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.)
7226 Lee DeForest Drive, Suite 203 Columbia, MD 21046		21046
(Address of principal executive offices)		(Zip Code)

(410) 423-7438

(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 a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o	Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)	Smaller reporting company 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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Common Stock, par value $0.0001 per share, as of October 31, 2008                12,557,669

 

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FORTRESS INTERNATIONAL GROUP, INC.

Table of Contents

	Page
PART I - FINANCIAL INFORMATION
Item 1.     Financial Statements
Consolidated Balance Sheets as of September 30, 2008 (unaudited) and as of December 31, 2007	1
Consolidated Statements of Operations (unaudited) for the three and nine months ended September 30, 2008 and September 30, 2007 (successor) and for the period from January 1, 2007 to January 19, 2007 (predecessor)	2
Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2008 and September 30, 2007 (successor) and for the period from January 1, 2007 to January 19, 2007 (predecessor)	3
Notes to Consolidated Financial Statements	4
Item 2.      Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.      Quantitative and Qualitative Disclosures about Market Risk	22
Item 4T.   Controls and Procedures	22
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	22
Item 3.      Defaults upon Senior Securities	23
Item 4.      Submission of Matters to a Vote of Security Holders	23
Item 5.      Other Information	23
Item 6.      Exhibits	23
SIGNATURES	24

 

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Item 1. Financial Statements

FORTRESS INTERNATIONAL GROUP, INC.

CONSOLIDATED BALANCE SHEETS

		September 30,			December 31,
		2008			2007
		(unaudited)			(audited)
Current Assets
Cash and cash equivalents		$	6,856,253		$	13,172,210
Contract and other receivables, net			20,932,470			18,349,140
Costs and estimated earnings in excess of billings on uncompleted contracts			4,721,578			1,322,254
Prepaid expenses and other current assets			499,497			301,487
Income taxes receivable			893,322			893,322
Total current assets			33,903,120			34,038,413
Property and equipment, net			903,669			1,044,545
Goodwill			18,813,509			20,714,967
Intangible assets, net			19,838,552			21,089,136
Other assets			150,973			512,000
Total assets		$	73,609,823		$	77,399,061
Liabilities and Stockholders’ Equity
Current Liabilities
Notes payable, current portion		$	182,384		$	1,650,306
Accounts payable and accrued expenses			16,266,264			16,121,492
Billings in excess of costs and estimated earnings on uncompleted contracts			11,145,410			3,880,279
Total current liabilities			27,594,058			21,652,077
Notes payable, less current portion			4,230,013			7,848,661
Other liabilities			59,960			44,648
Total liabilities			31,884,031			29,545,386
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; 12,730,629 and 12,150,400 issued; 12,557,669 and 11,992,325 outstanding at September 30, 2008 and December 31, 2007, respectively			1,273			1,214
Additional paid-in capital			60,699,980			55,268,012
Treasury stock, 172,960 and 158,075 shares at cost at September 30, 2008 and December 31, 2007, respectively			(861,663	)		(814,198	)
Accumulated deficit			(18,113,798	)		(6,601,353	)
Total stockholders’ equity			41,725,792			47,853,675
Total liabilities and stockholders’ equity		$	73,609,823		$	77,399,061

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

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FORTRESS INTERNATIONAL GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

														Predecessor
		Successor (Fortress International Group, Inc.)												(TSS/Vortech)
														For the period
														January 1,
		Three Months Ended						Nine Months Ended						through
		September 30, 2008			September 30,2007			September 30, 2008			September 30,2007			January 19, 2007
		(unaudited)			(unaudited)			(unaudited)			(unaudited)			(audited)
Results of Operations:
Revenue		$	25,781,523		$	12,692,772		$	65,363,481		$	32,232,016		$	1,412,137
Cost of revenue			20,660,103			10,749,331			54,719,170			27,378,926			1,108,276
Gross profit			5,121,420			1,943,441			10,644,311			4,853,090			303,861
Operating expenses:
Selling, general and administrative			4,838,291			3,964,468			15,275,116			10,026,448			555,103
Depreciation			125,716			137,032			355,810			289,708			33,660
Amortization of intangibles			702,569			567,109			2,104,067			1,574,671			-
Impairment loss on goodwill			2,973,000			-			4,190,000			-			-
Total operating costs			8,639,576			4,668,609			21,924,993			11,890,827			588,763
Operating loss			(3,518,156	)		(2,725,168	)		(11,280,682	)		(7,037,737	)		(284,902	)
Interest income (expense), net			(49,653	)		104,116			(194,661	)		476,388			3,749
Loss from operations before income taxes			(3,567,809	)		(2,621,052	)		(11,475,343	)		(6,561,349	)		(281,153	)
Income tax expense (benefit)			(349,898	)		-			37,102			(349,325	)		-
Net loss		$	(3,217,911	)	$	(2,621,052	)	$	(11,512,445	)	$	(6,212,024	)	$	(281,153	)
Per Common Share (Basic and Diluted):
Basic and diluted net loss		$	(0.26	)	$	(0.22	)	$	(0.95	)	$	(0.53	)	$	-
Weighted average common shares outstanding-basic and diluted			12,326,397			11,715,512			12,164,454			11,743,186			-

 

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

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		SMLB
Cash		$	2,000,000
Common stock			462,775
Promissory notes to sellers			15,248
Acquistion costs			151,133
Total purchase price		$	2,629,156
Cash and equivalents		$	56,573
Contracts and other receivables			387,612
Goodwill			2,693,060
Identifiable intangibles, net			271,000
Total assets acquired		$	3,408,245
Liabilities
Accounts payable and accrued expenses		$	137,309
Income taxes payable			131,662
Billings in excess of costs			510,117
Total liabilities assumed			779,089
Net assets acquired		$	2,629,156

 

2007 Acquisitions

 

Rubicon Integration, LLC

During the first quarter of 2008, the Company finalized its purchase price allocation associated with Rubicon, resulting in an increase in the value of customer relationship intangibles of $1.0 million and a corresponding decrease in goodwill.

