FORTRESS INTERNATIONAL GROUP, INC.

Table of Contents

		Page
PART I - FINANCIAL INFORMATION
Item 1.     Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2009 and as of December 31, 2008			1
Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2009 and June 30, 2008			2
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2009 and June 30, 2008			3
Notes to Condensed Consolidated Financial Statements			4
Item 2.      Management’s Discussion and Analysis of Financial Condition and Results of Operations			12
Item 3.      Quantitative and Qualitative Disclosures about Market Risk			21
Item 4T.   Controls and Procedures			21
PART II - OTHER INFORMATION
Item 1.      Legal Proceedings			22
Item 1A.   Risk Factors			22
Item 2.      Unregistered Sales of Equity Securities and Use of Proceeds			24
Item 3.      Defaults upon Senior Securities			24
Item 4.      Submission of Matters to a Vote of Security Holders			24
Item 5.      Other Information			24
Item 6.      Exhibits			24
SIGNATURES			25

 

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FORTRESS INTERNATIONAL GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

		(Unaudited)								(Unaudited)
		For the Three Months Ended								For the Six Months Ended
		June 30, 2009				June 30, 2008				June 30, 2009				June 30, 2008
Results of Operations:
Revenue		$	14,939,422			$	20,149,876			$	45,010,750			$	39,581,956
Cost of revenue			13,158,890				18,038,179				39,562,081				34,059,068
Gross profit			1,780,532				2,111,697				5,448,669				5,522,888
Operating expenses:
Selling, general and administrative			4,637,908				5,657,424				8,491,569				10,428,454
Depreciation and amortization			105,039				123,217				208,459				238,456
Amortization of intangibles			690,855				619,436				1,382,960				1,401,498
Impairment loss on goodwill and other intangibles			13,062,140				1,217,000				13,062,140				1,217,000
Total operating costs			18,495,942				7,617,077				23,145,128				13,285,408
Operating  loss			(16,715,410	)			(5,505,380	)			(17,696,459	)			(7,762,520	)
Interest income (expense), net			(52,271	)			(101,938	)			(87,819	)			(145,008	)
Loss from operations before income taxes			(16,767,681	)			(5,607,318	)			(17,784,278	)			(7,907,528	)
Income tax expense			-				387,000				-				387,000
Net loss		$	(16,767,681	)		$	(5,994,318	)		$	(17,784,278	)		$	(8,294,528	)
Per Common Share (Basic and Diluted):
Basic and diluted net loss		$	(1.32	)		$	(0.50	)		$	(1.40	)		$	(0.69	)
Weighted average common shares outstanding-basic and diluted			12,678,381				12,093,895				12,660,049				12,083,483

 

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

 

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FORTRESS INTERNATIONAL GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

		(Unaudited)
		For the Six Months Ended
		June 30, 2009				June 30, 2008
Cash Flows from Operating Activities:
Net loss		$	(17,784,278	)		$	(8,294,528	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			208,459				238,456
Amortization of intangibles			1,382,960				1,673,434
Impairment loss on goodwill and other intangibles			13,062,140				1,217,000
Provision for doubtful accounts			1,025,000				89,795
Stock and warrant-based compensation			946,740				1,012,417
Extinguishment of contract liabilities			(269,217	)			-
Other non-cash income, net			2,935				9,858
Changes in operating assets and liabilities, net of the effects from acquisitions:
Contracts and other receivables			7,668,648				1,385,817
Costs and estimated earnings in excess of billings on uncompleted contracts			1,441,882				(453,637	)
Prepaid expenses and other current assets			(463,314	)			(300,593	)
Other assets			(42,617	)			44,964
Accounts payable and accrued expenses			(9,193,492	)			2,139,835
Billings in excess of costs and estimated earnings on uncompleted contracts			(2,235,251	)			398,344
Other liabilities			(83,507	)			-
Net cash used in operating activities			(4,332,912	)			(838,838	)
Cash Flows from Investing Activities:
Purchase of property and equipment			(94,897	)			(192,291	)
Purchase of SMLB, net of cash acquired			-				(2,094,561	)
Purchase of Rubicon			(700,000	)			-
Purchase of Innovative			(353,187	)			-
Deferred acquisition costs			-				(21,785	)
Net cash used in investing activities			(1,148,084	)			(2,308,637	)
Cash Flows from Financing Activities:
Payments on notes payable			(27,511	)			(77,238	)
Payment on seller notes			(1,672,420	)			(1,517,753	)
Repurchase of treasury stock			-				(28,114	)
Net cash used in financing activities			(1,699,931	)			(1,623,105	)
Net decrease in cash			(7,180,927	)			(4,770,580	)
Cash, beginning of period			12,448,157				13,172,210
Cash, end of period		$	5,267,230			$	8,401,630
Supplemental disclosure of cash flow information:
Cash paid for interest		$	126,644			$	240,167
Cash paid for taxes			116,411				-
Supplemental disclosure of non-cash investing activities:
Issuance of common stock in connection with the acquisition of SMLB		$	-			$	500,000
Promissory notes payable issued in connection with the acquisition of SMLB			-				15,248
Promissory notes payable issued in connection with the acquistion of Rubicon			550,000				439,241

