**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-K/A**

 

**Amendment No. 1**

 

**(Mark One)**

 

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

 

**CommissionFile Number**

**000-50080**

 

**SI International, Inc.**

(Exact Name of Registrant asSpecified in Its Charter)

 

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

 

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

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

 

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

 

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

**CommonStock, $0.01 par value per share**

(Title of Class)

 

Indicate by check mark if theregistrant is a well-known seasoned issuer, as defined in Rule 405 of theSecurities Act. Yes o No ý

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

As of May 1, 2006, therewere 12,828,159 shares of SIInternational, Inc. Common Stock, $0.01 par value per share, outstanding.  

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Certain portions of theregistrant’s annual report to stockholders for the fiscal year ended December 31,2005 are incorporated 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 wasfiled with the Securities and Exchange Commission on April 25, 2006 areincorporated by reference into Part III of this Form 10-K.  

 

 

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EXPLANATORY NOTE: This Form 10-K/A is being filedfor the purpose of amending and restating Item 9A of our Form 10-K for theyear ended December 31, 2005 (the “Form 10-K”) to incorporate ourresponses to comments received from the Division of Corporation Finance of theSecurities and Exchange Commission (the “Staff”) in connection with the Staff’sreview of our Form 10-K. Unless otherwise indicated, all information inthis Form 10-K/A is as of December 31, 2005 and does not reflect anysubsequent information or events.  

 

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**SIINTERNATIONAL, INC.**

 

**FORM 10-K**

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

 

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**BUSINESSINFORMATION**

 

Throughout this document, weoccasionally distinguish between SI International, Inc., as a companyseparate from its subsidiaries, and SI International, Inc., as a companycombined with its subsidiaries. In order to clarify which entity we arereferring to in various discussions, we use the terms “SI International, Inc.”and “SI International” to refer to SI International, Inc. without itssubsidiaries. All other references, including “SI,” “the Company,” “we” and “us”refer to SI International and its subsidiaries.

 

*Some ofthe statements 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 that may causeour actual results, levels of activity, performance or achievements to bematerially different from any future results, levels of activity, performanceor achievements expressed or implied by such forward looking statements. In somecases, you can identify these statements by forward looking words such as “anticipate,”“believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,”“should,” “will,” and “would” or similar words. You should read statements thatcontain these words carefully because they discuss our future expectations,contain projections of our future results of operations or of our financialposition, or state other forward looking information. We believe that it isimportant to communicate our future expectations to our investors. However,there may be events in the future that we are not able to predictaccurately or control. The factors listed in the section captioned Item1A. “Risk Factors,” as well as any cautionary language in this Form 10 K,provide examples of risks, uncertainties, and events that may cause ouractual results to differ materially from the expectations we describe in ourforward looking statements.*

 

*Althoughwe believe that the expectations reflected in the forward looking statementsare reasonable, we cannot guarantee future results, levels of activity,performance or achievements. You should not place undue reliance on theseforward looking statements, which apply only as of the date of this Form 10K. Subsequent events and developments may cause our views to change.However, while we may elect to update these forward looking statements atsome point in the future, we specifically disclaim any obligation to do so.*

 

**PART I**

 

**Item 1.Business**  SI International, Inc. was organized as a Delaware corporation under thename of “SI International, Incorporated” on October 14, 1998.SI International conducts operations both in its own name and throughsubsidiaries, each of which is located in the U.S. but some of which haveinternational operations.

 

**Recent Events**

 

*ZenAcquisition.* OnFebruary 27, 2006, we closed the acquisition of Zen Technology, Inc, orZen, a Virginia corporation, pursuant to a Stock Purchase Agreement dated February 8,2006 (the “Zen Agreement”). Zenis a provider of critical IT services, specializing in managed networkservices, information assurance, software development and systems engineering,database and systems administration and IT consulting to various U.S.Government agencies. Zen’s largest clients include the Missile Defense Agency(MDA), Department of Defense’s Washington Headquarters Services (WHS), FederalCommunications Commission (FCC), the Pension Benefit Guaranty Corporation(PBGC), and the Federal Trade Commission (FTC). As a result of our acquisitionof Zen, we gained approximately 275 employees, of which approximately 50% holdsecurity clearances. The acquisition of Zen provides additional scale withexisting customers as well as diversification with new government customers.

 

Pursuant to the terms of theZen Agreement we acquired all of the outstanding capital stock of Zen for $60million in cash, of which we are withholding $6 million for 15 months in orderto secure post-closing indemnity obligations of the sellers. The purchase priceis subject to a two-way adjustment based upon whether the working capital ofZen as of the closing date was above or below the target working capitalspecified in the Zen Agreement. Each of the parties to the Zen Agreement hasmade customary representations and warranties and agreed to certainindemnification obligations. The transaction was

 

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

 

*Amendmentto Credit Facility.* On February 27, 2006, contemporaneouslywith our closing the acquisition of Zen, we entered into a First Amendment tothe Amended and Restated Credit Agreement, or First Amendment, with a syndicateof lenders, including Wachovia Bank, National Association, a national bankingassociation, which acted as administrative agent for the lenders.

 

The First Amendment amendedthe terms and conditions of the Amended and Restated Credit Agreement enteredinto on February 9, 2005, or the Credit Agreement, by (i) establishinga new term loan in the principal amount of approximately $129.3 million, whichreplaced the then existing term loan under the Credit Agreement, (ii) reducingboth the base rate margin and the LIBOR margin on the term facility, (iii) increasingthe leverage ratio for the financial covenants and (iv) amending certainrestrictive covenants. The principal balance of the new term loan is to berepaid in quarterly installments commencing March 31, 2006, with thebalance due upon the expiration of the Credit Agreement, as amended, or theAmended Credit Agreement, on February 9, 2011. If an event of defaultoccurs and is continuing, we may be required immediately to repay allamounts outstanding under the Amended Credit Agreement.

 

The funds borrowed under thenew term loan were used to (i) refinance the approximately $99.3 millionin principal outstanding under the then existing term loan under the CreditAgreement and to pay any and all fees and expenses related thereto; (ii) tofinance the acquisition of Zen and pay any and all fees and expenses relatedthereto; and (iii) to provide for working capital expenditures, and othergeneral corporate uses.

 

The borrowing capacity underthe Amended Credit Agreement totals approximately $189.3 million and iscomprised of a $60 million five-year revolving credit facility andapproximately $129.3 million term loan facility. Additionally, a $75 millionuncommitted incremental term loan facility will be available upon our requestat any time for up to two years from the date of the Credit Agreement from oneor more of the lenders.

 

*NVCContract Award.* On January 31, 2006, in a recompetitionfor our expiring National Visa Center, or NVC, contract, we were awarded thesuccessor contract for the NVC contract by the Department of State. Under thecontract, we anticipate performing over 20 million immigrant visa transactionseach year at the NVC in Portsmouth, New Hampshire and at the Kentucky ConsularCenter in Williamsburg, Kentucky. The prime contract has a one-year base periodand four one-year options with an announced value of approximately $84 million,inclusive of the options.

 

*Accelerationof Vesting of Stock Options.* On December 13, 2005, ourBoard of Directors approved the accelerated vesting of unvested stock optionspreviously awarded to employees, officers and directors as of December 7,2005 in light of new accounting regulations that were to come into effect January 1,2006. Based on the Statement of Financial Accounting Standards No. 123R, “Share-BasedPayment” (SFAS 123R), the Board took the action to accelerate the unvestedstock with the belief that it is in the best interest of stockholders, as itwill reduce the Company’s reported compensation expense in future periods.

 

**Overview**

 

We are a provider of missioncritical information technology and network solutions primarily to the FederalGovernment. Our business is guided by our experienced team of eight executiveofficers and over twenty-five other corporate officers who manage and areresponsible for successfully growing our business. As of the end of fiscal year2005, we employed over 4,000 employees. Approximately 85% of our employees holdFederal Government security clearances or have passed National Agency Checks.Approximately 15% of our employees hold Top Secret security clearances. Asignificant portion of our

 

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employees who hold Top Secret security clearancesalso hold Sensitive Compartmental Information clearances, which permit us tobid on highly classified 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 2005 and fiscal2004, we derived approximately 75% and 81%, 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 31, 2005 was approximately $854 million,of which approximately $191 million was funded. See “—Backlog” for adiscussion of how we calculate backlog.

 

**The Federal Government technologyservices market**

 

The ongoing transformationof the Federal Government’s information systems and communication networks iscreating an increase in its demand for information technology, or IT, services.According to INPUT, an independent market research firm, the federal marketdemand for vendor-furnished information systems and services is projected toincrease by $19.6 billion from $59.2 billion in government fiscal 2005 to $78.8billion in government fiscal 2010, a compound annual growth rate ofapproximately 5.9%. In addition, the addressable IT spending, which is theamount 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 $4.8 billion in government fiscal 2005 to $7.0billion in government fiscal 2010, representing a compounded annual growth rateof 7.8%. The Department of Homeland Security addressable portion of the ITbudget is projected by INPUT to grow from $4.5 billion in government fiscal2005 to $6.4 billion in government fiscal 2010, representing a compoundedannual growth rate of 7.6%. Spending for federal IT requested by the U.S.Office of Management and Budget (OMB) in government fiscal 2006 shows anincrease of 9.0% over the government fiscal 2005 request, according to INPUT.

 

We expect that the FederalGovernment’s need for the types of IT services that we provide will continue togrow in the foreseeable future, as a result of the high priority placed by thefederal government on the transformation of its IT programs. INPUT forecaststhat the percentage of IT spending that is contracted out by the federalgovernment will reach a high of 86% of total IT spending in government fiscal2010. According to INPUT, the government fiscal 2006 IT budget request of 7%over the enacted government fiscal 2005 budget, at a time when the request foroverall federal spending was nearly flat, demonstrated the importance theadministration places on IT as an integral part of federal businessprocesses.

 

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

 

•                    *Continued focus onmission-critical initiatives.* Since the events of September 11, 2001,the Federal Government has made the transformation of its IT infrastructure amajor priority. 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 $25.1 billion ingovernment fiscal 2005 to $34.1 billion in government fiscal 2010, representinga projected compounded annual growth rate of 6.1%. According to INPUT, growthin the commercial segment for the U.S. Air Force is projected to rise from $1.7billion in government fiscal 2005 to $2.6 billion in government fiscal year2010, a compounded annual growth rate of 8.9%.

 

•                    *Increased FederalGovernment reliance on outsourcing.* According to INPUT, outsourcingthrough the use of outside providers to provide Federal Government services isprojected to grow from $12.3 billion in government fiscal 2005 to $17 billionin government fiscal 2010, representing a projected compounded annual growthrate of 6.9%.

 

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We believe that the FederalGovernment is increasingly turning to the IT industry to execute supportprocesses and functions that were traditionally performed by Federal Governmentemployees. INPUT expects that Department of Defense (DoD) budgets will continueto grow over the next several governmental fiscal years and anticipates thateach of the defense agencies will move toward outsourcing more of theinformation technology functions that are not core to the war-fighting mission.Business process outsourcing, or BPO, is a relationship in which a contractoris responsible for performing an entire business operations function, includingthe information systems outsourcing that supports it. INPUT projects thatFederal Government BPO spending will grow from $555 million in governmentfiscal 2005 to $857 million in government fiscal in 2010, which represents acompounded annual growth rate of 9.1%. In addition, during this same period,INPUT projects a compounded annual growth rate for BPO spending by defenseagencies of 8.3%. According to INPUT, the size of the Federal Governmentworkforce, which includes only civilian employees and non-uniform militarypersonnel in federal civilian agencies and the DoD, decreased by 1.1 millionworkers during the period 1990 through 2000, representing a 22% decline.

 

We believe that homeland securitywill have the greatest impact on three specific segments of the FederalGovernment IT market: information security, communications and knowledgemanagement. We believe that the rapid pace of technological innovations and theFederal Government’s increasing reliance on complex IT infrastructure, combinedwith a decline in the size of the Federal Government workforce, as describedabove, make it increasingly difficult for many governmental agencies to operateand upgrade their IT systems. We expect that several trends will contribute tothe Federal Government’s increased use of service providers to fulfill a largerportion of its iIT responsibilities, and we believe that we will continue togain new engagements to the extent that the Federal Government increases itsreliance on outsourcing for its IT needs. These trends include:

 

•                    *The aging of the FederalGovernment’s workforce.* According to INPUT, the government hasestimated that more than 45% of federal IT workers will be eligible forretirement by 2008, and the average age of Federal Government employeesincreased from 42 years of age in 1990 to 47 years of age in 2005. In April 2001,the GAO concluded in a report that the Federal Government’s human capitalchallenges are adversely affecting the ability of many agencies to carry outtheir missions.

 

•                    *Increased FederalGovernment emphasis on competitive sourcing.* The current administration hasmade competitive sourcing a major initiative of its management agenda.According to the President’s Management Agenda, which was issued in 2001 andfor which progress reports continue to be issued, including most recentlyduring 2003, nearly half of all Federal Government employees perform tasksthat are available in the commercial marketplace. To the extent that the sizeof the Federal Government workforce decreases, we believe that the FederalGovernment will have an increased need for entities that offer the technicalskills, familiarity with government processes and procedures and skilledpersonnel that are necessary to meet the diverse IT requirements of the variousFederal Government agencies.

 

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

 

In the wake of the terroristattacks on September 11, 2001, there has been an increased emphasis onhomeland security, intelligence and national defense, including protectingcritical infrastructure. According to INPUT, the total addressable IT budgetfor the Department of Homeland Security is projected to grow from $4.5 billionin government fiscal 2005 to $6.4 billion in government fiscal 2010,representing a compound annual growth rate of 7.6%.

 

Although the total amount tobe spent for intelligence applications is classified, based on availableinformation, INPUT has forecasted that the addressable Federal Government ITspending in the intelligence community may be as much as $7.8 billion ingovernment fiscal 2005. We believe that there will continue to be increases inspending on federal intelligence activities, which are expected to representsignificant additional opportunities for us.

 

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***Increasedsimplicity of procurement.***

 

Through changes that beganwith the Federal Acquisition Streamlining Act of 1994, or FASA 94, the federalgovernment has developed a variety of accelerated contracting methods. Federalgovernmental agencies have increasingly been able to rely on multiplecontracting vehicles to procure needed services in an expedient manner.According to INPUT, the average time to procure products and services wasapproximately 100 days in government fiscal 2004 as compared to 278 days ingovernment fiscal 1995.

 

**Our Core Strengths**

 

We strategically built ourbusiness to respond specifically to the federal IT marketplace. We believe thatour core strengths position us to respond to the long-term trends and changingdemands of our market.

 

**Our Experienced Management Team**

 

On July 15, 2005, ourBoard of Directors approved a CEO succession plan, pursuant to which the Boardappointed S. Bradford Antle, formerly our President and Chief OperatingOfficer, to be the next President and Chief Executive Officer (CEO) succeedingRay J. Oleson, and to serve on our Board of Directors. Mr. Antleassumed these positions effective September 24, 2005. Mr. Antle, whojoined us in 1999, brings more than 25 years of management experience in ourindustry to his new position. In addition to his new role as CEO and member ofthe Board, Mr. Antle retained the position of President. Ray Olesoncontinues to serve as Executive Chairman of the Board.

 

Additionally, to furthersupport our growth during 2006 and beyond, our eight business units are nowincorporated into the Strategic Programs Group, the IT Solutions Group, and theMission Services Group. Each of these Business Groups is headed by an ExecutiveVice President, who reports to Mr. Antle.

 

Harry Gatanas is theExecutive Vice President of the Strategic Programs Group, where he oversees asignificant portion of our business with the DoD and the Intelligencecommunity. Mr. Gatanas is a retired U.S. Army general with over 30 yearsof experience in the military and intelligence community, including serving asCommanding General of the U.S. Army White Sands Missile Range.

 

Marylynn Stowers is theExecutive Vice President of the IT Solutions Group. She oversees a significantportion of business that addresses federal IT modernization. Ms. Stowershas more than 24 years of experience providing IT services to the FederalGovernment, such as Department of Homeland Security, Department of State,Department of Treasury, Internal Revenue Service, and the Intelligencecommunity.

 

Mike Becraft is theExecutive Vice President of the Mission Services Group. He is responsible for amajor portion of work with the Deparment of Homeland Security, Department ofState, and U.S. Army. Mr. Becraft has more than 37 years of Federalcivilian government and military experience. He joined us in 2003 as SeniorVice President of Homeland Security.

 

**Our Corporate Culture**

 

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.

 

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**Focus on Information TechnologyServices**

 

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

 

•       *Federal IT Modernization*.  Wedefine federal IT modernization to include designing, building 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,network solutions, 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, and 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-CriticalOutsourcing*.  We define mission-critical outsourcing asassisting the Federal Government with shortages of personnel, including for thepurpose of permitting re-assignment to higher priority government assignments,increasing operational efficiency, and improving the overall quality ofservice. We provide services in this focus area to both civilian agencies andthe DoD.

