The following discussion should be read in conjunction with our Financial Statements and related Notes thereto included elsewhere in this report.

The terms "we" and "our" as used throughout this Quarterly Report on Form 10-Q refer to Fortress International Group, Inc. and its consolidated subsidiaries, unless otherwise indicated.

Business Formation and Overview

We were incorporated in Delaware on December 20, 2004 as a special purpose acquisition company under the name "Fortress America Acquisition Corporation" for the purpose of acquiring an operating business that performs services in the homeland security industry. On July 20, 2005, we closed our initial public offering of 7,800,000 units (including underwriters exercise of an over-allotment option), resulting in proceeds net of fees to us of approximately $43.2 million.

On January 19, 2007, we acquired all of the outstanding membership interests of each of VTC, L.L.C., doing business as "Total Site Solutions" ("TSS"), and Vortech, L.L.C. ("Vortech" and, together with TSS, "TSS/Vortech") and simultaneously changed our name to "Fortress International Group, Inc." The acquisition fundamentally transformed the Company from a special purpose acquisition corporation to an operating business.

Building on the TSS/Vortech business, management continued an acquisition strategy to expand our geographical footprint, add complementary services, and diversify and expand our customer base. After acquiring TSS/Vortech, the Company continued its expansion through the acquisitions of Comm Site of South Florida, Inc. on May 7, 2007 ("Comm Site"), Innovative Power Systems, Inc. and Quality Power Systems, Inc. (collectively, "Innovative") on September 24, 2007, Rubicon Integration, LLC ("Rubicon") on November 30, 2007 and SMLB Ltd. ("SMLB") on January 2, 2008.

With the acquired companies, we provide comprehensive services for the planning, design, and development of mission-critical facilities and information infrastructure. We also provide a single source solution for highly technical mission-critical facilities such as data centers, operation centers, network facilities, server rooms, security operations centers, communications facilities and the infrastructure systems that are critical to their function. Our services include technology consulting, engineering and design management, construction management, system installations, operations management, and facilities management and maintenance.

Competition in Current Economic Environment

Our industry has been and may be further adversely impacted by the current economic environment and tight credit conditions. We have seen larger competitors seek to expand their services offerings including a focus in the mission-critical market. These larger competitors have an infrastructure and support greater than ours and accordingly, we have begun to experience some price pressure as some companies are willing to take on projects at lower margins. With certain customers, we have experienced a delay in spending, or deferral of projects to an indefinite commencement date due to the economic uncertainty or lack of access to capital. This type of delay was demonstrated by our largest customer, which led us to significantly reduce our backlog by $144.9 million to $63.2 million at December 31, 2008 and to $39.9 million at September 30, 2009, although a formal cancellation of contracted amounts has not been received.

We believe there are high barriers to entry into our sector for new competitors due to our specialized technology service offerings which we deliver to our customers, our top secret clearances, and our turnkey suite of deliverables offered. We compete for business based upon our reputation, past experience, and our technical engineering knowledge of mission-critical facilities and their infrastructure. We are developing and creating long term relationships with our customers because of our excellent reputation in the industry and will continue to create facility management relationships with our customers that we expect will provide us with steadier revenue streams to improve the value of our business. Finally, we seek to further expand our energy services that focus on operational cost savings that may be used to either fund the project or increase returns to the facility operator. We believe these barriers and our technical capabilities and experience will differentiate us to compete with new entrants into the market or pricing pressures.

Although we will closely monitor our proposal pricing and the volume of the work, we cannot be certain that our current margins will be sustained. Furthermore, given the environment, and that the volume of our contracts further decreased, we are taking additional measures to reduce our operating costs through additional reductions in general, administrative and marketing cost, reductions in personnel and related costs, including the possibility of terminating our regulatory reporting requirement and delisting of our stock. For further information see "Liquidity and Capital Resources " below.

Contract Backlog

We believe an indicator of our future performance is our backlog of uncompleted projects in process or recently awarded. Our backlog represents our estimate of anticipated revenue from executed and awarded contracts that have not been completed and that we expect will be recognized as revenues over the life of the contracts. We have broken our backlog into the following three categories: (i) technology consulting consisting of services related to consulting and/or engineering design contracts, (ii) construction management, and (iii) facility management.

Backlog is not a measure defined in generally accepted accounting principles, and our methodology for determining backlog may not be comparable to the methodology of other companies in determining their backlog. Our backlog is generally recognized under two categories: (1) contracts for which work authorizations have been or are expected to be received on a fixed-price basis, guaranteed maximum price basis and time and materials basis, and (2) contracts awarded to us where some, but not all, of the work have not yet been authorized. At September 30, 2009, we had authorizations to proceed with work for approximately $24.5 million, or 61% of our total backlog of $39.9 million. At December 31, 2008, we had authorizations to proceed with work for approximately $51.6 million, or 82% of our total backlog of $63.1 million. Additionally, approximately $24.4 million, or 61% of our backlog, relates to two customers at September 30, 2009 and $36.0 million, or 57%, to one customer at December 31, 2008.