 

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

 

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FORTRESS INTERNATIONAL GROUP, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(1)	Basis of Presentation

 

The unaudited condensed consolidated financial statements are for the three and six months ended June 30, 2009 and 2008 for Fortress International Group, Inc. (“Fortress” or the “Company”).  The results of operations attributable to each of our acquisitions are included in the condensed consolidated financial statements from the date of acquisition.

 

The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in the annual financial statements, prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), have been condensed or omitted pursuant to those rules and regulations. We recommend that you read these unaudited condensed consolidated financial statements in conjunction with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008, previously filed with the SEC. We believe that the unaudited condensed consolidated financial statements in this Quarterly Report on Form 10-Q reflect all adjustments that are necessary to fairly present the financial position, results of operations and cash flows for the interim periods presented. The results of operations for such interim periods are not necessarily indicative of the results that can be expected for the full year.

Nature of Business and Organization

 

The Company provides a single source solution for highly technical mission-critical facilities such as data centers, operations centers, network facilities, server rooms, security operations centers, communications facilities and the infrastructure systems that are critical to their function. The Company’s services consist of technology consulting, design and engineering, construction management, systems installations and facilities management.

 The Company experienced a significant and unexpected decrease in its revenues, caused by delays in starting projects or cancellations thereof during the three months ended June 30, 2009 resulting in a significant loss and negative cash flows from operations.  The Company is taking several actions, as elaborated below to address the liquidity concerns this has caused us.

The Company had $5.3 million and $12.4 million of cash at June 30, 2009 and December 31, 2008, respectively.  While the Company is taking actions to contain costs, until we fully align our expenses with our anticipated revenue stream, we expect to continue to need to use our available cash to fund operations.  The Company has no current funds available under a bank line of credit or other financing vehicles.

The Company revised its financial forecast during the second quarter of 2009 to try and better match costs with its anticipated revenues and have initiated selling, general and administrative cost reduction measures in an attempt to achieve positive cash flows from operations.  The Company is also evaluating additional measures to reduce benefit costs, professional fees and public company costs, including the possibility of terminating its regulatory reporting requirements and delisting our stock.

The Company’s cash on hand and projected cash from operations over the next twelve months may not be sufficient to meet our current operating plans, and will not allow us to meet its currently scheduled debt maturities over the next twelve months.  The Company is working with these debt holders, including amounts due to an officer, to restructure the existing current maturities of indebtedness totaling $2.2 million at June 30, 2009.

The consolidated financial statements included herein have been prepared on a going concern basis, which contemplates continuity of operations and the realization of assets and repayment of liabilities in the ordinary course of business. The Company believes that our existing cash resources, combined with projected cash flows from operations, may not be sufficient to execute our business plan and continue operations into the future.  The Company has taken steps to reduce its operating expenses such as payroll and related personnel costs through headcount reductions and furloughs of certain departments, professional and marketing to eliminate discretionary fees, and we continue to implement changes in its strategic direction aimed at achieving profitability and positive cash flow.  Although the Company has been able to fund our operations to date, there is no assurance that cash flow from our operations or our capital raising efforts will be able to attract the additional capital or other funds needed to sustain our operations. In order to preserve the Company’s limited financial resources, we may determine to voluntarily delist our securities from trading on NASDAQ deregister our securities under the Exchange Act and cease our reporting obligations with the SEC under the Exchange Act.  In addition, the Company continues to explore various strategic alternatives, including business combinations, private placements of debt or equity securities and sales of a division or some or all of the assets or a sale of the entire company.  If the Company is unable to obtain additional funding for operations, it may not be able to continue operations as proposed, requiring it to modify its business plan, curtail various aspects of its operations or cease operations entirely. In such event, investors may lose a portion or all of their investment.

