UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q


(Mark
One)


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





For the
quarterly period ended June 30, 2009





or





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





Commission
file number: 000-51426







FORTRESS
INTERNATIONAL GROUP, INC.


(Exact name of registrant as specified in its charter)





Delaware
            
            20-2027651(State
      or other jurisdiction of
              incorporation
      or organization)
            
            (I.R.S.
      Employer Identification No.)7226
      Lee DeForest Drive, Suite 203
              Columbia,
      Maryland
            
            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
xNo o





Indicate
by check mark whether each registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405
of this chapter) during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files).
Yes  o No o





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, 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 oNon-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 July 31,
2009 12,854,610












FORTRESS
INTERNATIONAL GROUP, INC.


Table
of Contents





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










PART I - FINANCIAL
INFORMATION





Item
1. Financial Statements





FORTRESS
INTERNATIONAL GROUP, INC.


CONDENSED
CONSOLIDATED BALANCE SHEETS




(Unaudited)June
      30,
            
            
            December
      31,2009
            
            
            2008Current
      AssetsCash
      and cash equivalents
            
            $
            5,267,230
            
            
            $
            12,448,157Contract
      and other receivables, net
            
            
            12,595,012
            
            
            
            21,288,660Costs
      and estimated earnings in excess of billings on uncompleted
      contracts
            
            
            2,300,648
            
            
            
            3,742,530Prepaid
      expenses and other current assets
            
            
            1,002,438
            
            
            
            539,124Total
      current assets
            
            
            21,165,328
            
            
            
            38,018,471Property
      and equipment, net
            
            
            710,925
            
            
            
            824,487Goodwill
            
            
            4,474,563
            
            
            
            4,811,000Other
      intangible assets, net
            
            
            211,134
            
            
            
            13,559,234Other
      assets
            
            
            268,470
            
            
            
            225,853Total
      assets
            
            $
            26,830,420
            
            
            $
            57,439,045Liabilities
      and Stockholders’ EquityCurrent
      LiabilitiesNotes
      payable, current portion
            
            $
            603,131
            
            
            $
            1,688,845Convertible
      note, current portion
            
            
            1,666,666
            
            
            
            -Accounts
      payable and accrued expenses
            
            
            14,089,665
            
            
            
            24,394,990Billings
      in excess of costs and estimated earnings on uncompleted
      contracts
            
            
            3,812,514
            
            
            
            6,047,765Total
      current liabilities
            
            
            20,171,976
            
            
            
            32,131,600Notes
      payable, less current portion
            
            
            247,492
            
            
            
            311,709Convertible
      notes, less current portion
            
            
            2,333,334
            
            
            
            4,000,000Other
      liabilities
            
            
            56,626
            
            
            
            137,198Total
      liabilities
            
            
            22,809,428
            
            
            
            36,580,507Commitments
      and Contingencies
            
            
            -
            
            
            
            -Stockholders’
      EquityPreferred
      stock- $.0001 par value; 1,000,000 shares authorized; no shares issued or
      outstanding
            
            
            -
            
            
            
            -Common
      stock- $.0001 par value, 100,000,000 shares authorized; 12,870,626 and
      12,797,296 issued; 12,695,046 and 12,621,716 outstanding at June 30,2009
      and December 31, 2008, respectively
            
            
            1,283
            
            
            
            1,279Additional
      paid-in capital
            
            
            62,208,954
            
            
            
            61,262,218Treasury
      stock, 175,580 shares at cost at June 30, 2009 and December 31,
      2008
            
            
            (869,381
            )
            
            
            (869,381
            )Accumulated
      deficit
            
            
            (57,319,864
            )
            
            
            (39,535,578
            )Total
      stockholders' equity
            
            
            4,020,992
            
            
            
            20,858,538Total
      liabilities and stockholders’ equity
            
            $
            26,830,420
            
            
            $
            57,439,045




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




1


FORTRESS
INTERNATIONAL GROUP, INC.


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS





(Unaudited)
            
            
            (Unaudited)For
      the ThreeMonths
      Ended
            
            
            For
      the SixMonths
      EndedJune
      30, 2009
            
            
            June
      30, 2008
            
            
            June
      30, 2009
            
            
            June
      30, 2008Results
      of Operations:Revenue
            
            $
            14,939,422
            
            
            $
            20,149,876
            
            
            $
            45,010,750
            
            
            $
            39,581,956Cost
      of revenue
            
            
            13,158,890
            
            
            
            18,038,179
            
            
            
            39,562,081
            
            
            
            34,059,068Gross
      profit
            
            
            1,780,532
            
            
            
            2,111,697
            
            
            
            5,448,669
            
            
            
            5,522,888Operating
      expenses:Selling,
      general and administrative
            
            
            4,637,908
            
            
            
            5,657,424
            
            
            
            8,491,569
            
            
            
            10,428,454Depreciation
      and amortization
            
            
            105,039
            
            
            
            123,217
            
            
            
            208,459
            
            
            
            238,456Amortization
      of intangibles
            
            
            690,855
            
            
            
            619,436
            
            
            
            1,382,960
            
            
            
            1,401,498Impairment
      loss on goodwill and other intangibles
            
            
            13,062,140
            
            
            
            1,217,000
            
            
            
            13,062,140
            
            
            
            1,217,000Total
      operating costs
            
            
            18,495,942
            
            
            
            7,617,077
            
            
            
            23,145,128
            
            
            
            13,285,408Operating  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
            
            
            
            -
            
            
            
            387,000Net
      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.




