing, and managing all sizesof acquisition programs. The practice area provides acquisition strategies,government required documentation (DoD 5000), and solicitation packages, aswell as, source selections and contract management support. The practice areamanages and oversees high-tech systems development; interprets and synchronizesrequirements with system architectures and integrated master plans; and,identifies and tracks technical and programmatic interdependencies andinteractions among requirements. The technical staff is skilled in providingsystems engineering technical assistance (SETA) support to client programs forcost, schedule, performance, risk management, and contracting activities.

·       *Integrated Solutions Development***–**The integrated solutions development practice focuses on the integration of commercial-off-the-shelf products with custom softwareengineering. Integrated solutions are deployed using structured CapabilityMaturity Model Integration (CMMI) practices to deliver services includingfeasibility studies and systems planning, enterprise architecture design, rapidprototype development, detailed systems design, implementation, independentverification and validation, testing, life-cycle documentation, and operationsand maintenance. This practice area specializes in legacy systems migration toenterprise-wide applications, database-driven web applications (internet,extranet, and intranet), work flow systems implementation, enterprise portaldevelopment, enterprise-wide IT integrated services, mobile and wirelesssolutions, business intelligence (data warehouse and mining solutions) andEnterprice Resource Planning systems implementation.

·       *Information Security***–** Theinformation security practice delivers analyses, methods and technologies thatenable clients to secure their information against unauthorized access andservice disruption. The solutions are designed to protect and defendinformation systems against malicious actions, reduce the threat to systemsecurity and proactively manage risk. The practice area provides securitypolicy and procedure development, threat determination and risk assessment,vulnerability analysis, system security engineering, network defense, securedocument processing, applications and web security, security evaluation andaccreditation and training.

·       *Records Management***–** The recordsmanagement practice specializes in application processing, data entry, case andfile management, large scale identification and credentialing systems, callcenter support, and analytical support services. The practice area servicesinclude the management and operation of integrated file tracking systems,electronic records management, large volume file processing, secure identitycard production, scanning operations to include documents and biometrics,storing and shipping of documents, quality control audits, secure filedestruction, and network installation.

·       *Learning Solutions***–** The learningsolutions practice focuses on the design, development and delivery of learningand performance interventions to meet the client’s individual andorganizational performance needs and manage change. The practice area providesfront end analysis, blended solutions, web-based and instructor-led training,electronic performance support systems (EPSS), human performance design, andlearning standards and learning infrastructure consulting. Our understandingand experience in the distance learning, *e*-Learning,and ever changing Learning Management Systems/Learning Content ManangementSystems environments provides our clients rapid design and deployment ofsolution-based programs to meet today’s requirements and tomorrow’s challenges.

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·       *Systems Engineering***–**The systemsengineering practice delivers mission and requirements analysis,enterprise/operational architecture modeling and development, systemapplication and development, system design, validation and verification,integrated logistics support, life cycle engineering, and complex simulation. Thetechnical staff is skilled in command, control, communications, computer andintelligence (C4I), engineering, object oriented analysis and design, systemtesting, requirements traceability and specialty disciplines, includingreliability/maintainability/availability engineering and safety and sustainingengineering. Many of these skills are focused on military space applications.

·       *Network Solutions***–**The networksolutions practice designs, engineers, deploys, and manages a full range ofnetworked communications and infrastructure solutions. The practice areaprovides IT and network requirements, definition and analysis, detailed systemsdesign, network and technology selection and procurement, global end-to-endinstallation, and spectrum/bandwidth management. These solutions encompassvoice, video, data, narrowband, broadband and wireless technologies. Applicationsinclude large scale enterprise networks for government, highly secure networks.

·       *Mission-critical Outsouring***–**Themission-critical outsouring practice uses domain expertise to operate clients’systems and processes vital to their businesses. The practice area offersprofessional services to perform business process and information technologyoutsourcing, sustaining engineering, logistics services, and call centeroperations.

**Clients**

We provide our services primarily to FederalGovernment clients such as the U.S. Air Force Space Command, the U.S. Army,U.S. Navy, the Department of State, the Department of Homeland Security,Department of Agriculture, National Institutes of Health, Federal RetirementThrift Investment Board, and the defense intelligence community. In fiscal2005, we derived approximately 98% of our total revenue from FederalGovernmental agencies and approximately 2% of our total revenue from commercialclients.

Our largest client is the DoD. We derivedapproximately 47% of our total revenue in fiscal 2005 and approximately 53% ofour total revenue in fiscal 2004 from the DoD and the Intelligence community.In fiscal 2005 and fiscal 2004, services we provided to the U.S. Air ForceSpace Command represented 23% and 26% of our total revenue, respectively. Wealso derived approximately 12% of our fiscal 2005 and 2004 revenue,respectively, from the Department of State. Each of these entities consists ofa substantial number of separate offices, each of which typically exercisesindependent decision making and funding authority. We believe our contract baseamong these separate offices is well diversified. In fiscal 2005 and fiscal2004, we derived approximately 75% and 81%, respectively, of our revenue fromcontracts on which we acted as prime contractor and derived approximately 25%and 19%, respectively, of our revenue from contracts on which we acted as asubcontractor.

We often subcontractportions of work to be performed under a contract or task order under which weare the prime contractor. Approximately 15% and 16%, respectively, of our totalrevenue in fiscal 2005 and fiscal 2004, respectively, was generated by workperformed by subcontractors. The subcontractors are sometimes responsible forcritical portions of the contracted services. Our subcontracting arrangementstypically specify that all terms of the primary contract pass down to thesubcontractor. We are not dependent upon any one subcontractor or group ofsubcontractors to provide a substantial degree of work for us. In addition, itis typical that a subcontractor on one engagement may be a competitor or a clientin other situations. We believe that cultivating good relationships with oursubcontractors is necessary to maintain our competitive position as well as tofacilitate meeting performance obligations under our contracts.

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**Backlog**

Backlog is our estimate of the amount of revenue weexpect to realize over the remaining life of awarded contracts and task orderswe have in hand as of the measurement date. Our total backlog consists offunded and unfunded backlog. We define funded backlog as estimated future revenueunder government contracts and task orders for which funding has beenappropriated by Congress and authorized for expenditure by the applicableagency, plus our estimate of the future revenue we expect to realize from ourcommercial contracts. Unfunded backlog is the difference between total backlogand funded backlog. Unfunded backlog reflects our estimate of future revenueunder awarded government contracts and task orders for which either funding hasnot yet been appropriated or expenditure has not yet been authorized. Our totalbacklog does not include estimates of revenue from government-wide acquisitioncontracts, or GWAC contracts, or General Services Administration, or GSA,schedules beyond awarded or funded task orders, but our unfunded backlog doesinclude estimates of revenue beyond awarded or funded task orders for othertypes of indefinite delivery, indefinite quantity, or ID/IQ, contracts, such asour contract with the U.S. Air Force Space Command.

Our total backlog as of December 31, 2005 wasapproximately $854 million, of which approximately $191 million wasfunded. There can be no assurance that we will receive the amounts we haveincluded in our backlog or that we will ultimately recognize the full amount ofour funded backlog as of December 31, 2005.

As of December 31, 2005, assuming that theacquisition of Zen had occurred on such date, our backlog was approximately$994 million, of which $233 million was funded.

We believe that backlog is not necessarily indicativeof the future revenue that we will actually receive from contract awards thatare included in calculating our backlog. We assess the potential value ofcontracts for purposes of backlog based upon several subjective factors. Thesesubjective factors include our judgments regarding historical trends (i.e., howmuch revenue we have received from similar contracts in the past), competition(i.e., how likely are we to successfully keep all parts of the work to beperformed under the contract) and budget availability (i.e., how likely is itthat the entire contract will receive the necessary funding). If we do notaccurately assess each of these factors, or if we do not include all of thevariables that affect the revenue that we recognize from our contracts, thepotential value of our contracts, and accordingly, our backlog, will notreflect the actual revenue received from contracts and task orders. As aresult, there can be no assurance that we will receive amounts included in ourbacklog or that monies will be appropriated by Congress or otherwise madeavailable to finance contracts and task orders included in our backlog. Manyfactors that affect the scheduling of projects could alter the actual timing ofrevenue on projects included in backlog. There is always the possibility that thecontracts could be adjusted or cancelled. We adjust our backlog on a quarterlybasis to reflect modifications to or renewals of existing contracts, awards ofnew contracts or approvals of expenditures. See Item 1A. “Risk Factors—Thecalculation of our backlog is subject to numerous uncertainties, and we may notreceive the full amounts of revenue estimated under the contracts included inour backlog, which could reduce our revenue in future periods.”

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**Employees**

As of December 31, 2005, we had over 4,000employees. Approximately 85% of our employees hold Federal Government securityclearances or have passed National Agency Checks. Approximately 15% of ouremployees hold Top Secret security clearances. A significant portion of ouremployees who hold Top Secret security clearances also hold SensitiveCompartmental Information clearances, which permit us to bid on highlyclassified projects. We have no unionized employees and do not have anycollective bargaining agreements. However, current contracts or contracts thatwe may pursue contracts may require us to have unionized employees. Furthermore,with our acquisition of Zen, we have added approximately 275 employees, ofwhich 50% hold security clearances. We believe we have a good relationship withour employees.

In addition to attractingand retaining qualified technical personnel, we believe that our success willdepend on the continued employment of our executive and senior management teamand its ability to generate new business and execute projects successfully. Webelieve that the personal reputations of our management team members and thebusiness relationships between individual members of our management team andgovernmental officials involved in the procurement process and related areasare critical elements of obtaining and maintaining client engagements in ourindustry, particularly with agencies performing classified operations. Tocreate and maintain these client relationships, identify potential businessopportunities and establish our reputation among our current and potentialclients, we depend on our senior management team. The loss of any of our seniorexecutives could cause us to lose client relationships or new businessopportunities, which could materially adversely affect our business.

**Competition**

We operate in markets that are highly competitive andinclude a large number of participants. We compete with many companies, bothlarge and small, for our contracts. We do not have a consistent number ofcompetitors against whom we repeatedly compete. If we anticipate that ourcombined resources may create a competitive advantage, we may team with othercompanies to perform work under contracts. These and other companies in ourmarket may compete more effectively than we can because they are larger, havegreater financial and other resources, have better or more extensiverelationships with governmental officials involved in the procurement processand have greater brand or name recognition.

As a result of the diverse requirements of the FederalGovernment and our commercial clients, we frequently form teams with thecompanies in our markets in order to compete for large procurements, whilebidding against them in other situations.

In each of our practiceareas, we generally bid against companies of varying sizes and specialties,from small businesses to multi-billion dollar corporations. Becauseof the current industry trend toward consolidation, some of these companies mayemerge better able to compete with us. Therefore, it is essential that wedifferentiate ourselves from these companies. We believe that our technicalabilities, client relationships, past performance, cost containment, reputationand ability to provide quality personnel give us a strong presence in themarkets we serve. In addition, we believe that our culture of respect for andcommitment to our clients and business partners greatly aids our business.While we believe these factors help to set us apart from other companies in ourmarkets, we may not be able to continue to maintain our competitive position,as new companies enter the marketplace and alliances and consolidations amongcompetitors emerge. Some companies in our markets have longer operatinghistories, greater financial and technological capabilities, greater brand orname recognition and/or larger client bases than we have.

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**GovernmentContracting and Regulatory Processes**

For fiscal 2005, approximately 98% of our revenue wasderived from work performed under Federal Government contracts. The governmentcontracting process differs in many ways from commercial contracting, andinvolves a high degree of Federal Government regulation and oversight.

Historically, agencies of the Federal Governmentwishing to procure services from contractors have been required to prepare arequest for proposal, known as an RFP, or some similar form of solicitation.The RFP is typically an extensive document describing the services desired andthe terms and conditions that form the final agreement, including the criteriathe soliciting agency will use to select the service provider. Interestedparties submit proposals in response to the RFP, which the agency evaluate,often requesting additional information and multiple discussions with offerorsprior to final award of the contract.

In recent years, the Federal Government has takensteps to streamline the procurement process. For example, in 1994, theenactment of FASA 94 made the procurement process substantially faster and lessburdensome for companies that secure certain contracts. FASA 94 was the firstof several statutory and regulatory changes in recent years that significantlyaltered government procurement practices by increasing the number and types ofprocurement contract “vehicles” available to Federal Government clients tosatisfy their requirements. Federal Governmental agencies are now more likelyto use flexible contract vehicles that permit a number of firms to compete forspecific orders. The General Services Administration Multiple Award ScheduleProgram, or GSA MAS Program, is an example of a flexible contract vehicleemployed by the Federal Government. Under the GSA MAS Program, GSA contractswith multiple vendors to provide goods and services, at predetermined prices,to specified authorized buyers. GSA schedules are listings of services andproducts, along with their respective prices, offered by approved contractors.The schedules are maintained by the GSA for use by any federal agency or otherauthorized entity. A contractor must successfully complete a pre-qualificationprocess in order to be selected by the GSA for inclusion of the contractor’sgoods or services on a GSA Schedule. When an agency selects services under aGSA schedule contract, the soliciting agency, or the GSA on its behalf,conducts a bidding process, limited to qualified GSA schedule contractors. Theprocess typically involves substantially less time and cost than thehistorical, non-GSA bidding process.

In addition to the GSA MAS Program, we also hold otherID/IQ contracts with other individual agencies, which are generally known astask order contracts. These are essentially umbrella contracts that set forththe basic terms and conditions under which the agency may order goods andservices from one, and in some cases, more than one, contractor. Contractorsundergo a competitive pre-selection process to become eligible to perform workunder ID/IQ contracts. A procuring agency then issues task orders for goods orservices to be performed or provided under a contract. When task orders areissued under multiple award ID/IQ contracts, each awardee typically has anopportunity to be considered for the task order. The agency desiring contractservices may conduct a competition among the interested awardees, resulting inthe issuance of a task order to a single contractor. These contracts haveincreased competition and pricing pressure by concentrating work under fewercontracts, and requiring competition both prior to the initial award of thecontract and throughout the term of the contract in order to obtain task ordersfor the services we provide, requiring that we make sustained post-awardmarketing efforts to realize revenue under each such contract. Moreover, evenif we are qualified to work on a particular new contract or a contract subjectto renewal, we might not be awarded business because of the Federal Government’spolicy and practice of procuring goods and services from multiple contractorsin order to maintain a diverse base of contractors. In addition, ID/IQcontracts do not obligate the Federal Government to purchase goods or servicesabove the minimum levels set forth in the contract.

A task order calls for a specific set of services tobe delivered by the contractor to a particular client agency. In our experience,the key factors in competing successfully for these task orders are technical 

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merit, cost, relevant pastperformance considerations and client trust. From time to time we are alsoparty to GWACs, which are ID/IQ contracts that permit the aggregation ofmultiple agencies’ requirements in a single contract, in order to encouragecontractors to offer the best possible prices and to reduce the costsassociated with multiple acquisitions.

For single-award large scale contracts, such asthose targeted by our Major Program initiative, interested contractors submitinformation indicating their desire to perform the required services. Theagency then solicits competitive proposals or bids from qualified contractorsby providing them with a formal RFP or similar solicitation. The RFP typicallydescribes the desired services, terms and conditions, and evaluation criteriathe agency will use. Offerors then submit proposals in response to the RFP, andthe agency evaluates the proposals and makes the award determination. Agenciesare encouraged to award contracts on a “best value” basis. This means that thecontractor selected for the award should, in the agency’s judgment, provide thegreatest overall benefit in response to the requirement, including technical merit,cost and relevant past performance considerations. The entire acquisitionprocess can sometimes take a year or more.

The competitiveprocess presents a number of risks, including the following:

·       weexpend substantial funds, managerial time and effort to prepare bids andproposals for contracts that we may not win;

·       wemay be unable to estimate accurately the resources and cost that will berequired to service any contract we win, which could result in substantial costoverruns; and

·       wemay encounter expense and delay if our competitors protest or challenge awardsof contracts to us in competitive bidding, and any such protest or challengecould result in a requirement to resubmit proposals on modified specificationsor in the termination, reduction or modification of the awarded contract.

·       wemay be choosen as one of the contractors for a multiple awared GWAC, ID/IQ orGSA Schedule contract, but not be awarded a sufficient number of tasks underthe contract to justify our time, effort, and expense in bidding on thecontract and subsequent task orders.

·       thegovernment may intitially award a GWAC, ID/IQ, or GSA Schedule contract butfail to provide funding for the number of task orders necessary to justify ourtime, effort, and expense in bidding on the contract and subsequent taskorders.

The government contractsfor which we compete typically have multiple year terms, and if we are unableto win a particular contract, we generally will be foreclosed from competingagain for that contract until its expiration several years later. In addition,upon the expiration of a contract, if the client requires further services ofthe type provided by the contract, there is frequently a competitive rebiddingprocess.

**Lawsand Regulations Affecting Our Business**

Federal Government contracts are subject to a numberof federal laws and regulations, including the Federal Acquisition Regulation,or FAR, and Cost Accounting Standards. These statutes and regulations containseveral rules that may affect us significantly.

The Anti-Deficiency Act prohibits Federal Governmentemployees from committing government funds, by contract or otherwise, in excessor in advance of appropriations, unless authorized by a specific statute. SinceCongress usually appropriates funds on a fiscal year basis, many of ourcontracts are funded by the applicable agency annually as Congress makesappropriations for future fiscal years. In addition, since funds are oftenallocated to agencies by the OMB, many of our contracts are incrementally funded.

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Disappointed bidders and contractors excluded fromcompeting for government contracts and task orders may submit a protest to acontracting officer or the GAO within time limits specified under FAR and GAObid protest rules. The U.S. Court of Federal Claims also has bid protestjurisdiction. Performance under a contract being protested may be suspendedwhile the protest is pending, and in cases where the contract is found to havebeen improperly awarded, the contract may be terminated.

Certain FAR clauses, such as the Limitation of Costand Limitation of Funds clauses, limit the Federal Government’s liability forexpenditures or obligations beyond those authorized by the applicable contract.In many cases, contracts are awarded for only one year with a number ofsuccessive option years (in many cases, four). Agencies are not obligated toexercise these option years, but in our experience most renewal options underour contracts have been exercised. In addition, certain FAR clauses allow theFederal Government to terminate contracts for convenience (i.e., at will),although the Federal Government is obligated to pay for costs incurred.

Larger contracts may also be subject to the Truth inNegotiations Act and Cost Accounting Standards. The Truth in Negotiations Actrequires us to provide current, accurate and complete cost or pricing data inconnection with the negotiation of a contract, modification or task order thatis not subject to full and open competition or other exceptions to the Act.Cost Accounting Standards are applicable to certain contracts and require thecontractor to apply consistent accounting practices and comply with specificcost accounting criteria. The FAR “Contract Cost Principles and Procedures”sets forth the rules regarding the allocability and allowability of costsincurred in connection with Federal Government contracts.

The FAR restricts government contractors fromparticipating in procurements when there is an Organizational Conflict ofInterest, or OCI, and establishes rules for avoiding, mitigating andneutralizing conflicts of interest in the issuance of contracts by the FederalGovernment. Virtually all government contracts, including ours, are subject tothe OCI rules. An OCI may arise because the nature of the work to be performedby a contractor has the potential, absent some restriction on futureactivities, to result in an unfair competitive advantage to the contractor orimpair the contractor’s objectivity in performing the contract or providingassistance or advice to the Federal Government. The government contractingofficer is responsible for resolving any significant potential OCIs before acontract award is made. Federal Government contractors have an obligation tomanage and, if necessary, report an OCI to the contracting officer. We have acompany-wide policy regarding care in the acceptance of and compliance withcontractual OCI provisions, which includes awareness training programs andcoordination and reporting systems. We review new contracts and task orders atthe time we receive them for potential OCI issues. Accordingly, we believe thatas a result of the systems we have in place, our backlog will not be affectedby OCI issues.

Our books and records are subject to audit by theDefense Contract Audit Agency, or DCAA, and other governmental audit agenciesto ensure that the costs and hourly rates for which we invoice the FederalGovernment under cost reimbursable and time and materials contracts are incompliance with the Cost Principles, Cost Accounting Standards and FARinvoicing regulations. Each fiscal year, we must submit final cost data to theFederal Government indicating our actual costs incurred for the prior year,exclusive of certain costs that are not recoverable by Federal Governmentcontractors. This data is audited, and subject to adjustments by the auditingagency based upon established guidance, which may affect our recovery on costreimbursable contracts for prior fiscal years. These audits may also result inassessment of penalties, interest costs and, in extreme cases, debarment. TheFederal Government retains a portion of the fee earned by us under costreimbursable contracts until contract completion and audit by the DCAA. Auditsof our business units by the DCAA have been completed for all fiscal yearsthrough 2001 without material adjustments. In the opinion of management, theaudits for other fiscal years through fiscal year 2005 will not result inadjustments that would have a material adverse effect on our financial positionor results of operations; however, future material adjustments are possible.

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Our conduct and performance is also subject to theFalse Claims Act. The False Claims Act prohibits contractors from knowinglysubmitting false or fraudulent claims to the Federal Government. We haveestablished standards of conduct for our employees and a reporting mechanismthat any of our employees can use to report inappropriate or illegalactivities.

From time to time we may engage in activities thatrequire us to comply with the various, U.S. Government export control laws andregulations administered by the U.S. Department of State, U.S. Department ofCommerce, U.S. Treasury Office of Foreign Assets Control, and the Bureau ofCustoms and Boarder Protection. We have dedicated personal assigned to maintainand coordinate our compliance activities in this area.

Copies of our Annual Report on Form 10-K,Quarterly Reports on Form 10-Q, Current Reports on Form 8-K,and amendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Exchange Act of 1934, as amended, are available free ofcharge on the Investor Relations section of our website at *www.si-intl.com*as soon as reasonably practicable after we electronically file the materialwith, or furnish the material to, the Securities and Exchange Commission, orSEC.

You may obtain a printed copy of any of the foregoingmaterials from us by writing to us at SI International, Inc., 12012 SunsetHills Road, Suite 800, Reston, Virginia 20190, Attention: InvestorRelations.

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**Item 1A. Risk Factors**

**Risks Related to Our Industry**

**Wedepend on contracts with the Federal Government for most of our revenue, andour business would be seriously harmed if the government ceased doing businesswith us or significantly decreased the amount of business it does with us.**

We derived 98.1% and 96.6% of our total revenue infiscal 2005 and in fiscal 2004, respectively, from Federal Governmentcontracts, either as a prime contractor or a subcontractor. This includes 46.9%and 52.8% of our total revenue in fiscal 2005 and in fiscal 2004, respectively,that we derived, either as a prime contractor or a subcontractor, fromcontracts with agencies of the DoD and Intelligence community. We expect thatwe will continue to derive most of our revenue for the foreseeable future fromwork performed under Federal Government contracts. If we were suspended orotherwise prohibited from contracting with the Federal Government generally, orwith any significant agency of the DoD or the Intelligence community, or if ourreputation or relationship with the Federal Government or any significantagency of the DoD or the Intelligence community were impaired, or if any of theforegoing otherwise ceased doing business with us or significantly decreasedthe amount of business it does with us, our business, prospects, financialcondition and operating results would be materially adversely affected.

Thefollowing chart provides certain information regarding our four largestcontracts for fiscal year 2005, in terms of revenues:

| ** **                                                                                                                      | ** **   | ** **                                     | ** ** | **Percent of  Revenues in** | ** **   | ** ** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|--------------|------------------------------------------------|------------|---------------------------------------|--------------|------------|------------|
| ** **                                                                                                                      | **Contract** | ** **                                     | ** ** | ** **                            | **Customer** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **Expiration Date** | ** ** |
| Command, Control,  Communications, Computer, Intelligence, Information, Technology,  Surveillance, and Reconnaissance (C4I2TSR) |         | U.S. Air Force   Space  Command |       | 18.8                                  |         | 17.3       |       | 2013* |   |
| National Visa Center (NVC)                                                                                                      |         | Department of   State                |       | 9.1                                   |         | 9.2        |       | 2011* |   |
|                                                                                                                                 |              |                                                |            |                                       |              |            |            |  |  |  |  |  |  |

 

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* Includes option periods.

**Ourbusiness could be adversely affected by changes in budgetary priorities of theFederal Government.**

Because we derive asignificant portion of our revenue from contracts with the Federal Government,we believe that the success and development of our business will continue todepend on our successful participation in Federal Government contract programs.Changes in Federal Government budgetary priorities could directly affect ourfinancial performance. A significant decline in government expenditures, ashift of expenditures away from programs that call for the types of servicesthat we provide, or a change in Federal Government contracting policies couldcause Federal Governmental agencies to reduce their expenditures undercontracts, to exercise their right to terminate contracts at any time withoutpenalty, not to exercise options to extend contracts, or to delay or not enterinto new contracts. Any of those actions could seriously harm our business,prospects, financial condition or operating results. Moreover, although ourcontracts with governmental agencies often contemplate that our services willbe performed over a period of several years, Congress usually must approvefunds for a given program each government fiscal year and may significantlyreduce or eliminate funding for a program. Significant reductions in theseappropriations by Congress could have a material adverse effect on ourbusiness. Additional factors that could have a serious adverse effect on ourFederal Government contracting business include:

·       changes in FederalGovernment programs or requirements;

·       budgetary prioritieslimiting or delaying Federal Government spending generally, or by specificdepartments or agencies in particular, and changes in fiscal policies oravailable funding, including potential governmental shutdowns;

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·       reduction in the FederalGovernment’s use of technology solutions firms; and

·       anincrease in the number of contracts reserved for small businesses which couldresult in our inability to compete directly for these prime contracts.

**Ourcontracts with the Federal Government may be terminated or adversely modifiedprior to completion, which could adversely affect our business.**

Federal Governmentcontracts generally contain provisions, and are subject to laws and regulations,that give the Federal Government rights and remedies not typically found incommercial contracts, including provisions permitting the Federal Governmentto:

·       terminate our existingcontracts;

·       reduce potential futureincome from our existing contracts;

·       modify some of the termsand conditions in our existing contracts;

·       suspend or permanentlyprohibit us from doing business with the Federal Government or with anyspecific government agency;

·       impose fines and penalties;

·       subject us to criminal prosecution;

·       subject the award of somecontracts to protest or challenge by competitors, which may require thecontracting federal agency or department to suspend our performance pending theoutcome of the protest or challenge and which may also require the governmentto solicit new proposals for the contract or result in the termination,reduction or modification of the awarded contract;

·       suspend work under existingmultiple year contracts and related task orders if the necessary funds are notappropriated by Congress;

·       decline to exercise anoption to extend an existing multiple year contract; and

·       claim rights intechnologies and systems invented, developed or produced by us.

The Federal Government may terminate a contract withus either “for convenience” (for instance, due to a change in its perceivedneeds or its desire to consolidate work under another contract) or if wedefault by failing to perform under the contract. If the Federal Governmentterminates a contract with us for convenience, we generally would be entitledto recover only our incurred or committed costs, settlement expenses and profiton the work completed prior to termination. If the Federal Governmentterminates a contract with us based upon our default, we generally would bedenied any recovery for undelivered work, and instead may be liable for excesscosts incurred by the Federal Government in procuring undelivered items from analternative source and other damages as authorized by law. As is common withgovernment contractors, we have experienced and continue to experienceoccasional performance issues under some of our contracts. We may in the futurereceive show-cause or cure notices under contracts that, if not addressed tothe Federal Government’s satisfaction, could give the government the right toterminate those contracts for default or to cease procuring our services underthose contracts.

