**UNITED STATES**

**SECURITIES ANDEXCHANGE 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 SEPTEMBER 24, 2005**                                                      |
| ** **          | ** ** | ** **                                                                                              |
| **o**               | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission File Number**

**000-50080**

 

**SI International, Inc.**

(Exactname of registrant as specified in its charter)

 

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

 

Registrant’s telephonenumber, including area code: **(703) 234-7000**

 

----

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90days.    ý  Yes    o  No

 

 Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act).   ý  Yes    o  No

 

Indicate by check mark whether the registrant is a shellcompany (as defined in Rule 12b-2 of the Act.)   oYes  ý No

 

As of October 25, 2005, there were 11,290,912 sharesoutstanding of the registrant’s common stock.

 

 

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**SIINTERNATIONAL, INC.**

**FORM 10-Q**

# **INDEX**

 
| **PART I.**   | ** ** | **FINANCIAL INFORMATION**                                                                                                                  | ** ** |
|--------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ITEM 1             |       | Financial Statements                                                                                                                       |       |
|               |       | Consolidated  Balance Sheets at September 24, 2005 (unaudited) and December 25,  2004                                            |       |
|               |       | Consolidated Statements of Operations for the three and nine months  ended September 24, 2005 and September 25, 2004 (unaudited) |       |
|               |       | Consolidated Statements of Cash Flows for the nine months ended  September 24, 2005 and September 25, 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**

 

**SIInternational, Inc. and Subsidiaries**

**Consolidated Balance Sheets**

**(Amountsin thousands, except share and per share data)**

 
| ** **                                                                                                                                                                                                                | ** ** | **September 24,  2005** | ** ** | **December 25,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                                                                | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| **Current  assets:**                                                                                                                                                                                                      | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Cash and cash equivalents                                                                                                                                                                                                 |       | $                            | 26,443     |                        | $          | 5,754 |   |
| Accounts receivable, net                                                                                                                                                                                                  |       | 80,052                       |       | 65,710                      |       |
| Other current assets                                                                                                                                                                                                      |       | 8,228                        |       | 6,243                       |       |
| Total  current assets                                                                                                                                                                                                     |       | 114,723                      |       | 77,707                      |       |
| **Property  and equipment, net**                                                                                                                                                                                          |       | 5,329                        |       | 4,971                       |       |
| **Intangible  assets, net**                                                                                                                                                                                               |       | 17,096                       |       | 6,575                       |       |
| **Other  assets**                                                                                                                                                                                                         |       | 5,680                        |       | 2,142                       |       |
| **Goodwill**                                                                                                                                                                                                              |       | 174,056                      |       | 120,712                     |       |
| Total assets                                                                                                                                                                                                              |       | $                            | 316,884    |                        | $          | 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                                                                                                                                                                                                          |       | 18,192                       |       | 11,225                      |       |
| Accrued expenses and other current  liabilities                                                                                                                                                                           |       | 26,123                       |       | 15,314                      |       |
| Deferred revenue                                                                                                                                                                                                          |       | —                       |       | 289                         |       |
| Note payable – former owner of acquired  business                                                                                                                                                                    |       | 2,280                        |       | —                      |       |
| Total  current liabilities                                                                                                                                                                                                |       | 47,595                       |       | 55,782                      |       |
| **Long-term  debt, net of current portion**                                                                                                                                                                               |       | 98,750                       |       | —                      |       |
| **Note  payable—former owner of acquired business**                                                                                                                                                                  |       | —                       |       | 2,280                       |       |
| **Other  long-term liabilities**                                                                                                                                                                                          |       | 9,450                        |       | 8,975                       |       |
| **Stockholders’  equity:**                                                                                                                                                                                           | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| **Common stock**—$0.01  par value per share; 50,000,000 shares authorized; 11,279,825 and 11,047,533 shares issued and outstanding as of  September 24, 2005 and December 25, 2004, respectively |       | 113                          |       | 111                         |       |
| Additional paid-in capital                                                                                                                                                                                                |       | 132,267                      |       | 128,192                     |       |
| Deferred compensation                                                                                                                                                                                                     |       | (103                         | )          | (208                        | )          |
| Retained earnings                                                                                                                                                                                                         |       | 28,812                       |       | 16,975                      |       |
| Total  stockholders’ equity                                                                                                                                                                                          |       | 161,089                      |       | 145,070                     |       |
| Total liabilities  and stockholders’ equity                                                                                                                                                                          |       | $                            | 316,884    |                        | $          | 212,107 |   |

 

***See accompanying notes***

 

3

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**SIInternational, Inc. and Subsidiaries**

**Consolidated Statements of Operations**

**(Amountsin thousands, except per share data)**

**Unaudited**

 
| ** **                                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **Sept. 24,  2005**    | ** ** | **Sept. 25,  2004**   | ** ** | **Sept. 24,  2005** | ** ** | **Sept. 25,  2004** | ** ** |
|                                             |       |                   |       |                  |       |   |   |   |   |
| **Revenue**                                      |       | $                      | 101,775    |                  | $          | 72,926 |   | $ | 281,475 |   | $ | 192,710 |   |
| **Costs  and expenses:**                         |       |                   |       |                  |       |   |   |   |   |
| Direct costs                                     |       | 62,743                 |       | 49,106                |       | 173,944 |   | 121,435 |   |
| Indirect costs                                   |       | 28,723                 |       | 17,615                |       | 80,231 |   | 53,974 |   |
| Depreciation and amortization                    |       | 504                    |       | 516                   |       | 1,586 |   | 1,704 |   |
| Amortization of intangible assets                |       | 612                    |       | 171                   |       | 1,680 |   | 477 |   |
|                                             |       |                   |       |                  |       |   |   |   |   |
| **Total  operating expenses**                    |       | 92,582                 |       | 67,408                |       | 257,441 |   | 177,590 |   |
| **Income  from operations**                      |       | 9,193                  |       | 5,518                 |       | 24,034 |   | 15,120 |   |
| **Other  income (expense)**                      |       | 64                     |       | (62                   | )          | (22 | ) | (62 | ) |
| **Interest  expense**                            |       | (1,690                 | )          | (693                  | )          | (4,446 | ) | (1,964 | ) |
| **Income  before provision for income taxes**    |       | 7,567                  |       | 4,763                 |       | 19,566 |   | 13,094 |   |
| **Provision  for income taxes**                  |       | 2,989                  |       | 1,881                 |       | 7,729 |   | 5,172 |   |
|                                             |       |                   |       |                  |       |   |   |   |   |
| **Net  income**                                  |       | $                      | 4,578      |                  | $          | 2,882 |   | $ | 11,837 |   | $ | 7,922 |   |
|                                             |       |                   |       |                  |       |   |   |   |   |
| **Earnings  per common share:**                  |       |                   |       |                  |       |   |   |   |   |
| Basic net income per common share                |       | $                      | 0.41       |                  | $          | 0.34 |   | $ | 1.06 |   | $ | 0.94 |   |
|                                             |       |                   |       |                  |       |   |   |   |   |   |   |   |   |
| Diluted net income per common share              |       | $                      | 0.39       |                  | $          | 0.33 |   | $ | 1.02 |   | $ | 0.89 |   |
|                                             |       |                   |       |                  |       |   |   |   |   |   |   |   |   |
| **Basic  weighted-average shares outstanding**   |       | 11,227                 |       | 8,483                 |       | 11,140 |   | 8,471 |   |
| **Diluted  weighted-average shares outstanding** |       | 11,698                 |       | 8,840                 |       | 11,595 |   | 8,897 |   |

 

***See accompanying notes***

 

4

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**SIInternational, Inc. and Subsidiaries**

