**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

 

**FORM 10-Q**

 

 
| **(Mark One)**

** ** | ** ** | ** **                                                                                                                             |
|---------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------|
| **x**                           | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  FOR THE QUARTER ENDED September 29, 2007** |
| ** **                      | ** ** | ** **                                                                                                                             |
| **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.**

(Exact name 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’stelephone number, including area code: **(703)234-7000**

 

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Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.   x  Yes   o  No

 

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b 2 of the Exchange Act. (Check one):

 

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

 

 

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

 

As of November 1, 2007, there were 13,177,598 sharesoutstanding of the registrant’s common stock.

 

 

 

 

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** **

**SI INTERNATIONAL, INC.**

**FORM 10-Q**

# **INDEX**

 

 
| ** **         | ** ** | ** **                                                                                                                                    | ** ** | **Page**   |
|--------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| **PART I.**        | ** ** | **FINANCIAL INFORMATION**                                                                                                                     | ** ** | ** ** |
| ITEM  1            |       | Financial Statements.                                                                                                                         |       | 3          |
|               |       | Consolidated  Balance Sheets (unaudited) at September 29, 2007 and December 30, 2006.                                                         |       | 3          |
|               |       | Consolidated  Statements of Operations for the three and nine months ended September 29,  2007 (unaudited) and September 30, 2006 (unaudited) |       | 4          |
|               |       |
|               |       | Consolidated Statements of Cash Flows for the nine  months ended September 29, 2007 (unaudited) and September 30, 2006  (unaudited)           |       | 5          |
|               |       |
|               |       | Notes to Consolidated Financial Statements                                                                                                    |       | 6          |
| ITEM 2             |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                   |       | 16         |
| ITEM 3             |       | Quantitative  and Qualitative Disclosures About Market Risk                                                                                   |       | 22         |
| ITEM 4             |       | Controls and  Procedures.                                                                                                                     |       | 23         |
|               |       |                                                                                                                                          |       |       |
| **PART II.**       | ** ** | **OTHER INFORMATION**                                                                                                                         | ** ** | ** ** |
| ITEM 1             |       | Legal Proceedings                                                                                                                             |       | 23         |
| ITEM 1A.           |       | Risk Factors                                                                                                                                  |       | 24         |
| ITEM 2             |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                  |       | 24         |
| ITEM 3             |       | Defaults Upon  Senior Securities.                                                                                                             |       | 24         |
| ITEM 4             |       | Submission of  Matters to a Vote of Security Holders.                                                                                         |       | 24         |
| ITEM 5             |       | Other Information                                                                                                                             |       | 24         |
| ITEM 6             |       | Exhibits.                                                                                                                                     |       | 24         |
| Signatures         |       | 25                                                                                                                                            |
| Index to  Exhibits |       | 26                                                                                                                                            |

 

 

 

2

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## ** **

## **PART I:  FINANCIAL INFORMATION**

 

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

**SIInternational, Inc. and Subsidiaries**

**Consolidated Balance Sheets**

**(Amounts in thousands, except share data)**

**Unaudited**

** **
| ** **                                                                                                                                                                                             | ** ** | **September 29,  2007** | ** ** | **December 30,  2006** | ** ** |    |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|---------|
| ** **                                                                                                                                                                                             | ** ** | ** **              | ** ** | ** **             | ** ** |    |
| **Assets**                                                                                                                                                                                             | ** ** | ** **              | ** ** | ** **             | ** ** |    |
| **Current assets:**                                                                                                                                                                                    | ** ** | ** **              | ** ** | ** **             | ** ** |    |
| Cash and cash equivalents                                                                                                                                                                              |       | $                       | 6,798      |                   | $          | 19,457  |   |   |
| Accounts receivable, net                                                                                                                                                                               |       | 110,618                 |       | 91,972                 |       |    |
| Other current assets                                                                                                                                                                                   |       | 9,041                   |       | 8,627                  |       |    |
| Total current assets                                                                                                                                                                                   |       | 126,457                 |       | 120,056                |       |    |
| **Property and equipment, net**                                                                                                                                                                        |       | 14,770                  |       | 12,372                 |       |    |
| **Goodwill**                                                                                                                                                                                           |       | 264,822                 |       | 220,626                |       |    |
| **Intangible assets, net**                                                                                                                                                                             |       | 29,052                  |       | 20,418                 |       |    |
| **Other assets**                                                                                                                                                                                       |       | 12,083                  |       | 7,661                  |       |    |
| Total assets                                                                                                                                                                                           |       | $                       | 447,184    |                   | $          | 381,133 |   |   |
|                                                                                                                                                                                                   |       |                    |       |                   |       |    |
| **Liabilities and stockholders’ equity**                                                                                                                                                          | ** ** | ** **              | ** ** | ** **             | ** ** |    |
| **Current liabilities:**                                                                                                                                                                               | ** ** | ** **              | ** ** | ** **             | ** ** |    |
| Note Payable — line of credit                                                                                                                                                                     |       | $                       | 20,000     |                   | $          | —  |   |   |
| Current portion of long-term debt                                                                                                                                                                      |       | 1,004                   |       | 754                    |       |    |
| Accounts payable                                                                                                                                                                                       |       | 24,263                  |       | 20,715                 |       |    |
| Note payable — former owner of acquired business                                                                                                                                                  |       | —                  |       | 5,839                  |       |    |
| Accrued expenses and other current liabilities                                                                                                                                                         |       | 33,756                  |       | 28,547                 |       |    |
| Total current liabilities                                                                                                                                                                              |       | 79,023                  |       | 55,855                 |       |    |
| **Long-term debt, net of current portion**                                                                                                                                                             |       | 93,512                  |       | 69,452                 |       |    |
| **Deferred income tax, net**                                                                                                                                                                           |       | 9,365                   |       | 8,961                  |       |    |
| **Other long-term liabilities**                                                                                                                                                                        |       | 10,082                  |       | 7,653                  |       |    |
| **Stockholders’ equity:**                                                                                                                                                                         | ** ** | ** **              | ** ** | ** **             | ** ** |    |
| Common stock—$0.01 par value per share; 50,000,000 shares authorized;  13,060,159 and 12,967,377 shares issued and outstanding as of September 29,  2007 and December 30, 2006, respectively |       | 131                     |       | 130                    |       |    |
| Additional paid-in capital                                                                                                                                                                             |       | 187,305                 |       | 184,845                |       |    |
| Retained earnings                                                                                                                                                                                      |       | 68,205                  |       | 54,065                 |       |    |
| Accumulated other comprehensive (loss) income                                                                                                                                                          |       | (439                    | )          | 172                    |       |    |
| Total stockholders’ equity                                                                                                                                                                        |       | 255,202                 |       | 239,212                |       |    |
| Total liabilities and stockholders’ equity                                                                                                                                                        |       | $                       | 447,184    |                   | $          | 381,133 |   |
|                                                                                                                                                                                                        |            |                         |            |                        |            |         |  |  |  |  |  |

 

***See accompanying notes***

** **

** **

 

3

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** **

**SI International, Inc. and Subsidiaries**

**Consolidated Statements of Operations**

**(Amounts in thousands, except per share data)**

**Unaudited**

 

 
| ** **                                  | ** ** | **Three Months Ended**  | ** ** | **Three Months Ended**  | ** ** |                    |
|---------------------------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------|
| ** **                                  | ** ** | **September 29,  2007** | ** ** | **September 30,  2006** | ** ** | **September 29,  2007** | ** ** | **September 30,  2006** | ** ** |   |
|                                        |       |                    |       |                    |       |                    |   |   |   |   |
| Revenue                                     |       | $                       | 141,109    |                    | $          | 119,869                 |   | $ | 373,602 |   | $ | 346,334 |   |   |
|                                        |       |                    |       |                    |       |                    |   |   |   |   |
| Operating costs and expenses:               |       |                    |       |                    |       |                    |   |   |   |   |
| Cost of services                            |       | 92,915                  |       | 77,092                  |       | 237,541                 |   | 218,669 |   |   |
| Selling, general and  administrative        |       | 36,462                  |       | 30,652                  |       | 102,681                 |   | 93,830 |   |   |
| Depreciation and amortization               |       | 935                     |       | 756                     |       | 2,548                   |   | 1,977 |   |   |
| Amortization of intangible assets.          |       | 1,370                   |       | 823                     |       | 2,887                   |   | 2,293 |   |   |
|                                        |       |                    |       |                    |       |                    |   |   |   |   |
| Total operating costs and expenses          |       | 131,682                 |       | 109,323                 |       | 345,657                 |   | 316,769 |   |   |
|                                        |       |                    |       |                    |       |                    |   |   |   |   |
| Income from operations                      |       | 9,427                   |       | 10,546                  |       | 27,945                  |   | 29,565 |   |   |
| Other (expense) income                      |       | (16                     | )          | 31                      |       | 486                     |   | (40 | ) |   |
| Interest expense                            |       | (2,201                  | )          | (1,720                  | )          | (5,170                  | ) | (6,195 | ) |   |
|                                        |       |                    |       |                    |       |                    |   |   |   |   |
| Income before provision for income taxes    |       | 7,210                   |       | 8,857                   |       | 23,261                  |   | 23,330 |   |   |
| Provision for income taxes                  |       | 2,827                   |       | 3,498                   |       | 9,121                   |   | 9,215 |   |   |
|                                        |       |                    |       |                    |       |                    |   |   |   |   |
| Net income                                  |       | $                       | 4,383      |                    | $          | 5,359                   |   | $ | 14,140 |   | $ | 14,115 |   |
|                                        |       |                    |       |                    |       |                    |   |   |   |   |
| Earnings per common share:                  |       |                    |       |                    |       |                    |   |   |   |   |
| Basic                                       |       | $                       | 0.34       |                    | $          | 0.42                    |   | $ | 1.09 |   | $ | 1.14 |   |
| Diluted                                     |       | $                       | 0.33       |                    | $          | 0.41                    |   | $ | 1.06 |   | $ | 1.11 |   |
| Basic weighted-average shares outstanding   |       | 13,050                  |       | 12,891                  |       | 13,012                  |   | 12,361 |   |   |
| Diluted weighted-average shares outstanding |       | 13,339                  |       | 13,198                  |       | 13,294                  |   | 12,753 |   |   |
|                                        |       |                    |       |                    |       |                    |   |   |   |   |
|                                             |            |                         |            |                         |            |                         |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***See accompanying notes***

** **

** **

** **

 

