**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**(Mark One)**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**For the fiscal year ended December 30, 2006**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**For the transition periodfrom              to              **

**Commission File Number000-50080**

**SI International, Inc.**

(Exact Name of Registrant as 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 Telephone Number, Including Area Code:**(703) 234-7000**

Securities to beregistered pursuant 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:

**CommonStock, $0.01 par value per share**(Title of Class)

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.Yes o  Nox

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 orSection 15(d) of the Act. Yes o  No x

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the 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  Noo

Indicate by check mark if disclosure of delinquent filerspursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of thisForm 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act. (Check one):

Large acceleratedfiler  o    Accelerated filer  x    Non-acceleratedfiler  o

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

Theaggregate market value of SI International, Inc. Common Stock held bynon-affiliates of the registrant as of June 30, 2006 was $329,174,406.

As ofMarch 1, 2007, there were 12,975,597 shares of SI International, Inc.Common Stock, $0.01 par value per share, outstanding.

**DOCUMENTS INCORPORATED BY REFERENCE**

Certain portions of the registrant’s annual report tostockholders for the fiscal year ended December 30, 2006 will beincorporated by reference into Part II and III of this Form 10-K.Certain portions of the definitive proxy statement to be used in connectionwith SI International, Inc.’s annual meeting of stockholders, which isexpected to be filed not later than 120 days after the registrant’s fiscal yearended December 30, 2006, will be incorporated by reference into Part IIIof this Form 10-K.

 

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**SI INTERNATIONAL, INC.FORM 10-K**
| **PART I**               |   |                                                                                                                    |   |   |   |
|-------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| ITEM 1                        |   | Business                                                                                                                |   | 3      |   |
| ITEM 1A                       |   | Risk  Factors                                                                                                           |   | 17     |   |
| ITEM 1B                  |   | Unresolved Staff Comments                                                                                               |   | 31     |   |
| ITEM 2                        |   | Properties                                                                                                              |   | 31     |   |
| ITEM 3                        |   | Legal Proceedings                                                                                                       |   | 32     |   |
| ITEM 4                        |   | Submission of Matters to a Vote of Security Holders                                                                     |   | 32     |   |
| **PART II**              |   |                                                                                                                    |   |   |   |
| ITEM 5                        |   | Market for the Company’s Common Equity and Related  Stockholder Matters and Issuer Purchases of Equity Securities  |   | 33     |   |
| ITEM 6                        |   | Selected Financial Data                                                                                                 |   | 34     |   |
| ITEM 7                        |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                   |   | 36     |   |
| ITEM 7A                       |   | Quantitative and Qualitative Disclosures About Market  Risk                                                             |   | 47     |   |
| ITEM 8                        |   | Financial Statements and Supplementary Data                                                                             |   | 48     |   |
| ITEM 9                        |   | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                              |   | 48     |   |
| ITEM 9A                       |   | Controls and Procedures                                                                                                 |   | 48     |   |
| ITEM  9B                      |   | Other  Information                                                                                                      |   | 50     |   |
| **PART III  ** |   |                                                                                                                    |   |   |   |
| ITEM  10                      |   | Directors,  Executive Officers and Corporate Governance                                                                 |   | 51     |   |
| ITEM  11                      |   | Executive  Compensation                                                                                                 |   | 51     |   |
| ITEM  12                      |   | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters    |   | 51     |   |
| ITEM  13                      |   | Certain  Relationships and Related Transactions, and Director Independence                                              |   | 51     |   |
| ITEM  14                      |   | Principal  Accountant Fees and Services                                                                                 |   | 51     |   |
| **PART IV**              |   |                                                                                                                    |   |   |   |
| ITEM 15                       |   | Exhibits and Financial Statement Schedules                                                                              |   | 51     |   |
|                          |   | Signatures                                                                                                              |   | 52     |   |

 

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**BUSINESSINFORMATION**

Throughout this document, we occasionally distinguishSI International, Inc., as a company separate from its subsidiaries, andSI International, Inc., as a company combined with its subsidiaries. Inorder to clarify which entity we are referring to in various discussions, weuse the terms “SI International, Inc.” and “SI International” to refer toSI International, Inc. without its subsidiaries. All other references,including “SI,” “the Company,” “we” and “us” refer to SI International and itssubsidiaries.

*Some of thestatements under Item 1. “Business,” Item 7. “Management’s Discussion andAnalysis of Financial Condition and Results of Operations,” and elsewhere inthis Form 10-K constitute forward looking statements. These statementsinvolve known and unknown risks, uncertainties, and other factors thatmay cause our actual results, levels of activity, performance orachievements to be materially different from any future results, levels ofactivity, performance or achievements expressed or implied by such forwardlooking statements. In some cases, you can identify these statements by forwardlooking words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,”“may,” “plan,” “potential,” “should,” “will,” and “would” or similar words. Youshould read statements that contain these words carefully because they discussour future expectations, contain projections of our future results ofoperations or of our financial position, or state other forward lookinginformation. We believe that it is important to communicate our futureexpectations to our investors. However, there may be events in the futurethat we are not able to predict accurately or control. The factors listed inthe section captioned Item 1A. “Risk Factors,” as well as any cautionarylanguage in this Form 10-K, provide examples of risks, uncertainties, andevents that may cause our actual results to differ materially from theexpectations we describe in our forward looking statements.*

*Although we believe that the expectations reflected inthe forward looking statements are reasonable, we cannot guarantee futureresults, levels of activity, performance or achievements. You should not placeundue reliance on these forward looking statements, which apply only as of thedate of this Form 10-K. Subsequent events and developments may causeour views to change. However, while we may elect to update these forwardlooking statements at some point in the future, we specifically disclaim anyobligation to do so.*

**PART I**

**Item1. Business:**   SI International, Inc. wasorganized as a Delaware corporation under the name of “SI International,Incorporated” on October 14, 1998. SI International conducts operationsboth in its own name and through subsidiaries, each of which is located in theU.S. but some of which have international operations.

**Recent Events**

*Subsidiary Consolidation.**  *On December 15, 2006, SI International mergedtwo of its wholly-owned subsidiaries, SI International Engineering Inc., aColorado corporation (“Engineering”) and SI International Telecom Corporation,a Delaware corporation (“SI Telecom”), into SI International as part of aninternal consolidation of legal entities. The merger of Engineering and SITelecom into the Company is not expected to impact business operations. Additionally,there may be tax advantages to the consolidation effort. Furthermore, we mayconsolidate other subsidiaries into SI International, when doing so would beconvenient and would not impact our business operations.

**Overview**

We are a provider of mission critical informationservices, technology and network solutions primarily to the Federal Government.Our business is guided by our experienced team of eight executive officers andover thirty other corporate officers who manage and are responsible forsuccessfully growing our business. As of the end of fiscal year 2006, weemployed approximately 4,300 employees. Approximately 84% of our employees holdFederal Government security clearances or have passed National Agency Checks. 

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Approximately 14% 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.

Our broad set of contractvehicles gives us extensive reach and enables us to deliver a full range of ourservices and solutions to the Federal Government. The strength of our serviceofferings and information technology expertise allows us to maintain substantialrelationships with clients, some of whom have been clients of ours, or of oneof our acquired businesses, for over 20 years. In fiscal 2006 and fiscal2005, we derived approximately 80% and 75%, respectively, of our revenue fromcontracts on which we acted as prime contractor. Acting as a prime contractorprovides us with stronger client relationships, as well as the visibility andaccess to new work that are not available when acting as a subcontractor. Ourtotal backlog as of December 30, 2006 was approximately$1,220 million, of which approximately $162 million was funded. See “—Backlog”for a discussion of how we calculate backlog.

**The FederalGovernment technology services market**

The ongoing transformation of the Federal Government’sinformation systems and communication networks is creating an increase in itsdemand for information technology, or IT, services. According to INPUT, anindependent market research firm, the federal market demand forvendor-furnished information systems and services is projected to increase by$17.2 billion from $63.3 billion in government fiscal 2006 to $80.5 billion ingovernment fiscal 2011, a compound annual growth rate of approximately 5.0%over the five-year period. In addition, the addressable IT spending, which isthe amount that is contracted out, for the U.S. Air Force, our single largestclient in terms of revenue for each of the last four completed fiscal years, isprojected by INPUT to grow from $5.6 billion in government fiscal 2006 to $7.3billion in government fiscal 2011, representing a compounded annual growth rateof 5.3%. The Department of Homeland Security addressable portion of the ITbudget is projected by INPUT to grow from $3.3 billion in government fiscal2006 to $4.4 billion in government fiscal 2011, representing a compoundedannual growth rate of 6.1%.

We expect that the Federal Government’s need for thetypes of IT services that we provide will continue to grow in the foreseeablefuture, as a result of the high priority placed by the federal government onthe transformation of its IT programs. INPUT forecasts that the percentage ofIT spending that is contracted out by the federal government will reach a highof over 86% of total IT spending in government fiscal 2011.

We believe the followingindustry trends will also continue to drive the Federal Government technologyservices market:

·       *Continued focus on mission-critical initiatives.**  *Since the events of September 11, 2001, theFederal Government has made the transformation of its IT infrastructure a majorpriority. According to INPUT, the Federal Government IT services “commercial”segment, which is comprised of outsourcing, professional services, systemsintegration and processing services, is projected to grow from $26.9 billion ingovernment fiscal 2006 to $34.7 billion in government fiscal 2011, representinga projected compounded annual growth rate of 5.2%.

·       *Increased Federal Government reliance on outsourcing.**  *According to INPUT, outsourcing through the use ofoutside providers to provide Federal Government services is projected to growfrom $13.3 billion in government fiscal 2006 to $17.7 billion in governmentfiscal 2011, representing a projected compounded annual growth rate of 5.9%.

·       *Enterprise architectural planning initiatives continue to be emphasized.  *Accordingto INPUT, the professional services market, which is comprised of softwaredevelopment, design and consulting, education and training, and the professionalservices associated with systems integration, is 

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projected to grow from$13.3 billion in government fiscal 2006 to $16.5 billion in government fiscal2011, representing a projected compounded annual growth rate of 4.5%. Over thepast few years, many major government programs, modernization, and reforminitiatives, including homeland security solutions, have depended on the use ofprofessional services. INPUT expects this trend to continue over the nextseveral years. Enterprise architectural planning initiatives continue to beemphasized as Office of Management and Budget (OMB) looks for opportunities toconsolidate agency systems, expand information sharing, and improve governmentmission performance.

We believe that the Federal Government is increasinglyturning to the IT industry to execute support processes and functions that weretraditionally performed by Federal Government employees. INPUT expects thatDepartment of Defense (DoD) budgets will continue to grow over the next severalgovernmental fiscal years and anticipates that each of the defense agencieswill move toward outsourcing more of the information technology functions thatare not core to the war-fighting mission. Business process outsourcing, or BPO,is a relationship in which a contractor is responsible for performing an entirebusiness operations function, including the information systems outsourcingthat supports it. INPUT projects that Federal Government BPO spending will growfrom $577 million in government fiscal 2006 to $840 million in governmentfiscal in 2011, which represents a compounded annual growth rate of 7.8%.

We believe thathomeland security will have the greatest impact on three specific segments ofthe Federal Government IT market: information security, communications andknowledge management. We believe that the rapid pace of technologicalinnovations and the Federal Government’s increasing reliance on complex ITinfrastructure, combined with a decline in the size of the Federal Governmentworkforce, as described above, make it increasingly difficult for manygovernmental agencies to operate and upgrade their IT systems. We expect thatseveral trends will contribute to the Federal Government’s increased use ofservice providers to fulfill a larger portion of its IT responsibilities, andwe believe that we will continue to gain new engagements to the extent that theFederal Government increases its reliance on outsourcing for its IT needs.These trends include:

·       *The aging of the Federal Government’s workforce.**  *According to INPUT, the government has estimated thatmore than 42% of federal IT workers will be eligible for retirement by 2008,and the average age of Federal Government employees increased from 42 years ofage in 1990 to 50 years of age in 2006. This “aging” effect is compounded bythe upcoming baby-boomer retirement wave, which Input estimates to begin withinthe next three or four years. According to the Washington Post in an articletitled “Job Shadowing Sheds Light on Defense Work” on February 5, 2007, “the[defense] department has about 69,000 technology professionals in its civilservice ranks, and officials estimate that 10,000 will be eligible to retire atthe end of this year.” In April 2001, the Government Accountability Office(GAO) concluded in a report that the Federal Government’s human capitalchallenges are adversely affecting the ability of many agencies to carry outtheir missions. Input believes that the expected decline in personnel spendingwill increase the proportional spending for the outsourcing of IT products andservices as IT continues to play an expanding role in government. INPUT expectsthat the outsourcing trend to continue in the future as OMB pushes agencies totransition services to shared services providers under its Line of Businessinitiatives.

·       *Increased Federal Government emphasis on competitive sourcing.**  *The current administration has made competitivesourcing a major initiative of its management agenda. According to thePresident’s Management Agenda, which was issued in 2001 and for which progressreports continue to be issued, including most recently during 2003, nearly halfof all Federal Government employees perform tasks that are available inthe commercial marketplace. To the extent that the size of the FederalGovernment workforce decreases, we believe that the Federal Government willhave an increased need for entities that offer the technical skills,familiarity with government processes and 

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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 $3.3 billion in government fiscal 2006 to $4.4 billion in governmentfiscal 2011, representing a compound annual growth rate of 6.1%.

Although the total amount to be spent for intelligenceapplications is classified, based on available information, INPUT estimatedthat the addressable Federal Government IT spending in the intelligencecommunity may have been as much as $8.8 billion in government fiscal 2006,and may grow to $11.7 billion by government fiscal 2011 representing acompounded annual growth rate of 6.0%. We believe that there will continue tobe increases in spending on federal intelligence activities, which are expectedto represent significant additional opportunities for us.

***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 award was approximately 70 days in government fiscal 2006 ascompared to 278 days in government fiscal 1995.

**Our Core Strengths**

We strategically built our business to respondspecifically to the federal IT marketplace. We believe that our corestrengths position us to respond to the long-term trends and changing demandsof our market.

**Our Experienced ManagementTeam**

OurPresident and Chief Executive Officer (CEO), S. Bradford Antle, who has beenwith us since 1999, brings more than 26 years of management experience in ourindustry. Mr. Antle also serves as a member of the Board of Directors. RayJ. Oleson continues to serve as Executive Chairman of the Board.

Additionally,to further support our growth, our eight business units are incorporated intothe Strategic Programs Group, the IT Solutions Group, and the Mission ServicesGroup. Each of these Business Groups is headed by an Executive Vice President,who reports to Mr. Antle.

MikeBecraft is the Executive Vice President of the Mission Services Group. He isresponsible for a major portion of work with the Department of HomelandSecurity, Department of State, and U.S. Army. Mr. Becraft has more than 38years of Federal civilian government and military experience. He joined us in2003 as Senior Vice President of Homeland Security.

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 33 years of experience in the military and intelligence community,including serving as the Acquisition Executive at the National Security Agency,and as the Commanding General of the U.S. Army White Sands Missile Range.

Marylynn Stowers is the Executive Vice President ofthe IT Solutions Group. She oversees a significant portion of business thataddresses federal IT modernization. Ms. Stowers has more than 25 years ofexperience providing IT services to the Federal Government, such as Departmentof Homeland 

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Security, Department ofState, Department of Treasury, Internal Revenue Service, and theIntelligence community.

**Our CorporateCulture**

Our corporate culture isbased on respect for clients, personnel, business partners and management. Weview our commitment to this culture of respect as a cornerstone of our company.We believe that our culture helps us build the relationships necessary to gainan in-depth understanding of our clients’ needs, business practices andinformation technology and network systems. In addition, we believe our cultureis a factor in helping our employee turnover rate remain low compared to othercompanies in our industry, helping us to maintain client domain knowledge andprovide consistent service to our clients. Further, we believe that ourcommitment to respect, combined with quality of performance, is an importantfactor in retaining clients and winning new referrals.

**Focus onInformation 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 best practicesacross many Federal Government agencies and industries. Our key focus areasare:

·       *Federal IT Modernization*.*  *Wedefine federal IT modernization to include designing, building and deployingsolutions that enable our clients to replace legacy applications and databasesand allow effective information sharing across agencies. We believe we have aproven track record of delivering true end-to-end solutions in this focus areathat encompass application and software development, systems engineering, networksolutions, and information security and performance support.

·       *Defense Transformation*.*  *Wedefine defense transformation to include development of solutions intended toenable the U.S. military to successfully adapt to the requirements ofnet-centric warfare through our deep capabilities in space systems engineering,enterprise and operational architecture, command and control, logistics, andmilitary satellite communications. In the area of space systems modernization,we are supporting clients such as Air Force Space Command, NORAD, NorthernCommand and U.S. Strategic Command.

·       *Homeland Defense*.*  *Wedefine homeland defense as defense of the U.S. homeland, which includes thedevelopment of large scale replicated databases, secure optical callsprocessing and identification systems, managing records, and processing visas.We are working in this focus area to provide advanced information technology toassist in meeting this challenge for clients that include Department ofHomeland Security, Department of State, Northern Command, Department of Energy,and Department of Agriculture.

·       *Mission-Critical Outsourcing*.*  *Wedefine mission-critical outsourcing as assisting the Federal Government withshortages of personnel, including for the purpose of permitting re-assignmentto higher priority government assignments, increasing operational efficiency,and improving the overall quality of service. We provide services in this focusarea to both civilian agencies and the DoD.

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In providing informationtechnology and network solutions to our customers, our skilled employees usetheir advanced technological training and extensive experience to implement ourstate-of-the-practice solutions. As of the end of fiscal year 2006, we employedapproximately 4,300 employees, many of whom possess security clearances andNational Agency Checks that allow us to bid on and perform classified workfor the Federal Government.

**Knowledge ofFederal 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. Webelieve that the insight provided by our officers and managers allows us todesign solutions that are responsive to our clients’ mission-critical needs.

**SuccessfulIntegration of Acquired Businesses**

We believe that a critical component of our success isour ability to identify, acquire and integrate companies that build or expandour suite of services to serve our clients’ needs more effectively.Members of our management team have substantial experience acquiring andsuccessfully integrating acquired entities. We believe that this experienceprovides a basis for our disciplined approach to identifying acquisitioncandidates and integrating acquired companies. By integrating corporate infrastructuressuch as marketing and sales, accounting, human resources and internal networks,we can save the expense of redundant functions. In addition, by integratingoperations, we establish a corporate-wide mission which can reduce internalcompetition and promote the cross-selling of newly augmented skill sets toincrease our client base.

Within the 15-monthperiod from January 1999 through March 2000, we identified, acquiredand integrated four federal IT companies with aggregate revenues of approximately$105 million, measured for the 12 months prior to their respectiveacquisition dates. In January, 2004, we acquired Matcom InternationalCorporation, or Matcom; in December 2004, we acquired Bridge TechnologyCorporation, or Bridge; in February 2005, we acquired ShenandoahElectronic Intelligence, Inc., or SEI; in February 2006, we acquiredZen Technology, Inc., or Zen. We successfully integrated each of theseacquisitions into our organization; and, we built and expanded our services andsolutions capabilities and our client relationships. We applied our disciplinedacquisition processes to integrate the acquired companies and successfully grewthese businesses.

**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 

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to gain access to newclients. We have launched a Major Programs initiative through which we intendto compete for large contracts over longer procurement periods. We believe thatfavorable client referrals are strategically important to our winning theseopportunities.

·       *Pursue strategic acquisitions.*We plan to continue utilizingour disciplined methodology to identify, evaluate and integrate strategicacquisitions. We have acquired and successfully integrated eight businessessince 1999. These acquisitions have positioned us with strategically importanttechnical skills in important client areas.

·       *Business Capabilities and Sales Integration*. Our businessunits are now incorporated into the Strategic Programs Group, the IT SolutionsGroup, and the Mission Services Group. Under our management structure (seeabove Our Experienced Management Team for more information about ourmanagement), these three business groups are better able to present integratedsolutions through the cross-marketing and delivery of our business capabilitiesto new and existing customers.

**Our Areas ofPractice**

We provide IT andnetwork solutions in the following eight practice areas to supplement the needsof our clients in the areas of Defense Transformation, Homeland Defense,Mission Critical Outsourcing and Federal IT Modernization.

·       *Program Management & Acquisition Support***—**The program management and acquisitionsupport practice assists clients with initiating, assembling, executing, andmanaging all sizes of acquisition programs. The practice area providesacquisition strategies, government required documentation (DoD 5000), andsolicitation packages, as well as, source selections and contract managementsupport. The practice area manages and oversees high-tech systems development;interprets and synchronizes requirements with system architectures andintegrated master plans; and, identifies and tracks technical and programmaticinterdependencies and interactions among requirements. The technical staff isskilled in providing systems engineering technical assistance (SETA) support toclient programs for cost, schedule, performance, risk management, andcontracting activities.

·       *Integrated Solutions Development***—**The integrated solutions development practice focuses on theintegration 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) andEnterprise 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.

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·       *Records Management***—**Therecords management practice specializes in application processing, data entry,case and file management, large scale identification and credentialing systems,call center 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***—**Thelearning solutions practice focuses on the design, development and delivery oflearning and 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 ManagementSystems environments provides our clients rapid design and deployment ofsolution-based programs to meet today’s requirements and tomorrow’s challenges.

·       *Systems Engineering***—**Thesystems engineering 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.The technical staff is skilled in command, control, communications, computerand intelligence (C4I), engineering, object oriented analysis and design,system testing, 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***—**Thenetwork solutions practice designs, engineers, deploys, and manages a fullrange of networked communications and infrastructure solutions. The practicearea provides IT and network requirements, definition and analysis, detailedsystems design, network and technology selection and procurement, globalend-to-end installation, and spectrum/bandwidth management. These solutionsencompass voice, video, data, narrowband, broadband and wireless technologies.Applications include large scale enterprise networks for government, highlysecure networks.

·       *Mission-critical Outsourcing***—**The mission-critical outsourcing practice uses domainexpertise to operate clients’ systems and processes vital to their businesses.The practice area offers professional services to perform business processand information technology outsourcing, sustaining engineering, logisticsservices, and call center operations.

**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,Missile Defense Agency, Department of Agriculture, National Institutes ofHealth, Federal Retirement Thrift Investment Board, and the defenseintelligence community. In fiscal 2006, we derived approximately 99% of ourtotal revenue from Federal Governmental agencies and approximately 1% of ourtotal revenue from commercial clients.

