ITEM 2 Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
There are a number of risk factors or uncertainties that could significantly impact our future financial performance, including the following:
• General economic or political conditions;

• Threatened or pending litigation;

• The timing of expenses incurred for corporate initiatives;

• Employee hiring, utilization, and turnover rates;

• The seasonality of spending in the federal government and for commercial clients;

• Delays in project contracted engagements;

• Unanticipated contract changes impacting profitability;

• Reductions in prices by our competitors;

• The ability to obtain follow-on work;

• Failure to properly manage projects resulting in additional costs;

• The cost of compliance for the Company's laboratories;

• The results of a negative government audit potentially impacting our costs, reputation and ability to work with the federal government;

• Loss of key personnel;

• The ability to compete in a highly competitive environment; and

• Federal funding delays due to wars in Iraq and Afghanistan.

Results of Operations
First Quarter Comparison of Fiscal Year 2010 and 2009

                                              For the Three-Month Periods Ended
                                           September 25,             September 26,
                                               2009                      2008

 GROSS REVENUE
 Program Management                      $          16,403         $          15,850
 Compliance and Environmental Programs               3,525                     4,560
 Professional Services                               2,738                     2,178
 National Security                                   2,048                     2,410

                                         $          24,714         $          24,998

Gross revenue for the first quarter of fiscal year 2010 was $24,714,000, a decrease of $284,000 (1%) compared to that reported in the first quarter of fiscal year 2009. Gross revenue in the Program Management business segment for the first quarter of fiscal year 2010 was $16,403,000, an increase of $552,000 (3%) higher than that reported in the first quarter of fiscal year 2009. The increase is primarily due to increased U.S. based construction work of $4,700,000 for the Air Force, which was largely offset by reduced work in Iraq of approximately $4,000,000. Gross revenues for the Compliance and Environmental Programs business segment for the first quarter of fiscal year 2010 was $3,525,000, a decrease of $1,035,000 (23%) compared to that reported in the first quarter of fiscal year 2009. The decrease is due to poor economic conditions creating budget shortfalls impacting the Company's municipal work due to budget shortfalls. Gross revenues for the Professional Services business segment for the first quarter of 2010 was $2,738,000, an increase of $560,000 (26%) compared to that reported in the first quarter of fiscal year 2009. The increase is attributable to continued work on additional, larger professional services outsourcing awards during fiscal year 2010. Gross revenue for the National Security business segment for the first quarter of fiscal year 2010 was $2,048,000, a decrease of $362,000 (15%) compared to that reported for the first quarter of fiscal year 2009. The decrease is due to slower than expected personal protective suit sales, which we believe is primarily a timing issue and a decline in chemical laboratory testing work during the quarter.

ITEM 2 Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Purchased services and materials decreased by $779,000 (6%) in the first quarter of fiscal year 2010 compared to the first quarter of fiscal year 2009. The decrease is attributable to the reduced chemical laboratory testing work and lower than anticipated protective suit sales during the first quarter of fiscal year 2010 in the Company's National Security business segment as mentioned above.
Direct costs of services and overhead include the cost to Versar of direct and overhead staff, including recoverable and unallowable costs that are directly attributable to contracts. Direct costs of services and overhead increased by $1,320,000 (16%) in the first quarter of fiscal year 2010 compared to that reported in the first quarter of fiscal year 2009. Approximately 40% of the increase is due to the business growth in the Professional Services business segment. The balance of the increase is due to additional costs required to support the U.S. based construction work and business growth initiatives in the telecommunications and green energy markets in the Program Management business segment.
Gross profit for the first quarter of fiscal year 2010 was $2,353,000, a decrease of $825,000 (26%) compared to that reported in the first quarter of fiscal year 2009. The decrease is primarily due to the increased direct costs of services and overhead in the Program Management business segment along with the continued poor operating performance in the Compliance and Environmental business segment in the first quarter of fiscal year 2010.