 

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

 

**Knowledge of Federal GovernmentContracting and Federal Agencies**

 

We believe that our in-depthknowledge of Federal Government contracting and the governmental agencies weserve and their procurement processes allows us to provide better solutions forour clients’ needs. Our experienced team of executive officers and seniormanagers brings to us their many years of experience and extensive contacts inthe industry. They provide us with an understanding of our clients’ needs andprocedures, as well as valuable mission-specific information. We believe thatthe insight provided by our officers and managers allows us to design solutionsthat are responsive to our clients’ mission-critical needs.

 

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**Successful Integration of AcquiredBusinesses**

 

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

 

Within the 15-month periodfrom January 1999 through March 2000, we identified, acquired andintegrated 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. We successfully integrated each ofthese acquisitions into our organization; and, we built and expanded ourservices and solutions capabilities and our client relationships. We appliedour disciplined acquisition processes to integrate the acquired companies andsuccessfully grew these businesses. On February 27, 2006, we acquired Zen,and we have commenced the integration process as we have done with our previousacquisitions.

 

**Our Growth Strategy**

 

We have implemented thefollowing strategies in order to reach our goal of becoming a leading providerof information technology and network solutions to our clients:

 

•       *Maintain and expand ourexisting client relationships.* We maintain relationships with our existingclients by adhering to our culture of respect and providing qualityperformance. We believe this helps us win renewals of our engagements. Inaddition, we use our knowledge of our clients’ needs to identify additionalopportunities and cross-sell new services to them.

 

•       *Leverage our existingclient base to win new clients.* We believe satisfied clients areone of our most effective marketing tools. Since FASA 94 went into effect,client referrals have become a crucial component of expedited procurementprocesses and are key to our winning new contracts. Since we focus ontechnology infrastructure improvement, we are able to transfer our skillsreadily from client to client. We plan to continue building a network ofclients and leveraging these relationships to gain access to new clients. Wehave launched a Major Programs initiative through which we intend to competefor large contracts over longer procurement periods. We believe that favorableclient referrals are strategically important to our winning theseopportunities.

 

•       *Pursue strategic acquisitions.* We plan to continue utilizing our disciplinedmethodology to identify, evaluate and integrate strategic acquisitions. We haveacquired and successfully integrated seven businesses since 1999 and we are inthe process of integrating our eighth acquisition, Zen, which we acquired in February 2006.This acquisition has positioned us with strategically important technicalskills in important client areas.

 

•       *Business Capabilities andSales Integration*.  Our business units are now incorporated intothe Strategic Programs Group, the IT Solutions Group, and the Mission ServicesGroup. Under our new management structure (see above Our Experienced ManagementTeam for more information about our management), these three business groupswill be better able to present integrated solutions through the cross-marketingand delivery of our business capabilities to new and existing customers.

 

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**Our Areas of Practice**

 

We provide IT and networksolutions in the following eight practice areas to supplement our clients needsin Defense Transformation, Homeland Defense, Mission Critical Outsourcing andFederal IT Modernization.

 

•       *Program Management &Acquisition Support***—** Theprogram management and acquisition support practice assists clients withinitiating, assembling, executing, and managing all sizes of acquisitionprograms. The practice area provides acquisition strategies, governmentrequired documentation (DoD 5000), and solicitation packages, as well as,source selections and contract management support. The practice area managesand oversees high-tech systems development; interprets and synchronizesrequirements with system architectures and integrated master plans; and,identifies and tracks technical and programmatic interdependencies andinteractions among requirements. The technical staff is skilled in providingsystems engineering technical assistance (SETA) support to client programs forcost, schedule, performance, risk management, and contracting activities.

 

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

 

•       *Information Security***—** The information security practice deliversanalyses, methods and technologies that enable clients to secure theirinformation against unauthorized access and service disruption. The solutionsare designed to protect and defend information systems against malicious actions,reduce the threat to system security and proactively manage risk. The practicearea provides security policy and procedure development, threat determinationand risk assessment, vulnerability analysis, system security engineering,network defense, secure document processing, applications and web security,security evaluation and accreditation and training.

 

•       *Records Management***—** The records management practice specializesin application processing, data entry, case and file management, large scaleidentification and credentialing systems, call center support, and analyticalsupport services. The practice area services include the management andoperation of integrated file tracking systems, electronic records management,large volume file processing, secure identity card production, scanningoperations to include documents and biometrics, storing and shipping ofdocuments, quality control audits, secure file destruction, and networkinstallation.

 

•       *Learning Solutions***—** The learning solutions practice focuses onthe design, development and delivery of learning and performance interventionsto meet the client’s individual and organizational performance needs and managechange. The practice area provides front end analysis, blended solutions,web-based and instructor-led training, electronic performance support systems(EPSS), human performance design, and learning standards and learninginfrastructure consulting. Our understanding and experience in the distancelearning, *e*-Learning, and everchanging Learning Management Systems/Learning Content Manangement Systemsenvironments provides our clients rapid design and deployment of solution-basedprograms to meet today’s requirements and tomorrow’s challenges.

 

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•       *Systems Engineering***—**The systems engineering practice deliversmission and requirements analysis, enterprise/operational architecture modelingand development, system application and development, system design, validationand verification, integrated logistics support, life cycle engineering, andcomplex simulation. The technical staff is skilled in command, control,communications, computer and intelligence (C4I), engineering, object orientedanalysis and design, system testing, requirements traceability and specialtydisciplines, including reliability/maintainability/availability engineering andsafety and sustaining engineering. Many of these skills are focused on militaryspace applications.

 

•       *Network Solutions***—**The network solutions practice designs,engineers, deploys, and manages a full range of networked communications andinfrastructure solutions. The practice area provides IT and networkrequirements, definition and analysis, detailed systems design, network andtechnology selection and procurement, global end-to-end installation, andspectrum/bandwidth management. These solutions encompass voice, video, data,narrowband, broadband and wireless technologies. Applications include largescale enterprise networks for government, highly secure networks.

 

•       *Mission-critical Outsouring***—**The mission-critical outsouring practice usesdomain expertise to operate clients’ systems and processes vital to theirbusinesses. The practice area offers professional services to perform businessprocess and information technology outsourcing, sustaining engineering,logistics services, and call center operations.

 

**Clients**

 

We provide our servicesprimarily to Federal Government clients such as the U.S. Air Force SpaceCommand, the U.S. Army, U.S. Navy, the Department of State, the Department ofHomeland Security, Department of Agriculture, National Institutes of Health,Federal Retirement Thrift Investment Board, and the defense intelligencecommunity. In fiscal 2005, we derived approximately 98% of our total revenue fromFederal Governmental agencies and approximately 2% of our total revenue fromcommercial clients.

 

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

 

We often subcontractportions of work to be performed under a contract or task order under which weare the prime contractor. Approximately 15% and 16%, respectively, of our totalrevenue in fiscal 2005 and fiscal 2004, respectively, was generated by workperformed by subcontractors. The subcontractors are sometimes responsible forcritical portions of the contracted services. Our subcontracting arrangementstypically specify that all terms of the primary contract pass down to thesubcontractor. We are not dependent upon any one subcontractor or group ofsubcontractors to provide a substantial degree of work for us. In addition, itis typical that a subcontractor on one engagement may be a competitor or 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.

 

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**Backlog**

 

Backlog is our estimate ofthe amount of revenue we expect to realize over the remaining life of awardedcontracts and task orders we have in hand as of the measurement date. Our totalbacklog consists of funded and unfunded backlog. We define funded backlog asestimated future revenue under government contracts and task orders for whichfunding has been appropriated by Congress and authorized for expenditure by theapplicable agency, plus our estimate of the future revenue we expect to realizefrom our commercial contracts. Unfunded backlog is the difference between totalbacklog and funded backlog. Unfunded backlog reflects our estimate of futurerevenue under awarded government contracts and task orders for which eitherfunding has not yet been appropriated or expenditure has not yet beenauthorized. Our total backlog does not include estimates of revenue fromgovernment-wide acquisition contracts, or GWAC contracts, or General ServicesAdministration, or GSA, schedules beyond awarded or funded task orders, but ourunfunded backlog does include estimates of revenue beyond awarded or fundedtask orders for other types of indefinite delivery, indefinite quantity, orID/IQ, contracts, such as our contract with the U.S. Air Force Space Command.

 

Our total backlog as of December 31,2005 was approximately $854 million, of which approximately$191 million was funded. There can be no assurance that we will receivethe amounts we have included in our backlog or that we will ultimatelyrecognize the full amount of our funded backlog as of December 31, 2005.

 

As of December 31,2005, assuming that the acquisition of Zen had occurred on such date, ourbacklog was approximately $994 million, of which $233 million was funded.

 

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 ordersincluded in our backlog. Many factors that affect the scheduling of projectscould alter the actual timing of revenue on projects included in backlog. Thereis always the possibility that the contracts could be adjusted or cancelled. Weadjust our backlog on a quarterly basis to reflect modifications to or renewalsof existing contracts, awards of new contracts or approvals of expenditures.See Item 1A. “Risk Factors—The calculation of our backlog is subject tonumerous uncertainties, and we may not receive the full amounts of revenueestimated under the contracts included in our backlog, which could reduce ourrevenue in future periods.”

 

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**Employees**

 

As of December 31,2005, we had over 4,000 employees. Approximately 85% of our employees holdFederal Government security clearances or have passed National Agency Checks.Approximately 15% of our employees hold Top Secret security clearances. Asignificant portion of our employees who hold Top Secret security clearancesalso hold Sensitive Compartmental Information clearances, which permit us tobid on highly classified projects. We have no unionized employees and do nothave any collective bargaining agreements. However, current contracts orcontracts that we may pursue contracts may require us to haveunionized employees. Furthermore, with our acquisition of Zen, we have added approximately275 employees, of which 50% hold security clearances. We believe we have a goodrelationship with our employees.

 

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

 

**Competition**

 

We operate in markets thatare highly competitive and include a large number of participants. We competewith many companies, both large and small, for our contracts. We do not have aconsistent number of competitors against whom we repeatedly compete. If weanticipate that our combined resources may create a competitive advantage,we may team with other companies to perform work under contracts.These and other companies in our market may compete more effectively thanwe can because they are larger, have greater financial and other resources,have better or more extensive relationships with governmental officialsinvolved in the procurement process and have greater brand or name recognition.

 

As a result of the diverserequirements of the Federal Government and our commercial clients, wefrequently form teams with the companies in our markets in order tocompete for large procurements, while bidding against them in other situations.

 

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

 

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**Government Contracting andRegulatory Processes**

 

For fiscal 2005,approximately 98% of our revenue was derived from work performed under FederalGovernment contracts. The government contracting process differs in many waysfrom commercial contracting, and involves a high degree of Federal Governmentregulation and oversight.

 

Historically, agencies ofthe Federal Government wishing to procure services from contractors have beenrequired to prepare a request for proposal, known as an RFP, or some similar form ofsolicitation. The RFP is typically an extensive document describing theservices desired and the terms and conditions that form the finalagreement, including the criteria the soliciting agency will use to select theservice provider. Interested parties submit proposals in response to the RFP,which the agency evaluate, often requesting additional information and multiplediscussions with offerors prior to final award of the contract.

 

In recent years, the FederalGovernment has taken steps to streamline the procurement process. For example,in 1994, the enactment of FASA 94 made the procurement process substantiallyfaster and less burdensome for companies that secure certain contracts. FASA 94was the first of several statutory and regulatory changes in recent years thatsignificantly altered government procurement practices by increasing the numberand types of procurement contract “vehicles” available to Federal Governmentclients to satisfy their requirements. 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 GSA schedule contractors.The process typically involves substantially less time and cost than thehistorical, non-GSA bidding process.

 

In addition to the GSA MASProgram, we also hold other ID/IQ contracts with other individual agencies,which are generally known as task order contracts. These are essentially umbrellacontracts that set forth the basic terms and conditions under which the agency may ordergoods and services from one, and in some cases, more than one, contractor.Contractors undergo 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 by concentratingwork under fewer contracts, and requiring competition both prior to the initialaward of the contract and throughout the term of the contract in order toobtain 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 aspecific set of services to be delivered by the contractor to a particularclient agency. In our experience, the key factors in competing successfully forthese task orders are technical

 

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merit, cost, relevant past performanceconsiderations and client trust. From time to time we are also party to GWACs,which are ID/IQ contracts that permit the aggregation of multiple agencies’requirements in a single contract, in order to encourage contractors to offerthe best possible prices and to reduce the costs associated with multipleacquisitions.

 

For single-award large scalecontracts, such as those targeted by our Major Program initiative, interestedcontractors submit information indicating their desire to perform therequired services. The agency then solicits competitive proposals or bids fromqualified contractors by providing them with a formal RFP or similarsolicitation. The RFP typically describes the desired services, terms andconditions, and evaluation criteria the agency will use. Offerors then submitproposals in response to the RFP, and the agency evaluates the proposals andmakes the award determination. Agencies are encouraged to award contracts on a “bestvalue” basis. This means that the contractor selected for the award should, inthe agency’s judgment, provide the greatest overall benefit in response to therequirement, including technical merit, cost and relevant past performanceconsiderations. The entire acquisition process can sometimes take a year ormore.

 

The competitive processpresents a number of risks, including the following:

 

•       we expend substantial funds, managerial timeand effort to prepare bids and proposals for contracts that we may notwin;

 

•       we may be unable to estimate accuratelythe resources and cost that will be required to service any contract we win,which could result in substantial cost overruns; and

 

•       we may encounter expense and delay ifour competitors protest or challenge awards of contracts to us in competitivebidding, and any such protest or challenge could result in a requirement toresubmit proposals on modified specifications or in the termination, reductionor modification of the awarded contract.

 

•       we may be choosen as one of thecontractors for a multiple awared GWAC, ID/IQ or GSA Schedule contract,but not be awarded a sufficient number of tasks under the contract to justifyour time, effort, and expense in bidding on the contract and subsequent taskorders.

 

•       the government may intitially award aGWAC, ID/IQ, or GSA Schedule contract but fail to provide funding for thenumber of task orders necessary to justify our time, effort, and expense inbidding on the contract and subsequent task orders.

 

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. In addition, uponthe expiration of a contract, if the client requires further services of thetype provided by the contract, there is frequently a competitive rebiddingprocess.

 

**Laws and Regulations Affecting OurBusiness**

 

Federal Government contractsare subject to a number of federal laws and regulations, including the FederalAcquisition Regulation, or FAR, and Cost Accounting Standards. These statutesand regulations contain several rules that may affect ussignificantly.

 

The Anti-Deficiency Actprohibits Federal Government employees from committing government funds, bycontract or otherwise, in excess or in advance of appropriations, unlessauthorized by a specific statute. Since Congress usually appropriates funds ona fiscal year basis, many of our contracts are funded by the applicable agencyannually as Congress makes appropriations for future fiscal years. In addition,since funds are often allocated to agencies by the OMB, many of our contractsare incrementally funded.

 

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Disappointed bidders andcontractors excluded from competing for government contracts and task orders may submita protest to a contracting officer or the GAO within time limits specifiedunder FAR and GAO bid protest rules. The U.S. Court of Federal Claims also hasbid protest jurisdiction. Performance under a contract being protested may besuspended while the protest is pending, and in cases where the contract isfound to have been improperly awarded, the contract may be terminated.

 

Certain FAR clauses, such asthe Limitation of Cost and Limitation of Funds clauses, limit the FederalGovernment’s liability for expenditures or obligations beyond those authorizedby the applicable contract. In many cases, contracts are awarded for only oneyear with a number of successive option years (in many cases, four). Agenciesare not obligated to exercise these option years, but in our experience mostrenewal options under our contracts have been exercised. In addition, certainFAR clauses allow the Federal Government to terminate contracts for convenience(i.e., at will), although the Federal Government is obligated to pay for costsincurred.

 

Larger contracts may alsobe subject to the Truth in Negotiations Act and Cost Accounting Standards. TheTruth in Negotiations Act requires us to provide current, accurate and completecost or pricing data in connection with the negotiation of a contract,modification or task order that is not subject to full and open competition orother exceptions to the Act. Cost Accounting Standards are applicable tocertain contracts and require the contractor to apply consistent accountingpractices and comply with specific cost accounting criteria. The FAR “ContractCost Principles and Procedures” sets forth the rules regarding theallocability and allowability of costs incurred in connection with FederalGovernment contracts.

