UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

ANNUAL REPORT
PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

( Mark One)

þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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

SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.

(Exact name of registrant as specified in its charter)

Delaware		90-0182158
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
3130 Fairview Park Drive, Suite 400, Falls Church, Virginia		22042
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: 703-564-2967

None.

Common Stock, par value $0.0001 per share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes þ No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes þ No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
þ Yes o No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12-b2 of the Exchange Act. (Check one):

Large Accelerated filer o       Accelerated Filer o       Non-Accelerated Filer þ

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

The aggregate market value of the common stock held non-affiliates of the registrant as of the close of business on June 30, 2005, was approximately $52.9 million based on the closing sale price of the registrant’s common stock, as reported on the Over the Counter Bulletin Board on that date.

As of March 15, 2006, there were 44,072,200 shares of the registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE. None.

TABLE OF CONTENTS

Forward-Looking Statements					1
PART I — FINANCIAL INFORMATION
Item 1.		Business			1
Item 1A.		Risk Factors			5
Item 1B.		Unresolved Staff Comments			7
Item 2.		Properties			7
Item 3.		Legal Proceedings			7
Item 4.		Submission of Matters to a Vote of Security Holders			7
Item 5.		Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchasers
		of Equity Securities			7
Item 6.		Selected Financial Data			9
Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			10
Item 7A.		Quantitative and Qualitative Disclosures About Market Risk			18
Item 8.		Financial Statements and Supplementary Data			18
Item 9.		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			44
Item 9A.		Controls and Procedures			44
Item 9B.		Other Information			45
Item 10.		Directors and Executive Officers of the Registrant			45
Item 11.		Executive Compensation			47
Item 12.		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			49
Item 13.		Certain Relationships and Related-Transactions			50
Item 14.		Principal Accountant Fees and Services			50
Item 15.		Exhibits and Financial Statements Schedules			50

  i

FORWARD-LOOKING STATEMENTS

Except for historical information, this report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements involve risks and uncertainties, including, among other things, statements regarding our business strategy, future revenues and anticipated costs and expenses. Such forward-looking statements include, among others, those statements including the words “expects,” “anticipates,” “intends,” “believes” and similar language. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in Part I, Item 1A. “Risk Factors.” You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this report. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances taking place after the date of this document.

Item 1. Business.

Spectrum Sciences & Software Holdings Corp. (the “Company” or “Spectrum Holdings”) is a premier technology and technical engineering solutions company focused on three primary target markets — national security, energy & environment, and transportation — with an emphasis on homeland security. The Company’s business offerings encompass business management services; procurement and acquisition support; design, engineering and construction; manufacturing technologies; border and transportation security; environmental management; information analysis; and infrastructure protection.

Spectrum Holdings was incorporated as Silva Bay International, Inc., a Delaware corporation, in August 1998. In April 2003, the Company changed its name from Silva Bay to Spectrum Sciences & Software Holdings Corp. in conjunction with the acquisition of Spectrum Sciences and Software, Inc. (“SSSI”), a Florida corporation. The Company began trading on the Over the Counter (“OTC”) Bulletin Board market in December 2003.

The Company acquired three companies during 2005: M&M Engineering, Ltd. (“M&M), Coast Engine and Equipment Company, Inc. (“CEECO”), and Horne Engineering Services, Inc. (“Horne”). The Horne acquisition was a merger that resulted in the management of Horne taking control of the Company effective June 2005. More information related to these mergers is included in Note 3 of our audited financial statements.

As a result of these acquisitions, the nature of the Company’s business has changed significantly, including our reportable segments. Before the acquisitions, the Company had three reportable segments: Management Services, Engineering and Information Technology, and Manufacturing. In 2005, these segments were consolidated into one segment, Security Solutions. Our current segments are consistent with how we manage the business and the products and services we offer.

Business Segments

The Company comprises four distinct operating companies that operate in five reportable segments: Security Solutions, Industrial and Offshore, Repair and Overhaul, Procurement Services, and Engineering Services. These segments are predominantly focused in the U.S. defense markets, with the exception of the Industrial and Offshore segment, which is primarily focused on the Canadian energy industry. Our goal is to be the vendor of choice in each of our selected markets. Financial information for each segment can be found in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the audited financial statements in Item 8.

Security Solutions

Our Security Solutions segment specializes in the manufacturing of aircraft and munitions support equipment for the U.S. Department of Defense. The segment also specializes in the development of software for weapon system range safety (Safe Range) and the Secure Borders Initiative (Safe Borders) (formerly known as America’s Shield Initiative). The Security Solutions segment, which employs approximately 65 employees, is based

in Ft. Walton Beach, Florida. Most of the Company’s contracts in this segment are with the U.S. Defense Department.

The segment’s manufacturing operations, with revenue of $4.2 million, accounted for approximately 75% of the segment’s revenues in 2005. The main products of the manufacturing group are U.S. Navy containers and launch tubes, missile shipment and storage containers, and aircraft maintenance stands for military aircraft. The manufacturing group has devoted considerable time to diversifying the product mix to better address client needs. This has included successfully completing 12 “first-article” tests for new products, all of which were accepted by the end customers and which resulted in new work. The group is expanding its services into military aircraft specialty parts based on the successful first-article testing and the needs of the customers. The group is also participating in the Defense Department’s Mentor-Protégé program and Foreign Military Sales area with a small minority business in Alabama. This teaming arrangement may help provide additional work in the future under this program.

The pricing of raw materials, primarily steel and aluminum, has directly affected the manufacturing unit. The increased price of these materials has negatively impacted some of the longer-term manufacturing contracts. The group has worked to limit the impact of rising material prices by renegotiating contracts and including price-escalation clauses in new contracts.

The manufacturing group has patents and pending patents on several technologies, in addition to proprietary research on munitions assembly systems.

The primary competitors for the manufacturing group are smaller manufacturing companies with the bandwidth to support larger contracts. The market is fragmented, and the number of competitors on the manufacturing side has been decreasing. Competition is primarily based on product quality and service offerings combined with pricing. The ability to compete for defense contracts depends on the ability of a given manufacturer to pass the first-article testing for new products and past delivery performance on similar contracts. In sole-source provider contracts, it is incumbent on the procuring agency to re-open the bidding for contracts to be competitively bid.

The segment’s software group focuses primarily on modeling and simulation and the Safe Borders tracking software. The group has developed the technology to simulate the effect and impact of various weapon systems based on the weapons’ “footprints,” which allows targeting simulation and analysis. The greater focus, however, is on the Safe Borders software and its integration with the upcoming Secure Borders Initiative. This software allows the tracking and monitoring of border areas.

We have certain intellectual property rights surrounding our software coding for Safe Borders, including certain algorithms and processing procedures that are proprietary. The names “Safe Borders” and “Safe Range” are registered trade names of the Company.

Industrial and Offshore

M&M, which operates in the Industrial and Offshore segment and is based in St. John’s, Newfoundland, Canada, is a provider of a complete range of mechanical contracting and steel fabrication services to the industrial and offshore energy sector. Its business includes the manufacture and installation of structural steel products, including storage tanks, pipe spooling, tote tanks, and caisson systems for the offshore and mining industries, in addition to the manufacture and repair of pressure vessels. M&M also provides specialized welding services for the oil and mining industries. All services are provided in eastern Canada.

M&M’s business is seasonal, with most work being performed between April and October. This is consistent with the staffing levels of the group. M&M significantly augments its base staff of 23 employees with contracted union workers, which can bring total headcount to approximately 500 at the peak of business.

M&M has not suffered significantly from increased raw material prices due to the short-term nature of its contracts. Few of its contracts take longer than six months to complete.

The two most significant customers for M&M in 2005 were Inco and Deer Lake Power, which accounted for 44.7% and 18.6% of its 2005 sales, respectively. M&M’s operations also rely on a contract between Liannu LLP,

a joint venture between M&M and a native Canadian individual (Innu), and Voisey’s Bay Nickel Company, owners of the Voisey’s Bay nickel mine in Labrador, Canada. This contract, which provides the vast majority of the revenue for the joint venture, provided $3.8 million, (18.6%) in revenue during 2005. Voisey’s Bay is a subsidiary of Inco, which makes the total revenue from Inco-related companies 63.3% of the revenue for this segment.

The competitive environment is largely localized to the province of Newfoundland and Labrador, Canada, which is primarily due to the fact that Newfoundland is an island. In addition, since M&M operates in a unionized environment, there are many issues that make bidding for work outside the province difficult. However, M&M is the largest mechanical and industrial contractor in the region, and many large-scale industrial developments are currently under way or in the early stages of development. For example, there are currently three operating offshore oil developments off the coast of Newfoundland, each of which M&M has been involved with in terms of construction and ongoing maintenance. Plans are also under way to further develop the offshore oil and natural gas fields in the coming years. In addition, Newfoundland and Labrador is home to an oil refinery, pulp and paper mills, hydroelectric power generation, and the largest nickel mine site in the world (Voisey’s Bay). All of these markets have provided significant work to M&M in the past and are expected to provide additional work in the future.

Generally, work in the region is awarded on the basis of invitations to tender bids. M&M is well known in the area and, therefore, is invited to bid on virtually every major mechanical and industrial tender package that arises. The award of contracts largely depends on price, but customers will typically consider the Company’s reputation and ability to get the work done properly and on time. On occasion, M&M has been awarded contracts for which it was not the low bidder simply due to the fact that it is a “preferred” supplier for certain customers.

Repair and Overhaul

The Repair and Overhaul segment provides services to the maritime industry, predominantly for on-board ship repair of HVAC and refrigeration systems, welding services, and custom flooring, insulation, and machinery installations. The group has also performed extensive work replacing navigation towers destroyed by Hurricane Katrina. This unit is based out of Port Canaveral, Florida and employs approximately 20 people.

The competitive environment of the segment is fairly limited, with the major competitor of the Company being Standard Marine. Many contract awards are issued with minimal competitive bidding; past performance is a key component of award decisions. The major clients of this segment are the U.S. Coast Guard, Disney Cruise Lines, Rinker Cement, and the U.S. Navy.

