##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark One) x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the Quarterly Period Ended October 3, 2004 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the transition period from  to Commission file number 0-21682 SPARTA, Inc. 
  Delaware
    
    63-0775889(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer Identification No.)
 25531 Commercentre Drive, Suite 120, Lake Forest, CA 92630-8873
(Address of principal executive offices)                    (Zip Code)
 (949) 768-8161
(Registrants telephone number, including area code)
 Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
 Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act or
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes x No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes o No x As of October 3, 2004 the registrant had 5,125,223 shares of common stock, $.01
par value per share, issued and outstanding.




---



SPARTA, Inc. QUARTERLY REPORT FOR THE PERIOD ENDED OCTOBER 3, 2004 INDEX PART I FINANCIAL INFORMATIONItem 1Financial StatementsItem 2Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 3Quantitative and Qualitative Disclosures About Market RiskItem 4Controls and ProceduresPART II OTHER INFORMATIONItem 1Legal ProceedingsItem 2Changes in Securities and Use of ProceedsItem 3Defaults Upon Senior SecuritiesItem 4Submission of Matters to a Vote of Security HoldersItem 5Other InformationItem 6Exhibits and Reports on Form 8-KSignatureExhibitsEXHIBIT 10.30EXHIBIT 10.31EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBTI 32.1
  - 1 -




---



##### Table of Contents



PART I 
 Item 1 Financial Statements - 2 -




---



##### Table of Contents



SPARTA, Inc.
CONSOLIDATED BALANCE SHEET
(Unaudited) September 30,
    
    December 31,2004
    
    2003ASSETSCurrent AssetsCash and cash equivalents
    
    $
    26,540,000
    
    
    $
    26,711,000Receivables, net
    
    
    46,307,000
    
    
    
    37,555,000Prepaid expenses
    
    
    998,000
    
    
    
    555,000Total current assets
    
    
    73,845,000
    
    
    
    64,821,000Equipment and improvements, net
    
    
    8,978,000
    
    
    
    8,367,000Other assets
    
    
    2,270,000
    
    
    
    2,097,000Total Assets
    
    $
    85,093,000
    
    
    $
    75,285,000LIABILITIES AND STOCKHOLDERS EQUITYCurrent LiabilitiesAccrued compensation
    
    $
    17,039,000
    
    
    $
    17,410,000Accounts payable and other accrued expenses
    
    
    8,474,000
    
    
    
    6,985,000Current portion of subordinated notes payable
    
    
    3,046,000
    
    
    
    2,335,000Income taxes payable
    
    
    285,000
    
    
    
    2,360,000Deferred income taxes
    
    
    925,000
    
    
    
    925,000Total current liabilities
    
    
    29,769,000
    
    
    
    30,015,000Subordinated notes payable
    
    
    8,114,000
    
    
    
    5,775,000Deferred income taxes
    
    
    228,000
    
    
    
    228,000Commitments and Contingencies (Note F)Stockholders EquityCommon stock, $.01 par value, 25,000,000 shares
authorized; 7,266,969 and 6,498,916 shares issued;
5,125,223 and 5,078,107 shares outstanding
    
    
    73,000
    
    
    
    65,000Additional paid-in capital
    
    
    67,784,000
    
    
    
    50,234,000Retained earnings
    
    
    30,105,000
    
    
    
    18,723,000Treasury stock, at cost
    
    
    (50,980,000
    )
    
    
    (29,755,000
    )Total stockholders equity
    
    
    46,982,000
    
    
    
    39,267,000Total Liabilities and Stockholders Equity
    
    $
    85,093,000
    
    
    $
    75,285,000
 The accompanying notes are an integral part of these consolidated financial statements - 3 -




---



##### Table of Contents



SPARTA, Inc.
CONSOLIDATED STATEMENT OF INCOME
(Unaudited) Three Months ended September 30,
    
    Nine Months ended September, 302004
    
    2003
    
    2004
    
    2003Sales
    
    $
    66,379,000
    
    
    $
    49,397,000
    
    
    $
    185,852,000
    
    
    $
    147,516,000Costs and expenses:Labor costs and related benefits
    
    
    31,787,000
    
    
    
    25,932,000
    
    
    
    91,773,000
    
    
    
    75,770,000Subcontractor costs
    
    
    22,463,000
    
    
    
    14,320,000
    
    
    
    59,919,000
    
    
    
    45,788,000Facility costs
    
    
    3,369,000
    
    
    
    2,685,000
    
    
    
    9,613,000
    
    
    
    7,748,000Travel and other costs
    
    
    2,492,000
    
    
    
    2,110,000
    
    
    
    6,730,000
    
    
    
    5,357,000Total costs and expenses
    
    
    60,111,000
    
    
    
    45,047,000
    
    
    
    168,035,000
    
    
    
    134,663,000Income from operations
    
    
    6,268,000
    
    
    
    4,350,000
    
    
    
    17,817,000
    
    
    
    12,853,000Interest income
    
    
    (69,000
    )
    
    
    (34,000
    )
    
    
    (204,000
    )
    
    
    (147,000
    )Interest expense
    
    
    44,000
    
    
    
    17,000
    
    
    
    124,000
    
    
    
    114,000Income before provision for
taxes on income
    
    
    6,293,000
    
    
    
    4,367,000
    
    
    
    17,897,000
    
    
    
    12,886,000Provision for taxes on income
    
    
    2,393,000
    
    
    
    1,778,000
    
    
    
    6,515,000
    
    
    
    5,256,000Net income
    
    $
    3,900,000
    
    
    $
    2,589,000
    
    
    $
    11,382,000
    
    
    $
    7,630,000Basic earnings per share
    
    $
    0.75
    
    
    $
    0.52
    
    
    $
    2.19
    
    
    $
    1.53Diluted earnings per share
    
    $
    0.69
    
    
    $
    0.48
    
    
    $
    2.00
    
    
    $
    1.41
 The accompanying notes are an integral part of these consolidated financial statements - 4 -