2





FORTRESS
INTERNATIONAL GROUP, INC.


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS





(Unaudited)For
      the Six Months EndedJune
      30, 2009
            
            
            June
      30, 2008Cash
      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
            
            
            
            238,456Amortization
      of intangibles
            
            
            1,382,960
            
            
            
            1,673,434Impairment
      loss on goodwill and other intangibles
            
            
            13,062,140
            
            
            
            1,217,000Provision
      for doubtful accounts
            
            
            1,025,000
            
            
            
            89,795Stock
      and warrant-based compensation
            
            
            946,740
            
            
            
            1,012,417Extinguishment
      of contract liabilities
            
            
            (269,217
            )
            
            
            -Other
      non-cash income, net
            
            
            2,935
            
            
            
            9,858Changes
      in operating assets and liabilities, net of the effects from
      acquisitions:Contracts
      and other receivables
            
            
            7,668,648
            
            
            
            1,385,817Costs
      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
            )
            
            
            44,964Accounts
      payable and accrued expenses
            
            
            (9,193,492
            )
            
            
            2,139,835Billings
      in excess of costs and estimated earnings on uncompleted
      contracts
            
            
            (2,235,251
            )
            
            
            398,344Other
      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
            
            
            
            13,172,210Cash,
      end of period
            
            $
            5,267,230
            
            
            $
            8,401,630Supplemental
      disclosure of cash flow information:Cash
      paid for interest
            
            $
            126,644
            
            
            $
            240,167Cash
      paid for taxes
            
            
            116,411
            
            
            
            -Supplemental
      disclosure of non-cash investing activities:Issuance
      of common stock in connection with the acquisition of SMLB
            
            $
            -
            
            
            $
            500,000Promissory
      notes payable issued in connection with the acquisition of
      SMLB
            
            
            -
            
            
            
            15,248Promissory
      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.




3


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.




4




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.




5




FORTRESS INTERNATIONAL GROUP, INC.


NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS




(2)           Accounts
Receivable, net





The
Company had accounts receivable allowances for doubtful accounts of $1.2
million and $0.2 million at June 30, 2009 and December 31, 2008,
respectively.





Bad debt
expense for the three and six months ending June 30, 2009 was approximately $1.0
million compared to $0.1 million for the three and six months ended June 30,
2008. The increase bad debt expense is associated with a single customer note
receivable that was fully reserved during the three months ended June 30, 2009
as more fully described below.





·
            The
      accounts receivable of $1.0 million, for which we provided a reserve for
      during the three months ended June 30, 2009 is due from a customer that
      had previously entered into a promissory note with us for $1.0
      million.  This note bears interest at 8% per annum with payments
      of interest only due monthly.  The balance of the note was due
      in full on June 15, 2009; however, the customer did not pay and
      indicated at that time its inability to satisfy the note
      balance.  The Company continues with its efforts to collect or
      otherwise monetize the receivable through either alternative financing
      solutions or legal recourse, including the potential pursuit of the
      building owners’ personal guarantees for the amount due.  The
      customer remains current on all other trade accounts and interest on the
      note.





Associated
with this customer, we have open purchase commitments totaling $3.4 million, of
which approximately $3.2 million is associated with equipment scheduled for
delivery to the site in October 2009 and has associated payment terms of paid
when paid.  With the customer’s inability to pay the note due on June
15, 2009, the Company is evaluating alternatives to either defer or exit the
purchase commitment for equipment related to this customer’s
project.  Remaining commitments under the project are primarily paid
when paid contractual terms with subcontractors and the Company has the ability
to affect a work stoppage in the event of nonpayment on account.





·
            Also,
      during the first quarter of 2009, the Company executed a promissory note
      receivable with another customer for $0.8 million.  This note
      has a six-month repayment schedule and does not bear interest given its
      short term nature.  At June 30, 2009, the balance on this note
      was $0.4 million.  The Company had received $200,000, plus two
      of the six remaining payments due under the
  note.





During
the three and six months ended June 30, 2008, the Company recognized a $0.7
million loss on a customer contract due to concerns as to whether the amounts
due from this customer were collectible. During the six months ended June 30,
2009, the Company finalized the extinguishment of approximately $0.3 million due
to two vendors’ as the result of a contract assignment. Pursuant to the contract
assignment these two vendors have relieved the Company of its obligation due to
these vendors which had been previously recorded by the Company. These vendors
will pursue collection remedy independently and without recourse to the Company
pursuant to the terms of the contract assignment. The Company recorded the
extinguishment of liabilities for the amount due to these two vendors as a
reduction to accounts payable and a reduction to cost of sales of $0.3 million
during the three months ended March 31, 2009.





As of
June 30, 2009 and December 31, 2008, we had accounts receivable, net totaling
$0.4 million and $1.0 million, respectively, due from customers to whom the
Company offered extended payment terms.  In addition, accounts
receivable, net included retainage associated with construction projects
totaling $1.0 million and $0.4 million at June 30, 2009 and December 31, 2008,
respectively.




6




FORTRESS
INTERNATIONAL GROUP, INC.


NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





(3)           Acquisitions





On
November 30, 2007, the Company acquired 100% of the membership interests of
Rubicon. The purchase agreement executed in connection with the
Rubicon transaction contains earn-out provisions that may require the
Company to make an additional payment to be calculated based on excess
profits during the applicable earn-out periods. Under the Rubicon earn-out
arrangement at December 31, 2008, the Company recorded approximately $0.5
million for the 2008 earn-out period which began December 1, 2007 and continued
through December 31, 2008 (2008 Rubicon Earn-out).  Per the terms of
the purchase agreement on March 31, 2009 the Company delivered the 2008 Rubicon
Earn-out calculation and the Rubicon sellers have separately responded with
a calculation of $1.7 million, based on varying interpretations of the
purchase agreement. On June 2, 2009, the Company and sellers finalized the 2008
Rubicon Earn-out which totaled $1.3 million, or an increase of $0.8 million from
December, 31, 2008.  Consideration was issued in the form of a cash
payment of $0.7 million and a seller note for $0.6 (See Note 10).





During
the three and six months ended June 30, 2009, the increase in cash paid for the
Rubicon and Innovative acquisitions totaled $0.7 million and $0.4 million,
respectively, and was attributable for achievement of certain profitability
targets, or 2008 earn-outs as stipulated in the respective purchase
agreements.





(4)
            Property
      and Equipment, net




Major
classes of property and equipment are summarized as follows:





June
      30,
            
            
            December
      31,2009
            
            
            2008Vehicles
            
            $
            164,576
            
            
            $
            164,576Trade
      equipment
            
            
            144,391
            
            
            
            139,143Leasehold
      improvements
            
            
            500,040
            
            
            
            500,040Furniture
      and fixtures
            
            
            38,694
            
            
            
            38,694Computer
      equipment and software
            
            
            942,195
            
            
            
            852,5451,789,896
            
            
            
            1,694,998Less
      accumulated
    depreciation
            
            
            (1,078,971
            )
            
            
            (870,511
            )Property
      and equipment, net
            
            $
            710,925
            
            
            $
            824,487




Depreciation
and leasehold amortization expense totaled $0.1 million and $0.1 million, and
$0.2 million and $0.2 million for the three- and six- month periods ended June
30, 2009 and 2008, respectively.





(5)           Goodwill
and Other Intangibles, net





The
Company recognized goodwill associated with its five acquisitions beginning in
2007 through 2008.  The following table set forth the gross carrying
value of our goodwill and any adjustments, other than impairment related, during
the six months ended June 30, 2009 for each respective transaction.





December
      31,
              
              
              
              
              
              June
      30,2008
              
              
              Additions
              
              
              2009TSS/Vortech
              
              $
              15,739,472
              
              
              $
              -
              
              
              $
              15,739,472Commsite
              
              
              134,623
              
              
              
              -
              
              
              
              134,623Innovative
              
              
              1,351,786
              
              
              
              -
              
              
              
              1,351,786Rubicon
              
              
              5,606,153
              
              
              
              760,563
              
              
              
              6,366,716SMLB,
      Ltd.
              
              
              2,542,909
              
              
              
              -
              
              
              
              2,542,909Total
              
              $
              25,374,943
              
              
              $
              760,563
              
              
              $
              26,135,506




During
the three months ended June 30, 2009, the Company finalized the Rubicon 2008
earn-out resulting in the additional consideration of approximately $0.8 million
(See Note 3).




7




FORTRESS
INTERNATIONAL GROUP, INC.


NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





Goodwill Impairment





The
Company has not realized the anticipated revenue from customers acquired in its
acquisitions and had experienced continued operating losses during the six
months ended June 30, 2009.  Based on the recurring operating losses,
lower than anticipated bookings and revisions to the Company’s forecast, the
Company performed an impairment analysis of the intangible assets acquired
pursuant to SFAS 142 to identify any impairment in the carrying value of the
goodwill related to the business in the second quarter of 2009. The
analyses of the business used both an income and market approach to
determine that the carrying value exceeded the current fair value of the
business at each referenced quarter, resulting in goodwill impairment of $1.1
million during the second quarter of 2009.  At June 30, 2009 and
December 31, 2008, the adjusted carrying value of goodwill was $4.5 million and
$4.8 million, respectively.





June
      30,
            
            
            December
      31,2009
            
            
            2008Gross
      carrying amount of goodwill
            
            $
            26,135,506
            
            
            $
            25,374,943Impairment
      loss on goodwill
            
            
            (21,660,943
            )
            
            
            (20,563,943
            )Net
      goodwill
            
            $
            4,474,563
            
            
            $
            4,811,000




Other
Intangibles, net





Other
intangible assets, net consisted of the following:




June
      30,2009
            
            
            December
      31,2008Carrying
            
            
            Accumulated
            
            
            Loss
      on
            
            
            Net
              Carrying
            
            
            Carrying
            
            
            Accumulated
            
            
            NetCarryingAmount
            
            
            Amortization
            
            
            Impairment
            
            
            Amount
            
            
            Amount
            
            
            Amortization
            
            
            AmountFinite
      Lived-Intangible assets:Customer
      relationships
            
            $
            17,630,000
            
            
            $
            (5,664,860
            )
            
            $
            (11,965,140
            )
            
            $
            -
            
            
            $
            17,630,000
            
            
            $
            (4,469,474
            )
            
            $
            13,160,526Non
      competition agreement
            
            
            740,600
            
            
            
            (589,466
            )
            
            
            
            
            
            
            151,134
            
            
            
            740,600
            
            
            
            (401,892
            )
            
            
            338,708Total
            
            
            18,370,600
            
            
            
            (6,254,326
            )
            
