** **

**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 
| x      | **QUARTERLY  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|--------|---------------------------------------------------------------------------------------------------------|
|   |                                                                                                    |
|   | **For the quarterly period ended December 31,  2007**                                              |
|   |                                                                                                    |
|   | **OR**                                                                                                  |
|   |                                                                                                    |
| o      | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE  ACT OF 1934** |
|   |                                                                                                    |
|   |                                                                                                    |

 

**Commission File No. 001-33083**

 

**STANLEY,INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                             | ** ** | **11-3658790**      |
|----------------------------------------------------------|------------|---------------------|
| (State or other jurisdiction of                          |       | (I.R.S. Employer    |
| incorporation or organization)                           |       | Identification No.) |
|                                                     |       |                |
| **3101 Wilson Boulevard, Suite 700  Arlington, VA** | ** ** |  

**22201**   |
| (Address of principal executive offices)                 |       | (Zip Code)          |

 

**(703) 684-1125**

 (Registrant’s telephone number,

 including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements 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.(Check one):

 

o Largeaccelerated filer      x Acceleratedfiler      o Non-accelerated filer

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).  Yes o  No x

 

Asof January 31, 2008, there were 22,418,587 shares of our Common Stock, parvalue $0.01 per share, outstanding.

 

 

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**STANLEY, INC. AND SUBSIDIARIES**

**FORM 10-Q**

**FOR THE QUARTER ENDED DECEMBER 31, 2007**

**INDEX**

** **
| ** **                                   | ** **                                                                                            | **Page** |
|----------------------------------------------|-------------------------------------------------------------------------------------------------------|----------|
| **PART 1 — FINANCIAL INFORMATION** |                                                                                                  |     |
| ITEM 1.                                      | FINANCIAL  STATEMENTS                                                                                 |     | 3 |
| ITEM 2.                                      | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATIONS |     | 14 |
| ITEM 3.                                      | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET  RISK                                           |     | 22 |
| ITEM  4.                                     | CONTROLS  AND PROCEDURES                                                                              |     | 23 |
| **PART II — OTHER INFORMATION**    |                                                                                                  |     |
| ITEM  1.                                     | LEGAL  PROCEEDINGS                                                                                    |     | 24 |
| ITEM  1A.                                    | RISK  FACTORS                                                                                         |     | 24 |
| ITEM 2.                                      | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF  PROCEEDS                                          |     | 24 |
| ITEM 3.                                      | DEFAULTS UPON SENIOR SECURITIES                                                                       |     | 24 |
| ITEM 4.                                      | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                   |     | 24 |
| ITEM  5.                                     | OTHER  INFORMATION                                                                                    |     | 24 |
| ITEM 6.                                      | EXHIBITS                                                                                              |     | 24 |
|                                              |                                                                                                       |          |  |  |  |

 

2

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**PART 1: FINANCIAL INFORMATION**

 

**ITEM 1.  FINANCIAL STATEMENTS**

 

**STANLEY, INC. AND SUBSIDIARIESCondensed Consolidated Statements of Income(unaudited)(in thousands, except per share data)**

** **
| ** **                            | ** ** | **Three Months Ended  December 31,** | ** ** | **Nine  Months Ended  December 31,** | ** ** |
|---------------------------------------|------------|-----------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                            | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2007** | ** ** |
| Revenues                              |       | $                                                   | 102,023    |                                      | $          | 147,083 |   | $ | 292,769 |   | $ | 430,803 |   |
|                                  |       |                                                |       |                                      |       |   |   |   |   |
| Operating costs and expenses:         |       |                                                |       |                                      |       |   |   |   |   |
| Cost of revenues                      |       | 86,686                                              |       | 123,660                                   |       | 248,106 |   | 363,538 |   |
| Selling, general and administrative   |       | 6,540                                               |       | 9,431                                     |       | 19,619 |   | 28,181 |   |
| Amortization of deferred compensation |       | 4,361                                               |       | 62                                        |       | 4,964 |   | 205 |   |
| Depreciation and amortization         |       | 1,353                                               |       | 1,694                                     |       | 4,047 |   | 5,005 |   |
| Total operating costs and expenses    |       | 98,940                                              |       | 134,847                                   |       | 276,736 |   | 396,929 |   |
| Operating income                      |       | 3,083                                               |       | 12,236                                    |       | 16,033 |   | 33,874 |   |
|                                  |       |                                                |       |                                      |       |   |   |   |   |
| Other  income (expense):              |       |                                                |       |                                      |       |   |   |   |   |
| Other income (expense)                |       | 95                                                  |       | 10                                        |       | (450 | ) | 16 |   |
| Interest expense - net                |       | (1,040                                              | )          | (919                                      | )          | (5,219 | ) | (3,120 | ) |
| Total other expenses                  |       | (945                                                | )          | (909                                      | )          | (5,669 | ) | (3,104 | ) |
| Income  before taxes                  |       | 2,138                                               |       | 11,327                                    |       | 10,364 |   | 30,770 |   |
|                                  |       |                                                |       |                                      |       |   |   |   |   |
| Provision for income taxes            |       | (878                                                | )          | (4,576                                    | )          | (4,198 | ) | (12,320 | ) |
| Net income                            |       | $                                                   | 1,260      |                                      | $          | 6,751 |   | $ | 6,166 |   | $ | 18,450 |   |
|                                  |       |                                                |       |                                      |       |   |   |   |   |
| Earnings per share:                   |       |                                                |       |                                      |       |   |   |   |   |
| Basic                                 |       | $                                                   | 0.06       |                                      | $          | 0.31 |   | $ | 0.38 |   | $ | 0.84 |   |
| Diluted                               |       | $                                                   | 0.06       |                                      | $          | 0.29 |   | $ | 0.34 |   | $ | 0.79 |   |
|                                  |       |                                                |       |                                      |       |   |   |   |   |
| Weighted-average shares:              |       |                                                |       |                                      |       |   |   |   |   |
| Basic                                 |       | 19,637                                              |       | 22,129                                    |       | 16,238 |   | 22,021 |   |
| Diluted                               |       | 21,676                                              |       | 23,552                                    |       | 18,216 |   | 23,340 |   |

 

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

 

3

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**STANLEY, INC. AND SUBSIDIARIES**

**Condensed Consolidated Balance Sheets**

**(in thousands, except share data)**

**(unaudited)**

** **
| ** **                                                                                                            | ** ** | **March 31, 2007** | ** ** | **December 31,  2007** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                                            | ** ** | ** **                   | ** ** | ** **                  | ** ** |
|                                                                                                                  |       |                         |       |                        |       |
| Current Assets:                                                                                                       |       |                         |       |                        |       |
| Cash                                                                                                                  |       | $                            | 12,736     |                        | $          | — |   |
| Accounts receivable - net                                                                                             |       | 110,029                      |       | 146,512                     |       |
| Prepaid and other current assets                                                                                      |       | 1,631                        |       | 3,983                       |       |
| Total current assets                                                                                                  |       | 124,396                      |       | 150,495                     |       |
|                                                                                                                  |       |                         |       |                        |       |
| Property and equipment - net                                                                                          |       | 11,736                       |       | 12,294                      |       |
| Goodwill                                                                                                              |       | 88,249                       |       | 113,611                     |       |
| Intangible assets - net                                                                                               |       | 9,417                        |       | 9,011                       |       |
| Deferred taxes                                                                                                        |       | 2,010                        |       | 1,036                       |       |
| Other assets                                                                                                          |       | 2,167                        |       | 2,275                       |       |
| Total assets                                                                                                          |       | $                            | 237,975    |                        | $          | 288,722 |   |
|                                                                                                                  |       |                         |       |                        |       |
| **Liabilities and Stockholders’  Equity**                                                                        | ** ** | ** **                   | ** ** | ** **                  | ** ** |
|                                                                                                                  |       |                         |       |                        |       |
| Current liabilities                                                                                                   |       |                         |       |                        |       |
| Line of credit                                                                                                        |       | $                            | —     |                        | $          | 16,816 |   |
| Accounts payable                                                                                                      |       | 24,476                       |       | 19,548                      |       |
| Accrued expenses and other liabilities                                                                                |       | 34,438                       |       | 53,943                      |       |
| Current portion of long-term debt                                                                                     |       | 1,000                        |       | 1,000                       |       |
| Deferred taxes                                                                                                        |       | 2,646                        |       | 929                         |       |
| Income taxes payable                                                                                                  |       | 917                          |       | —                      |       |
| Total current liabilities                                                                                             |       | 63,477                       |       | 92,236                      |       |
|                                                                                                                  |       |                         |       |                        |       |
| Long-term debt — net of current portion                                                                          |       | 36,750                       |       | 35,750                      |       |
| Other long-term liabilities                                                                                           |       | 3,596                        |       | 3,657                       |       |
| Total liabilities                                                                                                     |       | 103,823                      |       | 131,643                     |       |
|                                                                                                                  |       |                         |       |                        |       |
| Commitments and contingencies:                                                                                        |       |                         |       |                        |       |
| Stockholders’ equity                                                                                             |       |                         |       |                        |       |
| Common stock, $0.01 par value — 200,000,000 shares  authorized; 21,887,564   and 22,313,472 issued, respectively |       | 219                          |       | 223                         |       |
| Additional paid-in capital                                                                                            |       | 76,785                       |       | 81,683                      |       |
| Retained earnings                                                                                                     |       | 58,345                       |       | 76,490                      |       |
| Accumulated other comprehensive income                                                                                |       | (161                         | )          | (486                        | )          |
| Deferred compensation                                                                                                 |       | (1,036                       | )          | (831                        | )          |
| Total stockholders’ equity                                                                                       |       | 134,152                      |       | 157,079                     |       |
| Total liabilities and stockholders’ equity                                                                       |       | $                            | 237,975    |                        | $          | 288,722 |   |

 

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

 

4

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**STANLEY, INC. AND SUBSIDIARIES**

**Condensed Consolidated Statements of Cash Flows**

**(unaudited)**

**(in thousands)**

** **
| ** **                                                                         | ** ** | **Nine months ended** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                         | ** ** | **December 31,**           | ** ** |
| ** **                                                                         | ** ** | **2006**                        | ** ** | **2007** | ** ** |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                               | 6,166      |   | $ | 18,450 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                            |       |   |   |
| Depreciation and amortization                                                      |       | 4,047                           |       | 5,005 |   |
| Amortization of deferred compensation                                              |       | 4,964                           |       | 205 |   |
| Loss on disposal of property and equipment                                         |       | 189                             |       | 46 |   |
| Deferred taxes                                                                     |       | 351                             |       | (38 | ) |
| Income tax benefit from stock-based compensation                                   |       | 1,592                           |       | 2,134 |   |
| Stock compensation expense                                                         |       | 415                             |       | 1,508 |   |
| Changes in assets and liabilities — net of  acquisition effects:              |       |                            |       |   |   |
| Increase in accounts receivable                                                    |       | (7,966                          | )     | (31,679 | ) |
| Increase in prepaid income tax                                                     |       | (573                            | )          | (1,538 | ) |
| Increase in prepaid expenses and other current  assets                             |       | (137                            | )          | (576 | ) |
| Decrease (increase) in other assets                                                |       | 696                             |       | (108 | )  |
| Decrease in accounts payable                                                       |       | (2,546                          | )          | (5,050 | ) |
| Increase in accrued expenses                                                       |       | 8,265                           |       | 15,840 |   |
| Increase (decrease) in other liabilities                                           |       | 878                             |       | (117 | )  |
| Decrease in income taxes payable                                                   |       | (711                            | )          | (817 | ) |
| Net cash provided by operating activities                                          |       | 15,630                          |       | 3,265 |   |
|                                                                               |       |                            |       |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES:**                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Purchase of Morgan — net of cash acquired                                     |       | (417                            | )     | — |   |
| Purchase of Techrizon — net of cash acquired                                  |       | —                          |       | (30,559 | ) |
| Acquisition of property and equipment                                              |       | (2,040                          | )          | (2,406 | ) |
| Net cash used in investing activities                                              |       | (2,457                          | )          | (32,965 | ) |
|                                                                               |       |                            |       |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Net (repayments) borrowings under line-of-credit  agreements                       |       | (10,409                         | )          | 16,816 |   |
| Repayments on long-term debt                                                       |       | (62,000                         | )          | (1,000 | ) |
| Payments under capital lease obligations                                           |       | (17                             | )          | (112 | ) |
| Purchase of treasury stock                                                         |       | (259                            | )          | (260 | ) |
| Proceeds from exercise of stock options                                            |       | 1,110                           |       | 1,424 |   |
| Net proceeds from sale of stock in initial public  offering                        |       | 71,798                          |       | — |   |
| Proceeds from sale of treasury stock                                               |       | 197                             |       | — |   |
| Other                                                                              |       | 28                              |       | 96 |   |
| Net cash provided by financing activities                                          |       | 448                             |       | 16,964 |   |
|                                                                               |       |                            |       |   |   |
| **NET INCREASE (DECREASE) IN CASH**                                                |       | 13,621                          |       | (12,736 | ) |
| **CASH — Beginning of period**                                                |       | —                          |       | 12,736 |   |
| **CASH — End of period**                                                      |       | $                               | 13,621     |   | $ | — |   |
|                                                                               |       |                            |       |   |   |
| **SUPPLEMENTAL DISCLOSURES OF  CASH FLOW INFORMATION:**                            | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Cash paid during the period for:                                                   |       |                            |       |   |   |
| Income taxes                                                                       |       | $                               | 6,067      |   | $ | 12,403 |   |
| Interest                                                                           |       | $                               | 5,492      |   | $ | 2,853 |   |