**Consolidated Statements of Cash Flows**

**(Amountsin thousands)**

**Unaudited**

 
| ** **                                                                                       | ** ** | **Nine Months Ended**        | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                       | ** ** | **September 24,  2005** | ** ** | **September 25,  2004** | ** ** |
| **Cash  flows from operating activities:**                                                       |       |                         |       |   |   |
| Net income                                                                                       |       | $                            | 11,837     |   | $ | 7,922 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities:               |       |                         |       |   |   |
| Depreciation and amortization                                                                    |       | 1,586                        |       | 1,704 |   |
| Amortization of intangible assets                                                                |       | 1,680                        |       | 477 |   |
| Income tax benefit for stock option  exercises                                                   |       | 1,179                        |       | — |   |
| Stock-based compensation                                                                         |       | 93                           |       | 98 |   |
| Amortization of deferred financing costs                                                         |       | 513                          |       | 343 |   |
| Changes in operating assets and  liabilities, net of effect of acquisitions:                     |       |                         |       |   |   |
| Accounts receivable, net                                                                         |       | (1,865                       | )          | (4,025 | ) |
| Other current assets                                                                             |       | (1,896                       | )          | 919 |   |
| Other assets                                                                                     |       | (823                         | )          | (543 | ) |
| Accounts payable and accrued expenses                                                            |       | 12,788                       |       | 1,325 |   |
| Deferred revenue                                                                                 |       | (289                         | )          | (3,058 | ) |
| Other long term liabilities                                                                      |       | 1,180                        |       | 1,507 |   |
| Net cash  provided by operating activities                                                       |       | 25,983                       |       | 6,669 |   |
| **Cash  flows from investing activities:**                                                       |       |                         |       |   |   |
| Purchase of property and equipment                                                               |       | (1,537                       | )          | (1,050 | ) |
| Cash paid for acquisition of MATCOM  International Corp.                                         |       | (82                          | )          | (66,086 | ) |
| Cash paid for acquisition of Bridge  Technology Corporation                                      |       | (197                         | )          | — |   |
| Cash paid for acquisition of Shenandoah  Electronic Intelligence, Inc., net of cash assumed |       | (73,874                      | )          | — |   |
| Net cash  used in investing activities                                                           |       | (75,690                      | )          | (67,136 | ) |
| **Cash  flows from financing activities:**                                                       |       |                         |       |   |   |
| Proceeds from exercise of stock options                                                          |       | 2,910                        |       | 390 |   |
| Net (repayments) borrowings under line of  credit                                                |       | (28,954                      | )          | 16,000 |   |
| Proceeds from long-term debt                                                                     |       | 100,000                      |       | 30,000 |   |
| Repayments of long-term debt                                                                     |       | (250                         | )          | (3,000 | ) |
| Payments of debt issuance costs                                                                  |       | (3,231                       | )          | (1,202 | ) |
| Repayments of capital lease obligations                                                          |       | (79                          | )          | (109 | ) |
| Net cash  provided by financing activities                                                       |       | 70,396                       |       | 42,079 |   |
| **Net  change in cash and cash equivalents**                                                     |       | 20,689                       |       | (18,388 | ) |
| **Cash and  cash equivalents, beginning of period**                                              |       | 5,754                        |       | 23,252 |   |
| **Cash and  cash equivalents, end of period**                                                    |       | $                            | 26,443     |   | $ | 4,864 |   |
| **Supplemental  disclosures of cash flow information:**                                          |       |                         |       |   |   |
| Cash payments for interest                                                                       |       | $                            | 3,465      |   | $ | 1,368 |   |
| Cash payments for income taxes                                                                   |       | $                            | 3,045      |   | $ | 4,817 |   |
| Purchases of assets under capital lease                                                          |       | $                            | 126        |   | $ | — |   |

 

***See accompanying notes***

 

5

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**SIInternational, Inc. and Subsidiaries**

**Notes to consolidated financial statements**

**(Unaudited)**

 

**1.****             Basisof 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 and nine months ended September 24, 2005are not necessarily indicative of the results that may be expected for the yearending December 31, 2005. For further information, refer to the financialstatements and footnotes included in SI International’s Annual Report on Form 10-Kfor the year ended December 25, 2004. References to the “Company,” “we,” “us” and “our” refer to SIInternational, Inc. and its subsidiaries.

 

**2.****             Summaryof significant accounting 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 not falling after, 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 and nine-month periods presentedin this Form 10-Q include 13 weeks and 39 weeks, respectively.

 

**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 theFederal government or prime contractors doing business with the Federalgovernment accounted for a significant percent of revenues in the fiscalquarter and nine months ending September 24, 2005 and September 25,2004.

 

6

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| ** **                 | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|----------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                 | ** ** | **September  24, 2005** | ** ** | **September  25, 2004** | ** ** | **September  24, 2005** | ** ** | **September  25, 2004** | ** ** |
|                       |       |                    |       |                    |       |   |   |   |   |
| Department  of Defense     |       | 46.8                    | %          | 53.2                    | %          | 46.6 | % | 52.0 | % |
| Federal  civilian agencies |       | 51.5                    |       | 42.9                    |       | 51.6 |   | 44.3 |   |
| Commercial  entities       |       | 1.7                     |       | 3.9                     |       | 1.8 |   | 3.7 |   |
|                       |       |                    |       |                    |       |   |   |   |   |
| Total revenue              |       | 100.0                   | %          | 100.0                   | %          | 100.0 | % | 100.0 | % |

 

For the three and nine months ended September 24,2005 we had one contract that generated more than 10% of our revenue.  For the three and nine months ended September 24,2005, our C4I2TSR contract with the U.S Air Force Space Command representedapproximately 19.4% and 18.0% of our revenue, respectively.  The C4I2TSR contract representedapproximately 21.0% of our revenue for the three months ended September 25,2004 and 15.5% of revenue for the first nine months of 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):

 
| ** **                | ** ** | **September 24,  2005** | ** ** | **December 25,  2004** | ** ** |
|---------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                      |       |                         |       |                        |       |
| Deferred  loan costs      |       | $                            | 4,968      |                        | $          | 1,737 |   |
| Accumulated  amortization |       | (1,350                       | )          | (837                        | )          |
|                      |       | $                            | 3,618      |                        | $          | 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 September 24,2005 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 and nine months ended September 24,2005.

 

7

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| ** **                                                                                                                                   | ** ** | **Three Months Ended**       | ** ** | **Nine Months Ended**        | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                   | ** ** | **September 24,  2005** | ** ** | **September 25,  2004** | ** ** | **September 24,  2005** | ** ** | **September 25,  2004** | ** ** |
|                                                                                                                                         |       |                         |       |                         |       |   |   |   |   |
| Net income -  as reported                                                                                                                    |       | $                            | 4,578      |                         | $          | 2,882 |   | $ | 11,837 |   | $ | 7,922 |   |
| Add: total  stock-based employee compensation expense as reported under intrinsic value  method (APB No. 25) for all awards, net of tax |       | 19                           |       | 19                           |       | 56 |   | 59 |   |
| Deduct:  Total stock-based compensation expense determined under fair value based  method (SFAS No. 123) for all awards, net of tax     |       | (790                         | )          | (528                         | )          | (2,166 | ) | (1,567 | ) |
| Net income -  pro forma                                                                                                                      |       | $                            | 3,807      |                         | 2,373      |   | $ | 9,727 |   | 6,414 |   |
|                                                                                                                                         |       |                         |       |                         |       |   |   |   |   |
| Basic  earnings per share - as reported                                                                                                      |       | $                            | 0.41       |                         | 0.34       |   | $ | 1.06 |   | 0.94 |   |
|                                                                                                                                         |       |                         |       |                         |       |   |   |   |   |
| Diluted  earnings per share - as reported                                                                                                    |       | $                            | 0.39       |                         | 0.33       |   | $ | 1.02 |   | 0.89 |   |
|                                                                                                                                         |       |                         |       |                         |       |   |   |   |   |
| Basic  earnings per share - pro forma                                                                                                        |       | $                            | 0.34       |                         | 0.28       |   | $ | 0.87 |   | 0.76 |   |
|                                                                                                                                         |       |                         |       |                         |       |   |   |   |   |
| Diluted  earnings per share - pro forma                                                                                                      |       | $                            | 0.33       |                         | 0.27       |   | $ | 0.84 |   | 0.72 |   |
|                                                                                                                                              |            |                              |            |                              |            |  |  |  |  |  |  |  |  |

 

**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 common stock equivalents andother potentially dilutive securities outstanding during the period.

