**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

**(Mark One)**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED JUNE 30, 2007

 

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

**Commission File Number**

**000-50080**

**SI International, Inc.**

**(Exact name of registrantas specified in its charter)**

 

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

 

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

 

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Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.    x  Yes    o  No

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of“accelerated filer and large accelerated filer” in Rule 12b 2 of the ExchangeAct. (Check one):

Large acceleratedfiler  o                   Accelerated filer  x                            Non-acceleratedfiler  o

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theAct.)   oYes  xNo

As of August 1, 2007,13,141,072 shares outstanding of the registrant’s common stock.

 

 

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**SI INTERNATIONAL, INC.FORM 10-QINDEX**
|                    | ** ** | ** **                                                                                                                                      | ** ** | **Page** | ** ** |
|--------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| **PART I.**   |       | **FINANCIAL INFORMATION**                                                                                                                  |       |     |       |
| ITEM  1            |       | Financial  Statements                                                                                                                           |       | 3        |       |
|               |       | Consolidated  Balance Sheets at June 30, 2007 (unaudited) and December 30, 2006                                                                 |       | 3        |       |
|               |       | Consolidated Statements of Operations for the three and  six months ended June 30, 2007 (unaudited) and July 1, 2006 (unaudited) |       | 4        |       |
|               |       | Consolidated Statements of Cash Flows for the six  months ended June 30, 2007 (unaudited) and July 1, 2006 (unaudited)                          |       | 5        |       |
|               |       | Notes to Consolidated Financial Statements                                                                                                      |       | 6        |       |
| ITEM 2             |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                                     |       | 16       |       |
| ITEM 3             |       | Quantitative and Qualitative Disclosures About Market  Risk                                                                                     |       | 23       |       |
| ITEM 4             |       | Controls and Procedures                                                                                                                         |       | 24       |       |
| **PART  II.**      |       | **OTHER  INFORMATION**                                                                                                                          |       |     |       |
| ITEM  1            |       | Legal  Proceedings                                                                                                                              |       | 24       |       |
| ITEM  1A.          |       | Risk  Factors                                                                                                                                   |       | 24       |       |
| ITEM 2             |       | Unregistered Sales of Equity Securities and Use of  Proceeds                                                                                    |       | 25       |       |
| ITEM 3             |       | Defaults Upon Senior Securities                                                                                                                 |       | 25       |       |
| ITEM 4             |       | Submission of Matters to a Vote of Security Holders                                                                                             |       | 25       |       |
| ITEM  5            |       | Other  Information                                                                                                                              |       | 25       |       |
| ITEM 6             |       | Exhibits                                                                                                                                        |       | 25       |       |
| Signatures         |       | 26                                                                                                                                              |       |
| Index  to Exhibits |       | 27                                                                                                                                              |       |

 

2

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## **PART I: FINANCIAL INFORMATION**

### **Item1.   Financial Statements**

**SI International, Inc. and SubsidiariesConsolidated Balance Sheets(Amounts in thousands, except share data)**
| ** **                                                                                                                                                                                         | ** ** | **June 30,  2007** | ** ** | **December 30,  2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                         | ** ** | **(Unaudited)**         | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                                         | ** ** | ** **              | ** ** | ** **                  | ** ** |
| **Current assets:**                                                                                                                                                                                |       |                    |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                         |       | $                       | 10,892     |                        | $          | 19,457 |   |
| Accounts  receivable, net                                                                                                                                                                          |       | 103,652                 |       | 91,972                      |       |
| Other current  assets                                                                                                                                                                              |       | 9,139                   |       | 8,627                       |       |
| Total current assets                                                                                                                                                                               |       | 123,683                 |       | 120,056                     |       |
| **Property and equipment, net**                                                                                                                                                                    |       | 14,795                  |       | 12,372                      |       |
| **Goodwill**                                                                                                                                                                                       |       | 266,243                 |       | 220,626                     |       |
| **Intangible  assets, net**                                                                                                                                                                        |       | 28,790                  |       | 20,418                      |       |
| **Other assets**                                                                                                                                                                                   |       | 12,645                  |       | 7,661                       |       |
| Total assets                                                                                                                                                                                       |       | $                       | 446,156    |                        | $          | 381,133 |   |
| **Liabilities  and stockholders’ equity**                                                                                                                                                     | ** ** | ** **              | ** ** | ** **                  | ** ** |
| **Current liabilities:**                                                                                                                                                                           |       |                    |       |                        |       |
| Note payable—Line  of Credit                                                                                                                                                                  |       | $                       | 25,000     |                        | $          | — |   |
| Current portion  of long-term debt                                                                                                                                                                 |       | 1,004                   |       | 754                         |       |
| Accounts payable                                                                                                                                                                                   |       | 24,724                  |       | 20,715                      |       |
| Note  payable—former owner of acquired business                                                                                                                                               |       | —                  |       | 5,839                       |       |
| Accrued expenses  and other current liabilities                                                                                                                                                    |       | 33,254                  |       | 28,547                      |       |
| Total current  liabilities                                                                                                                                                                         |       | 83,982                  |       | 55,855                      |       |
| **Long-term  debt, net of current portion**                                                                                                                                                        |       | 93,825                  |       | 69,452                      |       |
| **Deferred  income tax, net**                                                                                                                                                                      |       | 8,772                   |       | 8,961                       |       |
| **Other long-term  liabilities**                                                                                                                                                                   |       | 9,209                   |       | 7,653                       |       |
| **Stockholders’ equity:**                                                                                                                                                                     |       |                    |       |                        |       |
| Common  stock—$0.01 par value per share; 50,000,000 shares authorized; 13,023,154 and  12,967,377 shares issued and outstanding as of June 30, 2007 and  December 30, 2006, respectively |       | 130                     |       | 130                         |       |
| Additional paid-in  capital                                                                                                                                                                        |       | 186,415                 |       | 184,845                     |       |
| Retained  earnings                                                                                                                                                                                 |       | 63,823                  |       | 54,065                      |       |
| Accumulated  other comprehensive income                                                                                                                                                            |       | —                  |       | 172                         |       |
| Total  stockholders’ equity                                                                                                                                                                   |       | 250,368                 |       | 239,212                     |       |
| Total liabilities and stockholders’ equity                                                                                                                                                    |       | $                       | 446,156    |                        | $          | 381,133 |   |

 

*** ***

***Seeaccompanying notes***

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*** ***

**SI International, Inc. and SubsidiariesConsolidated Statements of Operations(Amounts in thousands, except per share data)Unaudited**
| ** **                                  | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                  | ** ** | **June 30, 2007**      | ** ** | **July 1, 2006**     | ** ** | **June 30, 2007** | ** ** | **July 1, 2006** | ** ** |
|                                        |       |                             |       |                           |       |   |   |   |   |
| Revenue                                     |       | $                                | 118,794    |                           | $          | 119,233 |   | $ | 232,494 |   | $ | 226,465 |   |
| Operating costs and expenses:               |       |                             |       |                           |       |   |   |   |   |
| Cost of services                            |       | 73,733                           |       | 74,968                         |       | 144,625 |   | 141,577 |   |
| Selling, general and administrative         |       | 34,078                           |       | 32,632                         |       | 66,217 |   | 63,178 |   |
| Depreciation and amortization               |       | 822                              |       | 673                            |       | 1,616 |   | 1,221 |   |
| Amortization of intangible assets.          |       | 769                              |       | 823                            |       | 1,517 |   | 1,470 |   |
|                                        |       |                             |       |                           |       |   |   |   |   |
| Total operating  costs and expenses         |       | 109,402                          |       | 109,096                        |       | 213,975 |   | 207,446 |   |
|                                        |       |                             |       |                           |       |   |   |   |   |
| Income from  operations                     |       | 9,392                            |       | 10,137                         |       | 18,519 |   | 19,019 |   |
| Other income  (expense)                     |       | 430                              |       | (101                           | )          | 501 |   | (71 | ) |
| Interest expense                            |       | (1,572                           | )          | (2,693                         | )          | (2,969 | ) | (4,475 | ) |
|                                        |       |                             |       |                           |       |   |   |   |   |
| Income before  provision for income taxes   |       | 8,250                            |       | 7,343                          |       | 16,051 |   | 14,473 |   |
| Provision for  income taxes                 |       | 3,226                            |       | 2,901                          |       | 6,293 |   | 5,717 |   |
|                                        |       |                             |       |                           |       |   |   |   |   |
| Net income                                  |       | $                                | 5,024      |                           | $          | 4,442 |   | $ | 9,758 |   | $ | 8,756 |   |
|                                        |       |                                  |       |                                |       |   |   |   |   |
|                                        |       |                             |       |                           |       |   |   |   |   |
| Earnings per  common share:                 |       |                             |       |                           |       |   |   |   |   |
| Basic                                       |       | $                                | 0.39       |                           | $          | 0.35 |   | $ | 0.75 |   | $ | 0.72 |   |
| Diluted                                     |       | $                                | 0.38       |                           | $          | 0.34 |   | $ | 0.74 |   | $ | 0.70 |   |
| Basic weighted-average shares outstanding   |       | 13,011                           |       | 12,770                         |       | 12,994 |   | 12,096 |   |
| Diluted weighted-average shares outstanding |       | 13,302                           |       | 13,171                         |       | 13,276 |   | 12,532 |   |

 

 