Our Federal Government contracts typically have termsof one or more base years and one or more option years. Many of the optionperiods cover more than half of the contract’s potential term. Federalgovernmental agencies generally have the right not to exercise options toextend a contract. A decision to terminate or not to exercise options to extendour existing contracts could have a material adverse effect on our business,prospects, financial condition and results of operations.

Certain of our FederalGovernment contracts also contain “organizational conflict of interest” clausesthat could limit our ability to compete for certain related follow-oncontracts. For example, when we work 

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on thedesign of a particular solution, we may be precluded from competing for thecontract to install that solution. While we actively monitor our contracts toavoid these conflicts, we cannot guarantee that we will be able to avoid allorganizational conflict of interest issues.

**If wefail to establish and maintain important relationships with government entitiesand agencies, our ability to successfully bid for new business may be adverselyaffected.**

To develop new businessopportunities, we primarily rely on establishing and maintaining relationshipswith various government entities and agencies. We may be unable to successfullymaintain our relationships with government entities and agencies, and any failureto do so could materially adversely affect our ability to compete successfullyfor new business.

**Wederive significant revenue from contracts and task orders awarded through acompetitive acquisition process. If we are unable to win new awards or successfullycompete for renewal contracts, our business and prospects may be adverselyaffected.**

A significant number of our contracts and task orderswith the Federal Government are awarded through a competitive process. Weexpect that much of the business that we will seek in the foreseeable futurewill continue to be awarded through competitive bidding of new contracts andtask orders and contracts subject to renewal. Recently, members of Congress andadministration officials have authorized changes to the procurement processintended to increase competition among suppliers to the Federal Government.Budgetary pressures and reforms in the procurement process have caused manyFederal Government clients to increasingly purchase goods and services throughID/IQ, contracts, including GSA contracts, and other GWACs. These contractshave increased competition and pricing pressure by concentrating work underfewer contracts, and requiring competition both prior to the initial award ofthe contract and throughout the term of the contract in order to obtain taskorders for the services we provide, requiring that we make sustained post-awardmarketing efforts to realize revenue under each such contract. These contractsgenerally approve particular contractors to provide specified goods andservices to the applicable governmental agency but generally do not obligatethe agency to purchase any particular amount of goods or services. To procuregoods or services under the contract, the agency generally awards task orders toperform specified services or to supply specified goods pursuant to competitionamong approved contractors. Thus, the existence of a contract does not ensurefuture revenue; rather, the contract merely provides us the opportunity tocompete for additional work. An agency may administer an ID/IQ contract inwhich it procures goods and services for itself. Under the same contract, otherfederal agencies may also procure goods and services. These contracts are knownas GWACs. When multiple prime contractors hold GWACs for the same goods andservices, all of them are eligible to supply goods and services under thecontract. As a result, qualified contractors often compete with each other toobtain task orders under a GWAC. Similarly, GSA contracts, including contractscommonly known as GSA Schedule contracts, are procurement contractsadministered by the GSA on behalf of the entire Federal Government. Like manyother ID/IQ contracts, multiple contractors may be awarded GSA contracts forthe same goods and services. As a result, an agency may procure goods andservices from any contractor awarded the GSA contract at the prices and on theterms stated in the contract. Moreover, even if we are highly qualified to workon a particular new contract or a contract subject to renewal, we might not beawarded business because of the Federal Government’s policy and practice ofprocuring goods and services from multiple contractors in order to maintain adiverse base of contractors.

Thecompetitive process presents a number of risks, including the following:

·       weexpend substantial funds, managerial time and effort to prepare bids andproposals for contracts that we may not win;

·       wemay be unable to estimate accurately the resources and cost that will berequired to service any contract we win, which could result in substantial costoverruns; and

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·       wemay encounter expense and delay if our competitors protest or challenge awardsof contracts to us in competitive bidding, and any such protest or challengecould result in a requirement to resubmit proposals on modified specificationsor in the termination, reduction or modification of the awarded contract.

The government contractsfor which we compete typically have multiple year terms, and if we are unableto win a particular contract, we generally will be foreclosed from competingagain for that contract until its expiration several years later. If we areunable to win new contract awards, our business and prospects will be adverselyaffected. In addition, upon the expiration of a contract, if the clientrequires further services of the type provided by the contract, there isfrequently a competitive rebidding process. Approximately 19.5% of our revenuerecognized during fiscal 2005 was derived from contracts that, as of February 28,2006, are, or are expected to become, subject to recompetition bids prior tothe end of government fiscal 2006 (ending September 30, 2006). There canbe no assurance that we will win any particular bid or recompetition bid, orthat we will be able to replace business lost upon expiration or completion ofa contract, and the termination or nonrenewal of any of our significantcontracts or a substantial portion of our other contracts could materiallyadversely affect our operating results.

**Ourbusiness may suffer if our facilities or our employees are unable to obtain orretain the security clearances or other qualifications needed to performservices for our clients.**

Many of our FederalGovernment contracts require employees and facilities used in specificengagements to hold security clearances and to clear agency checks and DefenseSecurity Service checks. Many of our contracts require us to employ personnelwith specified levels of education, work experience and security clearances.Depending on the level of clearance, security clearances can be difficult andtime-consuming to obtain. If our employees or our facilities lose or are unableto obtain necessary security clearances or successfully clear necessary agencyor Defense Security Service checks, we may not be able to win new business andour existing clients could terminate their contracts with us or decide not torenew them. To the extent we cannot obtain or maintain the security clearancesnecessary for our facilities or our employees working on a particular contractor to the extent our facilities or our employees do not successfully clearnecessary agency checks or Defense Security Service checks, we may not derivethe revenue anticipated from the contract, and our operating results could be materiallyadversely affected.

**Wemust comply with a variety of laws, regulations and procedures and our failureto comply could harm our operating results.**

Wemust observe laws and regulations relating to the formation, administration andperformance of Federal Government contracts which affect how we do businesswith our clients and impose added costs on our business. For example, theFederal Acquisition Regulation and the industrial security regulations of theDepartment of Defense and related laws include provisions that:

·       allowour Federal Government clients to terminate or not renew our contracts if wecome under foreign ownership, control or influence;

·       requireus to disclose and certify cost and pricing data in connection with contractnegotiations;

·       requireus to prevent unauthorized access to classified information; and

·       require us to comply withlaws and regulations intended to promote various social or economic goals.

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Some of our activities are subject to the exportcontrol laws and regulations administered by the Department of State,Department of Commerce, Treasury Office of Foreign Assets Control, and theBureau of Customs and Boarder Protection Additionally, we are subject toindustrial security regulations of the DoD and other federal agencies that aredesigned to safeguard against foreigners’ access to classified information. Ifwe were to come under foreign ownership, control or influence, we could loseour facility security clearances, which could result in our Federal Governmentcustomers terminating or deciding not to renew our contracts, and could impairour ability to obtain new contracts.

In addition, our employees often must comply withprocedures required by the specific agency for which work is being performed,such as time recordation or prohibition on removal of materials from alocation.

Our failure to comply withapplicable laws, regulations or procedures, including federal procurementregulations and regulations regarding the protection of classified information,could result in contract termination, loss of security clearances, suspensionor prohibition from contracting with the Federal Government, civil fines anddamages and criminal prosecution and penalties, any of which could materiallyadversely affect our business.

**TheFederal Government may revise its procurement or other practices in a manneradverse to us.**

The Federal Government may revise its procurementpractices or adopt new contracting rules and regulations, such as costaccounting standards. It could also adopt new contracting methods relating toGSA contracts, GWACs or other government-wide contracts, or adopt new standardsfor contract awards intended to achieve certain social or other policyobjectives, such as establishing new set-aside programs for small or minority-ownedbusinesses. In addition, the Federal Government may face restrictions from newlegislation or regulations, as well as pressure from government employees andtheir unions, on the nature and amount of services the Federal Government mayobtain from private contractors. These changes could impair our ability toobtain new contracts or contracts under which we currently perform when thosecontracts are put up for recompetition bids. Any new contracting methods couldbe costly or administratively difficult for us to implement, and, as a result,could harm our operating results. For example, the Truthfulness, Responsibilityand Accountability in Contracting Act, proposed in 2001, would have limited andseverely delayed the Federal Government’s ability to use private servicecontractors. Although this proposal was not enacted, it or similar legislationcould be proposed at any time. Any reduction in the Federal Government’s use ofprivate contractors to provide federal information technology services couldmaterially adversely impact our business.

**Ourcontracts and administrative processes and systems are subject to audits andcost adjustments by the Federal Government, which could reduce our revenue,disrupt our business or otherwise adversely affect our results of operations.**

Federal governmentalagencies, including the DCAA, routinely audit and investigate governmentcontracts and government contractors’ administrative processes and systems.These agencies review our performance on contracts, pricing practices and coststructure. They also review our compliance with applicable laws, governmentregulations, policies and standards and the adequacy of our internal controlsystems and policies, including our purchasing, property, estimating,compensation and management information systems. Any costs found to beimproperly allocated to a specific contract will not be reimbursed, and anysuch costs already reimbursed must be refunded. Moreover, if any of ouradministrative processes and systems are found not to comply with theapplicable requirements, we may be subjected to increased government scrutinyor required to obtain additional governmental approvals that could delay orotherwise adversely affect our ability to compete for or perform contracts.Therefore, an unfavorable outcome to an audit by the DCAA or another governmentagency, such as the Defense Security Service, or DSS, which verifies securitycompliance, could materially adversely affect our 

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competitiveposition and result in a substantial reduction of our revenues. If a governmentinvestigation uncovers improper or illegal activities, we may be subject tocivil and criminal penalties and administrative sanctions, includingtermination of contracts, forfeitures of profits, suspension of payments, finesand suspension or debarment from doing business with the Federal Government. Inaddition, we could suffer serious reputational harm if allegations ofimpropriety were made against us.

**Failureto maintain strong relationships with other government contractors could resultin a decline in our revenue.**

We derived 24.6% of ourtotal revenue in fiscal 2005 and 19.4% of our total revenue in fiscal 2004 fromcontracts under which we acted as a subcontractor or from “teaming”arrangements in which we and other contractors bid together on particularcontracts or programs. As a subcontractor or team member, we often lack controlover fulfillment of a contract, and poor performance on the contract couldtarnish our reputation, even when we perform as required. We expect to continueto depend on relationships with other contractors for a portion of our revenuein the foreseeable future. Moreover, our revenue and operating results could bematerially adversely affected if any prime contractor or teammate chooses tooffer a client services of the type that we provide or if any prime contractoror teammate teams with other companies to independently provide those services.

**Thecalculation of our backlog is subject to numerous uncertainties, and we may notreceive the full amounts of revenue estimated under the contracts included inour backlog, which could reduce our revenue in future periods.**

Backlog is our estimate of the amount of revenue we expectto realize over the remaining life of the awarded contracts and task orders wehave in hand as of the measurement date. Our total backlog consists of fundedand unfunded backlog. We define funded backlog as estimated future revenuesunder government contracts and task orders for which funding has beenappropriated by Congress and authorized for expenditure by the applicableagency under our contracts, plus estimated future revenues we expect to receiveunder signed purchase orders with commercial clients. Unfunded backlog is thedifference between total backlog and funded backlog. Unfunded backlog reflectsour estimate of future revenues under awarded government contracts and taskorders for which either funding has not been appropriated or expenditures havenot been authorized. Our total backlog does not include estimates of revenuefrom GWAC or GSA schedules beyond contract or task order awards, but ourunfunded backlog does include estimates of revenue beyond contract or taskorder awards for other types of ID/IQ contracts, including our Command,Control, Communications, Computer, Intelligence, Information, Technology,Surveillance, and Reconnaissance (C4I2TSR) contract with the U.S. Air ForceSpace Command.

The calculation of backlogis highly subjective and is subject to numerous uncertainties and estimates,and there can be no assurance that we will in fact receive the amounts we haveincluded in our backlog. Our assessment of a contract’s potential value isbased upon factors such as historical trends, competition and budgetavailability. In the case of contracts which may be renewed at the option ofthe applicable agency, we generally calculate backlog by assuming that theagency will exercise all of its renewal options; however, the applicable agencymay elect not to exercise its renewal options. In addition, federal contractstypically are only partially funded at any point during their term, and all orsome of the work to be performed under a contract may remain unfunded unlessand until Congress makes subsequent appropriations and the procuring agencyallocates funding to the contract. Our estimate of the portion of backlog fromwhich we expect to recognize revenues in fiscal 2005 or any future period islikely to be inaccurate because the receipt and timing of any of these revenuesis dependent upon subsequent appropriation and allocation of funding and issubject to various contingencies, such as timing of task orders, many of whichare beyond our control. In addition, we may never receive revenues from some ofthe engagements that are included in our backlog and this risk is greater withrespect to unfunded backlog. 

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Theactual receipt of revenues on engagements included in backlog may never occuror may change because a program schedule could change, the program could becanceled, the governmental agency could elect not to exercise renewal optionsunder a contract or could select other contractors to perform services, or acontract could be reduced, modified or terminated. We adjust our backlog on aquarterly basis to reflect modifications to or renewals of existing contractsor task orders, awards of new contracts or task orders, or approvals ofexpenditures. Additionally, the maximum contract value specified under agovernment contract or task order awarded to us is not necessarily indicativeof the revenues that we will realize under that contract. We also deriverevenues from ID/IQ contracts, which typically do not require the government topurchase a specific amount of goods or services under the contract other than aminimum quantity which is generally very small. If we fail to realize revenueincluded in our backlog, our revenues and operating results for the thencurrent fiscal year as well as future reporting periods could be materially adverselyaffected.

**Lossof our GSA contracts or GWACs would impair our ability to attract new business.**

We are a prime contractorunder several GSA contracts and GWAC schedule contracts. We believe that ourability to continue to provide services under these contracts will continue tobe important to our business because of the multiple opportunities for newengagements each contract provides. If we were to lose our position as primecontractor on one or more of these contracts, we could lose substantial revenuesand our operating results could suffer. GSA contracts and other GWACs typicallyhave a one or two-year initial term with multiple options exercisable at thegovernment client’s discretion to extend the contract for one or more years. Wecannot be assured that our government clients will continue to exercise theoptions remaining on our current contracts, nor can we be assured that ourfuture clients will exercise options on any contracts we may receive in thefuture.

**Ifsubcontractors on our prime contracts are able to secure positions as primecontractors, we may lose revenue.**

For each of the pastseveral years, as the GSA schedule contracts and GWACs have increasingly beenused as contract vehicles, we have received substantial revenue from governmentclients relating to work performed by other information technology providersacting as subcontractors to us. In some cases, companies that have not held GSAschedule contracts or secured positions as prime contractors on GWACs haveapproached us in our capacity as a prime contractor, seeking to performservices as our subcontractor for a government client. Some of these providersthat are currently acting as subcontractors to us may in the future securepositions as prime contractors. If one or more of our current subcontractorsare awarded prime contractor status in the future, it could reduce or eliminateour revenue for the work they were performing as subcontractors to us. Revenuederived from work performed by our subcontractors represented approximately 15%and 16%, respectively of our revenue for each of fiscal 2005 and 2004.

**Risks Associated with International Operations**

**Ourinternational business exposes us to additional risks including exchange ratefluctuations, foreign tax and legal regulations and political or economicinstability that could materially adversely affect our operating results.**

In connection providingservices to our clients, we are sometimes required to engage in internationaloperations (including international operations under U.S. government contracts).Conducting international business subjects us to risks associated withoperating in and selling to foreign countries, including:

·       devaluationsand fluctuations in currency exchange rates;

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·       changesin or interpretations of foreign regulations that may adversely affect ourability to sell all of our products or repatriate profits to the United States;

·       impositionof limitations on conversions of foreign currencies into dollars;

·       impositionof limitations on or increase of withholding and other taxes on remittances andother payments by foreign subsidiaries or joint ventures;

·       compliancewith U.S. laws and regulations that apply extraterritorially which mayconflict, in whole or in part, with local laws and regulations in countrieswhere we operate;

·       compliancewith the local labor laws of the countries in which we operate;

·       hyperinflationor political instability in foreign countries;

·       potentialpersonal injury to our personnel who may be exposed to military conflictsituations in foreign countries;

·       impositionor increase of investment and other restrictions or requirements by foreigngovernments;

·       compliancewith U.S. export control laws and regulations, which may effect our ability toprovide goods and services abroad.

To the extent that ourcustomers request us to provide services and support outside of the UnitedStates, these and other risks associated with international operations arelikely to increase. Although such risks have not harmed our operating resultsin the past, no assurance can be given that such risks will not materiallyadversely affect our operating results in the future.

**Risks Related to Our Business**

**Wemay lose money or generate less than anticipated profits if we do not accuratelyestimate the cost of our performance under fixed price or time and materialscontracts.**

Some of our contracts require that we perform on afixed price basis. We derived 26.2% of our total revenue in fiscal 2005 and22.6% of our total revenue in fiscal 2004 from fixed price contracts. A fixedprice contract generally provides that we will receive a specified price forour performance under the contract, regardless of the cost to us of suchperformance. This requires that we accurately estimate the cost that we willincur to perform our obligations under any contract at the time that we submitour proposal to the applicable government agency. When making proposals forengagements on a fixed price basis, we rely on our estimates of costs andtiming for completing the projects. These estimates are subject to numerousvariables and uncertainties, and there can be no assurance that the costs ofperforming under any fixed price contract will not exceed, perhapssubstantially, our estimates. Any increased or unexpected costs orunanticipated delays in connection with the performance of fixed pricecontracts, including costs and delays caused by factors outside our control,could make these contracts less profitable than anticipated or could cause usto incur losses, which could be substantial, on these contracts. In the past,we have from time to time incurred losses on some fixed price contracts and ourprofits on some fixed price contracts have been less than anticipated. Ouroperating results could be materially adversely affected if the actual costs ofperforming under these contracts exceed our estimates.

Many of our contracts areperformed on a time and materials basis. A time and materials contracttypically provides that we are paid a fixed hourly rate for direct labor costsexpended and reimbursed for allowable materials, costs and expenses. We derived43.8% of our total revenues in fiscal 2005 and 46.3% of our total revenues forfiscal 2004 from time and materials contracts. While time and materials contractsare generally subject to less uncertainty than fixed price contracts, to theextent that our actual labor costs are higher than the contract rates, we maylose money on the contract.

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**Our margins andoperating results may suffer if cost reimbursable contracts increase as apercentage of our total government contracts.**

In general, costreimbursable contracts are the least profitable of our government contracts.Our cost reimbursable contracts generally provide for reimbursement of costs,which are determined to be reasonable, allowable and allocable to the contract,as well as payment of a fee representing the profit margin negotiated betweenus and the contracting agency, which may be fixed or performance based. Ourtime and materials contracts generally are more profitable than our costreimbursable contracts. Cost reimbursable contracts contributed 30.0% and 31.1%of our total revenues in fiscal 2005 and fiscal 2004, respectively. To theextent that cost reimbursable contracts represent an increased proportion ofour total government contracts, our operating results could be materiallyadversely affected.

**Ourmarkets are highly competitive, and many of the companies we compete against havesubstantially greater resources.**

We operate in highly competitive markets that includea large number of participants and involve intense competition to wincontracts. Many of our competitors may compete more effectively than we canbecause they are larger, have greater financial and other resources, havebetter or more extensive relationships with government officials involved inthe procurement process and have greater brand or name recognition. In order tostay competitive in our industry, we must attract and retain the highly skilledemployees necessary to provide our services and keep pace with changingtechnologies and client preferences. In addition, some of our competitors haveestablished alliances or strategic relationships among themselves or with thirdparties in order to increase their ability to address client needs. As aresult, new competitors or alliances among competitors may emerge and competemore effectively than we can. There is also a significant industry trendtowards consolidation which may result in the emergence of larger companiesthat may be better able to compete with us. If we are unable to competeeffectively, our business could be materially adversely affected.

**Ourfailure to attract and retain qualified employees, including our executive andsenior management team, may adversely affect our business.**

Our continued success depends to a substantial degreeon our ability to recruit and retain the technically skilled personnel we needto serve our clients effectively. Our business involves the development oftailored technology solutions for our clients, a process that relies heavilyupon the expertise and services of our employees. Competition for skilledpersonnel in the information technology services industry is intense, and technologyservice companies often experience high attrition among their skilledemployees. Recruiting and training these employees require substantialresources. Our failure to attract and retain technical personnel could increaseour costs of performing our contracts, reduce our ability to meet our clients’needs, limit our ability to win new business and constrain our ability to grow.

Certain types of servicesare subject to the Service Contract Act and the Davis-Bacon Act. TheseActs require that the contractor pay to all personnel assigned to the contractat least the prevailing wage and fringe benefits, as established by and inaccordance with the regulations promulgated by the Department of Labor. We havean established policy pursuant to which we evaluate RFP’s that include ServiceContract Act and Davis-Bacon Act requirements and, in the event of anaward to us, ensure our compliance with these requirements.

**Wemay be affected by intellectual property infringement claims.**

Our businessoperations may rely on intellectual property. Our employees develop some of thesoftware solutions and other forms of intellectual property that we use toprovide IT solutions to our customers, but we also may license technology fromother entities. Typically, under Federal Government contracts, our customersmay claim rights in the intellectual property we develop, making it impossiblefor 

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us toprevent their future use of our intellectual property. We are and may in thefuture be subject to claims from our employees or third parties who assert thatsoftware solutions and other forms of intellectual property that we used indelivering services and solutions to our customers infringe upon intellectualproperty rights of such employees or third parties. If our vendors, employeesor third parties assert claims that we or our customers are infringing on theirintellectual property, we could incur substantial costs to defend these claims.In addition, if any of these infringement claims are ultimately successful, wecould be required to:

·       ceaseselling or using products or services that incorporate the challenged softwareor technology;

·       obtaina license or additional licenses; or

·       redesign our products andservices that rely on the challenged software or technology.

**Asubstantial majority of our historical growth has been due to acquisitions andwe may have difficulty identifying and executing future acquisitions onfavorable terms, which may adversely affect our results of operations and stockprice.**

A substantial majority of our historical growth wasthe result of acquisitions, and the selective pursuit of acquisitions remainsone of our key growth strategies. We cannot assure you that we will be able toidentify and execute suitable acquisitions in the future on terms that arefavorable to us, or at all.

We may encounterother risks in executing our acquisition strategy, including:

·       increasedcompetition for acquisitions which may increase the price of our acquisitions;and

·       ourfailure to discover material liabilities during the due diligence process,including the failure of prior owners of any acquired businesses or theiremployees to comply with applicable laws or regulations such as the FederalAcquisition Regulation and health, safety, employment and environmental lawsand regulations, or their failure to fulfill their contractual obligations tothe Federal Government or other clients.

In connection with any future acquisitions, we maydecide to consolidate the operations of any acquired business with our existingoperations or to make other changes with respect to the acquired business,which could result in special charges or other expenses. Our results ofoperations also may be adversely affected by expenses we incur in makingacquisitions and, in the event that any goodwill resulting from present orfuture acquisitions is found to be impaired, by goodwill impairment charges. Asof December 31, 2005, assuming that the Zen acquisition had occurred onsuch date, we had approximately $225.3 million of goodwill resulting fromacquisitions on our balance sheet and, to the extent we make futureacquisitions, the amount of goodwill could increase, perhaps substantially. Anyof the businesses we acquire may also have liabilities or adverse operatingissues.

In addition, our abilityto make future acquisitions may require us to obtain additional financing andwe may be materially adversely affected if we cannot obtain additionalfinancing for any future acquisitions. To the extent that we seek to acquireother businesses in exchange for our common stock, fluctuations in our stockprice could have a material adverse effect on our ability to completeacquisitions and the issuance of common stock to acquire other businesses couldbe dilutive to our stockholders. To the extent that we use borrowings toacquire other businesses, our debt service obligations could increasesubstantially and relevant debt instruments may, among other things, imposeadditional restrictions on our operations, require us to comply with additionalfinancial covenants or require us to pledge additional assets to secure ourborrowings.

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**Wemay have difficulty integrating the operations of any companies we acquire,which may adversely affect our results of operations.**

The success of ouracquisition strategy will depend upon our ability to successfully integrate anybusinesses we may acquire in the future. The integration of these businessesinto our operations may result in unforeseen events or operating difficulties,absorb significant management attention and require significant financialresources that would otherwise be available for the ongoing development of ourbusiness. These integration difficulties could include the integration ofpersonnel with disparate business backgrounds, the transition to newinformation systems, coordination of geographically dispersed organizations,loss of key employees of acquired companies and reconciliation of differentcorporate cultures. For these or other reasons, we may be unable to retain keyclients or to retain or renew contracts of acquired companies. Moreover, anyacquired business may fail to generate the revenue or net income we expected orproduce the efficiencies or cost-savings that we anticipated. Any of theseoutcomes could materially adversely affect our operating results.

**If weare unable to manage our growth, our business may be adversely affected.**

Sustaining our growth hasplaced significant demands on our management, as well as on our administrative,operational and financial resources. If we continue to grow, we must improveour operational, financial and management information systems and expand,motivate and manage our workforce. If we are unable to do so, or if new systemsthat we implement to assist in managing any future growth do not produce theexpected benefits, our business, prospects, financial condition or operatingresults could be materially adversely affected.

**Systemsfailures may disrupt our business and have an adverse effect on our results ofoperations.**

Any systems failures, including failure of network,software or hardware systems, whether caused by us, a third-party serviceprovider, unauthorized intruders and hackers, computer viruses, naturaldisasters, power shortages or terrorist attacks, could cause loss of data andinterruptions or delays in our business or that of our clients. In addition,the failure or disruption of mail, communications or utilities could cause usto interrupt or suspend our operations or otherwise harm our business. Ourproperty and business interruption insurance may be inadequate to compensate usfor losses that may occur as a result of any system or operational failure ordisruption, and insurance to cover these types of risks may not be available inthe future on terms that we consider acceptable, if at all.

The systems and networksthat we maintain for our clients, although redundant in their design, couldalso fail. If a system or network we maintain were to fail or experienceservice interruptions, we might experience loss of revenue or face claims fordamages or contract termination. Our liability insurance may be inadequate tocompensate us for damages that we might incur and liability insurance to coverthese types of risks may not be available in the future on terms that weconsider acceptable, or at all.

**Ifour subcontractors fail to perform their contractual obligations, ourperformance as a prime contractor and our ability to obtain future businesscould be materially and adversely impacted.**

Approximately 15% and 16%,respectively, of our total revenue in each of fiscal 2005 and fiscal 2004 wasgenerated by work performed by subcontractors who perform a portion of the workwe are obligated to deliver to our clients. A failure by one or more of oursubcontractors to satisfactorily deliver on a timely basis the agreed-uponsupplies and/or perform the agreed-upon services may materially and adverselyaffect our ability to perform our obligations as a prime contractor. In extremecases, a subcontractor’s performance deficiency could result in the FederalGovernment terminating our contract for default. A default termination couldexpose us to liability for excess costs of reprocurement by the government andhave a material adverse effect on our ability to compete for future contractsand task orders.