 

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FORTRESS INTERNATIONAL GROUP, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

In an effort to meet working capital requirements and scheduled maturities of indebtedness absent restructuring, the Company engaged an investment banking firm in June 2009 to assist it with either raising additional capital, or the marketing for sale of a division or some or all of its assets or the entire company.  On July 9, 2009, our Board of Directors formed a Special Committee of independent directors whose exclusive purpose is to consider, evaluate, review and negotiate and advise on any proposed transaction, including any potential transactions with related parties, and to determine whether any proposed transaction is fair to and in the best interest of its stakeholders.  The Special Committee retained independent legal counsel and has the authority to retain and compensate any advisor in the fulfillment of its duties.  The Special Committee is currently considering the following alternatives:

·	Raising additional capital in the form of either debt, equity, or combination thereof.

·	The marketing of the Company will focus on the sale of non-cash flowing components of the business, as well as, any of the Company’s divisions or the entire company.

This process is ongoing.  However, the Company may not be successful in executing a sale of a division or some or all of its assets or a sale of the entire company or in obtaining additional financing on acceptable terms, on a timely basis, or at all, in which case, the Company may be forced to further curtail operations, or cease operations entirely.  In addition, if funds are available, the issuance of equity securities or securities convertible into equity could dilute the value of shares of the Company’s common stock and cause the market price to fall, and the issuance of debt securities could impose restrictive covenants that could impair its ability to engage in certain business transactions.

If the Company is not able to achieve these operational and financial objectives, it will not have sufficient financial resources to meet its financial obligations and the Company could be forced to seek reorganization under the U.S. Bankruptcy Code.

Recently Issued Accounting Pronouncements

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 167, “Amendments to FASB Interpretation No. 46(R)” (FAS 167). FAS 167 amends FIN 46(R), to require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity. This statement is effective for both interim and annual periods as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, and we are currently evaluating its impact on our financial position and results of operations.

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 166, “Accounting for Transfers of Financial Assets – an amendment of FASB Statement No. 140” (FAS 166). FAS 166 amends FASB Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (FAS 140), removing the concept of a qualifying special-purpose entity, and removing the exception from applying FASB Interpretation No. 46(R) (revised December 2003), “Consolidation of Variable Interest Entities” (FIN 46(R)), to qualifying special-purpose entities. This statement is effective for both interim and annual periods as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, and its impact will vary with each future transfer of financial assets.

In May 2009, the FASB issued Statement of Financial Accounting Standards No. 165, “Subsequent Events” (FAS 165). FAS 165 establishes general standards of accounting for and disclosing events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This statement is effective for interim and annual periods ending after June 15, 2009. In preparing the accompanying unaudited consolidated financial statements, the Company has reviewed, as determined necessary by the Company’s management, events that have occurred after June 30, 2009, up until the issuance of the financial statements, which occurred on August 13, 2009.

In April 2009, the FASB issued FASB Staff Position (“FSP”) 107-1 and Accounting Principles Board Opinion (“APB”) No. 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP 107-1”). FSP 107-1 amends SFAS 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP also amends APB 28, Interim Financial Reporting, to require these disclosures in summarized interim periods. The Company adopted the provisions of FSP 107-1 as of June 30, 2009. The adoption of FSP 107-1 did not affect the amount of any of the Company’s financial statement line items.