---



##### Table of Contents



SPARTA, Inc.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited) Nine Months ended September 30,2004
    
    2003Cash flows from operating activities:Net income
    
    $
    11,382,000
    
    
    $
    7,630,000Adjustments to reconcile net income to net
cash provided by operating activities:Depreciation and amortization
    
    
    1,816,000
    
    
    
    1,369,000Loss on sale of equipment
    
    
    11,000
    
    
    
    Stock-based compensation
    
    
    6,666,000
    
    
    
    4,242,000Tax benefit relating to stock plan
    
    
    2,497,000
    
    
    
    1,676,000Changes in assets and liabilities:Receivables, net
    
    
    (8,752,000
    )
    
    
    (1,097,000
    )Prepaid expenses
    
    
    (443,000
    )
    
    
    (46,000
    )Other assets
    
    
    (173,000
    )
    
    
    134,000Accrued compensation
    
    
    (371,000
    )
    
    
    1,658,000Accounts payable and other accrued expenses
    
    
    1,489,000
    
    
    
    1,782,000Income taxes payable
    
    
    (2,075,000
    )
    
    
    (625,000
    )Net cash from operating activities
    
    
    12,047,000
    
    
    
    16,723,000Cash flows from investing activities:Purchases of equipment and improvements
    
    
    (2,438,000
    )
    
    
    (1,265,000
    )Acquisition, net of cash acquired
    
    
    
    
    
    
    (140,000
    )Net cash used for investing activities
    
    
    (2,438,000
    )
    
    
    (1,405,000
    )Cash flows from financing activities:Proceeds from issuance of stock
    
    
    8,395,000
    
    
    
    5,404,000Cash purchases of treasury stock
    
    
    (16,348,000
    )
    
    
    (7,904,000
    )Principal payments on subordinated notes payable
    
    
    (1,827,000
    )
    
    
    (1,807,000
    )Net cash used for financing activities
    
    
    (9,780,000
    )
    
    
    (4,307,000
    )Net increase (decrease) in cash
    
    
    (171,000
    )
    
    
    11,011,000Cash and cash equivalents at beginning of period
    
    
    26,711,000
    
    
    
    17,780,000Cash and cash equivalents at end of period
    
    $
    26,540,000
    
    
    $
    28,791,000Supplemental disclosures of cash flow information:Cash paid during the period for:Interest
    
    $
    116,000
    
    
    $
    126,000Income taxes
    
    $
    6,110,000
    
    
    $
    4,257,000Non-cash investing and financing activities:Issuance of subordinated notes payable in connection
with purchases of treasury stock
    
    $
    4,877,000
    
    
    $
    183,000
 The accompanying notes are an integral part of these consolidated financial statements - 5 -




---



##### Table of Contents



SPARTA, INC.
Notes to Consolidated Financial Statements
(Unaudited) Note A  Basis of Presentation The accompanying financial information has been prepared in accordance
with the instructions to Form 10-Q and therefore does not necessarily include
all information and footnotes necessary for a fair presentation of financial
position, results of operations and cash flows in conformity with generally
accepted accounting principles. The Companys fiscal year is the 52 or 53-week period ending on the Sunday
closest to December 31. Fiscal year 2004 comprises the 53-week period ending
January 2, 2005, whereas fiscal year 2003 comprised the 52-week period ended
December 28, 2003. The third quarter of fiscal 2004 ended October 3, 2004,
whereas the corresponding third quarter in fiscal 2003 ended on September 28,
2003. The nine month period ending October 3, 2004 was comprised of 40 weeks
whereas the corresponding period in fiscal 2003 was comprised of 39 weeks. To
aid the reader of the financial statements, the year-end has been presented as
December 31, 2003 and the three-month and nine-month period ends have been
presented as September 30, 2004 and September 30, 2003. In the opinion of management, the unaudited financial information for the
three-month and nine-month periods ended September 30, 2004 and September 30,
2003 reflects all adjustments (which include only normal, recurring
adjustments) necessary for a fair presentation thereof. Certain
reclassifications have been made to the 2003 financial statements to conform to
2004 presentation. Note B  Income Taxes Income taxes for interim periods are computed using the estimated annual
effective rate method. During the three-month and nine-month periods ended
September 30, 2004, the Company recorded reductions to the income tax provision
of $0.1 million and $0.7 million, respectively. The reductions were the result
of the reversal of previously accrued taxes, primarily related to a favorable
audit of the Companys tax returns. - 6 -




---



##### Table of Contents



Note C  Computation of Earnings Per Share Three months ended September 30,
    
    Nine months ended September, 302004
    
    2003
    
    2004
    
    2003Basic EPSNet income
    
    $
    3,900,000
    
    
    $
    2,589,000
    
    
    $
    11,382,000
    
    
    $
    7,630,000Weighted average
shares outstanding
    
    
    5,166,864
    
    
    
    4,946,425
    
    
    
    5,202,309
    
    
    
    4,996,988Per share amounts
    
    $
    0.75
    
    
    $
    0.52
    
    
    $
    2.19
    
    
    $
    1.53Diluted EPSNet income
    
    $
    3,900,000
    
    
    $
    2,589,000
    
    
    $
    11,382,000
    
    
    $
    7,630,000Weighted average
shares outstanding
    
    
    5,166,864
    
    
    
    4,946,425
    
    
    
    5,202,309
    
    
    
    4,996,988Stock options
    
    
    407,901
    
    
    
    370,030
    
    
    
    413,798
    
    
    
    355,393Restricted stock
    
    
    61,613
    
    
    
    73,887
    
    
    
    61,613
    
    
    
    73,8875,636,378
    
    
    
    5,390,342
    
    
    
    5,677,720
    
    
    