4

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** **

**SI International, Inc. and Subsidiaries**

**Consolidated Statements of Cash Flows**

**(Amounts in thousands)**

**Unaudited**

** **
| ** **                                                                         | ** ** | **Nine Months Ended**   | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                         | ** ** | **September 29,  2007** | ** ** | **September 30,  2006** | ** ** |
| ** **                                                                         | ** ** | ** **              | ** ** | ** ** | ** ** |
| **Cash flows from operating activities:**                                          |       |                    |       |   |   |
| Net income                                                                         |       | $                       | 14,140     |   | $ | 14,115 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |       |                    |       |   |   |
| Depreciation and amortization                                                      |       | 2,548                   |       | 1,977 |   |
| Amortization of intangible assets                                                  |       | 2,887                   |       | 2,293 |   |
| Loss on disposal of fixed assets                                                   |       | 39                      |       | 10 |   |
| Stock-based compensation                                                           |       | 843                     |       | 140 |   |
| Amortization of deferred financing costs and debt discount                         |       | 626                     |       | 1,750 |   |
| Changes in operating assets and liabilities, net of effect of  acquisitions:       |       |                    |       |   |   |
| Accounts receivable, net                                                           |       | (6,376                  | )          | 11,307 |   |
| Other current assets                                                               |       | (254                    | )          | (10 | ) |
| Other assets                                                                       |       | (4,770                  | )          | (1,544 | ) |
| Accounts payable and Accrued expenses and other current liabilities                |       | (61                     | )          | (13,626 | ) |
| Other long-term liabilities                                                        |       | 3,031                   |       | 3,783 |   |
| Net cash provided by operating activities                                          |       | 12,653                  |       | 20,195 |   |
| **Cash flows from investing activities:**                                          |       |                    |       |   |   |
| Purchase of property and equipment                                                 |       | (4,678                  | )          | (7,006 | ) |
| Proceeds from sale of marketable securities                                        |       | 43,250                  |       | 27,850 |   |
| Purchase of marketable securities                                                  |       | (43,250                 | )          | (20,000 | ) |
| Former owner payable                                                               |       | (6,000                  | )          | (10,322 | ) |
| Cash paid for business acquisitions, net of cash assumed                           |       | (60,371                 | )          | (48,107 | ) |
| Net cash used in investing activities                                              |       | (71,049                 | )          | (57,585 | ) |
| **Cash flows from financing activities:**                                          |       |                    |       |   |   |
| Proceeds from exercise of stock options                                            |       | 1,373                   |       | 6,431 |   |
| Proceeds from issuance of common stock                                             |       | —                  |       | 40,255 |   |
| Income tax benefit from stock option exercises                                     |       | 244                     |       | 1,671 |   |
| Proceeds from line of credit, net                                                  |       | 20,000                  |       | — |   |
| Proceeds from long-term debt                                                       |       | 25,000                  |       | 30,000 |   |
| Repayments of long-term debt                                                       |       | (690                    | )          | (50,856 | ) |
| Payments of debt issuance costs                                                    |       | (108                    | )          | (552 | ) |
| Repayments of capital lease obligations                                            |       | (82                     | )          | (87 | ) |
| Net cash provided by financing activities                                          |       | 45,737                  |       | 26,862 |   |
| **Net change in cash and cash equivalents**                                        |       | (12,659                 | )          | (10,528 | ) |
| **Cash and cash equivalents, beginning of period**                                 |       | 19,457                  |       | 26,160 |   |
| **Cash and cash equivalents, end of period**                                       |       | $                       | 6,798      |   | $ | 15,632 |   |
| **Supplemental disclosures of cash flow  information:**                            |       |                    |       |   |   |
| Cash payments for interest                                                         |       | $                       | 5,687      |   | $ | 5,334 |   |
| Cash payments for income taxes                                                     |       | $                       | 7,924      |   | $ | 6,607 |   |
| Purchases of assets under capital leases                                           |       | $                       | —     |   | $ | 198 |   |

*** ***

***See accompanying notes***

 

 

 

 

5

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**SI International, Inc. and Subsidiaries**

**Notes to consolidated financialstatements**

**(Unaudited)**

**1.             Basisof Presentation:**

 

The accompanying unauditedconsolidated financial statements of SI International, Inc. and itssubsidiaries have been prepared in accordance with U.S. generally acceptedaccounting principles for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of theinformation and footnotes required by U.S. generally accepted accountingprinciples for complete financial statements. In the opinion of management, alladjustments (consisting of normal recurring accruals) considered necessary fora fair presentation have been included. Operating results for the quarter ended September 29, 2007 are notnecessarily indicative of the results that may be expected for the year endingDecember 29, 2007.  For further information,refer to the financial statements and footnotes included in SI International’sAnnual Report on Form 10-K for the year ended December 30, 2006.  References to the “Company,” “we,” “us” and “our”refer to SI International, Inc. and its subsidiaries.

 

**2.             Summaryof significant accounting policies:**

 

**Principles of consolidation**

 

The accompanying consolidated financial statements include the accountsof the Company and its wholly owned subsidiaries.  All significant intercompany transactions andaccounts have been eliminated in consolidation.

 

**Use of estimates**

 

The preparation of financial statements in conformity with U.S.generally accepted accounting principles requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expenses during thereporting period.  Actual results could differfrom those estimates.

 

**Reporting periods**

 

The Company’s fiscal year is based on the calendar year and ends eachyear on the Saturday nearest, but not falling after, December 31 of thatyear.  As a result, our fiscal year maybe comprised of 52 or 53 weeks. Typically, fiscal quarters also end on the Saturday nearest, but notfalling after, the end of the calendar quarter. However, we will end those fiscal quarters presented in our Forms 10-Q(the first three fiscal quarters) on the Saturday which provides us with a 13week quarter even if that Saturday falls after the end of the calendarquarter.  As a result, in the future, ifour fiscal year comprises 53 weeks, the first three quarters shall each becomprised of 13 weeks and the fourth quarter shall be comprised of 14weeks.  Consistent with this policy, ourthird quarter ended September 29, 2007 was a 13-week quarter.

 

**Cash and cash equivalents**

 

We consider cash on deposit and all highly liquid investments withoriginal maturities of three months or less to be cash and cash equivalents.

 

**Revenue Recognition**

 

The Company recognizesrevenue when a contract has been executed, the contract price is fixed anddeterminable, delivery of services or products has occurred, and collectibilityof the contract price is considered probable and can be reasonablyestimated.  Revenue is earned under costreimbursable, time and materials and fixed price contracts.

 

Under cost reimbursablecontracts, the Company is reimbursed for allowable costs and paid a fee, whichmay be fixed or performance-based. Revenue on cost reimbursable contractsis recognized as costs are incurred plus an estimate of applicable feesearned.  The Company considers fixed feesunder cost reimbursable contracts to be earned in proportion of the allowablecosts incurred in performance of the contract. For cost reimbursable contracts that include performance based feeincentives,

 

 

6

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the Company recognizes the relevant portion of the expected fee to beawarded by the customer at the time such fee can be reasonably estimated, basedon factors such as the Company’s prior award experience and communications withthe customer regarding performance.

 

Revenue on time andmaterials contracts is recognized based on direct labor hours expended atcontract billing rates and adding other billable direct costs.  For fixed price contracts that are based onunit pricing or level of effort, the Company recognizes revenue for the numberof units delivered in any given fiscal period. For fixed price contracts in which the Company is paid a specific amountto provide a particular service for a stated period of time, revenue isrecognized ratably over the service period.

 

For fixed price contractsthat provide for the delivery of a specific product with related customeracceptance provisions, revenue is recognized upon product delivery and customeracceptance.  However, a significant portionof the Company’s fixed price-completion contracts involve the design anddevelopment of complex client systems. For those contracts that are within scope of SOP 81-1, *Accounting for Performance of Construction-Type and CertainProduction-Type Contracts*, revenue is recognized on thepercentage-of-completion method using costs incurred in relation to totalestimated costs.

 

The Company’s contractswith agencies of the government are subject to periodic funding by therespective contracting agency.  Fundingfor a contract may be provided in full at inception of the contract orratably throughout the contract as the services are provided.  In evaluating the probability of funding forpurposes of assessing collectibility of the contract price, the Companyconsiders its previous experiences with its customers, communications with itscustomers regarding funding status, and the Company’s knowledge of availablefunding for the contract or program.  Iffunding is not assessed as probable, revenue recognition is deferred until realizationis deemed probable.

 

Contract revenuerecognition inherently involves estimation, including the contemplated level ofeffort to accomplish the tasks under contract, the cost of the effort, and anongoing assessment of progress toward completing the contract.  From time to time, as part of normalmanagement processes, facts develop that require management to revise itsestimated total costs or revenue expected. The cumulative impact of any revisions to estimates and the full impactof anticipated losses on any type of contract are recognized in the period inwhich they become known.

 

The allowability ofcertain costs under government contracts is subject to audit by thegovernment.  Certain indirect costs arecharged to contracts using provisional or estimated indirect rates, which aresubject to later revision based on government audits of those costs.  Management is of the opinion that costssubsequently disallowed, if any, would not be significant.

 

**Significant customers**

 

Revenue generated from contracts with the FederalGovernment or prime contractors doing business with the Federal Governmentaccounted for a significant percentage of revenue in the fiscal quarters endingSeptember 29, 2007 and September 30, 2006.

 
| ** **                | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|---------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                | ** ** | **September 29,  2007** | ** ** | **September 30,  2006** | ** ** | **September 29,  2007** | ** ** | **September 30,  2006** | ** ** |
|                      |       |                    |       |                    |       |   |   |   |   |
| Department of Defense     |       | 47.4                    | %          | 46.6                    | %          | 45.9 | % | 47.2 | % |
| Federal civilian agencies |       | 51.7                    | %          | 52.3                    | %          | 53.0 | % | 51.3 | % |
| Commercial entities       |       | 0.9                     | %          | 1.1                     | %          | 1.1 | % | 1.5 | % |
| Total revenue             |       | 100.0                   | %          | 100.0                   | %          | 100.0 | % | 100.0 | % |

 

For the quarters ended September 29, 2007 and September 30, 2006 ourCommand, Control, Communications, Computer, Intelligence, Information,Technology, Surveillance, and Reconnaissance contract vehicle (“C4I2TSR”) wasour only contract vehicle that generated more than 10% of our revenue.  C4I2TSR is an indefinite delivery, indefinitequantity (“ID/IQ”) contract vehicle administered and primarily used by the U.S.Air Force Space Command, however, it is also available for use by differentFederal Government agencies.  As projectsare issued under C4I2TSR for different customers, we assign and report revenuegenerated from any task order to the appropriate business unit.  Underthis approach, for the three and nine months ended September 29, 2007, revenuefrom the C4I2TSR contract represented approximately 14.4% and 16.8% of ourrevenue, respectively.  For the three and nine months ended September 30,2006, our C4I2TSR contract represented approximately 22.1% and 21.4% of ourrevenue, respectively.

