** **

**FORM 10-Q**

 

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

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

 

**For the quarterly period ended September 30, 2007**

 

**OR**

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

 

**For the transition periodfrom            to**

 

**Commission file number 0-23585.**

 

 

**SM&A**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                    | ** ** | **33-0080929**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State  or other jurisdiction of incorporation or organization) |       | (I.R.S.  Employer Identification No.) |
|                                                            |       |                                  |
| **4695 MacArthur Court, 8th Floor,  Newport Beach, California** | ** ** | **92660**                             |
| (Address  of principal executive offices)                       |       | (Zip  Code)                           |

 

**(949) 975-1550**

(Registrant’s telephone number, including area code)

 

**Not applicable**

(Former name, former address and former fiscal year, if changed sincelast report)

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

Yes x     No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of acceleratedfiler and large accelerated filer in Rule 12b-2 of the Exchange Act. (Checkone):

 

Large accelerated filer o     Acceleratedfiler x     Non-acceleratedfiler o

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).

 

Yes o     No x

 

Theregistrant had 18,949,575 shares of common stock, $0.0001 par value,outstanding as of September 30, 2007

 

 

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**SM&A**

 

**INDEX**

 
| **PART I. FINANCIAL INFORMATION**                           |
|-------------------------------------------------------------|
|                                                        |   |
| Cautionary Statement Related  to Forward Looking Statements |
|                                                        |   |
| How to Obtain SM&A SEC Filings                          |
|                                                        |   |
| Item 1.                                                     | Financial Statements: |
|                                                        | Condensed Consolidated  Balance Sheets |
|                                                        | Condensed Consolidated  Statements of Income |
|                                                        | Condensed Consolidated  Statements of Cash Flows |
|                                                        | Notes to Condensed  Consolidated Financial Statements |
| Item 2.                                                     | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
| Item 3.                                                     | Quantitative  and Qualitative Disclosures About Market Risk |
| Item 4.                                                     | Controls and  Procedures |
|                                                        |   |
| **PART II. OTHER  INFORMATION**                             |
|                                                        |   |
| Item 1.                                                     | Legal Proceedings |
| Item 2.                                                     | Unregistered  Sales of Equity Securities and Use of Proceeds |
| Item 3.                                                     | Defaults Upon  Senior Securities |
| Item 4.                                                     | Submission of  Matters to a Vote of Security Holders |
| Item 5.                                                     | Other Information |
| Item 6.                                                     | Exhibits |
|                                                        |   |
| **Signatures**                                              |

 

2

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**CAUTIONARY STATEMENT RELATED TOFORWARD LOOKING STATEMENTS**

 

*ThisQuarterly Report on Form 10-Q includes certain forward-looking statements asdefined within Section 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended, relating torevenue, revenue composition, earnings, projected plans, performance, contractprocurement, demand trends, future expense levels, trends in average headcountand gross margins, and the level of expected capital expenditures. Suchforward-looking statements are based on the beliefs of, estimates made by, andinformation currently available to SM&A management and are subject tocertain risks, uncertainties and assumptions. Any statements contained herein(including without limitation statements to the effect that the Company ormanagement “estimates,” “expects,” “anticipates,” “plans,” “believes,” “projects,”“continues,” “may,” “will,” “could,” or “would” or statements concerning “potential”or “opportunity” or variations thereof or comparable terminology or thenegative thereof) that are not statements of historical fact should beconstrued as forward-looking statements. The actual results of SM&A mayvary materially from those expected or anticipated in these forward-looking statements.The realization of such forward-looking statements may be impacted by certainimportant unanticipated factors including those discussed in “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,” atpages 12-15. Because of these and other factors that may affect SM&A’soperating results, past performance should not be considered as an indicator offuture performance, and investors should not use historical results toanticipate results or trends in future periods. The Company undertakes noobligation to publicly release the results of any revisions to theseforward-looking statements that may be made to reflect events or circumstancesafter the date hereof or to reflect the occurrence of unanticipated events. Readersshould carefully review the risk factors described in this and other documentsthat SM&A files from time to time with the Securities and ExchangeCommission (“SEC”), including subsequent Current Reports on Form 8-K, QuarterlyReports on Form 10-Q and Annual Reports on Form 10-K.*

 

**HOW TO OBTAIN SM&A SECFILINGS**

 

*All reports filed by SM&A with the SEC areavailable free of charge via EDGAR through the SEC website at www.sec.gov. Inaddition, the public may read and copy materials filed by the Company with theSEC at the SEC’s public reference room located at 450 Fifth St., N.W.,Washington, D.C. 20549. SM&A also provides copies of its Forms 8-K, 10-K,10-Q, Proxy and Annual Report at no charge to investors upon request and makeselectronic copies of its most recently filed reports available through itswebsite at www.smawins.com as soon as reasonably practicable after filing suchmaterial with the SEC.*

 

3

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**SM&A**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

(in thousands)

 
| ** **                                        | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|---------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                        | ** ** | **(unaudited)**              | ** ** | ** **                  | ** ** |
| **ASSETS**                                        |       |                         |       |                        |       |
| Current assets:                                   |       |                         |       |                        |       |
| Cash and cash equivalents                         |       | $                            | 2,776      |                        | $          | 15,143 |   |
| Investments                                       |       | 6,520                        |       | —                      |       |
| Accounts receivable, net                          |       | 24,849                       |       | 15,759                      |       |
| Prepaid expenses and other current assets         |       | 1,341                        |       | 871                         |       |
| Total current assets                              |       | 35,486                       |       | 31,773                      |       |
| Fixed assets, net                                 |       | 3,644                        |       | 3,446                       |       |
| Goodwill                                          |       | 6,183                        |       | —                      |       |
| Intangibles, net                                  |       | 2,003                        |       | —                      |       |
| Other assets                                      |       | 890                          |       | 407                         |       |
|                                              |       | $                            | 48,206     |                        | $          | 35,626 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**    | ** ** | ** **                   | ** ** | ** **                  | ** ** |
|                                              |       |                         |       |                        |       |
| Current liabilities:                              |       |                         |       |                        |       |
| Accounts payable                                  |       | $                            | 1,836      |                        | $          | 1,232 |   |
| Accrued compensation and related benefits         |       | 4,516                        |       | 2,112                       |       |
| Other current liabilities                         |       | 70                           |       | 42                          |       |
| Total current liabilities                         |       | 6,422                        |       | 3,386                       |       |
| Other liabilities                                 |       | 906                          |       | 644                         |       |
| Total liabilities                                 |       | 7,328                        |       | 4,030                       |       |
|                                              |       |                         |       |                        |       |
| Commitments, contingencies and subsequent  events |       |                         |       |                        |       |
|                                              |       |                         |       |                        |       |
| Stockholders’ equity:                        |       |                         |       |                        |       |
| Preferred stock                                   |       | —                       |       | —                      |       |
| Common stock                                      |       | 2                            |       | 2                           |       |
| Additional paid-in capital                        |       | 44,728                       |       | 39,893                      |       |
| Treasury stock                                    |       | (1,506                       | )          | (664                        | )          |
| Accumulated deficit                               |       | (2,346                       | )          | (7,635                      | )          |
| Total stockholders’ equity                   |       | 40,878                       |       | 31,596                      |       |
|                                              |       | $                            | 48,206     |                        | $          | 35,626 |   |