 

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

 

5

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**STANLEY, INC. AND SUBSIDIARIESNotes to Condensed Consolidated Financial Statements  (unaudited)(in thousands, except share and per share data, or as otherwise noted)**

 

**1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

***Description of Business***—Stanley, Inc.,together with its subsidiaries (“Stanley” or the “Company”), is a provider ofinformation technology services and solutions to U.S. defense and federalcivilian government agencies. Stanley offers its customers solutions to supportany stage of program, product development or business lifecycle through fiveservice areas: systems engineering, enterprise integration, operationallogistics, business process outsourcing and advanced engineering andtechnology. The Company has derived substantially all of its revenue from U.S.federal government agencies.

 

***Basis of Presentation***—Theaccompanying unaudited condensed consolidated financial statements have beenprepared in accordance with generally accepted accounting principles (“GAAP”)in the United States and pursuant to the rules and regulations of theSecurities and Exchange Commission (“SEC”). In the opinion of management, thesestatements reflect all adjustments necessary to fairly present the Company’sfinancial position as of December 31, 2007, and its results of operationsand its cash flows for the nine months ended December 31, 2006 and 2007.The results of operations for the interim periods are not necessarilyindicative of the results for the full year. For further information, refer tothe financial statements and footnotes presented in the Company’s Annual Reporton Form 10-K for the year ended March 31, 2007.

 

***Principles of Consolidation***—Theaccompanying condensed consolidated financial statements include the accountsof Stanley’s wholly-owned subsidiaries. All intercompany balances andtransactions have been eliminated in consolidation.

 

***Fair Value of Financial Instruments***—The fair valueof accounts receivable, accounts payable, accrued expenses, note payable, andthe swap contract approximates their respective carrying amounts.

 

***Revenue Recognition***—The Companyrecognizes revenue under its contracts when a contract has been executed, thecontract price is fixed and determinable, delivery of services or products hasoccurred, and collectibility is considered probable and can be reasonablyestimated. Revenue is earned under cost-plus-fee, fixed-price andtime-and-materials contracts. The Company uses a standard management process todetermine whether all required criteria for revenue recognition have been met,which includes regular reviews of the Company’s contract performance. Thisreview covers, among other matters, progress against a schedule, outstandingaction items, effort and staffing, quality, risks and issues, subcontractmanagement, costs incurred, commitments, and customer satisfaction. During thisreview, the Company determines whether the overall progress on a contract isconsistent with the effort expended.

 

Contractrevenue recognition inherently involves the use of estimates. Examples of estimatesinclude the contemplated level of effort to accomplish the tasks under thecontract, the cost of the effort, and an ongoing assessment of the Company’sprogress toward completing the contract. From time to time, as part of theCompany’s standard management process, facts develop that require the Companyto revise its estimated total costs and revenues. To the extent that a revisedestimate affects contract profit or revenue previously recognized, the Companyrecords the cumulative effect of the revision in the period in which the factsrequiring the revision become known. The full amount of an anticipated loss onany type of contract is recognized in the period in which it becomes probableand can be reasonably estimated.

 

Undercost-plus-fee contracts, revenues are recognized as costs are incurred andinclude an estimate of applicable fees earned. The Company considers fixed feesunder cost-plus-fee contracts to be earned in proportion to the allowable costsactually incurred in performance of the contract for level of effort contracts.For completion type cost-plus-fee contracts, fixed fees are earned inproportion to the percentage of work completed. For time-and-materialscontracts, revenues are computed by multiplying the number of direct labor-hoursexpended in performance of the contract by the contractual billing rates andadding other billable direct and indirect costs. For fixed-price contracts,revenues are recognized as services are performed, using thepercentage-of-completion method, applying the cost-to-cost or units of deliverymethod, in accordance with Accounting Research Bulletin No. 45, *Accounting for Long-Term Construction-Type Contracts* (“ARB45”) and American Institute of Certified Public Accountants (“AICPA”) Statementof Position 81-1, *Accounting for Performance ofConstruction-Type and Certain Production-Type Contracts* (“SOP81-1”).

 

Forcost-plus-award fee type contracts, the Company recognizes the expected fee tobe awarded by the customer at the time such fee can be reasonably estimated,based on factors such as prior award experience and communications with thecustomer regarding performance, including any interim performance evaluationsrendered by the customer. For cost-plus-incentive fee type contracts, themethod of calculating the incentive fee is specified in the contract and it istypically based on measuring actual costs to perform the contract against atarget cost to perform the contract. The Company prepares periodic estimates tocomplete the contract and adjusts the incentive fee as required based on thecontract incentive fee formula.

 

 

6

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TheCompany’s contracts with agencies of the government are subject to periodicfunding by the respective contracting agency. Funding for a contract may beprovided in full at inception of the contract or ratably throughout thecontract as the services are provided. From time to time, the Company mayproceed with work based on customer direction prior to the completion andsigning of formal contract documents. The Company has a formal internal reviewprocess and management approval prior to commencement of work. Revenueassociated with such work is recognized without profit and only when it can bereliably estimated and realization is probable. The Company bases its estimateson notices to proceed from its customers, previous experiences with thecustomer, communications with the customer regarding funding status, and itsknowledge of available funding for the contract or program. Pre-contract costsrelated to unsuccessful contract bids are expensed in the period in which theCompany is notified that the contract will not be issued.

 

Disputesoccasionally arise in the normal course of the Company’s business due to eventssuch as delays, changes in contract specifications, and questions of costallowability or collectibility. Such matters, whether claims or unapprovedchange orders in the process of negotiation, are recorded at the lesser oftheir estimated net realizable value or actual costs incurred, and only whenrealization is probable and can be reliably estimated.

 

Theallowability of certain costs under government contracts is subject to audit bythe government. Certain indirect costs are charged to contracts usingprovisional or estimated indirect rates, which are subject to later revisionbased on government audits of those costs. Management is of the opinion thatcosts subsequently disallowed, if any, would not be significant.

 

***Concentration of Risk***—Contractsfunded by federal government agencies account for substantially all of ourrevenues. For the three months ended December 31, 2006 and 2007, wederived approximately 68% of our revenues from the Department of Defense,including agencies within the intelligence community, and approximately 32% ofour revenues from federal civilian government agencies. The Company’s contractswith the Department of State for the provision of passport processing andsupport services, which is our largest revenue-generating contract, and with theDepartment of the Navy for production engineering and integration servicesunder various SPAWAR programs, accounted for approximately 16% and 14% of ourrevenues for the three months ended December 31, 2007, respectively.

 

Forthe nine months ended December 31, 2006 and 2007, we derived approximately67% and 68% of our revenues, respectively, from the Department of Defense,including agencies within the intelligence community, and approximately 33% and32% of our revenues, respectively, from federal civilian government agencies.The Company’s contracts with the Department of State for the provision ofpassport processing and support services, which is our largestrevenue-generating contract, and with the  Department of the Navy forproduction engineering and integration services under various SPAWAR programs,accounted for approximately 17% and 14% of our revenues for the nine monthsended December 31, 2007, respectively.

 

***Property and Equipment***—Property andequipment are carried at cost, less accumulated depreciation. Depreciation ofproperty and equipment is calculated using the straight-line method over theuseful lives, ranging from three to ten years. Leasehold improvements areamortized over the lesser of the useful life or the term of the lease. Repairsand maintenance are expensed as incurred. Depreciation expense related toproperty and equipment was $0.6 million and $0.7 million for the threemonths ended December 31, 2006 and 2007, respectively. Depreciationexpense related to property and equipment was $1.6 million and $2.1million for the nine months ended December 31, 2006 and 2007,respectively.

 

***Goodwill and Intangible Assets****—*Goodwillrepresents the excess of cost over the fair value of net tangible andidentifiable intangible assets of acquired companies. In accordance with SFAS No. 142,*Goodwill and Other Intangible Assets*(“SFAS No. 142”), the Company does not amortize goodwill; rather it testsgoodwill for impairment at least on an annual basis. Testing for impairment isa two-step process as prescribed by SFAS No. 142. The first step is a testfor potential impairment, while the second step measures the amount ofimpairment, if any. Under the guidelines of SFAS No. 142, the Company isrequired to perform an impairment test at least on an annual basis at any timeduring the fiscal year provided the test is performed at the same time everyyear. An impairment loss would be recognized when the assets’ fair value isbelow their carrying value. Stanley has elected December 31 as its testingdate. Based on the testing performed as of December 31, 2007, the Companydetermined that no impairments existed as of December 31, 2007. Customerrelationships and other intangibles are amortized on a straight-line basis overperiods ranging from two to seven years.

 

***Impairment of Long-Lived Assets***—Wheneverevents or changes in circumstances indicate that the carrying amount oflong-lived assets may not be fully recoverable, Stanley evaluates theprobability that future undiscounted net cash flows, without interest charges,will be less than the carrying amount of the assets. If any impairment wereindicated as a result of this review, Stanley would recognize a loss based onthe amount by which the carrying amount exceeds the estimated fair value.Stanley believes that no impairments existed as of December 31, 2007.

 

***Stock***-***Based Compensation***—Stanleyadopted the provisions of SFAS No. 123(R),*Share-based Payment* (“SFAS No. 123(R)”), on a prospective basisduring the fiscal year beginning April 1, 2006.

 

 

7

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***Earnings per share***—Basic earningsper share has been computed by dividing net income available to commonstockholders by the weighted-average number of shares of common stockoutstanding during each period. Shares issued during the period and sharesreacquired during the period are weighted for the portion of the period thatthey were outstanding. Diluted earnings per share considers the potentialdilution that could occur if securities or other contracts to issue commonstock were exercised or converted into common stock. The weighted-averagenumber of common shares outstanding is computed as follows:

 

| ** **                                          | ** ** | **Three Months Ended  December 31,** | ** ** | **Nine Months Ended  December 31,** | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                          | ** ** | **2006**                                                 | ** ** | **2007**                                                | ** ** | **2006** | ** ** | **2007** | ** ** |
| ** **                                          | ** ** | **(in thousands)**                                  | ** ** |
| Basic weighted-average  common shares outstanding   |       | 19,637                                                   |       | 22,129                                                  |       | 16,238 |   | 22,021 |   |
| Effect of potential  exercise of stock options      |       | 2,039                                                    |       | 1,423                                                   |       | 1,978 |   | 1,319 |   |
| Diluted weighted-average  common shares outstanding |       | 21,676                                                   |       | 23,552                                                  |       | 18,216 |   | 23,340 |   |

 

Alloptions to purchase common stock are included in the computation of dilutedearnings per share because the average fair value per common share was greaterthan the options’ exercise prices.