 

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FORTRESS INTERNATIONAL GROUP, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(10)	Notes Payable

		June 30,				December 31,
		2009				2008
Convertible, unsecured promissory note, due 2012 (6.0%)		$	4,000,000			$	4,000,000
Unsecured promissory note, due 2008 (6.0%)			-				-
Unsecured promissory note, due 2009 (6.0%)			-				1,575,618
Unsecured promissory note, due 2010 (6.0%)			120,572				120,572
Unsecured promissory note, due 2010 (6.0%)			471,429				-
Unsecured promissory note, due 2011 (6.0%)			246,996				283,457
Vehicle notes			11,626				20,907
Total debt			4,850,623				6,000,554
Less current portion			2,269,797				1,688,845
Total debt, less current portion		$	2,580,826			$	4,311,709

 

In connection with the Rubicon acquisition, the Company issued unsecured promissory notes totaling $0.6 million to the former owners of Rubicon based on their achievement of certain earnings targets for the year ended December 31, 2008, (“the 2008 earn-out”) (see Note 3) on June 2, 2009.  The note issued bears interest at 6% per annum and scheduled principal repayment is over one year with amortization of $39,286 per month and a final balloon payment of $78,571 due on May 15, 2010.  The repayment of the note may be accelerated, as any unpaid principal and interest is due immediately at closing if the Company sells the Rubicon division.

We have significant debt maturing during the remainder of 2009 and in 2010, including $4.0 million due to one of our executive officers related to our acquisition of Total Site Solution in 2007.  Based on our current level of liquidity, we may not be able to make scheduled principal and interest payments on our notes payable.

 

(11)	Related Party Transactions

The Company participates in transactions with the following entities affiliated through common ownership and management. The Audit Committee in accordance with its written charter reviews and approves in advance all related party transactions greater than $25,000 and follows a pre-approved process for contracts with related party for less than $25,000.

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.

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.

CTS Services, LLC (CTS) is 9% owned by the Company’s Chief Executive Officer. 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. On April 1, 2009, the Company’s Chief Executive Officer sold 46% of his interest in CTS, reducing his ownership to 9%.

 

L.H. Cranston Acquisition Group, Inc. L.H. Cranston Acquisition Group, Inc. (Cranston) was 25% owned by the Company’s Chief Executive Officer until the sale of his interest on February 28, 2009. 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.

 

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FORTRESS INTERNATIONAL GROUP, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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.

 

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 Company had an independent valuation, which determined the lease to be at fair value.

Chesapeake Tower Systems, LLC. As of June 30, 2009, Chesapeake Tower Systems, LLC (Chesapeake) is owned 100% by the Company’s Chief Executive Officer.  During the second quarter 2009 and concurrent with an expiring leased facility, the Company entered into a new lease for approximately 25,000 square feet of combined office and warehouse space from Chesapeake.  The lease commitment is for five years (Initial Term) with a two-year renewal option (Renewal Term).  During the Initial Term, annual rent is $124,000, plus operating expenses.  If the Company elects to extend the lease annual rent increases by  the greater of i) fair market rental as defined in the agreement, or ii) 3% increase in each year of the Renewal Term.  Additionally, Chesapeake provided $150,000 for tenant improvements and relocation costs.  The Company completed an independent appraisal, which determined the lease to be at fair value.

 

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, 2009 and 2008.  It should be noted that revenue represents amounts earned on contracts with related parties under which we provide services; and cost of revenue 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.

		Three Months				Three Months				Six Months				Six Months
		Ended				Ended				Ended				Ended
		June 30, 2009				June 30, 2008				June 30, 2009				June 30, 2008
Revenue
CTS Services, LLC		$	-				6,229			$	2,000			$	112,278
Chesapeake Mission Critical, LLC			17,385				23,439				156,658				53,003
Total		$	17,385				29,668			$	158,658			$	165,281
Cost of Revenue
CTS Services, LLC		$	880,726				434,396			$	1,500,938			$	793,019
Chesapeake Systems, LLC			-				133,021				-				147,931
Chesapeake Mission Critical, LLC			48,250				14,018				58,280				53,317
S3 Integration, LLC			191,636				109				338,597				37,515
LH Cranston & Sons, Inc.			10,852				7,500				269,749				7,500
Telco P&C, LLC			59,860				10,069				72,556				10,069
Total		$	1,191,324				599,113			$	2,240,120			$	1,049,351
Selling, general and administrative			-
Office rent paid on Chesapeake sublease agmt			54,833				60,826				136,538				118,334
Office rent paid to TPR Group Re Three, LLC			100,927				97,691				201,854				195,382
Office rent paid to Chesapeake Tower Systems, LLC			10,333				-				10,333				-
Total		$	166,093				158,517			$	348,725			$	313,716

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.

 

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.