***Seeaccompanying notes***

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*** ***

**SI International, Inc. and SubsidiariesConsolidated Statements of Cash Flows(Amounts in thousands)Unaudited**
| ** **                                                                         | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                         | ** ** | **June 30,  2007**        | ** ** | **July 1,  2006** | ** ** |
| **Cash  flows from operating activities:**                                         |       |                           |       |   |   |
| Net income                                                                         |       | $                              | 9,758      |   | $ | 8,756 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                           |       |   |   |
| Depreciation and amortization                                                      |       | 1,616                          |       | 1,221 |   |
| Amortization of intangible assets                                                  |       | 1,517                          |       | 1,470 |   |
| Loss on disposal of fixed assets                                                   |       | 39                             |       | 10 |   |
| Stock-based compensation                                                           |       | 516                            |       | 12 |   |
| Amortization of deferred financing costs                                           |       | 467                            |       | 1,366 |   |
| Changes in operating assets and liabilities, net of  effect of acquisitions:       |       |                           |       |   |   |
| Accounts receivable, net                                                           |       | 590                            |       | 5,326 |   |
| Other current assets                                                               |       | (635                           | )          | (989 | ) |
| Other assets                                                                       |       | (5,173                         | )          | (1,418 | ) |
| Accounts payable and accrued expenses                                              |       | 621                            |       | (13,228 | ) |
| Other long term liabilities                                                        |       | 1,536                          |       | 2,328 |   |
| Net cash provided  by operating activities                                         |       | 10,852                         |       | 4,854 |   |
| **Cash  flows from investing activities:**                                         |       |                           |       |   |   |
| Purchase of property and equipment                                                 |       | (3,770                         | )          | (5,028 | ) |
| Proceeds from sale of marketable securities                                        |       | 43,250                         |       | 13,850 |   |
| Purchase of marketable securities                                                  |       | (43,250                        | )          | (6,000 | ) |
| Former owner payable                                                               |       | (6,000                         | )          | (10,322 | ) |
| Cash paid for business acquisitions, net of cash  assumed                          |       | (60,162                        | )          | (47,992 | ) |
| Net cash used in  investing activities                                             |       | (69,932                        | )          | (55,492 | ) |
| **Cash  flows from financing activities:**                                         |       |                           |       |   |   |
| Proceeds from exercise of stock options                                            |       | 912                            |       | 5,245 |   |
| Proceeds from issuance of common stock                                             |       | —                         |       | 40,402 |   |
| Income tax benefit from stock option exercises                                     |       | 142                            |       | 1,614 |   |
| Borrowings under line of credit                                                    |       | 25,000                         |       | — |   |
| Proceeds from long-term debt                                                       |       | 25,000                         |       | 30,000 |   |
| Repayments of long-term debt                                                       |       | (377                           | )          | (45,856 | ) |
| Payments of debt issuance costs                                                    |       | (108                           | )          | (552 | ) |
| Repayments of capital lease obligations                                            |       | (54                            | )          | (92 | ) |
| Net cash  provided by financing activities                                         |       | 50,515                         |       | 30,761 |   |
| **Net  change in cash and cash equivalents**                                       |       | (8,565                         | )          | (19,877 | ) |
| **Cash  and cash equivalents, beginning of period**                                |       | 19,457                         |       | 26,160 |   |
| **Cash  and cash equivalents, end of period**                                      |       | 10,892                         |       | 6,283 |   |
| **Supplemental disclosures of cash flow  information:**                            |       |                           |       |   |   |
| Cash payments for interest                                                         |       | $                              | 2,875      |   | $ | 3,809 |   |
| Cash payments  for income taxes                                                    |       | $                              | 6,427      |   | $ | 5,946 |   |

 

*** ***

***Seeaccompanying notes***

5

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**SI International, Inc. and SubsidiariesNotes to consolidated financial statements(Unaudited)**

**1.             Basis of Presentation:**

The accompanying unauditedconsolidated financial statements of SI International, Inc. and itssubsidiaries have been prepared in accordance with accounting principlesgenerally accepted in the United States for interim financial information andwith the instructions to Form 10-Q and Article 10 ofRegulation S-X. Accordingly, they do not include all of the information andfootnotes required by U.S. generally accepted accounting principles forcomplete financial statements.  In theopinion of management, all adjustments (consisting of normal recurringaccruals) considered necessary for a fair presentation have been included.Operating results for the quarter ended June 30, 2007 are not necessarilyindicative of the results that may be expected for the year ending December 29,2007. For further information, refer to the financial statements and footnotesincluded in SI International’s Annual Report on Form 10-K for the yearended December 30, 2006.  References tothe “Company,” “we,” “us” and “our” refer to SI International, Inc. and itssubsidiaries.

**2.             Summary of significant accountingpolicies:**

**Principles of consolidation**

The accompanying consolidatedfinancial statements include the accounts of the Company and its wholly ownedsubsidiaries.   All significantintercompany transactions and accounts have been eliminated in consolidation.

**Use of estimates**

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

**Reporting periods**

The Company’s fiscal year isbased on the calendar year and ends each year on the Saturday nearest, but notfalling after, December 31 of that year. As a result, our fiscal year may be comprised of 52 or 53 weeks.  Typically, fiscal quarters also end on theSaturday nearest, but not falling after, the end of the calendar quarter.  However, we will end those fiscal quarterspresented in our Forms 10-Q (the first three fiscal quarters) on the Saturdaywhich provides us with a 13 week quarter even if that Saturday falls after theend of the calendar quarter.  As aresult, in the future, if our fiscal year comprises 53 weeks, the first threequarters shall each be comprised of 13 weeks and the fourth quarter shall becomprised of 14 weeks.  Consistent withthis policy, our second quarter ended June 30, 2007 was a 13 week quarter.

**Cash and cash equivalents**

We consider cash on deposit andall highly liquid investments with original maturities of three months or lessto be cash and cash equivalents.

**Revenue Recognition**

The Companyrecognizes revenue when a contract has been executed, the contract price is fixedand determinable, delivery of services or products has occurred, andcollectibility of the contract price is considered probable and can bereasonably estimated.  Revenue is earnedunder cost reimbursable, time and materials and fixed price contracts.

Under costreimbursable contracts, the Company is reimbursed for allowable costs, and paida fee, which may be fixed or performance-based. Revenues on costreimbursable contracts are recognized as costs are incurred plus an estimate ofapplicable fees earned. The Company considers fixed fees under costreimbursable contracts to be earned in proportion of the allowable costsincurred in performance of the contract. For cost reimbursable contracts thatinclude performance based fee incentives, the Company recognizes the relevantportion of the expected fee to be awarded by the customer at the time such feecan be

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reasonably estimated,based on factors such as the Company’s prior award experience andcommunications with the customer regarding performance.

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

For fixed pricecontracts that provide for the delivery of a specific product with relatedcustomer acceptance provisions, revenues are recognized upon product deliveryand customer acceptance.  However, asignificant portion of the Company’s fixed price-completion contracts involvethe design and development of complex, client systems.  For those contracts that are within scope ofSOP 81-1, *Accounting for Performance of Construction-Type andCertain Production-Type Contracts*, revenue is recognized on thepercentage-of-completion method using costs incurred in relation to totalestimated costs.

The Company’scontracts with agencies of the government are subject to periodic funding bythe respective contracting agency. Funding for a contract may be providedin full at inception of the contract or ratably throughout the contract as theservices are provided.  In evaluating theprobability of funding for purposes of assessing collectibility of the contractprice, the Company considers its previous experiences with its customers,communications with its customers regarding funding status, and the Company’sknowledge of available funding for the contract or program. If funding is notassessed as probable, revenue recognition is deferred until realization is deemedprobable.

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

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

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**Significantcustomers**

Revenue generated from contracts with the Federal government or primecontractors doing business with the Federal government accounted for asignificant percent of revenues in the fiscal quarters ending June 30,2007 and July 1, 2006.
| ** **                 | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                 | ** ** | **June 30, 2007**      | ** ** | **July 1, 2006**     | ** ** | **June 30, 2007** | ** ** | **July 1, 2006** | ** ** |
|                       |       |                             |       |                           |       |   |   |   |   |
| Department of  Defense     |       | 45.1                             | %          | 47.3                           | %          | 45.0 | % | 47.6 | % |
| Federal civilian  agencies |       | 53.4                             |       | 51.0                           |       | 53.4 |   | 50.6 |   |
| Commercial  entities       |       | 1.5                              |       | 1.7                            |       | 1.6 |   | 1.8 |   |
| Total revenue              |       | 100.0                            | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |

 

For the quarters ended June 30, 2007 and July 1, 2006, our Command,Control, Communications, Computer, Intelligence, Information, Technology,Surveillance, and Reconnaissance contract vehicle (C4I2TSR) was our only contract vehicle that generated more than 10% ofour revenue.  C4I2TSR is an ID/IQcontract vehicle administered and primarily used by the U.S. Air Force SpaceCommand, however, it is also available for use by different Federal governmentagencies.  As projects are issued underC4I2TSR for different customers, we assign and report revenue generated fromany task order to the appropriate Company business unit.  Under this approach, for the three and sixmonths ended June 30, 2007, revenue from the C4I2TSR contract representedapproximately 16.4% and 18.2% of our revenue, respectively.  For the three and six months ended July 1,2006, our C4I2TSR contract represented approximately 20.1% and 21.1% of ourrevenue, respectively.

**Deferredfinancing costs**

Costs incurred in establishingour credit facility are deferred and amortized as interest expense over theterm of the related debt using the effective interest method. These deferredcosts are reflected as a component of other assets in the accompanyingconsolidated balance sheets. The deferred financing costs consist of thefollowing (in thousands):

|                           | ** ** | **June 30,  2007** | ** ** | **December 30,  2006** | ** ** |
|---------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Deferred loan  costs      |       | $                       | 5,635      |                        | $          | 5,527 |   |
| Accumulated  amortization |       | (3,669                  | )          | (3,363                      | )          |
|                      |       | $                       | 1,966      |                        | $          | 2,164 |   |

 

**Fair value of financialinstruments**

The Company’s financialinstruments consist primarily of cash and cash equivalents, accountsreceivable, accounts payable, credit facilities, and notes payable. Inmanagement’s opinion, the carrying amounts of these financial instrumentsapproximate their fair values at June 30, 2007 and December 30, 2006.

**Stock-basedcompensation**

Effective January1, 2006, the Company adopted the provisions of Statement of FinancialAccounting Standards (SFAS) No. 123R using the modified prospective transitionmethod which required the Company to record compensation cost related tounvested stock awards as of December 31, 2005 by recognizing the unamortizedgrant date fair value of these awards over the remaining service periods ofthose awards with no change in historical reported earnings.  Awards granted after December 31, 2005 arevalued at fair value in accordance with the provisions of SFAS 123R andrecognized as an expense on a straight-line basis over the service periods ofeach award.   The Company accelerated thevesting of unvested stock options previously awarded to employees, officers anddirectors in December 2005. The Company had no unvested stock options onJanuary 1, 2006. The total stock compensation expense recognized for stockoptions and restricted stock awards during the quarter ended June 30, 2007 was$0.3 million. The total remaining unrecognized compensation expense related tothe unvested options and restricted stock awards as of June 30, 2007 was $2.8million and $2.3 million, respectively.