            
            (11,965,140
            )
            
            
            151,134
            
            
            
            18,370,600
            
            
            
            (4,871,366
            )
            
            
            13,499,234Indefinite
      Lived-Intangible assets:Trade
      name
            
            
            60,000
            
            
            
            -
            
            
            
            -
            
            
            
            60,000
            
            
            
            60,000
            
            
            
            -
            
            
            
            60,000Net
      other intangible assets
            
            $
            18,430,600
            
            
            $
            (6,254,326
            )
            
            $
            (11,965,140
            )
            
            $
            211,134
            
            
            $
            18,430,600
            
            
            $
            (4,871,366
            )
            
            $
            13,559,234




Based on
the lack of new contracts and revision in anticipated revenue from customers and
general condition of the Company, the Company evaluated long-lived customer
relationship intangible assets and determined the carrying value exceeded the
undiscounted cash flows at June 30, 2009.  Accordingly, the Company
performed a fair value assessment based on discounted cash flows of June 30,
2009, resulting in an impairment loss of $12.0 million for the three and six
months ended June 30, 2009.  At June 30, 2009, the adjusted net
carrying value of the aggregate customer relationship intangibles was
zero.





For the
three months ended June 30, 2009 and June 30, 2008, amortization expense,
excluding the impact of any impairment loss, totaling $0.7 million and $0.8
million, respectively, has been included in the accompanying consolidated
statement of operations related to the above intangibles of which zero and $0.2
million, respectively, is included in cost of revenue.





For the
six months ended June 30, 2009 and June 30, 2008, amortization expense totaling
$1.4 million and $1.7 million, respectively, has been included in the
accompanying consolidated statement of operations related to the above
intangibles of which zero and $0.3 million, respectively, is included in
cost of revenue.





(6)
            Basic
      and Diluted Net Loss per Share





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





For
      the Three Months
              Ended
      June 30,
            
            
            For
      the Six Months
              Ended
      June 30,2009
            
            
            2008
            
            
            2009
            
            
            2008Net
      loss
            
            $
            (16,767,681
            )
            
            $
            (5,994,318
            )
            
            $
            (17,784,278
            )
            
            $
            (8,294,528
            )Basic
      and diluted weighted average common shares
            
            
            12,678,381
            
            
            
            12,093,895
            
            
            
            12,660,049
            
            
            
            12,083,483Net
      loss per share
            
            $
            (1.32
            )
            
            $
            (0.50
            )
            
            $
            (1.40
            )
            
            $
            (0.69
            )




As of
June 30, 2009, there were unvested restricted stock, options to purchase units,
convertible unsecured promissory notes and warrants outstanding which were
convertible to purchase 715,337, 700,000, 533,333 and 15,710,300 shares of
common stock, respectively. These were excluded in the computation of
diluted net loss per common share for the three and six months ended June 30,
2009, as their inclusion would be anti-dilutive. On July 13, 2009, outstanding
warrants, including those attached to the option to purchase units, totaling
17,110,300 expired.




8




FORTRESS
INTERNATIONAL GROUP, INC.


NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





As of
June 30, 2008, there were unvested restricted stock, options to purchase units,
convertible unsecured promissory notes, and warrants outstanding which were
convertible to purchase 355,334, 2,100,000, 1,000,000 and 15,710,300 shares of
common stock, respectively. These were excluded in the computation of
diluted net loss per common share for the three and six months ended June 30,
2008, as their inclusion would be anti-dilutive.





(7)
            Employee
      Benefit Plans





For the
three months ended June 30, 2009 and 2008, the Company recorded non-cash
compensation expense included in selling, general and administrative expense
associated with vesting awards of $0.4 million and $0.6 million, respectively,
and in cost of revenue recorded $0.1 million and $0.1 million, respectively.
There was no other restricted stock activity.





For the
six months ended June 30, 2009 and 2008, the Company recorded non-cash
compensation expense included in selling, general and administrative expense
associated with vesting awards of $0.8 million and in cost of revenue recorded
$0.2 million. There was no other restricted stock activity.





(8)
            Options
      to Purchase Units and Warrants





At June
30, 2009 and December 31, 2008, there were options to purchase units and
warrants outstanding to purchase a total of 17,810,300 of common shares,
respectively.  On July 13, 2009, outstanding warrants, including those
attached to the option to purchase units, totaling 17,110,300
expired.  Accordingly, both the units and warrants ceased to trade on
the Nasdaq Capital Market and all outstanding units were converted to common
stock.





In 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 has
been determined using the Black-Scholes model and is recognized over the term of
the agreement. For the three and six months ended June 30, 2008, the computed
Black-Scholes value of the warrant declined zero and $141,422, respectively,
resulting in a corresponding reduction in selling, general and administrative
expense.





(9)
            Income
      Taxes




The
Company accounts for income taxes in accordance with SFAS No. 109, Accounting
for Income Taxes. 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 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. As of June 30, 2009 and December 31, 2008, a full valuation allowance
has been recorded against the Company’s deferred tax assets, as the Company has
concluded that under relevant accounting standards; it is more likely than not
that the deferred tax assets will not be realizable.





The
Company’s effective tax rate is based upon the rate expected to be applicable to
the full fiscal year.





Effective
January 1, 2007, the Company was required to adopt FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes (FIN 48). As of June 30, 2009, we do
not have any material gross unrecognized items.




