**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

| **(Mark One)** |
|---------------------|
| **ý**          |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934****** |
|                |   |   |
|                |   | **FOR THE QUARTER ENDED SEPTEMBER 27, 2003** |
|                |   |   |
| **o**               |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission File Number****000-50080**

 

**SI International, Inc.**

(Exact name of registrant as specified in itscharter)

 

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

 

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

 

----

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or15 (d) of the Securities Exchange Act of 1934 during the preceding 12months (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.    ý  Yes   o   No

 

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

 

As of November 3, 2003, there were8,447,578 shares outstanding of the registrant’s common stock.

 

 

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**SI INTERNATIONAL, INC.**

**FORM 10-Q**

# **INDEX**

 

 
| **PART I.**        | **FINANCIAL INFORMATION**                                                                                                                  |
|--------------------|--------------------------------------------------------------------------------------------------------------------------------------------|
| ITEM 1             | Financial Statements                                                                                                                       |
|               | Consolidated Balance Sheets at September 27, 2003 (unaudited)  and December 28, 2002 (audited)                                   |
|               | Consolidated Statements of Operations for  the three and nine months ended September 27, 2003 andSeptember 28,  2002 (unaudited) |
|               | Consolidated Statements of Cash Flows for  the nine months ended September 27, 2003 and September 28, 2002                       |
|               | Notes to Consolidated Financial Statements                                                                                                 |
| ITEM 2             | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                                |
| ITEM 3             | Quantitative and Qualitative Disclosures  About Market Risk                                                                                |
| ITEM 4             | Controls and Procedures                                                                                                                    |
|               |                                                                                                                                       |
| **PART  II.**      | **OTHER  INFORMATION**                                                                                                                     |
| ITEM 1             | Legal  Proceedings                                                                                                                         |
| ITEM 2             | Changes in Securities and Use of Proceeds                                                                                                  |
| ITEM 3             | Defaults Upon Senior Securities                                                                                                            |
| ITEM 4             | Submission of Matters to a Vote of Security  Holders                                                                                       |
| ITEM 5             | Other  Information                                                                                                                         |
| ITEM 6             | Exhibits and Reports on Form 8-K                                                                                                           |
| Signatures         |                                                                                                                                       |
| Index  to Exhibits |                                                                                                                                       |
| Certifications     |                                                                                                                                       |

 

2

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## **PART I:  FINANCIALINFORMATION**

### **Item 1.   FinancialStatements**

**SI International, Inc. and Subsidiaries**

**Consolidated Balance Sheets**

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

 
|                                                                                                                                                                                                                 |   | **September 27,  2003** |       | **December 28,  2002** |       |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|------------|-----------------------------|------------|
|                                                                                                                                                                                                                 |   | **(unaudited)**              |       |                        |       |
| **Assets**                                                                                                                                                                                                           |   |                         |       |                        |       |
| **Current assets:**                                                                                                                                                                                                  |   |                         |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                            |   | $                            | 22,546     |                        | $          | 10,856 |   |
| Accounts receivable, net                                                                                                                                                                                             |   | 30,979                       |       | 31,901                      |       |
| Other current assets                                                                                                                                                                                                 |   | 2,970                        |       | 3,741                       |       |
| Total current assets                                                                                                                                                                                                 |   | 56,495                       |       | 46,498                      |       |
| **Property and  equipment, net**                                                                                                                                                                                     |   | 4,016                        |       | 4,542                       |       |
| **Goodwill and  assembled workforce, net**                                                                                                                                                                           |   | 39,829                       |       | 39,829                      |       |
| **Other assets**                                                                                                                                                                                                     |   | 1,185                        |       | 1,446                       |       |
| Total assets                                                                                                                                                                                                         |   | $                            | 101,525    |                        | $          | 92,315 |   |
| **Liabilities and  stockholders’ equity**                                                                                                                                                                       |   |                         | ** ** |                        | ** ** |
| **Current  liabilities:**                                                                                                                                                                                            |   |                         |       |                        |       |
| Accounts payable and accrued expenses                                                                                                                                                                                |   | $                            | 17,425     |                        | $          | 12,712 |   |
| Deferred revenue                                                                                                                                                                                                     |   | 1,149                        |       | 1,074                       |       |
| Other current liabilities                                                                                                                                                                                            |   | 1,463                        |       | 2,775                       |       |
| Total current liabilities                                                                                                                                                                                            |   | 20,037                       |       | 16,561                      |       |
| **Other long-term  liabilities**                                                                                                                                                                                     |   | 2,327                        |       | 1,777                       |       |
| **Commitments and  contingencies**                                                                                                                                                                                   |   |                         | ** ** |                        | ** ** |
| **Stockholders’  equity:**                                                                                                                                                                                      |   |                         | ** ** |                        | ** ** |
| **Common stock**—$0.01  par value per share; 50,000,000 shares authorized; 8,447,519  and 8,439,741 shares issued and  outstanding as of September 27, 2003 and December 28, 2002,  respectively |   | 85                           |       | 85                          |       |
| Additional paid-in capital                                                                                                                                                                                           |   | 75,652                       |       | 75,682                      |       |
| Deferred compensation                                                                                                                                                                                                |   | (372                         | )          | (509                        | )          |
| Retained earnings (accumulated deficit)                                                                                                                                                                              |   | 3,796                        |       | (1,281                      | )          |
| Total stockholders’ equity                                                                                                                                                                                      |   | 79,161                       |       | 73,977                      |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                      |   | $                            | 101,525    |                        | $          | 92,315 |   |

 

###### ***See accompanying notes***

 

3

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**SI International, Inc. and Subsidiaries**

**Consolidated Statements of Operations**

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

**Unaudited**

 
|                                                                                                                                                                                                                                                    |   | **Three  Months Ended**    |   | **Nine  Months Ended**     |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------|--------|----------------------------|--------|
|                                                                                                                                                                                                                                                    |   | **Sept.  27,********2003** |   | **Sept.  28,********2002** |   | **Sept.  27,********2003** |   | **Sept.  28,********2002** |   |
|                                                                                                                                                                                                                                                    |   |                       |   |                       |   |   |   |   |   |
| **Revenue**                                                                                                                                                                                                                                             |   | $                          | 42,082 |                       | $      | 38,378 |   | $ | 124,130 |   | $ | 107,248 |   |
| **Costs and expenses:**                                                                                                                                                                                                                                 |   |                       |   |                       |   |   |   |   |   |
| Direct costs                                                                                                                                                                                                                                            |   | 25,837                     |   | 24,427                     |   | 75,127 |   | 65,428 |   |
| Indirect costs, including $33 and $35 of non-cash  stock-based compensation in fiscal quarters ended Sept. 27, 2003 and Sept.  28, 2002,  respectively and $100 and  $103 in the nine months ended Sept. 27, 2003 and Sept. 28, 2002, respectively |   | 12,318                     |   | 10,838                     |   | 38,648 |   | 36,479 |   |
| Depreciation and Amortization                                                                                                                                                                                                                           |   | 497                        |   | 523                        |   | 1,495 |   | 1,519 |   |
| Total operating expenses                                                                                                                                                                                                                                |   | 38,652                     |   | 35,788                     |   | 115,270 |   | 103,426 |   |
| **Income from operations**                                                                                                                                                                                                                              |   | 3,430                      |   | 2,590                      |   | 8,860 |   | 3,822 |   |
| **Interest expense**                                                                                                                                                                                                                                    |   | (161                       | )      | (659                       | )      | (469 | ) | (2,013 | ) |
| **Minority interests**                                                                                                                                                                                                                                  |   | —                     |   | (41                        | )      | — |   | (118 | ) |
| **Change in fair value of put  warrants**                                                                                                                                                                                                               |   | —                     |   | 1,031                      |   | — |   | 640 |   |
| **Income before provision for income  taxes**                                                                                                                                                                                                           |   | 3,269                      |   | 2,921                      |   | 8,391 |   | 2,331 |   |
| **Provision for  income taxes**                                                                                                                                                                                                                    |   | 1,290                      |   | 819                        |   | 3,314 |   | 694 |   |
| **Net income**                                                                                                                                                                                                                                          |   | 1,979                      |   | 2,102                      |   | 5,077 |   | 1,637 |   |
| **Dividends on redeemable cumulative  preferred stock**                                                                                                                                                                                                 |   | —                     |   | 591                        |   | — |   | 1,681 |   |
| **Net income (loss) attributable to  common stockholders**                                                                                                                                                                                              |   | $                          | 1,979  |                       | $      | 1,511 |   | $ | 5,077 |   | ($44 | ) |
|                                                                                                                                                                                                                                                    |   |                       |   |                       |   |   |   |   |   |
| **Earnings (loss) per common share:**                                                                                                                                                                                                                   |   |                       |   |                       |   |   |   |   |   |
| Basic net income (loss) per common share                                                                                                                                                                                                                |   | $                          | 0.23   |                       | $      | 0.57 |   | $ | 0.60 |   | $ | (0.02 | ) |
|                                                                                                                                                                                                                                                    |   |                       |   |                       |   |   |   |   |   |
| Diluted net income (loss) per common share                                                                                                                                                                                                              |   | $                          | 0.23   |                       | $      | 0.17 |   | $ | 0.60 |   | $ | (0.02 | ) |
|                                                                                                                                                                                                                                                    |   |                       |   |                       |   |   |   |   |   |
| **Basic weighted-average shares  outstanding**                                                                                                                                                                                                          |   | 8,447                      |   | 2,632                      |   | 8,446 |   | 2,632 |   |
| **Diluted weighted-average shares  outstanding**                                                                                                                                                                                                        |   | 8,612                      |   | 2,779                      |   | 8,457 |   | 2,632 |   |