 

** **

** **

 

7

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**Deferred financing costs**

 

Costs incurred in establishing our credit facility are deferred andamortized as interest expense over the term of the related debt using theeffective interest method.  Thesedeferred costs are reflected as a component of other assets in the accompanyingconsolidated balance sheets.  Thedeferred financing costs consist of the following (in thousands):

 

| ** **               | ** ** | **September 29,  2007** | ** ** | **December 30,  2006** | ** ** |
|--------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Deferred loan costs      |       | $                       | 5,635      |                        | $          | 5,527 |   |
| Accumulated amortization |       | (3,828                  | )          | (3,363                      | )          |
|                     |       | $                       | 1,807      |                        | $          | 2,164 |   |

 

**Fair value of financial instruments**

 

The Company’s financial instruments consist primarily of cash and cashequivalents, accounts receivable, accounts payable, credit facilities, andnotes payable.  In management’s opinion,the carrying amounts of these financial instruments approximate their fairvalues at September 29, 2007 and December 30, 2006.

 

**Stock-based compensation**

 

Effective January 1, 2006, the Company adopted theprovisions of Statement of Financial Accounting Standards (SFAS) No. 123R usingthe modified prospective transition method which required the Company to recordcompensation cost related to unvested stock awards as of December 31, 2005 byrecognizing the unamortized grant date fair value of these awards over theremaining service periods of those awards with no charge in historical reportedearnings.  Awards granted after December31, 2005 are valued at fair value in accordance with the provisions of SFAS No.123R and recognized as an expense on a straight-line basis over the serviceperiods of each award.  The Companyaccelerated the vesting of unvested stock options previously awarded toemployees, officers and directors in December 2005.  The Company had no unvested stock options onJanuary 1, 2006.  The total stockcompensation expense recognized for stock options and restricted stock awardsduring the three month and nine month periods ended September 29, 2007 was approximately$0.3 million and $0.8 million, respectively. The total remaining unrecognized compensation expense related to theunvested options and restricted stock awards as of September 29, 2007 was $2.6million and $1.7 million, respectively.

 

 

The fair value of eachoption is estimated on the date of grant using the Black-Scholes option-pricingmodel with the following assumptions used for grants during the fiscal periodsended September 29, 2007 and September 30, 2006:

 

| ** **                      | ** ** | **Period  Ended**        | ** ** |
|---------------------------------|------------|--------------------------|------------|
| ** **                      | ** ** | **September  29,  2007** | ** ** | **September  30,  2006** | ** ** |
| ** **                      | ** ** | ** **               | ** ** | ** ** | ** ** |
| Risk-free interest rate         |       | 4.67% — 5.03%       |       | 4.67—4.82% |   |
| Expected life of options        |       | 5 years                  |       | 5 years |   |
| Expected stock price volatility |       | 34.5%                    |       | 41.7% |   |
| Expected dividend yield         |       | 0%                       |       | 0% |   |

 

The risk-free interest isbased on U.S. Treasury yields in effect at the time of grant over the expectedterm of the option.  The expected life ofoptions is derived from the Company’s historical option exercise data.  The expected stock price volatility is basedon the historical volatility of the Company’s common stock.

 

 

 

8

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Prior to the adoption of SFAS No. 123R, the Companypresented all tax benefits related to the exercise of stock options asoperating cash flows in the consolidated statement of cash flows.  SFAS No. 123R requires the cash flowsresulting from the tax benefits generated from tax deductions in excess of thecompensation costs recognized for those options to be classified as financingcash flows.

**Earnings per share**

 

Basic earnings per share is computed by dividing reported earningsavailable to common stockholders by the weighted average number of sharesoutstanding without consideration of common stock equivalents or otherpotentially dilutive securities.  Dilutedearnings per share give effect to common stock equivalents and otherpotentially dilutive securities outstanding during the period.

 

The following details the computation of net income percommon share (in thousands):

 
| ** **                                  | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|---------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                  | ** ** | **September 29,  2007** | ** ** | **September 30,  2006** | ** ** | **September 29,  2007** | ** ** | **September 30,  2006** | ** ** |
|                                        |       |                    |       |                    |       |   |   |   |   |
| Net Income — Basic and Diluted         |       | $                       | 4,383      |                    | $          | 5,359 |   | $ | 14,140 |   | $ | 14,115 |   |
|                                        |       |                    |       |                    |       |   |   |   |   |
| **Weighted average share calculation:**     | ** ** | ** **              | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                        |       |                    |       |                    |       |   |   |   |   |
| Basic weighted-average shares outstanding   |       | 13,050                  |       | 12,891                  |       | 13,012 |   | 12,361 |   |
| Treasury stock effect of stock options      |       | 289                     |       | 307                     |       | 282 |   | 392 |   |
|                                        |       |                    |       |                    |       |   |   |   |   |
| Diluted weighted-average shares outstanding |       | 13,339                  |       | 13,198                  |       | 13,294 |   | 12,753 |   |
|                                             |            |                         |            |                         |            |  |  |  |  |  |  |  |  |

 

 

**Reclassifications**

 

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

 

**New accounting pronouncements**

 

In July 2006, the Financial Accounting Standards Board(FASB) issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty inIncome Taxes, an interpretation of FASB Statement No. 109, Accounting forIncome Taxes”.  FIN 48 provides guidanceon recognition, derecognition, measurement, classification, interest andpenalties, accounting in interim periods, disclosure and transition.  FIN 48 requires an entity to recognize thefinancial statement impact of a tax position when it is more likely than notthat the position will be sustained upon examination.  The amount recognized is measured as thelargest amount of benefit that is greater than fifty percent likely of beingrealized upon ultimate settlement.  Inaddition, FIN 48 permits an entity to recognize interest and penalties relatedto tax uncertainties either as income tax expense or operating expenses.

**The Company adopted the provisions of FIN 48 on January 1,2007.  The Company believes that itsincome tax filing positions will be sustained on audit and does not anticipateany adjustments that will result in a material effect on its financialposition, results of operations or cash flows. Therefore, no reserves for uncertain income tax position have beenrecorded.  The Company had recognizedinterest and penalties related to tax uncertainties as income tax expense andwill continue this treatment upon adoption of FIN 48.**

** **

**The Company is subject to U.S. federal income tax as wellas to income tax of multiple state jurisdictions.  Federal income tax returns of the Company aresubject to IRS examination for the 2003 through 2006 tax years.  State income tax returns are subject toexamination for a period of three to six years after filing.**

** **

In September 2006, theFASB issued SFAS No. 157, “Fair Value Measurements”.  SFAS No. 157 defines fair value, establishesa framework for measuring fair value and expands disclosures about fair valuemeasurements.  SFAS No. 157 is effectivefor fiscal years beginning after December 15, 2007.  The adoption of SFAS No. 157 is effectiveJanuary 1, 2008 for the Company. The Company believes that theadoption of this statement will not have a material effect on its financialcondition, results of operations or cash flows.

 

 

9

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In February 2007, the FASB issued StatementNo. 159, “*The Fair Value Option forFinancial Assets and Liabilities — Including an amendment of FASB StatementNo. 115*,” which permits entities to measure eligible items atfair value. For items where the fair value election is made, the Company willbe required to report unrealized gains or losses in earnings. SFAS 159 iseffective for fiscal years beginning after November 15, 2007. We arecurrently evaluating what effect, if any, the adoption of SFAS No. 159will have on our financial position, results of operations, or cash flows.

 

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

 

On June 8, 2007, the Company acquired LOGTEC, Inc., anOhio corporation (“LOGTEC”), pursuant to a Share Purchase Agreement dated May23, 2007 (the “LOGTEC Agreement”). LOGTEC specializes in acquisition and program management, systems andnetwork engineering and integration, software and web-based applicationdevelopment, data management and warehousing, information assurance, andtraining.  LOGTEC’s largest clients include the Air Force Materiel Command(AFMC) and Naval Air Systems Command (NAVAIR).

 

Under the terms of the LOGTECAgreement, the Company acquired all of the outstanding capital stock of LOGTECfor $60.4 million in cash, including $1.0 million paid related to a preliminaryworking capital adjustment and $0.5 million of transaction costs, of which $5.9million was deposited in escrow for 15 months after closing in order to securepost-closing indemnity obligations of the sellers.  The purchase price is further subject to atwo-way adjustment based upon whether the working capital of LOGTEC at theclosing of the acquisition is above or below the target working capitalspecified in the LOGTEC Agreement. Additionally, the Company has made an election under Section 338(h)(10)of the Internal Revenue Code, which effects the after tax valuation of theLOGTEC acquisition.   The transaction wasfunded through $10.4 million of cash-on-hand, borrowings of $25 million underthe newly amended term loan under our credit facility, and borrowing of $25million under our revolving line of credit under our credit facility.   LOGTEC’s trailing revenue for the yearending December 31, 2006 was approximately $54 million (unaudited).

 

Based on the preliminary valuation received from ourindependent appraiser, management has allocated approximately $44.2 million ofthe purchase price to goodwill based primarily on the excess of the purchaseprice over the estimated fair value of net assets acquired and approximately$11.5 million of the purchase price has been assigned to identifiableintangible assets of contractual customer relationships.  These intangible assets are being amortizedon an accelerated basis over their estimated useful life. The final results ofthe valuation may differ from management’s estimate currently recorded, and thebalances will be adjusted to reflect final results.  However, management does not anticipate thatany such adjustments will have a material effect on the Company’s financialposition or results of operations.