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





The
Company’s prior federal and state income tax filings since 2005 remain open
under statutes of limitation.  Innovative Power System Inc.’s statutes of
limitation are open from the 2005 tax year forward for both federal and
Commonwealth of Virginia purposes.  Quality Power Systems
Inc.’s statutes of limitation are open from the 2005 tax year forward for
both federal and Commonwealth of Virginia purposes. SMLB’s statutes of
limitation are open from the 2005 tax year forward for both federal and State of
Illinois purposes.




9


FORTRESS
INTERNATIONAL GROUP, INC.


NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS




(10)
            Notes
      Payable





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




10




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








June
      30,
            
            
            December
      31,2009
            
            
            2008Accounts
      receivable/(payable):CTS
      Services, LLC
            
            $
            10,512
            
            
            $
            50,437CTS
      Services, LLC
            
            
            (125,378
            )
            
            
            (584,460
            )Chesapeake
      Mission Critical, LLC
            
            
            17,385
            
            
            
            15,900Chesapeake
      Mission Critical, LLC
            
            
            (24,184
            )
            
            
            -Telco
      P&C, LLC
            
            
            89,925
            
            
            
            -Telco
      P&C, LLC
            
            
            (38,836
            )
            
            
            (21,154
            )LH
      Cranston & Sons, Inc.
            
            
            -
            
            
            
            (67,455
            )S3
      Integration, LLC
            
            
            (159,581
            )
            
            
            (53,630
            )Total
      Accounts receivable
            
            $
            117,822
            
            
            $
            66,337Total
      Accounts (payable)
            
            $
            (347,979
            )
            
            $
            (726,699
            )





11








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.




12




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
              
              
              2008Technology
      consulting
              
              $
              1.6
              
              
              $
              4.0Construction
      management
              
              
              28.4
              
              
              
              48.7Facilities
      management
              
              
              12.7
              
              
              
              10.5Total
              
              $
              42.7
              
              
              $
              63.2





13





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.




14





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. Unanticipated
changes in the financial condition of clients, or significant changes in the
economy could impact the reserves required.  Account balances are
charged off against the allowance after all means of collection have been
exhausted and the potential for recovery is considered remote.




Non-cash
Compensation




We apply
the expense recognition provisions of SFAS No. 123, “Accounting for
Stock-Based Compensation” (“SFAS No. 123”), therefore, the recognition of
the value of the instruments results in compensation or professional expenses
in our financial statements. The expense differs from other compensation
and professional expenses in that these charges are typically settled through
the issuance of common stock or stock purchase warrants, 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 triggering event. Purchased intangible assets
with a definite useful life are amortized on a straight-line basis over their
estimated useful lives.




The
estimated fair market value of identified intangible assets is amortized over
the estimated useful life of the related intangible asset. 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. In interim periods, we evaluate these assets for impairment when events
occur that suggest a possible impairment. Through the second quarter 2009, we
continued to incur operating losses and revised our forecasted revenues as we
have seen customer delays, a lack of new contracts and executed contracts have
been at margins lower than historic levels.  As a result of the
decline in performance and continued customer delays, during the interim period
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 $1.1 million during the three
and six months ended June 30, 2009.  At June 30, 2009, the net
carrying value of goodwill was $4.5 million.





Long-Lived
Assets (Excluding Goodwill)




In
accordance with the provisions of SFAS No. 144 in accounting for long-lived
assets such as property, equipment and intangible assets subject to
amortization, we review the assets for impairment. Based on the general
business condition of the Company and the goodwill impairment analysis, we
evaluated the carrying value of the asset and determined both the carrying value
of exceeded both undiscounted and discounted cash flows. During the three and
six months ended June 30, 2009, we recorded a permanent reduction in the
carrying value of $12.0 million, reducing the net carrying value of other
intangible assets to $0.2 million.




15




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.




16


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.





17





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





Revenue.Revenue
increased $5.4 million to $45.0 million for the six months ended June 30, 2009
from $39.6 million for the six months ended June 30, 2008. The increase is
primarily driven by $8.3 million increase in construction management services,
offset partially by a decrease of $2.4 million in facilities
management.





Cost of Revenue. Cost of
revenue increased $5.5 million to $39.6 million for the six months ended June
30, 2009 from $34.1 million for the six months ended June 30, 2008. The increase
is primarily driven by a $7.4 million increase in construction management
services, partially offset by a decrease of $1.8 million in facilities
management services.




Gross Margin
Percentage.Gross margin percentage decreased 1.9% to 12.1%
for the six months ended June 30, 2009 from 14.0% for the six months ended June
30, 2008.  During the six months ended June 30, 2008, gross margin
included a loss contract associated with the acquisition of SMLB, which totaled
approximately $0.7 million.  Excluding the loss contract from the
previous year, gross margin percentage declined 3.6% to 12.1% for the six months
ended June 30, 2009 from 15.7% for the six months ended June 30,
2008.  The decline in gross margin is primarily attributable to
contraction in gross margin percentage in the construction management services,
which decreased by 2.1% to 9.2% for the six months ended June 30, 2009 from
11.3% for the six months ended June 30, 2008.  The decline in gross
margin for construction management services is due to the competitive
environment in which we contracted work at lower than historic
margins.  We anticipate margins will continue at the current level or
potentially lower given the environment.