As of September 30, 2009, our backlog was approximately $39.9 million, compared to approximately $63.2 million at December 31, 2008. We believe that approximately 38% of the backlog at September 30, 2009 will be recognized during the remainder of the year. The following table reflects the value of our backlog in the above three categories as of September 30, 2009 and December 31, 2008, respectively.

(In millions)

                           September 30,       December 31,
                               2009                2008
Technology consulting     $           2.0     $          4.0
Construction management              27.3               48.7
Facilities management                10.6               10.5
Total                     $          39.9     $         63.2

Critical Accounting Policies and Estimates

Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP. The preparation of the financial statements included elsewhere in this Quarterly Report on Form 10-Q requires that management make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ significantly from those estimates.

We believe the following critical accounting policies affect the more significant estimates and judgments used in the preparation of our financial statements.

Revenue Recognition

We recognize revenue when pervasive evidence of an arrangement exists, the contract price is fixed or determinable, services have been rendered or goods delivered, and collectability is reasonably assured. Our revenue is derived from the following types of contractual arrangements: fixed-price contracts, time-and-materials contracts and cost-plus-fee contracts (including guaranteed maximum price contracts). Revenue from fixed-price contracts is accounted for under the application of ASC 605 (formerly Statement of Position (SOP) 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts), recognizing revenue on the percentage-of-completion method using costs incurred in relation to total estimated project costs. The cost to total cost method is used because management considers cost incurred and costs to complete to be the best available measure of progress in the contracts. Contract costs include all direct materials, subcontract and labor costs and those indirect costs related to contract performance, such as indirect labor, payroll taxes, employee benefits and supplies.

Revenue on time-and-material contracts is recognized based on the actual labor hours performed at the contracted billable rates, and costs incurred on behalf of the customer. Revenue on cost-plus-fee contracts is recognized to the extent of costs incurred, plus an estimate of the applicable fees earned. Fixed fees under cost-plus-fee contracts are recorded as earned in proportion to the allowable costs incurred in performance of the contract.

Contract revenue recognition inherently involves estimation. Examples of estimates include the contemplated level of effort to accomplish the tasks under the contract, the costs of the effort and an ongoing assessment of the Company's progress toward completing the contract. From time to time, as part of our standard management process, facts develop that require us to revise our estimated total costs on revenue. To the extent that a revised estimate affects contract profit or revenue previously recognized, we record the cumulative effect of the revision in the period in which the revisions become known. The full amount of an anticipated loss on any type of contract is recognized in the period in which it becomes probable and can reasonably be estimated.

Under certain circumstances, we may elect to work at risk prior to receiving an executed contract document. We have a formal procedure for authorizing any such at risk work to be incurred. Revenue, however, is deferred until a contract modification or vehicle is provided by the customer.

Allowance for Doubtful Accounts

The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We determine the allowance based on an analysis of our historical experience with bad debt write-offs and an aging of the accounts receivable balance. Unanticipated changes in the financial condition of clients, or significant changes in the economy could impact the reserves required. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

Non-cash Compensation

We apply the expense recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"), therefore, the recognition of the value of the instruments results in compensation or professional expenses in our financial statements. The expense differs from other compensation and professional expenses in that these charges are typically settled through the issuance of common stock or stock purchase warrants, which would have a dilutive effect upon earnings per share, if and when such warrants are exercised or restricted stock vests. The determination of the estimated fair value used to record the compensation or professional expenses associated with the equity or liability instruments issued requires management to make a number of assumptions and estimates that can change or fluctuate over time.

Goodwill and Other Purchased Intangible Assets

Goodwill represents the excess of costs over fair value of net assets of businesses acquired. Other purchased intangible assets include the fair value of items such as customer contracts, backlog and customer relationships. ASC 350 (formerly SFAS No. 142, " Goodwill and Other Intangible Assets)," establishes financial accounting and reporting for acquired goodwill and other intangible assets. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but rather tested for impairment on an annual basis or triggering event. Purchased intangible assets with a definite useful life are amortized on a straight-line basis over their estimated useful lives.

