Unassociated Document
 


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2007

or

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

Commission file number: 000-51426
 

 
FORTRESS INTERNATIONAL GROUP, INC.
 (Exact name of registrant as specified in its charter)

Delaware
 
20-2027651
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
9841 Broken Land Parkway
Columbia, Maryland
 
21046
(Address of principal executive offices)
 
(Zip Code)

(410) 312-9988
(Registrant's telephone number, including area code)

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

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

Indicated by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
 
As of August 13, 2007, 11,856,545 shares of the registrant's common stock, par value $0.0001 per share, were outstanding.
 


FORTRESS INTERNATIONAL GROUP, INC.
Table of Contents

   
Page
 
PART I - FINANCIAL INFORMATION
 
         
Item 1. Financial Statements
     
         
Consolidated Balance Sheets as of June 30, 2007 (unaudited) and as of December 31, 2006 (audited) (successor) and as of January 19, 2007 (unaudited) and December 31, 2006 (predecessor) (audited)
   
1
 
         
Consolidated Statements of Operations (unaudited) for the three and six months ended June 30, 2007 (successor) and June 30, 2006 (predecessor). Additionally, for the period from January 1, 2007 through January 19, 2007 (predecessor).
   
3
 
         
Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2007 and June 30, 2006 (successor) and for the period from January 1, 2007 through January 19, 2007 and the six months ended June 30, 2006 (predecessor)
   
5
 
         
Notes to Consolidated Financial Statements
   
6
 
         
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
   
16
 
         
Item 3. Quantitative and Qualitative Disclosures about Market Risk
   
26
 
         
Item 4. Controls and Procedures
   
26
 
 
PART II - OTHER INFORMATION
         
Item 1. Legal Proceedings
   
26
 
         
Item 1A. Risk Factors
   
27
 
         
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
   
27
 
         
Item 3. Defaults upon Senior Securities
   
27
 
         
Item 4. Submission of Matters to a Vote of Security Holders
   
27
 
         
Item 5. Other Information
   
28
 
         
Item 6. Exhibits
   
28
 
 
SIGNATURES



PART I - FINANCIAL INFORMATION

Fortress International Group, Inc.
Consolidated Balance Sheets

   
(Successor)
 
 (Predecessor)
 
   
June 30,
 
December 31,
 
 January 19,
 
December 31,
 
   
2007
 
2006
 
 2007
 
2006
 
   
(unaudited)
 
(audited)
 
 (unaudited)
 
(audited)
 
   
 
 
 
 
  
 
 
 
Assets
                  
                    
Current Assets
                  
Cash and cash equivalents
 
$
21,106,976
 
$
7,347
 
$
1,322,317
 
$
2,361,838
 
Contract and other receivables, net
   
8,977,676
   
   
6,261,988
   
9,960,851
 
Prepaid expenses and other current assets
   
746,264
   
3,750
   
233,894
   
125,276
 
Costs and estimated earnings in excess of billings
   
1,400,868
                   
on uncompleted contracts
         
   
1,559,045
   
480,540
 
Income tax recoverable
   
840,000
   
   
   
 
Due from affiliated entities
   
   
   
   
201,670
 
 
                         
Total Current Assets
   
33,071,784
   
11,097
   
9,377,244
   
13,130,175
 
                           
Investments held in trust
   
   
44,673,994
   
   
 
                           
Property and equipment, net
   
924,363
   
   
904,689
   
810,747
 
 
                         
Goodwill
   
14,912,946
   
   
   
 
 
                         
Intangible assets, net
   
19,185,065
   
   
   
 
                           
Deferred acquisition costs
   
   
869,853
   
   
 
 
                         
Other assets
   
371,823
   
   
64,158
   
21,190
 
                           
Deferred tax assets
   
   
490,675
   
   
 
                           
Total Assets
 
$
68,465,981
 
$
46,045,619
 
$
$10,346,091
 
$
13,962,112
 
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
1

 
Fortress International Group, Inc.
Consolidated Balance Sheets-Continued

   
(Successor)
 
 (Predecessor)
 
   
June 30,
 
December 31,
 
 January 19,
 
December 31,
 
   
2007
 
2006
 
 2007
 
2006
 
   
(unaudited)
 
(audited)
 
 (unaudited)
 
(audited)
 
                    
Liabilities and Stockholders’ Equity
                  
                    
Current Liabilities
                  
Notes payable–current portion
 
$
64,359
 
$
 
$
72,808
 
$
76,934
 
Accounts payable and accrued expenses
   
7,909,827
   
913,222
   
6,641,718
   
8,503,024
 
Advances from stockholder
         
20,000
   
   
 
Income taxes payable
   
   
586,283
   
   
 
Billings in excess of costs and estitmated earnings
                         
on uncompleted contracts
   
1,072,911
   
   
1,662,718
   
1,243,042
 
Deferred compensation payable
   
   
   
   
643,571
 
                           
Total Current Liabilities
   
9,047,097
   
1,519,505
   
8,377,244
   
10,466,571
 
                           
Notes payable
   
10,055,523
   
   
79,524
   
81,679
 
                           
Total Liabilities
   
19,102,620
   
1,519,505
   
8,456,768
   
10,548,250
 
                           
Common stock, subject to possible redemption 1,559,220 shares
   
   
8,388,604
   
   
 
                           
Interest income on common stock subject to possible redemption
   
   
541,735
   
   
 
                           
Total common stock subject to redemption
   
   
8,930,339
   
   
 
                           
Commitments and Contingencies
   
   
   
   
 
                           
Stockholders’ Equity
                         
Preferred stock- $.0001 par value; 1,000,000 shares authorized;
                         
no shares issued or outstanding
   
   
   
   
 
Common stock-- $.0001 par value, 100,000,000 shares authorized;
   
1,185
                   
11,856,545 and 9,550,000 issued; 11,856,545 and 9,550,000
                         
outstanding, respectively (which includes 0 and 1,559,220
                         
shares subject to possible redemption, respectively
         
955
   
   
 
Additional paid-in capital
   
52,864,132
   
34,819,062
   
   
 
Treasury stock, at cost 133,775 and 0 shares (successor);
   
(686,743
)
 
   
   
 
Retained earnings
   
(2,815,213
)
 
775,758
   
   
 
Members' equity
   
   
   
1,889,323
   
3,732,115
 
Note receivable from affiliate
   
   
   
   
(318,253
)
                           
Total Stockholders’ Equity
   
49,363,361
   
35,595,775
   
1,889,323
   
3,413,862
 
                           
Total Liabilities and Stockholders’ Equity
 
$
68,465,981
 
$
46,045,619
 
$
10,346,091
 
$
13,962,112
 

 
The accompanying notes are an integral part of these consolidated financial statements. 

2


Fortress International Group, Inc.
Consolidated Statements of Operations
 
 
 
(Successor)
 
(Predecessor)
 
 
 
 
 
 
 
  
 
 
 
 
 
For the Three Months Ended
June 30,
2007
 
For the Three Months Ended
June 30,
2006
 
 For the Three Months Ended
 June 30,
 2006
 
 
 
 
 
 
 
  
 
Revenue
 
$
10,862,307
 
$
 
$
18,445,839
 
Cost of Revenue
   
9,424,029
   
   
15,507,437
 
 
             
Gross Profit
   
1,438,278
   
   
2,938,402
 
 
             
Operating costs and expenses
             
Selling, general and administrative
   
3,424,040
   
121,753
   
1,681,169
 
Depreciation and amortization
   
97,245
   
     
Amortization of intangible assets
   
567,108
   
   
 
 
             
Total operating costs and expenses
   
4,088,393
   
121,753
   
1,681,169
 
 
             
Operating (loss) income
   
(2,650,115
)
 
(121,753
)
 
1,257,233
 
 
             
Other Income (Expense)
               
Interest income
   
423,898
   
410,904
   
 
Interest (expense)
   
(150,431
)
 
   
(4,733
)
 
             
Income (Loss) Before Income Taxes
   
(2,376,648
)
 
289,151
   
1,252,500
 
 
             
Income Tax (Benefit) Expense
   
182,316
   
98,312
   
 
 
             
Net (Loss) Income
 
$
(2,558,964
)
$
190,839
 
$
1,252,500
 
 
             
Weighted average number of shares outstanding
                   
-basic
   
12,013,491
   
9,550,000
   
 
-diluted
   
12,013,491
   
9,550,000
   
 
 
             
Weighted average shares outstanding exclusive of shares
             
subject to possible redemption
             
-basic
   
12,013,491
   
7,990,800
   
 
-diluted
   
12,013,491
   
7,990,800
   
 
 
             
Basic net income (loss) per share
             
-Net income
 
$
(0.21
)
$
0.02
 
$
 
 
             
Diluted net income (loss) per share
             
-Net income
 
$
(0.21
)
$
0.02
 
$
 
 
 
The accompanying notes are an integral part of these consolidated financial statements.

3


Fortress International Group, Inc.
Consolidated Statements of Operations-Continued

 
 
(Successor)
 
(Predecessor)
 
                   
   
For the Six Months
Ended
June 30,
2007
 
For the Six Months
Ended
June 30,
2006
 
For the period
from January 1,
2007 through
January 19,
2007
 
For the Six Months
Ended
June 30,
2006
 
 
 
 
 
 
 
  
 
 
 
Revenue
 
$
19,539,244
 
$
 
$
1,412,137
 
$
34,726,161
 
Cost of Revenue
   
16,629,595
   
   
1,108,276
   
28,719,264
 
 
                 
Gross Profit
   
2,909,649
   
   
303,861
   
6,006,897
 
 
                 
Operating costs and expenses
                 
Selling, general and administrative
   
6,061,980
   
297,955
   
555,103
   
3,333,944
 
Depreciation and amortization
   
152,676
   
   
33,660
     
Amortization of intangible assets
   
1,007,562
   
   
   
 
 
                 
Total operating costs and expenses
   
7,222,218
   
297,955
   
588,763
   
3,333,944
 
 
                 
Operating (loss) income
   
(4,312,569
)
 
(297,955
)
 
(284,902
)
 
2,672,953
 
 
                 
Other Income (Expense)
                   
Interest income
   
640,069
   
772,465
   
4,117
   
 
Interest (expense)
   
(267,797
)
 
   
(368
)
 
(9,698
)
 
                 
Income (Loss) Before Income Taxes
   
(3,940,297
)
 
474,510
   
(281,153
)
 
2,663,255
 
 
                 
Income Tax (Benefit) Expense
   
(349,325
)
 
161,334
   
   
 
 
                 
Net (Loss) Income
 
$
(3,590,972
)
$
313,176
 
$
(281,153
)
$
2,663,255
 
 
                 
Weighted average number of shares outstanding
                         
-basic
   
11,592,599
   
9,550,000
   
   
 
-diluted
   
11,592,599
   
9,550,000
   
   
 
 
                 
Weighted average shares outstanding exclusive of shares
                 
subject to possible redemption
                 
-basic
   
11,592,599
   
7,990,800
   
   
 
-diluted
   
11,592,599
   
7,990,800
   
   
 
 
                 
Basic net income (loss) per share
                 
-Net income
 
$
(0.31
)
$
0.03
 
$
 
$
 
 
                 
Diluted net income (loss) per share
                 
-Net income
 
$
(0.31
)
$
0.03
 
$
 
$
 

The accompanying notes are an integral part of these consolidated financial statements.