 

The following details the computation of net income per common share(in 000s):

 
| ** **                                   | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|----------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                   | ** ** | **September  24, 2005** | ** ** | **September  25, 2004** | ** ** | **September  24, 2005** | ** ** | **September  25, 2004** | ** ** |
|                                         |       |                    |       |                    |       |   |   |   |   |
| Net Income -  Basic and Diluted              |       | $                       | 4,578      |                    | $          | 2,882 |   | $ | 11,837 |   | $ | 7,922 |   |
|                                         |       |                    |       |                    |       |   |   |   |   |
| **Weighted  average share calculation:**     |       |                    |       |                    |       |   |   |   |   |
|                                         |       |                    |       |                    |       |   |   |   |   |
| Basic  weighted average shares outstanding   |       | 11,227                  |       | 8,483                   |       | 11,140 |   | 8,471 |   |
| Treasury  stock effect of stock options      |       | 471                     |       | 357                     |       | 455 |   | 426 |   |
|                                         |       |                    |       |                    |       |   |   |   |   |
| Diluted  weighted average shares outstanding |       | 11,698                  |       | 8,840                   |       | 11,595 |   | 8,897 |   |
|                                              |            |                         |            |                         |            |  |  |  |  |  |  |  |  |

 

**Reclassifications**

 

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

 

**New accounting pronouncements**

** **

InDecember 2004, the FASB issued FASB Statement No. 123(R) (revised2004), *Share Based Payment.* Statement123(R) addresses the accounting for share-based payment transactions inwhich an enterprise receives employee

 

8

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services in exchange for(a) equity instruments of the enterprise or (b) liabilities that arebased on the fair value of the enterprise’s equity instruments or that may besettled 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, *Accountingfor Stock Issued to Employees*, which was permitted under Statement123, as originally issued. The revised Statement requires entities to discloseinformation about the nature of the share-based payment transactions and theeffects of those transactions on the financial statements. 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.

 

Aspermitted by Statement 123, the Company currently accounts for share-basedpayments to employees using Opinion 25’s intrinsic value method and, as such,generally recognizes no compensation cost for employee stock options.Accordingly, the adoption of Statement 123(R)’s fair value method will have asignificant impact on our results of operations, although it will have noimpact on our overall financial position. The impact of adoption of Statement123(R) cannot be predicted at this time because it will depend on levels ofshare-based payments granted in the future. However, had we adopted Statement123(R) in prior periods, the impact of that standard would have approximatedthe impact of Statement 123 as described in the disclosure of pro forma netincome and earnings per share in the Stock-Based Compensation section ofthis note to our consolidated financial statements. Statement 123(R) alsorequires the benefits of tax deductions in excess of recognized compensationcost to be reported as a financing cash flow, rather than as an operating cashflow as required under current literature. This requirement will reduce netoperating cash flows and increase net financing cash flows in periods afteradoption.

 

InJuly 2005, the FASB issued an Exposure Draft of a proposed Interpretation,*Accounting for Uncertain Tax Positions – anInterpretation of FASB Statement No. 109*.  The proposed Interpretation (if adopted inits current form) would apply to all open tax positions accounted for inaccordance with FAS 109, *Accounting forIncome Taxes,* including those acquired in businesscombinations.  Under the proposedInterpretation, the recognition of a tax benefit would occur when it is “probable”that the position would be sustained upon audit.  The proposed Interpretation refers to FASBStatement No. 5, *Accounting forContingencies,* definition of “probable,” which represents a level ofassurance that is substantially higher than “more likely than not.”  The Board noted that, in determining if the “probable”threshold has been met, it should be assumed that the taxing authority willexamine the tax position. The proposed Interpretation differs from current rules whichallow for the recognition of a tax benefit if it is “more likely than not” thatthe position would be sustained upon audit. The proposed Interpretation, as currently drafted (and if adopted) wouldbe effective for fiscal years ending after December 15, 2005.  It is not certain that the Interpretationwill be adopted with the current effective date.  Management is in the process of determiningthe effect of this proposal on its financial statements.

 

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

 

OnFebruary 9, 2005, we completed the purchase of Shenandoah Electronic Intelligence, Inc.(SEI). SEI is a provider of critical business process outsourcing primarily forthe Department of Homeland Security (DHS). SEI’s services include: data andrecords management; applications processing; file and mail management;analytical support services; and secure optical card processing.

 

Asa result of this acquisition, we gained approximately 1,700 additionalemployees and increased our leased space to 28 offices and three warehouses atvarious U.S. locations for an aggregate of approximately 536,263 square feet in15 states (including approximately 27,090 square feet that are sub-leasedthrough the remaining terms of our primary leases).

 

Underthe terms of the definitive stock purchase agreement, we acquired SEI for $75million in cash, subject to certain adjustments totaling approximately $0.6million. The transaction was funded through cash-on-hand and borrowings from anew $160 million credit facility, which replaced the Company’s previous $80million credit facility.  The purchase priceis subject to adjustment as a result of certain tax elections.  The Company, in conjunction with the SEIstockholders, have made a 338(h)(10) tax election.  The definitive stock purchase agreement alsoprovides that the SEI stockholders will retain certain non-operating assets andcontingent accounts receivable.

 

Approximately$53.4 million of the purchase consideration has been allocated to goodwillbased primarily on the excess of the purchase price over the estimated fairvalue of net assets acquired, and approximately $12.2 million of the purchaseprice has been assigned to identifiable intangible assets on the basis ofcontractual customer relationships. The contractual customer relationships arebeing amortized using an accelerated method over their estimated remaining lifeof 14 years.

 

9

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Thetotal purchase price paid, including transaction costs of $1.0 million, hasbeen preliminarily allocated as follows (in thousands):

 
| Cash                                          |   | $      | 2,958  |   |
|-----------------------------------------------|--------|--------|--------|--------|
| Accounts receivable                           |   | 12,093 |   |
| Prepaid  expense and other current assets     |   | 353    |   |
| Property and  equipment                       |   | 331    |   |
| Accounts  payable & accrued expenses |   | (4,730 | )      |
| Contractual  customer relationships           |   | 12,200 |   |
| Goodwill                                      |   | 53,432 |   |
| Total  consideration                          |   | $      | 76,637 |   |

 

OnDecember 20, 2004, the Company completed the purchase of Bridge TechnologyCorporation, a provider of information technology and information management.The acquisition supports the company’s strategic growth plan to broaden itscustomer base into the intelligence agencies, and strengthen its portfolio ofmission-critical solutions. Under the terms of the acquisition agreement, theCompany acquired Bridge Technology for $30 million, subject to working capitaland other adjustments totaling approximately $1.7 million. Of the purchaseprice, $29.4 million was paid in cash and the $2.3 million was held asnote payable to be paid in June, 2006. Approximately $26.2 million of thepurchase consideration has been allocated to goodwill, and approximately $2.2million 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 6 years.