    5,426,268Per share amounts
    
    $
    0.69
    
    
    $
    0.48
    
    
    $
    2.00
    
    
    $
    1.41
 Note D  Accounting for Stock-Based Compensation The Company accounts for employee stock-based compensation in accordance
with the intrinsic value method described in Accounting Principles Board
Opinion No. 25 (APB 25) and related interpretations. Had compensation expense
for these plans been determined in accordance with the fair value method
described in Statement of Financial Accounting Standards No. 123, Accounting
for Stock-Based Compensation (SFAS 123), the Companys net income and net
income per share would have been reduced to the pro forma amounts in the
following table. Three months ended September 30,
    
    Nine months ended September 30,2004
    
    2003
    
    2004
    
    2003Net incomeAs reported
    
    $
    3,900,000
    
    
    $
    2,589,000
    
    
    $
    11,382,000
    
    
    $
    7,630,000Add after-tax stock-based
compensation expense
included in determining
net income
    
    
    653,000
    
    
    
    452,000
    
    
    
    1,313,000
    
    
    
    1,185,000Deduct after-tax stock-based
compensation expense as
if the fair value method had
been used
    
    
    (976,000
    )
    
    
    (773,000
    )
    
    
    (2,275,000
    )
    
    
    (2,101,000
    )Pro forma net income
    
    $
    3,577,000
    
    
    $
    2,268,000
    
    
    $
    10,420,000
    
    
    $
    6,714,000Basic EPSAs reported
    
    $
    0.75
    
    
    $
    0.52
    
    
    $
    2.19
    
    
    $
    1.53Pro forma
    
    
    0.69
    
    
    
    0.46
    
    
    
    2.00
    
    
    
    1.34Diluted EPSAs reported
    
    
    0.69
    
    
    
    0.48
    
    
    
    2.00
    
    
    
    1.41Pro forma
    
    
    0.64
    
    
    
    0.42
    
    
    
    1.86
    
    
    
    1.24
 - 7 -




---



##### Table of Contents



Note E  Stockholders Equity For the nine months ended September 30, 2004, proceeds from the issuance
of common stock, primarily as the result of exercises of stock options, totaled
$8.4 million. In addition, the Company repurchased a total of 717,744 common
shares at their current fair value totaling approximately $21.2 million. Of
this total, the Company repurchased $16.3 million for cash, and $4.9 million by
delivery of promissory notes. The promissory notes provide for principal
payments over periods ranging from two to seven years, plus interest. Treasury stock is shown at cost, and consisted of 2,138,553 shares and
1,420,809 shares of common stock at September 30, 2004 and December 31, 2003,
respectively. Repurchase of outstanding stock by the Company in exercise of
its right of repurchase upon termination of employment (as defined) are made at
estimated fair value. The stock price is calculated quarterly by the Company
using a formula approved by the Board of Directors (which the Company believes
estimates fair value). The stock price formula is evaluated annually by
reference to discounted cash flow analysis and other financial valuation
techniques. Certain employees are eligible to participate in a program whereby they
may exercise certain stock options by delivery of a note payable to the
Company. The notes are full recourse, are secured by the underlying shares of
common stock, bear interest at prime plus 0.5%, and are repaid through payroll
deductions over a period of less than one year. At September 30, 2004 and
December 31, 2003, the outstanding principal balances of these notes were
$868,000 and $560,000, respectively, and are included as an offset to
additional paid-in capital. Note F  Commitments and Contingencies The Company has no material investigations, claims, or lawsuits arising
out of its business, nor any known to be pending. The Company is subject to
certain legal proceedings and claims that arise in the ordinary course of its
business. In the opinion of management, the ultimate outcome of such matters
will not have a material impact on the Companys financial position, results of
operations or cash flows. During the third quarter of 2004, the U.S. government terminated for its
convenience several task orders on one contract. The contract value of the
terminated task orders totaled $23 million; however, approximately $9 million
of the total termination amount was incurred prior to the effective date of the
termination and has been, or is expected to be, paid to the Company. As of
September 30, 2004, the Company was unable to bill approximately $2 million of
costs incurred on the terminated task orders. These costs were incurred prior
to the effective date of the termination. The Company believes that the delay
in its ability to bill these costs is temporary and that these costs will
ultimately be paid by the U.S. government. The Company believes that this
termination will not have a material effect on the Companys financial
condition or results of operations. Note G  Recent Accounting Pronouncements In January 2003, the FASB issued FIN 46, which requires that certain
variable interest entities be consolidated by the primary beneficiary of the
entity if the equity investors in the entity do not have a controlling
financial interest or do not have sufficient equity at risk. FIN 46 is
effective immediately for all variable interest entities created after January
31, 2003. For all such entities created prior to February 1, 2003, FIN 46 is
effective for interim or annual fiscal periods ending after December 15, 2003.
Adoption of this statement did not have a material effect on the Companys
financial position or results of operations. - 8 -




---



##### Table of Contents



In December 2003, the FASB replaced FIN 46 with FIN 46R to clarify the
application of Accounting Research Bulletin Number 51, Consolidated Financial
Statements, to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support. FIN 46R was effective for all public entities
that have interest in variable interest entities or potential variable interest
entities commonly referred to as special-purpose entities for periods ending
after December 15, 2003. Application by public entities for all other types of
entities is required in financial statements for periods ending after March 15,
2004. Adoption of this statement did not have a material effect on the
Companys financial position and/or results of operations. In April 2003, the FASB issued SFAS 149, which amends and clarifies
accounting guidance on derivative instruments and hedging activities. In May
2003, the FASB issued SFAS 150, which addresses accounting for certain
financial instruments that have characteristics of both liabilities and equity.
The Company has not entered into derivative instruments covered by SFAS 149 or
financial instruments covered by SFAS 150. Adoption of these statements
therefore did not have a material effect on the Companys financial position or
results of operations. In March 2004, the EITF reached a consensus on EITF 03-01, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments
(EITF 03-01). EITF 03-01 provides guidance to determine when an investment is
considered to be impaired, whether that impairment is other than temporary, and
the measurement of an impairment loss. It also requires disclosure related to
unrealized losses that have not been recognized as other-than-temporary
impairments. The recognition and measurement guidance was effective for
other-than-temporary impairment evaluations in the third quarter of 2004 and
did not have a material impact to the Companys consolidated financial
position, results of operations or cash flows. The other provisions of EITF
03-01, which principally consist of disclosure requirements, are not expected
to have a material impact to the Companys consolidated financial position,
results of operations or cash flows. 
 Item 2 Managements Discussion and Analysis of Financial Condition and Results
of Operations Results of Operations The Companys fiscal year is the 52 or 53-week period ending on the Sunday
closest to December 31. Fiscal year 2004 comprises the 53-week period ending
January 2, 2005, whereas fiscal year 2003 comprised the 52 week period ended
December 28, 2003. The nine-month period ending October 3, 2004 was comprised
of 40 weeks whereas the corresponding period in 2003 comprised 39 weeks. - 9 -




