**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  MARCH 27, 2004**                                                     |
|                |                                                                                               |
| **o**               | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission File Number000-50080**

 

**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’s Telephone Number, Including Area Code: **(703) 234-7000**

 

----

 

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

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act).   

o Yes ý No

 

Asof May 3, 2004, there were 8,468,616 shares outstanding of the registrant’scommon stock.

 

 

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**SI INTERNATIONAL, INC.**

**FORM 10-Q**

# **INDEX**

 
| **PART I.**       | **FINANCIAL INFORMATION**                                                                                                  |   |
|-------------------|----------------------------------------------------------------------------------------------------------------------------|--------|
| ITEM 1            | Financial Statements                                                                                                       |   |
|              | Consolidated Balance Sheets at March 27, 2004 (unaudited) and  December 27, 2003                                 |   |
|              | Consolidated Statements of Operations for  the three months ended March 27, 2004 and March 29, 2003  (unaudited) |   |
|              | Consolidated Statements of Cash Flows for  the three months ended March 27, 2004 and March 29, 2003  (unaudited) |   |
|              | Notes to Consolidated Financial Statements                                                                                 |   |
| ITEM 2            | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                |   |
| ITEM 3            | Quantitative and Qualitative Disclosures  About Market Risk                                                                |   |
| ITEM 4            | Controls and Procedures                                                                                                    |   |
|              |                                                                                                                       |   |
| **PART II.**      | **OTHER INFORMATION**                                                                                                      |   |
| ITEM 1            | Legal Proceedings                                                                                                          |   |
| ITEM 2            | 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: FINANCIAL INFORMATION**

 

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

 

**SI International, Inc. and Subsidiaries**

**Consolidated Balance Sheets**

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

 
|                                                                                                                                                                                                       |   | **March 27,  2004** |    | **December 27,  2003** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|---------|-----------------------------|--------|
|                                                                                                                                                                                                       |   | **(unaudited)**          |    |                        |   |
| **Assets**                                                                                                                                                                                                 |   |                     |    |                        |   |
| **Current assets:**                                                                                                                                                                                        |   |                     |    |                        |   |
| Cash and cash equivalents                                                                                                                                                                                  |   | $                        | 4,453   |                        | $      | 23,252 |   |
| Accounts receivable, net                                                                                                                                                                                   |   | 52,061                   |    | 34,007                      |   |
| Other current assets                                                                                                                                                                                       |   | 6,751                    |    | 4,597                       |   |
| Total current assets                                                                                                                                                                                       |   | 63,265                   |    | 61,856                      |   |
| **Property and  equipment, net**                                                                                                                                                                           |   | 4,993                    |    | 3,768                       |   |
| **Goodwill**                                                                                                                                                                                               |   | 94,493                   |    | 39,829                      |   |
| **Intangible assets,  net**                                                                                                                                                                                |   | 4,910                    |    | —                      |   |
| **Other assets**                                                                                                                                                                                           |   | 1,774                    |    | 1,174                       |   |
| Total assets                                                                                                                                                                                               |   | $                        | 169,435 |                        | $      | 106,627 |   |
| **Liabilities and  stockholders’ equity**                                                                                                                                                             |   |                     |    |                        |   |
| **Current  liabilities:**                                                                                                                                                                                  |   |                     |    |                        |   |
| Accounts payable and accrued expenses                                                                                                                                                                      |   | $                        | 26,046  |                        | $      | 17,708 |   |
| Line of credit                                                                                                                                                                                             |   | 16,000                   |    | —                      |   |
| Current portion of long-term debt                                                                                                                                                                          |   | 4,500                    |    | —                      |   |
| Current portion of operating lease  obligations                                                                                                                                                            |   | 941                      |    | —                      |   |
| Escrow payable                                                                                                                                                                                             |   | 2,072                    |    | —                      |   |
| Deferred revenue                                                                                                                                                                                           |   | 3,975                    |    | 3,975                       |   |
| Other current liabilities                                                                                                                                                                                  |   | 444                      |    | 465                         |   |
| Total current liabilities                                                                                                                                                                                  |   | 53,978                   |    | 22,148                      |   |
| **Long-term debt, net  of current portion**                                                                                                                                                                |   | 25,500                   |    | —                      |   |
| **Long-term operating  lease obligations**                                                                                                                                                                 |   | 1,618                    |    | —                      |   |
| **Other long-term  liabilities**                                                                                                                                                                           |   | 4,278                    |    | 2,932                       |   |
| **Commitments and  contingencies**                                                                                                                                                                         |   |                     |    |                        |   |
| **Stockholders’  equity:**                                                                                                                                                                            |   |                     |    |                        |   |
| **Common stock**—$0.01  par value per share; 50,000,000 shares authorized; 8,463,148 and 8,451,507  shares issued and outstanding as of March 27, 2004 and December 27,  2003, respectively |   | 85                       |    | 85                          |   |
| Additional paid-in capital                                                                                                                                                                                 |   | 75,827                   |    | 75,704                      |   |
| Deferred compensation                                                                                                                                                                                      |   | (307                     | )       | (340                        | )      |
| Retained earnings                                                                                                                                                                                          |   | 8,456                    |    | 6,098                       |   |
| Total stockholders’ equity                                                                                                                                                                            |   | 84,061                   |    | 81,547                      |   |
| Total liabilities and stockholders’ equity                                                                                                                                                            |   | $                        | 169,435 |                        | $      | 106,627 |   |

 

###### ***See accompanyingnotes***

 

3

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**SIInternational, Inc. and SubsidiariesConsolidated Statements ofOperations(Amounts in thousands, except per share data)Unaudited**

 
|                                                                                                                                                            |   | **Three  Months Ended**  |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|
|                                                                                                                                                            |   | **March 27,  2004** |   | **March 29,  2003** |   |
|                                                                                                                                                            |   |                     |   |   |   |
| **Revenue**                                                                                                                                                     |   | $                        | 55,970 |   | $ | 41,324 |   |
| **Costs and expenses:**                                                                                                                                         |   |                     |   |   |   |
| Direct costs                                                                                                                                                    |   | 33,529                   |   | 25,026 |   |
| Indirect costs, including $32 and $35 of  non-cash stock-based compensation in fiscal quarters ended March 27,  2004 and March 29, 2003, respectively |   | 17,309                   |   | 13,163 |   |
| Depreciation and amortization                                                                                                                                   |   | 589                      |   | 512 |   |
| Amortization of intangible assets                                                                                                                               |   | 113                      |   | — |   |
| Total operating expenses                                                                                                                                        |   | 51,540                   |   | 38,701 |   |
| **Income from  operations**                                                                                                                                     |   | 4,430                    |   | 2,623 |   |
| **Interest expense**                                                                                                                                            |   | (534                     | )      | (162 | ) |
| **Income before  provision for income taxes**                                                                                                                   |   | 3,896                    |   | 2,461 |   |
| **Provision for  income taxes**                                                                                                                                 |   | 1,539                    |   | 973 |   |
| **Net income**                                                                                                                                                  |   | $                        | 2,357  |   | $ | 1,488 |   |
|                                                                                                                                                            |   |                     |   |   |   |
| **Earnings per common  share:**                                                                                                                                 |   |                     |   |   |   |
| Basic net income per common share                                                                                                                               |   | $                        | 0.28   |   | $ | 0.18 |   |
|                                                                                                                                                            |   |                     |   |   |   |
| Diluted net income per common share                                                                                                                             |   | $                        | 0.27   |   | $ | 0.18 |   |
|                                                                                                                                                            |   |                     |   |   |   |
| **Basic  weighted-average shares outstanding**                                                                                                                  |   | 8,458                    |   | 8,442 |   |
| **Diluted  weighted-average shares outstanding**                                                                                                                |   | 8,833                    |   | 8,442 |   |