 

***Derivative Instruments and HedgingActivities***—In accordance with SFAS No. 133,*Accounting for Derivative Instruments and HedgingActivities*  (“SFAS No. 133”),as amended by SFAS No. 138,*Accountingfor Certain Derivative Instruments and Certain Hedging Activities, an Amendmentof SFAS 133* and SFAS No. 149,*Amendment of Statement 133 on Derivative Instruments and HedgingActivities,* the fair value of the hedge arrangement is recorded asan asset or a liability in the accompanying unaudited condensed consolidatedbalance sheet at December 31, 2007. For qualifying cash flow hedges, SFAS No. 133,as amended, holds that the effective portion of derivative gains and losses berecorded as a component of other comprehensive income and be reclassified intoearnings in the same period in which the hedged transaction affects suchearnings. Any ineffectiveness is reported currently in earnings.

 

Asrequired by its senior credit facility dated February 16, 2006, Stanleyentered into an interest rate swap agreement on October 27, 2006 with amaturity date of January 31, 2012, an annual fixed rate of 5.28% and anotional amount of $19.0 million. The Company designated this swap agreement,at its inception, as a qualifying cash flow hedge. The fair value of the swapat December 31, 2007 of $0.8 million has been reported in “Accruedexpenses and other liabilities” with an offset, net of tax, included in“Accumulated other comprehensive income” in the accompanying unauditedcondensed consolidated balance sheets. None of the $0.8 million unrealized losswas recognized in earnings during the nine months ended December 31, 2007based on hedge ineffectiveness and none of the swap’s unrealized loss wasexcluded from the assessment of hedge effectiveness. Amounts in accumulatedother comprehensive income will be reclassified into earnings in the period inwhich variable interest payments (the hedged transaction) are made under thesenior credit facility. As of December 31, 2007, the estimated net amountof existing losses expected to be reclassified into earnings within the next 12months is zero.

 

***Segment Reporting***—Operatingsegments are defined as components of an enterprise for which separatefinancial information is available and evaluated regularly by the chiefoperating decision maker, or decision making group, in deciding how to allocateresources and assess performance. The Company currently has one reportablesegment for financial reporting purposes, which represents the Company’s corebusiness of providing information technology solutions and services for federalgovernment customers. The Company does not report revenue by product or serviceor groups of products or services because it is impracticable to do so.

 

***Use of Estimates***—Thepreparation of financial statements in conformity with GAAP requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities and the disclosure of contingent assets and liabilities at thedate of the financial statements and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from thoseestimates. Significant items subject to such estimates and assumptions includerevenue recognition, carrying amount and useful lives of long-lived assets,valuation allowances for accounts receivable and deferred tax assets, softwaredevelopment costs and loss contingencies, such as litigation, claims andassessments.

 

***Recently Adopted Accounting Pronouncements***—In July 2006,the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48,*Accounting for Uncertainty in Income Taxes**, an interpretation of FASB Statement No. 109* (“FIN48”). FIN 48 provides guidance on recognition, derecognition, measurement,classification, interest and penalties, accounting for interim periods, anddisclosures. FIN 48 requires an entity to recognize the financial statementimpact of a tax position when it is more likely than not that the position willbe sustained upon examination by a taxing authority. The amount recognized ismeasured at the largest amount of benefit that is greater than fifty percentlikely of being realized upon ultimate settlement. In addition, FIN 48 permitsan entity to recognize interest and penalties related to tax uncertainties asincome tax expense or operating expenses. FIN 48 is effective for fiscal yearsbeginning after December 15, 2006.

 

 

8

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TheCompany adopted the provisions of FIN 48 on April 1, 2007. The cumulativeeffects of applying this interpretation have been recorded as a decrease of$0.3 million to retained earnings, an increase of $0.5 million to net deferredtax assets, a decrease to income taxes payable of $0.1 million and an increasein liabilities of $0.5 million for unrecognized tax benefits and $0.4 millionfor interest and penalties. Since April 1, 2007, there has been anincrease of $0.2 million in the liability for gross unrecognized tax benefits.As of April 1 and December 31, 2007, the Company has $0.5 million and$0.7 million, respectively, in unrecognized tax benefits, the recognition ofwhich would not have a material impact on the effective tax rate. Included inthe balance of unrecognized tax positions at April 1 and December 31,2007 is $0.5 million and $0.7 million, respectively, related to tax positionsfor which it is reasonably possible that the total amounts could changesignificantly in the next twelve months. The amount represents unrecognized taxbenefits from foreign jurisdictions. The Company recognizes interest andpenalties accrued related to unrecognized tax benefits as interest expense andoperating expenses, respectively, in the accompanying unaudited condensedconsolidated statements of income, which is consistent with the recognition ofthese items in prior years. As of April 1 and December 31, 2007, theCompany accrued liabilities of $0.4 million for interest and penalties.

 

TheCongressional Joint Committee on Taxation is currently reviewing apre-acquisition period of one of our subsidiaries. We do not expect anyadjustments to result from this review. The Company is open to audit under thestatute of limitations for tax years 2003 through 2007 for federal and statejurisdictions and tax years 1998 through 2007 for foreign jurisdictions.

 

Asof December 31, 2007, there have been no material changes to the liabilityfor uncertain tax positions.

 

***Recently Issued Accounting Standards***—In September 2006,the FASB issued Statement of Financial Accounting Standards No. 157,*Fair Value Measurements* (“SFAS 157”).SFAS 157 provides guidance for measuring the fair value of assets andliabilities. It requires additional disclosures related to the extent to whichcompanies measure assets and liabilities at fair value, the information used tomeasure fair value, and the effect of fair value measurements on earnings. SFAS157 is effective for fiscal years beginning after November 15, 2007. TheCompany is in the process of determining what effect, if any, the adoption ofSFAS 157 will have on its financial position, results of operations, or cashflows.

 

InFebruary 2007, the FASB issued Statement of Financial Accounting StandardsNo. 159,*The Fair Value Option forFinancial Assets and Financial Liabilities-Including an Amendment of FASBStatement No. 115*  (“SFAS159”). SFAS 159 permits entities to measure many financial instruments andcertain other items at fair value to improve financial reporting by providingentities with the opportunity to mitigate volatility in reported earningscaused by measuring related assets and liabilities differently without havingto apply complex hedge accounting. Most of the provisions in SFAS 159 areelective. This statement will be effective for the Company in fiscal 2009, andit may be applied prospectively. Early adoption is permitted, provided theCompany also elects to apply the provisions of SFAS 157. The Company is in theprocess of determining what effect, if any, the application of the provisionsof SFAS 159 will have on its financial position, results of operations or cashflows.

 

InDecember 2007, the FASB issued SFAS No. 141(R), *BusinessCombinations* (SFAS 141(R)), and SFAS No. 160, *Non-ControllingInterests in Consolidated Financial Statements, an Amendment of ARB No. 51*(SFAS160). These new standards will significantly change the accounting for andreporting for business combination transactions and non-controlling interest inconsolidated financial statements. SFAS 141(R) and SFAS 160 are required to beadopted simultaneously and are effective for fiscal years beginning on or afterDecember 15, 2008. The company is in the process of determining what effect, ifany, the application of the provisions of SFAS 141(R) and SFAS 160 will have onits financial position, results of operations or cash flows.

 

***Reclassifications***—Certainreclassifications have been made to prior year presentations to conform to thecurrent presentation. In the fourth quarter of fiscal year 2007, the Companyreviewed the mapping of its operating expenses relative to cost of revenues,and Selling, General & Administrative expenses, or SG&A. Cost ofrevenues are direct and indirect contract costs, while SG&A expenses areperiod costs related to selling activities and overall support and managementof the business as a whole. As a result of this review, certain expensespreviously classified as cost of revenues in the first three quarters of fiscalyear 2007 were reclassified to SG&A to more closely align such costs withthe income statement captions that best capture the nature of the expenses.

 

***Stock Split and Amendment of Certificate ofIncorporation***—On August 28, 2006, the Company increased thenumber of authorized shares of common stock to 200,000,000 shares and on September 12,2006, the Company completed a thirty-for-one stock split of its outstandingcommon stock. The accompanying financial statements include the effects of thestock split and the resulting increase in the number of authorized shares ofcommon stock. All share and per share amounts included in the accompanyingfinancial statements for periods prior to the stock split have been restated toreflect the stock split.

 

**2****. ****ACCOUNTS RECEIVABLE**

 

Accountsreceivable consists of the following:

 

| ** **                             | ** ** | **As of**               | ** ** | **As of**                  | ** ** |
|----------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **March 31, 2007** | ** ** | **December 31, 2007** | ** ** |
| Billed receivables                     |       | $                            | 73,676     |                            | $          | 110,517 |   |
| Unbilled receivables                   |       | 36,962                       |       | 46,286                          |       |
| Less: Allowance for  doubtful accounts |       | (609                         | )          | (291                            | )          |
| Total                                  |       | $                            | 110,029    |                            | $          | 146,512 |   |

 

Consistentwith industry practice, certain receivables related to long-term contracts areclassified as current, although a portion of these amounts is not expected tobe billed and collected within one year. Unbilled accounts receivable areexpected to be billed and collected within one year except for $0.4 million,which relates to contract retainage, at December 31, 2007.

 

 

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**3.  PROPERTY AND EQUIPMENT**

 

Propertyand equipment consists of the following:

 

| ** **                                                                               | ** ** | **As of**               | ** ** | **As of**                  | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                                                                               | ** ** | **March 31, 2007** | ** ** | **December 31, 2007** | ** ** |
| Computers and peripherals                                                                |       | $                            | 4,008      |                            | $          | 4,578 |   |
| Software                                                                                 |       | 1,882                        |       | 2,522                           |       |
| Furniture and equipment                                                                  |       | 3,630                        |       | 4,199                           |       |
| Leasehold improvements                                                                   |       | 6,417                        |       | 7,248                           |       |
|                                                                                     |       | 15,937                       |       | 18,547                          |       |
|                                                                                     |       |                         |       |                            |       |
| Less: Accumulated  depreciation and amortization                                         |       | (4,201                       | )          | (6,253                          | )          |
| Property and equipment —  net                                                       |       | $                            | 11,736     |                            | $          | 12,294 |   |
|                                                                                     |       |                         |       |                            |       |
| Property and equipment included above that are under capital lease  obligations include: |       |                         |       |                            |       |
| Software                                                                                 |       | $                            | 569        |                            | $          | 650 |   |
| Furniture and equipment                                                                  |       | 80                           |       | 158                             |       |
| Less: Accumulated depreciation                                                           |       | (158                         | )          | (285                            | )          |
| Total                                                                                    |       | $                            | 491        |                            | $          | 523 |   |

 

**4.  ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES**

 

Accruedexpenses and other current liabilities consist of the following:

 

| ** **                     | ** ** | **As of**               | ** ** | **As of**                  | ** ** |
|--------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                     | ** ** | **March 31, 2007** | ** ** | **December 31, 2007** | ** ** |
| Accrued payroll-related  costs |       | $                            | 9,778      |                            | $          | 12,830 |   |
| Accrued contract costs         |       | 19,131                       |       | 32,899                          |       |
| Accrued indirect costs         |       | 2,807                        |       | 3,789                           |       |
| Other payables                 |       | 2,722                        |       | 4,425                           |       |
| Total accrued expenses         |       | $                            | 34,438     |                            | $          | 53,943 |   |

