**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 
| **(Mark One)** | ** ** | ** **                                                                                                       |
|---------------------|------------|------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                             |
| **ý**          | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 or  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**** ** |
|                |       |                                                                                                             |
| ** **          | ** ** | **FOR THE QUARTER ENDED MARCH 26, 2005**                                                                    |
|                |       |                                                                                                             |
| **o**               | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**          |

 

**CommissionFile Number**

**000-50080**

 

**SIInternational, Inc.**

(Exact name ofregistrant as specified in its charter)

 
| **Delaware**                                   |   | **52-2127278**      |
|------------------------------------------------|--------|---------------------|
| (State or other  jurisdiction of               |   | (I.R.S. Employer    |
| incorporation or  organization)                |   | Identification No.) |
|                                           |   |                |
| **12012  Sunset Hills Road  Reston. Virginia** |   | **20190-5869**      |
| (Address of principal  executive offices)      |   | (Zip Code)          |

 

Registrant’s telephone number, including areacode: **(703) 234-7000**

 

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Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.    ý Yes      o No

 

Indicateby check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).

ý Yes      o No

 

Asof May 2, 2005 there were 11,120,039 shares outstanding of the registrant’scommon stock.

 

 

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**SIINTERNATIONAL, INC.FORM 10-Q**

# **INDEX**

#  

| **PART I.**  | **FINANCIAL  INFORMATION**                                                                                                 |   |
|-------------------|----------------------------------------------------------------------------------------------------------------------------|--------|
| ITEM 1            | Financial Statements                                                                                                       |   |
|              | Consolidated Balance Sheets  at March 26, 2005 (unaudited) and December 25, 2004                                 |   |
|              | Consolidated  Statements of Operations for the three months ended March 26, 2005 and March 27,  2004 (unaudited) |   |
|              | Consolidated  Statements of Cash Flows for the three months ended March 26, 2005 and  March 27, 2004 (unaudited) |   |
|              | Notes to  Consolidated Financial Statements                                                                                |   |
| ITEM  2           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                |   |
| ITEM  3           | Quantitative  and Qualitative Disclosures About Market Risk                                                                |   |
| ITEM 4            | Controls and  Procedures                                                                                                   |   |
|              |                                                                                                                       |   |
| **PART II.** | **OTHER INFORMATION**                                                                                                      |   |
| ITEM 1            | Legal Proceedings                                                                                                          |   |
| ITEM  2           | Unregistered  Sales of Equity Securities and Use of Proceeds                                                               |   |
| ITEM 3            | Defaults Upon  Senior Securities                                                                                           |   |
| ITEM  4           | Submission  of Matters to a Vote of Security Holders                                                                       |   |
| ITEM 5            | Other Information                                                                                                          |   |
| ITEM 6            | Exhibits                                                                                                                   |   |
| Signatures        |                                                                                                                       |   |
| Index to Exhibits |                                                                                                                       |

 

2

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## **PART I:  FINANCIAL INFORMATION**

##  

### **Item 1.****  Financial Statements**

###  

**SI International, Inc.and SubsidiariesConsolidated Balance Sheets(Amounts in thousands, except share and per share data)**

 
| ** **                                                                                                                                                                                                             | ** ** | **March 26,  2005** | ** ** | **December 25,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                             | ** ** | **(Unaudited)**          | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                                                             | ** ** | ** **               | ** ** | ** **                  | ** ** |
| **Current  assets:**                                                                                                                                                                                                   | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Cash and  cash equivalents                                                                                                                                                                                             |       | $                        | 12,326     |                        | $          | 5,754 |   |
| Accounts  receivable, net                                                                                                                                                                                              |       | 76,488                   |       | 65,710                      |       |
| Deferred tax  asset                                                                                                                                                                                                    |       | 2,740                    |       | 2,740                       |       |
| Other  current assets                                                                                                                                                                                                  |       | 4,588                    |       | 3,503                       |       |
| Total  current assets                                                                                                                                                                                                  |       | 96,142                   |       | 77,707                      |       |
| **Property  and equipment, net**                                                                                                                                                                                       |       | 4,862                    |       | 4,971                       |       |
| **Intangible  assets, net**                                                                                                                                                                                            |       | 18,320                   |       | 6,575                       |       |
| **Other  assets**                                                                                                                                                                                                      |       | 5,637                    |       | 2,142                       |       |
| **Goodwill**                                                                                                                                                                                                           |       | 175,234                  |       | 120,712                     |       |
| Total assets                                                                                                                                                                                                           |       | $                        | 300,195    |                        | $          | 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                                                                                                                                                                                                      |       | 18,406                   |       | 11,225                      |       |
| Accrued  expenses and other current liabilities                                                                                                                                                                        |       | 20,545                   |       | 15,314                      |       |
| Deferred  revenue                                                                                                                                                                                                      |       | 166                      |       | 289                         |       |
| Total  current liabilities                                                                                                                                                                                             |       | 40,117                   |       | 55,782                      |       |
| **Long-term  debt, net of current portion**                                                                                                                                                                            |       | 99,000                   |       | —                      |       |
| **Note payable—former  owner of acquired business**                                                                                                                                                               |       | 2,280                    |       | 2,280                       |       |
| **Deferred  income tax**                                                                                                                                                                                               |       | 5,046                    |       | 5,046                       |       |
| **Other  long-term liabilities**                                                                                                                                                                                       |       | 4,748                    |       | 3,929                       |       |
| **Stockholders’  equity:**                                                                                                                                                                                        | ** ** | ** **               | ** ** | ** **                  | ** ** |
| **Common stock**—$0.01 par value per share;  50,000,000 shares authorized; 11,105,706 and 11,047,533 shares issued and  outstanding as of March 26, 2005 and December 25, 2004,  respectively |       | 111                      |       | 111                         |       |
| Additional  paid-in capital                                                                                                                                                                                            |       | 128,870                  |       | 128,192                     |       |
| Deferred  compensation                                                                                                                                                                                                 |       | (176                     | )          | (208                        | )          |
| Retained  earnings                                                                                                                                                                                                     |       | 20,199                   |       | 16,975                      |       |
| Total  stockholders’ equity                                                                                                                                                                                       |       | 149,004                  |       | 145,070                     |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                       |       | $                        | 300,195    |                        | $          | 212,107 |   |
|                                                                                                                                                                                                                        |            |                          |            |                             |            |  |  |  |  |

 

***See accompanyingnotes***

 

3

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**SIInternational, Inc. and SubsidiariesConsolidated Statements of Operations(Amounts in thousands, except per share data)Unaudited**

 
| ** **                                   | ** ** | **Three Months Ended**   | ** ** |
|----------------------------------------------|------------|--------------------------|------------|
| ** **                                   | ** ** | **March 26,  2005** | ** ** | **March 27,  2004** | ** ** |
|                                         |       |                     |       |   |   |
| Revenue                                      |       | $                        | 83,717     |   | $ | 55,970 |   |
| Costs and expenses:                          |       |                     |       |   |
| Direct costs                                 |       | 52,603                   |       | 33,529 |   |
| Indirect  costs                              |       | 23,580                   |       | 17,309 |   |
| Depreciation  and amortization               |       | 551                      |       | 589 |   |
| Amortization  of intangible assets.          |       | 457                      |       | 113 |   |
| Total  operating expenses                    |       | 77,191                   |       | 51,540 |   |
| Income from  operations                      |       | 6,526                    |       | 4,430 |   |
| Other  (expense)                             |       | (99                      | )          | — |   |
| Interest  expense                            |       | (1,097                   | )          | (534 | ) |
| Income  before provision for income taxes    |       | 5,330                    |       | 3,896 |   |
| Provision  for income taxes                  |       | 2,106                    |       | 1,539 |   |
| Net income                                   |       | $                        | 3,224      |   | $ | 2,357 |   |
|                                         |       |                     |       |   |   |
| Earnings per  common share:                  |       |                     |       |   |   |
| Basic net  income per common share           |       | $                        | 0.29       |   | $ | 0.28 |   |
|                                         |       |                     |       |   |   |
| Diluted net  income per common share         |       | $                        | 0.28       |   | $ | 0.27 |   |
|                                         |       |                     |       |   |   |
| Basic  weighted-average shares outstanding   |       | 11,063                   |       | 8,458 |   |
| Diluted  weighted-average shares outstanding |       | 11,627                   |       | 8,833 |   |