 

***See accompanying notes***

 

4

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**SI International, Inc. and Subsidiaries**

**Consolidated Statements of Cash Flows**

**(Amounts in thousands)**

**Unaudited**

** **
|                                                                               |   | **Nine Months Ended** |   |
|------------------------------------------------------------------------------------|--------|-----------------------|--------|
|                                                                               |   | **Sept. 27,  2003**   |   | **Sept. 28,  2002** |   |
| **Cash flows from operating activities:**                                          |   |                  |   |   |   |
| Net income                                                                         |   | $                     | 5,077  |   | $ | 1,637 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |   |                  |   |   |   |
| Depreciation and amortization                                                      |   | 1,495                 |   | 1,519 |   |
| Loss on disposal of fixed assets                                                   |   | 178                   |   | — |   |
| Stock-based compensation                                                           |   | 100                   |   | 103 |   |
| Amortization of deferred financing costs and debt  discount                        |   | 286                   |   | 224 |   |
| Change in fair value of put warrants                                               |   | —                |   | (640 | ) |
| Minority interests                                                                 |   | —                |   | 118 |   |
| Changes in operating assets and liabilities, net of  effect of acquisitions:       |   |                  |   |   |   |
| Accounts receivable                                                                |   | 922                   |   | 489 |   |
| Other current assets                                                               |   | 770                   |   | (1,917 | ) |
| Other assets                                                                       |   | (25                   | )      | 1,181 |   |
| Accounts payable and accrued expenses                                              |   | 4,712                 |   | 2,635 |   |
| Other current liabilities                                                          |   | 986                   |   | — |   |
| Deferred revenue                                                                   |   | 75                    |   | 207 |   |
|                                                                               |   |                  |   |   |   |
| Other long term liabilities                                                        |   | 545                   |   | 290 |   |
| Net cash provided by operating activities                                          |   | 15,121                |   | 5,846 |   |
| **Cash flows from investing activities:**                                          |   |                  |   |   |   |
| Purchase of property and equipment                                                 |   | (1,025                | )      | (1,117 | ) |
| Net cash used in investing activities                                              |   | (1,025                | )      | (1,117 | ) |
| **Cash flows from financing activities:**                                          |   |                  |   |   |   |
| Proceeds from issuance of common stock                                             |   | 8                     |   | — |   |
| Repayments of (proceeds from) bank overdrafts                                      |   | (2,201                | )      | 2 |   |
| Borrowings under line of credit                                                    |   | —                |   | 62,179 |   |
| Repayments of line of credit                                                       |   | —                |   | (63,941 | ) |
| Repayments of notes payable                                                        |   | (137                  | )      | (900 | ) |
| Repayments of long-term debt and borrowings from  stockholders                     |   | —                |   | (950 | ) |
| Repayments of capital leases                                                       |   | (76                   | )      | (125 | ) |
| Net cash used in financing activities                                              |   | (2,406                | )      | (3,735 | ) |
| **Net increase in cash and cash equivalents**                                      |   | 11,690                |   | 994 |   |
| **Cash and cash equivalents, beginning of period**                                 |   | 10,856                |   | 470 |   |
| **Cash and cash equivalents, end of period**                                       |   | $                     | 22,546 |   | $ | 1,464 |   |
| **Supplemental disclosures of cash flow information:**                             |   |                  |   |   |   |
| Cash payments for interest                                                         |   | $                     | 242    |   | $ | 1,426 |   |
| Cash payments for income taxes                                                     |   | $                     | 2,338  |   | $ | 1,640 |   |
| Purchases of assets under capital lease                                            |   | $                     | 122    |   | — |   |

 

***See accompanyingnotes***

 

5

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**SI International, Inc. and Subsidiaries**

 

**Notes to consolidated financial statemen****ts**

**(Unaudited)**

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

 

The accompanying unaudited consolidated financialstatements of SI International, Inc. and its subsidiaries (the “Company”) havebeen prepared in accordance with accounting principles generally accepted inthe United States for interim financial information and with the instructionsto Form 10-Q and Article 10 of Regulation S-X. Accordingly, theydo not include all of the information and footnotes required by accountingprinciples generally accepted in the United States for complete financialstatements. In the opinion of management, all adjustments (consisting of normalrecurring accruals) considered necessary for a fair presentation have beenincluded. Operating results for the quarter and nine months endedSeptember 27, 2003 are not necessarily indicative of the results that maybe expected for the year ending December 27, 2003. For furtherinformation, refer to the financial statements and footnotes included in SIInternational’s Annual Report on Form 10-K/A for the year endedDecember 28, 2002.

 

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

 

**Principles of consolidation**

 

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

 

**Use of estimates**

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financial statementsand the reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates.

 

**Reporting periods**

 

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

 

**Cash and cash equivalents**

 

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

 

The balancesof checks that the Company had written, but that had not yet been presented tothe bank for payment were $0 and $2.2 million at September 27, 2003 andDecember 28, 2002, respectively. These balances have been classified in other current liabilities in theaccompanying consolidated balance sheets.

 

**Revenue Recognition**

 

Our accounting policy regarding revenue recognition is written tocomply with the following criteria:  (1)a contract has been executed; (2) the contract price is fixed and determinable;(3) delivery of services or products has occurred; and (4) collectibility ofthe contract price is considered probable and can be reasonably estimated.  Compliance with these criteria may requireus to make significant judgments and estimates.

 

6

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**Significant customers**

 

Revenuegenerated from contracts with the federal government or prime contractors doingbusiness with the federal government accounted for a significant percentof revenues in the fiscal quarters and nine months ending September 27,2003 and September 28, 2002.

 
|                      |   | **Percent of revenues** |   |
|---------------------------|--------|-------------------------|--------|
|                      |   | **Three Months Ended**  |   | **Nine Months Ended** |   |
|                      |   | **Sept. 27,  2003**     |   | **Sept. 28,  2002** |   | **Sept. 27,  2003** |   | **Sept. 28,  2002** |   |
|                      |   |                    |   |   |   |   |   |   |   |
| Department of Defense     |   | 55.7                    | %      | 52.0 | % | 53.7 | % | 48.9 | % |
| Federal civilian agencies |   | 37.9                    |   | 42.1 |   | 39.8 |   | 44.3 |   |
| Commercial entities       |   | 6.4                     |   | 5.9 |   | 6.5 |   | 6.8 |   |
| Total revenue             |   | 100.0                   | %      | 100.0 | % | 100.0 | % | 100.0 | % |

 

For the thirdquarter of 2003 as well as the third quarter of 2002, we had two contracts thatgenerated more than 10% of our revenue. Our C4I2SR contract with the U.S. Air Force Space Command representedapproximately 24.6% and 25.4% of total revenue for the quarters endedSeptember 27, 2003 and September 28, 2002, respectively.   Our National Visa Center contract with theDepartment of State represented approximately 13.6% and 10.4% of total revenuefor the quarters ended September 27, 2003 and September 28, 2002,respectively.  For the nine months of2003 as well as the first nine months of 2002, these two contracts alsorepresented the contracts which generated more than 10% of total revenue.  Our C4I2SR contract representedapproximately 22.4% and 23.3% of total revenue for the nine months endedSeptember 27, 2003 and September 28, 2002, respectively.   Our National Visa Center contractrepresented approximately 14.3% and 10.9% of total revenue for the nine monthsended September 27, 2003 and September 28, 2002, respectively.

