**UNITED STATES********SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

| **(Mark One)** |
|----------------|
|           |
| **ý**     |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|           |   | **FOR THE  QUARTER ENDED JUNE 28, 2003** |
|           |   |   |
| **o**          |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission File Number**

**000-50080**

 

**SI International, Inc.**

(Exactname of registrant as specified in its charter)

 

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

 

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

 

----

 

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

 

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

 

As of August 4, 2003, there were 8,447,162shares outstanding of the registrant’s common stock.

 

 

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**SI INTERNATIONAL, INC.**

**FORM 10-Q**

**INDEX**

 
| **PART I.**    | **FINANCIAL INFORMATION**                                                                         |
|----------------|---------------------------------------------------------------------------------------------------|
| ITEM 1         | Financial Statements                                                                              |
|           | Consolidated Balance Sheets-June 28, 2003 and December 28, 2002                                   |
|           | Consolidated Statements of Operations-Three  and six months ended June 28, 2003 and June 29, 2002 |
|           | Consolidated Statements of Cash Flows-Six  months ended June 28, 2003 and June 29, 2002           |
|           | Notes to Consolidated Financial Statements                                                        |
| ITEM 2         | Management’s Discussion and Analysis of  Financial Condition and Results of Operations       |
| ITEM 3         | Quantitative and Qualitative Disclosures  About Market Risk                                       |
| ITEM 4         | Controls and Procedures                                                                           |
|           |                                                                                              |
| **PART II.**   | **OTHER INFORMATION**                                                                             |
| ITEM 1         | Legal Proceedings                                                                                 |
| ITEM 2         | Changes in Securities and Use of Proceeds                                                         |
| ITEM 3         | Defaults Upon Senior Securities                                                                   |
| ITEM 4         | Submission of Matters to a Vote of Security  Holders                                              |
| ITEM 5         | Other Information                                                                                 |
| ITEM 6         | Exhibits and Reports on Form 8-K                                                                  |
| Signatures     |
| Certifications |

 

2

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**PARTI:  FINANCIAL INFORMATION**

**Item1.   Financial Statements**

**SIInternational, Inc. and Subsidiaries**

**ConsolidatedBalance Sheets**

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

 
|                                                                                                                                                                                                |   | **June 28,  2003** |       | **December 28,  2002** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|------------------------|------------|
|                                                                                                                                                                                                |   | **(unaudited)**    |       |                   |       |
| **Assets**                                                                                                                                                                                          |   |               | ** ** |                   | ** ** |
| **Current assets:**                                                                                                                                                                                 |   |               |       |                   |       |
| Cash and cash equivalents                                                                                                                                                                           |   | $                  | 16,646     |                   | $          | 10,856 |   |
| Accounts receivable, net                                                                                                                                                                            |   | 27,212             |       | 31,901                 |       |
| Other current assets                                                                                                                                                                                |   | 2,882              |       | 3,741                  |       |
| Total current assets                                                                                                                                                                                |   | 46,740             |       | 46,498                 |       |
| **Property and  equipment, net**                                                                                                                                                                    |   | 4,162              |       | 4,542                  |       |
| **Goodwill and  assembled workforce, net**                                                                                                                                                          |   | 39,829             |       | 39,829                 |       |
| **Other assets**                                                                                                                                                                                    |   | 1,260              |       | 1,446                  |       |
| Total assets                                                                                                                                                                                        |   | $                  | 91,991     |                   | $          | 92,315 |   |
| **Liabilities and  stockholders’ equity**                                                                                                                                                      |   |               | ** ** |                   | ** ** |
| **Current  liabilities:**                                                                                                                                                                           |   |               |       |                   |       |
| Accounts payable and accrued expenses                                                                                                                                                               |   | $                  | 12,163     |                   | $          | 12,712 |   |
| Deferred revenue                                                                                                                                                                                    |   | 67                 |       | 1,074                  |       |
| Other current liabilities                                                                                                                                                                           |   | 437                |       | 2,775                  |       |
| Total current liabilities                                                                                                                                                                           |   | 12,667             |       | 16,561                 |       |
| **Other long-term  liabilities**                                                                                                                                                                    |   | 2,178              |       | 1,777                  |       |
| **Commitments and  contingencies**                                                                                                                                                                  |   |               | ** ** |                   | ** ** |
| **Stockholders’  equity:**                                                                                                                                                                     |   |               | ** ** |                   | ** ** |
| **Common stock**—$0.01 par value per  share; 50,000,000 shares authorized; 8,447,162 and 8,439,741 shares issued  and outstanding as of June 28, 2003 and December 28, 2002, respectively |   | 85                 |       | 85                     |       |
| Additional paid-in capital                                                                                                                                                                          |   | 75,649             |       | 75,682                 |       |
| Deferred compensation                                                                                                                                                                               |   | (406               | )          | (509                   | )          |
| Retained Earnings (accumulated deficit)                                                                                                                                                             |   | 1,818              |       | (1,281                 | )          |
| Total stockholders’ equity                                                                                                                                                                     |   | 77,146             |       | 73,977                 |       |
| Total liabilities and stockholders’ equity                                                                                                                                                     |   | $                  | 91,991     |                   | $          | 92,315 |   |

 

*See accompanying notes*

 

3

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**SI International, Inc. and Subsidiaries**

**ConsolidatedStatements of Operations**

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

**Unaudited**

 
|                                                                                                                                                                                                                                       |   | **Three  Months Ended** |   | **Six  Months Ended** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|-----------------------|--------|
|                                                                                                                                                                                                                                       |   | **June  28,  2003**     |   | **June  29,  2002**   |   | **June  28,  2003** |   | **June  29,  2002** |   |
|                                                                                                                                                                                                                                       |   |                    |   |                  |   |   |   |   |   |
| **Revenue**                                                                                                                                                                                                                                |   | $                       | 40,724 |                  | $      | 35,407 |   | $ | 82,048 |   | $ | 68,870 |   |
| **Costs and expenses:**                                                                                                                                                                                                                    |   |                    |   |                  |   |   |   |   |   |
| Direct costs                                                                                                                                                                                                                               |   | 24,264                  |   | 21,856                |   | 49,290 |   | 41,001 |   |
| Indirect costs, including $32 and $35 of non-cash  stock-based compensation in fiscal quarters ended June 28, 2003 and June 29,  2002, respectively and $67 and $69 in the six months ended June 28, 2003 and  June 29, 2002, respectively |   | 13,167                  |   | 13,923                |   | 26,330 |   | 25,641 |   |
| Depreciation and Amortization                                                                                                                                                                                                              |   | 486                     |   | 515                   |   | 998 |   | 996 |   |
| Total operating expenses                                                                                                                                                                                                                   |   | 37,917                  |   | 36,294                |   | 76,618 |   | 67,638 |   |
| **Income (loss) from operations**                                                                                                                                                                                                          |   | 2,807                   |   | (887                  | )      | 5,430 |   | 1,232 |   |
| **Interest expense**                                                                                                                                                                                                                       |   | (146                    | )      | (657                  | )      | (308 | ) | (1,354 | ) |
| **Minority interests**                                                                                                                                                                                                                     |   | —                  |   | (39                   | )      | — |   | (77 | ) |
| **Change in fair value of put  warrants**                                                                                                                                                                                                  |   | —                  |   | (301                  | )      | — |   | (391 | ) |
| **Income (loss) before provision for  (benefit from) income taxes**                                                                                                                                                                        |   | 2,661                   |   | (1,884                | )      | 5,122 |   | (590 | ) |
| **Provision for (benefit from)  income taxes**                                                                                                                                                                                             |   | 1,052                   |   | (689                  | )      | 2,024 |   | (125 | ) |
| **Net income (loss)**                                                                                                                                                                                                                      |   | 1,609                   |   | (1,195                | )      | 3,098 |   | (465 | ) |
| **Dividends on redeemable cumulative  preferred stock**                                                                                                                                                                                    |   | —                  |   | 557                   |   | — |   | 1,090 |   |
| **Net income (loss) attributable to  common stockholders**                                                                                                                                                                                 |   | $                       | 1,609  |                  | $      | (1,752 | ) | $ | 3,098 |   | $ | (1,555 | ) |
|                                                                                                                                                                                                                                       |   |                    |   |                  |   |   |   |   |   |
| **Earnings (loss) per common share:**                                                                                                                                                                                                      |   |                    |   |                  |   |   |   |   |   |
| Basic net income (loss) per common share                                                                                                                                                                                                   |   | $                       | 0.19   |                  | $      | (0.67 | ) | $ | 0.37 |   | $ | (0.59 | ) |
|                                                                                                                                                                                                                                       |   |                    |   |                  |   |   |   |   |   |
| Diluted net income (loss) per common share                                                                                                                                                                                                 |   | $                       | 0.19   |                  | $      | (0.67 | ) | $ | 0.37 |   | $ | (0.59 | ) |
|                                                                                                                                                                                                                                       |   |                    |   |                  |   |   |   |   |   |
| **Basic weighted-average shares  outstanding**                                                                                                                                                                                             |   | 8,447                   |   | 2,632                 |   | 8,445 |   | 2,632 |   |
| **Diluted weighted-average shares  outstanding**                                                                                                                                                                                           |   | 8,447                   |   | 2,632                 |   | 8,445 |   | 2,632 |   |