 

***See accompanyingnotes***

 

4

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**SIInternational, Inc. and SubsidiariesConsolidated Statements ofCash Flows(Amounts in thousands)Unaudited**

 
| ** **                                                                         | ** ** | **Three Months Ended**   | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                         | ** ** | **March 26,  2005** | ** ** | **March 27,  2004** | ** ** |
| **Cash  flows from operating activities:**                                         |       |                     |       |   |   |
| Net income                                                                         |       | $                        | 3,224      |   | $ | 2,357 |   |
|                                                                               |       |                     |       |   |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                     |       |   |   |
| Depreciation  and amortization                                                     |       | 551                      |       | 589 |   |
| Amortization  of intangible assets                                                 |       | 457                      |       | 113 |   |
| Deferred  income tax provision                                                     |       | —                   |       | 1,480 |   |
| Stock-based  compensation                                                          |       | 32                       |       | 32 |   |
| Amortization  of deferred financing costs                                          |       | 120                      |       | 108 |   |
| Changes in  operating assets and liabilities, net of effect of acquisitions:       |       |                     |       |   |   |
| Accounts  receivable                                                               |       | 1,699                    |       | (3,629 | ) |
| Other  current assets                                                              |       | (976                     | )          | (767 | ) |
| Other assets                                                                       |       | (454                     | )          | 469 |   |
| Accounts  payable and accrued expenses                                             |       | 4,231                    |       | 1,908 |   |
| Deferred  revenue                                                                  |       | (123                     | )          | — |   |
| Other long  term liabilities                                                       |       | 732                      |       | 97 |   |
| Net cash  provided by operating activities                                         |       | 9,493                    |       | 2,757 |   |
| **Cash  flows from investing activities:**                                         |       |                     |       |   |   |
| Purchase of  property and equipment, net                                           |       | (172                     | )          | (620 | ) |
| Cash paid  for acquisition of MATCOM                                               |       | (35                      | )          | (65,849 | ) |
| Cash paid  for acquisition of Bridge Tech.                                         |       | (99                      | )          | — |   |
| Cash paid  for acquisition of SEI, net of cash assumed                             |       | (71,154                  | )          | — |   |
| Net cash  used in investing activities                                             |       | (71,460                  | )          | (66,469 | ) |
| **Cash  flows from financing activities:**                                         |       |                     |       |   |   |
| Net  (repayments) borrowings under line of credit                                  |       | (28,954                  | )          | 16,000 |   |
| Proceeds  from long-term debt                                                      |       | 100,000                  |       | 30,000 |   |
| Payment of  debt issuance costs                                                    |       | (3,160                   | )          | (1,176 | ) |
| Proceeds  from exercise of stock options                                           |       | 678                      |       | 124 |   |
| Repayments  of capital lease obligations                                           |       | (25                      | )          | (35 | ) |
| Net cash  provided by financing activities                                         |       | 68,539                   |       | 44,913 |   |
| **Net  change in cash and cash equivalents**                                       |       | 6,572                    |       | (18,799 | ) |
| **Cash and  cash equivalents, beginning of period**                                |       | 5,754                    |       | 23,252 |   |
| **Cash and  cash equivalents, end of period**                                      |       | $                        | 12,326     |   | $ | 4,453 |   |
| **Supplemental  disclosures of cash flow information:**                            |       |                     |       |   |   |
| Cash  payments for interest                                                        |       | $                        | 41         |   | $ | 115 |   |
| Cash  payments (refund) for income taxes                                           |       | $                        | 296        |   | $ | (77 | ) |

 

***See accompanyingnotes***

 

5

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**SIInternational, Inc. and Subsidiaries**

 

**Notes to Consolidated Financial****Statements****(Unaudited)**

 

**1.****                                     ****Basis of Presentation**

 

The accompanying unaudited consolidated financialstatements of SI International, Inc. and its subsidiaries have beenprepared in accordance with accounting principles generally accepted in theUnited States for interim financial information and with the instructions to Form 10-Qand Article 10 of Regulation S-X. Accordingly, they do not includeall of the information and footnotes required by accounting principlesgenerally accepted in the United States for complete financial statements. Inthe opinion of management, all adjustments (consisting of normal recurringaccruals) considered necessary for a fair presentation have been included.Operating results for the quarter ended March 26, 2005 are not necessarilyindicative of the results that may be expected for the year ending December 31,2005. For further information, refer to the financial statements and footnotesincluded in SI International’s Annual Report on Form 10-K for the yearended December 25, 2004.  Referencesto the “Company,” “we,” “us” and “our” refer to SI International, Inc. andits subsidiaries.

 

**2.****                                     ****Summary of significantaccounting policies:**

 

**Principles of consolidation**

 

The accompanying consolidated financial statementsinclude the accounts of the Company and its wholly owned subsidiaries.   All significant intercompany transactionsand accounts have been eliminated in consolidation.

 

**Use of estimates**

 

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates.

 

**Reporting periods**

 

The Company’s fiscal year is based on the calendaryear and ends each year on the Saturday nearest but prior to December 31of that year, and our fiscal quarters end on the Saturday nearest but prior tothe applicable quarterly month end.  As aresult, our fiscal year may be comprised of 52 or 53 weeks.  The fiscal quarters presented in this Form 10-Qincludes 13 weeks.

 

**Cash and cash equivalents**

 

The Company considers all investments withmaturities of three months or less at the date of purchase to be cashequivalents.

 

**Revenue Recognition**

 

Our accounting policy regarding revenue recognitioncomplies with the following criteria:  (1) acontract has been executed; (2) the contract price is fixed anddeterminable; (3) delivery of services or products has occurred; and (4) collectibilityis considered probable and can be reasonably estimated.  Compliance with these criteria may require usto make significant judgments and estimates.

 

**Significant customers**

 

Revenue generated from contracts with the Federalgovernment or prime contractors doing business with the Federal governmentaccounted for a significant percent of revenues in the fiscal quarterending March 26, 2005 and March 27, 2004.

 

6

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| ** **                 | ** ** | **Three Months Ended**   | ** ** |
|----------------------------|------------|--------------------------|------------|
| ** **                 | ** ** | **March 26,  2005** | ** ** | **March 27,  2004** | ** ** |
|                       |       |                     |       |   |   |
| Department  of Defense     |       | 49.0                     | %          | 50.1 | % |
| Federal  civilian agencies |       | 48.9                     |       | 46.1 |   |
| Commercial  entities       |       | 2.1                      |       | 3.8 |   |
| Total  revenue             |       | 100.0                    | %          | 100.0 | % |

 

For the first quarter of 2005 we had one contractthat generated more than 10% of our revenue. Our C4I2SR contract with the U.S Air Force Space Command representedapproximately 17.8% of our revenue.  Forthe first quarter of 2004, we had two contracts that generated more than 10% ofour revenue.  Our C4I2SR contract withthe U.S. Air Force Space Command represented approximately 10.6% of totalrevenue for the quarter ended March 27, 2004.   Our National Visa Center contract with theDepartment of State represented approximately 10.2% of total revenue for thequarter ended March 27, 2004.