 

See accompanying notes to condensed consolidated financial statements

 

4

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**SM&A**

**CONDENSED CONSOLIDATED STATEMENTSOF INCOME**

(in thousands, except per share data)

(UNAUDITED)

 
| ** **                                        | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                        | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                        | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                           |       | $                                                    | 25,059     |                                                | $          | 17,025 |   | $ | 74,251 |   | $ | 53,017 |   |
| Cost of revenue                                   |       | 14,941                                               |       | 10,645                                              |       | 45,021 |   | 31,487 |   |
| Gross margin                                      |       | 10,118                                               |       | 6,380                                               |       | 29,230 |   | 21,530 |   |
|                                              |       |                                                 |       |                                                |       |   |   |   |   |
| Selling, general and administrative  expenses     |       | 7,095                                                |       | 5,859                                               |       | 20,620 |   | 17,272 |   |
| Operating income                                  |       | 3,023                                                |       | 521                                                 |       | 8,610 |   | 4,258 |   |
|                                              |       |                                                 |       |                                                |       |   |   |   |   |
| Interest income, net                              |       | 80                                                   |       | 158                                                 |       | 301 |   | 602 |   |
| Income before income taxes                        |       | 3,103                                                |       | 679                                                 |       | 8,911 |   | 4,860 |   |
|                                              |       |                                                 |       |                                                |       |   |   |   |   |
| Income tax expense                                |       | 1,268                                                |       | 261                                                 |       | 3,622 |   | 1,983 |   |
|                                              |       |                                                 |       |                                                |       |   |   |   |   |
| Net income                                        |       | $                                                    | 1,835      |                                                | $          | 418 |   | $ | 5,289 |   | $ | 2,877 |   |
|                                              |       |                                                 |       |                                                |       |   |   |   |   |
| Net income per share:                             |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                             |       | $                                                    | 0.10       |                                                | $          | 0.02 |   | $ | 0.28 |   | $ | 0.15 |   |
| Diluted                                           |       | $                                                    | 0.10       |                                                | $          | 0.02 |   | $ | 0.28 |   | $ | 0.15 |   |
|                                              |       |                                                 |       |                                                |       |   |   |   |   |
| Shares used in calculating net income per  share: |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                             |       | 18,874                                               |       | 18,730                                              |       | 18,758 |   | 19,235 |   |
| Diluted                                           |       | 19,021                                               |       | 18,910                                              |       | 18,930 |   | 19,419 |   |

 

See accompanying notes to condensed consolidated financial statements

 

5

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**SM&A**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

(in thousands)

(UNAUDITED)

 
| ** **                                                                                   | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| ** **                                                                                   | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                    | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Net income                                                                                   |       | $                                                   | 5,289      |   | $ | 2,877 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |       |                                                |       |   |   |
| Depreciation and amortization                                                                |       | 907                                                 |       | 639 |   |
| Stock-based compensation expense                                                             |       | 1,335                                               |       | 942 |   |
| Excess tax benefits from stock-based  compensation                                           |       | (118                                                | )          | — |   |
| Deferred income taxes                                                                        |       | (291                                                | )          | (202 | ) |
| Changes in operating assets and  liabilities, net of business acquisitions:                  |       |                                                |       |   |   |
| Accounts receivable                                                                          |       | (6,272                                              | )          | (6,280 | ) |
| Prepaid expenses and other current assets                                                    |       | (451                                                | )          | 339 |   |
| Accounts payable                                                                             |       | (847                                                | )          | 237 |   |
| Accrued compensation and related benefits                                                    |       | 1,696                                               |       | 935 |   |
| Other liabilities                                                                            |       | 386                                                 |       | 15 |   |
| Net cash provided by (used in) operating  activities                                         |       | 1,634                                               |       | (498 | ) |
|                                                                                         |       |                                                |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                    | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Purchases of fixed assets                                                                    |       | (944                                                | )          | (1,281 | ) |
| Proceeds from the sale of fixed assets                                                       |       | 18                                                  |       | — |   |
| Purchases of marketable securities                                                           |       | (16,520                                             | )          | — |   |
| Proceeds from sale of marketable securities                                                  |       | 10,000                                              |       | 4,950 |   |
| Cost of acquisitions, net of cash acquired                                                   |       | (6,455                                              | )          | — |   |
| Net cash (used in) provided by investing  activities                                         |       | (13,901                                             | )          | 3,669 |   |
|                                                                                         |       |                                                |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                    | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Proceeds from issuance of common stock                                                       |       | 666                                                 |       | 409 |   |
| Excess tax benefits from stock-based  compensation                                           |       | 118                                                 |       | 3 |   |
| Payment for repurchase of shares                                                             |       | (842                                                | )          | (7,262 | ) |
| Net cash used in financing activities                                                        |       | (58                                                 | )          | (6,850 | ) |
|                                                                                         |       |                                                |       |   |   |
| Net decrease in cash and cash equivalents  from continued operations                         |       | (12,325                                             | )          | (3,679 | ) |
| Net cash used in discontinued operations by  operating activities                            |       | (42                                                 | )          | (266 | ) |
| Net decrease in cash and cash equivalents                                                    |       | (12,367                                             | )          | (3,945 | ) |
| Cash and cash equivalents at beginning of  period                                            |       | 15,143                                              |       | 19,103 |   |
| Cash and cash equivalents at end of period                                                   |       | $                                                   | 2,776      |   | $ | 15,158 |   |
|                                                                                         |       |                                                |       |   |   |
| **SUPPLEMENTAL INFORMATION—CASH PAID FOR:**                                             |       |                                                |       |   |   |
| Income taxes                                                                                 |       | $                                                   | 4,057      |   | $ | 1,727 |   |
| Interest                                                                                     |       | $                                                   | 10         |   | $ | — |   |
|                                                                                         |       |                                                |       |   |   |
| **SUPPLEMENTAL DISCLOSURE OF NON-CASH  TRANSACTIONS:**                                       |       |                                                |       |   |   |
| Common stock issued for acquisitions                                                         |       | $                                                   | 2,716      |   | $ | — |   |
| Common stock issued to an employee                                                           |       | $                                                   | 50         |   | $ | — |   |
| Assets acquired under a capital lease                                                        |       | $                                                   | 160        |   | $ | — |   |

 

See accompanying notes to condensed consolidated financial statements

 

6

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**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**For the Three and Nine Months Ended September 30, 2007and 2006**

(UNAUDITED)

 

**Note 1.   Basis of Presentation and SignificantAccounting Policies**

 

The condensed consolidatedfinancial statements included herein are unaudited; such financial statementscontain all normal recurring accruals and adjustments that, in the opinion ofmanagement, are necessary to present fairly the consolidated financial positionof SM&A at September 30, 2007, the consolidated results of operations forthe three and nine months ended September 30, 2007 and 2006, and cash flows forthe nine months ended September 30, 2007 and 2006. Comprehensive income isequivalent to net income for the three and nine month periods ended September30, 2007 and 2006, respectively.