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The fair value of each option is estimated on the dateof grant using the Black-Scholes option-pricing model with the followingassumptions used for grants during the fiscal periods ended June 30, 2007 andJuly 1, 2006:

|                                  | ** ** | **Fiscal Year**        | ** ** |
|----------------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **June 30, 2007** | ** ** | **July 1, 2006** | ** ** |
| Risk-free  interest rate         |       | 4.67 – 5.03%           |       | 5.07% |   |
| Expected life of  options        |       | 5 years                     |       | 5 years |   |
| Expected stock  price volatility |       | 34.8%                       |       | 42.3% |   |
| Expected dividend yield          |       | 0%                          |       | 0% |   |

 

The risk-free interest is based on U.S. Treasuryyields in effect at the time of grant over the expected term of the option. Theexpected life of options is derived from the Company’s historical optionexercise data. The expected stock price volatility is based on the historicalvolatility of the Company’s common stock.

Prior to the adoption of SFAS No. 123R, the Companypresented all tax benefits related to the exercise of stock options asoperating cash flows in the consolidated statement of cash flows. SFAS No. 123Rrequires the cash flows resulting from the tax benefits generated from taxdeductions in excess of the compensation costs recognized for those options tobe classified as financing cash flows.

**Earnings pershare**

Basic earnings per share 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 earnings per share gives effect tocommon stock equivalents and other potentially dilutive securities outstandingduring the period.

The following details thecomputation of net income per common share (in thousands):
| ** **                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                   | ** ** | **June 30,  2007**          | ** ** | **July 1,  2006**         | ** ** | **June 30,  2007** | ** ** | **July 1,  2006** | ** ** |
|                                         |       |                             |       |                           |       |   |   |   |   |
| Net Income —  Basic and Diluted         |       | $                                | 5,024      |                           | $          | 4,442 |   | $ | 9,758 |   | $ | 8,756 |   |
|                                         |       |                             |       |                           |       |   |   |   |   |
| **Weighted  average share calculation:**     |       |                             |       |                           |       |   |   |   |   |
|                                         |       |                             |       |                           |       |   |   |   |   |
| Basic  weighted-average shares outstanding   |       | 13,011                           |       | 12,770                         |       | 12,994 |   | 12,096 |   |
| Treasury stock  effect of stock options      |       | 291                              |       | 401                            |       | 282 |   | 436 |   |
|                                         |       |                             |       |                           |       |   |   |   |   |
| Diluted  weighted-average shares outstanding |       | 13,302                           |       | 13,171                         |       | 13,276 |   | 12,532 |   |
|                                              |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |

 

**Reclassifications**

Certain prior year balances havebeen reclassified to conform to the presentation of the current year.

**New accounting pronouncements**

In July 2006, the Financial Accounting Standards Board(FASB) issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty inIncome Taxes, an interpretation of FASB Statement No. 109, Accounting forIncome Taxes”.  FIN 48 provides guidanceon recognition, derecognition, measurement, classification, interest andpenalties, accounting in interim 

9

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periods,disclosure and transition. FIN 48 requires an entity to recognize the financialstatement impact of a tax position when it is more likely than not that theposition will be sustained upon examination. The amount recognized is measuredas the largest amount of benefit that is greater than fifty percent likely ofbeing realized upon ultimate settlement. In addition, FIN 48 permits an entityto recognize interest and penalties related to tax uncertainties either asincome tax expense or operating expenses.

**The Company adopted the provisions of FIN 48 on January 1,2007. The Company believes that its income tax filing positions will besustained on audit and does not anticipate any adjustments that will result ina material effect on its financial position, results of operations or cashflows. Therefore, no reserves for uncertain income tax position have beenrecorded. The Company had recognized interest and penalties related to taxuncertainties as income tax expense and will continue this treatment uponadoption of FIN 48.**

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

InSeptember 2006, the FASB issued SFAS No. 157, “Fair ValueMeasurements”.  SFAS No. 157 defines fairvalue, establishes a framework for measuring fair value and expands disclosuresabout fair value measurements.  SFAS No.157 is effective for fiscal years beginning after December 15, 2007. The adoptionof SFAS No. 157 is effective January 1, 2008 for the Company. The Companybelieves that the adoption of this statement will not have a material effect onits financial condition, results of operations or cash flows.

**3.             Acquisitions:**

On June 8, 2007,the Company acquired LOGTEC, Inc., an Ohio corporation (“LOGTEC”), pursuant toa Share Purchase Agreement dated May 23, 2007 (the “LOGTEC Agreement”).  LOGTEC specializes in acquisition and programmanagement, systems and network engineering and integration, software andweb-based application development, data management and warehousing, informationassurance, and training.  LOGTEC’s largest clients include the Air ForceMateriel Command (AFMC) and Naval Air Systems Command (NAVAIR).

Under the terms of the LOGTEC Agreement, the Companyacquired all of the outstanding capital stock of LOGTEC for $60.2 million incash, including $0.9 million of working capital adjustment and $0.3 million oftransaction costs, of which $5.9 million was deposited in escrow for 15 monthsafter closing in order to secure post-closing indemnity obligations of thesellers.  The purchase price is subjectto a two-way adjustment based upon whether the working capital of LOGTEC at theclosing of the acquisition is above or below the target working capitalspecified in the LOGTEC Agreement. Additionally, the Company has made an election under Section 338(h)(10)of the Internal Revenue Code, which effects the after tax valuation of theLOGTEC acquisition.   The transaction wasfunded through $10 million of cash-on-hand, borrowings of $25 million under thenewly amended term loan under our credit facility, and borrowing of $25 millionunder our revolving line of credit under our credit facility.   LOGTEC’s trailing revenue for the yearending December 31, 2006 was approximately $54 million (unaudited).

Approximately$45.7 million of the purchase price has been allocated to goodwill basedprimarily on the excess of the purchase price over the estimated fair value ofnet assets acquired and approximately $9.9 million of the purchase price hasbeen assigned to identifiable Intangible assets of contractual customerrelationships. Each customer relationship, which includes each customer’scontract, is being amortized on an accelerated basis over its estimated usefullife of 13 years.

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The total purchase pricepaid, including transaction costs of $0.3 million, has been preliminarilyallocated as follows (in thousands):

| Cash and cash equivalents              |   | $      | 120    |   |
|----------------------------------------|--------|--------|--------|--------|
| Accounts  receivable                   |   | 12,270 |   |
| Other current  assets                  |   | 221    |   |
| Property and  equipment                |   | 314    |   |
| Accounts payable  and accrued expenses |   | (8,232 | )      |
| Intangible  assets                     |   | 9,889  |   |
| Goodwill                               |   | 45,654 |   |
| Total consideration                    |   | $      | 60,236 |   |

 

The followingunaudited proforma combined condensed statements of operations (in thousands,except per share) set forth the consolidated results of operations of theCompany for the three and six months ended June 30, 2007 and July 1, 2006as if the LOGTEC acquisition had occurred at the beginning of each periodpresented. This unaudited proforma information does not purport to beindicative of the actual financial position or the results that would actuallyhave occurred if the combination had been in effect for the three and sixmonths ended June 30, 2007 and July 1, 2006.

|                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                  | ** ** | **June 30,  2007**          | ** ** | **July 1,  2006**         | ** ** | **June 30,  2007** | ** ** | **July 1,  2006** | ** ** |
|                        |       |                             |       |                           |       |   |   |   |   |
| Revenue                     |       | $                                | 131,421    |                           | $          | 132,822 |   | $ | 259,930 |   | $ | 253,615 |   |
| Net income                  |       | $                                | 5,334      |                           | $          | 5,867 |   | $ | 10,332 |   | $ | 10,760 |   |
| Diluted earnings  per share |       | $                                | 0.40       |                           | $          | 0.45 |   | $ | 0.78 |   | $ | 0.86 |   |

 

The operations of LOGTEC have been included in theCompany’s statement of operations since it was acquired

**4.             Accounts receivable:**

Accounts receivable consists ofthe following (in thousands):

|                                                                                                    | ** ** | **June 30, 2007** | ** ** | **December 30, 2006** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
|                                                                                               |       |                        |       |                            |       |
| Billed accounts  receivable                                                                        |       | $                           | 54,413     |                            | $          | 46,540 |   |
| Unbilled  accounts receivable:                                                                     |       |                        |       |                            |       |
| Currently billable                                                                                 |       | 47,319                      |       | 41,192                          |       |
| Unbilled retainages and milestone paymentsexpected  to be billed within the next 12 months         |       | 3,206                       |       | 5,609                           |       |
| Indirect costs incurred and charged to cost-plus  contracts in excess of provisional billing rates |       | 156                         |       | 136                             |       |
|                                                                                               |       |                        |       |                            |       |
| Total unbilled  accounts receivable                                                                |       | 50,681                      |       | 46,937                          |       |
| Allowance for  doubtful accounts                                                                   |       | (1,442                      | )          | (1,505                          | )          |
|                                                                                               |       |                        |       |                            |       |
| Accounts  receivable, net                                                                          |       | $                           | 103,652    |                            | $          | 91,972 |   |

 

The currently billable amountsincluded as unbilled accounts receivable as of June 30, 2007 represent amountsthat are billed during the following quarter of the current year. They arebillings for services rendered prior to quarter-end, which are billed oncenecessary billing data has been collected and an invoice is produced.

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**5.              Property and equipment:**

Property and equipment consist ofthe following (in thousands):

|                                                      | ** ** | **June 30,  2007** | ** ** | **December 30,  2006** | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Computers and  equipment                             |       | $                       | 12,199     |                        | $          | 11,899 |   |
| Software                                             |       | 4,097                   |       | 2,972                       |       |
| Furniture and  fixtures                              |       | 6,233                   |       | 5,072                       |       |
| Leasehold  improvements                              |       | 5,639                   |       | 4,257                       |       |
|                                                 |       |                    |       |                        |       |
|                                                 |       | 28,168                  |       | 24,200                      |       |
| Less—Accumulated  depreciation and amortization |       | (13,373                 | )          | (11,828                     | )          |
|                                                 |       |                    |       |                        |       |
| Property and  equipment, net                         |       | $                       | 14,795     |                        | $          | 12,372 |   |

 

Property and equipment includesassets financed under capital lease obligations of approximately $281,000 and$341,000, net of accumulated amortization, as of June 30, 2007 andDecember 30, 2006, respectively.