4


Fortress International Group, Inc.
Consolidated Statements of Cash Flow

   
(Successor)
 
 (Predecessor)
 
                   
   
For the Six Months Ended
June 30,
2007
 
For the Six Months Ended
June 30,
2006
 
For the period from January 1, 2007 through January 19, 2007
 
For the Six Months Ended
June 30,
2006
 
Cash Flows from Operating Activities
                  
Net income (loss)
 
$
(3,590,972
)
$
313,176
 
$
(281,153
)
$
2,663,255
 
Adjustments to reconcile net income (loss) to net cash (used in)
                         
provided by operating activities:
                         
Depreciation and amortization
   
152,676
   
   
33,660
   
126,000
 
Amortization of intangibles
   
1,210,235
   
   
   
 
Deferred income taxes
   
490,675
   
(156,078
)
 
   
 
Income tax recoverable
   
(840,000
)
 
   
   
 
Stock-based compensation
   
465,433
   
   
   
 
Interest income on treasury bills
   
   
(953,442
)
 
   
 
Changes in assets and liabilities, net of effects of acquisitions:
                         
Contracts and other receivables
   
(2,715,688
)
 
   
3,698,863
   
(1,162,200
)
Costs and estimated earnings in excess of billings on uncompleted contracts
   
158,177
   
   
(1,078,505
)
 
(128,075
)
Prepaid expenses
   
(508,619
)
 
38,915
   
(108,618
)
 
(269,893
)
Due from affiliates
   
   
   
519,923
   
(22,909
)
Other assets
   
(307,665
)
 
   
(42,968
)
 
 
Accounts payable and accrued expenses
   
354,887
   
(62,224
)
 
(1,861,306
)
 
2,842,596
 
Billings in excess of costs and estitmated earnings on uncompleted contracts
   
(589,807
)
 
   
419,676
   
(889,545
)
Income taxes payable
   
(586,283
)
 
6,412
   
   
 
Deferred compensation payable
   
   
   
(643,571
)
 
25,500
 
Interest income attributable to common stock subject to possible redemption
   
   
190,593
   
   
 
                   
Net Cash (Used in) Provided by Operating Activities
   
(6,306,951
)
 
(622,648
)
 
656,001
   
3,184,729
 
                           
Cash Flows from Investing Activities
                         
Purchase of property and equipment
   
(172,350
)
 
   
(127,602
)
 
(38,427
)
Decrease in Investments held in Trust fund
   
44,673,994
   
   
   
 
Purchase of TSS/Vortech, net of cash received
   
(9,677,683
)
 
   
   
 
Purchase of Comm Site of South Florida, Inc. net of cash received
   
(135,000
)
 
   
   
 
Deferred acquisition costs
   
(981,357
)
 
(152,167
)
 
   
 
                           
Net Cash Provided by (Used in) Investing Activities
   
33,707,604
   
(152,167
)
 
(127,602
)
 
(38,427
)
                           
Cash Flows from Financing Activities
                         
Payments on notes payable
   
(32,450
)
 
   
(6,281
)
 
(37,156
)
Advances from shareholder
   
(20,000
)
 
   
   
 
Member distributions
   
   
   
(1,561,639
)
 
(1,918,500
)
Repurchase of common stock
   
(6,248,574
)
 
   
   
 
                           
Net Cash (Used in) Provided by Financing Activities
   
(6,301,024
)
 
   
(1,567,920
)
 
(1,955,656
)
                           
Net Increase (Decrease) in Cash
   
21,099,629
   
(774,815
)
 
(1,039,521
)
 
1,190,646
 
                           
Cash, beginning of period
   
7,347
   
992,547
   
2,361,838
   
1,737,075
 
                           
Cash, end of period
 
$
21,106,976
 
$
217,732
 
$
1,322,317
 
$
2,927,721
 
 
The accompanying notes are an integral part of these consolidated financial statements.

5


Fortress International Group, Inc.
Notes to the Consolidated Financial Statements

NOTE A - BASIS OF PRESENTATION 

The consolidated financial statements are for the three and six months ended June 30, 2007 and 2006 for Fortress International Group, Inc. (the “Successor Company”, “Fortress” or the “Company”) and are for the period January 1, 2007 to January 19, 2007 (the acquisition date) and the three and six months ended June 30, 2006 for VTC, L.L.C. t/a Total Site Solutions and Vortech, LLC ( collectively the “Predecessor Company” or “TSS/Vortech”).  The Company has included the results of operations for the acquisition of TSS/Vortech from the acquisition date through June 30, 2007 in its financial statements.

Except for the balance sheets of the Company and TSS/Vortech as of December 31, 2006, which are derived from audited financial statements, the accompanying consolidated financial statements are unaudited. In the opinion of management, all adjustments necessary for a fair statement of such financial position and results of operations have been included. All such adjustments are of a normal recurring nature. Interim results are not necessarily indicative of results for a full year.

The consolidated financial statements and notes are presented as required by Form 10-Q and do not contain certain information included in the Company’s annual financial statements and notes. These financial statements should be read in conjunction with the Company’s audited financial statements and the notes thereto filed with the Securities and Exchange Commission (“SEC”) in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. The interim financial statements of TSS/Vortech have also been presented in accordance with the requirements of Form 10-Q. Such information should be read in conjunction with the TSS/Vortech financial statements for the year ended December 31, 2006 included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

NOTE B - RECENT ACCOUNTING PRONOUNCEMENTS

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements (SFAS No. 157). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. Specifically, this Statement sets forth a definition of fair value, and establishes a hierarchy prioritizing the inputs to valuation techniques, giving the highest priority to quoted prices in active markets for identical assets and liabilities and the lowest priority to unobservable inputs. The provisions of SFAS No. 157 are generally required to be applied on a prospective basis, except to certain financial instruments accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, for which the provisions of SFAS No. 157 should be applied retrospectively. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.  The Company is evaluating the effect of this statement, if any, on its financial position or results of operations.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115 (SFAS No. 159). SFAS No. 159 permits an entity, at specified election dates, to choose to measure certain financial instruments and other items at fair value. The objective of SFAS No. 159 is to provide entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently, without having to apply complex hedge accounting provisions. SFAS No. 159 is effective for accounting periods beginning after November 15, 2007. The Company is currently assessing the impact of adopting SFAS No. 159 on the consolidated financial statements.

6


NOTE C - ACQUISITIONS

TSS/VORTECH

On January 19, 2007, the Company acquired all of the outstanding membership interests of TSS/Vortech pursuant to the Second Amended and Restated Membership Interest Purchase Agreement dated July 31, 2006, as amended by the Amendment to the Second Amended and Restated Membership Interest Purchase Agreement dated January 16, 2007 (the “Purchase Agreement”). The closing consideration consisted of (i) $11,000,000 in cash, (ii) the assumption of $154,599 of debt of TSS/Vortech, (iii) 2,602,813 shares of Fortress common stock, of which 2,534,988 shares were issued to the selling members and 67,825 shares were issued to Evergreen Capital LLC as partial payment of certain outstanding consulting fees, and (iv) $10,000,000 in two convertible promissory notes of $5,000,000 each, bearing interest at 6%.

All of the shares issued to the selling members (2,534,988 shares) were placed into escrow accounts as follows: 2,461,728 into the General Indemnity escrow to secure the rights of Fortress under the acquisition and 73,260 shares into the Balance Sheet escrow subject to TSS/Vortech delivering $1,000,000 in working capital. These shares will be released subject to certain conditions under the respective agreements. Based on a determination of net working capital at the acquisition date, the Company has recorded a payable for approximately $200,000, included in accounts payable and accrued expenses in the June 30, 2007 consolidated balance sheet, expected to be paid to the sellers as a purchase price adjustment. The share price was based upon the average closing price for twenty days prior to the public announcement of the purchase.

Shareholders owning 756,100 shares of Fortress common stock voted against the acquisition and requested to receive the pro rata share of cash in the Trust Fund. The Company remitted approximately $4,342,000 in exchange for these shares.

Upon consummation of the merger approximately $28.9 million was released from the trust account to be used by the Company.

Under the purchase method of accounting, the preliminary purchase price has been allocated to the net tangible and intangible assets acquired and liabilities assumed, based upon preliminary estimates, which assume that historical cost approximates fair value of the assets and liabilities of TSS/Vortech. As such, management estimates that a substantial portion of the excess purchase price will be allocated to non-amortizable intangible assets. These estimates are subject to change upon the finalization of the valuation of certain assets and liabilities and may be adjusted in accordance with the provisions of SFAS No. 141, Business Combinations.  Management has preliminarily estimated that the transaction will result in $14.7 million of goodwill that is expected to be deductible for income tax purposes. Additionally, management estimated that approximately $20.4 million of the purchase price is allocable to customer-related intangible assets, which include non-contractual customer relationships, order backlog, and trade name.  Such intangible assets will be amortized over periods ranging from one to fifteen years based upon factors such as customer relationships and contract periods.

We paid a premium (i.e., goodwill) over the fair value of the net tangible and preliminarily identified intangible assets acquired for a number of reasons, including the following:

 
·
TSS/Vortech has a broad range of experience, contacts and service offerings in the mission critical facility industry. TSS/Vortech has a very experienced and committed management team with strong core competencies. TSS has a significant number of personnel with security clearances which is important in the homeland security industry.