 

The total purchase pricepaid, including transaction costs of $0.5 million, has been preliminarilyallocated as follows (in thousands):

 

| Cash and cash equivalents             |   | $84     |   |
|---------------------------------------|--------|---------|--------|
| Accounts receivable                   |   | 12,269  |   |
| Other current assets                  |   | 222     |   |
| Property and equipment                |   | 314     |   |
| Accounts payable and accrued expenses |   | (8,197  | )      |
| Intangible assets                     |   | 11,520  |   |
| Goodwill                              |   | 44,243  |   |
| Total consideration                   |   | $60,455 |   |

 

The following unauditedproforma combined condensed statements of operations (in thousands, except pershare) set forth the consolidated results of operations of the Company for thethree and nine months ended September 29, 2007 and September 30, 2006 as if theLOGTEC acquisition had occurred at the beginning of each period presented. Thisunaudited proforma information does not purport to be indicative of the actualfinancial position or the results that would actually have occurred if thecombination had been in effect for the three and nine months ended September29, 2007 and September 30, 2006.

 

 

 

10

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| ** **                 | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|----------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                 | ** ** | **September 29,  2007** | ** ** | **September 30,  2006** | ** ** | **September 29,  2007** | ** ** | **September 30,  2006** | ** ** |
|                       |       |                    |       |                    |       |   |   |   |   |
| Revenue.                   |       | $                       | 141,109    |                    | $          | 133,444 |   | $ | 401,038 |   | $ | 387,058 |   |
| Net income                 |       | 4,383                   |       | 5,789                   |       | 14,481 |   | 16,810 |   |
| Diluted earnings per share |       | $                       | 0.33       |                    | $          | 0.44 |   | $ | 1.09 |   | $ | 1.32 |   |
|                       |       |                    |       |                    |       |   |   |   |   |

 

The operations of LOGTEC have been included inthe Company’s statement of operations since it was acquired.

**4.                    Accountsreceivable:**

 

Accounts receivable consists of the following (inthousands):

 

| ** **                                                                                         | ** ** | **September 29,  2007** | ** ** | **December 30,  2006** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
|                                                                                               |       |                    |       |                   |       |
| Billed accounts receivable                                                                         |       | $                       | 50,589     |                   | $          | 46,540 |   |
| Unbilled accounts receivable:                                                                      |       |                    |       |                   |       |
| Currently billable                                                                                 |       | 58,468                  |       | 41,192                 |       |
| Unbilled retainages and milestone paymentsexpected to be billed  within the next 12 months         |       | 2,875                   |       | 5,609                  |       |
| Indirect costs incurred and charged to cost-plus contracts in  excess of provisional billing rates |       | 128                     |       | 136                    |       |
| Total unbilled accounts receivable                                                                 |       | 61,471                  |       | 46,937                 |       |
| Allowance for doubtful accounts                                                                    |       | (1,442                  | )          | (1,505                 | )          |
|                                                                                               |       |                    |       |                   |       |
| Accounts receivable, net                                                                           |       | $                       | 110,618    |                   | $          | 91,972 |   |
|                                                                                               |       |                    |       |                   |       |

 

The currently billable amounts included asunbilled accounts receivable as of September 29, 2007 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.

 

** **

 

11

----

 

**5.             Propertyand equipment:**

 

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

 

| ** **                                      | ** ** | **September 29,  2007** | ** ** | **December 30,  2006** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| Computers and equipment                         |       | $                       | 12,213     |                   | $          | 11,899 |   |
| Software                                        |       | 4,231                   |       | 2,972                  |       |
| Furniture and fixtures                          |       | 6,251                   |       | 5,072                  |       |
| Leasehold improvements                          |       | 6,380                   |       | 4,257                  |       |
|                                            |       |                    |       |                   |       |
|                                            |       | 29,075                  |       | 24,200                 |       |
| Less: accumulated depreciation and amortization |       | (14,305                 | )          | (11,828                | )          |
|                                            |       |                    |       |                   |       |
| Property and equipment, net                     |       | $                       | 14,770     |                   | $          | 12,372 |   |
|                                            |       |                    |       |                   |       |

 

Property and equipment includes assets financed under capital leaseobligations of approximately $0.3 million, net of accumulated amortization, asof September 29, 2007 and approximately $0.3 million, net of accumulatedamortization, as of December 30, 2006.

 

**6.             Intangibleassets:**

 

                Intangible assets consist of the following (inthousands):

** **

| ** **                         | ** ** | **September 29,  2007** | ** ** | **December 30,  2006**                                                                                                    | ** ** |
|------------------------------------|------------|-------------------------|------------|---------------------------------------------------------------------------------------------------------------------------|------------|
| Contractual customer relationships |       | $37,856                 |       | $26,336                    |       |
|                               |       |                    |       |                                                                                                                      |       |
| Non-compete agreements             |       | 150                     |       | 150                                                                                                                       |       |
|                               |       |                    |       |                                                                                                                      |       |
| Total intangible assets            |       | 38,006                  |       | 26,486                                                                                                                    |       |
| Less: accumulated amortization     |       | (8,954)                 |       | (6,068)                                                                                                                   |       |
|                               |       |                    |       |                                                                                                                      |       |
|                               |       |                    |       |                                                                                                                      |       |
| Intangible assets, net             |       | $29,052                 |       | $20,418                                        |       |
|                               |       |                    |       |                                                                                                                      |       |

 

 

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

 

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

 

 

| ** **                                     | ** ** | **September 29,  2007** | ** ** | **December 30,  2006** | ** ** |
|------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| Accrued vacation                               |       | $9,434                  |       | $7,068                 |       |
| Accrued compensation                           |       | 9,423                   |       | 10,349                 |       |
| Accrued bonus                                  |       | 321                     |       | 4,413                  |       |
| Deferred revenue                               |       | 1,558                   |       | 1,081                  |       |
| Other accrued liabilities                      |       | 13,020                  |       | 5,636                  |       |
| Accrued expenses and other current liabilities |       | $33,756                 |       | $28,547                |       |

 

 

** **

 

12

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**8.             Debt:**

 

Debt consists of the following:
| ** **                                                                                                                                                                                                                                                                                                                                            | ** ** | **September 29,  2007** | ** ** | **December 30,  2006** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                            | ** ** | **(in thousands)**      | ** ** | **(in thousands)**     | ** ** |
| Credit facilities:                                                                                                                                                                                                                                                                                                                                    |       |                    |       |                   |       |
| Line of credit bears interest at LIBOR plus 200 to  275 base points or a specified base rate plus 100 to 175 basis points, interest  due monthly, principal due February 9, 2010                                                                                                                                                                 |       | $20,000                 |       | $—                |       |
| Term loan, as of September 29, 2007 bears interest  at LIBOR plus 200 basis points or a specified base rate plus 100 basis  points, with thirteen  consecutive  quarterly principal and interest payments of $250,904 starting on June 30,  2007, with the unpaid principal and interest of approximately $91.3 million  due on February 9, 2011 |       | 94,516                  |       | 70,206                 |       |
| Total debt                                                                                                                                                                                                                                                                                                                                            |       | $114,516                |       | $70,206                |       |

 

Since 2002, the Company has maintained a creditfacility with Wachovia Bank, National Association (“Wachovia Bank”) acting asAdministration Agent for a consortium of lenders.  The credit facility has been amended fromtime to time when the Company has made acquisitions.  The credit facility is secured by a pledge ofsubstantially all of our current and future tangible and intangible assets, aswell as those of our current and future subsidiaries, including accountsreceivable, inventory and capital stock. On February 9, 2005, we entered into our Amended and Restated CreditAgreement, which was subsequently amended by a First Amendment dated February27, 2006 (the “Credit Agreement”).  TheCredit Agreement consisted of a $60 million revolving credit facility expiringon February 9, 2010 and a term loan facility with an original principal balanceof approximately $129.0 million expiring on February 9, 2011.   As a result of the prepayment of principal,the Company had reduced the outstanding principal balance of the term loan toapproximately $70.0 million prior to the LOGTEC acquisition.

 

On June 8, 2007, contemporaneously with the closing ofthe LOGTEC acquisition, we entered into a Second Amendment to the Amended andRestated Credit Agreement (“Second Amendment”).   The Second Amendment increased the amount ofoutstanding term debt by $25 million, to a total of approximately $95million.  Additionally, the Companyborrowed approximately $25 million under the revolving credit facility. Theoutstanding balance under the revolving credit facility will accrue interest ata variable rate, with interest only payments being required until the facilitymatures on February 9, 2010.  The Companymay repay either or both of the term loan facility and the revolving creditfacility in whole or in part at anytime prior to their respective maturitydates. As we have the intent to repay the balance on the revolving creditfacility within the next twelve months, we have classified the outstandingbalance as a current liability.

 

**9.             Commitments and contingencies:**

 

**Leases**

As of September 29, 2007, the Company hasnon-cancelable operating leases, primarily for real estate, that expire overthe next ten years.   Rental expense during the quarter ended September29, 2007 was approximately $2.5 million, consistent with rental expense ofapproximately $2.5 million during the quarter ended September 30, 2006.

**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 theperiod(s) audited. The final rates, if different from the provisionalrates, may create an additional receivable or liability for the Company. TheCompany’s revenue recognition policy calls for revenue recognized on all costreimbursable government contracts to be recorded at actual rates unlesscollectibility is not reasonably assured. To the extent the indirect ratedifferential creates a liability for the Company, the differential isrecognized as a reduction to revenue when identified.

** **

** **

 

13

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**Litigation and claims**

The Company is a party to litigation and legal proceedings thatmanagement believes to be a part of the ordinary course of our business. Whilewe cannot predict the ultimate outcome of these matters, we currently believethat any ultimate liability arising out of these proceedings will not have amaterial adverse effect on our financial position. We may become involved inother legal and governmental, administrative or contractual proceedings in thefuture.

The SEI acquisition agreement provides for a purchase price adjustmentbased upon the working capital of SEI as of the closing date.  Subsequentto the closing date, we received a payment of $1.6 million in connection withservices performed prior to the closing date that SEI had not previouslybilled, and was not authorized to bill, its customer as of the closingdate.  The SEI selling stockholders have asserted that they are entitledto a credit in connection with the calculation of working capital adjustment inan amount equal to the amount received by us for this post-closing payment. We believe that, in accordance with GAAP, the SEI selling stockholders shouldnot receive the benefit of the post-closing payment.  In accordance withthe terms of the SEI acquisition agreement, the parties have jointly submittedthe issue to an independent accounting firm for resolution.  We anticipatethat this matter will be resolved before the end of 2007.