 

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

 

Thefollowing unaudited proforma combined condensed statements of operations (inthousands, except per share) set forth the consolidated results of operationsof the Company for the three and nine months ended September 24, 2005 and September 25,2004 as if the above described acquisitions had occurred at the beginning ofeach period presented. This unaudited proforma information does not purport tobe indicative of the actual results that would actually have occurred if thecombination had been in effect for the three and nine months ended September 24,2005 and September 25, 2004.

 
| ** **                  | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|-----------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                  | ** ** | **September  24, 2005** | ** ** | **September  25, 2004** | ** ** | **September  24, 2005** | ** ** | **September  25, 2004** | ** ** |
|                        |       |                    |       |                    |       |   |   |   |   |
| Revenue                     |       | $                       | 101,775    |                    | $          | 98,496 |   | $ | 289,900 |   | $ | 266,553 |   |
| Net income                  |       | $                       | 4,578      |                    | $          | 3,918 |   | $ | 11,785 |   | $ | 10,141 |   |
| Diluted  earnings per share |       | $                       | 0.39       |                    | $          | 0.44 |   | $ | 1.02 |   | $ | 1.14 |   |

 

Inaccordance with the purchase accounting method, the operations of MATCOM,Bridge Technology and SEI have been included in the Company’s statements ofoperations since the respective dates of acquisition.

 

**4.****             Accountsreceivable:**

 

Accounts receivable consists of the following(in thousands):

 
| ** **                                                                                         | ** ** | **September 24, 2005** | ** ** | **December 25, 2004** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|----------------------------|------------|
|                                                                                               |       |                        |       |                       |       |
| Billed  accounts receivable                                                                        |       | $                           | 41,167     |                       | $          | 33,247 |   |
| Unbilled  accounts receivable:                                                                     |       |                        |       |                       |       |
| Currently billable                                                                                 |       | 33,083                      |       | 26,400                     |       |
| Unbilled retainages and milestone payments expected  to be billed within the next 12 months        |       | 6,409                       |       | 5,714                      |       |
| Indirect costs incurred and charged to cost-plus  contracts in excess of provisional billing rates |       | 1,643                       |       | 1,493                      |       |
| Total  unbilled accounts receivable                                                                |       | 41,135                      |       | 33,607                     |       |
| Allowance  for doubtful accounts                                                                   |       | (2,250                      | )          | (1,144                     | )          |
| Accounts  receivable, net                                                                          |       | $                           | 80,052     |                       | $          | 65,710 |   |

 

10

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The currently billable amounts included asunbilled accounts receivable as of September 24, 2005 represent amounts thatare billed during the following quarter of the current year. They are billingsfor services rendered prior to quarter-end, which are billed once necessarybilling data has been collected and an invoice is produced.

 

**5.****             Propertyand equipment:**

 

Property and equipment consist of thefollowing (in thousands):

 
| ** **                                           | ** ** | **September 24, 2005** | ** ** | **December 25, 2004** | ** ** |
|------------------------------------------------------|------------|-----------------------------|------------|----------------------------|------------|
| Computers  and equipment                             |       | $                           | 8,358      |                       | $          | 8,007 |   |
| Software                                             |       | 2,357                       |       | 1,904                      |       |
| Furniture  and fixtures                              |       | 2,061                       |       | 1,576                      |       |
| Leasehold  improvements                              |       | 1,329                       |       | 1,086                      |       |
|                                                 |       | 14,105                      |       | 12,573                     |       |
| Less—Accumulated  depreciation and amortization |       | (8,776                      | )          | (7,602                     | )          |
| Property and  equipment, net                         |       | $                           | 5,329      |                       | $          | 4,971 |   |

 

Property and equipment includes assets financedunder capital lease obligations of approximately $309,000 and $332,000, net ofaccumulated amortization, as of September 24, 2005 and December 25,2004, respectively.

 

**6.****             Accruedexpenses and other current liabilities:**

 

Accrued expenses and other currentliabilities consist of the following (in thousands):

 

| ** **                                      | ** ** | **September 24, 2005** | ** ** | **December 25, 2004** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|----------------------------|------------|
|                                            |       |                        |       |                       |       |
| Accrued  vacation                               |       | $                           | 6,519      |                       | $          | 4,955 |   |
| Accrued  compensation                           |       | 9,754                       |       | 3,550                      |       |
| Accrued  bonus                                  |       | 4,919                       |       | 2,875                      |       |
| Other  accrued liabilities                      |       | 4,931                       |       | 3,934                      |       |
| Accrued  expenses and other current liabilities |       | $                           | 26,123     |                       | $          | 15,314 |   |

 

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

 

Debt, which is included in current and longterm liabilities in the accompanying balance sheets, consists of the following(in thousands):

 
| ** **                                                                                                                                                                                                                                                                                                                                            | ** ** | **September 24, 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 September 24, 2005, bears  interest at LIBOR plus 225 to 250 basis points or a specified base rate plus 125  to 150 basis points, interest due monthly, twenty—three $250,000 consecutive  quarterly principal payments starting on June 30, 2005, and a final  $94.25 million principal payment on February 9, 2011 |       | 99,750                      |       | —                     |       |
|                                                                                                                                                                                                                                                                                                                                                  |       |                        |       |                       |       |
| Total debt*                                                                                                                                                                                                                                                                                                                                           |       | $                           | 99,750     |                       | $          | 28,954 |   |

 

11

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* Excludes $2.3 million note payable in connection with the BridgeTechnology acquisition as described below.

 

Priorto the closing of the SEI acquisition, the credit facility (the 2004 creditfacility) consisted of a $30.0 million term loan and a $50.0 millionsecured revolving credit arrangement. The 2004 credit facility was secured by apledge of substantially all of our current and future tangible and intangibleassets, as well as those of our current and future subsidiaries, includingaccounts receivable, inventory and capital stock of our existing and futuresubsidiaries. In addition, the Company was required to maintain compliance withfinancial and nonfinancial covenants, including the requirement to maintaincertain leverage and fixed charge ratios, as defined in the credit agreement,as well as certain annual limits on our capital expenditures.

 

Contemporaneouswith the closing of our acquisition of SEI on February 9, 2005, theCompany amended and restructured its prior credit facility and increased itsborrowing capacity to $160 million, which is comprised of a $60 millionfive-year revolving credit facility and a $100 million six-year term loanfacility. Borrowings available under the amended credit facility were used tofurther the acquisitions of Bridge Technology and SEI. In addition, the amendedand restructured credit facility provides that up to an additional $75 millionin uncommitted incremental term loan funds are available to the Company uponits request at any time for up to two years from the amendment date from one ormore of the lenders under the credit facility.

 

Inconnection with the amended credit facility, the Company incurred financingcosts of $3.2 million. Such costs were capitalized as deferred financing costson the balance sheet and are being amortized over the six year term of the newcredit facility.  As of September 24,2005, the amounts outstanding under the term loan bore interest at LIBOR plus250 basis points.

 

Inconnection with the Bridge Technology acquisition, the Company also has anoutstanding note payable in the amount of $2.3 million, to be paid in June 2006,which is included in the accompanying balance sheet as Note payable – formerowner of acquired business.

 

**8.****             Commitmentsand contingencies:**

 

**Leases**

 

As of September 24, 2005, the Company hadnoncancelable operating leases, primarily for real estate, that expire over thenext ten years. Rental expense during the quarter ended September 24, 2005was approximately $2.0 million, compared to rental expense of approximately $1.6million during the quarter ended September 25, 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.