 
·
Our belief in TSS/Vortech’s business model and potential for growth, increasing demand in its industry and its complete service offering when compared to other similar companies. In addition TSS/Vortech can provide a platform to assist us in managing acquisitions in the future.

 
·
TSS/Vortech has been building a national business development organization to expand beyond its current regional presence.

7


The total purchase price paid, including transaction costs of approximately $1.8 million, has been preliminarily allocated as follows:


Cash
 
$
11,000,000
 
Common stock (2,602,813 shares valued per the purchase agreement)
   
14,211,359
 
Convertible notes payable to sellers
   
10,000,000
 
Transaction costs
   
1,773,068
 
Total purchase price
   
36,984,427
 
Purchase price allocation:
       
Current assets
   
9,377,244
 
Property and equipment
   
904,689
 
Intangible assets
   
20,395,300
 
Goodwill
   
14,713,572
 
Other assets
   
64,158
 
Total assets acquired
   
45,454,963
 
Current liabilities
   
8,391,012
 
Long-term liabilities
   
79,524
 
Total liabilities assumed
   
8,470,536
 
Net assets acquired
 
$
36,984,427
 

The preliminary estimated value and the weighted-average amortization period of each of the components of intangible assets are as follows:


       
Weighted-Average
 
   
Estimated Value
 
Amortization Period
 
Non-contractual customer relationships
 
$
16,100,000
   
8
   
years
 
Order Backlog
 
 
456,300
 
 
1
 
 
years
 
Trade Name
   
3,839,000
   
15
   
years
 
           
 
       
Total
 
$
20,395,300
             
 
Amortization expense totaling $681,183 and $1,210,235 has been included in the accompanying consolidated statement of operations related to the above intangibles, of which $114,075 and $202,673 is included in cost of revenue, for the three and six months ending June 30, 2007, respectively.

The results of operations for TSS/Vortech have been included in the Consolidated Statements of Operations from the acquisition date through June 30, 2007.

8


Unaudited pro forma results of operations are as follows. The amounts are shown as if the TSS acquisition had occurred on January 1, 2007:

   
Three months ended June 30,
 
   
2007
 
2006
 
Proforma revenue
 
$
10,862,307
 
$
18,445,839
 
Proforma operating (loss) income
   
(2,650,114
)
 
454,297
 
Proforma pretax (loss) income
   
(2,376,647
)
 
710,037
 
Proforma net (loss) income
   
(2,558,964
)
 
468,624
 
Net (loss) income per share (basic )
   
(0.21
)
 
0.05
 
Net (loss) income per share (diluted)
   
-
   
0.05
 
 
   
Six months ended June 30,
 
   
2007
 
2006
 
Proforma revenue
 
$
20,951,381
 
$
34,726,161
 
Proforma operating (loss) income
   
(4,597,471
)
 
1,164,763
 
Proforma pretax (loss) income
   
(4,221,450
)
 
1,661,228
 
Proforma net (loss) income
   
(3,872,125
)
 
1,096,410
 
Net (loss) income per share (basic )
   
(0.33
)
 
0.11
 
Net (loss) income per share (diluted)
   
-
   
0.11
 

This information is not necessarily indicative of the operational results that would have occurred if the acquisition had been consummated on the dates indicated nor is it necessarily indicative of future operating results of the combined enterprise.

Comm Site of South Florida, Inc.

On May 7, 2007 the Company purchased all of the assets of Comm Site of South Florida, Inc. for $150,000 paid in cash. In connection with this purchase, $135,000 has been allocated to Goodwill with the balance to other current assets and property and equipment, based on their historic cost which management believes approximates fair value.

NOTE D - INVESTMENTS HELD IN TRUST

The Company held certain investments in a trust account through January 19, 2007 consisting primarily of short term investments. All such investments have been disposed of as of June 30, 2007.

9


NOTE E - INCOME (LOSS) PER SHARE

Successor — Basic and diluted net loss per share information is presented in accordance with SFAS No. 128, Earnings Per Share.  Basic loss per share is calculated by dividing the net loss attributable to common stockholders by the weighted-average common shares outstanding during the period.  Diluted loss per share is calculated by dividing net loss attributable to common stockholders by the weighted average common shares outstanding which includes common stock equivalents.  The Company’s common stock equivalents consist of outstanding warrants.  For the three and six months ended June 30, 2007, a total of 15,600,000 common stock equivalents, were excluded from the calculation of diluted income per share as their impact would have been anti-dilutive. In addition, any impact from the conversion of our convertible notes payable discussed in Note I are excluded from the computation of earnings per share since their conversion would also be anti-dilutive.

Weighted average common shares are calculated as follows:

   
(Successor)
 
(Predecessor)
 
   
Three Months Ended June 30,
 
Three Months Ended June 30,
 
   
2007
 
2006
 
2007
 
2006
 
Net (loss) income allocable to
         
 
   
 
 
 
 
 
common stockholders not subject
                         
to possible redemption
 
$
(2,558,964
)
$
190,839
 
$
-
 
$
1,252,500
 
Weighted average number of
                         
shares outstanding - basic
   
12,013,491
   
9,550,000
   
-
   
-
 
Weighted average number of
                         
shares outstanding - diluted
   
12,013,491
   
9,550,000
   
-
   
-
 
Income (loss) per share - basic
 
$
(0.21
)
$
0.02
   
-
   
-
 
Income (loss) per share -
                         
diluted
 
$
(0.21
)
$
0.02
   
-
   
-
 
 
   
Six Months Ended
     
January 1,
through
 
Six Months
 
   
 June 30,
     
January 19,
 
Ended June 30,
 
 
 
2007
 
2006
 
2007
 
2006
 
Net (loss) income allocable to
                         
common stockholders not subject
                         
to possible redemption
 
$
(3,590,972
)
$
313,176
 
$
(281,153
)
$
2,663,255
 
Weighted average number of
                         
shares outstanding - basic
   
11,592,599
   
9,550,000
   
-
   
-
 
Weighted average number of
                         
shares outstanding - diluted
   
11,592,599
   
9,550,000
   
-
   
-
 
Income (loss) per share - basic
 
$
(0.31
)
$
0.03
   
-
   
-
 
Income (loss) per share -
                         
diluted
 
$
(0.31
)
$
0.03
   
-
   
-
 

No weighted average common shares or income (loss) per share amounts are shown for the Predecessor since the Predecessor was limited liability company whose capital structure consisted of membership interests. As such, no weighted average number of outstanding shares and earnings per share are presented.
 
NOTE F - EMPLOYEE STOCK-BASED COMPENSATION

On January 17, 2007, the stockholders of the Company approved the Fortress International Group, Inc. 2006 Omnibus Incentive Compensation Plan (the “Plan”). Under the Plan, the Company reserved 2.1 million shares of the Company’s common stock for issuance to employees and directors through incentive stock options, or non-qualified stock options or through restricted stock units. Pursuant to the Plan, on January 19, 2007 the Company issued of 574,000 shares of restricted stock with grant date value of $5.44 per share in connection with the acquisition of TSS.  The restricted stock units have a vesting period of three years.

On May 1, 2007 the Company issued a total of 86,832 shares of restricted stock with a grant date value of $5.43 per share to the non-employee members of the Board of Directors. These shares were issued as follows:
 
10

 
Each non-employee director was granted 10,000 shares which vest over a two year period, one third on the grant date, and each one-half of the remaining balance on the first and second anniversaries of the grant date. A total of 50,000 shares were issued to the non-employee directors under this arrangement.

Each of the two new members of the Board of Directors received a one-time grant of $100,000 worth of restricted stock which vests over a three year period, with each one third of the shares vesting on the first, second and third anniversaries of the grant date. A total of 36,832 shares were issued to the two new non-employee directors under this arrangement.

In addition on May 7, 2007 the Company issue 20,000 shares of restricted stock with a grant date value of $5.53 to an employee, these shares have a vesting period of three years.

We are accounting for these grants of restricted stock in accordance with SFAS No. 123(R), Share Based Payment, which requires that compensation costs related to share-based payment transactions be recognized in financial statements. Under the fair value recognition provisions of SFAS No. 123(R), the Company recognizes stock-based compensation based upon the fair value of the stock-based awards taking into account the effects of the employees expected exercise and post-vesting employment termination behavior.  The Company recognized $263,000 ($.02 per basic and diluted share) of stock-based compensation expense for the three months ended June 30, 2007, for the six months ended June 30, 2007 the company recognized $465,000 ($.04 per basic and diluted share). These amounts are recorded as selling, general and administrative expense. 

The Company did not grant any stock-based awards to employees prior to fiscal year 2007. 

NOTE G - COMMON STOCK REDEMPTION

Prior to the consummation of the acquisition of TSS/Vortech, the Company announced and implemented a common stock repurchase program under which it may purchase up to 3,000,000 shares of common stock, currently the Board of Directors has authorized the repurchase of up to 500,000 shares under this program.  For the three months ended June 30, 2007, the Company paid approximately $688,000 in cash to redeem 133,775 shares of common stock at an average price of $5.14 per share. For the six months ended June 30, 2007 the Company has paid approximately $1,909,000 in cash to redeem 354,775 shares at an average price of $5.38 per share.

On January 19, 2007, the Company announced that it would repurchase shares of those shareholders that voted against the acquisition of TSS and requested that their 756,100 shares be redeemed at the then per share trust value of $5.74 per share (including deferred interest of $0.38 per share). This program was completed in January 2007.

NOTE H - INCOME TAXES

The Company’s effective tax rates are based upon the effective tax to be applicable to the full fiscal year.  Through June 30, 2007, the Company has incurred certain tax losses which may be carried back for federal tax purposes resulting in an income tax recoverable of approximately $840,000.

The Company recorded income tax expense of $182,316 for the three months ended June 30, 2007 due primarily to the establishment of a valuation allowance equal to the balance of the remaining deferred tax assets. The impact of recording this valuation allowance also impacted the income tax benefit recorded of $349,325 in the six months ended June 30, 2007. The June 30, 2007 amount was offset in part by income taxes recoverable as a result of being able to carry carrying back a portion of the net operating loss to prior years. The Company evaluated its remaining deferred tax assets (consisting primarily of net operating loss carryforwards) remaining after carryback and has determined that it is more likely-than-not at this time that these assets will not be realized and has established a full valuation allowance for these amounts.