 

**5.  DEBT**

** **

| ** **                                                    | ** ** | **As of**               | ** ** | **As of**                  | ** ** |
|---------------------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                                                    | ** ** | **March 31, 2007** | ** ** | **December 31, 2007** | ** ** |
| Borrowings under the term  loan and revolving line of credit: |       |                         |       |                            |       |
| Revolving line of credit                                      |       | $                            | —     |                            | $          | 16,816 |   |
| Term loan                                                     |       | 37,750                       |       | 36,750                          |       |
| Total debt                                                    |       | 37,750                       |       | 53,566                          |       |
| Less: Current portion                                         |       | (1,000                       | )          | (17,816                         | )          |
| Debt — net of current portion                            |       | $                            | 36,750     |                            | $          | 35,750 |   |

 

OnOctober 10, 2007, Stanley entered into an Amended and Restated RevolvingCredit and Term Loan Agreement with a group of lenders for which SunTrustRobinson Humphrey, Inc. acted as sole book manager and lead arranger,SunTrust Bank acted as administrative agent and M&T Bank and BB&T Bankacted as co-documentation agents. The agreement amends and restates theprevious credit agreement entered into in February 2006. The amendedcredit agreement increased the amount of the lenders’ aggregate commitmentunder the facility from $87.0 million to $187.0 million, which includes a$150.0 million revolving credit facility and a $37.0 million term loan. Theterm loan commitment matures on January 31, 2012 and the revolving commitmentmatures on October 31, 2012. The agreement also increased the letter ofcredit commitment from $5.0 million to $10.0 million, 

 

 

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increasedthe swing line facility from $5.0 million to $20.0 million and eliminated therequirement to hedge a portion of the Company’s outstanding indebtedness underits senior credit facility. In connection with the agreement, Stanley paid feesof approximately $0.5 million.

 

Asof December 31, 2007, Stanley had $36.8 million of term loan indebtednessand $16.8 million of revolving indebtedness outstanding under its senior creditfacility, with a weighted-average interest rate of approximately 7.72% and7.00% for the nine months ended December 31, 2006 and 2007, respectively.As of December 31, 2007, Stanley’s borrowing availability under its $150.0million revolving credit facility was $133.1 million (including outstandingletters of credit). At December 31, 2007, the Company was in compliancewith all covenants under its senior credit facility. The obligations under itssenior credit facility are unconditionally guaranteed by each of its existingand subsequently acquired or organized subsidiaries and are secured on afirst-priority basis by security interests (subject to permitted liens) insubstantially all assets owned by the Company and each of its subsidiaries,including the shares of capital stock of its subsidiaries, subject to certainexceptions.

 

**6.  ACQUISITION**

 

OnApril 1, 2007, Stanley acquired Techrizon, LLC (“Techrizon”), a premierprovider of software, training, simulation and information security solutions,for $30.3 million, net of cash acquired, and financed the acquisition with acombination of existing cash and borrowings under its senior credit facility.Additionally, acquisition related costs of $0.3 million were incurred. Inaccordance with SFAS No. 141,*BusinessCombinations* (“SFAS No. 141”), the acquisition was accountedfor under the purchase method of accounting. Accordingly, the results of Techrizonhave been included in the accompanying condensed consolidated financialstatements since the date of acquisition. The purchase price has been allocatedto the assets acquired and liabilities assumed based upon their estimated fairvalues. Of the purchase consideration, $25.1 million has been allocated togoodwill, based upon the excess of the purchase price over the $2.7 millionestimated fair value of net tangible assets and $2.5 million has been assignedto other identifiable intangible assets. Included in identifiable intangiblesis $1.6 million, $0.8 million and $0.1 million related to customer contractsand relationships, order backlog and non-compete agreements, respectively,which are being amortized over periods of two to five years. The Company iscontinuing to evaluate the fair value of the assets and liabilities ofTechrizon, and will complete the purchase accounting entries related to theacquisition prior to the end of the Company’s fiscal year ending March 31,2008.

 

Thefollowing unaudited pro forma financial information presents consolidatedresults of operations data for the three months and nine months ended December 31,2006, as if the acquisition of Techrizon had occurred on April 1, 2006.The pro forma information is provided based on historical data that does notnecessarily reflect the actual results that would have occurred, nor is itnecessarily indicative of the future results of operations of the combinedentity. The pro forma financial information reflects the provision for federaland state income taxes at the Company’s effective rate of 40.5% for Techrizon’shistorical data. Prior to the acquisition, Techrizon was a limited liabilitycompany with all income, losses and tax credits flowing through to theindividual members.

 

| ** **                 | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                 | ** ** | **December 31, 2006**       | ** ** | **December 31, 2006**      | ** ** |
| Revenue                    |       | $                                | 109,390    |                            | $          | 315,029 |   |
| Net income                 |       | $                                | 1,777      |                            | $          | 8,175 |   |
| Basic earnings per share   |       | $                                | 0.09       |                            | $          | 0.50 |   |
| Diluted earnings per share |       | $                                | 0.08       |                            | $          | 0.45 |   |

 

**7****. ****STOCKHOLDERS’ EQUITY**

 

***Common Stock***

 

Stanleyhas one class of common stock, with each share of common stock having one voteper share. Holders of common stock share in dividends declared, if any, by theboard of directors.

 

Stanleypurchased 14,490 shares of treasury stock from one of its stockholders for $0.3million during the nine months ended December 31, 2007. The shares wererecorded at market price using the cost method of accounting.

 

***Deferred Compensation and Stock Options***

 

Underthe 2006 Omnibus Incentive Compensation Plan (the “Omnibus Plan”), Stanley isauthorized to provide awards for a maximum of 4,000,000 shares of common stockto any director, officer, employee or consultant. The Omnibus Plan allows forcash awards, restricted stock awards, restricted stock units, stockappreciation rights, performance units, fully vested shares, option awards andother equity-related awards. Vesting periods of these awards vary. Except asotherwise determined by the board of directors, the option awards may not havean exercise price less than the fair market value of the common stock on thedate the option is granted.

 

Priorto July 2006, under the Executive Deferred Compensation and EquityIncentive Plan (the “Executive Plan”), Stanley was authorized to provide awardsfor a maximum of 15,000,000 shares of common stock to key employees andnon-employee directors. The Executive Plan allowed for cash awards, restrictedstock awards, restricted stock trust awards and option awards. Vesting periodsof these awards vary. Holders of restricted stock awards have voting rightswith respect to the awards. The trustee of the restricted 

 

 

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stocktrust awards has voting rights with respect to the trust awards. The optionawards have an exercise price that ranges from 85% to 110% of the fair marketvalue of the common stock on the date the option was granted.

 

EffectiveApril 1, 2006, the Company adopted the provisions of SFAS No. 123(R) usingthe prospective-transition method. Under that transition method, compensationcost recognized in the nine months ended December 31, 2007 includescompensation cost for all share-based payments granted on or after April 1,2006, based on the grant-date fair value estimated in accordance with theprovisions of SFAS No. 123(R). The Company is required to account for anyportion of awards outstanding at the date of adoption of SFAS No.123(R) using the accounting principles originally applied to thoseawards.

 

TheCompany has presented all tax benefits resulting from stock-based compensationawarded prior to the adoption of SFAS No. 123(R) as operating cashflows in the accompanying unaudited condensed consolidated statements of cashflows. The tax benefits associated with share-based compensation in effect priorto the adoption of SFAS No. 123(R) were $1.6 million and $2.1 millionfor the nine months ended December 31, 2006 and 2007, respectively. Forshare-based payment transactions awarded subsequent to the adoption of SFAS No. 123(R),the tax benefits in excess of the compensation cost recognized should beclassified as financing cash flows. The excess tax benefits associated withshare-based payment transactions accounted for under SFAS No. 123(R) werezero and $0.1 million for the nine months ended December 31, 2006 and2007, respectively, and are disclosed within financing activities in theaccompanying unaudited condensed consolidated statements of cash flows.

 

Thefair value of each option award is estimated on the date of grant using theBlack-Scholes-Merton closed-form option-pricing model that uses the assumptionsnoted in the following table. Expected volatility is based on aweighted-average of the historical volatilities of similar public entities. Thevaluation model includes assumed forfeiture rates of 7.5 to 12.6 percent. Theexpected term of options granted is derived using the simplified method andrepresents the period of time that options granted are expected to beoutstanding. Options granted meet the criteria of “plain vanilla” for purposes ofapplying the simplified method. The risk-free rate for periods within thecontractual life of the option is based on the U.S. Treasury yield curve ineffect at the time of grant.

 

| ** **               | ** ** | **As of**                  | ** ** |
|--------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **December 31, 2007** | ** ** |
| Expected volatility      |       | 34.5                            | %          |
| Expected dividends       |       | 0.0                             | %          |
| Expected term (in years) |       | 3.3  - 6.5                      |       |
| Risk-free rate           |       | 4.1-5.1                         | %          |

 

Asummary of option activity as of December 31, 2007, and changes during thenine months then ended, are presented below:

 
| **Options**                            | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
|----------------------------------------|------------|------------|------------|-----------------------------------------|------------|
| Outstanding at  April 1, 2007     |       | 2,014,986  |       | $                                       | 4.87       |   |
| Granted                                |       | 559,125    |       | $                                       | 15.99      |   |
| Exercised                              |       | (289,616   | )          | $                                       | 4.92       |   |
| Forfeited                              |       | (163,965   | )          | $                                       | 9.29       |   |
| Outstanding at  December 31, 2007 |       | 2,120,530  |       | $                                       | 7.46       |   |
| Exercisable at  December 31, 2007 |       | 1,091,020  |       | $                                       | 3.00       |   |

 

Anoption summary as of December 31, 2007 is presented below:

 
| **Options**                                                      | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-  Average  Remaining  Contractual Term** | ** ** | **Aggregate  Intrinsic  Value ($000)** | ** ** |
|------------------------------------------------------------------|------------|------------|------------|-----------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------|------------|
| Outstanding at  December 31, 2007                           |       | 2,120,530  |       | $                                       | 7.46       |                                                     | 5.1        |                                        | $          | 52,083 |   |
| Exercisable at  December 31, 2007                           |       | 1,091,020  |       | $                                       | 3.00       |                                                     | 4.4        |                                        | $          | 31,657 |   |
| Unvested at  December 31, 2007, net of expected forfeitures |       | 952,297    |       | $                                       | 12.18      |                                                     | 5.8        |                                        | $          | 18,894 |   |

 

Duringthe nine months ended December 31, 2007, the Company granted 559,125option awards with a vesting period of three years. The options were issuedwith a weighted-average exercise price of $15.99. The total intrinsic value ofoptions exercised during the nine months ended December 31, 2007 was $4.8million.

 

Duringthe nine months ended December 31, 2006 and 2007, the Company recognized$0.4 million and $1.5 million of share-based employee compensation costs,respectively. As of December 31, 2007, there was $5.6 million of totalunrecognized compensation cost 

 

 

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relatedto unvested share-based compensation arrangements granted under the OmnibusPlan. That cost is expected to be recognized over a weighted-average period of2.6 years.

 

Duringthe nine months ended December 31, 2007, there were no modifications toshare-based payment arrangements.

 

Duringthe nine months ended December 31, 2007, the Company granted 161,882restricted stock awards at a weighted-average fair value of $15.81 per sharewith a vesting period of three years. During the nine months ended December 31,2007, 11,120 restricted stock awards at a weighted-average fair value of $15.26were forfeited. The assumed forfeiture rates applicable to the restrictedshares granted in the nine months ended December 31, 2007 was zero to fivepercent.