**6.             Intangibleassets:**

Intangibleassets consist of the following (in thousands):

|                                     | ** ** | **June 30,  2007** | ** ** | **December 30,  2006** | ** ** |
|-------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Contractual  customer relationships |       | $                       | 36,225     |                        | $          | 26,336 |   |
| Non-compete  agreements             |       | 150                     |       | 150                         |       |
| Total intangible  assets            |       | 36,375                  |       | 26,486                      |       |
| Less:  Accumulated amortization     |       | (7,585                  | )          | (6,068                      | )          |
| Intangible assets, net              |       | $                       | 28,790     |                        | $          | 20,418 |   |

 

Intangible assetsfrom acquisitions, which consist primarily of contractual customerrelationships, are amortized utilizing an accelerated method over 6 to 14years, based on their estimated useful lives. For the quarter ended June 30,2007, intangible assets increased by $9.9 million as a result of theacquisition of LOGTEC. The weighted-average amortization period of totalintangible assets as of June 30, 2007, is 10.7 years. Amortization expense isestimated to be $3.5 million, $3.6 million, $3.2 million, $3.0 million and $2.6million for the years 2007, 2008, 2009, 2010 and 2011, respectively.

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

Accrued expenses and othercurrent liabilities consist of the following (in thousands):

|                                                 | ** ** | **June 30,  2007** | ** ** | **December 30,  2006** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Accrued vacation                                |       | $                       | 9,161      |                        | $          | 7,068 |   |
| Accrued  compensation                           |       | 12,891                  |       | 10,349                      |       |
| Accrued bonus                                   |       | 249                     |       | 4,413                       |       |
| Deferred revenue                                |       | 1,734                   |       | 1,081                       |       |
| Other accrued  liabilities                      |       | 9,219                   |       | 5,636                       |       |
| Accrued expenses and  other current liabilities |       | $                       | 33,254     |                        | $          | 28,547 |   |

 

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**8.             Debt:**

Debt consists of thefollowing (in thousands):
| ** **                                                                                                                                                                                                                                                                                                                                  | ** ** | **June 30,  2007** | ** ** | **December 30,  2006** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Credit facilities:                                                                                                                                                                                                                                                                                                                          |       |                    |       |                        |       |
| Line of credit bears interest at LIBOR plus 200 to  275 base points or a specified base rate plus 100 to 175 basis points,  interest due monthly, principal due February 9, 2010                                                                                                                                                       |       | $                       | 25,000     |                        | $          | — |   |
| Term loan, as of June 30, 2007 bears interest at LIBOR  plus 200 basis points or a specified base rate plus 100 basis points, with  twenty-one consecutive quarterly principal and interest payments of $250,904  starting on June 30, 2007, with the unpaid principal and interest of  approximately $91.3 million due on February 9, 2011 |       | 94,829                  |       | 70,206                      |       |
| Total debt                                                                                                                                                                                                                                                                                                                                  |       | $                       | 119,829    |                        | $          | 70,206 |   |

 

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

On June 8, 2007,contemporaneously with the closing of the LOGTEC acquisition, we entered into aSecond Amendment to the Amended and Restated Credit Agreement (“SecondAmendment”) with a syndicate of lenders with Wachovia Bank acting asadministrative agent.  The SecondAmendment increased the amount of outstanding term debt by $25 million, to atotal of approximately $95 million.  Theoutstanding balance of term loan shall accrue interest at a variable rate.  The term loan facility requires quarterlyprincipal payments of $250,904 until final payment is required at the term loanmaturity date of February 9, 2011. Additionally, the Company borrowed approximately $25 million under therevolving credit facility. The outstanding balance under the revolving creditfacility will accrue interest at a variable rate, with interest only paymentsbeing required until the facility matures on February 9, 2010.  The Company may repay either or both of theterm loan facility and the revolving credit facility in whole or in part atanytime prior to their respective maturity dates. As we have the intent torepay the balance on the revolving credit facility within the next twelvemonths, we have classified the outstanding balance as a current liability.

**9.             Commitments and contingencies:**

**Leases**

As of June 30, 2007, the Company has noncancelableoperating leases, primarily for real estate, that expire over the next tenyears.   Rental expense during the quarter ended June 30, 2007 was approximately$2.2 million, compared to rental expense of approximately $2.3 million duringthe quarter ended July 1, 2006.

**Contract cost audits**

Payments to the Company on government costreimbursable contracts are based on provisional, or estimated indirect rates,which are subject to audit on an annual basis by the Defense Contract AuditAgency (DCAA). The cost audits result in the negotiation and determination ofthe final indirect cost rates that the Company may use for theperiod(s) audited. The final rates, if different from the provisionalrates, may create an additional receivable or liability for the Company. TheCompany’s revenue recognition policy calls for revenue recognized on all costreimbursable government contracts to be recorded at actual rates unlesscollectibility is not reasonably assured. To the extent the indirect ratedifferential creates a liability for the Company, the differential isrecognized as a reduction to revenue when identified.

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**Litigation and claims**

The Company is a party to litigation and legalproceedings that management believes to be a part of the ordinary course of ourbusiness. While we cannot predict the ultimate outcome of these matters, wecurrently believe that any ultimate liability arising out of these proceedingswill not have a material adverse effect on our financial position. We maybecome involved in other legal and governmental, administrative or contractualproceedings in the future.

The SEI acquisition agreement provides for a purchaseprice adjustment based upon the working capital of SEI as of the closingdate.  Subsequent to the closing date, we received a payment of $1.6million in connection with services performed prior to the closing date thatSEI had not previously billed, and was not authorized to bill, its customer asof the closing date.  The SEI selling stockholders have asserted that theyare entitled to a credit in connection with the calculation of working capitaladjustment in an amount equal to the amount received by us for thispost-closing payment.  We believe that, in accordance with GAAP, the SEIselling stockholders should not receive the benefit of the post-closing payment. In accordance with the terms of the SEI acquisition agreement, the parties havejointly submitted the issue to an independent accounting firm forresolution.  We anticipate that this matter will be resolved before theend of 2007.

In June 2006, the Company, through one of itssubsidiaries, was awarded a judgment, after a trial before a judge, in alawsuit filed in the Circuit Court of Fairfax County, Virginia against NationalTechnologies Associates, Inc. (“NTA”) in the amount of $841,612.  The Company’s claims arose out of the Company’sallegation that NTA breached a contract which obligated NTA to subcontractcertain work to the Company’s subsidiary. The Company did not record the judgment because NTA filed a motion forreconsideration before the trial court. The trial court judge granted NTA’s motion for reconsideration and ruledfor NTA, thereby overturning the judge’s original ruling.  The Company filed a petition with theVirginia Supreme Court requesting that it agree to hear an appeal of the trialcourt’s final judgment.  On or about May10, 2007, the Virginia Supreme Court denied our request to hear the case, withthe result that the final ruling of the trial court stands.  Management considers this matter to beconcluded.

**10.           Stockholders’ equity:**

**Stock incentive plans**

In April 2005, the Board of Directors voted toadopt the 2002 Amended and Restated Omnibus Stock Incentive Plan (the “Amendedand Restated Plan”) and the Amended and Restated Plan was approved by ourstockholders at the annual meeting of stockholders held in June 2005. TheAmended and Restated Plan amends and restates the Plan by (i) increasingthe number of shares of common stock reserved and available under the Plan by1,000,000 shares to a total share allocation of 2,920,000, (ii) permittingthe grant of deferred shares, performance shares and performance units,(iii) prohibiting repricing of options without prior stockholder approval,(iv) limiting the number of shares of common stock and performance unitssubject to awards a participant may receive in any calendar year to 300,000 and500,000, respectively, and adding other administrative provisions to complywith the performance-based compensation exception to the deduction limit ofSection 162(m) of the Internal Revenue Code of 1986, as amended;(v) eliminating the provision that previously provided for an automaticincrease in the number of shares reserved for issuance under the Amended andRestated Plan each fiscal year by a number equal to the lesser of 160,000shares and an amount determined by the Board of Directors, (vi) providingthat non-qualified stock option grants will be priced at one hundred percent(100%) of fair market value; (vii) providing for minimum vesting periodsof stock bonus awards, restricted common stock awards, stock appreciationrights, deferred shares, and other stock awards subject to the possibleacceleration of the vesting schedule at the discretion of the administrator;(viii) providing that future amendments to the Amended and Restated Plan thatincrease the number of shares allocated, modify participation requirements, ormaterially increase benefits accruing to the participants under the Plan willbe subject to stockholder approval; and (ix) making other technicalchanges to the Plan.

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A summary of optionactivity under the plan as of June 30, 2007, is presented below:

|                                       | ** ** | **Options** | ** ** | **Weighted-average  exercise price** | ** ** |
|---------------------------------------|------------|-------------|------------|-------------------------------------------|------------|
| Outstanding at December 30, 2006      |       | 1,468,305   |       | $                                         | 22.33      |   |
| 2007 grants                           |       | 132,300     |       | 28.42                                     |       |
| 2007 exercises                        |       | (55,777     | )          | 16.30                                     |       |
| 2007 forfeitures                      |       | (12,467     | )          | 28.37                                     |       |
| Balance, June 30, 2007                |       | 1,532,361   |       | $                                         | 23.02      |   |
| Options  exercisable at June 30, 2007 |       | 1,239,046   |       | $                                         | 21.66      |   |

 

Prior to fiscal 2006, awards under the Company’s stockincentive plan consisted principally of stock options.  During fiscal 2006, the Company revised itsstock incentive arrangement to provide restricted stock awards to directors andexecutives. The stock awards granted during fiscal 2006 were generally vestedratably over a period of four or five years. During fiscal 2007, the Companyrevised its stock incentive arrangement to issue restricted stock awards thatwill be fully vested only if the Company meets certain revenue targetdetermined by the Board of Directors.