TSS/Vortech is a limited liability company and incurred no material income taxes prior to the acquisition.

Effective January 1, 2007, the Company was required to adopt FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48).  FIN 48 prescribes a more-likely-than-not threshold of financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  This interpretation also provides guidance on derecognition of income tax assets and liabilities, classification of current and deferred tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods and income tax disclosures.  Since inception and through January 1, 2007, the adoption date of this standard, the Company was in essence a “blank check” company with no substantive operations. The Company files its tax returns as prescribed by the tax laws of the jurisdictions in which it operates. The Company’s 2004 through 2006 tax years are still subject to examination by the IRS. Various state jurisdiction tax years remain open to examination. As a result, management has concluded that the adoption of this standard had no material effect on its financial position or results of operations.
 
11

 
Management is in the process of evaluating the various tax positions associated with the acquisition of TSS/Vortech and is of the opinion that any deferred tax liabilities that would ultimately result from uncertain tax positions related to these entities would be covered by indemnification provisions provided in the acquisition agreements or would result in an adjustment to goodwill.

NOTE I - CONVERTIBLE PROMISSORY NOTES

In connection with the TSS/Vortech acquisition, the Company entered into two convertible promissory notes payable (in equal amounts with each the Company’s Chief Executive Officer and President ) totaling $10,000,000. The notes bear interest at six percent per year and have a term of five years. Interest only is payable during the first two years of each note with principal payments commencing on the second anniversary (January 19, 2009) and continuing throughout the balance of the term of the notes in equal quarterly installments totaling $833,333. At any time after the sixth month following the closing of the acquisition, the notes are convertible into shares of our common stock at a conversion price of $7.50 per share. At any time after the sixth month following the closing of the acquisition, the notes are automatically convertible if the average closing price of Fortress common stock for 20 consecutive trading days equals or exceeds $7.50 per share.

Principal payments are due on the above notes as follows:

Period ending
     
June 30,
 
Amount
 
       
2008
 
$
-
 
2009
   
1,666,667
 
2010
   
3,333,333
 
2011
   
3,333,333
 
2012
   
1,666,667
 
 
NOTE J - RELATED PARTY TRANSACTIONS

The Company participates in transactions with the following entities affiliated through common ownership and management:

S3 Integration LLC. S3 Integration LLC (S3 Integration) is owned 15% each by the Company’s Chief Executive Officer and President. S3 Integration provides commercial security systems design and installation services as a subcontractor to the Company.

Chesapeake Systems, LLC. (Chesapeake Systems) is 9% owned and significantly indebted to the Company’s Chief Executive Officer. Chesapeake Systems is a manufacturers’ representative and distributor of mechanical and electrical equipment and purchased certain assets of Chesapeake Tower Systems, Inc. in February 2007.
 
Chesapeake Mission Critical, LLC. (Chesapeake MC) is 9% owned each by the Company’s Chief Executive Officer and its President. Additionally, it is significantly indebted to the Company’s Chief Executive Officer. Chesapeake MC is a manufacturers’ representative and distributor of electrical equipment and purchased certain assets of Chesapeake Tower Systems, Inc. in February 2007.

Chesapeake Tower Systems, Inc. Chesapeake Tower Systems, Inc. (Chesapeake) is 100% owned by the Company’s Chief Executive Officer. On February 28, 2007 Chesapeake sold substantially all of its assets to Chesapeake Systems and Chesapeake MC and, except for an office space sublease agreement, does not engage in any business with the Company. Chesapeake was a manufacturer's representative and distributor of mechanical and electrical equipment, which Chesapeake sold to the Company. In addition, the Company acted as a subcontractor to Chesapeake for certain equipment installation on project-by-project basis.
 
12

 
CTS Services, LLC (CTS) is 55% owned by the Company’s Chief Executive Officer and 5% owned by the Company’s Treasurer. CTS is a mechanical contractor that acts as a subcontractor to the Company for certain projects. In addition, CTS utilizes the Company as a subcontractor on projects as needed.

L.H. Cranston Acquisition Group, Inc. L.H. Cranston Acquisition Group, Inc. (Cranston) is 25% owned by the Company’s Chief Executive Officer. Cranston is a mechanical, electrical and plumbing contractor that acts, directly or through its Subsidiary L.H. Cranston and Sons, Inc., as subcontractor to the Company on a project-by-project basis.

Telco P&C, LLC. Telco P&C, LLC is 55% owned by the Company’s Chief Executive Officer. Telco P&C is a specialty electrical installation company that acts as a subcontractor to the Company. The Company has also acted as a subcontractor to Telco as needed.

Automotive Technologies, Inc. Automotive Technologies, Inc. is 60% owned by the Company’s Chief Executive Officer and provides vehicle maintenance and repair services to the Company.

TPR Group, LLC. TPR Group, LLC is 100% owned by the Company’s Chief Executive Officer and has provided human resources, employee benefit, and administrative services to TSS/Vortech.

TPR Group Re Three, LLC. As of November 1, 2006, TPR Group Re Three, LLC (TPR Group Re Three) is owned 50% each by the Company’s Chief Executive Officer and its President. TPR Group Re Three leases office space to the Company under the terms of a real property lease to TSS/Vortech.

The following table sets forth transactions the Company has entered into with the above related parties for the three and six months ended June 30, 2007 and 2006. It should be noted that Revenue represents amounts earned on contracts with related parties under which we provide services; and Cost of Revenues represents costs incurred in connection with related parties which provide services to us on contracts for our customers. As such a direct relationship to the Revenue and Cost of Revenue information below by company should not be expected.
 
13


   
(Successor)
 
(Predecessor)
 
(Successor)
 
(Predecessor)
 
   
Three Months Ended June 30,
 
Six Months Ended June 30,
 
   
2007
 
2006
 
2007
 
2006
 
Revenue
                 
CTS Services, LLC
 
$
30,986
 
$
30,521
 
$
68,826
 
$
76,007
 
Chesapeake Systems, LLC
   
52,287
   
-
   
52,716
   
-
 
Chesapeake Mission Critical, LLC
   
27,216
   
-
   
27,216
   
-
 
Chesapeake Tower Systems, Inc.
   
-
   
5,028
   
-
   
12,175
 
S3 Integration, LLC
   
-
   
-
   
-
   
1,468
 
TPR Group, LLC
   
-
   
1,030
         
1,772
 
                           
Cost of Revenue
                         
CTS Services, LLC
 
$
230,964
 
$
2,082,432
 
$
470,392
 
$
2,866,976
 
Chesapeake Systems, LLC
   
160,304
   
-
   
160,304
   
-
 
Chesapeake Mission Critical, LLC
   
29,400
   
-
   
37,625
   
-
 
Chesapeake Tower Systems, Inc.
   
-
   
465,137
   
56,501
   
536,621
 
S3 Integration, LLC
   
130,743
   
3,500
   
218,922
   
3,500
 
LH Cranston & Sons, Inc.
   
121,100
   
204,816
   
131,877
   
300,119
 
Telco P&C, LLC
   
4,519
   
3,281
   
10,952
   
4,856
 
 
                         
Management fees paid to TPR Group, LLC
   
-
   
308,100
   
-
   
517,200
 
Office rent paid on Chesapeake sublease agmt
   
53,641
   
41,053
   
100,951
   
80,195
 
Office rent paid to TPR Group Re Three, LLC
   
90,494
   
-
   
191,478
   
-
 
Vehicle repairs to Automotive Technologies, Inc.
   
-
   
11,040
   
4,442
   
11,040
 
 
                         
 
   
June 30,
 
December 31,
 
   
2007
 
2006
 
Accounts receivable/(payable):
         
CTS Services, LLC
 
$
53,976
 
$
229,335
 
CTS Services, LLC
   
(332,019
)
 
(405,091
)
Chesapeake Systems, LLC
   
52,287
   
-
 
Chesapeake Systems, LLC
   
(159,279
)
 
-
 
Chesapeake Mission Critical, LLC
   
27,216
   
-
 
Chesapeake Mission Critical, LLC
   
(19,890
)
 
-
 
Chesapeake Tower Systems, Inc.
   
-
   
2,802
 
Telco P&C, LLC
   
(2,168
)
 
-
 
LH Cranston & Sons, Inc.
   
(68,000
)
 
-
 
S3 Integration, LLC
   
(70,025
)
     
 
14


NOTE K - SEGMENT INFORMATION

The Company reviewed its services by units to determine if any unit of the business is subject to risks and returns that are different than those of other units in the Company.  Based on this review, the Company has determined that all units of the Company are providing comparable services to its clients, and the Company has only one reportable segment.

NOTE L - COMMITMENTS

Employment Agreements

On January 19, 2007, the Company entered into employment agreements with its Chairman, Chief Executive Officer and President and a consulting agreement (the agreements) with an entity controlled by the Vice-Chairman, each of whom have been serving in that capacity since then. The employment agreements were filed as part of a current report on Form 8-K on January 25, 2007. The agreements specify annual salary, benefits and incentive compensation for the terms of the agreement.  The agreements also provide for twelve months salary if the employee or consultant is terminated other than for cause.

The agreements with the Chief Executive Officer and President also provide a share performance bonus, as described below:
Up to $5.0 million in additional shares of common stock will be issuable if during the period from the closing of the acquisition through July 13, 2008, certain share performance thresholds (alternative and not cumulative) set forth below are satisfied:
 
·
if the highest average share price of the Company’s common stock during any 60 consecutive trading day period between the closing of the acquisition and July 13, 2008 exceeds $9.00 per share but is no more than $10.00 per share, each of the Chief Executive Officer and President will be entitled to $0.5 million worth of additional shares; or
 
·
if the highest average share price of Company’s common stock during any 60 consecutive trading day period between the closing of the acquisition and July 13, 2008 exceeds $10.00 per share but is no more than $12.00 per share, each of the Chief Executive Officer and President will be entitled to $1.5 million worth of additional shares; or
 
·
if the highest average share price of Company’s common stock during any 60 consecutive trading day period between the closing of the acquisition and July 13, 2008 exceeds $12.00 per share but is no more than $14.00 per share, each of the Chief Executive Officer and President will be entitled to $3.0 million worth of additional shares; or
 
·
if the highest average share price of Company’s common stock during any 60 consecutive trading day period between the closing of the acquisition and July 13, 2008 exceeds $14.00 per share, each of the Chief Executive Officer and President will be entitled to $5.0 million worth of additional shares.
 