---



##### Table of Contents



The following tables present certain key operating data for the periods
indicated: Operating Results(amounts in thousands, except percentages)Three months ended September 30,
    
    Nine months ended September 30,2004
    
    2003
    
    2004
    
    2003Sales
    
    $
    66,379
    
    
    $
    49,397
    
    
    $
    185,852
    
    
    $
    147,516Sales by business area, as a
percentage of total sales:Ballistic Missile Defense (BMD)
    
    
    48
    %
    
    
    48
    %
    
    
    47
    %
    
    
    48
    %Other Dept of Defense (DoD)
    
    
    49
    %
    
    
    49
    %
    
    
    50
    %
    
    
    49
    %Non-DoD
    
    
    3
    %
    
    
    3
    %
    
    
    3
    %
    
    
    3
    %Gross profit (1)
    
    $
    6,770
    
    
    $
    4,561
    
    
    $
    19,296
    
    
    $
    13,566Gross profit as a % of costs (1)
    
    
    11.4
    %
    
    
    10.2
    %
    
    
    11.6
    %
    
    
    10.1
    %Income from operations
    
    $
    6,268
    
    
    $
    4,350
    
    
    $
    17,817
    
    
    $
    12,853Net income
    
    $
    3,900
    
    
    $
    2,589
    
    
    $
    11,382
    
    
    $
    7,630
  (1)
    
    Under SEC regulations, data derived from consolidated financial
information but not required by GAAP to be presented in the financial
statements are considered non-GAAP financial measures. Gross profit,
as defined, and gross profit as a percentage of costs are non-GAAP
financial measures. The Company defines gross profit as sales less
contract costs. Contract costs are all costs that are allowable for
and allocable to contracts under government procurement regulations.
As such, gross profit excludes certain unallowable expenses.
Management considers gross profit, and gross profit as a percentage of
costs, to be key measures of the Companys contract performance. They
should also be considered in conjunction with income from operations,
net income, and other measures of financial performance. The following
presents a reconciliation of gross profit to income from operations
(amounts in thousands): Three months ended September 30,
    
    Nine months ended September 30,2004
    
    2003
    
    2004
    
    2003Gross profit
    
    $
    6,770
    
    
    $
    4,561
    
    
    $
    19,296
    
    
    $
    13,566Less unallowable expenses
    
    
    (502
    )
    
    
    (211
    )
    
    
    (1,479
    )
    
    
    (713
    )Income from Operations
    
    $
    6,268
    
    
    $
    4,350
    
    
    $
    17,817
    
    
    $
    12,853
 The Companys sales for the three-month period ended September 30, 2004
increased 34%, from $49.4 million for the third quarter of 2003 to $66.4
million for the third quarter of 2004. Year-to-date sales for 2004 are $185.9
million, an increase of 26% above the first three quarters of 2003. The most
significant contributor to the Companys revenue growth was other DoD programs,
where revenues increased 35%, from $24.2 million for the three-month period
ended September 30, 2003 to $32.5 million for the corresponding period in 2004.
Similarly, year-to-date revenue on other DoD programs increased 31%, from
$71.5 million in 2003 to $93.7 million in 2004. The increase in other DoD
revenues was primarily due to revenue growth on training and range management
programs for the U.S. Army, on engineering support programs for the U.S. Army
and U.S. Air Force, and on composite production for unmanned air vehicle
components for a variety of military customers. In addition, other DoD
revenues increased due to increased revenue on programs for a variety of
intelligence agencies as a result of the governments increased focus on
intelligence in response to the terrorist attacks of September 11.
Revenue on BMD programs increased 20%, from $26.6 million during the third
quarter of 2003 to $31.8 million for the third quarter of 2004. Year-to-date,
BMD program revenue increased 22%, from $71.1 million in 2003 to $86.6 million
in 2004. In addition to continuing its work on BMD systems engineering and
technical analysis, the Company has generated growth in its BMD business base
through penetration of other BMD program elements. The gross profit rate (gross profit as a percentage of contract costs)
increased from 10.2% in the third quarter of 2003 to 11.4% in the third quarter
of 2004. Year-to-date gross profit increased from 10.1% for the nine months
ended September 30, 2003 to 11.6% for the nine months ended September 30, - 10 -