 

***See accompanyingnotes***

 

4

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**SIInternational, Inc. and Subsidiaries**

**ConsolidatedStatements of Cash Flows**

**(Amountsin thousands)**

**Unaudited**

 
|                                                                                      |   | **Six Months Ended** |   |
|-------------------------------------------------------------------------------------------|--------|----------------------|--------|
|                                                                                      |   | **June 28,  2003**   |   | **June 29,  2002** |   |
| **Cash flows from  operating activities:**                                                |   |                 |   |   |   |
| Net income (loss)                                                                         |   | $                    | 3,098  |   | $ | (465 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities: |   |                 |   |   |   |
| Depreciation and amortization                                                             |   | 998                  |   | 996 |   |
| Loss on disposal of fixed assets                                                          |   | 168                  |   | — |   |
| Stock-based compensation                                                                  |   | 67                   |   | 69 |   |
| Amortization of deferred financing costs  and debt discount                               |   | 188                  |   | 148 |   |
| Change in fair value of put warrants                                                      |   | —               |   | 391 |   |
| Minority interests                                                                        |   | —               |   | 77 |   |
| Changes in operating assets and  liabilities:                                             |   |                 |   |   |   |
| Accounts receivable                                                                       |   | 4,689                |   | 3,454 |   |
| Other current assets                                                                      |   | 859                  |   | (2,422 | ) |
| Other assets                                                                              |   | (2                   | )      | 26 |   |
| Accounts payable and accrued expenses                                                     |   | (549                 | )      | 270 |   |
| Deferred revenue                                                                          |   | (1,007               | )      | 1,006 |   |
| Other long term liabilities                                                               |   | 447                  |   | 249 |   |
| Net cash provided by operating activities                                                 |   | 8,956                |   | 3,799 |   |
| **Cash flows from  investing activities:**                                                |   |                 |   |   |   |
| Purchase of property and equipment                                                        |   | (786                 | )      | (839 | ) |
| Net cash used in investing activities                                                     |   | (786                 | )      | (839 | ) |
| **Cash flows from  financing activities:**                                                |   |                 |   |   |   |
| Proceeds from issuance of common stock                                                    |   | 4                    |   | — |   |
| Repayments (proceeds) from bank overdrafts                                                |   | (2,201               | )      | 1,102 |   |
| Borrowings under line of credit                                                           |   | —               |   | 40,080 |   |
| Repayments of line of credit                                                              |   | —               |   | (41,302 | ) |
| Repayments of notes payable                                                               |   | (137                 | )      | (900 | ) |
| Repayments of long-term debt and borrowings  from stockholders                            |   | —               |   | (1,125 | ) |
| Payments of capital leases                                                                |   | (46                  | )      | (86 | ) |
| Net cash used in financing activities                                                     |   | (2,380               | )      | (2,231 | ) |
| **Net increase in  cash and cash equivalents**                                            |   | 5,790                |   | 729 |   |
| **Cash and cash  equivalents, beginning of period**                                       |   | 10,856               |   | 470 |   |
| **Cash and cash  equivalents, end of period**                                             |   | $                    | 16,646 |   | $ | 1,199 |   |
| **Supplemental  disclosures of cash flow information:**                                   |   |                 |   |   |   |
| Cash payments for interest                                                                |   | $                    | 142    |   | $ | 963 |   |
| Cash payments for income taxes                                                            |   | $                    | 2,181  |   | $ | 1,640 |   |

 

***See accompanyingnotes***

 

5

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**SI International, Inc. and Subsidiaries**

 

**Notesto consolidated financial statements**

**(Unaudited)**

 

**1.****                                      Basisof Presentation**

 

Theaccompanying unaudited consolidated financial statements of SI International,Inc. and its subsidiaries (the “Company”) have been prepared in accordance withaccounting principles generally accepted in the United States for interimfinancial information and with the instructions to Form 10-Q andArticle 10 of Regulation S-X. Accordingly, they do not include all ofthe information and footnotes required by accounting principles generallyaccepted in the United States for complete financial statements. In the opinionof management, all adjustments (consisting of normal recurring accruals)considered necessary for a fair presentation have been included. Operatingresults for the quarter and six months ended June 28, 2003 are not necessarilyindicative of the results that may be expected for the year ending December 27,2003. For further information, refer to the financial statements and footnotesincluded in SI International’s Annual Report on Form 10-K/A for the yearended December 28, 2002.

 

**2.****                                      Summaryof significant accounting policies:**

 

**Principles of consolidation**

 

Theaccompanying consolidated financial statements include the accounts of theCompany and its wholly and majority-owned subsidiaries.  All significant intercompany transactionsand accounts have been eliminated in consolidation. 

 

**Useof estimates**

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States 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 financial statementsand the reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates. 

 

**Reportingperiods**

 

The Company’sfiscal year ends on the Saturday nearest to December 31 of that year.  All fiscal years presented include 52 weeks.The Company’s quarters end on the Saturday nearest to the applicable quarterlymonth-end.  All quarters presentedinclude 13 weeks. 

 

**Cashand cash equivalents**

 

The Companyconsiders all investments with maturities of three months or less at the dateof purchase to be cash equivalents. 

 

6

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The balance ofchecks the Company has written, but have not yet been presented to the bank forpayment is $0 and $2.2 million at June 28, 2003 and December 28, 2002,respectively.  These balances have beenclassified in other current liabilities in the accompanying consolidatedbalance sheets. 

 

**RevenueRecognition**

 

The Companyrecognizes revenue under its contracts 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. Direct contract costs are expensed asincurred. 

 

Under costreimbursable contracts, the Company is reimbursed for allowable costs, and paida fee. Revenues on cost reimbursable contracts are recognized as costs areincurred plus an estimate of applicable fees earned. The Company considersfixed fees under cost reimbursable contracts to be earned in proportion of theallowable costs incurred in performance of the contract. For cost reimbursablecontracts that include performance based fee incentives, the Company recognizesthe relevant portion of the expected fee to be awarded by the customer at thetime such fee can be reasonably estimated, based on factors such as theCompany’s prior award experience and communications from the customer regardingperformance. 

 

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

 

Fixed price contracts mayinclude either a product delivery or specific service performance throughout aperiod.  Revenue on fixed pricecontracts that provide for the Company to render services throughout a periodis recognized as earned according to contract terms as the service is providedon a proportionate performance basis. For fixed price contracts that provide for the delivery of a specificproduct with related customer acceptance provisions, revenues and associatedcontract costs are recognized upon product delivery and customer acceptance. 

 

The Company’s contracts withagencies of the government are subject to periodic funding by the respectivecontracting agency. Funding for a contract may be provided in full at inceptionof the contract or ratably throughout the contract as the services are provided.In evaluating the probability of funding for purposes of assessingcollectibility of the contract price, the Company considers its previousexperiences with its customers, communications with its customers regardingfunding status, and the Company’s knowledge of available funding for thecontract or program. If funding is not assessed as probable, revenuerecognition is deferred until realization is deemed probable. 

 

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

 

Theallowability of certain costs under government contracts is subject to audit bythe government. Certain indirect costs are charged to contracts usingprovisional or estimated indirect rates, which are subject to later revisionbased on government audits of those costs. Management is of the opinion thatcosts subsequently disallowed, if any, would not be significant.

 

**Significantcustomers**

 

Revenuegenerated from contracts with the federal government or prime contractors doingbusiness with the federal government accounted for a significant percentof revenues in the fiscal quarters and six months ended June 28, 2003 and June29, 2002. 