 

**Deferred financing costs**

 

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

 
|                     |   | **September 27,  2003** |   | **December 28,  2002** |   |
|--------------------------|--------|------------------------------|--------|-----------------------------|--------|
|                     |   |                         |   |                        |   |
| Deferred loan costs      |   | $                            | 1,120  |                        | $      | 1,093 |   |
| Accumulated amortization |   | (328                         | )      | (42                         | )      |
|                     |   | $                            | 792    |                        | $      | 1,051 |   |

 

**Deferred revenue**

 

At the end ofthe quarter ended September 27, 2003 and the fiscal year endedDecember 28, 2002, we received advance payments of approximately $1.1million from a customer to purchase equipment to be used in a contract. Theadvances were reflected as deferred revenue as of September 27, 2003 andDecember 28, 2002 in the accompanying consolidated balance sheets.

 

**Fair value of financial instruments**

 

The Company’sfinancial instruments 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 September 27, 2003 and December 28,2002.

 

7

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**Stock-based compensation**

 

InDecember 2002, the FASB issued SFAS No. 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure—an amendment of SFAS 123.”  This statement amends SFAS No. 123, “Accountingfor Stock-Based Compensation,” to provide alternative methods of transition fora voluntary change to the fair value based method of accounting for stock-basedemployee compensation.  In addition,this statement amends the disclosure requirements of SFAS No. 123 to requireprominent disclosures in both annual and interim financial statements about themethod of accounting for stock-based employee compensation and the effect ofthe method used on reported results. The Company has chosen to continue to account for stock-basedcompensation using the intrinsic value method prescribed in APB Opinion No. 25and related interpretations. Accordingly, compensation expense for stock options is measured as theexcess, if any, of the fair market value of the Company’s stock at the date ofthe grant over the exercise price of the related option.  The Company has adopted the annualdisclosure provisions of SFAS No. 148 in its financial reports for the yearended December 28, 2002 and has adopted the interim disclosure provisionsfor its financial reports for the quarter and nine months endedSeptember 27, 2003.

 
|                                                                                                                       |   | **Three Months Ended** |   | **Nine Months Ended** |   |
|----------------------------------------------------------------------------------------------------------------------------|--------|------------------------|--------|-----------------------|--------|
|                                                                                                                       |   | **Sept. 27,  2003**    |   | **Sept. 28,  2002**   |   | **Sept. 27,  2003** |   | **Sept. 28,  2002** |   |
|                                                                                                                       |   |                   |   |                  |   |   |   |   |   |
| Net income - as reported                                                                                                   |   | $                      | 1,979  |                  | $      | 2,102 |   | $ | 5,077 |   | $ | 1,637 |   |
| Add: total stock-based employee compensation expense as reported  under intrinsic value method (APB No. 25) for all awards |   |                   |   |                  |   |   |   |   |   |
|                                                                                                                       |   | 33                     |   | 35                    |   | 100 |   | 103 |   |
| Deduct: Total stock-based compensation expense determined under fair  value based method (SFAS No. 123) for all awards     |   | (114                   | )      | (57                   | )      | (534 | ) | (360 | ) |
|                                                                                                                       |   |                   |   |                  |   |   |   |   |   |
| Net income - Pro forma                                                                                                     |   | 1,898                  |   | 2,080                 |   | 4,643 |   | 1,380 |   |
|                                                                                                                       |   |                   |   |                  |   |   |   |   |   |
| Dividends on redeemable preferred stock                                                                                    |   | —                 |   | 591                   |   | — |   | 1,681 |   |
|                                                                                                                       |   |                   |   |                  |   |   |   |   |   |
| Net income (loss) attributable to common stockholders - Pro forma                                                          |   | 1,898                  |   | 1,489                 |   | 4,643 |   | (301 | ) |
|                                                                                                                       |   |                   |   |                  |   |   |   |   |   |
| Basic earnings (loss) per share - as reported                                                                              |   | 0.23                   |   | 0.57                  |   | 0.60 |   | (0.02 | ) |
|                                                                                                                       |   |                   |   |                  |   |   |   |   |   |
| Diluted earnings (loss) per share - as reported                                                                            |   | 0.23                   |   | 0.17                  |   | 0.60 |   | (0.02 | ) |
|                                                                                                                       |   |                   |   |                  |   |   |   |   |   |
| Basic earnings (loss) per share - Pro forma                                                                                |   | 0.23                   |   | 0.57                  |   | 0.55 |   | (0.11 | ) |
|                                                                                                                       |   |                   |   |                  |   |   |   |   |   |
| Diluted earnings (loss) per share - Pro forma                                                                              |   | 0.22                   |   | 0.16                  |   | 0.55 |   | (0.11 | ) |
|                                                                                                                            |        |                        |        |                       |        |  |  |  |  |  |  |  |  |

 

**Earnings (loss) per share**

 

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

 

8

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The following details the computation of net income (loss) per commonshare:

 
|                                                                  |   | **Three Months Ended** |   | **Nine Months Ended** |   |
|-----------------------------------------------------------------------|--------|------------------------|--------|-----------------------|--------|
|                                                                  |   | **Sept. 27,  2003**    |   | **Sept. 28,  2002**   |   | **Sept. 27,  2003** |   | **Sept. 28,  2002** |   |
|                                                                  |   |                   |   |                  |   |   |   |   |   |
| Net Income                                                            |   | $                      | 1,979  |                  | $      | 2,102 |   | $ | 5,077 |   | $ | 1,637 |   |
| Less: Dividends on redeemable cumulative  preferred stock             |   | —                 |   | 591                   |   | — |   | 1,681 |   |
|                                                                  |   |                   |   |                  |   |   |   |   |   |
| Net Income (loss) attributable to common  stockholders – Basic   |   | 1,979                  |   | 1,511                 |   | 5,077 |   | (44 | ) |
| Diluted effect of change in value of put  warrants                    |   | —                 |   | 1,031                 |   | — |   | — |   |
| Net Income (loss) attributable to common  stockholders – Diluted |   | 1,979                  |   | 480                   |   | 5,077 |   | (44 | ) |
|                                                                  |   |                   |   |                  |   |   |   |   |   |
| **Weighted average share calculation:**                               |   |                   |   |                  |   |   |   |   |   |
|                                                                  |   |                   |   |                  |   |   |   |   |   |
| Basic weighted average share outstanding                              |   | 8,447                  |   | 2,632                 |   | 8,446 |   | 2,632 |   |
| Treasury stock effect of stock options                                |   | 165                    |   | 39                    |   | 11 |   | — |   |
| Treasury stock effect of put warrants                                 |   | —                 |   | 108                   |   | — |   | — |   |
|                                                                  |   |                   |   |                  |   |   |   |   |   |
| Diluted weighted average shares outstanding                           |   | 8,612                  |   | 2,779                 |   | 8,457 |   | 2,632 |   |
|                                                                       |        |                        |        |                       |        |  |  |  |  |  |  |  |  |

 

**Reclassifications**

 

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

 

**New accounting pronouncements**

 

In November 2002, theFinancial Accounting Standards Board issued Interpretation No. 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others” (FIN 45).  FIN 45 elaborates on the disclosure to be made by a guarantor inits interim and annual financial statements about its obligations under certainguarantees that it has issued. It also clarifies that a guarantor is requiredto recognize, at the inception of a guarantee, a liability for the fair valueof the obligation undertaken in issuing the guarantee. The initial recognitionand initial measurement provisions of FIN 45 are applicable on a prospectivebasis to guarantees issued or modified after December 31, 2002. Thedisclosure requirements of FIN 45 are effective for financial statements ofinterim or annual periods ending after December 31, 2002. The Company doesnot expect adoption of FIN 45 to have a material effect on its financialcondition, results of operations or liquidity**.**

 

In January 2003, the FinancialAccounting Standards Board issued Interpretation No. 46, “Consolidation ofVariable Interest Entities (FIN 46).” FIN 46 clarifies the application of Accounting Research Bulletin No. 51,“Consolidated Financial Statements,” to certain entities in which equityinvestors do not have the characteristics of a controlling financial interestor do not have sufficient equity at risk for the entity to finance itsactivities without additional subordinated financial support from the otherparties. FIN 46 applies immediately to variable interest entities created afterJanuary 31, 2003. The Company does not expect adoption of FIN 46 to have a materialeffect on its financial condition, results of operations or liquidity.