A summary of restrictedawards activity under the plan as of June 30, 2007, is presented below:

|                                                    | ** ** | **Shares** | ** ** | **Weighted-average  fair value** | ** ** |
|----------------------------------------------------|------------|------------|------------|---------------------------------------|------------|
| Non-vested shares outstanding at December 30, 2006 |       | 32,200     |       | $                                     | 28.98      |   |
| 2007 grants                                        |       | 75,200     |       | 28.48                                 |       |
| 2007 vests                                         |       | —     |       | —                                |       |
| 2007 forfeitures                                   |       | (625       | )          | 28.61                                 |       |
| Non-vested  shares outstanding at June 30, 2007    |       | 106,775    |       | $                                     | 28.63      |   |

 

**Stock repurchase program**

During the Company’s Board of Directors meeting onDecember 6, 2005, the Board authorized the repurchase of up to 300,000 sharesof its common stock up to an aggregate maximum dollar amount of $8million.  The Company had approximately13.0 million shares outstanding as of June 30, 2007.  Timing and volume ofany purchases will be guided by management’s assessment of market conditions,securities law limitations, the number of shares of common stock outstanding,and alternative, potentially higher value uses for cash resources.  Therepurchase plan may be suspended or discontinued at any time without priornotice.

 

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

*The following discussion andanalysis should be read in conjunction with the consolidated financialstatements and related notes included elsewhere in this Form 10-Q. Thisdiscussion and analysis contains forward-looking statements that involveknown and unknown risks, uncertainties, and other factors that may cause ouractual results, level of activity, performance or achievements to be materiallydifferent from any future results, levels of activity, performance orachievements expressed or implied by such forward-looking statements. In somecases, you can identify these statements by forward-looking words such as “anticipate,”“believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,”“should,” “will,” and “would” or similar words. You should read statements thatcontain these words carefully because they discuss our future expectations,contain projections of our future results of operations or of our financialposition, or state other forward-looking information. We believe that it isimportant to communicate our future expectations to our investors. However,there may be events in the future that we are not able to predict accurately orcontrol. In particular, statements that wemake in this section relating to the sufficiency of anticipated sources ofcapital to meet our cash requirements are forward- looking statements.Our actual results could differ materially from those anticipated in theseforward-looking statements for many reasons, including as a result ofsome of the factors described below, elsewhere in this Form 10-Q and in thesection entitled “Risk Factors” in our Form 10-K  for the fiscal year ended December 30,2006.   You should not place unduereliance on these forward-looking statements, which apply only as of thedate of the filing of this Form 10-Q.*

*The Company’s fiscal year isbased on the calendar year and ends each year on the Saturday nearest, but notfalling after, December 31 of that year. Typically, fiscal quarters also end on the Saturday nearest, but notfalling after, the end of the calendar quarter. Similarly, we will end futurefiscal quarters on the Saturday which provides us with a 13 week quarter tocompare with the previous year’s quarterly results even if that Saturday fallsafter the end of the calendar quarter. As a result, our fiscal year may be comprised of 52 or 53 weeks.*

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

**Overview**

We are, first and foremost, a provider of informationtechnology and network solutions (IT) to the Federal government. Our clientsinclude the U.S. Air Force, U.S. Army, U.S. Navy, Department of State, MissileDefense Agency, Department of Homeland Security, Department of Energy,Department of Agriculture, Federal Retirement Thrift Investment Board, NationalGuard Bureau, and the Intelligence community. We combine our technology andindustry expertise to provide a full spectrum of state-of-the-practicesolutions and services, from design and development to implementation andoperations, which assist our clients in achieving mission success. We believethat our Company is distinguishable from our peers within the federal IT sectorin several important respects.

We employ a Rapid Response • Rapid Deployment®methodology that enables the rapid standing up of innovative solutions and theincorporation of additional capabilities in rapid succession. This capabilityallows us to respond to urgent IT imperatives quickly, often in a matter ofmonths, and within a well-defined budget. We can, therefore, provide solutionsfor current IT needs, while establishing a platform for advancing long-termtransformational objectives. We possess a proven ability to respond to highpriority information technology and network needs through innovation, and anenviable reputation for timely delivery of robust solutions on assignmentswhere failure is not an option. Our solutions enable clients to respond to newmandates, expand the scope of their missions, and reengineer underlyingbusiness processes. We have a demonstrated ability of turning troubled ITprojects into winning outcomes and realizing exceptional growth fromhigh-quality client engagements. We also utilize mature and proven processes tomanage and market large-scale ID/IQ contracts, such as C4I2TSR. We employ adiverse, innovative team that effectively utilizes small business partners’unique skills and expertise for mission critical IT projects.

For the fiscal quarters ended June 30, 2007 and July1, 2006, we received 98.5% and 98.3%, respectively, of our revenues fromservices we provided to various departments and agencies of the Federalgovernment, both directly and through other prime contractors and 1.5% and 1.7%respectively, of our total revenues from work performed for commercialentities.  The following table shows ourrevenues from the client groups listed as a percentage of total revenue. Revenuedata for the DoD includes revenue generated from work performed underengagements for both the DoD and the Intelligence community.

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| ** **                 | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                 | ** ** | **June 30,  2007**          | ** ** | **July 1,  2006**         | ** ** | **June 30,  2007** | ** ** | **July 1,  2006** | ** ** |
|                       |       |                             |       |                           |       |   |   |   |   |
| Department of  Defense     |       | 45.1                             | %          | 47.3                           | %          | 45.0 | % | 47.6 | % |
| Federal civilian  agencies |       | 53.4                             |       | 51.0                           | %          | 53.4 |   | 50.6 | % |
| Commercial  entities       |       | 1.5                              |       | 1.7                            | %          | 1.6 |   | 1.8 | % |
| Total revenue              |       | 100.0                            | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |

 

We have derived a substantial majority of our revenuesfrom governmental contracts under which we act as a prime contractor. We alsoprovide services indirectly as a subcontractor. The following table shows ourrevenues as prime contractor and as subcontractor as a percentage of our totalrevenue for the following periods:
| ** **              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **              | ** ** | **June 30,  2007**          | ** ** | **July 1,  2006**         | ** ** | **June 30,  2007** | ** ** | **July 1,  2006** | ** ** |
|                    |       |                             |       |                           |       |   |   |   |   |
| Prime contract  revenue |       | 78.5                             | %          | 77.9                           | %          | 79.2 | % | 77.8 | % |
| Subcontract  revenue    |       | 21.5                             |       | 22.1                           | %          | 20.8 |   | 22.2 | % |
| Total revenue           |       | 100.0                            | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |

 

Our services are provided to clients pursuant to threetypes of contracts: cost reimbursable, time and materials and fixed pricecontracts. The following table shows our revenues from each of these types ofcontracts as a percentage of our total revenue for the following periods:
| ** **          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **          | ** ** | **June 30,  2007**          | ** ** | **July 1,  2006**         | ** ** | **June 30,  2007** | ** ** | **July 1,  2006** | ** ** |
|                |       |                             |       |                           |       |   |   |   |   |
| Cost  reimbursable  |       | 29.1                             | %          | 29.6                           | %          | 30.5 | % | 30.7 | % |
| Time and  materials |       | 34.7                             |       | 36.5                           | %          | 34.0 |   | 36.8 | % |
| Fixed price         |       | 36.2                             |       | 33.9                           | %          | 35.5 |   | 32.5 | % |
| Total               |       | 100.0                            | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |

 

Under cost reimbursable contracts, the Company isreimbursed for allowable costs, and paid a fee, which may be fixed orperformance-based. Revenues on cost reimbursable contracts are recognized ascosts are incurred plus an estimate of applicable fees earned.  The Company considers fixed fees under costreimbursable contracts to be earned in proportion of the allowable costsincurred in performance of the contract. For cost reimbursable contracts that include performance based feeincentives, the Company recognizes the relevant portion of the expected fee tobe awarded by the client at the time such fee can be reasonably estimated,based on factors such as our prior award experience and communications with theclient regarding performance.

Revenue on time and materials contracts are recognizedbased on direct labor hours expended at contract billing rates and adding otherbillable direct costs.  To the extentthat our actual labor costs under a time and materials contract are higher orlower than the billing rates under the contract, our profit under the contractmay either be greater or less than we anticipated or

17

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we maysuffer a loss under the contract. We recognize revenues under time andmaterials contracts by multiplying the number of direct labor hours expended bythe contract billing rates and adding the effect of other billable directcosts.

For fixed price contracts that provide for thedelivery of a specific product with related customer acceptance provisions,revenues are recognized upon product delivery and customer acceptance.  However, a significant portion of the Company’sfixed price-completion contracts involve the design and development of complex,client systems. For those contracts that are within the scope of SOP 81-1,Accounting for Performance of Construction-Type and certain Production-TypeContracts, revenue is recognized on the percentage-of-completion method usingcosts incurred in relation to total estimated costs.

The Company’s contracts with agencies of thegovernment are subject to periodic funding by the respective contractingagency.  Funding for a contract may beprovided in full at inception of the contract or ratably throughout thecontract 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 notassessed as probable, revenue recognition is deferred until realization isprobable.

Contract revenue recognition inherently involvesestimation, including the contemplated level of effort to accomplish the tasksunder the contract, the cost of the effort, and an ongoing assessment ofprogress toward completing the contract. From time to time, as part of normal management processes, facts developthat require revisions to estimated total costs or revenues expected.  The cumulative impact of any revisions toestimates and the full impact of anticipated losses on any type of contract arerecognized in the period in which they become known.

The allowability of certain costs under governmentcontracts is subject to audit by the government.  Certain indirect costs are charged tocontracts using provisional or estimated indirect rates, which are subject tolater revision based on government audits of those costs.  Management is of the opinion that costssubsequently disallowed, if any, would not be significant.

**Recent Events**

*LOGTECAcquisition.*   On June8, 2007, the Company acquired LOGTEC, Inc., an Ohio corporation (“LOGTEC”),pursuant to a Share Purchase Agreement dated May 23, 2007 (the “LOGTECAgreement”).   Under the terms of theLOGTEC Agreement, the Company acquired all of the outstanding capital stock ofLOGTEC for $60.2 million in cash, including $0.9 million of working capitaladjustment and $0.3 million of transaction costs, of which $5.9 million was depositedin escrow for 15 months after closing in order to secure post-closing indemnityobligations of the sellers.  The purchaseprice is subject to a two-way adjustment based upon whether the working capitalof LOGTEC at the closing of the acquisition is above or below the targetworking capital specified in the LOGTEC Agreement.  Additionally, the Company has made anelection under Section 338(h)(10) of the Internal Revenue Code, which effectsthe after tax valuation of the LOGTEC acquisition.

