**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

** **

**FORM 10-Q**

** **

**x**                              QUARTERLYREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

**For the quarterly periodended**June 30, 2007

** **

**OR**

** **

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 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)

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes x  No o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act. (Check one):

oLarge accelerated filer      oAccelerated filer      x Non-acceleratedfiler

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

Asof August 3, 2007, there were 22,195,129 shares of our Common Stock, par value$0.01 per share, outstanding.

 

 

----

 

**STANLEY, INC. ANDSUBSIDIARIESFORM 10-QFOR THE QUARTER ENDED JUNE 30, 2007INDEX**
| **PART 1 — FINANCIAL  INFORMATION**                                                                      |   |   |   |
|---------------------------------------------------------------------------------------------------------------|--------|--------|--------|
| ITEM  1. FINANCIAL STATEMENTS                                                                                 |   |   |   |
| ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS |   |   |   |
| ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT  MARKET RISK                                            |   |   |   |
| ITEM 4. CONTROLS AND PROCEDURES                                                                               |   |   |   |
| **PART  II — OTHER INFORMATION**                                                                         |   |   |   |
| ITEM  1. LEGAL PROCEEDINGS                                                                                    |   |   |   |
| ITEM  1A. RISK FACTORS                                                                                        |   |   |   |
| ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND  USE OF PROCEEDS                                          |   |   |   |
| ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                                                       |   |   |   |
| ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS                                                  |   |   |   |
| ITEM  5. OTHER INFORMATION                                                                                    |   |   |   |
| ITEM 6.  EXHIBITS                                                                                             |   |   |   |

 

2

----

 

**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** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|
| ** **                             | ** ** | **June 30,**                | ** ** |
| ** **                             | ** ** | **2006**                         | ** ** | **2007** | ** ** |
| Revenues                               |       | $                                | 92,555     |   | $ | 133,481 |   |
|                                   |       |                             |       |   |   |
| Operating costs and  expenses:         |       |                             |       |   |   |
| Cost of revenues                       |       | 78,303                           |       | 112,329 |   |
| Selling, general  and administrative   |       | 6,521                            |       | 9,423 |   |
| Amortization of  deferred compensation |       | 249                              |       | 75 |   |
| Depreciation and  amortization         |       | 1,387                            |       | 1,609 |   |
| Total operating costs  and expenses    |       | 86,460                           |       | 123,436 |   |
| Operating income                       |       | 6,095                            |       | 10,045 |   |
|                                   |       |                             |       |   |   |
| Other income (expense):                |       |                             |       |   |   |
| Other income                           |       | 260                              |       | — |   |
| Interest expense  — net           |       | (2,145                           | )          | (1,062 | ) |
| Total other  expenses                  |       | (1,885                           | )          | (1,062 | ) |
| Income before  taxes                   |       | 4,210                            |       | 8,983 |   |
|                                   |       |                             |       |   |   |
| Provision for income  taxes            |       | (1,726                           | )          | (3,619 | ) |
| Net income                             |       | $                                | 2,484      |   | $ | 5,364 |   |
|                                   |       |                             |       |   |   |
| Earnings per share:                    |       |                             |       |   |   |
| Basic                                  |       | $                                | 0.17       |   | $ | 0.24 |   |
| Diluted                                |       | $                                | 0.15       |   | $ | 0.23 |   |
|                                   |       |                             |       |   |   |
| Weighted average  shares:              |       |                             |       |   |   |
| Basic                                  |       | 14,417                           |       | 21,898 |   |
| Diluted                                |       | 16,323                           |       | 23,361 |   |

 

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

3

----

** **

**STANLEY, INC.AND SUBSIDIARIESCondensed Consolidated Balance Sheets(in thousands, except share data)(unaudited)**
| ** **                                                                                                          | ** ** | **March 31, 2007** | ** ** | **June 30, 2007** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                                          | ** ** | ** **                   | ** ** | ** **                  | ** ** |
|                                                                                                                |       |                         |       |                        |       |
| Current Assets:                                                                                                     |       |                         |       |                        |       |
| Cash                                                                                                                |       | $                            | 12,736     |                        | $          | — |   |
| Accounts receivable — net                                                                                      |       | 110,029                      |       | 121,896                     |       |
| Prepaid and other current assets                                                                                    |       | 1,631                        |       | 3,391                       |       |
| Total current assets                                                                                                |       | 124,396                      |       | 125,287                     |       |
|                                                                                                                |       |                         |       |                        |       |
| Property and  equipment — net                                                                                  |       | 11,736                       |       | 12,455                      |       |
| Goodwill                                                                                                            |       | 88,249                       |       | 113,571                     |       |
| Intangible  assets — net                                                                                       |       | 9,417                        |       | 10,963                      |       |
| Deferred taxes                                                                                                      |       | 2,010                        |       | 1,867                       |       |
| Other assets                                                                                                        |       | 2,167                        |       | 2,040                       |       |
| Total assets                                                                                                        |       | $                            | 237,975    |                        | $          | 266,183 |   |
|                                                                                                                |       |                         |       |                        |       |
| **Liabilities  and Stockholders’ Equity**                                                                      | ** ** | ** **                   | ** ** | ** **                  | ** ** |
|                                                                                                                |       |                         |       |                        |       |
| Current  liabilities                                                                                                |       |                         |       |                        |       |
| Line of credit                                                                                                      |       | $                            | —     |                        | $          | 25,664 |   |
| Accounts payable                                                                                                    |       | 24,476                       |       | 18,356                      |       |
| Accrued expenses and other liabilities                                                                              |       | 34,438                       |       | 35,762                      |       |
| Current portion of long-term debt                                                                                   |       | 1,000                        |       | 1,000                       |       |
| Deferred taxes                                                                                                      |       | 2,646                        |       | 2,164                       |       |
| Income taxes payable                                                                                                |       | 917                          |       | 2,390                       |       |
| Total current liabilities                                                                                           |       | 63,477                       |       | 85,336                      |       |
|                                                                                                                |       |                         |       |                        |       |
| Long-term debt —  net of current portion                                                                       |       | 36,750                       |       | 36,500                      |       |
| Other long-term  liabilities                                                                                        |       | 3,596                        |       | 3,863                       |       |
| Total liabilities                                                                                                   |       | 103,823                      |       | 125,699                     |       |
|                                                                                                                |       |                         |       |                        |       |
| Commitments and  contingencies:                                                                                     |       |                         |       |                        |       |
| Stockholders’  equity                                                                                          |       |                         |       |                        |       |
| Common stock, $0.01 par value — 200,000,000 shares  authorized; 21,887,564 and 22,136,639 issued, respectively |       | 219                          |       | 221                         |       |
| Additional paid-in capital                                                                                          |       | 76,785                       |       | 78,030                      |       |
| Retained earnings                                                                                                   |       | 58,345                       |       | 63,404                      |       |
| Accumulated other comprehensive income                                                                              |       | (161                         | )          | 50                          |       |
| Less: Treasury stock; 0 and 14,490 shares at cost,  respectively                                                    |       | —                       |       | (260                        | )          |
| Deferred compensation                                                                                               |       | (1,036                       | )          | (961                        | )          |
| Total stockholders’ equity                                                                                     |       | 134,152                      |       | 140,484                     |       |
| Total liabilities and  stockholders’ equity                                                                    |       | $                            | 237,975    |                        | $          | 266,183 |   |

 

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

4

----

** **

**STANLEY, INC.AND SUBSIDIARIESCondensed Consolidated Statements of Cash Flows(unaudited)(in thousands)**
| ** **                                                                         | ** ** | **Three months ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                         | ** ** | **June 30,**                | ** ** |
| ** **                                                                         | ** ** | **2006**                         | ** ** | **2007** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                                         | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                                | 2,484      |   | $ | 5,364 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                             |       |   |   |
| Depreciation and amortization                                                      |       | 1,387                            |       | 1,609 |   |
| Amortization of deferred compensation                                              |       | 249                              |       | 75 |   |
| Loss on disposal of property and equipment                                         |       | 38                               |       | 14 |   |
| Income tax benefit from stock compensation                                         |       | 88                               |       | 442 |   |
| Stock compensation expense                                                         |       | 82                               |       | 378 |   |
| Changes in assets and liabilities - net of  acquisition effects:                   |       |                             |       |   |   |
| Decrease (increase) in accounts receivable                                         |       | 5,015                            |       | (7,063 | ) |
| Decrease in prepaid expenses and other current  assets                             |       | (1,002                           | )          | (1,522 | ) |
| (Decrease) increase in other assets                                                |       | (249                             | )          | 212 |   |
| Decrease in accounts payable                                                       |       | (3,128                           | )          | (6,242 | ) |
| Increase (decrease) in accrued expenses                                            |       | 1,795                            |       | (1,480 | ) |
| (Decrease) increase in other liabilities                                           |       | (107                             | )          | 229 |   |
| Increase in income taxes payable                                                   |       | 24                               |       | 1,573 |   |
| Net cash  provided by (used in) operating activities                               |       | 6,676                            |       | (6,411 | ) |
|                                                                               |       |                             |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                         | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Purchase of Morgan — net of cash acquired                                     |       | 138                              |       | — |   |
| Purchase of Techrizon — net of cash acquired                                  |       | —                           |       | (30,519 | ) |
| Acquisition of property and equipment                                              |       | (574                             | )          | (1,346 | ) |
| Net cash used in  investing activities                                             |       | (436                             | )          | (31,865 | ) |
|                                                                               |       |                             |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                         | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Net (repayments) borrowings under line-of-credit  agreements                       |       | (6,584                           | )          | 25,664 |   |
| Repayments on long-term debt                                                       |       | (250                             | )          | (250 | ) |
| Payments under capital lease obligations                                           |       | (4                               | )          | (40 | ) |
| Purchase of treasury stock                                                         |       | —                           |       | (260 | ) |
| Proceeds from exercise of stock options                                            |       | 401                              |       | 436 |   |
| Proceeds from sale of treasury stock                                               |       | 197                              |       | — |   |
| Other                                                                              |       | —                           |       | (10 | ) |
| Net cash (used  in) provided by financing activities                               |       | (6,240                           | )          | 25,540 |   |
|                                                                               |       |                             |       |   |   |
| **NET  DECREASE IN CASH**                                                          |       | —                           |       | (12,736 | ) |
| **CASH —  Beginning of period**                                               |       | —                           |       | 12,736 |   |
| **CASH —  End of period**                                                     |       | $                                | —     |   | $ | — |   |
|                                                                               |       |                             |       |   |   |
| **SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:**                            | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Cash paid during  the period for:                                                  |       |                             |       |   |   |
| Income taxes                                                                       |       | $                                | 1,588      |   | $ | 1,584 |   |
| Interest                                                                           |       | $                                | 1,994      |   | $ | 898 |   |
|                                                                               |       |                             |       |   |   |
| **SUPPLEMENTAL  DISCLOSURES OF NONCASH FINANCING ACTIVITIES:**                     | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Assets purchased under  a capital lease agreement                                  |       | $                                | 51         |   | $ | — | ­ |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

5

----

 

**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 ofBusiness***—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***—The accompanying condensed unaudited condensedconsolidated financial statements have been prepared in accordance withgenerally accepted accounting principles in the United States and pursuant tothe rules and regulations of the Securities and Exchange Commission. In theopinion of management, these statements reflect all adjustments necessary tofairly present the Company’s financial position as of June 30, 2007 and its results of operations and its cash flowsfor the three months ended June 30, 2006 and 2007. The results of operationsfor the interim period are not necessarily indicative of the results for thefull year. For further information, refer to the financial statements and footnotespresented in the Company’s Annual Report on Form 10-K for the year ended March31, 2007.

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

***Fair Value ofFinancial Instruments***—Thefair value of accounts receivable, accounts payable, accrued expenses, notepayable, and swap contract approximates their respective carrying amounts.

***Revenue Recognition***—The Company recognizes revenue under itscontracts when a contract has been executed, the contract price is fixed anddeterminable, delivery of services or products has occurred, and collectibilityis considered probable and can be reasonably estimated. Revenue is earned undercost-plus-fee, fixed-price and time-and-materials contracts. TheCompany uses a standard management process to determine whether all requiredcriteria for revenue recognition have been met, which includes regular reviewsof the Company’s 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, commitments,and client satisfaction. During this review, the Company determines whether theoverall progress on a contract is consistent with the effort expended.

Under cost-plus-fee contracts, revenues arerecognized as costs are incurred and include an estimate of applicable feesearned. The Company considers fixed fees under cost-plus-fee contracts tobe earned in proportion to the allowable costs actually incurred in performanceof the contract for level of effort contracts. For completion type cost-plus-feecontracts, fixed fees are earned in proportion to the percentage of workcompleted. For time-and-materials contracts, revenues are computed bymultiplying the number of direct labor-hours expended in performance ofthe contract by the contractual billing rates and adding other billable directand indirect costs. For fixed-price contracts, revenues are recognized asservices are performed, using the percentage-of-completion method, applying thecost-to-cost or units of delivery method, in accordance with AccountingResearch Bulletin No. 45 and American Institute of Certified PublicAccountants (“AICPA”) Statement of Position 81-1 “Accounting for Performance ofConstruction-Type and Certain Production-Type Contracts” (“SOP 81-1”).