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**Ourindebtedness and debt service obligations may increase substantially and wewill be subject to restriction under debt instruments.**

As of December 31, 2005, we had approximately $99.3million of debt outstanding under our Credit Agreement which had a  borrowing capacity of $160 million, comprisedof a $60 million five-year revolving credit facility and a $100 millionsix-year term loan facility. We further amended this Credit Agreement, pursuantto the First Amendment entered into contemporaneously with the closing of ouracquisition of Zen on February 27, 2006, which increased the availableterm loan amount to approximately $129.3 million. We had approximately $129.3million of debt outstanding under our Amended Credit Agreement on February 27,2006 following the closing of our acquisition of Zen.

Our leverage may increase as a result of any futureacquisitions and, accordingly, the amount of our indebtedness will likelyincrease, perhaps substantially.

Our indebtednesscould have significant negative consequences, including:

·       increasingour vulnerability to general adverse economic and industry conditions;

·       limitingour ability to obtain additional financing;

·       requiringthat a substantial portion of our cash flow from operations be applied to payour debt service obligations, thus reducing cash available for other purposes;

·       limitingour flexibility in planning for or reacting to changes in our business or inthe industry in which we compete; and

·       placingus at a possible disadvantage compared to our competitors with less leverage orbetter access to capital.

Our Amended Credit Agreement bears interest atvariable rates based upon prevailing market interest rates, which exposes us tothe risk of increased interest rates. Also, our Amended Credit Agreementrequires that we comply with various financial covenants and imposerestrictions on us, including restrictions on, among other things, our abilityto incur additional indebtedness or liens, make acquisitions and pay dividendson our capital stock.

Our ability to make scheduled payments of theprincipal of, to pay interest on, or to refinance, our debt will dependprimarily on our future performance, which to a certain extent is subject tothe economic, financial, competitive and other factors beyond our control.There can be no assurance that our business will continue to generatesufficient cash flow from operations in the future to service our debt or meetour other cash needs. If we are unable to generate this cash flow from ourbusiness, we may be required to refinance all or a portion of our existingdebt, sell assets or obtain additional financing to meet our debt obligationsand other cash needs. We cannot assure you that any such refinancing, sale ofassets or additional financing would be possible on terms that we would findacceptable.

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If we fail tocomply with the financial covenants in our Amended Credit Agreement, ourlenders may exercise remedies, including requiring immediate repayment of alloutstanding amounts. These financial covenants are calculated according to thedefinition of terms contained in the Amended Credit Agreement, which may differfrom calculations using generally accepted accounting principles, or GAAP. Thefinancial covenants in our credit facility following the acquisition of Zeninclude the following:

·       the First Amendment toCredit Agreement amended the leverage ratio that requires us to maintain aratio of funded debt to consolidated EBITDA for such period as follows:

| **Period**                                                                        | ** ** | ** ** | ** **   | **Amended Term Loan  Maximum Ratio** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------|--------------|-----------------------------------------------------|------------|
| First Amendment  Effective Date through fiscal quarter ending  June 30, 2006 |       |       | 3.75 to 1.00 |                                                |       |
| July 1, 2006  through fiscal quarter ending June 29, 2007               |       |       | 3.50 to 1.00 |                                                |       |
| June 30,  2007 through fiscal quarter ending June 27, 2008              |       |       | 3.00 to 1.00 |                                                |       |
| June 28, 2008 and  thereafter                                                |       |       | 2.75 to 1.00 |                                                |       |

 

·       afixed charge coverage ratio that requires us to maintain a ratio, on aconsolidated basis for the twelve month period ending on the last day of anyfiscal quarter, of (i) consolidated EBITDA less consolidated capitalexpenditures for such period, to (ii) the sum of consolidated interestexpense plus scheduled funded debt payments plus cash taxes for such period, ofgreater than or equal to 1.25 to 1.00; and

·       theamount of consolidated capital expenditures made in cash during any fiscal yearis limited to 2.00% of consolidated gross revenues plus the unused portion onconsolidated capital expenditures that would have been permitted in theprevious fiscal year in an amount not to exceed $1,000,000.

The borrowings and other amounts due under our AmendedCredit Agreement are secured by substantially all of our current and futuretangible and intangible assets, including accounts receivable, inventory andcapital stock of our existing or future subsidiaries. Our ability to obtainother debt financing may therefore be adversely affected because the lendersunder our Amended Credit Agreement will have a prior lien on our assets tosecure amounts we owe to them. In addition, upon the occurrence of specifiedevents of default under the Amended Credit Agreement, the lenders would beentitled to demand immediate repayment of all borrowings and other amountsoutstanding under the Amended Credit Agreement and to realize upon thecollateral pledged under the Amended Credit Agreement to satisfy ourobligations to them.

The AmendedCredit Agreement also requires us to comply with certain covenants, including,among others, provisions:

·       relatingto the maintenance of our assets securing the debt;

·       restrictingour ability to pledge assets or create other liens;

·       restrictingour ability to incur additional debt beyond certain levels and in certaincircumstances;

·       restrictingour ability to make certain distributions, investments and restricted payments,including dividend payments on our equity securities;

·       restrictingour ability to alter the conduct of our business or corporate existence;

·       restrictingour ability to amend, modify, cancel, terminate or fail to renew materialcontracts;

·       restrictingour ability to enter into transactions with affiliates;

·       restrictingour ability to consolidate, merge, or sell our assets;

·       restrictingour ability to purchase property or assets other than in the ordinary course ofbusiness; and

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·       restricting our ability toamend, modify or change our organizational documents, including our charter andbylaws.

**Risks Related to Our Common Stock**

**Provisionsof our charter and bylaws and Delaware law make a takeover of our company moredifficult.**

Our basic corporatedocuments and Delaware law contain provisions that might enable our managementto resist an attempt to take over our company. For example, our Board ofDirectors can issue shares of common stock and preferred stock withoutstockholder approval, and the board could issue stock to dilute and adverselyaffect various rights of a potential acquiror. Other provisions of our charterand bylaws that could deter or prevent a third party from acquiring us include:

·       thedivision of our Board of Directors into three separate classes serving staggeredthree-year terms;

·       theabsence of cumulative voting in the election of our directors, which means thatthe holders of a majority of the voting power of our outstanding capital stockhave the power to elect all of our directors;

·       limitationson the ability of our stockholders to remove directors and the provisionsrequiring that vacancies in our board of directors must be filled by theremaining directors;

·       prohibitionson our stockholders from acting by written consent or calling special meetings;and

·       proceduresfor advance notification of stockholder nominations.

We are subject to Section 203 of the DelawareGeneral Corporation Law that, subject to exceptions, would prohibit us fromengaging in any business combination with any interested stockholder, asdefined in that section, for a period of three years following the date onwhich that stockholder became an interested stockholder.

The board could use theseand other provisions to discourage, delay or prevent a change in the control ofour company or a change in our management. These provisions might alsodiscourage, delay or prevent an acquisition of our company at a price that youmay find attractive. These provisions could also make it more difficult for youand our other stockholders to elect directors and take other corporate actionsand could limit the price that investors might be willing to pay for shares ofour common stock.

**Futuresales of shares of our common stock and the resulting dilution that would occurwith such sales could cause the market price of our common stock to decline.**

Sales of a substantial number of shares of commonstock in the public market in the course of any offering made pursuant to aregistration statement, including any subsequent registration statement, or theperception that such sales could occur, could materially adversely affect themarket price of our common stock and make it more difficult for us to sellequity securities in the future at a time and price we deem appropriate. As of March 1,2006, we had 11,426,232 shares of common stock outstanding.

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**Item 2. Properties**

As of December 31, 2005, we leased 27 offices and3 warehouse at various U.S. locations for an aggregate of 544,970 square feet in 15 states and theDistrict of Columbia, of which we sublease 47,861 square feet to third parties.

Our corporate offices are located at 12012 SunsetHills Road, Reston, Virginia in approximately 68,000 square feet of leasedspace.

Our other majoroffices are located in Colorado Springs, Colorado, Harrisonburg, Virginia, andin the Washington DC metropolitan area.

·       OurColorado Springs properties consist of approximately 35,000 square feet under alease that expires in April 2006 and approximately 68,000 square feetunder a lease that expires in November 2006. Both of these leasedfacilities are being replaced by a new 2-building office campus totaling123,200 square feet. The lease of these campus buildings will begin in May 2006.

·       InHarrisonburg, Virginia we occupy an office (15,507 sq ft under a lease thatexpires in November 2013) and a contract-committed warehouse (120,000 sqft under a lease that expires August 2007).

·       InFairfax, Virginia we have an office consisting of approximately 37,000 squarefeet under a lease that expires in December 2009.

·       InArlington, Virginia, our office consists of approximately 14,100 square feetunder a lease that expires in December 2012.

·       InRockville, Maryland, we have an office consisting of approximately 24,000square feet under a lease expiring in November 2011.

·       OurColumbia, Maryland office occupies 21,223 square feet under a lease expiring in2012.

·       InBethesda, Maryland, as a result of acquiring Zen, we have office space ofapproximately 10,738 square feet under a lease that expires November 30,2008.

·       Inaddition, we have employees who work on engagements at other smaller operatinglocations around the United States.

All of our offices are innew, or reasonably modern, well-maintained buildings. The facilities aresubstantially utilized and are adequate for present operations. We do not ownany real estate.

**Item 3. Legal Proceedings**

From time to time, we are involved in litigation,claims and disputes that arise in the ordinary course of its business. Inaddition, we are subject to audit, review, and investigation by variousagencies of the Federal Government to determine compliance with applicablefederal statutes and regulations. As a Federal Government contractor, we aresubject to audit by certain federal agencies to determine if our performanceand administration of our government contracts are compliant with contractualrequirements and applicable federal statutes and regulations. While we cannot predict the ultimate outcome oflegal proceedings, government audits, investigations, claims and disputes towhich we are or may be subject, we currently believe, based uponinformation available to us as of the date of this filing, that any ultimateliability arising out of these matters will not have a material adverse effecton our financial position, results of operations, or cash flows.

The SEI acquisition agreement provides for apurchase price adjustment based upon the working capital of SEI as of theclosing date. Subsequent to the closing date, we received a payment of$1.6 million in connection with services performed prior to the closing datethat SEI had not previously billed, and was 

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not authorized to bill,its customer as of the closing date. The SEI selling stockholders haveasserted that they are entitled to a credit in connection with thecalculation of working capital adjustment in an amount equal to the amountreceived by us for this post-closing payment. We believe that, inaccordance with GAAP, the SEI selling stockholders should not receive thebenefit of the post-closing payment. In accordance with the terms of the SEIacquisition agreement, the parties have jointly submitted the issue to anindependent accounting firm for resolution. We anticipate that this matter willbe resolved before the end of 2006.

**Item 4. Submission ofMatters To a Vote of Security Holders:**   TheCompany had no matters submitted to stockholders for their consideration duringthe fourth quarter ended December 31, 2005.

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**PART II**

**Item 5. Market for theCompany’s Common Equity and Related Stockholder Matters and Issuer Purchases ofEquity Securities:****  **Since November 12,2002, SI International’s common stock has been publicly traded on the NasdaqNational Market under the symbol “SINT.” Prior to November 12, 2002, SIInternational’s common stock was not publicly traded. The high and low salesprices of SI International’s common stock for the time period indicated below,as reported by the Nasdaq National Market, were:

| ** **                          | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------------------------------|------------|----------|------------|---------|------------|
| Year ended  December 31, 2005: |       |     |       |    |       |
| First Quarter                       |       | $        | 31.29      |    | $          | 23.03 |   |
| Second Quarter                      |       | $        | 30.36      |    | $          | 22.31 |   |
| Third Quarter                       |       | $        | 33.64      |    | $          | 26.84 |   |
| Fourth Quarter                      |       | $        | 31.88      |    | $          | 24.80 |   |
| Year ended  December 25, 2004: |       |     |       |    |       |
| First Quarter                       |       | $        | 24.70      |    | $          | 16.25 |   |
| Second Quarter                      |       | $        | 28.77      |    | $          | 20.90 |   |
| Third Quarter                       |       | $        | 24.70      |    | $          | 16.93 |   |
| Fourth Quarter                      |       | $        | 32.64      |    | $          | 20.68 |   |

 

As of March 1, 2006, there wereapproximately 118 holders of record of our common stock. As of March 1,2006, the closing price of our common stock was $32.61.

We have never declared or paid any cash dividends onour common stock. We currently intend to retain earnings, if any, to supportour growth strategy and do not anticipate paying cash dividends in theforeseeable future.

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**Item 6. Selected FinancialData:****  **The selectedfinancial data presented below for our 2005, 2004, and 2003 fiscal years arederived from our audited consolidated financial statements included in this Form 10-K.The selected financial data presented below for our 2002 and 2001 fiscal yearsare derived from our audited consolidated financial statements not included inthis Form 10-K. You should read the selected financial datapresented below in conjunction with the consolidated financial statements, thenotes to the consolidated financial statements and with “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”included elsewhere in this Form 10-K. Our fiscal year is based onthe calendar year and ends each year on the Saturday closest to December 31of that year. **All fiscal years shown below, excluding 2005,include 52 weeks. Fiscal 2005 includes 53 weeks.**

| ** **                                               | ** ** | **Fiscal Year  SI International, Inc.**                          | ** ** |
|----------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **2005**                                                                        | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                               | ** ** | **(dollars in thousands, except per share data)** | ** ** |
| **Statement of Operations Data:**                        |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Revenue                                                  |       | $                                                                               | 397,919    |   | $ | 262,306 |   | $ | 168,287 |   | $ | 149,351 |   | $ | 146,583 |   |
| Costs and expenses:                                      |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Direct costs                                             |       | 246,481                                                                         |       | 166,774 |   | 101,940 |   | 91,240 |   | 87,071 |   |
| Indirect costs                                           |       | 113,015                                                                         |       | 71,917 |   | 51,569 |   | 49,404 |   | 49,495 |   |
| Depreciation                                             |       | 2,161                                                                           |       | 2,231 |   | 2,009 |   | 1,988 |   | 1,653 |   |
| Amortization                                             |       | 2,292                                                                           |       | 648 |   | — |   | — |   | 3,586 |   |
| Total operating expenses                                 |       | 363,949                                                                         |       | 241,570 |   | 155,518 |   | 142,632 |   | 141,805 |   |
| Income from operations                                   |       | 33,970                                                                          |       | 20,736 |   | 12,769 |   | 6,719 |   | 4,778 |   |
| Other income (expense)                                   |       | 12                                                                              |       | (1 | ) | — |   | — |   | — |   |
| Interest expense                                         |       | (6,103                                                                          | )          | (2,760 | ) | (606 | ) | (3,319 | ) | (3,451 | ) |
| Minority interests                                       |       | —                                                                          |       | — |   | — |   | (118 | ) | (144 | ) |
| Change in fair value of  put warrants                    |       | —                                                                          |       | — |   | — |   | 640 |   | (1,255 | ) |
| Income (loss) before  provision for income taxes         |       | 27,879                                                                          |       | 17,975 |   | 12,163 |   | 3,922 |   | (72 | ) |
| Provision for income  taxes                              |       | 10,942                                                                          |       | 7,098 |   | 4,784 |   | 1,439 |   | 657 |   |
| Net income                                               |       | 16,937                                                                          |       | 10,877 |   | 7,379 |   | 2,483 |   | (729 | ) |
| Dividends on redeemable  cumulative preferred stock |       | —                                                                          |       | — |   | — |   | 1,954 |   | 2,052 |   |
| Net income (loss)  attributable to common stockholders   |       | $                                                                               | 16,937     |   | $ | 10,877 |   | $ | 7,379 |   | $ | 529 |   | $ | (2,781 | ) |
| Earnings (loss) per common share:                        |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Basic earnings (loss)  per share                         |       | $                                                                               | 1.51       |   | $ | 1.20 |   | $ | 0.87 |   | $ | 0.16 |   | $ | (1.06 | ) |
| Diluted earnings (loss)  per share                       |       | 1.45                                                                            |       | 1.14 |   | 0.87 |   | (0.03 | ) | (1.06 | ) |
| **Balance Sheet Data (at period end):**                  |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                               |       | $                                                                               | 26,160     |   | $ | 3,754 |   | $ | 12,302 |   | $ | 10,856 |   | $ | 470 |   |
| Working capital                                          |       | 76,023                                                                          |       | 21,927 |   | 39,708 |   | 29,937 |   | 16,103 |   |
| Total assets                                             |       | 335,695                                                                         |       | 212,107 |   | 106,627 |   | 92,315 |   | 80,461 |   |
| Total debt, including  capital lease obligations         |       | 99,542                                                                          |       | 29,291 |   | 530 |   | 658 |   | 40,082 |   |
| Total stockholders’  equity (deficit)               |       | 167,869                                                                         |       | 145,070 |   | 81,547 |   | 73,977 |   | (2,431 | ) |
| **Other Financial Data:**                                |       |                                                                            |       |   |   |   |   |   |   |   |   |
| EBITDA(1)                                                |       | $                                                                               | 38,423     |   | $ | 23,615 |   | $ | 14,778 |   | $ | 8,707 |   | $ | 10,017 |   |
| Capital expenditures                                     |       | 2,727                                                                           |       | 1,225 |   | 1,291 |   | 1,653 |   | 2,577 |   |
| Net cash provided by  (used in) operations               |       | 26,599                                                                          |       | (1,655 | ) | 16,079 |   | 5,680 |   | (1,697 | ) |
| Net cash used in  investing activities                   |       | (74,821                                                                         | )          | (86,665 | ) | (12,241 | ) | (1,653 | ) | (2,577 | ) |
| Net cash provided by (used in) financing activities      |       | 70,628                                                                          |       | 79,772 |   | (2,392 | ) | 6,359 |   | 1,152 |   |

 

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(1)          EBITDA is defined asGAAP net income (loss) plus other expense (income), interest expense, incometaxes, depreciation and amortization, change in the value of put warrants andminority interest.

(2)          EBITDAas calculated by us may be calculated differently than EBITDA for othercompanies. We have provided EBITDA because we believe it is a commonly usedmeasure of financial performance in comparable companies and is provided tohelp investors evaluate companies on a consistent basis, as well as to enhancean understanding of our operating results. EBITDA should not be construed aseither:

·       analternative to net income (loss), as an indicator of our operating performance;or

·       asan alternative to cash flows as a measure of liquidity.

Reconciliationof Net Income to EBITDA is as follows:

| ** **                            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Net income                            |       | $        | 16,937     |     | $          | 10,877   |       | $        | 7,379      |     | $          | 2,483 |   | $ | (729 | ) |
| Other expense  (income)               |       | (12      | )          | 1        |       | —   |       | —   |       | —   |       |
| Interest expense                      |       | 6,103    |       | 2,760    |       | 606      |       | 3,319    |       | 3,451    |       |
| Minority interest                     |       | —   |       | —   |       | —   |       | 118      |       | 144      |       |
| Change in fair  value of put warrants |       | —   |       | —   |       | —   |       | (640     | )          | 1,255    |       |
| Provision for  income taxes           |       | 10,942   |       | 7,098    |       | 4,784    |       | 1,439    |       | 657      |       |
| Depreciation                          |       | 2,161    |       | 2,231    |       | 2,009    |       | 1,988    |       | 1,653    |       |
| Amortization                          |       | 2,292    |       | 648      |       | —   |       | —   |       | 3,586    |       |
| EBITDA                                |       | $        | 38,423     |     | $          | 23,615   |       | $        | 14,778     |     | $          | 8,707 |   | $ | 10,017 |   |

 

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**Item 7. Management’sDiscussion and Analysis of Financial Condition and Results of Operations:****  **The following discussion and analysis shouldbe read in conjunction with the Item 6. “Selected Consolidated Financial Data,”  the consolidated financial statements andrelated notes included elsewhere in this Form 10-K, and theforward-looking disclaimer language in italics before Item 1. “Business”.

*Our fiscal year is basedon a calendar year and ends each year on the Saturday closest to December 31of that year. As a result, our fiscal year may be comprised of 52 or 53 weeks**.***Our 2005fiscal year had 53 weeks. Our 2004 and 2003 fiscal years each had 52 weeks.**

**Overview**

We are, first and foremost, a provider of informationtechnology and network solutions (IT) to the Federal Government. Our clientsinclude the U.S. Air Force, U.S. Army, U.S. Navy, Department of State,Department of Homeland Security, Department of Energy, Department ofAgriculture, National Institutes of Health, Federal Retirement Thrift InvestmentBoard, National Guard Bureau, and the Intelligence community. We combine ourtechnology and industry expertise to provide a full spectrum ofstate-of-the-practice solutions and services, from design and development toimplementation and operations, which assist our clients in achieving missionsuccess. We believe that our company is distinguishable from our peers withinthe federal IT sector in several important respects.

We employ a “RapidResponse • Rapid DeploymentTM” methodology that enables the rapid standing up ofinnovative solutions and the incorporation of additional capabilities in rapidsuccession. This capability allows us to respond to urgent IT imperativesquickly, often in a matter of months, and within a well defined budget. We can,therefore, provide solutions for current IT needs, while establishing aplatform for advancing long-term transformational objectives. We possess aproven ability to respond to high priority information technology and networkneeds through innovation, and an enviable reputation for timely delivery ofrobust solutions on assignments where failure is not an option. Our MissionCritical, Mission Accomplished solutions enable clients to respond to newmandates, expand the scope of their missions, and reengineer underlyingbusiness processes. We have a demonstrated ability of turning troubled ITprojects into winning outcomes and realized exceptional growth fromhigh-quality client engagements. We also utilize mature and proven processes tomanage and market large-scale ID/IQ contracts, such as C4I2TSR. We employ adiverse, innovative team that effectively utilizes small business partners’unique skills and expertise for mission critical IT projects.

**Fiscal2005 Review and Fiscal 2006 Outlook**

During the past year, we experienced continued growthin our four key focus areas: Defense Transformation, Homeland Defense, FederalIT Modernization, and Mission-Critical Outsourcing. In terms of customerconcentration, the DoD continues to grow faster organically than our othercustomers, which is the result of ongoing defense transformation initiativesthat require our specialty in rapidly performing mission-critical work. Virtuallyall of our engagements with the DoD either directly support, or are closelyrelated to DoD Transformation goals. We will continue aligning our programs andcapabilities along our focus areas of Homeland Defense, Federal ITModernization, Mission-Critical Outsourcing, and Defense Transformation, giventhese sectors most accurately reflect our customer’s highest priorities. TheFederal Government’s increased use of technology as a weapon in the war onterrorism and to enhance operational efficiency among federal agencies droveour growth in 2005. We expect that government initiatives involving informationsharing, “net-centric” warfare, and business process transformation will beamong our customer base’s key focus areas in 2006.

With the SEI acquisition, our support to civilianagencies increased as a percentage of total revenue. SEI’s largest client wasthe Department of Homeland Security. The national priority on securing ourborders, along with urgent need for information sharing and other criticalDepartment of Homeland 

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Security issues, willcontinue driving the demand for budget increases in homeland defense. With theBridge acquisition, we expanded our presence in the Intelligence community. Webelieve that this ongoing need for improved intelligence collection will notdiminish. For the foreseeable future, we anticipate that DoD’s, Department ofHomeland Security’s, and the Intelligence community’s IT and networkrequirements will be the largest drivers of our organic growth. Also, strategicacquisitions that add value will continue to impact our future customer mix. Finally,the recent Zen acquisition provides us with greater access to new customers andadditional cross-selling opportunities for our portfolio of mission-criticalsolutions.

The addition of SEI and Bridge allowed us to continuesupporting our existing customer base, while strengthening our position withthe Deparment of Homeland Security and the Intelligence community. Afterconsummating the SEI and Bridge acquisitions, we realigned our practice areasin 2005 to reflect the additional areas of expertise that we obtained fromthese two companies. Our eight practice areas now consist of program management &acquisition support, integrated solutions development, information security,records management, learning solutions, systems engineering, network solutions,and mission-critical outsourcing.

In 2005, Congress delayed approving the governmentfiscal 2006 appropriations bills. For us, this impact was largely confined tonew project starts previously forecasted for our fourth quarter fiscal 2005. Evenin years where Congress passed appropriations bills in a timely fashion, it isnot uncommon for several months to pass before funding was actually issued. Withthe combination of the GSA’s reorganization and recent contract award delays,we expect that government agencies will continue moving away from using GSAcontract vehicles and start utilizing government-wide and agency-specificcontract vehicles more frequently in 2006 until the GSA reorganization iscomplete.

In fiscal 2005 and fiscal 2004, we received 98.1% and96.6%, respectively, of our revenues from services we provided to variousdepartments and agencies of the Federal Government, both directly and throughother prime contractors, and 1.9% and 3.4%, respectively, of our total revenuesfrom work performed for commercial entities. The following table shows ourrevenues from the client groups listed as a percentage of total revenue.Revenue data for the DoD includes revenue generated from work performed underengagements for both the DoD and the Intelligence community.

| ** **                 | ** ** | **Fiscal Year** | ** ** |
|----------------------------|------------|----------------------|------------|
| ** **                 | ** ** | **2005**             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Department of  Defense     |       | 46.9                 | %          | 52.8 | % | 54.5 | % |
| Federal civilian  agencies |       | 51.2                 | %          | 43.8 | % | 39.2 | % |
| Commercial  entities       |       | 1.9                  | %          | 3.4 | % | 6.3 | % |
| Total revenue              |       | 100.0                | %          | 100.0 | % | 100.0 | % |

 

As a result of the Zen acquisition, we believe thatthe percentage of our revenue attributable to the DoD and federal civilianagencies should increase, and the percentage of our revenue attributable tocommercial entities, including international operations, should decreasemarginally.

Wehave derived a substantial majority of our revenues from governmental contractsunder which we act as a prime contractor. We also provide services indirectlyas a subcontractor. The following table shows our revenues as prime contractorand as subcontractor as a percentage of our total revenue for the followingperiods:

| ** **              | ** ** | **Fiscal Year** | ** ** |
|-------------------------|------------|----------------------|------------|
| ** **              | ** ** | **2005**             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Prime contract  revenue |       | 75.4                 | %          | 80.6 | % | 84.3 | % |
| Subcontract  revenue    |       | 24.6                 | %          | 19.4 | % | 15.7 | % |
| Total revenue           |       | 100.0                | %          | 100.0 | % | 100.0 | % |

 

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As a result of the Zen acquisition, we believe thepercentage of our prime contract revenue may increase marginally.

Ourservices are provided under three types of contracts: cost reimbursable, timeand materials and fixed price contracts. The following table shows our revenuesfrom each of these types of contracts as a percentage of our total revenue forthe following periods:

| ** **          | ** ** | **Fiscal Year** | ** ** |
|---------------------|------------|----------------------|------------|
| ** **          | ** ** | **2005**             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Cost reimbursable   |       | 30.0                 | %          | 31.1 | % | 38.3 | % |
| Time and  materials |       | 43.8                 | %          | 46.3 | % | 35.1 | % |
| Fixed price         |       | 26.2                 | %          | 22.6 | % | 26.6 | % |
| Total               |       | 100.0                | %          | 100.0 | % | 100.0 | % |

 

As a result of the acquisition of Zen, we anticipatethat during fiscal year 2006 that the percentage of our revenue attributable totime and materials and fixed price contracts may increase marginally.