  

Business Formation and Overview

 

We were incorporated in Delaware on December 20, 2004 as a special purpose acquisition company under the name “Fortress America Acquisition Corporation” for the purpose of acquiring an operating business that performs services in the homeland security industry.  On July 20, 2005, we closed our initial public offering of 7,800,000 units (including underwriters exercise of an over-allotment option), resulting in proceeds net of fees to us of approximately $43.2 million.

 

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 acquisition fundamentally transformed the Company from a special purpose acquisition corporation to an operating business.

 

Building on the TSS/Vortech business, management continued an acquisition strategy to expand our geographical footprint, add complementary services, and diversify and expand our customer base. After acquiring TSS/Vortech, the Company continued its expansion through the acquisitions of Comm Site of South Florida, Inc. on May 7, 2007 (“Comm Site”), Innovative Power Systems, Inc. and Quality Power Systems, Inc. (collectively, “Innovative”) on September 24, 2007, Rubicon Integration, LLC (“Rubicon”) on November 30, 2007 and SMLB Ltd. (“SMLB”) on January 2, 2008.

With the acquired companies, 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.

Competition in Current Economic Environment

Our industry has been and may be further adversely impacted by the current economic environment and tight credit conditions.  We have seen larger competitors seek to expand their services offerings including a focus in mission-critical market.  These larger competitors have an infrastructure and support greater than ours and accordingly, we have begun to experience some price pressure as some companies are willing to take on projects at lower margins. With certain customers, we have experienced a delay in spending, or deferral of projects to an indefinite commencement date due to the economic uncertainty or lack of access to capital.  This type of delay was demonstrated by our largest customer, which led us to significantly reduce our backlog by $144.9 million to $63.2 million at December 31, 2008 and to $42.7 million at June 30, 2009 although a formal cancellation of contracted amounts has not been received.

 

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We believe there are high barriers to entry in our sector for new competitors due to our specialized technology service offerings which we deliver to 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.  Finally, we seek to further expand our energy services that focus on operational cost savings that may be used to either fund the project or increase returns to the facility operator.  We believe these barriers and our technical capabilities and experience will differentiate us to compete with new entrants into the market or pricing pressures.

 

Although we will closely monitor our proposal pricing and the volume of the work, we cannot be certain that our current margins will be sustained.  Furthermore, given the environment, and that the volume of our contracts further decreased, we are taking additional measures to reduce our operating costs through additional reductions in general, administrative and marketing cost, reductions in personnel and related costs, including the possibility of terminating our regulatory reporting requirement and delisting of our stock. For further information see “Liquidity and Capital Resources” below. 

Contract Backlog

We believe an indicator of our future performance is our backlog of uncompleted projects in process or recently awarded. Our backlog represents our estimate of anticipated revenue from executed and awarded contracts that have not been completed and that we expect will be recognized as revenues over the life of the contracts. We have broken our backlog into the following three categories: (i) technology consulting consisting of services related to consulting and/or engineering design contracts, (ii) construction management, and (iii) facility management.

Backlog is not a measure defined in generally accepted accounting principles, and our methodology for determining backlog may not be comparable to the methodology of other companies in determining their backlog. Our backlog is generally recognized under two categories: (1) contracts for which work authorizations have been or are expected to be received on a fixed-price basis, guaranteed maximum price basis and time and materials basis, and (2) contracts awarded to us where some, but not all, of the work have not yet been authorized. At June 30, 2009, we had authorizations to proceed with work for approximately $22.0 million, or 52% of our total backlog of $42.7 million. At December 31, 2008, we had authorizations to proceed with work for approximately $51.6 million, or 82% of our total backlog of $63.1 million. Additionally, approximately $25.6 million, or 60% of our backlog, relates to two customers at June 30, 2009 and $36.0 million, or 57%, to one customer at December 31, 2008.

 

As of June 30, 2009, our backlog was approximately $42.7 million, compared to approximately $63.2 million at December 31, 2008. We believe that approximately 41% of the backlog at June 30, 2009 will be recognized during the remainder of the year. The following table reflects the value of our backlog in the above three categories as of June 30, 2009 and December 31, 2008, respectively.

(In millions)

 

		June 30,				December 31,
		2009				2008
Technology consulting		$	1.6			$	4.0
Construction management			28.4				48.7
Facilities management			12.7				10.5
Total		$	42.7			$	63.2

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Critical Accounting Policies and Estimates

Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP. The preparation of the financial statements included elsewhere in this Quarterly Report on Form 10-Q requires that management make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ significantly from those estimates.