 

7

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|                      |   | **Percent of revenues** |   |
|---------------------------|--------|-------------------------|--------|
|                      |   | **Three Months Ended**  |   | **Six Months Ended** |   |
|                      |   | **June 28,  2003**      |   | **June 29,  2002** |   | **June 28,  2003** |   | **June 29,  2002** |   |
|                      |   |                    |   |   |   |   |   |   |   |
| Department of Defense     |   | 52.8                    | %      | 50.7 | % | 52.6 | % | 47.2 | % |
| Federal civilian agencies |   | 40.3                    |   | 43.7 |   | 40.8 |   | 45.5 |   |
| Commercial entities       |   | 6.9                     |   | 5.6 |   | 6.6 |   | 7.3 |   |
| Total revenue             |   | 100.0                   | %      | 100.0 | % | 100.0 | % | 100.0 | % |

 

For the secondquarter of 2003 as well as the second quarter of 2002, we had two contractsthat generated more than 10% of our revenue. Our C4I2SR contract with the U.S. Air Force Space Command representedapproximately 21.1% and 24.9% of total revenue for the quarters ended June 28,2003 and June 29, 2002, respectively.  Our National Visa Center contract with the Department of Staterepresented approximately 14.8% and 10.8% of total revenue for the quartersended June 28, 2003 and June 29, 2002, respectively.  For the first six months of 2003 as well as the first six monthsof 2002, these two contracts also represented the contracts which generatedmore than 10% of total revenue.  OurC4I2SR contract represented approximately 21.2% and 22.1% of total revenue forthe six months ended June 28, 2003 and June 29, 2002, respectively.   Our National Visa Center contractrepresented approximately 14.6% and 11.1% of total revenue for the six monthsended June 28, 2003 and June 29, 2002, respectively.  

 

**Deferredfinancing costs**

 

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

 
|                     |   | **June 28,  2003** |   | **December 28,  2002** |   |
|--------------------------|--------|--------------------|--------|------------------------|--------|
|                     |   |               |   |                   |   |
| Deferred loan costs      |   | $                  | 1,093  |                   | $      | 1,093 |   |
| Accumulated amortization |   | (226               | )      | (42                    | )      |
|                     |   | $                  | 867    |                   | $      | 1,051 |   |

 

At the end ofthe quarter ended June 28, 2003 and the fiscal year ended December 28, 2002, wereceived advance payments of approximately $0 and $1,074,000, respectively,from a customer to purchase equipment to be used in a contract. This advancewas reflected as deferred revenue as of December 28, 2002 in theaccompanying consolidated balance sheet. 

 

During thequarter ended June 28, 2003, we received an advanced payment of $67,000 from acustomer for future work.  This advancewas recorded as deferred revenue as of June 28, 2003 in the accompanyingconsolidated balance sheet.

 

**Fairvalue of financial instruments**

 

The Company’sfinancial instruments consist primarily of cash and cash equivalents, accountsreceivable, accounts payable, credit facilities, and long-term debt. Inmanagement’s opinion, the carrying amounts of these financial instrumentsapproximate their fair values at June 28, 2003 and December 28, 2002. 

 

**Stock-basedcompensation**

 

In December2002, the FASB issued SFAS No. 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure—an amendment of SFAS 123.”  This statement amends SFAS No. 123,“Accounting for Stock-Based Compensation,” to provide alternative methods oftransition for a voluntary change to the fair value based method of accountingfor stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS

 

8

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No. 123 to require prominentdisclosures in both annual and interim financial statements about the method ofaccounting for stock-based employee compensation and the effect of the methodused on reported results.  The Companyhas chosen to continue to account for stock-based compensation using theintrinsic value method prescribed in APB Opinion No. 25 and relatedinterpretations.  Accordingly,compensation expense for stock options is measured as the excess, if any, ofthe fair market value of the Company’s stock at the date of the grant over theexercise price of the related option.  The Company has adopted the annual disclosure provisions of SFASNo. 148 in its financial reports for the year ended December 28, 2002 and hasadopted the interim disclosure provisions for its financial reports for thequarter and six months ended June 28, 2003.

 
|                                                                                                                       |   | **Three Months Ended** |       | **Six Months Ended** |   |
|----------------------------------------------------------------------------------------------------------------------------|--------|------------------------|------------|----------------------|--------|
|                                                                                                                       |   | **June 28,  2003**     |       | **June 29,  2002**   |   | **June 28,  2003** |   | **June 29,  2002** |   |
|                                                                                                                       |   |                   |       |                 |   |   |   |   |   |
| Net income (loss) - as reported                                                                                            |   | $                      | 1,609      |                 | $      | (1,195 | ) | $ | 3,098 |   | $ | (465 | ) |
|                                                                                                                       |   |                   |       |                 |   |   |   |   |   |
| Add: total stock-based employee compensation expense as reported  under intrinsic value method (APB No. 25) for all awards |   |                   |       |                 |   |   |   |   |   |
|                                                                                                                       |   | 32                     |       | 35                   |   | 67 |   | 69 |   |
| Deduct: Total stock-based compensation expense determined under fair  value based method (SFAS No. 123) for all awards     |   |                   |       |                 |   |   |   |   |   |
|                                                                                                                       |   | (48                    | )          | (35                  | )      | (420 | ) | (290 | ) |
| Net income (loss) - Pro forma                                                                                              |   | 1,593                  |       | (1,195               | )      | 2,745 |   | (686 | ) |
|                                                                                                                       |   |                   |       |                 |   |   |   |   |   |
| Dividends on redeemable cumulative preferred stock                                                                         |   | —                 |       | 557                  |   | — |   | 1,090 |   |
|                                                                                                                       |   |                   |       |                 |   |   |   |   |   |
| Net income attributable to common stockholders - Pro forma                                                                 |   | $                      | 1,593      |                 | $      |  (1,752 | ) | $ | 2,745 |   | $ |  (1,776 | ) |
|                                                                                                                       |   |                   |       |                 |   |   |   |   |   |
| Basic earnings per common share - as reported                                                                              |   | $                      |  0.19 |                 | $      |  (0.67 | ) | $ | 0.37 |   | $ |  (0.59 | ) |
|                                                                                                                       |   |                   |       |                 |   |   |   |   |   |
| Diluted earnings per common share - as reported                                                                            |   | 0.19                   |       | (0.67                | )      | 0.37 |   | (0.59 | ) |
|                                                                                                                       |   |                   |       |                 |   |   |   |   |   |
| Basic earnings per common share - Pro forma                                                                                |   | 0.19                   |       | (0.67                | )      | 0.33 |   | (0.67 | ) |
|                                                                                                                       |   |                   |       |                 |   |   |   |   |   |
| Diluted earnings per common share - Pro forma                                                                              |   | 0.19                   |       | (0.67                | )      | 0.33 |   | (0.67 | ) |
|                                                                                                                            |        |                        |            |                      |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Earnings(loss) per share**

 

The Companyhas applied SFAS No. 128, “Earnings Per Share,” for all fiscal yearspresented in these consolidated financial statements. SFAS No. 128requires disclosure of basic and diluted earnings per share (EPS). Basic EPS iscomputed by dividing reported earnings available to common stockholders by theweighted average number of shares outstanding without consideration of commonstock equivalents or other potentially dilutive securities. Diluted EPS giveseffect to common stock equivalents and other potentially dilutive securitiesoutstanding during the period. Redeemable cumulative preferred stock isexcluded from diluted earnings per share as it is not convertible into commonstock. 

 

The following details thecomputation of net income (loss) per common share:

 

9

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|                                                                              |   | **Three Months Ended** |   | **Six Months Ended** |   |
|-----------------------------------------------------------------------------------|--------|------------------------|--------|----------------------|--------|
|                                                                              |   | **June 28,  2003**     |   | **June 29,  2002**   |   | **June 28,  2003** |   | **June 29,  2002** |   |
|                                                                              |   |                   |   |                 |   |   |   |   |   |
| Net income (loss)                                                                 |   | $                      | 1,609  |                 | $      | (1,195 | ) | $ | 3,098 |   | $ | (465 | ) |
| Dividends on redeemable cumulative  preferred stock                               |   | —                 |   | 557                  |   | — |   | 1,090 |   |
|                                                                              |   |                   |   |                 |   |   |   |   |   |
| Net income (loss) attributable to common  stockholders – basic & diluted |   | $                      | 1,609  |                 | $      |  (1,752 | ) | $ | 3,098 |   | $ |  (1,555 | ) |
|                                                                              |   |                   |   |                 |   |   |   |   |   |
| **Weighted average share calculation:**                                           |   |                   |   |                 |   |   |   |   |   |
|                                                                              |   |                   |   |                 |   |   |   |   |   |
| Basic & diluted weighted average shares  outstanding                          |   | 8,447                  |   | 2,632                |   | 8,445 |   | 2,632 |   |
|                                                                                   |        |                        |        |                      |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Reclassifications**

 

Certain prioryear balances have been reclassified to conform to the presentation of thecurrent year.