*CreditAmendment.*On June 8, 2007, contemporaneously with theclosing of the LOGTEC acquisition, we entered into a Second Amendment to theAmended and Restated Credit Agreement (“Second Amendment”) with a syndicate oflenders with Wachovia Bank acting as administrative agent. The Second Amendmentincreased the amount of outstanding term debt by $25 million, to a total ofapproximately $95 million.  Theoutstanding balance of term loan shall accrue interest at a variable rate.  The term loan facility requires quarterlyprincipal payments of $250,904 until final payment is required at the term loanmaturity date of February 9, 2011. Additionally, the Company borrowed approximately $25 million under therevolving credit facility. The outstanding balance under the revolving creditfacility will accrue interest at a variable rate, with interest only paymentsbeing required until the facility matures on February 9, 2010.  The Company may repay either or both of theterm loan facility and the revolving credit facility in whole or in part atanytime prior to their respective maturity dates. As we have the intent torepay the balance on the revolving credit facility within the next twelvemonths, we have classified the outstanding balance as a current liability.

**Liquidity and Capital Resources**

*General.*  Short-term liquidity requirements are created by our use of funds for workingcapital, capital expenditures, and the need to provide debt service. We expectto meet these requirements through a combination of cash flow from operationsand borrowings under our Credit Agreement.

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We anticipate that our long-term liquidityrequirements, including any further acquisitions, will be funded through acombination of cash flow from operations, borrowings under our CreditAgreement, additional secured or unsecured debt or the issuance of common orpreferred stock, each of which may be initially funded through borrowings underour Credit Agreement.

Under the terms of our Credit Agreement, the Companyis required to maintain compliance with financial and non-financialcovenants.  The Company is in compliancewith all such covenants as of June 30, 2007.

*Cash and Cash Equivalents.*  We consider cash on deposit and all highly liquid investments with originalmaturities of three months or less to be cash and cash equivalents. Cash andcash equivalents, as of the end of three months ending June 30, 2007 and July1, 2006 were $10.9 million and $6.3 million, respectively.

*Cash Flow.*  The following table sets forth our sources and uses of cash for the six monthsended June 30, 2007 and July 1, 2006.

|                                            | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------|------------|--------------------------------|------------|
| ** **                                 | ** ** | **June 30, 2007**    | ** ** | **July 1, 2006** | ** ** |
| ** **                                 | ** ** | **(in thousands)**        | ** ** |
| Net cash  provided by operations           |       | $                              | 10,852     |   | $ | 4,854 |   |
| Net cash used in  investing activities     |       | (69,932                        | )          | (55,492 | ) |
| Net cash  provided by financing activities |       | 50,515                         |       | 30,761 |   |
| Net decrease in cash                       |       | $                              | (8,565     | ) | $ | (19,877 | ) |

 

Our operating cash flow is primarily affected by theoverall profitability of our contracts, our ability to invoice and collect fromour clients in a timely manner, and our ability to manage our vendor payments.We bill most of our clients monthly after services are rendered. Cash providedby operations in the six months ended June30, 2007 was attributable to net income of $9.8 million, plus depreciation,amortization, and other non-cash items of $4.2 million, which was reducedby an increase in working capital and other operating assets and liabilities of$3.1 million. Cash used in operationsin the six months ended July 1, 2006 was attributable to net income of$8.8 million, plus depreciation, amortization and other non-cash items of $4.4million, and an increase in working capital and other operating assets andliabilities of $8.3 million.

Our cash flow used in investing activities consistsprimarily of capital expenditures, the purchase and sale of marketablesecurities, and acquisitions. During the sixmonths ended June 30, 2007, we paid $60.1 million for the LOGTEC acquisition,net of cash assumed, repaid $6.0 million of note payable to the former ownersof Zen, and invested $3.8 million in capital assets.  In the six months ended July 1, 2006,we paid $48.0 million for business acquisitions, net of cash assumed, repaid acontract settlement to a former owner for $10.3 million, and purchased capitalassets totaling $5.0 million. We partially offset the cash use with $7.9million of proceeds from the sale of marketable securities, net of purchases.

Our cash flow provided by financing activitiesconsists primarily of borrowing under and payments on our credit facility andproceeds from the issuance and exercise of common stock. For the six monthsended June 30, 2007, cash flow provided by financing activities primarilyconsists of borrowings of $25.0 million under the newly amended term loan, a borrowingof $25.0 million under the revolving line of credit, and proceeds of $0.9million from the exercise of stock options. These were partially offset by $0.4million of repayments of the term loan portion of our credit facility andcapital leases.  Cash provided by financing activities for the six months ended July 1,2006 was attributable to proceeds of $40.4 million from the sale of commonstock, $30.0 million of proceeds from the issuance of term debt, $5.2 millionof proceeds from the exercise of stock options and $1.1 million from othersources, net of $45.9 million repayment of term debt.

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**Results of Operations**

The following table sets forthcertain items from our consolidated statements of operations as a percentage ofrevenues for the periods indicated.
| ** **                                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                | ** ** | **June 30,  2007**          | ** ** | **July 1,  2006**         | ** ** | **June 30,  2007** | ** ** | **July 1,  2006** | ** ** |
|                                      |       |                             |       |                           |       |   |   |   |   |
| Revenue                                   |       | 100.0                            | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |
| Operating costs  and expenses:            |       |                             |       |                           |       |   |   |   |   |
| Cost of services                          |       | 62.1                             |       | 62.9                           |       | 62.2 |   | 62.5 |   |
| Selling, general and administrative       |       | 28.7                             |       | 27.4                           |       | 28.5 |   | 27.9 |   |
| Depreciation and amortization             |       | 0.7                              |       | 0.5                            |       | 0.7 |   | 0.5 |   |
| Amortization of intangible assets         |       | 0.6                              |       | 0.7                            |       | 0.6 |   | 0.7 |   |
| Total operating costs and expenses        |       | 92.1                             |       | 91.5                           |       | 92.0 |   | 91.6 |   |
| Income from  operations                   |       | 7.9                              |       | 8.5                            |       | 8.0 |   | 8.4 |   |
| Other income                              |       | 0.3                              |       | —                         |       | 0.2 |   | — |   |
| Interest expense                          |       | (1.3                             | )          | (2.3                           | )          | (1.3 | ) | (2.0 | ) |
| Income before  provision for income taxes |       | 6.9                              |       | 6.2                            |       | 6.9 |   | 6.4 |   |
| Provision for  income taxes               |       | 2.7                              |       | 2.4                            |       | 2.7 |   | 2.5 |   |
| Net income                                |       | 4.2                              | %          | 3.8                            | %          | 4.2 | % | 3.9 | % |

 

**Three months ended June 30, 2007compared with three months ended July 1, 2006**

*Revenue. * For the three months ended June30, 2007, our revenues decreased 0.4% to $118.8 million from$119.2 million for the three months ended July 1, 2006. Revenues from workunder Federal government contracts decreased 0.2% to $117.0 million forthe three months ended June 30, 2007 from $117.2 million for the three monthsended July 1, 2006. This decrease was attributable to the delay in task ordersunder our Command, Control, Communications, Computer, Intelligence,Information, Technology, Surveillance, and Reconnaissance contract vehicle(C4I2TSR), partially offset by increase in revenue in connection with theLOGTEC acquisition. We continue to focus primarily on opportunities for the Federalgovernment.

*Cost ofservices.*  Cost of services includes direct labor andother direct costs such as materials and subcontracts, incurred to provide ourservices and solutions to our customers. Generally, changes in cost of servicesare correlated to changes in revenue as resources are consumed in theproduction of that revenue.  For thethree months ended June 30, 2007, cost of services decreased 1.7% to$73.7 million from $75.0 million for the three months ended July 1,2006.  This decrease was attributableprimarily to the decrease in revenue. As a percentage of revenue, cost ofservices were 62.1% for the three months ended June 30, 2007 as compared to62.9% for the three months ended July 1, 2006.

*Selling,general and administrative expenses.* Selling, general and administrative expenses include facilities,selling, bid and proposal, indirect labor, fringe benefits and otherdiscretionary costs.  For the threemonths ended June 30, 2007, selling, general and administrative expensesincreased 4.4% to $34.1 million from $32.6 million for the threemonths ended July 1, 2006.  This$1.4 million increase was primarily attributable to the expected growth ofsupport functions necessary to facilitate and administer the growth in cost ofservices.  As a percentage of revenue,selling, general and administrative expenses were 28.7% for the three monthsended June 30, 2007 as compared to 27.4% for the three months ended July 1,2006.

*Depreciationand amortization.*Depreciation and amortization includes the depreciationof computers, furniture and other equipment, the amortization of third partysoftware we use internally, and leasehold improvements.  Forthe three months ended June 30, 2007, depreciation and amortization expense was$0.8 million, a slight increase compared to $0.7 million for the three monthsended July 1, 2006.  As a percentage ofrevenue, depreciation and amortization expense was 0.7% for the three monthsended June 30, 2007 compared to 0.6% for the three months ended July 1, 2006.

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*Amortization of intangibleassets.  *Amortization of intangible assets includes theamortization of intangible assets acquired in connection with acquisitions inaccordance with SFAS 142, Goodwill and Other Intangible Assets.  Identifiable intangible assets are amortizedover their useful lives.  Non-competeagreements are generally amortized straight-line over the term of theagreement, while contracts and related client relationships are amortized usingan accelerated method over their estimated useful lives.  For the three months ended June 30, 2007 andJuly 1, 2006, amortization of intangible assets was $0.8 million.   As a percentage of revenue, amortization ofintangible assets was 0.6% for the three months ended June 30, 2007 compared to0.7 % for the three months ended July 1, 2006.

*Income fromoperations.*  For the three months ended June 30, 2007,income from operations decreased 7.4% to $9.4 million from$10.1 million for the three months ended July 1, 2006. This decrease wasattributable primarily to decreased revenues. As a percentage of revenue, income from operations was 7.9% for thethree months ended June 30, 2007 compared to 8.5% for the three months endedJuly 1, 2006.

*Interestexpense.*  Interest expense decreased 41.6% to$1.6 million for the three months ended June 30, 2007 from$2.7 million for the three months ended July 1, 2006.  This decrease was attributable primarily tothe prepayments of the term loan during fiscal 2006.   As a percentage of revenue, interest expensewas 1.3% for the three months ended June 30, 2007 as compared to 2.3% for thethree months ended July 1, 2006.