 

12

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**Litigation and claims**

 

From time to time, theCompany is involved in litigation, claims and disputes that arise in theordinary course of its business.  Inaddition, the Company is subject to audit, review, and investigation by variousagencies of the Federal 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 andapplicable federal statutes and regulations. While the Company cannot predict the ultimate outcome of legalproceedings, government audits, investigations, claims and disputes to which itis or may be subject, the Company currently believes, based upon informationavailable to us as of the date of this filing, that any ultimate liabilityarising out of these matters will not have a material adverse effect on ourfinancial position, results of operations, or cash flows.

 

The SEI acquisitionagreement provides for a purchase price adjustment based upon the workingcapital of SEI as of the closing date.  Subsequent to the closing date,the Company received a payment of $1.6 million in connection with servicesperformed prior to the closing date that SEI had not previously billed, and wasnot authorized to bill, its customer as of the closing date.  The SEIselling stockholders have asserted that they are entitled to acredit in connection with the calculation of working capital adjustment inan amount equal to the amount received by the Company for this post-closing payment. The Company believes that, in accordance with GAAP, the SEI sellingstockholders should not receive the benefit of the post-closing payment. In accordance with the terms of the SEI acquisition agreement, the parties havejointly submitted the issue to an independent accounting firm for resolution.

 

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

 

**Stock option plan**

 

In 2002, the Company adopted the 2002 StockIncentive Plan, or the Plan, to grant stock options to purchase up to 1,600,000shares of its common stock to its employees and employees of itsaffiliates.  In March 2004, theBoard of Directors increased the number of reserved shares by 160,000, so thatthe total number of reserved shares totaled 1,760,000.  In March 2005, the Board of Directorsincreased the number of reserved shares by an additional 160,000 so that thetotal number of reserved shares totals 1,920,000.  Further, in March 2005, the Board ofDirectors authorized the acceleration of vesting of certain stock awards under thePlan 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.  The Board ofDirectors also authorized the amendment of certain prior stock option awardsissued under the Plan such that the exercise price of each such award wasgreater than or equal to the closing market price of our common stock on Nasdaqas of March 11, 2005.  With respectto such designated prior stock option awards, the Board of Directors authorizedan amendment to the stock option award to provide for the acceleration ofvesting upon the occurrence of certain change of control events.

 

In April 2005, the Board of Directors voted toadopt the 2002 Amended and Restated Omnibus Stock Incentive Plan (the “Amendedand Restated Plan”) and the Amended and Restated Plan was approved byour stockholders at the annualmeeting of stockholders held in June 2005. The Amended and Restated Plan amends and restates the Plan by (i) increasingthe number of shares of common stock reserved and available under the Plan by1,000,000 shares to a total share allocation of 2,920,000, (ii) permittingthe grant of deferred shares, performance shares and performance units, (iii) prohibitingrepricing of options without prior stockholder approval, (iv) limiting thenumber of shares of common stock and performance units subject to awards aparticipant may receive in any calendar year to 300,000 and 500,000,respectively, and adding other administrative provisions to comply with theperformance-based compensation exception to the deduction limit of Section 162(m)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

 

13

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shares allocated, modify participationrequirements, or materially increase benefits accruing to the participantsunder the Plan will be subject to stockholder approval; and (ix) makingother technical changes to the Plan.

 

As of September 24, 2005, the Company hadissued and outstanding 1,534,225 stock options, and had 240,831 sharespreviously exercised pursuant to stock option grants, for a total of 1,775,056 sharesexercised or stock options issued and outstanding under the Amended andRestated Plan against a ceiling of 2,920,000 shares of common stock authorizedunder this plan.  As of September 24,2005, the Company has issued and outstanding 107,622 stock options under stockoption plans other than the Amended and Restated Plan.  All such grants were made prior to theCompany’s initial public offering in November 2002, and no further grantswill be made under these plans.

 

**Item 2.  Management’s Discussionand Analysis of Financial Condition and Results of Operations**

 

*The following discussion and analysis should be read in conjunctionwith the consolidated financial statements and related notes included elsewherein this Form 10-Q. This discussion and analysis contains forward-lookingstatements that involve known and unknown risks, uncertainties, and otherfactors that may cause our actual results, level of activity, performance orachievements to be materially different from any future results, levels ofactivity, performance or achievements expressed or implied by suchforward-looking statements. In some cases, you can identify these statements byforward-looking words such as “anticipate,” “believe,” “could,” “estimate,” “expect,”“intend,” “may,” “plan,” “potential,” “should,” “will,” and “would” or similarwords. You should read statements that contain these words carefully becausethey discuss our future expectations, contain projections of our future resultsof operations or of our financial position, or state other forward-lookinginformation. We believe that it is important to communicate our futureexpectations to our investors. However, there may be events in the future thatwe are not able to predict accurately or control. In particular, statementsthat we make in this section relating to the sufficiency of anticipatedsources of capital to meet our cash requirements are forward- looking statements.Our actual results could differ materially from those anticipated in theseforward-looking statements for many reasons, including as a result of some ofthe factors described below, elsewhere in this Form 10-Q and in the section entitled“Risk Factors” in our Form 10-K  forthe fiscal year ended December 25, 2004.  You should not place undue reliance on these forward-looking statements,which apply only as of the date of the filing of this Form 10-Q.*

 

*Our fiscal year is based on the calendar year and ends each year on theSaturday nearest, but not falling after, December 31 of that year, and ourfiscal quarter end on the Saturday nearest but prior to the applicablequarterly month end.  As a result, ourfiscal year may be comprised of 52 or 53 weeks. The fiscal quarters and nine-month periods presented in this Form 10-Qinclude 13 weeks and 26 weeks, respectively.*

* *

*References to the “Company,” “we,” “us” and “our” refer to SIInternational, 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, Federal RetirementThrift Investment Board, the National Institutes of Health, the Department ofAgriculture, U.S. Air Force Electronic Systems Center, the U.S. Navy and theintelligence community.  We combine ourtechnology and industry expertise to provide a full spectrum ofstate-of-the-practice solutions and services, from design and development toimplementation and operations, which assist our clients in achieving missionsuccess.

 

In the three and nine months ended September 24,2005, we received 98.3% and 98.2%, respectively, of our revenues from serviceswe provided to various departments and agencies of the Federal government and 1.7%and 1.8%, respectively, of our total revenues from work performed forcommercial entities. In comparison, for the three months and nine months ended September 25,2004, we received 96.1% and 96.3%, respectively, of our revenues from serviceswe provided to Federal government agencies and 3.9% and 3.7%, respectively, oftotal revenues from work performed for commercial entities.  The following table shows our revenues from theclient groups listed as a percentage of total revenue. Revenue data for theDepartment of Defense includes revenue generated from work performed underengagements for both the Department of Defense and the intelligence community.