 

The FAR restricts governmentcontractors from participating in procurements when there is an OrganizationalConflict of Interest, or OCI, and establishes rules for avoiding,mitigating and neutralizing conflicts of interest in the issuance of contractsby the Federal Government. Virtually all government contracts, including ours,are subject to the OCI rules. An OCI may arise because the nature of thework to be performed by a contractor has the potential, absent some restrictionon future activities, to result in an unfair competitive advantage to thecontractor or impair the contractor’s objectivity in performing the contract orproviding assistance or advice to the Federal Government. The governmentcontracting officer is responsible for resolving any significant potential OCIsbefore a contract award is made. Federal Government contractors have anobligation to manage and, if necessary, report an OCI to the contracting officer.We have a company-wide policy regarding care in the acceptance of andcompliance with contractual OCI provisions, which includes awareness trainingprograms and coordination and reporting systems. We review new contracts andtask orders at the time we receive them for potential OCI issues. Accordingly,we believe that as a result of the systems we have in place, our backlog willnot be affected by OCI issues.

 

Our books and records aresubject to audit by the Defense Contract Audit Agency, or DCAA, and othergovernmental audit agencies to ensure that the costs and hourly rates for whichwe invoice the Federal Government under cost reimbursable and time andmaterials contracts are in compliance with the Cost Principles, Cost AccountingStandards and FAR invoicing regulations. Each fiscal year, we must submit finalcost data to the Federal Government indicating our actual costs incurred forthe prior year, exclusive of certain costs that are not recoverable by FederalGovernment contractors. This data is audited, and subject to adjustments by theauditing agency based upon established guidance, which may affect ourrecovery on cost 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 2005 will notresult in adjustments that would have a material adverse effect on ourfinancial position or results of operations; however, future materialadjustments are possible.

 

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Our conduct and performanceis also subject to the False Claims Act. The False Claims Act prohibitscontractors from knowingly submitting false or fraudulent claims to the FederalGovernment. We have established standards of conduct for our employees and areporting mechanism that any of our employees can use to report inappropriateor illegal activities.

 

From time to time we may engagein activities that require us to comply with the various, U.S. Governmentexport control laws and regulations administered by the U.S. Department ofState, U.S. Department of Commerce, U.S. Treasury Office of Foreign AssetsControl, and the Bureau of Customs and Boarder Protection. We have dedicatedpersonal assigned to maintain and coordinate our compliance activities in thisarea.

 

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

 

You may obtain aprinted copy of any of the foregoing materials from us by writing to us at SIInternational, Inc., 12012 Sunset Hills Road, Suite 800, Reston, Virginia20190, Attention: Investor Relations.

 

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**Item 1A.Risk Factors**

 

**RisksRelated to Our Industry**

 

**We depend on contracts with theFederal Government for most of our revenue, and our business would be seriouslyharmed if the government ceased doing business with us or significantlydecreased the amount of business it does with us.**

 

We derived 98.1% and 96.6%of our total revenue in fiscal 2005 and in fiscal 2004, respectively, fromFederal Government contracts, either as a prime contractor or a subcontractor.This includes 46.9% and 52.8% of our total revenue in fiscal 2005 and in fiscal2004, 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.

 

The following chart providescertain information regarding our two largest contracts for fiscal year 2005,in terms of revenues:  

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

 

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* Includes option periods.

 

**Our business could be adverselyaffected by changes in budgetary priorities of the Federal Government.**

 

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

 

•       changes in Federal Government programs orrequirements;

 

•       budgetary priorities limiting or delayingFederal Government spending generally, or by specific departments or agenciesin particular, and changes in fiscal policies or available funding, includingpotential governmental shutdowns;

 

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•       reduction in the Federal Government’s use oftechnology solutions firms; and

 

•       an increase in the number of contractsreserved for small businesses which could result in our inability to competedirectly for these prime contracts.

 

**Our contracts with the FederalGovernment may be terminated or adversely modified prior to completion,which could adversely affect our business.**

 

Federal Government contractsgenerally contain provisions, and are subject to laws and regulations, thatgive the Federal Government rights and remedies not typically found incommercial contracts, including provisions permitting the Federal Governmentto:

 

•       terminate our existing contracts;

 

•       reduce potential future income from ourexisting contracts;

 

•       modify some of the terms and conditions inour existing contracts;

 

•       suspend or permanently prohibit us from doingbusiness with the Federal Government or with any specific government agency;

 

•       impose fines and penalties;

 

•       subject us to criminal prosecution;

 

•       subject the award of some contracts toprotest or challenge by competitors, which may require the contractingfederal agency or department to suspend our performance pending the outcome ofthe protest or challenge and which may also require the government tosolicit new proposals for the contract or result in the termination, reductionor modification of the awarded contract;

 

•       suspend work under existing multiple yearcontracts and related task orders if the necessary funds are not appropriatedby Congress;

 

•       decline to exercise an option to extend anexisting multiple year contract; and

 

•       claim rights in technologies and systemsinvented, developed or produced by us.

 

The Federal Government may terminatea contract with us either “for convenience” (for instance, due to a change inits perceived needs or its desire to consolidate work under another contract)or if we 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. We may inthe future receive show-cause or cure notices under contracts that, if notaddressed to the Federal Government’s satisfaction, could give the governmentthe right to terminate those contracts for default or to cease procuring ourservices under those contracts.

 

Our Federal Governmentcontracts typically have terms of one or more base years and one or more optionyears. Many of the option periods cover more than half of the contract’spotential term. Federal governmental agencies generally have the right not toexercise options to extend a contract. A decision to terminate or not toexercise options to extend our existing contracts could have a material adverseeffect on our business, prospects, financial condition and results ofoperations.

 

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

 

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on the design of aparticular solution, we may be precluded from competing for the contract toinstall that solution. While we actively monitor our contracts to avoid theseconflicts, we cannot guarantee that we will be able to avoid all organizationalconflict of interest issues.

 

**If we fail to establish and maintain important relationshipswith government entities and agencies, our ability to successfully bid for newbusiness may be adversely affected.**

** **

To develop new business opportunities, we primarily rely onestablishing and maintaining relationships with various government entities andagencies. We may be unable to successfully maintain our relationships withgovernment entities and agencies, and any failure to do so could materiallyadversely affect our ability to compete successfully for new business.

 

**We derive significant revenue from contracts and task ordersawarded through a competitive acquisition process. If we are unable to win newawards or successfully compete for renewal contracts, our business andprospects may be adversely affected.**

** **

A significant number of our contracts and task orders with the FederalGovernment are awarded through a competitive process. We expect that much ofthe business that we will seek in the foreseeable future will continue to beawarded through competitive bidding of new contracts and task orders andcontracts subject to renewal. Recently, members of Congress and administrationofficials have authorized changes to the procurement process intended toincrease competition among suppliers to the Federal Government. Budgetarypressures and reforms in the procurement process have caused many FederalGovernment clients to increasingly purchase goods and services through ID/IQ,contracts, including GSA contracts, and other GWACs. These contracts haveincreased competition and pricing pressure by concentrating work under fewercontracts, and requiring competition both prior to the initial award of thecontract and throughout the term of the contract in order to obtain task ordersfor the services we provide, requiring that we make sustained post-awardmarketing efforts to realize revenue under each such contract. 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 awarded the GSA contract at the pricesand on the terms stated in the contract. Moreover, even if we are highlyqualified 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 competitive process presents a number of risks, including thefollowing:

 

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

 

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

 

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

 

The government contracts for which we compete typically have multipleyear terms, and if we are unable to win a particular contract, we generallywill be foreclosed from competing again for that contract until its expirationseveral years later. If we are unable to win new contract awards, our businessand prospects will be adversely affected. In addition, upon the expiration of acontract, if the client requires further services of the type provided by thecontract, there is frequently a competitive rebidding process. Approximately19.5% of our revenue recognized during fiscal 2005 was derived from contracts that,as of February 28, 2006, are, or are expected to become, subject torecompetition bids prior to the end of government fiscal 2006 (endingSeptember 30, 2006). 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 our employeesare unable to obtain or retain the security clearances or other qualificationsneeded to perform services for our clients.**

 

Many of our Federal Government contracts require employees and facilitiesused in specific engagements to hold security clearances and to clear agencychecks and Defense Security Service checks. Many of our contracts require us toemploy personnel with specified levels of education, work experience andsecurity clearances. Depending on the level of clearance, security clearancescan be difficult and time-consuming to obtain. If our employees or ourfacilities lose or are unable to obtain necessary security clearances orsuccessfully clear necessary agency or Defense Security Service checks, we maynot be able to win new business and our existing clients could terminate theircontracts with us or decide not to renew them. To the extent we cannot obtainor maintain the security clearances necessary for our facilities or our employeesworking on a particular contract or to the extent our facilities or ouremployees do not successfully clear necessary agency checks or Defense SecurityService checks, we may not derive the revenue anticipated from the contract,and our operating results could be materially adversely affected.

 

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

** **

We must observe laws and regulations relating to the formation,administration and performance of Federal Government contracts which affect howwe do business with our clients and impose added costs on our business. Forexample, the Federal Acquisition Regulation and the industrial securityregulations of the Department of Defense and related laws include provisionsthat:

 

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

 

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

 

•  requireus to prevent unauthorized access to classified information; and

 

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

 

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Some of our activities are subject to the export control laws andregulations administered by the Department of State, Department of Commerce,Treasury Office of Foreign Assets Control, and the Bureau of Customs andBoarder Protection Additionally, we are subject to industrial securityregulations of the DoD and other federal agencies that are designed tosafeguard against foreigners’ access to classified information. If we were tocome under foreign ownership, control or influence, we could lose our facilitysecurity clearances, which could result in our Federal Government customersterminating or deciding not to renew our contracts, and could impair ourability to obtain new contracts.

 

In addition, our employees often must comply with procedures requiredby 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 with applicable laws, regulations or procedures,including federal procurement regulations and regulations regarding theprotection of classified information, could result in contract termination,loss of security clearances, suspension or prohibition from contracting withthe Federal Government, civil fines and damages and criminal prosecution and penalties,any of which could materially adversely affect our business.

 

**The Federal Government may revise its procurement or otherpractices in a manner adverse to us.**

** **

The Federal Government may revise its procurement practices or adoptnew contracting rules and regulations, such as cost accounting standards.It could also adopt new contracting methods relating to GSA contracts, GWACs orother government-wide contracts, or adopt new standards for contract awardsintended to achieve certain social or other policy objectives, such asestablishing new set-aside programs for small or minority-owned businesses. Inaddition, the Federal Government may face restrictions from new legislation orregulations, as well as pressure from government employees and their unions, onthe nature and amount of services the Federal Government may obtain fromprivate contractors. These changes could impair our ability to obtain newcontracts or contracts under which we currently perform when those contractsare put up for recompetition bids. Any new contracting methods could be costlyor administratively difficult for us to implement, and, as a result, could harmour operating results. For example, the Truthfulness, Responsibility andAccountability in Contracting Act, proposed in 2001, would have limited andseverely delayed the Federal Government’s ability to use private servicecontractors. Although this proposal was not enacted, it or similar legislationcould be proposed at any time. Any reduction in the Federal Government’s use ofprivate contractors to provide federal information technology services couldmaterially adversely impact our business.

 

**Our contracts and administrative processes and systems aresubject to audits and cost adjustments by the Federal Government, which couldreduce our revenue, disrupt our business or otherwise adversely affect ourresults of operations.**

 

Federal governmental agencies, including the DCAA, routinely audit andinvestigate government contracts and government contractors’ administrativeprocesses and systems. These agencies review our performance on contracts,pricing practices and cost structure. They also review our compliance withapplicable laws, government regulations, policies and standards and theadequacy of our internal control systems and policies, including ourpurchasing, property, estimating, compensation and management informationsystems. Any costs found to be improperly allocated to a specific contract willnot be reimbursed, and any such costs already reimbursed must be refunded.Moreover, if any of our administrative processes and systems are found not tocomply with the applicable requirements, we may be subjected to increasedgovernment scrutiny or required to obtain additional governmental approvalsthat could delay or otherwise adversely affect our ability to compete for orperform contracts. Therefore, an unfavorable outcome to an audit by the DCAA oranother government agency, such as the Defense Security Service, or DSS, whichverifies security compliance, could materially adversely affect our

 

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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 reputational harm 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 24.6% of our total revenue in fiscal 2005 and 19.4% of our totalrevenue in fiscal 2004 from contracts under which we acted as a subcontractoror from “teaming” arrangements in which we and other contractors bid togetheron particular contracts or programs. As a subcontractor or team member, weoften lack control over fulfillment of a contract, and poor performance on thecontract could tarnish our reputation, even when we perform as required. Weexpect to continue to depend on relationships with other contractors for aportion of our revenue in the foreseeable future. Moreover, our revenue andoperating results could be materially adversely affected if any primecontractor or teammate chooses to offer a client services of the type that weprovide or if any prime contractor or teammate teams with other companies to independentlyprovide 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 we expect to realizeover the remaining life of the awarded contracts and task orders we have inhand as of the measurement date. Our total backlog consists of funded andunfunded backlog. We define funded backlog as estimated future revenues undergovernment contracts and task orders for which funding has been appropriated byCongress and authorized for expenditure by the applicable agency under ourcontracts, plus estimated future revenues we expect to receive under signedpurchase orders with commercial clients. Unfunded backlog is the differencebetween total backlog and funded backlog. Unfunded backlog reflects ourestimate of future revenues under awarded government contracts and task ordersfor which either funding has not been appropriated or expenditures have notbeen authorized. Our total backlog does not include estimates of revenue fromGWAC 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 is subject tonumerous uncertainties and estimates, and there can be no assurance that wewill 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; however, the applicable agency may elect not to exerciseits renewal options. In addition, federal contracts typically are onlypartially funded at any point during their term, and all or some of the work tobe performed under a contract may remain unfunded unless and until Congressmakes subsequent appropriations and the procuring agency allocates funding tothe contract. Our estimate of the portion of backlog from which we expect torecognize revenues in fiscal 2005 or any future period is likely to beinaccurate because the receipt and timing of any of these revenues is dependentupon subsequent appropriation and allocation of funding and is subject tovarious contingencies, such as timing of task orders, many of which are beyondour control. In addition, we may never receive revenues from some of theengagements that are included in our backlog and this risk is greater withrespect to unfunded backlog.

 

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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 GSA contracts or GWACs would impair our abilityto attract new business.**

 

We are a prime contractor under several GSA contracts and GWAC schedulecontracts. We believe that our ability to continue to provide services underthese contracts will continue to be important to our business because of themultiple opportunities for new engagements each contract provides. If we wereto lose our position as prime contractor on one or more of these contracts, wecould lose substantial revenues and our operating results could suffer. GSAcontracts and other GWACs typically have a one or two-year initial term withmultiple options exercisable at the government client’s discretion to extendthe contract for one or more years. We cannot be assured that our governmentclients will continue to exercise the options remaining on our currentcontracts, nor can we be assured that our future clients will exercise optionson any contracts we may receive in the future.

 

**If subcontractors on our prime contracts are able to securepositions as prime contractors, we may lose revenue.**

** **

For each of the past several years, as the GSA schedule contracts andGWACs have increasingly been used as contract vehicles, we have receivedsubstantial revenue from government clients relating to work performed by otherinformation technology providers acting as subcontractors to us. In some cases,companies that have not held GSA schedule contracts or secured positions asprime contractors on GWACs have approached us in our capacity as a primecontractor, seeking to perform services as our subcontractor for a governmentclient. Some of these providers that are currently acting as subcontractors tous may in the future secure positions as prime contractors. If one or more ofour current subcontractors are awarded prime contractor status in the future,it could reduce or eliminate our revenue for the work they were performing assubcontractors to us. Revenue derived from work performed by our subcontractorsrepresented approximately 15% and 16%, respectively of our revenue for each offiscal 2005 and 2004.

 

**Risks Associated with International Operations**

 

**Our international business exposes us to additional risksincluding exchange rate fluctuations, foreign tax and legal regulations andpolitical or economic instability that could materially adversely affect ouroperating results.**

** **

In connection providing services to our clients, we are sometimesrequired to engage in international operations (including internationaloperations under U.S. government contracts). Conducting international businesssubjects us to risks associated with operating in and selling to foreign countries,including:

 

•  devaluationsand fluctuations in currency exchange rates;

 

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

 

•  imposition of limitations on conversions offoreign currencies into dollars;

 

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

 

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

 

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

 

•  hyperinflationor political instability in foreign countries;

 

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

 

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

 

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

 

To the extent that our customers request us to provide services andsupport outside of the United States, these and other risks associated withinternational operations are likely to increase. Although such risks have notharmed our operating results in the past, no assurance can be given that suchrisks will not materially adversely affect our operating results in the future.