                                              For the Three-Month Periods Ended
                                           September 25,            September 26,
                                                2009                     2008

  GROSS PROFIT
  Program Management                      $          1,872         $          2,287
  Compliance and Environmental Programs                (52 )                    252
  Professional Services                                444                      421
  National Security                                     89                      218

                                          $          2,353         $          3,178

Gross profit for the Program Management business segment for the first quarter of fiscal year 2010 was $1,872,000, a decrease of $415,000 (18%) compared to that reported in the first quarter of fiscal year 2009. The decrease was due to the reduced international work as well as investments in the new business initiatives as mentioned above. Gross profit for the Compliance and Environmental business segment for the first quarter of fiscal year 2010 was a loss of $52,000, a decrease of $304,000 compared to that reported in the first quarter of fiscal year 2009. The decrease is due to the poor economic conditions creating severe budget constraints for our municipal clients. Gross profit for the Professional Services business segment for the first quarter of fiscal year 2010 was $444,000, an increase of $23,000 (5%) compared to that reported in the first quarter of fiscal year 2009. The increase is attributable to the increased gross revenue as mentioned above. Gross profit for the National Security business segment was $89,000, a decrease of $129,000 (59%) compared to that reported in the first quarter of fiscal year 2009. The decrease was due to delayed product shipments of personal protective equipment and reduced chemical laboratory testing work.
Selling, general and administrative expenses decreased by $61,000 (3%) during the first quarter of fiscal year 2010 compared to that reported in the first quarter of fiscal year 2009. The decrease is primarily due to reduced discretionary spending during the quarter.
Operating income for the first quarter of fiscal year 2010 was $378,000, a decrease of $764,000 (67%) compared to that reported for the first quarter of fiscal year 2009. The decrease is attributable to the reduced operating performance in the Program Management, Compliance and Environmental and National Security business segments during the first quarter of fiscal year 2010 as mentioned above.
Interest income for the first quarter of fiscal year 2010 was $32,000, a decrease of $31,000 compared to that reported in the first quarter of fiscal year 2009. The decrease is due to lower interest rates on the Company's cash balances held with the bank in the first quarter of fiscal year 2010.

ITEM 2 Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
During the first quarter of fiscal year 2009, the Company recorded a $352,000 loss on investments the Company was holding in FISCO Income Plus Funds. The FISCO fund received an immediate demand margin call from its broker, UBS, yet rather than allow the fund the customary time to satisfy the margin call to the end of the day, UBS demanded the fund cover all calls and puts at high premiums or they would take control of the fund and start liquidating the fund itself. The fund has terminated its relationship with UBS and transferred the assets to a new custodian. The fund is pursuing legal action against UBS to cover its losses to which the Company will be a part of any such settlement. Arbitration is currently scheduled for February 2010.
Income tax expense for the first quarter of fiscal year 2010 was $160,000, a $160,000 decrease from that reported in the first quarter of fiscal year 2009. The effective tax rates were 41% and 38% for the first quarter of fiscal year 2010 and 2009, respectively.
Versar's net income for the first quarter of fiscal year 2010 was $237,000 compared to $525,000 in the first quarter of fiscal year 2009. The decrease is attributable to the reduced operating performance in the Program Management, Compliance and Environmental and National Security business segments during the first quarter of fiscal year 2010.
Liquidity and Capital Resources
The Company's working capital as of September 25, 2009 was approximately $25,775,000, an increase of 1%. In addition, the Company's current ratio at September 25, 2009 was 3.39, compared to 3.04 reported on June 26, 2009. The Company's financial ratios have continued to improve during the first quarter of fiscal year 2010. Accounts receivables decreased by approximately $2 million primarily due to improved cash flow during the quarter.
The Company has a line of credit facility with United Bank (the Bank) that provides for advances up to $7.5 million based upon qualifying receivables. The line of credit is subject to certain covenants related to the maintenance of financial ratios. These covenants require a minimum tangible net worth of $22.5 million; a maximum total liabilities to tangible net worth ratio not exceed 2.5 to 1; and a minimum current ratio of at least 1.25 to 1. Borrowings under the extended line of credit will be at prime less 1/2% with a floor interest rate of 3.5%. Failure to meet the covenant requirements gives the Bank the right to demand outstanding amounts due under the line of credit, which may impact the Company's ability to finance its working capital requirements. As of September 25, 2009, the Company had no outstanding borrowings and was in compliance with the financial covenants. In October 2006, the Company obtained a letter of credit of approximately $1.6 million under the line of credit facility which serves as collateral for surety bond coverage provided by the Company's insurance carrier against project construction work. The letter of credit was reduced to $455,147 in January 2009. The letter of credit reduces the Company's availability on the line of credit. Availability under the line of credit at September 25, 2009 was approximately $7 million. Obligations under the credit facility are guaranteed by Versar and each subsidiary individually and are secured by accounts receivable, equipment and intangibles, plus all insurance policies on property constituting collateral of Versar and its subsidiaries. The line of credit matures in September 2010.
The Company believes that its current cash balance of over $7.7 million along with anticipated cash flows from operations will be sufficient to meet the Company's liquidity needs within the next fiscal year. Expected capital requirements for fiscal year 2010 are approximately $1,000,000, primarily for upgrades to maintain the Company's existing information technology systems. Such capital requirements will be funded through existing working capital.