During the second quarter of 2008, Rubicon achieved certain 2008 revenue bookings targets through June 30, 2008, which entitled the sellers under the purchase agreement to an unsecured promissory note of $0.4 million and resulted in a corresponding increase in goodwill (see Note 10). The Company recorded indefinite lived intangibles totaling $3.9 million associated with Rubicon transaction, of  which $2.3 million is expected to be deductible for income tax purposes.

 

TSS/Vortech

During the third quarter of 2008, shares issued to the selling members of TSS/Vortech were released from escrow. As of September 30, 2008, TSS/Vortech recorded indefinite lived intangibles were $16.5 million, of which $12.7 million is expected to be deductible for income taxes.

Purchase Price Allocation

 

Under business combination accounting, the purchase price for each of the acquired companies, Rubicon and SMLB, was allocated to the net tangible and identifiable intangible assets based on their estimated fair values as of the acquisition dates. The allocation of the purchase price was based upon valuations performed for each of the acquired companies. Subject to adjustment associated with working capital requirements and contingent consideration issuable upon achievement of certain financial targets, we finalized the Rubicon valuation in the first quarter of 2008 and SMLB during the second quarter 2008.

 

The valuations indicated that the estimated fair value of the assets acquired was less than the total of the purchase price paid and the liabilities assumed in the transactions. As a result, the excess purchase price was assigned to goodwill for each acquisition. The Company recorded goodwill associated with its acquisitions of SMLB and Rubicon totaling $6.1 million of which $2.3 million is expected to be deductible for income tax purposes.

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FORTRESS INTERNATIONAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Tangible and Other Intangible Long-Lived Assets

 

        In performing the purchase price allocation for each acquired company, the Company considered, among other factors, the intention for future use of acquired assets, analysis of historical financial performance and estimates of future performance of each acquired company’s products. The fair value of assets was based, in part, on a valuation using either a cost, income, or in some cases, market valuation approach and estimates and assumptions provided by management. The tangible assets primarily include personal property such as computers, software and service vehicles. Intangible assets consist primarily of customer relationships, order backlog and trade name.

 

		SMLB			Rubicon			Innovative			TSS/Vortech			Total
Intangible asset:
Trade name		$	36,000		$	460,000		$	60,000		$	4,930,000		$	5,486,000
In-place contracts			230,000			50,000			350,000			406,201			1,036,201
Customer relationships			-			2,970,000			560,000			14,100,000			17,630,000
Non competition agreement			5,000			685,000			50,600			-			740,600
Total intangible			271,000			4,165,000			1,020,600			19,436,201			24,892,801
Accumulated amortization			(152,122	)		(822,131	)		(382,483	)		(3,697,513	)		(5,054,249	)
Intangible assets, net		$	118,878		$	3,342,869		$	638,117		$	15,738,688		$	19,838,552

Impairment

 The Company has not realized the anticipated revenue from customers acquired in its acquisitions and had experienced continued operating losses during the nine months ended September 30, 2008. Based on the recurring operating losses and a revision to the Company’s forecast during the second quarter of 2008, the Company conducted analyses of the operations in order to identify any impairment in the carrying value of the goodwill related to the business. During the third quarter 2008, the Company’s market value declined further and we conducted additional analysis, which contemplated the market condition occurring through the third quarter. The analyses of the business using both an income approach and a market approach determined that the carrying value exceeded the current fair value of the business, resulting in goodwill impairment of $3.0 million for the three months ended September 30, 2008 and $4.2 million for the nine months ended September 30, 2008. At September 30, 2008, the adjusted carrying value of goodwill was $18.8 million.

For the three months ended September 30, 2008 and September 30, 2007, amortization expense totaling $0.8 million and $0.7 million, respectively, has been included in the accompanying consolidated statements of operations related to the above intangibles of which $0.2 million and $0.1 million, respectively, is included in cost of revenue.

For the nine months ended September 30, 2008 and September 30, 2007, amortization expense totaling $2.5 million and $1.9 million, respectively, has been included in the accompanying consolidated statements of operations related to the above intangibles of which $0.3 million and $0.3 million, respectively, is included in cost of revenue.

     Proforma Results

 

Unaudited pro forma results of operations are as follows. The amounts are shown as if the acquisitions had occurred at the beginning of the periods presented:

 

		Three Months			Nine  Months
		Ended			Ended
		September 30, 2007			September 30, 2007
Proforma revenue		$	15,894,628		$	44,642,765
Proforma operating loss			(2,052,390	)		(5,707,428	)
Proforma pretax loss			(2,068,684	)		(5,681,989	)
Proforma net loss			(2,515,304	)		(5,596,968	)
Pro forma basic and diluted net loss per share		$	(0.21	)	$	(0.45	)
Weighted average common shares			12,039,904			12,520,861

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.

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FORTRESS INTERNATIONAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(5)	Basic and Diluted Net Loss per Share

Basic and diluted net loss per common share is computed as follows:

		Successor
		Three Months Ended						Nine Months Ended
		September 30,			September 30,			September 30,			September 30,
		2008			2007			2008			2007
Net loss		$	(3,217,911	)	$	(2,621,052	)	$	(11,512,445	)	$	(6,212,024	)
Basic and diluted weighted average common shares			12,326,397			11,715,512			12,164,454			11,743,186
Net loss per share		$	(0.26	)	$	(0.22	)	$	(0.95	)	$	(0.53	)

 

 As of September 30, 2008, there were unvested restricted stock, options to purchase units and warrants outstanding to purchase a total of 18,165,634 shares of common stock and convertible unsecured promissory notes convertible into 533,333 shares of common stock. These were excluded in the computation of diluted net loss per common share for the three and nine months ended September 30, 2008, as their inclusion would be anti-dilutive.