 

Priorto the adoption of SFAS No. 123(R), the fair market value of each issuanceand grant was determined by the Company on a contemporaneous basis. The Companyrecorded stock-based deferred compensation in aggregate of approximately $1.4 millionin connection with compensatory grants of stock options and shares ofrestricted stock awarded during fiscal 2006 and 2007. Approximately, $0.2million of compensation expense was recognized during the nine months ended December 31,2007. The remaining deferred compensation of $0.8 million will be amortizedover the remaining three year vesting period of the awards.

 

**8.  COMMITMENTS AND CONTINGENCIES**

 

***Contract Cost Audits***—Substantiallyall payments to Stanley under cost-reimbursable contracts and subcontracts withthe U.S. Government are provisional payments, which are subject to potentialadjustments upon audit by the Defense Contract Audit Agency. Audits through December 31,2004 have been completed. In the opinion of management, adjustmentsresulting from the audits of all subsequent years are not expected to have amaterial effect on the Company’s financial position or results of operations.

 

 

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**ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*You should read the following discussion inconjunction with the unaudited and audited consolidated financial statementsand the accompanying notes included in this Form 10-Q and our annualreport on Form 10-K for the fiscal year ended March 31, 2007. Thisdiscussion contains forward-looking statements that involve risks anduncertainties. Our actual results may differ materially from those discussed inor implied by any of the forward-looking statements as a result of variousfactors, including but not limited to, those listed in**the“Risk Factors” section of this Report, as well as in our Annual Report on Form 10-Kfor the year ended March 31, 2007, filed by us with the Securities andExchange Commission on June 1, 2007, and our Quarterly Report on Form 10-Qfor the quarter ended June 30, 2007, filed by us with the SecuritiesExchange Commission on August 9, 2007.**Wecaution readers not to place undue reliance on any such forward-lookingstatements, which speak only as of the date made. We undertake no obligation topublicly update or revise any forward-looking statements, whether as a resultof new information, future events or otherwise, after the date of this Form 10-Q.*

 

**Overview**

 

Weprovide information technology services and solutions to U.S. defense andfederal civilian government agencies. We offer our customers solutions andexpertise to support their mission-essential needs at any stage of program,product development or business lifecycle through five service areas: systemsengineering, enterprise integration, operational logistics, business processoutsourcing and advanced engineering and technology. As a systems integrator,we apply these five service areas to enable our customers to achieveinteroperability between different business processes and informationtechnology systems.

 

Contractsfunded by federal government agencies account for substantially all of ourrevenues. As of December 31, 2007, we had more than 200 active contractualengagements across 44 federal government agencies. Our customers include theDepartment of Defense (including all major agencies within the Department ofDefense), the Department of State, the Department of Homeland Security, theDepartment of Transportation, the Department of the Treasury, NASA, theDepartment of Justice and the Department of Health and Human Services.

 

**Key Metrics Evaluated By Management**

 

Wemanage and assess the performance of our business by evaluating a variety offinancial and non-financial metrics derived from and in addition to our UnitedStates generally accepted accounting principles, or GAAP, results. The mostsignificant of these metrics are discussed below.

 

***Revenue Growth***

 

Weclosely monitor revenue growth in order to assess the performance of ourbusiness. In monitoring our revenue growth, we focus on both internal revenuegrowth and revenue growth through acquisitions. Our internal revenue growth isdriven primarily by two factors. First, internal revenue growth is driven byadding new customers and by obtaining new task orders and contracts with ourexisting customers. For example, over the past several years we have added theDepartment of the Treasury’s Office of the Comptroller of the Currency, theNational Guard Bureau, the Department of Transportation and agencies in theintelligence community as new customers. Second, internal revenue growth isdriven by increasing revenues under existing contracts and task orders withcustomers. For example, since the initial award of our contract with theDepartment of State for the provision of passport processing and supportservices, the scope of services provided by us, and the revenues generated bythose services, have grown significantly.

 

Ourrevenue growth strategy also includes the pursuit of strategic acquisitions. Wehave completed the following five acquisitions since 2000: our acquisition ofGCI Information Services, Inc. in January 2000, our acquisition ofCCI, Incorporated, or CCI, in September 2002, our acquisition of FuentezSystems Concepts, Inc., or FSC, in December 2003, our acquisition ofMorgan Research Corporation, or Morgan, in February 2006, and ouracquisition of Techrizon, LLC, or Techrizon, in April 2007.

 

 

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***Backlog***

 

Wemonitor backlog, which provides us with visibility of our future revenues, as ameasure of the strength of our target markets and our ability to retainexisting contracts and win new contracts. The following table summarizes ourbacklog as of the dates indicated:

 
| ** **    | ** ** | **As of December 31,** | ** ** |
|---------------|------------|---------------------------------------|------------|
| ** **    | ** ** | **2006**                              | ** ** | **2007** | ** ** |
| ** **    | ** ** | **(in millions)**                | ** ** |
| Backlog:      |       |                                  |       |   |   |
| Funded        |       | $                                     | 219.0      |   | $ | 326.6 |   |
| Unfunded      |       | 841.6                                 |       | 970.6 |   |
| Total Backlog |       | $                                     | 1,060.6    |   | $ | 1,297.2 |   |

 

Eachyear, a significant portion of our revenues is derived from our backlog, and asubstantial portion of our backlog represents work related to the continuationof services and solutions under contracts or projects where we are theincumbent provider.

 

Wedefine backlog as the amount of revenues we expect to realize (i) over theremaining base contract performance period and (ii) from the exercise bythe customer of option periods that we reasonably believe will be exercised, ineach case from signed contracts in existence as of the measurement date. We donot include contract ceiling values, which represent the maximum amount ofcontract awards that could be awarded to all contractors under government-wideacquisition contracts (“GWACs”) or agency-specific indefinitedelivery/indefinite quantity (“ID/IQ”) contracts in our backlog calculation. Wealso do not include in backlog (i) the expected amount of revenues thatwould be realized if, and when, we were successful in the re-compete of signedcontracts in existence as of the measurement date or (ii) the expectedamount of revenues that would be realized from future unidentified growth onsigned contracts and task orders in existence as of the measurement date.

 

Wedefine funded backlog as the portion of our backlog for which funding currentlyis appropriated and obligated to us under a signed contract or task order bythe purchasing agency, or otherwise authorized for payment to us by a customerupon completion of a specified portion of work, less the amount of revenue wehave previously recognized under the contract. Our funded backlog does notinclude the full potential value of our contracts, because Congress oftenappropriates funds to be used by an agency for a particular program or contracton a yearly or quarterly basis, even though the contract may call forperformance over a number of years. As a result, contracts typically are onlypartially funded at any point during their term, and all or some of the work tobe performed under the contracts may remain unfunded unless and until Congressmakes subsequent appropriations and the procuring agency allocates funding tothe contract.

 

***Contract Mix***

 

Wework with the federal government under contracts employing one of three typesof price structures: cost-plus-fee, time-and-materials and fixed-price.Cost-plus-fee contracts are typically lower risk arrangements and thus yieldlower profit margins than time-and-materials and fixed-price arrangements.Because the customer usually specifies the type of contract for a particularcontractual engagement, we generally do not influence the choice of contracttype. However, where we do have the opportunity to influence the contract type,and where customer requirements are clear, we prefer time-and-materials andfixed-price arrangements rather than cost-plus-fee arrangements becausetime-and-materials and fixed-price contracts, as compared with cost-plus-feecontracts, generally provide greater opportunity for the customer to managerisk and for us to generate higher margins. Our acquisition of Techrizon in April 2007has resulted in a shift in our contract mix toward a greater percentage oftime-and-materials contracts. The following table summarizes our historicalcontract mix, measured as a percentage of total revenues, for the periodsindicated:

 
| ** **         | ** ** | **Three Months Ended  December 31,** | ** ** | **Nine Months Ended  December 31,** | ** ** |
|--------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **         | ** ** | **2006**                                                 | ** ** | **2007**                                                | ** ** | **2006** | ** ** | **2007** | ** ** |
| Cost-plus-fee      |       | 52                                                       | %          | 47                                                      | %          | 53 | % | 48 | % |
| Time-and-materials |       | 33                                                       | %          | 38                                                      | %          | 32 | % | 36 | % |
| Fixed-price        |       | 15                                                       | %          | 15                                                      | %          | 15 | % | 16 | % |

 

***Headcount and Labor Utilization***

 

Wegenerate revenues primarily from services provided by our employees andsubcontractors, with services provided by our employees generally yieldinghigher profits than services provided by our subcontractors. Our ability tohire and deploy additional qualified employees is a key driver of our abilityto generate additional revenues, and our successful deployment of existingemployees on direct-billable jobs is a key driver of our profitability.

 

 

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***Indirect Costs***

 

Indirectcosts constitute a substantial portion of the costs associated with ourperformance of contracts for customers. We carefully monitor the amount bywhich our actual indirect costs under our contracts vary from those expected tobe incurred, which we refer to as indirect expense variance. Increased indirectrates can adversely affect our ability to achieve attractive contract pricing,our profitability, and our competitive position, by resulting in unexpectedincreased costs to our customers.

 

***Days Sales Outstanding***

 

Dayssales outstanding, or DSO, is a measure of how efficiently we manage thebilling and collection of our accounts receivable, our most significant workingcapital requirement. For the three months ended December 31, 2007, wereported DSO of 86 days, an increase from 77 days we reported for the threemonths ended September 30, 2007. The increase in DSO was primarily theresult of delayed payments of significant receivables from two customers due tothe restructuring of their payment processing systems.

 

***Unbilled Receivables***

 

Unbilledreceivables are comprised of work-in-process that will be billed in accordancewith contract terms and delivery schedules, as well as amounts billable uponfinal execution of contracts, contract completion, milestones or completion ofrate negotiations. Because the billing of unbilled receivables is contingent onthose events, changes in the relative amount of unbilled receivables have animpact on our working capital and liquidity.

 

Paymentsto us for performance on certain of our federal government contracts aresubject to audit by the DCAA and are also subject to government funding. Weprovide a reserve against our receivables for estimated losses that may resultfrom rate negotiations, audit adjustments and/or government fundingavailability. To the extent that actual adjustments due to rate negotiations,audit adjustments or government funding availability differ from our estimates,our revenue may be impacted. Because substantially all of our receivables comefrom contracts funded by the federal government, the likelihood of a materialloss on an uncollectible account from this activity is low.

 

**Critical Accounting Policies**

 

Thediscussion and analysis of our financial condition and results of operations isbased on our consolidated financial statements, which have been prepared inaccordance with GAAP. The preparation of these condensed consolidated financialstatements requires management to make estimates and assumptions that affectreported amounts, and actual results may differ from the estimates. Oursignificant accounting policies are described in Note 1 to our unauditedcondensed consolidated financial statements included in this report. Weconsider the following accounting policies to be critical to the understandingof our financial condition and results of operations because these policiesrequire the most difficult, subjective or complex judgments on the part of ourmanagement in their application, often as a result of the need to makeestimates about the effect of matters that are inherently uncertain, and arethe most important to our financial condition and operating results.

 

***Revenue Recognition***

 

Werecognize revenue under our contracts when a contract has been executed, thecontract price is fixed and determinable, delivery of services or products hasoccurred and collectibility is considered probable and can be reasonablyestimated. We use a standard management process to determine whether allrequired criteria for revenue recognition have been met, which includes regularreviews of our contract performance. This review covers, among other matters,progress against a schedule, outstanding action items, effort and staffing,quality, risks and issues, subcontract management, costs incurred, commitmentsand customer satisfaction. During this review, we determine whether the overallprogress on a contract is consistent with the effort expended.