Selling, general and administrative
expense.  Selling, general and administrative expenses
decreased $1.9 million to $8.5 million for the six months ended June 30, 2009
from $10.4 million for the six months ended June 30, 2008. The decrease is
primarily driven by $1.2 million decrease in salaries due to a reduction in
headcount of approximately 16% and additional furloughs, $0.5 million decrease
in professional fees and marketing efforts, and $0.7 million decrease in
acquisition 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 $0.2 million for the six months ended June 30,
2009 compared to $0.2 million for the six months ended June 30,
2008.




Amortization of intangible
assets.  Amortization expense remained consistent at $1.4
million for the six months ended June 30, 2009 from $1.4 million for the six
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 $11.8 million to $13.1 million for the six months
ended June 30, 2009 from $1.2 million for the six 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 six 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 six 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 six months ended June 30, 2008.





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




18




Financial
Condition, Liquidity and Capital Resources




For
      the Six Months Ended June 30,2009
            
            
            2008
            
            
            ChangeNet
      loss
            
            $
            (17,784,278
            )
            
            $
            (8,294,528
            )
            
            $
            (9,489,750
            )Adjustments
      to reconcile net loss to net cash used in operations:Amortization
      of intangibles
            
            
            1,382,960
            
            
            
            1,673,434
            
            
            
            (290,474
            )Impairment
      loss on goodwill and other intangibles
            
            
            13,062,140
            
            
            
            1,217,000
            
            
            
            11,845,140Stock
      and warrant-based compensation
            
            
            946,740
            
            
            
            1,012,417
            
            
            
            (65,677
            )Provision
      for doubtful accounts
            
            
            1,025,000
            
            
            
            89,795
            
            
            
            935,205Other
      non-cash items
            
            
            (57,823
            )
            
            
            248,314
            
            
            
            (306,137
            )Net
      adjustments to reconcile net income for non-cash items
            
            
            16,359,017
            
            
            
            4,240,960
            
            
            
            12,118,057Net
      change in working capital
            
            
            (2,907,651
            )
            
            
            3,214,730
            
            
            
            (6,122,381
            )Cash
      used in operations
            
            
            (4,332,912
            )
            
            
            (838,838
            )
            
            
            (3,494,074
            )Cash
      used in investing
            
            
            (1,148,084
            )
            
            
            (2,308,637
            )
            
            
            1,160,553Cash
      used in financing
            
            
            (1,699,931
            )
            
            
            (1,623,105
            )
            
            
            (76,826
            )Net
      decrease in cash
            
            
            (7,180,927
            )
            
            
            (4,770,580
            )
            
            
            (2,410,347
            )




Cash and
cash equivalents decreased $7.2 million to $5.3 million at June 30, 2009 from
$12.4 million at December 31, 2008. The decrease was primarily attributable to
$4.3 million used in operating activities, $1.1 million for investing
activities, and $1.7 million used in the repayment of notes
payable.





Operating
Activity





Net cash
used in operations operating activities totaled $4.3 million for the six months
ended June 30, 2009 compared to $0.9 million for the six months ended June 30,
2008. The decrease in operating cash flow was primarily attributable to an
increase in net loss of $9.5 million and a decrease in cash provided from
working capital of $6.1 million.  The decrease in net loss was
primarily driven by an increase in the non-cash items of approximately $12.1
million due to an increase in impairment loss on goodwill and other
intangibles.  The decrease in working capital was due to $5.8 million
decrease in contract related working capital including contract accounts
payable and billings in excess of costs and estimated earnings,
partially offset by changes in  contracts receivable and costs
and estimated earnings in excess of billings.





Investing
Activity





Net cash
used in investing activities decreased $1.2 million to $1.1 million for the six
months ended June 30, 2009 from $2.3 million for the six months ended June 30,
2008.  The decrease was attributable to decreased investing activity
associated with acquired companies.  For the six months ended June 30,
2009, cash was used primarily for the payment of contingent consideration
associated with the Rubicon 2008 earn-out and Innovative 2008 earn-out totaling
$0.7 million and $0.4 million, respectively.  For the six months ended
June 30, 2008, cash used for acquisitions and related activity was $2.3 million
due primarily to the SMLB acquisition of $2.1 million.




Financing
Activity




Net cash
used in financing increased $0.1 million to $1.7 million for the six months
ended June 30, 2009 from $1.6 million for the six months ended June 30,
2008.  For the six months ended June 30, 2009 and 2008 payments
consisted almost entirely of seller note repayments and the increase was
associated with an increase in the scheduled amounts due for Rubicon unsecured
promissory notes issued to the sellers.




19





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.





The
consolidated financial statements included herein have been prepared on a goingconcern basis, which contemplates
continuity of operations and the realization of assets and repayment of
liabilities in the ordinary course of business. Management 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.  Management has taken steps to reduce our 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 our
strategic direction aimed at achieving profitability and positive cash
flow.  Although we have 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 our limited financial resources, we
may determine to voluntarily delist our securities from trading on NASDAQ and
deregister our securities under the Exchange Act and cease our reporting
obligations with the SEC under the Exchange Act.  In addition,
management 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 our assets or a sale of the entire
company.  If we are unable to obtain additional funding for
operations, we may not be able to continue operations as proposed, requiring us
to modify our business plan, curtail various aspects of our operations or cease
operations entirely. In such event, investors may lose a portion or all of their
investment.