 

        We believe the following critical accounting policies affect the more significant estimates and judgments used in the preparation of our financial statements.

 

Revenue Recognition          

 

We recognize revenue when pervasive evidence of an arrangement exists, the contract price is fixed or determinable, services have been rendered or goods delivered, and collectability is reasonably assured. Our revenue is derived from the following types of contractual arrangements: fixed-price contracts, time-and-materials contracts and cost-plus-fee contracts (including guaranteed maximum price contracts). Revenue from fixed-price contracts is accounted for under the application of Statement of Position (SOP) 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts, recognizing revenue on the percentage-of-completion method using costs incurred in relation to total estimated project costs. The cost to total cost method is used because management considers cost incurred and costs to complete to be the best available measure of progress in the contracts. Contract costs include all direct materials, subcontract and labor costs and those indirect costs related to contract performance, such as indirect labor, payroll taxes, employee benefits and supplies.

 

Revenue on time-and-material contracts is recognized based on the actual labor hours performed at the contracted billable rates, and costs incurred on behalf of the customer. Revenue on cost-plus-fee contracts is recognized to the extent of costs incurred, plus an estimate of the applicable fees earned. Fixed fees under cost-plus-fee contracts are recorded as earned in proportion to the allowable costs incurred in performance of the contract.

Contract revenue recognition inherently involves estimation. Examples of estimates include the contemplated level of effort to accomplish the tasks under the contract, the costs of the effort and an ongoing assessment of the Company’s progress toward completing the contract. From time to time, as part of our standard management process, facts develop that require us to revise our estimated total costs on revenue. To the extent that a revised estimate affects contract profit or revenue previously recognized, we record the cumulative effect of the revision in the period in which the revisions become known. The full amount of an anticipated loss on any type of contract is recognized in the period in which it becomes probable and can reasonably be estimated.

 

Under certain circumstances, we may elect to work at risk prior to receiving an executed contract document. We have a formal procedure for authorizing any such at risk work to be incurred. Revenue, however, is deferred until a contract modification or vehicle is provided by the customer.  

 

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  Income Taxes

 

Deferred income taxes are provided for the differences between the basis of assets and liabilities for financial reporting and income tax purposes. Deferred tax assets and liabilities are measured using tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized.

 

We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities, which principally arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. We also must analyze income tax reserves, as well as determine the likelihood of recoverability of deferred tax assets, and adjust any valuation allowances accordingly. Considerations with respect to the recoverability of deferred tax assets include the period of expiration of the tax asset, planned use of the tax asset, and historical and projected taxable income, as well as tax liabilities for the tax jurisdiction to which the tax asset relates. Valuation allowances are evaluated periodically and will be subject to change in each future reporting period as a result of changes in one or more of these factors.

 

Effective January 1, 2007, we were 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 de-recognition 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, we were in essence a “blank check” company with no substantive operations. Management has concluded that the adoption of FIN 48 had no material effect on our financial position or results of operations. As of June 30, 2009, we do not have any material gross unrecognized tax benefit liabilities.

 

We believe the following critical accounting policies affect the more significant estimates and judgments used in the preparation of our financial statements.

 

Recently Issued Accounting Pronouncements

 In June 2009, the FASB issued Statement of Financial Accounting Standards No. 167, “Amendments to FASB Interpretation No. 46(R)” (FAS 167). FAS 167amends FIN 46(R), to require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity. This statement is effective for both interim and annual periods as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, and we are currently evaluating its impact on our financial position and results of operations.

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 166, “Accounting for Transfers of Financial Assets – an amendment of FASB Statement No. 140” (FAS 166). FAS 166 amends FASB Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (FAS 140), removing the concept of a qualifying special-purpose entity, and removing the exception from applying FASB Interpretation No. 46(R) (revised December 2003), “Consolidation of Variable Interest Entities” (FIN 46(R)), to qualifying special-purpose entities. This statement is effective for both interim and annual periods as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, and its impact will vary with each future transfer of financial assets.