 

Contractrevenue recognition inherently involves the use of estimates. Examples ofestimates include the contemplated level of effort to accomplish the tasksunder the contract, the cost of the effort and an ongoing assessment of ourprogress toward completing the contract. From time to time, as part of ourstandard management process, facts develop that require us to revise ourestimated total costs and revenues. To the extent that a revised estimateaffects contract profit or revenue previously recognized, we record thecumulative effect of the revision in the period in which the facts requiringthe revision become known. The full amount of an anticipated loss on any typeof contract is recognized in the period in which it becomes probable and can bereasonably estimated.

 

Undercost-plus-fee contracts, revenues are recognized as costs are incurred andinclude an estimate of applicable fees earned. We consider fixed fees undercost-plus-fee contracts to be earned in proportion to the allowable costsactually incurred in performance of the contract for level of effort contracts.For completion type cost-plus-fee contracts, fixed fees are earned inproportion to the percentage of work completed. For time-and-materialscontracts, revenues are computed by multiplying the number of directlabor-hours expended in performance of the contract by the contractual billingrates and adding other billable direct and indirect costs. For fixed-pricecontracts, revenues are recognized as services are performed, using thepercentage-of-completion method, applying the cost-to-cost or units of deliverymethod, in accordance with ARB 45 and SOP 81-1.

 

 

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Forcost-plus-award fee type contracts, we recognize the expected fee to be awardedby the customer at the time such fee can be reasonably estimated, based onfactors such as prior award experience and communication with the customerregarding performance, including any interim performance evaluations renderedby the customer. For cost-plus-incentive fee type contracts, the method ofcalculating the incentive fee is specified in the contract and it is typicallybased on measuring actual costs to perform the contract against a target costto perform the contract. We prepare periodic estimates to complete the contractand adjust the incentive fee as required based on the contract incentive feeformula.

 

Ourcontracts with agencies of the government are subject to periodic funding bythe respective contracting agency. Funding for a contract may be provided infull at inception of the contract or ratably throughout the contract as theservices are provided. From time to time, we may proceed with work based oncustomer direction prior to the completion and signing of formal contractdocuments. Such situations require completion of a formal internal reviewprocess and management approval prior to commencement of work. Additionally,revenue associated with such work is recognized without profit and only when itcan be reliably estimated and realization is probable. We base our estimates onnotices to proceed from our customers, previous experience with customers,communications with customers regarding funding status, and our knowledge ofavailable funding for the contract or program. Pre-contract costs related tounsuccessful contract bids are expensed in the period in which we are notifiedthat the contract will not be issued.

 

Disputesoccasionally arise in the normal course of our business due to events such asdelays, changes in contract specifications, and questions of cost allowabilityor collectibility. Such matters, whether claims or unapproved change orders inthe process of negotiation, are recorded at the lesser of their estimated netrealizable value or actual costs incurred, and only when the realization isprobable and can be reliably estimated. Claims against us are recognized wherea loss is considered probable and can be reasonably estimated in amount.

 

***Contract Cost Accounting***

 

Asa contractor providing services primarily to the federal government, we mustcategorize our costs as either direct or indirect and allowable or unallowable.Direct costs are those costs that are identified with specific contracts. Thesecosts include labor, travel, subcontractor and consultant services, third partymaterials we purchase under a contract and other non-labor costs incurred insupport of a contract. Indirect costs are those costs not identified withspecific contracts. Rather, indirect costs are allocated to contracts inaccordance with federal government rules and regulations. These coststypically include certain of our selling, general and administrative expenses,fringe benefit expenses, overhead expenses and depreciation and amortizationcosts. Direct and indirect costs that are not allowable under the FederalAcquisition Regulation or specific contract provisions cannot be considered forreimbursement under our federal government contracts. We must specificallyidentify these costs to ensure we comply with these requirements. Ourunallowable costs include a portion of our executive compensation, certainemployee morale activities, certain types of legal and consulting costs,interest expense and the amortization of identified intangible assets, amongothers.

 

***Goodwill and Intangible Assets***

 

Goodwillrepresents the excess of cost over the fair value of net tangible andidentifiable intangible assets of acquired companies. In accordance with SFAS No. 142,*Goodwill and Other Intangible Assets*  (“SFAS No. 142”), we do not amortizegoodwill. Rather, we test goodwill for impairment at least on an annual basis.Testing for impairment is a two-step process as prescribed by SFAS No. 142.The first step is a test for potential impairment, while the second stepmeasures the amount of impairment, if any. Under the guidelines of SFAS No. 142,we are required to perform an impairment test at least on an annual basis atany time during the fiscal year, provided that the test is performed at thesame time every year. An impairment loss would be recognized when the assets’fair value is below their carrying value. Based on the testing performed as of December 31,2007, we determined that no impairments existed as of December 31, 2007.Customer relationships, noncompete agreements and backlog and contracts areamortized on a straight-line basis over periods ranging from two to sevenyears.

 

 

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**Results of Operations**

 

Ourhistorical financial statements reflect the operating results of ouracquisitions from the date of acquisition. The following unaudited tables setforth the results of operations expressed in dollars (in thousands) and as apercentage of revenues, for the periods below:

 
| ** **                                                     | ** ** | **Three Months Ended  December 31,** | ** ** | **Nine Months Ended  December 31,** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **Consolidated Statements of Income Data** | ** ** | **2006**                                                 | ** ** | **2007**                                                | ** ** | **2006** | ** ** | **2007** | ** ** |
| Revenues                                                       |       | $                                                        | 102,023    |                                                    | $          | 147,083 |   | $ | 292,769 |   | $ | 430,803 |   |
| Operating costs and  expenses:                                 |       |                                                     |       |                                                    |       |   |   |   |   |
| Cost of revenues                                               |       | 86,686                                                   |       | 123,660                                                 |       | 248,106 |   | 363,538 |   |
| Selling, general and administrative                            |       | 6,540                                                    |       | 9,431                                                   |       | 19,619 |   | 28,181 |   |
| Amortization of deferred compensation                          |       | 4,361                                                    |       | 62                                                      |       | 4,964 |   | 205 |   |
| Depreciation and amortization                                  |       | 1,353                                                    |       | 1,694                                                   |       | 4,047 |   | 5,005 |   |
| Total operating costs and  expenses                            |       | 98,940                                                   |       | 134,847                                                 |       | 276,736 |   | 396,929 |   |
| Operating income                                               |       | 3,083                                                    |       | 12,236                                                  |       | 16,033 |   | 33,874 |   |
| Other income (expense):                                        |       |                                                     |       |                                                    |       |   |   |   |   |
| Other income (expense)                                         |       | 95                                                       |       | 10                                                      |       | (450 | ) | 16 |   |
| Interest expense—net                                      |       | (1,040                                                   | )          | (919                                                    | )          | (5,219 | ) | (3,120 | ) |
| Total other expenses                                           |       | (945                                                     | )          | (909                                                    | )          | (5,669 | ) | (3,104 | ) |
| Income before taxes                                            |       | 2,138                                                    |       | 11,327                                                  |       | 10,364 |   | 30,770 |   |
| Provision for income taxes                                     |       | (878                                                     | )          | (4,576                                                  | )          | (4,198 | ) | (12,320 | ) |
| Net income                                                     |       | $                                                        | 1,260      |                                                    | $          | 6,751 |   | $ | 6,166 |   | $ | 18,450 |   |

 
| ** **                                          | ** ** | **Three Months Ended  December 31,** | ** ** | **Nine Months Ended  December 31,** | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **As a Percentage of Revenues** | ** ** | **2006**                                                 | ** ** | **2007**                                                | ** ** | **2006** | ** ** | **2007** | ** ** |
| Revenues                                            |       | 100.0                                                    | %          | 100.0                                                   | %          | 100.0 | % | 100.0 | % |
| Operating costs and  expenses:                      |       |                                                     |       |                                                    |       |   |   |   |   |
| Cost of revenues                                    |       | 85.0                                                     |       | 84.1                                                    |       | 84.7 |   | 84.4 |   |
| Selling, general and administrative                 |       | 6.4                                                      |       | 6.4                                                     |       | 6.7 |   | 6.5 |   |
| Amortization of deferred compensation               |       | 4.3                                                      |       | —                                                  |       | 1.7 |   | — |   |
| Depreciation and amortization                       |       | 1.3                                                      |       | 1.2                                                     |       | 1.4 |   | 1.2 |   |
| Total operating costs and  expenses                 |       | 97.0                                                     |       | 91.7                                                    |       | 94.5 |   | 92.1 |   |
| Operating income                                    |       | 3.0                                                      |       | 8.3                                                     |       | 5.5 |   | 7.9 |   |
| Other income (expense):                             |       |                                                     |       |                                                    |       |   |   |   |   |
| Other income (expense)                              |       | 0.1                                                      |       | —                                                  |       | (0.2 | ) | — |   |
| Interest expense—net                           |       | (1.0                                                     | )          | (0.6                                                    | )          | (1.8 | ) | (0.7 | ) |
| Total other expenses                                |       | (0.9                                                     | )          | (0.6                                                    | )          | (2.0 | ) | (0.7 | ) |
| Income before taxes                                 |       | 2.1                                                      |       | 7.7                                                     |       | 3.5 |   | 7.2 |   |
| Provision for income taxes                          |       | (0.9                                                     | )          | (3.1                                                    | )          | (1.4 | ) | (2.9 | ) |
| Net income                                          |       | 1.2                                                      | %          | 4.6                                                     | %          | 2.1 | % | 4.3 | % |

 

Wegenerate revenues primarily from services provided by our employees andsubcontractors, with services provided by our employees generally yieldinghigher profits than services provided by our subcontractors. To a lesserdegree, we earn revenues through reimbursable travel and other reimbursabledirect and indirect costs to support the contractual effort and third-partyhardware and software that we purchase and integrate for customers as part of thesolutions we provide.

 

Ourmost significant expense is cost of revenues, which includes the costs ofdirect labor, subcontractors, materials, equipment, non-reimbursable travel andan allocation of indirect costs (other than selling, general and administrativeexpenses and depreciation). Indirect costs consist primarily of fringebenefits, human resources, recruiting, training, other overhead and certainother non-direct costs that are necessary to support direct labor. The numberand types of personnel, their salaries and other costs, can have a significantimpact on our cost of revenues.

 

 

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Ourselling, general and administrative expenses include costs not directlyassociated with performing work for our customers. These costs include wagesplus associated fringe benefits, stock-based compensation charges, rent, traveland insurance. Among the functions covered by these expenses are sales,business development, contract administration, legal, finance, accounting,human resources, information technology and general management. Most of thesecosts are allowable costs under the cost accounting standards for contractingwith the federal government and are recoverable under cost-plus-fee contracts.

 

Ourdepreciation and amortization expenses include the amortization of purchasedintangibles in connection with acquisitions and the amortization of leaseholdimprovements and the depreciation of property and equipment purchased in theordinary course of business.

 

Certainrevenues and payments we receive are based on provisional billings and paymentsthat are subject to adjustment after audit. Federal government agencies havethe right to challenge our cost estimates and allocation methodologies withrespect to government contracts. In addition, contracts with these agencies aresubject to audit and possible adjustment to give effect to unallowable costsunder cost-plus-fee contracts or to other regulatory requirements affectingboth cost-plus-fee and fixed-price contracts.

 

***Comparison of Results of Operationsfor the Three Months Ended December 31, 2006 and 2007***

 

***Revenues.***  Ourconsolidated revenues increased $45.1 million, or 44.2%, from $102.0 millionfor the three months ended December 31, 2006, to $147.1 million for thethree months ended December 31, 2007. The increase was primarily due to$10.6 million of increased revenues attributable to the operations ofTechrizon, $8.8 million of increased revenues attributable to expanding demandfor passport services for the Department of State’s Bureau of Consular Affairs,$7.1 million of increased revenues attributable to production and engineeringservices under various SPAWAR programs, $3.9 million of increased revenuesattributable to information systems support provided to the U.S. Marine Corps,to include software and network engineering services for the Marine CorpsRecruiting Command (“MCRC”), $3.4 million of increased revenue attributable toour contract with the U.S. Citizenship and Immigration Services, and $2.0million of increased revenues attributable to contracts that includespecialized engineering and technology services provided to the U.S. ArmyAviation and Missile Command (“AMCOM”). The balance of the increased revenuesof $9.3 million was primarily related to continued growth providing enterpriseintegration and operational support services for the Department of Defense, andongoing logistics support for the Army’s equipment reset effort in the UnitedStates and abroad.