NOTE M - MAJOR CUSTOMER

The Company earned approximately 10% and 29% of its revenue for the three and six months ended June 30, 2007, respectively, and approximately 67% of its revenue for both the three and six months ended June 30, 2006 under several contracts with one major customer. Accounts receivable from this customer were $887,633 at June 30, 2007 and $4,807,323 at December 31, 2006.

15


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

The following discussion should be read in conjunction with our Financial Statements and related Notes thereto included elsewhere in this report.

This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We have based these forward-looking statements on our current expectations and projections about future events. These forward-looking statements are subject to known and unknown risks, uncertainties and assumptions about us that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “continue,” “intend,” “project,” “goal,” “potential,” “target,” and similar terms or the negative of such terms. Factors that might cause or contribute to such a discrepancy include, but are not limited to, those described in “Risk Factors,” as well as by future decisions by us.

The terms “we” and “our” as used throughout this Quarterly Report on Form 10-Q refer to Fortress International Group, Inc. and its consolidated subsidiaries, unless otherwise indicated.
 
Company Overview
 
We were formed in Delaware on December 20, 2004 as a special purpose acquisition company formed under the name “Fortress America Acquisition Corporation” for the purpose of acquiring, through a merger, capital stock exchange, asset acquisition or other business combination, operating businesses in the homeland security industry.

On January 19, 2007, we acquired all of the outstanding membership interests of each of VTC, L.L.C., doing business as Total Site Solutions (“TSS”), and Vortech, L.L.C. (“Vortech” and, together with TSS, “TSS/Vortech”) and simultaneously changed our name to Fortress International Group, Inc. (the “Company”). The closing consideration consisted of (i) $11,000,000 in cash, (ii) the assumption of $154,599 of debt of TSS/Vortech, (iii) 3,176,813 shares of our stock, of which 2,534,988 shares were issued to the selling members, 67,825 shares were issued to Evergreen Capital LLC as partial payment of certain outstanding consulting fees and (iii) $10,000,000 in two convertible, interest-bearing promissory notes of $5,000,000 each.

We provide comprehensive services for the planning, design, and development of mission critical facilities and information infrastructure. We also provide a single source solution for highly technical mission-critical facilities such as data centers, operation centers, network facilities, server rooms, security operations centers, communications facilities and the infrastructure systems that are critical to their function. Our services include technology consulting, engineering and design management, construction management, system installations, operations management, and facilities management and maintenance.

During the past three years, our revenue growth has been driven mainly by government spending on homeland security initiatives spurred by the events of September 11, 2001. These events have also affected businesses, which are increasing spending on data security and privacy. These homeland security initiatives include projects that require the hardening, relocation, renovation and upgrade of mission-critical facilities to protect critical government information networks and data processing centers against attacks. In addition to these factors there are other drivers that cause our market to remain robust. Legislation such as Sarbanes Oxley compliance for publicly traded companies, HIPPA laws regarding protection and availability of data for healthcare organizations and the government’s critical infrastructure protection program for industries that are vital to our economy have resulted in such companies having the need to invest to protect their networks, the reliability of those networks, and maintain their ability to perform transactions that are financial or informational in nature. With respect to these critical infrastructure systems, the companies focus on physical security, network security, redundancies for uninterruptible power supply systems, electrical switch gear, stand-by power generators, heat rejection and cooling systems, fire protection systems, monitoring and control systems, and security systems, as well as the physical environment that houses critical operations. We help our customers plan for, prevent or mitigate against the consequences of attacks, power outages and natural disasters. We provide our services, directly and indirectly, to both government customers and private sector customers.
 
TSS has obtained a facility clearance from the United States Department of Defense. This clearance enables the companies to access and service restricted government projects. In addition to the facility clearance, TSS has successfully cleared over one-third of its employees, allowing them individual access to restricted projects and facilities. Several additional employees are currently in the process for clearance.
 
16

 
In the future, we expect to use enhanced resources to expand geographically through internal growth initiatives, as well as through potential acquisitions of specialized mission critical engineering or IT services firms (primarily in the United States).
 
Our customers include United States government and homeland defense agencies and private sector businesses that in some cases are the end user of the facility or in other cases, such as our major real estate investment trust, or REIT, customer, Corporate Office Properties Trust, are providing a facility to a government end user. We categorize contracts where a government agency is the ultimate end user of the facility as government-related contracts.
 
Our revenues are derived from fees for our professional services as well as revenues earned under construction management contracts and facility management contracts with varying terms.
 
We believe there are high barriers to entry in our sector for new competitors due to our specialized technology service offerings we deliver for our customers, our top secret clearances, and our turnkey suite of deliverables offered. We compete for business based upon our reputation, past experience, and our technical engineering knowledge of mission critical facilities and their infrastructure. We are developing and creating long term relationships with our customers because of our excellent reputation in the industry and will continue to create facility management relationships with our customers that we expect will provide us with steadier revenue streams to improve the value of our business.
 
Contract Backlog

We believe a strong indicator of our future performance is our backlog of uncompleted projects in process or recently awarded. Our backlog represents contracts that have been awarded that we believe will result in revenue in the future. We have broken our backlog into the following three categories: (i) technology consulting, which represents the value of future revenue under existing contacts for professional services related to consulting and/or engineering design contracts; (ii) construction management, which represents the value of future revenues for construction projects; and (iii) facility management, which represents the value of future revenues for providing recurring maintenance services on our customers’ mission critical facilities, networks and communication systems.

At June 30, 2007, our backlog was approximately $55.4 million, compared to approximately $20.6 million at December 31, 2006. We believe that most of the backlog at June 30, 2007 will be recognized during the remainder of 2007. The following table reflects the value of our backlog in the above three categories as of June 30, 2007 and as of December 31, 2006, respectively.
 
   
(Successor)
 
(Predecessor)
 
 
 
June 30,
2007
 
December 31,
2006
 
Technology consulting
 
$
2,666,000
 
$
1,266,000
 
Construction management
   
37,376,000
   
11,757,000
 
Facilities management
   
15,336,000
   
7,585,000
 
               
   
$
55,378,000
 
$
20,608,000
 

17


The tables below include pro-forma information to assist in the analysis of the results of operations:

FORTRESS INTERNATIONAL GROUP, INC.
Pro Forma Consolidated Statements of Operations

   
(Successor)
 
(Successor)
 
(Predecessor)
 
(Proforma)
 
 
 
For the Three Months Ended
June 30,
2007
 
For the Three Months Ended
June 30,
2006
 
For the Three Months Ended
June 30,
2006
 
For the Three Months Ended
June 30,
2006
 
                   
Revenue
 
$
10,862,307
 
$
 
$
18,445,839
 
$
18,445,839
 
Cost of Revenue
   
9,424,029
   
114,075
   
15,507,437
   
15,621,512
 
                           
Gross Profit
   
1,438,278
   
(114,075
)
 
2,938,402
   
2,824,327
 
                           
Operating costs and expenses
                         
Selling, general and administrative
   
3,424,040
   
121,753
   
1,598,894
   
1,720,647
 
Depreciation and amortization
   
97,245
   
   
82,275
   
82,275
 
Amortization of intangible assets
   
567,108
   
567,108
   
   
567,108
 
                           
Total operating costs and expenses
   
4,088,393
   
688,861
   
1,681,169
   
2,370,030
 
                           
Operating income
   
(2,650,115
)
 
(802,936
)
 
1,257,233
   
454,297
 
                           
Other Income (Expense)
                         
Interest income
   
423,898
   
410,904
   
   
410,904
 
Interest (expense)
   
(150,431
)
 
(150,431
)
 
(4,733
)
 
(155,164
)
                           
Income (Loss) Before Income Taxes
   
(2,376,648
)
 
(542,463
)
 
1,252,500
   
710,037
 
                           
As a Percentage of Revenue
                         
                           
Revenue
   
100.0
%
 
   
100.0
%
 
100.0
%
Cost of Revenue
   
86.8
%
 
   
84.1
%
 
84.7
%
                           
Gross Profit
   
13.2
%
 
   
15.9
%
 
15.3
%
                           
Operating costs and expenses
                         
Selling, general and administrative
   
31.5
%
 
   
8.7
%
 
9.3
%
Depreciation and amortization
   
0.9
%
 
   
0.4
%
 
0.4
%
Amortization of intangible assets
   
5.2
%
 
   
0.0
%
 
3.1
%
                           
Total operating costs and expenses
   
37.6
%
 
0.0
%
 
9.1
%
 
12.8
%
                           
Operating income
   
-24.4
%
 
0.0
%
 
6.8
%
 
2.5
%
                           
Other Income (Expense)
                         
Interest income
   
3.9
%
 
100.0
%
 
0.0
%
 
2.2
%
Interest (expense)
   
-1.4
%
 
-36.6
%
 
0.0
%
 
-0.8
%
                           
Income (Loss) Before Income Taxes
   
-21.9
%
 
-132.0
%
 
6.8
%
 
3.8
%

18


FORTRESS INTERNATIONAL GROUP, INC.
Pro Forma Consolidated Statements of Operations
   
(Successor)
 
(Predecessor)
 
Proforma
 
(Successor)
 
(Predecessor)
 
Proforma
 
 
 
For the Six Months Ended
June 30,
2007
 
For the period
from January 1,
2007 through
January 19,
2007
 
combined
For the Six Months Ended
June 30,
2007
 
For the Six Months Ended
June 30,
2006
 
For the Six Months Ended
June 30,
2006
 
combined
For the Six Months Ended
June 30,
2006
 
                           
Revenue
 
$
19,539,244
   
1,412,137
   
20,951,381
 
$
 
$
34,726,161
 
$
34,726,161
 
Cost of Revenue
   
16,629,595
   
1,108,276
   
17,737,871
   
202,673
   
28,719,264
   
28,921,937
 
                                       
Gross Profit
   
2,909,649
   
303,861
   
3,213,510
   
(202,673
)
 