 

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

 

OnMarch 9, 2000, the Company purchased all of the outstanding common stockof System Technology Associates, Inc. for consideration of approximately$33.0 million in cash and $4.8 million in subordinated notes in atransaction accounted for as a purchase. The subordinated notes bear interestat the prime rate plus 2 percent with $3.8 million due inMarch 2001, subject to collection of certain accounts receivable, and$1.0 million due in March 2002. Approximately

 

9

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$4.3 million of the noteswere repaid at maturity in March 2001 and 2002 and payments ofapproximately $343,000 of these notes had been withheld by the Company as ofSeptember 27, 2003 since certain accounts receivable have not been fullycollected.

 

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

 

Accountsreceivable consists of the following (in thousands):

 
|                                                                                               |   | **September 27, 2003** |   | **December 28, 2002** |   |
|----------------------------------------------------------------------------------------------------|--------|-----------------------------|--------|----------------------------|--------|
|                                                                                               |   |                        |   |                       |   |
| Billed accounts receivable                                                                         |   | $                           | 15,667 |                       | $      | 18,377 |   |
| Unbilled accounts receivable:                                                                      |   |                        |   |                       |   |
| Currently billable                                                                                 |   | 13,918                      |   | 11,926                     |   |
| Unbilled retainages and milestones payments  expected to be billed within the next 12 months       |   | 2,054                       |   | 2,054                      |   |
| Indirect costs incurred and charged to  cost-plus contracts in excess of provisional billing rates |   | 795                         |   | 640                        |   |
| Total unbilled accounts receivable                                                                 |   | 16,767                      |   | 14,620                     |   |
| Allowance for doubtful accounts                                                                    |   | (1,455                      | )      | (1,096                     | )      |
| Accounts receivable, net                                                                           |   | $                           | 30,979 |                       | $      | 31,901 |   |

 

The currentlybillable amounts included as unbilled accounts receivable as ofSeptember 27, 2003 represent amounts, which are billed during thefollowing quarter of the current year. They are billings for services renderedprior to quarter-end, which are billed once necessary billing data has beencollected and an invoice is produced.

 

Long-termunbilled accounts receivable of approximately $400,000 as of September 27,2003 and December 28, 2002 are included in other assets in theaccompanying consolidated balance sheets.

 

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

 

Property andequipment consist of the following (in thousands):

 
|                                                 |   | **September 27, 2003** |   | **December 28, 2002** |   |
|------------------------------------------------------|--------|-----------------------------|--------|----------------------------|--------|
| Computers and equipment                              |   | $                           | 6,217  |                       | $      | 5,620 |   |
| Software                                             |   | 1,852                       |   | 1,810                      |   |
| Furniture and fixtures                               |   | 1,328                       |   | 1,216                      |   |
| Leasehold improvements                               |   | 661                         |   | 692                        |   |
|                                                 |   | 10,058                      |   | 9,338                      |   |
| Less—Accumulated depreciation and  amortization |   | (6,042                      | )      | (4,796                     | )      |
|                                                 |   | $                           | 4,016  |                       | $      | 4,542 |   |

 

Property and equipment includes assets financed under capital leaseobligations of approximately $209,000 and $272,000, net of accumulateddepreciation, as of September 27, 2003 and December 28, 2002,respectively.

 

Depreciationexpense of approximately $0.5 million and $1.5 million was recorded in thequarter and nine months ended September 27, 2003, respectively, comparedto $0.5 million and $1.5 million in the quarter and nine months endedSeptember 28, 2002, respectively.

 

10

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

 

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

 

|                                  |   | **September 27, 2003** |   | **December 28, 2002** |   |
|---------------------------------------|--------|-----------------------------|--------|----------------------------|--------|
|                                  |   |                        |   |                       |   |
| Accounts payable                      |   | $                           | 7,626  |                       | $      | 6,660 |   |
| Accrued compensation and benefits     |   | 7,009                       |   | 5,216                      |   |
| Accrued interest                      |   | 90                          |   | 45                         |   |
| Other accrued liabilities             |   | 2,700                       |   | 791                        |   |
| Accounts payable and accrued expenses |   | $                           | 17,425 |                       | $      | 12,712 |   |

 

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

 

Debt, which isincluded in other current liabilities in the accompanying balance sheet,consists of the following (in thousands):

 
|                         |   | **September 27, 2003** |   | **December 28, 2002** |   |
|------------------------------|--------|-----------------------------|--------|----------------------------|--------|
| Notes payable:               |   |                        |   |                       |   |
| Indemnification note payable |   | $                           | 343    |                       | $      | 480 |   |
| Total debt                   |   | $                           | 343    |                       | $      | 480 |   |

 

Our creditfacility consists of a $35.0 million secured revolving creditarrangement.  As of September 27,2003, we had no borrowings outstanding under this credit facility.

 

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

 

**Leases**

 

As of September 27,2003, the Company had noncancelable operating leases, primarily for realestate, that expire over the next ten years. Rental expense during the quarterand nine months ended September 27, 2003 was approximately $1.3 millionand $4.0 million, respectively, compared to rental expense of approximately$1.1 million and $3.3 million during the quarter and nine months endedSeptember 28, 2002, respectively.

 

**Contract cost audits**

 

Payments tothe Company on government cost reimbursable contracts are based on provisional,or estimated indirect rates, which are subject to audit on an annual basis bythe Defense Contract Audit Agency (DCAA). The cost audits result in thenegotiation and determination of the final indirect cost rates that the Companymay use for the period(s) audited. The final rates, if different from theprovisional rates, may create an additional receivable or liability for theCompany. The Company’s revenue recognition policy calls for revenue recognizedon all cost reimbursable government contracts to be recorded at provisionalrates unless collectibility is reasonably assured for costs incurred at higherrates. To the extent the indirect rate differential creates a liability for theCompany, the differential is recognized as a reduction to revenue whenidentified.

 

**Litigation and claims**

 

We are notcurrently a party to any litigation or legal proceedings. We may becomeinvolved in legal and governmental, administrative or contractual proceedingsin the future.

 

11

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

 

**Stock option plan**

 

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

 

InJanuary 2001, the Company adopted the January 2001 Nonqualified StockOption Plan. Under the plan, the Company may grant stock options to directors,consultants, executives and other key employees of the Company and itsaffiliates to purchase its common stock. The Company may grant stock options topurchase up to 35,056 shares of its common stock.  No additional grants will be made under this plan.

 

InMarch 2001, the Company adopted the 2001 Service Award Stock Option Planto grant stock options to purchase up to 16,179 shares of its common stock toits employees and employees of its affiliates. No additional grants will be made under this plan.