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.

 

(6)	Employee Benefit Plans

Restricted Stock

 

During the nine months ended September 30, 2008 and September 30, 2007, the Company granted 132,000 and 770,832 restricted common shares, respectively, under the 2006 Omnibus Incentive Compensation Plan (“Plan”). During the nine months ended September 30, 2008, the weighted average fair value of these grants was $4.53 per share.

During the three months ended September 30, 2008 and September 30, 2007, non-cash compensation expense totaling $0.5 million and $0.3 million, respectively, has been included in the accompanying consolidated statements of operations related to vesting of awards, of which $0.1 million and zero, respectively, is in cost of revenue.

During the nine months ended September 30, 2008 and September 30, 2007, non-cash compensation expense totaling $1.5 million and $0.8 million, respectively, has been included in the accompanying consolidated statements of operations related to vesting of awards, of which $0.3 million and zero, respectively, is in cost of revenue. There was no other restricted stock activity.

(7)	Common Stock Repurchases

 

During the three months ended September 30, 2008, the Company repurchased 8,895 treasury shares with an aggregate value of $20,322 associated with vesting restricted stock of an employee. During the nine months ended September 30, 2008, the Company repurchased 14,885 treasury shares with an aggregate value of $47,465 associated with vesting restricted stock of an employee.  The Company paid the employee’s related taxes associated with the employee’s vested stock and decreased the shares issued to the employee by a corresponding value, resulting in a share issuance net of taxes to employee. The value of the shares netted for employee taxes represents treasury stock repurchased. There were no similar repurchases during 2007.

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.  During the nine months ended September 30, 2007, the Company repurchased 354,775 of the Company’s common shares valued in aggregate at $1.9 million. The plan was suspended in the third quarter of 2007; accordingly, there has been no activity under the plan in 2008.

 In January 2007, the Company repurchased 756,100 shares at an aggregate value of $4.3 million from those shareholders that voted against the acquisition of TSS/Vortech and requested that their shares be redeemed at the then per share trust value of $5.74 per share.

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FORTRESS INTERNATIONAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(8)	Options to Purchase Units and Warrants

At September 30, 2008 and December 31, 2007, there were outstanding options to purchase units and warrants to purchase 17,810,300 of common shares. Both the option to purchase units and warrants have a cashless exercise feature, whereby the holder may elect to receive a net amount of shares and forego the payment of the strike price.

In February 2007, the Company entered into a one year agreement with an advisor in which we were obligated to issue a warrant for the purchase of 125,000 shares of our common stock, in exchange for consulting services. The fair value of these warrants was determined using the Black-Scholes model and is recognized over the term of the agreement. For the three and nine months ended September 30, 2008, the computed Black-Scholes value of the warrant remained unchanged and decreased by $141,422, respectively, resulting in a corresponding decrease in selling, general and administrative expense for the nine months ended September 30, 2008. For the three and nine months ended September 30, 2007, the Company recognized $213,000 in selling, general and administrative expense associated with the warrant.

(9)	Income Taxes

 

The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes” (“SFAS No. 109”),. APB No. 28, Interim Financial Reporting, and FASB Interpretation No. 18, “Accounting for Income Taxes in Interim Periods.” Deferred income taxes are provided for the temporary differences between the financial reporting and tax basis of the Company’s assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.

 

The Company’s provision for income taxes reflects the establishment of a full valuation allowance against deferred tax assets as of September 30, 2008. SFAS No. 109 requires management to evaluate its deferred tax assets on a regular basis to reduce them to an amount that is realizable on a more likely than not basis.

 

The Company is in a net operating loss carryover position. The net operating losses not utilized can be carried forward for 20 years to offset future taxable income. For the year ended December 31, 2007, the Company recorded a partial valuation allowance against its deferred tax assets, as the Company concluded that under relevant accounting standards, it is more likely than not that a portion of deferred tax assets will be not be realizable.

Under SFAS No. 109, the Company evaluated available evidence to determine whether a full or partial valuation allowance of deferred tax assets should be recorded. As of September 30, 2008, cumulative losses in recent periods is evidence to support the need for a valuation allowance. Such evidence outweighs projections of future taxable income that may support the realization of deferred tax assets.

 

The Company is expected to record future deferred tax expense, primarily as the result of tax amortization resulting from the purchases of TSS/Vortech and Rubicon. Under SFAS No. 109, tax amortization on indefinite lived assets (goodwill and other intangibles) may not be offset by deferred tax assets that are not currently realizable, primarily deferred tax assets relating to net operating loss carryovers, because of valuation allowances.

The Company has recorded an income tax benefit of $349,898 for the three months ended September 30, 2008 which consists of income taxes currently payable of $37,102 net of a reduction in deferred tax liabilities of $387,000. For the nine months ended September 30, 2008, income expense of $37,102 has been recorded to reflect state income taxes.

 

The Company’s effective tax rate is based upon the rate expected to be applicable to the full fiscal year. The rate differs from that used in the three months ended September 30, 2007 primarily due to changes in the valuation allowance subsequent to that date.  

Effective January 1, 2007, the Company was required to adopt FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). The Company evaluates its uncertain tax positions on a quarterly basis and has not identified any changes in uncertain tax positions during the reporting period.

Management is in the process of evaluating the various tax positions associated with the acquisition of SMLB and is of the opinion that any deferred tax liabilities that would ultimately result from uncertain tax positions related to this acquisition is not anticipated to be material.

The Company files a consolidated federal tax return in states that allow it, and in other states it files separate company returns.