Under cost reimbursable contracts, we are reimbursedfor costs that are determined to be reasonable, allowable and allocable to thecontract, and paid a fee representing the profit margin negotiated between usand the contracting agency, which may be fixed or performance based. Under costreimbursable contracts we recognize revenues and an estimate of applicable feesearned as costs are incurred. We consider fixed fees under cost reimbursablecontracts to be earned in proportion to the allowable costs incurred inperformance of the contract. For performance-based fees under costreimbursable contracts, we recognize the relevant portion of the expected feeto be awarded by the client at the time such fee can be reasonably estimated,based on factors such as our prior award experience and communications with theclient regarding performance. In general, cost reimbursable contracts are theleast profitable of our government contracts.

Under time and materials contracts, we are reimbursedfor labor at fixed hourly rates and generally reimbursed separately forallowable materials, costs and expenses. To the extent that our actual laborcosts under a time and materials contract are higher or lower than the billingrates under the contract, our profit under the contract may either be greateror less than we anticipated or we may suffer a loss under the contract. Werecognize revenues under time and materials contracts by multiplying the numberof direct labor hours expended by the contract billing rates and adding theeffect of other billable direct costs. In general, we realize a higher profitmargin on work performed under time and materials contracts than costreimbursable contracts.

Under fixed price contracts, we perform specific tasksfor a fixed price. Compared to cost reimbursable and time and materialscontracts, fixed price contracts generally offer higher profit marginopportunities but involve greater financial risk because we bear the impact ofcost overruns in return for the full benefit of any cost savings. We generallydo not undertake complex, high-risk work, such as long-term softwaredevelopment, under fixed price terms. Fixed price contracts may include eithera product delivery or specific service performance over a defined period.Revenue on fixed price contracts that provide for the Company to renderservices throughout a period is recognized as earned according to contractterms as the service is provided on a proportionate performance basis. While asubstantial number of these contracts are generally less than six months induration, we have several multi-year contracts of this type in which thecustomer has the option to extend the contractual term beyond the current term.

If we anticipate a loss on a contract, we provide forthe full amount of anticipated loss at the time of that determination.

Our most significant expense is direct cost, whichconsists primarily of direct labor costs for program personnel and directexpenses incurred to complete contracts, including cost of materials andsubcontract 

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efforts. Our ability topredict accurately the number and types of personnel, their salaries, and othercosts, can have a significant impact on our direct cost.

The allowability of certain direct and indirect costsin federal contracts is subject to audit by the client, usually through theDCAA. Certain indirect costs are charged to contracts and paid by the clientusing provisional, or estimated, indirect rates, which are subject to laterrevision, based on the government audits of those costs.

Approximately 19.5% of ourrevenue recognized during fiscal 2005 was derived from contracts that, as of February 28,2006, are, or are expected to become, subject to competitive bids prior to theend of government fiscal 2006. We actively monitor our relationships with ourclients during our engagements, as well as the quality of the service weprovide, to assist in our efforts to win recompetition bids. In addition, westrive to maintain good relationships with a wide variety of governmentcontractors.

**Recent Events**

***Zen Acqusition.****  **On February 27, 2006, we closed theacquisition of Zen. Zen is a provider of critical IT services, specializing inmanaged network services, information assurance, software development andsystems engineering, database and systems administration and IT consulting tovarious U.S. Government agencies.  Zen’slargest clients include the Missile Defense Agency (MDA), Department ofDefense’s Washington Headquarters Services (WHS), Federal CommunicationsCommission (FCC), the Pension Benefit Guaranty Corporation (PBGC), and theFederal Trade Commission (FTC).  As aresult of our acquisition of Zen, we gained approximately 275 employees, ofwhich approximately 50% hold security clearances.  The acquisition of Zen provides additionalscale with existing customers as well as diversification with new governmentcustomers.*

*Pursuantto the terms of the Zen Agreement we acquired all of the outstanding capitalstock of Zen for $60 million in cash, of which we are withholding $6 millionfor 15 months in order to secure post-closing indemnity obligations of thesellers.  The purchase price is subjectto a two-way adjustment based upon whether the working capital of Zen as of theclosing date was above or below the target working capital specified in the ZenAgreement.  Each of the parties to theZen Agreement has made customary representations and warranties and agreed tocertain indemnification obligations.   Thetransaction was funded through cash-on-hand, a subordinated Seller’s Note inthe amount of $6 million, and borrowing from our newly amended credit facility,which is described below. We expect the acquisition to be accretive toearnings.  Zen’s trailing twelve monthsrevenue ended November 30, 2005, was approximately $38 million (unaudited).*

*Amendment to CreditFacility.*   On February 27, 2006, we enteredinto the First Amendment. The First Amendment provides new terms and conditionswith respect to the term loan portion of the Credit Agreement and increased theavailable term loan amount to approximately $129.3 million from approximately$99.3 million. The funds borrowed under the new term loan were used to (a) refinancethe initial term loan; (b) to finance the acquisition of Zen; and (c) toprovide for working capital, capital expenditures and other general corporatepurposes. The First Amendment amended the leverage ratio that requires us tomaintain a ratio of funded debt to consolidated EBITDA for such period asfollows:

| **Period**                                                                        | ** ** | ** ** | ** **   | **New Maximum Ratio** | ** ** | **Prior Maximum Ratio** | ** **   |
|-----------------------------------------------------------------------------------|------------|------------|--------------|---------------------------------|------------|-----------------------------------|--------------|
| First Amendment  Effective Date through fiscal quarter  ending June 30, 2006 |       |       | 3.75 to 1.00 |                            |       |                              | 3.50 to 1.00 | * * |   |
| July 1, 2006  through fiscal quarter ending June 29, 2007               |       |       | 3.50 to 1.00 |                            |       |                              | 3.25 to 1.00 | * * |   |
| June 30,  2007 through fiscal quarter ending June 27, 2008              |       |       | 3.00 to 1.00 |                            |       |                              | 3.00 to 1.00 | * * |   |
| June 28, 2008 and  thereafter                                                |       |       | 2.75 to 1.00 |                            |       |                              | 2.75 to 1.00 | * * |   |

* *

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*These ratios will be calculated inaccordance with the definitions and terms contained in the Amended CreditAgreement, which may be different than calculations pursuant to GAAP.*

*NVC Contract Award.*   OnJanuary 31, 2006, in a recompetition for our expiring National VisaCenter, or NVC, contract, we were awarded the successor contract for the NVCcontract by the Department of State. Under the contract, we anticipateperforming over 20 million immigrant visa transactions each year at the NVC inPortsmouth, New Hampshire and at the Kentucky Consular Center in Williamsburg,Kentucky. The prime contract has a one-year base period and four one-yearoptions with a potential value of approximately $84 million, inclusive of theoptions. The prior NVC contract generated 9.1% of our total revenues in fiscal2005 and 9.2% of our total revenues in fiscal 2004.

*Acceleration of Vesting of Stock Options.*   OnDecember 13, 2005, our Board of Directors approved the accelerated vestingof unvested stock options previously awarded to employees, officers anddirectors as of December 7, 2005 in light of new accounting regulationsthat were to come into effect January 1, 2006. Based on the Statement ofFinancial Accounting Standards No. 123R, “Share-Based Payment” (SFAS123R), the Board took the action to accelerate the unvested stock with thebelief that it is in the best interest of stockholders, as it will reduce theCompany’s reported compensation expense in future periods.

**Liquidityand Capital Resources**

*General.*   Short-termliquidity requirements are created by our use of funds for working capital,capital expenditures, and the need to provide debt service. We expect to meetthese requirements through a combination of cash flow from operations andborrowings under our Amended Credit Agreement.

Weanticipate that our long-term liquidity requirements, including any furtheracquisitions, will be funded through a combination of cash flow fromoperations, borrowings under our Amended Credit Agreement, additional securedor unsecured debt or the issuance of common or preferred stock, each of whichmay be initially funded through borrowings under our Amended Credit Agreement.

*Cash and Cash Equivalents.*   Weconsider cash on deposit and all highly liquid investments with originalmaturities of three months or less to be cash and cash equivalents. Cash andcash equivalents, including marketable securities, as of the end of fiscal2005, fiscal 2004, and fiscal 2003 were $34.0 million, $5.8 million, and$23.3 million, respectively.

*Cash Flow.*   Thefollowing table sets forth our sources and uses of cash for the years ended December 31,2005, 2004 and 2003.

| ** **                                           | ** ** | **Fiscal Year**    | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|
| ** **                                           | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                           | ** ** | **(in thousands)** | ** ** |
| Net cash provided  by (used in) operations           |       | $                       | 26,599     |   | $ | (1,655 | ) | $ | 16,079 |   |
| Net cash used in  investing activities               |       | (74,821                 | )          | (86,665 | ) | (12,241 | ) |
| Net cash provided  by (used in) financing activities |       | 70,628                  |       | 79,772 |   | (2,392 | ) |
| Net (decrease) increase  in cash                     |       | $                       | 22,406     |   | $ | (8,548 | ) | $ | 1,446 |   |

 

Our operating cash flow is primarily affected by theoverall profitability of our contracts, our ability to invoice and collect fromour clients in a timely manner, and our ability to manage our vendor payments.We bill most of our clients monthly after services are rendered. Cash providedby operations in fiscal 2005 was attributable to net income of $16.9 million,plus depreciation, amortization and other non-cash items of $9.9 million. Cashused in operations in fiscal 2004 was attributable to an increase in workingcapital of $18.6 million, partially offset by net income of $10.9 million plusdepreciation, amortization and other non-cash items of $6.0 million. Cashprovided by operations in fiscal 2003 was attributable to net income of$7.4 million plus depreciation, amortization and other non-cash items of$2.6 million and a decrease in working capital of $6.1 million.

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Our cash flow used in investing activities consistsprimarily of capital expenditures, the purchase and sale of marketablesecurities, and acquisitions. In fiscal 2005, we paid $74.0 million for SEI,purchased $42.1 million of marketable securities, and purchased capital assetstotalling $2.7 million. We partially offset the cash use with $36.2 million ofproceeds from the sale of marketable securities. In fiscal 2004, we paid $64.9million and $29.5 million, respectively, for Matcom and Bridge acquisitions,purchased $2.1 million of marketable securities, and purchased capital assetstotalling $1.2 million. We partially offset the cash use with $11.0 million ofproceeds from the sale of marketable securities. In fiscal 2003 we purchased$35.6 million of marketable securities and invested $1.3 million incapital assets. We partially offset the cash use with $24.7 million of proceedsfrom the sale of marketable securities.

Our cash flow provided byfinancing activities consists primarily of borrowings under and payments on ourcredit facility. Cash provided by financing activities for fiscal year 2005 wasattributable to proceeds of $100.0 million from the term loan portion of ourcredit facility, and proceeds of $3.7 million from the exercise of stockoptions. Cash provided by financing activities was partially offset byrepayments of borrowings under the line of credit portion of our creditfacility of $29.0 million, payment of debt issuance fees of $3.2 million,partial repayment of the term loan portion of our credit facility of $0.8million, and repayments of capital leases of $0.1 million. Cash provided byfinancing activities for fiscal year 2004 was attributable to proceeds of $51.2million from issuance of common stock from our underwritten public common stockoffering, proceeds of $30.0 million from the term loan portion of our creditfacility, proceeds of $29.0 million from borrowings on the line of creditportion of the credit facility, and proceeds of $0.9 million from the exerciseof stock options. Cash provided by financing activities was partially offset bythe repayment of $30.0 million for the term loan portion of our creditfacility, payment of debt issuance fees of $1.2 million, and repayments ofcapital lease obligations of $0.1 million. Cash used in financing activitiesfor fiscal year 2003 was attributable to repayments of bank overdrafts of$2.2 million, $0.1 million partial repayment of an outstanding notefrom the acquisition of Systems Technology Associates, and payments for ourcapital leases of $0.1million, partially offset by proceeds from the exerciseof stock options of $0.1 million.

**Results of Operations**

Thefollowing table sets forth certain items from our consolidated statements ofoperations as a percentage of revenues for the periods indicated.

| ** **                                | ** ** | **Fiscal Year** | ** ** |
|-------------------------------------------|------------|----------------------|------------|
| ** **                                | ** ** | **2005**             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenue                                   |       | 100.0                | %          | 100.0 | % | 100.0 | % |
| Costs and expenses:                       |       |                 |       |   |   |   |   |
| Direct costs                              |       | 61.9                 |       | 63.6 |   | 60.6 |   |
| Indirect costs                            |       | 28.4                 |       | 27.4 |   | 30.6 |   |
| Depreciation                              |       | 0.5                  |       | 0.9 |   | 1.2 |   |
| Amortization                              |       | 0.6                  |       | 0.2 |   | 0.0 |   |
| Total operating expenses                  |       | 91.4                 |       | 92.1 |   | 92.4 |   |
| Income from  operations                   |       | 8.6                  |       | 7.9 |   | 7.6 |   |
| Interest expense                          |       | (1.5                 | )          | (1.1 | ) | (0.4 | ) |
| Income before  provision for income taxes |       | 7.1                  |       | 6.8 |   | 7.2 |   |
| Provision for  income taxes               |       | 2.8                  |       | 2.7 |   | 2.8 |   |
| Net income                                |       | 4.3                  | %          | 4.1 | % | 4.4 | % |

 

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**Fiscalyear 2005 compared with fiscal year 2004**

*Revenue.**  *Substantially all of our revenue is derived fromservices and solutions provided to the Federal Government, primarily by ouremployees and, to a lesser extent, our subcontractors. Revenues from work underFederal Government contracts increased 54.0% to $390.3 million from$253.4 million for the same period in 2004. This increase was attributableto federal business acquired, new contract awards, successful recompetitionwins on existing programs and growth within existing programs in our three focusareas: Federal IT Modernization/ Mission-Critical Outsourcing, DefenseTransformation, and Homeland Defense. Commercial and other revenues decreased14.5% to $7.6 million in 2005 from $8.9 million in 2004. Thisdecrease was attributable to our continued focus on opportunities for theFederal Government. We expect revenue growth to continue primarily from FederalGovernment civilian and defense organizations.

*Directcosts.*   Direct costs include direct labor andother direct costs, such as materials and subcontracts, incurred to provide ourservices and solutions to our customers. Generally, changes in direct costs arecorrelated to changes in revenue as resources are consumed in the production ofthat revenue. The increase in direct costs from fiscal 2004 to fiscal 2005 wasattributable primarily to the increase in revenue. As a percentage of revenue,direct costs were 61.9% for fiscal 2005 as compared to 63.6% for fiscal 2004. Directcosts will continue to increase in conjunction to revenue growth.

*Indirectcosts.**  *Indirectcosts include facilities, selling, bid and proposal, indirect labor, fringebenefits and other discretionary costs. The increase in indirect costs fromfiscal 2004 to fiscal 2005 was primarily attributable to the expected growth ofsupport functions necessary to facilitate and administer the growth in directcosts. In fiscal 2005, indirect costs were 28.4% of revenue compared to 27.4%of revenue in fiscal 2004. However, we believe in future years, indirect costswill continue to grow, but should decrease as a percentage of sales.

*Depreciationand Amortization.**  *Depreciationand amortization includes the depreciation of computers, furniture and otherequipment, the amortization of third party software we use internally,leasehold improvements and intangible assets. As a percentage of revenue,depreciation was 0.5% for fiscal 2005 as compared to 0.9% for the same periodin fiscal 2004.

*Amortizationof Intangible Assets.**  *Amortizationof intangible assets includes the amortization of intangible assets acquired inconnection with the acquisitions in accordance with SFAS 142, Goodwill andOther Intangible Assets. We discontinued the amortization of goodwill effectiveDecember 30, 2001. Identifiable intangible assets are amortized over theirestimated useful lives. Non-compete agreements are generally amortizedstraight-line over the term of the agreement, while contracts and relatedclient relationships are amortized proportionately against the acquired backlog.For the fiscal year ended December 31, 2005, we amortized $2.3 million ofintangible assets which we capitalized in connection with the acquisitions ofBridge, SEI, and Matcom. For the fiscal year ended December 25, 2004, weamortized $0.6 million of intangible assets which we capitalized in connectionwith the acquisition of Matcom.

*Incomefrom operations.**  *Thisincrease in income from operations from fiscal 2004 to fiscal 2005 wasattributable primarily to the increase in revenue. As a percentage of revenue,income from operations was 8.6% for fiscal 2005 as compared to 7.9% in fiscal2004. We anticipate continued improvement in our operating margin.

*Interestexpense.**  *Interestexpense is primarily related to interest expense incurred or accrued under ouroutstanding borrowings under our credit facility and, going forward, to alesser extent, our interest rate swap agreement. The increase in interestexpense from fiscal 2004 to fiscal 2005 was attributable primarily to theborrowing of debt subsequent to the acquisitions of Bridge, SEI and Matcom. Asa percentage of revenue, interest expense was 1.5% for fiscal 2005 as comparedto 1.1% for the same period in fiscal 2004. We anticipate an increase ininterest expense in fiscal year 2006 due to increased borrowings under our 

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Amended Credit Agreementmade in connection with the Zen acquisition. Interest expense included $705,000and $1,000,000 of amortization and write-off of deferred financing costs duringfiscal 2005 and fiscal 2004.

*Provision for incometaxes.**  *Oureffective tax rate is typically greater than the federal statutory rate of 34%due primarily to state income tax rates and certain nondeductible expenses. Ourfiscal year 2005 tax provision represents an effective tax rate of 39.5%. Ourfiscal 2004 tax provision represents an effective tax rate of 39.3%.

**Fiscalyear 2004 compared with fiscal year 2003**

*Revenue.**  *Revenues from work under Federal Government contractsincreased 60.7% to $253.4 million from $157.7 million for the sameperiod in 2003. This increase was attributable to federal business acquired,new contract awards, successful recompetition wins on existing programs andgrowth within existing programs in our four focus areas: Federal ITModernization, Defense Transformation, Homeland Defense, and Mission-CriticalOutsourcing. Commercial and other revenues decreased 16.0% to $8.9 millionin 2004 from $10.6 million in 2003. This decrease was attributable to ourcontinued focus on opportunities for the Federal Government.

*Directcosts.**  *Theincrease in direct costs from fiscal 2003 to fiscal 2004 was attributableprimarily to the increase in revenue. As a percentage of revenue, direct costswere 63.6% for fiscal 2004 as compared to 60.6% for fiscal 2003.

*Indirectcosts.**  *Theincrease in indirect costs from fiscal 2003 to fiscal 2004 was primarilyattributable to the expected growth of support functions necessary tofacilitate and administer the growth in direct costs.

*Depreciationand Amortization.**  *Theincrease in depreciation and amortization from fiscal 2003 to fiscal 2004 wasattributed primarily to increased capital expenditures and the acquisition ofMatcom. As a percentage of revenue, depreciation was 0.9% for fiscal 2004 ascompared to 1.2% for the same period in fiscal 2003.

*Amortizationof Intangible Assets.**  *Forthe fiscal year ended December 25, 2004, we amortized $0.6 million ofintangible assets which we capitalized in connection with the acquisition ofMatcom. There was no amortization of intangible assets for the fiscal year endedDecember 27, 2003.

*Incomefrom operations.**  *Theincrease in income from operations from fiscal 2003 to fiscal 2004 wasattributable primarily to the increase in revenue. As a percentage of revenue,income from operations was 7.9% for fiscal 2004 as compared to 7.6% in fiscal2003.

*Interestexpense.**  *Theincrease in interest expense from fiscal 2003 to fiscal 2004 was attributableprimarily to the borrowing of debt subsequent to the acquisition of Matcom. Asa percentage of revenue, interest expense was 1.1% for fiscal 2004 as comparedto 0.4% for the same period in fiscal 2003. Interest expense included$1,000,000 and $379,000 of amortization and write-off of deferred financingcosts during fiscal 2004 and fiscal 2003.

*Provisionfor income taxes.**  *Ourfiscal year 2004 tax provision represents an effective tax rate of 39.5%. Ourfiscal 2003 tax provision represents an effective tax rate of 39.3%.

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Thefollowing table sets forth certain items from our consolidated statements ofoperations.

| ** **                         | ** ** | **Fiscal Year** | ** ** | **Percentage Change** | ** ** |
|------------------------------------|------------|----------------------|------------|----------------------------|------------|
| ** **                         | ** ** | **2005**             | ** ** | **2004**                   | ** ** | **2003** | ** ** | **2005 - 2004** | ** ** | **2004 - 2003** | ** ** |
| Revenue                            |       | $                    | 397,919    |                       | $          | 262,306 |   | $ | 168,287 |   |   | 51.7 | % |   |   | 55.9 | % |   |
| Direct Costs                       |       | 246,481              |       | 166,774                    |       | 101,940 |   |   | 47.8 | % |   |   | 63.6 | % |   |
| Indirect Costs                     |       | 113,015              |       | 71,917                     |       | 51,569 |   |   | 57.1 | % |   |   | 39.5 | % |   |
| Depreciation/Amortization          |       | 2,161                |       | 2,231                      |       | 2,009 |   |   | (3.1 | %) |   |   | 11.0 | % |   |
| Amortization of  Intangible Assets |       | 2,292                |       | 648                        |       | — |   |   | 253.7 | % |   |   | 100.0 | % |   |
| Income from  Operations            |       | 33,970               |       | 20,736                     |       | 12,769 |   |   | 63.8 | % |   |   | 62.4 | % |   |
| Other Income  (Expense)            |       | 12                   |       | (1)                        |       | 0 |   |   | 0.0 | % |   |   | 0.0 | % |   |
| Interest Expense                   |       | (6,103               | )          | (2,760                     | )          | (606 | ) |   | 121.1 | % |   |   | 355.4 | % |   |
| Provision for  Income Taxes        |       | 10,942               |       | 7,098                      |       | 4,784 |   |   | 54.2 | % |   |   | 48.4 | % |   |
| Net Income                         |       | 16,937               |       | 10,877                     |       | 7,379 |   |   | 55.7 | % |   |   | 47.4 | % |   |
|                                    |            |                      |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**SupplementalQuarterly Information**

Thefollowing table sets forth quarterly unaudited consolidated financial data forthe fiscal quarters of 2005 and 2004, expressed in dollars and as a percentageof total revenues for the respective periods. We believe that this unauditedfinancial information includes all adjustments, consisting only of normalrecurring adjustments, necessary for a fair presentation of the information foreach period. All of the fiscal quarters reflected in the following table hadthirteen weeks, except for the fourth quarter of fiscal 2005, which hasfourteen weeks.  Some unevenness ofrevenue from quarter to quarter exists primarily because of the timing ofpurchases of materials necessary to perform certain obligations under ourC4I2SR contract with U.S. Air Force Space Command. 

| ** **                       | ** ** | **Fiscal Year 2005**       | ** ** | **Fiscal Year 2004** | ** ** |
|----------------------------------|------------|--------------------------------------|------------|--------------------------------|------------|
| ** **                       | ** ** | **Q1**                               | ** ** | **Q2**                         | ** ** | **Q3** | ** ** | **Q4** | ** ** | **Q1** | ** ** | **Q2** | ** ** | **Q3** | ** ** | **Q4** | ** ** |
| ** **                       | ** ** | **(dollars in thousands)** | ** ** |
| Revenue                          |       | $                                    | 83,717     |                           | $          | 95,983 |   | $ | 101,775 |   | $ | 116,444 |   | $ | 55,970 |   | $ | 63,814 |   | $ | 72,926 |   | $ | 69,596 |   |
| Costs and expenses:              |       |                                 |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Direct costs                     |       | 52,603                               |       | 58,598                         |       | 62,743 |   | 72,537 |   | 33,529 |   | 38,801 |   | 49,106 |   | 45,339 |   |
| Indirect costs                   |       | 23,580                               |       | 27,929                         |       | 28,723 |   | 32,783 |   | 17,309 |   | 19,049 |   | 17,615 |   | 17,943 |   |
| Depreciation                     |       | 551                                  |       | 531                            |       | 504 |   | 575 |   | 589 |   | 598 |   | 516 |   | 527 |   |
| Amortization                     |       | 457                                  |       | 611                            |       | 612 |   | 612 |   | 113 |   | 192 |   | 171 |   | 171 |   |
| Total operating expenses         |       | 77,191                               |       | 87,669                         |       | 92,582 |   | 106,507 |   | 51,540 |   | 58,640 |   | 67,408 |   | 63,980 |   |
| Income from operations           |       | 6,526                                |       | 8,314                          |       | 9,193 |   | 9,937 |   | 4,430 |   | 5,174 |   | 5,518 |   | 5,616 |   |
| Other income (expense)           |       | (99                                  | )          | 14                             |       | 64 |   | 33 |   |   |   |   |   | (62 | ) | 61 |   |
| Interest expense                 |       | (1,097                               | )          | (1,659                         | )          | (1,690 | ) | (1,657 | ) | (534 | ) | (738 | ) | (693 | ) | (796 | ) |
| Provision for income taxes  |       | 2,106                                |       | 2,633                          |       | 2,989 |   | 3,214 |   | 1,539 |   | 1,752 |   | 1,881 |   | 1,926 |   |
| Net income                       |       | $                                    | 3,224      |                           | $          | 4,036 |   | $ | 4,578 |   | $ | 5,099 |   | $ | 2,357 |   | $ | 2,684 |   | $ | 2,882 |   | $ | 2,955 |   |
| Revenue                          |       | 100.0                                | %          | 100.0                          | %          | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
| Costs and expenses:              |       |                                 |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Direct costs                     |       | 62.8                                 |       | 61.1                           |       | 61.6 |   | 62.3 |   | 59.9 |   | 60.8 |   | 67.2 |   | 65.1 |   |
| Indirect costs                   |       | 28.2                                 |       | 29.1                           |       | 28.2 |   | 28.2 |   | 30.9 |   | 29.9 |   | 24.2 |   | 25.8 |   |
| Depreciation                     |       | 0.7                                  |       | 0.6                            |       | 0.5 |   | 0.5 |   | 1.1 |   | 0.9 |   | 0.7 |   | 0.8 |   |
| Amortization                     |       | 0.5                                  |       | 0.6                            |       | 0.6 |   | 0.5 |   | 0.2 |   | 0.3 |   | 0.2 |   | 0.2 |   |
| Total operating expenses         |       | 92.2                                 |       | 91.4                           |       | 90.9 |   | 91.5 |   | 92.1 |   | 91.9 |   | 92.3 |   | 91.9 |   |
| Income from operations           |       | 7.8                                  |       | 8.6                            |       | 9.1 |   | 8.5 |   | 7.9 |   | 8.1 |   | 7.7 |   | 8.1 |   |
| Other income (expense).          |       | (0.1                                 | )          | 0.0                            |       | 0.1 |   | 0.0 |   |   |   |   |   | (0.1 | ) | 0.1 |   |
| Interest expense                 |       | (1.3                                 | )          | (1.7                           | )          | (1.7 | ) | (1.4 | ) | (1.0 | ) | (1.2 | ) | (1.0 | ) | (1.1 | ) |
| Provision for income taxes  |       | 2.5                                  |       | 2.7                            |       | 2.9 |   | 2.7 |   | 2.7 |   | 2.7 |   | 2.6 |   | 2.8 |   |
| Net income                       |       | 3.9                                  | %          | 4.2                            | %          | 4.5 | % | 4.4 | % | 4.2 | % | 4.2 | % | 4.0 | % | 4.3 | % |

 

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**TabularDisclosure of Contractual Obligations**

Our contractualobligations as of December 31, 2005 are as follows (in thousands):

| ** **                       | ** ** | **Payment due by period** | ** ** |
|----------------------------------|------------|------------------------------------------|------------|
| **Contractual Obligations** | ** ** | ** **                               | ** ** | **Total** | ** ** | **1 year** | ** ** | **2 - 3 years** | ** ** | **4 - 5 years** | ** ** | **More than  5 years** | ** ** |
| Capital Lease                    |       | 324                                      |       |   | 116 |   |   |   | 160 |   |   |   | 48 |   |   |   | — |   |   |
| Operating Lease                  |       | 41,029                                   |       |   | 8,373 |   |   |   | 12,387 |   |   |   | 12,092 |   |   |   | 8,177 |   |   |
| Credit Agreement                 |       | 99,250                                   |       |   | 1,000 |   |   |   | 2,000 |   |   |   | 2,000 |   |   |   | 94,250 |   |   |
| **Total**                        | ** ** | **140,603**                              | ** ** | ** ** | **9,489** |   | ** ** | ** ** | **14,547** |   | ** ** | ** ** | **14,140** |   | ** ** | ** ** | **102,427** |   |   |
|                                  |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Purchase obligations related to existing contracts arewith the Federal Government and, in the event any contracts are terminated, wewould have the ability to submit a termination claim for outstanding purchases.