Contract revenue recognition inherently involves the useof estimates. Examples of estimates include the contemplated level of effort toaccomplish the tasks under contract, the cost of the effort, and an ongoingassessment of the Company’s progress toward completing the contract. From timeto time, as part of the Company’s standard management process, facts developthat require the Company to revise its estimated total costs and revenues. Tothe extent that a revised estimate affects contract profit or revenuepreviously recognized, the Company records the cumulative effect of therevision in the period in which the facts requiring the revision become known.The full amount of an anticipated loss on any type of contract is recognized inthe period in which it becomes probable and can be reasonably estimated.

For cost-plus-award fee type contracts, theCompany recognizes the expected fee to be awarded by the customer at the timesuch fee can be reasonably estimated, based on factors such as prior awardexperience and communications with the customer regarding performance,including any interim performance evaluations rendered by the customer. Forcost-plus-incentive fee type contracts, the method of calculatingincentive fee is specified in the contract and it is typically based onmeasuring actual costs to perform the contract against a target cost to performthe contract. The Company prepares periodic estimates to complete and adjuststhe incentive fee as required based on the contract incentive fee formula.

6

----

 

The Company’s contracts with agencies of the governmentare subject to periodic funding by the respective contracting agency. Fundingfor a contract may be provided in full at inception of the contract or ratablythroughout the contract as the services are provided. From time to time, theCompany may proceed with work based on client direction prior to the completionand signing of formal contract documents. The Company has a formal reviewprocess for approving any such work. Revenue associated with such work isrecognized only when it can be reliably estimated and realization is probable.The Company bases its estimates on previous experiences with the client,communications with the client regarding funding status, and its knowledge ofavailable funding for the contract or program. Pre-contract costs related tounsuccessful contract bids are expensed in the period in which the Company isnotified that the contract will not be issued.

Disputes occasionally arise in the normal course of theCompany’s business due to events such as delays, changes in contractspecifications, and questions of cost allowability or collectibility. Suchmatters, whether claims or unapproved change orders in the process ofnegotiation, are recorded at the lesser of their estimated net realizable valueor actual costs incurred, and only when realization is probable and can bereliably estimated. Claims against the Company are recognized where a loss isconsidered probable and can be reasonably estimated in amount.

The allowability of certain costs under governmentcontracts is subject to audit by the government. Certain indirect costs arecharged to contracts using provisional or estimated indirect rates, which aresubject to later revision based on government audits of those costs. Managementis of the opinion that costs subsequently disallowed, if any, would not besignificant.

***Concentration of Risk***—Contracts funded by federal government agenciesaccount for substantially all of our revenues. For the three months ended June 30, 2006 and 2007,we derived approximately 67% and 68% of our revenues, respectively, from theDepartment of Defense, including agencies within the intelligence community,and approximately 33% and 32% of our revenues, respectively, from federalcivilian government agencies. The Company’s contracts with the Department ofState for the provision of passport processing and support services, which isour largest revenue-generating contract, and with the  Department of the Navy for productionengineering and integration services under various SPAWAR programs, accountedfor approximately 17% and 13% of our revenues for the three months ended June30, 2007, respectively.

***Property and Equipment***—Property and equipment are carried at cost, lessaccumulated depreciation. Depreciation of property and equipment is calculatedusing the straight-line method over the useful lives, ranging from three toten years. Leasehold improvements are amortized over the lesser of theuseful life or the term of the lease. Repairs and maintenance are expensed asincurred. Depreciation expense related to property and equipment was $0.6 million and $0.7 million for the three months ended June30, 2006 and 2007, respectively.

***Goodwill andIntangible Assets****—*Goodwillrepresents the excess of cost over the fair value of net tangible and identifiableintangible 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 ittests goodwill for impairment at least on an annual basis. Testing for impairmentis a two-step process as prescribed by SFAS No. 142. The first step is atest for 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, 2006, the Companydetermined that no impairments existed as of December 31, 2006. Customerrelationships and other intangibles are amortized on a straight-line basis overperiods ranging from two to seven years.

***Impairment ofLong-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 June 30, 2007.

***Stock***-***Based Compensation***—Stanley adopted theprovisions of SFAS No. 123(R), *Share-based Payment*(“SFASNo. 123(R)”), on a prospective basis during the fiscal year beginning April 1,2006.

***Earnings per share***—Basic earnings per share has been computed bydividing net income available to common stockholders by the weighted averagenumber of shares of common stock outstanding during each period. Shares issuedduring the period and shares reacquired during the period are weighted for theportion of the period that they were outstanding. Diluted earnings per shareconsiders the potential dilution that could occur if securities or othercontracts to issue common stock were exercised or converted into common stock.The weighted average number of common shares outstanding is computed asfollows:

7

----

 

|                                                               | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                    | ** ** | **June 30,**                | ** ** |
| ** **                                                    | ** ** | **2006**                         | ** ** | **2007** | ** ** |
| ** **                                                    | ** ** | **(in thousands)**          | ** ** |
| Basic weighted  average common shares outstanding             |       | 14,417                           |       | 21,898 |   |
| Effect of stock  options and unvested restricted stock grants |       | 1,906                            |       | 1,463 |   |
| Diluted weighted  average common shares outstanding           |       | 16,323                           |       | 23,361 |   |

 

All options to purchase common stock are included in thecomputation of diluted earnings per share because the average fair value percommon share was greater than the options’ exercise prices.

***Derivative Instrumentsand Hedging Activities***— In accordance with SFAS No. 133, *Accounting for Derivative Instruments and HedgingActivities* (“SFAS No. 133”), as amended by SFAS No. 138, *Accounting for Certain Derivative Instruments andCertain Hedging Activities, an Amendment of SFAS 133* and SFASNo. 149, *Amendment of Statement 133 onDerivative Instruments and Hedging Activities,* the fair value of thehedge arrangement is recorded as an asset or a liability in the accompanyingcondensed consolidated balance sheet at June 30, 2007. For qualifying cash flow hedges, SFASNo. 133, as amended, holds that the effective portion of derivative gainsand losses be recorded as a component of other comprehensive income and bereclassified into earnings in the same period in which the hedged transactionaffects such earnings. Any ineffectiveness is reported currently in earnings.

As required by its senior credit facility, 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 a notionalamount of $19.0 million. The Company designated this swap agreement, at itsinception, as a qualifying cash flow hedge. The fair value of the swap at June30, 2007 of $0.1 million has been reported in “Other assets” with anoffset, net of tax, included in “Accumulated other comprehensive income” in theaccompanying condensed consolidated balance sheets. None of the $0.2 millionunrealized gain was recognized in earnings during the quarter ended June 30,2007 based 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 June 30, 2007, the estimated net amount ofexisting losses expected to be reclassified into earnings within the next 12months is zero.

***Segment Reporting***—Operating segments are defined as components ofan enterprise for which separate financial information is available andevaluated regularly by the chief operating decision maker, or decision makinggroup, in deciding how to allocate resources and assess performance. TheCompany currently has one reportable segment for financial reporting purposes,which represents the Company’s core business of providing informationtechnology solutions and services for federal government customers. The Companydoes not report revenue by product or service or groups of products or servicesbecause it is impracticable to do so.

***Use of Estimates***—The preparation of financial statements inconformity with generally accepted accounting principles requires management tomake estimates and assumptions that affect the reported amounts of assets andliabilities and the disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.Significant items subject to such estimates and assumptions include revenuerecognition, carrying amount and useful lives of long-lived assets, valuationallowances 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 AccountingStandards Board (“FASB”) issued Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes*, an interpretation of FASB StatementNo. 109, Accounting for Income Taxes (“FIN 48”). FIN 48 provides guidance onrecognition, derecognition, measurement, classification, interest andpenalties, accounting for interim periods, and disclosures. FIN 48 requires anentity to recognize the financial statement impact of a tax position when it ismore likely than not that the position will be sustained upon examination by ataxing authority. The amount recognized is measured at the largest amount ofbenefit that is greater than fifty percent likely of being realized uponultimate settlement. In addition, FIN 48 permits an entity to recognizeinterest and penalties related to tax uncertainties as income tax expense oroperating expenses. FIN 48 is effective for fiscal years beginning afterDecember 15, 2006.

The Company adopted theprovisions of FIN 48 on April 1, 2007. The cumulative effects of applying thisinterpretation have been recorded as a decrease of  $0.3 million to retained earnings, anincrease of $0.5 million to net deferred tax assets, a decrease to income taxespayable of $0.1 million and an increase in liabilities of $0.5 million forunrecognized tax benefits and $0.4 million for interest and penalties. As ofApril 1 and June 30, 2007 the Company has $0.5 million in unrecognized taxbenefits, the recognition of which would not have a material impact on theeffective tax rate. Included in the 

8

----

 

balance of unrecognizedtax positions at April 1 and June 30, 2007 is $0.5 million related to taxpositions for which it is reasonably possible that the total amounts couldchange significantly in the next twelve months. The amount representsunrecognized tax benefits from foreign jurisdictions. The Company recognizesinterest and penalties accrued related to unrecognized tax benefits as interestexpense and operating expenses, respectively, in the accompanying condensedconsolidated statements of income, which is consistent with the recognition ofthese items in prior years. As of April 1 and June 30, 2007, the Companyaccrued liabilities of $0.4 million for interest and penalties.

The Congressional JointCommittee on Taxation is currently reviewing a pre-acquisition period of one ofour subsidiaries. We do not expect any adjustments to result from this review.The Company is open to audit under the statute of limitations for tax years2003 through 2007 for federal and state jurisdictions and tax years 1998through 2007 for foreign jurisdictions.

As of June 30, 2007,there have been no material changes to the liability for uncertain taxpositions.

***Recently Issued Accounting Standards***— In September 2006, the FASB issuedStatement of Financial Accounting Standards 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. The Company is in the process of determining whateffect, if any, the adoption of SFAS 157 will have on its financial position,results of operations, or cash flows.

In February 2007,the FASB issued Statement of Financial Accounting Standards No. 159, *The Fair Value Option for Financial Assets andFinancial Liabilities—Including an Amendment of FASB Statement No. 115*(“SFAS 159”). SFAS 159 permits entities to measure many financialinstruments and certain other items at fair value to improve financialreporting by providing entities with the opportunity to mitigate volatility inreported earnings caused by measuring related assets and liabilitiesdifferently without having to apply complex hedge accounting. Most of theprovisions in SFAS 159 are elective. This statement will be effective for theCompany in fiscal 2009, and may be applied prospectively. Early adoption ispermitted provided the Company also elects to apply the provisions of SFAS 157.The Company is in the process of determining what effect, if any, theapplication of the provisions of SFAS 159 will have on its financial positionand results of operations.

***Reclassifications***— Certain reclassifications have been made toprior year presentations to conform to the current presentation. In thefourth quarter of fiscal year 2007, the Company reviewed the mapping of itsoperating expenses relative to cost of revenues, and Selling,General & Administrative expenses, or SG&A. Cost of revenues aredirect and indirect contract costs, while SG&A expenses are period costsrelated to selling activities and overall support and management of thebusiness as a whole. As a result of this review, certain expenses previouslyclassified as cost of revenues in the first three quarters of fiscal year 2007,were reclassified to SG&A to more closely align such costs with the incomestatement captions that best capture the nature of the expenses.

***Stock Split andAmendment of Certificate of Incorporation***— On August 28, 2006, the Company increased thenumber of authorized shares of common stock to 200,000,000 shares and onSeptember 12, 2006, the Company completed a thirty-for-one stock split of itsoutstanding common stock. The accompanying financial statements include theeffects of the stock split and the resulting increase in the number of authorizedshares of common stock. All share and per share amounts included in theaccompanying financial statements for periods prior to the stock split havebeen restated to reflect the stock split.

**2. ACCOUNTS RECEIVABLE**

Accounts receivable consists of the following:

|                                        | ** ** | **As of**               | ** ** | **As of**              | ** ** |
|----------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                             | ** ** | **March 31, 2007** | ** ** | **June 30, 2007** | ** ** |
| Billed  receivables                    |       | $                            | 73,676     |                        | $          | 98,143 |   |
| Unbilled  receivables                  |       | 36,962                       |       | 24,272                      |       |
| Less: Allowance  for doubtful accounts |       | (609                         | )          | (519                        | )          |
| Total                                  |       | $                            | 110,029    |                        | $          | 121,896 |   |

 

9

----

 

Consistent with industry practice, certain receivablesrelated to long-term contracts are classified as current, although a portion ofthese amounts is not expected to be billed and collected within one year.Unbilled accounts receivable are expected to be billed and collected within oneyear except for $0.5 million at June 30, 2007.