 

**Newaccounting pronouncements**

 

In November2002, the Financial Accounting Standards Board issued Interpretation No. 45,“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others” (FIN 45).  FIN 45 elaborates on the disclosure to bemade by a guarantor in its interim and annual financial statements about itsobligations under certain guarantees that it has issued. It also clarifies thata guarantor is required to recognize, at the inception of a guarantee, aliability for the fair value of the obligation undertaken in issuing theguarantee. The initial recognition and initial measurement provisions of FIN 45are applicable on a prospective basis to guarantees issued or modified afterDecember 31, 2002. The disclosure requirements of FIN 45 are effective forfinancial statements of interim or annual periods ending after December 31,2002. The Company does not expect adoption of FIN 45 to have a material effecton its financial condition, results of operations of liquidity**.**

 

In January2003, the Financial Accounting Standards Board issued Interpretation No. 46,“Consolidation of Variable Interest Entities” (FIN 46).  FIN 46 clarifies the application ofAccounting Research Bulletin No. 51, “Consolidated Financial Statements”, tocertain entities in which equity investors do not have the characteristics of acontrolling financial interest or do not have sufficient equity at risk for theentity to finance its activities without additional subordinated financialsupport from other parties. FIN 46 applies immediately to variable interestentities created after January 31, 2003. Management believes that the Company’sbusiness practice does not require the application of FIN 46. 

 

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

 

OnMarch 9, 2000, the Company purchased all of the outstanding common stockof System Technology Associates, Inc. for consideration of approximately$33.0 million in cash and $4.8 million in subordinated notes in atransaction accounted for as a purchase. The subordinated notes bear interestat the prime rate plus 2 percent with $3.8 million due in March 2001,subject to collection of certain accounts receivable, and $1.0 million duein March 2002. Approximately $4.3 million of the notes were repaid atmaturity in March 2001 and 2002 and payments of approximately $343,000 ofthese notes had been withheld by the Company as of June 28, 2003 since certainaccounts receivable have not been fully collected. 

 

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

 

Accountsreceivable consists of the following (in thousands): 

 

10

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|                                                                                               |   | **June 28, 2003** |   | **December 28, 2002** |   |
|----------------------------------------------------------------------------------------------------|--------|-------------------|--------|-----------------------|--------|
|                                                                                               |   |              |   |                  |   |
| Billed accounts receivable                                                                         |   | $                 | 13,234 |                  | $      | 18,377 |   |
| Unbilled accounts receivable:                                                                      |   |              |   |                  |   |
| Currently billable                                                                                 |   | 11,711            |   | 11,926                |   |
| Unbilled retainages and milestones payments  expected to be billed within the next 12 months       |   | 3,093             |   | 2,054                 |   |
| Indirect costs incurred and charged to  cost-plus contracts in excess of provisional billing rates |   | 629               |   | 640                   |   |
| Total unbilled accounts receivable                                                                 |   | 15,433            |   | 14,620                |   |
| Allowance for doubtful accounts                                                                    |   | (1,455            | )      | (1,096                | )      |
| Accounts receivable, net                                                                           |   | $                 | 27,212 |                  | $      | 31,901 |   |

 

The currentlybillable amounts included as unbilled accounts receivable as of June 28, 2003represent amounts, which are billed during the following quarter of the currentyear. They are billings for services rendered prior to quarter-end, which arebilled once necessary billing data has been collected and an invoice produced. 

 

Long-termunbilled accounts receivable of approximately $400,000 as of June 28, 2003 andDecember 28, 2002 are included in other assets in the accompanying consolidatedbalance sheets. 

 

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

 

Property andequipment consist of the following (in thousands): 

 
|                                                |   | **June 28, 2003** |   | **December 28, 2002** |   |
|-----------------------------------------------------|--------|-------------------|--------|-----------------------|--------|
| Computers and equipment                             |   | $                 | 5,947  |                  | $      | 5,620 |   |
| Software                                            |   | 1,852             |   | 1,810                 |   |
| Furniture and fixtures                              |   | 1,285             |   | 1,216                 |   |
| Leasehold improvements                              |   | 638               |   | 692                   |   |
|                                                |   | 9,722             |   | 9,338                 |   |
| Less—Accumulated depreciation and amortization |   | (5,560            | )      | (4,796                | )      |
|                                                |   | $                 | 4,162  |                  | $      | 4,542 |   |

 

Property and equipment includesassets financed under capital lease obligations of approximately $116,000 and$272,000, net of accumulated depreciation, as of June 28, 2003 andDecember 28, 2002, respectively. 

 

Depreciationexpense of approximately $0.5 million and $1.0 million and was recorded in thequarter and six months  ended June 28,2003, respectively compared to $0.5 million and $1.0 million in the quarter andsix months ended June 29, 2002, respectively.  

 

**6.****                                      Accountspayable and accrued expenses:**

 

Accountspayable and accrued expenses consists of the following (in thousands): 

 

11

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|                                  |   | **June 28, 2003** |   | **December 28, 2002** |   |
|---------------------------------------|--------|-------------------|--------|-----------------------|--------|
|                                  |   |              |   |                  |   |
| Accounts payable                      |   | $                 | 3,686  |                  | $      | 6,660 |   |
| Accrued compensation and benefits     |   | 5,438             |   | 5,216                 |   |
| Accrued interest                      |   | 90                |   | 45                    |   |
| Other accrued liabilities             |   | 2,949             |   | 791                   |   |
| Accounts payable and accrued expenses |   | $                 | 12,163 |                  | $      | 12,712 |   |

 

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

 

Debt consistsof the following and is included in other current liabilities on theaccompanying consolidated balance sheets (in thousands): 

 
|                         |   | **June 28, 2003** |   | **December 28, 2002** |   |
|------------------------------|--------|-------------------|--------|-----------------------|--------|
| Notes payable:               |   |              |   |                  |   |
| Indemnification note payable |   | $                 | 343    |                  | $      | 480 |   |
| Total debt                   |   | $                 | 343    |                  | $      | 480 |   |

 

Our creditfacility consists of a $35.0 million secured revolving creditarrangement.  As of June 28, 2003 andDecember 28, 2002, we have no borrowings outstanding under this creditfacility.  

 

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

 

**Leases**

 

As of June 28,2003, the Company has noncancelable operating leases, primarily for real estatethat expire over the next six years. Rental expense during the quarter and sixmonths ended June 28, 2003 was approximately $1.3 million and $2.7 million,respectively compared to rental expense of approximately $1.2 million and $2.2million during the quarter and six months ended June 29, 2002, respectively. 

 

**Contract cost audits**

 

Payments tothe Company on government cost reimbursable contracts are based on provisional,or estimated indirect rates, which are subject to audit on an annual basis bythe Defense Contract Audit Agency (DCAA). The cost audits result in thenegotiation and determination of the final indirect cost rates that the Companymay use for the period(s) audited. The final rates, if different from theprovisional rates, may create an additional receivable or liability for theCompany. The Company’s revenue recognition policy calls for revenue recognizedon all cost reimbursable government contracts to be recorded at actual ratesunless collectibility is not reasonably assured. To the extent the indirectrate differential creates a liability for the Company, the differential isrecognized as a reduction to revenue when identified. 

 

**Litigation and claims**

 

The Company isa party to litigation and legal proceedings that management believes to be apart of the ordinary course of its business. The Company may become involved inother legal and governmental, administrative or contractual proceedings in thefuture.  While the Company cannotpredict the ultimate outcome of these matters, the Company currently believes, based uponinformation available to us as of the date of this filing, that any ultimateliability arising out of these proceedings will not have a material adverseeffect on our financial position or results of operations.

 

12

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

 

**Stock option plans**

 

InDecember 1998, the Company adopted the 1998 Stock Option Plan to grantstock options to directors, consultants, executives, and other key employees ofthe Company. The Company may grant stock options to purchase up to 222,727shares of its common stock under this plan. 

 

InJanuary 2001, the Company adopted the 2001 Nonqualified Stock Option Plan.Under the plan, the Company may grant stock options to directors, consultants,executives and other key employees of the Company and its affiliate to purchaseits common stock. The Company may grant stock options to purchase up to 35,056shares of its common stock. 

 

InMarch 2001, the Company adopted the 2001 Service Award Stock Option Planto grant stock options to purchase up to 16,179 shares of its common stock toits employees and employees of its affiliates. 

 

In May 2002,the Company adopted the 2002 Stock Incentive Plan to grant stock options topurchase up to 1,700,000 shares of its common stock to its employees andemployees of its affiliates.  In October2002, the Company amended this amount to 1,600,000 shares of its common stock.