 

***See accompanyingnotes***

 

4

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**SI International, Inc. and Subsidiaries**

**Consolidated Statements of Cash Flows**

**(Amounts in thousands)**

**Unaudited**

 
|                                                                               |   | **Three  Months Ended**  |   |
|------------------------------------------------------------------------------------|--------|--------------------------|--------|
|                                                                               |   | **March 27,  2004** |   | **March 29,  2003** |   |
| **Cash flows from operating activities:**                                          |   |                     |   |   |   |
| Net income                                                                         |   | $                        | 2,357  |   | $ | 1,488 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |   |                     |   |   |   |
| Depreciation and amortization                                                      |   | 589                      |   | 512 |   |
| Amortization of intangible assets                                                  |   | 113                      |   | — |   |
| Loss on disposal of fixed assets                                                   |   | —                   |   | 168 |   |
| Deferred income tax provision                                                      |   | 1,480                    |   | — |   |
| Stock-based compensation                                                           |   | 32                       |   | 35 |   |
| Amortization of deferred financing costs                                           |   | 108                      |   | 96 |   |
| Changes in operating assets and  liabilities, net of effect of acquisitions:       |   |                     |   |   |   |
| Accounts receivable                                                                |   | (3,629                   | )      | 719 |   |
| Other current assets                                                               |   | (767                     | )      | 211 |   |
| Other assets                                                                       |   | 469                      |   | (1 | ) |
| Accounts payable and accrued expenses                                              |   | 1,908                    |   | 509 |   |
| Deferred revenue                                                                   |   | —                   |   | (1,017 | ) |
| Other long term liabilities                                                        |   | 97                       |   | 236 |   |
| Net cash provided by operating activities                                          |   | 2,757                    |   | 2,956 |   |
| **Cash flows from investing activities:**                                          |   |                     |   |   |   |
| Purchase of property and equipment, net                                            |   | (620                     | )      | (518 | ) |
| Cash paid for acquisition of MATCOM                                                |   | (65,849                  | )      | — |   |
| Net cash used in investing activities                                              |   | (66,469                  | )      | (518 | ) |
| **Cash flows from financing activities:**                                          |   |                     |   |   |   |
| Proceeds from bank overdrafts                                                      |   | —                   |   | 111 |   |
| Net borrowings (repayments) under line of  credit                                  |   | 16,000                   |   | — |   |
| Proceeds from long-term debt                                                       |   | 30,000                   |   | — |   |
| Payment of debt issuance costs                                                     |   | (1,176                   | )      | — |   |
| Repayments of notes payable                                                        |   | —                   |   | (137 | ) |
| Proceeds from exercise of stock options                                            |   | 124                      |   | 4 |   |
| Repayments of capital lease obligations                                            |   | (35                      | )      | (22 | ) |
| Net cash provided by (used in) financing  activities                               |   | 44,913                   |   | (44 | ) |
| **Net change in cash and cash equivalents**                                        |   | (18,799                  | )      | 2,394 |   |
| **Cash and cash equivalents, beginning of  period**                                |   | 23,252                   |   | 10,856 |   |
| **Cash and cash equivalents, end of period**                                       |   | $                        | 4,453  |   | $ | 13,250 |   |
| **Supplemental disclosures of cash flow  information:**                            |   |                     |   |   |   |
| Cash payments for interest                                                         |   | $                        | 115    |   | $ | 51 |   |
| Cash payments (refund) for income taxes                                            |   | $                        | (77    | ) | $ | 79 |   |

 

***See accompanyingnotes***

 

5

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**SI International, Inc. and Subsidiaries**

 

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

**(Unaudited)**

 

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

 

The accompanying unauditedconsolidated financial statements of SI International, Inc. and itssubsidiaries have been prepared in accordance with accounting principlesgenerally accepted in the United States for interim financial information andwith the instructions to Form 10-Q and Article 10 ofRegulation S-X. Accordingly, they do not include all of the informationand footnotes required by accounting principles generally accepted in theUnited States for complete financial statements. In the opinion of management,all adjustments (consisting of normal recurring accruals) considered necessaryfor a fair presentation have been included. Operating results for the quarterended March 27, 2004 are not necessarily indicative of the results thatmay be expected for the year ending December 25, 2004. For furtherinformation, refer to the financial statements and footnotes included in SIInternational’s Annual Report on Form 10-K/A for the year ended December 27,2003.  References to the “Company,”“we,” “us” and “our” refer to SI International, Inc. and its subsidiaries.

 

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

 

**Principles of consolidation**

 

The accompanying consolidated financial statements include the accountsof the Company and its wholly and majority-owned subsidiaries.   All significant intercompany transactionsand accounts have been eliminated in consolidation.

 

**Use of estimates**

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.

 

**Reporting periods**

 

The Company’s fiscal year is based on the calendar year and ends eachyear on the Saturday nearest but prior to December 31 of that year, andour fiscal quarters end on the Saturday nearest but prior to the applicablequarterly month end.  As a result, ourfiscal year may be comprised of 52 or 53 weeks.  The fiscal quarters presented in this Form 10-Q include 13 weeks.

 

**Cash and cash equivalents**

 

The Company considers all investments with maturities of three monthsor less at the date of purchase to be cash equivalents.

 

**Revenue Recognition**

 

Our accounting policy regarding revenuerecognition is written to comply with the following criteria:  (1) a contract has been executed; (2) thecontract price is fixed and determinable; (3) delivery of services or productshas occurred; and (4) collectibility of the contract price is considered probableand can be reasonably estimated. Compliance with these criteria may require us to make significantjudgments and estimates.