*Provision forincome taxes.*  The provision for income taxes was$3.2 million in the three months ended June 30, 2007, compared to$2.9 million for the three months ended July 1, 2006.   Our second quarters of 2007 and 2006 taxprovision, represents an estimated annual effective tax rate of 39.2% and39.5%, respectively. Our estimated annual effective tax rate is greater thanthe federal statutory rate of 35% due primarily to state income taxes.

**Six months ended June 30, 2007 comparedwith six months ended July 1, 2006**

*Revenue.*  For thesix months ended June 30, 2007, our revenues increased 2.7% to$232.5 million from $226.5 million for the six months ended July 1,2006.  Revenues from work under Federalgovernment contracts increased 2.8% to $228.7 million for the six monthsended June 30, 2007 from $222.5 million for the six months ended July 1, 2006.This increase was attributable to the projects added from the LOGTEC acquisition,the new contract awards, successful recompetition wins on existing programs,new contracts from and growth within existing programs in our four focus areas:Federal IT Modernization, Defense Transformation, Homeland Defense, and Mission-CriticalOutsourcing.  We continue to focusprimarily on opportunities for the Federal government.

*Cost ofservices.* Cost of servicesincludes direct labor and other direct costs such as materials andsubcontracts, incurred to provide our services and solutions to our customers.Generally, changes in costs of services are correlated to changes in revenue asresources are consumed in the production of that revenue.  For the six months ended June 30, 2007, costsof services increased 2.2% to $144.6 million from $141.6 million forthe six months ended July 1, 2006.  Thisincrease was attributable primarily to the increase in revenue. As a percentageof revenue, costs of services were 62.2% for the six months ended June 30, 2007as compared to 62.5% for the six months ended July 1, 2006.

*Selling,general and administrative expenses.*  Selling, general andadministrative expenses include facilities, selling, bid and proposal, indirectlabor, fringe benefits and other discretionary costs.  For the six months ended June 30, 2007, selling,general and administrative expenses increased 4.8% to $66.2 million from$63.2 million for the six months ended July 1, 2006.  This $3.0 million increase was primarilyattributable to the expected growth of support functions necessary tofacilitate and administer the growth in costs of services.  As a percentage of revenue, selling, generaland administrative expenses were 28.5% for the six months ended June 30, 2007as compared to 27.9% for the six months ended July 1, 2006.

*Depreciationand amortization.*Depreciation and amortization includes thedepreciation of computers, furniture and other equipment, the amortization ofthird party software we use internally, and leasehold improvements.  Forthe six months ended June 30, 2007, depreciation expense was $1.6 million, anincrease of $0.4 million compared to $1.2 million for the six months ended July1, 2006.  As a percentage of revenue,depreciation expense was 0.7% for the six months ended June 30, 2007 comparedto 0.5% for the six months ended July 1, 2006.

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*Amortization of intangibleassets.*Amortization ofintangible assets includes the amortization of intangible assets acquired inconnection with acquisitions in accordance with SFAS 142, Goodwill and OtherIntangible Assets.  Identifiable intangibleassets are amortized over their estimated useful lives.  Non-compete agreements are generallyamortized straight-line over the term of the agreement, while contracts andrelated client relationships are amortized using an accelerated method overtheir estimated useful lives. For the six months ended June 30, 2007 and July1, 2006, amortization of intangible assets was $1.5 million.  As a percentage of revenue, amortization ofintangible assets was 0.7% for the six months ended June 30, 2007 and July 1,2006.

*Income fromoperations.*  For the six months ended June 30, 2007,income from operations decreased 2.6% to $18.5 million from$19.0 million for the six months ended July 1, 2006. This decrease wasattributable primarily to increased operating expenses.  As a percentage of revenue, income fromoperations was 8.0% for the six months ended June 30, 2007 compared to 8.4% forthe six months ended July 1, 2006.

*Interestexpense.*  Interest expense decreased 33.7% to$2.7 million for the six months ended June 30, 2007 from $4.5 millionfor the six months ended July 1, 2006. This decrease was attributable primarilyto the prepayments of the term loan during fiscal 2006.  As a percentage of revenue, interest expensewas 1.3% for the six months ended June 30, 2007 as compared to 2.0% for the sixmonths ended July 1, 2006.

*Provision forincome taxes.*  The provision for income taxes was $6.3million in the six months ended June 30, 2007 compared to $5.7 million forthe six months ended July 1, 2006.  Oursecond quarters of 2007 and 2006 tax provision represent an estimated annualeffective tax rate of 39.2% and 39.5%, respectively. Our estimated annualeffective tax rate is greater than the federal statutory rate of 35% dueprimarily to state income taxes.

**Off-Balance Sheet Arrangements**

As of June 30, 2007, we have nooff-balance sheet arrangements that are reasonably likely to have a current orfuture material effect on our financial condition, revenues, or expenses,result of operations, liquidity, capital expenditures, or capital resources.

**Critical Accounting Policies andEstimates**

Our significant accounting policies are described inNote 2 to our accompanying consolidated financial statements. We considerthe accounting policies related to revenue recognition to be critical to theunderstanding of our results of operations. Our critical accounting policiesalso include the areas where we have made what we consider to be particularlydifficult, subjective or complex judgments in making estimates, and where theseestimates can significantly impact our financial results under differentassumptions and conditions. We prepare our financial statements in conformitywith U.S. generally accepted accounting principles. 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*

The Companyrecognizes revenue when a contract has been executed, the contract price isfixed and determinable, delivery of services or products has occurred, andcollectibility of the contract price is considered probable and can bereasonably estimated.  Revenue is earnedunder cost reimbursable, time and materials and fixed price contracts.

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

Revenue on timeand materials contracts are recognized based on direct labor hours expended atcontract billing rates and adding other billable direct costs.  For fixed price contracts that are based onunit pricing or level of effort, the Company 

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recognizes revenue forthe number of units delivered in any given fiscal period.  For fixed price contracts in which theCompany is paid a specific amount to provide a particular service for a statedperiod of time, revenue is recognized ratably over the service period.

For fixed pricecontracts that provide for the delivery of a specific product with relatedcustomer acceptance provisions, revenues are recognized upon product deliveryand customer acceptance.  However, asignificant portion of the Company’s fixed price-completion contracts involvethe design and development of complex, client systems.  For those contracts that are within scope ofSOP 81-1, *Accounting for Performance of Construction-Type andCertain Production-Type Contracts*, revenue is recognized on thepercentage-of-completion method using costs incurred in relation to totalestimated costs.

The Company’scontracts with agencies of the government are subject to periodic funding bythe respective contracting agency. Funding for a contract may be providedin full at inception of the contract or ratably throughout the contract as theservices are provided.  In evaluating theprobability of funding for purposes of assessing collectibility of the contractprice, the Company considers its previous experiences with its customers,communications with its customers regarding funding status, and the Company’sknowledge of available funding for the contract or program. If funding is notassessed as probable, revenue recognition is deferred until realization isdeemed probable.

Contract revenuerecognition inherently involves estimation, including the contemplated level ofeffort to accomplish the tasks under contract, the cost of the effort, and anongoing assessment of progress toward completing the contract. From time totime, as part of normal management processes, facts develop that requiremanagement to revise its estimated total costs or revenues expected. Thecumulative impact of any revisions to estimates and the full impact ofanticipated losses on any type of contract are recognized in the period inwhich they become known.

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

*Stock-Based Compensation*

Effective January1, 2006, the Company adopted the provisions of SFAS No. 123R using the modifiedprospective transition method, which required the Company to recordcompensation cost related to unvested stock awards as of December 31, 2005 byrecognizing the unamortized grant date fair value of these awards over theremaining service periods of those awards with no change in historical reportedearnings.  Awards granted after December31, 2005 are valued at fair value in accordance with the provisions of SFAS123R and recognized as an expense on a straight-line basis over the service periodsof each award.   The Company acceleratedthe vesting of unvested stock options previously awarded to employees, officersand directors in December 2005. The Company had no unvested stock options onJanuary 1, 2006. The total stock compensation expense recognized for stockoptions and restricted stock awards during the quarter ended June 30, 2007 was$0.3 million. The total remaining unrecognized compensation expense related tothe unvested options and restricted stock awards as of June 30, 2007 was $2.8million and $2.3 million, respectively.

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

We are exposed to certain financial market risks, themost predominant being fluctuations in interest rates for borrowings under ourcredit facility. Interest rate fluctuations are monitored by our management asan integral part of our overall risk management program, which recognizes theunpredictability of financial markets and seeks to reduce the potentiallyadverse effect on our results of operations. As part of this strategy, we mayuse interest rate swap arrangements to manage or hedge our interest rate risk.We do not use derivative financial instruments for speculative or tradingpurposes.

As of June 30, 2007, we had $119.8 million outstandingunder our Credit Agreement. A 1% change in interest rates would have resultedin our interest expense fluctuating by approximately $206,000 for the threemonths ended June 30, 2007.

Effective February 14, 2006, an interest swapagreement came into effect which reduced our exposure associated with themarket volatility of floating LIBOR interest rates. This agreement has anotional principal amount of $30.0 million and, as of June 30, 2007, had arate ranging from 4.05% to 4.74%. This agreement is a hedge against term debt,which bears interest at LIBOR plus a margin which has a current rate rangingfrom 7.32% to 7.34%. At stated monthly intervals the difference between theinterest on the floating LIBOR-based debt and the interest calculated in the swapagreement are settled in cash. The estimated value of the swap at June 30, 2007was $0.2 million.

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

**Item 4. Controls and Procedures.**

*Evaluation of Disclosure Controls and Procedures.*The Company performed an evaluation under the supervision and with theparticipation of management, including the Company’s Chief Executive Officerand Chief Financial Officer, of the design and operation of the Company’sdisclosure controls and procedures as of June 30, 2007.  Based upon the evaluation, the Company’sChief Executive Officer and Chief Financial Officer have concluded that, as ofJune 30, 2007, the Company’s disclosure controls and procedures were effective.

*Changes in Internal Control Over Financial Reporting.*During the three and six months ended June 30, 2007, therewere no changes in the Company’s internal control over financial reporting thathad materially affected, or are reasonably likely to materially affect, theCompany’s internal control for financial reporting.