 

InMay 2002, the Company adopted the 2002 Stock Incentive Plan to grant stockoptions to purchase up to 1,700,000 shares of its common stock to its employeesand employees of its affiliates.  InOctober 2002, the Company amended this amount to 1,600,000 shares of itscommon stock.  The terms of the 2002Stock Incentive Plan state that this ceiling of 1,600,000 shares of commonstock shall automatically increase at the beginning of each fiscal year by anumber of shares equal to the lesser of 160,000 shares of common stock and anamount determined by the Company’s Board of Directors.  Through the date of this report, theCompany’s Board of Directors has not authorized any increase to the number of sharesallocated to the 2002 Stock Incentive Plan. Therefore, the current number of shares of the Company’s common stockallocated to this plan remains 1,600,000. As of September 27, 2003, the Company had issued 867,310 stockoptions under the 2002 Stock Incentive Plan against a ceiling of 1,600,000shares of common stock authorized under this plan.

 

**Item 2.   Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

*The following discussion and analysis shouldbe read in conjunction with the consolidated financial statements and relatednotes included elsewhere in this Form 10-Q. This discussion and analysiscontains forward-looking statements that**involve known andunknown risks, uncertainties,and other factors that may causeour actual results, level of activity,performance or achievements to bematerially different from any future results, levels of activity, performanceor achievements expressed or implied by such forward-looking statements. In some cases, you can identify thesestatements by forward-looking words such as “anticipate,” “believe,” “could,”“estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “should,” “will,”and “would” or similar words. Youshould read statements that contain these words carefully because they discussour future expectations, contain projections of our future results ofoperations or of our financial position, or state other forward-lookinginformation. We believe that it is important to communicate our futureexpectations to our investors. However, there may be events in the future that we are not able to predictaccurately or control.In particular, statements that we make in this section relating to thesufficiency of anticipated sources of capital to meet our cash requirements areforward- looking statements. Our actual results could differ materially fromthose anticipated in these forward-looking statements for many reasons,including as a result of some of the factors described below,  elsewhere in this Form 10-Q and in the section entitled“Risk Factors” in our Form 10-K/A for the fiscal year ended December 28,2002.   You should not place unduereliance on these forward-looking statements, which apply only as of the dateof the filing of this Form 10-Q.*

 

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

 

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

 

12

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**Overview**

 

We are aprovider of information technology and network solutions primarily to thefederal government. Our clients include the U.S. Air Force Space Command, U.S.Army, the Department of State, the Immigration and Naturalization Service,which has now transitioned to become the Bureau of Citizenship and ImmigrationServices in the Department of Homeland Security, and the intelligencecommunity. In addition, we provide our services to a small number of commercialentities. We combine our technology and industry expertise to provide a fullspectrum of state-of-the-practice solutions and services, from design anddevelopment to implementation and operations, to assist our clients inachieving their missions. Our service offerings focus primarily on our clients’mission-critical needs in the areas of:

 

•                  informationtechnology applications;

 

•                  systemsengineering;

 

•                  network andtelecommunications engineering; and

 

•                  mission-criticaloutsourcing.

 

In the threeand nine months ended September 27, 2003, we received 93.6% and 93.5%,respectively, of our revenues from services we provided to various departmentsand agencies of the federal government and 6.4% and 6.5%, respectively of ourtotal revenues from work performed for commercial entities. In comparison, forthe three and nine months ended September 28, 2002, we received 94.1% and93.2%, respectively of our revenues from services we provided to federalgovernment agencies and 5.9% and 6.8%, respectively of total revenues from workperformed for commercial entities.  Thefollowing table shows our revenues from the client groups listed as apercentage of total revenue. Revenue data for the Department of Defenseincludes revenue generated from work performed under engagements for both theDepartment of Defense and the intelligence community.

 
|                      |   | **Three Months Ended** |   | **Nine Months Ended**   |   |
|---------------------------|--------|------------------------|--------|-------------------------|--------|
|                      |   | **Sept. 27,  2003**    |   | **Sept. 28,**

**2002** |   | **Sept. 27,  2003** |   | **Sept. 28,  2002** |   |
|                      |   |                   |   |                    |   |   |   |   |   |
| Department of Defense     |   | 55.7                   | %      | 52.0                    | %      | 53.7 | % | 48.9 | % |
| Federal civilian agencies |   | 37.9                   | %      | 42.1                    | %      | 39.8 | % | 44.3 | % |
| Commercial entities       |   | 6.4                    | %      | 5.9                     | %      | 6.5 | % | 6.8 | % |
| Total revenue             |   | 100.0                  | %      | 100.0                   | %      | 100.0 | % | 100.0 | % |

 

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

 
|                   |   | **Three Months Ended** |   | **Nine Months Ended** |   |
|------------------------|--------|------------------------|--------|-----------------------|--------|
|                   |   | **Sept. 27,  2003**    |   | **Sept. 28,  2002**   |   | **Sept. 27,  2003** |   | **Sept. 28,  2002** |   |
|                   |   |                   |   |                  |   |   |   |   |   |
| Prime contract revenue |   | 85.0                   | %      | 84.4                  | %      | 83.7 | % | 82.3 | % |
| Subcontract revenue    |   | 15.0                   | %      | 15.6                  | %      | 16.3 | % | 17.7 | % |
| Total revenue          |   | 100.0                  | %      | 100.0                 | %      | 100.0 | % | 100.0 | % |

 

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

 

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|               |   | **Three  Months Ended** |   | **Nine Months Ended** |   |
|--------------------|--------|-------------------------|--------|-----------------------|--------|
|               |   | **Sept. 27,  2003**     |   | **Sept. 28,  2002**   |   | **Sept. 27,  2003** |   | **Sept. 28,  2002** |   |
|               |   |                    |   |                  |   |   |   |   |   |
| Cost reimbursable  |   | 40.4                    | %      | 42.2                  | %      | 38.4 | % | 40.9 | % |
| Time and materials |   | 32.4                    | %      | 41.8                  | %      | 35.6 | % | 43.1 | % |
| Fixed price        |   | 27.2                    | %      | 16.0                  | %      | 26.0 | % | 16.0 | % |
| Total              |   | 100.0                   | %      | 100.0                 | %      | 100.0 | % | 100.0 | % |

 

Under costreimbursable contracts, we are reimbursed for costs that are determined to bereasonable, allowable and allocable to the contract, and paid a feerepresenting the profit margin negotiated between us and the contractingagency, which may be fixed or performance based. Under cost reimbursable contractswe recognize revenues and an estimate of applicable fees earned as costs areincurred. We consider fixed fees under cost reimbursable contracts to be earnedin proportion to the allowable costs incurred in performance of the contract.For performance-based fees under cost reimbursable contracts, we recognize therelevant portion of the expected fee to be awarded by the client at the timesuch fee can be reasonably estimated, based on factors such as our prior awardexperience and communications with the client regarding performance. Ingeneral, cost reimbursable contracts are the least profitable of our governmentcontracts. In the three and nine months ended September 27, 2003, 40.4%and 38.4%, respectively, of our revenues were derived from cost reimbursablecontracts.  In the three and nine monthsended September 28, 2002, 42.2% and 40.9%, respectively, of our revenueswere derived from cost reimbursable contracts.

 

Under time andmaterials contracts, we are reimbursed for labor at fixed hourly rates andgenerally reimbursed separately for allowable materials, costs and expenses. Tothe extent that our actual labor costs under a time and materials contract arehigher or lower than the billing rates under the contract, our profit under thecontract may either be greater or less than we anticipated or we may suffer aloss under the contract. We recognize revenues under time and materialscontracts by multiplying the number of direct labor hours expended by thecontract billing rates and adding the effect of other billable direct costs. Ingeneral, we realize a higher profit margin on work performed under time andmaterials contracts than cost reimbursable contracts. In the three and ninemonths ended September 27, 2003, 32.4% and 35.6%, respectively, of ourrevenues were derived from time and materials contracts.  In the three and nine months endedSeptember 28, 2002, 41.8% and 43.1%, respectively, of our revenues werederived from time and material contracts.