 

6

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**Significant customers**

 

Revenue generated from contracts with the Federal government or primecontractors doing business with the Federal government accounted for asignificant percent of revenues in the fiscal quarter endingMarch 27, 2004 and March 29, 2003.

 
|                      |   | **Three  Months Ended**  |   |
|---------------------------|--------|--------------------------|--------|
|                      |   | **March 27,  2004** |   | **March 29,  2003** |   |
|                      |   |                     |   |   |   |
| Department of Defense     |   | 50.1                     | %      | 51.6 | % |
| Federal civilian agencies |   | 46.1                     |   | 42.1 |   |
| Commercial entities       |   | 3.8                      |   | 6.3 |   |
| Total revenue             |   | 100.0                    | %      | 100.0 | % |

 

For the first quarter of 2004 as well as the first quarter of 2003, wehad two contracts that generated more than 10% of our revenue.  Our C4I2SR contract with the U.S. Air ForceSpace Command represented approximately 10.6% and 21.3% of total revenue forthe quarters ended March 27, 2004 and March 29, 2003,respectively.   Our National Visa Centercontract with the Department of State represented approximately 10.2% and 14.5%of total revenue for the quarters ended March 27, 2004 and March 29,2003, respectively.

 

**Deferred financing costs**

 

Costs incurred in establishing our credit facility are deferred andamortized as interest expense over the term of the related debt using theeffective interest method. These deferred costs are reflected as a component ofother assets in the accompanying consolidated balance sheets. The deferredfinancing costs consist of the following (in thousands):

 
|                     |   | **March 27,  2004** |   | **December 27,  2003** |   |
|--------------------------|--------|--------------------------|--------|-----------------------------|--------|
|                     |   |                     |   |                        |   |
| Deferred loan costs      |   | $                        | 2,291  |                        | $      | 1,120 |   |
| Accumulated amortization |   | (529                     | )      | (421                        | )      |
|                     |   | $                        | 1,762  |                        | $      | 699 |   |

 

**Deferred revenue**

 

At the end of the quarter ended March 27, 2004 and the fiscal yearended December 27, 2003, we received advance payments of approximately$3,908,000 out of the $3,975,000 total deferred revenue from a customer topurchase equipment to be used in a contract. The advances were reflected asdeferred revenue as of March 27, 2004 and December 27, 2003 in the accompanyingconsolidated balance sheets.

 

**Fair value of financial instruments**

 

The Company’s financial instruments consist primarily of cash and cashequivalents, accounts receivable, accounts payable, credit facilities, andnotes payable. In management’s opinion, the carrying amounts of these financialinstruments approximate their fair values at March 27, 2004 andDecember 27, 2003.

 

**Stock-based compensation**

 

In December 2002, the FASB issued SFAS No. 148, “Accounting forStock-Based Compensation—Transition and Disclosure—an amendment of SFAS123.”  This statement amends SFAS No.123, “Accounting for Stock-Based Compensation,” to provide alternative methodsof transition for a voluntary change to the fair value based method ofaccounting for stock-based employee compensation.  In addition, this statement amends the disclosure requirements ofSFAS

 

7

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No. 123 to require prominent disclosures in both annual and interimfinancial statements about the method of accounting for stock-based employeecompensation and the effect of the method used on reported results.  The Company has chosen to continue toaccount for stock-based compensation using the intrinsic value method prescribedin APB Opinion No. 25 and related interpretations.  Accordingly, compensation expense for stock options is measuredas the excess, if any, of the fair market value of the Company’s stock at thedate of the 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 27, 2003 and has adopted the interim disclosure provisionsfor its financial reports for the quarter ended March 27, 2004.

 
|                                                                                                                        |   | **Three  Months Ended**  |   |
|-----------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|
|                                                                                                                        |   | **March 27,  2004** |   | **March 29,  2003** |   |
|                                                                                                                        |   |                     |   |   |   |
| Net income - as reported                                                                                                    |   | $                        | 2,357  |   | $ | 1,488 |   |
|                                                                                                                        |   |                     |   |   |   |
| Add: total stock-based employee  compensation expense as reported under intrinsic value method (APB No. 25)  for all awards |   | 32                       |   | 35 |   |
|                                                                                                                        |   |                     |   |   |   |
| Deduct: Total stock-based compensation  expense determined under fair value based method (SFAS No. 123) for all  awards     |   | (865)                    |   | (372 | ) |
|                                                                                                                        |   |                     |   |   |   |
| Net income - pro forma                                                                                                      |   | 1,524                    |   | 1,151 |   |
|                                                                                                                        |   |                     |   |   |   |
| Basic earnings per share - as reported                                                                                      |   | 0.28                     |   | 0.18 |   |
|                                                                                                                        |   |                     |   |   |   |
| Diluted earnings per share - as reported                                                                                    |   | 0.27                     |   | 0.18 |   |
|                                                                                                                        |   |                     |   |   |   |
| Basic earnings per share - pro forma                                                                                        |   | 0.18                     |   | 0.14 |   |
|                                                                                                                        |   |                     |   |   |   |
| Diluted earnings per share - pro forma                                                                                      |   | 0.17                     |   | 0.14 |   |
|                                                                                                                             |        |                          |        |  |  |  |  |

 

**Earnings per share**

 

Basic EPS is computed by dividing reported earnings available to commonstockholders by the weighted average number of shares outstanding withoutconsideration of common stock equivalents or other potentially dilutivesecurities. Diluted EPS gives effect to common stock equivalents and otherpotentially dilutive securities outstanding during the period. Redeemablecumulative preferred stock is excluded from diluted earnings per share as it isnot convertible into common stock.

 

The following details the computation of net income per common share:

 
|                                        |   | **Three  Months Ended**  |   |
|---------------------------------------------|--------|--------------------------|--------|
|                                        |   | **March 27,  2004** |   | **March 29,  2003** |   |
|                                        |   |                     |   |   |   |
| Net Income – Basic and Diluted         |   | $                        | 2,357  |   | $ | 1,488 |   |
|                                        |   |                     |   |   |   |
| **Weighted average  share calculation:**    |   |                     |   |   |   |
|                                        |   |                     |   |   |   |
| Basic weighted average shares outstanding   |   | 8,458                    |   | 8,442 |   |
| Treasury stock effect of stock options      |   | 375                      |   | — |   |
|                                        |   |                     |   |   |   |
| Diluted weighted average shares outstanding |   | 8,833                    |   | 8,442 |   |
|                                             |        |                          |        |  |  |  |  |

 

8

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**Reclassifications**

 

Certain prior year balances have been reclassified to conform to thepresentation of the current year.