 

**Deferred financing costs**

 

Costs incurred in establishing our credit facilityare deferred and amortized as interest expense over the term of the relateddebt using the effective interest method. These deferred costs are reflected asa component of other assets in the accompanying consolidated balance sheets.The deferred financing costs consist of the following (in thousands):

 
| ** **                | ** ** | **March 26,  2005** | ** ** | **December 25,  2004** | ** ** |
|---------------------------|------------|--------------------------|------------|-----------------------------|------------|
|                      |       |                     |       |                        |       |
| Deferred  loan costs      |       | $                        | 4,897      |                        | $          | 1,737 |   |
| Accumulated  amortization |       | (957                     | )          | (837                        | )          |
|                      |       | $                        | 3,940      |                        | $          | 900 |   |

 

**Fair value of financial instruments**

 

The Company’s financial instruments consistprimarily of cash and cash equivalents, accounts receivable, accounts payable,credit facilities, and notes payable. In management’s opinion, the carryingamounts of these financial instruments approximate their fair values at March 26,2005 and December 25, 2004.

 

**Stock-based compensation**

 

In December 2002, the FASB issued SFAS No. 148,“Accounting for Stock-Based Compensation—Transition and Disclosure—an amendmentof SFAS 123.”  This statement amends SFASNo. 123, “Accounting for Stock-Based Compensation,” to provide alternativemethods of transition for a voluntary change to the fair value based method ofaccounting for stock-based employee compensation.  In addition, this statement amends thedisclosure requirements of SFAS No. 123 to require prominent disclosuresin both annual and interim financial statements about the method of accountingfor stock-based employee compensation and the effect of the method used onreported results.  The Company has chosento continue to account for stock-based compensation using the intrinsic valuemethod prescribed in APB Opinion No. 25 and related interpretations.  Accordingly, compensation expense for stockoptions is measured as the excess, if any, of the fair market value of theCompany’s stock at the date of the grant over the exercise price of the relatedoption.  The Company has adopted theannual disclosure provisions of SFAS No. 148 in its financial reports forthe year ended December 25, 2004 and has adopted the interim disclosureprovisions for its financial reports for the quarter ended March 26, 2005.

 

7

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| ** **                                                                                                                                   | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                                   | ** ** | **March 26,**     | ** ** | **March 27,** | ** ** |
| ** **                                                                                                                                   | ** ** | **2005**               | ** ** | **2004** | ** ** |
|                                                                                                                                         |       |                   |       |   |   |
| Net income -  as reported                                                                                                                    |       | $                      | 3,224      |   | $ | 2,357 |   |
|                                                                                                                                         |       |                   |       |   |   |
| Add: total  stock-based employee compensation expense as reported under intrinsic value  method (APB No. 25) for all awards, net of tax |       | 19                     |       | 19 |   |
|                                                                                                                                         |       |                   |       |   |   |
| Deduct:  Total stock-based compensation expense determined under fair value based  method (SFAS No. 123) for all awards, net of tax     |       | (642                   | )          | (523 | ) |
|                                                                                                                                         |       |                   |       |   |   |
| Net income -  pro forma                                                                                                                      |       | 2,601                  |       | 1,853 |   |
|                                                                                                                                         |       |                   |       |   |   |
| Basic  earnings per share - as reported                                                                                                      |       | 0.29                   |       | 0.28 |   |
|                                                                                                                                         |       |                   |       |   |   |
| Diluted  earnings per share - as reported                                                                                                    |       | 0.28                   |       | 0.27 |   |
|                                                                                                                                         |       |                   |       |   |   |
| Basic  earnings per share - pro forma                                                                                                        |       | 0.24                   |       | 0.22 |   |
|                                                                                                                                         |       |                   |       |   |   |
| Diluted  earnings per share - pro forma                                                                                                      |       | 0.22                   |       | 0.21 |   |
|                                                                                                                                              |            |                        |            |  |  |  |  |

 

**Earnings per share**

 

Basic earnings per share is computed by dividingreported earnings available to common stockholders by the weighted averagenumber of shares outstanding without consideration of common stock equivalentsor other potentially dilutive securities. Diluted earnings per share gives effect to commonstock equivalents and other potentially dilutive securities outstanding duringthe period.

 

Thefollowing details the computation of net income per common share:

 
| ** **                                   | ** ** | **Three Months Ended**   | ** ** |
|----------------------------------------------|------------|--------------------------|------------|
| ** **                                   | ** ** | **March 26,  2005** | ** ** | **March 27,  2004** | ** ** |
|                                         |       |                     |       |   |   |
| Net Income –  Basic and Diluted         |       | $                        | 3,224      |   | $ | 2,357 |   |
|                                         |       |                     |       |   |   |
| **Weighted  average share calculation:**     |       |                     |       |   |   |
|                                         |       |                     |       |   |   |
| Basic  weighted average shares outstanding   |       | 11,063                   |       | 8,458 |   |
| Treasury  stock effect of stock options      |       | 564                      |       | 375 |   |
|                                         |       |                     |       |   |   |
| Diluted  weighted average shares outstanding |       | 11,627                   |       | 8,833 |   |
|                                              |            |                          |            |  |  |  |  |

 

**Reclassifications**

 

Certain prior year balances have been reclassifiedto conform to the presentation of the current year.

 

**New accounting pronouncements**

 

In December 2004, the FASB issued FASBStatement No. 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) liabilitiesthat are based on the fair value of the enterprise’s equity instruments or thatmay be settled by the issuance of such equity instruments. Statement123(R) requires an entity to recognize the grant-date fair-value of stockoptions and other equity-based compensation issued to employees in the incomestatement. The revised Statement generally requires 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

 

8

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transactions on the financial statements. Statement123(R) is effective for the Company as of its fiscal year beginning January 1,2006. All public companies must use either the modified prospective or themodified retrospective transition method.

 

As permitted by Statement 123, the Company currentlyaccounts for share-based payments to employees using Opinion 25’s intrinsicvalue method and, as such, generally recognizes no compensation cost foremployee stock options. Accordingly, the adoption of Statement 123(R)’s fairvalue method will have a significant impact on our results of operations,although it will have no impact on our overall financial position. The impactof adoption of Statement 123(R) cannot be predicted at this time because itwill depend on levels of share-based payments granted in the future. However,had we adopted Statement 123(R) in prior periods, the impact of that standardwould have approximated the impact of Statement 123 as described in thedisclosure of pro forma net income and earnings per share in the Stock-Based Compensationsection of this note to our consolidated financial statements. Statement123(R) also requires the benefits of tax deductions in excess of recognizedcompensation cost to be reported as a financing cash flow, rather than as anoperating cash flow as required under current literature. This requirement willreduce net operating cash flows and increase net financing cash flows inperiods after adoption.

 

**3.****                                     ****Acquisitions:**

 

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

 

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

 

Under the terms of the definitive stock purchaseagreement, we acquired SEI for $75 million in cash, subject to certainadjustments. The transaction was funded through cash-on-hand and borrowingsfrom a new $160 million credit facility. The purchase price is subject toadjustment as a result of certain tax elections. The definitive stock purchaseagreement also provides that the SEI stockholders will retain certainnon-operating assets and contingent accounts receivable.

 

Approximately $54.7 million of the purchaseconsideration has been allocated to goodwill based primarily on the excess ofthe purchase price over the estimated fair value of net assets acquired, andapproximately $12.2 million of the purchase price has been assigned toidentifiable intangible assets on the basis of contractual customerrelationships. The contractual customer relationships are being amortized usingan accelerated method over their estimated remaining life of 14 years.

 

The total purchase price paid, including transactioncosts of $0.8 million, has been preliminarily allocated as follows (inthousands):

 
| Cash                                          |   | $      | 2,958   |   |
|-----------------------------------------------|--------|--------|---------|--------|
| Accounts  receivable                          |   | 12,093 |    |
| Prepaid  expense and other current assets     |   | 353    |    |
| Property and  equipment                       |   | 331    |    |
| Accounts  payable & accrued expenses |   | (5,886 | )  |
| Other long  term liabilities                  |   | (450   | )  |
| Contractual  customer relationships           |   | 12,200 |    |
| Goodwill                                      |   | 54,740 |    |
| Total  consideration                          |   | $      | 76,338  |   |

 

On December 20, 2004, the Company completed thepurchase of Bridge Technology Corporation, a provider of information technologyand information management. The acquisition supports the company’s strategicgrowth plan to broaden its customer base into the intelligence agencies, andstrengthen its portfolio of mission-critical solutions. Under the terms of theacquisition agreement, the Company acquired Bridge Technology for $30 million,subject to working capital and other adjustments. Of the purchase price,$29.4 million was paid in cash and the $2.3 million was held as notepayable to be paid in June, 2006. Approximately $26.1 million of the purchaseconsideration has been allocated to goodwill, and approximately $2.2 million ofthe purchase price has been assigned to identifiable intangible assets on thebasis of contractual

 

9

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customer relationships. The contractual customer relationships are beingamortized using an accelerated method over their estimated remaining life of 6years.