 

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| ** **                 | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **Sept. 24,  2005**    | ** ** | **Sept. 25,  2004**   | ** ** | **Sept. 24,  2005** | ** ** | **Sept. 25,  2004** | ** ** |
|                       |       |                   |       |                  |       |   |   |   |   |
| Department  of Defense     |       | 46.8                   | %          | 53.2                  | %          | 46.6 | % | 52.0 | % |
| Federal  civilian agencies |       | 51.5                   | %          | 42.9                  | %          | 51.6 | % | 44.3 | % |
| Commercial  entities       |       | 1.7                    | %          | 3.9                   | %          | 1.8 | % | 3.7 | % |
| Total revenue              |       | 100.0                  | %          | 100.0                 | %          | 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 as prime contractorbecause it provides us with stronger client relationships. The following tableshows our revenues as prime contractor and as subcontractor as a percentage ofour total revenue for the following periods:

 
| ** **              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **              | ** ** | **Sept. 24,  2005**    | ** ** | **Sept. 25,  2004**   | ** ** | **Sept. 24,  2005** | ** ** | **Sept. 25,  2004** | ** ** |
|                    |       |                   |       |                  |       |   |   |   |   |
| Prime  contract revenue |       | 74.8                   | %          | 81.2                  | %          | 74.7 | % | 79.9 | % |
| Subcontract  revenue    |       | 25.2                   | %          | 18.8                  | %          | 25.3 | % | 20.1 | % |
| Total revenue           |       | 100.0                  | %          | 100.0                 | %          | 100.0 | % | 100.0 | % |

 

Our services are provided under three typesof contracts: cost reimbursable, time and materials and fixed price contracts.The following table shows our revenues from each of these types of contracts asa percentage of our total revenue for the following periods:

 
| ** **          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------|------------|------------------------|------------|-----------------------|------------|
| ** **          | ** ** | **Sept. 24,  2005**    | ** ** | **Sept. 25,  2004**   | ** ** | **Sept. 24,  2005** | ** ** | **Sept. 25,  2004** | ** ** |
|                |       |                   |       |                  |       |   |   |   |   |
| Cost  reimbursable  |       | 29.5                   | %          | 33.3                  | %          | 28.4 | % | 28.5 | % |
| Time and  materials |       | 44.5                   | %          | 46.6                  | %          | 48.8 | % | 48.1 | % |
| Fixed price         |       | 26.0                   | %          | 20.1                  | %          | 22.8 | % | 23.4 | % |
| Total               |       | 100.0                  | %          | 100.0                 | %          | 100.0 | % | 100.0 | % |

 

Under cost reimbursable contracts, we are reimbursedfor costs that are determined to be reasonable, allowable and allocable to thecontract, and paid a fee representing the profit margin negotiated between usand the contracting agency, which may be fixed or performance based. Under costreimbursable contracts we recognize revenues and an estimate of applicable feesearned as costs are incurred. We consider fixed fees under cost reimbursablecontracts to be earned in proportion to the allowable costs incurred inperformance of the contract. For performance-based fees under 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 and nine monthsended September 24, 2005, 29.5% and 28.4%, respectively, of our revenueswere derived from cost reimbursable contracts. In the three and nine months ended September 25, 2004, 33.3% and 28.5%,respectively, of our revenues were derived from cost reimbursable 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 cost

 

15

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reimbursable contracts. In the three and ninemonths ended September 24, 2005, 44.5% and 48.8%, respectively, of ourrevenues were derived from time and materials contracts.  In the three and nine months ended September 25,2004, 46.6% and 48.1%, respectively, of our revenues were derived from time andmaterial 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 and nine months ended September 24, 2005, 26.0% and 22.8%,respectively, of our revenues were derived from fixed price contracts.   In the three and nine months ended September 25,2004, 20.1% and 23.4%, respectively, of our revenues were derived from fixedprice 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 itemsfrom our consolidated statements of operations as a percent of revenues for theperiods indicated.

 
| ** **                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **Sept. 24,  2005**    | ** ** | **Sept. 25,  2004**   | ** ** | **Sept. 24,  2005** | ** ** | **Sept. 25,  2004** | ** ** |
|                                      |       |                   |       |                  |       |   |   |   |   |
| Revenue                                   |       | 100.0                  | %          | 100.0                 | %          | 100.0 | % | 100.0 | % |
| Costs and  expenses:                      |       |                   |       |                  |       |   |   |   |   |
| Direct costs                              |       | 61.6                   |       | 67.2                  |       | 61.8 |   | 63.0 |   |
| Indirect costs                            |       | 28.2                   |       | 24.2                  |       | 28.5 |   | 28.0 |   |
| Depreciation                              |       | 0.5                    |       | 0.7                   |       | 0.6 |   | 0.9 |   |
| Amortization                              |       | 0.6                    |       | 0.2                   |       | 0.6 |   | 0.2 |   |
| Total operating expenses                  |       | 90.9                   |       | 92.3                  |       | 91.5 |   | 92.1 |   |
| Income from  operations                   |       | 9.1                    |       | 7.7                   |       | 8.5 |   | 7.9 |   |
| Other income  (expense)                   |       | 0.0                    |       | (0.1                  | )          | 0.0 |   | (0.0 | ) |
| Interest  expense                         |       | 1.7                    |       | 1.0                   |       | 1.6 |   | 1.1 |   |
|                                      |       |                   |       |                  |       |   |   |   |   |
| Income  before provision for income taxes |       | 7.4                    |       | 6.6                   |       | 6.9 |   | 6.8 |   |
| Provision  for income taxes               |       | 2.9                    |       | 2.6                   |       | 2.7 |   | 2.7 |   |
|                                      |       |                   |       |                  |       |   |   |   |   |
| Net income                                |       | 4.5                    | %          | 4.0                   | %          | 4.2 | % | 4.1 | % |

 

16

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**Three months ended September 24, 2005compared with three months ended September 25, 2004**

 

*Revenue.*  For the three months ended September 24,2005, our revenues increased 39.6% to $101.8 million from $72.9 millionfor the three months ended September 25, 2004. Revenues from work under FederalGovernment contracts increased 42.9% to $100.1 million for the threemonths ended September 24, 2004 from $70.0 million for the three monthsended September 25, 2004. Thisincrease was attributable to the acquisitions of MATCOM, Bridge Technology andSEI, new contract awards, successful recompetition wins on existing programs,new contracts from and growth within existing programs in our four focus areas:Federal IT Modernization, Defense Transformation, Homeland Defense, and Mission-CriticalOutsourcing.  Commercial revenuesdecreased 40.5% to $1.7 million in the three months ended September 24,2005 from $2.9 million in the three months ended September 25, 2004.  Thisdecrease was attributable to our continued focus on opportunities for theFederal government.

 

*Direct costs.*  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 September 24, 2005,direct costs increased 27.8% to $62.7 million from $49.1 million forthe three months ended September 25, 2004. This increase was attributableprimarily to the increase in revenue. As a percentage of revenue, direct costswere 61.6% for the three months ended September 24, 2005 as compared to 63.0%for the three months ended September 25, 2004.

 

*Indirect costs.*  Indirect costs include facilities, selling,bid and proposal, indirect labor, fringe benefits and other discretionarycosts. For the three months ended September 24, 2005, indirect costsincreased 63.1% to $28.7 million from $17.6 million for the threemonths ended September 25, 2004.  This $11.1 million increase wasprimarily attributable to the expected growth of support functions necessary tofacilitate and administer the growth in direct costs as well as the integrationof Bridge Technology and SEI.  As apercentage of revenue, indirect costs were 28.2% for the three months ended September 24,2005 as compared to 24.2% for the three months ended September 25, 2004.

 

*Depreciation.*Forthe three months ended September 24, 2005, depreciation expense decreased 2.4%to $0.50 million from $0.52 million for the three months ended September 25,2004.  As a percentage of revenue,depreciation expense was 0.5% for the three months ended September 24, 2005compared to 0.7% for the three months ended September 25, 2004.

 

*Amortization of intangible assets.*Forthe three months ended September 24, 2005, amortization of intangibleassets was $0.6 million, compared to $0.17 million for the three months ended September 25,2004.  This increase was attributed to the acquisition of Bridge Technologyand SEI.  The contractual customerrelationships are being amortized using an accelerated method over theirestimated remaining lives.