 

**10.          Stockholders’ equity:**

 

**Stock incentive plans**

In April 2005, the Board of Directors voted to adopt the 2002Amended and Restated Omnibus Stock Incentive Plan (the “Amended and RestatedPlan”), and the Amended and Restated Plan was approved by our stockholders atthe annual meeting of stockholders held in June 2005. The Amended andRestated Plan amends and restates the Plan by (i) increasing the number ofshares of common stock reserved and available under the Plan by 1,000,000shares to a total share allocation of 2,920,000, (ii) permitting the grantof deferred shares, performance shares and performance units,(iii) prohibiting repricing of options without prior stockholder approval,(iv) limiting the number of shares of common stock and performance unitssubject to awards a participant may receive in any calendar year to 300,000 and500,000, respectively, and adding other administrative provisions to complywith the performance-based compensation exception to the deduction limit ofSection 162(m) of the Internal Revenue Code of 1986, as amended;(v) eliminating the provision that previously provided for an automaticincrease in the number of shares reserved for issuance under the Amended andRestated Plan each fiscal year by a number equal to the lesser of 160,000shares or an amount determined by the Board of Directors, (vi) providingthat non-qualified stock option grants will be priced at one hundred percent(100%) of fair market value; (vii) providing for minimum vesting periodsof stock bonus awards, restricted common stock awards, stock appreciationrights, deferred shares, and other stock awards subject to the possibleacceleration of the vesting schedule at the discretion of the administrator;(viii) providing that future amendments to the Amended and Restated Planthat increase the number of shares allocated, modify participationrequirements, or materially increase benefits accruing to the participantsunder the Plan will be subject to stockholder approval; and (ix) makingother technical changes to the Plan.

A summary ofoption activity under the plan as of September 29, 2007, is presented below:

 

| ** **                                | ** ** | **Options** | ** ** | **Weighted-average  exercise price** | ** ** |
|-------------------------------------------|------------|-------------|------------|--------------------------------------|------------|
| Outstanding at December 30, 2006          |       | 1,468,305   |       | $22.33                               |       |
| 2007 grants                               |       | 132,400     |       | 28.42                                |       |
| 2007 exercises                            |       | (86,584     | )          | 15.87                                |       |
| 2007 forfeitures                          |       | (15,743     | )          | 28.20                                |       |
| Outstanding at September  29, 2007        |       | 1,498,378   |       | $23.18                               |       |
| Options exercisable at September 29, 2007 |       | 1,234,893   |       | $21.98                               |       |

 

 

 

 

14

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Prior to fiscal 2006, awards under the Company’s stock incentive planconsisted principally of stock options. During fiscal 2006, the Company revised its stock incentive arrangementto provide restricted stock awards to directors and executives.  The stock awards granted during fiscal 2006were generally vested ratably over a period of four or five years.  During fiscal 2007, the Company revised itsstock incentive arrangement to issue restricted stock awards that will be fullyvested only if the Company meets certain revenue targets determined by theBoard of Directors.

A summary of restricted awards activity under the plan as of September30, 2006, is presented below:

 

| ** **                                                          | ** ** | **Shares** | ** ** | **Weighted-average  fair value** | ** ** |
|---------------------------------------------------------------------|------------|------------|------------|----------------------------------|------------|
| Non-vested restricted  stock outstanding at December 30, 2006       |       | 32,200     |       | $29.98                           |       |
| 2007 grants                                                         |       | 75,200     |       | 28.48                            |       |
| 2007 vestings                                                       |       | (6,198     | )          | 28.65                            |       |
| 2007 forfeitures                                                    |       | (625       | )          | 28.61                            |       |
| Non—vested restricted  stock outstanding at September 29, 2007 |       | 100,577    |       | $28.63                           |       |

 

**Stock repurchase program**

During the Company’s Board of Directors meeting onDecember 6, 2005, the Board authorized the repurchase of up to 300,000 sharesof its common stock up to an aggregate maximum dollar amount of $8million.  The Company had approximately 13.1 million shares outstanding asof September 29, 2007.  Timing and volume of any purchases will be guidedby management’s assessment of market conditions, securities law limitations,the number of shares of common stock outstanding, and alternative, potentiallyhigher value uses for cash resources.  The repurchase plan may besuspended or discontinued at any time without prior notice.

 

 

 

15

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**Item 2.   Management’s Discussion and Analysis ofFinancial 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 other factors thatmay cause our actual results, level of activity, performance or achievements tobe materially different from any future results, levels of activity,performance or achievements expressed or implied by such forward-lookingstatements. In some cases, you can identify these statements by forward-lookingwords such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,”“may,” “plan,” “potential,” “should,” “will,” and “would” or similar words. Youshould read statements that contain these words carefully because they discussour future expectations, contain projections of our future results of operationsor of our financial position, or state other forward-looking information. Webelieve that it is important to communicate our future expectations to ourinvestors. However, there may be events in the future that we are not able topredict accurately or control. Inparticular, statements that we make in this section relating to the sufficiencyof anticipated sources of capital to meet our cash requirements are forward-looking statements. Our actual results could differ materially from thoseanticipated in these forward-looking statements for many reasons,including as a result of some of the factors described below, elsewhere in thisForm 10-Q and in the section entitled “Risk Factors” in our Form 10-K  for the fiscal year ended December 30,2006.   You should not place unduereliance on these forward-looking statements, which apply only as of thedate of the filing of this Form 10-Q.*

 

*The Company’s fiscal year is based on the calendar year and ends eachyear on the Saturday nearest, but not falling after, December 31 of thatyear.  Typically, fiscal quarters alsoend on the Saturday nearest, but not falling after, the end of the calendarquarter.  Similarly, we will end futurefiscal quarters on the Saturday which provides us with a 13 week quarter tocompare with the previous year’s quarterly results even if that Saturday fallsafter the end of the calendar quarter. As a result, our fiscal year may be comprised of 52 or 53 weeks.*

 

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

 

**Overview**

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

We employ a Rapid Response • Rapid Deployment®methodology that enables the rapid implementation of innovative solutions andthe incorporation of additional capabilities in rapid succession. Thiscapability allows us to respond to urgent client IT imperatives quickly, oftenin a matter of months, and within a well-defined budget. We can, therefore,provide solutions for current client IT needs, while establishing a platformfor advancing long-term transformational objectives. We possess a provenability to respond to high priority information technology and network needsthrough innovation, and an enviable reputation for timely delivery of robustsolutions on assignments where failure is not an option. Our solutions enableclients to respond to new mandates, expand the scope of their missions, andreengineer underlying business processes. We have a demonstrated ability ofturning troubled IT projects into winning outcomes and realizing exceptionalgrowth from high-quality client engagements. We also utilize mature and provenprocesses to manage and market large-scale ID/IQ contracts, such as C4I2TSR. Weemploy a diverse, innovative team that effectively utilizes small businesspartners’ unique skills and expertise for mission critical client IT projects.

For the fiscal quarters ended September 29, 2007 and September 30,2006, we received 99.1% and 98.9%, respectively, of our revenue from serviceswe provided to various departments and agencies of the Federal Government, bothdirectly and through other prime contractors and 0.9% and 1.1%, respectively,of our total revenue from work performed for commercial entities. The followingtable shows our revenue from the client groups listed as a percentage of totalrevenue. Revenue data for the DoD includes revenue generated from workperformed under engagements for both the DoD and the Intelligence community.

 

 

16

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| ** **                | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|---------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                | ** ** | **September 29,  2007** | ** ** | **September 30,  2006** | ** ** | **September 29,  2007** | ** ** | **September 30,  2006** | ** ** |
|                      |       |                    |       |                    |       |   |   |   |   |
| Department of Defense     |       | 47.4                    | %          | 46.6                    | %          | 45.9 | % | 47.2 | % |
| Federal civilian agencies |       | 51.7                    | %          | 52.3                    | %          | 53.0 | % | 51.3 | % |
| Commercial entities       |       | 0.9                     | %          | 1.1                     | %          | 1.1 | % | 1.5 | % |
|                      |       |                    |       |                    |       |   |   |   |   |
| Total revenue             |       | 100.0                   | %          | 100.0                   | %          | 100.0 | % | 100.0 | % |
|                      |       |                    |       |                    |       |   |   |   |   |

 

We have derived a substantial majority of our revenuefrom governmental contracts under which we act as a prime contractor. We alsoprovide services indirectly as a subcontractor. The following table shows ourrevenue as prime contractor and as subcontractor as a percentage of our totalrevenue for the following periods:
| ** **             | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **             | ** ** | **September 29,  2007** | ** ** | **September 30,  2006** | ** ** | **September 29,  2007** | ** ** | **September 30,  2006** | ** ** |
|                   |       |                    |       |                    |       |   |   |   |   |
| Prime contract revenue |       | 77.4                    | %          | 79.9                    | %          | 78.5 | % | 79.2 | % |
| Subcontract revenue    |       | 22.6                    | %          | 20.1                    | %          | 21.5 | % | 20.8 | % |
| Total revenue          |       | 100.0                   | %          | 100.0                   | %          | 100.0 | % | 100.0 | % |

 

Our services are provided to clients pursuant to threetypes of contracts: cost reimbursable, time and materials and fixed pricecontracts. The following table shows our revenue from each of these types ofcontracts as a percentage of our total revenue for the following periods:
| ** **         | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|--------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **         | ** ** | **September 29,  2007** | ** ** | **September 30,  2006** | ** ** | **September 29,  2007** | ** ** | **September 30,  2006** | ** ** |
|               |       |                    |       |                    |       |   |   |   |   |
| Cost reimbursable  |       | 25.8                    | %          | 32.8                    | %          | 28.7 | % | 31.6 | % |
| Time and materials |       | 36.3                    | %          | 39.3                    | %          | 34.8 | % | 40.5 | % |
| Fixed price        |       | 37.9                    | %          | 27.9                    | %          | 36.5 | % | 27.9 | % |
| Total              |       | 100.0                   | %          | 100.0                   | %          | 100.0 | % | 100.0 | % |

 

 

**Recent Events**

None.

 

**Liquidity and Capital Resources**

*General.*   Short-term liquidityrequirements are created by our use of funds for working capital, capitalexpenditures, and the need to provide debt service. We expect to meet theserequirements through a combination of cash flow from operations and borrowingsunder our Credit Agreement, as amended.

We anticipate that our long-term liquidity requirements, including anyfurther acquisitions, will be funded through a combination of cash flow fromoperations, borrowings under our Credit Agreement, as amended, additionalsecured or unsecured debt or the issuance of common or preferred stock, each ofwhich may be initially funded through borrowings under our Credit Agreement, asamended.

Under the terms of our Credit Agreement, as amended, the Company isrequired to maintain compliance with financial and non-financialcovenants.  The Company is in compliancewith all such covenants as of September 29, 2007.