**3. PROPERTY AND EQUIPMENT**

Property and equipment consists of the following:

|                                                                                          | ** ** | **As of**               | ** ** | **As of**              | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                               | ** ** | **March 31, 2007** | ** ** | **June 30, 2007** | ** ** |
| Computers and  peripherals                                                               |       | $                            | 4,008      |                        | $          | 4,304 |   |
| Software                                                                                 |       | 1,882                        |       | 2,034                       |       |
| Furniture and  equipment                                                                 |       | 3,630                        |       | 3,797                       |       |
| Leasehold  improvements                                                                  |       | 6,417                        |       | 7,216                       |       |
|                                                                                     |       | 15,937                       |       | 17,351                      |       |
|                                                                                     |       |                         |       |                        |       |
| Less:  Accumulated depreciation and amortization                                         |       | (4,201                       | )          | (4,896                      | )          |
| Property and  equipment — net                                                       |       | $                            | 11,736     |                        | $          | 12,455 |   |
|                                                                                     |       |                         |       |                        |       |
| Property and  equipment included above that are under capital lease obligations include: |       |                         |       |                        |       |
| Software                                                                                 |       | $                            | 569        |                        | $          | 569 |   |
| Furniture and equipment                                                                  |       | 80                           |       | 80                          |       |
| Less: Accumulated depreciation                                                           |       | (158                         | )          | (193                        | )          |
| Total                                                                                    |       | $                            | 491        |                        | $          | 456 |   |

 

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

Accrued expenses consist of the following:

|                         | ** ** | **As of**               | ** ** | **As of**              | ** ** |
|-------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **              | ** ** | **March 31, 2007** | ** ** | **June 30, 2007** | ** ** |
| Accrued payroll  costs  |       | $                            | 9,778      |                        | $          | 11,164 |   |
| Accrued contract  costs |       | 19,131                       |       | 18,676                      |       |
| Accrued indirect  costs |       | 2,807                        |       | 2,636                       |       |
| Other payables          |       | 2,722                        |       | 3,286                       |       |
| Total accrued expenses  |       | $                            | 34,438     |                        | $          | 35,762 |   |

 

**5. DEBT**

|                                                               | ** ** | **As of**               | ** ** | **As of**              | ** ** |
|---------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                    | ** ** | **March 31, 2007** | ** ** | **June 30, 2007** | ** ** |
| Borrowings under  the term loan and revolving line of credit: |       |                         |       |                        |       |
| Revolving line of credit                                      |       | $                            | —     |                        | $          | 25,664 |   |
| Term loan                                                     |       | 37,750                       |       | 37,500                      |       |
| Total debt                                                    |       | 37,750                       |       | 63,164                      |       |
| Less: Current portion                                         |       | (1,000                       | )          | (26,664                     | )          |
| Debt — net of  current portion                           |       | $                            | 36,750     |                        | $          | 36,500 |   |

 

On February 16, 2006 Stanley entered into a new senior credit facilitythat included a $50.0 million revolving credit facility. As of June 30,2007, Stanley had $37.5 million of term loan indebtedness and $25.7million of revolving indebtedness outstanding 

10

----

 

under its senior credit facility with a weighted average interest rateof 7.45% and 7.29% for the three months endedJune 30, 2006 and 2007,respectively. As of June 30, 2007, Stanley’s borrowing availability under itsrevolving credit facility was $24.3million. At June 30, 2007, theCompany was in compliance with all covenants under its senior credit facility.The obligations under its senior credit facility are unconditionally guaranteedby each of its existing and subsequently acquired or organized subsidiaries andsecured subsidiaries and secured on a first-priority basis by securityinterests (subject to permitted liens) in substantially all assets owned by theCompany and each of its subsidiaries, including the shares of capital stock ofits subsidiaries, subject to certain exceptions.

**6.  ACQUISITION**

On April 1, 2007, Stanley acquiredTechrizon, LLC (“Techrizon”), a premier provider of software, training,simulation and information security solutions, for $30.3 million, net of cashacquired and financed the acquisition with a combination of existing cash andborrowings under its senior credit facility. Additionally, acquisition relatedcosts of $0.2 million were incurred. In accordance with SFAS No. 141,*Business Combinations* (“SFAS No. 141”), the acquisition wasaccounted for under the purchase method of accounting. Accordingly, the resultsof Techrizon have been included in the accompanying condensed consolidatedfinancial statements since the date of acquisition. The purchase price has beenallocated to the assets acquired and liabilities assumed based upon theestimated fair values. Of the purchase consideration, $25.1 million has beenallocated to goodwill, based upon the excess of the purchase price over the$2.7 million estimated fair value of net tangible assets and $2.5 millionassigned to other identifiable intangible assets. Included in identifiableintangibles is $1.6 million, $0.8 million and $0.1 million related to customercontracts and relationships, order backlog and non-compete agreements,respectively, which are being amortized over periods of two to five years. TheCompany is continuing to evaluate the fair value of the assets and liabilitiesof Techrizon, and will complete the purchase accounting entries related to theacquisition prior to the end of the Company’s fiscal year ending March 31,2008.

The following unaudited pro forma financialinformation presents consolidated results of operations data for the threemonths ended June 30, 2006, as if the acquisition of Techrizon had occurred onApril 1, 2006. The pro forma information is provided based on historical datathat does not necessarily reflect the actual results that would have occurred,nor is it necessarily indicative of the future results of operations of thecombined entity. The pro forma financial information reflects the provision forfederal and state income taxes at the Company’s effective rate of 41% forTechrizon’s historical data. Prior to the acquisition, Techrizon was a limitedliability company with all income, losses and tax credits flowing through tothe individual members.

|                             | ** ** | **Three Months Ended** | ** ** |
|-----------------------------|------------|----------------------------------|------------|
| ** **                  | ** ** | **June 30, 2006**      | ** ** |
| Revenue                     |       | $                                | 99,820     |   |
| Net income                  |       | $                                | 3,211      |   |
| Basic earnings  per share   |       | $                                | 0.22       |   |
| Diluted earnings per  share |       | $                                | 0.20       |   |

 

**7.  STOCKHOLDERS’ EQUITY**

***CommonStock***

Stanley has one class ofcommon stock, with each share of common stock having one vote per share.Holders of common stock share equally in any dividends declared by the board ofdirectors.

Stanley purchased 14,490shares of treasury stock from one of its shareholders for $0.3 million duringthe three months ended June 30, 2007. The shares were recorded at cost.

***InitialPublic Offering***

On October 23, 2006,Stanley completed its initial public offering of 5.3 million shares (6.3million shares including shares sold by selling stockholders) at a price of$13.00 per share. After full exercise of the underwriters’ over-allotmentoption to purchase an additional 945,000 shares, aggregate net proceeds to theCompany after underwriting discounts and offering expenses were approximately$71.8 million. On October 23, 2006, the Company paid down $61.5 million oflong-term debt with proceeds from the offering.

11

----

*** ***

***DeferredCompensation and Stock Options***

Under the 2006 OmnibusIncentive Compensation Plan (the “Omnibus Plan”), Stanley is authorized to provideawards for a maximum of 4,000,000 shares of common stock to any director,officer, employee or consultant. The Omnibus Plan allows for cash awards,restricted stock awards, restricted stock units, stock appreciation rights,performance units, fully vested shares, option awards and other equity-relatedawards. Vesting periods of these awards vary. Except as otherwise determined bythe board of directors, the option awards may not have an exercise price lessthan the fair market value of the common stock on the date the option isgranted.

Prior to July 2006, underthe Executive Deferred Compensation and Equity Incentive Plan (the “ExecutivePlan”), Stanley was authorized to provide awards for a maximum of 15,000,000shares of common stock to key employees and non-employee directors. TheExecutive Plan allowed for cash awards, restricted stock awards, restrictedstock trust awards and option awards. Vesting periods of these awards vary.Holders of restricted stock awards have voting rights with respect to theawards. The trustee of the restricted stock trust awards has voting rights withrespect to the trust awards. The option awards have an exercise price thatranges from 85% to 110% of the fair market value of the common stock on thedate the option was granted.

Effective April 1, 2006,the Company adopted the provisions of SFAS No. 123(R) using theprospective-transition method. Under that transition method, compensation costrecognized in the three months ended June 30, 2007 includes compensation costfor all share-based payments granted on or after April 1, 2006 based on thegrant-date fair value estimated in accordance with the provisions of SFAS No.123(R). The Company is required to account for any portion of awardsoutstanding at the date of adoption of SFAS No. 123(R) using the accountingprinciples originally applied to those awards.

The Company has presentedall tax benefits resulting from stock based compensation awarded prior to theadoption of SFAS No. 123(R) as operating cash flows in the accompanyingcondensed consolidated statements of cash flows. The tax benefits associatedwith share based compensation in effect prior to the adoption of SFAS No.123(R) were $0.1 million and $0.4 million for the three months ended June 30,2006 and 2007, respectively. For share-based payment transactions awardedsubsequent to the adoption of SFAS No. 123(R), the tax benefits in excess ofthe compensation cost recognized should be classified as financing cash flows.The excess tax benefits associated with share-based payment transactionsaccounted for under SFAS No. 123(R) were zero and five thousand dollars for thethree months ended June 30, 2006 and 2007, respectively, and are displayedwithin financing activities in the accompanying condensed consolidated statementsof cash flows.

The fair value of eachoption award is estimated on the date of grant using the Black-Scholes-Mertonclosed-form option-pricing model that uses the assumptions noted in thefollowing table. Expected volatility is based on a weighted-average of thehistorical volatilities of similar public entities. The valuation modelincludes assumed forfeiture rates of 7.5 to 10.0 percent. The expected term ofoptions granted is derived using the simplified method and represents theperiod of time that options granted are expected to be outstanding. Optionsgranted meet the criteria of “plain vanilla” for purposes of applying thesimplified method. The risk-free rate for periods within the contractual lifeof the option is based on the U.S. Treasury yield curve in effect at the timeof grant.

|                           | ** ** | **As of**              | ** ** |
|---------------------------|------------|-----------------------------|------------|
| ** **                | ** ** | **June 30, 2007** | ** ** |
| Expected  volatility      |       | 34.4%                       |       |
| Expected  dividends       |       | 0.0%                        |       |
| Expected term  (in years) |       | 3.3 - 6.5                   |       |
| Risk-free rate            |       | 4.6%-5.1%                   |       |

 

12

----

 

A summary ofoption activity as of June 30, 2007, and changes during the three months thenended, are presented below:
| **Options**                   | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|-------------------------------|------------|------------|------------|----------------------------------------|------------|
| Outstanding at  April 1, 2007 |       | 2,014,986  |       | $                                      | 4.87       |   |
| Granted                       |       | 521,525    |       | $                                      | 15.26      |   |
| Exercised                     |       | (102,800   | )          | $                                      | 4.25       |   |
| Forfeited                     |       | (81,300    | )          | $                                      | 7.86       |   |
| Outstanding at  June 30, 2007 |       | 2,352,411  |       | $                                      | 7.10       |   |
| Exercisable at June 30,  2007 |       | 1,282,936  |       | $                                      | 3.36       |   |

 

An option summary as of June 30,2007 is presented below:
| **Options**                                             | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual Term** | ** ** | **Aggregate  Intrinsic  Value ($000)** | ** ** |
|---------------------------------------------------------|------------|------------|------------|----------------------------------------|------------|---------------------------------------------------------|------------|---------------------------------------------|------------|
| Outstanding at  June 30, 2007                           |       | 2,352,411  |       | $                                      | 4.87       |                                                    | 5.8        |                                        | $          | 24,747 |   |
| Exercisable at  June 30, 2007                           |       | 1,282,936  |       | $                                      | 3.36       |                                                    | 5.3        |                                        | $          | 18,301 |   |
| Unvested at June 30,  2007, net of expected forfeitures |       | 989,264    |       | $                                      | 11.59      |                                                    | 6.4        |                                        | $          | 5,962 |   |

 

During the three months endedJune 30, 2007, the Company granted 521,525 stock option awards with a vestingperiod of three years. The options were issued with a weighted-average exerciseprice of $15.26. The total intrinsic value of options exercised during thethree months ended June 30, 2007 was$1.3 million.

During the three monthsended June 30, 2006 and 2007, the Company recognized $0.1 million and $0.4million of share-based employee compensation costs, respectively. As of June30, 2007, there was $6.0 million of total unrecognized compensation costrelated to nonvested share-based compensation arrangements granted under theOmnibus Plan. That cost is expected to be recognized over a weighted-averageperiod of 3.2 years.

The following tableillustrates, in accordance with the provisions of SFAS No. 123(R), the effecton net income and earnings per share if the Company had applied the fair valuerecognition provision of SFAS No. 123(R) to stock-based employee compensationfor stock option awards granted prior to April 1, 2006.
| ** **                                                                                                                                     | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                                                     | ** ** | **June 30,**                | ** ** |
| ** **                                                                                                                                     | ** ** | **2006**                         | ** ** | **2007** | ** ** |
| Net income, as  reported                                                                                                                       |       | $                                | 2,484      |   | $ | 5,364 |   |
| Add: stock-based  compensation, included in net income as reported, net of related tax effects                                                 |       | —                           |       | — |   |
| Deduct: Total  stock-based employee compensation expense as determined under the fair value  method for all awards, net of related tax effects |       | (32                              | )          | (32 | ) |
| Pro forma net  income                                                                                                                          |       | $                                | 2,452      |   | $ | 5,332 |   |
| Basic earnings  per share:                                                                                                                     |       |                             |       |   |   |
| As reported                                                                                                                                    |       | $                                | 0.17       |   | $ | 0.24 |   |
| Pro forma                                                                                                                                      |       | $                                | 0.17       |   | $ | 0.24 |   |
| Diluted earnings  per share:                                                                                                                   |       |                             |       |   |   |
| As reported                                                                                                                                    |       | $                                | 0.15       |   | $ | 0.23 |   |
| Pro forma                                                                                                                                      |       | $                                | 0.15       |   | $ | 0.23 |   |

 

During the three monthsended  June 30, 2007, there were nomodifications to share-based payment arrangements.