Our largest client is the DoD. We derived approximately47% of our total revenue in fiscal 2006 and 2005 from the DoD and theIntelligence community. In both fiscal years 2006 and 2005, work we performedunder our Command, Control, Communications, Computer, Intelligence,Information, Technology, Surveillance, and Reconnaissance contract vehicle(C4I2TSR) represented approximately 21% of our total revenue. The primarycustomer under the C4I2TSR contract vehicle is the U.S. Air Force 

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Space Command, however,other Federal government entities typically exercising independent decisionmaking and funding authority use C4I2TSR. We believe our contract base is welldiversified. In fiscal 2006 and fiscal 2005, we derived approximately 80% and75%, respectively, of our revenue from contracts on which we acted as primecontractor and derived approximately 20% and 25%, respectively, of our revenuefrom contracts on which we acted as a subcontractor.

We often subcontractportions of work to be performed under a contract or task order under which weare the prime contractor. Approximately 19% and 15%, respectively, of our totalrevenue in fiscal 2006 and fiscal 2005, 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 aclient in other situations. We believe that cultivating good relationships withour subcontractors is necessary to maintain our competitive position as well asto facilitate meeting performance obligations under our contracts.

**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 futurerevenue under 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 30, 2006 wasapproximately $1,220 million, of which approximately $162 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 fullamount of our funded backlog as of December 30, 2006.

We believe that backlog isnot necessarily indicative of the future revenue that we will actually receivefrom contract awards that are included in calculating our backlog. We assessthe potential value of contracts for purposes of backlog based upon severalsubjective factors. These subjective factors include our judgments regardinghistorical trends (i.e., how much revenue we have received from similarcontracts in the past), competition (i.e., how likely are we to successfullykeep all parts of the work to be performed under the contract) and budgetavailability (i.e., how likely is it that the entire contract will receive thenecessary funding). If we do not accurately assess each of these factors, or ifwe do not include all of the variables that affect the revenue that werecognize from our contracts, the potential value of our contracts, andaccordingly, our backlog, will not reflect the actual revenue received fromcontracts and task orders. As a result, there can be no assurance that we willreceive amounts included in our backlog or that monies will be appropriated byCongress or otherwise made available to finance contracts and task orders includedin our backlog. Many factors that affect the scheduling of projects could alterthe actual timing of revenue on projects included in backlog. There is alwaysthe possibility that the contracts could be adjusted or cancelled. We adjustour backlog on a quarterly basis to reflect modifications to or renewals ofexisting 

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contracts,awards of new contracts or approvals of expenditures. See Item 1A. “RiskFactors—The calculation of our backlog is subject to numerous uncertainties,and we may not receive the full amounts of revenue estimated underthe contracts included in our backlog, which could reduce our revenue in futureperiods.”

**Employees**

Asof December 30, 2006, we had approximately 4,300 employees. Approximately84% of our employees hold Federal Government security clearances or have passedNational Agency Checks. Approximately 14% of our employees hold Top Secretsecurity clearances. A significant portion of our employees who hold Top Secretsecurity clearances also hold Sensitive Compartmental Information clearances,which permit us to bid on highly classified projects. We have no unionizedemployees and do not have any collective bargaining agreements. However,current contracts or contracts that we may pursue may require us tohave unionized employees. We believe we have a good relationship with our employees.

In addition to attracting and retaining qualifiedtechnical personnel, we believe that our success will depend on the continuedemployment of our executive and senior management team and its ability togenerate new business and execute projects successfully. We believe that thepersonal reputations of our management team members and the businessrelationships 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 business opportunities,which could materially adversely affect our business.

**Competition**

Wecompete for contracts in highly competitive markets against a large number ofcompanies both large and small. Because of the large number of companiescompeting in these markets, we do not repeatedly compete against the samecompanies. We may team with other companies to perform work under contractswhen we feel that our combined resources may create a competitive advantage.However, our competitors may compete more effectively than we can for variousreasons, including that they are larger than us, have greater financial andother resources, have better or more extensive relationships with governmentalofficials involved in the procurement process, or have greater brand or namerecognition.

As aresult of the diverse requirements of the Federal Government and our commercialclients, we frequently form teams with the companies in our markets inorder to compete for large procurements, while bidding against them in othersituations.

In each of our practice areas, we generally bidagainst companies of varying sizes and specialties, from small businesses tomulti-billion dollar corporations. Because of the current industry trendtoward consolidation, some of these companies may emerge better able tocompete with us. Therefore, it is essential that we differentiate ourselvesfrom these companies. We believe that our technical abilities, clientrelationships, past performance, cost containment, reputation and ability toprovide quality personnel give us a strong presence in the markets we serve. Inaddition, we believe that our culture of respect for and commitment to ourclients and business partners greatly aids our business. While we believe thesefactors help to set us apart from other companies in our markets, wemay not be able to continue to maintain our competitive position, as newcompanies 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 2006, approximately 99% 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 a requestfor proposal, known as an RFP, or some similar form of solicitation. TheRFP is typically an extensive document describing the services desired and theterms 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 evaluates,often requesting additional information and multiple discussions withofferors prior to final award of the contract.

Over the years, the Federal Government has taken stepsto streamline the procurement process. Federal Governmental agencies are nowmore likely to use flexible contract vehicles that permit a number of firms tocompete for specific orders. The General Services Administration Multiple AwardSchedule Program, or GSA MAS Program, is an example of a flexible contractvehicle employed by the Federal Government. Under the GSA MAS Program, GSAcontracts with multiple vendors to provide goods and services, at predeterminedprices, to specified authorized buyers. GSA schedules are listings of servicesand products, along with their respective prices, offered by approvedcontractors. The schedules are maintained by the GSA for use by any federalagency or other authorized entity. A contractor must successfully complete apre-qualification process in order to be selected by the GSA for inclusion ofthe contractor’s goods or services on a GSA Schedule. When an agency selectsservices under a GSA schedule contract, the soliciting agency, or the GSAon its behalf, conducts a bidding process, limited to qualified GSAschedule contractors. The process typically involves substantially lesstime and cost than the historical, 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 toperform work under ID/IQ contracts. A procuring agency then issues taskorders for goods or services to be performed or provided under a contract. Whentask orders are issued under multiple award ID/IQ contracts, each awardeetypically has an opportunity to be considered for the task order. The agencydesiring contract services may conduct a competition among the interestedawardees, resulting in the issuance of a task order to a single contractor.These contracts have increased competition and pricing pressure byconcentrating work under fewer contracts, and requiring competition both priorto the initial award of the contract and throughout the term of the contract inorder to obtain task orders for the services we provide, requiring that we makesustained post-award marketing efforts to realize revenue under each suchcontract. Moreover, even if we are qualified to work on a particular newcontract or a contract subject to renewal, we might not be awarded businessbecause of the Federal Government’s policy and practice of procuring goods andservices from multiple contractors in order to maintain a diverse base ofcontractors. In addition, ID/IQ contracts do not obligate the FederalGovernment to purchase goods or services above the minimum levels set forth inthe contract.

A task order calls for a specific set of services tobe delivered by the contractor to a particular client agency. In ourexperience, the key factors in competing successfully for these task orders aretechnical merit, cost, relevant past performance considerations and clienttrust. From time to time we are also a party to GWACs, which are ID/IQcontracts that permit the aggregation of multiple agencies’ requirements in asingle contract, in order to encourage contractors to offer the best possibleprices and to reduce the costs associated with multiple acquisitions.

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Forsingle-award large scale contracts, such as those targeted by our Major Programinitiative, interested contractors submit information indicating their desireto perform the required services. The agency then solicits competitiveproposals or bids from qualified contractors by providing them with a formalRFP or similar solicitation. The RFP typically describes the desired services,terms and conditions, and evaluation criteria the agency will use. Offerorsthen submit proposals in response to the RFP, and the agency evaluates theproposals and makes the award determination. Agencies are encouraged to awardcontracts on a “best value” basis. This means that the contractor selected forthe award should, in the agency’s judgment, provide the greatest overallbenefit in response to the requirement, including technical merit, cost andrelevant past performance considerations. The entire acquisition process cansometimes take a year or more.

The competitive process presents a number of risks,including the following:

·       we expend substantialfunds, managerial time and effort to prepare bids and proposals for contractsthat we may not win;

·       we may be unable toestimate accurately the resources and cost that will be required to service anycontract we win, which could result in substantial cost overruns; and

·       we may encounterexpense and delay if our competitors protest or challenge awards of contractsto us in competitive bidding, and any such protest or challenge could result ina requirement to resubmit proposals on modified specifications or in the termination,reduction or modification of the awarded contract.

·       we may be chosen asone of the contractors for a multiple award GWAC, ID/IQ or GSASchedule 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.

·       the governmentmay initially award a GWAC, ID/IQ, or GSA Schedule contract but failto provide funding for the number of task orders necessary to justify our time,effort, and expense in bidding on the contract and subsequent task orders.

Foradditional information regarding the risks presented by the competitiveprocess, please see Item 1A. Risk Factors below.

The government contracts for which we competetypically have multiple year terms, and if we are unable to win a particularcontract, we generally will be foreclosed from competing again for thatcontract until its expiration several years later. In addition, upon theexpiration of a contract, if the client requires further services of the typeprovided by the contract, there is frequently a competitive rebidding process.

**Laws and RegulationsAffecting Our Business**

FederalGovernment contracts are subject to a number of federal laws and regulations,including the Federal Acquisition Regulation, or FAR, and Cost AccountingStandards. These statutes and regulations contain several rules thatmay affect us significantly.

TheAnti-Deficiency Act prohibits Federal Government employees from committinggovernment funds, by contract or otherwise, in excess or in advance ofappropriations, unless authorized by a specific statute. Since Congress usuallyappropriates funds on a fiscal year basis, many of our contracts are funded bythe applicable agency annually as Congress makes appropriations for futurefiscal years. In addition, since funds are often allocated to agencies by theOMB, many of our contracts are incrementally funded.

Disappointedbidders and contractors excluded from competing for government contracts andtask orders may submit a protest to a contracting officer or the GAOwithin time limits specified under FAR and GAO bid protest rules. The U.S.Court of Federal Claims also has bid protest jurisdiction. Performance under acontract being protested may be suspended while the protest is pending,and in cases where the contract is found to have been improperly awarded, thecontract may be terminated.

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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 Truthin Negotiations Act and Cost Accounting Standards. The Truth in NegotiationsAct requires us to provide current, accurate and complete cost or pricing datain connection with the negotiation of a contract, modification or task orderthat is not subject to full and open competition or other exceptions to theAct. Cost Accounting Standards are applicable to certain contracts and requirethe contractor to apply consistent accounting practices and comply withspecific cost accounting criteria. The FAR “Contract Cost Principles andProcedures” sets forth the rules regarding the allocability andallowability of costs incurred 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 beperformed by 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 oncost reimbursable contracts for prior fiscal years. These audits may alsoresult in assessment of penalties, interest costs and, in extreme cases,debarment. The Federal Government retains a portion of the fee earned by usunder cost reimbursable contracts until contract completion and audit by theDCAA. Audits of our business units by the DCAA have been completed for allfiscal years through 2001 without material adjustments. In the opinion ofmanagement, the audits for other fiscal years through fiscal year 2006 will notresult in adjustments that would have a material adverse effect on ourfinancial position or results of operations; however, future materialadjustments are possible.

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.

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From time to time we may engage in activitiesthat require us to comply with the various U.S. Government export control lawsand regulations administered by the U.S. Department of State, U.S. Departmentof Commerce, U.S. Treasury Office of Foreign Assets Control, and the Bureau ofCustoms and Border Protection. We have dedicated personnel 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*  assoon as reasonably practicable after we electronically file the material with,or furnish the material to, the Securities and Exchange Commission, or SEC.

You may obtain a printed copy of any of theforegoing materials from us by writing to us at SI International, Inc.,12012 Sunset Hills Road, Suite 800, Reston, Virginia 20190, Attention:Investor Relations.

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**Item 1A.**                RiskFactors

**Risks Related toOur Industry**

**We depend on contracts with the Federal Government formost of our revenue, and our business would be seriously harmed if thegovernment ceased doing business with us or significantly decreased the amountof business it does with us.**

We derived approximately 99% and 98.1% of our totalrevenue in fiscal 2006 and in fiscal 2005, respectively, from FederalGovernment contracts, either as a prime contractor or a subcontractor. Thisincludes 46.6% and 46.9% of our total revenue in fiscal 2006 and in fiscal2005, respectively, that we derived, either as a prime contractor or asubcontractor, from contracts with agencies of the DoD and Intelligencecommunity. We expect that we will continue to derive most of our revenue forthe foreseeable future from work performed under Federal Government contracts.If we were suspended or otherwise prohibited from contracting with the FederalGovernment generally, or with any significant agency of the DoD or theIntelligence community, or if our reputation or relationship with the FederalGovernment or any significant agency of the DoD or the Intelligence communitywere impaired, or if any of the foregoing otherwise ceased doing business withus or significantly decreased the amount of business it does with us, ourbusiness, prospects, financial condition and operating results would bematerially adversely affected.

Thefollowing chart provides certain information regarding our largest contracts (exclusiveof GSA multiple award schedules) or individual task orders (inclusive of taskand delivery orders issued on GSA multiple award schedules) for fiscal years2006 and 2005, in terms of revenues:

| ** **                                                                                                                               | ** ** | ** **                                   | ** ** | **Percent of   Revenues in** | ** ** | **Expiration** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------|------------|----------------|------------|
| **Contract or Task Order**                                                                                                | ** ** | ** **                                   | ** ** | **Contracting Agency**                 | ** ** | **2006**       | ** ** | **2005** | ** ** | **Date** | ** ** |
| Command, Control, Communications, Computer,  Intelligence, Information, Technology, Surveillance, and Reconnaissance  (C4I2TSR) contract |       | U.S. Air Force Space  Command |       |                                        | 21.4       |           |       |   | 20.7 |   |   |   | 2013 | * |   |
|                                                                                                                                          |            |                                              |            |                                             |            |                |            |  |  |  |  |  |  |  |  |  |  |

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*                    Includes optionperiods.

Although our contract withthe Department of Homeland Security known as the Service Center OperationsTeam, or SCOT, contract represents less than 10% of our revenues, it remains animportant contract. The SCOT contract had a four-year term that, with theFederal Government’s exercise of the final option year, extended through June 2006.Since June 2006, the contract has been extended on an interim basis whilethe contract is recompeted. If we fail to win the SCOT contract recompete, orany of our other significant contracts, our business would be materially andadversely affected.

**Our business couldbe adversely affected by changes in budgetary priorities of the FederalGovernment.**

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 andmay significantly reduce or eliminate funding for a program. Significantreductions in these 

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appropriationsby Congress could have a material adverse effect on our business. Additionalfactors that could have a serious adverse effect on our Federal Governmentcontracting 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;

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

·       an increase in the numberof contracts reserved for small businesses which could result in our inabilityto compete directly for these prime contracts.

**Our contracts with the Federal Government may beterminated or adversely modified prior to completion, which could adverselyaffect our business.**

Federal Governmentcontracts generally contain provisions, and are subject to laws andregulations, that give the Federal Government rights and remedies not typicallyfound in commercial contracts, including provisions permitting the FederalGovernment to:

·       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 criminalprosecution;

·       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 thegovernment to solicit new proposals for the contract or result in thetermination, 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 contractwith us either “for convenience” (for instance, due to a change in itsperceived needs or its desire to consolidate work under another contract) or ifwe default by failing to perform under the contract. If the FederalGovernment terminates a contract with us for convenience, we generally would beentitled to recover only our incurred or committed costs, settlement expensesand profit on the work completed prior to termination. If the FederalGovernment terminates a contract with us based upon our default, we generallywould be denied any recovery for undelivered work, and instead may beliable for excess costs incurred by the Federal Government in procuringundelivered items from an alternative source and other damages as authorized bylaw. As is common with government contractors, we have experienced and continueto experience occasional performance issues under some of our contracts. Wemay in the future receive show-cause or cure notices under contracts that,if not 

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addressed to the FederalGovernment’s satisfaction, could give the government the right to terminatethose contracts for default or to cease procuring our services under thosecontracts.

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 on the design of a particular solution, wemay be precluded from competing for the contract to install that solution.While we actively monitor our contracts to avoid these conflicts, we cannotguarantee that we will be able to avoid all organizational conflict of interestissues.

**If we fail to establish and maintain importantrelationships with government entities and agencies, our ability tosuccessfully bid for new business may be adversely affected.**

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 anyfailure to do so could materially adversely affect our ability to competesuccessfully for new business.

**We derive significant revenue from contracts and taskorders awarded through a competitive acquisition process. If we are unable towin new awards or successfully compete for renewal contracts, our business andprospects may be adversely affected.**

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 ordersto perform specified services or to supply specified goods pursuant tocompetition among approved contractors. Thus, the existence of a contract doesnot ensure future revenue; rather, the contract merely provides us theopportunity to compete for additional work. An agency may administer an ID/IQcontract in which it procures goods and services for itself. Under the samecontract, other federal agencies may also procure goods and services. Thesecontracts are known as GWACs. When multiple prime contractors hold GWACs forthe same goods and services, all of them are eligible to supply goods andservices under the contract. As a result, qualified contractors often competewith each other to obtain task orders under a GWAC. Similarly, GSA contracts,including contracts commonly known as GSA Schedule contracts, are procurementcontracts administered by the GSA on behalf of the entire Federal Government.Like many other ID/IQ contracts, multiple contractors may be awarded GSAcontracts for the same goods and services. As a result, an agency may procuregoods and services from any contractor 

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awarded the GSA contractat the prices and on the terms stated in the contract. Moreover, even if we arehighly qualified to work on a particular new contract or a contract subject torenewal, 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.

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 awards ofcontracts to us in competitive bidding, and any such protest or challenge couldresult in a requirement to resubmit proposals on modified specifications or inthe termination, reduction or modification of the awarded contract.

The government contracts forwhich we compete typically have multiple year terms, and if we are unable towin a particular contract, we generally will be foreclosed from competing againfor that contract until its expiration several years later. If we are unable towin new contract awards, our business and prospects will be adversely affected.In addition, upon the expiration of a contract, if the client requires furtherservices of the type provided by the contract, there is frequently acompetitive rebidding process. There can be no assurance that we will win anyparticular bid or recompetition bid, or that we will be able to replacebusiness lost upon expiration or completion of a contract, and the terminationor nonrenewal of any of our significant contracts or a substantial portion ofour other contracts could materially adversely affect our operating results.

**Our business may suffer if our facilities or ouremployees are unable to obtain or retain the security clearances or otherqualifications needed to perform services 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 bematerially adversely affected.

**We must comply with a variety of laws, regulations andprocedures and our failure to comply could harm our operating results.**

We must observelaws and regulations relating to the formation, administration and performanceof Federal Government contracts which affect how we do business with ourclients and impose added costs on our business. For example, the FederalAcquisition Regulation and the industrial security regulations of the DoD andrelated laws include provisions that:

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

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

·       requireus to prevent unauthorized access to classified information; and

·       requireus to comply with laws and regulations intended to promote various social oreconomic goals.

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 Border 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 with proceduresrequired by the specific agency for which work is being performed, such as timerecordation or prohibition on removal of materials from a location.

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.

**The FederalGovernment may revise its procurement or other practices in a manner adverse tous.**

The Federal Government mayrevise its procurement practices or adopt new contracting rules andregulations, such as cost accounting standards. It could also adopt newcontracting methods relating to GSA contracts, GWACs or other government-widecontracts, or adopt new standards for contract awards intended to achieve certainsocial or other policy objectives, such as establishing new set-aside programsfor small or minority-owned businesses. In addition, the Federal Government mayface restrictions from new legislation or regulations, as well as pressure fromgovernment employees and their unions, on the nature and amount of services theFederal Government may obtain from private contractors. These changes couldimpair our ability to obtain new contracts or contracts under which wecurrently perform when those contracts are put up for recompetition bids. Anynew contracting methods could be costly or administratively difficult for us toimplement, and, as a result, could harm our operating results. For example, theU.S. Small Business Administration enacted a rule that is to becomeeffective on June 30, 2007, concerning the small business certificationthat companies must provide under contract vehicles with small businessesset-asides. Under certain circumstances, this rule may require companiesto recertify as small businesses after they have been acquired by largercompanies. A company that cannot recertify as a small business may experiencedecreased task orders awarded under contract vehicles, including on contractswith small business set-aside requirements. Additionally, recent changes in theacquisition regulations concerning the process for awarding a time andmaterials and labor hour service contracts may make it more difficult to obtainsuch contracts in the future.

**Our contracts and administrative processes and systemsare subject to audits and cost adjustments by the Federal Government, whichcould reduce our revenue, disrupt our business or otherwise adversely affectour 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 

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applicablelaws, government regulations, policies and standards and the adequacy of ourinternal control systems and policies, including our purchasing, property,estimating, compensation and management information systems. Any costs found tobe improperly 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 scrutiny orrequired 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 competitive position andresult 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 harm to our reputation if allegations ofimpropriety were made against us.

**Failure to maintain strong relationships with othergovernment contractors could result in a decline in our revenue.**

We derived approximately20% of our total revenue in fiscal 2006 and 25% of our total revenue in fiscal2005 from contracts 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.

**The calculation of our backlog is subject to numerousuncertainties, and we may not receive the full amounts of revenue estimatedunder the contracts included in our backlog, which could reduce our revenue infuture periods.**

Backlog is our estimate of the amount of revenue weexpect to realize over the remaining life of the awarded contracts and taskorders we have in hand as of the measurement date. Our total backlog consistsof funded and unfunded backlog. We define funded backlog as estimated futurerevenues under 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 our unfundedbacklog does include estimates of revenue beyond contract or task order awardsfor 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 Force Space Command.

The calculation of backlog is highly subjective and issubject to numerous uncertainties and estimates, and there can be no assurancethat we will in fact receive the amounts we have included in our backlog. Ourassessment of a contract’s potential value is based upon factors such ashistorical trends, competition and budget availability. In the case ofcontracts which may be renewed at the option of the applicable agency, wegenerally calculate backlog by assuming that the agency will exercise all ofits renewal options; 

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however, the applicableagency may elect not to exercise its renewal options. In addition, federalcontracts typically are only partially funded at any point during their term,and all or some of the work to be performed under a contract may remainunfunded unless and until Congress makes subsequent appropriations and theprocuring agency allocates funding to the contract. Our estimate of the portionof backlog from which we expect to recognize revenues in fiscal 2006 or anyfuture period is likely to be inaccurate because the receipt and timing of anyof these revenues is dependent upon subsequent appropriation and allocation offunding and is subject to various contingencies, such as timing of task orders,many of which are beyond our control. In addition, we may never receiverevenues from some of the engagements that are included in our backlog and thisrisk is greater with respect to unfunded backlog.