 

*Income fromoperations.*  Forthe three months ended September 24, 2005, income from operations increased66.6% to $9.2 million from $5.5 million for the three months ended September 25,2004. This increase was attributable primarily to increased revenues.  As a percentage of revenue, income fromoperations was 9.1% for the three months ended September 24, 2005 comparedto 7.7% for the three months ended September 25, 2004.

 

*Interest expense.*  Interest expense increased 143.9% to $1.69 millionfor the three months ended September 24, 2005 from $0.69 million forthe three months ended September 25, 2004. This increase was attributable primarily to increased borrowings underour credit facility made in connection with the acquisitions of BridgeTechnology and SEI.  As apercentage of revenue, interest expense was 1.7% for the three months ended September 24,2005 as compared to 1.0% for the three months ended September 25, 2004.  Weanticipate interest expense to remain at higher levels throughout fiscal year2005 as compared to the same periods in 2004.

 

*Provisionfor/benefit from income taxes.*  The provision for income tax was $3.0 millionin the three months ended September 24, 2005, compared to $1.9 millionfor the three months ended September 25, 2004.   Our thirdquarters of 2005 and 2004 tax provision, represents an estimated annualeffective tax rate of 39.5%. Our estimated annual effective tax rate is greaterthan the federal statutory rate of 34% due primarily to state income taxes.

 

17

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**Nine months ended September 24, 2005compared with nine months ended September 25, 2004**

 

*Revenue.*  For the nine months ended September 24,2005, our revenues increased 46.2% to $281.5 million from $192.7 millionfor the nine months ended September 25, 2004. Revenues from work under FederalGovernment contracts increased 49.2% to $276.6 million for the nine monthsended September 24, 2005 from $185.5 million for the nine months ended September 25,2004. This increase was attributable tothe acquisitions of MATCOM, Bridge Technology and SEI, new contract awards,successful recompetition wins on existing programs, new contracts from, andgrowth within existing programs in our four focus areas: Federal ITModernization, Defense Transformation, Homeland Defense, and Mission-CriticalOutsourcing.  Commercial revenuesdecreased 31.2% to $4.9 million in the nine months ended September 24, 2005from $7.2 million in the nine months ended September 25, 2004.  The decrease was attributable primarily toincrease in our focus on Federal Government support.

 

*Direct costs.*  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 nine months ended September 24, 2005,direct costs increased 43.2% to $173.9 million from $121.4 million for thenine months ended September 25, 2004. This increase was attributableprimarily to the increase in revenue. As a percentage of revenue, direct costswere 61.8% for the nine months ended September 24, 2005 as compared to 63.0%for the nine months ended September 25, 2004.

 

*Indirect costs.*  Indirect costs include facilities, selling,bid and proposal, indirect labor, fringe benefits and other discretionarycosts. For the nine months ended September 24, 2005, indirect costsincreased 48.6% to $80.2 million from $54.0 million for the nine monthsended September 25, 2004.  This $26.3 million increase was primarilyattributable to the expected growth of support functions necessary to facilitateand administer the growth in direct costs as well as the integration of BridgeTechnology and SEI.  As apercentage of revenue, indirect costs were 28.5% for the nine months ended September 24,2005 as compared to 28.0% for the nine months ended September 25, 2004.

 

*Depreciation.*Forthe nine months ended September 24, 2005 was $1.6 million as compared to $1.7million for the nine months ended September 25, 2004.  As a percentage of revenue, depreciationexpense was 0.6% for the nine months ended September 24, 2005 compared to 0.9%for the nine months ended September 25, 2004.

 

*Amortization of intangible assets.*Forthe nine months ended September 24, 2005, amortization of intangibleassets was $1.7 million, compared to $0.5 million for the nine months ended September 25,2004.  This increase was attributed to the acquisition of Bridge Technologyand SEI.  The contractual customerrelationships are being amortized using an accelerated method over theirestimated remaining lives.

 

*Income fromoperations.*  Forthe nine months ended September 24, 2005, income from operations increased59.0% to $24.0 million from $15.1 million for the nine months ended September 25,2004. This increase was attributable primarily to the higher revenue.  As a percentage of revenue, income fromoperations was 8.5% for the nine months ended September 24, 2005 comparedto 7.9% for the nine months ended September 25, 2004.

 

*Interest expense.*  Interest expense increased 126.4% to $4.45 millionfor the nine months ended September 24, 2005 from $1.96 million forthe nine months ended September 25, 2004. This increase was attributable primarily to increased borrowings underour credit facility made in connection with the acquisitions of BridgeTechnology and SEI.  As apercentage of revenue, interest expense was 1.6% for the nine months ended September 24,2005 as compared to 1.1% for the nine months ended September 25, 2004.  Weanticipate interest expense to remain at higher levels throughout fiscal year2005 as compared to the same periods in 2004.

 

*Provisionfor/benefit from income taxes.*  The provision for income tax was $7.7 millionin the nine months ended September 24, 2005, compared to $5.2 millionfor the nine months ended September 25, 2004.   Ourfirst three quarters of 2005 and 2004 tax provision, represents an estimatedannual effective tax rate of 39.5%. Our estimated annual effective tax rate isgreater than the federal statutory rate of 34% due primarily to state incometaxes.

 

18

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**Liquidity and 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 $26.0 millionfor the nine months ended September 24, 2005 compared with $6.7 millionfor the nine months ended September 24, 2004.  Cash provided by operations in the ninemonths ended September 24, 2005 was attributable to net income of $11.8 million,depreciation, amortization, income tax benefit, and other non-cash items of $5.1million, and a decrease in working capital and other operating assets andliabilities of $9.1 million. Cash provided by operations in the ninemonths ended September 25, 2004 was attributable to net income of $7.9 million,depreciation, amortization and other non-cash items of $2.6 million, offset byan increase in net operating assets by $3.8 million.

 

Cash used in investing activities was $75.7 millionfor the nine months ended September 24, 2005 compared with $67.1 millionfor the nine months ended September 25, 2004.  For the nine months ended September 24,2005, we acquired SEI, net of cash assumed, for $73.9 million and paidadditional cash for the acquisitions of Bridge Technologies and MATCOM of $0.2million and $0.1 million, respectively. We also invested $1.5 million in capital assets.  For the nine months ended September 25,2004, we acquired MATCOM for $66.1 million and invested $1.0 million in capitalassets.

 

Cash provided by financing activities was $70.4million for the nine months ended September 24, 2005, compared with $42.1 millionfor the nine months ended September 25, 2004.  Cash provided by financing activities for thenine months ended September 24, 2005 was attributable to $100.0 million oflong term debt provided by our credit facility and $2.9 million provided byproceeds from the exercise of stock options, partially offset by $29.0 millioncurtailment of our line of credit, $3.2 million of payments related to debtissuance costs, $0.3 million repayments of long-term debt and capital leasepayments.  Cash provided by financingactivities for the nine months ended September 25, 2004 was attributableto $16.0 million net borrowings under our revolving line of credit, $30.0million of long-term debt provided by our credit facility and $0.4 millionprovided by proceeds from the exercise of stock options, partially offset by$1.2 million of payments related to debt issuance costs, $3.0 million forrepayment of long-term debt, and $0.1 million of capital lease payments.

 

Cash and cash equivalents as of September 24,2005 and December 25, 2004 were $26.4 million and $5.8 million,respectively.