Procurement Services

The Procurement Services segment provides procurement consulting services consisting of providing staffing and procurement expertise in executing all phases of the procurement cycle from proposal preparation to closeout. We also perform material procurement for acquisition support contracts. We provide staffing to reinforce capabilities, meet surge requirements, or prepare for inspections/audits of contracts and subcontracts. We assist in supplementing client staff domestically and internationally for short periods or for sustained operations. Staffing is often task-organized to meet specific procurement requirements, such as purchasing, subcontracting, or lower-tier subcontract management. We provide buyers, subcontract administrators and compliance professionals. We support clients using our own purchasing system, or we can use the client’s purchasing system to meet government or commercial mission needs. The segment is based out of our corporate headquarters in Falls Church, Virginia, and employs 26 people.

The volume of business is primarily from the support of major infrastructure construction or logistics projects, such as disaster relief, peacekeeping, nation building and military operations. This has been particularly true in 2005 as a result of events in Iraq and Hurricane Katrina. Most of our revenue in this segment has come from two clients, and our ability to retain these clients is based on our performance.

The industry is fairly fragmented for procurement outsourcing, with many small companies competing. The competition for new work primarily centers on past performance, the experience required for the procurement at hand, and price. The ability to quickly deploy the right staff to meet specific procurement requirements is key to success in this business.

Engineering Services

The Engineering Services segment focuses on providing engineering, environmental science, and occupational safety and health services to a predominantly governmental client base. This work is primarily focused in the areas of U.S. national security, energy and environment, and occupational safety and health. This is a service-based segment that relies on its people to maintain the reputation of the Company to expand operations and improve our marketability. The Company has been successful in recruiting top-level candidates to staff open client-focused positions. The applicant pool for the expertise we need appears to be sufficiently deep to meet our needs. This segment is primarily based out of our Falls Church, Virginia, headquarters and employs approximately 100 people.

The national security work is primarily focused on adjunct staffing and management studies on behalf of the U.S. Army Corps of Engineers, U.S. Customs and Border Protection and the U.S. Army Chemical Materials Agency. In addition to the staffing and management studies, we provide engineering and design services to the U.S. Air Force for base security upgrades. This is a very large, competitive market segment with some of the largest businesses and institutions in the country competing, in addition to numerous small and emerging businesses. Success is dependant on high performance, expert personnel, intimate knowledge of the organizations being served, and strong relationships with the clients and our private sector partners. This market sector is dependant on the federal budget cycle, federal expenditures, and related priorities.

The energy and environment market place is dominated by several large contractors, including Bechtel National and Battelle, with many small and emerging companies competing as well. The competition for new work is focused on having the specific technical capabilities, as well as the longstanding relationships and existing contracts that enable incumbents on projects to expand their services. The services we provide include engineering, environmental sampling and remediation, policy development and support, outreach, cultural and natural resources studies, underwater capping of contaminated river sediments, and environmental compliance support to federal entities.

Our occupational health and safety work is predominantly with the Department of Transportation, with our two major clients being the Transportation Security Administration and the Federal Aviation Administration. The services we perform include client staff augmentation, policy development and implementation, hazard assessment, and investigation services to assess hazardous conditions and compliance with policies and to make improvements to those policies. Successful competition in this area depends primarily on past performance and customer relationships. No single competitor of the Company dominates the industry.

Backlog

The Company is reporting two types of backlog: funded and unfunded. These classifications differ significantly in terms of their expected value to the Company and the expected realization of these amounts. The funded backlog, as shown in the table below, includes all contracts that have been awarded and funded by the client, in most cases a governmental entity. Funded contracts are subject to changes in work scope, delays in project startup, and cancellation by the client. The unfunded backlog comprises contract awards that, at present, have no funding or confirmed orders on which to rely. An example of this would be GSA schedule awards that are indefinite delivery/indefinite quantity awards. While these contracts have the potential to generate revenue, the amount, timing and certainty of those revenues are unknown.

(Dollars shown in 000’s)

		2006				2007				2008+				Total
Security Solutions		$	1,579			$	—			$	—			$	1,579
Repair and Overhaul			141				—				—				141
Engineering Services			12,696				3,992				—				16,688
Procurement Services			16,335				—				—				16,335
Total Funded Backlog		$	30,751			$	3,992			$	—			$	34,743

The amount of unfunded backlog as of March 15, 2006, is approximately $123 million.

The Industrial and Offshore segment has no backlog due to the short-term nature of work in the segment.

Environmental Matters

Our operations include the use and disposal of hazardous materials. The Company never takes title to hazardous materials. We are subject to various federal, state, and local laws and regulations relating to the protection of the environment, including those governing the discharge of pollutants into the air and water, the management and disposal of hazardous substances and wastes, the cleanup of contaminated sites, and the maintenance of a safe workplace. We believe that we are in compliance with environmental laws and regulations and that we have no known liabilities under environmental requirements that would have a material adverse impact on our business, results of operations, or financial condition. Over the past three years, we have not incurred any material costs relating to environmental compliance.

Item 1A. Risk Factors.

The Company is subject to several risk factors that could have a direct and material impact on the operations of the Company. These risk factors are described below.

We may not receive the full amount of our contract awards.

The Company receives many government contract awards that include both funded and unfunded amounts. While the Company believes that most contracts will become fully funded and executed, there are occasions where the final executed amount of the contract may be substantially less than the contract award. Congress often appropriates funds for our clients on an annual basis, even though our contracts may call for services over a number of years. As a result, Congress may elect not to fund a particular contract in future years. Additionally, the funded amounts on contracts may not be fully recognized as revenue if the priorities of the contract-issuing agencies change and funding is re-appropriated for other uses.

Increased raw material prices may adversely affect contract profitability.

The Company has experienced significant increases in both steel and aluminum raw material prices. Continued increases in the price of raw materials could have a negative impact on the profitability of the Company. Many of our contracts in our manufacturing operations are fixed-price contracts and are not automatically re-priced when raw material costs increase. We aggressively pursue our contract rights to receive compensation for these increased costs, where available, but not all contracts have price-adjustment clauses that allow the Company to recover such cost increases.

Loss of bonding may adversely impact our Canadian operations.

The Company has obtained bonding in Canada through posting a cash deposit with a Canadian surety company. This was the only option available for securing adequate bonding for M&M to continue its operations. The loss of such bonding could have a material adverse impact on the revenues and related profitability of M&M. The Company is currently seeking non-cash secured bonding. Failure to obtain such bonding could adversely affect the Company through reduced revenue and profit.

Our quarterly operating results may fluctuate significantly as a result of factors outside of our control, which could cause the market price of our common stock to decline.

Our revenue and operating results could vary significantly from quarter to quarter. In addition, we cannot predict with certainty our future revenue or results of operations. As a consequence, our operating results may fall below the expectations of securities analysts and investors, which could cause the price of our common stock to decline. Factors that may affect our operating results include, without limitation, the following:

•

Fluctuations in revenue earned on contracts;

	•		Commencement, completion, or termination of contracts during any particular quarter;
	•		Variable purchasing patterns under GSA schedule contracts and agency-specific indefinite delivery/indefinite quantity contracts;
	•		Provision of services under a share-in-savings or performance-based contract;
	•		Additions and departures of key personnel;
	•		Strategic decisions by us or our competitors, such as acquisitions, divestitures, spin-offs, joint ventures, strategic investments, or changes in business strategy;
	•		Contract mix, the extent of use of subcontractors, and the level of third-party hardware and software purchases for customers;
	•		Changes in presidential administrations and senior federal government officials that affect the timing of procurements;
	•		Changes in policy or budgetary measures that adversely affect government contracts in general;
	•		The seasonality of our business; and
	•		Changes in the volume of material procurements we perform.

Reductions in revenue in a particular quarter could lead to lower profitability in that quarter because a relatively large amount of our expenses are fixed in the short-term. We may incur significant operating expenses during the startup and early stages of large contracts and may not receive corresponding payments or revenue in that same quarter. We may also incur significant or unanticipated expenses when contracts expire or are terminated or are not renewed. In addition, payments due to us from government agencies may be delayed due to billing cycles or as a result of failures of governmental budgets to gain Congressional and administration approval in a timely manner.

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

Our business involves providing services that require our employees to operate in various countries around the world, including Iraq. These countries may be experiencing political upheaval or unrest, and in some cases war or terrorism. Certain senior-level employees or executives may, on occasion, be part of the teams deployed to provide services in these countries. As a result, it is possible that certain of our employees or executives will suffer injury or bodily harm in the course of these deployments. It is also possible that we will encounter unexpected costs in connection with additional risks inherent with sending our employees to dangerous locations, such as increased insurance costs, as well as the repatriation of our employees or executives for reasons beyond our control. These problems could cause our actual results to differ materially from those anticipated.

Unfavorable government audit results could force the Company to adjust previously reported operating results and could subject us to a variety of penalties and sanctions.

A significant portion of our revenue comes from payments made by the U.S. government on prime contracts and subcontracts. The costs of these contracts are subject to audit by the Defense Contract Audit Agency (DCAA). Disallowance of these contract costs by the DCAA could adversely affect the Company’s financial statements. Management periodically reviews its estimates of allowable and unallowable costs based on the results of government audits and makes adjustments as necessary.

If the government discovers improper or illegal activities, by the Company or its employees, the Company may be subject to civil and criminal penalties and administrative sanctions, including contract termination, forfeiture of profits, suspension of payments, fines, and suspension or disbarment from conducting future business with the government. In addition, the Company could suffer serious harm to its reputation if allegations of impropriety were made against it, whether or not true. The Company is not aware of any instances of improper or illegal activities of its employees.

Horne is the only subsidiary subject to incurred costs at this time. Horne is current on its DCAA audits through 2002 and has not had any significant audit findings in any recent DCAA audit.

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.

As of March 15, 2006, the Company’s headquarters were located in administrative offices leased by the Company in Falls Church, Virginia. Information about the Company’s key operating facilities is set forth below:

Segment		Location		Leased/Owned		Usage
Security Solutions		Ft. Walton Beach, FL		Owned		Manufacturing
		Ft. Walton Beach, FL		Leased
Industrial and Offshore		St. John’s, Newfoundland		Owned		Manufacturing
Repair and Overhaul		Port Canaveral, FL		Leased		Fabrication

The facilities for Procurement Services and Engineering Services include general office space that is either leased by the Company or provided to the Company by clients.