In connection with ouracquisition of Zen, we borrowed approximately $129.3 million in long-termdebt which will be repaid in consecutive quarterly payments of $323,125 each,starting from March 31, 2006 through December 31, 2010, and a finalpayment of approximately $122.8 million on February 9, 2011.

**Effects of Inflation**

We generally have beenable to price our contracts in a manner to accommodate the rates of inflationexperienced in recent years. Under our time and materials contracts, laborrates are usually adjusted annually by predetermined escalation factors. Ourcost reimbursable contracts automatically adjust for changes in cost. Under ourfixed-price contracts, we include a predetermined escalation factor, but wehave generally have not been adversely affected by inflation.

**Off-Balance Sheet Arrangements**

**During fiscal 2005, we were not aparty to any off-balance sheet arrangements.**

**CriticalAccounting Policies and Estimates**

Our significant accountingpolicies are described in Note 2 to our accompanying consolidatedfinancial statements. We consider the accounting policies related to revenuerecognition to be critical to the understanding of our results of operations.Our critical accounting policies also include the areas where we have made whatwe consider to be particularly difficult, subjective or complex judgments inmaking estimates, and where these estimates can significantly impact ourfinancial results under different assumptions and conditions. We prepare ourfinancial statements in conformity with accounting principles generallyaccepted in the United States. As such, we are required to make certainestimates, judgments and assumptions that we believe are reasonable based uponthe information available. These estimates, judgments and assumptions affectthe reported amounts of assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expenses during the periodspresented. Actual results could be different from these estimates.

*Revenue Recognition*

We recognize revenue under its contracts when acontract has been executed, the contract price is fixed and determinable,delivery of services or products has occurred, and collectibility of thecontract price is considered probable and can be reasonably estimated. Revenueis earned under cost reimbursable, time and materials and fixed pricecontracts. Direct contract costs are expensed as incurred.

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Under cost reimbursable contracts, we are reimbursedfor allowable costs, and paid a fee, which may be fixed or performance-based.Revenues on cost reimbursable contracts are recognized as costs are incurredplus an estimate of applicable fees earned. We consider fixed fees under costreimbursable contracts to be earned in proportion of the allowable costsincurred in performance of the contract. For cost reimbursable contracts thatinclude performance based fee incentives, we recognize the relevant portion ofthe expected fee to be awarded by the customer at the time such fee can bereasonably estimated, based on factors such as our prior award experience andcommunications with the customer regarding performance.

Revenue on time and materials contracts are recognizedbased on direct labor hours expended at contract billing rates and adding otherbillable direct costs.

Fixed price contracts may include either a productdelivery or specific service performance throughout a period. For fixed pricecontracts that are based on unit pricing, we recognize revenue for the numberof units delivered in any given fiscal period. For fixed price contracts thatare based on the proportionate performance method and involve a specifiednumber of similar acts, we recognize revenue based on the proportion of thoseacts completed compared to the number of total specified acts required by thecontract. For fixed price contracts that are based on the proportionateperformance method and involve a specified number of defined but not similaracts, we recognize revenue based on the proportion of the project’s percentagetotal costs incurred compared to the estimated total costs associated with theentire transaction. For fixed price contracts that provide for the delivery ofa specific product with related customer acceptance provisions, revenues andassociated contract costs are recognized upon product delivery and customeracceptance.

Our contracts with agencies of the government aresubject to periodic funding by the respective contracting agency. Funding for acontract may be provided in full at inception of the contract or ratablythroughout the contract as the services are provided. In evaluating theprobability of funding for purposes of assessing collectibility of the contractprice, we consider our previous experiences with our customers, communicationswith our customers regarding funding status, and our knowledge of availablefunding for the contract or program. If funding is not assessed as probable,revenue recognition is deferred until realization is deemed probable.

Contract revenue recognition inherently involves estimation,including the contemplated level of effort to accomplish the tasks undercontract, the cost of the effort, and an ongoing assessment of progress towardcompleting the contract. From time to time, as part of the normal managementprocesses, facts develop that require revisions to estimated total costs orrevenues expected. The cumulative impact of any revisions to estimates and thefull impact of anticipated losses on any type of contract are recognized in theperiod in which they become known.

The allowability ofcertain costs under government contracts is subject to audit by the government.Certain indirect costs are charged to contracts using provisional or estimatedindirect rates, which are subject to later revision based on government audits ofthose costs. Management is of the opinion that costs subsequently disallowed,if any, would not be significant.

*Stock BasedCompensation*

We account for stock-based compensation using theintrinsic value method prescribed in APB Opinion No. 25 and relatedinterpretations. Accordingly, compensation expense for stock options ismeasured as the excess, if any, of the fair market value of our stock at thedate of the grant over the exercise price of the related option. We haveadopted the annual disclosure provisions of SFAS No. 148 in our financialreports for the year ended December 31, 2003. The disclosures determinecompensation cost for our stock options based on SFAS No. 123, whichreflects the fair value of each option estimated on the date of grant using theBlack-Scholes option-pricing model.

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In December 2004, theFASB issued FASB Statement No. 123(R) (revised 2004), *Share Based Payment.* Statement 123(R) addressesthe accounting for share-based payment transactions in which an enterprisereceives employee services in exchange for (a) equity instruments of theenterprise or (b) liabilities that are based on the fair value of theenterprise’s equity instruments or that may be settled by the issuance of suchequity instruments. Statement 123(R) requires an entity to recognize thegrant-date fair-value of stock options and other equity-based compensationissued to employees in the income statement. The revised Statement generallyrequires that an entity account for those transactions using the fair-value-basedmethod, and eliminates the intrinsic value method of accounting in APB Opinion No. 25,*Accounting for Stock Issued to Employees*,which was permitted under Statement 123, as originally issued. The revisedStatement requires entities to disclose information about the nature of theshare-based payment transactions and the effects of those transactions on thefinancial statements. Statement 123(R) is effective for the Company beginningJanuary 1, 2006. All public companies must use either the modified prospectiveor the modified retrospective transition method. (See “—Recent Events” abovefor a discussion of changes to our Stock Option programs.)

**Item 7A. Quantitative and Qualitative DisclosuresAbout Market Risk.**

We are exposed to certain financial market risks, themost predominant being fluctuations in interest rates for borrowings under ourcredit facility. Interest rate fluctuations are monitored by our management asan integral part of our overall risk management program, which recognizes theunpredictability of financial markets and seeks to reduce the potentiallyadverse effect on our results of operations. As part of this strategy, we mayuse interest rate swap arrangements to manage or hedge our interest rate risk. Wedo not use derivative financial instruments for speculative or tradingpurposes.

As of December 31, 2005, we had $99.25 millionoutstanding under our Credit Agreement. A 1% change in interest rates wouldhave resulted in our interest expense fluctuating by approximately $250,000 forthe three months ended December 31, 2005.

Effective February 14, 2006, an interest swapagreement came into effect which reduced our exposure associated with themarket volatility of floating LIBOR interest rates. This agreement has anotional principal amount of $30.0 million and, as of December 31,2005, had a rate ranging from 4.05% to 4.74%. This agreement is a hedge againstterm debt, which bears interest at LIBOR plus a margin which has a currentoverall rate of 5.78%. At stated monthly intervals the difference between theinterest on the floating LIBOR-based debt and the interest calculated in theswap agreement are settled in cash.

In addition, historically,our investment positions have been relatively small and short-term in nature.We have typically made investments in a fund with an effective average maturityof fewer than 40 days and a portfolio make-up consisting primarily ofcommercial paper and notes, variable rate instruments, and, to a lesser degree,overnight securities and bank instruments. Since our initial public offering,the Board of Directors approved an investment policy that requires us to investin relatively short-term, high quality, and high liquidity obligations.

**Item 8. Financial Statements and Supplementary Data.**

The consolidated financial statements of SIInternational, Inc. are submitted on pages F-1 through F-36of this report.

49

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**Item 9.**                        Changesin and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

**Item 9A.**                Controlsand Procedures.

*QuarterlyAssessment.**  *Wecarried out an assessment as of December 31, 2005 of the effectiveness ofthe design and operation of our disclosure controls and procedures and ourinternal control over financial reporting. This assessment was done under thesupervision and with the participation of management, including our ChiefExecutive Officer and Chief Financial Officer. Rules adopted by the SECrequire that we present the conclusions of our Chief Executive Officer andChief Financial Officer about the effectiveness of our disclosure controls andprocedures and the conclusions of our management about the effectiveness of ourinternal control over financial reporting as of the end of the period coveredby this Annual Report on Form 10-K.

*CEOand CFO Certifications.**  *Includedas Exhibits 31.1 and 31.2 to this Annual Report on Form 10-K areforms of “Certification” of our Chief Executive Officer and Chief FinancialOfficer. The forms of Certification are required in accordance with Section 302of the Sarbanes-Oxley Act of 2002. This section of the Annual Report on Form 10-Kthat you are currently reading is the information concerning the assessmentreferred to in the Section 302 certifications and this information shouldbe read in conjunction with the Section 302 certifications for a morecomplete understanding of the topics presented.

*DisclosureControls and Procedures and Internal Control over Financial Reporting.**  *Management is responsible for establishing andmaintaining adequate disclosure controls and procedures and internal controlover financial reporting. Disclosure controls and procedures are designed withthe objective of ensuring that information required to be disclosed in ourreports filed or submitted under the Exchange Act, such as this Annual Reporton Form 10-K, is recorded, processed, summarized and reported withinthe time periods specified in the SEC’s rules and forms. Disclosurecontrols and procedures are also designed with the objective of ensuring thatsuch information is accumulated and communicated to our management, includingour Chief Executive Officer and Chief Financial Officer, as appropriate toallow timely decisions regarding required disclosure.

Internal control over financial reporting is a processdesigned by, or under the supervision of our Chief Executive Officer and ChiefFinancial Officer, and effected by our Board of Directors, management and otherpersonnel, to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with GAAP and includes those policies and proceduresthat:

·       pertainto the maintenance of records that in reasonable detail accurately and fairlyreflect the transactions and dispositions of our assets;

·       providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with GAAP, and that ourreceipts and expenditures are being made only in accordance with authorizationsof management or our Board of Directors; and

·       providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use or disposition of our assets that could have a materialadverse effect on our financial statements.

*Limitationson the Effectiveness of Controls.**  *Management,including our Chief Executive Officer and Chief Financial Officer, do notexpect that our disclosure controls and procedures or internal control overfinancial reporting will prevent all errors and all fraud. A control system, nomatter how well conceived and operated, can provide only reasonable, notabsolute, assurance that the objectives of the control system are met. Further,the design of a control system must reflect the fact that there are resourceconstraints, and 

50

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the benefits of controlsmust be considered relative to their costs. Because of the inherent limitationsin all control systems, no assessment of controls can provide absoluteassurance that all control issues and instances of fraud, if any, within theCompany have been detected. These inherent limitations include the realitiesthat judgments in decision-making can be faulty, and that breakdowns can occurbecause of simple error or mistake. Additionally, controls can be circumventedby the individual acts of some persons, by collusion of two or more people, orby management’s override of the control. The design of any system of controls alsois based in part upon certain assumptions about the likelihood of futureevents, and there can be no assurance that any design will succeed in achievingits stated goals under all potential future conditions; over time, controls maybecome inadequate because of changes in conditions, or the degree of compliancewith the policies or procedures may deteriorate. Because of the inherentlimitations in a cost-effective control system, misstatements due to error orfraud may occur and not be detected.

*Scopeof the Assessments.**  *Theassessment by our Chief Executive Officer and Chief Financial Officer of ourdisclosure controls and procedures and the assessment by our management of ourinternal control over financial reporting included a review of procedures anddiscussions with our Disclosure Control Committee and others in the Company. Inthe course of the assessments, management sought to identify data errors,control problems or acts of fraud and to confirm that appropriate correctiveaction, including process improvements, were being undertaken. Management usedthe framework in Internal Control—Integrated Framework issued by the Committeeof Sponsoring Organizations of the Treadway Commission (COSO) to assess theeffectiveness of our internal control over financial reporting.

Our internal control over financial reporting is alsoassessed on an ongoing basis by management and other personnel in ourAccounting and Internal Audit departments. Management’s annual assessment ofour internal control over financial reporting is audited by our independentregistered public accounting firm. We consider the results of these variousassessment activities as we monitor our disclosure controls and procedures andinternal control over financial reporting and when deciding to makemodifications as necessary. Management’s intent in this regard is that thedisclosure controls and procedures and the internal control over financialreporting will be maintained and updated (including with improvements andcorrections) as conditions warrant. Among other matters, management sought inits assessment to determine whether there were any “material weaknesses” in theCompany’s internal control over financial reporting, or whether management hadidentified any acts of fraud involving senior management, management, or otherpersonnel who have a significant role in our internal control over financialreporting. This information was important both for the assessment generally andbecause the Section 302 certifications require that our Chief ExecutiveOfficer and Chief Financial Officer disclose that information to the AuditCommittee of the Board of Directors and to our independent auditors and toreport on related matters in this section of the Annual Report on Form 10-K.In the Public Company Accounting Oversight Board’s Auditing Standard No. 2,a “material weakness” is defined as a significant deficiency, or a combinationof significant deficiencies, that results in more than a remote likelihood thata material misstatement of the annual or interim financial statements will notbe prevented or detected. A “significant deficiency” is defined as a “controldeficiency,” or a combination of control deficiencies, that adversely affectsthe ability to initiate, authorize, record, process or report externalfinancial data reliably in accordance with GAAP such that there is more than aremote likelihood that a misstatement of the annual or interim financialstatements that is more than inconsequential will not be prevented or detected.A “control deficiency” exists when the design or operation of a control doesnot allow management or employees, in the normal course of performing theirassigned functions, to prevent or detect misstatements on a timely basis.Management also sought to deal with other control matters in the assessment,and in each case if a problem was identified, management considered whatrevision, improvement and/or correction was necessary to be made in accordancewith our on-going procedures.

*Evaluationof Disclosure Controls and Procedures.**  *As of the end of the period covered by this report,we carried out an evaluation, under the supervision and with the participationof our management, 

51

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including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures.

*Management’sReport on Internal Control over Financial Reporting.**  *Our management is responsible for establishing andmaintaining adequate internal control over financial reporting, as such term isdefined in Exchange Act Rules 13a-15(f) and 15d-15(f).Under the supervision and with the participation of our management, includingChief Executive Officer and Chief Financial Officer, we conducted an evaluationof the effectiveness of our internal control over financial reporting as of December 31,2005 based upon the framework in Internal Control—Integrated Framework issuedby the Committee of Sponsoring Organizations of the Treadway Commission (COSO).Based on that evaluation, our management concluded that our internal controlover financial reporting was effective as of December 31, 2005.

Management’s assessment of the effectiveness of ourinternal control over financial reporting as of December 31, 2005 has beenaudited by Ernst & Young, LLP, an independent registered publicaccounting firm, as stated in their report that is included elsewhere herein.

*Changes in InternalControl Over Financial Reporting.**  *Therewere no changes in our internal control over financial reporting for the fiscalyear ended December 31, 2005 that has materially affected, or isreasonably likely to materially affect, our internal control for financialreporting.

**Item 9B. Other Information.**

None.

52

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**PART III**

The information requiredby Items 10, 11, 12, 13 and 14 of Part III of Form 10-K hasbeen omitted in reliance on General Instruction G(3) and is incorporatedherein by reference to the definitive proxy statement of SI International, Inc.for its 2006 annual meeting of stockholders to be filed with the SEC pursuantto Regulation 14A promulgated under the Securities Exchange Act of 1934,as amended.

**PART IV**

**Item 15. Exhibits and Financial Statement Schedules.**

(a)   Documentsfiled as part of this Report

1.                 FinancialStatements.

| A. |   | Report of Independent  Registered Public Accounting Firm                                                                                                    |   |   |   |
|----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| B. |   | Report of Independent  Registered Public Accounting Firm on Internal Control over Finanacial  Reporting                                                     |   |   |   |
| C. |   | Consolidated Balance  Sheets as of December 31, 2005 and December 25, 2004                                                                        |   |   |   |
| D. |   | Consolidated Statements  of Operations for the fiscal years ended December 31, 2005,  December 25, 2004 and December 27, 2003                |   |   |   |
| E. |   | Consolidated Statements  of Stockholders’ Equity for the fiscal years ended December 31, 2005,  December 25, 2004 and December 27, 2003 |   |   |   |
| F. |   | Consolidated Statements  of Cash Flows for the fiscal years ended December 31, 2005,  December 25, 2004 and December 27, 2003                |   |   |   |
| G. |   | Notes to Consolidated  Financial Statements                                                                                                                 |   |   |   |

 

2.                 FinancialStatement Schedules.

Schedule II—Valuation and Qualifying Accounts

3.                 Exhibits.

The exhibits required by this item are set forth onthe Index to Exhibits attached hereto.

(b)         Exhibits.

See Item 15(a)(3) above.

(c)   NotApplicable.

53

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**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized, onthe 15th day of March, 2006.
|            | **SI INTERNATIONAL, INC.** |
|------------|---------------------------------|
|       | By:                             | /s/ S. BRADFORD ANTLE |
|       |                            | **S. Bradford Antle** |
| ** ** |                            | ***President and Chief Executive  Officer*** |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the Registrant and incapacities and on the dates indicated.

| ** **                              | **Signatures** | ** **                                                                     | ** ** | ** **          | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|-----------------------------------------|----------------|--------------------------------------------------------------------------------|------------|---------------------|-----------|------------|------------|------------|----------|------------|
| /s/ S. BRADFORD ANTLE                   |           | President, Chief  Executive Officer                                            |       | March 15, 2006 |
| **S. Bradford Antle**                   |           | and Director (Principal  Executive Officer)                                    |       |                |
| /s/ THOMAS E. DUNN                      |           | Executive Vice  President, Chief                                               |       | March 15, 2006 |
| **Thomas E. Dunn**                      |           | Financial Officer and  Treasurer (Principal Financial and  Accounting Officer) |       |                |
| /s/ RAY J. OLESON                       |           | Executive  Chairman of the Board                                               |       | March 15, 2006 |
| **Ray J. Oleson**                       |           |                                                                           |       |                |
| /s/ CHARLES A. BOWSHER                  |           | Director                                                                       |       | March 15, 2006 |
| **Charles A. Bowsher**                  |           |                                                                           |       |                |
| /s/ JAMES E. CRAWFORD, III         |           | Director                                                                       |       | March 15, 2006 |
| **James E. Crawford, III**         |           |                                                                           |       |                |
| /s/ WALTER J. CULVER, JR.               |           | Director                                                                       |       | March 15, 2006 |
| **Walter J. Culver, Jr.**               |           |                                                                           |       |                |
| /s/ WALTER C. FLORENCE                  |           | Director                                                                       |       | March 15, 2006 |
| **Walter C. Florence**                  |           |                                                                           |       |                |
| /s/ GENERAL R. THOMAS MARSH** **   |           | Director                                                                       |       | March 15, 2006 |
| **General R. Thomas Marsh (USAF-Ret.)** |           |                                                                           |       |                |
| /s/ EDWARD H. SPROAT                    |           | Director                                                                       |       | March 15, 2006 |
| **Edward H. Sproat**                    |           |                                                                           |       |                |
| /s/ JOHN P. STENBIT                     |           | Director                                                                       |       | March 15, 2006 |
| **John P. Stenbit**                     |           |                                                                           |       |                |

 

 

54

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**INDEX TO EXHIBITS**

| EXHIBIT NO. | ** ** | **DESCRIPTION**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1         |       | Stock Purchase Agreement  among the Company, SEI, and the stockholders of SEI dated January 12, 2005  (filed as Exhibit 99.1 to the Company’s Current Report on Form 8-K  filed March 1, 2005 and incorporated by reference). (The appendices and  exhibits have been omitted pursuant to Item 601(b)(2) of Regulation S-K.  SI International, Inc., hereby undertakes to furnish supplementally to the  Securities and Exchange Commission copies of any omitted appendices and  exhibits upon request by the Securities and Exchange Commission). |
| 2.2         |       | Stock Purchase Agreement  among the Company, Zen, and the stockholders of Zen dated February 8,  2006(*). (The appendices and exhibits have been omitted pursuant to Item  601(b)(2) of Regulation S-K. SI International, Inc., hereby undertakes to  furnish supplementally to the Securities and Exchange Commission copies of  any omitted appendices and exhibits upon request by the Securities and  Exchange Commission).                                                                                                                                         |
| 3.1         |       | Second Restated  Certificate of Incorporation (filed as Exhibit 3.1 to the Company’s  Registration Statement on Form S-1/A (File No. 333-87964) filed on October  25, 2002 (the “Third Amendment”) and incorporated herein by reference).                                                                                                                                                                                                                                                                                                                |
| 3.2         |       | Amended and Restated  Bylaws, as amended (filed as Exhibit 3.2 to the Company’s Current Report on  Form 8-K filed on October 11, 2005 and incorporated herein by reference).                                                                                                                                                                                                                                                                                                                                                                                       |
| 4.1         |       | Registration Rights  Agreement, as amended (filed as Exhibit 4.1 to the Third Amendment and  incorporated herein by reference).                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 4.2         |       | Specimen Certificate of  our common stock (filed as Exhibit 4.2 to the Company’s Registration  Statement on Form S-1/A (File No. 333-87964) filed on November 5, 2002 (the  “Fourth Amendment”) and incorporated herein by reference).                                                                                                                                                                                                                                                                                                                   |
| 4.3         |       | Stock Purchase  Agreement, as amended (filed as Exhibit 4.3 to the Company’s Registration  Statement on Form S-1/A (File No. 333-87964) filed on November 8, 2002 (the  “Fifth Amendment”), and incorporated herein by reference).                                                                                                                                                                                                                                                                                                                       |
| 4.4         |       | Amendment to Stock  Purchase Agreements (filed as Exhibit 4.4 to the Fourth Amendment and  incorporated herein by reference).                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.1        |       | 2002 Amended and  Restated Omnibus Stock Incentive Plan (filed as Annex B to the Company’s  Proxy Statement on Schedule 14A for the 2005 Annual Meeting of Stockholders  filed on April 21, 2005 and incorporated herein by reference).                                                                                                                                                                                                                                                                                                                       |
| 10.2        |       | January 2001  Nonqualified Stock Option Plan (filed as Exhibit 10.2 to the Company’s  Registration Statement on Form S-1/A (File No. 333-87964) filed on June 24,  2002 (the “First Amendment”) and incorporated herein by reference).                                                                                                                                                                                                                                                                                                                   |
| 10.3        |       | SI International, Inc.  2001 Service Award Stock Option Plan (filed as Exhibit 10.3 to the First  Amendment and incorporated herein by reference).                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.4        |       | 1998 Stock Option Plan  (filed as Exhibit 10.5 to the First Amendment and incorporated herein by  reference).                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| 10.5        |       | Non-Qualified Deferred  Compensation Plan, as amended (filed as Exhibit 10.13 to the Company’s Annual  Report on Form 10-K for the fiscal year ended December 25, 2004 and  incorporated herein by reference).                                                                                                                                                                                                                                                                                                                                                     |
| 10.6        |       | Form of SI  International, Inc. Stock Option Agreement Evidencing Grant of Stock Options  Under the SI International, Inc. 2002 Stock Incentive Plan, Including Notice  of Stock Option Grant (filed as Exhibit 99.1 to the Company’s Current Report  on Form 8-K filed on March 17, 2006 and incorporated herein by reference).                                                                                                                                                                                                                                   |

55

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| 10.7  |   | Notice of Stock Option Acceleration of Vesting  (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on  December 13, 2005 and incorporated herein by reference).                         |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.8  |   | Amended and Restated  Credit Agreement (filed as Exhibit 99.1 to the Company’s Current Report on  Form 8-K filed February 15, 2005 and incorporated herein by reference).                                     |
| 10.9  |   | First Amendment to  Amended and Restated Credit Agreement (filed as Exhibit 99.1 to the Company’s  Current Report on Form 8-K filed March 3, 2006 and incorporated herein by  reference).                     |
| 10.10 |   | Executive Employment  Agreement with S. Bradford Antle (filed as Exhibit 10.6 to the Third  Amendment and incorporated herein by reference).                                                                       |
| 10.11 |   | Executive Employment  Agreement with Thomas E. Dunn (filed as Exhibit 10.8 to the Third Amendment  and incorporated herein by reference).                                                                          |
| 10.12 |   | Executive Employment  Agreement with Thomas E. Lloyd (filed as Exhibit 10.9 to the Third Amendment  and incorporated herein by reference).                                                                         |
| 10.13 |   | Executive Employment  Agreement with Ray J. Oleson (filed as Exhibit 10.10 to the Third Amendment  and incorporated herein by reference).                                                                          |
| 10.14 |   | Executive Employment  Agreement with Paul R. Brubaker (filed as Exhibit 10.1 to the Company’s  Current Report on Form 8-K filed on March 22, 2005 and incorporated herein by  reference).                     |
| 10.15 |   | Executive Employment  Agreement with Harry D. Gatanas (filed as Exhibit 10.1 to the Company’s  Current Report on Form 8-K/A filed on November 14, 2005 and incorporated  herein by reference).                |
| 10.16 |   | Executive Employment  Agreement with Marylynn Stowers (filed as Exhibit 10.1 to the Company’s Current  Report on Form 8-K/A on February 2, 2006 and incorporated herein by  reference).                       |
| 10.17 |   | Executive Employment  Agreement with P. Michael Becraft (filed as Exhibit 10.1 to the Company’s  Current Report on Form 8-K/A filed on February 24, 2006 and incorporated  herein by reference).              |
| 10.18 |   | Consulting Services  Agreement with Walter J. Culver (filed as Exhibit 10.12 to the Company’s  Annual Report on Form 10-K for the fiscal year ended December 25, 2004 and  incorporated herein by reference). |
| 10.19 |   | Form of Indemnification  Agreement (filed as Exhibit 10.11 to the Third Amendment and incorporated  herein by reference).                                                                                          |
| 21.1  |   | Subsidiaries of the  registrant (*).                                                                                                                                                                               |
| 23.1  |   | Consent of Ernst &  Young LLP (*).                                                                                                                                                                             |
| 31.1  |   | Certifications of Chief  Executive Officer and Chief Financial Officer pursuant to Rule 13a 14(a)  as adopted pursuant to Section 302 of the Sarbanes Oxley Act of 2002 (*).                             |
| 32.1  |   | Certifications of Chief  Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section  1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002  (*).                             |

----

*                    Indicatesfiled herewith.