 

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

 

OnJanuary 21, 2004, the Company completed the purchase of MATCOMInternational Corp., or MATCOM, a provider of information technology, systemsengineering, logistics, and training. Under the terms of the merger agreement, the Company acquired MATCOM for$65.8 million, of which $63.7 million was paid in cash to the seller and$2.1 million was placed in escrow related to seller’s obligations forunforeseen liabilities and collection of certain accounts receivable.  The transaction was funded through cash onhand and borrowings under the credit facility. Contemporaneously with the closing of the acquisition of MATCOM, weamended our credit facility to increase the maximum amount of availableborrowings from $35.0 million to $80.0 million, of which $30.0 million iscomprised of a term loan and the remainder of a revolving credit facility, andto extend the maturity of the credit facility to January 21, 2008.  Approximately $54.7 million of the purchaseconsideration has been allocated to goodwill based primarily on the excess ofthe purchase price over the estimated fair value of net assets acquired and$5.0 million assigned to identifiable intangible assets of contractual customerrelationships. The contractual customer relationships are being amortized acceleratedover its estimated remaining life of 11 years.

 

Thetotal purchase price paid, including transaction costs of $1.2 million, wasallocated as follows:

 
| Cash                                     |   | $      | 26     |   |
|------------------------------------------|--------|--------|--------|--------|
| Accounts receivable                      |   | 14,425 |   |
| Prepaid expense and other current assets |   | 1,650  |   |
| Income tax receivable                    |   | 1,216  |   |
| Property and equipment                   |   | 1,195  |   |
| Accounts payable and accrued expenses    |   | (9,427 | )      |
| Deferred rent                            |   | (31    | )      |
| Deferred income tax                      |   | (1,768 | )      |
| Contractual customer relationships       |   | 5,023  |   |
| Goodwill                                 |   | 54,664 |   |
| Total consideration                      |   | $      | 66,973 |   |

 

Thefollowing unaudited proforma combined condensed statements of operations (inthousands, except per share) set forth the consolidated results of operationsof the Company for the three months ended March 27, 2004 andMarch 29, 2003 as if the above described acquisition had occurred at thebeginning of each period presented. This unaudited proforma  information does not purport to beindicative of the actual financial position or the results that would actuallyhave occurred if the combination had been in effect for the three months endedMarch 27, 2004 and March 29, 2003.

 
|                       |   | **March 27,  2004** |   | **March 29,  2003** |   |
|----------------------------|--------|--------------------------|--------|--------------------------|--------|
|                       |   |                     |   |                     |   |
| Revenue                    |   | $                        | 59,486 |                     | $      | 58,185 |   |
| Net income                 |   | $                        | 2,508  |                     | $      | 1,916 |   |
| Diluted earnings per share |   | $                        | 0.28   |                     | $      | 0.23 |   |

 

**4.  Accounts receivable:**

 

Accounts receivable consists of the following (in thousands):

 
|                                                                                               |   | **March 27,  2004** |   | **December 27,  2003** |   |
|----------------------------------------------------------------------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
|                                                                                               |   |                     |   |                        |   |
| Billed accounts receivable                                                                         |   | $                        | 27,782 |                        | $      | 18,215 |   |
| Unbilled accounts receivable:                                                                      |   |                     |   |                        |   |
| Currently billable                                                                                 |   | 22,123                   |   | 13,137                      |   |
| Unbilled retainages and milestones payments  expected to be billed within the next 12 months       |   | 2,631                    |   | 3,127                       |   |
| Indirect costs incurred and charged to  cost-plus contracts in excess of provisional billing rates |   | 1,053                    |   | 768                         |   |
| Total unbilled accounts receivable                                                                 |   | 25,807                   |   | 17,032                      |   |
| Allowance for doubtful accounts                                                                    |   | (1,528                   | )      | (1,240                      | )      |
| Accounts receivable, net                                                                           |   | $                        | 52,061 |                        | $      | 34,007 |   |

 

9

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The currently billable amounts included as unbilled accounts receivableas of March 27, 2004 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.

 

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

 

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

 
|                                                 |   | **March 27,  2004** |   | **December 27,  2003** |   |
|------------------------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
| Computers and equipment                              |   | $                        | 7,570  |                        | $      | 6,389 |   |
| Software                                             |   | 2,210                    |   | 1,914                       |   |
| Furniture and fixtures                               |   | 1,576                    |   | 1,339                       |   |
| Leasehold improvements                               |   | 777                      |   | 676                         |   |
|                                                 |   | 12,133                   |   | 10,318                      |   |
| Less—Accumulated depreciation and  amortization |   | (7,140                   | )      | (6,550                      | )      |
| Property and equipment, net                          |   | $                        | 4,993  |                        | $      | 3,768 |   |

 

Property and equipment includes assets financed under capital leaseobligations of approximately $146,000 and $178,000, net of accumulatedamortization, as of March 27, 2004 and December 27, 2003,respectively.

 

Depreciation and amortization expense of approximately $0.6 million wasrecorded in the quarter ended March 27, 2004, compared to $0.5 million inthe quarter ended March 29, 2003.

 

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

 

Accounts payable and accrued expenses consist of the following (inthousands):

 
|                                  |   | **March 27,  2004** |   | **December 27,  2003** |   |
|---------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
|                                  |   |                     |   |                        |   |
| Accounts payable                      |   | $                        | 10,966 |                        | $      | 6,965 |   |
| Accrued compensation and benefits     |   | 10,479                   |   | 5,675                       |   |
| Other accrued liabilities             |   | 4,601                    |   | 5,068                       |   |
| Accounts payable and accrued expenses |   | $                        | 26,046 |                        | $      | 17,708 |   |

 

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

 

Debt, which is included in current and long term liabilities in theaccompanying balance sheets, consists of the following (in thousands):

 

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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   | **March 27,  2004** |   | **December 27,  2003** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
| Credit facilities:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |   |                     |   |                        |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |                     |   |                        |   |
| Line of credit at March 27, 2004,  bears interest at LIBOR plus 275 to 350 basis points or a specified base rate  plus 175 to 250 basis points, interest due monthly, principal due  January 21, 2008                                                                                                                                                                                                                                                                                      |   | $                        | 16,000 |                        | $      | — |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |                     |   |                        |   |
| Term loan at March 27, 2004, bears  interest at LIBOR plus 275 to 350 basis points or a specified base rate plus  175 to 250 basis points, interest due monthly, three $1.5 million quarterly  principal payments starting on June 30, 2004, eight $1.875 million  quarterly principal payments starting on March 31, 2005, three $2.25  million quarterly principal payments starting on March 31, 2007, and a  final $3.75 million principal payment on December 31, 2007 |   | 30,000                   |   | —                      |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |   |                     |   |                        |   |
| Notes payable:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |   |                     |   |                        |   |
| Indemnification note payable                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |   | 340                      |   | 340                         |   |
| Total debt                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |   | $                        | 46,340 |                        | $      | 340 |   |

 

The original credit facility (the 2002 credit facility) consisted of$35.0 million secured revolving credit arrangement with Wachovia Bank, N.A.acting as Administration Agent for a consortium of lenders.  With the closing of the acquisition ofMATCOM, the Company amended the 2002 credit facility in January 2004. Theamended credit facility (the 2004 credit facility) consists of a $30 millionterm loan and a $50.0 million secured revolving credit arrangement.  The 2004 credit facility is securedby a pledge of substantially all of our current and future tangible andintangible assets, as well as those of our current and future subsidiaries,including accounts receivable, inventory and capital stock of our existing andfuture subsidiaries.  In addition, theCompany is required to maintain compliance with financial and nonfinancialcovenants.