During the three monthsended  June 30, 2007, the Company granted146,285 restricted stock awards at an estimated fair value of $15.26 per sharewith a vesting period of three years. The assumed forfeiture rate applicable tothe restricted shares granted in the three months ended  June 30, 2007 was five percent.

13

----

 

Prior to the adoption ofSFAS No. 123(R), the fair market value of each issuance and grant wasdetermined by the Company on a contemporaneous basis. The Company recordedstock-based deferred compensation of approximately $1.4 million in connectionwith compensatory grants of stock options and shares of restricted stockawarded during fiscal 2006 and 2007. Approximately, $0.1 million ofcompensation expense was recognized during the three months ended June 30,2007. The remaining deferred compensation will be amortized over the remainingfour year vesting period of the awards.

**8.  COMMITMENTS AND CONTINGENCIES**

****Contract Cost Audits****— Substantially all payments to Stanley undercost-reimbursable contracts and subcontracts with the U.S. Government areprovisional payments, which are subject to potential adjustments upon audit bythe Defense Contract Audit Agency. Audits through December 31, 2003 havebeen completed. In the opinion of management, adjustments resulting from theaudits of all subsequent years are not expected to have a material effect onthe Company’s financial position or results of operations.

 

14

----

 

**ITEM 2.  MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

*You shouldread the following discussion in conjunction with the audited and unauditedconsolidated financial statements and the accompanying notes included in thisForm 10-Q and our annual report on Form 10-K for the fiscal year ended March31, 2007. This discussion contains forward-looking statements that involverisks and uncertainties. Our actual results may differ materially from thosediscussed in or implied by any of the forward-looking statements as a result ofvarious factors, including but not limited to, those listed in Item 1A of PartII of this Form 10-Q under the caption “Risk Factors” and elsewhere is thisfiling. We caution readers not to place undue reliance on any suchforward-looking statements, which speak only as of the date made. We undertakeno obligation to publicly update or revise any forward-looking statements,whether as a result of new information, future events or otherwise, after thedate of this Form 10-Q.*

**Overview**

We provideinformation technology services and solutions to U.S. defense and federalcivilian government agencies. We offer our customers solutions and expertise tosupport their mission-essential needs at any stage of program, productdevelopment 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 June 30, 2007, we had more than 200 activecontractual engagements across 44 federal government agencies. Our customersinclude the Department of Defense (including all major agencies within theDepartment of Defense), the Department of State, the Department of HomelandSecurity, the Department of Transportation, the Department of the Treasury,NASA, the Department of Justice and the Department of Health and HumanServices.

**Key Metrics Evaluated By Management**

We manage andassess the performance of our business by evaluating a variety of financial andnon-financial metrics derived from and in addition to our United Statesgenerally accepted accounting principles, or GAAP, results. The mostsignificant of these metrics are discussed below.

***Revenue Growth***

We closelymonitor revenue growth in order to assess the performance of our business. Inmonitoring our revenue growth, we focus on both internal revenue growth andrevenue growth through acquisitions. Our internal revenue growth is drivenprimarily by two factors. First, internal revenue growth is driven by addingnew customers and by obtaining new task orders and contracts with our existingcustomers. 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.

Our revenuegrowth strategy also includes the pursuit of strategic acquisitions. We havecompleted the following five acquisitions since 2000: our acquisition of GCIInformation Services, Inc. in January 2000, our acquisition of CCI,Incorporated, or CCI, in September 2002, our acquisition of Fuentez SystemsConcepts, Inc., or FSC, in December 2003, our acquisition of Morgan ResearchCorporation, or Morgan, in February 2006, and our acquisition of Techrizon,LLC, or Techrizon, in April 2007.

15

----

*** ***

***Backlog***

We monitor backlog, which provides us withvisibility of our future revenues, as a measure of the strength of our targetmarkets and our ability to retain existing contracts and win new contracts. Thefollowing table summarizes our backlog as of the dates indicated:
| ** **    | ** ** | **As of June 30,** | ** ** |
|---------------|------------|-----------------------------------|------------|
| ** **    | ** ** | **2006**                          | ** ** | **2007** | ** ** |
| ** **    | ** ** | **(in millions)**            | ** ** |
| Backlog:      |       |                              |       |   |   |
| Funded        |       | $                                 | 201.7      |   | $ | 241.5 |   |
| Unfunded      |       | 631.3                             |       | 744.5 |   |
| Total Backlog |       | $                                 | 833.0      |   | $ | 986.0 |   |

 

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

We definebacklog as the amount of revenues we expect to realize (i) over the remainingbase contract performance period and (ii) from the exercise by the customer ofoption periods that we reasonably believe will be exercised, in each case fromsigned contracts in existence as of the measurement date. We do not includecontract ceiling values, which represent the maximum amount of contract awardsthat could be awarded to all contractors under GWAC or ID/IQ contracts, in ourbacklog calculation. We also do not include in backlog (i) the expected amountof revenues that would be realized if, and when, we were successful in there-compete of signed contracts in existence as of the measurement date or (ii)the expected amount of revenues that would be realized from future unidentifiedgrowth on signed contracts and task orders in existence as of the measurement date.

We definefunded backlog as the portion of our backlog for which funding currently isappropriated and obligated to us under a signed contract or task order by thepurchasing agency, or otherwise authorized for payment to us by a customer uponcompletion of a specified portion of work, less the amount of revenue we havepreviously recognized under the contract. Our funded backlog does not includethe full potential value of our contracts, because Congress often appropriatesfunds to be used by an agency for a particular program or contract on a yearlyor quarterly basis, even though the contract may call for performance over anumber of years. As a result, contracts typically are only partially funded atany point during their term, and all or some of the work to be performed underthe contracts may remain unfunded unless and until Congress makes subsequentappropriations and the procuring agency allocates funding to the contract.

***Contract Mix***

We work withthe federal government under contracts employing one of three types of pricestructures: cost-plus-fee, time-and-materials and fixed-price. Cost-plus-feecontracts are typically lower risk arrangements and thus yield lower profitmargins than time-and-materials and fixed-price arrangements. Because thecustomer usually specifies the type of contract for a particular contractualengagement, we generally do not influence the choice of contract type. However,where we do have the opportunity to influence the contract type, and wherecustomer requirements are clear, we prefer time-and-materials and fixed-pricearrangements rather than cost-plus-fee arrangements because time-and-materialsand fixed-price contracts, as compared with cost-plus-fee contracts, generallyprovide greater opportunity for the customer to save money and for us togenerate higher margins. Our acquisition of Techrizon in April 2007 hasresulted 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** | ** ** |
|--------------------|------------|----------------------------------|------------|
| ** **         | ** ** | **June 30,**                | ** ** |
| ** **         | ** ** | **2006**                         | ** ** | **2007** | ** ** |
| Cost-plus-fee      |       | 53%                              |       | 48% |   |
| Time-and-materials |       | 32%                              |       | 36% |   |
| Fixed-price        |       | 15%                              |       | 16% |   |

 

16

----

*** ***

***Headcount and Labor Utilization***

We generaterevenues primarily from services provided by our employees and subcontractors,with services provided by our employees generally yielding higher profits thanservices provided by our subcontractors. Our ability to hire and deployadditional qualified employees is a key driver of our ability to generateadditional revenues, and our successful deployment of existing employees ondirect-billable jobs is a key driver of our profitability.

***Indirect Costs***

Indirect costsconstitute a substantial portion of the costs associated with our performanceof contracts for customers. We carefully monitor the amount by which our actualindirect costs under our contracts vary from those expected to be incurred,which we refer to as indirect expense variance. Increased indirect rates canadversely affect our ability to achieve attractive contract pricing, ourprofitability and our competitive position, by resulting in unexpectedincreased costs to our customers.

***Days Sales Outstanding***

Days salesoutstanding, or DSO, is a measure of how efficiently we manage the billing andcollection of our accounts receivable, our most significant working capitalrequirement. For the three months ended June 30, 2007, wereported DSO of 81 days, an increase from 78 days we reported for the yearended March 31, 2007. The increase in DSO is attributable primarily tosignificant revenue growth and delays in payment of certain largereceivables.

***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.

Payments to usfor performance on certain of our federal government contracts are subject toaudit by the DCAA and are subject to government funding. We provide a reserveagainst our receivables for estimated losses that may result from ratenegotiations, audit adjustments and/or government funding availability. To theextent that actual adjustments due to rate negotiations, audit adjustments orgovernment funding availability differ from our estimates, our revenue may beimpacted. Due to the fact that substantially all of our receivables come fromcontracts funded by the federal government, the likelihood of a material losson an uncollectible account from this activity is low.

**Critical Accounting Policies**

The discussionand analysis of our financial condition and results of operations is based onour consolidated financial statements, which have been prepared in accordancewith GAAP. The preparation of these consolidated financial statements requiresmanagement to make estimates and assumptions that affect reported amounts, andactual results may differ from the estimates. Our significant accountingpolicies are described in Note 1 to our unaudited consolidated financialstatements included in this filing. We consider the following accountingpolicies to be critical to the understanding of our financial condition andresults of operations because these policies require the most difficult,subjective or complex judgments on the part of our management in theirapplication, often as a result of the need to make estimates about the effectof matters that are inherently uncertain, and are the most important to ourfinancial condition and operating results.

***Revenue Recognition***

We recognizerevenue under our contracts when a contract has been executed, the contractprice is fixed and determinable, delivery of services or products has occurredand collectibility is considered probable and can be reasonably estimated. Weuse a standard management process to determine whether all required criteriafor revenue recognition have been met, which includes regular reviews of ourcontract performance. This review covers, among other matters, progress againsta schedule, outstanding action items, effort and staffing, quality, risks andissues, subcontract management, costs incurred, commitments and satisfaction.During this review, we determine whether the overall progress on a contract isconsistent with the effort expended.

Contractrevenue recognition inherently involves the use of estimates. Examples ofestimates include the contemplated level of effort to accomplish the tasksunder 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 

17

----

 

require us to revise our estimated total costs and revenues. To theextent that a revised estimate affects contract profit or revenue previouslyrecognized, we record the cumulative effect of the revision in the period inwhich the facts requiring the revision become known. The full amount of ananticipated loss on any type of contract is recognized in the period in whichit becomes probable and can be reasonably 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 the percentage-of-completionmethod, applying the cost-to-cost or units of delivery method, in accordancewith Accounting Research Bulletin No. 45 and American Institute of CertifiedPublic Accountants (“AICPA”) Statement of Position 81-1 “Accounting forPerformance of Construction-Type and Certain Production-Type Contracts” (“SOP81-1”).

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 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 and adjustthe incentive fee as required based on the contract incentive fee formula.

Our contractswith agencies of the government are subject to periodic funding by therespective contracting agency. Funding for a contract may be provided in fullat inception of the contract or ratably throughout the contract as the servicesare provided. From time to time, we may proceed with work based on customerdirection prior to the completion and signing of formal contract documents.Such situations require completion of a formal internal review process andmanagement approval prior to commencement of work. Additionally, revenueassociated with such work is recognized without profit and only when it can bereliably 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***

As acontractor 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, 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 costs typicallyinclude certain of our selling, general and administrative expenses, fringebenefit expenses and depreciation and amortization costs. Direct and indirectcosts that are not allowable under the Federal Acquisition Regulation orspecific contract provisions cannot be considered for reimbursement under ourfederal government contracts. We must specifically identify these costs toensure we comply with these requirements. Our unallowable costs include aportion of our executive compensation, certain employee morale activities,certain types of legal and consulting costs and the amortization of identifiedintangible assets, among others. A key element to our historical success hasbeen our ability to manage indirect cost growth and unallowable costs inconnection with integration of acquired businesses.

***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, *Goodwilland Other Intangible Assets*(“SFAS No. 142”), we do not amortize goodwill. Rather, we testgoodwill 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 test forpotential impairment, while the second step measures the amount of impairment,if any. Under the guidelines of SFAS No. 142, we are required to perform animpairment test at least 

18

----

 

on an annual basis at any time during the fiscal year, provided thatthe test is performed at the same time every year. An impairment loss would berecognized when the assets’ fair value is below their carrying value. Based on the testing performed as of December 31,2006, we determined that no impairments existed as of December 31, 2006. Customerrelationships, noncompete agreements and backlog and contracts are amortized ona straight-line basis over periods ranging from two to seven years.