In May 2009, the FASB issued Statement of Financial Accounting Standards No. 165, “Subsequent Events” (FAS 165). FAS 165 establishes general standards of accounting for and disclosing events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This statement is effective for interim and annual periods ending after June 15, 2009. In preparing the accompanying unaudited consolidated financial statements, the Company has reviewed, as determined necessary by the Company’s management, events that have occurred after June 30, 2009, up until the issuance of the financial statements, which occurred on August 5, 2009.

 

In April 2009, the FASB issued FASB Staff Position (“FSP”) 107-1 and Accounting Principles Board Opinion (“APB”) No. 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP 107-1”). FSP 107-1 amends SFAS 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP also amends APB 28, Interim Financial Reporting, to require these disclosures in summarized interim periods. We adopted the provisions of FSP 107-1 as of June 30, 2009. The adoption of FSP 107-1 did not affect the amount of any of our financial statement line items.

 

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Results of operations for the three months ended June 30, 2009 compared with the three months ended June 30, 2008.

Revenue.  Revenue decreased $5.2 million to $14.9 million for the three months ended June 30, 2009 from $20.1 million for the three months ended June 30, 2008. The decrease is primarily driven by a $1.0 million decrease in technology consulting services, $2.2 million decrease in construction management services, and $2.0 million decrease in facilities management services.  During the three months ended June 30, 2009 we experienced a significant and unexpected decline in our revenue of $15.2 million, or 50% from $30.1 million for the three months ended March 31, 2009.  This decline in revenue resulted from both the delay in beginning projects and the cancellation of other projects.  Some of these projects were included in our backlog.

Cost of Revenue. Cost of revenue decreased $4.8 million to $13.2 million for the three months ended June 30, 2009 from $18.0 million for the three months ended June 30, 2008. The decrease is primarily driven by a $3.3 million decrease in construction management and $1.5 million decrease in facilities management services.

 

Gross Margin Percentage. Gross margin percentage increased to 11.9% for the three months ended June 30, 2009 compared to 10.5% for the three months ended June 30, 2008. The increase in the gross margin is attributable primarily to the inclusion of a loss contract associated with the acquisition of SMLB, which totaled approximately $0.7 million for the three months ended June 30, 2008.  Excluding the loss contract from the previous year, gross margin percentage declined 2.1% to 11.9% for the three months ended June 30, 2009 from 14% for the three months ended June 30, 2008.  The decline in gross margin is attributable primarily to contraction in gross margin percentage in the technology consulting services, which decreased by 29.9% to 11.7% for the three months ended June 30, 2009 from 41.6% for the three months ended June 30, 2008.  The decline in gross margin for technology consulting services is due to the competitive environment in which we have contracted work at lower than historic margins.

Selling, general and administrative expenses.  Selling, general and administrative expenses decreased $1.1 million to $4.6 million for the three months ended June 30, 2009 from $5.7 million for the three months ended June 30, 2008. The decrease is primarily driven by $0.7 million decrease in salaries due to a reduction in headcount and furloughs, $0.4 million decrease in professional fees and marketing efforts, and $0.7 million decrease in acquisitions related costs.  We incurred no acquisition related costs in 2009.  The preceding declines were offset partially by a $1.0 million increase in provision for bad debt expense due to a single customer.

We have continued to experience delays in the timing of revenues associated with certain customers and contracted work is at lower margins than the prior year.  Accordingly, we continue to evaluate our selling, general and administrative costs with the objective of achieving profitability based on our revised forecasted business. 

Depreciation.  Depreciation remained consistent at $0.1 million for the three months ended June 30, 2009 compared to $0.1 million for the three months ended June 30, 2008.

 

Amortization of intangible assets.   Amortization expense remained consistent at $0.7 million for the three months ended June 30, 2009 from $0.6 million for the three months ended June 30, 2008.  The consistent expense correlates to the consistency in average amortizable carrying values and lives of finite lived intangibles during the reported periods.

Impairment loss on goodwill and other intangibles, net.   Impairment loss on goodwill and other intangibles increased $11.9 million to $13.1 million for the three months ended June 30, 2009 from $1.2 million for the three months ended June 30, 2008.  The increase in the expense is primarily attributable to the impairment of carrying values associated with finite lived customer intangibles.  We have not realized the anticipated revenue from customers acquired in our acquisitions and have experienced continued operating losses in the current year.