The actual receipt ofrevenues on engagements included in backlog may never occur or may changebecause a program schedule could change, the program could be canceled, thegovernmental agency could elect not to exercise renewal options under acontract or could select other contractors to perform services, or a contractcould be reduced, modified or terminated. We adjust our backlog on a quarterlybasis to reflect modifications to or renewals of existing contracts or taskorders, awards of new contracts or task orders, or approvals of expenditures.Additionally, the maximum contract value specified under a government contractor task order awarded to us is not necessarily indicative of the revenues thatwe will realize under that contract. We also derive revenues from ID/IQcontracts, which typically do not require the government to purchase a specificamount of goods or services under the contract other than a minimum quantitywhich is generally very small. If we fail to realize revenue included in ourbacklog, our revenues and operating results for the then current fiscal year aswell as future reporting periods could be materially adversely affected.

**Loss of our GSAcontracts 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 substantialrevenues and our operating results could suffer. GSA contracts and other GWACstypically have a one or two-year initial term with multiple options exercisableat the government client’s discretion to extend the contract for one or moreyears. We cannot be assured that our government clients will continue toexercise the options remaining on our current contracts, nor can we be assuredthat our future clients will exercise options on any contracts we may receivein the future.

**If subcontractors on our prime contracts are able tosecure positions as prime contractors, 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 19%and 15%, respectively, of our revenue for each of fiscal 2006 and 2005.

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**Risks Associatedwith International Operations**

**Our international business exposes us to additionalrisks including exchange rate fluctuations, foreign tax and legal regulationsand political or economic instability that could materially adversely affect ouroperating results.**

In connectionproviding services to our clients, we are sometimes required to engage ininternational operations (including international operations under U.S.government contracts). Conducting international business subjects us to risksassociated with operating in and selling to foreign countries, including:

·       devaluationsand fluctuations in currency exchange rates;

·       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;

·       hyperinflation,nationalization, or political instability in foreign countries;

·       militaryactivities or terrorist incidents in foreign countries, including those whichmay result in the closure of ports and border crossings or the risk of personalinjury to our personnel;

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

·       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 toOur Business**

**We may lose money or generate less than anticipatedprofits if we do not accurately estimate the cost of our performance underfixed price or time and materials contracts.**

Some of our contracts require that we perform on afixed price basis. We derived 28.0% of our total revenue in fiscal 2006 and26.2% of our total revenue in fiscal 2005 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 

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and delays caused byfactors outside our control, could make these contracts less profitable thananticipated or could cause us to incur losses, which could be substantial, onthese contracts. In the past, we have from time to time incurred losses on somefixed price contracts and our profits on some fixed price contracts have beenless than anticipated. Our operating results could be materially adverselyaffected if the actual costs of performing under these contracts exceed ourestimates.

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 derived40.2% of our total revenues in fiscal 2006 and 43.8% of our total revenues forfiscal 2005 from time and materials contracts. While time and materialscontracts are generally subject to less uncertainty than fixed price contracts,to the extent that our actual labor costs are higher than the contract rates,we may lose money on the contract. Additionally, recent changes in federalacquisition rules concerning the procedures for authorizing time andmaterial and labor hour service contracts may affect our ability to obtain timeand material contracts in the future.

**Our margins and operating results may suffer if costreimbursable contracts increase as a percentage of our total governmentcontracts.**

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 cost reimbursablecontracts. Cost reimbursable contracts contributed 31.8% and 30.0% of our totalrevenues in fiscal 2006 and fiscal 2005, respectively. To the extent that costreimbursable contracts represent an increased proportion of our totalgovernment contracts, our operating results could be materially adverselyaffected.

**Our markets are highly competitive, and many of thecompanies we compete against have substantially greater resources.**

We operate in highlycompetitive markets that include a large number of participants and involveintense competition to win contracts. Many of our competitors may compete moreeffectively than we can because they are larger, have greater financial andother resources, have better or more extensive relationships with governmentofficials involved in the procurement process and have greater brand or namerecognition. In order to stay competitive in our industry, we must attract andretain the highly skilled employees necessary to provide our services and keeppace with changing technologies and client preferences. In addition, some ofour competitors have established alliances or strategic relationships amongthemselves or with third parties in order to increase their ability to addressclient needs. As a result, new competitors or alliances among competitors mayemerge and compete more effectively than we can. There is also a significantindustry trend towards consolidation which may result in the emergence oflarger companies that may be better able to compete with us. If we are unableto compete effectively, our business could be materially adversely affected.

**Our failure to attract and retain qualified employees,including our executive and senior management team, may adversely affect ourbusiness.**

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, especially those with Top Secret or SCI clearances, in theinformation technology services industry is intense, and technology servicecompanies often experience high attrition among their skilled employees.Recruiting and training these 

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employees requiressubstantial resources. Our failure to attract and retain technical personnelcould increase our costs of performing our contracts, reduce our ability tomeet our clients’ needs, limit our ability to win new business and constrainour ability to grow.

Certain types of servicesare subject to the Service Contract Act and the Davis-Bacon Act. These Actsrequire that the contractor pay to all personnel assigned to the contract atleast 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 an award tous, ensure our compliance with these requirements.

**We may be affectedby 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 us to prevent their future use of our intellectual property. We are and mayin the future be subject to claims from our employees or third parties whoassert that certain software solutions and other forms of intellectual propertythat we used in delivering services and solutions to our customers infringeupon intellectual property rights of such employees or third parties. If ourvendors, employees or third parties assert claims that we or our customers areinfringing on their intellectual property, we could incur substantial costs todefend these claims. In addition, if any of these infringement claims areultimately successful, we could be required to:

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

·       obtaina license or additional licenses; or

·       redesignour products and services that rely on the challenged software or technology.

**Employee misconduct could adversely affect ourbusiness and reputation, as well as expose us to other risks and losses.**

While we endeavor toensure that our employees adhere to all applicable laws and regulationsgoverning their conduct, as well as to our  polices, including our Code ofEthics and Business Conduct, we may be unable to prevent our employees fromengaging in misconduct, fraud or other improper activities that could adverselyaffect our business and reputation. Although we take steps to ensure that ouremployees do not engage in misconduct, such steps may not be effective and wemay incur substantial costs in investigating any allegations of misconduct inaddition to any penalties that may be imposed should misconduct be found toexist. Such penalties may include civil and/or criminal liability, loss ofsecurity clearances, or suspension and debarment under various federalgovernment laws and regulations such as those concerning procurement, theprotection of classified information, export compliance, the pricing of laborand other costs in government contracts, time card fraud and violations of theAnti-Kickback Act.

**A substantial majority of our historical growth hasbeen due to acquisitions and we may have difficulty identifying and executingfuture acquisitions on favorable terms, which may adversely affect our resultsof operations and stock price.**

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.

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

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

·       thepotential impact on the companies we might seek to acquire due to changes inthe U.S. Small Business Administration rules concerning recertification asa small business in order to continue to qualify for small business set-asideawards; 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 30, 2006, we had approximately $220.6 million of goodwillresulting from acquisitions on our balance sheet and, to the extent we makefuture acquisitions, the amount of goodwill could increase, perhapssubstantially. Any of the businesses we acquire may also have liabilities oradverse operating issues.

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.

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

The success of our acquisitionstrategy will depend upon our ability to successfully integrate any businesseswe may acquire in the future. The integration of these businesses into ouroperations may result in unforeseen events or operating difficulties, absorbsignificant management attention and require significant financial resourcesthat would otherwise be available for the ongoing development of our business.These integration difficulties could include the integration of personnel withdisparate business backgrounds, the transition to new information systems,coordination of geographically dispersed organizations, loss of key employeesof acquired companies and reconciliation of different corporate cultures. Forthese or other reasons, we may be unable to retain key clients or to retain orrenew contracts of acquired companies. Moreover, any acquired business may failto generate the revenue or net income we expected or produce the efficienciesor cost-savings that we anticipated. Any of these outcomes could materiallyadversely affect our operating results.

**If we are unable tomanage 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 

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operational,financial and management information systems and expand, motivate and manageour workforce. If we are unable to do so, or if new systems that we implementto assist in managing any future growth do not produce the expected benefits,our business, prospects, financial condition or operating results could bematerially adversely affected.

**Systems failuresmay 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.

**Security breaches in government systems that wedevelop, integrate, maintain or manage could adversely affect our business andreputation, as well as expose us to other risks and losses.**

Many of the systems wedevelop, integrate, maintain or manage involve protecting information relatingto national security and other sensitive government functions. A securitybreach in one of these systems could result in damage to our customers, as wellas expose us to unknown risks or losses that could exceed the policy limits ofour insurance. Additionally, such a security breach could substantially harmour reputation, including rendering us ineligible for work on sensitive orclassified projects.

**If our subcontractors fail to perform theircontractual obligations, our performance as a prime contractor and our abilityto obtain future business could be materially and adversely impacted.**

Approximately 19% and 15%,respectively, of our total revenue in each of fiscal 2006 and fiscal 2005 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.

**Our indebtedness and debt service obligations mayincrease substantially and we will be subject to restriction under debtinstruments.**

On February 9, 2005, we entered into the Amendedand Restated Credit Agreement with a syndicate of lenders, including WachoviaBank, National Association, a national banking association, which acted asadministrative agent for the lenders. 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, with Wachovia Bank, NationalAssociation continuing to act as administrative agent for the lenders(collectively, the Amended and Restated Credit Agreement and 

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the First Amendment shallbe known as the “Amended Credit Agreement”). As of December 30, 2006, wehad approximately $70.2 million of debt outstanding under our Amended CreditAgreement.

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 of assetsor additional financing would be possible on terms that we would findacceptable.

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:

·       theFirst Amendment to Credit Agreement amended the leverage ratio that requires usto maintain a ratio of funded debt to consolidated EBITDA for such period asfollows:

| **Period**                                                           | ** ** | ** ** | ** **   | **Amended Term Loan   Maximum Ratio** | ** ** |
|----------------------------------------------------------------------|------------|------------|--------------|-----------------------------------------------------------|------------|
| 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

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·       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 Amended CreditAgreement also requires us to comply with certain covenants, including, amongothers, 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

·       restrictingour ability to amend, modify or change our organizational documents, includingour charter and bylaws.

**Risks Related toOur Common Stock**

**Provisions of ourcharter 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 servingstaggered three-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;

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·       limitationson the ability of our stockholders to remove directors and the provisions requiringthat vacancies in our board of directors must be filled by the remainingdirectors;

·       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 also discourage,delay or prevent an acquisition of our company at a price that you may findattractive. These provisions could also make it more difficult for you and ourother stockholders to elect directors and take other corporate actions andcould limit the price that investors might be willing to pay for shares of ourcommon stock.

**Future sales of shares of our common stock and theresulting dilution that would occur with such sales could cause the marketprice of our common stock to decline.**

Sales of a substantialnumber of shares of common stock in the public market in the course of anyoffering made pursuant to a registration statement, including any subsequentregistration statement, or the perception that such sales could occur, couldmaterially adversely affect the market price of our common stock and make itmore difficult for us to sell equity securities in the future at a time andprice we deem appropriate. As of March 1, 2006, we had 12,975,597 sharesof common stock outstanding.

**Item 1B.**               UnresolvedStaff Comments:

None.

**Item 2. Properties:****  **As of December 30, 2006, weleased 32 offices and 3 warehouses at various U.S. locations for an aggregateof 583,655 square feet in 17 states and the District of Columbia, of which wesublease 6,575 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 Campus is a 121,888 square foot facility that replaces twoother locations nearby.

·       InHarrisonburg, Virginia we occupy two offices (15,507 sq ft under a lease thatexpires in November 2013 and 40,948 which expires October 2016) and acontract-committed warehouse (120,000 sq ft under a lease which we expectto  be assumed by the US Government inthe first quarter of 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.

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

·       InBethesda, Maryland, we have office space of approximately 10,738 square feetunder 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 in new, or modern,well-maintained buildings. The facilities are substantially utilized and areadequate for present operations. We do not own any real estate.

**Item 3. Legal Proceedings:****  **We are a party to litigation andlegal proceedings that we believe to be a part of the ordinary course of ourbusiness. While we cannot predict the ultimate outcome of these matters, wecurrently believe that any ultimate liability arising out of these proceedingswill not have a material adverse effect on our financial position. We maybecome involved in other legal and governmental, administrative or contractualproceedings in the future.

The SEI acquisition agreement provides for a purchaseprice adjustment based upon the working capital of SEI as of the closing date. Subsequentto the closing date, we received a payment of $1.6 million in connection withservices performed prior to the closing date that SEI had not previouslybilled, and was not authorized to bill, its customer as of the closing date. TheSEI selling stockholders have asserted that they are entitled to a credit inconnection with the calculation of working capital adjustment in an amount equalto the amount received 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 2007.

In June 2006, the Company, through one of itssubsidiaries, was awarded a judgment, after a trial before a judge, in alawsuit filed in the Circuit Court of Fairfax County, Virginia against NationalTechnologies Associates, Inc. (“NTA”) in the amount of $841,612. TheCompany’s claims arose out of the Company’s allegation that NTA breached a contractwhich obligated NTA to subcontract certain work to the Company’s subsidiary. TheCompany did not record the judgment because NTA filed a motion forreconsideration before the trial court. The trial court judge granted NTA’smotion for reconsideration, thereby overturning the judge’s original ruling.The Company has filed a petition with the Virginia Supreme Court requestingthat it agree to hear an appeal of the trial court’s final judgment. TheCompany cannot presently determine the ultimate outcome of the matter.

**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 30, 2006.

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**PART II**

**Item 5. Market for the Company’s Common Equity andRelated Stockholder Matters and Issuer Purchases of Equity Securities:****  **Since November 12, 2002, SIInternational’s common stock has been publicly traded on the NASDAQ NationalMarket 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 indicatedbelow, as reported by the NASDAQ National Market, were:

| ** **                          | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------------------------------|------------|----------|------------|---------|------------|
| Year ended  December 30, 2006: |       |     |       |    |       |
| First Quarter                       |       | $        | 35.50      |    | $          | 27.39 |   |
| Second Quarter                      |       | $        | 36.26      |    | $          | 28.17 |   |
| Third Quarter                       |       | $        | 32.15      |    | $          | 26.41 |   |
| Fourth Quarter                      |       | $        | 35.00      |    | $          | 30.34 |   |
| 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 |   |

 

As of March 1, 2007, there were approximately 138holders of record of our common stock. As of March 1, 2007, the closingprice of our common stock was $28.10.

We have never declared orpaid any cash dividends on our common stock. We currently intend to retainearnings, if any, to support our growth strategy and do not anticipate payingcash dividends in the foreseeable future.

**Comparative Stock PricePerformance Graph**

*The comparisons onthe following graph and table are required by the Securities and ExchangeCommission and are not intended to forecast or be indicative of possible futureperformance of our common stock. The information contained in this table shallnot be deemed to be “soliciting material” or to be “filed” with the Securitiesand Exchange Commission, nor shall it be incorporated by reference into anyprevious or future filings under the Securities Act or the Exchange Act.*

The following graph compares the cumulative totalstockholder return on our common stock from November 12, 2002 (the firsttrading in common stock of SI International) through December 29, 2006,with the cumulative total return on (i) the NASDAQ Stock Market—U.S. indexand (ii) a peer group composed of SI International and the following otherFederal Government Service Providers with whom we compete: CACIInternational Inc., Dynamics Research Corp., ManTech International Corp.,MTC Technologies Inc., NCI, Inc., and SRA International Inc. BecauseTitan was acquired by L-3 Communications in 2005 and Titan’s stock is nolonger listed or publicly traded, Titan’s stock can no longer be tracked forpurposes of stock price performance and has not been included in graph below. InSeptember 2006, ICF International, Inc., a provider of professionalservices to the U.S. federal government, completed an initial public offering. BecauseICF provides similar services to the federal government to those provided by SIInternational and to offset the loss of previously identified peer companies asa result of acquisitions, SI International has chosen to add ICF to its peergroup. In October 2006, Stanley, Inc., a provider of informationtechnology services and solutions to U.S. federal government, completed aninitial public offering. Because Stanley provides similar services to thefederal government to those provided by SI International and to offset the lossof previously identified peer companies as a result of acquisitions, SIInternational has chosen to add Stanley to its peer group.

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The graph assumes aninvestment of $100 on November 12, 2002 in each of *SIInternational*, the NASDAQ Stock Market—U.S. index and the members ofour peer group. The comparison also assumes that all dividends are reinvestedand all returns are market-cap weighted. The historical information set forthbelow is not necessarily indicative of future performance.

**Comparisonof Cumulative Total Return Among SI International, Inc*.*,The NASDAQ Stock Market—U.S. Index and Federal Government ServicesProvider Index**

****

 

| ** **                                  | ** ** | **December 29, 2006** | ** ** |
|---------------------------------------------|------------|---------------------------------|------------|
| SI International                            |       |                            | $          | 231.57 |   |   |
| NASDAQ Stock  Market U.S. Index             |       |                            | 178.97     |   |   |
| Federal Government  Services Provider Index |       |                            | 153.29     |   |   |

 

**Item6. Selected Financial Data:****  **The selected financial data presented below for our2006, 2005, 2004, and 2003 fiscal years are derived from our auditedconsolidated financial statements included in this Form 10-K. Theselected financial data presented below for our 2002 fiscal year is derivedfrom our audited consolidated financial statements not included in this Form 10-K.You should read the selected financial data presented below in conjunction withthe consolidated financial statements, the notes to the consolidated financialstatements and with “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” included elsewhere in this Form 10-K.Our fiscal year is based on the calendar year and ends each year on theSaturday closest to, but not falling after, December 31 of that year. **All fiscal years shown below other than 2005, include52 weeks. Fiscal 2005 includes 53 weeks.**

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| ** **                                               | ** ** | **Fiscal Year  SI International, Inc.**                          | ** ** |
|----------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **2006**                                                                        | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                               | ** ** | **(dollars in thousands, except per share data)** | ** ** |
| **Statement of Operations Data:**                        | ** ** | ** **                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                                  |       | $                                                                               | 461,970    |   | $ | 397,919 |   | $ | 262,306 |   | $ | 168,287 |   | $ | 149,351 |   |
| Costs and expenses:                                      |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Cost of services                                         |       | 290,675                                                                         |       | 246,481 |   | 166,774 |   | 101,940 |   | 91,240 |   |
| Selling, general and  administrative                     |       | 124,847                                                                         |       | 113,015 |   | 71,917 |   | 51,569 |   | 49,404 |   |
| Depreciation and  amortization                           |       | 2,692                                                                           |       | 2,161 |   | 2,231 |   | 2,009 |   | 1,988 |   |
| Amortization of  intangible assets                       |       | 3,116                                                                           |       | 2,292 |   | 648 |   | — |   | — |   |
| Total operating expenses                                 |       | 421,330                                                                         |       | 363,949 |   | 241,570 |   | 155,518 |   | 142,632 |   |
| Income from operations                                   |       | 40,640                                                                          |       | 33,970 |   | 20,736 |   | 12,769 |   | 6,719 |   |
| Other income (expense)                                   |       | 88                                                                              |       | 12 |   | (1 | ) | — |   | — |   |
| Interest expense                                         |       | (7,731                                                                          | )          | (6,103 | ) | (2,760 | ) | (606 | ) | (3,319 | ) |
| Minority interests                                       |       | —                                                                          |       | — |   | — |   | — |   | (118 | ) |
| Change in fair value of  put warrants                    |       | —                                                                          |       | — |   | — |   | — |   | 640 |   |
| Income before provision  for income taxes                |       | 32,997                                                                          |       | 27,879 |   | 17,975 |   | 12,163 |   | 3,922 |   |
| Provision for income  taxes                              |       | 12,844                                                                          |       | 10,942 |   | 7,098 |   | 4,784 |   | 1,439 |   |
| Net income                                               |       | 20,153                                                                          |       | 16,937 |   | 10,877 |   | 7,379 |   | 2,483 |   |
| Dividends on redeemable  cumulative preferred stock |       | —                                                                          |       | — |   | — |   | — |   | 1,954 |   |
| Net income attributable  to common stockholders          |       | $                                                                               | 20,153     |   | $ | 16,937 |   | $ | 10,877 |   | $ | 7,379 |   | $ | 529 |   |
| Earnings per common share:                               |       |                                                                            |       |   |   |   |   |   |   |   |   |
| Basic                                                    |       | $                                                                               | 1.61       |   | $ | 1.51 |   | $ | 1.20 |   | 0.87 |   | $ | 0.16 |   |
| Diluted                                                  |       | 1.56                                                                            |       | 1.45 |   | 1.14 |   | 0.87 |   | (0.03 | ) |
| **Balance Sheet Data (at period end):**                  | ** ** | ** **                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash  equivalents                               |       | $                                                                               | 19,457     |   | $ | 26,160 |   | $ | 3,754 |   | $ | 12,302 |   | $ | 10,856 |   |
| Working capital                                          |       | 64,201                                                                          |       | 76,023 |   | 21,927 |   | 39,708 |   | 29,937 |   |
| Total assets                                             |       | 381,133                                                                         |       | 335,695 |   | 212,107 |   | 106,627 |   | 92,315 |   |
| Total debt, including  capital lease obligations         |       | 70,577                                                                          |       | 99,542 |   | 29,291 |   | 530 |   | 658 |   |
| Total stockholders’  equity                         |       | 239,212                                                                         |       | 167,869 |   | 145,070 |   | 81,547 |   | 73,977 |   |
| **Other Financial Data:**                                | ** ** | ** **                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| EBITDA(1)                                                |       | $                                                                               | 46,448     |   | $ | 38,423 |   | $ | 23,615 |   | $ | 14,778 |   | $ | 8,707 |   |
| Capital expenditures                                     |       | 8,507                                                                           |       | 2,727 |   | 1,225 |   | 1,291 |   | 1,653 |   |
| Net cash provided by  (used in) operations               |       | 32,256                                                                          |       | 26,599 |   | (1,655 | ) | 16,079 |   | 5,680 |   |
| Net cash used in  investing activities                   |       | (58,981                                                                         | )          | (74,821 | ) | (86,665 | ) | (12,241 | ) | (1,653 | ) |
| Net cash provided by (used in) financing activities      |       | 20,022                                                                          |       | 70,628 |   | 79,772 |   | (2,392 | ) | 6,359 |   |

----

(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.