 

On January 21, 2004, the Company completed thepurchase of MATCOM, 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 condensedstatements of operations (in thousands, except per share) set forth theconsolidated results of operations of the Company for the three months ended March 26,2005 and March 27, 2004 as if the above described acquisitions hadoccurred at the beginning of each period presented. This unaudited proformainformation does not purport to be indicative of the actual financial positionor the results that would actually have occurred if the combination had been ineffect for the three months ended March 26, 2005 and March 27, 2004.

 
| ** **                  | ** ** | **Three Months Ended**  | ** ** |
|-----------------------------|------------|-------------------------|------------|
| ** **                  | ** ** | **March 26, 2005** | ** ** | **March 27, 2004** | ** ** |
| Revenue                     |       | $                       | 92,143     |   | $ | 80,858 |   |
| Net income                  |       | $                       | 3,225      |   | $ | 3,437 |   |
| Diluted  earnings per share |       | $                       | 0.28       |   | $ | 0.39 |   |

 

In accordance with the purchase accounting method,the operations of the MATCOM, Bridge Technology and SEI have been included inthe Company’s statement of operations since the respective date of acquisition.

 

**4.****                                     ****Accounts receivable:**

 

Accounts receivable consists of the following (inthousands):

 
| ** **                                                                                          | ** ** | **March 26, 2005** | ** ** | **December 25, 2004** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
|                                                                                                |       |                    |       |                       |       |
| Billed  accounts receivable                                                                         |       | $                       | 36,774     |                       | $          | 33,247 |   |
| Unbilled  accounts receivable:                                                                      |       |                    |       |                       |       |
| Currently  billable                                                                                 |       | 35,581                  |       | 26,400                     |       |
| Unbilled  retainages and milestone payments expected to be billed within the next 12  months        |       | 4,846                   |       | 5,714                      |       |
| Indirect  costs incurred and charged to cost-plus contracts in excess of provisional  billing rates |       | 1,537                   |       | 1,493                      |       |
| Total  unbilled accounts receivable                                                                 |       | 41,964                  |       | 33,607                     |       |
| Allowance  for doubtful accounts                                                                    |       | (2,250                  | )          | (1,144                     | )          |
| Accounts  receivable, net                                                                           |       | $                       | 76,488     |                       | $          | 65,710 |   |

 

The currently billable amounts included as unbilledaccounts receivable as of March 26, 2005 represent billings during thefollowing quarter of the current year for services rendered prior toquarter-end, which are billed once necessary billing data has been collectedand an invoice is produced.

 

**5.****                                     ****Property and equipment:**

 

Property and equipment consist of the following (inthousands):

 

10

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| ** **                                           | ** ** | **March 26, 2005** | ** ** | **December 25, 2004** | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| Computers  and equipment                             |       | $                       | 8,187      |                       | $          | 8,007 |   |
| Software                                             |       | 2,017                   |       | 1,904                      |       |
| Furniture  and fixtures                              |       | 1,612                   |       | 1,576                      |       |
| Leasehold  improvements                              |       | 1,140                   |       | 1,086                      |       |
|                                                 |       | 12,956                  |       | 12,573                     |       |
| Less—Accumulated  depreciation and amortization |       | (8,094                  | )          | (7,602                     | )          |
| Property and  equipment, net                         |       | $                       | 4,862      |                       | $          | 4,971 |   |

 

Propertyand equipment includes assets financed under capital lease obligations ofapproximately $291,000 and $332,000, net of accumulated amortization, as of March 26,2005 and December 25, 2004, respectively.

 

**6.****                                     ****Accrued expenses and othercurrent liabilities:**

 

Accrued expenses and other current liabilitiesconsist of the following (in thousands):

 
| ** **                                      | ** ** | **March 26, 2005** | ** ** | **December 25, 2004** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
|                                            |       |                    |       |                       |       |
| Accrued  compensation                           |       | $                       | 8,133      |                       | $          | 3,550 |   |
| Accrued  vacation                               |       | 6,124                   |       | 4,955                      |       |
| Accrued  bonus                                  |       | 837                     |       | 2,875                      |       |
| Other  accrued liabilities                      |       | 5,451                   |       | 3,934                      |       |
| Accrued  expenses and other current liabilities |       | $                       | 20,545     |                       | $          | 15,314 |   |

 

**7.****                                     ****Debt:**

 

Debt, which is included in current and long termliabilities in the accompanying balance sheets, consists of the following (inthousands):

 
| ** **                                                                                                                                                                                                                                                                                                                                | ** ** | **March 26, 2005** | ** ** | **December 25, 2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| Credit  facilities:                                                                                                                                                                                                                                                                                                                       |       |                    |       |                       |       |
| Line of  credit at December 25, 2004, bears interest at LIBOR plus 275 to 350  basis 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  March 26, 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 million principal payment on February 9, 2011 |       | 100,000                 |       | —                     |       |
| Total debt                                                                                                                                                                                                                                                                                                                                |       | $                       | 100,000    |                       | $          | 28,954 |   |

 

Prior to the closing of the SEI acquisition, thecredit facility (the 2004 credit facility) consisted of a $30.0 million termloan and a $50.0 million secured revolving credit arrangement. The 2004credit facility was secured by a pledge of substantially all of our current andfuture tangible and intangible assets, as well as those of our current andfuture subsidiaries, including accounts receivable, inventory and capital stockof our existing and future subsidiaries. In addition, the Company was requiredto maintain compliance with financial and nonfinancial covenants, including therequirement to maintain certain leverage and fixed charge ratios, as defined inthe credit agreement, as well as certain annual limits on our capitalexpenditures.

 

Contemporaneous with the closing of our acquisitionof SEI on February 9, 2005, the Company amended and restructured its priorcredit facility and increased its borrowing capacity to $160 million, which iscomprised of a $60 million five-year revolving credit facility and a $100million six-year term loan facility. Borrowings available under the amendedcredit facility were used to further the acquisitions of Bridge Technology andSEI. In addition, the amended and restructured credit facility provides that upto an additional $75 million in uncommitted incremental term loan funds are

 

11

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availableto the Company upon its request at any time for up to two years from theamendment date from one or more of the lenders under the credit facility.

 

In connection with the amended credit facility, theCompany incurred financing costs of $3.2 million. Such costs were capitalizedas deferred financing costs on the balance sheet and are being amortized overthe six year term of the new credit facility.

 

In connection with the Bridge Technology acquisition,the Company also has an outstanding note payable in the amount of $2.3 million,to be paid in June 2006, which is included in the accompanying balancesheet as Note payable – former owner of acquired business.

 

**8.****                                     ****Commitments andcontingencies:**

 

**Leases**

 

As of March 26, 2005, the Company hadnoncancelable operating leases, primarily for real estate, that expire over thenext ten years. Rental expense during the quarter ended March 26, 2005 wasapproximately $1.9 million, compared to rental expense of approximately $1.7million during the quarter ended March 27, 2004.

 

**Contract cost audits**

 

Payments to the Company on government costreimbursable contracts are based on provisional or estimated indirect rates,which are subject to audit on an annual basis by the Defense Contract AuditAgency (DCAA). The cost audits result in the negotiation and determination ofthe final indirect cost rates that the Company may use for the period(s)audited. The final rates, if different from the provisional rates, may createan additional receivable or liability for the Company. The Company’s revenuerecognition policy calls for revenue recognized on all cost reimbursablegovernment contracts to be recorded at provisional rates unless collectibilityis reasonably assured for costs incurred at higher rates. To the extent theindirect rate differential creates a liability for the Company the differentialis recognized as a reduction to revenue when identified.