---



##### Table of Contents



2004. The increase in the gross profit rate is primarily attributable to the mix of
contract types, as the Company has continued to experience a decline in the
percentage of revenues derived from cost reimbursable contracts. During the
three-month and nine-month periods ended September 30, 2004, time and material
and fixed price contracts comprised 43% and 42%, respectively, of total sales,
compared with 36% and 35% of total sales in the corresponding periods in 2003.
The Company generally earns higher profits on time and material and fixed price
contracts than it does on cost reimbursable contracts, due to the greater risk
associated with such contract types. The Company earned net interest income during the third quarters of 2004
and 2003 and for the nine-month periods ended September 30, 2004 and 2003. The
increase in net interest income for the three- and nine-month periods in 2004,
compared to the corresponding periods in 2003, is primarily attributable to
higher average levels of invested cash and lower average debt levels in 2004.
Both the Companys investments in cash equivalents and the Companys long-term
debt are floating rate. Accordingly, the change in average short- and
medium-term interest rates from 2003 to 2004 had a minimal effect on net
interest. The Companys effective income tax rate was 38% and 41% during the third
quarter of 2004 and 2003, respectively, and 36% and 41% for the corresponding
nine-month periods. The decrease in the effective tax rate in 2004 is
primarily attributable to a reduction in the income tax provision during the
second and third quarters. The reduction, which totaled $0.7 million, was the
result of the reversal of previously accrued taxes, primarily related to a
favorable audit of the Companys tax returns. The decrease in the effective
tax rate in 2004 is also attributable to a decline in the Companys effective
state tax rate. Backlog Funded annualized contract backlog represents all current contracts on
which the Company expects to perform during the next 12 months for which the
Company has received funding from its customer. Unfunded annualized contract
backlog includes the expected value during the next 12 months of future
incremental funding on existing contracts and on certain proposals where the
Company expects a high probability of winning the procurement. Multi-year
contract backlog represents total funded and unfunded contract backlog, without
regard to when the relevant contracts will be performed. Historically, the Companys end-of-year annualized contract backlog has
generally been indicative of its revenues in the following year. For example,
annualized contract backlog as a percentage of the following years sales was
86%, 88%, and 96%, in 2003, 2002, and 2001, respectively. Although the
Companys backlog has historically been indicative of its future revenues,
there can be no assurance that this will continue. The Companys backlog is
typically subject to variations from year to year as contracts are completed,
major existing contracts are renewed, or major new contracts are awarded.
Additionally, all U.S. Government contracts included in backlog, whether or not
funded, may be terminated at the convenience of the U.S. Government. Moreover,
U.S. Government contracts are conditioned upon the continuing availability of
congressional appropriations. New presidential administrations, changes in the composition of Congress, and disagreement or
significant delay between Congress and the Administration in reaching a defense
budget accord can all significantly affect the timing of funding on the
Companys contract backlog. Delays in contract funding resulting from these
factors may have a significant adverse effect on the Companys financial
position and results of operations. - 11 -




---



##### Table of Contents



The following table compares the Companys contract backlog as of the
dates indicated: Contract Backlog(amounts in thousands)September 30,
    
    December 31,
    
    September 30,2004
    
    2003
    
    2003Funded
    
    $
    95,400
    
    
    $
    76,900
    
    
    $
    85,200Unfunded
    
    
    127,700
    
    
    
    126,200
    
    
    
    113,900Total annualized contract backlog
    
    $
    223,100
    
    
    $
    203,100
    
    
    $
    199,100By business area:BMD
    
    $
    100,800
    
    
    $
    90,800
    
    
    $
    92,100Other DoD
    
    
    115,000
    
    
    
    105,100
    
    
    
    100,900Non-DoD
    
    
    7,300
    
    
    
    7,200
    
    
    
    6,100Total annualized contract backlog
    
    $
    223,100
    
    
    $
    203,100
    
    
    $
    199,100Multi-year contract backlog
    
    $
    737,000
    
    
    $
    556,000
    
    
    $
    655,000
 The annualized contract backlog increased from $203.1 million at the end
of 2003 to $223.1 million as of September 30, 2004, an increase of 10%. BMD
contract backlog increased $10.0 million, or 11%, during the first nine months
of 2004, as the Company continued to expand its BMD engineering support
provided to both the Missile Defense Agency and the U.S. Army. Other DoD
contract backlog increased $9.9 million, or 9% during the first nine months of
2004, primarily in intelligence programs for the national and military
intelligence communities and in training and range support programs for the
U.S. Army. Non-DoD contract backlog increased $0.1 million, or 1%, during the
first nine months of 2004. In the third quarter of 2004, the Company had eight significant
competitive contract/task-order wins and ten significant competitive
contract/task-order losses. In the Missile Defense Sector, the Space and
Missile Defense Operation (SMDO), as a subcontractor to Lockheed Martin, won a
competitive contract from the U.S. Strategic Command for the Integrated Systems
Planning and Analysis Network. This is an $8 million contract over a period of
ten years, with the potential to evolve into a $20 million effort. The
Advanced Systems Technology Operation (ASTO) won a competitive contract with
the Joint Single Integrated Air Picture Systems Engineering Organization for
the Integrated Air and Missile Defense (IAMD) program. This is a $3.2 million
effort over two years. ASTO also won a role as a subcontractor to Schafer
Corporation on a Multiple Award Task Order Contract for the Office of Naval
Research. The Company anticipates revenues on this Indefinite
Delivery/Indefinite Quantity (IDIQ) contract of $1.0 million over five years. In the Mission Systems Sector, the Defense Systems and Technology
Operation (DSTO) won a role as a subcontractor on two Systems Engineering and
Technical Assistance (SETA) contracts from the Space and Naval Warfare Systems
Command. The Company is a subcontractor to Tri Star Engineering, Inc. on the
Small SETA Multiple Award Contract and a subcontractor to Science Applications
International Corporation (SAIC) on the Large SETA Multiple Award Contract.
Both awards are four-year IDIQ contracts with large ceilings. The Company anticipates revenues
totaling $4 million on each contract. In the National Systems Security Sector, the Applied Communications and
Technology Operation (ACTO) won a classified contract from the Defense Advanced
Research Projects Agency (DARPA) valued at $1.75 million over nine months. As
a subcontractor to the QSS Group, Inc., the Information Systems and Security
Operation (ISSO) won a task on the National Security Agencys (NSA) ATLAS 
HIGHSTREET IDIQ contract valued at $2.5 million over five years. - 12 -