 

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

 

**Leases**

 

As of March 27, 2004, the Company had noncancelable operatingleases, primarily for real estate, that expire over the next ten years. Rentalexpense during the quarter ended March 27, 2004 was approximately $1.7million, compared to rental expense of approximately $1.4 million during thequarter ended March 29, 2003.

 

**Contract cost audits**

 

Payments to the Company on government cost reimbursable contracts arebased on provisional, or estimated indirect rates, which are subject to auditon an annual basis by the Defense Contract Audit Agency (DCAA). The cost auditsresult in the negotiation and determination of the final indirect cost ratesthat the Company may use for the period(s) audited. The final rates, ifdifferent from the provisional rates, may create an additional receivable orliability for the Company. The Company’s revenue recognition policy calls forrevenue recognized on all cost reimbursable government contracts to be recordedat provisional rates unless collectibility is reasonably assured for costsincurred at higher rates. To the extent the indirect rate differential createsa liability for the Company, the differential is recognized as a reduction torevenue when identified.

 

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**Litigation and claims**

 

From time to time, theCompany is involved in litigation, claims and disputes that arise in theordinary course of its business.  Inaddition, the Company is subject to audit, review, and investigation by variousagencies of the federal government to determine compliance with applicablefederal statutes and regulations.  As aGovernment contractor, the Company is subject to audit by certain federalagencies to determine if the Company’s performance and administration of itsgovernment contracts are compliant with contractual requirements and applicablefederal statutes and regulations.  While theCompany cannot predict the ultimate outcome of legal proceedings, governmentaudits, investigations, claims and disputes to which it is or may be subject,the Company currentlybelieves, based upon information available to us as of the date of this filing,that any ultimate liability arising out of these matters will not have amaterial adverse effect on our financial position, results of operations, orcash flows.

 

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

 

**Stock option plan**

 

In 2002, the Company adopted the 2002 Stock Incentive Plan to grantstock options to purchase up to 1,600,000 shares of its common stock to itsemployees and employees of its affiliates. In March 2004, the Board of Directors increased the number ofreserved shares by 160,000 so that the total number of reserved sharesincreased from 1,600,000 to 1,760,000. The terms of the 2002 Stock Incentive Plan state that this ceiling of1,600,000 shares of common stock shall automatically increase at the beginningof each fiscal year by a number of shares equal to the lesser of 160,000 sharesof common stock and an amount determined by the Company’s Board ofDirectors.  As of March 27, 2004,the Company had issued 1,364,279 stock options under the 2002 Stock IncentivePlan against a ceiling of 1,760,000 shares of common stock authorized underthis 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 thesection entitled “Risk Factors” in our Form 10-K/A  for the fiscal year ended December 27,2003.   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 the calendar yearand ends each year on the Saturday closest to but prior to December 31 ofthat year, and our fiscal quarter ends 13 weeks after the conclusion of theprevious fiscal quarter.*

 

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

 

**Overview**

 

Weare, first and foremost, a provider of information technology and networksolutions to the Federal government. Prior to the acquisition of MATCOM, our clients included U.S. Air ForceSpace Command, the Department of State, the U.S. Army, the Department ofHomeland Security, the Department of Agriculture, the U.S. Navy and the intelligencecommunity.  The addition of MATCOM willallow us to continue to support our existing customer base, while strengtheningour position with the U.S. Army, U.S. Navy, U.S. Air Force Electronic SystemsCenter, and U.S. Department of Agriculture, and opening new clientrelationships with the Federal Retirement Thrift Investment Board and NationalInstitutes of Health. We combine our 

 

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technologyand industry expertise to provide a full spectrum of state-of-the-practicesolutions and services, from design and development to implementation andoperations, which assist our clients in achieving mission success.

 

In the three months ended March 27, 2004, we received 96.2% of ourrevenues from services we provided to various departments and agencies of theFederal government and 3.8% of our total revenues from work performed forcommercial entities. In comparison, for the three months ended March 29,2003, we received 93.7% of our revenues from services we provided to Federalgovernment agencies and 6.3% of total revenues from work performed forcommercial entities.  The followingtable shows our revenues from the client groups listed as a percentage of totalrevenue. Revenue data for the Department of Defense includes revenue generatedfrom work performed under engagements for both the Department of Defense andthe intelligence community.

 
|                      |   | **Three  Months Ended** |   |
|---------------------------|--------|-------------------------|--------|
|                      |   | **March  27, 2004**     |   | **March  29, 2003** |   |
|                      |   |                    |   |   |   |
| Department of Defense     |   | 50.1                    | %      | 51.6 | % |
| Federal civilian agencies |   | 46.1                    | %      | 42.1 | % |
| Commercial entities       |   | 3.8                     | %      | 6.3 | % |
| Total revenue             |   | 100.0                   | %      | 100.0 | % |

 

We have derived a substantial majority of our revenues fromgovernmental contracts under which we act as a prime contractor. We alsoprovide services indirectly as a subcontractor. We intend to focus on retainingand increasing the percentage of our business as prime contractor because itprovides us with stronger client relationships. The following table shows ourrevenues as prime contractor and as subcontractor as a percentage of our totalrevenue for the following periods:

 
|                   |   | **Three  Months Ended**  |   |
|------------------------|--------|--------------------------|--------|
|                   |   | **March 27,  2004** |   | **March 29,  2003** |   |
|                   |   |                     |   |   |   |
| Prime contract revenue |   | 79.4                     | %      | 82.5 | % |
| Subcontract revenue    |   | 20.6                     | %      | 17.5 | % |
| Total revenue          |   | 100.0                    | %      | 100.0 | % |

 

Our services are provided under three types of contracts: costreimbursable, time and materials, and fixed price contracts. The followingtable shows our revenues from each of these types of contracts as a percentageof our total revenue for the following periods:

 
|               |   | **Three Months  Ended**  |   |
|--------------------|--------|--------------------------|--------|
|               |   | **March 27,  2004** |   | **March 29,  2003** |   |
|               |   |                     |   |   |   |
| Cost reimbursable  |   | 23.3                     | %      | 36.8 | % |
| Time and materials |   | 51.0                     | %      | 38.9 | % |
| Fixed price        |   | 25.7                     | %      | 24.3 | % |
| Total              |   | 100.0                    | %      | 100.0 | % |