 

**Litigation and claims**

 

From time to time, the Company is involved inlitigation, claims and disputes that arise in the ordinary course of itsbusiness.  In addition, the Company issubject to audit, review, and investigation by various agencies of the Federalgovernment to determine compliance with applicable federal statutes andregulations.  As a Federal governmentcontractor, the Company is subject to audit by certain federal agencies todetermine if the Company’s performance and administration of its governmentcontracts are compliant with contractual requirements and applicable federalstatutes and regulations.  While theCompany cannot predict the ultimate outcome of legal proceedings, governmentaudits, investigations, claims and disputes to which it is or may be subject,the Company currently believes, based upon information available to us as ofthe date of this filing, that any ultimate liability arising out of thesematters will not have a material adverse effect on our financial position,results of operations, or cash flows.

 

**9.****                                     ****Stockholders’ equity:**

 

**Stock option plan**

 

In 2002, the Company adopted the 2002 StockIncentive Plan to grant stock options to purchase up to 1,600,000 shares of itscommon stock to its employees and employees of its affiliates.  In March, 2004, the Board of Directorsincreased the number of reserved shares by 160,000, so that the total number ofreserved shares totaled 1,760,000.  In March 2005,the Board of Directors increased the number of reserved shares by an additional160,000 so that the total number of reserved shares totals 1,920,000.  The terms of the 2002 Stock Incentive Planstate that this ceiling of 1,920,000 shares of common stock shall automaticallyincrease at the beginning of each fiscal year by a number of shares equal tothe lesser of 160,000 shares of common stock and an amount determined by theCompany’s Board of Directors.  As of March 26,2005, the Company had issued 1,770,354 stock options under the 2002 StockIncentive Plan against a ceiling of 1,920,000 shares of common stock authorizedunder this plan.

 

In March 2005, the Board of Directorsauthorized the acceleration of vesting of future award, and certain prior stockoption awards under SI International’s 2002 Stock Incentive Plan, or the Plan,upon the occurrence of certain change of control events.  With this change, future stock awards mayinclude provisions for acceleration of vesting upon the occurrence of certainchange of control events.  With respectto prior stock option awards, the Board authorized vesting accelerationprovisions for those grants where the exercise price of each such award wasgreater than or equal to the closing market price of our

 

12

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common stock on Nasdaq as of March 11, 2005.

 

In April 2005, the Board of Directors voted toadopt the 2002 Amended and Restated Omnibus Stock Incentive Plan (the “Amendedand Restated Plan”) and has recommended the Amended and Restated Plan to theCompany’s stockholders for approval at the annual meeting of stockholders to beheld in June 2005.  The Amended andRestated Plan amends and restates the 2002 Stock Incentive Plan (the “Plan”) by(i) increasing the number of shares of common stock reserved and availableunder the Plan by 1,000,000 shares, (ii) permitting the grant of deferredshares, performance shares and performance units, (iii) prohibitingrepricing of options without prior stockholder approval, (iv) limiting thenumber of shares of common stock and performance units subject to awards aparticipant may receive in any calendar year to 300,000 and 500,000,respectively, and adding other administrative provisions to comply with theperformance-based compensation exception to the deduction limit of Section 162(m)of the Internal Revenue Code of 1986, as amended; (v) eliminating theprovision that previously provided for an automatic increase in the number ofshares reserved for issuance under the Amended and Restated Plan each fiscalyear by a number equal to the lesser of 160,000 shares and an amount determinedby the Board of Directors, (vi) providing that non-qualified stock optiongrants will be priced at one hundred percent (100%) of fair market value; (vii) providingfor minimum vesting periods of stock bonus awards, restricted common stockawards, stock appreciation rights, deferred shares, and other stock awardssubject to the possible acceleration of the vesting schedule at thediscretion of the administrator; (viii) providing that future amendmentsto the Amended and Restated Plan that increase the number of shares allocated,modify participation requirements, or materially increase benefits accruing tothe participants under the Plan will be subject to stockholder approval; and (ix) makingother technical changes to the Plan.

 

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

 

*The following discussion andanalysis should be read in conjunction with the consolidated financialstatements and related notes included elsewhere in this Form 10-Q. Thisdiscussion and analysis contains forward-looking statements that involve knownand unknown risks, uncertainties, and other factors that may cause our actualresults, level of activity, performance or achievements to be materiallydifferent from any future results, levels of activity, performance or achievementsexpressed or implied by such forward-looking statements. In some cases,you 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 predict accurately orcontrol. In particular, statements that we make in this section relatingto the sufficiency of anticipated sources of capital to meet our cashrequirements are forward- looking statements. Our actual results could differmaterially from those anticipated in these forward-looking statements for manyreasons, including as a result of some of the factors described below,elsewhere in this Form 10-Q and in the section entitled “Risk Factors”in our Form 10-K  for the fiscalyear ended December 25, 2004.   Youshould not place undue reliance on these forward-looking statements, whichapply only as of the date of the filing of this Form 10-Q.*

 

*Our fiscal year is based on thecalendar year and ends each year on the Saturday nearest, but not fallingafter, December 31 of that year, and our fiscal quarter ends 13 weeksafter the conclusion of the previous fiscal quarter, except in such cases whereour fiscal year is 53 weeks long.  In thecase where our fiscal year is 53 weeks long, the fourth fiscal quarter willinclude 14 weeks.*

 

*References to the “Company,” “we,”“us” and “our” refer to SI International, Inc. and its subsidiaries.*

 

**Overview**

 

We are a provider of information technology andnetwork solutions to the Federal government. Our clients include U.S. Air Force Space Command, the Department ofState, the U.S. Army, the Department of Homeland Security, FederalRetirement Thrift Investment Board, the National Institutes of Health, theDepartment of Agriculture, U.S. Air Force Electronic Systems Center, the U.S.Navy and the intelligence community.  Wecombine our technology and industry expertise to provide a full spectrum of state-of-the-practicesolutions and services, from design and development to implementation andoperations, which assist our clients in achieving mission success.

 

13

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In the three months ended March 26, 2005, wereceived 97.9% of our revenues from services we provided to various departmentsand agencies of the Federal government and 2.1% of our total revenues from workperformed for commercial entities. In comparison, for the three months ended March 27,2004, we received 96.2% of our revenues from services we provided to Federalgovernment agencies and 3.8% of total revenues from work performed forcommercial entities.  The following tableshows our revenues from the client groups listed as a percentage of totalrevenue. Revenue data for the Department of Defense includes revenue generatedfrom work performed under engagements for both the Department of Defense andthe intelligence community.

 
| ** **                 | ** ** | **Three Months Ended**   | ** ** |
|----------------------------|------------|--------------------------|------------|
| ** **                 | ** ** | **March 26,  2005** | ** ** | **March 27,  2004** | ** ** |
|                       |       |                     |       |   |   |
| Department  of Defense     |       | 49.0                     | %          | 50.1 | % |
| Federal  civilian agencies |       | 48.9                     | %          | 46.1 | % |
| Commercial  entities       |       | 2.1                      | %          | 3.8 | % |
| Total  revenue             |       | 100.0                    | %          | 100.0 | % |

 

We have derived a substantial majority of ourrevenues from governmental contracts under which we act as a prime contractor.We also provide services indirectly as a subcontractor. We intend to focus onretaining and increasing the percentage of our business in which we act asprime contractor because it provides us with stronger client relationships. Thefollowing table shows our revenues as prime contractor and as subcontractor asa percentage of our total revenue for the following periods:

 
| ** **              | ** ** | **Three Months Ended**   | ** ** |
|-------------------------|------------|--------------------------|------------|
| ** **              | ** ** | **March 26,  2005** | ** ** | **March 27,  2004** | ** ** |
|                    |       |                     |       |   |   |
| Prime contract  revenue |       | 77.6                     | %          | 79.4 | % |
| Subcontract  revenue    |       | 22.4                     | %          | 20.6 | % |
| Total  revenue          |       | 100.0                    | %          | 100.0 | % |

 

Our services are provided underthree types of contracts: cost reimbursable, time and materials, and fixedprice contracts. The following table shows our revenues from each of thesetypes of contracts as a percentage of our total revenue for the followingperiods:

 
| ** **          | ** ** | **Three Months Ended**   | ** ** |
|---------------------|------------|--------------------------|------------|
| ** **          | ** ** | **March 26,  2005** | ** ** | **March 27,  2004** | ** ** |
|                |       |                     |       |   |   |
| Cost  reimbursable  |       | 34.2                     | %          | 23.3 | % |
| Time and  materials |       | 47.2                     | %          | 51.0 | % |
| Fixed price         |       | 18.6                     | %          | 25.7 | % |
| Total               |       | 100.0                    | %          | 100.0 | % |

 

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

 

14

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ended March 26, 2005, 34.2% of our revenues were derived from costreimbursable contracts.  In the threemonths ended March 27, 2004, 23.3% of our revenues were derived from costreimbursable contracts.