---



##### Table of Contents



Finally as the prime contractor, the Military Systems Operation (MSO) won
the Offensive Missile Systems contract from the Missile and Space Intelligence
Center, a $43 million effort over five years. In the third quarter, ASTO had three competitive losses. The first was as
a subcontractor to Coleman Technologies, Inc. for a SETA bid to the Missile
Defense Agency QS organization. The subcontract to Sparta was valued at $2
million over four years. The second was as a subcontractor to Draper
Laboratories for a bid to DARPA on the Joint Unmanned Combat Air Systems
program. The value of this effort was $2.5 million over five years. The
third, as a subcontractor to Anteon Corporation, was a SETA bid to the Joint
Theater Air and Missile Defense Organization. The value of this subcontract to
SPARTA was $12.5 million over a five-year period. The Defense Program
Operation (DPO) lost a bid to DARPA for the Real Time Adversarial Intelligence
and Decision program. DPO bid the effort as the prime contractor, and the
value was $8 million over three years. As a subcontractor to Booz Allen
Hamilton, the Technical and Acquisition Support Operation (TASO) lost a
competitive bid for the Operations Planning Training and Resource Support
Services contract from the U.S. Army at Fort Hood, Texas. The value of this
effort was $32 million over five years. Bidding as the prime contractor, DSTO lost the DARPA Terahertz Imaging
Focal Plane Array Technology contract, valued at $3 million over eighteen
months. As a subcontractor to Alion Science and Technology Corporation, DSTO
also lost a role on the SETA contract for the Joint Program Executive Office
for Chemical and Biological Defense, an effort valued at $20 million over five
years. DSTO also lost a bid to the Defense Threat Reduction Agency on their
Global Strike program, a $3.6 million four-year effort. DSTO was a
subcontractor to Cubic Corporation on this effort. Finally, ISSO lost two competitive bids to the NSA. The first was for the
Engineering Technical Support II  Computer Network Defense and Response
Systems program where the Company was a subcontractor to Titan Corporation.
This contract was valued at $2 million over three years. The second was for
the Defense Against Cyber Attacks on Mobile Ad Hoc Networks where the Company
bid as a subcontractor to the Johns Hopkins University. This was a $2 million
contract over three years. Liquidity and Capital Resources The following tables sets forth, for the periods indicated, selected
financial information: Balance atSeptember 30
    
    December 31,
    
    September 30,2004
    
    2003
    
    2003Cash and cash equivalents
    
    $
    26,540,000
    
    
    $
    26,711,000
    
    
    $
    26,646,000Stockholders equity
    
    $
    46,982,000
    
    
    $
    39,267,000
    
    
    $
    35,867,000Subordinated notes payable
    
    $
    11,160,000
    
    
    $
    8,110,000
    
    
    $
    8,730,000Borrowings under line of credit
    
    
    
    
    
    
    
    
    
    
    Number of days sales in
receivables
(year-to-date average)
    
    
    62
    
    
    
    62
    
    
    
    63Current ratio
    
    
    2.5
    
    
    
    2.1
    
    
    
    2.2
 - 13 -




---



##### Table of Contents



Overview The Companys principal sources of capital for funding its operations are
funds generated by ongoing business activities and proceeds from the exercise
of stock options and the issuance of common stock. These sources may be
augmented, if necessary, by borrowings under the Companys bank line of credit.
The principal uses of capital are for the repurchase of common stock,
repayments of amounts borrowed under the bank line of credit, principal
payments on subordinated promissory notes, and capital expenditures. U.S. Government contracts are conditioned upon the continuing availability
of congressional appropriations. Congress usually appropriates funds on a
fiscal year basis, even though contract performance may take several years.
Consequently, at the outset of a major program, the contract is usually
partially funded and additional monies are normally committed to the contract
by the procuring agency only as Congress makes appropriations for future years.
These appropriations are therefore subject to changes as a result of increases
or decreases in the overall budget. New presidential administrations, change
in the composition of Congress, and disagreement or significant delay between
Congress and the Administration in reaching a defense budget accord can all
significantly affect the timing of funding on the Companys contract backlog.
Delays in contract funding resulting from these factors may have a significant
adverse effect on the Companys liquidity and days sales outstanding (DSO). The Companys bank line of credit provides for borrowings of up to $6.0
million, and matures July 2, 2007. Borrowings under the line of credit
agreement are secured by accounts receivable and certain equipment and
improvements, and bear interest at the prime rate. The line of credit
agreement prohibits the payment of dividends by the Company without the banks
prior consent and requires the Company to maintain certain financial ratios.
The Company was in compliance with all such requirements at September 30, 2004.
The Company believes that, as in the past, it will be able to renew its
banking agreement under similar terms. There were no amounts outstanding under
the bank line of credit at September 30, 2004. Generally, the Company limits its stockholders to current employees and
directors of the Company. Accordingly, the Companys Amended and Restated
Certificate of Incorporation places restrictions on the transferability of the
Companys common stock and grants the Company the right, but not the
obligation, to repurchase the shares held by any stockholder whose association
with the Company terminates. Although not obligated to do so, the Company
generally exercises its right to repurchase the stockholdings of all
individuals terminating their association with the Company, so as to retain all
stockholdings among active employees and directors. As of September 30, 2004,
the percentage of the Companys outstanding common stock held by former
employees totaled approximately 3.5%. In addition to repurchasing the stockholdings of terminated employees, the
Company has established and maintains a program that periodically permits the
Companys stockholders to offer shares for sale to the Company. The Companys
repurchase program, which is conducted on a quarterly basis, is a voluntary
program on the part of the Company, and the Companys stockholders therefore
have no right to compel the Company to repurchase any of the stockholders shares.
There can be no assurance that the Company will continue its voluntary
repurchase program. Moreover, the number of shares that the Company may
repurchase is subject to legal restrictions imposed by applicable corporate law
affecting the ability of corporations generally to repurchase shares of their
capital stock. In addition, the number of shares which the Company may
repurchase is subject to a self-imposed quarterly repurchase limitation which
is designed to ensure that the Companys repurchase of its shares does not
materially impair the Companys liquidity or financial condition. The Board of
Directors may approve waivers to the self-imposed quarterly repurchase
limitation. - 14 -