The estimated fair market value of identified intangible assets is amortized over the estimated useful life of the related intangible asset. We have a process pursuant to which we typically retain third-party valuation experts to assist us in determining the fair market values and useful lives of identified intangible assets. In interim periods, we evaluate these assets for impairment when events occur that suggest a possible impairment. Through the second quarter 2009, we continued to incur operating losses and revised our forecasted revenues as we have seen customer delays, a lack of new contracts and executed contracts have been at margins lower than historic levels. As a result of the decline in performance and continued customer delays, during the interim period we evaluated the carrying value of goodwill and other long-lived intangible assets for impairment. Utilizing a third party firm we determined the carrying value of goodwill was in excess of the fair value, resulting in an aggregate impairment on goodwill of approximately $1.1 million during the nine months ended September 30, 2009. At September 30, 2009, the net carrying value of goodwill was $4.5 million.

Long-Lived Assets (Excluding Goodwill)

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

Income Taxes

Deferred income taxes are provided for the differences between the basis of assets and liabilities for financial reporting and income tax purposes. Deferred tax assets and liabilities are measured using tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized.

We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities, which principally arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. We also must analyze income tax reserves, as well as determine the likelihood of recoverability of deferred tax assets, and adjust any valuation allowances accordingly. Considerations with respect to the recoverability of deferred tax assets include the period of expiration of the tax asset, planned use of the tax asset, and historical and projected taxable income, as well as tax liabilities for the tax jurisdiction to which the tax asset relates. Valuation allowances are evaluated periodically and will be subject to change in each future reporting period as a result of changes in one or more of these factors.

Effective January 1, 2007, we were required to adopt ASC 740 (formerly FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes). ASC 740 prescribes a more-likely-than-not threshold of financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on de-recognition of income tax assets and liabilities, classification of current and deferred tax assets and liabilities, accounting for interest and penalties associated with tax positions, accounting for income taxes in interim periods and income tax disclosures. Since inception and through January 1, 2007, the adoption date of this standard, we were in essence a "blank check" company with no substantive operations. Management has concluded that the adoption of ASC 740 had no material effect on our financial position or results of operations. As of September 30, 2009, we do not have any material gross unrecognized tax benefit liabilities.

We believe the following critical accounting policies affect the more significant estimates and judgments used in the preparation of our financial statements.

Recently Issued Accounting Pronouncements

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 167, "Amendments to FASB Interpretation No. 46(R)" (FAS 167). FAS 167 amends ASC
810 (formerly FIN 46(R)), to require an enterprise to perform an analysis to determine whether the enterprise's variable interest or interests give it a controlling financial interest in a variable interest entity. This statement is effective for both interim and annual periods as of the beginning of each reporting entity's first annual reporting period that begins after November 15, 2009, and we are currently evaluating its impact on our financial position and results of operations.

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 166, "Accounting for Transfers of Financial Assets - an amendment of FASB Statement No. 140" (FAS 166). FAS 166 amends ASC 860 (formerly FAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"), removing the concept of a qualifying special-purpose entity, and removing the exception from applying ASC 810 to qualifying special-purpose entities. This statement is effective for both interim and annual periods as of the beginning of each reporting entity's first annual reporting period that begins after November 15, 2009, and its impact will vary with each future transfer of financial assets.

In May 2009, the FASB issued ASC 855 (SFAS No. 165, "Subsequent Events"). ASC 165 establishes general standards of accounting for and disclosing events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This statement is effective for interim and annual periods ending after June 15, 2009. In preparing the accompanying unaudited consolidated financial statements, the Company has reviewed, as determined necessary by the Company's management, events that have occurred after September 30, 2009, up until the issuance of the financial statements, which occurred on November 16, 2009.

In April 2009, the FASB issued ASC 825 (formerly FASB Staff Position 107-1 and Accounting Principles Board Opinion ("APB") No. 28-1, Interim Disclosures about Fair Value of Financial Instruments). ASC 825 amends SFAS 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. ASC 825 also amends ASC 270 (formerly APB 28, Interim Financial Reporting), to require these disclosures in summarized interim periods. We adopted the provisions of ASC 825 as of June 30, 2009. The adoption of AS 825 did not affect the amount of any of our financial statement line items.

Results of operations for the three months ended September 30, 2009 compared with the three months ended September 30, 2008

Revenue. Revenue decreased $9.8 million to $16.0 million for the three months ended September 30, 2009 from $25.8 million for the three months ended September 30, 2008. The decrease is primarily driven by a $7.8 million decrease in construction management services and an aggregate $2.0 million decrease in our technology consulting and facilities management services. This decline in revenue resulted from both the delay in beginning projects and the cancellation of other projects.

Cost of Revenue. Cost of revenue decreased $8.1 million to $12.6 million for the three months ended September 30, 2009 from $20.7 million for the three months ended September 30, 2008. The decrease is primarily driven by a $6.5 million decrease in construction management and an aggregate decrease of $1.5 million in technology consulting and facilities management services.