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Reconciliationof Net Income to EBITDA is as follows:

| ** **                            | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Net income                            |       | $        | 20,153     |     | $          | 16,937   |       | $        | 10,877     |     | 7,379      |   | $ | 2,483 |   |
| Other (income)  expense               |       | (88      | )          | (12      | )          | 1        |       | —   |       | —   |       |
| Interest expense                      |       | 7,731    |       | 6,103    |       | 2,760    |       | 606      |       | 3,319    |       |
| Minority interest                     |       | —   |       | —   |       | —   |       | —   |       | 118      |       |
| Change in fair  value of put warrants |       | —   |       | —   |       | —   |       | —   |       | (640     | )          |
| Provision for  income taxes           |       | 12,844   |       | 10,942   |       | 7,098    |       | 4,784    |       | 1,439    |       |
| Depreciation and  amortization        |       | 2,692    |       | 2,161    |       | 2,231    |       | 2,009    |       | 1,988    |       |
| Amortization of  intangible assets    |       | 3,116    |       | 2,292    |       | 648      |       | —   |       | —   |       |
| EBITDA                                |       | $        | 46,448     |     | $          | 38,423   |       | $        | 23,615     |     | $          | 14,778 |   | $ | 8,707 |   |
|                                       |            |          |            |          |            |          |            |          |            |          |            |  |  |  |  |  |

 

**Item 7. Management’sDiscussion and Analysis of Financial Condition and Results of Operations:****  **The following discussion andanalysis should be read in conjunction with the Item 6. “Selected ConsolidatedFinancial Data,” the consolidated financial statements and related notesincluded elsewhere in this Form 10-K, and the forward-lookingdisclaimer language in italics before Item 1. “Business”.

*Our fiscal year is based on a calendar year and endseach year on the Saturday closest to, but not falling after, December 31of that year. As a result, our fiscal year may be comprised of 52 or 53 weeks. **Our 2005 fiscal year had 53 weeks. Our 2006 and 2004fiscal 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 ThriftInvestment Board, National Guard Bureau, and the Intelligence community. Wecombine our technology 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 Deployment®” methodology that enables therapid standing up of innovative solutions and the incorporation of additionalcapabilities in rapid succession. This capability allows us to respond tourgent IT imperatives quickly, often in a matter of months, and within a welldefined budget. We can, therefore, provide solutions for current IT needs,while establishing a platform for advancing long-term transformationalobjectives. We possess a proven ability to respond to high priority informationtechnology and network needs through innovation, and an enviable reputation fortimely delivery of robust solutions on assignments where failure is not anoption. Our solutions enable clients to respond to new mandates, expand thescope of their missions, and reengineer underlying business processes. We havea demonstrated ability of turning troubled IT projects into winning outcomesand realized exceptional growth from high-quality client engagements. We alsoutilize mature and proven processes to manage and market large-scale ID/IQcontracts, such as C4I2TSR. We employ a diverse, innovative team thateffectively utilizes small business partners’ unique skills and expertise formission critical IT projects.

**Fiscal 2006 Reviewand Fiscal 2007 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 customer concentration,our work for DoD customers continues to grow at a faster pace  than our 

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other customers, which isthe result of ongoing defense transformation initiatives that require ourspecialty in rapidly performing mission-critical work. Virtually all of ourengagements with the DoD either directly support, or are closely related to DoDTransformation goals. We will continue aligning our programs and capabilitiesalong our focus areas of Homeland Defense, Federal IT Modernization,Mission-Critical Outsourcing, and Defense Transformation given these sectorsmost accurately reflect our customer’s highest priorities. The FederalGovernment’s increased use of technology drove our growth in 2006. We expectthat government initiatives involving information sharing, “net-centric”warfare, and business process transformation will be among our customer base’skey focus areas in 2007.

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 of securing ourborders, along with urgent need for information sharing and other criticalDepartment of Homeland Security issues, will continue driving the demand forbudget increases in homeland defense. With the Bridge acquisition, we expandedour presence in the Intelligence community. We believe that this ongoing needfor improved intelligence collection will not diminish. For the foreseeablefuture, we anticipate that the IT and network requirements of DoD, Departmentof Homeland Security, and the Intelligence community will be the largestdrivers of our organic growth. Also, strategic acquisitions that add valuewill continue to impact our future customer mix. Finally, the recent Zenacquisition provides us with greater access to new customers and additionalcross-selling opportunities for our portfolio of mission-critical solutions.

The addition of SEI and Bridge allowed us to continuesupporting our existing customer base, while strengthening our position withthe Department 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.Even in years where Congress passed appropriations bills in a timely fashion,it is not uncommon for several months to pass before funding was actuallyissued. With the combination of the GSA’s reorganization and recent contractaward delays, we expect that government agencies will continue moving away fromusing GSA contract vehicles and start utilizing government-wide andagency-specific contract vehicles more frequently in 2007 until the GSAreorganization is complete.

Infiscal 2006 and fiscal 2005, we received approximately 99% and 98%,respectively, of our revenues from services we provided to various departmentsand agencies of the Federal Government, both directly and through other primecontractors, and approximately 1% and 2%, 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** | ** ** |
|----------------------------|------------|----------------------|------------|
| ** **                 | ** ** | **2006**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Department of  Defense     |       | 46.6%                |       | 46.9% |   | 52.8% |   |
| Federal civilian  agencies |       | 51.9%                |       | 51.2% |   | 43.8% |   |
| Commercial  entities       |       | 1.5%                 |       | 1.9% |   | 3.4% |   |
| Total revenue              |       | 100.0%               |       | 100.0% |   | 100.0% |   |

 

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We have derived asubstantial majority of our revenues from governmental contracts under which weact as a prime contractor. We also provide services indirectly as asubcontractor. The following table shows our revenues as prime contractor andas subcontractor as a percentage of our total revenue for the followingperiods:

| ** **              | ** ** | **Fiscal Year** | ** ** |
|-------------------------|------------|----------------------|------------|
| ** **              | ** ** | **2006**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Prime contract  revenue |       | 79.6%                |       | 75.4% |   | 80.6% |   |
| Subcontract  revenue    |       | 20.4%                |       | 24.6% |   | 19.4% |   |
| Total revenue           |       | 100.0%               |       | 100.0% |   | 100.0% |   |

 

Our services are providedpursuant to three types of contracts: cost reimbursable, time and materials andfixed price contracts. The following table shows our revenues from each ofthese types of contracts as a percentage of our total revenue for the followingperiods:

| ** **          | ** ** | **Fiscal Year** | ** ** |
|---------------------|------------|----------------------|------------|
| ** **          | ** ** | **2006**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Cost reimbursable   |       | 31.8%                |       | 30.0% |   | 31.1% |   |
| Time and  materials |       | 40.2%                |       | 43.8% |   | 46.3% |   |
| Fixed price         |       | 28.0%                |       | 26.2% |   | 22.6% |   |
| Total               |       | 100.0%               |       | 100.0% |   | 100.0% |   |

                                                                   

Under cost reimbursable contracts, we are reimbursedfor costs that are determined to be reasonable, allowable and allocable to thecontract, and pay 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 cost reimbursablecontracts, we recognize the relevant portion of the expected fee to be awardedby the client at the time such fee can be reasonably estimated, based onfactors such as our prior award experience and communications with the clientregarding performance. In general, cost reimbursable contracts are the leastprofitable 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. As discussed above, in our Risk Factors, changes to theacquisition regulations applicable to time and material and labor hour servicecontracts may result in the awarding of fewer such contracts, or a reduction inthe term of such 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 

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of these contracts aregenerally less than six months in duration, we have several multi-yearcontracts of this type in which the customer has the option to extend thecontractual 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 efforts. Our ability to predict accurately the number and types ofpersonnel, their salaries, and other costs, can have a significant impact onour 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.

We actively monitor ourrelationships with our clients during our engagements, as well as the qualityof the service we provide, to assist in our efforts to win recompetition bids.In addition, we strive to maintain good relationships with a wide variety ofgovernment contractors.

**Recent Events**

*Subsidiary Consolidation.**  *On December 15, 2006, SI International mergedtwo of its wholly-owned subsidiaries, SI International Engineering Inc., aColorado corporation (“Engineering”), and SI International Telecom Corporation,a Delaware corporation (“SI Telecom”), into SI International as part of aninternal consolidation of legal entities. The merger of Engineering and SITelecom into the Company is not expected to impact business operations. Additionally,there may be tax advantages to the consolidation effort. Furthermore, we mayconsolidate other subsidiaries into SI International, when doing be convenientand would not impact our business operations.

**Liquidity andCapital Resources**

*General.**  *Short-term liquidity requirementsare created by our use of funds for working capital, capital expenditures, andthe need to provide debt service. We expect to meet these requirements througha combination of cash flow from operations and borrowings under our AmendedCredit Agreement.

We anticipate that our long-term liquidityrequirements, including any further acquisitions, will be funded through acombination of cash flow from operations, borrowings under our Amended CreditAgreement, additional secured or unsecured debt or the issuance of common orpreferred stock, each of which may be initially funded through borrowingsunder our Amended Credit Agreement.

*Cashand 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 fiscal year2006, fiscal year 2005, and fiscal year 2004 were $19.5 million, $34.0 million,and $5.8 million, respectively.

*Cash Flow.**  *The following table sets forth oursources and uses of cash for fiscal years 2006, 2005 and 2004.

| ** **                                 | ** ** | **Fiscal Year**    | ** ** |
|--------------------------------------------|------------|-------------------------|------------|
| ** **                                 | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                 | ** ** | **(in thousands)** | ** ** |
| Net cash provided  by (used in) operations |       | $                       | 32,256     |   | $ | 26,599 |   | $ | (1,655 | ) |
| Net cash used in  investing activities     |       | (58,981                 | )          | (74,821 | ) | (86,665 | ) |
| Net cash provided  by financing activities |       | 20,022                  |       | 70,628 |   | 79,772 |   |
| Net (decrease) increase  in cash           |       | $                       | (6,703     | ) | $ | 22,406 |   | $ | (8,548 | ) |

 

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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 year 2006 was attributable to net income of$20.2 million plus depreciation, amortization and other non-cash items of$11.0 million, and a decrease in working capital of $1.1 million. Cashprovided by operations in fiscal year 2005 was mainly attributable to netincome of $16.9 million, plus depreciation, amortization and other non-cashitems of $9.9 million. Cash used in operations in fiscal year 2004 wasattributable to an increase in working capital of $18.6 million, partiallyoffset by net income of $10.9 million plus depreciation, amortization and othernon-cash items of $6.0 million.

Our cash flow used in investing activities consistsprimarily of capital expenditures, the purchase and sale of marketablesecurities, and acquisitions. In fiscal 2006, we paid $48.4 million to acquireZen, repaid a contract settlement and a note payable to former owners for $10.3million, purchased $42 million of marketable securities, and purchased capitalassets totaling $8.5 million. We partially offset the cash use with $49.8million of proceeds from the sale of marketable securities. In fiscal year2005, we paid $74.0 million for SEI, purchased $42.1 million of marketablesecurities, and purchased capital assets totaling $2.7 million. We partiallyoffset the cash use with $36.2 million of proceeds from the sale of marketablesecurities and $8.0 million of former owner payable. In fiscal year 2004, wepaid $64.9 million and $29.5 million, respectively, to acquire Matcom andBridge, purchased $2.1 million of marketable securities, and purchased capitalassets totaling $1.2 million. We partially offset the cash use with $11.0million of proceeds from the sale of marketable securities.

Our cash flow provided byfinancing activities consists primarily of borrowings under and payments on ourcredit facility and proceeds from the issuance and exercise of common stock. Cashprovided by financing activities for fiscal year 2006 was attributable toproceeds of $40.3 million from the sale of common stock, $30.0 million ofproceeds from the issuance of term debt, $7.4 million of proceeds from theexercise of stock options and $2.1 million of income tax benefit fromstock option exercises, net of $59.1 million repayment of term debt, payment ofdebt issuance fees of $0.6 million, and repayments of capital leases of $0.1million. 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 credit portionof the credit facility, and proceeds of $0.9 million from the exercise of stockoptions. Cash provided by financing activities was partially offset by therepayment of $30.0 million for the term loan portion of our credit facilitypayment of debt issuance fees of $1.2 million, and repayments of capital leaseobligations of $0.1 million.

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**Results ofOperations**

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

| ** **                                | ** ** | **Fiscal Year** | ** ** |
|-------------------------------------------|------------|----------------------|------------|
| ** **                                | ** ** | **2006**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue                                   |       | 100.0                | %          | 100.0 | % | 100.0 | % |
| Costs and  expenses:                      |       |                 |       |   |   |   |   |
| Cost of services                          |       | 62.9                 |       | 61.9 |   | 63.6 |   |
| Selling, general and administrative       |       | 27.0                 |       | 28.5 |   | 27.4 |   |
| Depreciation and amortization             |       | 0.6                  |       | 0.5 |   | 0.9 |   |
| Amortization of intangible assets         |       | 0.7                  |       | 0.6 |   | 0.2 |   |
| Total operating expenses                  |       | 91.2                 |       | 91.5 |   | 92.1 |   |
| Income from  operations                   |       | 8.8                  |       | 8.5 |   | 7.9 |   |
| Interest expense                          |       | (1.6                 | )          | (1.5 | ) | (1.1 | ) |
| Income before  provision for income taxes |       | 7.2                  |       | 7.0 |   | 6.8 |   |
| Provision for  income taxes               |       | 2.8                  |       | 2.7 |   | 2.7 |   |
| Net income                                |       | 4.4                  | %          | 4.3 | % | 4.1 | % |

                                                                                                                                                                                                     

**Fiscal year 2006compared with fiscal year 2005**

*Revenue.**  *Substantially all of our revenue isderived from services and solutions provided to the Federal Government,primarily by our employees and, to a lesser extent, our subcontractors.Revenues from work under Federal Government contracts increased 16.6% to $455.3 millionfrom $390.3 million for the same period in 2005. This increase wasattributable to the acquisition and integration of Zen in the first quarter of2006, new contract awards, successful recompetition wins on existing programsand growth within existing programs in our three focus areas: Federal ITModernization/Mission-Critical Outsourcing, Defense Transformation, andHomeland Defense. Commercial and other revenues decreased 11.6% to$6.7 million in 2006 from $7.6 million in 2005. This decrease wasattributable to our continued focus on opportunities for the FederalGovernment. We expect revenue growth to continue primarily from FederalGovernment civilian and defense organizations.

*Costof services.**  *Costof services includes direct labor and other direct costs, such as materials andsubcontracts, incurred to provide our services and solutions to our customers.Generally, changes in cost of services are correlated to changes in revenue asresources are consumed in the production of that revenue. Please note that inour reported financial statements prior to the second quarter ended July 1,2006, we referred to cost of services as “direct costs”. We expect to use theterm cost of services in all future periods. The increase in cost of servicesfrom fiscal 2005 to fiscal 2006 was attributable primarily to the increase inrevenue. As a percentage of revenue, cost of services were 62.9% for fiscal2006 as compared to 61.9% for fiscal 2005. Cost of services will continue toincrease in conjunction to revenue growth.

*Selling,general and administrative expenses.**  *Selling, general and administrativeexpenses include facilities, selling, bid and proposal, indirect labor, fringebenefits and other discretionary costs. Please note that in our reportedfinancial statements prior to the second quarter ended July 1, 2006, wereferred to selling, general and administrative expenses as “indirect costs”.We expect to use the term selling, general and administrative expenses in allfuture periods. The increase in selling, general and administrative expensesfrom fiscal 2005 to fiscal 2006 was primarily attributable to the expectedgrowth of support functions necessary to facilitate and administer the growthin cost of services as well as the integration of Zen. In fiscal 2006, selling,general and administrative expenses were 27.0% of revenue compared to 28.5% ofrevenue in fiscal 2005. We believe in future years, indirect costs willcontinue to grow, but should decrease as a percentage of revenue.

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*Depreciation andAmortization.**  *Depreciationand amortization includes the depreciation of computers, furniture and otherequipment, the amortization of third party software we use internally, andleasehold improvements. As a percentage of revenue, depreciation was 0.6% forfiscal 2006 as compared to 0.5% for the same period in fiscal 2005.

*Amortization of IntangibleAssets.**  *Amortizationof intangible assets includes the amortization of intangible assets acquired inconnection with our acquisitions in accordance with SFAS 142, Goodwill andOther Intangible Assets. Identifiable intangible assets are amortized overtheir estimated useful lives. Non-compete agreements are generally amortizedstraight-line over the term of the agreement, while contracts and relatedclient relationships are amortized using an accelerated method over theirestimated useful lives. For the fiscal year ended December 30, 2006, weamortized $3.1 million of intangible assets which we capitalized in connectionwith the acquisitions of Zen, SEI, Bridge and Matcom. For the fiscal year endedDecember 31, 2005, we amortized $2.3 million of intangible assets which wecapitalized in connection with the acquisitions of SEI, Bridge, and Matcom.

*Income from operations.**  *This increase in income fromoperations from fiscal 2005 to fiscal 2006 was attributable primarily to theincrease in revenue. As a percentage of revenue, income from operations was8.8% for fiscal 2006 as compared to 8.5% in fiscal 2005. We anticipate thatthis trend of improving operating margins will continue, but we also expectshort-term fluctuations in our operating margins from time to time, such aswhen we incur substantial start-up costs associated with new customercontracts.

*Interest expense.**  *Interest expense is primarilyrelated to interest expense incurred under our outstanding borrowings under ourcredit facility and, going forward, to a lesser extent, our interest rate swapagreement. The increase in interest expense from fiscal 2005 to fiscal 2006 wasattributable primarily to the increased borrowings under our Amended CreditAgreement in connection with the Zen acquisition and the $1.1 million write offof loan origination fees due to the prepayments on the term loan. As apercentage of revenue, interest expense was 1.6% for fiscal 2006 as compared to1.5% for the same period in fiscal 2005. Interest expense included $1,821,000and $705,000 of amortization and write-off of deferred financing costs duringfiscal years 2006 and 2005, respectively.

*Provision for income taxes.**  *Our effective tax rate is typicallygreater than the federal statutory rate of 34% due primarily to state incometax rates and certain nondeductible expenses. Our fiscal year 2006 taxprovision represents an effective tax rate of 38.9%. Our fiscal 2005 taxprovision represents an effective tax rate of 39.3%.

**Fiscal year 2005 comparedwith fiscal year 2004**

*Revenue.**  *Substantially all of our revenue isderived from services and solutions provided to the Federal Government, primarilyby our employees and, to a lesser extent, our subcontractors. Revenues fromwork under Federal Government contracts increased 54.0% to $390.3 millionfrom $253.4 million for the same period in 2004. This increase wasattributable to federal business acquired, new contract awards, successfulrecompetition wins on existing programs and growth within existing programs inour three focus areas: Federal IT Modernization/ Mission-CriticalOutsourcing, Defense Transformation, and Homeland Defense. Commercial and otherrevenues decreased 14.5% to $7.6 million in 2005 from $8.9 million in2004. This decrease was attributable to our continued focus on opportunitiesfor the Federal Government. We expect revenue growth to continue primarily fromFederal Government civilian and defense organizations.

*Cost of services.**  *Cost of services includes directlabor and other direct costs, such as materials and subcontracts, incurred toprovide our services and solutions to our customers. Generally, changes in costof services are correlated to changes in revenue as resources are consumed inthe production of that revenue. The increase in cost of services from fiscal2004 to fiscal 2005 was attributable primarily to the increase in revenue. As apercentage of revenue, cost of services were 61.9% for fiscal 2005 as comparedto 63.6% for fiscal 2004. Direct costs will continue to increase in conjunctionto revenue growth.

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*Selling, general andadministrative expenses.**  *Selling, general and administrative expenses includefacilities, selling, bid and proposal, indirect labor, fringe benefits andother discretionary costs. The increase in selling, general and administrativeexpenses from fiscal 2004 to fiscal 2005 was primarily attributable to theexpected growth of support functions necessary to facilitate and administer thegrowth in cost of services. In fiscal 2005, selling, general and administrativeexpenses were 28.5% of revenue compared to 27.4% of revenue in fiscal 2004.However, we believe in future years, selling, general and administrativeexpenses will continue to grow, but should decrease as a percentage of sales.

*Depreciation andAmortization.**  *Depreciationand amortization includes the depreciation of computers, furniture and otherequipment, the amortization of third party software we use internally, andleasehold improvements. As a percentage of revenue, depreciation was 0.5% forfiscal 2005 as compared to 0.9% for the same period in fiscal 2004.

*Amortization of IntangibleAssets.**  *Amortizationof intangible assets includes the amortization of intangible assets acquired inconnection with our acquisitions in accordance with SFAS 142, Goodwill andOther Intangible Assets. Identifiable intangible assets are amortized overtheir estimated useful lives. Non-compete agreements are generally amortizedstraight-line over the term of the agreement, while contracts and relatedclient relationships are amortized using an accelerated method over theirestimated useful lives. For the fiscal year ended December 31, 2005, weamortized $2.3 million of intangible assets which we capitalized in connectionwith the acquisitions of Bridge, SEI, and Matcom. For the fiscal year ended December 25,2004, we amortized $0.6 million of intangible assets which we capitalized inconnection with the acquisition of Matcom.

*Income from operations.**  *This increase in income fromoperations from fiscal 2004 to fiscal 2005 was attributable primarily to theincrease in revenue. As a percentage of revenue, income from operations was8.5% for fiscal 2005 as compared to 7.9% in fiscal 2004. We anticipatecontinued improvement in our operating margin.

*Interest expense.**  *Interest expense is primarilyrelated to interest expense incurred under our outstanding borrowings under ourcredit facility and, going forward, to a lesser extent, our interest rate swapagreement. The increase in interest expense from fiscal 2004 to fiscal 2005 wasattributable primarily to the borrowing of debt subsequent to the acquisitionsof Bridge, SEI and Matcom. As a percentage of revenue, interest expense was1.5% for fiscal 2005 as compared to 1.1% for the same period in fiscal 2004. Weanticipate an increase in interest expense in fiscal year 2006 due to increasedborrowings under our Amended Credit Agreement made in connection with the Zenacquisition. Interest expense included $705,000 and $1,000,000 of amortizationand write-off of deferred financing costs during fiscal 2005 and fiscal 2004.

*Provision for income taxes.**  *Our effective tax rate is typicallygreater than the federal statutory rate of 34% due primarily to state incometax rates and certain nondeductible expenses. Our fiscal year 2005 taxprovision represents an effective tax rate of 39.3%. Our fiscal 2004 taxprovision represents an effective tax rate of 39.5%.