 

Under fixedprice contracts, we perform specific tasks for a fixed price. Compared to costreimbursable and time and materials contracts, fixed price contracts generallyoffer higher profit margin opportunities but involve greater financial riskbecause we bear the impact of cost overruns in return for the full benefit ofany cost savings. We generally do not undertake complex, high-risk work, suchas long-term software development, under fixed price terms. Fixed pricecontracts may include either a product delivery or specific service performanceover a defined period.  Revenue on fixedprice contracts that provide for the Company to render services throughout aperiod is recognized as earned according to contract terms as the service isprovided on a proportionate performance basis. These contracts are generally less than six months in duration.  For fixed price contracts that provide forthe delivery of a specific product with related customer acceptance provisions,revenues are recognized as those products are delivered and accepted.  In the three and nine months endedSeptember 27, 2003, 27.2% and 26.0%, respectively, of our revenues werederived from fixed price contracts.   Inthe three and nine months ended September 28, 2002, 16.0% and 16.0%, respectively,of our revenues were derived from fixed price contracts.

 

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

 

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

 

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

 

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We activelymonitor our relationships with our clients during our engagements, as well asthe quality of the service we provide, to assist in our efforts to winrecompetition bids. In addition, we strive to maintain good relationships witha wide variety of government contractors.

 

**Results of Operations**

 

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

 
|                                           |   | **Three Months Ended** |   | **Nine Months Ended** |   |
|------------------------------------------------|--------|------------------------|--------|-----------------------|--------|
|                                           |   | **Sept. 27,  2003**    |   | **Sept. 28,  2002**   |   | **Sept. 27,  2003** |   | **Sept. 28,  2002** |   |
|                                           |   |                   |   |                  |   |   |   |   |   |
| Revenue                                        |   | 100.0                  | %      | 100.0                 | %      | 100.0 | % | 100.0 | % |
| Costs and expenses:                            |   |                   |   |                  |   |   |   |   |   |
| Direct costs                                   |   | 61.3                   |   | 63.7                  |   | 60.5 |   | 61.0 |   |
| Indirect costs                                 |   | 29.3                   |   | 28.2                  |   | 31.1 |   | 34.0 |   |
| Depreciation                                   |   | 1.2                    |   | 1.4                   |   | 1.2 |   | 1.4 |   |
| Amortization                                   |   | —                 |   | —                |   | — |   | — |   |
| Total operating expenses                       |   | 91.8                   |   | 93.3                  |   | 92.8 |   | 96.4 |   |
| Income from operations                         |   | 8.2                    |   | 6.7                   |   | 7.2 |   | 3.6 |   |
| Other income (expense)                         |   | —                 |   | —                |   | — |   | — |   |
| Interest expense                               |   | (0.4                   | )      | (1.7                  | )      | (0.4 | ) | (1.9 | ) |
| Minority interests                             |   | —                 |   | (0.1                  | )      | — |   | (0.1 | ) |
| Change in fair value of put warrants           |   | —                 |   | 2.7                   |   | — |   | 0.6 |   |
| Income before provision for  income taxes |   | 7.8                    |   | 7.6                   |   | 6.8 |   | 2.2 |   |
| Provision for  income taxes               |   | 3.1                    |   | 2.1                   |   | 2.7 |   | 0.6 |   |
| Net income                                     |   | 4.7                    | %      | 5.5                   | %      | 4.1 | % | 1.6 | % |

 

**Three months ended September 27, 2003compared with three months ended September 28, 2002**

 

*Revenue.*  For the three months ended September 27,2003, our revenues increased 9.6% to $42.1 million from $38.4 millionfor the three months ended September 28, 2002. Revenues from work underfederal government contracts increased 9.0% to $39.4 million for the threemonths ended September 27, 2003 from $36.1 million for the three monthsended September 28, 2002. This increase was primarily attributable toincreased activity in our outsourcing, learning and network solutionsservices.  Commercial revenues increased20.5% to $2.7 million in the three months ended September 27, 2003 from$2.3 million in the three months ended September 28, 2002.  The increase was attributable to increasedactivity in our support to the pharmaceutical industry.

 

*Direct costs.*  Direct costs include direct labor costs andother direct costs such as materials and subcontracts. Generally, changes indirect costs are correlated to changes in revenue as resources are consumed inthe production of that revenue. For the three months ended September 27,2003, direct costs increased 5.8% to $25.8 million from $24.4 millionfor the three months ended September 28, 2002. This increase wasattributable primarily to the increase in revenue. As a percentage of revenue,direct costs were 61.3% for the three months ended September 27, 2003 ascompared to 63.7% for the three months ended September 28, 2002.

 

*Indirect costs.*  Indirect costs include costs associated withfacilities, selling, bid and proposal, indirect labor, fringe benefits andother discretionary costs. For the three months ended September 27, 2003,indirect costs increased 13.7% to $12.3 million from $10.8 millionfor the three months ended September 28, 2002.  This increase was attributable primarily to increases in fringebenefits and other personnel related costs. As a percentage of revenue, indirect costs were 29.3% for the threemonths ended September 27, 2003 as compared to 28.2% for the three monthsended September 28, 2002.

 

*Depreciation.*Forthe three months ended September 27, 2003, depreciation expense decreased5.0% to $0.50

 

15

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million from $0.52 million forthe three months ended September 28, 2002.  This decrease was attributable primarily to reduced levels ofcapital expenditures and the disposal of certain assets made in connection witha facility relocation. As a percentage of revenue, depreciation expense was1.2% for the three months ended September 27, 2003 compared to 1.4% forthe three months ended September 28, 2002.

 

*Income from operations.*  For the three months endedSeptember 27, 2003, income from operations increased 32.4% to$3.4 million from $2.6 million for the three months endedSeptember 28, 2002. This increase was attributable primarily to increasedrevenues and gross margin improvement. As a percentage of revenue, income from operations was 8.2% for thethree months ended September 27, 2003 compared to 6.7% for the threemonths ended September 28, 2002.

 

*Interest expense.*  Interest expense declined 75.6% to$0.16 million for the three months ended September 27, 2003 from$0.66 million for the three months ended September 28, 2002. Thisdecline was attributable primarily to the repayment of debt with proceedsgenerated from the Company’s initial public offering. As a percentage ofrevenue, interest expense was 0.4% for the three months endedSeptember 27, 2003 as compared to 1.7% for the three months endedSeptember 28, 2002.  Interestexpense included approximately $98,000 and $46,000 of amortization of deferredfinancing costs for the three months ended September 27, 2003 andSeptember 28, 2002, respectively.

 

*Provision for/benefit of  income taxes.*  The provision for income tax was$1.3 million in the three months ended September 27, 2003, comparedto $0.8 million for the three months ended September 28, 2002.   For the three months endedSeptember 27, 2003, we have recorded an expense for income tax, whichreflects an effective rate of 39.5%, due to a higher effective state tax rateand certain nondeductible expenses incurred. For the three months ended September 28, 2002, the effective taxrate was less than the federal statutory rate of 34% due primarily to theeffect of state income taxes and put warrants.

 

**Nine months ended September  27, 2003compared with nine months ended September  28, 2002**

 

*Revenue.*  For the nine months ended September 27,2003, our revenues increased 15.7% to $124.1 million from$107.2 million for the nine months ended September 28, 2002. Revenuesfrom work under federal government contracts increased 16.1% to $116.0 millionfor the nine months ended September 27, 2003 from $99.9 million for thenine months ended September 28, 2002. This increase was attributableprimarily to increased activities in our outsourcing, learning, consulting andnetwork solutions services.  Commercialrevenues increased 10.7% to $8.1 million in the nine months endedSeptember 27, 2003 from $7.3 million in the nine months endedSeptember 28, 2002.  The increasewas attributable primarily to increased activity in our support to thepharmaceutical industry.

 

*Direct costs.*  Direct costs include direct labor costs andother direct costs such as materials and subcontracts. Generally, changes indirect costs are correlated to changes in revenue as resources are consumed inthe production of that revenue. For the nine months ended September 27,2003, direct costs increased 14.8% to $75.1 million from$65.4 million for the nine months ended September 28, 2002. Thisincrease was attributable primarily to the increase in revenue. As a percentageof revenue, direct costs were 60.5% for the nine months endedSeptember 27, 2003 as compared to 61.0% for the nine months endedSeptember 28, 2002.