 

**Risks Related to Our Business**

 

**We may lose money or generate less than anticipated profitsif we do not accurately estimate the cost of our performance under fixed priceor time and materials contracts.**

** **

Some of our contracts require that we perform on a fixed price basis.We derived 26.2% of our total revenue in fiscal 2005 and 22.6% of our totalrevenue in fiscal 2004 from fixed price contracts. A fixed price contractgenerally provides that we will receive a specified price for our performanceunder the contract, regardless of the cost to us of such performance. Thisrequires that we accurately estimate the cost that we will incur to perform ourobligations under any contract at the time that we submit our proposal to theapplicable government agency. When making proposals for engagements on a fixedprice basis, we rely on our estimates of costs and timing for completing theprojects. These estimates are subject to numerous variables and uncertainties,and there can be no assurance that the costs of performing under any fixedprice contract will not exceed, perhaps substantially, our estimates. Anyincreased or unexpected costs or unanticipated delays in connection with theperformance of fixed price contracts, including costs 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 are performed on a time and materials basis. Atime and materials contract typically provides that we are paid a fixed hourlyrate for direct labor costs expended and reimbursed for allowable materials,costs and expenses. We derived 43.8% of our total revenues in fiscal 2005 and46.3% of our total revenues for fiscal 2004 from time and materials contracts.While time and materials contracts are generally subject to less uncertaintythan fixed price contracts, to the extent that our actual labor costs arehigher than the contract rates, we may lose money on the contract.

 

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

** **

In general, cost reimbursable contracts are the least profitable of ourgovernment contracts. Our cost reimbursable contracts generally provide forreimbursement of costs, which are determined to be reasonable, allowable andallocable to the contract, as well as payment of a fee representing the profitmargin negotiated between us and the contracting agency, which may be fixed orperformance based. Our time and materials contracts generally are moreprofitable than our cost reimbursable contracts. Cost reimbursable contractscontributed 30.0% and 31.1% of our total revenues in fiscal 2005 and fiscal2004, respectively. To the extent that cost reimbursable contracts represent anincreased proportion of our total government contracts, our operating resultscould be materially adversely affected.

 

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

** **

We operate in highly competitive markets that include a large number ofparticipants and involve intense competition to win contracts. Many of ourcompetitors may compete more effectively than we can because they are larger,have greater financial and other resources, have better or more extensiverelationships with government officials involved in the procurement process andhave greater brand or name recognition. In order to stay competitive in ourindustry, we must attract and retain the highly skilled employees necessary toprovide our services and keep pace with changing technologies and clientpreferences. In addition, some of our competitors have established alliances orstrategic relationships among themselves or with third parties in order toincrease their ability to address client needs. As a result, new competitors oralliances among competitors may emerge and compete more effectively than wecan. There is also a significant industry trend towards consolidation which mayresult in the emergence of larger companies that may be better able to competewith us. If we are unable to compete effectively, our business could bematerially 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 degree on our ability torecruit and retain the technically skilled personnel we need to serve ourclients effectively. Our business involves the development of tailoredtechnology solutions for our clients, a process that relies heavily upon theexpertise and services of our employees. Competition for skilled personnel inthe information technology services industry is intense, and technology servicecompanies often experience high attrition among their skilled employees.Recruiting and training these employees require substantial resources. Ourfailure to attract and retain technical personnel could increase our costs ofperforming our contracts, reduce our ability to meet our clients’ needs, limitour ability to win new business and constrain our ability to grow.

 

Certain types of services are subject to the Service Contract Act andthe Davis-Bacon Act. These Acts require that the contractor pay to allpersonnel assigned to the contract at least the prevailing wage and fringebenefits, as established by and in accordance with the regulations promulgatedby the Department of Labor. We have an established policy pursuant to which weevaluate RFP’s that include Service Contract Act and Davis-Bacon Actrequirements and, in the event of an award to us, ensure our compliance withthese requirements.

 

**We may be affected by intellectual property infringementclaims.**

** **

Our business operations may rely on intellectual property. Ouremployees develop some of the software solutions and other forms of intellectualproperty that we use to provide IT solutions to our customers, but we also maylicense technology from other entities. Typically, under Federal Governmentcontracts, our customers may claim rights in the intellectual property wedevelop, making it impossible for

 

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us to prevent their futureuse of our intellectual property. We are and may in the future be subject toclaims from our employees or third parties who assert that software solutions andother forms of intellectual property that we used in delivering services andsolutions to our customers infringe upon intellectual property rights of suchemployees or third parties. If our vendors, employees or third parties assertclaims that we or our customers are infringing on their intellectual property,we could incur substantial costs to defend these claims. In addition, if any ofthese infringement claims are ultimately 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.

 

**A substantial majority of our historical growth has been dueto acquisitions and we may have difficulty identifying and executing futureacquisitions on favorable terms, which may adversely affect our results ofoperations and stock price.**

 

A substantial majority of our historical growth was the result of acquisitions,and the selective pursuit of acquisitions remains one of our key growthstrategies. We cannot assure you that we will be able to identify and executesuitable acquisitions in the future on terms that are favorable to us, or atall.

 

We may encounter other risks in executing our acquisition strategy,including:

 

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

 

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

 

In connection with any future acquisitions, we may decide toconsolidate 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 or futureacquisitions is found to be impaired, by goodwill impairment charges. As ofDecember 31, 2005, assuming that the Zen acquisition had occurred on suchdate, we had approximately $225.3 million of goodwill resulting fromacquisitions on our balance sheet and, to the extent we make futureacquisitions, the amount of goodwill could increase, perhaps substantially. Anyof the businesses we acquire may also have liabilities or adverse operatingissues.

 

In addition, our ability to make future acquisitions may require us toobtain additional financing and we may be materially adversely affected if wecannot obtain additional financing for any future acquisitions. To the extentthat we seek to acquire other businesses in exchange for our common stock,fluctuations in our stock price could have a material adverse effect on ourability to complete acquisitions and the issuance of common stock to acquireother businesses could be dilutive to our stockholders. To the extent that weuse borrowings to acquire other businesses, our debt service obligations couldincrease substantially and relevant debt instruments may, among other things,impose additional restrictions on our operations, require us to comply withadditional financial covenants or require us to pledge additional assets tosecure our borrowings.

 

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

** **

The success of our acquisition strategy will depend upon our ability tosuccessfully integrate any businesses we may acquire in the future. Theintegration of these businesses into our operations may result in unforeseenevents or operating difficulties, absorb significant management attention andrequire significant financial resources that would otherwise be available forthe ongoing development of our business. These integration difficulties couldinclude the integration of personnel with disparate business backgrounds, thetransition to new information systems, coordination of geographically dispersedorganizations, loss of key employees of acquired companies and reconciliationof different corporate cultures. For these or other reasons, we may be unableto retain key clients or to retain or renew contracts of acquired companies.Moreover, any acquired business may fail to generate the revenue or net incomewe expected or produce the efficiencies or cost-savings that we anticipated.Any of these outcomes could materially adversely affect our operating results.

 

**If we are unable to manage our growth, our business may beadversely affected.**

** **

Sustaining our growth has placed significant demands on our management,as well as on our administrative, operational and financial resources. If we continueto grow, we must improve our operational, financial and management informationsystems and expand, motivate and manage our workforce. If we are unable to doso, or if new systems that we implement to assist in managing any future growthdo not produce the expected benefits, our business, prospects, financialcondition or operating results could be materially adversely affected.

 

**Systems failures may disrupt our business and have an adverseeffect on our results of operations.**

** **

Any systems failures, including failure of network, software orhardware systems, whether caused by us, a third-party service provider,unauthorized intruders and hackers, computer viruses, natural disasters, powershortages or terrorist attacks, could cause loss of data and interruptions ordelays in our business or that of our clients. In addition, the failure ordisruption of mail, communications or utilities could cause us to interrupt orsuspend our operations or otherwise harm our business. Our property andbusiness interruption insurance may be inadequate to compensate us for lossesthat may occur as a result of any system or operational failure or disruption,and insurance to cover these types of risks may not be available in the futureon terms that we consider acceptable, if at all.

 

The systems and networks that we maintain for our clients, althoughredundant in their design, could also fail. If a system or network we maintainwere to fail or experience service interruptions, we might experience loss ofrevenue or face claims for damages or contract termination. Our liabilityinsurance may be inadequate to compensate us for damages that we might incurand liability insurance to cover these types of risks may not be available inthe future on terms that we consider acceptable, or at all.

 

**If our subcontractors fail to perform their contractualobligations, our performance as a prime contractor and our ability to obtainfuture business could be materially and adversely impacted.**

** **

Approximately 15% and 16%, respectively, of our total revenue in eachof fiscal 2005 and fiscal 2004 was generated by work performed bysubcontractors who perform a portion of the work we are obligated to deliver toour clients. A failure by one or more of our subcontractors to satisfactorilydeliver on a timely basis the agreed-upon supplies and/or perform theagreed-upon services may materially and adversely affect our ability to performour obligations as a prime contractor. In extreme cases, a subcontractor’sperformance deficiency could result in the Federal Government terminating ourcontract for default. A default termination could expose us to liability forexcess costs of reprocurement by the government and have a material adverseeffect on our ability to compete for future contracts and task orders.

 

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**Our indebtedness and debt service obligations may increasesubstantially and we will be subject to restriction under debt instruments.**

** **

As of December 31, 2005, we had approximately $99.3 million ofdebt outstanding under our Credit Agreement which had a  borrowingcapacity of $160 million, comprised of a $60 million five-year revolving creditfacility and a $100 million six-year term loan facility. We further amendedthis Credit Agreement, pursuant to the First Amendment entered intocontemporaneously with the closing of our acquisition of Zen onFebruary 27, 2006, which increased the available term loan amount toapproximately $129.3 million. We had approximately $129.3 million of debt outstandingunder our Amended Credit Agreement on February 27, 2006 following theclosing of our acquisition of Zen.

 

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

 

Our indebtedness could 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 at variable rates basedupon prevailing market interest rates, which exposes us to the risk ofincreased interest rates. Also, our Amended Credit Agreement requires that wecomply with various financial covenants and impose restrictions on us,including restrictions on, among other things, our ability to incur additionalindebtedness or liens, make acquisitions and pay dividends on our capitalstock.

 

Our ability to make scheduled payments of the principal of, to payinterest on, or to refinance, our debt will depend primarily on our futureperformance, which to a certain extent is subject to the economic, financial,competitive and other factors beyond our control. There can be no assurancethat our business will continue to generate sufficient cash flow fromoperations in the future to service our debt or meet our other cash needs. Ifwe are unable to generate this cash flow from our business, we may be requiredto refinance all or a portion of our existing debt, sell assets or obtainadditional financing to meet our debt obligations and other cash needs. Wecannot assure you that any such refinancing, sale of assets or additionalfinancing would be possible on terms that we would find acceptable.

 

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If we fail to comply with the financial covenants in our Amended CreditAgreement, our lenders may exercise remedies, including requiring immediaterepayment of all outstanding amounts. These financial covenants are calculatedaccording to the definition of terms contained in the Amended Credit Agreement,which may differ from calculations using generally accepted accountingprinciples, or GAAP. The financial covenants in our credit facility followingthe acquisition of Zen include 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** | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| First Amendment Effective Date through  fiscal quarter ending June 30, 2006 |       | 3.75 to 1.00                                        |       |
| July 1, 2006 through fiscal quarter  ending June 29, 2007              |       | 3.50 to 1.00                                        |       |
| June 30, 2007 through fiscal quarter  ending June 27, 2008             |       | 3.00 to 1.00                                        |       |
| June 28, 2008 and thereafter                                                |       | 2.75 to 1.00                                        |       |

 

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

 

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

 

The borrowings and other amounts due under our Amended Credit Agreementare secured by substantially all of our current and future tangible andintangible assets, including accounts receivable, inventory and capital stockof our existing or future subsidiaries. Our ability to obtain other debtfinancing may therefore be adversely affected because the lenders under ourAmended Credit Agreement will have a prior lien on our assets to secure amountswe owe to them. In addition, upon the occurrence of specified events of defaultunder the Amended Credit Agreement, the lenders would be entitled to demandimmediate repayment of all borrowings and other amounts outstanding under theAmended Credit Agreement and to realize upon the collateral pledged under theAmended Credit Agreement to satisfy our obligations to them.

 

The Amended Credit Agreement also requires us to comply with certaincovenants, including, among others, provisions:

 

•  relatingto the maintenance of our assets securing the debt;

 

•  restrictingour ability to pledge assets or create other liens;

 

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

 

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

 

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

 

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

 

•  restrictingour ability to enter into transactions with affiliates;

 

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

 

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

 

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

 

**Risks Related to Our Common Stock**

** **

**Provisions of our charter and bylaws and Delaware law make atakeover of our company more difficult.**

** **

Our basic corporate documents and Delaware law contain provisions thatmight enable our management to resist an attempt to take over our company. Forexample, our Board of Directors can issue shares of common stock and preferredstock without stockholder approval, and the board could issue stock to diluteand adversely affect various rights of a potential acquiror. Other provisionsof our charter and bylaws that could deter or prevent a third party fromacquiring 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;

 

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

 

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

 

•  proceduresfor advance notification of stockholder nominations.

 

We are subject to Section 203 of the Delaware General CorporationLaw that, subject to exceptions, would prohibit us from engaging in anybusiness combination with any interested stockholder, as defined in thatsection, for a period of three years following the date on which thatstockholder became an interested stockholder.

 

The board could use these and other provisions to discourage, delay orprevent a change in the control of our company or a change in our management.These provisions might also discourage, delay or prevent an acquisition of ourcompany at a price that you may find attractive. These provisions could alsomake it more difficult for you and our other stockholders to elect directorsand take other corporate actions and could limit the price that investors mightbe willing to pay for shares of our common stock.

 

**Future sales of shares of our common stock and the resultingdilution that would occur with such sales could cause the market price of ourcommon stock to decline.**

** **

Sales of a substantial number of shares of common stock in the publicmarket in the course of any offering made pursuant to a registration statement,including any subsequent registration statement, or the perception that suchsales could occur, could materially adversely affect the market price of ourcommon stock and make it more difficult for us to sell equity securities in thefuture at a time and price we deem appropriate. As of March 1, 2006, wehad 11,426,232 shares of common stock outstanding.

 

31

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**Item 2. Properties**

** **

As of December 31, 2005, we leased 27 offices and 3 warehouse atvarious U.S. locations for an aggregate of 544,970 square feet in 15 states andthe District of Columbia, of which we sublease 47,861 square feet to thirdparties.

 

Our corporate offices are located at 12012 Sunset Hills Road, Reston,Virginia in approximately 68,000 square feet of leased space.

 

Our other major offices are located in Colorado Springs, Colorado,Harrisonburg, Virginia, and in the Washington DC metropolitan area.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

All of our offices are in new, or reasonably modern, well-maintainedbuildings. The facilities are substantially utilized and are adequate forpresent operations. We do not own any real estate.

 

**Item 3. Legal Proceedings**

** **

From time to time, we are involved in litigation, claims and disputesthat arise in the ordinary course of its business. In addition, we are subjectto audit, review, and investigation by various agencies of the FederalGovernment to determine compliance with applicable federal statutes andregulations. As a Federal Government contractor, we are subject to audit bycertain federal agencies to determine if our performance and administration ofour government contracts are compliant with contractual requirements andapplicable federal statutes and regulations. Whilewe cannot predict the ultimate outcome of legal proceedings, government audits,investigations, claims and disputes to which we are or may be subject, wecurrently believe, based upon information available to us as of the date ofthis filing, that any ultimate liability arising out of these matters will nothave a material adverse effect on our financial position, results ofoperations, or cash flows.

 

The SEI acquisition agreement provides for a purchase priceadjustment based upon the working capital of SEI as of the closing date.Subsequent to the closing date, we received a payment of $1.6 million inconnection with services performed prior to the closing date that SEI had notpreviously billed, and was

 

32

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

 

**Item 4. Submission of Matters To a Vote of SecurityHolders:**  The Company had no matters submitted to stockholders for their consideration during thefourth quarter ended December 31, 2005.

 

33

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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 indicated below,as reported by the Nasdaq National Market, were:

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

 

As of March 1, 2006, therewere approximately 118 holders of record of our common stock. As ofMarch 1, 2006, the closing price of our common stock was $32.61.

 

We have never declared or paid any cash dividends on our common stock.We currently intend to retain earnings, if any, to support our growth strategyand do not anticipate paying cash dividends in the foreseeable future.

 

34

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**Item 6. Selected Financial Data:  **The selected financial data presented belowfor our 2005, 2004, and 2003 fiscal years are derived from our auditedconsolidated financial statements included in this Form 10-K. The selectedfinancial data presented below for our 2002 and 2001 fiscal years are derivedfrom our audited consolidated financial statements not included in thisForm 10-K. You should read the selected financial data presented below inconjunction with the consolidated financial statements, the notes to theconsolidated financial statements and with “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” included elsewherein this Form 10-K. Our fiscal year is based on the calendar year and endseach year on the Saturday closest to December 31 of that year. **All fiscal years shown below, excluding 2005, include52 weeks. Fiscal 2005 includes 53 weeks.**

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

 

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(1)    EBITDA is defined as GAAP net income (loss)plus other expense (income), interest expense, income taxes, depreciation andamortization, change in the value of put warrants and minority interest.