 

Accounting measurements atinterim dates inherently involve greater reliance on estimates than at year-end.The results of operations for the three and nine months ended September 30,2007 are not necessarily indicative of the results to be expected for the fullfiscal year.

 

The accompanying unauditedcondensed consolidated financial statements do not include footnotes andcertain financial presentations normally required under generally acceptedaccounting principles. Therefore, these financial statements should be read inconjunction with our audited consolidated financial statements and notesthereto for the year ended December 31, 2006, included in our Annual Report onForm 10-K/A filed with the Securities and Exchange Commission (“SEC”) on March16, 2007.

 

***Significant Accounting Policies***

 

*Goodwill.*Goodwillrepresents the excess of purchase consideration over the fair value of assetsacquired less liabilities assumed in a business acquisition. The Companyaccounts for its goodwill in accordance with the provisions of Statement ofFinancial Accounting Standards No. 142, “*Goodwill andOther Intangible Assets*.” Under these rules, goodwill and otherintangible assets deemed to have indefinite useful lives are not amortized butare subject to impairment tests at least annually, or more frequently ifcircumstances occur that indicate impairment may have occurred.

 

#### **Note 2.   Net Income PerShare**

####  

The following table illustrates the number of sharesused in the computation of basic and diluted net income per share (inthousands):

 
| ** **                                                                                     | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                     | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| Denominator for basic income per share:  weighted-average shares outstanding during the period |       | 18,874                                               |       | 18,730                                              |       | 18,758 |   | 19,235 |   |
| Incremental shares attributable to dilutive  outstanding stock options                         |       | 147                                                  |       | 180                                                 |       | 172 |   | 184 |   |
| Denominator for diluted income per share                                                       |       | 19,021                                               |       | 18,910                                              |       | 18,930 |   | 19,419 |   |

 

Anti-dilutiveshares excluded from the foregoing reconciliation are 1,657,628, 1,384,952,1,534,628 and 1,320,250 for the three and nine months ended September 30, 2007and 2006, respectively.

 

**Note 3.   Investmentsin Marketable Securities**

 

During the nine months ended September 30, 2007, theCompany purchased short-term state issued securities for $16.5 million and sold$10.0 million of its marketable securities for investment activities.  Therewere no realized gains or losses upon disposal.  For the three and ninemonths ended September 30, 2007 and 2006, our interest income on theseinvestments was approximately $69,000 and $18,000 and $144,000 and $97,000,respectively.

 

7

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#### **Note 4.   Stock-BasedCompensation**

####  

The fair value of each stock option is estimated onthe date of grant using the Black-Scholes option pricing model with thefollowing weighted-average assumptions for the three and nine months endedSeptember 30, 2007 and 2006, respectively:

 
| ** **                                      | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                      | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| Stock price volatility                          |       | 42.00                                                | %          | 77.75                                               | %          | 59.02 | % | 77.14 | % |
| Risk-free interest rate                         |       | 4.40                                                 | %          | 4.66                                                | %          | 4.65 | % | 4.86 | % |
| Expected life (in years)                        |       | 3.58                                                 |       | 3.21                                                |       | 3.73 |   | 3.13 |   |
| Forfeiture rate                                 |       | 10.45                                                | %          | 11.81                                               | %          | 9.84 | % | 12.19 | % |
| Stock dividend yield                            |       | N/A                                                  |       | N/A                                                 |       | N/A |   | N/A |   |
| Weighted-average fair value per option  granted |       | $                                                    | 2.58       |                                                | $          | 3.50 |   | $ | 3.11 |   | $ | 4.20 |   |
|                                                 |            |                                                      |            |                                                     |            |  |  |  |  |  |  |  |  |

 

Thefollowing table summarizes stock option activity for the nine months endedSeptember 30, 2007:

 
| ** **                        | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Weighted-  Average  Fair Value of  Options Granted** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-----------------------------------|------------|------------|------------|---------------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at December 31, 2006  |       | 1,851,787  |       | $                                           | 7.43       |                                                                  |       |                            |       |   |
| Granted                           |       | 962,610    |       | 6.65                                        |       | $                                                                     | 3.11       |                            |       |   |
| Exercised                         |       | (103,137   | )          | 2.66                                        |       |                                                                  |       |                            |       |
| Cancelled, Forfeited or Expired   |       | (259,250   | )          | 7.26                                        |       |                                                                  |       |                            |       |
| Outstanding at September 30, 2007 |       | 2,452,010  |       | $                                           | 7.35       |                                                                  |       |                            | $          | 18,010,938 |   |
| Exercisable at September 30, 2007 |       | 1,248,710  |       | $                                           | 7.78       |                                                                  |       |                            | $          | 9,714,112 |   |
|                                   |            |            |            |                                             |            |                                                                       |            |                                 |            |  |  |  |

 

Thetotal intrinsic value of options exercised during the nine months endedSeptember 30, 2007 and 2006 was $463,000 and $38,000, respectively.

 

TheCompany recorded $436,000 and $313,000 and $1.3 million and $942,000 instock-based compensation expense before income tax benefit for stock options inits results of operations for the three and nine months ended September 30,2007 and 2006, respectively. As of September 30, 2007, there was $3.5 millionof total unrecognized compensation cost related to unvested awards which willbe amortized to expense over the weighted-average period of 4.0 years.

 

TheCompany received $274,000 and $10,000 in cash from option exercises during thenine months ended September 30, 2007 and 2006, respectively. The Company alsoreceived $390,000 and $399,000 from the purchase of shares under the ESPPduring the nine months ended September 30, 2007 and 2006, respectively. Uponthe exercise of options and stock purchase shares granted under the ESPP, theCompany issues new common stock from its authorized shares.

 

**Note 5.   Acquisitions**

 

***Project Planning, Incorporated.***

 

OnFebruary 9, 2007, the Company purchased Project Planning, Incorporated (“PPI”),a provider of consulting, education, and implementation and support servicesfor enterprise project management solutions based in Andover, Massachusetts. Theacquisition was made pursuant to a Stock Purchase Agreement dated February 9,2007. The aggregate purchase price could be up to $15.0 million, which consistsof $13.0 million in cash and 333,333 shares of common stock of the Companyvalued at $6.64 per share. At closing, the Company paid $4.5 million of thecash portion of the purchase price and delivered to the seller 333,333 sharesof the Company’s common stock. The Company could pay up to an additional $9.5million of the remaining cash portion of the purchase price over a three yearperiod upon satisfaction of certain revenue goals.

 

Theacquisition was accounted for using the purchase method of accounting wherebythe total purchase price, including transaction expenses, was allocated totangible and intangible assets acquired based on estimated fair market values,with the remainder classified as goodwill. The estimated fair market valueswere obtained by an independent third party valuation provider. Net tangibleassets were valued at their respective historical carrying amounts as theseapproximate fair values.