* *

* *

 

17

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*Cash and Cash Equivalents.*   We consider cash on depositand all highly liquid investments with original maturities of three months orless to be cash and cash equivalents. Cash and cash equivalents, includingmarketable securities, as of the end of three months ending September 29, 2007and September 30, 2006 was $6.8 million and $15.6 million, respectively.

*Cash Flow.*   The following table setsforth our sources and uses of cash for the nine months ended September 29, 2007and September 30, 2006.

|  ** **                    | ** ** | **Nine  Months Ended**   |
|-------------------------------------|------------|--------------------------|
| ** **                          | ** ** | **September  29,  2007** | ** ** | **September  30,  2006** | ** ** |
| **Net cash provided by (used in):** | ** ** | **(in thousands)**  |   |
| Operating activities                |       | $                        | 12,653 |   | $ | 20,195 |   |
| Investing activities                |       | (71,049)                 |   | (57,585) |   |
| Financing activities                |       | 45,737                   |   | 26,862 |   |
| Net decrease in cash                |       | $                        | (12,659) |   | $ | (10,528) |   |
|                                     |            |                          |  |  |  |  |  |  |

 

Our operating cash flow is primarily affected by the overallprofitability of our contracts, our ability to invoice and collect from ourclients in a timely manner, and our ability to manage our vendor payments. Webill most of our clients monthly after services are rendered. Cash provided byoperations in the nine months ended September 29, 2007 was attributable to netincome of $14.1 million, plus depreciation, amortization and other non-cashitems of $6.9 million, which was reduced by an increase in working capital andother operating assets and liabilities of $8.4 million.  Cash providedby operations in the nine months ended September 30, 2006 was attributable tonet income of $14.1 million, depreciation, amortization, and other non-cashitems of $6.2 million, which was reduced by an increase in working capital andother operating assets and liabilities of $0.1 million.

Our cash flow used in investing activities consists primarily ofcapital expenditures, the purchase and sale of marketable securities, andacquisitions. In the nine months ended September 29, 2007, we paid $60.4million for the LOGTEC acquisition, net of cash assumed, repaid $6.0 million ofnote payable to the former owners of Zen Technology, Inc.  and invested $4.7 million in capitalassets.  During the nine months endedSeptember 30, 2006, we paid $48.1 million for business acquisitions, net ofcash assumed, repaid a contract settlement to a former owner for $10.3 million,and purchased capital assets totaling $7.0 million. We partially offset thecash use with $7.8 million of proceeds from the sale of marketable securities,net of purchases.

Our cash flow provided by financing activities consists primarily ofborrowing under and payments on our credit facility and proceeds from theissuance and exercise of common stock. For the nine months ended September 29, 2007, cash flow provided byfinancing activities primarily consists of borrowing of $25.0 million under thenewly amended term loan, an advance of $25 million on our revolving line ofcredit,  and proceeds of $1.6 millionfrom the exercise of stock options. These were partially offset by a $5.0 million repayment of our revolvingline of credit and $0.9 million of repayments of the term loan portion of ourcredit facility and capital leases.  Forthe nine months ended September 30, 2006, cash flow provided by financingactivities was attributed to proceeds of $40.3 million from the sale of commonstock, $30.0 million of proceeds from the issuance of term debt, $6.4million of proceeds from the exercise of stock options and $1.7million of income tax benefit from stock option exercises, net of $50.9million repayment of term debt and $0.6 million of other items.

** **

** **

 

18

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**Results of Operations**

 

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

 
| ** **                               | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**  | ** ** |
|------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                               | ** ** | **September 29,  2007** | ** ** | **September 30, 2006** | ** ** | **September 29, 2007** | ** ** | **September 30, 2006** | ** ** |
|                                     |       |                    |       |                   |       |   |   |   |   |
| Revenue                                  |       | 100.0                   | %          | 100.0                  | %          | 100.0 | % | 100.0 | % |
| Operating costs and expenses:            |       |                    |       |                   |       |   |   |   |   |
| Cost of services                         |       | 65.8                    |       | 64.3                   |       | 63.5 |   | 63.1 |   |
| Selling, general and administrative      |       | 25.8                    |       | 25.6                   |       | 27.5 |   | 27.1 |   |
| Depreciation and amortization            |       | 0.7                     |       | 0.6                    |       | 0.7 |   | 0.6 |   |
| Amortization of intangible assets        |       | 1.0                     |       | 0.7                    |       | 0.8 |   | 0.7 |   |
|                                     |       |                    |       |                   |       |   |   |   |   |
| Total operating costs and expenses       |       | 93.3                    |       | 91.2                   |       | 92.5 |   | 91.5 |   |
| Income from operations                   |       | 6.7                     |       | 8.8                    |       | 7.5 |   | 8.5 |   |
| Other (expense) income                   |       | 0.0                     |       | 0.0                    |       | 0.1 |   | 0.0 |   |
| Interest expense                         |       | 1.6                     |       | 1.4                    |       | 1.4 |   | 1.8 |   |
|                                     |       |                    |       |                   |       |   |   |   |   |
| Income before provision for income taxes |       | 5.1                     |       | 7.4                    |       | 6.2 |   | 6.7 |   |
| Provision for income taxes               |       | 2.0                     |       | 2.9                    |       | 2.4 |   | 2.6 |   |
|                                     |       |                    |       |                   |       |   |   |   |   |
| Net income                               |       | 3.1                     | %          | 4.5                    | %          | 3.8 | % | 4.1 | % |

 

**Three months ended September 29, 2007compared with three months ended September 30, 2006**

 

*Revenue.*  For the three months endedSeptember 29, 2007, our revenue increased 17.7% to $141.1 million from$119.9 million for the three months ended September 30, 2006. Revenue fromwork under Federal Government contracts increased 18.0% to $139.8 millionfor the three months ended September 29, 2007 from $118.5 million for the threemonths ended September 30, 2006. This increase was attributable tothe acquisition and integration of LOGTEC in the second quarter of 2007, newcontract awards, successful recompetition wins on existing programs, and newcontracts from and growth within existing programs in our four focus areas:Federal IT Modernization, Defense Transformation, Homeland Defense, and Mission-CriticalOutsourcing.   We continue to focus primarily on opportunities for the FederalGovernment.

 

*Cost of services.*  Cost of services includes directlabor and other direct costs such as materials and subcontracts, incurred toprovide our services and solutions to our customers. Generally, changes in costof services are correlated to changes in revenue as resources are consumed inthe production of that revenue.  For thethree months ended September 29, 2007, cost of services increased 20.5% to$92.9 million from $77.1 million for the three months ended September30, 2006. This increase was attributable primarily to an increase in revenuedue to the LOGTEC acquisition. As a percentage of revenue, cost of serviceswere 65.8% for the three months ended September 29, 2007 as compared to 64.3%for the three months ended September 30, 2006. This increase was attributableprimarily to the expenses incurred during the initial stages of our work underour contract with the United States Patent and Trademark Office.

 

*Selling, general andadministrative expenses.* Selling, general andadministrative expenses include facilities, selling, bid and proposal, indirectlabor, fringe benefits and other discretionary costs.  For the three months ended September 29,2007, selling, general and administrative expenses increased 18.9% to$36.5 million from $30.7 million for the three months ended September30, 2006.  This $5.8 million increasewas primarily attributable to the expected growth of support functionsnecessary to facilitate and administer the growth in cost of services as wellas the integration of LOGTEC.  As a percentage of revenue, selling, general and administrative expenseswere 25.8% for the three months ended September 29, 2007 as compared to 25.6%for the three months ended September 30, 2006.

 

*Depreciation and amortization.*Depreciation and amortization includes thedepreciation of computers, furniture and other equipment, the amortization ofthird party software we use internally, and leasehold improvements.  For thethree months ended September 29, 2007, depreciation and amortization expensewas $0.9 million, a slight increase compared to $0.8 million for the threemonths ended September 30, 2006.  As apercentage of revenue, depreciation and amortization expense was 0.7% for thethree months ended September 29, 2007 compared to 0.6% for the three monthsended September 30, 2006.

 

* *

* *

 

19

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*Amortization of intangibleassets.*Amortization of intangibleassets includes the amortization of intangible assets acquired in connectionwith acquisitions in accordance with SFAS No. 142, Goodwill and OtherIntangible Assets.  Identifiableintangible assets are amortized over their useful lives.  Non-compete agreements are generallyamortized straight-line over the term of the agreement, while contracts andrelated client relationships are amortized using an accelerated method over theirestimated useful lives. For the three months ended September 29, 2007,amortization of intangible assets was $1.4 million, compared to $0.8 millionfor the three months ended September 30, 2006.  This increase was attributable primarily tothe LOGTEC acquisition.  As a percentageof revenue, amortization of intangible assets was 1.0% for the three monthsended September 29, 2007 compared to 0.7 % for the three months ended September30, 2006.

 

*Income from operations.*  For the three months endedSeptember 29, 2007, income from operations decreased 10.5% to $9.4 millionfrom $10.5 million for the three months ended September 30, 2006. Thisdecrease was attributable primarily to the expenses incurred during the initialstages of our work under our contract with the United States Patent and TrademarkOffice.   As a percentage of revenue,income from operations was 6.7% for the three months ended September 29, 2007compared to 8.8% for the three months ended September 30, 2006.

 

*Interest expense.*  Interest expense increased 28.0%to $2.2 million for the three months ended September 29, 2007 from$1.7 million for the three months ended September 30, 2006.  This increase was attributable primarily toan increase in our outstanding debt under our revolving credit facility andterm debt credit facility incurred in order to finance the LOGTECacquisition.   As a percentage ofrevenue, interest expense was 1.6% for the three months ended September 29,2007 as compared to 1.4% for the three months ended September 30, 2006.

 

*Provision for income taxes.*  The provision for income taxeswas $2.8 million in the three months ended September 29, 2007, compared to$3.5 million for the three months ended September 30, 2006.   Our third quarters of 2007 and2006 tax provision, represent an estimated annual effective tax rate of 39.2 %and 39.5%, respectively. Our estimated annual effective tax rate is greaterthan the federal statutory rate of 35% due primarily to state income taxes.