 

Under time and materials contracts, we arereimbursed for labor at fixed hourly rates and generally reimbursed separatelyfor allowable materials, costs and expenses. To the extent that our actuallabor costs under a time and materials contract are higher or lower than thebilling rates under the contract, our profit under the contract may be eithergreater or less than we anticipated or we may suffer a loss under the contract.We recognize revenues under time and materials contracts by multiplying thenumber of direct labor hours expended by the contract billing rates and addingthe effect of other billable direct costs. In general, we realize a higherprofit margin on work performed under time and materials contracts than costreimbursable contracts. In the three months ended March 26, 2005, 47.2% ofour revenues were derived from time and materials contracts.  In the three months ended March 27,2004, 51.0% of our revenues were derived from time and material contracts.

 

Under fixed price contracts, we perform specifictasks for a fixed price. Compared to cost reimbursable and time and materialscontracts, fixed price contracts generally offer higher profit marginopportunities but involve greater financial risk because we bear the impact ofcost overruns in return for the full benefit of any cost savings. We generallydo not undertake complex, high-risk work, such as long-term softwaredevelopment, under fixed price terms. Fixed price contracts may include eithera product delivery or specific service performance over a defined period.  Revenue on fixed price contracts that providefor the Company to render services throughout a period is recognized as earnedaccording to contract terms as the service is provided on a proportionateperformance basis.  These contracts aregenerally less than six months in duration. For fixed price contracts that provide for the delivery of a specificproduct with related customer acceptance provisions, revenues are recognized asthose products are delivered and accepted. In the three months ended March 26, 2005, 18.6% of our revenueswere derived from fixed price contracts.  In the three months ended March 27, 2004, 25.7% of our revenueswere derived from fixed price contracts.

 

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

 

Our most significant expense is direct cost, whichconsists primarily of direct labor costs for program personnel and directexpenses incurred to complete contracts, including cost of materials andsubcontractor costs. Our ability to predict accurately the number and types ofpersonnel, their salaries, and other costs, can have a significant impact onour direct cost.

 

The allowability of certain direct and indirectcosts in federal contracts is subject to audit by the client, usually throughthe DCAA. Certain indirect costs are charged to contracts and paid by theclient using provisional, or estimated, indirect rates, which are subject tolater revision, based on the government audits of those costs.

 

We actively monitor our relationships with ourclients during our engagements, as well as the quality of the service weprovide, to assist in our efforts to win recompetition bids. In addition, westrive to maintain good relationships with a wide variety of governmentcontractors.

 

**Results of Operations**

 

The following table sets forth certain items fromour consolidated statements of operations as a percent of revenues for theperiods indicated.

 
| ** **                                | ** ** | **Three Months Ended**   | ** ** |
|-------------------------------------------|------------|--------------------------|------------|
| ** **                                | ** ** | **March 26,  2005** | ** ** | **March 27,  2004** | ** ** |
|                                      |       |                     |       |   |   |
| Revenue                                   |       | 100.0                    | %          | 100.0 | % |
| Costs and  expenses:                      |       |                     |       |   |   |
| Direct costs                              |       | 62.8                     |       | 59.9 |   |
| Indirect  costs                           |       | 28.2                     |       | 30.9 |   |
| Depreciation                              |       | 0.7                      |       | 1.1 |   |
| Amortization                              |       | 0.5                      |       | 0.2 |   |
| Total  operating expenses                 |       | 92.2                     |       | 92.1 |   |
| Income from  operations                   |       | 7.8                      |       | 7.9 |   |
| Other  (expense)                          |       | (0.1                     | )          | — |   |
| Interest  expense                         |       | (1.3                     | )          | (1.0 | ) |
| Income  before provision for income taxes |       | 6.4                      |       | 6.9 |   |
| Provision  for income taxes               |       | 2.5                      |       | 2.7 |   |
| Net income                                |       | 3.9                      | %          | 4.2 | % |

 

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**Three months ended March 26, 2005 compared withthree months ended March 27, 2004**

 

*Revenue.*  Forthe three months ended March 26, 2005, our revenues increased 49.6% to$83.7 million from $56.0 million for the same period in 2004.Revenues from work under Federal government contracts increased 52.2% to$81.9 million for the three months ended March 26, 2005 from$53.8 million for the same period in 2004. This increase was attributableto new contract awards, successful recompetition wins on existing programs, newcontracts from acquisitions and growth within existing programs in our fourfocus areas: Federal IT Modernization, Defense Transformation, HomelandDefense, and Mission-Critical Outsourcing. For the three months ended March 26,2005, commercial and other revenues decreased 18.2% to $1.8 million from$2.2 million the same period in 2004. This decrease was attributable toour continued focus on opportunities for the Federal government.

 

*Directcosts.*  Direct costs include direct labor and otherdirect costs such as materials and subcontracts. Generally, changes in directcosts are correlated to changes in revenue as resources are consumed in theproduction of that revenue. For the three months ended March 26, 2005,direct costs increased 56.9% to $52.6 million from $33.5 million forthe three months ended March 27, 2004. This increase was attributableprimarily to the increase in revenue. As a percentage of revenue, direct costswere 62.8% for the three months ended March 26, 2005 as compared to 59.9%for the three months ended March 27, 2004.

 

*Indirect costs.* Indirect costs include facilities, selling, bid and proposal, indirectlabor, fringe benefits and other discretionary costs. For the three monthsended March 26, 2005, indirect costs increased 36.2% to $23.6 millionfrom $17.3 million for the same period in 2004. This $6.3 millionincrease was primarily attributable to the expected growth of support functionsnecessary to facilitate and administer the growth in direct costs as well asthe integration of Bridge Technology and SEI.

 

*Depreciation.*  Forthe three months ended March 26, 2005, depreciation remained flat at$0.6 million compared to the same period in 2004. As a percentage ofrevenue, depreciation was 0.7% for the three months ended March 26, 2005as compared to 1.1% for the same period in 2004.

 

*Amortization.*  Forthe three months ended March 26, 2005, amortization of intangible assetsincreased to $0.5 million from $0.1 million for the same period in 2004.  This increase was attributed to the acquisitionof Bridge Technology and SEI.

 

*Incomefrom operations.*  For the three months ended March 26,2005, income from operations increased 47.3% to $6.5 million from$4.4 million for the same period in 2004. This increase was attributableprimarily to increased revenue. As a percentage of revenue, income fromoperations was 7.8% for the three months ended March 26, 2005 as comparedto 7.9% for the same period in 2004.

 

*Interestexpense.*  For the three months ended March 26,2005, interest expense increased 105.4% to $1.1 million from $0.5 millionfor the same period in 2004. This increase was attributable primarily toincreased borrowings under our credit facility made in connection with theacquisitions of Bridge Technology and SEI. As a percentage of revenue, interest expense was 1.3% for the threemonths ended March 26, 2005 as compared to 1.0% for the same period in2004.  We anticipate interest expense toremain at higher levels throughout fiscal year 2005 as compared to the sameperiods in 2004.