 

Debtconsists of the following (in thousands):

 
| ** **                                                                                                                                                                                                                                                                                                                                       | ** ** | **September 24, 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 September 24, 2005, bears  interest at LIBOR plus 225 to 250 basis points or a specified base rate plus 125  to 150 basis points, interest due monthly, twenty-three $250,000 consecutive  quarterly principal payments starting on June 30, 2005, and a final  $94.25 million principal payment on February 9, 2011 |       | 99,750                      |       | —                     |       |
|                                                                                                                                                                                                                                                                                                                                             |       |                        |       |                       |       |
| Total debt*                                                                                                                                                                                                                                                                                                                                      |       | $                           | 99,750     |                       | $          | 28,954 |   |

 

----

* Excludes $2.3 million note payable in connection with the BridgeTechnology acquisition as described below.

 

19

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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.

 

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 customaryconditions, to make up to $60 million of revolving credit borrowings andalso provides 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 amended credit facilitywill, at our option, bear interest either at floating rates equal to LIBOR plusa spread 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.  As of September 24,2005, the amounts outstanding under the term loan bore interest at LIBOR plus250 basis points.

 

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 of ourcurrent and future subsidiaries, including accounts receivable, inventory andcapital stock of our existing and future subsidiaries. The new credit facilityrequires us to make mandatory prepayments of outstanding borrowings, with acorresponding reduction in the maximum amount of borrowings available under thefacility; net proceeds from certain insurance recoveries and asset sales, 100%of the net proceeds from debt issuances, and 50% of the net proceeds fromcertain equity issuances are subject to specified exceptions. Also, the newcredit facility includes a number of restrictive covenants including, amongother things, limitations on our leverage and capital expenditures, limitationson our ability to incur additional indebtedness or liens, requirements that wemaintain minimum ratios of cash flow to fixed charges and prohibitions onpayment of dividends on our capital stock, limitations on our ability to enterinto mergers, acquisitions or sales of our assets, and prohibitions on certaintransactions among our subsidiaries and affiliated companies. The new creditfacility also contains events of default, including, among other events, anytransaction resulting in a new stockholder or group of stockholders acquiringcontrol of our board of directors or ownership of greater than 40% of ouroutstanding capital stock, any default by us under any material governmentcontract or other material contract to which we are a party, and the suspensionof our ability to enter into contracts with the federal, state or localgovernments 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 foracquisitions or otherwise, we may seek additional equity or debt financing.  As of September 24, 2005, approximately$44.9 million was available under the Company’s shelf registration statementfor the issuance of common stock, preferred stock, depositary shares, debtsecurities and warrants exercisable for common or preferred stock.

 

In connection with the Bridge Technologyacquisition, 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 theaccompanying balance sheet as a Note payable. – former owner of acquiredbusiness.

 

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

 

**Off-Balance Sheet Arrangements**

 

As of September 24, 2005, we have nooff-balance sheet arrangements that are reasonably likely to have a current orfuture material effect on our financial condition, revenues, or expenses,result of operations, liquidity, capital expenditures, or capital resources.

 

20

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**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 orproducts has occurred; and (4) collectibility of the contract price isconsidered probable and can be reasonably estimated. Compliance with thesecriteria may require us to 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 September 24,2005.  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 QualitativeDisclosures About Market Risk.**

 

We are exposed to certain financialmarket risks, the most predominant being fluctuations in interest rates forborrowings under our credit facility. Interest rate fluctuations are monitored by our management as anintegral part of our overall risk management program, which recognizes theunpredictability of financial markets and seeks to reduce the potentiallyadverse effect on our results of operations. As part of this strategy, we may use interest rate swap arrangements tomanage or hedge our interest rate risk.

 

21

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As of September 24, 2005, wehad $99.75 million outstanding under our credit facility.  A 1% change in interest rates would haveresulted in our interest expense fluctuating by approximately $250,000 for thethree months ended September 24, 2005.

 

In addition, historically, ourinvestment positions have been relatively small and short-term in nature. Wehave typically made investments in a fund with an effective average maturity offewer than 40 days and a portfolio make-up consisting primarily of commercialpaper and notes, variable rate instruments, and, to a lesser degree, overnightsecurities and bank instruments.  Sinceour initial public offering, the Board of Directors approved an investmentpolicy that requires us to invest in relatively short-term, high quality, andhigh liquidity obligations.

 

**Item 4.     Controls and Procedures.**

 

*Evaluation of Disclosure Controlsand Procedures.* TheCompany performed an evaluation under the supervision and with theparticipation of management, including the Company’s Chief Executive Officerand Chief Financial Officer, of the design and operation of the Company’sdisclosure controls and procedures as of September 24, 2005.  Based upon the evaluation, the Company’sChief Executive Officer and Chief Financial Officer have concluded that, as of September 24,2005, the Company’s disclosure controls and procedures were effective.

 

*Changes in Internal Control OverFinancial Reporting.*Duringthe three months ended September 24, 2005, there were no changes in theCompany’s internal control over financial reporting that has materiallyaffected, or is reasonably likely to materially affect, the Company’s internalcontrol for financial reporting.

 

**PART II:  OTHER INFORMATION**

 

**Item 1.   Legal Proceedings**

 

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.

 

The SEI acquisition agreement provides for apurchase price adjustment based upon the working capital of SEI as of theclosing date.  Subsequent to the closing date, the Company received apayment of $1.6 million in connection with services performed prior to theclosing date that SEI had not previously billed, and was not authorized tobill, its customer as of the closing date.  The SEI sellingstockholders have asserted that they are entitled to a credit inconnection with the calculation of working capital adjustment in an amountequal to the amount received by the Company for thispost-closing payment.  The Company believes that, in accordancewith GAAP, the SEI selling stockholders should not receive the benefit ofthe post-closing payment.  In accordance with the terms of the SEIacquisition agreement, the parties have jointly submitted the issue to anindependent accounting firm for resolution.

 

**Item 2. Unregistered Sales of EquitySecurities and Use of Proceeds**

 

None.

 

**Item 3. Defaults Upon Senior Securities**

 

None.

 

22

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**Item 4.   Submission of Matters To a Vote ofSecurity Holders**

 

None.

 

**Item 5. Other Information**

 

None.

 

**Item 6.  Exhibits**

 

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

 

23

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SIGNATURES

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                        | SI INTERNATIONAL, INC.       |
|-----------------------------|------------------------------|
|                        |                         |
|                        |                         |
|                        | /s/ THOMAS E. DUNN           |
|                        | Thomas E. Dunn               |
|                        | Executive Vice President and |
|                        | Chief Financial Officer      |
|                        |                         |
|                        |                         |
| Date: November 2, 2005 |                         |

 

24

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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 Corp., and the stockholders of MATCOM International Corp.,  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, Shenandoah Electronic  Intelligence, Inc. (“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  Current Report on Form 8-K filed October 11, 2005 and incorporated  herein by reference).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 4.1                  |       | Registration  Rights Agreement, as amended (filed as Exhibit 4.1 to the Third  Amendment and incorporated herein by reference).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.2                  |       | Specimen  Certificate of our common stock (filed as Exhibit 4.2 to the Company’s  Registration Statement on Form S-1/A (File No. 333-87964) filed on  November 5, 2002 (the “Fourth Amendment) and incorporated herein by  reference).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.3                  |       | Stock  Purchase Agreement, as amended (filed as Exhibit 4.3 to the 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).                                                                                                           |
| 10.14 |   | SI  International, Inc. 2002 Amended and Restated Omnibus Stock Incentive  Plan (filed as Annex B to the Company’s Proxy Statement on Schedule 14A  for the 2005 Annual Meeting of Stockholders and incorporated herein by reference). |
| 10.15 |   | Form of  SI International, inc. Stock Option Agreement Evidencing Grant of Stock  Options Under the SI International, inc. 2002 Amended and Restated Omnibus  Stock Inventive Plan, Including Notice of Stock Option Grant (filed  herewith).    |
| 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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