We conducted analyses of the operations in order to identify any impairment in the carrying value of the goodwill and other intangibles related to our business. Analyzing our business using both an income approach and a market approach determined that the carrying value exceeded the current fair value of our business, resulting in goodwill impairment of $1.1 million for the three months ended June 30, 2008. At June 30, 2009, the adjusted carrying value of goodwill was $4.5 million.

Based on the lack of new contracts and revision in anticipated revenue from acquired customers and the general operating condition of the Company, we evaluated long-lived customer relationship intangible assets and determined that the carrying value exceeded the undiscounted cash flows.  Accordingly, we performed a fair value assessment based on discounted cash flows, resulting in an impairment loss of $12.0 million for the three months ended June 30, 2009.  At June 30, 2009, the adjusted net carrying value of other intangibles was $0.2 million.  No impairment of customer relationship intangibles was recorded for the three months ended June 30, 2008.

Interest income (expense), net. Our interest income (expense), net remained consistent at ($0.1 million) for the three months ended June 30, 2009 compared to( $0.1million) for the three months ended June 30, 2008.

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Non-Cash Activity

During the six months ended June 30, 2009, in connection with the purchase of Rubicon, we issued to the sellers $0.6 million of unsecured promissory notes bearing interest at 6% per annum and repayable over a one-year term.  The notes were issued in association with the achievement of certain profit targets, as defined in the purchase agreement, for the year ended December 31, 2008.  The repayment of the note may be accelerated, as any unpaid principal and interest is due immediately at closing if the Company sells the Rubicon division.

During the six months ended June 30, 2008, in connection with the achievement of certain bookings targets, we issued to the Rubicon sellers $0.4 million of unsecured promissory notes.

Liquidity and Capital Resources

We had $5.3 million and $12.4 million of unrestricted cash and cash equivalents at June 30, 2009 and December 31, 2008, respectively. During the six months ended June 30, 2009, we have had no capital transactions; as a result, during the six months ended June 30, 2009, we have financed our operations primarily with cash on hand as negative cash flow was generated from operations. While we are taking actions to contain costs, until we fully align our expenses with our anticipated revenue stream, we expect to continue to need to use our available cash to fund our operations.

Based on an unexpected lack of closed contracts and continued customer delays experienced in the last three months, we revised our financial forecast during the second quarter of 2009 to try and better match costs with expected revenues.  We initiated selling, general and administrative cost reduction measures during the six months ended  June 30, 2009, which approximate annual savings of $0.4 million.  In an effort to attempt to achieve positive cash flows from operations and align costs with forecasted revenues in the future, we are evaluating additional measures to reduce benefit costs, professional fees and public company costs with the possibility of regulatory reporting requirements and delisting our stock off NASDAQ.  Subsequent to the second quarter 2009, we have further implemented cost reductions in payroll with projected annual savings of $2.2 million.

As required cash on hand and projected cash from operations over the next twelve months may not allow us to meet our current operating plans, and are not anticipated to allow us to meet our scheduled debt maturities over the next twelve months and we are working to restructure existing current maturities of indebtedness totaling $2.2 million at June 30, 2009.  The current maturities due are comprised of the following significant components:

·

Unsecured, promissory note of $1.6 million due March 31, 2010 - This note was issued on January 19, 2007 as consideration with the acquisition of Total Site Solutions.  The note was restructured in August 2008, resulting in the deferral until March 31, 2010 of all maturing principal and accruing interest payable.  Additionally, approximately $1.0 million of the note was converted to equity at $7.50 per share in August of 2008.  Mr. Gallagher, our President, is the holder of the note.

·

Unsecured promissory note of $0.5 million due May 15, 2010 - This note includes monthly payments of approximately $39,000 plus interest at 5%.  This note was issued to the Rubicon sellers on June 2, 2009 as contingent consideration issued for the achievement of certain profit targets.  Three members of our current management hold approximately 46% of the notes, which corresponds to their prior ownership in the sold enterprise.

 

PART II - OTHER INFORMATION

Item 5. Other Information.

 

Not applicable.

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, 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, 2009	By:	/s/ Thomas P. Rosato
		Thomas P. Rosato
		Chief Executive Officer (Principal Executive Office)

 

Date: August 14, 2009	By:	/s/ Timothy C. Dec
		Timothy C. Dec
		Chief Financial Officer (Principal Financial Officer)

 

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