6,006,897
   
5,804,224
 
                                       
Operating costs and expenses
                                     
Selling, general and administrative
   
6,061,980
   
555,103
   
6,617,083
   
297,955
   
3,207,944
   
3,505,899
 
Depreciation and amortization
   
152,676
   
33,660
   
186,336
   
   
126,000
   
126,000
 
Amortization of intangible assets
   
1,007,562
   
   
1,007,562
   
1,007,562
   
   
1,007,562
 
                                       
Total operating costs and expenses
   
7,222,218
   
588,763
   
7,810,981
   
1,305,517
   
3,333,944
   
4,639,461
 
                                       
Operating income
   
(4,312,569
)
 
(284,902
)
 
(4,597,471
)
 
(1,508,190
)
 
2,672,953
   
1,164,763
 
                                       
Other Income (Expense)
                                   
Interest income
   
640,069
   
4,117
   
644,186
   
772,465
   
   
772,465
 
Interest (expense)
   
(267,797
)
 
(368
)
 
(268,165
)
 
(266,302
)
 
(9,698
)
 
(276,000
)
                                       
Income (Loss) Before Income Taxes
   
(3,940,297
)
 
(281,153
)
 
(4,221,450
)
 
(1,002,027
)
 
2,663,255
   
1,661,228
 
                                       
As a Percentage of Revenue
                                     
                                       
Revenue
   
100.0
%
 
100.0
%
 
100.0
%
 
   
100.0
%
 
100.0
%
Cost of Revenue
   
85.1
%
 
78.5
%
 
84.7
%
 
   
82.7
%
 
83.3
%
                                       
Gross Profit
   
14.9
%
 
21.5
%
 
15.3
%
       
17.3
%
 
16.7
%
                                       
Operating costs and expenses
                                     
Selling, general and administrative
   
31.0
%
 
39.3
%
 
31.6
%
       
9.2
%
 
10.1
%
Depreciation and amortization
   
0.8
%
 
2.4
%
 
0.9
%
       
0.4
%
 
0.4
%
Amortization of intangible assets
   
5.2
%
 
0.0
%
 
4.8
%
     
0.0
%
 
2.9
%
                                       
Total operating costs and expenses
   
37.0
%
 
41.7
%
 
37.3
%
     
9.6
%
 
13.4
%
                                       
Operating income
   
-22.1
%
 
-20.2
%
 
-21.9
%
 
0.0
%
 
7.7
%
 
3.4
%
                                       
Other Income (Expense)
                                     
Interest income
   
3.3
%
 
0.3
%
 
3.1
%
 
100.0
%
 
0.0
%
 
2.2
%
Interest (expense)
   
-1.4
%
 
0.0
%
 
-1.3
%
 
-34.5
%
 
0.0
%
 
-0.8
%
                                       
Income (Loss) Before Income Taxes
   
-20.2
%
 
-19.9
%
 
-20.1
%
 
-129.7
%
 
7.7
%
 
4.8
%
 
The pro forma results of operations shown above are not necessarily indicative of the results of operations that may have actually occurred had the acquisition taken place on the dates noted, or the future financial position or operating results of us or TSS/Vortech.

Critical Accounting Policies

Revenue Recognition
 
Revenues from contracts other than time and material contracts are recognized on the percentage of completion method, measured by the percentage of total costs incurred to date to estimated total costs for each contract. This method is used because management considers cost incurred and costs to complete to be the best available measure of progress in the contracts. Revenues from time and materials contracts are recognized as work is performed.
 
Contract costs include all direct materials, subcontract and labor costs and those indirect costs related to contract performance, such as indirect labor, payroll taxes and supplies. General and administrative expenses are charged to expense as incurred. Provisions for estimated losses on uncompleted contracts are made in the period in which losses are determined.
 
19

 
The asset, “Costs and estimated earnings in excess of billings on uncompleted contracts,” represents revenue recognized in excess of amounts billed. The liability, “Billings in excess of costs and estimated earnings on uncompleted contracts,” represented billings in excess of revenue recognized. As these long-term contracts extend over one or more years, revisions in cost and profit estimates during the course of the contract are reflected in the accounting period in which the facts which require the revisions are determined.

Goodwill and Other Intangible Assets

Management has preliminarily estimated that the acquisition of TSS/Vortech will result in $14.7 million of goodwill that is expected to be deductible for income tax purposes. Additionally, management has estimated that approximately $20.4 million of the purchase price is allocable to customer-related intangible assets, which include non-contractual customer relationships, order backlog, and trade name. 

Goodwill arising from our acquisition of TSS/Vortech is not amortized but instead will be tested for impairment at the reporting unit level at least annually in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets. We plan to perform an impairment assessment annually. Application of the goodwill impairment test requires significant judgments including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth, the period over which cash flows will occur, and determination of the weighted average cost of capital. Changes in these estimates and assumptions could materially affect the determination of fair value and/or goodwill impairment for each reporting unit.
 
We amortize other intangible assets over their estimated useful lives and review the long-lived assets for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable and at least annually. Determining whether impairment has occurred typically requires various estimates and assumptions, including determining which cash flows are directly related to the potentially impaired asset, the useful life over which cash flows will occur, their amount and the asset’s residual value, if any. In turn, measurement of an impairment loss requires a determination of fair value, which is based on the best information available

Allowance for Doubtful Accounts
 
We make ongoing estimates relating to the collectibility of our accounts receivable and maintain an allowance for estimated losses resulting from the inability of our customers to make required payments. Estimates used in determining accounts receivable allowances are based on specific customer account reviews and historical experience of credit losses. We also apply judgment including assessments about changes in economic conditions, concentration of receivables among customers and industries, recent write-off trends, rates of bankruptcy, and credit quality of specific customers. Unanticipated changes in the financial condition of customers, the resolution of various disputes, or significant changes in the economy could impact the reserves required.

Income Taxes
 
We make judgments and interpretations based on enacted tax laws, published tax guidance, as well as estimates of future earnings. These judgments and interpretations affect the provision for income taxes, deferred tax assets and liabilities and the valuation allowance. The deferred tax assets were evaluated under the guidelines of SFAS No. 109, Accounting for Income Taxes, and a determination of the basis of objective factors was made that the net assets will be realized through future years’ table income. In the event that actual results differ from these estimates and assessments, additional valuation allowances may be required.
 
Results of Operations for the Successor Company

Three months ended June 30, 2007 compared with the three months ended June 30, 2006

The following analysis of the Company provides comprehensive information as to the results of our operations since our acquisition of TSS/Vortech compared to our operations prior to this acquisition when we operated as a special purpose acquisition company. Following this analysis, we also present a comparison of our current results to pro forma results as though the acquisition had occurred on January 1, 2006.

Revenue and cost of revenue. We had no revenue or cost of revenue during the three months ended June 30, 2006. For the three months ended June 30, 2007 we had $10.9 million of revenue and $9.4 million of cost of revenue (including $114,000 of amortization of order backlog).
 
20

 
Gross margin decreased during the three months ended June 30, 2007 due to margin erosion of $0.3 million which occurred on contracts with our major customer as these contracts were completed.

The revenue and cost of revenue for the three months ended June 30, 2007 were due to our acquisition of TSS/Vortech during the first quarter of 2007.

Selling, general and administrative expenses. For the three months ended June 30, 2007, we incurred $3.4 million of selling, general and administrative expenses related to operations of TSS/Vortech which were acquired on January 19, 2007. Our selling, general and administrative expenses were $122,000 for the three months ended June 30, 2006 related primarily to the pursuit of acquisition candidates.

We granted employees 574,000 shares of common stock which had a grant date value of $5.44 share on January 19, 2007. These shares cliff-vest on January 19, 2010. In addition, on May 1, 2007 we granted 106,832 shares of common stock to our non-employee directors and one employee with a grant date value of $5.43 which vest over the next three years. We recorded approximately $263,000 of compensation expense related to these shares in the three months ended June 30, 2007, respectively.
 
Depreciation and amortization of intangible assets. During the three months ended June 30, 2007, we incurred depreciation and amortization expense of $664,000 related to assets purchased in our acquisition of TSS/Vortech.

Prior to our acquisition of TSS/Vortech, we did not incur any depreciation or amortization expense.

Interest income. Our interest income was $424,000 earned during the three months ended June 30, 2007 in comparison to $411,000 for the three months ended June 30, 2006.

Interest expense. For the three months ended June 30, 2007, interest expense was $150,000. We did not incur any interest expense during the three months ended June 30, 2006. This interest expense is attributable to the debt acquired with the acquisition of TSS/Vortech which consists of notes payable due to the sellers of $10,000,000 that have an interest rate of 6% per annum.

Income tax benefit (expense). We recorded an income tax expense of $182,000 for the three months ended June 30, 2007. For the three months ended June 30, 2006 we recorded an income tax expense of $98,000.

The amount above for the three months ended June 30, 2007 reflect the value of a potential loss carryback to prior periods at the effective federal tax rate of 34% net of a valuation allowance recorded on the deferred tax assets. The Company’s effective tax rates are based upon the effective tax to be applicable to the full fiscal year.

Six months ended June 30, 2007 compared with the six months ended June 30, 2006

Revenue and cost of revenue. We had no revenue or cost of revenue during the six months ended June 30, 2006. For the six months ended June 30, 2007, we had $19.5 million of revenue and $16.6 million of cost of revenue (including $203,000 of amortization of order backlog).

The increase in revenue and cost of revenue for the six months ended June 30, 2007 were due to our acquisition of TSS/Vortech during the first quarter of 2007.

Selling, general and administrative expenses. For the six months ended June 30, 2007, we incurred $6.1 million of selling, general and administrative expenses related to operations of TSS/Vortech. Our selling, general and administrative expenses were $298,000 for the six months ended June 30, 2006 related primarily to the pursuit of acquisition candidates.

We granted employees 574,000 shares of common stock which had a grant date value of $5.44 share on January 19, 2007. These shares cliff-vest on January 19, 2010. In addition, on May 1, 2007 we granted 106,832 shares of common stock to our non-employee directors and one employee with a grant date value of $5.43 which vest over the next three years. We recorded approximately $465,000 of compensation expense related to these shares in the six months ended June 30, 2007.
 
21

 
Depreciation and amortization of intangible assets. During the six months ended June 30, 2007, we incurred depreciation and amortization expense of $1,160,000 related to assets purchased in our acquisition of TSS/Vortech. Prior to our acquisition of TSS/Vortech, we did not incur any depreciation or amortization expense.