 

**Item 2.  Management’s Discussion and Analysis of Financial Condition and Resultsof Operations**

 

*The following discussion and analysis shouldbe read in conjunction the consolidated financial statements and related notesincluded elsewhere in this Form 10-Q. This discussion and analysis containsforward-looking statements that**involve known andunknown risks, uncertainties,and other factors that may causeour actual results, level of activity,performance or achievements to bematerially different from any future results, levels of activity, performanceor achievements expressed or implied by such forward-looking statements. In some cases, you can identify thesestatements by forward-looking words 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 discuss ourfuture expectations, contain projections of our future results of operations orof 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 to predict accurately or control. In particular, statements that we make inthis section relating to the sufficiency of anticipated sources of capital tomeet our cash requirements are forward- looking statements. Our actual resultscould differ materially from those anticipated in these forward-lookingstatements for many reasons, including as a result of some of the factorsdescribed below,  elsewhere in this Form10-Q and in the section entitled “Risk Factors” in our Form 10-K/A for thefiscal year ended December 28, 2002..  You should not place undue reliance on these forward-looking statements,which apply only as of the date of the filing of this Form 10-Q.*

 

*Our fiscal year is based on a calendar yearand ends each year on the Saturday closest to December 31 of that year. Asa result, our fiscal year may be comprised of 52 or 53 weeks. Our 2002 fiscalyear had 52 weeks and our 2003 fiscal year has 52 weeks.  Our quarters end on the Saturday nearest tothe applicable quarterly month-end. Each quarter in 2002 had 13 weeks and our quarters in 2003 each have 13weeks.*

* *

**Overview**

 

We are aprovider of information technology and network solutions primarily to thefederal government. Our clients include the U.S. Air Force Space Command, U.S.Army, the Department of State, the Immigration and Naturalization Service andthe intelligence community. In addition, we provide our services to a smallnumber of commercial entities. We combine our technological and industryexpertise to provide a full spectrum of state-of-the-practice solutions andservices, from design and development to implementation and operations, toassist our clients in achieving their missions. Our service offerings focusprimarily on our clients’ mission-critical needs in the areas of: 

 

•                  informationtechnology applications; 

 

•                  systemsengineering; 

 

•                  network andtelecommunications engineering; and 

 

13

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•                  mission-criticaloutsourcing. 

 

SI International is a pioneer in the area of OperationalArchitecture, or OA, which has emerged as an enabling technology to supportdefense transformation.  OA makes itpossible to design complex C4I systems from the users’ perspective and thenintegrate the architectures of multiple systems so that the user can leverageshared information. OA also makes it possible to develop systems that enableeffective joint force operations, improve situational awareness on thebattlefield, and enhance the ability to respond to asymmetric threats.  Our OA efforts fall primarily within ourSystems Engineering area of focus and our capabilities are at the forefront ofthis emerging discipline.

 

In the threeand six months ended June 28, 2003, we received 93.1% and 93.4%, respectivelyof our revenues from services we provided to various departments and agenciesof the federal government and 6.9% and 6.6%, respectively of our total revenuesfrom work performed for commercial entities. In comparison, for the three andsix months ended June 29, 2002, we received 94.4% and 92.7%, respectively ofour revenues from services we provided to federal government agencies and 5.6%and 7.3%, respectively of total revenues from work performed for commercialentities.  The following table shows ourrevenues from the client groups listed as a percentage of total revenue.Revenue data for the Department of Defense includes revenue generated from workperformed under engagements for both the Department of Defense and theintelligence community. 

 
|                      |   | **Three Months Ended** |   | **Six Months Ended** |   |
|---------------------------|--------|------------------------|--------|----------------------|--------|
|                      |   | **June 28,  2003**     |   | **June 29,  2002**   |   | **June 28,  2003** |   | **June 29,  2002** |   |
|                      |   |                   |   |                 |   |   |   |   |   |
| Department of Defense     |   | 52.8                   | %      | 50.7                 | %      | 52.6 | % | 47.2 | % |
| Federal civilian agencies |   | 40.3                   | %      | 43.7                 | %      | 40.8 | % | 45.5 | % |
| Commercial entities       |   | 6.9                    | %      | 5.6                  | %      | 6.6 | % | 7.3 | % |
|                      |   |                   |   |                 |   |   |   |   |   |
| Total revenue             |   | 100.0                  | %      | 100.0                | %      | 100.0 | % | 100.0 | % |

 

We havederived a substantial majority of our revenues from governmental contractsunder which we act as a prime contractor. We also provide services indirectlyas a subcontractor. We intend to focus on retaining and increasing thepercentage of our business as prime contractor because it provides us withstronger client relationships. The following table shows our revenues as primecontractor and as subcontractor as a percentage of our total revenue for thefollowing periods: 

 
|                   |   | **Three Months Ended** |   | **Six Months Ended** |   |
|------------------------|--------|------------------------|--------|----------------------|--------|
|                   |   | **June 28,  2003**     |   | **June 29,  2002**   |   | **June 28,  2003** |   | **June 29,  2002** |   |
|                   |   |                   |   |                 |   |   |   |   |   |
| Prime contract revenue |   | 83.4                   | %      | 82.4                 | %      | 83.0 | % | 81.1 | % |
| Subcontract revenue    |   | 16.6                   | %      | 17.6                 | %      | 17.0 | % | 18.9 | % |
|                   |   |                   |   |                 |   |   |   |   |   |
| Total revenue          |   | 100.0                  | %      | 100.0                | %      | 100.0 | % | 100.0 | % |

 

Our servicesare provided under three types of contracts: cost reimbursable, time andmaterials and fixed price contracts. The following table shows our revenuesfrom each of these types of contracts as a percentage of our total revenue forthe following periods: 

 

14

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|               |   | **Three  Months Ended** |   | **Six Months Ended** |   |
|--------------------|--------|-------------------------|--------|----------------------|--------|
|               |   | **June 28,  2003**      |   | **June 29,  2002**   |   | **June 28,  2003** |   | **June 29,  2002** |   |
|               |   |                    |   |                 |   |   |   |   |   |
| Cost reimbursable  |   | 37.9                    | %      | 43.2                 | %      | 37.4 | % | 40.1 | % |
| Time and materials |   | 35.6                    | %      | 41.1                 | %      | 37.2 | % | 43.8 | % |
| Fixed price        |   | 26.5                    | %      | 15.7                 | %      | 25.4 | % | 16.1 | % |
|               |   |                    |   |                 |   |   |   |   |   |
| Total              |   | 100.0                   | %      | 100.0                | %      | 100.0 | % | 100.0 | % |

 

Under costreimbursable contracts, we are reimbursed for costs that are determined to bereasonable, allowable and allocable to the contract, and paid a feerepresenting the profit margin negotiated between us and the contractingagency, which may be fixed or performance based. Under cost reimbursablecontracts we recognize revenues and an estimate of applicable fees earned ascosts are incurred. We consider fixed fees under cost reimbursable contracts tobe earned in proportion to the allowable costs incurred in performance of thecontract. For performance-based fees under cost reimbursable contracts, werecognize the relevant portion of the expected fee to be awarded by the clientat the time such fee can be reasonably estimated, based on factors such as ourprior award experience and communications with the client regardingperformance. In general, cost reimbursable contracts are the least profitableof our government contracts. In the three and six months ended June 28, 2003,37.9% and 37.4%, respectively, of our revenues were derived from costreimbursable contracts.  In the threeand six months ended June 29, 2002, 43.2% and 40.1%, respectively, of ourrevenues were derived from cost reimbursable contracts. 

 

Under time andmaterials contracts, we are reimbursed for labor at fixed hourly rates andgenerally reimbursed separately for allowable materials, costs and expenses. Tothe extent that our actual labor costs under a time and materials contract arehigher or lower than the billing rates under the contract, our profit under thecontract may either be greater or less than we anticipated or we may suffer aloss under the contract. We recognize revenues under time and materialscontracts by multiplying the number of direct labor hours expended by thecontract billing rates and adding the effect of other billable direct costs. Ingeneral, we realize a higher profit margin on work performed under time andmaterials contracts than cost reimbursable contracts. In the three and sixmonths ended June 28, 2003, 35.6% and 37.2%, respectively, of our revenues werederived from time and materials contracts. In the three and six months ended June 29, 2002, 41.1% and 43.8%,respectively, of our revenues were derived from time and materialcontracts.  

 

Under fixedprice contracts, we perform specific tasks for a fixed price. Compared to costreimbursable and time and materials contracts, fixed price contracts generallyoffer higher profit margin opportunities but involve greater financial riskbecause we bear the impact of cost overruns in return for the full benefit ofany cost savings. We generally do not undertake complex, high-risk work, suchas long-term software development, under fixed price terms. Fixed pricecontracts may include either a product delivery or specific service performanceover a defined period.  Revenue on fixedprice contracts that provide for the Company to render services throughout aperiod is recognized as earned according to contract terms as the service isprovided on a proportionate performance basis. These contracts are generally less than six months in duration.  For fixed price contracts that provide forthe delivery of a specific product with related customer acceptance provisions,revenues are recognized as those products are delivered and accepted.  In the three and six months ended June 28,2003, 26.5% and 25.4%, respectively, of our revenues were derived from fixedprice contracts.   In the three and sixmonths ended June 29, 2002, 15.7% and 16.1%, respectively, of our revenues werederived from fixed price contracts.