ITEM 2 Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Critical Accounting Policies and Related Estimates That Have a Material Effect on Versar's Consolidated Financial Statements Below is a discussion of the accounting policies and related estimates that we believe are the most critical to understanding the Company's consolidated financial position and results of operations which require management judgments and estimates, or involve uncertainties. Information regarding our other accounting policies is included in the notes to our consolidated financial statements included elsewhere in this report on Form 10-Q and in our annual report on Form 10-K filed for fiscal year 2009.
Revenue recognition: Contracts in process are stated at the lower of actual costs incurred plus accrued profits or incurred costs reduced by progress billings. On cost-plus fee contracts, revenue is recognized to the extent of costs incurred plus a proportionate amount of fee earned, and on time-and-material contracts, revenue is recognized to the extent of billable rates times hours delivered plus material and other reimbursable costs incurred. The Company records income from major fixed-price contracts, extending over more than one accounting period, using the percentage-of-completion method. During the performance of such contracts, estimated final contract prices and costs are periodically reviewed and revisions are made as required. Fixed price contracts can be significantly impacted by changes in contract performance, contract delays, liquidated damages and penalty provisions, and contract change orders, which may affect the revenue recognition on a project. Revisions to such estimates are made when they become known. Detailed quarterly project reviews are conducted with project managers to review all project progress accruals and revenue recognition.
There is the possibility that there will be future and currently unforeseeable adjustments to our estimated contract revenues, costs and margins for fixed price contracts, particularly in the later stages of these contracts. Such adjustments are common in the construction industry given the nature of the contracts. These adjustments could either positively or negatively impact our estimates due to the circumstances surrounding the negotiations of change orders, the impact of schedule slippage, subcontractor claims and contract disputes which are normally resolved at the end of the contract.
Allowance for doubtful accounts: Disputes arise in the normal course of the Company's business on projects where the Company is contesting with customers for collection of funds because of events such as delays, changes in contract specifications and questions of cost allowability and collectibility. Such disputes, whether claims or unapproved change orders in process of negotiation, are recorded at the lesser of their estimated net realizable value or actual costs incurred and only when realization is probable and can be reliably estimated.
Management reviews outstanding receivables on a quarterly basis and assesses the need for reserves, taking into consideration past collection history and other events that bear on the collectibility of such receivables. All receivables over 60 days old are reviewed as part of this process.
Asset retirement obligation: The Company recorded an asset retirement obligation associated with the estimated clean-up costs for its chemical laboratory in its National Security business segment. In accordance with ASC-410-20-05 (formerly SFAS 143, Accounting for Asset Retirement Obligation), the Company estimated the costs to clean up the laboratory and return it to its original state at a present value of approximately $497,000. The Company currently estimates the amortization and accreation expense to be approximately $180,000 to $190,000 per year over the next 11/2 years. The Company is rigorously pursuing reimbursement for such costs and other costs from the U.S. Army as a significant portion of the chemical agent that was used in the chemical laboratory was government owned. If the Company determines that the estimated clean up cost is larger than expected or the likelihood of recovery from the U.S. Army is remote, such adjustments will be reflected when they become known.