 

*Indirect costs.*  Indirect costs include costs associated withfacilities, selling, bid and proposal, indirect labor, fringe benefits andother discretionary costs. For the nine months ended September 27, 2003,indirect costs increased 5.9% to $38.6 million from $36.5 million forthe nine months ended September 28, 2002. The increase was attributable primarily to indirect costs associatedwith increased revenue, partially offset by other indirect cost savings.  As a percentage of revenue, indirect costswere 31.1% for the nine months ended September 27, 2003 as compared to 34.0%for the nine months ended September 28, 2002.

 

*Depreciation.*Forthe nine months ended September 27, 2003 and September 28, 2002,depreciation expense was $1.5 million. As a percentage of revenue, depreciation expense was 1.2% for the ninemonths ended September 27, 2003 compared to 1.4% for the nine months endedSeptember 28, 2002.

 

*Income from operations.*  For the nine months ended September 27,2003, income from operations increased 131.8% to $8.9 million from a$3.8 million for the nine months ended September 28, 2002. Thisincrease was attributable primarily to the higher revenue and indirect cost savings.  As a percentage of revenue, income from operations was 7.2% forthe nine months ended September 27, 2003 compared to 3.6% for the ninemonths ended September 28, 2002.

 

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*Interest expense.*  Interest expense declined 76.7% to$0.47 million for the nine months ended September 27, 2003 from$2.01 million for the nine months ended September 28, 2002. Thisdecline was attributable primarily to the repayment of debt with proceedsgenerated from the Company’s initial public offering. As a percentage ofrevenue, interest expense was 0.4% for the nine months ended September 27,2003 as compared to 1.9% for the nine months ended September 28,2002.  Interest expense included$286,000 and $224,000 of amortization of deferred financing costs for the ninemonths ended September 27, 2003 and September 28, 2002, respectively.

 

*Provision for income taxes.*  The provision for income tax was$3.3 million in the nine months ended September 27, 2003, comparedto  $0.7 million for the ninemonths ended September 28, 2002.  For the nine months ended September 27, 2003, we have recorded anexpense for income tax, which reflects an effective rate of 39.5% due to a highereffective state tax rate and certain nondeductible expenses incurred.

 

**Liquidity and Capital Resources**

 

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

 

Net cashprovided by operations was $15.1 million for the nine months endedSeptember 27, 2003 compared with $5.8 million for the nine monthsended September 28, 2002.  Cashprovided by operations in the nine months ended September 27, 2003 wasattributable to net income of $5.1 million, depreciation, amortization andother non-cash items of $2.1 million, decrease in working capital and otheroperating assets and liabilities of $7.9 million. Cash provided by operationsin the nine months ended September 28, 2002 was attributable to net incomeof $1.6 million, non-cash items of $1.3 million and a decrease in workingcapital and other operating assets and liabilities of $2.9 million.

 

Cash used ininvesting activities was $1.0 million for the nine months endedSeptember 27, 2003 compared with $1.1 million for the nine months endedSeptember 28, 2002.  For both ninemonths ended September 27, 2003 and September 28, 2002, our investingactivities were primarily attributed to the purchase of capital assets.

 

Cash used infinancing activities was $2.4 million for the nine months endedSeptember 27, 2003, compared with $3.7 million for the nine months endedSeptember 28, 2002.  Cash used infinancing activities for the nine months ended September 27, 2003 wasattributable to repayments for notes and leases of $0.2 million and repaymentof bank overdrafts of $2.2 million. Cash used in financing activities in the nine months endedSeptember 28, 2002 was primarily attributable to the repayment of acontingency note in the amount of $0.9 million to the seller related to theacquisition of SI Engineering and the repayments of the line of credit,long-term debt and other items of $2.8 million.

 

We maintain a$35.0 million secured revolving credit facility.  As of September 27, 2003 we did not have any borrowingsunder the credit facility.

 

For the ninemonths ended September 27, 2003 as well as the nine months endedSeptember 28, 2002, we had two contracts that generated more than 10% ofour revenue.  Our C4I2SR contract withthe U.S. Air Force Space Command represented approximately 22.4% and 23.3% oftotal revenue for each of the nine months ended September 27, 2003 andSeptember 28, 2002, respectively.  Our National Visa Center contract with the Department of Staterepresented approximately 14.3% and 10.9% of total revenue for the nine monthsended September 27, 2003 and September 28, 2002, respectively.

 

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

 

**Critical Accounting Policies and Estimates**

 

Oursignificant accounting policies are described in Note 2 to ouraccompanying consolidated financial statements. We consider the accountingpolicies related to revenue recognition to be critical to the understanding ofour results of operations.  Our criticalaccounting policies also include the areas where we have made what we considerto be particularly difficult, subjective or complex judgments in makingestimates, and where these estimates can significantly impact our financialresults under different assumptions and conditions. We prepare our financialstatements in conformity with

 

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accounting principles generallyaccepted in the United States. As such, we are required to make certainestimates, judgments and assumptions that we believe are reasonable based uponthe information available. These estimates, judgments and assumptions affectthe reported amounts of assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expenses during the periodspresented. Actual results could be different from these estimates.

 

*Revenue Recognition*

 

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

 

For costreimbursable contracts with fixed fees and fixed price contracts, we estimatethe applicable fees earned as costs are incurred or services are provided. Thisprocess requires estimation of the contemplated level of effort to accomplishthe tasks under contract, the cost of such effort and ongoing assessmenttowards completing the contract. We utilize a number of management processes tomonitor contract performance and revenue estimates, including monthlyin-process reviews. For cost reimbursable contracts with performance-basedfees, we estimate the applicable fees earned based on historical experience andperformance evaluations from our customers. For fixed price contracts, whichare based on unit pricing, we recognize revenue for the number of unitsdelivered in any given fiscal period. For fixed price contracts, which are based on the proportionateperformance method and involve a specified number of similar acts, we recognizerevenue based on the proportion of those acts completed compared to the numberof total specified acts required by the contract.  For fixed price contracts, which are based on the proportionateperformance method and involve a specified number of defined but not similaracts, we recognize revenue based on the proportion of the project’s percentagetotal costs incurred  compared to theestimated total costs associated with the entire transaction.  Occasionally, facts may develop that requirerevisions to estimated total costs or revenues expected. The cumulative effectof any such revisions is recorded in the period in which the facts requiringthe revision become known. The full amount of anticipated losses on anycontract type are recognized in the period in which they become known.

 

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

 

**Effect of Recently Issued AccountingStandards**

 

In November 2002, the FinancialAccounting Standards Board issued Interpretation No. 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others” (FIN 45). FIN 45 elaborates on the disclosureto be made by a guarantor in its interim and annual financial statements aboutits obligations under certain guarantees that it has issued. It also clarifiesthat a guarantor is required to recognize, at the inception of a guarantee, aliability for the fair value of the obligation undertaken in issuing theguarantee. The initial recognition and initial measurement provisions of FIN 45are applicable on a prospective basis to guarantees issued or modified afterDecember 31, 2002. The disclosure requirements of FIN 45 are effective forfinancial statements of interim or annual periods ending afterDecember 31, 2002. The Company does not expect adoption of FIN 45 to havea material effect on its financial condition, results of operations or liquidity**.**

 

In December 2002, the FASB issued Statement ofFinancial Accounting Standards No. 148, “Accounting for Stock-BasedCompensation — Transition and Disclosure an Amendment of FASB StatementNo. 123” (“SFAS 148”). SFAS 148 amends SFAS 123 to provide alternativemethods of transition for a voluntary change to the fair value-based method ofaccounting for stock-based employee compensation. In addition, SFAS 148 amendsthe disclosure requirements of SFAS 123 to require more prominent disclosuresin both annual and interim financial statements regarding the method ofaccounting for stock-based employee compensation and the effect of the methodused on reported results. The alternative methods of transition of SFAS 148 areeffective for fiscal years ending after December 15, 2002. The disclosureprovision of SFAS 148 is effective for interim periods beginning afterDecember 15, 2002. The Company follows APB 25 in accounting for itsemployee stock options. The Company does not expect the adoption of SFAS 148 tohave a material impact on its operating results or financial position.