 

Under cost reimbursable contracts, we are reimbursed for costs that aredetermined to be reasonable, allowable and allocable to the contract, and paida fee representing the profit margin negotiated between us and the contractingagency, which may be fixed or performance based. Under cost reimbursablecontracts we recognize revenues and an estimate of applicable fees earned ascosts are incurred. We consider fixed fees under cost reimbursable contracts tobe earned in proportion to the allowable costs incurred in performance of thecontract. For performance-based fees under cost reimbursable contracts, werecognize the relevant portion of the expected fee to be awarded by the clientat the time such fee can be reasonably estimated, based on factors such as ourprior award experience and communications with the client regarding 

 

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performance. In general, cost reimbursable contracts are the leastprofitable of our government contracts. In the three months endedMarch 27, 2004, 23.3% of our revenues were derived from cost reimbursablecontracts.  In the three months endedMarch 29, 2003, 36.8% of our revenues were derived from cost reimbursablecontracts.

 

Under time and materials contracts, we are reimbursed for labor atfixed hourly rates and generally reimbursed separately for allowable materials,costs and expenses. To the extent that our actual labor costs under a time andmaterials contract are higher or lower than the billing rates under thecontract, our profit under the contract may either be greater or less than weanticipated or we may suffer a loss under the contract. We recognize revenuesunder time and materials contracts by multiplying the number of direct laborhours expended by the contract billing rates and adding the effect of otherbillable direct costs. In general, we realize a higher profit margin on workperformed under time and materials contracts than cost reimbursable contracts.In the three months ended March 27, 2004, 51.0% of our revenues werederived from time and materials contracts. In the three months ended March 29, 2003, 38.9% of our revenueswere derived from time and material contracts.

 

Under fixed price contracts, we perform specific tasks for a fixedprice. Compared to cost reimbursable and time and materials contracts, fixedprice contracts generally offer higher profit margin opportunities but involvegreater financial risk because we bear the impact of cost overruns in returnfor the full benefit of any cost savings. We generally do not undertakecomplex, high-risk work, such as long-term software development, under fixedprice terms. Fixed price contracts may include either a product delivery orspecific service performance over a defined period.  Revenue on fixed price contracts that provide for the Company torender services throughout a period is recognized as earned according tocontract terms as the service is provided on a proportionate performancebasis.  These contracts are generallyless than six months in duration.  Forfixed price contracts that provide for the delivery of a specific product withrelated customer acceptance provisions, revenues are recognized as thoseproducts are delivered and accepted.  Inthe three months ended March 27, 2004, 25.7% of our revenues were derivedfrom fixed price contracts.   In thethree months ended March 29, 2003, 24.3% of our revenues were derived fromfixed price contracts.

 

If we anticipate a loss on a contract, we provide for the full amountof anticipated loss at the time of that determination.

 

Our most significant expense is direct cost, which consists primarilyof direct labor costs for program personnel and direct expenses incurred tocomplete contracts, including cost of materials and subcontractor costs. Ourability to predict accurately the number and types of personnel, theirsalaries, and other costs, can have a significant impact on our direct cost.

 

The allowability of certain direct and indirect costs in federalcontracts is subject to audit by the client, usually through the DCAA. Certainindirect costs are charged to contracts and paid by the client usingprovisional, or estimated, indirect rates, which are subject to later revision,based on the government audits of those costs.

 

We actively monitor our relationships with our clients during ourengagements, as well as the quality of the service we provide, to assist in ourefforts to win recompetition bids. In addition, we strive to maintain goodrelationships with a wide variety of government contractors.

 

**Results of Operations**

 

The following table sets forth certain items from our consolidatedstatements of operations as a percent of revenues for the periods indicated.

 
|                                           |   | **Three  Months Ended**  |   |
|------------------------------------------------|--------|--------------------------|--------|
|                                           |   | **March 27,  2004** |   | **March 29,  2003** |   |
|                                           |   |                     |   |   |   |
| Revenue                                        |   | 100.0                    | %      | 100.0 | % |
| Costs and expenses:                            |   |                     |   |   |   |
| Direct costs                                   |   | 59.9                     |   | 60.6 |   |
| Indirect costs                                 |   | 30.9                     |   | 31.9 |   |
| Depreciation                                   |   | 1.1                      |   | 1.2 |   |
| Amortization                                   |   | 0.2                      |   | — |   |
| Total operating expenses                       |   | 92.1                     |   | 93.7 |   |
| Income from operations                         |   | 7.9                      |   | 6.3 |   |
| Other income (expense)                         |   | —                   |   | — |   |
| Interest expense                               |   | (1.0                     | )      | (0.4 | ) |
| Income before provision for  income taxes |   | 6.9                      |   | 5.9 |   |
| Provision for  income taxes               |   | 2.7                      |   | 2.3 |   |
| Net income                                     |   | 4.2                      | %      | 3.6 | % |

 

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**Three months ended March 27, 2004compared with three months ended March 29, 2003**

 

*Revenue.*  For the three months endedMarch 27, 2004, our revenues increased 35.4% to $56.0 million from$41.3 million for the same period in 2003. Revenues from work underFederal government contracts increased 39.1% to $53.8 million from$38.7 million for the same period in 2003. This increase was attributableto new contract awards, successful recompetition wins on existing programs, newcontracts from acquisitions and growth within existing programs in our fourfocus areas: Federal IT Modernization, Defense Transformation, HomelandDefense, and Mission-Critical Outsourcing. Commercial and other revenuesdecreased 17.8% to $2.2 million in 2003 from $2.6 million in 2003.This decrease was attributable to our continued focus on opportunities for theFederal government.

 

*Direct costs.*  Direct costs include directlabor and other direct costs such as materials and subcontracts. Generally,changes in direct costs are correlated to changes in revenue as resources areconsumed in the production of that revenue. For the three months endedMarch 27, 2004, direct costs increased 34.0% to $33.5 million from$25.0 million for the three months ended March 29, 2003. Thisincrease was attributable primarily to the increase in revenue. As a percentageof revenue, direct costs were 59.9% for the three months ended March 27,2004 as compared to 60.6% for the three months ended March 29, 2003.

 

*Indirect costs.*  Indirect costs includefacilities, selling, bid and proposal, indirect labor, fringe benefits andother discretionary costs. For the three months ended March 27, 2004,indirect costs increased 31.5% to $17.3 million from $13.2 millionfor the same period in 2003. This $4.1 million increase was primarilyattributable to the expected growth of support functions necessary tofacilitate and administer the growth in direct costs as well as the integrationof MATCOM.