 

8

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TheCompany acquired identifiable intangible assets of $1.2 million.  Of theidentifiable intangibles acquired, $1.1 million has been assigned to customerrelationships and $30,000 to non-compete agreements. The acquired intangibleshave been assigned definite lives and are subject to amortization, as describedin the table below.

 
| **Intangible Asset Category** | ** ** | **Amortization Period** |
|-------------------------------|------------|-------------------------|
| Customer  relationships       |       | 6 years                 |
| Non-compete  agreements       |       | 3 years                 |

 

Thefollowing details the allocation of the purchase price for the acquisition:

 
| Cash and cash equivalents         |   | $     | 345    |   |
|-----------------------------------|--------|-------|--------|--------|
| Accounts receivable, no allowance |   | 1,786 |   |
| Fixed assets, net                 |   | 41    |   |
| Other assets                      |   | 144   |   |
| Assumed liabilities               |   | (708  | )      |
| Customer relationships            |   | 1,130 |   |
| Non-compete agreements            |   | 30    |   |
| Goodwill                          |   | 4,288 |   |
|                              |   | $     | 7,056  |   |

 

Thefollowing represents a summary of the purchase price consideration:

 
| Cash                                                          |   | $     | 4,465  |   |
|---------------------------------------------------------------|--------|-------|--------|--------|
| Issuance of common stock (333,333 shares at  $6.64 per share) |   | 2,213 |   |
| Other direct acquisition costs                                |   | 378   |   |
|                                                          |   | $     | 7,056  |   |

 

***Performance Management Associates, Inc.***

 

OnSeptember 14, 2007, the Company acquired Performance Management Associates,Inc. (“PMA”), an Earned Value Management System (“EVMS”) consulting provider. EVMSis an important project management technique that incorporates cost, schedulingand technical performance measurements to provide an outlook on how a projectis progressing and to point out potential issues. The acquisition was madepursuant to a Stock Purchase Agreement dated September 14, 2007. The aggregatepurchase price could be up to $5.0 million, which consists of $4.5 million incash and 80,671 shares of common stock of the Company valued at $6.24 per share.At closing, the Company paid approximately $2.0 million of the $2.5 millioncash portion of the purchase price holding back $500,000, which is included inaccounts payable, and delivered to the seller 80,671 shares of the Company’scommon stock. The Company could pay up to an additional $2.0 million of theremaining cash portion of the purchase price over a three year period uponsatisfaction of certain retention, revenue and profit targets.

 

Theacquisition was accounted for using the purchase method of accounting wherebythe total purchase price, including transaction expenses, was allocated totangible and intangible assets acquired based on estimated fair market values,with the remainder classified as goodwill. The estimated fair market valueswere obtained by an independent third party valuation provider. Net tangibleassets were valued at their respective historical carrying amounts as theseapproximate fair values.

 

Aspart of the purchase, the Company acquired identifiable intangible assets of$981,000.  Of the identifiable intangibles acquired, $962,000 has beenassigned to customer relationships and $19,000 to non-compete agreements. Theacquired intangibles have been assigned definite lives and are subject toamortization, as described in the table below.

 
| **Intangible Asset Category** | ** ** | **Amortization Period** |
|-------------------------------|------------|-------------------------|
| Customer  relationships       |       | 4 years                 |
| Non-compete  agreements       |       | 3 years                 |

 

9

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Thefollowing details the preliminary allocation of the purchase price for theacquisition:

 
| Cash and cash equivalents         |   | $      | 720    |   |
|-----------------------------------|--------|--------|--------|--------|
| Accounts receivable, no allowance |   | 1,032  |   |
| Other assets                      |   | 13     |   |
| Assumed liabilities               |   | (1,461 | )      |
| Customer relationships            |   | 962    |   |
| Non-compete agreements            |   | 19     |   |
| Goodwill                          |   | 1,895  |   |
|                              |   | $      | 3,180  |   |

 

Thefollowing represents a preliminary summary of the purchase price consideration:

 
| Cash                                                         |   | $   | 2,405  |   |
|--------------------------------------------------------------|--------|-----|--------|--------|
| Issuance of common stock (80,671 shares at  $6.24 per share) |   | 503 |   |
| Other direct acquisition costs                               |   | 272 |   |
|                                                         |   | $   | 3,180  |   |

 

***Unaudited Pro Forma Financial Information***

 

Thepro forma combined results set forth below are not necessarily indicative ofthe results that actually would have occurred if the acquisitions of PPI andPMA had been completed as of the beginning of 2006 or 2007, nor are theynecessarily indicative of future consolidated results. The following presentsthe unaudited pro forma combined results of operations of the Company with theacquisitions (in thousands, except for share information).

 
| ** **                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                             | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| Revenue                                |       | $                                                    | 25,973     |                                                | $          | 20,273 |   | $ | 78,579 |   | $ | 61,869 |   |
| Net income                             |       | $                                                    | 1,824      |                                                | $          | 974 |   | $ | 5,256 |   | $ | 4,426 |   |
| Pro forma net income per common share: |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                  |       | $                                                    | 0.10       |                                                | $          | 0.05 |   | $ | 0.28 |   | $ | 0.23 |   |
| Diluted                                |       | $                                                    | 0.10       |                                                | $          | 0.05 |   | $ | 0.28 |   | $ | 0.22 |   |

 

**Note 6.   IntangibleAssets and Goodwill**

 

***Intangible Assets***

 

Intangibleassets consist of amounts related to the 2007 acquisitions, consisting of PPIand PMA. Intangible assets at September 30, 2007 consisted of the following (inthousands):

 
| ** **                     | ** ** | **Amount** | ** ** | **Weighted  Average  Amortization  Period** | ** ** |
|--------------------------------|------------|------------|------------|---------------------------------------------|------------|
| Client relationships           |       | $          | 2,092      |                                        | 4.9        |   |
| Non-compete agreements         |       | 49         |       | 3.0                                         |       |
|                           |       | 2,141      |       |                                        |       |
| Less: accumulated amortization |       | (138       | )          |                                        |       |
| Intangible assets, net         |       | $          | 2,003      |                                        |       |   |

 

10

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Thetotal expected future amortization related to intangible assets are as followsfor the years ended December 31:

 
| **(in thousands)** | ** ** | **Total** | ** ** | **Non-Compete  Agreements** | ** ** | **Customer  Relationships** | ** ** |
|-------------------------|------------|-----------|------------|-----------------------------|------------|-----------------------------|------------|
| 2007                    |       | $         | 112        |                        | $          | 5                           |       | $ | 107 |   |
| 2008                    |       | 445       |       | 16                          |       | 429                         |       |
| 2009                    |       | 445       |       | 16                          |       | 429                         |       |
| 2010                    |       | 434       |       | 5                           |       | 429                         |       |
| 2011                    |       | 359       |       | —                      |       | 359                         |       |
| Thereafter              |       | 208       |       | —                      |       | 208                         |       |
| Totals                  |       | $         | 2,003      |                        | $          | 42                          |       | $ | 1,961 |   |

 

TheCompany recorded amortization expense related to the acquired amortizableintangibles of $61,000 and $138,000 during the three and nine months endedSeptember 30, 2007, respectively. The Company had no amortizable intangibles in2006.