 

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In January 2003, the FinancialAccounting Standards Board issued Interpretation No. 46, “Consolidation ofVariable Interest Entities (FIN 46). FIN 46 clarifies the application ofAccounting Research Bulletin No. 51, “Consolidated Financial Statements, tocertain entities in which equity investors do not have the characteristics of acontrolling financial interest or do not have sufficient equity at risk for theentity to finance its activities without additional subordinated financialsupport from the other parties. FIN 46 applies immediately to variable interestentities created after January 31, 2003. Management believes that the Company does not expect adoption of FIN 46.The Company does not expect adoption of FIN 46 to have a material effect on its financialcondition, results of operations or liquidity.

 

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

 

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

 

**Item 4.     Controlsand Procedures.**

 

The Companyhas established and maintains disclosure controls and procedures that aredesigned to ensure that material information required to be disclosed by theCompany in the reports that it files under the Securities Exchange Act of 1934,as amended, is recorded, processed, summarized and reported within the timeperiods specified in the Securities and Exchange Commission’s rules and forms,and that such information is accumulated and communicated to the Company’smanagement, including the Chief Executive Officer and Chief Financial Officer,as appropriate, to allow timely decisions regarding required disclosure.

 

Within the 90days prior to the filing date of this quarterly report, under the supervisionand with the participation of the Company’s Chief Executive Officer and ChiefFinancial Officer, the Company carried out an evaluation of the effectivenessof the design and operation of disclosure controls and procedures. Based uponthat evaluation, the Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures are effective as of thedate of such evaluation in timely alerting them to material informationrelating to the Company (including its consolidated subsidiaries) required tobe included in the Company’s periodic SEC filings.

 

There havebeen no significant changes to the Company’s internal controls or in otherfactors that could significantly affect internal controls subsequent to the datethe Company carried out its evaluation.

 

## **PART II: OTHER INFORMATION**

 

**Item1.  LegalProceedings**

 

We are notcurrently a party to any litigation or legal proceedings. We may becomeinvolved in legal and governmental, administrative or contractual proceedingsin the future.

 

**Item 2.  Changes in Securities and Use ofProceeds**

 

James E. Crawford III, amember of the Company’s Board of Directors, is a member of Frontenac CompanyVII, L.L.C. (“Frontenac LLC”), along with Paul D. Carbery, James E. Cowie, RodneyL. Goldstein, Martin J. Koldyke, M. Laird Koldyke, Laura P. Pearl and Jeremy H.Silverman.  Walter C. Florence, a memberof the Company’s Board of Directors, is affiliated with Frontenac LLC and is alimited partner of Frontenac Masters VII L.P. (“Masters”).  Frontenac LLC is the general partner ofFrontenac VII Limited Partnership (“FVII”) and has the sole power to direct thevote and disposition of the shares held by FVII.  Frontenac LLC is the general partner of Masters and has the solepower to direct the vote and disposition of the shares held by Masters.  The members of Frontenac LLC have the sharedpower to direct the voting and disposition of the shares directly held by FVIIand Masters.

 

On September 11, 2003,FVII distributed 500,000 shares of the Company’s common stock that were notregistered

 

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under the Securities Act of1933 in a pro rata distribution to the limited partners of FVII.  Following such distribution, FVII held2,702,705 shares of the Company’s common stock.  On September 11, 2003, Masters sold 25,000 shares of theCompany’s common stock that were not registered under the Securities Act of1933. After such sale, FVII and Masters continue to hold 2,702,705 and 135,165shares of the Company’s common stock, respectively.  Frontenac LLC is deemed to beneficially own the 2,837,870 sharesof common stock held by FVII and Masters.

 

During the third quarter ofour fiscal year 2003, we did not use any of the proceeds from our initialpublic offering.

 

**Item 3.  DefaultsUpon Senior Securities**

None.

 

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

None.

 

**Item 5. Other Information**

None.

 

**Item 6.  Exhibitsand Reports on Form 8-K**

 

(a)          Exhibits

 

The exhibits required bythis item are set forth on the Index to Exhibits attached hereto.

 

 

(b)         Reports on Form 8-K

 

•                             Current Report on Form 8-K dated July 29, 2003 announcingfinancial results for the Company’s fiscal second quarter ended June 28,2003 as well as its earnings guidance for the third quarter of fiscal 2003.

 

•                             Current Report on Form 8-K dated September 11, 2003 announcingthat Frontenac VII Limited Partnership, a stockholder of the Company,distributed 500,000 shares of the Company’s common stock to the limitedpartners of the Frontenac VII Limited Partnership.

 

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**SIGNATURES**

 

**Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized, onthe            day ofNovember, 2003.**

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

 

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INDEX TO EXHIBITS

 
| **EXHIBIT  NO.** |   | **DESCRIPTION**                                                                                                                                                                                                                                            |
|------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1              |   | Second Restated  Certificate of Incorporation (filed as Exhibit 3.1 to the Company’s  Registration Statement on Form S-1/A (File No. 333-87964) filed on  October 25, 2002 (the “Third Amendment) and incorporated herein by  reference).   |
| 3.2              |   | Amended and Restated  Bylaws, as amended (filed as Exhibit 3.2 to the Company’s Registration  Statement on Form S-1/A (File No. 333-87964) filed on November 8, 2002  (the “Fifth Amendment) and incorporated herein by reference).         |
| 4.1              |   | Registration Rights  Agreement, as amended (filed as Exhibit 4.1 to the Third Amendment and  incorporated herein by reference).                                                                                                                            |
| 4.2              |   | Specimen Certificate of  our common stock (filed as Exhibit 4.2 to the Company’s Registration  Statement on Form S-1/A (File No. 333-87964) filed on November 5, 2002  (the “Fourth Amendment) and incorporated herein by reference).       |
| 4.3              |   | Stock Purchase Agreement,  as amended (filed as Exhibit 4.3 to the Fifth Amendment and incorporated  herein by reference).                                                                                                                                 |
| 4.4              |   | Amendment to Stock  Purchase Agreements (filed as Exhibit 4.4 to the Fourth Amendment and  incorporated herein by reference).                                                                                                                              |
| 10.1             |   | Form of 2002 Stock  Incentive Plan (filed as Exhibit 10.1 to the Third Amendment and incorporated  herein by reference).                                                                                                                                   |
| 10.2             |   | January 2001  Nonqualified Stock Option Plan (filed as Exhibit 10.2 to the Company’s  Registration Statement on Form S-1/A (File No. 333-87964) filed on  June 24, 2002 (the “First Amendment) and incorporated herein by  reference). |
| 10.3             |   | SI International, Inc. 2001  Service Award Stock Option Plan (filed as Exhibit 10.3 to the First Amendment  and incorporated herein by reference).                                                                                                         |
| 10.4             |   | 1998 Stock Option Plan  (filed as Exhibit 10.5 to the First Amendment and incorporated herein by  reference).                                                                                                                                              |
| 10.5             |   | Credit Agreement (filed as  Exhibit 10.1 to the Company’s Current Report on Form 8-K filed  November 12, 2002 and incorporated herein by reference).                                                                                             |
| 10.6             |   | Executive Employment  Agreement with S. Bradford Antle (filed as Exhibit 10.6 to the Third  Amendment and incorporated herein by reference).                                                                                                               |
| 10.7             |   | Executive Employment  Agreement with Walter J. Culver (filed as Exhibit 10.7 to the Third Amendment  and incorporated herein by reference).                                                                                                                |
| 10.8             |   | Executive Employment  Agreement with Thomas E. Dunn (filed as Exhibit 10.8 to the Third Amendment  and incorporated herein by reference).                                                                                                                  |
| 10.9             |   | Executive Employment  Agreement with Thomas E. Lloyd (filed as Exhibit 10.9 to the Third Amendment  and incorporated herein by reference).                                                                                                                 |
| 10.10            |   | Executive Employment  Agreement with Ray J. Oleson (filed as Exhibit 10.10 to the Third Amendment  and incorporated herein by reference).                                                                                                                  |
| 10.11            |   | Form of Indemnification  Agreement (filed as Exhibit 10.11 to the Third Amendment and incorporated  herein by reference).                                                                                                                                  |
| 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 (filed  herewith)                                                             |
| 32.1             |   | Certifications of Chief  Financial 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 (filed herewith)                                                |

 

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