All of the Company's prior federal and state income tax filings since inception remain open under statutes of limitation.  Innovative Power System Inc.'s statutes of limitation are open from the 2002 tax year forward for both federal and Virginia purposes.  Quality Power Systems Inc.'s statutes of limitation are open from the 2003 tax year forward for both federal and Virginia purposes. SMLB’s statutes of limitation are open from the 2006 tax year forward for both federal and Illinois purposes.

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FORTRESS INTERNATIONAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

(10)	Notes Payable

 

		September 30,			December 31,
		2008			2007
Convertible, unsecured promissory note, due 2012 (6.0%)		$	4,022,356		$	7,500,000
Unsecured promissory note, due 2011 (6.0%)			331,688			394,611
Unsecured promissory note, due 2008 (6.0%)			-			1,517,753
Unsecured promissory note, due 2011 (6.0%)			15,248			-
Vehicle notes			43,105			86,603
Total debt			4,412,397			9,498,967
Less current portion			182,384			1,650,306
Total debt, less current portion		$	4,230,013		$	7,848,661

In connection with the acquisition of TSS/Vortech, on January 19, 2007, the Company issued two convertible, unsecured promissory notes, with an aggregate value of $10,000,000 to the sellers. During the third quarter of 2007, the Company entered into an agreement with its Chief Executive Officer (the “CEO”), one of the selling members, to retire $2,500,000 of the note due to him by paying $2,000,000 and the CEO used the proceeds to repurchase the Company’s common stock and warrants. The prepayment discount realized of $500,000 has been recorded as additional paid-in capital. 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 principal installments totaling $625,000, as adjusted for the early repayment of the CEO notes.

During the third quarter 2008, the Chief Executive Officer and Chief Operating Officer, both of the selling members, entered into an agreement with the Company to convert $2,500,000 and $1,000,000, respectively, of their respective notes into equity at a conversion price of $7.50 per share, resulting in the aggregate issuance of 466,667 common shares. The conversion has been recorded as additional paid-in capital. In addition, the Chief Operating Officer agreed to postpone any principal and interest payments payable to him under his remaining $4,000,000 promissory note until March, 2010, with such interest to be accrued to the outstanding principal. The notes are convertible at any time by the selling members at a conversion price of $7.50 per share and are automatically convertible if the average closing price of the Company’s common stock for 20 consecutive trading days equals or exceeds $7.50 per share.

In connection with the acquisition of Innovative, on September 24, 2007, the Company issued an unsecured promissory note to the sellers in the amount of $300,000. The note bears interest at six percent per year and has a three year term. Quarterly principal installments of $15,000 plus interest are due commencing December 31, 2007, with a final balloon payment of $120,000 due on December 31, 2010. Based on achieving certain earnings targets through December 31, 2007 and net of a purchase price adjustment associated with working capital, the Innovative sellers received an additional promissory note of $64,611 at December 31, 2007. The additional unsecured promissory note is in a similar form of the unsecured promissory note issued at closing, bearing interest at six percent per year and has a three-year term. Quarterly principal installments of $3,231 plus interest are due commencing March 31, 2008 with a final balloon payment of $25,844 due on March 31, 2011.

In connection with the Rubicon acquisition, the Company was obligated to issue unsecured promissory notes totaling $1.5 million and $2.0 million contingent on Rubicon achieving certain earnings targets for the month ended December 31, 2007 and certain revenue bookings targets for 2008, respectively. Rubicon exceeded earnings targets for the month ended December, 31 2007, resulting in the issuance of a promissory note totaling $1.5 million which was paid in the first quarter of 2008.

Of the $2.0 million contingent note, approximately $0.4 million was issued at June 30, 2008 based on Rubicon’s achievement of revenue bookings targets through that date. The issued note bears interest at six percent per annum from the acquisition date and was paid on July 31, 2008. At December 31, 2008, the Company may be required to issue and pay up to $1.6 million or the balance of the note contingent on Rubicon’s achievement of certain revenue booking targets in the second half of 2008. Any contingent note issuance will have earned interest at six percent per annum from the purchase date through payment. At September 30, 2008, revenue bookings were not determinable beyond a reasonable doubt and the remaining $1.6 million contingent note has not been issued.

In connection with the acquisition of SMLB, on January 2, 2008, the Company issued unsecured promissory notes with an aggregate value of $500,000 to the sellers. The notes bear interest at six percent per year and has a three-year term. During the three months ended June 30, 2008, the Company reduced the seller notes to $15,248 based on a $484,752 working capital adjustment in accordance with the terms of the purchase agreement. Principal installments net of the adjustment of $3,050, $3,050 and $9,148, plus accrued interest, are due on January 2, 2009, January 2, 2010 and January 2, 2011, respectively. The Company may prepay the notes any time at its election without penalty.

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FORTRESS INTERNATIONAL GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(11)  Related Party Transactions

Our 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 parties for less than $25,000.

 

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% by each of 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 by, 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 by each of 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. Except for an office space sublease agreement, Chesapeake 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.

 

CS Technology, Inc. CS Technology, Inc. (CST) is majority owned by a nephew of the Company’s Chief Executive Officer. CST is in the Technology Consulting business and is a customer of the Company.

CTS Services, LLC (CTS) is 55% 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.

L.H. Cranston Acquisition Group, Inc . L.H. Cranston Acquisition Group, Inc. is 25% owned by the Company’s Chief Executive Officer. L.H. Cranston Acquisition Group 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 (Telco) is 55% owned by the Company’s Chief Executive Officer. Telco 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. CTS purchased 100% of Telco’s membership interests in the first quarter of 2008.

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 Re Three LLC. TPR Group Re Three, LLC (TPR Group Re Three) is 50% owned by each of 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.