Interest income. For the six months ended June 30, 2007, interest income was $640,000 in comparison to $772,000 for the six months ended June 30, 2006. Interest income decreased on a year to date basis because of the decrease in cash invested due to the purchase of TSS/Vortech and the related transaction costs.

Interest expense. For the six months ended June 30, 2007, interest expense was $268,000. We did not incur any interest expense during the six months ended June 30, 2006. This interest expense is attributable to the debt acquired with the acquisition of TSS/Vortech which consists of notes payable due to the sellers of $10,000,000 that have an interest rate of 6% per annum.

Income tax benefit (expense). For the six months ended June 30, 2007, we had an income tax benefit of $349,000 and for the six months ended June 30, 2006, income tax expense was $161,000.

The amounts above for the six months ended June 30, 2007 reflect the value of a potential loss carryback to prior periods at the effective federal tax rate of 34% net of a valuation allowance recorded on the deferred tax assets. The Company’s effective tax rates are based upon the effective tax to be applicable to the full fiscal year.

Results of Operations on a Pro Forma Combined Basis for the Successor Company

The acquisition of TSS/Vortech was our first business combination and accordingly, we do not believe a comparison of the results of operations for the three and six months ended June 30, 2007 and June 30, 2006 is very beneficial to our investors. In order to assist investors in better understanding the changes in our business between the three and six months ended June 30, 2007 and June 30, 2006, we are presenting in the discussion below pro forma results of operations for the Company and TSS/Vortech for the three and six months ended June 30, 2007 and June 30, 2006 as if the acquisition of TSS/Vortech occurred on January 1, 2007 and January 1, 2006, respectively. We derived the pro forma results of operations from (i) the unaudited consolidated financial statements of TSS/Vortech for the period from December 31, 2006 to January 19, 2007 (the date of the acquisition) and the six months ended June 30, 2006, and (ii) our unaudited consolidated financial statements for the six months ended June 30, 2007 and June 30, 2006.
 
The pro forma results of operations are not necessarily indicative of the results of operations that may have actually occurred had the acquisition taken place on the dates noted, or the future financial position or operating results of us or TSS/Vortech. The pro forma adjustments are based upon available information and assumptions that we believe are reasonable.

Three months ended June 30, 2007 compared with the three months ended June 30, 2006

Revenue and cost of revenue. We had $10.9 million of revenues and $9.4 million of cost of revenue earned in the three months ended June 30, 2007 compared to $18.4 million of revenue and $15.6 million of cost of revenue earned in the three months ended June 30, 2006.

The decrease in revenue was primarily due to a reduction in construction management revenue earned on projects for the three months ended June 30, 2007as compared to the same six month period in 2006.

Management believes that the decline in revenue when comparing the three months ended June 30, 2007 to June 30, 2006 results from the fact that we relied heavily in its first three years of operations on a few long-term contracts from one major customer. Starting in the last quarter of 2005 and continuing through all of 2006 and 2007, we are implementing a strategy to replace these contracts with new revenue from a broader base of customers in both the public and the private sectors. In order to continue a revenue level equal or higher to the revenue recognized in the first six months of 2006, the Company needed to replace its backlog at December 31, 2005 of $39.7 million with new sales as the backlog diminished. New backlog additions for the year 2006 were approximately $41.0 million and our backlog at December 31, 2006 was $20.6 million. As a result, our revenue on a quarter to quarter basis for the first six months of 2007 has declined.
 
22

 
Backlog additions were only $8.0 million in the third quarter and $13.2 million for the fourth quarter of 2006, which affected revenue in our first and second quarters of 2007. New backlog additions increased to $15.2 million in the first quarter and $44.1 million in the second quarter of 2007. Backlog increased again in the second quarter of 2007 by $30.7 million. If we are able to sustain this increasing trend of closing new business, our revenue per quarter should increase correspondingly. We believe backlog takes an average of six months to be recognized proportionately as revenue on projects utilizing the percentage of completion method. Delays in project mobilization may also cause some inconsistencies in our revenue recognition from quarter to quarter. Our total backlog at June 30, 2007 was $55.4 million of which a majority of it should be recognized as revenue in the third and forth quarters of 2007.
 
The cost of revenues decreased in relation to our reduction in revenue for the three months ended June 30, 2007 and 2006. Cost of revenue decreased to $9.4 million with a gross profit margin of 13.2% for the three months ended June 30, 2007 compared to $15.6 million with a gross profit margin of 15.3% for the three months ended June 30, 2006.

Gross profit margin decreased because there are fixed costs included in cost of revenue which were spread over less revenue. In addition, there was margin erosion of $0.3 million which occurred on contracts with our major customer as these contracts were completed.

Revenue from our largest customer (in 2006) was only $1.1 million for the three months ended June 30, 2007 compared to $12.3 million for the three months ended June 30, 2006.

The reduction of revenue from this customer has been replaced with revenue from new customers as stated in our diversification strategy. Approximately 10% of our revenue during the quarter came from this customer compared to 67% in the three months ended June 30, 2006. Our strategy is to continue to diversify our customer base and become less reliant on this single customer.

Selling, general and administrative expenses. Selling, general and administrative expenses were $3.4 million for the three months ended June 30, 2007 compared to $1.7 million for the three months ended June 30, 2006. The increase as a percentage of revenue increased to 31.5% of revenue from 9.3% of revenue for the three months ended June 30, 2007 and 2006.  

The increase in these costs is attributable to (i) an increase in the number of sales and marketing personnel added to the Company to implement our strategic plan, (ii) marketing expenses to get into the private industry marketplace, (iii) non cash compensation of restricted stock awards given to key employees, (iv) the costs associated with being a public company and (v) increased rent and occupancy costs as we increased our office space for the technology consulting group and other support personnel and opened offices in other locations. These increased additional costs versus the prior year period ending June 30 are:

       
Three months
 
Six months
 
   
 
         
·
   
Sales salaries and expenses
 
$
511,000
 
$
942,000
 
·
   
Marketing expenses
   
95,000
   
325,000
 
·
   
Non cash compensation for restricted stock
   
263,000
   
465,000
 
·
   
Public company costs
   
431,000
   
841,000
 
·
   
Rent and occupancy costs
   
223,000
   
401,000
 
 
Depreciation and amortization of intangible assets. Depreciation and amortization of intangible assets expense was $664,000 for the three months ended June 30, 2007 compared to $649,000 for the three months ended June 30, 2006. Our depreciation expense increased $15,000 due to the increase in property and equipment purchased related to the new office space leased in the fourth quarter of 2006.

Interest income. Interest income was $424,000 for the three months ended June 30, 2007 compared to $411,000 for the three months ended June 30, 2006.

Interest expense. Interest expense was $150,000 for the three months ended June 30, 2007 compared to $4,700 for the three months ended June 30, 2006.

Six months ended June 30, 2007 compared with the six months ended June 30, 2006

Revenue and cost of revenue. We had $19.5 million of revenues and $16.6 million of cost of revenue earned in the six months ended June 30, 2007 compared to $34.7 million of revenue and $28.9 million of cost of revenue earned in the six months ended June 30, 2006. The decrease in revenue was primarily due to a reduction in construction management revenue earned on projects for the six months ended June 30, 2007 compared to the same six month period in 2006.
 
23

 
Management believes that the decline in revenue when comparing the six months ended June 30, 2007 to June 30, 2006 results from the fact that the Company relied heavily in its first three years of operations on a few long-term contracts from one major customer. Starting in the last quarter of 2005 and continuing through all of 2006 and 2007 the Company is implementing a strategy to replace these contracts with new revenue from a broader base of customers in both the public and the private sectors. In order to continue a revenue level equal or higher to the revenue recognized in the first six months of 2006, we needed to replace its backlog at December 31, 2005 of $39.7 million with new sales as the backlog diminished. New backlog additions for the year 2006 were approximately $41.0 million and our backlog at December 31, 2006 was $20.6 million. As a result, our revenue on a quarter to quarter basis for the first six months of 2007 has declined.

Backlog additions were only $8.0 million in the third quarter and $13.2 million for the fourth quarter of 2006, which affected revenue in our first and second quarters of 2007. New backlog additions increased to $15.2 million in the first quarter and $44.1 million in the second quarter of 2007. Backlog increased again in the second quarter of 2007 by $30.7 million. If the Company is able to sustain this increasing trend of closing new business, its revenue per quarter should increase correspondingly. We believe backlog takes an average of six months to be recognized proportionately as revenue on projects utilizing the percentage of completion method. Delays in project mobilization may also cause some inconsistencies in our revenue recognition from quarter to quarter. Our total backlog at June 30, 2007 was $55.4 million of which a majority of it should be recognized as revenue in the third and forth quarters of 2007.
 
The cost of revenues decreased in relation to our reduction in revenue for the six months ended June 30, 2007 and 2006.
Cost of revenue decreased to $17.7 million with a gross profit margin of 15.3% for the six months ended June 30, 2007 compared to $28.9 million with a gross profit margin of 16.7% for the six months ended June 30, 2006.

Gross profit margin decreased because there are fixed costs included in cost of revenue which were spread over less revenue. In addition, there was margin erosion of $0.3 million which occurred on contracts with our major customer as these contracts were completed.

Revenue from our largest customer for the six months ended June 30, 2007 was $6.1 million compared to $23.1 million for the six months ended June 30, 2006.

The reduction of revenue from this customer has been replaced with revenue from new customers as stated in our diversification strategy. Approximately 29% and 67% of our revenue came from this customer in the six months ended June 30, 2007 and 2006, respectively. Our strategy is to continue to diversify our customer base and become less reliant on this single customer.

Selling, general and administrative expenses. Selling, general and administrative expenses were $6.6 million for the six months ended June 30, 2007 compared to $3.5 million for the six months ended June 30, 2006. The increase as a percentage of revenue to 31.6% from 10.5% of revenue for the six months ended June 30, 2007 and 2006. 