 

**Nine months ended September 29, 2007compared with nine months ended September 30, 2006**

 

*Revenue.*    For the nine months endedSeptember 29, 2007, our revenue increased 7.9% to $373.6 million from$346.3 million for the nine months ended September 30, 2006.  Revenue from work under Federal Governmentcontracts increased 8.3% to $369.3 million for the nine months endedSeptember 29, 2007 from $341.0 million for the nine months ended September 30,2006. This increase was attributable to the projects added from the LOGTECacquisition, new contract awards, successful recompetition wins on existingprograms, and new contracts from and growth within existing programs in ourfour focus areas: Federal IT Modernization, Defense Transformation, HomelandDefense, and Mission-Critical Outsourcing. Wecontinue to focus primarily on opportunities for the FederalGovernment.

 

*Cost of services.* Cost of services includes direct labor and other direct costs such asmaterials and subcontracts, incurred to provide our services and solutions toour customers. Generally, changes in costs of services are correlated tochanges in revenue as resources are consumed in the production of that revenue.For the nine months ended September 29, 2007, costs of services increased 8.6%to $237.5 million from $218.7 million for the nine months ended September30, 2006. This increase was attributable primarily to the increase in revenuedue to the LOGTEC acquisition. As a percentage of revenue, costs of serviceswere 63.6% for the nine months ended September 29, 2007 as compared to 63.1%for the nine months ended September 30, 2006.

 

*Selling, general andadministrative expenses.*  Selling, general and administrative expensesinclude facilities, selling, bid and proposal, indirect labor, fringe benefitsand other discretionary costs.  For thenine months ended September 29, 207, selling, general and administrativeexpenses increased 9.4% to $102.7 million from $93.8 million for the ninemonths ended September 30, 2006.  This $8.9 millionincrease was primarily attributable to the expected growth of support functionsnecessary to facilitate and administer the growth in costs of services as wellas the integration of LOGTEC.  As a percentage of revenue, selling, general and administrative expenseswere 27.5% for the nine months ended September 29, 2007 as compared to 27.1%for the nine months ended September 30, 2006.

 

 

 

20

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*Depreciation and amortization.*Depreciation and amortization includes thedepreciation of computers, furniture and other equipment, the amortization ofthird party software we use internally, and leasehold improvements.  For thenine months ended September 29, 2007, depreciation expense was $2.6 million, aslight increase compared to $2.0 million for the nine months ended September30, 2006.  However, as a percentage ofrevenue, depreciation expense was 0.7% for the nine months ended September 29,2007 compared to 0.6% for the nine months ended September 30, 2006.

 

*Amortization of intangibleassets.*Amortization of intangibleassets includes the amortization of intangible assets acquired in connectionwith acquisitions in accordance with SFAS No. 142, Goodwill and OtherIntangible Assets.  Identifiableintangible assets are amortized over their estimated useful lives.  Non-compete agreements are generallyamortized straight-line over the term of the agreement, while contracts andrelated client relationships are amortized using an accelerated method overtheir estimated useful lives. For the nine months ended September 29, 2007,amortization of intangible assets was $2.9 million, compared to $2.3 millionfor the nine months ended September 30, 2006. This increase was attributableprimarily to the LOGTEC acquisition. As a percentage of revenue amortization ofintangible assets was 0.8% for the nine months ended September 29, 2007compared to 0.7 % for the nine months ended September 30, 2006.

 

*Income from operations.*  For the nine months endedSeptember 29, 2007, income from operations decreased 5.5% to $27.9 million from$29.6 million for the nine months ended September 30, 2006. This decreasewas attributable primarily to increased operating costs.  As a percentage of revenue, income fromoperations was 7.5% for the nine months ended September 29, 2007 compared to8.5% for the nine months ended September 30, 2006.

 

*Interest expense.*  Interest expense increased 16.5%to $5.2 million for the nine months ended September 29, 2007 from $6.2 millionfor the nine months ended September 30, 2006. This increase was attributableprimarily to an increase in our outstandingdebt under our revolving credit facility and term debt credit facility incurredin order to finance the LOGTEC acquisition.    As apercentage of revenue, interest expense was 1.4% for the nine months endedSeptember 29, 2007 as compared to 1.8% for the nine months ended September 30,2006.

 

*Provision for income taxes.*  The provision for income taxeswas $9.1 million in the nine months ended September 29, 2007, compared to$9.2 million for the nine months ended September 30, 2006.   Our year to date 2007 and 2006tax provision represents an estimated annual effective tax rate of 39.2% and39.5% respectively.  Our estimated annualeffective tax rate is greater than the federal statutory rate of 35% dueprimarily to state income taxes.

 

**Off-Balance Sheet Arrangements**

 

As of September 29, 2007, we have no off-balance sheet arrangements thatare reasonably likely to have a current or future material effect on ourfinancial condition, revenue, or expenses, result of operations, liquidity,capital expenditures, or capital resources.

 

**Critical Accounting Policies and Estimates**

 

Our significant accounting policies are described inour Form 10-K for the fiscal year ended December 30, 2006, as well asNote 2 to our accompanying consolidated financial statements.  We consider the accounting policies relatedto revenue recognition to be critical to the understanding of our results ofoperations.  Our critical accountingpolicies also include the areas where we have made what we consider to beparticularly difficult, subjective or complex judgments in making estimates,and where these estimates can significantly impact our financial results underdifferent assumptions and conditions.  Weprepare our financial statements in conformity with U.S. generally acceptedaccounting principles.  As such, we arerequired to make certain estimates, judgments and assumptions that we believeare reasonable based upon the information available.  These estimates, judgments and assumptionsaffect the reported amounts of assets and liabilities at the date of thefinancial statements and the reported amounts of revenue and expenses duringthe periods presented. Actual results could be different from these estimates.

*Revenue Recognition*

The Company recognizes revenue when a contract has been executed, thecontract price is fixed and determinable, delivery of services or products hasoccurred, and collectibility of the contract price is considered probable andcan be reasonably estimated. Revenue is earned under cost reimbursable, timeand materials and fixed price contracts.

 

 

21

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Under cost reimbursable contracts, the Company is reimbursed forallowable costs, and paid a fee, which may be fixed or performance-based.Revenue on cost reimbursable contracts is recognized as costs are incurred plusan estimate of applicable fees earned. The Company considers fixed fees undercost reimbursable contracts to be earned in proportion of the allowable costsincurred in performance of the contract. For cost reimbursable contracts thatinclude performance based fee incentives, the Company recognizes the relevantportion of the expected fee to be awarded by the customer at the time such feecan be reasonably estimated, based on factors such as the Company’s prior awardexperience and communications with the customer regarding performance.

Revenue on time and materials contracts is recognized based on directlabor hours expended at contract billing rates and adding other billable directcosts.  For fixed price contracts thatare based on unit pricing or level of effort, the Company  recognizes revenue for the number of unitsdelivered in any given fiscal period. For fixed price contracts in which theCompany is paid a specific amount to provide a particular service for a statedperiod of time, revenue is recognized ratably over the service period.

For fixed price contracts that provide for the delivery of a specificproduct with related customer acceptance provisions, revenue is recognized uponproduct delivery and customer acceptance. However, a significant portion of the Company’s fixed price-completioncontracts involve the design and development of complex, client systems.  For those contracts that are within the scopeof SOP 81-1, *Accounting for Performance ofConstruction-Type and Certain Production-Type Contracts*, revenue isrecognized on the percentage-of-completion method using costs incurred inrelation to total estimated costs.

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

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

The allowance of certain costs under governmentcontracts is subject to audit by the government. Certain indirect costs are chargedto contracts using provisional or estimated indirect rates, which are subjectto later revision based on government audits of those costs. Management is ofthe opinion that costs subsequently disallowed, if any, would not besignificant.

*Stock Based Compensation*

Effective January 1, 2006, theCompany adopted the provisions of SFAS No. 123R using the modified prospectivetransition method, which required the Company to record compensation costrelated to unvested stock awards as of December 31, 2005, by recognizing theunamortized grant date fair value of these awards over the remaining serviceperiods of those awards with no change in historical reported earnings.  Awards granted after December 31, 2005 arevalued at fair value in accordance with the provisions of SFAS No. 123R andrecognized as an expense on a straight-line basis over the service periods ofeach award.  The Company accelerated the vesting ofunvested stock options previously awarded to employees, officers and directorsin December 2005. The Company had no unvested stock options on January 1,2006.  The total stock compensationexpense recognized for stock options and restricted stock awards during thequarter ended September 29, 2007 was $0.3 million.  The total remaining unrecognized compensationexpense related to unvested options and restricted stock awards as of September29, 2007 was $2.6 million and $1.7 million, respectively.

**Item 3. Quantitative and QualitativeDisclosures About Market Risk.**

We are exposed to certain financial market risks, the most predominantbeing fluctuations in interest rates for borrowings under our credit facility.Interest rate fluctuations are monitored by our management as an integral partof our overall risk management program, which recognizes the unpredictabilityof financial markets and seeks to reduce the potentially adverse effect on ourresults of operations. As part of this strategy, we may use interest rate swaparrangements to manage or hedge our interest rate risk. We do not usederivative financial instruments for speculative or trading purposes.

 

 

 

22

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As of September 29, 2007 we had $114.5 million outstanding under ourCredit Agreement, as amended. A 1% change in interest rates would have resultedin our interest expense fluctuating by approximately $0.3 million for the threemonths ended September 29, 2007.

SI International, Inc. currently has two interest rate swaps with atotal notional value of $60.0 million.

Effective February 14, 2006, an interest swap agreement came intoeffect which reduced our exposure associated with the market volatility offloating LIBOR interest rates. This agreement has a notional principal amountof $30.0 million divided into three tranches. As of September 29, 2007, theinterest rates of these tranches ranged from 4.05% to 4.74%. This agreement isa hedge against term debt, which bears interest at LIBOR plus a margin whichhas a current rate ranging from 7.20% to 7.90%. At stated monthly intervals,the difference between the interest on the floating LIBOR-based debt and theinterest calculated in the swap agreement are settled in cash. The estimatedvalue of the swap at September 29, 2007 was $0.1 million.  The swap matures on February 14, 2008.

Effective August 13, 2007, a second interest swap agreement came intoeffect which further reduces our exposure associated with the market volatilityof floating LIBOR interest rates. This agreement has a notional principalamount of $30.0 million as of September 29, 2007, and had a rate of5.045%.  Effective February 13, 2008, thenotional value increases to $60.0 million. This agreement is a hedge against term debt, which bears interest atLIBOR plus a margin which has a current rate ranging from 7.20% to 7.90%. Atstated three-month intervals, the difference between the interest on thefloating LIBOR-based debt and the interest calculated in the swap agreement aresettled in cash. The estimated value of the swap at September 29, 2007 was($0.7) million.  The swap matures on August13, 2010.