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		September 30,			December 31,
		2008			2007
Technology consulting		$	6.8		$	3.9
Construction management			195.9			154.1
Facilities management			15.0			14.9
Total		$	217.7		$	172.9

The backlog amounts are estimates, subject to changes or cancellations. The actual customer purchase orders to perform work may vary in scope and amount from the backlog amounts presented herein. Additionally, some of our customers may be dependent on additional funding resources, which in the current economic environment may be difficult for them to obtain. Accordingly, we can provide no assurance that we will in fact be awarded the maximum amount of such contracts or be awarded any amount at all.

Critical Accounting Policies and Estimates

 Our financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”). The preparation of these financial statements 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 material contracts and cost-plus-fee contracts (including guaranteed maximum price contracts). Our primary source of revenue is from fixed price contracts and we apply 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.

 

Revenue from fixed price contracts is 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 costs 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 its standard management process, facts develop that require us to revise its 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 becomes 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.

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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.

Additionally, in the event the collection of revenue is not reasonably assured, we recognize revenue when we are paid for the service. We expense any related contracted costs as they are incurred.

          

Allowance for Doubtful Accounts

The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We determine the allowance based on an analysis of our historical experience with bad debt write-offs and an aging of the accounts receivable balance. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

 

As of September 30, 2008, accounts receivable of $1.4 million is due from a customer to whom we have offered extended payment terms. The customer has executed a promissory note in the same amount bearing interest at 8% per annum with payments of interest only due monthly and the balance in full is due on December 15, 2008. This amount was recognized as revenue in the nine months ended September 30, 2008. We have a history of conducting business with this customer and therefore believe collectibility is reasonably assured.

 

Non-cash Compensation

 

We apply the expense recognition provisions of SFAS No. 123(R), “Accounting for Stock-Based Compensation” (“SFAS No. 123(R)”), therefore, the recognition of the value of the instruments results in compensation expense in our financial statements. The expense differs from other compensation and professional expenses in that these charges, though generally permitted to be settled in cash, are typically settled through the issuance of common stock, which would have a dilutive effect upon earnings per share, if and when such warrants are exercised or restricted stock vests. The determination of the estimated fair value used to record the compensation or professional expenses associated with the equity or liability instruments issued requires management to make a number of assumptions and estimates that can change or fluctuate over time.

 

Goodwill and Other Purchased Intangible Assets

 

Goodwill represents the excess of costs over fair value of net assets of businesses acquired. Other purchased intangible assets include the fair value of items such as customer contracts, backlog and customer relationships. SFAS No. 142, “Goodwill and Other Intangible Assets”(“SFAS No. 142”), establishes financial accounting and reporting for acquired goodwill and other intangible assets. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but rather tested for impairment on an annual basis or purchased intangible assets with a definite useful life are amortized on a straight-line basis over their estimated useful lives. We have a process pursuant to which we typically retain third-party valuation experts to assist us in determining the fair market values and useful lives of identified intangible assets. Certain techniques require us to make estimates and assumptions about the future financial performance of the acquired businesses that may change in the future.

Our intangible assets consist of trade name, in-place contracts, customer relationships, and non-competition agreements with amortizable lives of 1-8 years for the finite lived intangibles. The Company annually tests for the impairment of goodwill pursuant to the requirements of SFAS No. 142 and of the other purchased intangible assets pursuant to the requirements of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” If events or changes in circumstances indicate that an asset value might be impaired, we will test during the interim period in which those changes occur. Through the third quarter 2008, we continued to incur operating losses, revised our forecasted revenues as certain of our acquisitions have not delivered originally anticipated revenues, and experienced a market decline in our equity value. As a result of these potential impairment indicators, we evaluated the carrying value of goodwill and other long-lived intangible assets for impairment. Utilizing a third party firm we determined the carrying value of goodwill was in excess of the fair value, resulting in an aggregate impairment on goodwill of approximately $4.2 million.

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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 “special purpose acquistion” company with no substantive operations. Management concluded that the adoption of FIN 48 had no material effect on our financial position or results of operations. As of September 30, 2008, we do not have any material gross unrecognized tax benefit liabilities. However, management is still in the process of evaluating the various tax positions associated with the acquisition of SMLB and is of the opinion that any deferred tax liabilities that would ultimately result from uncertain tax positions related to these entities may be covered by indemnification provisions provided in the acquisition agreement or may result in an adjustment to goodwill.

 

Use of Estimates

 

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. The most critical estimates and assumptions are made in determining the allowance for doubtful accounts, revenue recognition, recovery of long-lived assets, useful lives of long-lived assets, accruals for estimated tax and stock compensation expense. Actual results could differ from those estimates and assumptions.

Consolidated Statements of Operations

 

														Predecessor
		Successor (Fortress International Group, Inc.)												(TSS/Vortech)
														For the period
														January 1,
		Three Months Ended						Nine Months Ended						through
		September 30, 2008			September 30,2007			September 30, 2008			September 30,2007			January 19, 2007
		(unaudited)			(unaudited)			(unaudited)			(unaudited)			(audited)
Results of Operations:
Revenue		$	25,781,523		$	12,692,772		$	65,363,481		$	32,232,016		$	1,412,137
Cost of revenue			20,660,103			10,749,331			54,719,170			27,378,926			1,108,276
Gross profit			5,121,420			1,943,441			10,644,311			4,853,090			303,861
Operating expenses:
Selling, general and administrative			4,838,291			3,964,468			15,275,116			10,026,448			555,103
Depreciation			125,716			137,032			355,810			289,708			33,660
Amortization of intangibles			702,569			567,109			2,104,067			1,574,671			-
Impairment loss on goodwill			2,973,000			-			4,190,000			-			-
Total operating costs			8,639,576			4,668,609			21,924,993			11,890,827			588,763
Operating loss			(3,518,156	)		(2,725,168	)		(11,280,682	)		(7,037,737	)		(284,902	)
Interest income (expense), net			(49,653	)		104,116			(194,661	)		476,388			3,749
Loss from operations before income taxes			(3,567,809	)		(2,621,052	)		(11,475,343	)		(6,561,349	)		(281,153	)
Income tax expense (benefit)			(349,898	)		-			37,102			(349,325	)		-
Net loss		$	(3,217,911	)	$	(2,621,052	)	$	(11,512,445	)	$	(6,212,024	)	$	(281,153	)

Results of operations for the Successor company for the three months ended September 30, 2008 compared with the three months ended September 30, 2007.