 

If weanticipate a loss on a contract, we provide for the full amount of anticipatedloss at the time of that determination. 

 

Our mostsignificant expense is direct cost, which consists primarily of direct laborcosts for program personnel and direct expenses incurred to complete contracts,including cost of materials and subcontractor costs. Our ability to predictaccurately the number and types of personnel, their salaries, and other costs,can have a significant impact on our direct cost. 

 

Theallowability of certain direct and indirect costs in federal contracts issubject to audit by the client, usually through the DCAA. Certain indirectcosts are charged to contracts and paid by the client using provisional, orestimated, indirect rates, which are subject to later revision, based on thegovernment audits of those costs. 

 

Approximately3.5% of our revenue recognized during the six months ended June 28, 2003 willbecome subject to competitive bids prior to the end of the government fiscal2003.  In comparison, 14.8% of ourrevenue recognized during the six months ended June 29, 2002 was derived fromcontracts that we expected to become subject to competitive bids prior to

 

15

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the end of government fiscal2002, which corresponds to the third quarter of fiscal 2002.  We actively monitor our relationships withour clients during our engagements, as well as the quality of the service weprovide, to assist in our efforts to win recompetition bids. In addition, westrive to maintain good relationships with a wide variety of governmentcontractors. 

 

**Resultsof Operations**

 

The followingtable sets forth certain items from our consolidated statements of operationsas a percent of revenues for the periods indicated. 

 
|                                                            |   | **Three Months Ended** |   | **Six Months Ended** |   |
|-----------------------------------------------------------------|--------|------------------------|--------|----------------------|--------|
|                                                            |   | **June 28,  2003**     |   | **June 29,  2002**   |   | **June 28,  2003** |   | **June 29,  2002** |   |
|                                                            |   |                   |   |                 |   |   |   |   |   |
| Revenue                                                         |   | 100.0                  | %      | 100.0                | %      | 100.0 | % | 100.0 | % |
| Costs and expenses:                                             |   |                   |   |                 |   |   |   |   |   |
| Direct costs                                                    |   | 59.6                   |   | 61.7                 |   | 60.1 |   | 59.5 |   |
| Indirect costs                                                  |   | 32.3                   |   | 39.3                 |   | 32.1 |   | 37.2 |   |
| Depreciation                                                    |   | 1.2                    |   | 1.5                  |   | 1.2 |   | 1.5 |   |
| Amortization                                                    |   | —                 |   | —               |   | — |   | — |   |
| Total operating expenses                                        |   | 93.1                   |   | 102.5                |   | 93.4 |   | 98.2 |   |
| Income (loss) from operations                                   |   | 6.9                    |   | (2.5                 | )      | 6.6 |   | 1.8 |   |
|                                                            |   |                   |   |                 |   |   |   |   |   |
| Interest expense                                                |   | (0.4                   | )      | (1.9                 | )      | (0.4 | ) | (2.0 | ) |
| Minority interests                                              |   | —                 |   | (0.1                 | )      | — |   | (0.1 | ) |
| Change in fair value of put warrants                            |   | —                 |   | (0.9                 | )      | — |   | (0.6 | ) |
| Income (loss) before provision for (benefit  from) income taxes |   | 6.5                    |   | (5.4                 | )      | 6.2 |   | (0.9 | ) |
| Provision for (benefit from) income taxes                       |   | 2.6                    |   | (1.9                 | )      | 2.5 |   | (0.2 | ) |
| Net income (loss)                                               |   | 3.9                    | %      | (3.5%                | )      | 3.7 | % | (0.7% | ) |

 

**Threemonths ended June 28, 2003 compared with three months ended June 29, 2002**

 

*Revenue.*  For the three months ended June 28, 2003,our revenues increased 15.0% to $40.7 million from $35.4 million forthe three months ended June 29, 2002. Revenues from work under federalgovernment contracts increased 13.4% to $37.9 million for the three monthsended June 28, 2003 from $33.4 million for the three months ended June 29,2002. This increase was primarily attributable to increased activity in ouroutsourcing, learning and network solutions services.  Commercial revenues increased 40.5% to $2.8 million in the threemonths ended June 28, 2003 from $2.0 million in the three months ended June 29,2002.  The increase was attributable toincreased activity in our support to the pharmaceutical industry.

 

*Direct costs.*  Direct costs include direct labor and otherdirect costs such as materials and subcontracts. Generally, changes in directcosts are correlated to changes in revenue as resources are consumed in theproduction of that revenue. For the three months ended June 28, 2003, directcosts increased 11.0% to $24.3 million from $21.9 million for thethree months ended June 29, 2002. This increase was attributable primarily tothe increase in revenue. As a percentage of revenue, direct costs were 59.6%for the three months ended June 28, 2003 as compared to 61.7% for the threemonths ended June 29, 2002. 

 

*Indirect costs.*  Indirect costs include facilities, selling,bid and proposal, indirect labor, fringe benefits and other discretionarycosts. For the three months ended June 28, 2003, indirect costs decreased 5.4%to $13.2 million from $13.9 million for the three months ended June29, 2002.  This decrease was attributableprimarily to indirect cost savings initiatives.  As a percentage of revenue, indirect costs were 32.3% for thethree months ended June 28, 2003 as compared to 39.3% for the three monthsended June 29, 2002.

 

16

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*Depreciation.*Forthe three months ended June 28, 2003, depreciation expense decreased 5.6% to$0.49 million from $0.52 million for the three months ended June 29, 2002.  This decrease was attributable primarily toreduced levels of capital expenditures and the disposal of certain assets madein connection with a facility relocation. As a percentage of revenue,depreciation expense was 1.2% for the three months ended June 28, 2003 comparedto 1.5% for the three months ended June 29, 2002. 

 

*Income from operations.*  For the three months ended June 28, 2003,income from operations increased 416.5% to $2.8 million from a$0.9 million loss for the three months ended June 29, 2002. This increasewas attributable primarily to increased revenues, gross margin improvement andindirect cost savings.  As a percentageof revenue, income from operations was 6.9% for the three months ended June 28,2003 compared to (2.5%) for the three months ended June 29, 2002. 

 

*Interest expense.*  Interest expense declined 77.8% to$0.15 million for the three months ended June 28, 2003 from$0.66 million for the three months ended June 29, 2002. This decline wasattributable primarily to the repayment of debt with proceeds generated fromthe Company’s initial public offering. As a percentage of revenue, interestexpense was 0.4% for the three months ended June 28, 2003 as compared to 1.9%for the three months ended June 29, 2002. Interest expense included $91,300 and $43,800 of amortization ofdeferred financing costs for the second quarters of 2003 and 2002,respectively.

 

*Provision for/benefit from income taxes.*  The provision for income tax was$1.1 million in the three months ended June 28, 2003, compared to abenefit of $0.7 million for the three months ended June 29, 2002.   For the three months ended June 28, 2003,we have recorded an expense for income tax, which reflects an effective rate of39.5%.  For the three months ended June29, 2002, the effective tax rate was greater than the federal statutory rate of34% due primarily to the effect of state income taxes and put warrants.  

 

**Sixmonths ended June 28, 2003 compared with six months ended June 29, 2002**

 

*Revenue.*  For the six months ended June 28, 2003, ourrevenues increased 19.1% to $82.0 million from $68.9 million for thesix months ended June 29, 2002. Revenues from work under federal governmentcontracts increased 20.1% to $76.6 million for the six months ended June28, 2003 from $63.8 million for the six months ended June 29, 2002. Thisincrease was attributable primarily to increased activities in our outsourcing,learning and network solutions services. Commercial revenues increased 6.4% to $5.4 million in the six monthsended June 28, 2003 from $5.0 million in the six months ended June 29,2002.  The increase was attributableprimarily to increased activity in our support to the pharmaceutical industryduring the second quarter of 2003.

 

*Direct costs.*  Direct costs include direct labor and otherdirect costs such as materials and subcontracts. Generally, changes in directcosts are correlated to changes in revenue as resources are consumed in theproduction of that revenue. For the six months ended June 28, 2003, directcosts increased 20.2% to $49.3 million from $41.0 million for the sixmonths ended June 29, 2002. This increase was attributable primarily to theincrease in revenue. As a percentage of revenue, direct costs were 60.1% forthe six months ended June 28, 2003 as compared to 59.5% for the six monthsended June 29, 2002. 