Gross Margin Percentage. Gross margin percentage increased 1.4% to 21.3% for the three months ended September 30, 2009 compared to 19.9% for the three months ended September 30, 2008. The increase in gross margin was primarily attributable to a single construction project that was near complete in the third quarter 2009 and a change in the mix in which a larger portion of total services were comprised of facilities management services. We anticipate margins will continue around 15% or potentially lower given the current competitive environment.

Selling, general and administrative expenses. Selling, general and administrative expenses decreased $1.7 million to $3.1 million for the three months ended September 30, 2009 from $4.8 million for the three months ended September 30, 2008. The decrease is primarily driven by $0.7 million decrease in salaries and related employee expenses due to a reduction in headcount and variable compensation, $0.5 million decrease in acquisitions related costs, and $0.3 million decrease in marketing efforts and professional fees. We incurred no acquisition related costs during the nine months ended September 30, 2009.

We have continued to experience delays in the timing of revenues associated with certain customers and contracted work is at lower margins than the prior year. Accordingly during the third quarter of 2009, the Company instituted 10% reduction in salaries for employees and further reduced headcount. We continue to evaluate our selling, general and administrative costs with the objective of achieving profitability based on our revised forecasted business.

Depreciation. Depreciation remained consistent at $0.1 million for the three months ended September 30, 2009 compared to $0.1 million for the three months ended September 30, 2008.

Amortization of intangible assets. Amortization expense decreased $0.6 million to $0.1 million for the three months ended September 30, 2009 from $0.7 million for the three months ended September 30, 2008. The decrease in expense correlates to the decrease in average amortizable carrying values of finite lived intangibles, as the net amortizable carrying amount of finite lived intangibles totaled $0.1 million and $14.4 million at September 30, 2009 and September 30, 2008, respectively. The decrease in carrying value was primarily attributable to an impairment loss of $12.0 million on finite lived customer intangibles during the second quarter of 2009. At September 30, 2009, the adjusted net carrying value of other intangibles was $0.2 million.

Impairment loss on goodwill and other intangibles, net. We did not record any impairment losses during the three months ended September 30, 2009. During the three months ended September 30, 2008, we had experienced continued operating losses and a decline in market value and accordingly conducted analyses of our operations in order to identify any impairment in the carrying value of the goodwill and other intangibles related to our business. Analyzing our business using both an income approach and a market approach determined that the carrying value exceeded the current fair value of our business, resulting in goodwill impairment of $3.0 million for the three months ended September 30, 2008.

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

Income tax expense (benefit). Income tax (benefit) decreased to zero for the three months ended September 30, 2009 from ($0.4) million for the three months ended September 30, 2008. The prior year tax benefit was associated with the decrease in our deferred tax liabilities associated with our decrease in our tax deductible goodwill. No such decrease was recorded in 2009, nor was any benefit was recorded for the three months ended September 30, 2009.

Results of operations for the nine months ended September 30, 2009 compared with the nine months ended September 30, 2008

Revenue. Revenue decreased $4.4 million to $61.0 million for the nine months ended September 30, 2009 from $65.4 million for the nine months ended September 30, 2008. The decrease is primarily driven by $3.4 million decrease in our facilities management services and $1.4 million decrease in technology consulting services. The decrease in facilities management services is attributable to lower volume of federal government contracts and the fact that we had one significant project that concluded in 2008.

Cost of Revenue. Cost of revenue decreased $2.5 million to $52.2 million for the nine months ended September 30, 2009 from $54.7 million for the nine months ended September 30, 2008. The decrease is primarily driven by a $2.7 million decrease in facilities management services and $0.7 million decrease in technology consulting; partially offset by an increase construction management services.

Gross Margin Percentage. Gross margin percentage decreased 1.8% to 14.5% for the nine months ended September 30, 2009 from 16.3% for the nine months ended September 30, 2008. The decline in gross margin is primarily attributable to contraction in gross margin percentage in the construction management services, which decreased by 1.9% to 11.3% for the nine months ended September 30, 2009 from 13.2% for the nine months ended September 30, 2008. The decline in gross margin for construction management services is due to the competitive environment in which we contracted work at lower than historic margins. We anticipate margins will continue at the current level or potentially lower given the environment.

Selling, general and administrative expense. Selling, general and administrative expenses decreased $3.7 million to $11.6 million for the nine months ended September 30, 2009 from $15.3 million for the nine months ended September 30, 2008. The decrease is primarily driven by $2.1 million decrease in salaries due to a reduction in headcount and furloughs, $1.2 million decrease in acquisition related costs, and $0.5 million decrease in professional fees and marketing efforts. We incurred no acquisition related costs in 2009.

We have continued to experience delays in the timing of revenues associated with certain customers and contracted work is at lower margins than the prior year. Accordingly, we continue to evaluate our selling, general and . . .