---



##### Table of Contents



Cash Flow Information During the nine months ended September 30, 2004 the Companys cash
balances declined $0.2 million compared with the prior year end. Operating activities generated $12 million in cash during the first nine
months of 2004. The Company generated $11.4 million in net income through the
nine months ended September 30, 2004. Non-cash expenses totaled $8.5 million,
of which $6.7 million related to the Companys practice of issuing shares of
common stock in connection with certain compensation and benefit plans. The
Company expects to continue to follow this practice for the foreseeable future.
The Company also generated cash flow (in the form of a reduction in its income
tax liabilities) of $2.5 million as a result of the income tax benefit relating
to its stock compensation plans. The Company used $10.3 million in cash for working capital during the
first three quarters of 2004, principally to reduce income taxes payable and to
fund an increase in accounts receivable. Year-to-date sales through September
30, 2004 increased 26% in comparison with the corresponding period in 2003, and
accounts receivable increased 23% from $37.6 million at December 31, 2003 to
$46.3 million at September 30, 2004. Average year-to-date DSO of 62 days as of
September 30, 2004 is unchanged from 62 days as of December 31, 2003, but
decreased slightly from 63 days as of September 30, 2003. The relatively
constant DSO resulted in an increase in accounts receivable commensurate with
the increase in sales. The Company continues to emphasize rapid billing and
collection of its receivables, however, there can be no assurance that the
Company will be able to reduce, or maintain, its average DSO. Approximately 25% of the increase in accounts receivable stems from a
delay in the Companys ability to bill approximately $2 million in costs
incurred on certain task orders (on one contract) that were terminated for the
convenience of the U.S. government during the third quarter of 2004. The
unbilled costs related to the terminated task orders were incurred prior to the
effective date of the termination. The Company believes that the delay in its
ability to bill these costs is temporary and the costs will ultimately be paid
by the U.S. government. The Company believes that this termination will not
have a material effect on the Companys financial condition or results of
operations. Through the nine months ended September 30, 2004 the Companys capital
expenditures totaled approximately $2.4 million, an increase of $1.2 million
over the corresponding period in 2003. The increase in capital expenditures is
primarily attributable to growth in the number of employees, requiring
investment in computer equipment, software, and improvements to leased
facilities. The Company currently does not expect a significant change in its
level of capital expenditures. In connection with the aforementioned stock repurchase policies; during
the nine months ended September 30, 2004, the Company repurchased a total of
717,744 common shares totaling approximately $21.2 million of which $11.3
million was repurchased during the third quarter. Of the yearto-date total,
$4.9 million was repurchased in exchange for promissory notes and $16.3 million
was repurchased for cash. Year-to-date principal payments on promissory notes as of the end of the
third quarter of 2004 totaled $1.8 million. Proceeds from the issuance of
common stock, primarily as the result of exercises of stock options, totaled
$8.4 million. The Company anticipates that its existing capital resources and access to
its line of credit will be sufficient to fund planned operations for the next
year and for the foreseeable future. The Companys significant contractual obligations relate to subordinated
promissory notes and operating lease commitments. As of September 30, 2004 the
Company has no significant commercial - 15 -




---



##### Table of Contents



commitments, nor significant commitments
for capital expenditures. As of September 30, 2004 contractual obligations are
payable as follows: Payments Due by Period(amounts in thousands)Total
    
    Current
    
    1-3 years
    
    4-5 years
    
    After 5 yearsSubordinated Promissory Notes
    
    $
    11,160
    
    
    $
    3,046
    
    
    $
    5,159
    
    
    $
    1,891
    
    
    $
    1,064Operating Leases
    
    
    29,850
    
    
    
    6,452
    
    
    
    12,321
    
    
    
    8,856
    
    
    
    2,221Total Contractual Obligations
    
    $
    41,010
    
    
    $
    9,498
    
    
    $
    17,480
    
    
    $
    10,747
    
    
    $
    3,285
 Recent Accounting Pronouncements In January 2003, the FASB issued FIN 46, which requires that certain
variable interest entities be consolidated by the primary beneficiary of the
entity if the equity investors in the entity do not have a controlling
financial interest or do not have sufficient equity at risk. FIN 46 is
effective immediately for all variable interest entities created after January
31, 2003. For all such entities created prior to February 1, 2003, FIN 46 is
effective for interim or annual fiscal periods ending after December 15, 2003.
Adoption of this statement did not have a material effect on the Companys
financial position or results of operations. In December 2003, the FASB replaced FIN 46 with FIN 46R to clarify the
application of Accounting Research Bulletin Number 51, Consolidated Financial
Statements, to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support. FIN 46R was effective for all public entities
that have interest in variable interest entities or potential variable interest
entities commonly referred to as special-purpose entities for periods ending
after December 15, 2003. Application by public entities for all other types of
entities is required in financial statements for periods ending after March 15,
2004. Adoption of this statement did not have a material effect on the
Companys financial position or results of operations. In April 2003, the FASB issued SFAS 149, which amends and clarifies
accounting guidance on derivative instruments and hedging activities. In May
2003, the FASB issued SFAS 150, which addresses accounting for certain
financial instruments that have characteristics of both liabilities and equity.
The Company has not entered into derivative instruments covered by SFAS 149 or
financial instruments covered by SFAS 150. Adoption of these statements
therefore did not have a material effect on the Companys financial position or
results of operations. In March 2004, the EITF reached a consensus on EITF 03-01, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments
(EITF 03-01). EITF 03-01 provides guidance to determine when an investment is
considered to be impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. It also requires
disclosure related to unrealized losses that have not been recognized as
other-than-temporary impairments. The recognition and measurement guidance was
effective for other-than-temporary impairment evaluations in the third quarter
of 2004 and did not have a material impact to the Companys consolidated
financial position, results of operations or cash flows. The other provisions
of EITF 03-01, which principally consist of disclosure requirements, are not
expected to have a material impact to the Companys consolidated financial
position, results of operations or cash flows. - 16 -