 

***Cost of Revenues.***  Our costof revenues increased $37.0 million, or 42.7%, from $86.7 million for the threemonths ended December 31, 2006, to $123.7 million for the three monthsended December 31, 2007. This increase was primarily the result ofadditional costs attributable to revenues generated by Techrizon’s operations,in addition to the cost of revenues associated with the increased servicesprovided under the contracts referred to above. Cost of revenues represented84.1% of total revenues for the three months ended December 31, 2007, ascompared to 85.0% of total revenues for the three months ended December 31,2006. This decrease was primarily the result of a greater proportion oftime-and-material contracts, which generally produce higher gross margins,versus cost-plus-fee contracts.

 

***Selling, General and Administrative.***  Ourselling, general and administrative expense increased $2.9 million, or 44.2%,from $6.5 million for the three months ended December 31, 2006, to $9.4million for the three months ended December 31, 2007. This increase wasprimarily due to higher selling, general and administrative expenses to supportexpanding operations from organic and acquired growth, FAS 123(R) share-basedpayment expenses, higher recruiting costs to expand our workforce, andadditional costs associated with being a public company, including costsassociated with legal, internal and external audit, tax and Sarbanes-Oxleycompliance services.

 

***Amortization of DeferredCompensation.***  Our amortization of deferred compensationexpense decreased $4.3 million from $4.4 million for the three months ended December 31,2006, to $0.1 million for the three months ended December 31, 2007. Theamortization of deferred compensation expense for the three months ended December 31,2006 was primarily due to the acceleration of the vesting periods of certainrestricted stock grants related to our initial public offering.

 

***Depreciation and Amortization.***  Ourdepreciation and amortization expense increased $0.3 million, or 25.1%, from$1.4 million for the three months ended December 31, 2006, to $1.7 millionfor the three months ended December 31, 2007. The increase in depreciationand amortization was primarily due to the amortization of intangible assetsassociated with the Techrizon acquisition as well as additional depreciationexpense associated with capital expenditures during fiscal 2007.

 

***Other Income.***  Ourother income decreased $0.1 million from $0.1 million for the three monthsended December 31, 2006, to $0.0 million for the three months ended December 31,2007. The other income for the three months ended December 31, 2006resulted from a net unrealized gain in the fair value of our interest rate swapagreement.

 

***Interest Expense, Net.***  Our netinterest expense decreased $0.1 million from $1.0 million for the three monthsended December 31, 2006, to $0.9 million for the three months ended December 31,2007. The decrease in net interest expense was due to the repayment of termloan borrowings with the proceeds from our initial public offering completed inOctober 2006 and decreased interest rates under our amended creditfacility offset by borrowings used to finance the acquisition of Techrizon.

 

***Net Income.***  Our netincome increased $5.5 million from $1.3 million for the three months ended December 31,2006, to $6.8 million for the three months ended December 31, 2007. Theprimary reasons for the increase in net income were higher operating income,the prior year acceleration of the vesting periods of certain restricted stockgrants, lower interest expense, profits from Techrizon and a slightly lowereffective income tax rate.

 

 

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***Comparison of Results of Operationsfor the Nine Months Ended December 31, 2006 and 2007***

 

***Revenues.***  Ourconsolidated revenues increased $138.0 million, or 47.1%, from $292.8 millionfor the nine months ended December 31, 2006, to $430.8 million for thenine months ended December 31, 2007. The increase was primarily due to$30.4 million of increased revenues attributable to expanding demand forpassport services for the Department of State’s Bureau of Consular Affairs,$30.9 million of increased revenues attributable to the acquisition ofTechrizon, $24.3 million of increased revenue attributable to production andengineering services under various SPAWAR programs, $11.9 million of increasedrevenues attributable to information systems support provided to the U.S.Marine Corps, to include software and network engineering services for theMCRC, and $11.3 million of increased revenues attributable to specializedengineering and technology services provided to AMCOM and PEO STRI. The balanceof the increased revenues of $29.2 million was related to continued growthproviding enterprise integration and operational support services for the Departmentof Defense, and ongoing logistics support for the Army’s equipment reset effortin the United States and abroad.

 

***Cost of Revenues.***  Our costof revenues increased $115.4 million, or 46.5%, from $248.1 million for the sixmonths ended December 31, 2006, to $363.5 million for the nine monthsended December 31, 2007. This increase was primarily the result ofadditional costs attributable to revenues generated by Techrizon’s operations,in addition to the cost of revenues associated with the increased servicesprovided under the contracts referred to above. Cost of revenues represented84.4% of total revenues for the nine months ended December 31, 2007, ascompared to 84.7% of total revenues for the nine months ended December 31,2006. This decrease was primarily the result of a greater proportion oftime-and-material contracts, which generally produce higher gross margins,versus cost-plus-fee contracts.

 

***Selling, General and Administrative.***  Ourselling, general and administrative expense increased $8.6 million, or 43.6%,from $19.6 million for the nine months ended December 31, 2006, to $28.2million for the nine months ended December 31, 2007. This increase wasprimarily due to higher selling, general and administrative expenses to supportexpanding operations from organic and acquired growth, FAS 123(R) share-basedpayment expenses, higher recruiting costs to expand our workforce, andadditional costs associated with being a public company, including costsassociated with legal, internal and external audit, tax and Sarbanes-Oxleycompliance services. Selling, general and administrative expenses represented6.5% of total revenues for the nine months ended December 31, 2007, ascompared to 6.7% of total revenues for the nine months ended December 31,2006. This decrease was primarily the result of efficiencies in our corporatestructure on a higher revenue base.

 

***Amortization of DeferredCompensation.***  Our amortization of deferred compensationexpense decreased $4.8 million from $5.0 million for the nine months ended December 31,2006, to $0.2 million for the nine months ended December 31, 2007. Theamortization of deferred compensation expense for the nine months ended December 31,2006 were primarily due to the acceleration of the vesting periods of certainrestricted stock grants related to our initial public offering.

 

***Depreciation and Amortization.***  Ourdepreciation and amortization expense increased $1.0 million, or 23.7%, from$4.0 million for the nine months ended December 31, 2006, to $5.0 millionfor the nine months ended December 31, 2007. The increase in depreciationand amortization was primarily due to the amortization of intangible assetsassociated with the Techrizon acquisition as well as additional depreciationexpense associated with capital expenditures during fiscal 2007.

 

***Other Expense.***  Ourother expense decreased $0.5 million from $0.5 million for the nine monthsended December 31, 2006, to $0.0 million for the nine months ended December 31,2007. The other expense for the nine months ended December 31, 2006resulted from a net unrealized loss in the fair value of our interest rate swapagreement.

 

***Interest Expense, Net.***  Our netinterest expense decreased $2.1 million, or 40.2%, from $5.2 million for thenine months ended December 31, 2006, to $3.1 million for the nine monthsended December 31, 2007. The decrease in net interest expense was due tothe repayment of term loan borrowings with the proceeds from our initial publicoffering completed in October 2006 and reduced interest rates under ouramended credit facility offset by borrowings used to finance the acquisition ofTechrizon.

 

***Net Income.***  Our netincome increased $12.3 million from $6.2 million for the nine months ended December 31,2006, to $18.5 million for the nine months ended December 31, 2007. Theprimary reasons for the increase in net income are higher operating income, theprior year acceleration of the vesting periods of certain restricted stockawards, lower interest expense, profits from Techrizon and a slightly lowereffective income tax rate.

 

**Liquidity and Capital Resources**

 

Ourprimary liquidity needs are to finance the costs of operations pending thebilling and collection of accounts receivable, to service our debt, to makecapital expenditures and to make selective strategic acquisitions. Based uponour current operations, we expect that our cash flow from operations, togetherwith amounts we are able to borrow under our senior credit facility, will be

 

 

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adequateto meet our anticipated needs for the foreseeable future. In addition, weexpect that our cash flow from operations will be adequate to meet allcontractual obligations under the senior credit facility and our operatingleases. Although we have no specific plans to do so, to the extent we decide topursue one or more significant strategic acquisitions, we will likely need toincur additional debt or sell additional equity.

 

***Cash Flows***

 

Accountsreceivable represents our largest working capital requirement. We bill most ofour customers monthly after services are rendered. Our operating cash flow isprimarily affected by the overall profitability of our contracts, our abilityto invoice and collect from our customers in a timely manner, and our abilityto manage our vendor payments.

 
| ** **                                | ** ** | **Nine Months Ended  December 31,** | ** ** |
|-------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                | ** ** | **2006**                                           | ** ** | **2007** | ** ** |
| ** **                                | ** ** | **(in millions)**                             | ** ** |
| Net cash provided by operating activities |       | $                                                  | 15.6       |   | $ | 3.3 |   |
| Net cash used in investing activities     |       | $                                                  | (2.5       | ) | $ | (33.0 | ) |
| Net cash provided by financing activities |       | $                                                  | 0.4        |   | $ | 17.0 |   |

 

Netcash provided by operating activities of $3.3 million for the nine months endedDecember 31, 2007 primarily reflected our net income plus depreciation andamortization expenses for that period and a $15.8 million increase in accruedexpenses, partially offset by a $31.7 million increase in accounts receivableand a $5.1 million decrease in accounts payable. For the nine months ended December 31,2006, net cash provided by operating activities of $15.6 million consistedprimarily of net income plus depreciation and amortization expenses, an $8.3million increase in accrued expenses and a $1.6 million income tax benefit fromstock-based compensation, partially offset by an $8.0 million increase inaccounts receivable.

 

Netcash used in investing activities of $33.0 million for the nine months ended December 31,2007 consisted primarily of $30.6 million to complete the acquisition ofTechrizon. Net cash used in investing activities of $2.5 million for the ninemonths ended December 31, 2006 consisted primarily of the purchase ofequipment in the ordinary course of business.

 

Netcash provided by financing activities of $17.0 million for the nine monthsended December 31, 2007 consisted primarily of $16.8 million of borrowingsunder the revolving portion of our senior credit facility to support theacquisition of Techrizon. Net cash provided by financing activities of $0.4million for the nine months ended December 31, 2006 consisted primarily of$71.8 million in net proceeds received from the sale of stock in our initialpublic offering, offset by $62.0 million of repayments on long-term debt and$10.4 million of net repayments of our line of credit.

 

***Credit Facility and BorrowingCapacity***

 

OnOctober 10, 2007, we entered into an Amended and Restated Revolving Creditand Term Loan Agreement (the “Amended Credit Agreement”) with a group oflenders for which SunTrust Robinson Humphrey, Inc. acted as sole bookmanager and lead arranger, SunTrust Bank acted as administrative agent andM&T Bank and BB&T Bank acted as co-documentation agents. The AmendedCredit Agreement amends and restates the previous credit agreement entered intoin February 2006. In connection with the Amended Credit Agreement, we paidfees of approximately $0.5 million.

 

TheAmended Credit Agreement increased the amount of the lenders’ aggregatecommitment under the facility from $87.0 million to $187.0 million, whichincludes a $150.0 million revolving credit facility and a $37.0 million termloan. The term loan commitment matures on January 31, 2012 and therevolving commitment matures on October 31, 2012. The Amended CreditAgreement also increased the letter of credit commitment from $5.0 million to$10.0 million, increased the swing line facility from $5.0 million to $20.0million and eliminated the requirement to hedge a portion of our outstandingindebtedness under our senior credit facility.