 

*Depreciation.*  For the three months endedMarch 27, 2004, depreciation increased by 15.0% to $0.6 million from$0.5 million for the same period in 2003. As a percentage of revenue,depreciation was 1.1% for the three months ended March 27, 2004 ascompared to 1.2% for the same period in 2003.

 

*Amortization.*  For the three months endedMarch 27, 2004, amortization of intangible assets increased to $0.1million from $0 for the same period in 2003. This increase was attributed to the acquisition of MATCOM onJanuary 21, 2004.

 

*Income from operations.*  Forthe three months ended March 27, 2004, income from operations increased68.9% to $4.4 million from $2.6 million for the same period in 2003.This increase was attributable primarily to increased revenue. As a percentageof revenue, income from operations was 7.9% for the three months endedMarch 27, 2004 as compared to 6.3% for the same period in 2003.

 

*Interest expense.*  For the three months endedMarch 27, 2004, interest expense increased 229.6% to $0.5 millionfrom $0.2 million for the same period in 2003. This increase wasattributable primarily to increased borrowings under our credit facility madein connection with the acquisition of MATCOM. As a percentage of revenue, interest expense was 1.0% for the threemonths ended March 27, 2004 as compared to 0.4% for the same period in2003.  We anticipate interest expense toremain at higher levels throughout fiscal year 2004 as compared to the sameperiods in 2003.

 

*Provision for income taxes.*  Theprovision for income tax was $1.5 million for the three months endedMarch 27, 2004, compared to a provision of $1.0 million for thecomparable period in 2003. Our first quarter of 2004 tax provision representsan effective tax rate of 39.5%. Our tax provision for the same period of 2003represents an effective tax rate of 37.1%. Our effective tax rate is greaterthan the federal statutory rate of 34% due primarily to state income tax rates.

 

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**Liquidity and Capital Resources**

 

Ourprimary liquidity needs are the financing of working capital, capitalexpenditures and acquisitions. We have historically relied primarily on cashflow from operations, borrowings under our credit facility and from some of ourstockholders and the sale of common and preferred stock to provide for our cashneeds.

 

Net cash provided by operations was $2.8 million for the three monthsended March 27, 2004 compared with $3.0 million for the three monthsended March 29, 2003.  Cashprovided by operations in the three months ended March 27, 2004 wasattributable to net income of $2.4 million, depreciation, amortization,deferred tax provision, and other non-cash items of $2.3 million, and offset byan increase in working capital and other operating assets and liabilities of$1.9 million. Cash provided by operations in the three months endedMarch 29, 2003 was attributable to net income of $1.5 million, non-cashitems of $0.8 million and a decrease in working capital and other operatingassets and liabilities of $0.7 million.

 

Cash used in investing activities was $66.5 million for the threemonths ended March 27, 2004 compared with $0.5 million for the threemonths ended March 29, 2003.  Forthe three months ended March 27, 2004, we acquired MATCOM for $65.9million and invested $0.6 million in capital assets.  For the three months ended March 29, 2003, we invested $0.5million in capital assets.

 

Cash provided by (used in) financing activities was $44.9 million forthe three months ended March 27, 2004, compared with ($44,000) for thethree months ended March 29, 2003. Cash provided by financing activities for the three months endedMarch 27, 2004 was attributable to $16.0 million net borrowings under ourrevolving line of credit and $30.0 million of long-term debt provided by ourcredit facility and $0.1 million provided by proceeds from the exercise ofstock options, partially offset by $1,176,000 of debt issuance fee payments and$35,000 of capital lease payments.  Cashused in financing activities for the three months ended March 29, 2003 wasattributable to payments for notes and capital leases of $159,000, andpartially offset by bank overdrafts of $111,000.

 

Cashand cash equivalents as of March 27, 2004 and December 27, 2003 were$4.5 million and $23.3 million, respectively.

 

Inconnection with the acquisition of MATCOM on January 21, 2004, we amendedour credit facility to increase the borrowing capacity from $35 million to$80 million and extended the term to January 21, 2008.

 

Theamended credit facility includes a $30 million term loan and a$50 million revolving credit facility. Under the term loan, we arerequired to make three $1.5 million quarterly principal payments startingon June 30, 2004, eight $1.875 million quarterly principal paymentsstarting on March 31, 2005, three $2.25 million quarterly principalpayments starting on March 31, 2007, and a final $3.75 millionprincipal payment on December 31, 2007.

 

Theamended credit facility permits us, subject to our compliance with financialand nonfinancial covenants and customary conditions, to make up to$50.0 million of revolving credit borrowings and also provides for theissuance of letters of credit, although the amount of available revolvingcredit borrowings are reduced by the amount of any outstanding letters ofcredit issued under the facility.

 

Anyborrowings outstanding under the facility will, at our option, bear interesteither at floating rates equal to LIBOR plus a spread ranging from 275 to 350basis points or a specified base rate plus a spread ranging from 175 to 250basis points, with the exact spread determined upon the basis of our ratio ofoutstanding indebtedness to our earnings before interest, taxes, anddepreciation and amortization expense, as defined in the new credit facility.

 

Weand each of our existing and future subsidiaries are jointly and severallyliable with respect to the payment of all borrowings and other amounts due andperformance of all obligations under the new credit facility. The new creditfacility is secured by a pledge of substantially all of our current and futuretangible and intangible assets, as well as those of our current and futuresubsidiaries, including accounts receivable, inventory and capital stock of ourexisting and future subsidiaries. The new credit facility requires us to makemandatory prepayments of outstanding borrowings, with a corresponding reductionin the maximum amount of borrowings available under the facility, with net proceedsfrom certain insurance recoveries and asset sales, and with 100% of the netproceeds from debt issuances, and with 50% of the net proceeds from certainequity issuances subject to specified exceptions. Also, the new credit facilityincludes a number of restrictive covenants including, among other things,limitations on our leverage and capital expenditures, limitations on ourability to incur additional indebtedness or liens, requirements that wemaintain minimum ratios of cash flow to fixed charges and prohibitions onpayment of dividends on our capital stock, limitations on our ability to enterinto mergers, acquisitions or sales of our assets, and prohibitions on certain 

 

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transactionsamong our subsidiaries and affiliated companies. The new credit facility alsocontains events of default, including, among other events, any transactionresulting in a new stockholder or group of stockholders acquiring control ofour board of directors or ownership of greater than 40% of our outstandingcapital stock, any default by us under any material government contract orother material contract to which we are a party, the suspension of our abilityto enter into contracts with the federal, state or local governments generally.