 

(2)    EBITDA as calculated by us may be calculateddifferently than EBITDA for other companies. We have provided EBITDA because webelieve it is a commonly used measure of financial performance in comparablecompanies and is provided to help investors evaluate companies on a consistentbasis, as well as to enhance an understanding of our operating results. EBITDAshould not be construed as either:

 

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

 

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

 

Reconciliation of Net Income to EBITDA is as follows:

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

 

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**Item 7. Management’s Discussion and Analysis ofFinancial Condition and Results of Operations:  **The following discussion and analysis should be readin conjunction with the Item 6. “Selected Consolidated Financial Data,” the consolidated financial statements and related notes included elsewhere inthis Form 10-K, and the forward-looking disclaimer language in italicsbefore Item 1. “Business”.

 

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

 

**Overview**

** **

We are, first and foremost, a provider of information technology andnetwork solutions (IT) to the Federal Government. Our clients include the U.S.Air Force, U.S. Army, U.S. Navy, Department of State, Department of HomelandSecurity, Department of Energy, Department of Agriculture, National Institutesof Health, Federal Retirement Thrift Investment Board, National Guard Bureau,and the Intelligence community. We combine our technology and industryexpertise to provide a full spectrum of state-of-the-practice solutions andservices, from design and development to implementation and operations, whichassist our clients in achieving mission success. We believe that our company isdistinguishable from our peers within the federal IT sector in severalimportant respects.

 

We employ a “Rapid Response • Rapid DeploymentTM” methodology thatenables the rapid standing up of innovative solutions and the incorporation ofadditional capabilities in rapid succession. This capability allows us torespond to urgent IT imperatives quickly, often in a matter of months, andwithin a well defined budget. We can, therefore, provide solutions for currentIT needs, while establishing a platform for advancing long-termtransformational objectives. We possess a proven ability to respond to highpriority information technology and network needs through innovation, and anenviable reputation for timely delivery of robust solutions on assignmentswhere failure is not an option. Our Mission Critical, Mission Accomplishedsolutions enable clients to respond to new mandates, expand the scope of theirmissions, and reengineer underlying business processes. We have a demonstratedability of turning troubled IT projects into winning outcomes and realizedexceptional growth from high-quality client engagements. We also utilize matureand proven processes to manage and market large-scale ID/IQ contracts, such asC4I2TSR. We employ a diverse, innovative team that effectively utilizes smallbusiness partners’ unique skills and expertise for mission critical ITprojects.

 

**Fiscal 2005 Review and Fiscal 2006 Outlook**

 

During the past year, we experienced continued growth in our four keyfocus areas: Defense Transformation, Homeland Defense, Federal ITModernization, and Mission-Critical Outsourcing. In terms of customer concentration,the DoD continues to grow faster organically than our 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 as a weapon in the war on terrorismand to enhance operational efficiency among federal agencies drove our growthin 2005. We expect that government initiatives involving information sharing, “net-centric”warfare, and business process transformation will be among our customer base’skey focus areas in 2006.

 

With the SEI acquisition, our support to civilian agencies increased asa percentage of total revenue. SEI’s largest client was the Department ofHomeland Security. The national priority on securing our borders, along withurgent need for information sharing and other critical Department of Homeland

 

37

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

 

The addition of SEI and Bridge allowed us to continue supporting ourexisting customer base, while strengthening our position with the Deparment ofHomeland Security and the Intelligence community. After consummating the SEIand Bridge acquisitions, we realigned our practice areas in 2005 to reflect theadditional areas of expertise that we obtained from these two companies. Oureight practice areas now consist of program management & acquisitionsupport, integrated solutions development, information security, recordsmanagement, learning solutions, systems engineering, network solutions, andmission-critical outsourcing.

 

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

 

In fiscal 2005 and fiscal 2004, we received 98.1% and 96.6%,respectively, of our revenues from services we provided to various departmentsand agencies of the Federal Government, both directly and through other primecontractors, and 1.9% and 3.4%, respectively, of our total revenues from workperformed for commercial entities. The following table shows our revenues fromthe client groups listed as a percentage of total revenue. Revenue data for theDoD includes revenue generated from work performed under engagements for boththe DoD and the Intelligence community.

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

 

As a result of the Zen acquisition, we believe that the percentage ofour revenue attributable to the DoD and federal civilian agencies shouldincrease, and the percentage of our revenue attributable to commercialentities, including international operations, should decrease marginally.

 

We have derived a substantial majority of our revenues fromgovernmental contracts under which we act as a prime contractor. We alsoprovide services indirectly as a subcontractor. The following table shows ourrevenues as prime contractor and as subcontractor as a percentage of our totalrevenue for the following periods:

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

 

38

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As a result of the Zen acquisition, we believe the percentage of ourprime contract revenue may increase marginally.

 

Our services are provided under three types of contracts: costreimbursable, time and materials and fixed price contracts. The following tableshows our revenues from each of these types of contracts as a percentage of ourtotal revenue for the following periods:

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

 

As a result of the acquisition of Zen, we anticipate that during fiscalyear 2006 that the percentage of our revenue attributable to time and materialsand fixed price contracts may increase marginally.

 

Under cost reimbursable contracts, we are reimbursed for costs that aredetermined to be reasonable, allowable and allocable to the contract, and paida fee representing the profit margin negotiated between us and the contractingagency, which may be fixed or performance based. Under cost reimbursablecontracts we recognize revenues and an estimate of applicable fees earned ascosts are incurred. We consider fixed fees under cost reimbursable contracts tobe earned in proportion to the allowable costs incurred in performance of thecontract. For performance-based fees under cost reimbursable contracts, werecognize the relevant portion of the expected fee to be awarded by the clientat the time such fee can be reasonably estimated, based on factors such as ourprior award experience and communications with the client regardingperformance. In general, cost reimbursable contracts are the least profitableof our government contracts.

 

Under time and materials contracts, we are reimbursed for labor atfixed hourly rates and generally reimbursed separately for allowable materials,costs and expenses. To the extent that our actual labor costs under a time andmaterials contract are higher or lower than the billing rates under thecontract, our profit under the contract may either be greater or less than weanticipated or we may suffer a loss under the contract. We recognize revenuesunder time and materials contracts by multiplying the number of direct laborhours expended by the contract billing rates and adding the effect of otherbillable direct costs. In general, we realize a higher profit margin on workperformed under time and materials contracts than cost reimbursable contracts.

 

Under fixed price contracts, we perform specific tasks for a fixedprice. Compared to cost reimbursable and time and materials contracts, fixedprice contracts generally offer higher profit margin opportunities but involvegreater financial risk because we bear the impact of cost overruns in returnfor the full benefit of any cost savings. We generally do not undertakecomplex, high-risk work, such as long-term software development, under fixedprice terms. Fixed price contracts may include either a product delivery orspecific service performance over a defined period. Revenue on fixed pricecontracts that provide for the Company to render services throughout a periodis recognized as earned according to contract terms as the service is providedon a proportionate performance basis. While a substantial number of thesecontracts are generally less than six months in duration, we have severalmulti-year contracts of this type in which the customer has the option toextend the contractual term beyond the current term.

 

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

 

Our most significant expense is direct cost, which consists primarilyof direct labor costs for program personnel and direct expenses incurred tocomplete contracts, including cost of materials and subcontract

 

39

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

 

The allowability of certain direct and indirect costs in federalcontracts is subject to audit by the client, usually through the DCAA. Certainindirect costs are charged to contracts and paid by the client usingprovisional, or estimated, indirect rates, which are subject to later revision,based on the government audits of those costs.

 

Approximately 19.5% of our revenue recognized during fiscal 2005 wasderived from contracts that, as of February 28, 2006, are, or are expectedto become, subject to competitive bids prior to the end of government fiscal2006. We actively monitor our relationships with our clients during ourengagements, as well as the quality of the service we provide, to assist in ourefforts to win recompetition bids. In addition, we strive to maintain goodrelationships with a wide variety of government contractors.

 

**Recent Events**

** **

*Zen Acqusition.  *OnFebruary 27, 2006, we closed the acquisition of Zen. Zen is a provider ofcritical IT services, specializing in managed network services, informationassurance, software development and systems engineering, database and systemsadministration and IT consulting to various U.S. Government agencies.  Zen’slargest clients include the Missile Defense Agency (MDA), Department of Defense’sWashington Headquarters Services (WHS), Federal Communications Commission(FCC), the Pension Benefit Guaranty Corporation (PBGC), and the Federal TradeCommission (FTC).  As a result of our acquisition of Zen, we gainedapproximately 275 employees, of which approximately 50% hold securityclearances.  The acquisition of Zen provides additional scale withexisting customers as well as diversification with new government customers.

* *

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.  The purchase price is subject to a two-wayadjustment based upon whether the working capital of Zen as of the closing datewas above or below the target working capital specified in the ZenAgreement.  Each of the parties to the Zen Agreement has made customaryrepresentations and warranties and agreed to certain indemnificationobligations.   The transaction was funded through cash-on-hand, asubordinated Seller’s Note in the amount of $6 million, and borrowing from ournewly amended credit facility, which is described below. We expect theacquisition to be accretive to earnings.  Zen’s trailing twelve monthsrevenue ended November 30, 2005, was approximately $38 million (unaudited).

* *

*Amendment to Credit Facility.*  On February 27, 2006, we entered into the First Amendment. The FirstAmendment provides new terms and conditions with respect to the term loanportion of the Credit Agreement and increased the available term loan amount toapproximately $129.3 million from approximately $99.3 million. The fundsborrowed under the new term loan were used to (a) refinance the initialterm loan; (b) to finance the acquisitýionof Zen; and (c) to provide for working capital, capital expenditures andother general corporate purposes. The First Amendment amended the leverageratio that requires us to maintain a ratio of funded debt to consolidatedEBITDA for such period as follows:

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

 

40

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These ratios will be calculated in accordance withthe definitions and terms contained in the Amended Credit Agreement, which may bedifferent than calculations pursuant to GAAP.

 

*NVCContract Award.* On January 31, 2006, in a recompetitionfor our expiring National Visa Center, or NVC, contract, we were awarded thesuccessor contract for the NVC contract by the Department of State. Under thecontract, we anticipate performing over 20 million immigrant visa transactionseach year at the NVC in Portsmouth, New Hampshire and at the Kentucky ConsularCenter in Williamsburg, Kentucky. The prime contract has a one-year base periodand four one-year options with a potential value of approximately $84 million,inclusive of the options. The prior NVC contract generated 9.1% of our totalrevenues in fiscal 2005 and 9.2% of our total revenues in fiscal 2004.

 

*Accelerationof Vesting of Stock Options.* On December 13, 2005, ourBoard of Directors approved the accelerated vesting of unvested stock optionspreviously awarded to employees, officers and directors as of December 7,2005 in light of new accounting regulations that were to come into effect January 1,2006. Based on the Statement of Financial Accounting Standards No. 123R, “Share-BasedPayment” (SFAS 123R), the Board took the action to accelerate the unvestedstock with the belief that it is in the best interest of stockholders, as itwill reduce the Company’s reported compensation expense in future periods.

 

**Liquidity and Capital Resources**

 

*General.* Short-term liquidity requirements are createdby our use of funds for working capital, capital expenditures, and the need toprovide debt service. We expect to meet these requirements through acombination of cash flow from operations and borrowings under our AmendedCredit Agreement.

 

We anticipate that ourlong-term liquidity requirements, including any further acquisitions, will befunded through a combination of cash flow from operations, borrowings under ourAmended Credit Agreement, additional secured or unsecured debt or the issuanceof common or preferred stock, each of which may be initially fundedthrough borrowings under our Amended Credit Agreement.

 

*Cash andCash Equivalents.* We consider cash on deposit and all highlyliquid investments with original maturities of three months or less to be cashand cash equivalents. Cash and cash equivalents, including marketablesecurities, as of the end of fiscal 2005, fiscal 2004, and fiscal 2003 were$34.0 million, $5.8 million, and $23.3 million, respectively.

 

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

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

 

Our operating cash flow isprimarily affected by the overall profitability of our contracts, our abilityto invoice and collect from our clients in a timely manner, and our ability tomanage our vendor payments. We bill most of our clients monthly after servicesare rendered. Cash provided by operations in fiscal 2005 was attributable tonet income of $16.9 million, plus depreciation, amortization and other non-cashitems of $9.9 million. Cash used in operations in fiscal 2004 was attributableto an increase in working capital of $18.6 million, partially offset by netincome of $10.9 million plus depreciation, amortization and other non-cashitems of $6.0 million. Cash provided by operations in fiscal 2003 wasattributable to net income of $7.4 million plus depreciation, amortizationand other non-cash items of $2.6 million and a decrease in working capitalof $6.1 million.

 

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Our cash flow used ininvesting activities consists primarily of capital expenditures, the purchaseand sale of marketable securities, and acquisitions. In fiscal 2005, we paid$74.0 million for SEI, purchased $42.1 million of marketable securities, andpurchased capital assets totalling $2.7 million. We partially offset the cashuse with $36.2 million of proceeds from the sale of marketable securities. Infiscal 2004, we paid $64.9 million and $29.5 million, respectively, for Matcomand Bridge acquisitions, purchased $2.1 million of marketable securities, andpurchased capital assets totalling $1.2 million. We partially offset the cashuse with $11.0 million of proceeds from the sale of marketable securities. Infiscal 2003 we purchased $35.6 million of marketable securities and invested$1.3 million in capital assets. We partially offset the cash use with$24.7 million of proceeds from the sale of marketable securities.

 

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

 

**Results of Operations**

 

The following table setsforth certain items from our consolidated statements of operations as apercentage of revenues for the periods indicated.

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

 

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**Fiscal year 2005 compared withfiscal year 2004**

 

*Revenue.  *Substantially all of our revenue is derived from services and solutionsprovided to the Federal Government, primarily by our employees and, to a lesserextent, our subcontractors. Revenues from work under Federal Governmentcontracts increased 54.0% to $390.3 million from $253.4 million forthe same period in 2004. This increase was attributable to federal businessacquired, new contract awards, successful recompetition wins on existingprograms and growth within existing programs in our three focus areas: FederalIT Modernization/ Mission-Critical Outsourcing, Defense Transformation, andHomeland Defense. Commercial and other revenues decreased 14.5% to$7.6 million in 2005 from $8.9 million in 2004. 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.

 

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

 

*Indirectcosts.  *Indirect costs include facilities, selling,bid and proposal, indirect labor, fringe benefits and other discretionarycosts. The increase in indirect costs from fiscal 2004 to fiscal 2005 wasprimarily attributable to the expected growth of support functions necessary tofacilitate and administer the growth in direct costs. In fiscal 2005, indirectcosts were 28.4% of revenue compared to 27.4% of revenue in fiscal 2004.However, we believe in future years, indirect costs will continue to grow, butshould decrease as a percentage of sales.

 

*Depreciationand Amortization.  *Depreciation and amortization includes thedepreciation of computers, furniture and other equipment, the amortization ofthird party software we use internally, leasehold improvements and intangibleassets. As a percentage of revenue, depreciation was 0.5% for fiscal 2005 ascompared to 0.9% for the same period in fiscal 2004.

 

*Amortizationof Intangible Assets.  *Amortization of intangible assets includesthe amortization of intangible assets acquired in connection with theacquisitions in accordance with SFAS 142, Goodwill and Other Intangible Assets.We discontinued the amortization of goodwill effective December 30, 2001.Identifiable intangible assets are amortized over their estimated useful lives.Non-compete agreements are generally amortized straight-line over the term ofthe agreement, while contracts and related client relationships are amortizedproportionately against the acquired backlog. For the fiscal year ended December 31,2005, we amortized $2.3 million of intangible assets which we capitalized inconnection with the acquisitions of Bridge, SEI, and Matcom. For the fiscalyear ended December 25, 2004, we amortized $0.6 million of intangibleassets which we capitalized in connection with the acquisition of Matcom.

 

*Incomefrom operations.  *This increase in income from operations fromfiscal 2004 to fiscal 2005 was attributable primarily to the increase inrevenue. As a percentage of revenue, income from operations was 8.6% for fiscal2005 as compared to 7.9% in fiscal 2004. We anticipate continued improvement inour operating margin.

 

*Interestexpense.  *Interest expense is primarily related tointerest expense incurred or accrued 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

 

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Amended Credit Agreement made in connection with theZen acquisition. Interest expense included $705,000 and $1,000,000 ofamortization and write-off of deferred financing costs during fiscal 2005 andfiscal 2004.

 

*Provisionfor income taxes.  *Our effective tax rate is typically greaterthan the federal statutory rate of 34% due primarily to state income tax ratesand certain nondeductible expenses. Our fiscal year 2005 tax provisionrepresents an effective tax rate of 39.5%. Our fiscal 2004 tax provisionrepresents an effective tax rate of 39.3%.