**Results of Operations**

Our historicalfinancial statements reflect the operating results of our acquisitions from thedate of acquisition. The following tables set forth the results of operationsexpressed in dollars (in thousands) and as a percentage of revenues, for theperiods below:
| ** **                                                    | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                    | ** ** | **June 30,**                | ** ** |
| **Consolidated Statement of Income Data** | ** ** | **2006**                         | ** ** | **2007** | ** ** |
| ** **                                                    | ** ** | **(unaudited)**                  | ** ** |
| Revenues                                                      |       | $                                | 92,555     |   | $ | 133,481 |   |
| Operating costs  and expenses:                                |       |                             |       |   |   |
| Cost of revenues                                              |       | 78,303                           |       | 112,329 |   |
| Selling, general and administrative                           |       | 6,521                            |       | 9,423 |   |
| Amortization of deferred compensation                         |       | 249                              |       | 75 |   |
| Depreciation and amortization                                 |       | 1,387                            |       | 1,609 |   |
| Total operating costs and expenses                            |       | 86,460                           |       | 123,436 |   |
| Operating income                                              |       | 6,095                            |       | 10,045 |   |
| Other income  (expense):                                      |       |                             |       |   |   |
| Other income                                                  |       | 260                              |       | — |   |
| Interest expense — net                                   |       | (2,145                           | )          | (1,062 | ) |
| Total other expenses                                          |       | (1,885                           | )          | (1,062 | ) |
| Income before taxes                                           |       | 4,210                            |       | 8,983 |   |
| Provision for  income taxes                                   |       | (1,726                           | )          | (3,619 | ) |
| Net income                                                    |       | $                                | 2,484      |   | $ | 5,364 |   |

 
| ** **                                          | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|
| ** **                                          | ** ** | **June 30,**                | ** ** |
| **As a Percentage of Revenues** | ** ** | **2006**                         | ** ** | **2007** | ** ** |
| ** **                                          | ** ** | **(unaudited)**                  | ** ** |
| Revenues                                            |       | 100.0                            | %          | 100.0 | % |
| Operating costs  and expenses:                      |       |                             |       |   |   |
| Cost of revenues                                    |       | 84.6                             |       | 84.2 |   |
| Selling, general and administrative                 |       | 7.0                              |       | 7.0 |   |
| Amortization of deferred compensation               |       | 0.3                              |       | 0.1 |   |
| Depreciation and amortization                       |       | 1.5                              |       | 1.2 |   |
| Total operating costs and expenses                  |       | 93.4                             |       | 92.5 |   |
| Operating income                                    |       | 6.6                              |       | 7.5 |   |
| Other income  (expense):                            |       |                             |       |   |   |
| Other income                                        |       | 0.3                              |       | 0.0 |   |
| Interest expense — net                         |       | (2.3                             | )          | (0.8 | ) |
| Total other expenses                                |       | (2.0                             | )          | (0.8 | ) |
| Income before taxes                                 |       | 4.5                              |       | 6.7 |   |
| Provision for  income taxes                         |       | (1.9                             | )          | (2.7 | ) |
| Net income                                          |       | 2.7                              | %          | 4.0 | % |

 

We generaterevenues primarily from services provided by our employees and subcontractors,with services provided by our employees generally yielding higher profits thanservices provided by our subcontractors. To a lesser degree, we earn revenuesthrough reimbursable travel and other reimbursable direct and indirect costs tosupport the contractual effort and third-party hardware and software that wepurchase and integrate for customers as part of the solutions we provide.

19

----

 

Our mostsignificant expense is cost of revenues, which includes the costs of directlabor, subcontractors, materials, equipment, travel and an allocation ofindirect costs (other than selling, general and administrative expenses anddepreciation). Indirect costs consist primarily of fringe benefits, humanresources, recruiting, training, other overhead and certain other non-directcosts that are necessary to support direct labor. The number and types ofpersonnel, their salaries and other costs, can have a significant impact on ourcost of revenues.

Our selling,general and administrative expenses include costs not directly associated withperforming work for our customers. These costs include wages plus associatedfringe benefits, stock-based compensation charges, rent, travel and insurance.Among the functions covered by these expenses are sales, business development,contract administration, purchasing, legal, finance, accounting, humanresources, information technology and general management. Most of these costsare allowable costs under the cost accounting standards for contracting withthe 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 our business.

Ouramortization of deferred compensationincludes stock-based compensation related to pre-FAS123(R) awardsamortized over the vesting period of the awards.

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 Operations for theThree Months Ended June 30, 2006and***2007

***Revenues.*** Our consolidated revenues increased $40.9 million, or 44.2% from $92.6 million for the three months ended June 30, 2006, to $133.5million for the three months ended June30,  2007. The increase wasprimarily due to $9.6 million of increased revenues attributable to theacquisition of Techrizon, $9.0 million of increased revenues attributable toexpanding demand for passport services for the Department of State’s Bureau ofConsular Affairs and $7.1 million of increased revenues attributable to Morganrelated contracts that include specialized engineering and technology servicesprovided to the U.S. Army Aviation and Missile Command (“AMCOM”) and the U.S.Army Program Executive Office for Simulation, Training and Instrumentation (“PEOSTRI”). The balance of the increased revenues of $15.2 million were related tocontinued growth providing enterprise integration and operational supportservices for the Department of Defense, and ongoing logistics support for theArmy’s equipment reset effort in the United States and abroad.

***Cost of Revenues.***  Our cost of revenues increased $34.0million, or 43.3%, from $78.3 million for the three monthsended June 30,  2006, to $112.3million for the three months ended June30, 2007. This increase was primarily the result of additional costsattributable to revenues generated by Techrizon operations, in addition to thecost of revenues associated with the increased services provided under thecontracts referred to above.

***Selling, General and Administrative.***  Our selling, general and administrativeexpense increased $2.9 million, or 44.5%, from $6.5 million for the three months ended June 30,  2006, to $9.4 million for the three monthsended June 30,  2007. This increase was primarily due to selling, general andadministrative expenses attributable to Techrizon operations, higher recruitingcosts to expand our highly trained and specialized workforce, and additionalcosts associated with being a public company, including costs associated withlegal, audit, tax and Sarbanes-Oxley compliance services.

***Depreciation and Amortization.***  Our depreciation and amortization expense increased $0.2 million, or 16.0%,from $1.4 million for the three monthsended June 30, 2006, to $1.6 million for the three monthsended June 30,  2007. The increase in depreciation and amortization wasprimarily due to the amortization of intangible assets associated with theTechrizon acquisition as well as additional depreciation expense associatedwith capital expenditures during fiscal 2007.

***Interest Expense, Net.***  Our net interest expense decreased $1.0 million from $2.1million for the three months ended June30, 2006, to $1.1 millionfor the three months ended June 30,  2007. The decrease in net interestexpense was due to the repayment of term loan borrowings with the proceeds fromour initial public offering completed in October 2006.

20

----

*** ***

***Net Income.***  Our net income increased $2.9 millionfrom $2.5 million for the threemonths ended June 30, 2006, to $5.4 million for the three months ended June 30, 2007. The primaryreasons for the increase in net income are higher operating margins, lowerinterest expense, and profits from Techrizon.

**Inflation**

We do notbelieve that inflation has had a material effect on our business for the threeyears ended June 30, 2007.

**Liquidity and Capital Resources**

Our primaryliquidity needs are to finance the costs of operations pending the billing andcollection of accounts receivable, to service our debt, to make capitalexpenditures and to make selective strategic acquisitions. Based upon ourcurrent operations, we expect that our cash flow from operations, together withamounts we are able to borrow under our senior credit facility, will beadequate to meet our anticipated needs for the foreseeable future. In addition,we expect 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.
| ** **                                           | ** ** | **Three months ended  June 30,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                        | ** ** | **2007** | ** ** |
| ** **                                           | ** ** | **(in millions)  (unaudited)**             | ** ** |
| Net cash  provided by (used in) operating activities |       | $                                               | 6.7        |   | $ | (6.4 | ) |
| Net cash used in  investing activities               |       | $                                               | (0.4       | ) | $ | (31.9 | ) |
| Net cash (used in)  provided by financing activities |       | $                                               | (6.2       | ) | $ | 25.5 |   |

 

Net cash usedin operating activities of $6.4 million for the three months ended   June 30, 2007, primarilyreflected our net income plus depreciation and amortization expenses for thatperiod, a $7.1 million increase in accounts receivable, a $6.2 million decreasein accounts payable, partially offset by a $1.5 million decrease in accruedexpenses. For the three months ended   June 30,  2006, net cash provided byoperating activities of $6.7 millionconsisted primarily of net income and a $5.0 million decrease in accountsreceivable and a $1.8 million increase in accrued expenses, offset by a $3.1million decrease in accounts payable.

Net cash usedin investing activities of $31.9 million for the three months ended  June30, 2007, consisted primarily of $30.5 million to complete theacquisition of Techrizon. Net cash used in investing activities of $0.4 million in the three months ended  June 30, 2006, consisted of the purchase of equipment in theordinary course of business.

Net cash provided by financing activities of $25.5million for the three monthsended  June 30, 2007, consisted primarily of $25.7million of borrowings under the revolving portion of our senior credit facilityto finance the acquisition of Techrizon. Net cash used in financing activitiesof $6.2 million for the three months ended  June 30,  2006, consisted primarily of $6.6million of net repayments of our line of credit.

***Credit Facility and Borrowing Capacity***

On February 16,2006, in order to finance our acquisition of Morgan and to refinance ourthen-outstanding indebtedness, we entered into a new senior credit facilitythat includes a $50.0 million revolving credit facility. As of June 30,2007, we had $37.5million of term loan indebtedness outstanding under our senior credit facility.As of June 30, 2007, ourborrowing availability under the revolving portion of our senior creditfacility was $24.3 million. Theobligations under our senior credit facility are unconditionally guaranteed byeach of our existing and subsequently acquired or organized subsidiaries andsecured on a first-priority basis by security interests (subject to permittedliens) in substantially all assets 

21

----

 

owned by us and each of our subsidiaries, including the shares ofcapital stock of our subsidiaries, subject to certain exceptions.

Under theterms of the senior credit facility, we are entitled to request an increase inthe size of the credit facility by an amount not greater than $75 million inthe aggregate. If any lender elects not to increase its commitment under thesenior credit facility, we may designate another bank or other financialinstitution to become a party to the credit facility.

The creditagreement also contains a number of affirmative and restrictive covenants,including limitations on mergers, consolidations and dissolutions; sales ofassets; investments and acquisitions; indebtedness and liens; repurchases ofshares of capital stock and options to purchase shares of capital stock;transactions with affiliates; sale and leaseback transactions; and restrictedpayments.

In addition,the credit agreement provides that we are required to meet the followingfinancial covenants:

·                  a fixed chargecoverage ratio as of the end of any fiscal quarter of not less than 1.50 to1.00, based upon the ratio of (i) consolidated EBITDA (as defined in the creditagreement) less the actual amount paid by us and our subsidiaries in cash onaccount of capital expenditures and taxes over the period consisting of thefour consecutive fiscal quarters ending on or immediately prior to thedetermination date to (ii) consolidated cash interest expense for such period,scheduled principal payments required to be made on consolidated total debtduring such period and certain restricted payments paid during such period;

·                  a maximumleverage ratio based upon the ratio of (i) consolidated total debt to (ii)consolidated EBITDA (as defined in the credit agreement), which required us tomaintain a ratio of 4.25 to 1.00 for each fiscal quarter ending on or prior toDecember 31, 2006, to maintain a ratio of 3.50 to 1.00 for each fiscal quarterending after December 31, 2006 and on or prior to December 31, 2007, and aratio of 3.00 to 1.00 for each fiscal quarter ending after  December 31, 2007; and

·                  a minimumconsolidated net worth equal to the sum of (i) 85% of our consolidated networth as of December 31, 2005, (ii) 50% of consolidated net income (as definedin the credit agreement) on a cumulative basis for all preceding fiscalquarters, commencing with the fiscal quarter ended March 31, 2006, and (iii)100% of the amount by which our total stockholders’ equity is increased asresult of any public or private offering of our common stock after the closingdate of our credit agreement.

As of June30, 2007, we were in compliance with all covenants under our seniorcredit facility.

**Capital Expenditures**

We haverelatively low capital expenditure requirements. Our capital expenditures were$0.6 million and $1.4 million for the three months ended June 30,  2006 and  2007, respectively. Substantially all of these expendituresconsisted of leasehold improvements and purchases of office equipment due toinvestments made in connection with our relocation to a new headquartersfacility in fiscal 2006.

**Off-Balance Sheet Arrangements**

We did nothave any significant off-balance sheet arrangements as defined in Item 303(a)(4)(ii)of SEC Regulation S-K as of June 30, 2007.

**Recent Accounting Pronouncements**

In July 2006, theFinancial Accounting Standards Board (“FASB”) issued Interpretation No. 48, *Accounting for Uncertainty in Income Taxes, an interpretation of FASBStatement No. 109, Accounting for Income Taxes*(“FIN 48”). FIN 48provides guidance on recognition, derecognition, measurement, classification,interest and penalties, accounting for interim periods and disclosures. FIN 48requires an entity to recognize the financial statement impact of a taxposition when it is more likely than not that the position will be sustainedupon examination. The amount recognized is measured at the largest amount ofbenefit that is greater than fifty percent likely of being realized uponultimate settlement. In addition, FIN 48 permits an entity to recognizeinterest and penalties related to tax uncertainties as income tax expense oroperating expenses. FIN 48 is effective for fiscal years beginning afterDecember 15, 2006. We adopted the provisions of FIN 48 on April 1, 2007. Thecumulative effects of applying this interpretation have been recorded as adecrease of $0.3 million to retained earnings, an increase of $0.5 million tonet deferred tax assets, and 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.

22

----

 

In September 2006, the FASB issued Statement of Financial AccountingStandards No. 157, *Fair Value Measurements*(“SFAS157”). 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. We are inthe process of determining what effect, if any, the adoption of SFAS 157 willhave on our financial position, results of operations, or cash flows.