 

***Goodwill***

 

Asummary of goodwill as of September 30, 2007 is as follows (in thousands):

 
| ** **                         | ** ** | **Total** | ** ** |
|------------------------------------|------------|-----------|------------|
| Balance as of January 1, 2007 |       | $         | —     |   |
| Acquisition of PPI                 |       | 4,288     |       |
| Acquisition of PMA                 |       | 1,895     |       |
| Balance as of September 30, 2007   |       | $         | 6,183      |   |

 

**Note 7.   CreditFacility**

 

The Company has a revolvingcredit agreement which allows for borrowings up to $10.0 million at the primerate minus one half of one percent (-0.50%) per annum or LIBOR plus two and onequarter percent (2.25%) per annum. The revolving credit agreement is renewableannually on April 30th of each year. Borrowings under the revolvingcredit agreement are unsecured. The agreement requires the Company to comply withcertain financial covenants pertaining to its tangible net worth, ratio oftotal liabilities to tangible net worth, and ratio of current assets to currentliabilities (as defined in the agreement). The agreement also contains certainnegative covenants which, among other things, restrict the Company’s ability toincur additional indebtedness of more than $1.0 million in excess of the $10.0million limit set forth in the credit agreement and make capital expendituresin excess of $3.0 million without the prior written approval of the lender. AtSeptember 30, 2007, the Company was in compliance with its covenants and had nooutstanding borrowings under the line of credit. The bank had issued a letterof credit for $64,000 and $9.9 million was available.

 

11

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**Note 8.   Stockholders’Equity**

 

TheCompany’s Board of Directors (“Board”) has previously authorized a plan torepurchase up to $30.0 million of the Company’s common stock. For the ninemonths ended September 30, 2007 and 2006, the Company repurchased 139,417shares at a total cost of $842,000 and 1,153,900 shares at a total cost of $7.3million, respectively. Since the inception of the share repurchase plan, theCompany has repurchased 3,354,860 shares at a total cost of$24.2 million. The Company intends torepurchase shares from time to time, at prevailing prices, in the open market. Theshare repurchase plan may be suspended or discontinued at any time. Sharesrepurchased under the plan prior to our reincorporation in the state ofDelaware were cancelled. After the date of reincorporation (November 30, 2006),the shares are included in treasury shares.

 

Aroll-forward of the Company’s stockholders equity for the nine months endedSeptember 30, 2007 is presented below (in thousands, except share data):

 
| ** **                                         | ** ** | **Nine Months Ended September 30, 2007** | ** ** |
|----------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                         | ** ** | **Common  Shares**                                                | ** ** | **Common  Stock and  Additional  Paid-In  Capital** | ** ** | **Treasury  Stock** | ** ** | **Accumulated  Deficit** | ** ** | **Stockholders’  Equity** | ** ** |
| Balances at December 31, 2006                      |       | 18,502,827                                                        |       | $ | 39,895 |   | $ | (664 | ) | $ | (7,635 | ) | $ | 31,596 |   |
| Proceeds from the issuance of common stock         |       | 172,161                                                           |       | 716 |   | — |   | — |   | 716 |   |
| Excess tax benefits from stock-based  compensation |       | —                                                            |       | 118 |   | — |   | — |   | 118 |   |
| Stock-based compensation expense                   |       | —                                                            |       | 1,285 |   | — |   | — |   | 1,285 |   |
| Repurchased treasury shares                        |       | (139,417                                                          | )          | — |   | (842 | ) | — |   | (842 | ) |
| Common stock issued for acquisitions               |       | 414,004                                                           |       | 2,716 |   | — |   | — |   | 2,716 |   |
| Net income                                         |       | —                                                            |       | — |   | — |   | 5,289 |   | 5,289 |   |
| Balances at December 31, 2006                      |       | 18,949,575                                                        |       | $ | 44,730 |   | $ | (1,506 | ) | $ | (2,346 | ) | $ | 40,878 |   |

 

**Note 9.   Commitment andContingencies**

 

TheCompany entered into employment agreements with its Chief Executive Officer andits President and Chief Operating Officer and into benefit agreements withother executives of the Company (collectively “Agreements”). Under the terms ofeach of the Agreements, the Company may be obligated to pay a severance paymentranging from six months to one year of the respective employee’s base salary,depending on the date of termination, if the employment is terminated by theCompany without cause. In addition, the Agreements have a change of controlprovisions that may require the Company to pay up to twelve months of currentannual base salary and up to eighteen months of health and life insurancebenefits.

 

**Note 10.  SubsequentEvent**

 

OnNovember 5, 2007, the Company announced that Mr. Handy, the Company’s SeniorVice President, Chief Financial Officer and Corporate Secretary has put in hisresignation from the Company effective November 9, 2007. The Company is activelyseeking a replacement and has engaged a national retained search firm for help.In the interim, Dan Hart, Vice President and Controller, will assume the dutiesof Mr. Handy.

 

12

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

 

SM&A is the world’sleading provider of competition management (business capture and proposaldevelopment) services, and a leading provider of program services (post-awardrisk mitigation and profit maximizing) services. Under these two service lines,our approximately 350 employees and consultants provide strategy, proposalmanagement, program management, systems engineering, program planning, andother high-value technical support to major industrial customers in thedefense, homeland security, aerospace, information technology, and engineeringsectors. Since 1982, we have managed more than 1,000 proposals worth more than$340 billion for our clients and have achieved an 85% win rate on awardedcontracts.

 

**Results of Operations**

 

## **Three Months Ended September 30, 2007 Compared toThree Months Ended September 30, 2006**

##  

Thefollowing table sets forth certain historical operating results (in millions):

 
| ** **                                    | ** ** | **Three Months Ended September 30,** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                    | ** ** | **2007**                                                 | ** ** | **2006** | ** ** | **Change** | ** ** |
| ** **                                    | ** ** | **$**                                                    | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| Revenue                                       |       | 25.1                                                     |       | 100.0 |   | 17.0 |   | 100.0 |   | 8.1 |   | 47.6 |   |
| Cost of revenue                               |       | 15.0                                                     |       | 59.6 |   | 10.6 |   | 62.4 |   | 4.4 |   | 41.5 |   |
| Gross margin                                  |       | 10.1                                                     |       | 40.4 |   | 6.4 |   | 37.6 |   | 3.7 |   | 57.8 |   |
| Selling, general and administrative  expenses |       | 7.1                                                      |       | 28.3 |   | 5.9 |   | 34.7 |   | 1.2 |   | 20.3 |   |
| Operating income                              |       | 3.0                                                      |       | 12.0 |   | 0.5 |   | 2.9 |   | 2.5 |   | 500.0 |   |
| Interest income, net                          |       | 0.1                                                      |       | 0.4 |   | 0.2 |   | 1.2 |   | (0.1 | ) | (50.0 | ) |
| Income tax expense                            |       | 1.3                                                      |       | 5.2 |   | 0.3 |   | 1.8 |   | 1.0 |   | 333.3 |   |
| Net income                                    |       | 1.8                                                      |       | 7.2 |   | 0.4 |   | 2.4 |   | 1.4 |   | 350.0 |   |

 

*Revenue.*Revenueincreased $8.1 million, or 47.6%, to $25.1 million for the three months endedSeptember 30, 2007 compared to $17.0 million for the same period of the prioryear. The acquisitions completed in fiscal 2007 contributed $2.7 million or10.8% of total revenue for the three months ended September 30, 2007. Theincrease in our revenue was realized across all of our service lines and marketverticals. The following table is provided to display our revenue resultscompared to the same period of the prior year.