Revenue. Revenue increased $13.1 million to $25.8 million for the three months ended September 30, 2008 from $12.7 million for the three months ended September 30, 2007. The increase was primarily driven by a $12.3 million increase in our construction management services and the inclusion of $1.9 million of revenue associated with the acquisitions of Innovative, Rubicon and SMLB.

Cost of Revenue. Cost of revenue increased $10.0 million to $20.7 million for the three months ended September 30, 2008 from $10.7 million for the three months ended September 30, 2007. The increase was primarily driven by a volume increase in our construction management services and the inclusion of $1.2 million of cost of revenue associated with the acquisitions of Innovative, Rubicon, and SMLB.

 

Gross Margin Percentage. Gross margin percentage increased by 4.6% to 19.9% for the three months ended September 30, 2008 compared to 15.3 % for the three months ended September 30, 2007. Excluding the effect of gross margin contribution associated with the acquisitions of Innovative, Rubicon and SMLB, gross margin percentage increased to 18.9% for the three months ended September 30, 2008 from 15.3% for the three months ended September 30, 2007. The overall increase in gross profit was primarily attributable improved profitability on our construction management contracts; however, we expect our total gross margin percentage to approximate 16.0%.

Selling, general and administrative expenses . Selling, general and administrative expenses increased $0.8 million to $4.8 million for the three months ended September 30, 2008 from $4.0 million for the three months ended September 30, 2007. The increase was primarily driven by professional fees of approximately $0.5 million that we expensed associated with abandoned acquisitions and the inclusion of $0.6 million of selling, general and administrative expenses associated with the acquisitions of Innovative, Rubicon, and SMLB.

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As we have experienced delays in the timing of revenues associated with certain customers, we began implementing a plan to restructure expenses to align with current operating revenues. The plan seeks to reduce operating costs associated with personnel and related costs, professional fees, and sales and marketing, which we anticipate will result in lower total selling, general and administrative costs.

Depreciation. Depreciation remained consistent at $0.1 million for the three months ended September 30, 2008 compared to $0.1 million for the three months ended September 30, 2007.

 

Amortization of intangible assets. Amortization expense increased $0.1 million to $0.7 million for the three months ended September 30, 2008 compared to $0.6 million for the three months ended September 30, 2007. The increase is attributable to an increase in amortizable intangible assets as a result of our acquisitions of Innovative, Rubicon and SMLB.

Impairment loss on intangibles. We have experienced continued operating losses and had a decline in our equity market value during the three months ended September 30, 2008. Based on these potential impairment indicators, 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, we determined that the carrying value exceeded the current fair value of our business, resulting in goodwill impairment of $3.0 million for the three months ended September 30, 2008. At September 30, 2008, the adjusted carrying value of goodwill was $18.8 million.

Interest income (expense), net. Our interest income (expense), net, decreased $0.2 million to ($0.1) million for the three months ended September 30, 2008 from $0.1 million for the three months ended September 30, 2007. The decrease in interest income was due primarily to a lower average invested balance in the three months ended September 30, 2008 compared to the three months ended September 30, 2007.

Income tax expense (benefit). Income tax (benefit) increased $0.4 million to ($0.4) million for the three months ended September 30, 2008 from zero for the three months ended September 30, 2007. The tax benefit was associated with the decrease in our deferred tax liability associated with a decrease in our tax deductible goodwill.

Results of operations for the Successor company for the nine months ended September 30, 2008 compared with the nine months ended September 30, 2007.

Revenue. Revenue increased $33.2 million to $65.4 million for the nine months ended September 30, 2008 from $32.2 million for the nine months ended September 30, 2007. The increase was primarily driven by a $24.1 million increase in our construction management services and the inclusion of $10.5 million of revenue associated with the acquisitions of Innovative, Rubicon, and SMLB.

Cost of Revenue. Cost of revenue increased $27.3 million to $54.7 million for the nine months ended September 30, 2008 from $27.4 million for the nine months ended September 30, 2007. The increase was driven by the increase in revenue primarily from our construction management services and the inclusion of $8.3 million of cost of revenue associated with the acquisitions of Innovative, Rubicon, and SMLB.

 

Gross Margin Percentage. Gross margin percentage increased 1.2% to 16.3% for the nine months ended September 30, 2008 compared to 15.1% for the nine months ended September 30, 2007. The increase in gross profit was primarily attributable to improved profitability on our construction management contracts.

Selling, general and administrative expenses. Selling, general and administrative expenses increased $5.3 million to $15.3 million for the nine months ended September 30, 2008 from $10.0 million for the nine months ended September 30, 2007. The increase was primarily driven by $2.2 million of selling, general and administrative expenses associated with the acquisitions of Innovative, Rubicon and SMLB, and $1.2 million that we expensed associated with abandoned acquisitions.

As we have experienced delays in the timing of revenues associated with certain customers and margins have contracted, we began implementing a plan to restructure expenses to align with current operating revenues. The plan seeks to reduce operating costs associated with personnel and related costs, professional fees, and sales and marketing, which we anticipate will result in lower total selling, general and administrative costs.