 

**Fiscal year 2004 compared withfiscal year 2003**

 

*Revenue.  *Revenues from work under Federal Government contracts increased 60.7%to $253.4 million from $157.7 million for the same period in 2003.This increase was attributable to federal business acquired, new contractawards, successful recompetition wins on existing programs and growth withinexisting programs in our four focus areas: Federal IT Modernization, Defense Transformation,Homeland Defense, and Mission-Critical Outsourcing. Commercial and otherrevenues decreased 16.0% to $8.9 million in 2004 from $10.6 millionin 2003. This decrease was attributable to our continued focus on opportunitiesfor the Federal Government.

 

*Directcosts.  *The increase in direct costs from fiscal 2003to fiscal 2004 was attributable primarily to the increase in revenue. As apercentage of revenue, direct costs were 63.6% for fiscal 2004 as compared to60.6% for fiscal 2003.

 

*Indirectcosts.  *The increase in indirect costs from fiscal2003 to fiscal 2004 was primarily attributable to the expected growth ofsupport functions necessary to facilitate and administer the growth in directcosts.

 

*Depreciationand Amortization.  *The increase in depreciation and amortizationfrom fiscal 2003 to fiscal 2004 was attributed primarily to increased capitalexpenditures and the acquisition of Matcom. As a percentage of revenue,depreciation was 0.9% for fiscal 2004 as compared to 1.2% for the same periodin fiscal 2003.

 

*Amortizationof Intangible Assets.  *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. There was no amortization ofintangible assets for the fiscal year ended December 27, 2003.

 

*Incomefrom operations.  *The increase in income from operations fromfiscal 2003 to fiscal 2004 was attributable primarily to the increase inrevenue. As a percentage of revenue, income from operations was 7.9% for fiscal2004 as compared to 7.6% in fiscal 2003.

 

*Interestexpense.  *The increase in interest expense from fiscal2003 to fiscal 2004 was attributable primarily to the borrowing of debtsubsequent to the acquisition of Matcom. As a percentage of revenue, interestexpense was 1.1% for fiscal 2004 as compared to 0.4% for the same period infiscal 2003. Interest expense included $1,000,000 and $379,000 of amortizationand write-off of deferred financing costs during fiscal 2004 and fiscal 2003.

 

*Provisionfor income taxes.  *Our fiscal year 2004 tax provision representsan effective tax rate of 39.5%. Our fiscal 2003 tax provision represents aneffective tax rate of 39.3%.

 

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The following table sets forthcertain items from our consolidated statements of operations.

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

 

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**Supplemental Quarterly Information**

 

The following table setsforth quarterly unaudited consolidated financial data for the fiscal quartersof 2005 and 2004, expressed in dollars and as a percentage of total revenuesfor the respective periods. We believe that this unaudited financialinformation includes all adjustments, consisting only of normal recurringadjustments, necessary for a fair presentation of the information for eachperiod. All of the fiscal quarters reflected in the following table hadthirteen weeks, except for the fourth quarter of fiscal 2005, which hasfourteen weeks. Some unevenness of revenue from quarter to quarter existsprimarily because of the timing of purchases of materials necessary to perform certainobligations under our C4I2SR contract with U.S. Air Force Space Command. 

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

 

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**Tabular Disclosure of ContractualObligations**

 

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

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

 

Purchase obligations relatedto existing contracts are with the Federal Government and, in the event anycontracts are terminated, we would have the ability to submit a terminationclaim for outstanding purchases.

 

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

 

**Effects of Inflation**

 

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

 

**Off-Balance Sheet Arrangements**

 

During fiscal 2005, we werenot a party to any off-balance sheet arrangements.

 

**Critical Accounting Policies andEstimates**

 

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 financial statementsand the reported amounts of revenue and expenses during the periods presented.Actual results could be different from these estimates.

 

*Revenue Recognition*

 

We recognize revenue underits contracts when a contract has been executed, the contract price is fixedand determinable, delivery of services or products has occurred, andcollectibility of the contract price is considered probable and can bereasonably estimated. Revenue is earned under cost reimbursable, time andmaterials and fixed price contracts. Direct contract costs are expensed asincurred.

 

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Under cost reimbursablecontracts, we are 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. Weconsider fixed fees under cost reimbursable contracts to be earned inproportion of the allowable costs incurred in performance of the contract. Forcost reimbursable contracts that include performance based fee incentives, werecognize the relevant portion of the expected fee to be awarded by thecustomer at the time such fee can be reasonably estimated, based on factorssuch as our prior award experience and communications with the customerregarding performance.

 

Revenue on time andmaterials contracts are recognized based on direct labor hours expended atcontract billing rates and adding other billable direct costs.

 

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

 

Our contracts with agenciesof the government 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, we consider our previous experiences with our customers,communications with our customers regarding funding status, and our knowledge ofavailable funding for the contract or program. If funding is not assessed asprobable, revenue recognition is deferred until realization is deemed probable.

 

Contract revenue recognitioninherently involves estimation, including the contemplated level of effort toaccomplish the tasks under contract, the cost of the effort, and an ongoingassessment of progress toward completing the contract. From time to time, as part ofthe normal management processes, facts develop that require revisions toestimated total costs or revenues expected. The cumulative impact of anyrevisions to estimates and the full impact of anticipated losses on any type ofcontract are recognized in the period in which they become known.

 

The allowability of certaincosts under government contracts is subject to audit by the government. Certainindirect costs are charged to contracts using provisional or estimated indirectrates, which are subject to later revision based on government audits of thosecosts. Management is of the opinion that costs subsequently disallowed, if any,would not be significant.

 

*Stock Based Compensation*

 

We account for stock-basedcompensation using the intrinsic value method prescribed in APB Opinion No. 25and related interpretations. Accordingly, compensation expense for stockoptions is measured as the excess, if any, of the fair market value of ourstock at the date of the grant over the exercise price of the related option.We have adopted the annual disclosure provisions of SFAS No. 148 in ourfinancial reports for the year ended December 31, 2003. The disclosuresdetermine compensation cost for our stock options based on SFAS No. 123,which reflects the fair value of each option estimated on the date of grantusing the Black-Scholes option-pricing model.

 

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In December 2004, theFASB issued FASB Statement No. 123(R) (revised 2004), *Share Based Payment.* Statement123(R) addresses the accounting for share-based payment transactions inwhich 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 settledby the issuance of such equity instruments. Statement 123(R) requires anentity 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 permitted under Statement 123, as originally issued. The revisedStatement requires entities to disclose information about the nature of theshare-based payment transactions and the effects of those transactions on thefinancial statements. Statement 123(R) is effective for the Companybeginning January 1, 2006. All public companies must use either the modifiedprospective or the modified retrospective transition method. (See “—RecentEvents” above for a discussion of changes to our Stock Option programs.)

 

**Item 7A.Quantitative and Qualitative Disclosures About Market Risk.**

 

We are exposed to certainfinancial market risks, the most predominant being fluctuations in interestrates for borrowings under our credit facility. Interest rate fluctuations aremonitored by our management as an integral part of our overall riskmanagement program, which recognizes the unpredictability of financial marketsand seeks to reduce the potentially adverse effect on our results ofoperations. As part of this strategy, we may use interest rate swaparrangements to manage or hedge our interest rate risk. We do not usederivative financial instruments for speculative or trading purposes.

 

As of December 31,2005, we had $99.25 million outstanding under our Credit Agreement. A 1% changein interest rates would have resulted in our interest expense fluctuating byapproximately $250,000 for the three months ended December 31, 2005.

 

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

 

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

 

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

 

The consolidated financialstatements of SI International, Inc. are submitted on pages F-1through F-36 of this report.

 

49

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**Item 9.****                         ****Changes in and Disagreementswith Accountants on Accounting and Financial Disclosure.**

 

None.

 

**Item 9A.****                ****Controls and Procedures.**

 

*QuarterlyAssessment.  *We carried out an assessment as of December 31,2005 of the effectiveness of the design and operation of our disclosurecontrols and procedures and our internal control over financial reporting. Thisassessment was done under the supervision and with the participation ofmanagement, including our Chief Executive Officer and Chief Financial Officer. Rules adoptedby the SEC require that we present the conclusions of our Chief ExecutiveOfficer and Chief Financial Officer about the effectiveness of our disclosurecontrols and procedures and the conclusions of our management about theeffectiveness of our internal control over financial reporting as of the end ofthe period covered by this Annual Report on Form 10-K.

 

*CEO andCFO Certifications.  *Included as Exhibits 31.1 and 31.2 to thisAnnual Report 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 are currentlyreading is the information concerning the assessment referred to in the Section 302certifications and this information should be read in conjunction with the Section 302certifications for a more complete understanding of the topics presented.

 

*DisclosureControls and Procedures and Internal Control over Financial Reporting.  *Management is responsible for establishing and maintaining adequatedisclosure controls and procedures and internal control over financialreporting. Our disclosure controls andprocedures are designed to provide reasonable assurance that informationrequired to be disclosed in our reports filed or submitted under the ExchangeAct, such as 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 andprocedures are also designed to provide reasonable assurance that suchinformation is accumulated and communicated to our management, including ourChief Executive Officer and Chief Financial Officer, as appropriate to allowtimely decisions regarding required disclosure.  

 

Internal control overfinancial reporting is a process designed by, or under the supervision of ourChief Executive Officer and Chief Financial Officer, and effected by our Boardof Directors, management and other personnel, to provide reasonable assuranceregarding the reliability of financial reporting and the preparation offinancial statements for external purposes in accordance with GAAP and includesthose policies and procedures that:

 

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

 

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

 

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

 

*Limitationson the Effectiveness of Controls.  *Management, including our Chief ExecutiveOfficer and Chief Financial Officer, do not expect that our disclosure controlsand procedures or internal control over financial reporting will prevent allerrors and all fraud. A control system, no matter how well conceived andoperated, can provide only reasonable, not absolute, assurance that theobjectives of the control system are met. Further, the design of a controlsystem must reflect the fact that there are resource constraints, and

 

50

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the benefits of controls must be considered relativeto their costs. Because of the inherent limitations in all control systems, noassessment of controls can provide absolute assurance that all control issuesand instances of fraud, if any, within the Company have been detected. Theseinherent limitations include the realities that judgments in decision-makingcan be faulty, and that breakdowns can occur because of simple error ormistake. Additionally, controls can be circumvented by the individual acts ofsome persons, by collusion of two or more people, or by management’s overrideof the control. The design of any system of controls also is based in part uponcertain assumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions; over time, controls may become inadequatebecause of changes in conditions, or the degree of compliance with the policiesor procedures may deteriorate. Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

*Scope ofthe Assessments.  *The assessment by our Chief Executive Officerand Chief Financial Officer of our disclosure controls and procedures and theassessment by our management of our internal control over financial reportingincluded a review of procedures and discussions with our Disclosure ControlCommittee and others in the Company. In the course of the assessments,management sought to identify data errors, control problems or acts of fraudand to confirm that appropriate corrective action, including processimprovements, were being undertaken. Management used the framework in InternalControl—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO) to assess the effectiveness ofour internal control over financial reporting.

 

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

 

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

 

51

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including our Chief Executive Officer and ChiefFinancial Officer, of the effectiveness of the design and operation of ourdisclosure controls and procedures. Based upon the evaluation, our ChiefExecutive Officer and our Chief Financial Officer have concluded that as of December 31,2005 the Company’s disclosure controls and procedures were effective at thereasonable assurance level.  

 

*Management’sReport on Internal Control over Financial Reporting.  *Our management is responsible for establishing and maintaining adequateinternal control over financial reporting, as such term is defined in ExchangeAct Rules 13a-15(f) and 15d-15(f). Under the supervision and with theparticipation of our management, including Chief Executive Officer and ChiefFinancial Officer, we conducted an evaluation of the effectiveness of ourinternal control over financial reporting as of December 31, 2005 basedupon the framework in Internal Control—Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO). Basedon that evaluation, our management concluded that our internal control overfinancial reporting was effective as of December 31, 2005.

 

Management’s assessment ofthe effectiveness of our internal control over financial reporting as of December 31,2005 has been audited by Ernst & Young, LLP, an independent registeredpublic accounting firm, as stated in their report that is included elsewhereherein.

 

*Changes inInternal Control Over Financial Reporting.  *There were no changes in our internal control over financial reportingfor the fiscal year ended December 31, 2005 that has materially affected,or is reasonably likely to materially affect, our internal control forfinancial reporting.

 

**Item 9B.Other Information.**

 

None.

 

52

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**PART III**

 

The information required byItems 10, 11, 12, 13 and 14 of Part III of Form 10-K has been omittedin reliance on General Instruction G(3) and is incorporated herein byreference to the definitive proxy statement of SI International, Inc. forits 2006 annual meeting of stockholders filed with the SEC pursuant toRegulation 14A promulgated under the Securities Exchange Act of 1934, asamended.  

 

**PART IV**

 

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

 
| (a)    |   | Documents filed as part of this Report |
|--------|--------|---------------------------------------------|
|   |   |                                        |   |
|   |   | 1.                                          | Financial Statements |
|   |   |                                        |   |

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

 
|   |   | 2.     | Financial Statement Schedules                                                               |
|--------|--------|--------|---------------------------------------------------------------------------------------------|
|   |   |   |                                                                                        |
|   |   |   | Schedule II—Valuation and Qualifying Accounts                                     |
|   |   |   |                                                                                        |
|   |   | 3.     | Exhibits                                                                                    |
|   |   |   |                                                                                        |
|   |   |   | The exhibits required by this item are set forth  on the Index to Exhibits attached hereto. |

 
| (b)    |   | Exhibits                     |
|--------|--------|------------------------------|
|   |   |                         |
|   |   | See Item 15(a)(3) above |
|   |   |                         |
| (c)    |   | Not Applicable               |

 

**SIGNATURES**

 

Pursuant to the requirementsof Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized, on the 10 day of May, 2006.  

 
| ** ** | **SI INTERNATIONAL, INC.** |
|------------|---------------------------------|
|       | By:                             | /s/ S. BRADFORD ANTLE |
|       |                            | **S. Bradford Antle** |
|       |                            | ***President and  Chief Executive Officer*** |

 

53

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**INDEX TOEXHIBITS**

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

 

54

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| 10.5 |   | Non-Qualified Deferred Compensation Plan, as  amended (filed as Exhibit 10.13 to the Company’s Annual Report on Form 10-K  for the fiscal year ended December 25, 2004 and incorporated herein by  reference).                                                                                                                                  |
|------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.6 |   | Form of SI International, Inc. Stock  Option Agreement Evidencing Grant of Stock Options Under the SI International, Inc.  2002 Stock Incentive Plan, Including Notice of Stock Option Grant (filed as Exhibit 99.1  to the Company’s Current Report on Form 8-K filed on March 17, 2006  and incorporated herein by reference). |

 

55

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

 

----

*                 Indicatesfiled herewith.  

 

**          Previously filed  

 

56

----

 

**INDEX TOFINANCIAL STATEMENTS**

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

 

F-1

----

 

**Report of Independent Registered Public Accounting Firm**

 

**The Board of Directors andStockholders of SI International, Inc.**

 

We have audited the accompanying consolidatedbalance sheets of SI International, Inc. and subsidiaries (as defined inNote 1) (the Company) as of December 31, 2005 and December 25, 2004,and the related consolidated statements of operations, stockholders’ equity,and cash flows for the fiscal years ended December 31, 2005, December 25,2004, and December 27, 2003. Our audits also included the financialstatement schedule listed in the index at Item 15. These financialstatements and schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to 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 31,2005 and December 25, 2004, and the consolidated results of its operationsand its cash flows for the fiscal years ended December 31, 2005, December 25,2004, and December 27, 2003 in conformity with U.S. generally acceptedaccounting principles. Also, in our opinion, the related financial statementschedule, when considered to the basic financial statements taken as a whole,presents fairly, in all material respects, the information set forth therein.

 

We also have audited, in accordance with thestandards of the Public Company Accounting Oversight Board (United States), theeffectiveness of SI International, Inc. and its subsidiaries internalcontrol over financial reporting as of December 31, 2005, based oncriteria established in Internal Control—Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission and our reportdated March 3, 2006 expressed an unqualified opinion thereon.

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

 

F-2

----

 

**Report of Independent Registered Public Accounting Firm**

 

**The Board of Directors andStockholders of SI International, Inc.**

 

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

 

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

 

A company’s internal control over financialreporting is a process designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accountingprinciples. A company’s internal control over financial reporting includesthose policies and procedures that (1) pertain to the maintenance ofrecords that, in reasonable detail, accurately and fairly reflect thetransactions 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 accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internalcontrol over financial reporting may not prevent or detect misstatements.Also, projections of any evaluation of effectiveness to future periods aresubject to the risk that controls may become inadequate because of changesin conditions, or that the degree of compliance with the policies or proceduresmay deteriorate.

 

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

 

We also have audited, in accordance with thestandards of the Public Company Accounting Oversight Board (United States), theconsolidated balance sheets of SI International, Inc. and subsidiaries asof December 31, 2005 and December 25, 2004, and the relatedconsolidated statements of operations, stockholders’ equity, and cash flows forthe fiscal years ended December 31, 2005, December 25, 2004, and December 27,2003 and our report dated March 3, 2006 expressed an unqualified opinionthereon**.**

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

 

F-3

----

 

**SI International, Inc.Consolidated balance sheetsAs of December 31, 2005 and December 25, 2004**

**(Amounts inthousands, except share and per share data)**

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

 

The accompanying notes arean integral part of these consolidated balance sheets.