In February 2007, the FASB issued Statement of FinancialAccounting Standards No. 159, *The FairValue Option for Financial Assets and Financial Liabilities—Including anAmendment of FASB Statement No. 115* (“SFAS 159”). SFAS 159permits entities to measure many financial instruments and certain other itemsat fair value to improve financial reporting by providing entities with theopportunity to mitigate volatility in reported earnings caused by measuringrelated assets and liabilities differently without having to apply complexhedge accounting. Most of the provisions in SFAS 159 are elective. Thisstatement will be effective for the Company in fiscal 2009, and may be appliedprospectively. Early adoption is permitted provided the Company also elects toapply the provisions of SFAS 157. The Company is in the process of determiningwhat effect, if any, the application of the provisions of SFAS 159 will have onits financial position and results of operations.

Several other new accounting standards became effective during theperiods presented or will be effective subsequent to June 30, 2007. None ofthese new standards had or is expected to have a significant impact on ourfinancial position, results of operation or cash flows.

**ITEM 3.  QUANTITATIVE ANDQUALITATIVE DISCUSSION ABOUT MARKET RISK**

Our principalexposure to market risk relates to changes in interest rates. From time totime, we enter into interest rate swap agreements to effectively limit exposureto interest rate movements within the parameters of our interest rate hedgingpolicy. As of June 30, 2007, all of the outstanding debt under our seniorcredit facility was subject to floating interest rate risk. In October 2006, weentered into an interest rate swap agreement covering $19.0 million of our termindebtedness under which the swap and term debt maturities match. Even aftergiving effect to this agreement, we are exposed to risks due to fluctuations inthe market value of this agreement and changes in interest rates with respectto the portion of our senior credit facility that is not covered by thisagreement. A hypothetical change in the interest rate of 100 basis points wouldhave changed quarterly cash interest expense by $0.2 million.

**ITEM 4.  CONTROLS AND PROCEDURES**

As of June30, 2007, under the supervision and with the participation of our management,including our chief executive officer and our chief financial officer, we haveevaluated the effectiveness of the design and operation of our disclosurecontrols and procedures pursuant to Rule 13a-15 of the Securities Exchange Actof 1934. Based on this evaluation, our chief executive officer and our chieffinancial officer have concluded that our disclosure controls and proceduresare effective in timely alerting management, including the chief executiveofficer and chief financial officer, of material information about us requiredto be included in periodic Securities and Exchange Commission filings. However,in evaluating the disclosure controls and procedures, management recognizedthat any controls and procedures, no matter how well designed and operated, canprovide only reasonable assurance of achieving the desired control objectivesand management necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

There were nochanges in our internal control over financial reporting during the threemonths ended June 30, 2007 that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

23

----

 

**PART 2: OTHER INFORMATION**

**ITEM 1. LEGAL PROCEEDINGS**

Neither we, norany 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**

*Any of therisks described below could materially adversely affect our business, financialcondition and operating results.*

**Risks Related to Our Business**

***We depend on contracts with federalgovernment agencies for substantially all of our revenues. If our relationshipswith these agencies were harmed, our revenues and operating results coulddecline.***

Revenues fromfederal government contracts, either as a prime contractor or as asubcontractor, accounted for 99.9% of our revenues for the three months endedJune 30, 2007. We believe that federal government contracts will continue to bethe source of substantially all of our revenues for the foreseeable future. Forthis reason, any issue that compromises our relationship with agencies of thefederal government in general, or with the Department of Defense or Departmentof State in particular, would cause serious harm to our business. Among the keyfactors in maintaining our relationships with federal government agencycustomers are our performance on individual contracts and task orders, thestrength of our professional reputation and the relationships of our keyexecutives with customer personnel. To the extent that our performance does notmeet customer expectations, or our reputation or relationships with one or morekey customers are impaired, our revenues and operating results could decline asa result.

***Changes in the spending policies or budgetpriorities of the federal government, and the Department of Defense inparticular, could cause us to lose revenues.***

Changes infederal government fiscal or spending policies, or in the Department of Defensebudget allocation, could directly affect our financial performance. Among thefactors that could harm our business are:

·                  curtailmentof the federal government’s use of technology services firms;

·                  asignificant decline in spending by the federal government in general or byspecific departments or agencies in particular;

·                  reductionsin federal government programs or requirements;

·                  ashift in spending to federal programs and agencies that we do not support orwhere we currently do not have contracts or key relationships;

·                  delaysin the payment of our invoices by government payment offices;

·                  federalgovernmental shutdowns, such as the shutdown that occurred during the government’s1996 fiscal year, and other potential delays in the government appropriationsprocess, such as federal agencies having to operate under a continuing fundingresolution because of delays in Congressional budget appropriations;

·                  emergencyspending that reduces funds available for other government priorities, such asthe emergency spending for relief following hurricanes Katrina and Rita; and

·                  generaleconomic and political conditions, including any event that reduces federal taxreceipts or results in a change in spending priorities of the federalgovernment.

These or otherfactors could cause federal government agencies and departments to reduce theirpurchases under contracts, to exercise their right to terminate contracts ornot to exercise options to renew contracts, any of which could cause us to loserevenues.

In particular,revenues earned from contracts with the Department of Defense, including fromsubcontracts having the Department of Defense as the ultimate purchaser,represented approximately 68% of our revenues for the three months ended  June 30, 2007.In the past, the U.S. defense budget has declined from time to time, resultingin a slowing of new program starts, program delays and program cancellations.These reductions may cause defense-related government 

24

----

 

contractors to experience declining revenues, increased pressure onoperating margins and, in some cases, net losses. Current federal governmentspending levels on defense-related programs are in part related to the U.S.military operations in Afghanistan and Iraq and may not be sustainable,including as a result of changes in government leadership, policies orpriorities. Future levels of expenditures and authorizations fordefense-related programs may decrease or shift to programs in areas where we donot provide services. Any such decline or shift in defense-related expenditurescould harm our revenues and operating results.

In addition,any limitations imposed on spending by other federal government agencies thatresult from efforts to reduce the federal deficit may limit both the continuedfunding of our existing contracts and our ability to obtain additionalcontracts. Our backlog consists exclusively of contracts with federaldepartments and agencies, and the continuation of these contracts, or award ofadditional contracts from these agencies, could be materially harmed by federalgovernment spending reductions or budget cutbacks at these departments oragencies.

***Our revenues may decline materially if we areunable to obtain a new award of our passport processing services contract withthe Department of State in September 2007 or if we are unable to renew any ofour other significant contracts.***

We earn asignificant portion of our revenues from the provision of passport processingand support services to the Department of State. Revenues from these serviceswere approximately 17% of our revenues for the three months ended June 30, 2007. Thefixed initial term of our contract with the Department of State for theprovision of passport processing and support services has expired, and we arecurrently performing these services pursuant to the Department of State’sexercise of a one-year renewal option that expires in September 2007. Wecurrently expect the Department of State to subject this contract torecompetition before awarding a new contract and while we will participate inthe recompetition there can be no guarantee of acceptance of our proposal. Ourrevenues may decline materially if we are unable to obtain a renewal of thiscontract or any of our other significant contracts. This contract is relatedbut separate from the recently awarded ten year contract worth $164 millionwith the State Department to conduct passport book personalization services inup to two contractor-supplied and operated turnkey facilities.

***We may not realize the full value of ourbacklog, which may result in lower than expected revenues.***

Our totalbacklog represents the amount of revenues we expect to realize over theremaining base contract performance period and from the exercise of all optionperiods that we reasonably believe will be exercised, in each case from signedcontracts in existence as of the measurement date. We do not include contractceilings for government-wide acquisition contracts, or GWACs, oragency-specific indefinite delivery/indefinite quantity, or ID/IQ, contracts inour backlog calculation. Congress typically appropriates funds for our federalgovernment customers on an annual basis, even though their contracts with usmay call for performance that is expected to take a number of years. As aresult, contracts typically are only partially funded at any point during theirterm, and all or some of the work to be performed under the contracts mayremain unfunded unless and until Congress makes subsequent appropriations andthe procuring agency allocates funding to the contract.

We may neverrealize some of the revenues that are included in our total backlog, and thereis a higher degree of risk in this regard with respect to unfunded backlog. Asof June 30, 2007, our total backlog was approximately $986.0million, of which approximately $241.5 million was funded. In addition, therecan be no assurance that our backlog will result in actual revenues in anyparticular period. This is because the actual receipt, timing and amount ofrevenues under contracts included in backlog are subject to variouscontingencies, many of which are beyond our control. For example, the actualreceipt of revenues from contracts included in backlog may never occur or maybe delayed because a program schedule could change or the program could becancelled, or a contract could be reduced, modified or terminated early,including as a result of a lack of appropriated funds. In addition, the factthat our backlog may translate into revenue does not guarantee that thecontracts will be profitable.

***Loss of our position as a qualifiedcontractor under one or more General Services Administration schedules, or as aprime contractor on one or more of our contracts, would impair our operatingresults and our ability to win new business.***

In recentyears, the federal government has increasingly relied on General ServicesAdministration, or GSA, schedules and multi-award ID/IQ contracts for itsprocurement needs. When using GSA schedules and multi-award ID/IQ contracts, aprocuring officer chooses providers from a pre-selected group of contractors,and contractors that are not part of the group generally will not be notifiedof, and will not be able to compete for, these contracts or task orders.Accordingly, our ability to maintain our existing business and win new businessdepends on our ability to maintain our position as a GSA schedule contractorand a prime contractor on multi-award ID/IQ contracts.

25

----

 

If we were tolose any of our GSA schedules or our prime contractor position on any of ourcontracts, we could lose revenues, and our ability to win new business and ouroperating results could decline as a result. Similarly, unless we aresuccessful in expanding our GSA schedule presence and our base of multi-awardID/IQ contracts, our ability to grow our business may be hindered.

***Most of our revenues are earned fromcontracts with limited initial terms. We may expend significant resources inconnection with these contracts that we may not recover if our customers do notexercise their contract extension options.***

Our contractstypically have a one or two year initial term, with multiple options that areexercisable by our government customers to extend the contract for one or moreadditional years. Our customers may not exercise any of their extensionoptions. Moreover, because we believe that our contracts with limited initialterms represent the early portion of longer customer programs, we expendsignificant financial and personnel resources and expand our operations to beable to fulfill these programs beyond the initial contract term. If asignificant number of our contracts are not extended beyond their initialterms, we may be unable to recover the costs we incurred, we may not recognizeanticipated revenues and our operating results may be harmed.

***The loss of one or more members of our seniormanagement team could impair our relationships with government customers andour ability to compete and could disrupt the management of our business.***

We believethat our success depends on the continued contributions of the members of oursenior management team. Our senior management team has extensive industryexperience, and the relationships and reputation that members of our seniormanagement team have established and maintain with government personnelcontribute to our ability to maintain good customer relations and to identifynew business opportunities. The loss of the services of one or more of oursenior executives could impair our ability to identify and secure newcontracts, to maintain good customer relations and to otherwise manage ourbusiness, any of which could harm our business and operating results.Currently, the Chief Financial Officer is the only member of our seniormanagement that has entered into an Change in Control and Severance Agreement.

***If we fail to attract and retain skilledemployees, we might not be able to perform under our contracts and our abilityto maintain and grow our business could be limited.***

The growth ofour business and revenues depends in large part upon our ability to attract andretain sufficient numbers of highly qualified individuals who have advancedinformation technology skills and appropriate security clearances, and who workwell with our defense and federal civilian government customers. Competitionfor such personnel is intense, and recruiting, training and retention costsplace significant demands on our resources. If we are unable to recruit andretain a sufficient number of qualified employees, our ability to maintain andgrow our business could be limited. Furthermore, we could be required to engagelarger numbers of contracted personnel, which could reduce our profit margins.In addition, many of our professional personnel may have specific knowledge ofand experience with our federal government customers’ operations, and we obtainsome of our contracts based on that knowledge and experience. The loss ofservices of key personnel could impair our ability to perform required servicesunder some of our contracts and to retain such contracts, as well as ourability to win new business.

***We face intense competition from manycompetitors that have greater resources than we do, which could result in pricereductions, reduced profitability and loss of market share.***

We operate inhighly competitive markets and generally encounter intense competition to wincontracts and task orders. For example, we must often discount our GSA schedulerates in order to secure contracts from many of our customers in competitivesituations. Many of our competitors have greater financial, technical,marketing and public relations resources, larger customer bases and greaterbrand or name recognition than we do. We expect that the number of suchcompetitors will grow through industry consolidation and the increasingparticipation in the federal government services market by traditionalconsulting and outsourcing providers and hardware and software manufacturersthat seek to increase their service offerings. These competitors could, amongother things:

·                  divertsales from us by winning very large-scale government contracts due to differentor greater technical capabilities, past performance on large-scale contracts,geographic presence, price and the availability of key professional personnel;

·                  forceus to charge lower prices in order to win or maintain contracts;

·                  harmour relationships; and

·                  seekto hire our employees.

26

----

 

If we losebusiness to our competitors or are forced to lower our prices, our revenues andour operating profits could decline and we could suffer a loss of market share.

In addition,we may face competition from our subcontractors who, from time to time, seek toobtain prime contractor status on contracts for which they currently serve as asubcontractor for us. If one or more of our current subcontractors are awardedprime contractor status on such contracts in the future, it would divert salesfrom us and could force us to charge lower prices in order to ensure that weretain our prime contractor status.