**PART II: OTHER INFORMATION**

**Item1.  Legal Proceedings**

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

The SEI acquisition agreement provides for a purchaseprice adjustment based upon the working capital of SEI as of the closingdate.  Subsequent to the closing date, we received a payment of $1.6million in connection with services performed prior to the closing date thatSEI had not previously billed, and was not authorized to bill, its customer asof the closing date.  The SEI selling stockholders have asserted that theyare entitled to a credit in connection with the calculation of working capitaladjustment in an amount equal to the amount received by us for thispost-closing payment.  We believe that, in accordance with GAAP, the SEIselling stockholders should not receive the benefit of the post-closingpayment.  In accordance with the terms of the SEI acquisition agreement,the parties have jointly submitted the issue to an independent accounting firmfor resolution.  We anticipate that this matter will be resolved beforethe end of 2007.

In June 2006, the Company, through one of itssubsidiaries, was awarded a judgment, after a trial before a judge, in alawsuit filed in the Circuit Court of Fairfax County, Virginia against NationalTechnologies Associates, Inc. (“NTA”) in the amount of $841,612.  The Company’s claims arose out of the Company’sallegation that NTA breached a contract which obligated NTA to subcontractcertain work to the Company’s subsidiary. The Company did not record the judgment because NTA filed a motion forreconsideration before the trial court. The trial court judge granted NTA’s motion for reconsideration and ruledfor NTA, thereby overturning the judge’s original ruling.  The Company filed a petition with theVirginia Supreme Court requesting that it agree to hear an appeal of the trialcourt’s final judgment.  On or about May10, 2007, the Virginia Supreme Court denied our request to hear the case, withthe result that the final ruling of the trial court stands.  Management considers this matter to be concluded.

**Item 1A.  Risk Factors**

There are nomaterial updates to the risk factors previously disclosed in our Form 10-K forthe year ended December 30, 2006.

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

None.

**Item 3.  Defaults Upon Senior Securities**

None.

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

During the fiscal quarter ended June 30, 2007, we submitted certainmatters to a vote of our stockholders through the notice of annual meeting ofstockholders and the solicitation of proxies related thereto.  The proxy materials related to the Registrant’sFifth Annual Meeting of Stockholders were distributed on or about May 21, 2007and the annual meeting of stockholders was held on June 22, 2007 in Vienna,Virginia.  As of the record date prior tosuch meeting, 13,106,792 shares of our common stock were outstanding andentitled to vote at the meeting.  At theannual stockholders meeting of June 22, 2007, 11,573,156 shares of our commonstock were present in person or by proxy, representing 88.3% of our outstandingshares of common stock.

The following sets forth the matters presented for avote by the stockholders and the votes cast for, withheld, abstained, andbroker non-votes:
| **Matter**                                                                                                            | ** ** | **Votes For** | ** ** | **Votes  Withheld** | ** ** | **Abstentions** | ** ** | **Broker Non-Votes** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|-----------------|------------|---------------------------|------------|
| (1) Election of Mr. Ray J. Oleson as a Class II  director with a term serving until the 2010 Annual Meeting           |       | 11,148,013         |       | 425,143             |       |            |       |                      |       |
| (2) Election of General R. Thomas Marsh as a Class  II director with a term serving until the 2010 Annual Meeting     |       | 11,422,323         |       | 150,833             |       |            |       |                      |       |
| (3) Election of Mr. John P. Stenbit as a Class II  director with a term serving until the 2010 Annual Meeting         |       | 11,420,389         |       | 152,767             |       |            |       |                      |       |
| (4) Ratification of the appointment of Ernst &  Young LLP as our independent auditors for the current fiscal year |       | 11,564,518         |       | 5,998               |       | 2,640           |       |                      |       |

 

**Item5.  Other Information**

None.

**Item 6.  Exhibits**

The exhibitsrequired by this item are set forth on the Index to Exhibits attached hereto.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.
|    |   | SI INTERNATIONAL, INC.                |
|--------------|--------|---------------------------------------|
|         |   |                                  |
|         |   |                                  |
|         |   | /s/ Thomas E. Dunn                    |
|    |   | Thomas E. Dunn                        |
|    |   | Executive Vice President,             |
|    |   | Chief Financial Officer and Treasurer |

Date:  August 8, 2007

 

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**INDEX TO EXHIBITS**
| Exhibit No. | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                            |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1         |       | Share Purchase Agreement among the Company, LOGTEC,  Inc., and the stockholders of LOGTEC, Inc. dated May 23, 2007.* (The  appendices and exhibits have been omitted pursuant to Item 601(b)(2) of  Regulation S-K. SI International, Inc. hereby undertakes to furnish  supplementally to the Securities and Exchange Commission copies of any  omitted appendices and exhibits upon request by the Securities and Exchange  Commission). |
| 3.1         |       | Second Restated Certificate of Incorporation (filed  as Exhibit 3.1 to the Company’s Registration Statement on Form S-1/A  (File No. 333-87964) filed on October 25, 2002 (the “Third  Amendment”) and incorporated herein by reference).                                                                                                                                                               |
| 3.2         |       | Amended and Restated Bylaws, as amended (filed as  Exhibit 3.2 to the Company’s Current Report on Form 8-K filed  October 11, 2005 and incorporated herein by reference).                                                                                                                                                                                                                                                   |
| 4.1         |       | Registration Rights Agreement, as amended (filed as  Exhibit 4.1 to the Third Amendment and incorporated herein by  reference).                                                                                                                                                                                                                                                                                                       |
| 4.2         |       | Specimen Certificate of our common stock (filed as  Exhibit 4.2 to the Company’s Registration Statement on Form S-1/A  (File No. 333-87964) filed on November 5, 2002 (the “Fourth  Amendment) and incorporated herein by reference).                                                                                                                                                                        |
| 4.3         |       | Stock Purchase Agreement, as amended (filed as  Exhibit 4.3 to the Fifth Amendment and incorporated herein by  reference).                                                                                                                                                                                                                                                                                                            |
| 4.4         |       | Amendment to Stock Purchase Agreements (filed as  Exhibit 4.4 to the Fourth Amendment and incorporated herein by  reference).                                                                                                                                                                                                                                                                                                         |
| 10.1        |       | 2002 Amended and Restated Omnibus Stock Incentive  Plan (filed as Annex B to the Company’s Proxy Statement on Schedule 14A for  the 2005 Annual Meeting of Stockholders filed on April 21, 2005 and  incorporated herein by reference).                                                                                                                                                                                               |
| 10.2        |       | January 2001 Nonqualified Stock Option Plan  (filed as Exhibit 10.2 to the Company’s Registration Statement on  Form S-1/A (File No. 333-87964) filed on June 24,  2002 (the “First Amendment) and incorporated herein by reference).                                                                                                                                                                   |
| 10.3        |       | SI International, Inc. 2001 Service Award Stock  Option Plan (filed as Exhibit 10.3 to the First Amendment and  incorporated herein by reference).                                                                                                                                                                                                                                                                               |
| 10.4        |       | 1998 Stock Option Plan (filed as Exhibit 10.5  to the First Amendment and incorporated herein by reference).                                                                                                                                                                                                                                                                                                                          |
| 10.5        |       | Non-Qualified Deferred Compensation Plan, as amended  (filed as Exhibit 10.13 to the 2004 10-K and incorporated herein by  reference).                                                                                                                                                                                                                                                                                                     |
| 10.6        |       | Form of SI International, Inc. Stock Option  Agreement Evidencing Grant of Stock Options Under the SI International, Inc.  2002 Amended and Restated Omnibus Stock Incentive Plan, Including Notice of  Stock Option Grant (filed as Exhibit 99.1 to the Company’s Current Report on  Form 8-K filed on March 17, 2005 and incorporated herein by reference).                                                                         |
| 10.7        |       | Amended and Restated Credit Agreement, dated as of  February 9, 2005 (filed as Exhibit 99.1 to the Company’s Current Report  on Form 8-K filed February 15, 2005 and incorporated herein by  reference).                                                                                                                                                                                                                    |
| 10.8        |       | First Amendment to Amended and Restated Credit  Agreement, dated February 27, 2006 (filed as Exhibit 10.1 to the  Company’s Current Report on Form 8-K filed March 3, 2006 and  incorporated herein by reference).                                                                                                                                                                                                          |
| 10.9        |       | Second Amendment to Amended and Restated Credit  Agreement, dated June 8, 2007 (filed as Exhibit 10.1 to the Company’s Current  Report no Form 8-K filed June 11, 2007 and incorporated by herein by  reference).                                                                                                                                                                                                                     |
| 10.10       |       | Executive Employment Agreement with S. Bradford  Antle. *                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.11       |       | Executive Employment Agreement with Thomas E. Dunn.  *                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.12       |       | Executive Employment Agreement with Thomas E. Lloyd  (filed as Exhibit 10.9 to the Third Amendment and incorporated herein by  reference).                                                                                                                                                                                                                                                                                            |
| 10.13       |       | Executive Employment Agreement with Ray J. Oleson. *                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.14       |       | Executive Employment Agreement with Leslee H. Gault  (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K/A filed on  October 2, 2006 and incorporated herein by reference).                                                                                                                                                                                                                                            |

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| Exhibit No. | ** ** | **Description**                                                                                                                                                                                        |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.15       |       | Executive Employment Agreement with Harry D. Gatanas  (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K/A  filed November 15, 2005 and incorporated herein by reference).   |
| 10.16       |       | Executive Employment Agreement with Marylynn Stowers  (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K/A  filed February 2, 2006 and incorporated herein by reference).    |
| 10.17       |       | Executive Employment Agreement with P. Michael  Becraft (filed as Exhibit 10.1 to the Company’s Current Report on Form  8-K/A filed February 24, 2006 and incorporated herein by reference). |
| 10.18       |       | Consulting Services Agreement with Walter J. Culver  (filed as Exhibit 10.12 to the 2004 10-K and incorporated herein by  reference).                                                                  |
| 10.19       |       | Form of Indemnification Agreement (filed as  Exhibit 10.11 to the Third Amendment and incorporated herein by  reference).                                                                    |
| 31.1        |       | Certifications of Chief Executive Officer and Chief  Financial Officer pursuant to Rule 13a-14(a) as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 .*              |
| 32.1        |       | Certifications of Chief Executive Officer and Chief  Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant  to Section 906 of the Sarbanes Oxley Act of 2002.*           |

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*                    Indicatesfiled herewith.

 

 

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