ITEM 2 Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Goodwill and other intangible assets: The carrying value of goodwill is approximately $776,000 relating to the acquisition of Versar Global Solutions, Inc., which is now part of the Program Management business segment. In performing its goodwill impairment analysis, management has utilized a market-based valuation approach to determine the estimated fair value of the Program Management business segment. Management engages outside professionals and valuation experts annually, as necessary, to assist in performing this analysis and will test more often if events and circumstances warranted it. Should the Program Management business segment's financial performance not meet estimates, then impairment of goodwill would have to be further assessed to determine whether a write down of goodwill value would be warranted. If such a write down were to occur, it would negatively impact the Company's financial position and results of operations. However, it would not impact the Company's cash flow or financial debt covenants.
Share-based compensation: The Company records stock based compensation in accordance with the fair value provisions of ASC 718-10-1 (formerly SFAS No. 123R, "Share-Based Payment"). This statement requires companies to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards (the "fair-value-based" method).
There was no share-based compensation expense recorded during the first quarter of fiscal year 2009 and 2010 as all previously granted stock options were fully vested except 10,000 shares of non-qualified stock options which will vest based on the achievement of certain conditions are met, the Company will record the related expense.
The Company also awarded 125,000 shares and 121,500 shares of restricted stock to directors and employees in fiscal years 2009 and 2008, respectively. In the first quarter of fiscal year 2010, the Company awarded 46,000 shares of restricted stock to key employees in recognition of their outstanding performance in the prior year, and recorded compensation expense of $82,000 for the first quarter of fiscal year 2010.
New accounting pronouncements: In June 2009, the FASB issued the FASB Accounting Standards Codification TM and the Hierarchy of Generally Accepted Accounting Principles ("Codification") codified in ASC 105. The Codification is now the source for authoritative United States generally accepted accounting principles ("GAAP") recognized by the FASB to be applied by nongovernmental entities. The guidance in ASC 105 is effective for financial statements issued for interim and annual periods ending after September 15, 2009 the Codification will supersede all then-existing non-SEC accounting and reporting standards. Effective with our first quarter of 2010, references to legacy GAAP will be replaced by references to the Codification, where appropriate.
In September 2009, the FASB ratified the final consensus on Emerging Issues Task Force ("EITF") Issue 08-1, Revenue Arrangements With multiple Deliverables, ("Issue 08-1") which will supersede ASC 605-25 (formerly EITF Issue 00-21, Revenue Arrangements With Multiple Deliverables). Issue 08-1 addresses how arrangement consideration should be allocated to separate units of accounting, when applicable. Although Issue 08-1 retains the criteria from ASC 605-25 for when delivered items in a multiple deliverable arrangement should be considered separate units of accounting, it removes the previous separation criterion under ASC 605-25 that objective and reliable evidence of the fair value of any undelivered items must exist for the delivered items to be considered a separate unit or separate units of accounting. The final consensus is effective for fiscal years beginning on or after June 15, 2010. Entities can elect to apply Issue 08-1 prospectively to new or materially modified arrangements after the effective date or retrospectively for all periods presented. Issue 08-1 was issued as Accounting Standards Update ("ASU") 2009-13 in October 2009 and amended ASC 605-25. The Company does not anticipate that ASU 2009-13 will have any impact on the Company's financial position or results of operations.
In September 2009, the FASB ratified the final consensus on EITF Issue 09-3, Software Revenue Recognition, ("Issue 09-3") which will amend ASC 985-605 (formerly EITF Issue 03-5, Applicability of AICPA Statement of Position 97-2 to Certain Arrangements That Contain Software Elements). Issue 09-3 excludes from the scope of Issue 09-3 all tangible products containing both software and non-software components that function together to deliver the product's essential functionality. As such, the entire product would be outside the scope of ASC 985-605 and would be accounted for under other accounting literature (e.g., ASC 605-25 (as amended by Issue 08-1)). The final consensus is effective for fiscal years beginning on or after June 15, 2010. Entities can elect to apply Issue 09-3 prospectively to new or materially modified arrangements after the effective date or retrospectively for all periods presented. Issue 09-3 was issued as ASU

ITEM 2 Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
2009-14 in October 2009. The Company does not anticipate that ASU 2009-14 will have any impact on the Company's financial position or results of operations.
In August 2009, the FASB issued ASU 2009-05 to provide guidance on measuring fair value of liabilities under ASC 820 (formerly FSP FAS 157-f). The guidance clarifies how entities should estimate the fair value of liabilities. ASC 820, as amended, includes clarifying guidance for circumstances in which a quoted price in an active market is not available, the effect of the existence of liability transfer restrictions, and the effect of quoted prices for the identical liability, including when the identical liability is traded as an asset. ASU 2009-05 is effective for the first interim or annual reporting period beginning after August 29, 2008. . The Company will adopt this guidance during the second quarter of fiscal year 2010, and does not believe that the adoption of the amended guidance in ASC 820 will have a significant effect on its consolidated financial statements.
In April 2009, the FASB issued authoritative guidance for fair value . . .