Depreciation. Depreciation remained consistent at $0.4 million for the nine months ended September 30, 2008 compared to $0.3 million for the nine months ended September 30, 2007.

 

Amortization of intangible assets. Amortization expense increased $0.5 million to $2.1 million for the nine months ended September 30, 2008 from $1.6 million for the nine months ended September 30, 2007. The increase is attributable to an increase in the amortizable intangible assets as a result of our acquisitions of Innovative, Rubicon and SMLB.

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Impairment loss on intangibles. Through the third quarter 2008, we continued to incur operating losses, revised our forecasted revenues as certain of our acquisitions have not delivered originally anticipated revenues, and experienced a market decline in our equity value. Based on these potential impairment indicators, we conducted an 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, we determined that the carrying value exceeded the current fair value of our business, resulting in goodwill impairment of $4.2 million for the nine months ended September 30, 2008. At September 30, 2008, the adjusted carrying value of goodwill was $18.8 million.

Interest income (expense), net. Our interest income (expense), net, decreased $0.7 million to ($0.2) million for the nine months ended September 30, 2008 from $0.5 million for the nine months ended September 30, 2007. The decrease in interest income was due primarily to a lower average invested balance in the nine months ended September 30, 2008 compared to nine months ended September 30, 2007.

Income tax expense (benefit). Income tax expense (benefit) decreased $0.3 million to zero for the nine months ended September 30, 2008 from ($0.3) million for the nine months ended September 30, 2007. For the nine months ended September 30, 2007, income tax benefit was $0.3 million reflecting the value of a NOL carryback to prior periods at an effective federal rate of 34%, net of a valuation allowance on deferred tax assets.

Financial Condition, Liquidity and Capital Resources

 

We have historically incurred net losses and have used our cash and investments to fund our operating and investing activities. We believe that operational improvements, strategic investments and complementary acquisitions will improve the cash flows of our business. Our efforts are continuing and may include further acquisitions and realignment of our sales, general and administrative expenses. We cannot be sure, however, as to the amount and timing of the associated financial impact. Summary cash flows for the nine months ended September 30, 2008 and 2007 and for the period January 1, through January 19, 2007 (Predecessor) are as follows:

 

								Predecessor
		Successor (Fortress International Group, Inc.)						(TSS/Vortech)
								For the period
		For the nine			For the nine			January 1,
		months ended			months ended			through
		September 30, 2008			September 30, 2007			Janaury 19, 2007
Net cash provided by (used in) operating activities		$	(1,896,152	)	$	(5,618,627	)	$	656,001
Net cash provided by (used in) investing activities			(2,331,281	)		31,989,260			(127,602	)
Net cash provided by (used in) financing activities			(2,088,524	)		(8,447,522	)		(1,567,920	)
Net increase (decrease) in cash		$	(6,315,957	)	$	17,923,111		$	(1,039,521	)

 

Cash and cash equivalents decreased $6.3 million to $6.9 million at September 30, 2008 from $13.2 million at December 31, 2007. The decrease was primarily attributable to $1.9 million from operating activities, $2.1 million for the purchase of SMLB and $2.0 million for the repayment of promissory notes issued in connection with the Rubicon acquisition.

Operating Activity

Net cash used in operations decreased $3.7 million to $1.9 million for the nine months ended September 30, 2008 from $5.6 million used in operations for the nine months ended September 30, 2007. The decline in cash used in operating cash flows is primarily attributable to working capital as follows:

Increase in net loss. Net loss increased $5.3 million to $11.5 million for the nine months ended September 30, 2008 from $6.2 million for the nine months ended September 30, 2007. The increase in net loss was primarily attributable to a $5.0 million increase in non-cash items consisting of the impairment loss on goodwill, amortization of intangibles and equity-based compensation expense.

 

Increase in working capital. Net changes in operating assets and liabilities decreased approximately $4.1 million primarily due to trade receivables and payables, which accounts for the improvement or decline in cash used by operating activities. The decrease is primarily attributable to managing our trade accounts receivable and corresponding payables.

Investing Activity

Net cash used in investing increased $34.3 million to $2.3 million used in investing activities for the nine months ended September 30, 2008 from $32.0 million provided by investing activities for the nine months ended September 30, 2007. The increase was primarily attributable to our transition to an operating Company in the first quarter of 2007 and the release of investments held in trust for general operating purposes.

 

Sale of investments held in Trust. Upon the approval of the TSS/Vortech acquisition, we had a cash inflow from the sale of approximately $44.7 million in trust investments, which funded the cash portion of the acquisition and repurchase of common stock from dissenting shareholders electing to receive their IPO proceeds back and provided cash for future ongoing operations.

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Acquisitions. Net cash used to acquire businesses decreased $10.2 million to $2.1 million for the nine months ended September 30, 2008 from $12.3 million for the nine months ended September 30, 2007. In the first quarter of 2008, we acquired SMLB, Ltd. which had a significantly lower enterprise value and in turn lower cash purchase price component as compared to TSS/Vortech acquisition, which occurred in the first quarter of 2007.

 

Financing Activity

 

Net cash used in financing decreased $6.3 million to $2.1 million for the nine months ended September 30, 2008 from $8.4 million for the nine months ended September 30, 2007. The decrease in cash used in financing activities was attributable fundamentally to different activity as described in the following:

 

·	Repayment of seller notes. During the nine months ended September 30, 2008, we repaid $2.0 million of unsecured promissory notes that were issued to the Rubicon sellers upon achievement of certain financial targets at December 31, 2007 and June 30, 2008.

·

Repurchase of common stock. During the first quarter of 2007, we used $6.2 million to repurchase our common stock associated with the election of conversion rights by our dissenting shareholders in connection with our acquisition of TSS/Vortech and $1.3 million in a share buyback program. The share buyback program was suspended in the third quarter of 2007; however, during 2008 we repurchased 14,885 shares at an average price of $3.19 per share for employee taxes associated with net issuance of vesting restricted stock.