56

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**INDEXTO FINANCIAL STATEMENTS**

|                                                                                                                                              | ** ** | **PAGE** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| **SI INTERNATIONAL, INC.**                                                                                                                   |       |     |
| Report of Independent Registered Public Accounting  Firm                                                                                     |       | F 2      |
| Report of Independent Registered Public Accounting  Firm on Internal Control over Financial Reporting                                        |       | F-3      |
| Consolidated Balance Sheets as of December 31, 2005  and December 25, 2004                                                                   |       | F-4      |
| Consolidated Statements of Operations for the fiscal  years ended December 31, 2005, December 25, 2004 and December 27, 2003            |       | F-5      |
| Consolidated Statements of Stockholders’ Equity for  the fiscal years ended December 31, 2005, December 25, 2004 and December 27,  2003 |       | F-6      |
| Consolidated Statements of Cash Flows for the fiscal  years ended December 31, 2005, December 25, 2004 and December 27, 2003            |       | F-7      |
| Notes to Consolidated Financial Statements                                                                                                   |       | F-8      |

 

F-1

----

**Report of Independent Registered Public AccountingFirm**

**TheBoard of Directors**andStockholders of SI International, Inc.

We have audited the accompanying consolidated balancesheets of SI International, Inc. and subsidiaries (as defined in Note 1)(the Company) as of December 31, 2005 and December 25, 2004, and therelated consolidated statements of operations, stockholders’ equity, and cashflows for the fiscal years ended December 31, 2005, December 25, 2004,and December 27, 2003. Our audits alsoincluded the financial statement schedule listed in the index at Item 15. Thesefinancial statements and schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the consolidated financialposition of SI International, Inc. and subsidiaries at December 31,2005 and December 25, 2004, and the consolidated results of its operationsand its cash flows for the fiscal years ended December 31, 2005, December 25,2004, and December 27, 2003 in conformity with U.S. generally acceptedaccounting principles. Also, in our opinion, the related financial statementschedule, when considered to the basic financial statements taken as a whole,presents fairly, in all material respects, the information set forth therein.

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of SIInternational, Inc. and its subsidiaries internal control over financialreporting as of December 31, 2005, based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated March 3,2006 expressed an unqualified opinion thereon.

|                    |   | /s/ Ernst & Young LLP |
|--------------------|--------|--------------------------------|
| McLean, Virginia   |   |                           |
| March 3, 2006 |   |                           |

 

F-2

----

**Reportof Independent Registered Public Accounting Firm**

**TheBoard of Directors and Stockholders of**SI International, Inc.

We have audited management’s assessment, included inthe accompanying Management’s Report on Internal Control over FinancialReporting that SI International, Inc. and subsidiaries (as defined inNote 1) maintained effective internal control over financial reporting asof December 31, 2005, based on criteriaestablished in Internal Control—Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission (the COSO criteria).SI International’s management is responsible for maintaining effective internalcontrol over financial reporting and for its assessment of the effectiveness ofinternal control over financial reporting. Our responsibility is to express anopinion on management’s assessment and an opinion on the effectiveness of thecompany’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

In our opinion, management’s assessment that SIInternational, Inc. and subsidiaries maintained effective internal controlover financial reporting as of December 31, 2005, is fairly stated, in allmaterial respects, based on the COSO criteria. Also, in our opinion, SIInternational, Inc. maintained, in all material respects, effectiveinternal control over financial reporting as of December 31, 2005, basedon****the COSO criteria**.**

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated balance sheets ofSI International, Inc. and subsidiaries as of December 31, 2005 and December 25,2004, and the related consolidated statements of operations, stockholders’equity, and cash flows for the fiscal years ended December 31, 2005, December 25,2004, and December 27, 2003 and our report dated March 3, 2006expressed an unqualified opinionthereon**.**

|                    |   | /s/ Ernst & Young LLP |
|--------------------|--------|---------------------------|
| McLean, Virginia   |   |
| March 3, 2006 |   |
|                    |        |                           |  |

 

F-3

----

**SI International, Inc.Consolidated balancesheetsAs of December 31, 2005 and December 25, 2004(Amounts in thousands, except share and per share data)**

| ** **                                                                                                                                                                                                                | ** ** | **December 31,  2005** | ** ** | **December 25,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                                                                                                                                                | ** ** |                        | ** ** | ** **                  |       |   | ** ** | ** ** |   |
| **Current assets:**                                                                                                                                                                                                       |       |                        |       | ** **                  |       |   |   |   |   |
| Cash and cash equivalents                                                                                                                                                                                                 |       |                        | $          | 26,160                      | ** ** |   |   | $ | 3,754 |   |   |
| Marketable securities                                                                                                                                                                                                     |       |                        | 7,850      | ** **                  |       |   | 2,000 |   |   |
| Accounts receivable, net                                                                                                                                                                                                  |       |                        | 93,633     | ** **                  |       |   | 65,710 |   |   |
| Deferred tax asset                                                                                                                                                                                                        |       |                        | 422        | ** **                  |       |   | 2,740 |   |   |
| Other current assets                                                                                                                                                                                                      |       |                        | 6,276      | ** **                  |       |   | 3,503 |   |   |
| Total current  assets                                                                                                                                                                                                     |       |                        | 134,341    | ** **                  |       |   | 77,707 |   |   |
| **Property and equipment, net**                                                                                                                                                                                           |       |                        | 5,908      | ** **                  |       |   | 4,971 |   |   |
| **Intangible  assets, net**                                                                                                                                                                                               |       |                        | 16,483     | ** **                  |       |   | 6,575 |   |   |
| **Other  assets**                                                                                                                                                                                                         |       |                        | 5,655      | ** **                  |       |   | 2,142 |   |   |
| **Goodwill**                                                                                                                                                                                                              |       |                        | 173,308    | ** **                  |       |   | 120,712 |   |   |
| Total assets                                                                                                                                                                                                              |       |                        | $          | 335,695                     | ** ** |   |   | $ | 212,107 |   |   |
| **Liabilities  and stockholders’ equity**                                                                                                                                                                            | ** ** |                        | ** ** | ** **                  |       |   | ** ** | ** ** |   |
| **Current liabilities:**                                                                                                                                                                                                  |       |                        |       | ** **                  |       |   |   |   |   |
| Note Payable—Line of Credit                                                                                                                                                                                          |       |                        | $          | —                      | ** ** |   |   | $ | 28,954 |   |   |
| Current portion of long-term debt                                                                                                                                                                                         |       |                        | 1,000      | ** **                  |       |   | — |   |   |
| Accounts payable                                                                                                                                                                                                          |       |                        | 25,364     | ** **                  |       |   | 11,225 |   |   |
| Accrued expenses and other current liabilities                                                                                                                                                                            |       |                        | 29,674     | ** **                  |       |   | 15,603 |   |   |
| Note payable—former owner of acquired business                                                                                                                                                                       |       |                        | 2,280      | ** **                  |       |   | — |   |   |
| Total current  liabilities                                                                                                                                                                                                |       |                        | 58,318     | ** **                  |       |   | 55,782 |   |   |
| **Long-term debt, net of current portion**                                                                                                                                                                                |       |                        | 98,250     | ** **                  |       |   | — |   |   |
| **Note  payable—former owner of acquired business**                                                                                                                                                                  |       |                        | —     | ** **                  |       |   | 2,280 |   |   |
| **Deferred  income tax**                                                                                                                                                                                                  |       |                        | 5,221      | ** **                  |       |   | 5,046 |   |   |
| **Other  long-term liabilities**                                                                                                                                                                                          |       |                        | 6,037      | ** **                  |       |   | 3,929 |   |   |
| **Stockholders’  equity:**                                                                                                                                                                                           |       |                        |       | ** **                  |       |   |   |   |   |
| **Common stock**—$0.01 par value  per share; 50,000,000 shares authorized; 11,341,222 and 11,047,533 shares  issued and outstanding as of December 31, 2005 and  December 25, 2004, respectively |       |                        | 114        | ** **                  |       |   | 111 |   |   |
| Additional paid-in capital                                                                                                                                                                                                |       |                        | 133,843    | ** **                  |       |   | 128,192 |   |   |
| Deferred compensation                                                                                                                                                                                                     |       |                        | —     | ** **                  |       |   | (208 | ) |   |
| Retained earnings                                                                                                                                                                                                         |       |                        | 33,912     | ** **                  |       |   | 16,975 |   |   |
| Total  stockholders’ equity                                                                                                                                                                                          |       |                        | 167,869    | ** **                  |       |   | 145,070 |   |   |
| Total liabilities and  stockholders’ equity                                                                                                                                                                          |       |                        | $          | 335,695                     | ** ** |   |   | $ | 212,107 |   |   |

 

The accompanying notes are an integral part of these consolidated balance sheets.

F-4

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**SI International, Inc.Consolidated statementsof operationsFor the fiscal years ended December 31, 2005, December 25, 2004, andDecember 27, 2003(Amounts in thousands, except per share data)**

| ** **                                       | ** ** | **Fiscal Year** | ** ** |
|--------------------------------------------------|------------|----------------------|------------|
| ** **                                       | ** ** | **2005**             | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Revenue**                                      |       | $                    | 397,919    |   | $ | 262,306 |   | $ | 168,287 |   |
| **Costs and expenses:**                          |       |                 |       |   |   |   |   |
| Direct costs                                     |       | 246,481              |       | 166,774 |   | 101,940 |   |
| Indirect costs                                   |       | 113,015              |       | 71,917 |   | 51,569 |   |
| Depreciation                                     |       | 2,161                |       | 2,231 |   | 2,009 |   |
| Amortization                                     |       | 2,292                |       | 648 |   | — |   |
| Total operating  expenses                        |       | 363,949              |       | 241,570 |   | 155,518 |   |
| **Income from operations**                       |       | 33,970               |       | 20,736 |   | 12,769 |   |
| **Other  income (expense)**                      |       | 12                   |       | (1 | ) | — |   |
| **Interest  expense**                            |       | (6,103               | )          | (2,760 | ) | (606 | ) |
| **Income  before provision for income taxes**    |       | 27,879               |       | 17,975 |   | 12,163 |   |
| **Provision  for income taxes**                  |       | 10,942               |       | 7,098 |   | 4,784 |   |
| **Net  income**                                  |       | $                    | 16,937     |   | $ | 10,877 |   | $ | 7,379 |   |
| **Earnings  per common share:**                  |       |                 |       |   |   |   |   |
| Basic net income per common share                |       | $                    | 1.51       |   | $ | 1.20 |   | $ | 0.87 |   |
| Diluted net income per common share              |       | $                    | 1.45       |   | $ | 1.14 |   | $ | 0.87 |   |
| **Basic weighted-average shares outstanding**    |       | 11,185               |       | 9,041 |   | 8,446 |   |
| **Diluted  weighted-average shares outstanding** |       | 11,690               |       | 9,507 |   | 8,488 |   |

 

The accompanying notes are an integral part of these consolidated statements.

F-5

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**SI International, Inc.Consolidated statementsof stockholders’ equityFor the fiscal years ended December 31, 2005, December 25, 2004, andDecember 27, 2003(Amounts in thousands, except share data)**

| ** **                                                              | ** ** | **Stockholders’ equity (deficit)** | ** ** |
|-------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                              | ** ** | **Common stock**                             | ** ** | **Additional** | ** ** | ** ** | ** ** | **Retained  earnings** | ** ** | ** ** | ** ** |
| ** **                                                              | ** ** | **Shares**                                        | ** ** | **Amount** | ** ** | **paid-in  Capital** | ** ** | **Deferred  Compensation** | ** ** | **(Accumulated  deficit)** | ** ** | **Total** | ** ** |
| **Balance,  December 28, 2002**                                    |       |                                              | 8,439,741  |   |   |   | 85 |   |   | 75,682 |   |   | (509 | ) |   |   | (1,281 | ) |   | 73,977 |   |
| Exercise of stock  options                                              |       |                                              | 11,766     |   |   |   | — |   |   | 67 |   |   | — |   |   |   | — |   |   | 67 |   |
| Compensatory stock  option grants/amortization of deferred compensation |       |                                              | —     |   |   |   | — |   |   | (37 | ) |   | 169 |   |   |   | — |   |   | 132 |   |
| Offering costs                                                          |       |                                              | —     |   |   |   | — |   |   | (8 | ) |   | — |   |   |   | — |   |   | (8 | ) |
| Net income                                                              |       |                                              | —     |   |   |   | — |   |   | — |   |   | — |   |   |   | 7,379 |   |   | 7,379 |   |
| **Balance,  December 27, 2003**                                    |       |                                              | 8,451,507  |   |   |   | $ | 85 |   |   | $ | 75,704 |   |   | $ | (340 | ) |   |   | $ | 6,098 |   |   | $ | 81,547 |   |
| Exercise of stock  options                                              |       |                                              | 76,026     |   |   |   | 1 |   |   | 929 |   |   | — |   |   |   | — |   |   | 930 |   |
| Amortization of  deferred compensation                                  |       |                                              | —     |   |   |   | — |   |   | (3 | ) |   | 132 |   |   |   | — |   |   | 129 |   |
| Option exercise  tax effect                                             |       |                                              | —     |   |   |   | — |   |   | 348 |   |   | — |   |   |   | — |   |   | 348 |   |
| Offering proceeds,  net of offering costs                               |       |                                              | 2,520,000  |   |   |   | 25 |   |   | 51,214 |   |   | — |   |   |   | — |   |   | 51,239 |   |
| Net income                                                              |       |                                              | —     |   |   |   | — |   |   | — |   |   | — |   |   |   | 10,877 |   |   | 10,877 |   |
| **Balance,  December 25, 2004**                                    |       |                                              | 11,047,533 |   |   |   | $ | 111 |   |   | $ | 128,192 |   |   | $ | (208 | ) |   |   | $ | 16,975 |   |   | $ | 145,070 |   |
| Exercise of stock  options                                              |       |                                              | 293,689    |   |   |   | 3 |   |   | 3,735 |   |   | — |   |   |   | — |   |   | 3,738 |   |
| Amortization of  deferred compensation                                  |       |                                              | —     |   |   |   | — |   |   | (12 | ) |   | 136 |   |   |   | — |   |   | 124 |   |
| Stock-based  compensation                                               |       |                                              | —     |   |   |   | — |   |   | 415 |   |   | 72 |   |   |   | — |   |   | 487 |   |
| Option exercise  tax effect                                             |       |                                              | —     |   |   |   | — |   |   | 1,561 |   |   | — |   |   |   | — |   |   | 1,561 |   |
| Other                                                                   |       |                                              | —     |   |   |   | — |   |   | (48 | ) |   | — |   |   |   | — |   |   | (48 | ) |
| Net income                                                              |       |                                              | —     |   |   |   | — |   |   | — |   |   | — |   |   |   | 16,937 |   |   | 16,937 |   |
| **Balance, December 31, 2005**                                     |       |                                              | 11,341,222 |   |   |   | $ | 114 |   |   | $ | 133,843 |   |   | $ | — |   |   |   | $ | 33,912 |   |   | $ | 167,869 |   |

 

The accompanying notes are an integral part of these consolidated statements.

F-6

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**SI International, Inc.Consolidated statementsof cash flowsFor the fiscal years ended December 31, 2005, December 25, 2004, andDecember 27, 2003(Amounts in thousands)**

| ** **                                                                                       | ** ** | **Fiscal Year** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                       | ** ** | **2005**             | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Cash flows from operating activities:**                                                        |       |                 |       |   |   |   |   |
| Net income                                                                                       |       | $                    | 16,937     |   | $ | 10,877 |   | $ | 7,379 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities:               |       |                 |       |   |   |   |   |
| Depreciation and  amortization                                                                   |       | 2,161                |       | 2,231 |   | 2,009 |   |
| Amortization of  intangible assets                                                               |       | 2,292                |       | 648 |   | — |   |
| Loss on disposal of fixed  assets                                                                |       | 56                   |       | 14 |   | 178 |   |
| Income tax benefit for  stock option exercises                                                   |       | 1,561                |       | 348 |   | — |   |
| Stock-based  compensation                                                                        |       | 611                  |       | 132 |   | 132 |   |
| Deferred income tax  provision                                                                   |       | 2,493                |       | 1,686 |   | (98 | ) |
| Amortization of deferred  financing costs and debt discount                                      |       | 705                  |       | 416 |   | 379 |   |
| Non-cash loss due to  early repayment of debt                                                    |       | —               |       | 584 |   | — |   |
| Changes in operating assets and liabilities, net of  effect of acquisitions:                     |       |                 |       |   |   |   |   |
| Accounts receivable, net                                                                         |       | (14,629              | )          | (16,096 | ) | (2,106 | ) |
| Other current assets                                                                             |       | (2,684               | )          | 116 |   | (266 | ) |
| Other assets                                                                                     |       | (1,000               | )          | (668 | ) | (106 | ) |
| Accounts payable and  accrued expenses                                                           |       | 15,421               |       | 143 |   | 4,996 |   |
| Deferred revenue                                                                                 |       | (275                 | )          | (3,686 | ) | 2,901 |   |
| Other long term  liabilities                                                                     |       | 2,950                |       | 1,600 |   | 681 |   |
| Net cash provided by  (used in) operating activities                                             |       | 26,599               |       | (1,655 | ) | 16,079 |   |
| **Cash flows from investing activities:**                                                        |       |                 |       |   |   |   |   |
| Purchase of property and  equipment, net                                                         |       | (2,727               | )          | (1,225 | ) | (1,291 | ) |
| Proceeds from sale of  marketable securities                                                     |       | 36,200               |       | 11,000 |   | 24,650 |   |
| Purchase of marketable  securities.                                                              |       | (42,050              | )          | (2,050 | ) | (35,600 | ) |
| Former owner payable.                                                                            |       | 8,041                |       | — |   | — |   |
| Cash paid for acquisition  of MATCOM International Corp.                                         |       | (82                  | )          | (64,918 | ) | — |   |
| Cash paid for acquisition  of Bridge Tech. Corp., net of cash assumed                            |       | (197                 | )          | (29,472 | ) | — |   |
| Cash paid for acquisition  of Shenandoah Electronic Intelligence, Inc., net of cash assumed |       | (74,006              | )          | — |   | — |   |
| Net cash used in  investing activities                                                           |       | (74,821              | )          | (86,665 | ) | (12,241 | ) |
| **Cash flows from financing activities:**                                                        |       |                 |       |   |   |   |   |
| Proceeds from issuance of  common stock, net of offering costs                                   |       | (48                  | )          | 51,239 |   | — |   |
| Proceeds from exercise of  stock options                                                         |       | 3,738                |       | 927 |   | 59 |   |
| Repayments of bank  overdrafts                                                                   |       | —               |       | — |   | (2,201 | ) |
| Net (repayments)  borrowings under line of credit                                                |       | (28,954              | )          | 28,954 |   | — |   |
| Payments of debt issuance  fees                                                                  |       | (3,238               | )          | (1,202 | ) | — |   |
| Repayments of notes  payable                                                                     |       | —               |       | — |   | (140 | ) |
| Proceeds from long-term  debt                                                                    |       | 100,000              |       | 30,000 |   | — |   |
| Repayments of long-term  debt and borrowings from stockholders                                   |       | (750                 | )          | (30,000 | ) | — |   |
| Repayments of capital  lease obligations                                                         |       | (120                 | )          | (146 | ) | (110 | ) |
| Net cash provided by  (used in) financing activities                                             |       | 70,628               |       | 79,772 |   | (2,392 | ) |
| **Net  change in cash and cash equivalents**                                                     |       | 22,406               |       | (8,548 | ) | 1,446 |   |
| **Cash and cash equivalents,  beginning of period**                                              |       | 3,754                |       | 12,302 |   | 10,856 |   |
| **Cash and cash equivalents, end  of period**                                                    |       | $                    | 26,160     |   | $ | 3,754 |   | $ | 12,302 |   |
| **Supplemental disclosures of cash flow  information:**                                          |       |                 |       |   |   |   |   |
| Cash payments for  interest                                                                      |       | $                    | 5,059      |   | $ | 1,857 |   | $ | 339 |   |
| Cash payments for income  taxes                                                                  |       | $                    | 3,593      |   | $ | 6,181 |   | $ | 3,920 |   |
| **Supplemental disclosure of noncash activities:**                                               |       |                 |       |   |   |   |   |
| Equipment acquired under capital leases                                                          |       | $                    | 126        |   | $ | 289 |   | $ | 122 |   |

 

The accompanying notes are an integral part of these consolidated statements.

F-7

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**SI International, Inc.Notes to consolidatedfinancial statements**

**1. Business:**

SI International, Inc. (the Company or SI), wasincorporated on October 14, 1998, under the laws of the state of Delaware.The Company is a provider of information technology and network solutions withthe Federal Government as a major client. The Company offers a broad spectrumof solutions and services, including design, development, implementation andoperations to assist clients in achieving their missions. The Company combinestechnological and industry experience to provide solutions through serviceofferings in the areas of information technology applications, systemsengineering, network and telecom engineering and outsourcing.

On January 1, 2001, the Company separated itstelecommunications operations, which it obtained pursuant to an acquisition infiscal year 2000, by contributing the net assets of the telecommunicationsoperations to a sister company, SI International Telecom Corporation (SITelecom), in exchange for 5,000 shares of senior participating preferred stockin SI Telecom (SI Telecom Transaction). Warrant holders and options holders ofthe Company received warrants and options in SI Telecom, and the existingminority shareholders in SI received a comparable minority ownership in SITelecom. In addition, SI International, L.L.C. (SI L.L.C.), the majority ownerof SI, contributed $1.1 million in cash and received 44,624 shares of SITelecom junior participating preferred stock (see Note 13). Upon completionof these transactions, the effective ownership structure of SI Telecom on afully diluted basis was identical with the ownership of SI. Both SI and SITelecom were owned in majority by SI L.L.C.

In October 2002, SI Telecom was merged back intoSI, (the SI Telecom Merger) such that SI Telecom became a wholly ownedsubsidiary of SI. The SI Telecom junior participating preferred stock and SITelecom common shares held by minority shareholders were exchanged for SIshares based on a ratio of 0.005 SI common shares for each share of SI Telecomcommon stock.

Since November 12,2002, our common stock has been publicly traded on the Nasdaq National Marketunder the symbol “SINT”. The completion of the initial public offering in November of2002 raised $47.1 million (after offering costs) in equity capital throughthe sale of 3,850,000 shares of common stock. On October 6, 2004, theCompany completed its secondary offering which raised $51.2 million (afteroffering costs) cash through the sale of 2,520,000 shares of common stock.

**2. Summaryof significant accounting policies:**

**Principles of consolidation**

The accompanyingconsolidated financial statements include the accounts of the Company and itswholly and majority-owned subsidiaries. All significant intercompanytransactions and accounts have been eliminated in consolidation.

**Use of estimates**

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates.

F-8

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**Reporting periods**

The Company’s fiscal yearends on the Saturday nearest December 31. **All fiscalyears presented, excluding 2005, include 52 weeks**. **Fiscal 2005 includes 53 weeks.**The Company’s quarters end onthe Saturday nearest to the applicable quarterly month-end.

**Cash and cashequivalents**

The Company considers allinvestments with original maturities of three months or less at the date ofpurchase to be cash equivalents.

**Marketablesecurities**

During fiscal 2004, the Company invested in auctionrate securities which are associated with municipal bond offerings, and hadfinal maturity dates ranging from 2004 to 2034. These securities werepreviously classified as cash and cash equivalents. The accompanying December25, 2004 Consolidated Balance Sheet has been adjusted to reflect thereclassification of $2.0 million in auction rate securities from cash and cashequivalents to marketable securities. This reclassification had no impact onthe Company’s debt covenants or interest expense. 

At the end of fiscal 2005, marketable securitiesconsisted primarily of auction rate securities with final maturity datesranging from 2024 to 2035. All of these securities were sold during February2006.

The Company’s marketablesecurities are classified as available for sale and are recorded at quotedmarket prices that approximate cost. Both realized and unrealized gains andlosses were not material in the fiscal years ended 2005, 2004 and 2003.

**Revenue recognition**

The Company recognizes revenue under its contractswhen a contract has been executed, the contract price is fixed anddeterminable, delivery of services or products has occurred, and collectibilityof the contract price is considered probable and can be reasonably estimated.Revenue is earned under cost reimbursable, time and materials and fixed pricecontracts. Direct contract costs are expensed as incurred.

Under cost reimbursable contracts, the Company isreimbursed for allowable costs, and paid a fee, which may be fixed or performance-based.Revenues on cost reimbursable contracts are recognized as costs are incurredplus an estimate of applicable fees earned. The Company considers fixed feesunder cost reimbursable contracts to be earned in proportion of the allowablecosts incurred in performance of the contract. For cost reimbursable contractsthat include performance based fee incentives, the Company recognizes therelevant portion of the expected fee to be awarded by the customer at the timesuch fee can be reasonably estimated, based on factors such as the Company’sprior award experience and communications with the customer regardingperformance.

Revenue on time and materials contracts are recognizedbased on direct labor hours expended at contract billing rates and adding otherbillable direct costs.

Fixed price contracts may include either a productdelivery or specific service performance throughout a period. For fixed pricecontracts that are based on unit pricing, the Company recognizes revenue forthe number of units delivered in any given fiscal period. For fixed pricecontracts that are based on the proportionate performance method and involve aspecified number of similar acts, the Company recognizes revenue based on theproportion of those acts completed compared to the number of total specifiedacts required by the contract. For fixed price contracts that are based on theproportionate performance method and involve a specified number of defined butnot similar acts, the Company recognizes revenue based on the proportion of theproject’s percentage total costs incurred compared to the estimated total costsassociated with the entire transaction. For fixed price contracts that providefor 

F-9

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the delivery of a specificproduct with related customer acceptance provisions, revenues and associatedcontract costs are recognized upon product delivery and customer acceptance.

The Company’s contracts with agencies of thegovernment are subject to periodic funding by the respective contractingagency. Funding for a contract may be provided in full at inception of thecontract or ratably throughout the contract as the services are provided. Inevaluating the probability of funding for purposes of assessing collectibilityof the contract price, the Company considers its previous experiences with itscustomers, communications with its customers regarding funding status, and theCompany’s knowledge of available funding for the contract or program. Iffunding is not assessed as probable, revenue recognition is deferred untilrealization is deemed probable.

Contract revenue recognition inherently involvesestimation, including the contemplated level of effort to accomplish the tasksunder contract, the cost of the effort, and an ongoing assessment of progresstoward completing the contract. From time to time, as part of the normalmanagement processes, facts develop that require revisions to estimated totalcosts or revenues expected. The cumulative impact of any revisions to estimatesand the full impact of anticipated losses on any type of contract arerecognized in the period in which they become known.