The increase in these costs is attributable to (i) an increase in the number of sales and marketing personnel added to the Company to implement our strategic plan, (ii) marketing expenses to get into the private industry marketplace, (iii) non cash compensation of restricted stock awards given to key employees, (iv) the costs associated with being a public company and (v) increased rent and occupancy costs as we increased our office space for the technology consulting group and other support personnel and opened offices in other locations. These increased additional costs versus the prior year period ending June 30 are:

       
Three months
 
Six months
 
   
 
         
·
   
Sales salaries and expenses
 
$
511,000
 
$
942,000
 
·
   
Marketing expenses
   
95,000
   
325,000
 
·
   
Non cash compensation for restricted stock
   
263,000
   
465,000
 
·
   
Public company costs
   
431,000
   
841,000
 
·
   
Rent and occupancy costs
   
223,000
   
401,000
 
 
Depreciation and amortization of intangible assets. Depreciation and amortization of intangible assets expense was $1,194,000 for the six months ended June 30, 2007 compared to $1,134,000 for the six months ended June 30, 2006. Our depreciation expense increased $60,000 due to the increase in property and equipment purchased related to the new office space leased in the fourth quarter of 2006.
 
24

 
Interest income. For the six months ended June 30, 2007, interest income was $644,000 compared to $772,000 for six months ending June 30, 2006. Interest income decreased for the six month period because of the decrease in cash invested due to the purchase of TSS/Vortech and the related transaction costs.

Interest expense. Interest expense was $268,000 for the six months ended June 30, 2007 compared to $276,000 for the six months ended June 30, 2006.

Financial Condition, Liquidity and Capital Resources

Financial Condition

Total assets increased $22.5 million to $68.5 million as of June 30, 2007 compared to $46.0 million as of December 31, 2006, due to our acquisition of TSS/Vortech during the first quarter of 2007. At June 30, 2007, we no longer had $44.7 million in short term investments, as we did at December 31, 2006 as a portion of those funds were used to acquire TSS/Vortech and the remainder was available to us and recorded as cash. At June 30, 2007 we had $33.1 million in current assets of which $21.1 million was cash, $9.0 million in contract accounts receivable and $3.0 million in other current assets.
 
Our total liabilities increased to $19.1 million as of June 30, 2007 from $1.5 million as of December 31, 2006, primarily due to the acquisition noted above. Accordingly our current liabilities increased to $9.0 million at June 30, 2007 from $1.5 million at December 31, 2006.

Liquidity and Capital Resources

During the six months ended June 30, 2007 net cash used in operating activities for the period was $6.3 million. Cash used by operating activities is primarily driven by the net loss adjusted for working capital changes which were primarily changes in accounts receivable, other current assets, accounts payable and work in process adjustments.

Net cash provided by investing activities was $33.7 million for the six months ended June 30, 2007. During the six months ended June 30, 2007, we had $44.7 million from the sale of short-term securities, while we invested $11 million toward the purchase of TSS/Vortech and used $1.3 million used for deferred acquisition costs and fixed assets. Net cash used by financing activities was $6.3 million for the six months ended June 30, 2007. This was principally used to repurchase shares of our common stock associated with the buyout of the dissenting shareholders and the previously announced share repurchase program.

We expect to retain future earnings if any for use in possible expansion of our business and do not anticipate paying any cash dividends in the foreseeable future.

Historically, we have funded our business activities with cash flow from operations and borrowings under credit facilities.

Our primary liquidity needs are to finance the costs of operations, acquire capital assets and to make selective strategic acquisitions.  We expect to meet our short-term requirements through funds generated from operations. We also intend on pursuing a credit facility in the future.  Our strategic acquisition cash requirements will also be funded by cash generated from operations and the aforementioned credit facility.

Off Balance Sheet Arrangements 

As of the six months ended June 30, 2007, we do not have any off balance sheet arrangements.

Recent Accounting Pronouncements

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 (SFAS No. 157), Fair Value Measurements.  SFAS No. 157 provides a new single authoritative definition of fair value and enhanced guidance for measuring the fair value of assets and liabilities.  It requires additional disclosures related to the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings.  SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.  We are currently evaluating what effect, if any, the adoption of SFAS No. 157 will have on our financial position, results of operations, or cash flows.
 
25

 
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115 (SFAS No. 159). SFAS No. 159 permits an entity, at specified election dates, to choose to measure certain financial instruments and other items at fair value. The objective of SFAS No. 159 is to provide entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently, without having to apply complex hedge accounting provisions. SFAS No. 159 is effective for accounting periods beginning after November 15, 2007. The Company will adopt SFAS No. 159 for the fiscal year beginning January 1, 2008 and is currently assessing the impact of adopting SFAS No. 159 on the consolidated financial statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Refer to our Annual Report on Form 10-K for the year ended December 31, 2006 for a complete discussion of our market risk. There have been no material changes to the market risk information included in the Annual Report 10-K for the year December 31, 2006.

Item 4. Controls and Procedures.

Our management performed an evaluation under the supervision and with the participation of our Chief Executive Officer (principal executive officer) who is also currently the Chief Financial Officer of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of June 30, 2007. Based upon that evaluation, our Chief Executive Officer has concluded that as of June 30, 2007, our disclosure controls and procedures were ineffective.

Changes in Internal Control Over Financial Reporting

Through December 31, 2006, we had no operations, no full-time personnel and very few personnel of any kind. Our activities from inception in late 2005 and into 2006 focused on completing our initial public offering, identifying acquisition candidates and then completing the acquisition of TSS/Vortech. As of December 31, 2006, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer of the effectiveness of the design and operation of our “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, our Chief Executive Officer concluded that our disclosure controls and procedures were effective at that time for the purpose of ensuring that the information required to be disclosed in our reports filed with the SEC under the Exchange Act is (1) recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms and (2) is accumulated and communicated to our management, including the Chief Executive Officer, as appropriate to allow timely decisions regarding required disclosure.
 
In January 2007 we acquired TSS/Vortech and re-evaluated our internal control process during the first quarter of 2007. As a result of this re-evaluation, we have determined that our internal control over financial reporting is ineffective. We had neither the resources, nor the personnel, to provide for an adequate internal control environment. The following material weaknesses in our internal control over financial reporting were noted at March 31, 2007: (i) we did not have the ability to segregate duties; (ii) we lacked the formal documentation of policies and procedures that were in place; and (iii) we lacked adequate financial personnel. 

We have begun to address the internal control weaknesses summarized above beginning in the first quarter of 2007, with the goal of eliminating such deficiencies by the end of 2007. We are working with a certified public accounting firm to serve as our internal auditors to further enhance our internal control environment and have hired a Chief Financial Officer expected to start on August 20, 2007. The acquisition of TSS/Vortech will require the development of more robust disclosure controls and procedures, which we are currently developing. Management will continue to monitor, evaluate and test the operating effectiveness of these controls during the remainder of 2007.  

There were no other changes in our internal control over financial reporting for the first six months of 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

We are not currently subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us.
 
26

 
Item 1A. Risk Factors.

There are no material updates to the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2006.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.


   
Purchases of Equity Securities by Issuer
             
           
Total Number of
 
Maximum Number
     
           
Shares Purchased as
 
of Shares (or Units)
     
           
Part of Publicly
 
that May Yet Be
     
   
Total Number of
 
Average Price Paid
 
Announced Plans
 
Purchased Under the
     
Period
 
Shares Purchased
 
per Share
 
or Programs
 
Plans or Programs
     
January 1-31, 2007
   
116,000
 
$
5.49
   
116,000
   
384,000
       
February 1-28, 2007
   
94,500
 
$
5.60
   
210,500
   
289,500
       
March 1-31, 2007
   
10,500
 
$
5.33
   
221,000
   
279,000
   
(1
)
April 1-30, 2007
   
0
   
---------
   
221,000
   
279,000
       
May 1-31, 2007
   
29,300
 
$
5.21
   
250,300
   
249,700
       
June 1-30, 2007
   
104,475
 
$
5.11
   
354,775
   
145,225
       
                                 
                                 
January 1-31, 2007
   
756,100
 
$
5.38
   
1,110,875
   
0
   
(2
)
                                 
Total
   
1,110,875
 
$
5.38
   
1,110,875
             

(1) On January 12, 2007 the company announced a stock repurchase program of up to 3,000,000 shares of the Company’s common stock, from time to time, subject to market conditions. The Board of Directors has authorized repurchases of up to 500,000 shares under this program and the repurchase program will continue until completion or termination by the Board of Directors.

(2) The Company repurchased the shares of those shareholders that voted against the acquisition of TSS/Vortech and requested that their shares be redeemed at the then per share trust value. This program was completed in January 2007.

Recent Sales of Unregistered Securities

During May 2007, we issued 106,832 shares of restricted stock to our non-employee directors and one employee. Such shares of restricted stock were issued in reliance on the exemption from registration under Section 4(2) of the Securities Act of 1933.

Item 3. Defaults Upon Senior Securities.

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders.

At the annual meeting of stockholders held on June 19, 2007, the stockholders elected three Class II directors to serve on our Board of Director for a three-year term expiring in 2010 and voted upon additional two Board proposals contained within our Proxy Statement dated May 22, 2007.
The three Class II nominees were elected with the following vote:
 
27

 
 
For
Withheld
Harvey L. Weiss
10,857,851 
155,191
Donald L. Nickles
11,012,042
1,000
William L. Jews
11,012,042
1,000

The Board proposals were approved with the following vote:


Proposal
 
For
 
Against
 
Abstention (other than Broker Non-Votes)
 
Broker Non-Votes
Approval of amendment to the certificate of incorporation to increase the number of authorized shares of common stock to 100,000,000 shares of common stock
 
10,627,196
 
385,846
 
0
 
0
                 
Ratify the selection of Grant Thornton LLP, as registered public accounting firm for the year ending December 31, 2007
 
11,012,042
 
1,000
 
0
 
0

Item 5. Other Information.

On August 1, 2007, our common stock, warrants and units commenced trading on the NASDAQ Capital Market under the symbols FIGI, FIGIW and FIGIU, respectively.

Item 6. Exhibits.
 
31.1
Section 302 Certification by Principal Executive Officer
   
31.2
Section 302 Certification by Principal Financial Officer
   
32.1
Section 906 Certification by Principal Executive Officer and Principal Financial Officer
 
28


SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
         
 
 
FORTRESS INTERNATIONAL GROUP, INC.
     
 
Date: August 14, 2007
 
 
By:
 
/s/ Thomas P. Rosato
 
 
 
 

Thomas P. Rosato
 
 
 
 
Chief Executive Officer
(Principal Executive Officer
and Principal Financial Officer)

29