 

*Indirect costs.*  Indirect costs include facilities, selling,bid and proposal, indirect labor, fringe benefits and other discretionarycosts. For the six months ended June 28, 2003, indirect costs increased 2.7% to$26.3 million from $25.6 million for the six months ended June 29, 2002.  The increase was attributable primarily toincreased revenue, partially offset by indirect cost increases.  As a percentage of revenue, indirect costswere 32.1% for the six months ended June 28, 2003 as compared to 37.2% for thesix months ended June 29, 2002.

 

*Depreciation.*Forthe six months ended June 28, 2003 and June 29, 2002, depreciation expense was$1.0 million.  As a percentage ofrevenue, depreciation expense was 1.2% for the six months ended June 28, 2003compared to 1.5% for the six months ended June 29, 2002. 

 

*Income from operations.*  For the six months ended June 28, 2003,income from operations increased 340.7% to $5.4 million from$1.2 million for the six months ended June 29, 2002. This increase wasattributable primarily to the  higherrevenue, partially offset by indirect cost increases.  As a percentage of revenue, income from operations was 6.6% forthe six months ended June 28, 2003 compared to 1.8% for the six months endedJune 29, 2002. 

 

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*Interest expense.*  Interest expense declined 77.3% to$0.31 million for the six months ended June 28, 2003 from$1.35 million for the six months ended June 29, 2002. This decline wasattributable primarily to the repayment of debt with proceeds generated fromthe Company’s initial public offering. As a percentage of revenue, interestexpense was 0.4% for the six months ended June 28, 2003 as compared to 2.0% forthe six months ended June 29, 2002.  Interestexpense included $188,000 and $87,500 of amortization of deferred financingcosts for the six months ended June 28, 2003 and June 29, 2002, respectively.

 

*Provision for/benefit from income taxes.*  The provision for income tax was$2.0 million in the six months ended June 28, 2003, compared to a benefitof $0.1 million for the six months ended June 29, 2002.   For the six months ended June 28, 2003, wehave recorded an expense for income tax, which reflects an effective rate of39.5%.

 

**Liquidityand Capital Resources**

 

Our primaryliquidity needs are the financing of working capital, capital expenditures andacquisitions. We rely on cash flow from operations, borrowings under our creditfacility and the sale of common stock to provide for our cash needs. 

 

Net cashprovided by (used in) operations was $9.0 million for the six months ended June28, 2003 compared with $3.8 million for the six months ended June 29,2002.  Cash provided by operations inthe six months ended June 28, 2003 was attributable to net income of$3.1 million, depreciation, amortization and other non-cash items of $1.4million, decrease in working capital and other operating assets and liabilitiesof $4.5 million. Cash provided by operations in the six months ended June 29,2002 was attributable to a net loss of $0.5 million, non-cash items of $1.7million and a decrease in working capital and other operating assets andliabilities of $2.6 million.

 

Cash used ininvesting activities was $0.8 million for the six months ended June 28, 2003and June 29, 2002.  For both six monthsended June 28, 2003 and June 29, 2002, our investing activities were primarilyattributed to the purchase of capital assets. 

 

Cash used infinancing activities was $2.4 million for the six months ended June 28, 2003,compared with $2.2 million for the six months ended June 29, 2002.  Cash used in financing activities for thesix months ended June 28, 2003 was attributable to repayments for notes andleases of $0.2 million repayment of bank overdrafts of $2.2 million.  Cash used in financing activities in the sixmonths ended June 29, 2002 was primarily attributable to the repayment of acontingency note in the amount of $0.9 million to the seller related to theacquisition of SI Engineering and the repayment of long-term debt and otheritems of $1.3 million.

 

Cash and cashequivalents as of June 28, 2003 and June 29, 2002 were $16.6 million and$1.2 million, respectively. 

 

We maintain a$35.0 million secured revolving credit facility.  As of June 28, 2003 we did not have any borrowings under thecredit facility.

 

 For the six months ended June 28, 2003 aswell as the six months ended June 29, 2002, we had two contracts that generatedmore than 10% of our revenue.  OurC4I2SR contract with the U.S. Air Force Space Command represented approximately21.2% and 22.1% of total revenue for each of the six months ended June 28, 2003and June 29, 2002, respectively.   OurNational Visa Center contract with the Department of State representedapproximately 14.6% and 11.1% of total revenue for the six months ended June28, 2003 and June 29, 2002, respectively. 

 

Financial datafor all of our subsidiaries are included in our consolidated financialstatements. 

 

**CriticalAccounting Policies and Estimates**

 

Oursignificant accounting policies are described in Note 2 to our accompanyingconsolidated 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

 

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difficult, subjective orcomplex judgments in making estimates, and where these estimates cansignificantly impact our financial results under different assumptions andconditions. We prepare our financial statements in conformity with accountingprinciples generally accepted in the United States. As such, we are required tomake certain estimates, judgments and assumptions that we believe arereasonable based upon the information available. These estimates, judgments andassumptions affect the reported amounts of assets and liabilities at the dateof the financial statements and the reported amounts of revenue and expensesduring the periods presented. Actual results could be different from theseestimates. 

 

*Revenue Recognition*

* *

Our accountingpolicy regarding revenue recognition is written to comply with the followingcriteria: (1) a contract has been executed; (2) the contract price isfixed and determinable; (3) delivery of services or products has occurred;and (4) collectibility of the contract price is considered probable andcan be reasonably estimated. Compliance with these criteria may require us tomake significant judgments and estimates. 

 

For costreimbursable contracts with fixed fees and our fixed price contracts, weestimate the applicable fees earned as costs are incurred or services areprovided. This process requires estimation of the contemplated level of effortto accomplish the tasks under contract, the cost of the effort and ongoingassessment towards completing the contract. We utilize a number of managementprocesses to monitor contract performance and revenue estimates, includingmonthly in-process reviews. For cost reimbursable contracts with performance-basedfees, we estimate the applicable fees earned based on historical experience andperformance evaluations from our customers. For fixed price contracts, whichare based on unit pricing, we recognize revenue for the number of units deliveredin any given fiscal period.  For fixedprice contracts, which are based on the proportionate performance method andinvolve a specified number of similar acts, we recognize revenue based on theproportion of those acts completed compared to the number of total specifiedacts per the contract.  For fixed pricecontracts, which are based on the proportionate performance method and involvea specified number of defined but not similar acts, we recognize revenue basedon the proportion of the project’s percentage total costs incurred  compared to the estimated total costsassociated with the entire transaction. Occasionally, facts may develop that require revisions to estimated totalcosts or revenues expected. The cumulative effect of any such revisions is recordedin the period in which the facts requiring the revision become known. The fullamount of anticipated losses on any contract type are recognized in the periodin which they become known. 

 

In addition,certain indirect costs are charged to contracts and paid by the client usingprovisional, or estimated, indirect rates that are subject to later revisionbased on government audits. Any costs found to be improperly allocated to aspecific contract will not be reimbursed, and any such costs already reimbursedmust be refunded. 

 

**Effectof Recently Issued Accounting Standards**

 

In November2002, the Financial Accounting Standards Board issued Interpretation No. 45,“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others” (FIN 45). FIN 45 elaborates onthe disclosure to be made by a guarantor in its interim and annual financialstatements about its obligations under certain guarantees that it has issued.It also clarifies that a guarantor is required to recognize, at the inceptionof a guarantee, a liability for the fair value of the obligation undertaken inissuing the guarantee. The initial recognition and initial measurementprovisions of FIN 45 are applicable on a prospective basis to guarantees issuedor modified after December 31, 2002. The disclosure requirements of FIN 45 areeffective for financial statements of interim or annual periods ending afterDecember 31, 2002. The Company does not expect adoption of FIN 45 to have amaterial effect on its financial condition, results of operations of liquidity**.**

 

In December 2002, the FASBissued Statement of Financial Accounting Standards No. 148, “Accountingfor Stock-Based Compensation — Transition and Disclosure an Amendment of FASBStatement No. 123” (“SFAS 148”). SFAS 148 amends SFAS 123 to providealternative methods of transition for a voluntary change to the fairvalue-based method of accounting for stock-based employee compensation. Inaddition, SFAS 148 amends the disclosure requirements of SFAS 123 to requiremore prominent disclosures in both annual and interim financial statementsregarding the method of accounting for stock-based employee compensation andthe effect of the method used on reported results. The alternative methods oftransition of SFAS 148 are effective for fiscal years ending afterDecember 15, 2002. The disclosure provision of SFAS 148 is

 

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effective for interim periods beginning afterDecember 15, 2002. The Company follows APB 25 in accounting for itsemployee stock options. The Company does not expect the adoption of SFAS 148 tohave a material impact on its operating results or financial position.