The following table sets forth certain items from ourconsolidated statements of operations.

| ** **                           | ** ** | **Fiscal Year** | ** ** | **Percentage Change** | ** ** |
|--------------------------------------|------------|----------------------|------------|----------------------------|------------|
| ** **                           | ** ** | **2006**             | ** ** | **2005**                   | ** ** | **2004** | ** ** | **2006-2005** | ** ** | **2005-2004** | ** ** |
| Revenue                              |       | $                    | 461,970    |                       | $          | 397,919 |   | $ | 262,306 |   |   | 16.1 | % |   |   | 51.7 | % |   |
| Cost of services                     |       | 290,675              |       | 246,481                    |       | 166,774 |   |   | 17.9 | % |   |   | 47.8 | % |   |
| Selling, general and  administrative |       | 124,847              |       | 113,015                    |       | 71,917 |   |   | 10.5 | % |   |   | 57.1 | % |   |
| Depreciation and  Amortization       |       | 2,692                |       | 2,161                      |       | 2,231 |   |   | 24.6 | % |   |   | (3.1 | )% |   |
| Amortization of  Intangible Assets   |       | 3,116                |       | 2,292                      |       | 648 |   |   | 36.0 | % |   |   | 253.7 | % |   |
| Income from Operations               |       | 40,640               |       | 33,970                     |       | 20,736 |   |   | 19.6 | % |   |   | 63.8 | % |   |
| Other Income (Expense)               |       | 88                   |       | 12                         |       | (1 | ) |   | 633.3 | % |   |   | 0.0 | % |   |
| Interest Expense                     |       | (7,731               | )          | (6,103                     | )          | (2,760 | ) |   | 26.7 | % |   |   | 121.1 | % |   |
| Provision for Income  Taxes          |       | 12,844               |       | 10,942                     |       | 7,098 |   |   | 17.4 | % |   |   | 54.2 | % |   |
| Net Income                           |       | 20,153               |       | 16,937                     |       | 10,877 |   |   | 19.0 | % |   |   | 55.7 | % |   |
|                                      |            |                      |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

                                                                                                                                                                                                                                                

 

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**SupplementalQuarterly Information**

Thefollowing table sets forth quarterly unaudited consolidated financial data forthe fiscal quarters of 2006 and 2005, 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 hadfourteen weeks. Some unevenness of revenue from quarter to quarter existsprimarily because of the timing of purchases of materials necessary toperform certain obligations under our C4I2SR contract with U.S. Air ForceSpace Command.

| ** **                                 | ** ** | **Fiscal Year 2006**       | ** ** | **Fiscal Year 2005** | ** ** |
|--------------------------------------------|------------|--------------------------------------|------------|--------------------------------|------------|
| ** **                                 | ** ** | **Q1**                               | ** ** | **Q2**                         | ** ** | **Q3** | ** ** | **Q4** | ** ** | **Q1** | ** ** | **Q2** | ** ** | **Q3** | ** ** | **Q4** | ** ** |
| ** **                                 | ** ** | **(dollars in thousands)** | ** ** |
| Revenue                                    |       | $                                    | 107,232    |                           | $          | 119,233 |   | $ | 119,869 |   | $ | 115,636 |   | $ | 83,717 |   | $ | 95,983 |   | $ | 101,775 |   | $ | 116,444 |   |
| Costs and expenses:                        |       |                                 |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of services                           |       | 66,609                               |       | 74,968                         |       | 77,092 |   | 72,006 |   | 52,603 |   | 58,598 |   | 62,743 |   | 72,537 |   |
| Selling, general & administrative |       | 30,546                               |       | 32,632                         |       | 30,652 |   | 31,017 |   | 23,580 |   | 27,929 |   | 28,723 |   | 32,783 |   |
| Depreciation and amortization              |       | 548                                  |       | 673                            |       | 756 |   | 715 |   | 551 |   | 531 |   | 504 |   | 575 |   |
| Amortization of intangible assets          |       | 647                                  |       | 823                            |       | 823 |   | 823 |   | 457 |   | 611 |   | 612 |   | 612 |   |
| Total operating expenses                   |       | 98,350                               |       | 109,096                        |       | 109,323 |   | 104,561 |   | 77,191 |   | 87,669 |   | 92,582 |   | 106,507 |   |
| Income from operations                     |       | 8,882                                |       | 10,137                         |       | 10,546 |   | 11,075 |   | 6,526 |   | 8,314 |   | 9,193 |   | 9,937 |   |
| Other income (expense)                     |       | 30                                   |       | (101                           | )          | 31 |   | 128 |   | (99 | ) | 14 |   | 64 |   | 33 |   |
| Interest expense                           |       | (1,782                               | )          | (2,693                         | )          | (1,720 | ) | (1,536 | ) | (1,097 | ) | (1,659 | ) | (1,690 | ) | (1,657 | ) |
| Provision for income taxes                 |       | 2,816                                |       | 2,901                          |       | 3,498 |   | 3,629 |   | 2,106 |   | 2,633 |   | 2,989 |   | 3,214 |   |
| Net income                                 |       | $                                    | 4,314      |                           | $          | 4,442 |   | $ | 5,359 |   | $ | 6,038 |   | $ | 3,224 |   | $ | 4,036 |   | $ | 4,578 |   | $ | 5,099 |   |
| Revenue                                    |       | 100.0                                | %          | 100.0                          | %          | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
| Costs and expenses:                        |       |                                 |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of services                           |       | 62.1                                 |       | 62.9                           |       | 64.3 |   | 62.3 |   | 62.8 |   | 61.1 |   | 61.6 |   | 62.3 |   |
| Selling, general & administrative |       | 28.5                                 |       | 27.4                           |       | 25.6 |   | 26.8 |   | 28.2 |   | 29.1 |   | 28.2 |   | 28.2 |   |
| Depreciation and amortization              |       | 0.5                                  |       | 0.5                            |       | 0.6 |   | 0.6 |   | 0.7 |   | 0.6 |   | 0.5 |   | 0.5 |   |
| Amortization of intangible assets          |       | 0.6                                  |       | 0.7                            |       | 0.7 |   | 0.7 |   | 0.5 |   | 0.6 |   | 0.6 |   | 0.5 |   |
| Total operating expenses                   |       | 91.7                                 |       | 91.5                           |       | 91.2 |   | 90.4 |   | 92.2 |   | 91.4 |   | 90.9 |   | 91.5 |   |
| Income from operations                     |       | 8.3                                  |       | 8.5                            |       | 8.8 |   | 9.6 |   | 7.8 |   | 8.6 |   | 9.1 |   | 8.5 |   |
| Other income (expense)                     |       | 0.0                                  |       | (0.1                           | )          | 0.0 |   | 0.1 |   | (0.1 | ) | 0.0 |   | (0.1 | ) | 0.0 |   |
| Interest expense                           |       | (1.7                                 | )          | (2.3                           | )          | (1.4 | ) | (1.3 | ) | (1.3 | ) | (1.7 | ) | (1.7 | ) | (1.4 | ) |
| Provision for income taxes                 |       | 2.6                                  |       | 2.4                            |       | 2.9 |   | 3.2 |   | 2.5 |   | 2.7 |   | 2.9 |   | 2.7 |   |
| Net income                                 |       | 4.0                                  | %          | 3.7                            | %          | 4.5 | % | 5.2 | % | 3.9 | % | 4.2 | % | 4.5 | % | 4.4 | % |

 

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**Tabular Disclosureof Contractual Obligations**

Ourcontractual obligations as of December 30, 2006 are as follows (inthousands):

| ** **                       | ** ** | **Payment due by period** | ** **  | ** ** | ** ** |
|----------------------------------|------------|------------------------------------------|-------------|------------|------------|
| **Contractual Obligations** | ** ** | ** **                               | ** **  | **Total**  | ** ** | **1 year** | ** ** | **2 - 3 years** | ** ** | **4 - 5 years** | ** ** | **More than   5 years** | ** ** |
| Capital Lease                    |       | $                                        | 425         |       | $          | 143 |   |   | $ | 200 |   |   |   | $ | 82 |   |   |   | $ | — |   |   |
| Operating Lease                  |       | 57,093                                   |        | 9,161      |       |   | 17,481 |   |   |   | 15,618 |   |   |   | 14,833 |   |   |
| Credit Agreement                 |       | 70,206                                   |        | 754        |       |   | 1,507 |   |   |   | 67,945 |   |   |   | — |   |   |
| **Total**                        | ** ** | **$**                                    | **127,724** | ** ** | **$**      | **10,058** | ** ** | ** ** | **$** | **19,188** |   | ** ** | ** ** | **$** | **83,645** |   | ** ** | ** ** | **$** | **14,833** |   |   |
|                                  |            |                                          |             |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Purchase obligations related to existing contracts arewith the Federal Government and, in the event any contracts areterminated, we would have the ability to submit a termination claim foroutstanding purchases.

In connection with ouracquisition of Zen, we increased our total long-term debt to approximately$129.3. During the fiscal year ended December 30, 2006, the Company madeprepayments and regular quarterly payments totaling $59.0 million ofoutstanding term debt under the First Amendment, after which the remainingprincipal balance as of December 30, 2006, was approximately $70.2million. As a result of the pay down of principal, the Company’s quarterlypayment was reduced from $323,125 to $188,404 in consecutive quarterly paymentsstarting from December 29, 2006 through December 30, 2010, and afinal payment of approximately $67.2 million on February 9, 2011.

**Effects ofInflation**

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 SheetArrangements**

During fiscal year 2006,we were not a party to any off-balance sheet arrangements.

**Critical AccountingPolicies 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.

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***RevenueRecognition***

*The Company recognizes revenue whena contract 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.*

*Under cost reimbursable contracts,the Company is reimbursed for allowable costs, and paid a fee, which may befixed or performance-based. Revenues on cost reimbursable contracts arerecognized as costs are incurred plus an estimate of applicable fees earned.The Company considers fixed fees under cost reimbursable contracts to be earnedin proportion of the allowable costs incurred in performance of the contract.For cost reimbursable contracts that include performance based fee incentives,the Company recognizes the relevant portion of the expected fee to be awardedby the customer at the time such fee can be reasonably estimated, based onfactors such as the Company’s prior award experience and communications withthe 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. For fixed price contracts that are based on unit pricingor level of effort, the Company recognizes revenue for the number of unitsdelivered in any given fiscal period.  Forfixed price contracts in which the Company is paid a specific amount to providea particular service for a stated period of time, revenue is recognized ratablyover the service period.

For fixed price contracts that provide for thedelivery of a specific product with related customer acceptance provisions,revenues are recognized upon product delivery and customer acceptance.  However, a significant portion of theCompany’s fixed price-completion contracts involve the design and developmentof complex, client systems.  For thosecontracts that are within scope of SOP 81-1, Accounting for Performance ofConstruction-Type and Certain Production-Type Contracts, revenue is recognizedon the percentage-of-completion method using costs incurred in relation to totalestimated costs. 

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 the contract, the cost of the effort, and an ongoing assessment ofprogress toward completing the contract. From time to time, as part of thenormal management processes, facts develop that require revisions to estimatedtotal costs or revenues expected. The cumulative impact of any revisions toestimates and 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.

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***StockBased Compensation***

In December 2004, the Financial AccountingStandards Board (FASB) issued Statement of Financial Accounting Standards (SFAS)No. 123R, *Share Based Payment.*SFAS No. 123R 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. SFAS No. 123R 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 SFAS No. 123Rgenerally 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 under SFAS No. 123,as originally issued. The revised SFAS No. 123R requires entities todisclose information about the nature of the share-based payment transactionsand the effects of those transactions on the financial statements. All publiccompanies must use either the modified prospective or the modifiedretrospective transition method.

Effective January 1, 2006, the Company adoptedthe provisions of SFAS No. 123R using the modified prospective transitionmethod. Due to the use of the modified prospective method, prior interimperiods and fiscal years will not reflect any restated amounts. As disclosed inthe stock incentive plan section of Note 10, the Company accelerated thevesting of all unvested stock options previously awarded to employees, officersand directors in December 2005. The Company had no unvested stock optionson January 1, 2006. The Company issued 171,025 shares of stock options and32,825 shares of restricted stock during the fiscal year ended December 30,2006. The stock compensation expense recognized during the fiscal year ended December 30,2006 was $0.3 million. As of December 30, 2006, the total remainingunrecognized compensation expense related to unvested options and restrictedstock awards was $1.8 million and $0.8 million, respectively, which will berecognized over the weighted average period of 3 years.

**Item 7A. Quantitative andQualitative Disclosures About Market Risk:****  **We are exposed to certain financialmarket risks, the most predominant being fluctuations in interest rates forborrowings under our credit facility. Interest rate fluctuations are monitoredby our management as an integral part of our overall risk managementprogram, which recognizes the unpredictability of financial markets and seeksto reduce the potentially adverse effect on our results of operations. Aspart of this strategy, we may use interest rate swap arrangements tomanage or hedge our interest rate risk. We do not use derivative financialinstruments for speculative or trading purposes.

As of December 30, 2006, we had $70.2 millionoutstanding under our Credit Agreement. A 1% change in interest rates wouldhave resulted in our interest expense fluctuating by approximately $0.7 millionfor the twelve months ended December 30, 2006.

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 30,2006, 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 current rateranging from 7.35% to 7.46%. At stated monthly intervals the difference betweenthe interest on the floating LIBOR-based debt and the interest calculated inthe swap 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.

47

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**Item8.   Financial Statements andSupplementary Data:****  **Theconsolidated financial statements of SI International, Inc. are submittedon pages F-1 through F-27 of this report.

**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 30, 2006 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.**  *Included as Exhibits 31.1 and 31.2 to this AnnualReport on Form 10-K are forms of “Certification” of our ChiefExecutive Officer and Chief Financial Officer. The forms of Certification arerequired in accordance with Section 302 of the Sarbanes-Oxley Act of 2002.This section of the Annual Report on Form 10-K that you arecurrently reading is the information concerning the assessment referred to inthe Section 302 certifications and this information should be read inconjunction with the Section 302 certifications for a more completeunderstanding of the topics presented.

*DisclosureControls and Procedures and Internal Control over Financial Reporting.**  *Management is responsible forestablishing and maintaining adequate disclosure controls and procedures andinternal control over financial reporting. Our disclosure controls andprocedures are designed to provide reasonable assurance that information requiredto be disclosed in our reports filed or submitted under the Exchange Act, suchas this Annual Report on Form 10-K, is recorded, processed,summarized and reported within the time periods specified in the SEC’s rules andforms. Our disclosure controls and procedures are also designed to providereasonable assurance that such information is accumulated and communicated toour management, including our Chief Executive Officer and Chief FinancialOfficer, as appropriate to allow timely decisions regarding requireddisclosure.

Internal controlover financial reporting is a process designed by, or under the supervision ofour Chief Executive Officer and Chief Financial Officer, and effected by ourBoard of Directors, management and other personnel, to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with GAAP andincludes those policies and procedures that:

·       pertain to the maintenanceof records that in reasonable detail accurately and fairly reflect thetransactions and dispositions of our assets;

·       provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with GAAP, and that our receipts andexpenditures are being made only in accordance with authorizations ofmanagement or our Board of Directors; and

·       provide reasonableassurance regarding prevention or timely detection of unauthorized acquisition,use or disposition of our assets that could have a material adverse effect onour financial statements.

48

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*Limitationson the Effectiveness of Controls.**  *Management, including our ChiefExecutive Officer and Chief Financial Officer, do not expect that ourdisclosure controls and procedures or internal control over financial reportingwill prevent all errors and all fraud. A control system, no matter how wellconceived and operated, can provide only reasonable, not absolute, assurancethat the objectives of the control system are met. Further, the design of acontrol system must reflect the fact that there are resource constraints, andthe benefits of controls must be considered relative to their costs. Because ofthe inherent limitations in all control systems, no assessment of controls canprovide absolute assurance that all control issues and instances of fraud, ifany, within the Company have been detected. These inherent limitations includethe realities that judgments in decision-making can be faulty, and thatbreakdowns can occur because of simple error or mistake. Additionally, controlscan be circumvented by the individual acts of some persons, by collusion of twoor more people, or by management’s override of the control. The design of anysystem of controls also is based in part upon certain assumptions aboutthe likelihood of future events, and there can be no assurance that any designwill succeed in achieving its stated goals under all potential futureconditions; over time, controls may become inadequate because of changesin conditions, or the degree of compliance with the policies or proceduresmay deteriorate. Because of the inherent limitations in a cost-effectivecontrol system, misstatements due to error or fraud may occur and not bedetected.

*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 correctiveactions, 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 make modificationsas necessary. Management’s intent in this regard is that the disclosurecontrols and procedures and the internal control over financial reporting willbe maintained and updated (including improvements and corrections) asconditions warrant. Among other matters, management sought in its assessment todetermine whether there were any “material weaknesses” in the Company’sinternal control over financial reporting, or whether management had identifiedany acts of fraud involving senior management, management, or other personnelwho have a significant role in our internal control over financial reporting.This information was important for management to use in its assessmentgenerally, and also because Section 302 certifications require that ourChief Executive Officer and Chief Financial Officer disclose that informationto the Audit Committee of the Board of Directors and to our independentauditors and to report on related matters in this section of the AnnualReport on Form 10-K. In the Public Company Accounting OversightBoard’s Auditing Standard No. 2, a “material weakness” is defined as asignificant deficiency, or a combination of significant deficiencies, thatresults in more than a remote likelihood that a material misstatement of theannual or interim financial statements will not be prevented or detected. A “significantdeficiency” is defined as a “control deficiency,” or a combination of controldeficiencies, that adversely affects the ability to initiate, authorize,record, process or report external financial data reliably in accordance withGAAP such that there is more than a remote likelihood that a misstatement ofthe annual or interim financial statements that is more than inconsequentialwill not be prevented or detected. A “control deficiency” exists when thedesign or operation of a control does not allow management or employees, in thenormal course of performing their assigned functions, to prevent or detectmisstatements on a timely basis. Management also sought to deal with othercontrol matters in 

49

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the assessment, and ineach case if a problem was identified, management considered what revision,improvement and/or correction was necessary to be made in accordance with ouron-going procedures.

*Evaluationof Disclosure Controls and Procedures.**  *As of the end of the period coveredby this report, we carried out an evaluation, under the supervision and withthe participation of our management, including our Chief Executive Officer andChief Financial Officer, of the effectiveness of the design and operation ofour disclosure controls and procedures. Based upon the evaluation, our ChiefExecutive Officer and our Chief Financial Officer have concluded that as of December 30,2006 the Company’s disclosure controls and procedures were effective at the reasonableassurance level.

*Management’sReport on Internal Control over Financial Reporting.**  *Our management is responsible forestablishing and maintaining adequate internal control over financialreporting, as such term is defined in Exchange Act Rules 13a-15(f) and15d-15(f). Under the supervision and with the participation of ourmanagement, including Chief Executive Officer and Chief Financial Officer, weconducted an evaluation of the effectiveness of our internal control overfinancial reporting as of December 30, 2006 based upon the framework inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). Based on that evaluation, ourmanagement concluded that our internal control over financial reporting waseffective as of December 30, 2006.

Management’s assessment of the effectiveness of ourinternal control over financial reporting as of December 30, 2006 has beenaudited by Ernst & Young, LLP, an independent registered publicaccounting firm, as stated in their report that is included elsewhere herein.

*Changes in Internal ControlOver Financial Reporting.**  *There were no changes in our internal control overfinancial reporting for the fiscal year ended December 30, 2006 that havematerially affected, or are reasonably likely to materially affect, ourinternal control for financial reporting.

**Item 9B.**               OtherInformation:

None.

50

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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 2007 annual meeting of stockholders filed with the SEC pursuant toRegulation 14A promulgated under the Securities Exchange Act of 1934, asamended.

**PART IV**

**Item15.**                 Exhibits andFinancial Statement Schedules:

(a)           Documents filed aspart of this Report

1.                FinancialStatements

A.              Report ofIndependent Registered Public Accounting Firm

B.               Report ofIndependent Registered Public Accounting Firm on Internal Control overFinancial Reporting

C.               ConsolidatedBalance Sheets as of December 30, 2006 and December 31, 2005

D.              ConsolidatedStatements of Operations for the fiscal years ended December 30, 2006,December 31, 2005, and December 25, 2004

E.               ConsolidatedStatements of Stockholders’ Equity for the fiscal years ended December 30,2006, December 31, 2005 and December 25, 2004

F.                ConsolidatedStatements of Cash Flows for the fiscal years ended December 30, 2006,December 31, 2005 and December 25, 2004

G.             Notes to ConsolidatedFinancial Statements

2.                FinancialStatement Schedules

Schedule II—Valuationand Qualifying Accounts

3.                Exhibits

The exhibitsrequired by this item are set forth on the Index to Exhibits attached hereto.

(b)          Exhibits

See Item15(a)(3) above

(c)           Not Applicable

51

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized, on the 13th day of March, 2007.
|        | ** ** | **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 and                             |       | March 13, 2007       |
| **S. Bradford Antle**                    |           | Director (Principal  Executive Officer)                             |       |                 |
| /s/ Thomas E. Dunn                       |           | Executive Vice  President, Chief Financial                          |       | March 13,  2007 |
| **Thomas E. Dunn**                       |           | Officer and Treasurer  (Principal Financial and Accounting Officer) |       |                 |
| /s/ Ray J. Oleson                        |           | Executive  Chairman of the Board                                    |       | March 13,  2007 |
| **Ray J. Oleson**                        |           |                                                                |       |                 |
| /s/ Maureen A. Baginski                  |           | Director                                                            |       | March 13,  2007 |
| **Maureen A. Baginski**                  |           |                                                                |       |                 |
| /s/ Charles A. Bowsher                   |           | Director                                                            |       | March 13,  2007 |
| **Charles A. Bowsher**                   |           |                                                                |       |                 |
| /s/ James E. Crawford, III          |           | Director                                                            |       | March 13,  2007 |
| **James E. Crawford, III**          |           |                                                                |       |                 |
| /s/ Walter J. Culver                     |           | Director                                                            |       | March 13,  2007 |
| **Walter J. Culver**                     |           |                                                                |       |                 |
| /s/ General R. Thomas Marsh****          |           | Director                                                            |       | March 13,  2007 |
| **General R. Thomas Marsh (USAF-Ret.)**  |           |                                                                |       |                 |
| /s/ General Dennis J. Reimer             |           | Director                                                            |       | March 13,  2007 |
| **General Dennis J. Reimer  (USA-Ret.)** |           |                                                                |       |                 |
| /s/ Edward H. Sproat                     |           | Director                                                            |       | March 13,  2007 |
| **Edward H. Sproat**                     |           |                                                                |       |                 |
| /s/ John P. Stenbit                      |           | Director                                                            |       | March 13,  2007 |
| **John P.  Stenbit**                     |           |                                                                |       |                 |

 

52

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**INDEXTO EXHIBITS**
| EXHIBIT   NO.   | ** ** | **DESCRIPTION**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|-----------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   2.1 |       | Stock Purchase Agreement among the Company, Zen, and  the stockholders of Zen dated February 8, 2006. (filed as  Exhibit 99.1 to the Company’s Annual Report on Form 10-K/A  filed on May 12, 2006 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). |
|   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 4.1 to the Company’s  Registration Statement on Form S-8 filed on December 22, 2006  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).                                                                                                                                                                                                                      |

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| 10.7  |   | 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).                                    |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.8  |   | 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).                     |
| 10.90 |   | Executive Employment  Agreement with S. Bradford Antle (filed as Exhibit 10.6 to the Third  Amendment and incorporated herein by reference).                                                                                 |
| 10.10 |   | Executive Employment Agreement  with Thomas E. Dunn (filed as Exhibit 10.8 to the Third Amendment and  incorporated herein by reference).                                                                                    |
| 10.11 |   | Executive Employment  Agreement with Thomas E. Lloyd (filed as Exhibit 10.9 to the Third  Amendment and incorporated herein by reference).                                                                                   |
| 10.12 |   | Executive Employment  Agreement with Ray J. Oleson (filed as Exhibit 10.10 to the Third  Amendment and incorporated herein by reference).                                                                                    |
| 10.13 |   | Executive Employment  Agreement with Leslee H. Gault (filed as Exhibit 10.1 to the Company’s  Current Report on Form 8-K/A filed on October 2, 2006 and  incorporated herein by reference).                   |
| 10.14 |   | 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).                |
| 10.15 |   | 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).                       |
| 10.16 |   | 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).              |
| 10.17 |   | 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). |
| 10.18 |   | 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.