 

Underthe terms of the amended credit facility, we are entitled to request anincrease in the size of the credit facility by an amount not greater than$125.0 million in the aggregate. If any lender elects not to increase itscommitment under the senior credit facility, we may designate another bank orother financial institution to become a party to the credit facility.

 

TheAmended Credit Agreement also contains a number of affirmative and restrictivecovenants, including limitations on mergers, consolidations and dissolutions;sales of assets; investments and acquisitions; indebtedness and liens;repurchases of shares of capital stock and options to purchase shares ofcapital stock; transactions with affiliates; sale and leaseback transactions;and restricted payments.

 

Inaddition, the Amended Credit Agreement provides that we are required to meetthe following financial covenants:

 

·                  a fixed charge coverage ratio as of the endof any fiscal quarter of not less than 1.35 to 1.00, based upon the ratio of (i) consolidatedEBITDA (as defined in the Amended Credit Agreement) less the actual amount paidby us and our

 

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subsidiaries in cash on account of capital expenditures and taxes to (ii) consolidatedinterest expense for such period, scheduled principal payments required to bemade on consolidated total debt during such period and certain restrictedpayments paid during such period, in each case measured for the fourconsecutive fiscal quarters ending on or immediately prior to such date; and

 

·                  a maximum leverage ratio not greater than3.75 to 1.00, based upon the ratio of (i) consolidated total debt to (ii) consolidatedEBITDA (as defined in the Amended Credit Agreement).

 

Asof December 31, 2007, we had $36.8 million of term loan indebtedness and$16.8 million of revolving indebtedness outstanding under our senior creditfacility. As of December 31, 2007, our borrowing availability under ouramended $150.0 million revolving credit facility was $133.1 million (includingoutstanding letters of credit). As of December 31, 2007, we were incompliance with all covenants under our senior credit facility. The obligationsunder our senior credit facility are unconditionally guaranteed by each of ourexisting and subsequently acquired or organized subsidiaries and securedsubsidiaries and are secured on a first-priority basis by security interests(subject to permitted liens) in substantially all assets owned by us and eachof our subsidiaries, including the shares of capital stock of our subsidiaries,subject to certain exceptions.

 

**Capital Expenditures**

 

Wehave relatively low capital expenditure requirements. Our capital expenditureswere $2.0 million and $2.4 million for the nine months ended December 31,2006 and 2007, respectively. Substantially all of these expenditures consistedof leasehold improvements and purchases of office equipment.

 

**Off-Balance Sheet Arrangements**

 

Wedo not have any significant off-balance sheet arrangements as defined in Item303(a)(4)(ii) of SEC Regulation S-K as of December 31, 2007.

 

**Recent Accounting Pronouncements**

 

InJuly 2006, the Financial Accounting Standards Board (“FASB”) issuedInterpretation No. 48,*Accounting forUncertainty in Income Taxes, an interpretation of FASB Statement No. 109,Accounting for Income Taxes* (“FIN 48”). FIN 48 provides guidance on recognition, derecognition,measurement, classification, interest and penalties, accounting for interimperiods and disclosures. FIN 48 requires an entity to recognize the financialstatement impact of a tax position when it is more likely than not that theposition will be sustained upon examination. The amount recognized is measuredat the largest amount of benefit that is greater than fifty percent likely ofbeing realized upon ultimate settlement. In addition, FIN 48 permits an entityto recognize interest and penalties related to tax uncertainties as income taxexpense or operating expenses. FIN 48 is effective for fiscal years beginningafter December 15, 2006. We adopted the provisions of FIN 48 on April 1,2007. The cumulative effects of applying this interpretation have been recordedas a decrease of $0.3 million to retained earnings, an increase of $0.5 millionto net deferred tax assets, a decrease to income taxes payable of $0.1 millionand an increase in liabilities of $0.5 million for unrecognized tax benefitsand $0.4 million for interest and penalties.

 

InSeptember 2006, the FASB issued Statement of Financial AccountingStandards No. 157,*Fair ValueMeasurements* (“SFAS 157”). SFAS 157 provides guidance for measuringthe fair value of assets and liabilities. It requires additional disclosuresrelated to the extent to which companies measure assets and liabilities at fairvalue, the information used to measure fair value, and the effect of fair valuemeasurements on earnings. SFAS 157 is effective for fiscal years beginningafter November 15, 2007. We are in the process of determining what effect,if any, the adoption of SFAS 157 will have on our financial position, resultsof operations, or cash flows.

 

InFebruary 2007, the FASB issued Statement of Financial Accounting StandardsNo. 159,*The Fair Value Option forFinancial Assets and Financial Liabilities-Including an Amendment of FASBStatement No. 115*  (“SFAS159”). SFAS 159 permits entities to measure many financial instruments andcertain other items at fair value to improve financial reporting by providingentities with the opportunity to mitigate volatility in reported earningscaused by measuring related assets and liabilities differently without havingto apply complex hedge accounting. Most of the provisions in SFAS 159 areelective. This statement will be effective for us in fiscal 2009, and it may beapplied prospectively. Early adoption is permitted, provided we also elect toapply the provisions of SFAS 157. We are in the process of determining whateffect, if any, the application of the provisions of SFAS 159 will have on ourfinancial position, results of operations or cash flows.

 

InDecember 2007, the FASB issued SFAS No. 141(R), *Business Combinations*(SFAS 141(R)), and SFAS No. 160, *Non- Controlling**Interest in Consolidated Financial Statements*,*an Amendment of ARB No. 51* (SFAS 160).These new standards will significantly change the accounting for and reportingfor business combination transactions and non-controlling interests inconsolidated financial statements. SFAS 141(R) and SFAS 160 are required to beadopted simultaneously and are effective for fiscal years beginning on or afterDecember 15, 2008. We are in the process of determining what effect, if any,the application of the provisions of SFAS 141(R) and SFAS 160 will have on ourfinancial position, results of operations or cash flows.

 

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**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

Ourprincipal exposure to market risk relates to changes in interest rates. Fromtime to time, we enter into interest rate swap agreements to effectively limitexposure to interest rate movements within the parameters of our interest ratehedging policy. As of

December 31,2007, all of the outstanding debt under our senior credit facility, with theexception of that portion covered by an interest rate swap, was subject tofloating interest rate risk. In October 2006, we entered into an interestrate swap agreement currently covering $18.6 million of our term indebtednessunder which the swap and term debt maturities match. Even after giving effectto this agreement, we are exposed to risks due to fluctuations in the marketvalue of this agreement and changes in interest rates with respect to theportion of our senior credit facility that is not covered by this agreement. Ahypothetical increase in the interest rate of 100 basis points would haveincreased our nine month interest expense on that portion of our outstandingdebt not covered by the interest rate swap by $0.3 million.

 

**ITEM 4.  CONTROLS AND PROCEDURES**

 

Asof December 31, 2007, under the supervision and with the participation ofour management, including our chief executive officer and our chief financialofficer, we have evaluated the effectiveness of the design and operation of ourdisclosure controls and procedures pursuant to Rule 13a-15 of theSecurities Exchange Act of 1934. Based on this evaluation, our chief executive officerand our chief financial officer have concluded that our disclosure controls andprocedures are effective in timely alerting management, including the chiefexecutive officer and chief financial officer, of material information about usrequired to be included in periodic Securities and Exchange Commission filings.However, in evaluating the disclosure controls and procedures, managementrecognized that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives and management necessarily was required to apply itsjudgment in evaluating the cost-benefit relationship of possible controls andprocedures.

 

Therewere no changes in our internal control over financial reporting during thethree months ended December 31, 2007 that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II:OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

Neitherwe, nor any of our subsidiaries, are currently subject to any material legalproceedings, nor, to our knowledge, is any material legal proceeding threatenedagainst us.

 

**ITEM 1A. RISK FACTORS**

 

Ourbusiness is subject to certain risks and events that, if they occur, couldadversely affect our financial condition and results of operations and thetrading price of our common stock. For a discussion of these risks, pleaserefer to the “Risk Factors” section of our Annual Report on Form 10-K forthe year ended March 31, 2007, filed by us with the Securities andExchange Commission on June 1, 2007, and our Quarterly Report on Form 10-Qfor the quarter ended June 30, 2007, filed by us with the SecuritiesExchange Commission on August 9, 2007. In connection with our preparationof this quarterly report, management has determined that the following riskfactor should be read in connection with the existing risk factors disclosed inour Annual Report on Form 10-K for the fiscal year ended March 31,2007 and our Quarterly Report on Form 10-Q for the quarter ended June 30,2007.

 

***Our employees’ attempt to form a union and negotiate a collectivebargaining agreement on our contract with the United States Citizenship &Immigration Services, Department of Homeland Security, may negatively impactour profitability on that contract.***

 

Webegan performance on a new engagement with the United States Citizenship &Immigration Services (“USCIS”), Department of Homeland Security on December 3,2007.  The USCIS contract involves work at service centers in St. Albans,Vermont and Laguna Niguel, California.  On December 21, 2007, theUnited Electrical, Radio and Machine Workers of America (“UE”), filed apetition with the National Labor Relations Board (“NLRB”), Region 1, in Boston,Massachusetts, seeking a secret ballot election for employees at the USCISVermont Service Center (“VSC”).  An election date has not been set by theNLRB.  On January 25, 2008, the UE filed a petition with the NLRB,Region 21, in Los Angeles, California, seeking a secret ballot election foremployees in the USCIS California Service Center (“CSC”).  An electiondate has not been set by the NLRB.  If either or both of the servicecenter employees become unionized, we would enter into good faith negotiationsfor a collective bargaining agreement (“CBA”) amongst the parties, settingforth the wages, benefits and working conditions for all of our employees atthe VSC and CSC.  Our revenues on this contract may be impacted if anyagreed upon CBA alters the wages and/or benefits in a manner that isinconsistent with our initial bid for this work.

 

**ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES ANDUSE OF PROCEEDS**

 

None.

 

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

 

None.

 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

 

None.

 

**ITEM 5. OTHER INFORMATION**

 

None.

 

**ITEM 6. EXHIBITS**

 

Seethe exhibit index.

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned.

 
|       | **STANLEY, INC.**                                                                                                                         |
|------------|-------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** **                                                                                                                                |
|       | **/s/ PHILIP O. NOLAN**                                                                                                                   |
|       | Philip  O. Nolan   Chairman, President and Chief Executive Officer   (Principal Executive Officer)   February 6, 2008                |
|       |                                                                                                                                      |
|       | **/s/ BRIAN J. CLARK**                                                                                                                    |
|       | Brian  J. Clark   Executive Vice President, Chief Financial Officer and Treasurer   (Principal Financial Officer)   February 6, 2008 |

 

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**EXHIBIT INDEX**

** **
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                             |
|----------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                  |       | Amended  and Restated Certificate of Incorporation of Stanley, Inc., incorporated  by reference to Exhibit 3.1 to   Pre-Effective Amendment No. 2 to the Registration Statement  on Form S-1 (File No. 333-134053), filed July 28, 2006. |
|                 |       |                                                                                                                                                                                                                                                                        |
| 3.3                  |       | Amended  and Restated Bylaws of Stanley, Inc., incorporated by reference to  Exhibit 3.3 to Pre-Effective   Amendment No. 2 to the Registration Statement on Form S-1  (File No. 333-134053), filed July 28, 2006.                  |
|                 |       |                                                                                                                                                                                                                                                                        |
| 31.1                 |       | Certification  of Chief Executive Officer pursuant to Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended.                                                                                                                                         |
|                 |       |                                                                                                                                                                                                                                                                        |
| 31.2                 |       | Certification  of Chief Financial Officer pursuant to Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended.                                                                                                                                         |
|                 |       |                                                                                                                                                                                                                                                                        |
| 32.1                 |       | Certification  of Chief Executive Officer and Chief Financial Officer pursuant to U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                    |

 

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