 

F-4

----

 

**SI International, Inc.Consolidated statements of operationsFor the fiscal years ended December 31, 2005, December 25, 2004, and December 27,2003**

**(Amounts inthousands, except per share data)**

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

 

The accompanying notes arean integral part of these consolidated statements.

 

F-5

----

 

**SI International, Inc.Consolidated statements of stockholders’ equityFor the fiscal years ended December 31, 2005, December 25, 2004, and December 27,2003**

**(Amounts inthousands, except share data)**

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

 

The accompanying notes arean integral part of these consolidated statements.

 

F-6

----

 

**SI International, Inc.Consolidated statements of cash flowsFor the fiscal years ended December 31, 2005, December 25, 2004, and December 27,2003**

**(Amounts inthousands)**

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

 

The accompanying notes arean integral part of these consolidated statements.

 

F-7

----

 

** **

**SI International, Inc.**

** **

**Notes toconsolidated financial statements**

 

**1. Business:**

 

SI International, Inc. (the Company or SI), was incorporated onOctober 14, 1998, under the laws of the state of Delaware. The Company isa provider of information technology and network solutions with the FederalGovernment as a major client. The Company offers a broad spectrum of solutionsand services, including design, development, implementation and operations toassist clients in achieving their missions. The Company combines technologicaland industry experience to provide solutions through service offerings in theareas of information technology applications, systems engineering, network andtelecom engineering and outsourcing.

 

On January 1, 2001, the Company separated its telecommunicationsoperations, which it obtained pursuant to an acquisition in fiscal year 2000,by contributing the net assets of the telecommunications operations to a sistercompany, SI International Telecom Corporation (SI Telecom), in exchange for5,000 shares of senior participating preferred stock in SI Telecom (SI TelecomTransaction). Warrant holders and options holders of the Company receivedwarrants and options in SI Telecom, and the existing minority shareholders inSI received a comparable minority ownership in SI Telecom. In addition, SIInternational, L.L.C. (SI L.L.C.), the majority owner of SI, contributed$1.1 million in cash and received 44,624 shares of SI Telecom juniorparticipating preferred stock (see Note 13). Upon completion of thesetransactions, the effective ownership structure of SI Telecom on a fullydiluted basis was identical with the ownership of SI. Both SI and SI Telecomwere owned in majority by SI L.L.C.

 

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

 

Since November 12, 2002, our common stock has been publicly tradedon the Nasdaq National Market under the symbol “SINT”. The completion of theinitial public offering in November of 2002 raised $47.1 million(after offering costs) in equity capital through the sale of 3,850,000 sharesof common stock. On October 6, 2004, the Company completed its secondaryoffering which raised $51.2 million (after offering costs) cash through thesale of 2,520,000 shares of common stock.

 

**2. Summary of significant accounting policies:**

 

**Principles of consolidation**

 

The accompanying consolidated financial statements include the accountsof the Company and its wholly and majority-owned subsidiaries. All significantintercompany transactions and accounts have been eliminated in consolidation.

 

**Use of estimates**

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.

 

F-8

----

 

**Reporting periods**

 

The Company’s fiscal year ends on the Saturday nearestDecember 31. **All fiscal years presented,excluding 2005, include 52 weeks**. **Fiscal2005 includes 53 weeks.**The Company’s quarters end on the Saturdaynearest to the applicable quarterly month-end.

 

**Cash and cash equivalents**

 

The Company considers all investments with original maturities of threemonths or less at the date of purchase to be cash equivalents.

 

**Marketable securities**

 

During fiscal 2004, the Company invested in auction rate securitieswhich are associated with municipal bond offerings, and had final maturitydates ranging from 2004 to 2034. These securities were previously classified ascash and cash equivalents. The accompanying December 25, 2004 ConsolidatedBalance Sheet has been adjusted to reflect the reclassification of $2.0 millionin auction rate securities from cash and cash equivalents to marketablesecurities. This reclassification had no impact on the Company’s debt covenantsor interest expense.

 

At the end of fiscal 2005, marketable securities consisted primarily ofauction rate securities with final maturity dates ranging from 2024 to 2035.All of these securities were sold during February 2006.

 

The Company’s marketable securities are classified as available forsale and are recorded at quoted market prices that approximate cost. Bothrealized and unrealized gains and losses were not material in the fiscal yearsended 2005, 2004 and 2003.

 

**Revenue recognition**

 

The Company recognizes revenue under its contracts when a contract hasbeen executed, the contract price is fixed and determinable, delivery ofservices or products has occurred, and collectibility of the contract price isconsidered probable and can be reasonably estimated. Revenue is earned undercost reimbursable, time and materials and fixed price contracts. Directcontract costs are expensed as incurred.

 

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

 

Revenue on time and materials contracts are recognized based on directlabor hours expended at contract billing rates and adding other billable directcosts.

 

Fixed price contracts may include either a product delivery or specificservice performance throughout a period. For fixed price contracts that arebased on unit pricing, the Company recognizes revenue for the number of unitsdelivered in any given fiscal period. For fixed price contracts that are basedon the proportionate performance method and involve a specified number ofsimilar acts, the Company recognizes revenue based on the proportion of thoseacts completed compared to the number of total specified acts required by thecontract. For fixed price contracts that are based on the proportionateperformance method and involve a specified number of defined but not similaracts, the Company recognizes revenue based on the proportion of the project’spercentage total costs incurred compared to the estimated total costsassociated with the entire transaction. For fixed price contracts that providefor

 

F-9

----

 

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

 

The Company’s contracts with agencies of the government are subject toperiodic funding by the respective contracting agency. Funding for a contractmay be provided in full at inception of the contract or ratably throughout thecontract as the services are provided. In evaluating the probability of fundingfor purposes of assessing collectibility of the contract price, the Companyconsiders its previous experiences with its customers, communications with itscustomers regarding funding status, and the Company’s knowledge of availablefunding for the contract or program. If funding is not assessed as probable,revenue recognition is deferred until realization is deemed probable.

 

Contract revenue recognition inherently involves estimation, includingthe contemplated level of effort to accomplish the tasks under contract, thecost of the effort, and an ongoing assessment of progress toward completing thecontract. From time to time, as part of the normal management processes, factsdevelop that require revisions to estimated total costs or revenues expected.The cumulative impact of any revisions to estimates and the full impact ofanticipated losses on any type of contract are recognized in the period inwhich they become known.

 

The allowability of certain costs under government contracts is subjectto audit by the government. Certain indirect costs are charged to contractsusing provisional or estimated indirect rates, which are subject to laterrevision based on government audits of those costs. Management is of theopinion that costs subsequently disallowed, if any, would not be significant.

 

**Significant customers**

 

Revenue generated from contracts with the Federal Government, bothdirectly and through other prime contractors, accounted for a significantpercentage of revenues in the fiscal years 2005, 2004, and 2003.

 

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

 

We had only one contract that generated more than 10% of our revenuefor fiscal year 2005 and 2004. For the fiscal year ended December 27, 2003we had two contracts that generated more than 10% of our revenue. For thefiscal year 2005, fiscal 2004, and fiscal 2003, revenue from our C4I2SRcontract with the U.S. Air Force Space Command represented approximately 19%,17%, and 22%, respectively, of total revenue. Our National Visa Center contractwith the Department of State represented approximately 14% of total revenue forthe fiscal year ended December 27, 2003.

 

**Concentrations of Credit risk**

 

The Company’s assets that are exposed to credit risk consist primarilyof cash and cash equivalents and accounts receivable. Accounts receivableconsist primarily of billed and unbilled amounts, including indirect cost ratevariances, due from various agencies of the Federal Government or primecontractors doing business with the Federal Government, and other commercialcustomers. The Company historically has not experienced significant lossesrelated to accounts receivable and therefore, believes that credit risk relatedto accounts receivable is minimal. The Company maintains cash balances that mayat times exceed

 

F-10

----

 

federally insured limits.The Company maintains this cash at high-credit quality institutions and, as aresult, believes credit risk related to its cash is minimal.

 

**Accounts receivable and allowance for doubtful accounts**

 

Accounts receivable are recorded at their face amount less an allowancefor doubtful accounts. The Company maintains an allowance for doubtful accountsat an amount that it estimates to be sufficient to cover the risk of collectingless than full payment on receivables. On a monthly basis the Companyreevaluates its receivables, especially receivables that are past due, andreassesses the allowance for doubtful accounts based on specific clientcollection issues.

 

**Property and equipment**

 

Property and equipment are stated at historical cost, net ofaccumulated depreciation and amortization. Depreciation and amortization arecomputed generally using a straight-line method over the estimated useful livesof the related assets, as follows:

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

 

**Deferred financing costs**

 

Costs incurred in raising debt are deferred and amortized as interestexpense over the term of the related debt using the effective interest method.These deferred costs are reflected as a component of other assets in theaccompanying consolidated balance sheets. The deferred financing costs consistof the following (in thousands):

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

 

During 2004, the Company wrote off approximately $584,000 of deferredloan costs related to the payoff of its term loan under the 2004 credit facility.Amortization of deferred financing costs was $705,000, $416,000 and $379,000 infiscal years 2005, 2004 and 2003, respectively.

 

**Impairment of long-lived assets**

 

Long-lived assets, including property and equipment, are reviewed forimpairment whenever events or changes in circumstances indicate that thecarrying amount should be addressed pursuant to Statement of FinancialAccounting Standards (SFAS) No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets and for Long-Lived Assets.” Pursuant to SFASNo. 144, impairment is determined by comparing the carrying value of theselong-lived assets to an estimate of the future undiscounted cash flows expectedto result from the use of the assets and eventual disposition. In the event animpairment exists, a loss is recognized based on the amount by which thecarrying value exceeds the fair value of the asset, which is generallydetermined by using quoted market prices or valuation techniques such as thediscounted present value of expected future cash flows, appraisals, or otherpricing models as appropriate. The Company believes that no such impairmentexisted in December 31, 2005 and December 25, 2004. In the event thatthere are changes in the planned use of the Company’s long-term assets or itsexpected future undiscounted cash flows are reduced significantly, the Company’sassessment of its ability to recover the carrying value of these assets couldchange.

 

F-11

----

 

**Goodwill and other intangible assets**

 

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

 

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

 

**Fair value of financial instruments**

 

The Company’s financial instruments consist primarily of cash and cashequivalents, marketable securities, accounts receivable, accounts payable,credit facilities, and long-term debt. In management’s opinion, the carryingamounts of these financial instruments approximate their fair values atDecember 31, 2005 and December 25, 2004.

 

**Stock-based compensation**

 

The Company accounts for stock-based compensation using the intrinsicvalue method prescribed in APB Opinion No. 25 and related InterpretationsNo. 44. Accordingly, compensation expense for stock options is measured asthe excess, if any, of the fair market value of the Company’s stock at the dateof the grant over the exercise price of the related option. The Company adoptedthe annual disclosure provisions of SFAS No. 148 in its financial reportsfor the year ended December 31, 2003.

 

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

 

F-12

----

 

Had compensation costs for the Company’s stock options been determinedbased on SFAS No. 123, “Accounting for Stock-Based Compensation,” theCompany’s net income and earnings per share would have been as follows (inthousands, except per share amounts):

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

 

The fair value of each option is estimated on the date of grant usingthe Black-Scholes option-pricing model with the following assumptions used forgrants during the fiscal years ended December 31, 2005, December 25,2004, and December 27, 2003:

 

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

 

**Income taxes**

 

Income taxes are accounted for using an asset and liability approachthat requires the recognition of taxes payable or refundable for the currentyear and deferred tax liabilities and assets for the future tax consequences ofevents that have been recognized in the Company’s financial statements or taxreturns. The measurement of current and deferred tax liabilities and assets arebased on provisions of the enacted tax law; the effects of future changes intax laws or rates are not considered. Net deferred tax assets are reduced, ifnecessary, by a valuation allowance for the amount of any tax benefits that,based on available evidence, are not expected to be realized.

 

**Earnings (loss) per share**

 

The Company has applied SFAS No. 128, “Earnings Per Share,” forall fiscal years presented in these consolidated financial statements. SFASNo. 128 requires disclosure of basic and diluted earnings per share (EPS).Basic EPS is computed by dividing reported earnings available to commonstockholders by the weighted average number of shares outstanding withoutconsideration of common stock equivalents or other potentially dilutivesecurities. Diluted EPS gives effect to common stock equivalents and otherpotentially dilutive securities outstanding during the period.

 

F-13

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The following details the computation of net income (loss) per commonshare:

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

 

**Segment reporting**

 

SFAS No. 131, “Disclosure about Segments of an Enterprise andRelated Information,” establishes standards for the way that public businessenterprises report information about operating segments in annual financialstatements and requires that these enterprises report selected informationabout operating segments in interim financial reports. SFAS No. 131 alsoestablishes standards for related disclosures about products and services,geographic areas and major customers. Management has concluded that the Companyoperates in one segment based upon the information used by management inevaluating the performance of its business and allocating resources andcapital.

 

**Reclassifications**

 

Certain prior year amounts have been reclassified to conform to thepresentation of the current year.

 

**New accounting pronouncements**

 

In December 2004, the FASB issued FASB StatementNo. 123(R) (revised 2004), *ShareBased Payment.* Statement 123(R) addresses the accounting forshare-based payment transactions in which an enterprise receives employeeservices in exchange for (a) equity instruments of the enterprise or(b) liabilities that are based on the fair value of the enterprise’sequity instruments or that may be settled by the issuance of such equityinstruments. Statement 123(R) requires an entity to recognize thegrant-date fair-value of stock options and other equity-based compensationissued to employees in the income statement. The revised Statement generallyrequires that an entity account for those transactions using the fair-value-basedmethod, and eliminates the intrinsic value method of accounting in APB OpinionNo. 25, *Accounting for Stock Issued toEmployees*, which was permitted under Statement 123, asoriginally issued. The revised Statement requires entities to discloseinformation about the nature of the share-based payment transactions and theeffects of those transactions on the financial statements.Statement 123(R) is effective for the Company for the fiscal yearbeginning January 1, 2006. All public companies must use either themodified prospective or the modified retrospective transition method.  

 

As permitted by Statement 123, the Company currently accounts forshare-based payments to employees using Opinion 25’s intrinsic value methodand, as such, generally recognizes no compensation cost for employee stockoption grants. Accordingly, the adoption of Statement 123(R)’s fair valuemethod will have a significant impact on our result of operations, although itwill have no impact on our overall financial position. The impact of adoptionof Statement 123(R) cannot be predicted at this time because it will depend onlevels of share-based payments granted in the future. However, had we adoptedStatement 123(R) in prior periods, the impact of that standard would haveapproximated the impact of Statement 123 as described in the disclosure of proforma net income and earnings per share in the Stock-Based Compensation sectionof this note to our consolidated financial statements. Statement 123(R) alsorequires the benefits of tax deductions in excess of recognized compensationcost to be reported as a financing cash flow, rather than as an operating cashflow as required under current literature. This

 

F-14

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requirement will reduce netoperating cash flows and increase net financing cash flows in periods afteradoption.

 

In July 2005, the FASB issued an Exposure Draft of a proposedInterpretation, *Accounting for Uncertain TaxPositions—an Interpretation of FASB Statement No. 109*. Theproposed Interpretation (if adopted in its current form) would apply to allopen tax positions accounted for in accordance with FAS 109, *Accounting for Income Taxes,* includingthose acquired in business combinations. Under the proposed Interpretation, therecognition of a tax benefit would occur when it is “probable” that theposition would be sustained upon audit. The proposed Interpretation refers toFASB Statement No. 5, *Accounting forContingencies,* definition of “probable,” which represents a level ofassurance that is substantially higher than “more likely than not.”  TheBoard noted that, in determining if the “probable” threshold has been met, itshould be assumed that the taxing authority will examine the tax position. Theproposed Interpretation differs from current rules which allow for therecognition of a tax benefit if it is “more likely than not” that the positionwould be sustained upon audit. The proposed Interpretation, as currentlydrafted (and if adopted) would be effective for fiscal years ending afterDecember 15, 2005. It is not certain that the Interpretation will beadopted with the current effective date. Management is in the process ofdetermining the effect of this proposal on its financial statements.

 

**3. Acquisitions:**

 

On February 27, 2006, we completed the purchase of Zen and enteredinto the First Amendment with our lenders as more fully set forth inNote 12, Subsequent Events.

 

On February 9, 2005, we completed the purchase of ShenandoahElectronic Intelligence, Inc. (SEI). SEI is a provider of criticalbusiness process outsourcing primarily for the Department of Homeland Security(DHS). SEI’s services include: data and records management; applicationsprocessing; file and mail management; analytical support services; and secureoptical card processing at one of the largest facilities of its kind.