20




In an
effort to meet our working capital requirements and scheduled maturities of
indebtedness absent restructuring, we engaged an investment banking firm in June
2009 to assist us with either raising additional capital, or the marketing for
sale of a division or some or all of our assets or our 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 our
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 comprised of Asa
Hutchinson, William L. Jews, and John Morton III (Chairman).  The
Special Committee is currently considering the following
alternatives:





·
            Raising
      additional capital in the form of 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, we may not be successful in executing a
sale of a division or some or all of our assets or a sale of our entire company
or in obtaining additional financing on acceptable terms, on a timely basis, or
at all, in which case, we 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 our common stock and cause the market price to fall, and
the issuance of debt securities could impose restrictive covenants that could
impair our ability to engage in certain business transactions.





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





Off Balance Sheet
Arrangements





As of
June 30, 2009, we do not have any off balance sheet arrangements





Item
3. Quantitative and Qualitative Disclosures about Market Risk.




The
information called for by this item is not required as we are a smaller
reporting company.




Item 4T. Controls and
Procedures.




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 the end of the period covered by the report. Based upon that evaluation,
our Chief Executive Officer and Chief Financial Officer have concluded that as
of June 30, 2009, our disclosure controls and procedures were
ineffective.





Changes in Internal Control over
Financial Reporting




There
were no changes in the Company’s internal control over financial reporting for
the second quarter of 2009 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
of 1934, as amended.




21




PART
II - OTHER INFORMATION





Item
1. Legal Proceedings.




We are
not a party to any material litigation in any court, and management is not aware
of any contemplated proceeding by any governmental authority against us. From
time to time, we are involved in various legal matters and proceedings
concerning matters arising in the ordinary course of business. We currently
believe that any ultimate liability arising out of these matters and proceedings
will not have a material adverse effect on our financial position, results of
operations or cash flows.




Item
1A. Risk Factors.




This Quarterly
Report on Form 10-Q contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those anticipated
in these forward-looking statements as a result of certain factors, including
the risks faced by us described below and elsewhere in this Quarterly Report on
Form 10-Q. If any of the following risks actually occur, they could materially
adversely affect our business, financial condition, operating results or
prospects and the trading price of our securities. Additional risks and
uncertainties that we do not presently know or that we currently deem immaterial
may also impair our business, financial condition, operating results and
prospects and the trading price of our securities.





Risks
Related to our Financial Condition and Capital Requirements





We
need substantial additional funds to continue operations, which we may not be
able to raise on favorable terms, or at all.





Management
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 for the next twelve months. We intend to attempt to obtain
additional resources through strategic alternatives which may include the sale
of a division and/or some or all of our assets to another company or equity or
debt financing.  In the event we are unsuccessful in the near-term in
our efforts to secure additional resources, we may be required to cease
operations entirely. If we raise additional funds by issuing equity securities,
our stockholders will experience dilution of their ownership interests. If we
raise additional funds by issuing debt or other senior securities, then the
rights, preferences and privileges of our existing common stock may be junior to
any rights, preferences or privileges that may be established in connection with
any such issuances.





We cannot
be certain that additional funding will be available on acceptable terms, or at
all. If adequate funds are not available, we may be unable to continue our
operations.





We
may need to continue to implement a reduction in expenses across our
operations.





We need
substantial additional capital to fund our current operations. If we are unable
to secure additional financing on acceptable terms in the near future, we may
need to implement additional cost reduction initiatives, such as further
reductions in the cost of our workforce and the discontinuation of a number of
business initiatives and the possible delisting and deregistration of our
securities under the Exchange Act, to further reduce our rate of cash
utilization and extend our existing cash balances. We believe that these
additional cost reduction initiatives, if undertaken, would provide us with
additional time to continue our pursuit of additional funding sources and also
strategic alternatives. In the event that we are unable to obtain financing on
acceptable terms and reduce our expenses, we may be required to limit or cease
our operations, pursue a plan to sell our operating assets, or otherwise modify
our business strategy, which could materially harm our future business
prospects.





In
order to preserve our limited remaining financial resources, we may decide to
voluntarily delist our securities from trading on the Nasdaq Capital Market and
terminate the registration of our securities under the Securities Exchange Act
of 1934, as amended (“Exchange Act”), and thereafter cease filing reports with
the Securities and Exchange Commission, which could result in you not having a
viable trading market for our securities.





Given the
increasing cost and resource demands of being a public company, we may decide to
voluntarily delist our securities from trading on the Nasdaq Capital Market and
terminate the registration of our securities under the Exchange Act, and
thereafter cease filing reports with the Securities and Exchange
Commission.  We may do so for a period of time until our assets and
stockholder base are sufficient to warrant public trading again. During such
time, there would be a substantial decrease in disclosure by us of our
operations and prospects, and a substantial decrease in the liquidity in our
common stock even though stockholders may still continue to trade our common
stock on the “Pink Sheets”, a centralized electronic quotation service for
over-the-counter securities (so long as market makers demonstrate an interest in
trading in our common stock). However, we can give no assurance that trading in
our stock will continue on the Pink Sheets or on any other securities exchange
or quotation medium. Accordingly, stockholders’ ability to effectuate trades in
our common stock following delisting is likely to be materially adversely
impacted.




22




We
may need to liquidate the Company in a voluntary dissolution under Delaware law
or to seek protection under the provisions of the U.S. Bankruptcy Code, and in
that event, it is unlikely that stockholders would receive any value for their
shares.