The two facilities for our Security Solutions segment are fully utilized. Accordingly, we are evaluating alternatives to expand our operations in Ft. Walton Beach, Florida in order to increase revenue. The Company’s other facilities for manufacturing and fabrication appear sufficient to meet its needs at this time. However, should we be successful in winning any large contract awards, we may need to increase our facility space.

Item 3. Legal Proceedings.

Information regarding legal proceedings involving the Company is included in Note 17 to the Company’s consolidated financial statements under the heading “Legal Matters” in Part II, Item 8 of this report, which is incorporated herein by reference.

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

No matter was submitted to a vote of the Company’s shareholders during the fourth quarter of 2005.

PART II

Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

(a) Market Performance of Common Stock, Stockholders of Record and Dividends on Common Stock. The common stock of the Company is listed on the OTC Bulletin Board electronic quotation system and trades under the symbol “SPSC.” The common stock was first traded on December 5, 2003, under such symbol. The following table sets forth the high and low bids quotation for our stock for each quarterly period beginning in 2004 as reported on the OTC Bulletin Board.

		High				Low
2004
First Quarter		$	2.81			$	1.60
Second Quarter		$	4.02			$	0.70
Third Quarter		$	1.55			$	0.58
Fourth Quarter		$	1.69			$	1.14
2005
First Quarter		$	2.60			$	1.45
Second Quarter		$	2.36			$	1.00
Third Quarter		$	1.63			$	0.91
Fourth Quarter		$	1.17			$	0.57

There were approximately 100 stockholders of record on March 15, 2006. A significant number of the outstanding shares that are beneficially owned by individuals or entities are registered in a street name. The Company believes there are approximately 11,000 beneficial owners of its common stock as of March 15, 2006.

The Company has never paid any cash dividends and has no current intention to pay a dividend in the foreseeable future.

(b) Equity Compensation Plans. The following table summarizes our equity compensation plans as of December 31, 2005:

Number of

Number of securities

securities to

remaining available for

be issued upon

future issuance under

exercise

Weighted-average

equity compensation

of outstanding

exercise price of

plans (excluding

options,

outstanding options,

securities

warrants and rights

warrants and rights

reflected in column (a))

Plan Category

(a)

(b)

(c)

Equity compensation plans approved by security holders

0

$

0

1,000,000

(1)

Equity compensation plans not approved by security holders

5,837,800

(2)

$

1.80

3,041,000

(3)

Total

5,837,800

4,041,000

2004 Non-Statutory Stock Option Plan

The 2004 Non-Statutory Stock Option Plan was adopted by the Board of Directors on March 11, 2004. The plan was intended to advance the interests of the Company by encouraging and enabling eligible employees, non-employee directors, consultants and advisors to acquire proprietary interests in the Company, and by providing the participating employees, non-employee directors, consultants, and advisors with an additional incentive to promote the success of the Company. Under this plan, a maximum of 10,000,000 shares of the Company’s common stock, par value $0.0001, were authorized for issue. Options issued under this plan would expire one year from the date of issue.

Amended and Restated Number 1 2004 Non-Statutory Stock Option Plan

The Amended and Restated Number 1 2004 Non-Statutory Stock Option Plan was adopted by the Board of Directors on April 16, 2004. This restated plan took the same form as the 2004 Non-Statutory Stock Option Plan with the exception that the maximum number of options shares authorized under this plan was increased to 30,000,000 shares of the Company’s common stock, par value $0.0001.

Amended and Restated Number 2 2004 Non-Statutory Stock Option Plan

The Amended and Restated Number 2 2004 Non-Statutory Stock Option Plan was adopted by the Board of Directors on November 15, 2004. This restated plan took the same form as the earlier plans, except that it amended the expiration date on future stock options issued from one year to three years and likewise extended the expiration date of any options issued pursuant to such prior stock option plans. No additional options shares were authorized under this amended plan.

Item 6. Selected Financial Data (Dollars shown in $000’s except per share data).

		2005				2004				2003				2002				2001
Revenue		$	53,698			$	11,134			$	13,330			$	12,261			$	11,877
Income (loss) from Continuing Operations			(4,492	)			(40,618	)			381				(79	)			438
Per share of Common Stock-basic & diluted			(0.11	)			(1.21	)			0.02				(0.00	)			0.02
Net Income (loss)			(3,986	)			(40,307	)			206				(611	)			232
Per share of Common Stock-basic & diluted			(0.09	)			(1.20	)			0.01				(0.03	)			0.01
Total Assets			49,404				31,212				4,634				5,128				6,123
Long-term Debt			2,814				—				2,456				2,006				2,114
Shareholder Equity			35,097				28,621				(889	)			(1,176	)			(473	)
EBITDA			(1,566	)			(38,878	)			732				(158	)			757
Adjusted EBITDA		$	(1,566	)		$	(38,878	)		$	732			$	340			$	757

The financial information above is reflective of the operations since 2000. Prior to April 2003, Spectrum Holdings’ predecessor company, Silva Bay International, Inc., was a non-reporting entity that had no financial activity. The information shown above for the years 2001 and 2002 is for SSSI, which the Company acquired on April 3, 2003.

The Company uses certain measures of performance that are not required by, or presented in accordance with generally accepted accounting principles (GAAP). Specifically, the Company uses non-GAAP financial measures, EBITDA and Adjusted EBITDA. These measures should not be considered as an alternative to income from operations, net income, net income per share, or any other performance measure derived in accordance with GAAP.

EBITDA represents net income before interest, taxes, non-cash stock option awards to employees or directors, depreciation, and amortization. We use EBITDA to facilitate operating performance comparisons from period to period. We believe EBITDA facilitates company-to-company comparisons by excluding potential differences caused by variations in capital structures (affecting interest expense), taxation, and the age and book depreciation of facilities and equipment (affecting depreciation expense), which may vary from company to company. We also use EBITDA to evaluate and price potential acquisition candidates.

In addition to EBITDA, we use a measure called Adjusted EBITDA, which we define as EBITDA that excludes the effects of discontinued operations, cumulative effects of accounting changes, and other non-operating items that represent non-recurring events. Our management does not view these types of charges as indicative of the status of our operations.

EBITDA Reconciliation
(Dollars shown in 000’s)

		2005				2004				2003				2002				2001
Net Income (loss)		$	(3,986	)		$	(40,307	)		$	206			$	(611	)		$	232
Depreciation/Amortization			715				176				139				149				183
Interest expense (income)			(20	)			(125	)			295				304				328
Tax expense (benefit)			325				(21	)			92				—				—
Options issued to employees/directors			1,400				1,399			$	—				—				—
EBITDA		$	(1,566	)		$	(38,878	)			732			$	(158	)		$	743
Cumulative effect of accounting change			—				—				—				91				—
Loss from discontinued operations			—				—				—				407				—
Adjusted EBITDA		$	(1,566	)			(38,878	)		$	732			$	340			$	743

Quarterly Financial Data
(Dollars shown in 000’s except per share amounts)

		2005
		Q1				Q2				Q3				Q4
Revenue		$	2,543			$	11,796			$	16,820			$	22,539
Gross Profit			394				1,675				2,084				2,819
Net Income (loss)			(1,745	)			(1,058	)			(57	)			(1,126	)
Basic & diluted earnings per share		$	(0.05	)		$	(0.03	)		$	(0.00	)		$	(0.03	)

		2004
		Q1				Q2				Q3				Q4
Revenue		$	3,597			$	3,419			$	3,009			$	1,109
Gross Profit			322				364				166				(906	)
Net Income (loss)			(13,581	)			(26,682	)			(690	)			646
Basic & diluted earnings per share		$	(0.70	)		$	(0.73	)		$	(0.02	)		$	0.02

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The financial and business analysis below provides information that the Company believes is relevant to an assessment and understanding of the Company’s consolidated financial position, results of operations, and cash flows. This financial and business analysis should be read in conjunction with the consolidated financial statements and related notes.

The following discussion and certain other sections of this report contain statements reflecting the Company’s views about its future performance and constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995. These views involve risks and uncertainties that are difficult to predict and, accordingly, the Company’s actual results may differ materially from the results discussed in such forward-looking statements. Readers should consider that various factors, including changes in general economic conditions and competitive market conditions; price pressures; relationships with key customers; and other factors discussed in Part I, Item 1A, “Risk Factors,” and the sections entitled “Executive-Level Overview” and “Critical Accounting Estimates” below, may affect the Company’s performance. The Company undertakes no obligation to publicly update any forward-looking statements as a result of new information, future events, or otherwise.

Executive-Level Overview

The Company grew and changed dramatically in 2005 as a result of mergers and acquisitions. The Company now has four wholly owned subsidiaries — SSSI, M&M, CEECO, and Horne — and five business segments. In addition to expanding its market base and business offerings, the Company installed a new management team, placed top

priority on issues of corporate governance, implemented changes to make operations more efficient and internal controls sound, and created a platform for well-managed, sustainable growth.

The Company’s Security Solutions business segment is represented by SSSI. Located in Fort Walton Beach, Florida, SSSI is now focused on manufacturing critical, customized equipment components for the Department of Defense. We have installed an experienced management team to oversee operations, augmented our financial and contract capability, identified high-technology equipment that will make us more profitable, and instituted improved pricing and cost-control procedures. Because of strong business relationships and successful first-article work this past year, we expect revenue in 2006 to be almost twice what is was last year. Among its upcoming projects, SSSI will be building a new Advanced Medium-Range Air-to-Air Missile (AMRAAM) container for the U.S. Air Force and serving as the Air Force’s container repair center, manufacturing spare parts and equipment to support the AMRAAM program, and supporting the requirement to install an additional seat in the C-130 Aircraft.

The Industrial and Offshore business segment is represented by M&M and its wholly owned subsidiary, M&M Offshore Limited. Based in St. John’s, Newfoundland, M&M provides services to the industrial and energy industry in eastern Canada. In 2005, M&M accounted for 38 percent of Spectrum Holdings’ operational revenue and contributed $735,000 of operating profit. Operationally, however, M&M is a challenge to integrate into the Spectrum Holdings family because of its geographic location and distinct corporate culture and because it is subject to a completely separate set of laws and regulations. Therefore, we are assessing strategic alternatives for the M&M subsidiary. M&M’s revenues have been fairly consistent from year to year, and we expect this to continue. For reasons of climate, M&M’s operations are seasonal and backlog rarely carries over from year to year.