 
| **For the three months ended September 30,  (in millions)** | ** ** | **2007** | ** ** | **2006** | ** ** | **% Growth** | ** ** |
|------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|-------------------|------------|
| **Revenues by Market Vertical**                                                                |       |     |       |     |       |              |       |
| Aerospace and Defense (A&D)                                                                |       | $        | 18.1       |     | $          | 12.7              |       | 43 | % |
| Non Aerospace and Defense (SIIT)                                                               |       | 7.0      |       | 4.3      |       | 63                | %          |
| Total                                                                                          |       | $        | 25.1       |     | $          | 17.0              |       | 48 | % |
|                                                                                           |       |     |       |     |       |              |       |
| **Revenues by Service Line**                                                                   |       |     |       |     |       |              |       |
| Competition Management                                                                         |       | $        | 13.6       |     | $          | 9.8               |       | 39 | % |
| Program Services                                                                               |       | 11.5     |       | 7.2      |       | 60                | %          |
| Total                                                                                          |       | $        | 25.1       |     | $          | 17.0              |       | 48 | % |

 

Startingin 2006, our focus on expanding our Program Services offerings led to twoacquisitions in fiscal 2007. These acquisitions, along with our latest solutionofferings, have generated consistent sequential quarterly revenue growth. Ourgrowth has also been generated by our Account Executives’ ability to buildvalued long term relationships with our clients. Our clients repeatedly engageus for our services as they understand how valuable we are in helping them bothwin and execute on their competitively awarded programs.

 

*Gross Margin.*Gross margin increased $3.7 million, or 57.8%, to $10.1 million for the threemonths ended September 30, 2007 compared to $6.4 million for the same period ofthe prior year. The increase in gross margin dollars is due to the increase insales as discussed above and an improvement in our gross margin as a percentageof revenue. As a percentage of revenue, gross margin increased to 40.4% for thethree months ended September 30, 2007 compared to 37.6% for the same period ofthe prior year. The increase was due to an increase in the level of successfees earned and revenue mix. We recorded success fees of $439,000 and $103,000for the three months ended September 30, 2007 and 2006, respectively. We expectour gross margins to be approximately 39.0% to 40.0% for fiscal year 2007.

 

13

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*Selling, General and Administrative Expenses.*Selling,**general andadministrative expenses (“SG&A”) consist principally of salary and benefitcosts for executive, sales and administrative personnel, stock-basedcompensation, depreciation and amortization, training and recruiting,professional services and other general corporate activities.

 

OnJuly 18, 2007, the Board of Directors accepted the resignation of Cynthia A.Davis as Chief Executive Officer and as a Director, and the Company and Ms.Davis entered into a separation agreement including a mutual release of claimsand a payment of $475,000 by the Company. Cathy L. McCarthy was elected asPresident and Chief Executive Officer following the resignation of Ms. Davisand entered into an employment agreement with the Company, and was granted200,000 stock options vesting quarterly over four years. Ms. McCarthy was alsoelected to the Board of Directors. The expense associated with this transition,which includes a payment of $475,000 to Ms. Davis and legal and professionalfees of approximately $125,000, are included in SG&A for the three monthsended September 30, 2007.

 

Thefollowing table is provided to display our SG&A results segregating theseareas of cost for comparison purposes:

 
| **For the three months ended September 30,  (in millions)** | ** ** | **2007** | ** ** | **2006** | ** ** | **% Growth** | ** ** |
|------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|-------------------|------------|
| SG&A before stock based compensation,  acquisitions, and management transition expenses    |       | $        | 5.6        |     | $          | 5.6               |       | 0 | % |
| Stock based compensation expense                                                               |       | 0.4      |       | 0.3      |       | 33                | %          |
| Acquisitions SG&A                                                                          |       | 0.5      |       | —   |       | 100               | %          |
| Management transition expenses                                                                 |       | 0.6      |       | —   |       | 100               | %          |
| Total SG&A                                                                                 |       | $        | 7.1        |     | $          | 5.9               |       | 20 | % |

 

Excludingstock based compensation expense, acquisitions, and management transitionexpenses, SG&A was consistent with the prior year and as a percentage ofrevenue decreased to 22.3% for the three months ended September 30, 2007, ascompared to 32.9% for the same period of the prior year.

 

*Operating Income*.Operating income increased $2.5 million, or 500.0% to $3.0 million for thethree months ended September 30, 2007, compared to approximately $500,000 forthe same period of the prior year. As a percentage of revenue, operating incomeincreased to 12.0% for the three months ended September 30, 2007, as comparedto 2.9% for the same period of the prior year. Operating income increased dueto the increase in sales and gross profit offset by an increase in SG&A asdiscussed above.

 

*Income Tax Expense*. Our effective incometax rates for the three months ended September 30, 2007 and 2006 were 40.9% and38.4%, respectively.

 

14

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**Nine Months Ended September 30, 2007 Compared to Nine Months EndedSeptember 30, 2006**

 

Thefollowing table sets forth certain historical operating results (in millions):

 
| ** **                                    | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                    | ** ** | **2007**                                                | ** ** | **2006** | ** ** | **Change** | ** ** |
| ** **                                    | ** ** | **$**                                                   | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| Revenue                                       |       | 74.2                                                    |       | 100.0 |   | 53.0 |   | 100.0 |   | 21.2 |   | 40.0 |   |
| Cost of revenue                               |       | 45.0                                                    |       | 60.6 |   | 31.5 |   | 59.4 |   | 13.5 |   | 42.9 |   |
| Gross margin                                  |       | 29.2                                                    |       | 39.4 |   | 21.5 |   | 40.6 |   | 7.7 |   | 35.8 |   |
| Selling, general and administrative  expenses |       | 20.6                                                    |       | 27.8 |   | 17.3 |   | 32.6 |   | 3.3 |   | 19.1 |   |
| Operating income                              |       | 8.6                                                     |       | 11.6 |   | 4.2 |   | 7.9 |   | 4.4 |   | 104.8 |   |
| Interest income, net                          |       | 0.3                                                     |       | 0.4 |   | 0.6 |   | 1.1 |   | (0.3 | ) | (50.0 | ) |
| Income tax expense                            |       | 3.6                                                     |       | 4.9 |   | 2.0 |   | 3.8 |   | 1.6 |   | 80.0 |   |
| Net income                                    |       | 5.3                                                     |       | 7.1 |   | 2.8 |   | 5.3 |   | 2.5 |   | 89.3 |   |

 

*Revenue.*Revenueincreased $21.2 million, or 40.0%, to $74.2 million for the nine months endedSeptember 30, 2007 compared to $53.0 million for the same period of the prioryear. The acquisitions we completed in fiscal 2007 contributed $5.8 million or7.8% of total revenue for the nine months ended September 30, 2007. Theincrease in our revenue was realized across all of our service lines and ourtraditional aerospace and defense vertical. The following table is provided todisplay our revenue results compared to the same period of the prior year.