 

In addition, historically, our investment positionshave been relatively small and short-term in nature. We have typically madeinvestments in a fund with an effective average maturity of fewer than 40 daysand a portfolio make-up consisting primarily of commercial paper and notes,variable rate instruments, and, to a lesser degree, overnight securities andbank instruments.  Since our initialpublic offering, the Board of Directors approved an investment policy thatrequires us to invest in relatively short-term, high quality, and highliquidity obligations.

**Item 4.    Controls and Procedures.**

*Evaluation of Disclosure Controls and Procedures.* The Company performed an evaluationunder the supervision and with the participation of management, including theCompany’s Chief Executive Officer and Chief Financial Officer, of the designand operation of the Company’s disclosure controls and procedures as ofSeptember 29, 2007.  Based upon theevaluation, the Company’s Chief Executive Officer and Chief Financial Officerhave concluded that, as of September 29, 2007, the Company’s disclosurecontrols and procedures were effective.

*Changes in Internal Control Over FinancialReporting.*Duringthe three and nine months ended September 29, 2007, there were no changes inthe Company’s internal control over financial reporting that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol for financial reporting.

*LOGTEC*.  Since the acquisition of LOGTEC, the Companyhas focused on extending its compliance program for disclosure controls andprocedures and internal control over financial reporting to includeLOGTEC.  In addition, the Company has established procedures tosubstantiate the financial information related to the LOGTEC businessincluded in this report.  However, at this time, the Company haselected not to include an assessment of LOGTEC in management’sreport on the effectiveness of the Company’s internal controlover financial reporting to be included in the Company’s Form 10-K for the yearended December 29, 2007. This decision is in accordance with guidance fromthe Division of Corporation Finance and Office of the Chief Accountant of theSecurities and Exchange Commission providing that a company may elect not toinclude an acquired subsidiary in its management report on theeffectiveness of the company’s internal control over financial reporting for aperiod of up to one year from the acquisition date.

**PARTII:  OTHER INFORMATION**

**Item 1.      Legal Proceedings**

 

From time to time, the Company is involved in litigation, claims anddisputes that arise in the ordinary course of its business.  In addition, the Company is subject to audit,review, and investigation by various agencies of the Federal Government todetermine compliance with applicable federal statutes and regulation.  As a Federal Government contractor, theCompany is subject to audit by certain federal agencies to determine if theCompany’s performance and administration of its

 

23

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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, resultsof operations, or cash flows.

The SEI acquisition agreement provides for a purchase price adjustmentbased upon the working capital of SEI as of the closing date.  Subsequentto the closing date, we received a payment of $1.6 million in connection 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 a credit inconnection with the calculation of working capital adjustment in an amountequal to the amount received by us for this post-closing payment.  Webelieve that, in accordance with GAAP, the SEI selling stockholders should notreceive the benefit of the post-closing payment.  In accordance with theterms of the SEI acquisition agreement, the parties have jointly submitted theissue to an independent accounting firm for resolution.  We anticipatethat this matter will be resolved before the end of 2007.

**Item1A.  Risk Factors**

 

There are no material updates to the risk factorspreviously disclosed in our Form 10-K for the year ended December 30, 2006.

 

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

 

None.

 

**Item 3.  Defaults Upon Senior Securities**

 

None.

 

**Item 4.   Submissionof Matters To a Vote of Security Holders**

 

None.

 

**Item5.  Other Information**

 

None.

 

**Item 6.  Exhibits**

 

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

 

 

24

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SIGNATURES

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

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

 

 

 

Date:  November 7, 2007

 

 

25

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**INDEX TO EXHIBITS**

** **
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                    | ** ** |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **       | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                         | ** ** |
| 2.1              |       | Share Purchase Agreement among the Company, LOGTEC,  Inc. and the shareholders of LOGTEC, Inc., dated May 23, 2007 (filed as  Exhibit 2.1 to the Company’s Quarterly Report on Form 10-Q filed on August 8,  2007 and incorporated herein by reference.)                                                                                                      |       |
|             |       |                                                                                                                                                                                                                                                                                                                                                               |       |
| 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              |       | Second Amended and Restated Bylaws, as amended (filed  as Exhibit 3.2 to the Company’s Current Report on Form 8-K  filed October 2, 2007 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             |       | 2002 Amended and Restated Omnibus Stock Incentive  Plan (filed as Annex B to the Company’s Proxy Statement on Schedule 14A for  the 2005 Annual Meeting of Stockholders filed on April 21, 2005 and  incorporated herein by reference.)                                                                                                                       |       |
|             |       |                                                                                                                                                                                                                                                                                                                                                               |       |
| 10.2             |       | January 2001 Nonqualified Stock Option Plan  (filed as Exhibit 10.2 to the Company’s Registration Statement on  Form S-1/A (File No. 333-87964 filed on June 24,  2002 (the “First Amendment and incorporated herein by reference.)                                                                                             |       |
|             |       |                                                                                                                                                                                                                                                                                                                                                               |       |
| 10.3             |       | SI International, Inc. 2001 Service Award Stock  Option Plan (filed as Exhibit 10.3 to the First Amendment and  incorporated herein by reference.)                                                                                                                                                                                                       |       |
| 10.4             |       | 1998 Stock Option Plan (filed as Exhibit 10.5 to  the First Amendment and incorporated herein by reference.)                                                                                                                                                                                                                                                  |       |
|             |       |                                                                                                                                                                                                                                                                                                                                                               |       |
| 10.5             |       | Non-Qualified Deferred Compensation Plan, as amended  (filed as Exhibit 10.13 to the Company’s 2004 10-K and incorporated herein by  reference.)                                                                                                                                                                                                              |       |
|             |       |                                                                                                                                                                                                                                                                                                                                                               |       |
| 10.6             |       | Form of SI International, Inc. Stock Option Agreement  Evidencing Grant of Stock Options Under the SI International, Inc. 2002  Amended and Restated Omnibus Stock Incentive Plan, Including Notice of Stock  Option Grant (filed as Exhibit 99.1 to the Company’s Current Report on Form  8-K filed on March 17, 2005 and incorporated herein by reference.) |       |
|             |       |                                                                                                                                                                                                                                                                                                                                                               |       |
| 10.7             |       | Amended and Restated Credit Agreement, dated as of  February 9, 2005 (filed as Exhibit 99.1 to the Company’s Current Report  on Form 8-K filed February 15, 2005 and incorporated herein by  reference.)                                                                                                                                            |       |
|             |       |                                                                                                                                                                                                                                                                                                                                                               |       |
| 10.8             |       | First Amendment to Amended and Restated Credit Agreement,  dated February 27, 2006 (filed as Exhibit 10.1 to the Company’s Current  Report on Form 8-K filed March 3, 2006 and incorporated herein by  reference.)                                                                                                                                  |       |
|             |       |                                                                                                                                                                                                                                                                                                                                                               |       |
| 10.9             |       | Second Amendment to Amended and Restated Credit  Agreement, dated June 8, 2007 (filed as Exhibit 10.1 to the Company’s Current  Report on Form 8-K filed June 11, 2007 and incorporated herein by reference.)                                                                                                                                                 |       |
|             |       |                                                                                                                                                                                                                                                                                                                                                               |       |
| 10.10            |       | Executive Employment Agreement with S. Bradford Antle  (filed as Exhibit 10.10 to the Company’s Quarterly Report on Form 10-Q filed  on August 8, 2007 and incorporated herein by reference.)                                                                                                                                                            |       |
|             |       |                                                                                                                                                                                                                                                                                                                                                               |       |
| 10.11            |       | Executive Employment Agreement with Thomas E. Dunn  (filed as Exhibit 10.11 to the Company’s Quarterly Report on Form 10-Q  filed on August 8, 2007 and incorporated herein by reference.)                                                                                                                                                               |       |
|             |       |                                                                                                                                                                                                                                                                                                                                                               |       |
| 10.12            |       | Executive Employment Agreement with Thomas E. Lloyd  (filed as Exhibit 10.9 to the Third Amendment and incorporated herein by  reference.)                                                                                                                                                                                                                    |       |
|             |       |                                                                                                                                                                                                                                                                                                                                                               |       |
| 10.13            |       | Executive Employment Agreement with Ray J. Oleson  (filed as Exhibit 10.13 to the Company’s Quarterly Report on Form 10-Q  filed on August 8, 2007 and incorporated herein by reference.)                                                                                                                                                                |       |

 

 

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| 10.14                        |   | Executive Employment  Agreement with Leslee H. Gault (filed as Exhibit 10.1 to the Company’s Current  Report on Form 8-K/A filed on October 2, 2006 and incorporated herein by  reference.)        |   |
|------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                         |   |                                                                                                                                                                                                    |   |
| 10.15                        |   | Executive Employment  Agreement with Harry D. Gatanas (filed as Exhibit 10.1 to the Company’s  Current Report on Form 8-K/A filed November 15, 2005 and incorporated herein  by reference.)   |   |
|                         |   |                                                                                                                                                                                                    |   |
| 10.16                        |   | Executive Employment  Agreement with Marylynn Stowers (filed as Exhibit 10.1 to the Company’s  Current Report on Form 8-K/A filed February 2, 2006 and incorporated herein  by reference.)    |   |
|                         |   |                                                                                                                                                                                                    |   |
| 10.17                        |   | Executive Employment  Agreement with P. Michael Becraft (filed as Exhibit 10.1 to the  Company’s Current Report on Form 8-K/A filed February 24, 2006 and  incorporated herein by reference.) |   |
|                         |   |                                                                                                                                                                                                    |   |
| 10.18                        |   | Consulting Services  Agreement with Walter J. Culver (filed as Exhibit 10.12 to the 2004 10-K and  incorporated herein by reference.)                                                                   |   |
|                         |   |                                                                                                                                                                                                    |   |
| 10.19                        |   | Form of  Indemnification Agreement (filed as Exhibit 10.11 to the Third Amendment  and incorporated herein by reference.)                                                                     |   |
|                         |   |                                                                                                                                                                                                    |   |
| 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 (*.)        |   |
|                         |   |                                                                                                                                                                                                    |   |
| * Indicates filed  herewith. |   |
|                         |   |                                                                                                                                                                                                    |   |
|                              |        |                                                                                                                                                                                                         |        |  |

 

 

 

 

 

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