---



##### Table of Contents



Effects of Federal Funding for Defense Programs The Company continues to derive over 95% of its revenues from contracts
with U.S. government agencies. The Companys government contracts may be
terminated, in whole or in part, at the convenience of the customer (as well as
in the event of default). In the event of a termination for convenience, the
customer is generally obligated to pay the costs incurred by the Company under
the contract plus a fee based upon work completed. During the third quarter of
2004, the U.S. government terminated for its convenience several task orders on
one contract. The contract value of the terminated task orders totaled $23
million, however, approximately $9 million of the total termination amount was
incurred prior to the effective date of the termination and has been, or is
expected to be, paid to the Company. As of September 30, 2004, the Company was
unable to bill approximately $2 million of costs incurred on the terminated
task orders. These costs were incurred prior to the effective date of the
termination. The Company believes that the delay in its ability to bill these
costs is temporary and that these costs will ultimately be paid by the U.S.
government. The Company believes that this termination will not have a
material effect on the Companys financial condition or results of operations.
The Company does not anticipate any additional termination of programs or
contracts in 2004. However, no assurances can be given that such events will
not occur. In addition to the right of the U.S. government to terminate contracts for
convenience, U.S. government contracts are conditioned upon the continuing
availability of congressional appropriations. These appropriations are
therefore subject to changes as a result of increases or decreases in the
overall budget. New presidential administrations, change in the composition of
Congress, and disagreement or significant delay between Congress and the
Administration in reaching a defense budget accord can all significantly affect
the timing of funding on the Companys contract backlog. Delays in contract
funding resulting from these factors may have a significant adverse effect on
the Companys revenue recognition, liquidity, and DSO. Forward-Looking Statements All statements in this report that do not directly and exclusively relate
to historical facts constitute forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995. These statements
represent the Companys intentions, plans, expectations and beliefs, and are
subject to risks, uncertainties and other factors, many of which are outside
the Companys control. These factors could cause our actual results,
performance, achievements or industry results to differ materially from the
results, performance or achievements expressed or implied by such
forward-looking statements. These factors are described in more detail in the
Companys Annual Report on Form 10-K for the fiscal year ended December 28,
2003, and such other filings that the Company makes with the SEC from time to
time. Due to such uncertainties and risks, readers are cautioned not to place
undue reliance on such forward-looking statements, which speak only as of the
date hereof. 
 Item 3 Quantitative and Qualitative Disclosures about Market Risk Refer to item 7A in the Companys Annual Report on Form 10-K for the year ended
December 28, 2003. 
 Item 4 Controls and Procedures  (a)
    
    Evaluation of Disclosure Controls and Procedures - 17 -




---



##### Table of Contents



Management has evaluated the effectiveness of the Companys disclosure
controls and procedures (as such term is defined in Rules 13a-15(e) or
15d-15(e) under the Securities Exchange Act of 1934, as amended) as of October
3, 2004. Based on the results of this evaluation, management believes that
such controls and procedures are operating effectively.  (b)
    
    Changes in Internal Controls There has been no change in the Companys internal control over financial
reporting that occurred in the quarterly period covered by this report that has
materially affected, or is reasonably likely to materially affect the Companys
internal control over financial reporting. 
 Part II OTHER INFORMATION 
 Item 1 Legal Proceedings The Company has no material investigations, claims, or lawsuits arising
out of its business, nor any known to be pending. The Company is subject to
certain legal proceedings and claims that arise in the ordinary course of its
business. In the opinion of management, the ultimate outcome of such matters
will not have a material impact on the Companys financial position, results of
operations or cash flows. 
 Item 2 Changes in Securities and Use of Proceeds Not Applicable 
 Item 3 Defaults Upon Senior Securities Not Applicable 
 Item 4 Submission of Matters to a Vote of Security Holders Not Applicable 
 Item 5 Other Information Not Applicable 
 Item 6 Exhibits and Reports on Form 8-K (a) Exhibits Exhibit 10.30
    
    Third Amended and Restated Loan Agreement dated July 1, 2004
between the Company and Union Bank of California, N.A.Exhibit 10.31
    
    Commercial Promissory Note dated
July 1, 2004 between the
Company and Union Bank of California, N.A.
 - 18 -




---



##### Table of Contents



Exhibit 31.1
    
    Certification of Chief Executive Officer Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002Exhibit 31.2
    
    Certification of Chief Financial Officer Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002Exhibit 32.1
    
    Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.Exhibit 32.2
    
    Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
  (b)
    
    Reports on Form 8-KOn July 22, 2004, SPARTA, Inc issued a memorandum to its stockholders and
its employees dated July 21, 2004 regarding Second Quarter 2004 Report
and Stock Price Evaluation reporting (1) the establishment of the price
of its common stock at $31.16 per share, and (2) revenues and net income
for the fiscal quarter ended July 4, 2004. Pursuant to the Commissions
regulations, the foregoing information was disclosed on Form 8-K filed
July 28, 2004. - 19 -




---



##### Table of Contents



Signature Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. SPARTA, INC.(Registrant)Date: November 10, 2004
    
    By:
    
    /s/ David E. SchreimanDavid E. SchreimanVice President andChief Financial Officer
 - 20 -




---



##### Table of Contents



EXHIBIT INDEX Exhibit 10.30
    
    Third Amended and Restated Loan Agreement dated July 1, 2004
between the Company and Union Bank of California, N.A.Exhibit 10.31
    
    Commercial Promissory Note dated
July 1, 2004 between the
Company and Union Bank of California, N.A.Exhibit 31.1
    
    Certification of Chief Executive Officer Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002Exhibit 31.2
    
    Certification of Chief Financial Officer Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002Exhibit 32.1
    
    Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.Exhibit 32.2
    
    Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.