54

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**INDEXTO FINANCIAL STATEMENTS**

| **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 30, 2006 and December 31, 2005                                                                        |       | F-4        |       |
| Consolidated Statements of Operations for the fiscal  years ended December 30, 2006, December 31, 2005 and  December 25, 2004                |       | F-5        |       |
| Consolidated Statements of Stockholders’ Equity for  the fiscal years ended December 30, 2006, December 31, 2005 and  December 25, 2004 |       | F-6        |       |
| Consolidated Statements of Cash Flows for the fiscal  years ended December 30, 2006, December 31, 2005 and  December 25, 2004                |       | F-7        |       |
| Notes to Consolidated Financial Statements                                                                                                                  |       | F-8        |       |

 

F-1

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**Report ofIndependent Registered Public Accounting Firm**

The Board of Directors and Stockholders of SIInternational, Inc.

We have audited the accompanying consolidated balancesheets of SI International, Inc. and subsidiaries as of December 30,2006 and December 31, 2005, and the related consolidated statements ofoperations, stockholders’ equity, and cash flows for the fiscal years ended December 30,2006, December 31, 2005 and December 25, 2004. Our audits alsoincluded the financial statement schedule listed in the index at Item 15.These financial statements and schedule are the responsibility of theCompany’s management. Our responsibility is to express an opinion on thesefinancial statements 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 obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor 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 30,2006 and December 31, 2005, and the consolidated results of its operationsand its cash flows for the fiscal years ended December 30, 2006, December 31,2005 and December 25, 2004, 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 30, 2006, based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated March 6,2007 expressed an unqualified opinion thereon.
|                    |   | /s/ Ernst & Young LLP |
|--------------------|--------|---------------------------|
| McLean, Virginia   |   |                      |
| March 6, 2007 |   |                      |

 

F-2

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**Report ofIndependent Registered Public Accounting Firm**

TheBoard of Directors and Stockholders of SI International, Inc.

Wehave audited management’s assessment, included in the accompanying Management’sReport on Internal Control over Financial Reporting that SI International, Inc.and subsidiaries (as defined in Note 1) maintained effective internalcontrol over financial reporting as of December 30, 2006, based oncriteria established in Internal Control—Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission (the COSOcriteria). SI International’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the company’s internal control over financialreporting based on our audit.

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in all materialrespects. Our audit included obtaining an understanding of internal controlover financial reporting, evaluating management’s assessment, testing andevaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinion.

Acompany’s internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. A company’s internal controlover financial reporting includes those policies and procedures that (1) pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Becauseof its inherent limitations, internal control over financial reportingmay not prevent or detect misstatements. Also, projections of anyevaluation of effectiveness to future periods are subject to the risk thatcontrols may become inadequate because of changes in conditions, or thatthe degree of compliance with the policies or procedures may deteriorate.

Inour opinion, management’s assessment that SI International, Inc. andsubsidiaries maintained effective internal control over financial reporting asof December 30, 2006, is fairly stated, in all material respects, based onthe COSO criteria. Also, in our opinion, SI International, Inc.maintained, in all material respects, effective internal control over financialreporting as of December 30, 2006, based on the COSO criteria.

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated balance sheets of SI International, Inc.and subsidiaries as of December 30, 2006 and December 31, 2005, andthe related consolidated statements of operations, stockholders’ equity, andcash flows for the fiscal years ended December 30, 2006, December 31,2005, and December 25, 2004 and our report dated March 6, 2007expressed an unqualified opinion thereon.
|                     |   | /s/ Ernst & Young LLP |
|---------------------|--------|---------------------------|
| McLean, Virginia    |   |                      |
| March 6,  2007 |   |                      |

 

F-3

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**SI International, Inc.Consolidated Balance SheetsAs of December 30 2006 and December 31, 2005(Amounts in thousands, except share data)**

| ** **                                                                                                                                                                                                                | ** ** | **December 30,  2006** | ** ** | **December 31,   2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------------|------------|
| **Assets**                                                                                                                                                                                                                | ** ** |                        | ** ** | ** **                        |       |   | ** ** | ** ** |   |
| **Current assets:**                                                                                                                                                                                                       | ** ** |                        | ** ** | ** **                        |       |   | ** ** | ** ** |   |
| Cash and cash equivalents                                                                                                                                                                                                 |       |                        | $          | 19,457                            | ** ** |   |   | $ | 26,160 | ** ** |   |
| Marketable securities                                                                                                                                                                                                     |       |                        | —     | ** **                        |       |   | 7,850 | ** ** |   |
| Accounts receivable, net                                                                                                                                                                                                  |       |                        | 91,972     | ** **                        |       |   | 93,633 | ** ** |   |
| Deferred tax asset                                                                                                                                                                                                        |       |                        | 1,408      | ** **                        |       |   | 422 | ** ** |   |
| Other current assets                                                                                                                                                                                                      |       |                        | 7,219      | ** **                        |       |   | 6,276 | ** ** |   |
| Total current  assets                                                                                                                                                                                                     |       |                        | 120,056    | ** **                        |       |   | 134,341 | ** ** |   |
| **Property  and equipment, net**                                                                                                                                                                                          |       |                        | 12,372     | ** **                        |       |   | 5,908 | ** ** |   |
| **Intangible  assets, net**                                                                                                                                                                                               |       |                        | 20,418     | ** **                        |       |   | 16,483 | ** ** |   |
| **Other  assets**                                                                                                                                                                                                         |       |                        | 7,661      | ** **                        |       |   | 5,655 | ** ** |   |
| **Goodwill**                                                                                                                                                                                                              |       |                        | 220,626    | ** **                        |       |   | 173,308 | ** ** |   |
| Total assets                                                                                                                                                                                                              |       |                        | $          | 381,133                           | ** ** |   |   | $ | 335,695 | ** ** |   |
| **Liabilities  and stockholders’ equity**                                                                                                                                                                            | ** ** |                        | ** ** | ** **                        |       |   | ** ** | ** ** |   |
| **Current liabilities:**                                                                                                                                                                                                  | ** ** |                        | ** ** | ** **                        |       |   | ** ** | ** ** |   |
| Accounts payable                                                                                                                                                                                                          |       |                        | $          | 20,715                            | ** ** |   |   | $ | 25,364 | ** ** |   |
| Accrued expenses and other current liabilities                                                                                                                                                                            |       |                        | 28,547     | ** **                        |       |   | 29,674 | ** ** |   |
| Note payable—former owner of acquired business                                                                                                                                                                       |       |                        | 5,839      | ** **                        |       |   | 2,280 | ** ** |   |
| Current portion of long-term debt                                                                                                                                                                                         |       |                        | 754        | ** **                        |       |   | 1,000 | ** ** |   |
| Total current liabilities                                                                                                                                                                                                 |       |                        | 55,855     | ** **                        |       |   | 58,318 | ** ** |   |
| **Long-term  debt, net of current portion**                                                                                                                                                                               |       |                        | 69,452     | ** **                        |       |   | 98,250 | ** ** |   |
| **Deferred  income tax**                                                                                                                                                                                                  |       |                        | 8,961      | ** **                        |       |   | 5,221 | ** ** |   |
| **Other  long-term liabilities**                                                                                                                                                                                          |       |                        | 7,653      | ** **                        |       |   | 6,037 | ** ** |   |
| **Stockholders’  equity:**                                                                                                                                                                                           | ** ** |                        | ** ** | ** **                        |       |   | ** ** | ** ** |   |
| **Common stock**—$0.01  par value per share; 50,000,000 shares authorized; 12,967,377 and 11,341,222  shares issued and outstanding as of December 30, 2006 and  December 31, 2005, respectively |       |                        | 130        | ** **                        |       |   | 114 | ** ** |   |
| Additional paid-in capital                                                                                                                                                                                                |       |                        | 184,845    | ** **                        |       |   | 133,843 | ** ** |   |
| Accumulated other comprehensive income                                                                                                                                                                                    |       |                        | 172        | ** **                        |       |   | — | ** ** |   |
| Retained earnings                                                                                                                                                                                                         |       |                        | 54,065     | ** **                        |       |   | 33,912 | ** ** |   |
| Total  stockholders’ equity                                                                                                                                                                                          |       |                        | 239,212    | ** **                        |       |   | 167,869 | ** ** |   |
| Total liabilities and  stockholders’ equity                                                                                                                                                                          |       |                        | $          | 381,133                           | ** ** |   |   | $ | 335,695 | ** ** |   |

 

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

F-4

----

**SI International, Inc.Consolidated Statements of OperationsFor the fiscal years ended December 30, 2006, December 31, 2005 and December 25,2004(Amounts in thousands, except per share data)**

| ** **                                       | ** ** | **Fiscal Year** | ** ** |
|--------------------------------------------------|------------|----------------------|------------|
| ** **                                       | ** ** | **2006**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Revenue**                                      |       | $                    | 461,970    |   | $ | 397,919 |   | $ | 262,306 |   |
| **Costs  and expenses:**                         | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cost of services                                 |       | 290,675              |       | 246,481 |   | 166,774 |   |
| Selling, general and administrative              |       | 124,847              |       | 113,015 |   | 71,917 |   |
| Depreciation and amortization                    |       | 2,692                |       | 2,161 |   | 2,231 |   |
| Amortization of intangible assets                |       | 3,116                |       | 2,292 |   | 648 |   |
| Total operating  expenses                        |       | 421,330              |       | 363,949 |   | 241,570 |   |
| **Income  from operations**                      |       | 40,640               |       | 33,970 |   | 20,736 |   |
| **Other  income (expense)**                      |       | 88                   |       | 12 |   | (1 | ) |
| **Interest  expense**                            |       | (7,731               | )          | (6,103 | ) | (2,760 | ) |
| **Income  before provision for income taxes**    |       | 32,997               |       | 27,879 |   | 17,975 |   |
| **Provision  for income taxes**                  |       | 12,844               |       | 10,942 |   | 7,098 |   |
| **Net  income**                                  |       | $                    | 20,153     |   | $ | 16,937 |   | $ | 10,877 |   |
| **Earnings  per common share:**                  | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                            |       | $                    | 1.61       |   | $ | 1.51 |   | $ | 1.20 |   |
| Diluted                                          |       | $                    | 1.56       |   | $ | 1.45 |   | $ | 1.14 |   |
| **Basic weighted-average shares outstanding**    |       | 12,507               |       | 11,185 |   | 9,041 |   |
| **Diluted  weighted-average shares outstanding** |       | 12,896               |       | 11,690 |   | 9,507 |   |

 

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

F-5

----

**SI International, Inc.Consolidated Statements of Stockholders’ EquityFor the fiscal years ended December 30, 2006, December 31, 2005, and December 25,2004(Amounts in thousands, except share data)**

| ** **                                                 | ** ** | **Stockholders’ equity** | ** ** |
|------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                 | ** ** | **Common stock**              | ** ** | **Additional  paid-in  Capital** | ** ** | **Deferred  Compensation** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Total** | ** ** |
| **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 |   |
| Exercise of stock options and vesting of restricted  stock |       | 426,155                            |       | 4 |   |   | 7,360 |   |   |   | — |   |   |   | — |   |   |   | — |   |   | 7,364 |   |
| Offering proceeds, net of offering costs                   |       | 1,200,000                          |       | 12 |   |   | 40,243 |   |   |   | — |   |   |   | — |   |   |   | — |   |   | 40,255 |   |
| Stock-based compensation                                   |       | —                             |       | — |   |   | 346 |   |   |   | — |   |   |   | — |   |   |   | — |   |   | 346 |   |
| Option exercise tax effect                                 |       | —                             |       | — |   |   | 2,117 |   |   |   | — |   |   |   | — |   |   |   | — |   |   | 2,117 |   |
| Unrealized gain on interest rate swap                      |       | —                             |       | — |   |   | — |   |   |   | — |   |   |   | — |   |   |   | 172 |   |   | 172 |   |
| Tax reserve adjustment                                     |       | —                             |       | — |   |   | 936 |   |   |   | — |   |   |   | — |   |   |   | — |   |   | 936 |   |
| Net income                                                 |       | —                             |       | — |   |   | — |   |   |   | — |   |   |   | 20,153 |   |   |   | — |   |   | 20,153 |   |
| **Balance,  December 30, 2006**                       |       | 12,967,377                         |       | $ | 130 |   |   | $ | 184,845 |   |   |   | $ | — |   |   |   | $ | 54,065 |   |   |   | $ | 172 |   |   | $ | 239,212 |   |

 

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

F-6

----

**SI International, Inc.Consolidated Statements of Cash FlowsFor the fiscal years ended December 30, 2006, December 31, 2005 and December 25,2004(Amounts in thousands)**

| ** **                                                                                   | ** ** | **Fiscal Year** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                   | ** ** | **2006**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Cash flows from operating activities:**                                                    | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                                   |       | $                    | 20,153     |   | $ | 16,937 |   | $ | 10,877 |   |
| Adjustments to reconcile net income to net cash  provided by (used in) operating activities: |       |                 |       |   |   |   |   |
| Depreciation and  amortization                                                               |       | 2,692                |       | 2,161 |   | 2,231 |   |
| Amortization of  intangible assets                                                           |       | 3,116                |       | 2,292 |   | 648 |   |
| Loss on disposal of  fixed assets                                                            |       | 25                   |       | 56 |   | 14 |   |
| Income tax benefit for  stock option exercises                                               |       | —               |       | 1,561 |   | 348 |   |
| Stock-based compensation                                                                     |       | 346                  |       | 611 |   | 132 |   |
| Deferred income tax  provision                                                               |       | 2,645                |       | 2,493 |   | 1,686 |   |
| Amortization of deferred  financing costs and debt discount                                  |       | 2,143                |       | 705 |   | 1,000 |   |
| Changes in operating assets and liabilities, net of  effect of acquisitions:                 |       |                 |       |   |   |   |   |
| Accounts receivable, net                                                                     |       | 12,361               |       | (14,629 | ) | (16,096 | ) |
| Other current assets                                                                         |       | (534                 | )          | (2,684 | ) | 116 |   |
| Other assets                                                                                 |       | (3,260               | )          | (1,000 | ) | (668 | ) |
| Accounts payable and  accrued expenses                                                       |       | (10,944              | )          | 15,421 |   | 143 |   |
| Deferred revenue                                                                             |       | 2,383                |       | (275 | ) | (3,686 | ) |
| Other long term  liabilities                                                                 |       | 1,130                |       | 2,950 |   | 1,600 |   |
| Net cash provided by  (used in) operating activities                                         |       | 32,256               |       | 26,599 |   | (1,655 | ) |
| **Cash flows from investing activities:**                                                    | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchase of property and  equipment                                                          |       | (8,507               | )          | (2,727 | ) | (1,225 | ) |
| Proceeds from sale of  marketable securities                                                 |       | 49,850               |       | 36,200 |   | 11,000 |   |
| Purchase of marketable  securities                                                           |       | (42,000              | )          | (42,050 | ) | (2,050 | ) |
| Former owner payable                                                                         |       | (10,322              | )          | 8,041 |   | — |   |
| Cash paid for business  acquisitions, net of cash assumed                                    |       | (48,002              | )          | (74,285 | ) | (94,390 | ) |
| Net cash used in  investing activities                                                       |       | (58,981              | )          | (74,821 | ) | (86,665 | ) |
| **Cash flows from financing activities:**                                                    | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from issuance  of common stock, net of offering costs                               |       | 40,255               |       | (48 | ) | 51,239 |   |
| Proceeds from exercise  of stock options                                                     |       | 7,364                |       | 3,738 |   | 927 |   |
| Income tax benefit for  stock option exercises                                               |       | 2,117                |       | — |   | — |   |
| Net (repayments)  borrowings under line of credit                                            |       | —               |       | (28,954 | ) | 28,954 |   |
| Payments of debt  issuance fees                                                              |       | (552                 | )          | (3,238 | ) | (1,202 | ) |
| Proceeds from long-term  debt                                                                |       | 30,000               |       | 100,000 |   | 30,000 |   |
| Repayments of long-term  debt                                                                |       | (59,044              | )          | (750 | ) | (30,000 | ) |
| Repayments of capital  lease obligations                                                     |       | (118                 | )          | (120 | ) | (146 | ) |
| Net cash provided by  financing activities                                                   |       | 20,022               |       | 70,628 |   | 79,772 |   |
| **Net  change in cash and cash equivalents**                                                 |       | (6,703               | )          | 22,406 |   | (8,548 | ) |
| **Cash and cash equivalents,  beginning of period**                                          |       | 26,160               |       | 3,754 |   | 12,302 |   |
| **Cash and cash equivalents, end  of period**                                                |       | $                    | 19,457     |   | $ | 26,160 |   | $ | 3,754 |   |
| **Supplemental  disclosures of cash flow information:**                                      | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash payments for  interest                                                                  |       | $                    | 6,872      |   | $ | 5,059 |   | $ | 1,857 |   |
| Cash payments for income  taxes                                                              |       | $                    | 8,032      |   | $ | 3,593 |   | $ | 6,181 |   |
| **Supplemental  disclosure of noncash activities:**                                          | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Equipment acquired under capital leases                                                      |       | $                    | 198        |   | $ | 126 |   | $ | 289 |   |

 

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

F-7

----

**SI International, Inc.Notes to Consolidated Financial Statements**

**1. Business:**

SIInternational, Inc. (referred to in these Notes as either the “Company” or“SI International”), was incorporated on October 14, 1998, under the lawsof the state of Delaware. The Company is a provider of information technologyand network solutions with the Federal Government as a major client. TheCompany offers a broad spectrum of solutions and services, including design,development, implementation and operations to assist clients in achieving theirmissions. The Company combines technological and industry experience to providesolutions through service offerings in the areas of program management andacquisition support, integrated solutions development, information security,records management, learning solutions, systems engineering, network solutionsand mission-critical outsourcing.

On January 1,2001, the Company separated its telecommunications operations, which itobtained pursuant to an acquisition in fiscal year 2000, by contributing thenet assets of the telecommunications operations to a sister company, SITelecom. In October 2002, SI Telecom was merged back into SI International,such that SI Telecom became a wholly-owned subsidiary of SI International. On December 15,2006, SI International merged two of its wholly-owned subsidiaries, SIInternational Engineering Inc., a Colorado corporation (“Engineering”) and SIInternational Telecom Corporation, a Delaware corporation (“SI Telecom”),into SI International as part of an internal consolidation of legal entities.The mergers were completed according to an Agreement and Plan of Mergerunder which Engineering and SI Telecom were merged into SI International,which continues as the surviving corporation.

Since November 12, 2002, our common stock hasbeen publicly traded on the NASDAQ National Market under the symbol “SINT”. Thecompletion of the initial public offering in November of 2002 raised$47.1 million (after offering costs) in equity capital through the sale of3,850,000 shares of common stock. On October 6, 2004, the Companycompleted its secondary offering which raised $51.2 million (after offeringcosts) cash through the sale of 2,520,000 shares of common stock. On April 7, 2006, we raised $40.3million (after offering costs) through the sale of 1,200,000 shares of commonstock.

**2. Summary of significantaccounting policies:**

**Principles ofconsolidation**

The accompanying consolidated financial statementsinclude the accounts of the Company and its’ wholly and majority-ownedsubsidiaries. All significant intercompany transactions and accounts have beeneliminated in consolidation.

**Use of estimates**

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ fromthose estimates.

**Reporting periods**

The Company’s fiscal year ends on the Saturday closestto, but not falling after, December 31 of that year.**All fiscal years presented, excluding 2005, include52 weeks**. **Fiscal year 2005includes 53 weeks.**The Company’s quarters end on the Saturdaynearest to the applicable quarterly month-end.

F-8

----

**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 years 2005 and 2006, the Companyinvested in auction rate securities which are associated with municipal bondofferings. At the end of fiscal year 2005, marketable securities consistedprimarily of auction rate securities with final maturity dates ranging from2024 to 2035. At the end of fiscal 2006, all of the auction rate securitiesinvested in during the fiscal period were sold.

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 2006, 2005 and 2004.

**Revenue recognition**

*The Company recognizes revenue whena contract 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.*

*Under cost reimbursable contracts,the Company is reimbursed for allowable costs, and paid a fee, which may befixed or performance-based. Revenues on cost reimbursable contracts arerecognized as costs are incurred plus an estimate of applicable fees earned.The Company considers fixed fees under cost reimbursable contracts to be earnedin proportion of the allowable costs incurred in performance of the contract.For cost reimbursable contracts that include performance based fee incentives,the Company recognizes the relevant portion of the expected fee to be awardedby the customer at the time such fee can be reasonably estimated, based on factorssuch as the Company’s prior award experience and communications with thecustomer regarding performance.*

Revenue on time and materials contracts are recognizedbased on direct labor hours expended at contract billing rates and adding otherbillable direct costs. For fixed price contracts that are based on unit pricingor level of effort, the Company recognizes revenue for the number of unitsdelivered in any given fiscal period. For fixed price contracts in which the Company is paid a specific amountto provide a particular service for a stated period of time, revenue isrecognized ratably over the service period.

For fixed price contracts that provide for thedelivery of a specific product with related customer acceptance provisions,revenues are recognized upon product delivery and customer acceptance.  However, a significant portion of theCompany’s fixed price-completion contracts involve the design and developmentof complex, client systems.  For thosecontracts that are within scope of SOP 81-1, Accounting for Performance ofConstruction-Type and Certain Production-Type Contracts, revenue is recognizedon the percentage-of-completion method using costs incurred in relation tototal estimated costs. 

The Company’s contracts with agencies of the governmentare subject to periodic funding by the respective contracting agency. Fundingfor a contract 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, the Company considers its previous experiences with its customers,communications with its customers regarding funding status, and the Company’sknowledge of available funding for the contract or program. If funding is notassessed as probable, revenue recognition is deferred until realization isdeemed probable.