***We derive substantially all of our revenuesfrom contracts awarded through competitive procurement processes, which canimpose substantial costs upon us and negatively impact our operating results.***

We derivesubstantially all of our revenues from federal government contracts that areawarded through competitive procurement processes. Competitive procurementimposes substantial costs and presents a number of risks to us, including:

·                  theneed to bid on engagements in advance of knowing the complete design or fullrequirements, which may result in unforeseen difficulties in executing theengagement and cost overruns;

·                  thesubstantial cost and managerial time and effort that we spend to prepare bidsand proposals for contracts that may not be awarded to us and schedules thatmay not be used; and

·                  theexpense and delay that we may face if our competitors protest or challengecontract awards made to us pursuant to competitive procedures, and the riskthat any such protest or challenge could result in the resubmission of offers,or in termination, reduction or modification of the awarded contract.

The costs weincur in the competitive procurement process may be substantial, and, to theextent we participate in competitive procurements and are unable to winparticular contracts, these costs could negatively affect our operatingresults. In addition, GSA schedule contracts, GWACs, blanket purchaseagreements and other ID/IQ contracts do not guarantee more than a minimalamount of work for us, but instead provide us access to work generally throughfurther competitive procedures. The increasing reliance by the federalgovernment on GSA schedules, GWACs and other multi-award ID/IQ contracts forits procurement needs has led to increased competition and pricing pressure,requiring that we make sustained post-award efforts to realize revenues underthese contracts.

***We may lose money on some contracts if wemiscalculate the resources we need to perform under the contract.***

We provideservices to the federal government under contracts with three basic types ofprice structure: cost-plus-fee, time-and-materials and fixed-price. For the threemonths ended  June30, 2006, we derived approximately53%, 32% and 15% ofrevenues from cost-plus-fee, time-and-materials and fixed-price contracts,respectively. For the three monthsended   June 30, 2007, we derived approximately 48%, 36% and 16% of revenues from cost-plus-fee,time-and-materials and fixed-price contracts, respectively. Each of these typesof contracts, to varying degrees, involves the risk that we underestimate ourcost of fulfilling the contract, and we occasionally have suffered in the past,and may suffer in the future, reduced profits or financial losses on ourcontracts, thereby causing our operating results to decline as a result. Thisrisk is greater for fixed-price contracts, where we bear the full impact ofcost overruns, and an increase of fixed-price contracts in our contract mixwould increase our exposure to this risk.

***Our margins and operating results may sufferif we experience unfavorable changes in the proportion of cost-plus-fee orfixed-price contracts in our total contract mix.***

Althoughfixed-price contracts entail a greater risk of a reduced profit or financialloss on a contract compared to other types of contracts we enter into,fixed-price contracts typically provide higher profit opportunities because wereceive the benefit of cost savings. In contrast, cost-plus-fee contracts aresubject to statutory limits on profit margins, and generally are the leastprofitable of our contract types. Our federal government customers typicallydetermine what type of contract we enter into. Cost-plus-fee and fixed-pricecontracts accounted for approximately 53% and 15%, respectively, of our revenues forthe three months ended  June 30, 2006,and approximately 48% and 16%, respectively, of our revenues forthe three months ended  June 30, 2007. To the extent that we enter into more cost-plus-fee orless fixed-price contracts in proportion to our total contract mix in thefuture, our margins and operating results may suffer.

***Our cash flow and profitability could bereduced if expenditures are incurred prior to the final receipt of a contract.***

We providevarious professional services and sometimes procure equipment and materials onbehalf of our federal government customers under various contractualarrangements. From time to time, in order to ensure that we satisfy ourcustomers’ delivery requirements and schedules, we may elect to initiate workin advance of receiving final authorization 

27

----

 

from the government customer or a prime contractor. If our governmentor prime contractor customers’ requirements should change or if the governmentor the prime contractor should direct the anticipated procurement to a contractorother than us, our pre-contract costs might not be recoverable. This couldreduce anticipated earnings or result in a loss, negatively affecting our cashflow and profitability.

***Failure to maintain strong relationships withother contractors could result in a decline in our revenues.***

We estimatethat revenues derived from contracts in which we acted as a subcontractor toother companies represented approximately 26% of our revenues forthe three months ended  June30, 2007. As a subcontractor, we often lack control over fulfillment ofa contract, and poor performance on the contract could tarnish our reputation,even when we perform as required. As a prime contractor, we often rely on othercompanies to perform some of the work under a contract. We expect to continueto depend on relationships with other contractors for portions of our deliveryof services and revenues in the foreseeable future. Our business, prospects,financial condition and operating results could be harmed if other contractors eliminateor reduce their subcontract relationships with us, whether because they chooseto establish relationships with our competitors or because they choose todirectly offer services that compete with our business, or if the governmentterminates or reduces other prime contractors’ programs or does not award themnew contracts.

***If our subcontractors fail to perform theircontractual obligations, our performance and reputation as a prime contractorand our ability to obtain future business could suffer.***

As a primecontractor, we often rely significantly upon other companies as subcontractorsto perform work we are obligated to perform for our customers. We estimate thatrevenues derived from work performed by our subcontractors representedapproximately 29% of our revenues for the three months ended June 30, 2007. Ifone or more of our subcontractors fail to perform satisfactorily theagreed-upon services on a timely basis, or violate government contractingpolicies, laws or regulations, our ability to perform our obligations or meetour customers’ expectations as a prime contractor may be compromised. In somecases, we have limited involvement in the work performed by the subcontractorsbut are nevertheless responsible for the work performed. In extreme cases,performance or other deficiencies on the part of our subcontractors couldresult in a customer terminating our contract for default. A defaulttermination could expose us to liability for the agency’s costs ofreprocurement, damage our reputation and hurt our ability to compete for futurecontracts and task orders.

***Unfavorable government audit results couldsubject us to a variety of penalties and sanctions, and could harm ourreputation and relationships with our customers.***

The federalgovernment audits and reviews our performance on contracts, pricing practices,cost structure and compliance with applicable laws, regulations and standards.Like most large government contractors, our contracts are audited and reviewedon a continual basis by federal agencies, including the Defense Contract AuditAgency, or the DCAA. An unfavorable audit of us, including any companies wehave acquired or may acquire, or any of our subcontractors could have asubstantial adverse effect on our operating results. For example, any coststhat were previously reimbursed could subsequently be disallowed. In this case,cash we have already collected may need to be refunded and future operatingmargins may be reduced.

Our incurred costsubmissions have been audited by the DCAA through March 31, 2005 forStanley, through December 31, 2004 for Morgan, through March 31, 2004for FSC, CCI, and GCI, and through December 31, 2003 for Techrizon. Costsfor which Stanley was reimbursed after March 31, 2005, costs for whichMorgan was reimbursed after December 31, 2004, costs forwhich FSC, CCI and GCI were reimbursed after March 31, 2004, andcosts for which Techrizon was reimbursed after December 31, 2003, may besubsequently disallowed upon the completion of future audits. In addition, non-auditreviews by the U.S. government may still be conducted on all of our currentgovernment contracts.

If agovernment audit uncovers improper or illegal activities, we may be subject tocivil and criminal penalties and administrative sanctions, includingtermination of contracts, forfeiture of profits, suspension of payments, finesand suspension or debarment from doing business with government agencies. Inaddition, we could suffer serious harm to our reputation if allegations ofimpropriety were made against us, whether or not true.

***If we experience systems or servicesfailures, our reputation could be harmed and our customers could assert claimsagainst us for damages or refunds.***

We create,implement and maintain information technology and engineering systems, andprovide services, that are often critical to our customers’ operations, some ofwhich involve classified or other sensitive information, and may be conductedin war-zones or other hazardous environments. We have experienced and may inthe future experience some 

28

----

 

systems or services failures, schedule or delivery delays, and otherproblems in connection with our work. If our solutions, services, products,including third-party products we may resell to our customers, or otherapplications have significant defects or errors, are subject to delivery delaysor fail to meet our customers’ expectations, we may:

·                  loserevenues due to adverse customer reactions;

·                  berequired to provide additional services to customers at no charge;

·                  receivenegative publicity, which could damage our reputation and harm our ability toattract or retain customers; or

·                  sufferclaims for substantial damages.

The successfulassertion of any large claims against us could seriously harm our business.Even if not successful, these claims could result in significant legal andother costs, may be a distraction to our management and may harm ourreputation.

***Security breaches in sensitive governmentsystems could result in the loss of customers and negative publicity.***

Many of thesystems we develop, integrate and maintain involve managing and protectinginformation involved in intelligence, national security and other sensitive orclassified government functions. A security breach in one of these systemscould cause serious harm to our business, damage our reputation and prevent usfrom being eligible for further work on sensitive or classified systems forfederal government customers. We could incur losses from such a security breachthat could exceed the policy limits under our professional liability insuranceprogram. Damage to our reputation or limitations on our eligibility foradditional work resulting from a security breach in one of the systems wedevelop, install and maintain could materially reduce our revenues.

***Our failure to obtain and maintain necessarysecurity clearances may limit our ability to perform classified work forgovernment customers, which could cause us to lose business.***

Somegovernment contracts require us to maintain facility security clearances andrequire some of our employees to maintain individual security clearances.Obtaining and maintaining security clearances for employees involves a lengthyprocess, and it is difficult to identify, recruit and retain employees whoalready hold security clearances. If our employees lose or are unable to timelyobtain security clearances or we lose a facility clearance, the governmentcustomer may terminate the contract or decide not to renew it upon itsexpiration. As a result, to the extent we cannot obtain or maintain therequired security clearances for a particular contract, or we fail to obtainthem on a timely basis, we may not derive the revenues anticipated from thecontract, which could harm our operating results. To the extent we are not ableto obtain facility security clearances or engage employees with the requiredsecurity clearances for a particular contract, we will be unable to performthat contract and we may not be able to compete for or win new awards forsimilar work.

***Our quarterly operating results may fluctuatesignificantly as a result of factors outside of our control, which could causethe market price of our common stock to decline.***

Our revenuesand operating results will vary from quarter to quarter and, as a result, ouroperating results may fall below the expectations of securities analysts andinvestors, which could cause the price of our common stock to decline. Factorsthat may affect our operating results include those listed in this “RiskFactors” section and others that are specific to our industry such as:

·                  fluctuationsin revenues earned on government contracts;

·                  seasonalfluctuations in our staff utilization rates;

·                  commencement,completion or termination of contracts during any particular quarter;

·                  variablepurchasing patterns under GSA schedule contracts, GWACs, blanket purchaseagreements and other ID/IQ contracts;

·                  changesin contract requirements by our government agency customers;

·                  changesin the extent to which we use subcontractors; and

·                  changesin presidential administrations and senior federal government officials thataffect the timing of technology procurement.

Reductions inrevenues in a particular quarter could lead to lower profitability in thatquarter because a relatively large amount of our expenses are fixed in theshort-term. We may incur significant operating expenses during the start-up and

29

----

 

early stages of large contracts and may not receive correspondingpayments in the same quarter. We may also incur additional expenses whencontracts expire or are terminated or not renewed. In addition, payments due tous from government agencies may be delayed due to billing cycles or as a resultof failures of governmental budgets to gain Congressional and administrationapproval in a timely manner.

***We may be harmed by intellectual propertyinfringement claims.***

Many of theservices and solutions that we provide to our customers involve extensive useof software and other intellectual property. As a result, we could becomesubject to claims of third parties who assert that software and other forms ofintellectual property that we use in delivering services and solutions infringeupon intellectual property rights of those third parties, and we could incursubstantial costs to defend those claims. In addition, if any of theseinfringement claims are ultimately successful, in addition to paying damages,we could be required to take any of the following actions, each of which couldentail significant expenses or result in a significant reduction in revenues:

·                  ceaseselling or using services or solutions that incorporate the challenged softwareor technology;

·                  obtaina license or additional licenses from third parties; or

·                  redesignour services and solutions that rely on the challenged software or technology.

***We may incur substantial costs andliabilities in connection with acquisitions.***

We havecompleted five acquisitions since 2000, including the acquisition of Techrizonin April 2007, and expect to consider further acquisitions and investments inthe future. If we make an acquisition or investment, we may:

·                  issuestock that would dilute current stock ownership;

·                  incurdebt that would restrict our cash flow;

·                  assumeliabilities;

·                  incurlarge and immediate write-offs;

·                  incurunanticipated costs;

·                  incurunanticipated liabilities under purchase and sale agreements with targetcompanies;

·                  foregoprocurement opportunities as a result of organizational conflict of interest,or OCI, concerns;

·                  experiencerisks associated with entering markets in which we have no or limited priorexperience; or

·                  losekey employees from the acquired operations.

In connectionwith any acquisition we make, there may be liabilities that we fail to discoveror that we inadequately assess. In addition, acquired operations may notperform according to the forecasts that we used to determine the purchaseprice. If the acquired entity fails to achieve these forecasts, or if we arenot successful in offering our services to the customer base of the acquiredentity or otherwise do not achieve the anticipated benefits of the acquisition,our financial condition and operating results may decline as a result. Inaddition, if we incur a substantial amount of indebtedness in order to financeone or more acquisitions, our increased leverage may restrict our business andoperations, reduce our cash flows or restrict our future access to sufficientfunding to finance desired growth.

***We may not successfully integrate companiesthat we have acquired or may acquire in the future.***

The process ofintegrating companies requires a significant amount of resources and managementattention which detracts from attention to our business. If we are unable tointegrate the operations of Techrizon, which we acquired in April 2007, orof any company we may acquire in the future as planned, our management’sattention may continue to be diverted from the operation of our business, ouroperations could be disrupted and we may be unable to deliver our services toour customers as planned, any of which would hinder implementation of ourbusiness plan, harm our relationships with our customers and force us to incurunanticipated expenses.