The Repair and Overhaul segment, represented by CEECO, is headquartered in Port Canaveral, Florida. CEECO has a solid, niche-market business model serving government and industrial customers in Florida and the U.S. Gulf Coast area. CEECO has been helping the Coast Guard to rebuild portions of the waterway navigation system in the Mississippi River Delta damaged by Hurricane Katrina. CEECO posted $2 million in revenue in 2005 and is poised for at least a 25-percent increase in 2006. The main drivers of this growth are expected to be ship repair, refurbishment and replacement operations, production of buoys for the Coast Guard, and contracts designed to improve U.S. long-term maritime safety and communications security.

The Procurement Services segment is managed from Horne’s headquarters in Falls Church, Virginia, but also provides services at client sites elsewhere in the United States and abroad. Although it was a part of the Company for only two-thirds of the year and its profit margins were below the overall average for our operations, the Procurement Services business segment has proven to be an efficient and growing revenue generator, providing 30 percent of our total 2005 revenue, contributed $992,000 of our total 2005 operating profit, and strong cash flow. This segment’s success has resulted from our strong relationships with several major contractors, the in-house expertise we have developed, and our ability to staff up rapidly to meet customer requirements both nationally and internationally. We expect the revenue for this group to grow substantially during 2006. The demand for procurement work is directly related to the level of major infrastructure reconstruction activity, and significant fluctuations in this demand could materially affect the Company’s revenue.

The Engineering Services segment, also represented by Horne, consolidates all our non-manufacturing engineering operations. With work performed at Horne facilities and customer sites, this segment focuses on providing engineering, environmental remediation, and occupational safety and health services. Although part of Spectrum Holdings for only two-thirds of 2005, Engineering Services accounted for 17 percent of the Company’s revenue and contributed $340,000 of operating profit. The software engineering group that is responsible for the Safe Range and Safe Borders programs was transferred from the Security Solutions segment to the Engineering Services segment at the beginning of 2006. We expect revenues in this business segments to grow substantially during 2006.

The business synergy created by the merger with Horne has resulted in some exciting prospects for the Company. At this time, we are pursuing roles on four large-scale contracts related to homeland security, environmental restoration, critical infrastructure, and emergency preparedness: the multi-billion-dollar Integrated Wireless Network (IWN) procurement collaborative effort by the Departments of Justice, Homeland Security, and the Treasury; the SBInet component of U.S. Customs and Border Protection’s Secure Borders Initiative; the $3

billion Kuwait Environmental Remediation Program for remediating and restoring water and other natural resources damaged during Iraq’s 1991 invasion of Kuwait; and a major infrastructure program for a confidential client.

Except for the Industrial and Offshore segment associated with M&M, the Company is largely dependent on the amount of U.S. government contracting in the areas of homeland security, environmental management, infrastructure reconstruction, and munitions management. Significant changes to the spending levels in these areas may have a direct impact on the operations of the Company. Absent such changes, however, management expects the Company’s organic growth to be in the range of 15 to 20 percent. Success in winning any one of the “breakthrough” contracts that we currently are pursuing could spur a significantly greater growth rate for the Company.

Accretive acquisitions will also be part of our growth strategy. We continue to keep an eye out for like-minded companies that will enable us to expand our core capabilities and market reach. Of particular interest would be technology-oriented companies with core competencies in areas such as geospatial intelligence systems, disease surveillance data modeling, and mission-centered human resource management systems.

Critical Accounting Estimates

Management’s Discussion and Analysis of Financial Condition and Results of Operations are based upon our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and determine whether contingent assets and liabilities, if any, are disclosed in the financial statements. On an ongoing basis, we evaluate our estimates and assumptions, including those related to long-term contracts, product returns, bad debts, inventories, fixed asset lives, income taxes, environmental matters, litigation and other contingencies. We base our estimates and assumptions on historical experience and on various factors that are believed to be reasonable under the circumstances, including current and expected economic conditions, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from our estimates under different assumptions or conditions.

We believe that the following critical accounting estimates, among others, require us to make significant estimates and judgments in the preparation of our financial statements:

Revenue Recognition

The Company’s principal method of revenue recognition is percentage-of-completion for longer term fixed-price contracts and cost plus fee on reimbursable and time-and-materials contracts. This methodology is used by all segments with the exception of Repair and Overhaul, which utilizes the completed contract method for revenue recognition. There is no material difference in the results of using completed contract method versus percentage-of completion method due to the short-term nature of the Repair and Overhaul contracts.

Revenue on fixed-price contracts is generally recognized using the percentage-of-completion method based on the ratio of total costs incurred to date compared to estimated total costs to complete the contract, which the Company believes is the best measure of progress toward completion. Estimates of costs to complete include material, direct labor, overhead, and allowable general and administrative expenses for our government contracts. These cost estimates are reviewed and, as necessary, revised on a contract-by-contract basis. If, as a result of this review, we determine that a loss on a contract is probable, then the full amount of estimated loss is charged to operations in the period it is determined that it is probable a loss will be realized from the full performance of the contract. Significant management judgments and estimates, including, but not limited, to the estimated costs to complete projects, must be made and used in connection with the revenue recognized in any accounting period.

Management believes the above methods and criteria are the best available measures of progress for such contracts. Because of the inherent uncertainties in estimating costs and revenues, it is reasonably possible that the estimates used will change in the future.

The Company performs equipment and material procurement contracts as a subcontractor. These contracts require the Company to acquire large dollar items for federal governmental entities through prime contractors. The Company recognizes revenues under these contracts on a gross basis when the goods are shipped to the end user. The Company uses the gross method of revenue recognition, as prescribed under EITF 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent,” as the Company is the primary obligor in the transaction and is obligated to pay the supplier for work performed regardless of whether the customer accepts the work. The Company is responsible for the acceptability of the product and has the latitude and negotiability to determine both the suppliers and the price in the transaction. The customer has the right of return. Although the Company does not take title to the goods, the Company conducts all business under these contracts as a stand-alone entity using its own financial, staffing, and facility resources. The Company is compensated for the material purchases at a fixed fee percentage.

Net Operating Loss Carry-Forwards

We have not recognized the benefit in our financial statements with respect to approximately $11.0 million in net operating loss carry-forwards for federal income tax purposes as of December 31, 2005. This benefit was not recognized due to the possibility that the net operating loss carry-forward would not be utilized, for various reasons, including the potential that we might not have sufficient profits to use the carry-forward or that the carry-forward may be limited as a result of changes in our equity ownership. We intend to use this carry-forward to offset our future taxable income subject to any limitations. If we were to use any of this net operating loss carry-forward to reduce our future taxable income and the Internal Revenue Service were to then successfully assert that our carry-forward is subject to limitation as a result of capital transactions occurring in 2003 or otherwise, we may be liable for back taxes, interest, and, possibly, penalties.

Goodwill

The Company records the excess of purchase cost over the fair value of net tangible assets of acquired companies as goodwill. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” the Company does not record amortization expense related to goodwill. In the fourth quarter of each year, or as an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount, the Company completes a review of the market value of that investment and related goodwill.

Determining market values requires the Company to make significant estimates and assumptions. The Company’s judgments are based on historical experience, current market trends, consultations with external valuation specialists, and other information. While the Company believes that the estimates and assumptions underlying the valuation methodology are reasonable, different assumptions could result in a different market value.

The Company is evaluating strategic alternatives related to M&M, which has a goodwill balance of $1.7 million as of December 31, 2005. The Company believes that the overall value of the M&M subsidiary has not deteriorated since its acquisition in February 2005.

Overall Results of Operations

		For the Year ended December 31,
		(Dollars shown in 000’s)
		2005								2004								2003
Revenues		$	53,698				100.0	%		$	11,134				100.0	%		$	13,330				100.0	%
Cost of Revenue			46,726				87.0	%			11,188				100.5	%			11,681				87.6	%
Gross Profit		$	6,972				13.0	%		$	(54	)			-0.5	%		$	1,649				12.4	%

The overall results of operations were directly impacted by the acquisitions of M&M, CEECO and Horne. These acquisitions contributed approximately $48.1 million of revenue for the year and $7.6 million of gross profit. This level of growth is not expected to continue in 2006. However, we do expect to see continued growth in both revenue and gross profit in 2006 as a result of CEECO and Horne being included in the Company’s consolidated financial statements for a full twelve months. The growth in revenues from these subsidiaries during 2006 for the

months they were not included in 2005 is expected to be approximately $30.0 million, which is primarily due to the expected volume of procurement activity. Procurement activity varies greatly from quarter to quarter and year to year, and the gross margin is typically our lowest margin work. Approximately 80% of the $30.0 million of comparable-period revenue growth is expected from procurement. This increase in revenue may be impacted by the results of the evaluation of strategic alternatives regarding M&M. The exact timing of any activity regarding M&M may have a material impact on the income statement because M&M’s business is seasonal, with the majority of its revenue occurring between April and October. Overall, we expect revenue growth of 10% on our base business from 2005 adjusted by those items discussed above. The decrease in SSSI revenue over the past two years was caused by the completion of the Gila Bend contract in September 2004. This is further discussed under the Security Solutions segment below.

The low gross profit margin for the Company in 2004 was due to the low-margin Gila Bend contract and the ten first articles manufactured for verification purposes in pursuit of large-volume government contracts. The overall gross profit margin for 2006 is expected to remain consistent with 2005. This takes into account the increased low-margin procurement work and improved profitability in the munitions area. The net impact of all of these changes should result in no change to the gross margin percentage for the Company.