F-9

----

Contract revenue recognition inherently involvesestimation, including the contemplated level of effort to accomplish the tasksunder the contract, the cost of the effort, and an ongoing assessment ofprogress toward completing the contract. From time to time, as part of thenormal management processes, facts develop that require revisions to estimatedtotal costs or revenues expected. The cumulative impact of any revisions toestimates and 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 subsequently disallowed,if any, would not be significant.

**Significantcustomers**

Revenuegenerated from contracts with the Federal Government, both directly and throughother prime contractors, accounted for a significant percentage of revenues in thefiscal years 2006, 2005 and 2004.

| ** **                 | ** ** | **% of revenues   Fiscal year** | ** ** |
|----------------------------|------------|-----------------------------------------------------|------------|
| ** **                 | ** ** | **2006**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Department of  Defense     |       | 46.6                                                | %          | 46.9 | % | 52.8 | % |
| Federal civilian  agencies |       | 51.9                                                |       | 51.2 |   | 43.8 |   |
| Commercial  entities       |       | 1.5                                                 |       | 1.9 |   | 3.4 |   |
| Total revenue              |       | 100.0                                               | %          | 100.0 | % | 100.0 | % |

 

We had only one contractthat generated more than 10% of our revenue for fiscal years 2006, 2005 and2004. For the fiscal year 2006, fiscal year 2005 and fiscal year 2004, revenuefrom our C4I2SR contract with the U.S. Air Force Space Command representedapproximately 21%, 21%, and 17%, respectively, of total revenue.

**Concentrations ofCredit 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 and unbilledamounts, including indirect cost rate variances, due from various agencies ofthe Federal Government or prime contractors doing business with the FederalGovernment, and other commercial customers. The Company historically has notexperienced significant losses related to accounts receivable and therefore,believes that credit risk related to accounts receivable is minimal. TheCompany maintains cash balances that may at times exceed federally insuredlimits. The Company maintains this cash at high-credit quality institutionsand, as a result, believes credit risk related to its cash is minimal.

**Accounts receivableand allowance for doubtful accounts**

Accounts receivable arerecorded at their face amount less an allowance for doubtful accounts. The Companymaintains an allowance for doubtful accounts at an amount that it estimates tobe sufficient to cover the risk of collecting less than full payment onreceivables. On a monthly basis the Company reevaluates its receivables,especially receivables that are past due, and reassesses the allowance fordoubtful accounts based on specific client collection issues.

F-10

----

**Property andequipment**

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, asfollows:

| 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 financingcosts**

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 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Deferred loan  costs     |       |                        | $          | 5,527                       |       |   |   | $ | 4,975 |   |   |
| Accumulated amortization |       |                        | (3,363     | )                           |       |   | (1,542 | ) |   |
|                     |       |                        | $          | 2,164                       |       |   |   | $ | 3,433 |   |   |

 

During 2006 and 2004, theCompany wrote off approximately $1,131,000 and $584,000, respectively, ofdeferred loan costs related to the prepayments of its term loan. Amortizationof deferred financing costs was $690,000, $705,000 and $416,000 in fiscal years2006, 2005 and 2004, respectively.

**Impairment oflong-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 during the fiscal years ended December 30,2006 and December 31, 2005. In the event that there are changes in theplanned use of the Company’s long-term assets or its expected futureundiscounted cash flows are reduced significantly, the Company’s assessment ofits ability to recover the carrying value of these assets could change.

**Goodwill**

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 IntangibleAssets.” SFAS No. 142 requires the use of a non-amortization approach toaccount for purchased goodwill and certain intangibles. Under the non-amortizationapproach, goodwill and certain intangibles are not amortized into results ofoperations, but instead are reviewed for impairment at least annually andwritten down and charged to operations only in the periods in which therecorded value of goodwill and certain intangibles is more than its fair value.In the years ended December 30, 2006 and 

F-11

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December 31, 2005,the Company completed its annual impairment test of goodwill. The analysisindicated that no impairment of goodwill exists; however, future impairmentreviews may result in the recognition of such impairment.

The total amount ofgoodwill as of December 30, 2006 is $220.6 million, of which $174.4million is expected to be deductible for income tax purposes.

**Intangible assets**

Intangibleassets consist of the following (in thousands):

| ** **                          | ** ** | **December 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Contractual  customer relationships |       |                        | $          | 26,336                      |       |   |   | $ | 19,436 |   |   |
| Non-compete  agreements             |       |                        | 150        |                        |       |   | — |   |   |
| Total intangible  assets            |       |                        | 26,486     |                        |       |   | 19,436 |   |   |
| Less: accumulated  amortization     |       |                        | (6,068     | )                           |       |   | (2,953 | ) |   |
| Intangible assets, net              |       |                        | $          | 20,418                      |       |   |   | $ | 16,483 |   |   |

 

Intangible assets fromacquisitions, which consist primarily of contractual customer relationships,are amortized utilizing an accelerated method over 6 to 14 years, based ontheir estimated useful lives. The weighted-average amortization period of totalintangible assets as of December 30, 2006, is 6.1 years. Amortizationexpense is estimated to be $2.9 million, $2.5 million, $2.2 million, $2.2million and $1.8 million for the years 2007, 2008, 2009, 2010 and 2011,respectively.

**Fair value offinancial 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 30, 2006and December 31, 2005.

**Stock-basedcompensation**

Effective January 1, 2006, the Company adoptedthe provisions of SFAS No. 123R, “ShareBased Payment” using the modified prospective transition method. Due tothe use of the modified prospective method, prior interim periods and fiscalyears will not reflect any restated amounts. The Company accelerated thevesting of all unvested stock options previously awarded to employees, officersand directors in December 2005; thus, the Company had no unvested stockoptions on January 1, 2006. The Company issued 171,025 shares of stockoptions in fiscal year 2006. The total stock compensation expense recognizedduring the fiscal year ended December 30, 2006 was $0.2 million. The totalremaining unrecognized compensation expense related to the unvested options asof December 30, 2006 was $1.8 million, which will be recognized over the weightedaverage period of three years.

The company also issued 32,825 shares of restrictedstock awards to directors and employees under its 2002 Amended and RestatedOmnibus Stock Incentive Plan during fiscal year 2006. The fair value of therestricted stock awards is determined based on the grant date stock price. Thecompensation expense for restricted stock awards is recognized on astraight-line basis over the vesting term which is typically five yearsbeginning on the date of grant. The total compensation expense recognizedduring the fiscal year ended December 30, 2006 was $0.1 million. The totalremaining unrecognized compensation expense related to the unvested restrictedstock awards as of December 30, 2006 was $0.8 million, which will berecognized over the weighted average period of three years.

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Priorto the adoption of SFAS No. 123R, the Company accounted for stock-basedcompensation using the intrinsic value method prescribed in APB Opinion No. 25and related interpretations. Accordingly, compensation expense for stockoptions was measured as the excess, if any, of the fair market value of theCompany’s stock at the date of the grant over the exercise price of the relatedoption. The following table illustrates the effect on net income and earningsper share if the compensation costs for the Company’s stock options had beendetermined based on SFAS No. 123.

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

 

Thefair value of each option is estimated on the date of grant using theBlack-Scholes option-pricing model with the following assumptions used forgrants during the fiscal years ended December 30, 2006, December 31,2005 and December 25, 2004:

| ** **                       | ** ** | **Fiscal Year** | ** ** |
|----------------------------------|------------|----------------------|------------|
| ** **                       | ** ** | **2006**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Risk-free  interest rate         |       | 4.53-5.07            | %          | 3.99-4.39 | % | 4.00 | % |
| Expected life of  options        |       | 5 years              |       | 5-7 years |   | 7 years |   |
| Expected stock  price volatility |       | 38%-44               | %          | 45%-50 | % | 55%-60 | % |
| Expected dividend yield          |       | 0                    | %          | 0 | % | 0 | % |

 

The risk-free interest rate is based on U.S. Treasuryyields in effect at the time of grant over the expected term of the option. Theexpected life of options is derived from the Company’s historical optionexercise data. The expected stock price volatility is based on the historicalvolatility of the Company’s common stock.

Prior to the adoption ofSFAS No. 123R, the Company presented all tax benefits related to theexercise of stock options as operating cash flows in the consolidated statementof cash flows. SFAS No. 123R requires the cash flows resulting from thetax benefits generated from tax deductions in excess of the compensation costsrecognized for those options to be classified as financing cash flows.

**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.

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**Earnings 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.

Thefollowing details the computation of net income per common share:

| ** **                                                    | ** ** | **Fiscal Year** | ** ** |
|---------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                    | ** ** | **2006**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income                                                    |       | $                    | 20,153     |   | $ | 16,937 |   | $ | 10,877 |   |
| **Weighted average share  calculation:**                      | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic weighted  average shares outstanding                    |       | 12,507               |       | 11,185 |   | 9,041 |   |
| Treasury stock  effect of stock options and restricted stocks |       | 389                  |       | 505 |   | 466 |   |
| Diluted weighted average  shares outstanding                  |       | 12,896               |       | 11,690 |   | 9,507 |   |
|                                                               |            |                      |            |  |  |  |  |  |  |  |

 

**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 accountingpronouncements**

SFAS No. 123R addresses the accounting forshare-based payment transactions in which an enterprise receives employeeservices in exchange for (a) equity instruments of the enterprise or (b) liabilitiesthat are based on the fair value of the enterprise’s equity instruments or thatmay be settled by the issuance of such equity instruments. SFAS No. 123R requiresan entity to recognize the grant-date fair-value of stock options and otherequity-based compensation issued to employees in the income statement. Therevised Statement generally requires that an entity account for thosetransactions using the fair-value-based method, and eliminates the intrinsicvalue method of accounting in APB Opinion No. 25, “Accounting for Stock Issued to Employees,” which was permittedunder Statement 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.

Effective January 1, 2006, the Company adoptedthe provisions of SFAS No. 123R using the modified prospective transitionmethod. Due to the use of the modified prospective method, prior interimperiods and fiscal years will not reflect any restated amounts. As disclosed inthe stock incentive plan section of Note 10, the Company accelerated thevesting of unvested stock options previously awarded to employees, officers anddirectors in December 2005. The Company had no unvested stock options on January 1,2006. The Company issued 171,025 shares of stock options and 32,825 shares ofrestricted stock awards during the fiscal year ended December 30, 2006.The total stock compensation expense recognized for the fiscal 

F-14

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period was $0.3 million.Had we adopted SFAS No. 123R in prior periods, the impact of that standardwould have approximated the impact of SFAS No. 123 as described in thedisclosure of pro forma net income and pro forma earnings per share in theStock-Based Compensation section of this note to our consolidated financialstatements. Statement 123R also requires the benefits of tax deductions inexcess of recognized compensation cost to be reported as a financing cash flow,rather than as an operating cash flow as required under APB No. 25. Theadoption of this requirement reduced net operating cash flows and increased netfinancing cash flows in periods after adoption.

In July 2006, the Financial Accounting StandardsBoard (FASB) issued Interpretation No. 48 (FIN 48), “Accounting forUncertainty in Income Taxes, an interpretation of FASB Statement No. 109,Accounting for Income Taxes”. FIN 48 provides guidance on recognition,derecognition, measurement, classification, interest and penalties, accountingin interim periods, disclosure and transition. FIN 48 requires an entity torecognize the financial statement impact of a tax provision when it is morelikely than not that the position will be sustained upon examination. Theamount recognized is measured as the largest amount of benefit that is greaterthan fifty percent likely of being realized upon ultimate settlement. Inaddition, FIN 48 permits an entity to recognize interest and penalties relatedto tax uncertainties either as income tax expense or operating expenses. FIN 48is effective for fiscal years beginning after December 15, 2006.

The Company adopted the provisions of FIN 48 on January 1,2007. The adoption of this statement will not have material effect on itsfinancial condition, results of operations or cash flow. The company hadrecognized interest and penalties related to tax uncertainties as income taxexpense and will continue this treatment upon adoption of FIN 48. During thefiscal years ended 2006, 2005 and 2004, the Company recognized immaterialincome tax expenses related to interest and penalties for tax uncertainties.

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements”. SFAS No. 157 defines fair value, establishes aframework for measuring fair value and expands disclosures about fair valuemeasurements. SFAS No. 157 is effective for fiscal years beginning after December 15,2007. The adoption of SFAS No. 157 is effective January 1, 2008 for theCompany. The Company believes that the adoption of this statement will not havea material effect on its financial condition, results of operations or cashflows.

In September 2006,the SEC issued Staff Accounting Bulletin No. 108 (SAB 108), “FinancialStatements—Considering the Effects of Prior Year Misstatements When QuantifyingMisstatements in Current Year Financial Statements”. SAB 108 requires the useof the “rollover” and “iron curtain” approaches when attempting to quantifypossible misstatements in the financial statements. If under either approach amisstatement is determined to have a material effect on the financialstatements, the financial statements must be adjusted. The Company adopted SAB108 for the fiscal year ended December 30, 2006. The adoption of thisstatement did not have a material effect on its financial condition, results ofoperations or cash flow.

**3. Acquisitions:**

On February 27, 2006, we completed the purchaseof Zen and entered into the first amendment to our amended and restated creditfacility with our lenders as more fully set forth in Note 8, Debt. Zen isa provider of critical IT services, specializing in managed network services,information assurance, software development and systems engineering, databaseand systems administration and IT consulting to various U.S. Governmentagencies. Pursuant to the terms of the Zen Agreement we acquired all of theoutstanding capital stock of Zen for $60 million in cash, of which we arewithholding $6 million for 15 months in order to secure post-closing indemnityobligations of the sellers.

Approximately $47.8 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. 

F-15

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Approximately $6.9 millionand $0.2 million of the purchase price have been assigned to the identifiableintangible assets of contractual customer relationships and non-competitionagreements, respectively. Each customer relationship, which includes each customer’scontract, is being amortized on an accelerated basis over their remaininguseful life of 9 years. The non-compete agreements are being amortized on astraight-line basis over a 3-year period.

Thetotal purchase price paid, including transaction costs of $0.9 million, hasbeen preliminarily allocated as follows (in thousands):

| Cash                                          |   | $       | 2,542  |   |
|-----------------------------------------------|--------|---------|--------|--------|
| Accounts  receivable                          |   | 10,701  |   |
| Prepaid expense  and other current assets     |   | 129     |   |
| Property and  equipment                       |   | 491     |   |
| Accounts  payable & accrued expenses |   | (12,240 | )      |
| Other long term  liabilities                  |   | (41     | )      |
| Intangible assets                             |   | 7,050   |   |
| Goodwill                                      |   | 47,806  |   |
| Total consideration                           |   | $       | 56,438 |   |

 

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 its kind.Under the terms of the definitive stock purchase agreement, we acquired SEI for$75 million in cash, subject to certain adjustments totaling approximately $0.6million. Approximately $52.6 million of the purchase consideration has beenallocated to goodwill based primarily on the excess of the purchase price overthe estimated fair value of net assets acquired, and approximately $12.2million of the purchase price has been assigned to identifiable intangibleassets of contractual customer relationships. The contractual customerrelationships are being amortized on an accelerated basis over their estimatedremaining life of 14 years.

On December 20, 2004, the Company completed thepurchase of Bridge Corporation, a provider of information technology andinformation management. Under the terms of the acquisition agreement, theCompany acquired Bridge for $30 million, subject to working capital and otheradjustments totaling approximately $1.7 million. Of the purchase price, $29.4 millionwas paid in cash and $2.3 million was paid in June 2006. Approximately$26.2 million of the purchase consideration has been allocated to goodwill, andapproximately $2.2 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 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$54.4 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.

F-16

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The following unauditedproforma combined condensed statements of operations (in thousands, except pershare) set forth the consolidated results of operations of the Company for thetwelve months ended December 30, 2006 and December 31, 2005 as if theacquisitions of Zen and SEI had occurred at the beginning of each periodpresented. This unaudited proforma information does not purport to beindicative of the actual results that would actually have occurred if thecombination had been in effect for the twelve months ended December 30,2006 and December 31, 2005.

| ** **                  | ** ** | **Twelve Months Ended** | ** ** |
|-----------------------------|------------|-----------------------------------|------------|
| ** **                  | ** ** | **December 30,  2006**       | ** ** | **December 31,  2005** | ** ** |
| Revenue                     |       |                              | $          | 469,512 |   |   |   | $ | 444,935 |   |   |
| Net income                  |       |                              | $          | 20,209 |   |   |   | $ | 17,846 |   |   |
| Diluted earnings per  share |       |                              | $          | 1.57 |   |   |   | $ | 1.53 |   |   |

 

In accordance with thepurchase accounting, the operations of the MATCOM, Bridge, SEI and Zen havebeen included in the Company’s statements of operations since the respectivedates of acquisition.

**SCOT Settlement**

On December 7,2005, the Company settled a prior dispute with a Federal customer, resulting inthe Company receiving payment of $10.8 million on December 27, 2005.  Components of this payment are as follows (inthousands):

| 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. Accountsreceivable:**

Accountsreceivable consists of the following (in thousands):

| ** **                                                                                                           | ** ** | **December 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Billed accounts  receivable                                                                                          |       |                        | $          | 46,540                      |       |   |   | $ | 47,939 |   |   |
| Unbilled accounts  receivable:                                                                                       |       |                        |       |                        |       |   |   |   |   |
| Currently billable                                                                                                   |       |                        | 41,192     |                        |       |   | 40,094 |   |   |
| Unbilled retainages and milestones payments expected  to be billed within the next 12 months                         |       |                        | 5,609      |                        |       |   | 5,546 |   |   |
| Indirect costs incurred and charged to cost-plus  contracts in excess of provisional billing rates (see Note 9) |       |                        | 136        |                        |       |   | 1,563 |   |   |
| Total unbilled  accounts receivable                                                                                  |       |                        | 46,937     |                        |       |   | 47,203 |   |   |
| Allowance for  doubtful accounts                                                                                     |       |                        | (1,505     | )                           |       |   | (1,509 | ) |   |
| Accounts receivable, net                                                                                             |       |                        | $          | 91,972                      |       |   |   | $ | 93,633 |   |   |

 

The currently billableamounts included as unbilled accounts receivable as of December 30, 2006and December 31, 2005 represent amounts which are billed during the firstquarter of the subsequent year. They are billings for services rendered priorto year-end, which are billed once necessary billing data has been collectedand an invoice produced.

F-17

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**5. Property andequipment:**

Propertyand equipment consist of the following (in thousands):

| ** **                                           | ** ** | **December 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Computers and  equipment                             |       |                        | $          | 11,899                      |       |   |   | $ | 8,691 |   |   |
| Software                                             |       |                        | 2,972      |                        |       |   | 2,623 |   |   |
| Furniture and  fixtures                              |       |                        | 5,072      |                        |       |   | 2,356 |   |   |
| Leasehold  improvements                              |       |                        | 4,257      |                        |       |   | 1,581 |   |   |
|                                                 |       |                        | 24,200     |                        |       |   | 15,251 |   |   |
| Less—Accumulated  depreciation and amortization |       |                        | (11,828    | )                           |       |   | (9,343 | ) |   |
|                                                 |       |                        | $          | 12,372                      |       |   |   | $ | 5,908 |   |   |

 

Property and equipmentincludes assets financed under capital lease obligations of approximately$341,000 and $273,000, net of accumulated depreciation, as of December 30,2006 and December 31, 2005, respectively. The increase in the value of Property and Equipment is primarily relatedto the furnishings in our new Colorado Springs Campus—a 121,888 square footfacility that replaces two other locations nearby.

**6. Accrued expensesand other current liabilities:**

Accruedexpenses and other current liabilities consist of the following (in thousands):

| ** **                                      | ** ** | **December 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Accrued vacation                                |       |                        | $          | 7,068                       |       |   |   | $ | 6,183 |   |   |
| Accrued  compensation                           |       |                        | 10,349     |                        |       |   | 9,638 |   |   |
| Accrued bonus                                   |       |                        | 4,413      |                        |       |   | 6,755 |   |   |
| Other accrued  liabilities                      |       |                        | 6,717      |                        |       |   | 7,098 |   |   |
| Accrued expenses and  other current liabilities |       |                        | $          | 28,547                      |       |   |   | $ | 29,674 |   |   |

 

**7. Income taxes:**

The Company accounts for income taxes in accordancewith SFAS No. 109, “Accounting for Income Taxes,” which requiresrecognition of deferred tax assets and liabilities for the expected future taxconsequences of events that have been included in the financial statements orincome tax returns. Under this method, deferred tax assets and liabilities aredetermined based on the differences between the financial statement and the taxbasis of assets and liabilities using enacted tax rates for the year in whichthe differences are expected to reverse.

F-18

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

| ** **                            | ** ** | **December 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Deferred tax  assets (liabilities):   |       |                        |       |                        |       |   |   |   |   |
| Accounts payable and accrued expenses |       |                        | $          | 1,981                       |       |   |   | $ | 1,969 |   |   |
| Allowance for doubtful accounts       |       |                        | 156        |                        |       |   | 623 |   |   |
| Net operating loss                    |       |                        | 222        |                        |       |   | 796 |   |   |
| Deferred rent                         |       |                        | 873        |                        |       |   | 794 |   |   |
| Lease payable                         |       |                        | —     |                        |       |   | 312 |   |   |
| Deferred compensation                 |       |                        | 1,565      |                        |       |   | 861 |   |   |
| Stock compensation                    |       |                        | 529        |                        |       |   | 395 |   |   |
| Deferred revenue                      |       |                        | 770        |                        |       |   | — |   |   |
| Total deferred  tax asset             |       |                        | 6,096      |                        |       |   | 5,750 |   |   |
| Prepaid expenses                      |       |                        | (32        | )                           |       |   | (13 | ) |   |
| Intangible assets                     |       |                        | (11,372    | )                           |       |   | (7,646 | ) |   |
| Unbilled revenue                      |       |                        | (810       | )                           |       |   | (2,470 | ) |   |
| Depreciation and amortization         |       |                        | (473       | )                           |       |   | (420 | ) |   |
| Deferred Costs                        |       |                        | (832       | )                           |       |   | — |   |   |
| Other                                 |       |                        | (130       | )                           |       |   | — |   |   |
| Total deferred  tax liability         |       |                        | (13,649    | )                           |       |   | (10,549 | ) |   |
| Net deferred tax  liability           |       |                        | $          | (7,553                      | )          |   |   | $ | (4,799 | ) |   |

 

As discussed above SI Telecom was merged into the Company. SI Telecom had approximately$570,224 in net operating loss carryforwards as of December 30, 2006,which will be used to offset income generated by the Company. These operatingloss carryforwards will expire in 2021. Management believes that  it is more likely than not thatthese net operating loss carryforwards will be benefited on a future tax returnand therefore no valuation allowance was required.