The allowability ofcertain costs under government contracts is subject to audit by the government.Certain indirect costs are charged to contracts using provisional or estimatedindirect rates, which are subject to later revision based on government auditsof those costs. Management is of the opinion that costs subsequentlydisallowed, if any, would not be significant.

**Significant customers**

Revenuegenerated from contracts with the Federal Government, both directly and throughother prime contractors, accounted for a significant percentage of revenues inthe fiscal years 2005, 2004, and 2003.

| ** **                 | ** ** | **% of revenues  Fiscal year** | ** ** |
|----------------------------|------------|-----------------------------------------------|------------|
| ** **                 | ** ** | **2005**                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| Department of  Defense     |       | 46.9                                          | %          | 52.8 | % | 54.5 | % |
| Federal civilian  agencies |       | 51.2                                          |       | 43.8 |   | 39.2 |   |
| Commercial  entities       |       | 1.9                                           |       | 3.4 |   | 6.3 |   |
| Total revenue              |       | 100.0                                         | %          | 100.0 | % | 100.0 | % |

 

We had only one contractthat generated more than 10% of our revenue for fiscal year 2005 and 2004. Forthe fiscal year ended December 27, 2003 we had two contracts thatgenerated more than 10% of our revenue. For the fiscal year 2005, fiscal 2004,and fiscal 2003, revenue from our C4I2SR contract with the U.S. Air Force SpaceCommand represented approximately 19%, 17%, and 22%, respectively, of totalrevenue. Our National Visa Center contract with the Department of Staterepresented approximately 14% of total revenue for the fiscal year ended December 27,2003.

**Concentrations of Credit risk**

The Company’s assets thatare exposed to credit risk consist primarily of cash and cash equivalents andaccounts receivable. Accounts receivable consist primarily of billed andunbilled amounts, including indirect cost rate variances, due from variousagencies of the Federal Government or prime contractors doing business with theFederal Government, and other commercial customers. The Company historicallyhas not experienced significant losses related to accounts receivable andtherefore, believes that credit risk related to accounts receivable is minimal.The Company maintains cash balances that may at times exceed 

F-10

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federallyinsured limits. The Company maintains this cash at high-credit qualityinstitutions and, as a result, believes credit risk related to its cash isminimal.

**Accountsreceivable and allowance for doubtful accounts**

Accounts receivable arerecorded at their face amount less an allowance for doubtful accounts. TheCompany maintains an allowance for doubtful accounts at an amount that itestimates to be sufficient to cover the risk of collecting less than fullpayment on receivables. On a monthly basis the Company reevaluates itsreceivables, especially receivables that are past due, and reassesses theallowance for doubtful accounts based on specific client collection issues.

**Property and equipment**

Propertyand equipment are stated at historical cost, net of accumulated depreciationand amortization. Depreciation and amortization are computed generally using astraight-line method over the estimated useful lives of the related assets, as follows:

| Software, computers and  equipment |   | 3-5 years                                                            |
|------------------------------------|--------|----------------------------------------------------------------------|
| Furniture and fixtures             |   | 5-7 years                                                            |
| Leasehold improvements             |   | Shorter of the estimated useful life of the asset or  the lease term |

 

**Deferred financing costs**

Costsincurred in raising debt are deferred and amortized as interest expense overthe term of the related debt using the effective interest method. Thesedeferred costs are reflected as a component of other assets in the accompanyingconsolidated balance sheets. The deferred financing costs consist of thefollowing (in thousands):

| ** **                | ** ** | **December 31,  2005** | ** ** | **December 25,  2004** | ** ** |
|---------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Deferred loan  costs      |       |                        | $          | 4,975                       |       |   |   | $ | 1,737 |   |   |
| Accumulated  amortization |       |                        | (1,542     | )                           |       |   | (837 | ) |   |
|                      |       |                        | $          | 3,433                       |       |   |   | $ | 900 |   |   |

 

During 2004, the Companywrote off approximately $584,000 of deferred loan costs related to the payoffof its term loan under the 2004 credit facility. Amortization of deferredfinancing costs was $705,000, $416,000 and $379,000 in fiscal years 2005, 2004and 2003, respectively.

**Impairment of long-lived assets**

Long-lived assets,including property and equipment, are reviewed for impairment whenever eventsor changes in circumstances indicate that the carrying amount should beaddressed pursuant to Statement of Financial Accounting Standards (SFAS) No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets and forLong-Lived Assets.” Pursuant to SFAS No. 144, impairment is determined bycomparing the carrying value of these long-lived assets to an estimate of thefuture undiscounted cash flows expected to result from the use of the assetsand eventual disposition. In the event an impairment exists, a loss isrecognized based on the amount by which the carrying value exceeds the fairvalue of the asset, which is generally determined by using quoted market pricesor valuation techniques such as the discounted present value of expected futurecash flows, appraisals, or other pricing models as appropriate. The Companybelieves that no such impairment existed in December 31, 2005 and December 25,2004. In the event that there are changes in the planned use of the Company’slong-term assets or its expected future undiscounted cash flows are reducedsignificantly, the Company’s assessment of its ability to recover the carryingvalue of these assets could change.

F-11

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**Goodwilland other intangible assets**

Goodwill represents the excess of cost over net assetsacquired resulting from the Company’s acquisitions. Effective January 1, 2002,the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets.” SFASNo. 142 requires the use of a non-amortization approach to account forpurchased goodwill and certain intangibles. Under the non-amortization approach,goodwill and certain intangibles are not amortized into results of operations,but instead are reviewed for impairment at least annually and written down andcharged to operations only in the periods in which the recorded value ofgoodwill and certain intangible is more than its fair value. In the year endedDecember 31, 2005 and December 25, 2004, the Company completed its annualimpaired test of goodwill. The analysis indicated that no impairment ofgoodwill exists; however, future impairment reviews may results in therecognition of such impairment.

Intangible assets from acquisitions, which consistprimarily of contractual customer relationships, are amortized utilizing anaccelerated method over 6 to 14 years, based on their estimated useful lives. Amortizationexpense is estimated to be $2.1 million, $1.8 million, $1.6 million, $1.5million and $1.5 million for the years 2006, 2007, 2008, 2009 and 2010,respectively.

**Fair value of financial instruments**

The Company’s financialinstruments consist primarily of cash and cash equivalents, marketablesecurities, accounts receivable, accounts payable, credit facilities, andlong-term debt. In management’s opinion, the carrying amounts of thesefinancial instruments approximate their fair values at December 31, 2005and December 25, 2004.

**Stock-based compensation**

The Company accounts for stock-basedcompensation using the intrinsic value method prescribed in APB Opinion No. 25and related Interpretations No. 44. Accordingly, compensation expense forstock options is measured as the excess, if any, of the fair market value ofthe Company’s stock at the date of the grant over the exercise price of therelated option. The Company adopted the annual disclosure provisions of SFAS No. 148in its financial reports for the year ended December 31, 2003.

On December 13, 2005, the Company’s Board ofDirectors approved the accelerated vesting of unvested stock options previouslyawarded to employees, officers, and directors as of December 7, 2005 inlight of new FASB statement No. 123(R) that will take effect on January 1,2006. The Board took the action with the belief that it is in the best interestof stockholders, as it will reduce the Company’s reported compensation expensein future periods. As a result of the acceleration, the Company expects toeliminate expense relating to outstanding options of approximately $4.2 millionin fiscal 2006, $3.4 million in fiscal 2007, and $1.8 million in fiscal 2008 ona pre-tax basis, based upon the Company’s value calculations using theBlack-Scholes methodology. The acceleration generated compensation expense ofapproximately $0.5 million determined under the intrinsic value method.

F-12

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Hadcompensation costs for the Company’s stock options been determined based onSFAS No. 123, “Accounting for Stock-Based Compensation,” the Company’snet income and earnings per share would have been as follows (in thousands,except per share amounts):

| ** **                                                                                                                                   | ** ** | **Fiscal Year** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                                                                   | ** ** | **2005**             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income—as reported                                                                                                                  |       | $                    | 16,937     |   | $ | 10,877 |   | $ | 7,379 |   |
| Add: Total stock-based  employee compensation expense as reported under intrinsic value method (APB  No. 25) for all awards, net of tax |       | 371                  |       | 80 |   | 80 |   |
| Deduct: Total  stock-based compensation expense determined under fair value based  method (SFAS No. 123) for all awards, net of tax     |       | (10,137              | )          | (1,939 | ) | (945 | ) |
| Net income—Pro  forma                                                                                                                   |       | $                    | 7,171      |   | $ | 9,018 |   | $ | 6,514 |   |
| Basic earnings  per share—as reported                                                                                                   |       | $                    | 1.51       |   | $ | 1.20 |   | $ | 0.87 |   |
| Diluted earnings  per share—as reported                                                                                                 |       | $                    | 1.45       |   | $ | 1.14 |   | $ | 0.87 |   |
| Basic earnings  per share—Pro forma                                                                                                     |       | $                    | 0.64       |   | $ | 1.00 |   | $ | 0.77 |   |
| Diluted earnings per  share—Pro forma                                                                                                   |       | $                    | 0.61       |   | $ | 0.95 |   | $ | 0.77 |   |

 

Thefair value of each option is estimated on the date of grant using the Black-Scholesoption-pricing model with the following assumptions used for grantsduring the fiscal years ended December 31, 2005, December 25, 2004,and December 27, 2003:

| ** **                       | ** ** | **Fiscal Year** | ** ** |
|----------------------------------|------------|----------------------|------------|
| ** **                       | ** ** | **2005**             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Risk-free  interest rate         |       | 3.99-4.39%           |       | 4% |   | 4% |   |
| Expected life of  options        |       | 5-7 years            |       | 7 years |   | 9 years |   |
| Expected stock  price volatility |       | 45%-50%              |       | 55%-60% |   | 70% |   |
| Expected dividend yield          |       | 0%                   |       | 0% |   | 0% |   |

 

**Income taxes**

Income taxes are accountedfor using an asset and liability approach that requires the recognition oftaxes payable or refundable for the current year and deferred tax liabilitiesand assets for the future tax consequences of events that have been recognizedin the Company’s financial statements or tax returns. The measurement ofcurrent and deferred tax liabilities and assets are based on provisions of theenacted tax law; the effects of future changes in tax laws or rates are notconsidered. Net deferred tax assets are reduced, if necessary, by a valuationallowance for the amount of any tax benefits that, based on available evidence,are not expected to be realized.

**Earnings (loss) per share**

The Company has applied SFAS No. 128, “EarningsPer Share,” for all fiscal years presented in these consolidated financialstatements. SFAS No. 128 requires disclosure of basic and diluted earningsper share (EPS). Basic EPS is computed by dividing reported earnings availableto common stockholders by the weighted average number of shares outstandingwithout consideration of common stock equivalents or other potentially dilutivesecurities. Diluted EPS gives effect to common stock equivalents and otherpotentially dilutive securities outstanding during the period.

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Thefollowing details the computation of net income (loss) per common share:

| ** **                                   | ** ** | **Fiscal Year** | ** ** |
|----------------------------------------------|------------|----------------------|------------|
| ** **                                   | ** ** | **2005**             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income                                   |       | $                    | 16,937     |   | $ | 10,877 |   | $ | 7,379 |   |
| **Weighted  average share calculation:**     |       |                 |       |   |   |   |   |
| Basic weighted  average share outstanding    |       | 11,185               |       | 9,041 |   | 8,446 |   |
| Treasury stock  effect of stock options      |       | 505                  |       | 466 |   | 42 |   |
| Diluted weighted average  shares outstanding |       | 11,690               |       | 9,507 |   | 8,488 |   |
|                                              |            |                      |            |  |  |  |  |  |  |  |

 

**Segment reporting**

SFAS No. 131, “Disclosureabout Segments of an Enterprise and Related Information,” establishes standardsfor the way that public business enterprises report information about operatingsegments in annual financial statements and requires that these enterprisesreport selected information about operating segments in interim financialreports. SFAS No. 131 also establishes standards for related disclosuresabout products and services, geographic areas and major customers. Managementhas concluded that the Company operates in one segment based upon theinformation used by management in evaluating the performance of its businessand allocating resources and capital.

**Reclassifications**

Certain prior year amountshave been reclassified to conform to the presentation of the current year.

**New accounting pronouncements**

In December 2004, the FASB issued FASB Statement No. 123(R) (revised2004), *Share Based Payment.*Statement 123(R) addresses the accounting for share-based paymenttransactions in which an enterprise receives employee services in exchange for (a) equityinstruments of the enterprise or (b) liabilities that are based on thefair value of the enterprise’s equity instruments or that may be settled by theissuance of such equity instruments. Statement 123(R) requires an entityto recognize the grant-date fair-value of stock options and other equity-basedcompensation issued to employees in the income statement. The revised Statementgenerally requires that an entity account for those transactions using thefair-value-based method, and eliminates the intrinsic value method ofaccounting in APB Opinion No. 25, *Accountingfor Stock Issued to Employees*, which was permitted underStatement 123, as originally issued. The revised Statement requiresentities to disclose information about the nature of the share-based paymenttransactions and the effects of those transactions on the financial statements.Statement 123(R) is effective for the Company for the fiscal yearbeginning January 1, 2006. All public companies must use either themodified prospective or the modified retrospective transition method..

As permitted by Statement 123, the Company currentlyaccounts for share-based payments to employees using Opinion 25’s intrinsicvalue method and, as such, generally recognizes no compensation cost foremployee stock option grants. Accordingly, the adoption of Statement 123(R)’sfair value method will have a significant impact on our result of operations,although it will have no impact on our overall financial position. The impactof adoption of Statement 123(R) cannot be predicted at this time because itwill depend on levels of share-based payments granted in the future. However,had we adopted Statement 123(R) in prior periods, the impact of that standardwould have approximated the impact of Statement 123 as described in thedisclosure of pro forma net income and earnings per share in the Stock-BasedCompensation section of this note to our consolidated financial statements.Statement 123(R) also requires the benefits of tax deductions in excess ofrecognized compensation cost to be reported as a financing cash flow, ratherthan as an operating cash flow as required under current literature. This 

F-14

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requirement will reducenet operating cash flows and increase net financing cash flows in periods afteradoption.

In July 2005,the FASB issued an Exposure Draft of a proposed Interpretation, *Accounting for Uncertain Tax Positions—anInterpretation of FASB Statement No. 109*. The proposedInterpretation (if adopted in its current form) would apply to all open taxpositions accounted for in accordance with FAS 109, *Accounting for Income Taxes,* includingthose acquired in business combinations. Under the proposed Interpretation, therecognition of a tax benefit would occur when it is “probable” that theposition would be sustained upon audit. The proposed Interpretation refers toFASB Statement No. 5, *Accounting forContingencies,* definition of “probable,” which represents a level ofassurance that is substantially higher than “more likely than not.”  The Board noted that, in determining if the “probable”threshold has been met, it should be assumed that the taxing authority willexamine the tax position. The proposed Interpretation differs from current rules whichallow for the recognition of a tax benefit if it is “more likely than not” thatthe position would be sustained upon audit. The proposed Interpretation, ascurrently drafted (and if adopted) would be effective for fiscal years endingafter December 15, 2005. It is not certain that the Interpretation will beadopted with the current effective date. Management is in the process ofdetermining the effect of this proposal on its financial statements.

**3. Acquisitions:**

On February 27, 2006, we completed the purchaseof Zen and entered into the First Amendment with our lenders as more fully set forthin Note 12, Subsequent Events.

On February 9, 2005, we completed the purchase ofShenandoah Electronic Intelligence, Inc. (SEI). SEI is a provider ofcritical business process outsourcing primarily for the Department of HomelandSecurity (DHS). SEI’s services include: data and records management;applications processing; file and mail management; analytical support services;and secure optical card processing at one of the largest facilities of itskind.

As a result of this acquisition, we gainedapproximately 1,700 additional employees and increased our leased space to 28offices and 3 warehouses at various U.S. locations for an aggregate ofapproximately 536,263 square feet in 15 states (including approximately 27,090square feet that are sub-leased through the remaining terms of our primaryleases).

Under the terms of the definitive stock purchaseagreement, we acquired SEI for $75 million in cash, subject to certainadjustments totaling approximately $0.6 million. The transaction was fundedthrough cash-on-hand and borrowings from a new $160 million credit facility.The purchase price is subject to adjustment as a result of certain taxelections. The Company, in conjunction with the SEI stockholders, have made a338(h)(10) tax election. The definitive stock purchase agreement alsoprovides that the SEI stockholders will retain certain non-operating assets andcontingent accounts receivable.

Approximately $52.7 million of the purchaseconsideration has been allocated to goodwill based primarily on the excess ofthe purchase price over the estimated fair value of net assets acquired, andapproximately $12.2 million of the purchase price has been assigned toidentifiable intangible assets of contractual customer relationships. Thecontractual customer relationships are being amortized accelerated over itsestimated remaining life of 14 years.

F-15

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Thetotal purchase price paid, including transaction costs of $1.2 million, hasbeen preliminarily allocated as follows (in thousands):

| Cash                                          |   | $      | 2,957  |   |
|-----------------------------------------------|--------|--------|--------|--------|
| Accounts  receivable                          |   | 12,909 |   |
| Prepaid expense  and other current assets     |   | 353    |   |
| Property and  equipment                       |   | 331    |   |
| Accounts payable &  accrued expenses |   | (4,665 | )      |
| Contractual  customer relationships           |   | 12,200 |   |
| Goodwill                                      |   | 52,684 |   |
| Total consideration                           |   | $      | 76,769 |   |

 

On December 20, 2004, the Company completed thepurchase of Bridge Corporation, a provider of information technology andinformation management. The acquisition supports the company’s strategic growthplan to broaden its customer base into the intelligence agencies, andstrengthen its portfolio of mission-critical solutions. Under the terms of theacquisition agreement, the Company acquired Bridge for $30 million, subject toworking capital and other adjustments totaling approximately $1.7 million. Ofthe purchase price, $29.4 million was paid in cash and the $2.3 millionwas held as note payable to be paid in June, 2006. Approximately $26.2 million of the purchase consideration has beenallocated to goodwill, and approximately $2.2 million of the purchase price hasbeen assigned to identifiable intangible assets on the basis of contractual customerrelationships. The contractual customer relationships are being amortized usingan accelerated method over their estimatedremaining life of 6 years.

On January 21, 2004, the Company completed thepurchase of MATCOM International Corp., a provider of information technology,systems engineering, logistics, and training. Under the terms of the mergeragreement, the Company acquired MATCOM for $65.8 million. Approximately$54.6 million of the purchase consideration has been allocated to goodwill, andapproximately $5.0 million of the purchase price has been assigned toidentifiable intangible assets on the basis of contractual customerrelationships. The contractual customer relationships are being amortized usingan accelerated method over their estimated remaining life of 11 years.

Thefollowing unaudited proforma combined condensed statements of operations (inthousands, except per share) set forth the consolidated results of operationsof the Company for the twelve months ended December 31, 2005 and December 25,2004 as if the above described acquisitions, not including Zen, had occurred atthe beginning of each period presented. This unaudited proforma informationdoes not purport to be indicative of the actual results that would actuallyhave occurred if the combination had been in effect for the twelve months endedDecember 31, 2005 and December 25, 2004.

| ** **                  | ** ** | **Twelve Months Ended** | ** ** |
|-----------------------------|------------|-----------------------------------|------------|
| ** **                  | ** ** | **December 31,  2005**       | ** ** | **December 25,  2004** | ** ** |
| Revenue                     |       |                              | $          | 406,345 |   |   |   | $ | 359,691 |   |   |
| Net income                  |       |                              | $          | 16,832 |   |   |   | $ | 9,619 |   |   |
| Diluted earnings per  share |       |                              | $          | 1.44 |   |   |   | $ | 1.01 |   |   |

 

In accordance with thepurchase accounting, the operations of the MATCOM, Bridge and SEI have beenincluded in the Company’s statement of operations since the respective date ofacquisition.

F-16

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**SCOT Settlement**

OnDecember 7, 2005, the Company settled a prior dispute with a Federal customer,resulting in the Company receiving payment of $10.8 million on December 27,2005.   Components of this payment are asfollows (in thousands):

| Settlement proceeds  paid to the former Shenandoah Electronic Intelligence, Inc. (SEI) selling  stockholder in accordance with the terms of the February 5, 2005 acquisition  agreement |   | $     | 8,049  |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------|--------|--------|
| Goodwill in  accordance with SFAS 141 which addresses accounting for such pre-acquisition  contingencies                                                                                |   | 881   |   |
| Incentive payment  to employees in accordance with the terms of the contract                                                                                                            |   | 533   |   |
| Revenue  associated with post-acquisition services                                                                                                                                      |   | 1,339 |   |
| Total amount received                                                                                                                                                                   |   | $     | 10,802 |   |

 

**4. Accounts receivable:**

Accountsreceivable consists of the following (in thousands):

| ** **                                                                                                            | ** ** | **December 31,  2005** | ** ** | **December 25,  2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Billed accounts  receivable                                                                                           |       |                        | $          | 47,939                      |       |   |   | $ | 33,247 |   |   |
| Unbilled accounts  receivable:                                                                                        |       |                        |       |                        |       |   |   |   |   |
| Currently billable                                                                                                    |       |                        | 40,094     |                        |       |   | 26,400 |   |   |
| Unbilled retainages and milestones payments expected  to be billed within the next 12 months                          |       |                        | 5,546      |                        |       |   | 5,714 |   |   |
| Indirect costs incurred and charged to cost-plus  contracts in excess of provisional billing rates  (see Note 9) |       |                        | 1,563      |                        |       |   | 1,493 |   |   |
| Total unbilled  accounts receivable                                                                                   |       |                        | 47,203     |                        |       |   | 33,607 |   |   |
| Allowance for  doubtful accounts                                                                                      |       |                        | (1,509     | )                           |       |   | (1,144 | ) |   |
| Accounts receivable, net                                                                                              |       |                        | $          | 93,633                      |       |   |   | $ | 65,710 |   |   |

 

Thecurrently billable amounts included as unbilled accounts receivable as of December 31,2005 represent amounts which are billed during the first quarter of thesubsequent year. They are billings for services rendered prior to year-end,which are billed once necessary billing data has been collected and an invoiceproduced.

**5. Property and equipment:**

Propertyand equipment consist of the following (in thousands):

| ** **                                           | ** ** | **December 31,  2005** | ** ** | **December 25,  2004** | ** ** |
|------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Computers and  equipment                             |       |                        | $          | 8,691                       |       |   |   | $ | 8,007 |   |   |
| Software                                             |       |                        | 2,623      |                        |       |   | 1,904 |   |   |
| Furniture and  fixtures                              |       |                        | 2,356      |                        |       |   | 1,576 |   |   |
| Leasehold  improvements                              |       |                        | 1,581      |                        |       |   | 1,086 |   |   |
|                                                 |       |                        | 15,251     |                        |       |   | 12,573 |   |   |
| Less—Accumulated  depreciation and amortization |       |                        | (9,343     | )                           |       |   | (7,602 | ) |   |
|                                                 |       |                        | $          | 5,908                       |       |   |   | $ | 4,971 |   |   |

 

Property and equipmentincludes assets financed under capital lease obligations of approximately 

F-17

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$273,000and $332,000, net of accumulated depreciation, as of December 31, 2005 andDecember 25, 2004, respectively.

Depreciationexpense of approximately $2.2 million, $2.2 million, and$2.0 million was recorded in fiscal years 2005, 2004 and 2003,respectively.

**6. Accruedexpenses:**

Accruedexpenses consist of the following (in thousands):

| ** **                                      | ** ** | **December 31,  2005** | ** ** | **December 25,  2004** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Accrued vacation                                |       |                        | $          | 6,183                       |       |   |   | $ | 4,955 |   |   |
| Accrued  compensation                           |       |                        | 9,638      |                        |       |   | 3,550 |   |   |
| Accrued bonus                                   |       |                        | 6,755      |                        |       |   | 2,875 |   |   |
| Other accrued  liabilities                      |       |                        | 7,098      |                        |       |   | 4,223 |   |   |
| Accrued expenses  and other current liabilities |       |                        | $          | 29,674                      |       |   |   | $ | 15,603 |   |   |

 

**7. Income taxes:**

The Companyaccounts for income taxes in accordance with SFAS No. 109, “Accounting forIncome Taxes,” which requires recognition of deferred tax assets and liabilitiesfor the expected future tax consequences of events that have been included inthe financial statements or income tax returns. Under this method, deferred taxassets and liabilities are determined based on the differences between thefinancial statement and the tax basis of assets and liabilities using enactedtax rates for the year in which the differences are expected to reverse.

Thetax effect of significant temporary differences, which comprise the deferredtax assets and liabilities, are as follows (in thousands):

| ** **                            | ** ** | **December 31,  2005** | ** ** | **December 25,  2004** | ** ** |
|---------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Deferred tax  assets (liabilities):   |       |                        |       |                        |       |   |   |   |   |
| Accounts payable and accrued expenses |       |                        | $          | 1,969                       |       |   |   | $ | 2,081 |   |   |
| Allowance for doubtful accounts       |       |                        | 623        |                        |       |   | 476 |   |   |
| Net operating loss                    |       |                        | 796        |                        |       |   | 808 |   |   |
| Deferred rent                         |       |                        | 794        |                        |       |   | 568 |   |   |
| Lease payable                         |       |                        | 312        |                        |       |   | 703 |   |   |
| Deferred compensation                 |       |                        | 861        |                        |       |   | 486 |   |   |
| Stock compensation                    |       |                        | 395        |                        |       |   | 159 |   |   |
| Other                                 |       |                        | —     |                        |       |   | 31 |   |   |
| Total deferred  tax asset             |       |                        | 5,750      |                        |       |   | 5,312 |   |   |
| Prepaid expenses                      |       |                        | (13        | )                           |       |   | (6 | ) |   |
| Intangible assets                     |       |                        | (7,646     | )                           |       |   | (5,108 | ) |   |
| Unbilled revenue                      |       |                        | (2,470     | )                           |       |   | (2,394 | ) |   |
| Depreciation and amortization         |       |                        | (420       | )                           |       |   | (110 | ) |   |
| Total deferred  tax liability         |       |                        | (10,549    | )                           |       |   | (7,618 | ) |   |
| Net deferred tax liability            |       |                        | $          | (4,799                      | )          |   |   | $ | (2,306 | ) |   |

 

SI Telecom has approximately $2,040,000 in netoperating loss carryforwards, which will expire in 2021. These losses can onlybe used to offset income generated by SI Telecom. Management believes that 

F-18

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it is more likely than notthat these net operating loss carryforwards will be benefited on a future taxreturn and therefore no valuation allowance was required.