 
| **For the nine months ended September 30,  (in millions)** | ** ** | **2007** | ** ** | **2006** | ** ** | **% Growth** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|-------------------|------------|
| **Revenues by Market Vertical**                                                               |       |     |       |     |       |              |       |
| Aerospace and Defense (A&D)                                                               |       | $        | 58.0       |     | $          | 39.0              |       | 49 | % |
| Non Aerospace and Defense (SIIT)                                                              |       | 16.2     |       | 14.0     |       | 16                | %          |
| Total                                                                                         |       | $        | 74.2       |     | $          | 53.0              |       | 40 | % |
|                                                                                          |       |     |       |     |       |              |       |
| **Revenues by Service Line**                                                                  |       |     |       |     |       |              |       |
| Competition Management                                                                        |       | $        | 42.9       |     | $          | 33.0              |       | 30 | % |
| Program Services                                                                              |       | 31.3     |       | 20.0     |       | 57                | %          |
| Total                                                                                         |       | $        | 74.2       |     | $          | 53.0              |       | 40 | % |

 

Startingin 2006, our focus on expanding our Program Services offerings led to twoacquisitions in fiscal 2007. These acquisitions, along with our latest solutionofferings, have generated consistent sequential quarterly revenue growth. Ourgrowth has also been generated by our Account Executives’ ability to buildvalued long term relationships with our clients. Our clients repeatedly engageus for our services as they understand how valuable we are in helping them bothwin and execute on their competitively awarded programs.

 

*Gross Margin.*Gross margin increased $7.7 million, or 35.8%, to $29.2 million for the ninemonths ended September 30, 2007 compared to $21.5 million for the same periodof the prior year. The increase in gross margin dollars is due to the increasein sales as discussed above offset by a decrease in gross margin as apercentage of revenue. As a percentage of revenue, gross margin decreased to39.4% for the nine months ended September 30, 2007 compared to 40.6% for thesame period of the prior year. The decline was due to a reduction in the levelof success fees earned and revenue mix. We recorded success fees of $557,000and $910,000 for the nine months ended September 30, 2007 and 2006, respectively.We expect our gross margins to be approximately 39.0% to 40.0% for fiscal year2007.

 

*Selling, General and Administrative Expenses.*Selling,**general andadministrative expenses consist principally of salary and benefit costs forexecutive, sales and administrative personnel, stock-based employeecompensation, depreciation and amortization, training and recruiting,professional services and other general corporate activities.

 

OnMarch 31, 2007, the Company’s Chairman and Chief Executive Officer, Steven S.Myers, retired and on April 1, 2007, was replaced by Cynthia Davis as ChiefExecutive Officer. Ms. Davis was also elected to the Board of Directors. Acurrent board member, Dwight Hanger, replaced Mr. Myers as Chairman of theBoard. The expense associated with this transition, which includes a retirementpayment of $500,000 and legal and professional fees of approximately $200,000,are included in SG&A for the nine months ended September 30, 2007.

 

15

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Subsequently,effective July 18, 2007, the Board of Directors accepted the resignation ofCynthia A. Davis as Chief Executive Officer and as a Director, and the Companyand Ms. Davis entered into a separation agreement including a mutual release ofclaims and a payment of $475,000 by the Company. Cathy L. McCarthy was electedas President and Chief Executive Officer following the resignation of Ms. Davisand entered into an employment agreement with the Company, and was granted200,000 stock options vesting quarterly over four years. The expense associatedwith this transition, which includes a payment of $475,000 to Ms. Davis andlegal and professional fees of approximately $125,000, are included in SG&Afor the nine months ended September 30, 2007.

 

Thefollowing table is provided to display our SG&A results segregating theseareas of cost for comparison purposes:

 
| **For the nine months ended September 30,  (in millions)** | ** ** | **2007** | ** ** | **2006** | ** ** | **% Growth** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|-------------------|------------|
| SG&A before stock based compensation,  acquisitions, and management transition expenses   |       | $        | 16.8       |     | $          | 16.4              |       | 2 | % |
| Stock based compensation expense                                                              |       | 1.3      |       | 0.9      |       | 44                | %          |
| Acquisitions SG&A                                                                         |       | 1.2      |       | —   |       | 100               | %          |
| Management transition expenses                                                                |       | 1.3      |       | —   |       | 100               | %          |
| Total SG&A                                                                                |       | $        | 20.6       |     | $          | 17.3              |       | 19 | % |

 

SG&Aexpenses increased $3.3 million, or 19.1%, to $20.6 million for the nine monthsended September 30, 2007, as compared to $17.3 million for the same period ofthe prior year. Excluding stock based compensation, acquisitions, andmanagement transition related expenses, SG&A as a percentage of revenuedecreased to 22.6% for the nine months ended September 30, 2007, as compared to30.9% for the same period of the prior year. The current period increase ofapproximately $400,000, excluding the items noted in the table above, was dueto increased recruiting and training expenses associated with our strongrevenue growth.

 

*Operating Income*.Operating income increased $4.4 million, or 104.8% to $8.6 million for the ninemonths ended September 30, 2007, compared to $4.2 million for the same periodof the prior year. As a percentage of revenue, operating income increased to11.6% for the nine months ended September 30, 2007, as compared to 7.9% for thesame period of the prior year. Operating income primarily increased due to theincrease in sales offset by a decrease in gross profit as a percentage of salesand an increase in selling, general and administrative expenses, as discussedabove.

 

*Income Tax Expense*. Our effective incometax rates for the nine months ended September 30, 2007 and 2006 were 40.6% and40.8%, respectively.

 

**Capital Resources and Liquidity**

 

Ourworking capital increased to $29.1 million at September 30, 2007 from $28.4million at December 31, 2006. In addition, our cash and cash equivalents plusinvestments decreased to $9.3 million at September 30, 2007, from $15.1 millionat December 31, 2006. The decrease in cash and cash equivalents plusinvestments was due to the funds used for acquisitions of approximately $6.0million, our share buyback activity in which the Company repurchased $842,000of common shares during the nine months ended September 30, 2007, and theincrease in the number of day’s sales outstanding (“DSO”). Periodically, whenour larger client’s contracts are under renewal we are authorized to continueproviding our services while the extended contract is being processed. Thisprocess can take two to three months to finalize at which time we invoice allunbilled amounts. Our clients will typically pay the balances within 60 daysupon receipt of our invoices. As the majority of these renewals have beencompleted, we expect to reduce our DSO’s to approximately our historicalaverage DSO of 70 days before the end of this fiscal year.

 

Webelieve we have sufficient working capital available under the line of creditand that cash generated by continuing operations will be sufficient to fundoperations for at least the next twelve months.

 

16

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**Item 3.   Quantitative and Qualitative Disclosures AboutMarket Risk**

 

TheCompany currently has no instruments that are sensitive to market risk.

 

**Item 4.   Controls and Procedures**

 

***Evaluation of Disclosure Controls andProcedures***

 

Ourmanagement, with the participation of our principal executive officer andprincipal financial officer, has evaluated the effectiveness of the design andoperation of our disclosure controls and procedures (as defined in Rules13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended)as of the end of the period covered by this quarterly report on Form 10-Q. Basedon this evaluation, our principal executive officer and principal financialofficer concluded that these disclosure controls and procedures are effectiveand designed to ensure that the information required to be disclosed in our reportsfiled or submitted under the Securities Exchange Act of 1934 is recorded,processed, summarized, and reported within the requisite time periods.