Security Solutions

		For the Year ended December 31,
		(Dollars shown in 000’s)
		2005								2004								2003
Revenues		$	5,624				100.0	%		$	11,134				100.0	%		$	13,330				100.0	%
Cost of Revenue			6,236				110.9	%			11,188				100.5	%			11,681				87.6	%
Gross Profit		$	(612	)			-10.9	%		$	(54	)			-0.5	%		$	1,649				12.4	%

The Security Solutions segment has evolved from a segment that generated most of its revenue from range maintenance contracts in 2003 to a unit that was primarily a manufacturing unit in 2005. Manufacturing revenue has grown almost 100% over the past two years, while range maintenance revenue has decreased by 97%. Range maintenance revenue was approximately $9.3 million in 2003, $7.0 million in 2004 and $0.3 million in 2005. This contrasts with the manufacturing group’s revenue of $2.2 million in 2003, $2.7 million in 2004, and $4.2 million in 2005.

The majority of the range maintenance revenue was from the Gila Bend contract that was completed in September 2004. This contract also contributed to the negative gross profit swing from 2003 to 2004 as less favorable bid rates for the final contract year, combined with Department of Labor actions and the settlement of a harassment suit, resulted in negative gross profits. The Department of Labor actions and the settlement cost the Company $0.5 million.

The remaining decrease in gross profit in 2004 was the result of the successful completion of ten first-article tests in the manufacturing group. First-article tests are the opportunity for a manufacturer to demonstrate its ability to manufacture a given product to client specifications in order to qualify to receive future awards. The Company has historically expensed these costs as incurred, thereby decreasing gross margin since no revenue is recognized against such costs.

In 2005, revenue from manufacturing continued to increase — approximately 58% from 2004 — as a direct result of the successful first-article work in 2004. Contracts for U.S. Navy tubes and various military aircraft stands contributed directly to that increase. The Company expects manufacturing revenue to continue to increase in 2006 — by approximately 100% from 2005 levels — as we continue to increase contract orders as a direct result of our performance on the previous first-article work.

The third component of Security Solutions is the software group. The revenue from this group has been decreasing over the three-year period — from $1.8 million in 2003 to $1.5 million in 2004 to $1.1 million in 2005. The decrease from 2004 to 2005 was due to additional time spent on non-billable activity related to our positioning on

the new Secure Borders Initiative and time spent on a lawsuit against two former employees of SSSI. The software group will be part of the Engineering Services segment in 2006.

Gross profit margins in the Security Solutions segment remained negative in 2005 as a result of a foreign military sales contract that is operating at a loss due to increased raw material prices, increased non-revenue activity related to the Safe Borders program, and closeout costs on the Gila Bend contract. We expect margins to improve substantially during 2006 since we are renegotiating contracts with unfavorable raw material pricing, we have instituted better pricing and cost-control procedures, and we have a stronger contract base to absorb any first-article work that may be undertaken.

Industrial and Offshore

		For the Year ended December 31,
		(Dollars shown in 000’s)
		2005								2004								2003
Revenues		$	20,542				100.0	%			—				100.0	%			—				100.0	%
Cost of Revenue			17,253				84.0	%			—				100.0	%			—				100.0	%
Gross Profit		$	3,289				16.0	%			—				0.0	%			—				0.0	%

The Company’s Industrial and Offshore segment was created with the acquisition of M&M in February 2005. The revenue from M&M was for eleven months, but closely approximates a full year’s earnings due to the seasonality of the business. Very little activity occurs between November and March due to the weather in Newfoundland. The gross profit margins are in line with the historical gross margins for this segment prior to the acquisition of M&M by the Company. M&M also has investments in several joint ventures that are not reflected in the figures shown above in accordance with generally accepted accounting principles. While the net impact of these investments was not material during 2005, these investments did provide significant net income for M&M in prior years.

As previously discussed, the Company has retained outside advisors to assist in evaluating strategic options related to M&M. We expect revenue and gross margins to be consistent with 2005 pending any strategic decisions.

This unit is also affected by foreign exchange rates between the U.S. and Canadian dollars. The exchange rate has improved from a U.S. reporting standpoint as the Canadian dollar has strengthened since the acquisition of M&M. A change in the exchange rate could directly affect the results of this unit. While not material to the overall operations of the Company, any significant change in the exchange rates may be material to the results of this segment.

Repair and Overhaul

		For the Year ended December 31,
		(Dollars shown in 000’s)
		2005								2004								2003
Revenues		$	1,921				100.0	%		$	—				100.0	%		$	—				100.0	%
Cost of Revenue			1,186				61.7	%			—				100.0	%			—				100.0	%
Gross Profit		$	735				38.3	%		$	—				0.0	%		$	—				0.0	%

The Repair and Overhaul segment was created with the acquisition of CEECO in March 2005. The revenue for this group is not seasonal, and we expect revenues to grow substantially during 2006, mainly due to new work from the Hurricane Katrina cleanup and the addition of two more months of operations.

The main source of new work has been the replacement and repair of maritime navigation towers damaged by Hurricane Katrina. This work is in addition to our base repair and installation work on a variety of seagoing vessels. We expect revenue to increase by 25% in 2006 as we expand our operations. This segment is dependant on the services of Louis Rogers for the signing and completion of most contracts. Mr. Rogers was the previous owner of CEECO and is under contract with the Company through February 2007.

Engineering Services

		For the Year ended December 31,
		(Dollars shown in 000’s)
		2005								2004								2003
Revenues		$	9,324				100.0	%		$	—				100.0	%		$	—				100.0	%
Cost of Revenue			7,196				77.2	%			—				100.0	%			—				100.0	%
Gross Profit		$	2,128				22.8	%		$	—				0.0	%		$	—				0.0	%

This segment was acquired as part of the acquisition of Horne in May 2005. The revenue for this segment can be expected to grow during 2006 as a result of adding four additional months of operations. The segment will also increase by the addition of the software group transferring from the Security Solutions segment in 2006. Combined, these changes should increase revenue by approximately 50% for 2006 as compared with 2005 revenue. Additionally, we are actively pursuing new contracts that could increase that growth rate significantly.

The gross margin of approximately 23% is consistent with the margins earned prior to the Company’s acquisition of Horne. The margin rates going forward will depend on the revenue produced by the software group with the Safe Range software package and our role with the new Secure Borders Initiative. If we are not successful in securing our position within the new programs, our profit margins in the software group and within this segment may be negatively affected. Conversely, if we are successful in securing a market for our services beyond our current position, our margins may increase. At this time, we are unable to provide any guidance on how successful we may be related to this issue.

Procurement Services

		For the Year ended December 31,
		(Dollars shown in 000’s)
		2005								2004								2003
Revenues		$	16,287				100.0	%		$	—				100.0	%		$	—				100.0	%
Cost of Revenue			14,855				91.2	%			—				100.0	%			—				100.0	%
Gross Profit		$	1,432				8.8	%		$	—				0.0	%		$	—				0.0	%

The Procurement Services segment was acquired as part of the Horne acquisition in May 2005. This segment derives its revenue from two sources: material procurement and acquisition services. The split of revenue between these two areas determines the operating margin for the segment. The materials component is normally high-revenue, low-margin work. The services piece is the opposite, with most services being smaller dollar but having a much higher margin.

We expect the revenue for this group to grow substantially during 2006 due to the timing of the 2005 work in relation to the timing of the acquisition of Horne. The majority of the material procurement was performed prior to the acquisition. Thus, a disproportionate share of services revenue was recognized in the revenue and margin figures shown above. We expect revenue from our Procurement Services to be approximately $5 million in 2006. We expect our material procurement revenue to be in a range of $10 to $30 million for the year. The variability of this work makes estimation difficult.

Operating Expenses

		For the Year ended December 31,
		(Dollars shown in 000’s)
		2005				2004				2003
Selling, General & Administrative		$	11,464			$	40,564			$	1,268

The decrease in operating expenses is primarily due to a net reduction in stock option expenses of approximately $33.1 million during 2005. This reduction is offset by the increased cost associated with the acquisitions and management of the new subsidiaries. We expect operating expenses to increase moderately in 2006 as a result of owning all of the acquired companies for a full year, pending any strategic decisions related to M&M.

Backlog by Segment

The Company is reporting two types of backlog: funded and unfunded. These classifications differ significantly in terms of their expected value to the Company and the expected realization of the amounts. The funded backlog, as shown in the table below, includes all contracts that have been awarded and funded by the client, in most cases a government entity. Funded contracts are subject to changes in work scope, delays in project startup, and cancellation by the client. The unfunded backlog is comprised of contract awards that, at present, have no funding or confirmed orders on which to rely. An example of this is GSA schedule awards that are indefinite delivery/indefinite quantity awards. While these contracts have the potential to generate revenue, the amount, timing, and certainty of those revenues are unknown.

Backlog

		(Dollars shown in 000’s)
		2006				2007				2008+				Total
Security Solutions		$	1,579			$	—			$	—			$	1,579
Repair and Overhaul			141				—				—				141
Engineering Services			12,696				3,992				—				16,688
Procurement Services			16,335				—				—				16,335
Total Funded Backlog		$	30,751			$	3,992			$	—			$	34,743

The amount of unfunded backlog as of March 15, 2006 is approximately $123 million.

The Industrial and Offshore segment has no backlog due to the short-term nature of its work.

Liquidity and Capital Resources

Cash and cash equivalents totaled approximately $7.7 million at December 31, 2005. During 2005, the Company used approximately $12.3 million cash for the three acquisitions that occurred during the year. These funds were provided by liquidating our short-term investments. The Company’s operations and lines of credit have provided sufficient cash flow to operate the business, but these cash flows were not sufficient to fund the acquisitions that occurred.

The Company anticipates that funds from operations combined with our operating lines of credit will be sufficient to provide for our 2006 operations and purchases of plant and equipment, including the possible expansion of our manufacturing facilities in Florida. The Company does not know if the funds available from operations will be sufficient for any acquisitions that may be undertaken during the year. Should the Company make any acquisitions, other sources of financing may or may not be required.

The Company’s working capital position at December 31, 2005, was $14.0 million, compared with $26.3 million at December 31, 2004.

The Company has two lines of credit available to draw on for future cash needs. The main line of credit in the amount of $6.0 million covers the U.S. operations. M&M maintains its own line of credit that has up to $1.4 million (Canadian) available depending on the amount of receivables outstanding. Neither of these lines had any outstanding balances at December 31, 2005.