 

In January2003, the Financial Accounting Standards Board issued Interpretation No. 46,“Consolidation of Variable Interest Entities (FIN 46). FIN 46 clarifies theapplication of Accounting Research Bulletin No. 51, “Consolidated FinancialStatements, to certain entities in which equity investors do not have the characteristicsof a controlling financial interest or do not have sufficient equity at riskfor the entity to finance its activities without additional subordinatedfinancial support from the other parties. FIN 46 applies immediately tovariable interest entities created after January 31, 2003.  Management believes that the Company doesnot expect adoption of FIN 46. Management believes that the Company’s businesspractice does not require the adoption of FIN 46. 

 

**Item3.   Quantitative and QualitativeDisclosures About Market Risk.**

 

Historically, our investmentpositions have been relatively small and short-term in nature. We havetypically made investments in a fund with an effective average maturity offewer than 40 days having a portfolio make-up consisting primarily ofcommercial paper and notes and variable rate instruments, and to a much smallerextent overnight securities and bank instruments.  Since our initial public offering, the Board of Directorsapproved an investment policy that requires we invest in relatively short-term,high quality, and high liquidity obligations.

 

**Item4.    Controls and Procedures.**

 

The Company has establishedand maintains disclosure controls and procedures that are designed to ensurethat material information required to be disclosed by SI International in thereports that it files under the Securities Exchange Act of 1934 is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated tothe Company’s management, including the Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow timely decisions regarding requireddisclosure.

 

Within the 90 days prior to the filing date of this quarterlyreport, under the supervision and with the participation of SI International’sChief Executive Officer and Chief Financial Officer, the Company carried out anevaluation of the effectiveness of the design and operation of disclosure controlsand procedures. Based upon that evaluation, the Chief Executive Officer andChief Financial Officer concluded that our disclosure controls and proceduresare effective as of the date of such evaluation in timely alerting them tomaterial information relating to the Company (including its consolidatedsubsidiaries) required to be included in SI International’s periodic SECfilings.

 

There have been nosignificant changes to the Company’s internal controls or in other factors thatcould significantly affect internal controls subsequent to the date the Companycarried out its evaluation.

 

**PART II: OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

We are a partyto litigation and legal proceedings that we believe to be a part of theordinary course of our business. While we cannot predict the ultimate outcomeof these matters, wecurrently believe, based upon information available to us as of the date ofthis filing, that any ultimate liability arising out of these proceedings willnot have a material adverse effect on our financial position. Wemay become involved in other legal and governmental, administrative orcontractual proceedings in the future.

 

**Item2.  Changes in Securities and Use ofProceeds**

 

None. 

 

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**Item3.  Defaults Upon Senior Securities**

 

None.

 

**Item4.   Submission of Matters To a Vote ofSecurity Holders**

 

During thefiscal quarter ended June 28, 2003, we submitted certain matters to a vote ofour stockholders through the notice of annual meeting of stockholders and thesolicitation of proxies related thereto. The proxy materials related to the Registrant’s Annual Meeting ofStockholders were distributed and the annual meeting of stockholders washeld on June 6, 2003.  As of the recorddate prior to such meeting, 8,447,162 shares of the Registrant’s common stockwere outstanding and entitled to vote at the meeting.  At the Annual Stockholders meeting on June 6, 2003, 7,152,009shares of the Registrant’s common stock were present in person or by proxy,representing 84.6% of the outstanding shares of common  stock of the Registrant.  The following sets forth the matterspresented for a vote by the stockholders and the votes cast for, withheld,abstained, and broker non-votes:

 
| **Matter** |                                                                                                                  | **Votes For** |      | **Votes  Withheld** |   | **Abstentions** |   | **Broker  Non-Votes** |
|------------|-----------------------------------------------------------------------------------------------------------------------|---------------|-----------|---------------------|--------|-----------------|--------|-----------------------|
| (1)        | Election of  Mr. Charles Bowsher as a Class I director with a term serving until  the 2006 Annual Meeting             |          | 7,136,869 |                | 15,140 |            | 0      |                  | 0 |
| (2)        | Election of  Dr. Walter J. Culver as a Class I director with a term serving until  the 2006 Annual Meeting            |          | 7,136,869 |                | 15,140 |            | 0      |                  | 0 |
| (3)        | Election of  Mr. Edward Sproat as a Class I director with a term serving until the  2006 Annual Meeting               |          | 7,136,869 |                | 15,140 |            | 0      |                  | 0 |
| (4)        | Ratification of the  appointment of Ernst & Young LLP as our independent accountants for the  current fiscal year |          | 7,142,269 |                | 0      |            | 1,900  |                  | 0 |

 

**Item 5. Other Information**

 

None.

 

**Item6.  Exhibits and Reports on Form 8-K**

 
| (a)    | Documents  filed as part of this Report |
|--------|-----------------------------------------|
|   |                                    |   |
|   | 1.                                      | Financial  Statements |
|   |                                    |   |
|   |                                    | A. | Consolidated  Balance Sheets as of June 28, 2003 and December 28, 2002 |
|   |                                    | B. | Consolidated  Statements of Operations for the three and six months ended June 28, 2003 and  June 29, 2002 |
|   |                                    | C. | Consolidated  Statements of Stockholders’ Equity for the three and six months ended June  28, 2003 and June 29, 2002 |
|   |                                    | D. | Consolidated  Statements of Cash Flows for the six months ended June 28, 2003 and June 29,  2002 |
|   |                                    | E. | Notes to  Consolidated Financial Statements |
|   |                                    |   |
|   | 2.                                      | Supplementary  Financial Data. |
|   |                                    | None. |
|   |                                    |   |
|   | 3.                                      | Exhibits. |

 

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| **EXHIBIT  NO.** |   | **DESCRIPTION**                                                |
|------------------|--------|----------------------------------------------------------------|
| 3.1*             |   | Second Restated  Certificate of Incorporation                  |
| 3.2*             |   | Amended and Restated  Bylaws, as amended                       |
| 4.1*             |   | Registration Rights  Agreement, as amended                     |
| 4.2*             |   | Specimen Certificate of  our common stock                      |
| 4.3*             |   | Stock Purchase Agreement,  as amended                          |
| 4.4*             |   | Amendment to Stock  Purchase Agreements                        |
| 10.1*            |   | Form of 2002 Stock  Incentive Plan                             |
| 10.2*            |   | January 2001 Nonqualified  Stock Option Plan                   |
| 10.3*            |   | SI International, Inc.  2001 Service Award Stock Option Plan   |
| 10.4*            |   | 1998 Stock Option Plan                                         |
| 10.5**           |   | Credit Agreement                                               |
| 10.6*            |   | Executive Employment  Agreement with S. Bradford Antle         |
| 10.7*            |   | Executive Employment  Agreement with Walter J. Culver          |
| 10.8*            |   | Executive Employment  Agreement with Thomas E. Dunn            |
| 10.9*            |   | Executive Employment  Agreement with Thomas E. Lloyd           |
| 10.10*           |   | Executive Employment  Agreement with Ray J. Oleson             |
| 10.11*           |   | Form of Indemnification  Agreement                             |
| 31.1             |   | Certification of CEO  pursuant to Rule 302                     |
| 31.2             |   | Certification of CFO  pursuant to Rule 302                     |
| 32.1             |   | Certification of Chief  Executive Officer pursuant to Rule 906 |
| 32.2             |   | Certification of Chief  Financial Officer pursuant to Rule 906 |

 

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* Incorporated by referenceherein from Exhibits to the Registrant’s Registration Statement onForm S-1 (File No. 333-87964) as declared effective by the Commissionon November 8, 2002. 

**Incorporated by referenceherein from the Registrant’s Current Report on Form 8-K filed on November 18,2002.

 

(b)  Reports on Form 8-K 

 

•                       Current Report on Form 8-K dated March31, 2003 containing Regulation FD disclosure and announcing thatthe Company was not selected for award of a contract on the Western RangeOperations Communication and Information procurement issued by the U.S. AirForce.  The Company was not the incumbent on this contract and theannouncement indicated that, as of the date of the filing, the development didnot affect the Company’s prior earnings guidance for the first quarter and fullyear 2003. 

 

•                       Current Reporton Form 8-K dated April 29, 2003, containing Regulation FD disclosure andannouncing financialresults for the Company’s fiscal first quarter ended March 29, 2003 as well asits earnings guidance for the second quarter of fiscal 2003.

 

•                       CurrentReport on Form 8-K dated April 29, 2003, containing Regulation FD disclosureand setting forth materials related to the Company to be distributed to itsinvestors or potential investors.

 

(c)  Exhibits. The exhibits required by this item are listed under Item 6(a)(3).

 

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**SIGNATURES**

 

**Pursuant to the requirements of Section 13 or15(d) of the Securities Exchange Act of 1934, the registrant has duly causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized, on the 11th day of August, 2003.**

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

 

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