 

Whilethe Company’s disclosure controls and procedures provide reasonable assurancethat the appropriate information will be available on a timely basis, thisassurance is subject to limitations inherent in any control system, no matterhow well designed and administered.

 

***Changes in Internal Controls***

 

Therewas no change in our internal control over financial reporting (as defined inRules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, asamended) identified in connection with the evaluation of our internal controlperformed during our last fiscal quarter that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

17

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**PART II - OTHER INFORMATION**

 

**Item 1.   Legal Proceedings**

 

Weare involved in routine litigation incidental to the conduct of our business. Thereare currently no material pending litigation proceedings to which we are aparty or to which any of our property is subject.

 

**Item 2.   Unregistered Sales of Equity Securities and Use ofProceeds**

 

***Issuance of Unregistered Securities***

 

Aspreviously disclosed in the Current Report on Form 8-K filed by theCompany on September 19, 2007, the Company issued 80,671 shares of itscommon stock to the stockholders of PMA on September 14, 2007, aspartial consideration in the amount of approximately $500,000 for theacquisition by the Company of all of the outstanding capital stock of PMA fromthose stockholders. The issuance of these shares of common stock was made inreliance on the exemption from registration provided by Section 4(2) ofthe Securities Act of 1933.

 

***Issuer Purchases of Equity Securities***

 

Information aboutsecurities purchased under the Company’s share repurchase program isincorporated by reference to Note 8 to the condensed consolidated financialstatements.

 
| **Period**                               | ** ** | **Total Number  of Shares  Purchased** | ** ** | **Average  Price Paid  Per Share** | ** ** | **Total Number  of Shares  Purchased as  Part of a  Publicly  Announced  Plan** | ** **    | **Approximate  Dollar Value of  Shares That  May Yet Be  Purchased  Under The Plan** | ** ** |
|------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|---------------|-------------------------------------------------------------------------------------------------------------------------|------------|
| **Beginning balance at January 1, 2007** | ** ** | **3,215,443**                                    | ** ** | **$**                                        | **7.27**   | ** **                                                                                               | **3,215,443** | ** **                                                                                                              | **$**      | **6,639,411** | ** ** |
| January 2007                             |       | 139,417                                          |       | 6.04                                         |       | 3,354,860                                                                                                |          | 5,797,093                                                                                                               |       |
| February 2007                            |       | —                                           |       | —                                       |       | —                                                                                                   |          | —                                                                                                                  |       |
| March 2007                               |       | —                                           |       | —                                       |       | —                                                                                                   |          | —                                                                                                                  |       |
| April 2007                               |       | —                                           |       | —                                       |       | —                                                                                                   |          | —                                                                                                                  |       |
| May 2007                                 |       | —                                           |       | —                                       |       | —                                                                                                   |          | —                                                                                                                  |       |
| June 2007                                |       | —                                           |       | —                                       |       | —                                                                                                   |          | —                                                                                                                  |       |
| July 2007                                |       | —                                           |       | —                                       |       | —                                                                                                   |          | —                                                                                                                  |       |
| August 2007                              |       | —                                           |       | —                                       |       | —                                                                                                   |          | —                                                                                                                  |       |
| September 2007                           |       | —                                           |       | —                                       |       | —                                                                                                   |          | —                                                                                                                  |       |
| **Total as of September 30, 2007**       | ** ** | **3,354,860**                                    | ** ** | **$**                                        | **7.21**   | ** **                                                                                               | **3,354,860** | ** **                                                                                                              | **$**      | **5,797,093** | ** ** |

 

**Item 3.**  Defaults Upon Senior Securities

** **

**NotApplicable.**

** **

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

** **

None.

 

**Item 5.****  ****Other Information**

 

None.

 

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**Item 6.   Exhibits**

 

**INDEX TO EXHIBITS**

 

***Exhibits (numbered in accordance with item 601 of Regulation S-K).***

 

2.1           StockPurchase Agreement, by and among Project Planning Inc., Richard Bowe, itsShareholder, and SM&A.

Filed on February 12, 2007 asExhibit 99.2 to the registrant’s Current Report on Form 8-K and incorporatedherein by reference.

 

2.2           StockPurchase Agreement, by and among Performance Management Associates, Inc., JamesA. Wrisley and Paulette Wrisley, its Shareholders, and SM&A.

Filed on September 19, 2007 asExhibit 10.1 to the registrant’s Current Report on Form 8-K and incorporatedherein by reference.

 

3.1           Amendedand Restated Articles of Incorporation, a California corporation.

Filed on March 15, 2002 as Exhibit3.1 to the registrant’s Annual Report on Form 10-K and incorporated herein byreference.

 

3.2           Amendedand Restated Bylaws of the Registrant, a California corporation.

Filed on May 3, 2002 as Exhibit 3.2to the registrant’s Quarterly Report on Form 10-Q and incorporated herein byreference.

 

3.3           Certificateof Incorporation of SM&A, a Delaware corporation.

Filed on December 6, 2006 asExhibit 3.1 to the registrant’s Current Report on Form 8-K and incorporatedherein by reference.

 

3.4           Bylawsof SM&A, a Delaware corporation.

Filed on December 6, 2006 asExhibit 3.3 to the registrant’s Current Report on Form 8-K and incorporatedherein by reference.

 

3.5           Agreementand Plan of Merger, between SM&A, a California corporation, and SM&A, aDelaware corporation.

Filed on December 6, 2006 asExhibit 2.1 to the registrant’s Current Report on Form 8-K and incorporatedherein by reference.

 

10.3         EmploymentAgreement of Cathy L. McCarthy

Filed on July 23, 2007 as Exhibit10.1 to the registrant’s Current Report on Form 8-K and incorporated herein byreference.

 

10.5         SeparationAgreement of Cynthia A. Davis.

Filed on July 23, 2007 as Exhibit10.2 to the registrant’s Current Report on Form 8-K and incorporated herein byreference.

 

10.7         EmploymentAgreement of James A. Wrisley.

Filed on September 19, 2007 asExhibit 10.2 to the registrant’s Current Report on Form 8-K and incorporatedherein by reference.

 

31.1         Certificateof Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of2002.

Filed herewith.

 

31.2         Certificateof Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of2002.

Filed herewith.

 

32            Certificationof Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of2002.

Filed herewith.

 

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 
|                         | SM&A                                        |   |
|-------------------------|-------------------------------------------------|--------|
|                    | (Registrant)                                    |
|                    |                                            |
|                    |                                            |
| Dated: November 7, 2007 | /s/ STEVE D. HANDY                              |   |
|                    | Steve D. Handy                                  |
|                    | Senior Vice President,  Chief Financial Officer |
|                    | and Secretary                                   |
|                    |                                            |
|                    |                                            |
| Dated: November 7, 2007 | /s/ CATHY McCARTHY                              |   |
|                    | Cathy McCarthy                                  |
|                    | President and Chief  Executive Officer          |

 

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