Theprovision for income taxes consists of the following for the fiscal years (inthousands):

| ** **                     | ** ** | **Fiscal year** | ** ** |
|--------------------------------|------------|----------------------|------------|
| ** **                     | ** ** | **2005**             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Current  provision:            |       |                 |       |   |   |   |   |
| Federal                        |       | $                    | 7,100      |   | $ | 4,472 |   | $ | 4,301 |   |
| State                          |       | 1,349                |       | 940 |   | 581 |   |
| Deferred  provision (benefit): |       |                 |       |   |   |   |   |
| Federal                        |       | 2,269                |       | 1,490 |   | (86 | ) |
| State                          |       | 224                  |       | 196 |   | (12 | ) |
| Provision for income  taxes    |       | $                    | 10,942     |   | $ | 7,098 |   | $ | 4,784 |   |

 

Areconciliation of income taxes at the Federal statutory income tax rate to theprovision for income taxes is as follows (in thousands):

| ** **                                             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Income taxes at  the Federal statutory income tax rate |       | $        | 9,757      |     | $          | 6,291    |       | $ | 4,257 |   |
| State income  taxes, net of Federal benefit            |       | 1,090    |       | 738      |       | 370      |       |
| Other, net                                             |       | 95       |       | 69       |       | 157      |       |
| Provision for income  taxes                            |       | $        | 10,942     |     | $          | 7,098    |       | $ | 4,784 |   |

 

**8. Debt:**

Debtconsists of the following (in thousands):

| ** **                                                                                                                                                                                                                                                                                                                                       | ** ** | **December 31,  2005** | ** ** | **December 25,  2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Credit  facilities:                                                                                                                                                                                                                                                                                                                              |       |                        |       |                        |       |   |   |   |   |
| Line of credit at December 25, 2004, bears  interest at LIBOR plus 275 to 350 base points or a specified base rate plus  170 to 250 basis points, interest due monthly, principal due January 21,  2008                                                                                                                                |       |                        | $          | —                      |       |   |   | $ | 28,954 |   |   |
| Term loan at  December 31, 2005, bears interest at LIBOR plus 225 to 250 basis points  or a specified base rate plus 125 to 150 basis points, interest due monthly,  twenty-three $250,000 consecutive quarterly principal payments starting on  June 30, 2005, and a final $94.25 million principal payment on  February 9, 2011 |       |                        | 99,250     |                        |       |   | — |   |   |
| Total debt*                                                                                                                                                                                                                                                                                                                                      |       |                        | $          | 99,250                      |       |   |   | $ | 28,954 |   |   |

----

*                    Excludes $2.3million note payable in connection with the Bridge acquisition as describedbelow.

The original credit facility (the 2002 creditfacility) consisted of a $35.0 million secured revolving credit arrangementwith Wachovia Bank, N.A. acting as Administration Agent for a consortium oflenders. With the closing of the acquisition of Matcom, the Company amended the2002 credit facility in January 2004. The amended credit facility (the2004 credit facility) consists of a $30.0 million term loan and a$50.0 million secured revolving credit arrangement. The 2004 credit facilitywas secured by a pledge of substantially all of our current and future tangibleand intangible assets, as well as those of our current 

F-19

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and future subsidiaries,including accounts receivable, inventory and capital stock of our existing andfuture subsidiaries.

Contemporaneously with the closing of our acquisitionof SEI on February 9, 2005, the Company entered into the Credit Agreementwhich increased its borrowing capacity to $160 million, which is comprised of a$60 million five-year revolving credit facility and a $100 million six-yearterm loan facility. Borrowings available under the Credit Agreement were usedas part of the acquisitions of Bridge and SEI. In addition, the CreditAgreement provides that up to an additional $75 million in uncommittedincremental term loan funds are available to the Company upon its request atany time for up to two years from one or more of the lenders under the CreditAgreement.

The annual maturity of long-term debt is$1.0 million for each of the five fiscal years subsequent toDecember 31, 2005 and approximately $94.3 million thereafter.

Any borrowings under the Credit Agreement, at theCompany’s option, bears interest either at floating rates equal to LIBOR plus aspread ranging from 200 to 270 basis points or an alternate base rate plus aspread ranging from 100 to 175 basis points, with the exact spread determinedupon the leverage ratio as defined in the Credit Agreement.

In connection with the Credit Agreement, the Company hadincurred approximately $3.2 million financing costs. Such costs werecapitalized as deferred financing costs on the balance sheet and amortized overthe six year term of the Credit Agreement.

This credit facility was amended contemporaneouslywith the signing of the definitive Stock Purchase Agreement relating to theacquisition of Zen on February 27, 2006.

The Company had approximately $129.3 million ofoutstanding debt under our Amended Credit Agreement on February 27, 2006and following the closing of our acquisition of Zen. The Company is required torepay $323,125 in consecutive quarterly payments starting from March 31,2006 through December 31, 2010, and a final payment of $122.8 million onFebruary 9, 2011. As with the previous credit facilities, the company isrequired to maintain compliance with financial and non-financial covenantsincluding, maintaining certain leverage and fixed charge ratios, as certainannual limits on our capital expenditures.

The Company also has outstanding a note payable in theamount of $2.3 million, to be paid in June, 2006 for the acquisition ofBridge.

**9. Commitments and contingencies:**

**Leases**

As of December 31, 2005, the Company hasnoncancelable operating leases, primarily for real estate, that expire over thenext seven years. Rental expense during fiscal year 2005, 2004 and 2003 wasapproximately $8.1 million, $6.6 million and $5.4 million,respectively.

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Futureminimum lease payments under noncancelable operating and capital leases as ofDecember 31, 2005 are as follows (in thousands):

| **Fiscal year**                            | ** ** | ** ** | ** ** | **Capital** | ** ** | **Operating** | ** ** |
|-------------------------------------------------|------------|------------|------------|-------------|------------|---------------|------------|
| 2006                                            |       |       | $          | 116         |       |          |       | $ | 8,373 |   |   |
| 2007                                            |       |       | 88         |        |       |          | 6,327      |   |   |
| 2008                                            |       |       | 72         |        |       |          | 6,060      |   |   |
| 2009                                            |       |       | 30         |        |       |          | 6,157      |   |   |
| 2010                                            |       |       | 18         |        |       |          | 5,935      |   |   |
| Thereafter                                      |       |       | —     |        |       |          | 8,177      |   |   |
| Total minimum  lease payments                   |       |       | 324        |        |       |          | $          | 41,029 |   |   |
| Less—Interest  element of payment          |       |       | (32        | )           |       |          |       |   |   |
| Present value of  future minimum lease payments |       |       | 292        |        |       |          |       |   |   |
| Current portion                                 |       |       | 101        |        |       |          |       |   |   |
| Long-term capital lease                         |       |       | $          | 191         |       |          |       |   |   |   |

 

 

Subsequent to the purchaseof SEI and Zen, the Company assumed certain capital and operating leases heldat the time of purchase.

**Contract cost audits**

Payments to the Company ongovernment cost reimbursable contracts are based on provisional, or estimatedindirect rates, which are subject to audit on an annual basis by the DefenseContract Audit Agency (DCAA). The cost audits result in the negotiation anddetermination of the final indirect cost rates that the Company may use for theperiod(s) audited. The final rates, if different from the provisionalrates, may create an additional receivable or liability for the Company. TheCompany’s revenue recognition policy calls for revenue recognized on all costreimbursable government contracts to be recorded at actual rates unlesscollectibility is not reasonably assured. To the extent the indirect ratedifferential creates a liability for the Company, the differential isrecognized as a reduction to revenue when identified.

**Litigation and claims**

We are a party tolitigation and legal proceedings that we believe to be a part of the ordinarycourse of our business. While we cannot predict the ultimate outcome of thesematters, we currently believe that any ultimate liability arising out of theseproceedings will not have a material adverse effect on our financial position.We may become involved in other legal and governmental, administrative orcontractual proceedings in the future.

The SEI acquisition agreement provides for a purchaseprice adjustment based upon the working capital of SEI as of the closingdate.  Subsequent to the closing date, wereceived a payment of $1.6 million in connection with services performed priorto the closing date that SEI had not previously billed, and was not authorizedto bill, its customer as of the closing date. The SEI selling stockholders have asserted that they are entitled to acredit in connection with the calculation of working capital adjustment in anamount equal to the amount received by us for this post-closing payment.  We believe that, in accordance with GAAP, theSEI selling stockholders should not receive the benefit of the post-closingpayment.  In accordance with the terms ofthe SEI acquisition agreement, the parties have jointly submitted the issue toan independent accounting firm for resolution. We anticipate that this matter will be resolved before the end of 2006.

F-21

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**10. Stockholders’ equity:**

**Common stock**

In November 2002, the Company completed itsinitial public offering. The Company issued 3,850,000 shares of common stockfor total net proceeds of approximately $47.1 million. In October 2004, the Company andaffiliates of Frontenac, one of the Company’s investors, sold an aggregate of3,200,000 shares of the Company’s common stock in an underwritten publicoffering priced at $21.85 per share. Of the 3,200,000 shares offered, 2,200,000shares were sold by the Company and 1,000,000 shares were sold by the sellingstockholders. The Company did not receive any of the proceeds from the sale ofcommon stock by the selling stockholders. The Company also granted theunderwriters an option to purchase up to 320,000 shares solely to coverover-allotments, which the underwriters exercised. In connection with this offering, the Company received approximately$51.2 million in net proceeds, which was primarily used to payoff $27.0 millionof term loan borrowings and $16.0 million of borrowings under the revolvingline of credit.

**Stock option plans**

In 2002, the Company adopted the 2002 Stock IncentivePlan, or the Plan, to grant stock options to purchase up to 1,600,000 shares ofits common stock to its employees and employees of its affiliates. In March 2004,the Board of Directors increased the number of reserved shares by 160,000, sothat the total number of reserved shares totaled 1,760,000. In March 2005,the Board of Directors increased the number of reserved shares by an additional160,000 so that the total number of reserved shares totals 1,920,000. Further,in March 2005, the Board of Directors authorized the acceleration ofvesting of certain stock awards under the Plan upon the occurrence of certainchange of control events. With this change, future stock awards may includeprovisions for acceleration of vesting upon the occurrence of certain change ofcontrol events. The Board of Directors also authorized the amendment of certainprior stock option awards issued under the Plan such that the exercise price ofeach such award was greater than or equal to the closing market price of ourcommon stock on Nasdaq as of March 11, 2005. With respect to suchdesignated prior stock option awards, the Board of Directors authorized anamendment to the stock option award to provide for the acceleration of vestingupon the occurrence of certain change of control events.

In April 2005, the Board of Directors voted toadopt the 2002 Amended and Restated Omnibus Stock Incentive Plan (the “Amendedand Restated Plan”) and the Amended and Restated Plan was approved by ourstockholders at the annual meeting of stockholders held in June 2005. TheAmended and Restated Plan amends and restates the Plan by (i) increasingthe number of shares of common stock reserved and available under the Plan by1,000,000 shares to a total share allocation of 2,920,000, (ii) permittingthe grant of deferred shares, performance shares and performance units, (iii) prohibitingrepricing of options without prior stockholder approval, (iv) limiting thenumber of shares of common stock and performance units subject to awards aparticipant may receive in any calendar year to 300,000 and 500,000,respectively, and adding other administrative provisions to comply with theperformance-based compensation exception to the deduction limit of Section 162(m) ofthe Internal Revenue Code of 1986, as amended; (v) eliminating theprovision that previously provided for an automatic increase in the number ofshares reserved for issuance under the Amended and Restated Plan each fiscalyear by a number equal to the lesser of 160,000 shares and an amount determinedby the Board of Directors, (vi) providing that non-qualified stock optiongrants will be priced at one hundred percent (100%) of fair market value; (vii) providingfor minimum vesting periods of stock bonus awards, restricted common stockawards, stock appreciation rights, deferred shares, and other stock awardssubject to the possible acceleration of the vesting schedule at the discretionof the administrator; (viii) providing that future amendments to theAmended and Restated Plan that increase the number of shares allocated, modifyparticipation requirements, or materially increase benefits accruing to theparticipants under the Plan will be subject to stockholder approval; and (ix) makingother technical changes to the Plan.

F-22

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On December 13, 2005, the Board of Directorsapproved the accelerated vesting of unvested stock options previously awardedto employees, officers and directors as of December 7, 2005 in light ofnew accounting regulations that were to come into effect January 1, 2006. Basedon the Statement of Financial Accounting Standards No. 123R, “Share-BasedPayment” (SFAS 123R), the Board took the action to accelerate the unvestedstock with the belief that it is in the best interest of stockholders, as itwill reduce the Company’s reported compensation expense in future periods.

TheCompany’s option activity and price information for the three-year period endedDecember 31, 2005 is as follows:

| ** **                                     | ** ** | **Options** | ** ** | **Shares  exercisable** | ** ** | **Weighted-average  exercise price** | ** ** |
|------------------------------------------------|------------|-------------|------------|-------------------------|------------|-------------------------------------------|------------|
| Balance,  December 28, 2002               |       | 976,080     |       |                    |       |                                      | $          | 13.27 |   |   |
| Options exercisable at December 28, 2002  |       |        |       | 342,649                 |       |                                      | 3.40       |   |   |
| 2003 grants                                    |       | 165,741     |       |                    |       |                                      | 12.37      |   |   |
| 2003 exercise                                  |       | (11,766     | )          |                    |       |                                      | (5.68      | ) |   |
| 2003 forfeitures                               |       | (79,002     | )          |                    |       |                                      | (13.17     | ) |   |
| Balance,  December 27, 2003               |       | 1,051,053   |       |                    |       |                                      | $          | 13.18 |   |   |
| Options exercisable at December 27, 2003  |       |        |       | 275,699                 |       |                                      | 12.47      |   |   |
| 2004 grants                                    |       | 551,285     |       |                    |       |                                      | 18.00      |   |   |
| 2004 exercise                                  |       | (76,026     | )          |                    |       |                                      | (12.24     | ) |   |
| 2004 forfeitures                               |       | (121,055    | )          |                    |       |                                      | (15.44     | ) |   |
| Balance,  December 25, 2004               |       | 1,405,257   |       |                    |       |                                      | $          | 14.93 |   |   |
| Options exercisable at December 25, 2004  |       |        |       | 546,646                 |       |                                      | 13.40      |   |   |
| 2005 grants                                    |       | 687,097     |       |                    |       |                                      | 28.19      |   |   |
| 2005 exercise                                  |       | (293,689    | )          |                    |       |                                      | (12.73     | ) |   |
| 2005 forfeitures                               |       | (47,728     | )          |                    |       |                                      | (18.00     | ) |   |
| Balance,  December 31, 2005               |       | 1,750,937   |       |                    |       |                                      | $          | 20.29 |   |   |
| Options  exercisable at December 31, 2005 |       |        |       | 1,750,937               |       |                                      |       |   |   |

 

Thefollowing table shows the number of options, the weighted average remaininglife, and the options exercisable for each exercise price of optionsoutstanding at December 31, 2005.

|        | ** ** | **Number of  Options** | ** ** | **Range of  Exercise  Price** | ** ** | **Weighted  Avg. Exercise  Price** | ** ** | **Weighted  Average  Remaining Life** | ** ** | **Options  Exercisable** | ** ** |
|--------|------------|-----------------------------|------------|------------------------------------|------------|-----------------------------------------|------------|--------------------------------------------|------------|--------------------------|------------|
|        |       | 112,199                     |       | 1.58 –   9.27       |       |                                    | 8.97       |                                       |       |                     | 2.6        |   |   | 112,199 |   |
|        |       | 509,101                     |       | 10.81 – 14.00                 |       |                                    | 13.80      |                                       |       |                     | 6.9        |   |   | 509,101 |   |
|   |       | 384,283                     |       | 16.40 – 19.26                 |       |                                    | 16.77      |                                       |       |                     | 8.0        |   |   | 384,283 |   |
|        |       | 232,945                     |       | 20.55 – 26.60                 |       |                                    | 25.54      |                                       |       |                     | 8.9        |   |   | 232,945 |   |
|   |       | 364,948                     |       | 26.80 – 29.87                 |       |                                    | 28.09      |                                       |       |                     | 9.1        |   |   | 364,948 |   |
|        |       | 146,900                     |       | 30.46 – 31.53                 |       |                                    | 30.84      |                                       |       |                     | 9.8        |   |   | 146,900 |   |
|   |       | 561                         |       | 556.26                             |       |                                    | 556.26     |                                       |       |                     | 2.1        |   |   | 561 |   |
| Total  |       | 1,750,937                   |       |                               |       |                                    |       |                                       |       |                     |       |   |   | 1,750,937 |   |

 

Each stock option grant establishes the vestingschedule applicable to the grant. The weighted-average remainingcontractual life of the stock options outstanding as of December 31, 2005and December 25, 2004 was 7.8 years and 7.8 years, respectively.

F-23

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During its fiscal year ended 2001 and continuing intothe fiscal year ended 2002, the Company issued options with exercise priceswhich were less than the fair value of SI’s common stock at the date of optiongrant. Total deferred compensation related to these option grants was $518,000for the fiscal year ended December 28, 2002 and $142,000 for the fiscalyear ended December 29, 2001. This deferred compensation were amortized toexpense over the related option’s vesting period. Such non-cash stock-basedcompensation expense totaled $196,000 in fiscal year 2005, $132,000 in fiscalyear 2004, and $132,000 in fiscal year 2003.

Theweighted-average fair value of stock options granted in fiscal year 2005,2004, and 2003 was $14.50, $13.28 and $7.80, respectively.

**Stock repurchase program**

During the company’s Boardof Directors meeting on December 6, 2005, the Board authorized the repurchaseof up to 300,000 shares of its common stock up to an aggregate maximum dollaramount of $8 million.  The Company hasapproximately 11.3 million shares outstanding as of December 31, 2005.  Timing and volume of any purchases will beguided by management’s assessment of market conditions, securities lawlimitations, the number of shares of common stock outstanding, and alternative,potentially higher value uses for cash resources.  The repurchase plan may be suspended ordiscontinued at any time without prior notice.

**11. Retirement plans:**

SI hasa defined contribution 401(k) Retirement/Savings Plan (the Plan) toprovide retirement benefits for all eligible employees of the Company.Employees are eligible to participate in the Plan beginning on the first of themonth following the start of employment and attainment of age 21. Under thePlan, eligible employees may contribute from 1% to 15% of pre-tax compensation.The Plan also allows after-tax contribution up to 5% of compensation. At itsdiscretion, the Company may make an annual matching contribution and an annualprofit-sharing contribution. For fiscal year 2004, there was no profit-sharingcontribution made to the Plan by the Company. A profit-sharing contributionof $1,200,000 and $370,000 was made by the Company for fiscal years 2005 and2003, respectively. The Company’s matching contribution to the Plan for fiscalyears 2005, 2004 and 2003 was approximately $1.8 million, $1.1 millionand $0.7 million.

**12. Subsequent Events:**

On February 27, 2006, we closed the acquisition of Zen.Zen is a provider of critical IT services, specializing in managed networkservices, information assurance, software development and systems engineering,database and systems administration and IT consulting to various U.S.Government agencies.  Zen’s largestclients include the Missile Defense Agency (MDA), Department of Defense’sWashington Headquarters Services (WHS), Federal Communications Commission(FCC), the Pension Benefit Guaranty Corporation (PBGC), and the Federal TradeCommission (FTC). 

Pursuant to the terms of the Zen Agreement we acquiredall of the outstanding capital stock of Zen for $60 million in cash, of whichwe are withholding $6 million for 15 months in order to secure post-closingindemnity obligations of the sellers. The purchase price is subject to atwo-way adjustment based upon whether the working capital of Zen as of theclosing date was above or below the target working capital specified in the ZenAgreement. Each of the parties to the Zen Agreement has made customaryrepresentations and warranties and agreed to certain indemnification obligations.The transaction was funded through cash-on-hand, a subordinated Seller’s Notein the amount of $6 million, and borrowing from our newly amended creditfacility, which is described below. The purchase price is also subject to 

F-24

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adjustment as a result ofcertain tax elections. Zen’s trailing twelve months revenue ended November 30,2005, was approximately $38 million (unaudited).

Approximately $52.0 million of the purchaseconsideration has been allocated to goodwill based primarily on the excess ofthe purchase price over the estimated fair value of net assets acquired andapproximately $7.0 million and $0.2 million of the purchase price has beenassigned to identifiable Intangible assets of contractual customerrelationships and non-compete agreements, respectively. Each customerrelationship, which includes each customer’s contract, is being amortized on anaccelerated basis over its useful life. The non-compete agreements areamortized on a straight-line basis over a 3-year period.

The totalpurchase price paid, including transaction costs of $0.4 million, has been preliminarilyallocated as follows (in thousands):

| Cash and cash equivalents              |   | 3,503   |   |
|----------------------------------------|--------|---------|--------|
| Accounts  receivable                   |   | 11,027  |   |
| Other current  assets                  |   | 2,885   |   |
| Property and  equipment                |   | 466     |   |
| Other assets                           |   | 19      |   |
| Accounts payable  and accrued expenses |   | (13,182 | )      |
| Other long term  liabilities           |   | (41     | )      |
| Notes Payable                          |   | (3,400  | )      |
| Intangible assets                      |   | 7,150   |   |
| Goodwill                               |   | 51,973  |   |
| Total consideration                    |   | 60,400  |   |

 

On February 27, 2006, contemporaneously with ourclosing the acquisition of Zen, we entered into the First Amendment with asyndicate of lenders, including Wachovia Bank, National Association, a nationalbanking association, which acted as administrative agent for the lenders.

The terms and conditions of the Amended CreditAgreement (i) establish a new term loan in the principal amount ofapproximately $129.3 million, which replaced the then existing term loan underthe Credit Agreement, (ii) reduce both the base rate margin and the LIBORmargin on the term facility, (iii) increase the leverage ratio for thefinancial covenants and (iv) amend certain restrictive covenants. The principalbalance of the new term loan is to be repaid in quarterly installmentscommencing March 31, 2006, with the balance due upon the expiration of the AmendedCredit Agreement on February 9, 2011. If an event of default occurs and iscontinuing, we may be required immediately to repay all amounts outstandingunder the Amended Credit Agreement.

The funds borrowed under the new term loan were usedto (i) refinance the approximately $99.3 million in principal outstandingunder the then existing term loan under the Credit Agreement and to pay any andall fees and expenses related thereto; (ii) to finance the acquisition of Zenand pay any and all fees and expenses related thereto; and (iii) to provide forworking capital expenditures, and other general corporate uses.

The borrowing capacity under the Amended CreditAgreement totals approximately $189.3 million and is comprised of a $60 millionfive-year revolving credit facility and approximately $129.3 million term loanfacility. Additionally, a $75 million uncommitted incremental term loanfacility will be available upon our request at any time for up to two yearsfrom the date of the Credit Agreement from one or more of the lenders.

F-25

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Effective February 14, 2006, an interest swapagreement came into effect which reduced  our exposure associated with the marketvolatility of floating LIBOR interest rates. This agreement has a notionalprincipal amount of $30 million and, as of December 31, 2005, had a rate rangingfrom 4.05% to 4.74%. This agreement is a hedge against term debt, which bearsinterest at LIBOR plus a margin which has a current overall rate of 5.78%. Atstated monthly intervals the difference between the interest on the floatingLIBOR-based debt and the interest calculated in the swap agreement are settledin cash.

On January 31, 2006,we announced that the company had been awarded a contract for Management andOperation of the National Visa Center and Kentucky Consular Center by theDepartment of State. Under the contract, our work will be performed at the NationalVisa Center in Portsmouth, New Hampshire and at the Kentucky Consular Center inWilliamsburg, Kentucky. The prime contract has a one-year base period and fourone-year options periods.

**13.Interim financial data (unaudited)**

| ** **                          | ** ** | **Fiscal Year 2005**       | ** ** | **Fiscal Year 2004** | ** ** |
|-------------------------------------|------------|--------------------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **Q1**                               | ** ** | **Q2**                         | ** ** | **Q3** | ** ** | **Q4** | ** ** | **Q1** | ** ** | **Q2** | ** ** | **Q3** | ** ** | **Q4** | ** ** |
| ** **                          | ** ** | **(dollars in thousands)** | ** ** |
| Revenue                             |       | $                                    | 83,717     |                           | $          | 95,983 |   | $ | 101,775 |   | $ | 116,444 |   | $ | 55,970 |   | $ | 63,814 |   | $ | 72,926 |   | $ | 69,596 |   |
| Income from  operations             |       | 6,526                                |       | 8,314                          |       | 9,193 |   | 9,937 |   | 4,430 |   | 5,174 |   | 5,518 |   | 5,616 |   |
| Net income                          |       | $                                    | 3,224      |                           | $          | 4,036 |   | $ | 4,578 |   | $ | 5,099 |   | $ | 2,357 |   | $ | 2,684 |   | $ | 2,882 |   | $ | 2,955 |   |
| Basic net income  per share         |       | $                                    | 0.29       |                           | $          | 0.36 |   | $ | 0.41 |   | $ | 0.45 |   | $ | 0.28 |   | $ | 0.32 |   | $ | 0.34 |   | $ | 0.27 |   |
| Diluted net income per  share  |       | $                                    | 0.28       |                           | $          | 0.35 |   | $ | 0.39 |   | $ | 0.43 |   | $ | 0.27 |   | $ | 0.30 |   | $ | 0.33 |   | $ | 0.26 |   |

 

F-26

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**SIInternational, Inc. and Subsidiaries(See Note 1 to Consolidated Financial Statements)Schedule II—Valuation and Qualifying Accounts(In Thousands)**

| **Description**                                   | ** ** | ** ** | ** ** | **Balance at  beginning of  period** | ** ** | **Charged to  costs and  expenses** | ** ** | **Acquired in  business  combinations** | ** ** | **Deductions** | ** ** | **Balance at  end of  period** | ** ** |
|---------------------------------------------------|------------|------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|----------------|------------|------------------------------------------|------------|
| For the fiscal year  ended December 28, 2002 |       |       |       |                                           |       |                                          |       |                                         |       |           |       |                                     |       |   |   |   |   |   |   |   |   |
| Deducted from  assets accounts:                   |       |       |       |                                           |       |                                          |       |                                         |       |           |       |                                     |       |   |   |   |   |   |   |   |   |
| Allowance for doubtful accounts                   |       |       | 630        |                                           |       |                                          | 472        |                                         |       |           | —     |                                     |       |   | 6 |   |   |   | 1,096 |   |   |
| For the fiscal year ended  December 27, 2003 |       |       |       |                                           |       |                                          |       |                                         |       |           |       |                                     |       |   |   |   |   |   |   |   |   |
| Deducted from  assets accounts:                   |       |       |       |                                           |       |                                          |       |                                         |       |           |       |                                     |       |   |   |   |   |   |   |   |   |
| Allowance for doubtful accounts                   |       |       | 1,096      |                                           |       |                                          | 144        |                                         |       |           | —     |                                     |       |   | — |   |   |   | 1,240 |   |   |
| For the fiscal year  ended December 25, 2004 |       |       |       |                                           |       |                                          |       |                                         |       |           |       |                                     |       |   |   |   |   |   |   |   |   |
| Deducted from  assets accounts:                   |       |       |       |                                           |       |                                          |       |                                         |       |           |       |                                     |       |   |   |   |   |   |   |   |   |
| Allowance for doubtful accounts                   |       |       | 1,240      |                                           |       |                                          | —     |                                         |       |           | —     |                                     |       |   | 96 |   |   |   | 1,144 |   |   |
| For the fiscal year  ended December 31, 2005 |       |       |       |                                           |       |                                          |       |                                         |       |           |       |                                     |       |   |   |   |   |   |   |   |   |
| Deducted from  assets accounts:                   |       |       |       |                                           |       |                                          |       |                                         |       |           |       |                                     |       |   |   |   |   |   |   |   |   |
| Allowance for  doubtful accounts                  |       |       | 1,144      |                                           |       |                                          | 52         |                                         |       |           | 1,106      |                                     |       |   | 793 |   |   |   | 1,509 |   |   |

 

F-27

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