Theprovision for income taxes consists of the following (in thousands):

| ** **                  | ** ** | **Fiscal year** | ** ** |
|-----------------------------|------------|----------------------|------------|
| ** **                  | ** ** | **2006**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Current provision:          |       |                 |       |   |   |   |   |
| Federal                     |       | $                    | 8,587      |   | $ | 7,100 |   | $ | 4,472 |   |
| State                       |       | 1,612                |       | 1,349 |   | 940 |   |
| Deferred provision:         |       |                 |       |   |   |   |   |
| Federal                     |       | 2,228                |       | 2,269 |   | 1,490 |   |
| State                       |       | 417                  |       | 224 |   | 196 |   |
| Provision for income  taxes |       | $                    | 12,844     |   | $ | 10,942 |   | $ | 7,098 |   |

 

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

| ** **                                             | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Income taxes at  the Federal statutory income tax rate |       | $        | 11,549     |     | $          | 9,757    |       | $ | 6,291 |   |
| State income  taxes, net of Federal benefit            |       | 1,317    |       | 1,090    |       | 738      |       |
| Other, net                                             |       | (22      | )          | 95       |       | 69       |       |
| Provision for income  taxes                            |       | $        | 12,844     |     | $          | 10,942   |       | $ | 7,098 |   |

 

F-19

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**8. Debt:**

Debtconsists of the following (in thousands):

| ** **                                                                                                                                                                                                                                                                                                                                                                                          | ** ** | **December 30,  2006** | ** ** | **December 31,   2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------------|------------|
| Credit facilities:                                                                                                                                                                                                                                                                                                                                                                                  |       |                        |       |                              |       |   |   |   |   |
| Line of credit bears interest at LIBOR plus 200 to  275 base points or a specified base rate plus 100 to 175 basis points,  interest due monthly, principal due February 9, 2010                                                                                                                                                                                                               |       |                        | $          | —                            |       |   |   | $ | — |   |   |
| Term loan,  pursuant to the First Amendment, as of December 30, 2006 bears interest  at LIBOR plus 200 basis points or a specified base rate plus 100 basis  points, with seventeen consecutive quarterly principal and interest payments  of $188,404 starting on December 29, 2006, with the unpaid principal and  interest of approximately $67.2 million due on February 9, 2011 |       |                        | 70,206     |                              |       |   | 99,250 |   |   |
| Total debt*                                                                                                                                                                                                                                                                                                                                                                                         |       |                        | $          | 70,206                            |       |   |   | $ | 99,250 |   |   |

----

*                    Excludes debtof approximately $6.0 million (including imputed interest) payable as of December 30,2006 in connection with the acquisition of Zen; and $2.3 million  payable as of December 31, 2005 (butpaid in June 2006) in connection with the Bridge acquisition.

Since 2002, the Company has maintained a creditfacility with Wachovia Bank, N.A. acting as Administration Agent for aconsortium of lenders. The credit facility has been amended from time to timewhen the Company has made acquisitions. The credit facility is secured by apledge of substantially all of our current and future tangible and intangibleassets, as well as those of our current and future subsidiaries, includingaccounts receivable, inventory and capital stock.

On February 9, 2005, contemporaneously with theclosing of our acquisition of SEI, the Company entered into an Amended andRestated Credit Agreement (the “Credit Agreement”) which increased itsborrowing capacity to $160 million, which is comprised of a $60 million five-yearrevolving credit facility and a $100 million six-year term loan facility.Additionally, the Credit Agreement provides that up to an additional $75million in uncommitted incremental term loan funds are available to the Companyupon its request at any time for up to two years from one or more of thelenders under the Credit Agreement.

On February 27,2006, contemporaneously with the closing of our acquisition of Zen, we enteredinto a First Amendment to the Credit Agreement (the “First Amendment”). The CreditAgreement, as amended by the First Amendment, is referred to herein as the “AmendedCredit Agreement”. The Company had approximately $129.3 million of outstandingdebt under its First Amendment on February 27, 2006 following the closingof our acquisition of Zen. The outstanding balance as of December 30, 2006was approximately $70.2 million. As with the previous credit facilities, we arerequired to maintain compliance with financial and non-financial covenantsincluding, maintaining certain leverage and fixed charge ratios, as well ascertain annual limits on our capital expenditures. The First Amendment amendedthe leverage ratio that requires us to maintain a ratio of funded debt toconsolidated EBITDA for such period as follows:

| **Period**                                                           | ** ** | ** ** | ** **   | **New Maximum Ratio** | ** ** | **Prior Maximum Ratio** | ** **   |
|----------------------------------------------------------------------|------------|------------|--------------|---------------------------------|------------|-----------------------------------|--------------|
| 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 |   |   |

 

F-20

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These ratios will be calculated in accordance with thedefinitions and terms contained in the Amended Credit Agreement, which may bedifferent than calculations pursuant to GAAP. At December 30, 2006, theCompany was in compliance with its debt covenants.

In connection with the Credit Agreement, the Companyincurred approximately $3.2 million financing costs. With respect to theFirst Amendment, the Company incurred approximately $0.6 million in financingcosts. Such costs associated with the Credit Agreement were capitalized asdeferred financing costs on the balance sheet and amortized over the six yearterm of the Credit Agreement. Such costs associated with the First Amendmentare being amortized over the five year term of the First Amendment.

At the time the Company borrows funds from either ofthe loan facilities under the Amended Credit Agreement, it may choose from twointerest rate options. The Company may elect to have the borrowings bearinterest at floating rates equal to LIBOR plus a spread ranging from 200 to 270basis points or an alternative base rate plus a spread ranging from 100 to 175basis points. Under either the LIBOR or alternative base rate option, the exactinterest rate spread will be determined based upon the Company’s leverage ratioas defined in the Amended Credit Agreement.

During the fiscal year ended December 30, 2006,the Company made prepayments and regular quarterly payments totaling $59.0million of outstanding term debt under the First Amendment, after which theremaining principal balance as of December 30, 2006, was approximately$70.2 million. As a result of the pay down of principal, the Company’squarterly payment was reduced from $323,125 to $188,404 in consecutivequarterly payments starting from December 29, 2006 through December 30,2010, with a final payment of approximately $67.2 million on February 9,2011. The amount of deferred loan origination fees written off in connectionwith the pay down in the fiscal year ended December 30, 2006 was $1.1million.

Theannual maturities of long-term debt as of December 30, 2006 are as follows(in thousands):

| **Fiscal year** | ** ** | ** ** | ** ** | **Maturity** | ** ** |
|----------------------|------------|------------|------------|--------------|------------|
| 2007                 |       | $          | 754        |         |
| 2008                 |       | 754        |       |
| 2009                 |       | 754        |       |
| 2010                 |       | 754        |       |
| 2011                 |       | 67,190     |       |
| Thereafter           |       | —     |       |
| Total long-term debt |       | 70,206     |       |
|                      |            |            |            |              |            |  |

 

The Company also had anote payable outstanding in the amount of $2.3 million as of December 31,2005, which was paid in June 2006 for the acquisition of Bridge, and has anote payable with a face value of $6.0 million including imputed interestas of December 30, 2006, payable in May 2007 for the acquisition ofZen.

**9. Commitments andcontingencies:**

**Leases**

As of December 30, 2006, the Company hasnoncancelable operating leases, primarily for real estate, that expire over thenext ten years. Rental expense during fiscal years 2006, 2005 and 2004 wasapproximately $9.4 million, $8.1 million, and $6.6 million,respectively.

F-21

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Futureminimum lease payments under noncancelable operating and capital leases as of December 30,2006 are as follows (in thousands):

| **Fiscal year**                            | ** ** | ** ** | ** ** | **Capital** | ** ** | **Operating** | ** ** |
|-------------------------------------------------|------------|------------|------------|-------------|------------|---------------|------------|
| 2007                                            |       |       | $          | 143         |       |          |       | $ | 9,161 |   |   |
| 2008                                            |       |       | 121        |        |       |          | 8,780      |   |   |
| 2009                                            |       |       | 79         |        |       |          | 8,701      |   |   |
| 2010                                            |       |       | 67         |        |       |          | 8,508      |   |   |
| 2011                                            |       |       | 15         |        |       |          | 7,110      |   |   |
| Thereafter                                      |       |       | —     |        |       |          | 14,833     |   |   |
| Total minimum  lease payments                   |       |       | 425        |        |       |          | $          | 57,093 |   |   |
| Less—Interest  element of payment          |       |       | (53        | )           |       |          |       |   |   |
| Present value of  future minimum lease payments |       |       | 372        |        |       |          |       |   |   |
| Current portion                                 |       |       | 115        |        |       |          |       |   |   |
| Long-term capital lease                         |       |       | $          | 257         |       |          |       |   |   |   |

 

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

**Contract costaudits**

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 andclaims**

We are a party to litigation and legal proceedingsthat we believe to be a part of the ordinary course of our business. While wecannot predict the ultimate outcome of these matters, we currently believe thatany ultimate liability arising out of these proceedings will not have amaterial adverse effect on our financial position. We may become involved inother legal and governmental, administrative or contractual proceedings in thefuture.

The SEI acquisition agreement provides for a purchaseprice adjustment based upon the working capital of SEI as of the closing date. Subsequentto the closing date, we received a payment of $1.6 million in connection withservices performed prior to the closing date that SEI had not previouslybilled, and was not authorized to bill, its customer as of the closing date. TheSEI selling stockholders have asserted that they are entitled to a credit inconnection with the calculation of working capital adjustment in an amountequal to the amount received by us for this post-closing payment. We believethat, in accordance with GAAP, the SEI selling stockholders should not receivethe benefit of the post-closing payment. In accordance with the terms of theSEI acquisition 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 2007.

In June 2006, theCompany, through one of its subsidiaries, was awarded a judgment, after a trialbefore a judge, in a lawsuit filed in the Circuit Court of Fairfax County,Virginia against National Technologies Associates, Inc. (“NTA”) in theamount of $841,612. The Company’s claims arose out of the 

F-22

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Company’sallegation that NTA breached a contract which obligated NTA to subcontractcertain work to the Company’s subsidiary. The Company did not record thejudgment because NTA filed a motion for reconsideration before the trial court.The trial court judge granted NTA’s motion for reconsideration, therebyoverturning the judge’s original ruling. The Company has filed a petition withthe Virginia Supreme Court requesting that it agree to hear an appeal of thetrial court’s final judgment. The Company cannot presently determine theultimate outcome of the matter.

**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 and affiliates of Frontenac, one of the Company’s investors, soldan aggregate of 3,200,000 shares of the Company’s common stock in anunderwritten public offering priced at $21.85 per share. Of the 3,200,000shares offered, 2,200,000 shares were sold by the Company and 1,000,000 shareswere sold by the selling stockholders. The Company did not receive any of theproceeds from the sale of common stock by the selling stockholders. The Companyalso granted the underwriters an option to purchase up to 320,000 shares solelyto cover over-allotments, which the underwriters exercised. In connection withthis offering, the Company received approximately $51.2 million in netproceeds, which was primarily used to pay off $27.0 million of term loanborrowings and $16.0 million of borrowings under the revolving line of credit.

On April 7, 2006, weissued 1,200,000 shares of common stock in an underwritten public offering atan initial price to the public of $34.00 per share under our shelf registrationstatement on Form S-3 (No. 333-113827) declared effectiveby the SEC on May 21, 2004. Net sale proceeds to the Company, afterdeducting underwriting discounts and commissions, but before other expensesrelating to the sale, totaled approximately $40.3 million. The Company used thenet proceeds from the sale together with cash on hand to pay down outstandingterm debt under the First Amendment.

**Stock incentiveplans**

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 

F-23

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without prior stockholderapproval, (iv) limiting the number of shares of common stock andperformance units subject to awards a participant may receive in any calendaryear to 300,000 and 500,000, respectively, and adding other administrativeprovisions to comply with the performance-based compensation exception to thededuction limit of Section 162(m) of the Internal Revenue Code of1986, as amended; (v) eliminating the provision that previously providedfor an automatic increase in the number of shares reserved for issuance underthe Amended and Restated Plan each fiscal year by a number equal to the lesserof 160,000 shares and an amount determined by the Board of Directors, (vi) providingthat non-qualified stock option grants will be priced at one hundred percent(100%) of fair market value; (vii) providing for minimum vesting periodsof stock bonus awards, restricted common stock awards, stock appreciationrights, deferred shares, and other stock awards subject to the possibleacceleration of the vesting schedule at the discretion of the administrator; (viii) providingthat future amendments to the Amended and Restated Plan that increase thenumber of shares allocated, modify participation requirements, or materiallyincrease benefits accruing to the participants under the Plan will be subjectto stockholder approval; and (ix) making other technical changes to thePlan.

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.Based on SFAS No. 123R, the Board took the action to accelerate theunvested stock options with the belief that it is in the best interest ofstockholders, as it will reduce the Company’s reported compensation expense infuture periods. The acceleration generated compensation expense ofapproximately $0.4 million determined under the intrinsic value method.

TheCompany’s option activity and price information for the three-year period endedDecember 30, 2006 is as follows:

| ** **                                     | ** ** | **Options** | ** ** | **Shares  exercisable** | ** ** | **Weighted-average  exercise price** | ** ** |
|------------------------------------------------|------------|-------------|------------|-------------------------|------------|-------------------------------------------|------------|
| 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 exercises                                 |       | (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 exercises                                 |       | (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               |       |                                      |       |   |   |
| 2006 grants                                    |       | 171,025     |       |                    |       |                                      | 29.25      |   |   |
| 2006 exercises                                 |       | (425,530    | )          |                    |       |                                      | (17.33     | ) |   |
| 2006 forfeitures                               |       | (28,127     | )          |                    |       |                                      | (27.76     | ) |   |
| Balance,  December 30, 2006               |       | 1,468,305   |       |                    |       |                                      | $          | 22.33 |   |   |
| Options exercisable at  December 30, 2006 |       |        |       | 1,302,055               |       |                                      | 21.46      |   |   |

 

F-24

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Thefollowing table shows the number of options outstanding, the weighted averageexercise price, the weighted average remaining life, and the optionsexercisable for each range of exercise prices of options outstanding at December 30,2006.

| ** ** | ** ** | **Range of  Exercise  Price**                                                    | ** ** | **Number of  Options  Outstanding** | ** ** | **Weighted  Avg. Exercise  Price** | ** ** | **Weighted  Average  Remaining Life** | ** ** | **Options  Exercisable** | ** ** | **Weighted  Avg. Exercise  Price** | ** ** |
|------------|------------|---------------------------------------------------------------------------------------|------------|------------------------------------------|------------|-----------------------------------------|------------|--------------------------------------------|------------|--------------------------|------------|-----------------------------------------|------------|
|       |       | $    1.58  –   9.27                           |       |                                     | 42,682     |                                    |       |                                       | $          | 8.97                     |       |                                    |       | 2.6 |   |   | 42,682 |   |   | $ | 8.97 |   |   |
|       |       | $  10.81  – 14.00                                                      |       |                                     | 340,388    |                                    |       |                                       | $          | 13.79                    |       |                                    |       | 5.9 |   |   | 340,388 |   |   | $ | 13.79 |   |   |
|       |       | $  16.40  – 19.26                                                      |       |                                     | 286,323    |                                    |       |                                       | $          | 16.50                    |       |                                    |       | 7.0 |   |   | 286,323 |   |   | $ | 16.50 |   |   |
|       |       | $  20.55  – 26.60                                                      |       |                                     | 173,522    |                                    |       |                                       | $          | 25.90                    |       |                                    |       | 8.0 |   |   | 173,522 |   |   | $ | 25.90 |   |   |
|       |       | $  26.80  – 29.87                                                      |       |                                     | 441,693    |                                    |       |                                       | $          | 28.31                    |       |                                    |       | 8.6 |   |   | 301,068 |   |   | $ | 28.16 |   |   |
|       |       | $  30.46  – 32.83                                                      |       |                                     | 183,175    |                                    |       |                                       | $          | 31.09                    |       |                                    |       | 8.9 |   |   | 157,550 |   |   | $ | 30.94 |   |   |
|       |       | $556.26              |       |                                     | 522        |                                    |       |                                       | $          | 556.26                   |       |                                    |       | 1.0 |   |   | 522 |   |   | $ | 556.26 |   |   |
| Total      |       |                                                                                  |       |                                     | 1,468,305  |                                    |       |                                       | $          | 22.33                    |       |                                    |       | 7.5 |   |   | 1,302,055 |   |   | $ | 21.46 |   |   |

 

Each stock option grant establishes the vestingschedule applicable to the grant. The weighted-average remaining contractuallife of the stock options outstanding and exercisable as of December 30,2006 was 7.2 years with the maximum contractual term of 10 years. Theweighted-average remaining contractual life of the stock options outstandingand exercisable as of December 31, 2005 was 7.8 years.

The weighted-average grant-date fair value of optionsgranted during the fiscal years ended December 30, 2006, December 31,2005 and December 25, 2004 was $12.75, $14.50 and $13.28 respectively. Thetotal intrinsic value of options exercised during the fiscal years ended December 30,2006, December 31, 2005 and December 25, 2004 was $6.4 million, $4.9million and $1.0 million, respectively. The total intrinsic value of optionsoutstanding and exercisable as of December 30, 2006 was $15.5 million and$14.9 million, respectively.

Prior to fiscal 2006, the Company’s stock incentiveplan consisted principally of stock options. During fiscal 2006, the Companyrevised its stock incentive arrangement to provide restricted stock awards todirectors and employees.

Asummary of non-vested stock options and restricted awards under the plan as of December 30,2006, is presented below:

| ** **                                               | ** ** | **Stock options** | ** ** | **Weighted  average  fair value** | ** ** | **Restricted  awards** | ** ** | **Weighted  average  fair value** | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|----------------------------------------|------------|------------------------|------------|----------------------------------------|------------|
| Non-vested shares  outstanding at December 31, 2005 |       |                   | —     |                                   |       |                   | $          | —                                 |       |   |   | — |   |   |   | $ | — |   |   |
| Granted                                                  |       |                   | 171,025    |                                   |       |                   | 12.75      |                                   |       |   | 32,825 |   |   |   | 29.04 |   |   |
| Vested                                                   |       |                   | (4,775     | )                                      |       |                   | 12.75      |                                   |       |   | (625 | ) |   |   | 32.00 |   |   |
| Forfeited                                                |       |                   | —     |                                   |       |                   | —     |                                   |       |   | — |   |   |   | — |   |   |
| Non-vested shares  outstanding at December 30, 2006 |       |                   | 166,250    |                                   |       |                   | $          | 12.75                                  |       |   |   | 32,200 |   |   |   | $ | 28.98 |   |   |

 

During its fiscal yearended 2001 and continuing into the fiscal year ended 2002, the Company issuedoptions with exercise prices which were less than the fair value of SIInternational’s common stock at the date of option grant. Total deferredcompensation related to these option grants was $518,000 for the fiscal yearended December 28, 2002 and $142,000 for the fiscal year ended December 29,2001. This deferred compensation was amortized to expense over the relatedoption’s vesting period. Such non-cash stock-based compensation expense totaled$196,000 in fiscal year 2005, $132,000 in fiscal year 2004, and $132,000 infiscal year 2003.

F-25

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**Stock repurchaseprogram**

During the company’s Boardof Directors meeting on December 6, 2005, the Board authorized therepurchase of up to 300,000 shares of its common stock up to an aggregate maximumdollar amount of $8 million. The Company has approximately 13.0 million sharesoutstanding as of December 30, 2006. Timing and volume of any purchaseswill be guided 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 besuspended or discontinued at any time without prior notice.

**11. Retirementplans:**

SI International has adefined contribution 401(k) Retirement/Savings Plan (the Plan) to provideretirement benefits for all eligible employees of the Company. Employees areeligible to participate in the Plan beginning on the first of the monthfollowing the start of employment and attainment of age 21. Under the Plan,eligible employees may contribute from 1% to 15% of pre-tax compensation. ThePlan also allows for after-tax contribution up to 5% of compensation. TheCompany makes an annual matching contribution and, at its discretion, may makean annual profit-sharing contribution. For fiscal years 2006 and 2004, therewas no profit-sharing contribution made to the Plan by the Company. Aprofit-sharing contribution of $1.0 million was made by the Company for fiscalyear 2005. The Company’s matching contribution to the Plan for fiscal years2006, 2005 and 2004 was approximately $2.1 million, $1.8 million, and$1.1 million.

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

| ** **                    | ** ** | **Fiscal Year 2006**       | ** ** | **Fiscal Year 2005** | ** ** |
|-------------------------------|------------|--------------------------------------|------------|--------------------------------|------------|
| ** **                    | ** ** | **Q1**                               | ** ** | **Q2**                         | ** ** | **Q3** | ** ** | **Q4** | ** ** | **Q1** | ** ** | **Q2** | ** ** | **Q3** | ** ** | **Q4** | ** ** |
| ** **                    | ** ** | **(dollars in thousands)** | ** ** |
| Revenue                       |       | $                                    | 107,232    |                           | $          | 119,233 |   | $ | 119,869 |   | $ | 115,636 |   | $ | 83,717 |   | $ | 95,983 |   | $ | 101,775 |   | $ | 116,444 |   |
| Income from operations        |       | 8,882                                |       | 10,137                         |       | 10,546 |   | 11,075 |   | 6,526 |   | 8,314 |   | 9,193 |   | 9,937 |   |
| Net income                    |       | $                                    | 4,314      |                           | $          | 4,442 |   | $ | 5,359 |   | $ | 6,038 |   | $ | 3,224 |   | $ | 4,036 |   | $ | 4,578 |   | $ | 5,099 |   |
| Basic net income per share    |       | $                                    | 0.38       |                           | $          | 0.35 |   | $ | 0.42 |   | $ | 0.47 |   | $ | 0.29 |   | $ | 0.36 |   | $ | 0.41 |   | $ | 0.45 |   |
| Diluted net income  per share |       | $                                    | 0.36       |                           | $          | 0.34 |   | $ | 0.41 |   | $ | 0.45 |   | $ | 0.28 |   | $ | 0.35 |   | $ | 0.39 |   | $ | 0.43 |   |

 

F-26

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**SI International, 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 |   |   |
| For the fiscal  year ended December 30, 2006 |       |       |       |                                           |       |                                          |       |                                         |       |           |       |                                     |       |   |   |   |   |   |   |   |   |
| Deducted from  assets accounts:                   |       |       |       |                                           |       |                                          |       |                                         |       |           |       |                                     |       |   |   |   |   |   |   |   |   |
| Allowance for  doubtful accounts                  |       |       | 1,509      |                                           |       |                                          | —     |                                         |       |           | —     |                                     |       |   | 4 |   |   |   | 1,505 |   |   |

 

F-27

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