 

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

 

Under the terms of the definitive stock purchase agreement, we acquiredSEI for $75 million in cash, subject to certain adjustments totalingapproximately $0.6 million. The transaction was funded through cash-on-hand andborrowings from a new $160 million credit facility. The purchase price issubject to adjustment as a result of certain tax elections. The Company, inconjunction with the SEI stockholders, have made a 338(h)(10) taxelection. The definitive stock purchase agreement also provides that the SEIstockholders will retain certain non-operating assets and contingent accountsreceivable.

 

Approximately $52.7 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 accelerated over its estimated remaining lifeof 14 years.

 

F-15

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The total purchase price paid, including transaction costs of $1.2million, has been preliminarily allocated as follows (in thousands):

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

 

On December 20, 2004, the Company completed the purchase of BridgeCorporation, a provider of information technology and information management.The acquisition supports the company’s strategic growth plan to broaden itscustomer base into the intelligence agencies, and strengthen its portfolio ofmission-critical solutions. 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 million was paid in cash and the $2.3 million was held as note payableto be 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 customer relationships.The contractual customer relationships are being amortized using anaccelerated method over their estimatedremaining life of 6 years.

 

On January 21, 2004, the Company completed the purchase of MATCOMInternational Corp., a provider of information technology, systems engineering,logistics, and training. Under the terms of the merger agreement, the Companyacquired MATCOM for $65.8 million. Approximately $54.6 million of thepurchase consideration has been allocated to goodwill, and approximately $5.0million of the purchase price has been assigned to identifiable intangibleassets on the basis of contractual customer relationships. The contractualcustomer relationships are being amortized using an accelerated method overtheir estimated remaining life of 11 years.

 

The following unaudited proforma combined condensed statements ofoperations (in thousands, except per share) set forth the consolidated resultsof operations of the Company for the twelve months ended December 31, 2005and December 25, 2004 as if the above described acquisitions, notincluding Zen, had occurred at the beginning of each period presented. Thisunaudited proforma information does not purport to be indicative of the actualresults that would actually have occurred if the combination had been in effectfor the twelve months ended December 31, 2005 and December 25, 2004.

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

 

In accordance with the purchase accounting, the operations of theMATCOM, Bridge and SEI have been included in the Company’s statement ofoperations since the respective date of acquisition.

 

F-16

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**SCOT Settlement**

 

On December 7, 2005, the Company settled a prior dispute with a Federalcustomer, resulting in the Company receiving payment of $10.8 million onDecember 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. Accounts receivable:**

 

Accounts receivable consists of the following (in thousands):

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

 

The currently billable amounts included as unbilled accounts receivableas of December 31, 2005 represent amounts which are billed during thefirst quarter of the subsequent year. They are billings for services renderedprior to year-end, which are billed once necessary billing data has beencollected and an invoice produced.

 

**5. Property and equipment:**

 

Property and equipment consist of the following (in thousands):

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

 

Property and equipment includes assets financed under capital leaseobligations of approximately

 

F-17

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

 

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

 

**6. Accrued expenses:**

 

Accrued expenses consist of the following (in thousands):

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

 

**7. Income taxes:**

 

The Company accounts for income taxes in accordance with SFASNo. 109, “Accounting for Income Taxes,” which requires recognition ofdeferred tax assets and liabilities for the expected future tax consequences ofevents that have been included in the financial statements or income taxreturns. Under this method, deferred tax assets and liabilities are determinedbased on the differences between the financial statement and the tax basis ofassets and liabilities using enacted tax rates for the year in which thedifferences are expected to reverse.

 

The tax effect of significant temporary differences, which comprise thedeferred tax assets and liabilities, are as follows (in thousands):

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

 

SI Telecom has approximately $2,040,000 in net operating losscarryforwards, which will expire in 2021. These losses can only be used tooffset income generated by SI Telecom. Management believes that

 

F-18

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

 

The provision for income taxes consists of the following for the fiscalyears (in thousands):

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

 

A reconciliation of income taxes at the Federal statutory income taxrate to the provision for income taxes is as follows (in thousands):

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

 

**8. Debt:**

 

Debt consists of the following (in thousands):

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

 

----

*                    Excludes $2.3 million note payable inconnection with the Bridge acquisition as described below.

 

The original credit facility (the 2002 credit facility) consisted of a$35.0 million secured revolving credit arrangement with Wachovia Bank, N.A.acting as Administration Agent for a consortium of lenders. With the closing ofthe acquisition of Matcom, the Company amended the 2002 credit facility inJanuary 2004. The amended credit facility (the 2004 credit facility)consists of a $30.0 million term loan and a $50.0 million securedrevolving credit arrangement. The 2004 credit facility was secured by a pledgeof substantially all of our current and future tangible and intangible assets,as well as those of our current

 

F-19

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

 

Contemporaneously with the closing of our acquisition of SEI on February 9,2005, the Company entered into the Credit Agreement which increased itsborrowing capacity to $160 million, which is comprised of a $60 millionfive-year revolving credit facility and a $100 million six-year term loanfacility. Borrowings available under the Credit Agreement were used as part ofthe acquisitions of Bridge and SEI. In addition, the Credit Agreement providesthat up to an additional $75 million in uncommitted incremental term loan fundsare available to the Company upon its request at any time for up to two yearsfrom one or more of the lenders under the Credit Agreement.

 

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

 

Any borrowings under the Credit Agreement, at the Company’s option,bears interest either at floating rates equal to LIBOR plus a spread rangingfrom 200 to 270 basis points or an alternate base rate plus a spread rangingfrom 100 to 175 basis points, with the exact spread determined upon theleverage ratio as defined in the Credit Agreement.

 

In connection with the Credit Agreement, the Company had incurredapproximately $3.2 million financing costs. Such costs were capitalized asdeferred financing costs on the balance sheet and amortized over the six yearterm of the Credit Agreement.

 

This credit facility was amended contemporaneously with the signing ofthe definitive Stock Purchase Agreement relating to the acquisition of Zen onFebruary 27, 2006.

 

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

 

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

 

**9. Commitments and contingencies:**

 

**Leases**

 

As of December 31, 2005, the Company has noncancelable operatingleases, primarily for real estate, that expire over the next seven years.Rental expense during fiscal year 2005, 2004 and 2003 was approximately$8.1 million, $6.6 million and $5.4 million, respectively.

 

F-20

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Future minimum lease payments under noncancelable operating and capitalleases as of December 31, 2005 are as follows (in thousands):

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

 

Subsequent to the purchase of SEI and Zen, the Company assumed certaincapital and operating leases held at the time of purchase.

 

**Contract cost audits**

 

Payments to the Company on government cost reimbursable contracts arebased on provisional, or estimated indirect rates, which are subject to auditon an annual basis by the Defense Contract Audit Agency (DCAA). The cost auditsresult in the negotiation and determination of the final indirect cost ratesthat the Company may use for the period(s) audited. The final rates, ifdifferent from the provisional rates, may create an additional receivable orliability for the Company. The Company’s revenue recognition policy calls forrevenue recognized on all cost reimbursable government contracts to be recordedat actual rates unless collectibility is not reasonably assured. To the extentthe indirect rate differential creates a liability for the Company, thedifferential is recognized as a reduction to revenue when identified.

 

**Litigation and claims**

 

We are a party to litigation and legal proceedings that we believe tobe a part of the ordinary course of our business. While we cannot predict theultimate outcome of these matters, we currently believe that any ultimateliability arising out of these proceedings will not have a material adverseeffect on our financial position. We may become involved in other legal andgovernmental, administrative or contractual proceedings in the future.

 

The SEI acquisition agreement provides for a purchase price adjustmentbased 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 closingdate.  The SEI selling stockholders have asserted that they are entitledto a credit in connection with the calculation of working capital adjustment inan amount equal to the amount received by us for this post-closingpayment.  We believe that, in accordance with GAAP, the SEI sellingstockholders should not receive the benefit of the post-closing payment. In accordance with the terms of the SEI acquisition agreement, the parties havejointly submitted the issue to an independent accounting firm forresolution.  We anticipate that this matter will be resolved before theend of 2006.

 

F-21

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**10. Stockholders’ equity:**

 

**Common stock**

 

In November 2002, the Company completed its initial publicoffering. The Company issued 3,850,000 shares of common stock for total netproceeds of approximately $47.1 million.In October 2004, the Company and affiliates of Frontenac, one ofthe Company’s investors, sold an aggregate of 3,200,000 shares of the Company’scommon stock in an underwritten public offering priced at $21.85 per share. Ofthe 3,200,000 shares offered, 2,200,000 shares were sold by the Company and1,000,000 shares were sold by the selling stockholders. The Company did notreceive any of the proceeds from the sale of common stock by the sellingstockholders. The Company also granted the underwriters an option to purchaseup to 320,000 shares solely to cover over-allotments, which the underwritersexercised. In connection with this offering,the Company received approximately $51.2 million in net proceeds, which wasprimarily used to payoff $27.0 million of term loan borrowings and $16.0 millionof borrowings under the revolving line of credit.

 

**Stock option plans**

 

In 2002, the Company adopted the 2002 Stock Incentive Plan, or thePlan, to grant stock options to purchase up to 1,600,000 shares of its commonstock to its employees and employees of its affiliates. In March 2004, theBoard of Directors increased the number of reserved shares by 160,000, so thatthe total number of reserved shares totaled 1,760,000. In March 2005, theBoard 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 to adopt the 2002Amended and Restated Omnibus Stock Incentive Plan (the “Amended and RestatedPlan”) and the Amended and Restated Plan was approved by our stockholders atthe annual meeting of stockholders held in June 2005. The Amended andRestated Plan amends and restates the Plan by (i) increasing the number ofshares of common stock reserved and available under the Plan by 1,000,000shares to a total share allocation of 2,920,000, (ii) permitting the grantof deferred shares, performance shares and performance units,(iii) prohibiting repricing of options without prior stockholder approval,(iv) limiting the number of shares of common stock and performance unitssubject to awards a participant may receive in any calendar year to 300,000 and500,000, respectively, and adding other administrative provisions to comply withthe performance-based compensation exception to the deduction limit ofSection 162(m) of the Internal Revenue Code of 1986, as amended;(v) eliminating the provision that previously provided for an automaticincrease in the number of shares reserved for issuance under the Amended andRestated Plan each fiscal year by a number equal to the lesser of 160,000shares 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) providing that future amendments to the Amended and Restated Planthat increase the number of shares allocated, modify participationrequirements, or materially increase benefits accruing to the participants underthe Plan will be subject to stockholder approval; and (ix) making othertechnical changes to the Plan.

 

F-22

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On December 13, 2005, the Board of Directors approved theaccelerated vesting of unvested stock options previously awarded to employees,officers and directors as of December 7, 2005 in light of new accountingregulations that were to come into effect January 1, 2006. Based on theStatement of Financial Accounting Standards No. 123R, “Share-Based Payment”(SFAS 123R), the Board took the action to accelerate the unvested stock withthe belief that it is in the best interest of stockholders, as it will reducethe Company’s reported compensation expense in future periods.

 

The Company’s option activity and price information for the three-yearperiod ended December 31, 2005 is as follows:

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

 

The following table shows the number of options, the weighted averageremaining life, and the options exercisable for each exercise price of optionsoutstanding at December 31, 2005.

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

 

Each stock option grant establishes the vesting schedule applicable tothe grant. The weighted-average remaining contractual life of the stock optionsoutstanding as of December 31, 2005 and December 25, 2004 was7.8 years and 7.8 years, respectively.

 

F-23

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During its fiscal year ended 2001 and continuing into the fiscal yearended 2002, the Company issued options with exercise prices which were lessthan the fair value of SI’s common stock at the date of option grant. Totaldeferred compensation related to these option grants was $518,000 for thefiscal year ended December 28, 2002 and $142,000 for the fiscal year endedDecember 29, 2001. This deferred compensation were amortized to expenseover the related option’s vesting period. Such non-cash stock-basedcompensation expense totaled $196,000 in fiscal year 2005, $132,000 in fiscalyear 2004, and $132,000 in fiscal year 2003.

 

The weighted-average fair value of stock options granted in fiscal year2005, 2004, and 2003 was $14.50, $13.28 and $7.80, respectively.

 

**Stock repurchase program**

 

During the company’s Board of Directors meeting on December 6, 2005,the Board authorized the repurchase of up to 300,000 shares of its common stockup to an aggregate maximum dollar amount of $8 million.  The Company hasapproximately 11.3 million shares outstanding as of December 31, 2005. Timing and volume of any purchases will be guided by management’s assessment ofmarket conditions, securities law limitations, the number of shares of commonstock outstanding, and alternative, potentially higher value uses for cashresources.  The repurchase plan may be suspended or discontinued at anytime without prior notice.

 

**11. Retirement plans:**

 

SI has a defined contribution 401(k) Retirement/Savings Plan (thePlan) to provide retirement benefits for all eligible employees of the Company.Employees are eligible to participate in the Plan beginning on the first of themonth following the start of employment and attainment of age 21. Under thePlan, eligible employees may contribute from 1% to 15% of pre-tax compensation.The Plan also allows after-tax contribution up to 5% of compensation. At itsdiscretion, the Company may make an annual matching contribution and an annualprofit-sharing contribution. For fiscal year 2004, there was no profit-sharingcontribution made to the Plan by the Company. A profit-sharing contribution of$1,200,000 and $370,000 was made by the Company for fiscal years 2005 and 2003,respectively. The Company’s matching contribution to the Plan for fiscal years2005, 2004 and 2003 was approximately $1.8 million, $1.1 million and$0.7 million.

 

**12. Subsequent Events:**

 

On February 27, 2006, we closed the acquisition of Zen. Zen is aprovider 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.  Zen’s largest clients include the Missile Defense Agency (MDA),Department of Defense’s Washington Headquarters Services (WHS), FederalCommunications Commission (FCC), the Pension Benefit Guaranty Corporation(PBGC), and the Federal Trade Commission (FTC).

 

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. The purchase price is subject to a two-wayadjustment based upon whether the working capital of Zen as of the closing datewas above or below the target working capital specified in the Zen Agreement.Each of the parties to the Zen Agreement has made customary representations andwarranties and agreed to certain indemnification obligations. The transactionwas funded through cash-on-hand, a subordinated Seller’s Note in the amount of$6 million, and borrowing from our newly amended credit facility, which isdescribed below. The purchase price is also subject to

 

F-24

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

 

Approximately $52.0 million of the 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 $7.0 millionand $0.2 million of the purchase price has been assigned to identifiableIntangible assets of contractual customer relationships and non-competeagreements, respectively. Each customer relationship, which includes eachcustomer’s contract, is being amortized on an accelerated basis over its usefullife. The non-compete agreements are amortized on a straight-line basis over a3-year period.

 

The total purchase price paid, including transaction costs of $0.4million, has been preliminarily allocated as follows (in thousands):

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

 

On February 27, 2006, contemporaneously with our closing theacquisition of Zen, we entered into the First Amendment with a syndicate oflenders, including Wachovia Bank, National Association, a national bankingassociation, which acted as administrative agent for the lenders.

 

The terms and conditions of the Amended Credit Agreement (i) establisha new term loan in the principal amount of approximately $129.3 million, whichreplaced the then existing term loan under the Credit Agreement, (ii) reduceboth the base rate margin and the LIBOR margin on the term facility,(iii) increase the leverage ratio for the financial covenants and (iv)amend certain restrictive covenants. The principal balance of the new term loanis to be repaid in quarterly installments commencing March 31, 2006, with thebalance due upon the expiration of the Amended Credit Agreement on February 9,2011. If an event of default occurs and is continuing, we may be requiredimmediately to repay all amounts outstanding under the Amended CreditAgreement.

 

The funds borrowed under the new term loan were used to (i) refinancethe approximately $99.3 million in principal outstanding under the thenexisting term loan under the Credit Agreement and to pay any and all fees andexpenses related thereto; (ii) to finance the acquisition of Zen and pay anyand all fees and expenses related thereto; and (iii) to provide for workingcapital expenditures, and other general corporate uses.

 

The borrowing capacity under the Amended Credit Agreement totalsapproximately $189.3 million and is comprised of a $60 million five-yearrevolving credit facility and approximately $129.3 million term loan facility.Additionally, a $75 million uncommitted incremental term loan facility will beavailable upon our request at any time for up to two years from the date of theCredit Agreement from one or more of the lenders.

 

F-25

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

 

On January 31, 2006, we announced that the company had beenawarded a contract for Management and Operation of the National Visa Center andKentucky Consular Center by the Department of State. Under the contract, ourwork will be performed at the National Visa Center in Portsmouth, New Hampshireand at the Kentucky Consular Center in Williamsburg, Kentucky. The prime contracthas a one-year base period and four one-year options periods.

 

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

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

 

F-26

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**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                                    |       |

 

F-27

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