***A preference for minority-owned, small andsmall disadvantaged businesses could impact our ability to be a primecontractor on certain governmental procurements.***

As a result ofthe Small Business Administration, or SBA, set-aside program, the federalgovernment may decide to restrict certain procurements only to bidders thatqualify as minority-owned, small or small disadvantaged businesses. As a result,we would not be eligible to perform as a prime contractor on those programs andwould be restricted to a maximum of 49% of the work as a subcontractor on thoseprograms. An increase in the amount of procurements under the SBA set-aside 

30

----

 

program may impact our ability to bid on new procurements as a primecontractor or restrict our ability to recompete on incumbent work that isplaced in the set-aside program.

***Our employees may engage in misconduct orother improper activities, which could harm our business.***

A significantnumber of our employees are involved in government contracting and billingprocesses, which require compliance with a number of procurement laws andregulations. In addition, in the course of our business, our employeesroutinely obtain access to sensitive or classified government information. As aresult, we are exposed to the risk that employee fraud or other misconductcould occur. Misconduct by employees could include intentional or unintentionalfailures to comply with federal government procurement regulations, engaging inunauthorized activities or falsifying time records. Employee misconduct couldalso involve the improper use of our customers’ sensitive or classifiedinformation, which could result in regulatory sanctions against us and seriousharm to our reputation. It is not always possible to deter employee misconduct,and the precautions we take to prevent and detect this activity may not beeffective in controlling unknown or unmanaged risks or losses, which couldmaterially harm our business.

***Our business commitments require ouremployees to travel to potentially dangerous places, which may result in injuryto our employees.***

Our businessinvolves providing services that require some of our employees to operate incountries that may be experiencing political unrest, war or terrorism,including Afghanistan and Iraq. Certain senior level employees or executivesmay, on occasion, be part of the teams deployed to provide services in thesecountries. As a result, it is possible that certain of our employees orexecutives will suffer injury or bodily harm in the course of thesedeployments. It is also possible that we will encounter unexpected costs inconnection with additional risks inherent in sending our employees to dangerouslocations, such as increased insurance costs, as well as the repatriation ofour employees or executives for reasons beyond our control. These problemscould cause our actual results to differ materially from those anticipated.

**Risks Related to Our Industry**

***Federal government contracts containprovisions giving government customers a variety of rights that are unfavorableto us, including the ability to terminate a contract at any time forconvenience.***

Federalgovernment contracts contain provisions and are subject to laws and regulationsthat provide government customers with rights and remedies not typically foundin commercial contracts. These rights and remedies allow government customers,among other things, to:

·                  terminateexisting contracts, with short notice, for convenience, as well as for default;

·                  reduceorders under or otherwise modify contracts;

·                  forcontracts subject to the Truth in Negotiations Act, reduce the contract priceor cost where it was increased because a contractor or subcontractor duringnegotiations furnished cost or pricing data that was not complete, accurate andcurrent;

·                  forsome contracts, demand a refund, make a forward price adjustment or terminate acontract for default if a contractor provided inaccurate or incomplete dataduring the contract negotiation process, or reduce the contract price undercertain triggering circumstances, including the revision of pricelists or otherdocuments upon which the contract award was predicated, the granting of morefavorable discounts or terms and conditions than those contained in suchdocuments and the granting of certain special discounts to certain customers;

·                  terminateour facility security clearances and thereby prevent us from receivingclassified contracts;

·                  cancelmulti-year contracts and related orders if funds for contract performance forany subsequent year become unavailable;

·                  declineto exercise an option to renew a multi-year contract or issue task orders inconnection with ID/IQ contracts;

·                  claimrights in solutions, systems and technology produced by us;

·                  prohibitfuture procurement awards with a particular agency due to a finding of OCIbased upon prior related work performed for the agency that would give acontractor an unfair advantage over competing contractors or the existence ofconflicting roles that might bias a contractor’s judgment;

·                  subjectthe award of contracts to protest by competitors, which may require thecontracting federal agency or department to suspend our performance pending theoutcome of the protest and may also result in a requirement to resubmit offersfor the contract or in the termination, reduction or modification of theawarded contract; and

31

----

 

·                  suspendor debar us from doing business with the federal government.

If a federalgovernment customer terminates one of our contracts for convenience, we mayrecover only a portion of our incurred or committed costs, settlement expensesand profit on work completed prior to the termination. If a federal governmentcustomer were to unexpectedly terminate, cancel or decline to exercise anoption to renew one or more of our significant contracts or suspend or debar usfrom doing business with the federal government, our revenues and operatingresults would be materially harmed.

***Our failure to comply with complexprocurement laws and regulations could cause us to lose business and subject usto a variety of penalties.***

We must complywith laws and regulations relating to the formation, administration andperformance of federal government contracts, which affect how we do businesswith our federal government customers and may increase our expenses. Among themost significant laws and regulations are:

·                  theFederal Acquisition Regulation, and agency regulations analogous orsupplemental to the Federal Acquisition Regulation, which comprehensivelyregulate the formation, administration, and performance of governmentcontracts, including provisions relating to the avoidance of conflicts ofinterest and intra-organizational conflicts of interest;

·                  theTruth in Negotiations Act, which requires certification and disclosure of allcost and pricing data in connection with some contract negotiations;

·                  theProcurement Integrity Act, which requires evaluation of ethical conflictssurrounding procurement activity and establishing certain employmentrestrictions for individuals who participate in the procurement process;

·                  theCost Accounting Standards, which impose accounting requirements that govern ourright to reimbursement under some cost-based government contracts;

·                  laws,regulations and executive orders restricting the use and dissemination ofinformation classified for national security purposes and the exportation ofspecified products, technologies, and technical data; and

·                  compliancewith antitrust laws.

If a governmentreview or investigation uncovers improper or illegal activities, we may besubject to civil and criminal penalties and administrative sanctions, includingthe termination of our contracts, the forfeiture of profits, the suspension ofpayments owed to us, fines and our suspension or debarment from doing businesswith federal government agencies. In particular, the civil False Claims Actprovides for treble damages and potentially substantial civil penalties where,for example, a contractor presents a false or fraudulent claim to thegovernment for payment or approval, or makes a false statement in order to geta false or fraudulent claim paid or approved by the government. Actions underthe civil False Claims Act may be brought by the government or by other personson behalf of the government. These provisions of the civil False Claims Actpermit parties, such as our employees, to sue us on behalf of the governmentand share a portion of any recovery. Any failure to comply with applicable lawsand regulations could result in contract termination, damage to our reputation,price or fee reductions or suspension or debarment from contracting with thegovernment, each of which could lead to a material reduction in our revenues.

***The failure by Congress to timely approvebudgets for the federal agencies we contract with could delay or reducespending and cause us to lose revenues.***

On an annualbasis, Congress must approve budgets that govern spending by each of thefederal agencies we contract with. When Congress is unable to agree on budgetpriorities, and thus is unable to pass the annual budget on a timely basis,Congress typically enacts a continuing resolution that allows federalgovernment agencies to operate at spending levels approved in the previousbudget cycle. Operation by government agencies on the basis of a continuingresolution may delay or cancel funding we expect to receive from customers onwork we are already performing and is likely to result in new initiatives beingdelayed, and in some cases being cancelled.

***The adoption of new procurement laws orregulations could reduce the amount of services that are outsourced by thefederal government and could cause us to lose future revenues.***

Newlegislation or procurement regulations could cause federal agencies to adoptrestrictive procurement practices regarding the use of outside serviceproviders. For example, the American Federation of Government Employees, thelargest federal employee union, strongly endorses legislation that may restrictthe procedure by which services are outsourced to government contractors. Ifsuch legislation were to be enacted, it would likely reduce the amount ofinformation technology services that could be outsourced by the federalgovernment, which could materially reduce our future expected revenues.

32

----

*** ***

***The Office of Management and Budget processfor ensuring government agencies properly support capital planning initiatives,including information technology investments, could reduce or delay federalinformation technology spending and cause us to lose revenue.***

The Office ofManagement and Budget, or OMB, supervises spending by federal agencies andenforces the Government Performance Results Act. This Act requires, among otherthings, that federal agencies make an adequate business justification tosupport capital planning initiatives, including all information technologyinvestments. The factors considered by the OMB include, among others, whetherthe proposed information technology investment is expected to achieve anappropriate return on investment, whether related processes arecontemporaneously reviewed, whether interoperability with existing systems andthe capacity for these systems to share data across government agencies hasbeen considered and whether existing commercial off-the-shelf products arebeing utilized to the extent possible. If our customers do not adequatelyjustify proposed information technology investments to the OMB, the OMB mayrefuse funding for their new or continuing information technology investments,and we may lose revenue as a result.

**Risks Related to Our Common Stock**

***Our executive officers and directors as agroup and our Employee Stock Ownership Plan, or ESOP, own a significantpercentage of our common stock, and as a result have significant influence overour affairs and policies.***

Our executiveofficers and directors as a group beneficially own approximately 29% of ouroutstanding common stock. For so long as our executive officers and directorscontinue to own a significant portion of our outstanding common stock, theywill have significant influence over matters submitted to our stockholders forapproval and exercise significant control over our business policies andaffairs, including the election of directors, amendments to our certificate ofincorporation and determinations with respect to mergers and other businesscombinations, including those that may result in a change of control.  In addition, the ESOP beneficially ownsapproximately 24% of our outstanding common stock. Substantially all of theparticipants in the ESOP are our employees. If these participants act together,they will also be able to exert influence over matters submitted to ourstockholders for approval, and if they act together with our executive officersand directors, they will be able to determine the outcome of matters submittedfor stockholder approval. The interests of our executive officers and directorsand the ESOP participants may conflict with your interests as a stockholder.

***Provisions of our charter documents mayinhibit potential acquisition bids that stockholders may consider favorable, and the market price of our commonstock may be lower as a result.***

Provisions ofour certificate of incorporation and by-laws, as amended and restated, maydeter, delay or prevent a third-party from acquiring us. These provisionsinclude:

·                  limitationson who may call special meetings of stockholders;

·                  theabsence of cumulative voting in the election of directors;

·                  theinability of stockholders to act by written consent;

·                  advancenotice requirements for nominations for election to the board of directors andfor stockholder proposals; and

·                  theauthority of our board of directors to issue, without stockholder approval, upto 500,000 shares of preferred stock with such terms as the board of directorsmay determine and to issue additional shares of our common stock.

Theseprovisions could have the effect of delaying, deferring or preventing a changein control of our company, discourage others from making tender offers for ourshares, lower the market price of our stock or impede the ability of ourstockholders to change our management, even if such changes would be beneficialto our stockholders.

***A substantial number of shares will beeligible for sale in the near future, which could cause our common stock priceto decline.***

Prior to ourinitial public offering in October 2006, substantially all of our common stockwas held by our employees, including through our ESOP. If our existingstockholders sell, or the market perceives that our stockholders intend tosell, substantial amounts of our common stock in the public market, the marketprice of our common stock could decline significantly. These sales also mightmake it more difficult for us to sell equity or equity-related securities inthe future at a time and price that we deem appropriate. In connection with ourinitial public offering, our executive officers, directors, the sellingstockholders (other than the ESOP), and certain other stockholders entered intolock-up agreements. In accordance with these lock-up agreements, 5,069,628shares of common stock will be available for sale in the public market 360 daysafter October 17, 2006. These lock-up agreements are subject to a number ofexceptions and Citigroup Global 

33

----

 

Markets Inc., on behalf of the underwriters in the initial publicoffering, may release these stockholders from their lock-up agreements with theunderwriters at any time and without notice, which would allow for earlier saleof shares in the public market. As restrictions on resale end, the market priceof our common stock could drop significantly if the holders of restrictedshares sell them or are perceived by the market as intending to sell them. Inaddition, our ESOP holds 6,237,454 shares of our common stock, amajority of which is allocated to employee accounts. Under certaincircumstances, such as the termination of an employee’s employment with us, theESOP may distribute shares to ESOP participants (or sell shares in the market),depending on the elections of ESOP participants. In addition, pursuant todiversification rights that were available to ESOP participants during the90-day period beginning March 31, 2007, 746,359 shares held by the ESOP will besold in the public market during the quarter ended September 30, 2007.

**ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

None.

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES**

None.

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

None.

**ITEM 5. OTHER INFORMATION**

None.

**ITEM 6. EXHIBITS**

See the exhibitindex.

 

34

----

 

**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused 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  August 9, 2007                     |
|   |       |                                                                                                 |
|   |       |                                                                                                 |
|   | ** ** | **/s/  BRIAN J. CLARK**                                                                              |
|   |       | Brian J. Clark  Chief Financial Officer and Treasurer  (Principal Financial Officer)  August 9, 2007 |

 

35

----

** **

**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.                                                              |
| 10.1        |       | Membership Interest Purchase Agreement, dated April  1, 2007, by and among Oklahoma Acquisitions Corp., the Members of Techrizon,  LLC and Sellers’ Representative, incorporated by reference to Exhibit 10.1  to the Company’s Current Report on Form 8-K (File No. 001-33083), filed April  2, 2007. |
| 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.                                                                                                                                         |

 

36

----