 

*Provisionfor income taxes.*  The provision for income tax was$2.1 million for the three months ended March 26, 2005, compared to aprovision of $1.5 million for the comparable period in 2004.  Our first quarters of 2005 and 2004 taxprovision, represents an estimated annual effective tax rate of 39.5%. Ourestimated annual effective tax rate is greater than the federal statutory rateof 34% due primarily to state income taxes.

 

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### **Liquidityand Capital Resources**

###  

Our primary liquidity needs are the financing ofworking capital, capital expenditures and acquisitions. We have historicallyrelied primarily on cash flow from operations, borrowings under our creditfacility and from some of our stockholders and the sale of common and preferredstock to provide for our cash needs.

 

Net cash provided by operations was $9.5 million forthe three months ended March 26, 2005 compared with $2.8 million forthe three months ended March 27, 2004. Cash provided by operations in the three months ended March 26,2005 was attributable to net income of $3.2 million, depreciation,amortization, and other non-cash items of $1.2 million, and a decrease inworking capital and other operating assets and liabilities of $5.1 million.Cash provided by operations in the three months ended March 27, 2004 wasattributable to net income of $2.4 million, depreciation, amortization,deferred tax provision, and other non-cash items of $2.3 million, and offset byan increase in working capital and other operating assets and liabilities of$1.9 million.

 

Cash used in investing activities was $71.5 millionfor the three months ended March 26, 2005 compared with $66.5 million forthe three months ended March 27, 2004. During the three months ended March 26, 2005, we acquired SEI for$71.2 million, completed payments for Bridge Technology and MATCOM acquisitionsof $0.1 million and $35,000, respectively and invested $0.2 million in capitalassets.  During the three months ended March 27,2004, we acquired MATCOM for $65.9 million and invested $0.6 million in capitalassets.

 

Cash provided by financing activities was $68.5million for the three months ended March 26, 2005, compared with $44.9million for the three months ended March 27, 2004.  Cash provided by financing activities for thethree months ended March 26, 2005 was attributable to $100.0 million oflong term debt provided by our credit facility, $29.0 million in debtrepayment, and $0.7 million provided by proceeds from the exercise of stockoptions, partially offset by $3.2 million of payments related to debt issuancecosts and $25,000 of capital lease payments. Cash provided by financing activities for the three months ended March 27,2004 was attributable to $16.0 million net borrowings under our revolving lineof credit and $30.0 million of long-term debt provided by our credit facilityand $0.1 million provided by proceeds from the exercise of stock options,partially offset by $1.2 million of payments related to debt issuance costs and$35,000 of capital lease payments.

 

Cash and cash equivalents as of March 26, 2005and December 25, 2004 were $12.3 million and $5.8 million,respectively.

 

Debtconsists of the following (in thousands):

 
| ** **                                                                                                                                                                                                                                                                                                                                | ** ** | **March 26, 2005** | ** ** | **December 25, 2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| Credit  facilities:                                                                                                                                                                                                                                                                                                                       |       |                    |       |                       |       |
| Line of  credit at December 25, 2004, bears interest at LIBOR plus 275 to 350  basis 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  March 26, 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 million principal payment on February 9, 2011 |       | 100,000                 |       | —                     |       |
| Total debt                                                                                                                                                                                                                                                                                                                                |       | $                       | 100,000    |                       | $          | 28,954 |   |

 

In connection with the acquisition of BridgeTechnology and SEI, we amended our credit facility to increase the borrowingcapacity from $80 million to $160 million and extended the term to February 9,2011.

 

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The amended credit facility includes a$100 million term loan and a $60 million revolving credit facility.Under the term loan, we are required to make twenty-three $250,000 quarterlyprincipal payments starting on June 30, 2005 and a final$94.25 million principal payment on February 9, 2011.

 

The amended credit facility permits us, subject toour compliance with financial and nonfinancial covenants and customary conditions,to make up to $60.0 million of revolving credit borrowings and alsoprovides for the issuance of letters of credit, although the amount ofavailable revolving credit borrowings is reduced by the amount of anyoutstanding letters of credit issued under the facility.

 

Any borrowings outstanding under the facility will,at our option, bear interest either at floating rates equal to LIBOR plus aspread ranging from 200 to 275 basis points or a specified base rate plus aspread ranging from 100 to 175 basis points, with the exact spread determinedupon the basis of our ratio of outstanding indebtedness to our earnings beforeinterest, taxes, and depreciation and amortization expense, as defined in thenew credit facility.

 

We and each of our existing and future subsidiariesare jointly and severally liable with respect to the payment of all borrowingsand other amounts due and performance of all obligations under the new creditfacility. The new credit facility is secured by a pledge of substantially allof our current and future tangible and intangible assets, as well as those ofour current and future subsidiaries, including accounts receivable, inventoryand capital stock of our existing and future subsidiaries. The new creditfacility requires us to make mandatory prepayments of outstanding borrowings,with a corresponding reduction in the maximum amount of borrowings availableunder the facility; net proceeds from certain insurance recoveries and assetsales, 100% of the net proceeds from debt issuances, and 50% of the netproceeds from certain equity issuances are subject to specified exceptions.Also, the new credit facility includes a number of restrictive covenantsincluding, among other things, limitations on our leverage and capitalexpenditures, limitations on our ability to incur additional indebtedness orliens, requirements that we maintain minimum ratios of cash flow to fixedcharges and prohibitions on payment of dividends on our capital stock,limitations on our ability to enter into mergers, acquisitions or sales of ourassets, and prohibitions on certain transactions among our subsidiaries andaffiliated companies. The new credit facility also contains events of default,including, among other events, any transaction resulting in a new stockholderor group of stockholders acquiring control of our board of directors orownership of greater than 40% of our outstanding capital stock, any default byus under any material government contract or other material contract to whichwe are a party, and the suspension of our ability to enter into contracts withthe federal, state or local governments generally.

 

We currently anticipate that cash flow fromoperations and borrowings available under our new credit facility will besufficient to meet our presently anticipated capital needs for at least thenext twelve months, but may be insufficient to provide funds necessary for anyfuture acquisitions we may make, whether during the next twelve months orthereafter. To the extent that we require additional funds,whether for acquisitions or otherwise, we may seek additional equity or debtfinancing. As of March 26, 2005, approximately $44.9 million wasavailable under the Company’s shelf registration statement for the issuance ofcommon stock, preferred stock, depositary shares, debt securities and warrantsexercisable for common or preferred stock.

 

Financial data for all of our subsidiaries areincluded in our consolidated financial statements.

 

**Critical Accounting Policies and Estimates**

 

Our significant accounting policies are described inNote 2 to our accompanying consolidated financial statements. We considerthe accounting policies related to revenue recognition to be critical to theunderstanding of our results of operations. Our critical accounting policies also include the areas where we havemade what we consider to be particularly difficult, subjective or complexjudgments in making estimates, and where these estimates can significantlyimpact our financial results under different assumptions and conditions. Weprepare our financial statements in conformity with accounting principlesgenerally accepted in the United States. As such, we are required to makecertain estimates, judgments and assumptions that we believe are reasonablebased upon the information available. These estimates, judgments andassumptions affect the reported amounts of assets and liabilities at the dateof the financial statements and the reported amounts of revenue and expensesduring the periods presented. Actual results could be different from theseestimates.

 

*Revenue Recognition*

 

Our accounting policy regarding revenue recognitioncomplies with the following criteria: (1) a contract has been executed; (2) thecontract price is fixed and determinable; (3) delivery of services or productshas occurred; and

 

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(4) collectibility of the contract price is considered probableand can be reasonably estimated. Compliance with these criteria may require usto make significant judgments and estimates.