Based on
our current operating plan and excluding our ability to raise new capital
through either an equity or debt financing or a sale of a division or business,
we believe that our existing cash resources, combined with projected cash flows
from operations, may not be sufficient to execute our business plan and continue
operations for the next twelve months. We are currently evaluating our strategic
alternatives with respect to all aspects of our business. We cannot assure our
stockholders that any actions that we take would raise or generate sufficient
capital to fully address the uncertainties of our financial position. As a
result, we may be unable to realize value from our assets and discharge our
liabilities in the normal course of business. If we are unable to consummate a
strategic transaction, such as the sale of divisions of our company or some or
all of our assets to another company or an equity or debt financing, we would
likely need to liquidate our company in a voluntary dissolution under Delaware
law or to seek protection under the provisions of the U.S. Bankruptcy Code. In
that event, we or a trustee appointed by the court may be required to liquidate
our assets. In either of these events, we might realize significantly less value
from our assets, than their carrying values on our financial statements. The
funds resulting from the liquidation of our assets would be used first to
satisfy obligations to creditors before any funds would be available to our
stockholders, and any shortfall in the proceeds would directly reduce the
amounts available for distribution, if any, to our creditors and to our
stockholders. In the event we were required to liquidate under Delaware law or
the federal bankruptcy laws, it is highly unlikely that stockholders would
receive any value for their shares.





SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS




This
Quarterly Report on Form 10-Q and, in particular, our Management’s Discussion
and Analysis of Financial Condition and Results of Operations set forth in Part
I—Item 2 contain or incorporate a number of forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Exchange Act including statements regarding:





·
            deliver
      services and products that meet customer demands and generate acceptable
      margins;





·
            increase
      sales volume by attracting new customers, retaining existing customers and
      growing the overall number of customers to minimize a significant portion
      of our revenues being dependent on a limited number of
      customers;





·
            risks
      relating to revenues and backlog under customer contracts, many of which
      can be cancelled on short notice;





·
            our
      ability to manage and meet contractual terms of complex
      projects;





·
            uncertainty
      related to current economic
conditions;





·
            uncertainty
      related to demand for our services and products;·
            our
      ability to raise additional funds to continue
  operations;·
            uncertainty
      related to our effort to meet our working capital requirements and
      scheduled maturities of indebtedness absent
  restructuring;·
            uncertainty
      related to our ability to implement a reduction in our
      expenses;·
            uncertainty
      related to our ability to meet all of the terms and conditions of our debt
      obligations;·
            our
      ability to continue as a going concern; and·
            our
      liquidity.




Any or
all of our forward-looking statements in this Quarterly Report on Form 10-Q may
turn out to be wrong. They can be affected by inaccurate assumptions we might
make or by known or unknown risks and uncertainties. Many factors mentioned in
our discussion in this Quarterly Report on Form 10-Q will be important in
determining future results. Consequently, no forward-looking statement can be
guaranteed. Actual future results may vary materially.




23




Without
limiting the foregoing, the words “believes,” “anticipates,” ”plans,” “expects”
and similar expressions are intended to identify forward-looking statements.
There are a number of factors that could cause actual events or results to
differ materially from those indicated by such forward-looking statements, many
of which are beyond our control, including the factors set forth under “Item 1A.
Risk Factors” of our 2008 Annual Report on Form 10-K, as updated or supplemented
by this Quarterly Report on Form 10-Q. In addition, the forward-looking
statements contained herein represent our estimate only as of the date of this
filing and should not be relied upon as representing our estimate as of any
subsequent date. While we may elect to update these forward-looking statements
at some point in the future, we specifically disclaim any obligation to do so to reflect actual results, changes
in assumptions or changes in other factors affecting such forward-looking
statements.





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




Not
applicable.





Item
3. Defaults upon Senior Securities.





Not
applicable.





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




At the
Company’s 2009 Annual Meeting of Stockholders held on June 5, 2009, the
stockholders of the Company re-elected the following persons as Class I
directors of the Company to serve until the 2012 Annual Meeting of Stockholders
and until their successors are duly elected and qualified: Gerard J. Gallagher,
Asa Hutchinson and David J. Mitchell.





The
results of the voting were as follows:




Votes
      For
            
            
            Votes
              WithheldGerard
      J. Gallagher
            
            
            10,597,419
            
            
            
            216,960Asa
      Hutchinson
            
            
            9,546,769
            
            
            
            1,267,610David
      J. Mitchell
            
            
            9,506,769
            
            
            
            1,307,610




Currently,
Gerard J. Gallagher, Asa Hutchinson, John Morton, III, Thomas P. Rosato, Harvey
L. Weiss and William L. Jews serve as members of the Board of Directors of the
Company.





In
addition, at the Annual Meeting, the stockholders ratified the Board’s approval
of Grant Thornton LLP as the Company’s independent registered public accounting
firm for the year ending December 31, 2009, with 10,774,334 votes for
ratification, zero votes against ratification, and 40,045 abstentions and
zero broker non-votes.





Item
5. Other Information.




Not
applicable.





Item
6. Exhibits.




31.1*
            Certification
      of Fortress International Group, Inc. Chief Executive Officer pursuant to
      Section 302 of the Sarbanes-Oxley Act of 2002.31.2*
            Certification
      of Fortress International Group, Inc. Chief Financial Officer pursuant to
      Section 302 of the Sarbanes-Oxley Act of 2002.32.1‡
            Certification
      of Fortress International Group, Inc. Chief Executive Officer and Chief
      Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.







* Filed
herewith.


‡
Furnished herewith.




24


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. RosatoThomas
      P. RosatoChief
      Executive Officer (Principal Executive Office)




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




25