Contractual Obligations

The Company has certain obligations and commitments to make future payments under contracts. At December 31, 2005, the aggregate contractual obligations and commitments are:

		(Dollars shown in 000’s)
		Total				Current				1 — 3 Years				3 — 5 Years				5+ Years
Operating Leases		$	1,396			$	894			$	455			$	47			$	—
Capital Leases			674				211				340				99				24
Debt Service			2,140				117				237				126				1,660
Purchase Obligations			—				—				—				—				—
Total Commitments		$	4,210			$	1,222			$	1,032			$	272			$	1,684

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Interest Rate Risk

At December 31, 2005, the Company had no amounts outstanding under a revolving credit facility. We have not historically mitigated our exposure to fluctuations in interest rates by entering into interest rate hedge agreements, nor do we have any plans to do so in the immediate future.

Cash and cash equivalents, as of December 31, 2005, were approximately $7.7 million and are primarily invested in money market interest-bearing accounts. A hypothetical 10% adverse change in the average interest rate on our money market cash investments would have had no material effect on net income for the twelve months ended December 31, 2005.

Our adjustable rate mortgages contain interest rate floors and ceilings that limit the impact of significant changes in interest rates.

Foreign Exchange Risk

We are exposed to foreign currency risks due to both transactions and translations between functional and reporting currencies in our Canadian subsidiaries. We are exposed to the impact of foreign currency fluctuations due to the operations of and net monetary asset and liability positions in our Canadian subsidiaries.

In addition, we estimate that an immediate 10% change in foreign exchange rates would affect reported net income or loss by an immaterial amount. We do not currently utilize any derivative financial instruments to hedge foreign currency risks.

Item 8. Financial Statements and Supplementary Data.

The following documents are filed as part of this Annual Report on Form 10-K:

Financial Statements

Report of Independent Registered Certified Public Accounting Firm			[19]
Consolidated Balance Sheets: December 31, 2005 and 2004			[20]
Consolidated Statements of Operations and Comprehensive Income (Loss): Years ended December 31, 2005, 2004 and 2003			[21]
Consolidated Statements of Stockholders’ Equity: Years ended December 31, 2005, 2004, 2003			[22]
Consolidated Statements of Cash Flows: Years ended December 31, 2005, 2004 and 2003			[23]
Notes to Consolidated Financial Statements			[24]

Report of Independent Registered Certified Public Accounting Firm

TO THE BOARD OF DIRECTORS AND STOCKHOLDERS
Spectrum Sciences & Software Holdings Corp.:

We have audited the accompanying consolidated balance sheets of Spectrum Sciences & Software Holdings Corp. and Subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations and comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Spectrum Sciences & Software Holdings Corp. and Subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.

/s/ TEDDER, JAMES, WORDEN & ASSOCIATES, P.A.

Orlando, Florida
March 10, 2006

SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.
Consolidated Balance Sheets
(Dollars shown in 000’s except share amounts)

		December				December
		31, 2005				31, 2004
ASSETS
Current assets:
Cash and cash equivalents		$	7,652			$	5,667
Short-term investments			—				18,795
Receivables			16,959				2,760
Due from Stockholder			—				705
Inventories			557				79
Prepaid expenses & other current assets			513				882
Total current assets			25,681				28,888
Property and equipment, net			7,597				2,281
Goodwill			15,222				—
Investments in joint ventures			746				—
Deferred tax asset			77				—
Other assets			81				43
TOTAL ASSETS		$	49,404			$	31,212
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	8,426			$	1,026
Accrued expenses			2,006				483
Due to related party			—				705
Deferred revenues			376				229
Provision for contract losses			—				148
Income taxes payable			156				—
Deferred income taxes			426				—
Current portion of long-term debt			332				—
Total current liabilities			11,722				2,591
Long term debt, less current portion			2,482				—
TOTAL LIABILITIES			14,204				2,591
Commitments and contingencies (Note 17)
Minority interest			103				—
Stockholders’ equity:
Preferred stock, $0.0001 par value; 20,000,000 shares authorized, none issued			—				—
Common stock, $0.0001 par value; 80,000,000 shares authorized, 44,072,200 and 38,969,300 issued and outstanding			4				3
Additional paid-in capital			79,866				69,895
Accumulated deficit			(45,264	)			(41,278	)
Accumulated other comprehensive income			491				1
Total stockholders’ equity			35,097				28,621
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	49,404			$	31,212

     See accompanying notes to consolidated financial statements.

SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.
Consolidated Statements of Operations and Comprehensive Income (Loss)
(Dollars shown in 000’s except share amounts)

		12 months ended
		December 31,
		2005				2004				2003
Revenues		$	53,698			$	11,134			$	13,330
Cost of revenues			46,726				11,188				11,681
Gross profit			6,972				(54	)			1,649
Operating expenses			11,464				40,564				1,268
Income (Loss) from operations			(4,492	)			(40,618	)			381
Total non-operating income (expense), net			930				290				(83	)
Loss before provision for income taxes			(3,562	)			(40,328	)			298
Income tax benefit (expense)			(325	)			21				(92	)
Loss before minority interest			(3,887	)			(40,307	)			206
Minority interest (income) expense			99				0				0
Net (Loss) Income			(3,986	)			(40,307	)			206
Weighted average common shares outstanding:
Basic and diluted			42,250,363				33,616,188				18,845,112
(Loss) income per share:
Basic and diluted		$	(0.09	)		$	(1.20	)		$	0.01
Net (Loss) Income			(3,986	)			(40,307	)			206
Foreign currency translation adjustments			491				0				0
Unrealized gain on available for sale securities			(1	)			1				0
Total comprehensive (loss) income		$	(3,496	)		$	(40,306	)		$	206

See accompanying notes to consolidated financial statements.

SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.
Consolidated Statements of Stockholders’ Equity
(Dollars shown in 000’s except share amounts)

																		Accumulated
																		Other
																		Comprehensive
		Common Stock												Accumulated				Income
		Shares				Amount				APIC				Deficit				(Loss)				Total
Balance at December 31, 2002			600				1				—				(1,177	)			—				(1,176	)
Recapitalization of Silva Bay International, Inc.			16,344,000				1				69												70
Issuance of share to effectuate recapitalization			2,500,000				—				—												—
Dissolution of Spectrum Sciences & Software, Inc.			(600	)			(1	)															(1	)
Issuance of shares to legal counsel			7,000				—				10												10
Net income															206								206
Balance at December 31, 2003			18,851,000				1				79				(971	)			—				(891	)
Stock options issued for consulting services											32,945												32,945
Exercise of stock options			20,078,300				2				35,281												35,283
Stock options issued to employees											1,399												1,399
Stock options issued for consulting services											125												125
Exercise of stock options			40,000				—				66												66
Unrealized gain on investments																			1				1
Net loss															(40,307	)							(40,307	)
Balance at December 31, 2004			38,969,300				3				69,895				(41,278	)			1			$	28,621
Stock options issued to employees and directors			—				—				1,400				—				—				1,400
Exercise of stock options			2,900				—				4				—				—				4
Issuance of common stock for acquisition of Horne Engineering Services, Inc.			5,100,000				1				8,567				—				—				8,568
Unrealized loss on investments			—				—				—				—				(1	)			(1	)
Foreign currency translation			—				—				—				—				491				491
Net loss			—				—				—				(3,986	)			—				(3,986	)
Balance as of December 31, 2005			44,072,200			$	4			$	79,866			$	(45,264	)		$	491			$	35,097
Disclosure of reclassification amount:																			2005
Reclassification adjustment for losses included in net loss																		$	1

See accompanying notes to the consolidated financial statements.

SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.
Consolidated Statements of Cash Flows
(Dollars shown in 000’s)

		2005				2004				2003
Cash flows from operating activities
Net income (loss)		$	(3,986	)		$	(40,307	)		$	206
Adjustments to reconcile net loss to net cash used in operating activities issuance of stock options to related party for consulting services			—				32,945				—
Investor relations expenses paid by a related party			—				2,763				—
Stock options issued to employees and directors			1,400				1,399				—
Stock options issued to service providers			—				125				10
Write-down of obsolete inventory			—				—				45
Depreciation			715				176				139
Deferred income taxes			440				11				46
Earnings in joint ventures			460				—				—
Minority interest			99				—				—
(Gain) Loss on disposal of equipment			(5	)			45				(22	)
Realized (gain) loss on the sale of bonds			(1	)			12				—
Change in balance sheet items
Receivables			(6,492	)			(1,032	)			357
Inventory			(58	)			43				124
Prepaid Expenses			580				(831	)			(10	)
Accounts Payable			5,272				(246	)			(143	)
Accrued Expenses			(220	)			(51	)			(74	)
Deferred Revenue			(201	)			192				37
Provision for contract losses			(148	)			148				—
Other balance sheet changes			(137	)			(87	)			11
Net cash (used in) provided by continuing operations			(2,282	)			(4,695	)			726
Net cash (used in) discontinued operations			0				0				(15	)
Net cash (used in) provided by operations			(2,282	)			(4,695	)			711
Cash flows from investing activities
Purchases of available for sale investments, net			—				(22,807	)			—
Maturities of available for sale investments, net			18,795				4,000				—
Business acquisitions, net of cash received			(12,276	)			—				—
Purchase of property and equipment			(763	)			(497	)			(71	)
Proceeds from the sale of equipment			75				—				22
Investments in joint ventures,net			701				—				—
Net cash provided by (used in) investing activities			6,532				(19,304	)			(49	)
Cash flows from financing activities
Repayment of debt			(481	)			(2,782	)			(184	)
Net (repayments) borrowings on lines of credit			(1,828	)			—				(551	)
Advances and accrued interest from related parties, net			(278	)			(68	)			136
Proceeds for the exercise of stock options			4				31,819				—
Net cash provided by (used in) financing activities			(2,583	)			28,969				(599	)
Currency impact on cash and cash equivalents			318				0				0
Net increase in cash and cash equivalents			1,985				4,970				63
Cash and cash equivalents at beginning of period			5,667				697				634
Cash and cash equivalents at end of period		$	7,652			$	5,667			$	697

See accompanying notes to the consolidated financial statements.

SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.
Notes to Consolidated Financial Statements

1. ORGANIZATION AND NATURE OF BUSINESS

Spectrum Sciences & Software Holdings Corp. (the “Company” or “Spectrum Holdings”), headquartered in Falls Church, Virginia, has five reportable segments: Security Solutions, Industrial and Offshore, Repair and Overhaul, Engineering Services, and Procurement Services. Security Solutions includes the design and construction of munitions ground support equipment and containers for the shipping and storage of munitions and software to assist in hazard management and weapons impact analysis. The Security Solutions segment comprises the previously reported segments of Management Services, Manufacturing, and Engineering and Information Technology. Industrial and Offshore operations include the Company’s engineering, mechanical contracting and steel fabrication operations in the Province of Newfoundland, Canada. The Company’s Repair and Overhaul segment is engaged in providing specialized fabrication and maintenance for ships, lifeboats and maritime navigation systems. The Company’s Engineering Services segment provides services to the federal government in the areas of energy and the environment, homeland defense, and transportation. The Procurement Services segment provides acquisition support services to both government and commercial clients.

The Company acquired M&M Engineering, Ltd. (“M&M”), Coast Engine and Equipment Company, Inc. (“CEECO”), and Horne Engineering Services, Inc. (“Horne”) during the 2005 fiscal year. Details of these acquisitions are included in Note 3.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Financial Statement Presentation

The consolidated financial statements include the accounts of majority-owned subsidiaries: intercompany transactions are eliminated. Investments in unconsolidated joint ventures were adjusted to fair market value upon the acquisition of M&M and Horne, respectively. The investments are now recorded under the cost or equity method.

Revenue Recognition

The Company’s principal method of revenue recognition is percentage of completion for longer term fixed price contracts and cost plus on reimbursable time-and-materials contracts. This methodology is used by all segments with the exception of Repair and Overhaul. This segment utilizes the completed contract revenue recognition model. There is no material difference in the results of using completed contract versus percentage of completion due to the short-term nature of the Repair and Overhaul contracts.

Revenue on fixed price contracts is generally recognized using the percentage-of-completion method based on the ratio of total costs incurred to date compared to estimated total costs to complete the contract, which the Company believes is the best measure of progress toward completion. Estimates of costs to complete include material, direct labor, overhead, and allowable general and administrative expenses for our government contracts. These cost estimates are reviewed and, as necessary, revised on a contract-by-contract basis. If, as a result of this review, we determine that a loss on a contract is probable, then the full amount of estimated loss is charged to operations in the period it is determined that it is probable a loss will be realized from the full performance of the contract. Significant management judgments and estimates, including but not limited to the estimated costs to complete projects, must be made and used in connection with the revenue recognized in any accounting period.

Management believes the above methods and criteria are the best available measures of progress for such contracts. Because of the inherent uncertainties in estimating costs and revenues, it is reasonably possible that the estimates used will change in the future.

The Company performs equipment and material procurement contracts as a subcontractor. These contracts require the Company to acquire large dollar items for federal governmental entities through prime contractors. The Company recognizes revenue under these contracts on a gross basis when the goods are shipped to the end user. The Company uses the gross method of revenue recognition, as prescribed under EITF 99-19, “Reporting Revenue

SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.
Notes to Consolidated Financial Statements

Gross as a Principal versus Net as an Agent,” as the Company is the primary obligor in the transaction and is obligated to pay the supplier for work performed regardless of whether the customer accepts the work. The Company is responsible for the acceptability of the product and has the latitude and negotiability to determine both the suppliers and the price in the transaction. The customer has the right of return. Although the Company does not take title to the goods, the Company conducts all business under these contracts as a stand-alone entity using its own financial, staffing and facility resources. The Company is compensated for the material purchases at a fixed fee percentage.

Use of Estimates

The preparation of financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Accordingly, results could differ from those estimates and assumptions.

Cash Equivalents

The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.

Fair Value of Financial Instruments

The carrying amount of cash and cash equivalents, receivables, accounts payable, and accrued expenses approximates fair value because of the short-term nature of those instruments. The carrying amount and fair market value of the Company’s short-term investments are the same since short-term investments are recorded at fair value. Debt is recorded at the cash settlement value of the underlying notes which approximates fair value as the interest rates are adjustable.

Significant Customers and Credit Risks

Service revenue from individual customers which constituted greater than 10% of the Company’s consolidated service revenue for each of the years 2005, 2004, and 2003 is set forth below:

		Year Ended December 31,
		2005				2004				2003
Customer A			23.7	%				*				*
Customer B			27.1	%				*				*
Customer C				*			60.1	%			67.8	%

Due to the nature of the Company’s business and the relative size of certain contracts, it is not unusual for a significant customer in one year to be insignificant in the next. However, it is possible that the loss of any single significant customer could have a material adverse effect on the Company’s results of operations. The Company’s primary customers are government entities. If a single government entity’s revenue exceeds 10% of the Company’s revenue, it is disclosed above.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to credit risk consist of cash and cash equivalents, accounts receivable, and unbilled services. As of December 31, 2005, substantially all of the Company’s cash and cash equivalents were held in or invested with domestic banks. Accounts receivable from individual customers which constituted 10% or more of the Company’s consolidated accounts receivable for each of the years ended December 31, 2005, 2004, and 2003 is set forth below:

SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.
Notes to Consolidated Financial Statements

		Year Ended December 31,
		2005				2004				2003
Customer A			15.4	%				*				*
Customer B			31.0	%				*				*
Customer C				*			60.0	%			61.8	%

In determining the allowance for doubtful accounts, the Company analyzes the aging of the accounts receivable, historical bad debts, customer creditworthiness, and specific situations involving our customers. As the majority of our work is government related, the risk of uncollectiblity is greatly reduced.

Inventories

Inventory costs are stated at the lower of cost or market, determined by either the average cost or first-in, first-out method. Inventory costs normally consist of work in progress with raw materials or finished goods. The Company strives to order raw materials and parts for delivery as needed. On occasion, the Company will advance purchase raw materials where the discounted price of those materials is sufficient to justify the carrying costs of said material.

Property & Equipment

Property and equipment acquired as part of the acquisitions of M&M, CEECO, and Horne were adjusted to their approximate fair value at the time of acquisition, respectively. All other property and equipment are recorded at cost less accumulated depreciation. Depreciation is computed on both an accelerated basis and straight-line methods over the estimated useful lives of the underlying assets. Routine maintenance and repairs are expensed as incurred. Major replacements and improvements are capitalized.

Goodwill

The Company records the excess of purchase cost over the fair value of net tangible assets of acquired companies as goodwill. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” the Company does not record amortization expense related to goodwill. In the fourth quarter of each year, or as an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount, the Company completes a review of the market value of that investment and related goodwill.

Impairment of Long-Lived Assets

The Company reviews the recoverability of its long-lived assets groups, including furniture and equipment, computer hardware and software and leasehold improvements, when events or changes in circumstances occur that indicate the carrying value of the asset may not be recoverable. The assessment of possible impairment is based on the Company’s ability to recover the carrying value of the asset from the expected future pre-tax cash flows (undiscounted and without interest charges) of the related operations. If these cash flows are less than the carrying value of such asset, an impairment loss is recognized for the difference between estimated fair value and carrying value. The Company’s primary measure of fair value is based on discounted cash flows. The measurement of impairment requires the Company to make estimates of these cash flows related to long-lived assets, as well as other fair value determinations.

Income Taxes

The Company accounts for income taxes utilizing the asset and liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enacted date. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.
Notes to Consolidated Financial Statements

Research and Development Costs

Research and development costs are expensed as incurred. The Company incurred approximately $216,000, $225,700 and $71,400 in 2005, 2004, and 2003, respectively. These costs are included in operating expenses in the accompanying statements of operations and comprehensive income (loss).

Earnings (Loss) Per Share

The Company reports its earnings (loss) per share in accordance with Financial Accounting Standards Board (FASB) Statement No. 128, “Earnings Per Share.” Statement No. 128 requires the presentation of basic and diluted loss per share on the face of the statement of operations and comprehensive income (loss).

Basic earnings (loss) per share (“EPS”) is calculated by dividing net income (loss) by the weighted-average number of common shares outstanding during the reporting period. Diluted EPS is computed in a manner consistent with that of basic EPS while giving effect to the impact of common stock equivalents. The Company’s common stock equivalents consist of employee, director, and consultant stock options to purchase common stock. Common stock equivalents were not included in the computation of diluted earnings (loss) per share for the twelve months ended December 31, 2005, and 2004, as the inclusion of these common stock equivalents would be anti-dilutive as the Company is in a net loss position and including such shares would reduce the net loss per share. The Company had no outstanding stock options as of December 31, 2003, thus basic and diluted EPS were the same.

Financial Instruments and Short-Term Investments

Short-term investments generally mature between three months and two years from the purchase date. Investments with maturities beyond one year may be classified as short-term based on their highly liquid nature and because they represent the investment of cash that is available for current operations. All short-term investments are classified as available for sale and are recorded at market value using the specific identification method; unrealized gains and losses are reflected in Other Comprehensive Income. Investments consist of debt instruments. Debt securities are classified as available for sale and are recorded at market using the specific identification method. Unrealized gains and losses (excluding other-than-temporary impairments) are reflected in Other Comprehensive Income.

Investments are considered to be impaired when a decline in fair value is judged to be other than temporary. The Company employs a systematic methodology that considers available evidence in evaluating potential impairment of its investments. If the cost of an investment exceeds its fair value, the Company evaluates, among other factors, general market conditions, the duration and extent to which the fair value is less than cost, as well as our intent and ability to hold the investment. The Company also considers specific adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, changes in technology, operational and financing cash flow factors, and rating agency actions. Once a decline in fair value is determined to be other than temporary, an impairment charge is recorded and a new cost basis for the investment is established.

Foreign Currency Translation

The Company’s functional currency is the U.S. dollar, except that the functional currency of M&M is the Canadian dollar. In the accompanying consolidated financial statements, the monetary assets, with the exception of plant and equipment, and certain liabilities of M&M were translated to U.S. dollars using the December 31, 2005, exchange rate of 0.858 Canadian dollar to 1.00 U.S. dollar. All monetary consolidated statements of operations items of M&M were translated at the average exchange rate for the eleven months ended December 31, 2005, of 0.8249 Canadian dollar to 1.00 U.S. dollar. The Company had no foreign operations until the acquisition of M&M on February 1, 2005.