Non-Cash Activities

During the nine months ended September 30, 2008, we issued total unsecured promissory notes totaling $0.5 million as purchase consideration. In connection with the acquisitions of SMLB, we initially issued $0.5 million of unsecured promissory notes that were reduced in the second quarter 2008 to $15,248 pursuant to the working capital requirements per the original purchase agreement. Consistent with the Rubicon purchase agreement in exchange for achieving specified financial targets through June 30, 2008, we issued an additional $0.4 million of unsecured promissory notes.

During the third quarter 2008, the Chief Executive Officer and Chief Operating Officer, both of the selling members of TSS/Vortech, entered into an agreement with the Company to convert $2,500,000 and $1,000,000, respectively, of their respective notes into common stock at a conversion price of $7.50 per share, resulting in the aggregate issuance of 466,667 common shares. The conversion has been recorded as an increase to additional paid-in capital. In addition, the Chief Operating Officer agreed to postpone any principal and interest payments payable to him under his remaining $4,000,000 promissory note until March, 2010, with such interest to be accrued to the outstanding principal. At September 30, 2008, $4,000,000 of the seller notes remains outstanding, which are convertible at $7.50 per shares to 533,333 shares of the Company’s common stock.

For a discussion of our acquisitions, see Note 3 of the Notes to Consolidated Financial Statements-Acquisitions.

Liquidity

In the third quarter of 2008, we initiated a plan to restructure expenses to realign them with the current operating revenues and gross margins as certain customers have delayed their spending. Our plan seeks to reduce operating costs associated with professional fees, sales and marketing, and personnel and related costs.

We believe that our current cash and cash equivalents and expected future cash generated from operations will satisfy our expected working capital, capital expenditure and investment requirements through the next twelve months. We may elect to secure additional capital in the future, if available and at acceptable terms, to improve our liquidity or fund acquisitions. The amounts involved in any such transaction, individually or in the aggregate, may be material and differ in structure relative to past acquisitions. To the extent that we raise additional capital through the sale of equity securities, the issuance of such securities could result in dilution to our existing shareholders. If we raise additional funds through the issuance of debt securities, the terms of such debt could impose additional restrictions on our operations. Additional capital, if required, may not be available on acceptable terms, if at all. If we are unable to obtain additional financing, we may be required to reduce the scope of acquisition plans, which could impact our business, financial condition and earnings.

Off Balance Sheet Arrangements   

At September 30, 2008, we do not have any off balance sheet arrangements.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Refer to our annual report on Form 10-K for the year ended December 31, 2007, as amended, for a complete discussion of our market risk. There have been no material changes to the market risk information included in our Annual Report on form 10-K, as amended, for the year ended December 31, 2007.

 

 

Our management performed an evaluation under the supervision and with the participation of our Chief Executive Officer (principal executive officer) and our Chief Financial Officer (principal 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 September 30, 2008. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of September 30, 2008, our disclosure controls and procedures were ineffective.

Changes in Internal Control over Financial Reporting 

 

There were no other changes in the Company’s internal control over financial reporting for the third quarter of 2008 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting as such term is defined in Rule 13a-15 and 15d-15 of the Exchange Act.

 

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.

Item 1A. Risk Factors

In addition to the other information set forth in this Form 10-Q, you should carefully consider the factors discussed in Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2007 and subsequent quarterly reports, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results as well as adversely affect the value of an investment in our common stock.

There have been no material updates to the risk factors previously disclosed in our Form 10-K for the year ended December 31, 2007.

 

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

 

The table set forth below shows all repurchases of securities by us during the quarter ended September 30, 2008:

								Total Shares			Approximate Dollar
					Average			Purchased as Part of			Amount of Shares Yet
Monthly Period During the Quarter		Total Shares			Price Paid			Publically Announced			To Be Purchase Under
Ended September 30, 2008		Purchased			per Share			Plans			Plans
July 1, 2008-July 31, 2008			8,028		$	2.27			-			-
August, 1 2008-August 31, 2008			-		$
September 1, 2008- September 30, 2008			867		$	1.31			-			-
Total			8,895		$	2.18

The Company repurchased 8,895 shares for employee taxes associated with net issuance of vesting restricted stock.

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Item 3. Defaults upon Senior Securities.

Not applicable.

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

Not applicable.

Item 5. Other Information.

 

Item 6. Exhibits.

Exhibit Number		Description
10.1		Amendment to Employment Agreement between Fortress International Group, Inc. and Thomas P. Rosato, dated August 26, 2008.
10.2		Amendment to Employment Agreement between Fortress International Group, Inc. and Gerard G. Gallagher, dated August 26, 2008.
10.3		Amendment to Employment Agreement between Fortress International Group, Inc. and Harvey L. Weiss, dated August 26, 2008.
10.4		Amendment to Employment Agreement between Fortress International Group, Inc. and Timothy C. Dec, dated August 26, 2008.
10.5		Amendment to Consulting Agreement between Fortress International Group, Inc. and Washington Capital Advisors, Inc. , dated August 26, 2008.
31.1		Certificate of Fortress International Group, Inc. Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certificate of Fortress International Group, Inc. Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1‡		Certificate of Fortress International Group, Inc. Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

‡ Furnished herewith.

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SIGNATURES

 

Pursuant to the requirements 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: November 14, 2008	By:	/s/ Thomas P. Rosato
		Thomas P. Rosato
		Chief Executive Officer (Authorized Officer and Principal Executive Office)

 

Date: November 14, 2008	By:	/s/ Timothy C. Dec
		Timothy C. Dec
		Chief Financial Officer (Authorized Officer and Principal Financial and Accounting Officer)

 

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