 

For cost reimbursable contracts with fixed fees andfixed price contracts, we estimate the applicable fees earned as costs areincurred or services are provided. This process requires estimation of thecontemplated level of effort to accomplish the tasks under contract and thecost of such effort, as well as ongoing assessment towards completing thecontract. We utilize a number of management processes to monitor contractperformance and revenue estimates, including monthly in-process reviews. Forcost reimbursable contracts with performance-based fees, we estimate theapplicable fees earned based on historical experience and performanceevaluations from our customers. For fixed price contracts that are based onunit pricing, we recognize revenue for the number of units delivered in anygiven 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 pricecontracts that are based on the proportionate performance method and involve aspecified number of defined but not similar acts, we recognize revenue based onthe proportion of the project’s percentage total costs incurred compared to theestimated total costs associated with the entire transaction.  Occasionally, facts may develop that requirerevisions to estimated total costs or revenues expected. The cumulative effectof any such revisions is recorded in the period in which the facts requiringthe revision become known. The full amounts of anticipated losses on anycontract type are recognized in the period in which they become known.

 

In addition, certain indirect costs are charged tocontracts and paid by the client using provisional, or estimated, indirectrates that are subject to later revision based on government audits. Any costsfound to be improperly allocated to a specific contract will not be reimbursed,and any such costs already reimbursed must be refunded.

 

*Stock Based Compensation*

 

We account for stock-based compensation using theintrinsic value method prescribed in APB Opinion No. 25 and relatedinterpretations. Accordingly, compensation expense for stock options ismeasured as the excess, if any, of the fair market value of the Company’s stockat the date of the grant over the exercise price of the related option. We haveadopted the annual disclosure provisions of SFAS No. 148 in our financialreports for the year ended December 25, 2004 and have adopted the interimdisclosure provisions in our financial reports for the quarter ended March 26,2005.  The disclosures determine compensation cost for the Company’s stockoptions based on SFAS No. 123, which reflects the fair value of eachoption estimated on the date of grant using the Black-Scholes option-pricingmodel.

 

**Item 3.****    Quantitative and Qualitative Disclosures About Market Risk.**

 

Historically, our investment positions have beenrelatively small and short-term in nature. We have typically made investmentsin a fund with an effective average maturity of fewer than 40 days and aportfolio make-up consisting primarily of commercial paper and notes, variablerate instruments, and, to a lesser degree, overnight securities and bankinstruments.  Since our initial publicoffering, the Board of Directors approved an investment policy that requires usto invest in relatively short-term, high quality, and high liquidityobligations.

 

**Item 4.****    Controls and Procedures.**

 

*Evaluationof Disclosure Controls and Procedures.* The Company performed an evaluation underthe supervision and with the participation of management, including the Company’sChief Executive Officer and Chief Financial Officer, of the design andoperation of the Company’s disclosure controls and procedures as of March 26,2005.  Based upon the evaluation, theCompany’s Chief Executive Officer and Chief Financial Officer have concludedthat, as of March 26, 2005, the Company’s disclosure controls andprocedures were effective.

 

*Changes in Internal Control Over Financial Reporting.*During the three months ended March 26,2005, there were no changes in the Company’s internal control over financialreporting that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control for financial reporting.

 

**PART II:  OTHERINFORMATION**

 

**Item 1.****   LegalProceedings**

 

From time to time, the Company is involved inlitigation, claims and disputes that arise in the ordinary course of itsbusiness.  In addition, the Company issubject to audit, review, and investigation by various agencies of the Federal

 

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government to determine compliance with applicablefederal statutes and regulations.  As aFederal government contractor, the Company is subject to audit by certainfederal agencies to determine if the Company’s performance and administrationof its government contracts are compliant with contractual requirements and applicablefederal statutes and regulations.  Whilethe Company cannot predict the ultimate outcome of legal proceedings,government audits, investigations, claims and disputes to which it is or may besubject, the Company currently believes, based upon information available to usas of the date of this filing, that any ultimate liability arising out of thesematters will not have a material adverse effect on our financial position,results of operations, or cash flows.

 

**Item 2.****  Unregistered Sales of Equity Securities andUse of Proceeds**

 

None.

 

**Item 3.****  Defaults Upon SeniorSecurities**

 

None.

 

**Item 4.****   Submission of Matters Toa Vote of Security Holders**

 

None.

 

**Item 5.****  OtherInformation**

 

None.

 

**Item 6.****  Exhibits**

 

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

 

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SIGNATURES

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|   | SI INTERNATIONAL, INC.       |
|--------|------------------------------|
|   |                         |
|   |                         |
|   | /s/ THOMAS E. DUNN           |   |
|   | Thomas E. Dunn               |
|   | Executive Vice President and |
|   | Chief Financial Officer      |

 

 

Date:  May 3, 2005

 

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**INDEX TO EXHIBITS**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1                  |       | Agreement and Plan of Merger among the Company, Link Acquisition  Corporation, a Delaware corporation and a wholly-owned subsidiary of the  Company, Matcom International Corporation, and the stockholders of Matcom  International Corporation, dated as of December 17, 2003, as amended by  the First Amendment to Agreement and Plan of Merger, dated as of January 21,  2004 (filed as Exhibit 2.1 to the Company’s Current Report on Form 8-K  filed January 28, 2004 and incorporated herein 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                  |       | Agreement and Plan of Merger among the Company, Link Acquisition2  Corporation, a Delaware corporation and a wholly-owned subsidiary of the  Company, Bridge Technology Corporation, and the stockholders of Bridge  Technology Corporation, dated as of November 30, 2004 (filed as Exhibit 2.2  to the Company’s Current Report on Form 10-K filed March 10, 2005  (the “2004 10-K”) and incorporated herein 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.)                                                                                      |
| 2.3                  |       | 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).                                                                                                                                                                                                                                                                                            |
| 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 Registration Statement on Form S-1/A (File No. 333-87964)  filed on November 8, 2002 (the “Fifth Amendment) and incorporated herein  by reference).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 4.1                  |       | 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 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                 |       | Form of 2002 Stock Incentive Plan (filed as Exhibit 10.1 to  the Third Amendment and incorporated herein by reference).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.2                 |       | January 2001 Nonqualified Stock Option Plan (filed as Exhibit 10.2  to the Company’s Registration Statement on Form S-1/A (File No. 333-87964)  filed on June 24, 2002 (the “First Amendment) and incorporated herein by  reference).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.3                 |       | SI International, Inc. 2001 Service Award Stock Option Plan  (filed as Exhibit 10.3 to the First Amendment and incorporated herein by  reference).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.4                 |       | 1998 Stock Option Plan (filed as Exhibit 10.5 to the First  Amendment and incorporated herein by reference).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.5                 |       | 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).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.6                 |       | Executive Employment Agreement with S. Bradford Antle (filed as Exhibit 10.6  to the Third Amendment and incorporated herein by reference).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.7                 |       | Executive Employment Agreement with Paul R. Brubaker (filed as Exhibit 99.1  to the Company’s Current Report on Form 8-K filed March 22, 2005  and incorporated herein by reference).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |

 

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| 10.8  |   | Executive Employment Agreement with Thomas E. Dunn (filed as Exhibit 10.8  to the Third Amendment and incorporated herein by reference).                                                   |
|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.9  |   | Executive Employment Agreement with Thomas E. Lloyd (filed as Exhibit 10.9  to the Third Amendment and incorporated herein by reference).                                                  |
| 10.10 |   | Executive Employment Agreement with Ray J. Oleson (filed as Exhibit 10.10  to the Third Amendment and incorporated herein by reference).                                                   |
| 10.11 |   | Form of Indemnification Agreement (filed as Exhibit 10.11  to the Third Amendment and incorporated herein by reference).                                                              |
| 10.12 |   | Consulting Services Agreement with Walter J. Culver (filed as Exhibit 10.12  to the 2004 10-K and incorporated herein by reference).                                                       |
| 10.13 |   | Non-Qualified Deferred Compensation Plan, as amended (filed as Exhibit 10.13  to the 2004 10-K and incorporated herein by reference).                                                      |
| 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 (*). |

 

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* Indicates filed herewith.

 

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