Stock Based Compensation

The Company has adopted the fair value recognition provisions of the Statement of Financial Accounting Standards No. 123R, “Share-Based Payment.” Accordingly, the fair values of stock option awards are determined using the Black-Sholes model. The compensation expense is recognized on a straight-line basis over the vesting period. The Company has traditionally not included a vesting period for option grants.

SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.
Notes to Consolidated Financial Statements

3. ACQUISITIONS

M&M Engineering, Ltd.

On February 1, 2005, the Company acquired M&M, a provider of a complete range of mechanical contracting and steel fabrication services to the industrial and offshore energy sector, for $6,768,202 in cash; a combination of the purchase of 100% of the common stock of M&M and an issuance of 1,000 preferred shares to the Company. The purchase price for the common stock of M&M was $5,958,802 in cash. Pursuant to the Purchase Agreement, M&M redeemed 1,000 of its preferred shares held by EnerNorth Industries Inc., for $809,400 immediately prior to closing the acquisition and issued the same number of preferred shares to the Company for $809,400. The total cost of the acquisition includes approximately $353,000 of acquisition-related expenses – for a total cost of approximately $7,121,000. The primary purpose of this acquisition was to diversify the Company’s corporate customer base beyond U.S. federal government contracting and to capitalize on the growth potential in the natural resource sector to include: the offshore oil and gas industries, the hydroelectric sector, mining, and the pulp and paper industries in Newfoundland and Labrador, Canada.

Coast Engine and Equipment Company, Inc.

On February 25, 2005, the Company acquired 100% of CEECO, a provider of service to the maritime industry predominantly for on-board ship repair of HVAC and refrigeration systems; welding services; and custom flooring, insulation, and machinery installations. The purchase price for CEECO included an initial cash payment of $300,000 plus an earn-out over the next three years. Under the terms of the purchase agreement, the Company will pay the former shareholders of CEECO a total purchase price of up to $900,000 over a three-year period. The purchase price is payable in cash and common stock of the Company and is subject to certain adjustments, including, without limitation, adjustments based on CEECO’s earnings during such three-year period. In addition to the $300,000 cash payment for CEECO, there were approximately $36,000 of acquisition related expenses. Pursuant to a security agreement executed in connection with the purchase agreement, the former shareholders of CEECO will retain a security interest in all of the assets of CEECO until the total purchase price has been paid. The Company has a three-year employment contract with Louis T. Rogers, former owner of CEECO. The CEECO acquisition allows the Company to take advantage of other non-government customer bases in the south-central Florida region. It also provides the opportunity to pursue business opportunities within the U.S. Coast Guard and U.S. Navy by increasing the Company’s presence in that market. As of December 31, 2005, CEECO has met the purchase price EBITDA goals for the first year, as defined in the purchase agreement. While these results must be verified through year-end audit, three-quarters of the first year earn-out of $200,000, or $150,000 has been accrued.

Horne Engineering Services, Inc.

On May 11, 2005, the Company acquired all of the issued and outstanding capital stock of Horne Engineering Services, Inc. (“Horne”), from its shareholders, Darryl K. Horne, Charlene M. Horne and Michael M. Megless (the “Horne Shareholders”), pursuant to an Agreement and Plan of Merger (the “Merger Agreement”). Pursuant to the Merger Agreement, Horne was merged with and into Horne Acquisition LLC, a wholly owned subsidiary of the Company. The purchase price for the capital stock of Horne was $4.5 million in cash and 6.1 million unregistered shares of the Company’s common stock (the “Shares”). Additional shares of common stock could subsequently become issuable by the Company to the Horne Shareholders to the extent that the average closing price of the Company’s common stock on NASD OTC Bulletin Board, or other public securities market, for the trading days during the two month period ending on May 11, 2007 is less than $3.25 per share, subject to Horne (on a stand alone basis) meeting or exceeding 2005 gross revenues of $75 million with EBITDA (as defined in the Merger Agreement) of $3.25 million (the “2005 EBITDA”) and EBITDA of not less than $3.25 million in 2006. Pursuant to an Amendment and Waiver Agreement entered into among the parties to the Merger Agreement on May 11, 2005 (the “Amendment”), the Company held back 4.0 million of the Shares payable to the former Horne Shareholders under the Merger Agreement (the “Hold Back Shares”), with the disposition of those shares subject to two conditions. First, the Amendment requires the Company to release 3.0 million of the Hold Back Shares to the former Horne Shareholders promptly upon receiving certain third-party consents relating to certain of Horne’s contracts, which are specified in the Amendment. As of November 11, 2005, the Company received the required consents. Second, if Horne’s 2005 EBITDA is less than $3.25 million (the “EBITDA Shortfall”), the Company will be entitled to recover any remaining Hold Back Shares limited such that the value of the recovered Hold Back Shares, based on the closing price of the Company’s common stock on May 11, 2005, does not exceed three times

SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.
Notes to Consolidated Financial Statements

the EBITDA Shortfall. Based on Horne’s operating results for 2005, the remaining 1.0 million shares will not be issued to the Horne Shareholders and the price guarantee on the issued shares is no longer effective.

The total cost of the Horne acquisition was approximately $13.6 million, consisting of cash of $4.5 million, acquisition costs of $524,000 and 5.1 million shares of the Company’s common stock valued at $1.68 per share, or $8.6 million. The share price of the Company’s common stock was determined based on the average share price at the time of the acquisition.

In connection with the Merger Agreement, the Company and the Horne Shareholders entered into a Registration Rights Agreement, dated May 11, 2005 (the “Rights Agreement”), pursuant to which the Company agreed to prepare and file a registration statement pursuant to Rule 415 under the Securities Act of 1933, as amended (the “Securities Act”), covering the resale from time to time of all of the shares of the Company’s common stock issued to the Horne Shareholders pursuant to the Merger Agreement.

Upon the closing of the Merger Agreement, Messrs. Horne and Megless were appointed to the Company’s Board of Directors. In connection with the Merger Agreement, Messrs. Horne and Megless executed Employment Agreements with the Company, dated as of May 11, 2005 (the “Employment Agreements”), pursuant to which such individuals were appointed Chief Executive Officer (“CEO”), and Chief Financial Officer (“CFO”), respectively. Pursuant to a Stock Option Agreement executed in connection with the Merger Agreement, Mr. Horne received an option to purchase 1.0 million shares of the Company’s common stock at an exercise price of $1.65 per share, subject to Horne meeting the revenue and EBITDA targets for 2005 as described above. Based on Horne’s operating results for 2005, these options are forfeited. The Company also reserved 2.0 million shares of the Company’s common stock for the issuance of stock options to be granted to the employees of Horne at the discretion of Mr. Horne.

The primary purpose of the Horne acquisition was to effectuate a business combination pursuant to which the management of Horne would replace Spectrum’s then-current management team. Although Horne was acquired by the Company, Horne’s management has assumed management responsibilities of the Company.

Each acquisition described above was accounted for under the purchase method of accounting. Accordingly, the purchase price has been allocated to reflect the fair value of assets and liabilities acquired at the date of acquisition.

Pro Forma Results (Unaudited)

The results of these acquisitions, had they been consummated at the beginning of each period shown, are included in the pro forma information below. The historical revenues and earnings of M&M, CEECO, and Horne for the twelve months ended December 31, 2005 and 2004, have been combined with the revenues and earnings of Spectrum Sciences & Software Holdings Corp. for the twelve months ended December 31, 2005 and 2004, respectively. This pro forma information does not necessarily reflect the results of operations that would have occurred had the acquisitions taken place at the beginning of each twelve month period and is not necessarily indicative of results that may be obtained in the future.

		Twelve months ended
		December 31,
		(Dollars shown in 000’s except per share amounts)
		2005				2004
Revenue		$	76,813			$	49,637
Net loss			(3,552	)			(38,830	)
Loss per share — Basic & Diluted		$	(0.08	)		$	(1.16	)

For the twelve month period ended December 31, 2005, the Company incurred $1.4 million in stock-based compensation expense, a $1.8 million loss for SSSI, and significant positive earnings contributions from the acquired companies. The net loss reported above was also significantly impacted by merger and acquisition activity during the period, including costs for accounting and legal fees, investor relations, and consulting fees, as well as by Hurricane Dennis, the second hurricane to hit the Florida Gulf Coast in less than a year. The loss for the twelve months ended December 31, 2004 includes approximately $34.5 million of stock compensation expense.

SPECTRUM SCIENCES & SOFTWARE HOLDINGS CORP.
Notes to Consolidated Financial Statements

Purchase Price Allocation

The allocation of the purchase prices for M&M, CEECO and Horne are as follows:

		(Dollars shown in 000’s)
		M&M				CEECO				Horne
Assets Acquired
Cash		$	188			$	40			$	—
Accounts Receivable			3,197				117				4,081
Inventory			374				29				—
Property and Equipment			2,508				65				372
Investments in joint ventures			1,569				—				311
Other			387				28				198
		$	8,223			$	279			$	4,962
Liabilities Assumed
Debt			(1,102	)			(27	)			(1,835	)
Accounts payable and accruals			(1,258	)			(28	)			(2,641	)
Deferred Taxes			(417	)			—				(221	)
			(2,777	)			(55	)			(4,697	)
Goodwill			1,675				262				13,285
Total consideration		$	7,121			$	486			$	13,550

The goodwill from the M&M and CEECO acquisitions are fully allocated to the Industrial and Offshore and Repair and Overhaul segments, respectively. The preliminary allocation of goodwill from the Horne acquisition provides $11.5 million of goodwill to Engineering Services and $1.8 million of goodwill to Procurement Services. These allocation may be adjusted pending final purchase accounting. None of the goodwill is deductible for tax purposes.

4. SHORT-TERM INVESTMENTS (000’s)

						Unrealized				Unrealized				Recorded
		Cost Basis				Gains				Losses				Basis
December 31, 2004
Short-term investments:
Certificate of Deposit		$	879			$	—			$	—			$	879
US government and Agency securities			17,915				17				(16	)			17,916
Total short-term investments		$	18,794			$	17			$	(16	)		$	18,795