 

Wecurrently anticipate that cash flow from operations and borrowings availableunder our new credit facility will be sufficient to meet our presentlyanticipated capital needs for at least the next twelve months, but may beinsufficient to provide funds necessary for any future acquisitions we maymake, whether during the next twelve months or thereafter. To the extent thatwe require additional funds, whether for acquisitions or otherwise, we may seekadditional equity or debt financing.  OnMarch 22, 2004, we filed a shelf registration statement with theSecurities and Exchange Commission relating to the future offering of up to anaggregate of $100 million of our common stock, preferred stock, depositaryshares, debt securities and warrants exercisable for common or preferredstock.  The shelf registration statementalso registers the offering of up to 1,500,000 shares of common stock held byour largest stockholder, affiliates of Frontenac Company.  We believe the shelf registration statementwill provide us with more efficient and immediate access to capital marketswhen considered appropriate.  As ofMarch 27, 2004, the shelf registration statement had not yet been declaredeffective by the Securities and Exchange Commission.  Therefore, we have not issued any securities pursuant to theshelf registration statement.  However,equity or debt financing may not be available to us on terms that areacceptable to us, if at all, and any equity financing may be dilutive to ourstockholders. To the extent that we obtain additional debt financing, our debtservice obligations will increase and the relevant debt instruments may, amongother things, impose additional restrictions on our operations, require us tocomply with additional financial covenants or require us to pledge assets tosecure our borrowings.

 

Financialdata for all of our subsidiaries are included in our consolidated financialstatements.

 

**Critical Accounting Policies and Estimates**

 

Our significant 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 accounting principles generally accepted in theUnited States. As such, we are required to make certain estimates, judgmentsand assumptions that we believe are reasonable based upon the informationavailable. These estimates, judgments and assumptions affect the reportedamounts of assets and liabilities at the date of the financial statements andthe reported amounts of revenue and expenses during the periods presented.Actual results could be different from these estimates.

 

 *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 ofservices or products has occurred; and (4) collectibility of the contractprice is considered probable and can be reasonably estimated. Compliance withthese criteria may require us to make significant judgments and estimates.

 

For cost reimbursable contracts with fixed fees and fixed pricecontracts, we estimate the applicable fees earned as costs are incurred orservices are provided. This process requires estimation of the contemplatedlevel of effort to accomplish the tasks under contract, the cost of such effortand ongoing assessment towards completing the contract. We utilize a number ofmanagement processes to monitor contract performance and revenue estimates,including monthly in-process reviews. For cost reimbursable contracts withperformance-based fees, we estimate the applicable fees earned based onhistorical experience and performance evaluations from our customers. For fixedprice contracts, which are based on unit pricing, we recognize revenue for thenumber of units delivered 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 requiring 

 

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the 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 paidby the client using provisional, or estimated, indirect rates that are subjectto later revision based on government audits. Any costs found to be improperlyallocated to a specific contract will not be reimbursed, and any such costsalready reimbursed must be refunded.

 

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

 

Historically,our investment positions have been relatively small and short-term in nature.We have typically made investments in a fund with an effective average maturityof fewer than 40 days and a portfolio make-up consisting primarily ofcommercial paper and notes, variable rate instruments, and, to a lesser degree,overnight securities and bank instruments. Since our initial public offering, the Board of Directors approved aninvestment policy that requires us to invest in relatively short-term, highquality, and high liquidity obligations.

 

**Item4.****           Controls and Procedures.**

 

The Company hasestablished and maintains disclosure controls and procedures that are designedto ensure that material information required to be disclosed by the Company inthe reports that it files under the Securities Exchange Act of 1934, asamended, is recorded, processed, summarized and reported within the time periodsspecified in the Securities and Exchange Commission’s rules and forms, and thatsuch information is accumulated and communicated to the Company’s management,including the Chief Executive Officer and Chief Financial Officer, asappropriate, to allow timely decisions regarding required disclosure.

 

Under the supervision andwith 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 as ofMarch 27, 2004.  Based upon thatevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures are effective at the reasonableassurance level as of March 27, 2004 in timely alerting them to materialinformation relating to the Company (including its consolidated subsidiaries)required to be included in the Company’s periodic SEC filings.

 

Duringthe three months ended March 27, 2004, there were no significant changes to the Company’sinternal control over financial reporting that materially affected, or arereasonable likely to materially affect, the Company’s internal control overfinancial reporting

 

**PART II:****                 ****OTHERINFORMATION**

 

**Item 1.****           Legal Proceedings**

 

From time to time, theCompany is involved in litigation, claims and disputes that arise in theordinary course of its business.  Inaddition, the Company is subject to audit, review, and investigation by variousagencies of the federal government to determine compliance with applicablefederal statutes and regulations.  As aGovernment contractor, the Company is subject to audit by certain federalagencies to determine if the Company’s performance and administration of itsgovernment contracts are compliant with contractual requirements and applicablefederal statutes and regulations.  While theCompany cannot predict the ultimate outcome of legal proceedings, governmentaudits, investigations, claims and disputes to which it is or may be subject,the Company currentlybelieves, based upon information available to us as of the date of this filing,that any ultimate liability arising out of these matters will not have amaterial adverse effect on our financial position, results of operations, orcash flows.

 

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

 

Weare furnishing the following information regarding the use of proceeds from ourinitial public offering which closed in November, 2002.  Our net offering proceeds after expenseswere approximately $47,069,573. From November 15, 2002 untilDecember 28, 2002 we used $31.1 million to repay outstandingborrowings under our credit facility, $10.1 million to repay loansdirectly received from several of our stockholders, and $1.4 million torepurchase outstanding warrants. The

 

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remainingproceeds, approximately $4.5 million, were used as a part of the source offunds for the acquisition of MATCOM in January 2004.

 

**Item3.****           Defaults Upon Senior Securities**

 

None.

 

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

 

None.

 

**Item5.****           Other Information**

 

None.

 

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

 

(a)          Exhibits

 

Theexhibits required by this item are set forth on the Index to Exhibits attachedhereto.

 

(b)         Reportson Form 8-K

 

 

•                       Current Report on Form 8-K datedJanuary 15, 2004 announcing the delay of the Command, Control,Communications, Computers, Intelligence, Information Technology, Surveillanceand Reconnaissance (C4I2TSR) contract.

 

•                       Current Report on Form 8-K datedJanuary 28, 2004 announcing close of the MATCOM International Corp.acquisition.

 

•                       Current Report on Form 8-K/A datedMarch 17, 2004 providing pro forma financial statements for the MATCOMInternational Corp. acquisition

 

•                       Current Report on Form 8-K datedMarch 17, 2004 filing as an exhibit a consent of Ernst & Young LLP.

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or15(d) of the Securities Exchange Act of 1934, the registrant has duly causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized, on the 11th day of May, 2004.

 
|   | SI  INTERNATIONAL, INC. |
|--------|-------------------------|
|   |                    |
|   |                    | /s/ Thomas E. Dunn |   |
|   |                    | 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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