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

For the Fiscal year ended: December 31, 2006

OR

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

For the transition period from                      to                     

Commission File Number: 000-50373

Horne International, Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: 703-641-1100

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

None.

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

Common Stock, par value $.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. þ

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 by non-affiliates of the registrant as of the close of business on June 30, 2006, was approximately $33.9 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, 2007, there were 41,774,082 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			8
Item 3.		Legal Proceedings			8
Item 4.		Submission of Matters to a Vote of Security Holders			8
Item 5.		Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			8
Item 6.		Selected Financial Data			9
Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			11
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			47
Item 9A.		Controls and Procedures			47
Item 9B.		Other Information			47
Item 10.		Directors and Executive Officers of the Registrant			47
Item 11.		Executive Compensation			50
Item 12.		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			56
Item 13.		Certain Relationships and Related Transactions			57
Item 14.		Principal Accountant Fees and Services			58
Item 15.		Exhibits and Financial Statements Schedules			58

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.

Horne International, Inc. (the “Company” or “We”, “Us”, “Our” or similar terms) is a premier technology and technical engineering solutions company focused on three primary target markets — national security, energy and environment, and transportation — with an emphasis on homeland security. The Company’s service areas encompass program engineering, technology, manufacturing, maritime and industrial repair, environment, safety & health, acquisition services, public outreach, and business process engineering.

The Company 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 & Software, Inc. (“SSSI”), a Florida corporation. The Company began trading on the Over the Counter (“OTC”) Bulletin Board market in December 2003. In August 2006, the Company changed its name from Spectrum Sciences & Software Holdings Corp. to Horne International, Inc.

The Company acquired three companies during 2005: M&M Engineering, Ltd. (“M&M”), Coast Engine and Equipment Company, Inc. (“CEECO”), and Horne Engineering Services, LLC (“Horne Engineering”). M&M was subsequently sold in June 2006. The Horne Engineering acquisition was a merger that resulted in the management of Horne Engineering assuming managerial control of the Company effective June 2005. More information related to these acquisitions and dispositions is included in Note 3 of our audited financial statements.

As a result of these acquisitions and dispositions, the nature of the Company’s business has changed significantly, including our reportable segments. Prior to the 2005 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, and as a result of our 2005 acquisitions, we added Industrial and Offshore, Repair and Overhaul, Procurement Services, and Engineering Services. For the year ended December 31, 2006, we have amended our reportable segments back to three due to the disposition of our M&M subsidiary (Industrial and Offshore) and to better reflect how we manage our businesses. We have consolidated the Engineering and Procurement Services into the Services segment. These segments better reflect how we manage the business and allocate our resources. The Industrial and Offshore segment reported in 2005 related solely to the operations of M&M and is no longer reported as a result of the sale of M&M.

Prior to the sale of M&M, the Company operated in both the United States and Canada with some contract work being performed at customer sites in the Middle East. The sale of M&M concluded the Company’s Canadian operations.

Business Segments

The Company comprises three distinct operating companies that each operate in their own reportable segments: Security Solutions (SSSI), Repair and Overhaul (CEECO), and Services (Horne Engineering). These segments are predominantly focused in the U.S. defense markets, although all segments also serve commercial customers. Financial information for each segment can be found in Item 7., “Management’s Discussion and Analysis of

Financial Condition and Results of Operations,” and Note 17 to the audited financial statements in Item 8. The Company previously reported the Industrial and Offshore segment that was disposed of with the sale of M&M Engineering Ltd. in June 2006.

Security Solutions

Our Security Solutions segment specializes in the manufacturing of aircraft and munitions support equipment for the U.S. Department of Defense. The Security Solutions segment, which employs approximately 50 employees, is based out of and operates in Ft. Walton Beach, Florida. Most of the Company’s contracts in this segment are with the U.S. Department of Defense.

The segment’s manufacturing operations, with revenue of $3.6 million, accounted for approximately 92% of the segment’s revenues in 2006. 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 group is expanding its services into military aircraft specialty parts based on successful first-article testing and the needs of the customers. This segment is participating in the Defense Department’s Mentor-Protégé program and in the Foreign Military Sales area with a small disadvantaged 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 affected 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 primary competitors for the manufacturing group are smaller manufacturing companies with the flexibility 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 a manufacturer’s ability to pass the first-article testing for new products and on its past performance on similar contracts.

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.

Services

The Services segment focuses on providing program engineering, occupational safety and health, environmental sciences, acquisition and procurement, business process engineering, public outreach, and information technology services, including modeling and simulation, software development, GIS/geospatial products and services, and technology integration. Our primary customer in this segment is the U.S. Government, with specific focus within the Departments of Homeland Security, Defense, and Transportation. 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 required expertise appears to be sufficiently deep to meet our needs. This segment is primarily based out of our Fairfax, Virginia, headquarters and employs approximately 100 people.

The market addressed by the Services segment is a very large, competitive market 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 segment’s software group focuses primarily on modeling and simulation through both the Safe Range and 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 with respect to our coding for the Safe Borders tracking software, including certain algorithms and processing procedures that are proprietary. The names “Safe Borders” and “Safe Range” (the modeling and simulation software we developed for weapon system range safety) are registered trade names of the Company.

Discontinued Operations

Discontinued operations includes the results of our M&M Engineering Ltd. subsidiary that was sold in June 2006 and represented our Industrial and Offshore segment.

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 government entity. Funded contracts are subject to changes in work scope, delays in project startup, and cancellation by the client. The backlog figures shown below are as of March 15, 2007.

Funded Backlog (all dollars in thousands)

The Company reported funded backlog of $30,751 at March 15, 2006 with Security Solutions having $1,579, Repair and Overhaul $141, and Services $29,031,

The amount of unfunded backlog was approximately $97 million at March 15, 2007. 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. As such, the amount of revenue recognized under these contracts may be significantly less than the amount of unfunded backlog disclosed above.

Government Contracts

Most of our business is conducted under contracts with or related to U.S. government entities. We are awarded government contracts either on a sole-source basis or through a competitive bidding process. Our U.S. government contract types include fixed-price contracts, cost reimbursable contracts (including cost-plus-fixed fee, cost-plus-award fee, and cost-plus-incentive fee), and time and materials contracts.

Material Government Contract Provisions

The funding of U.S. government programs is subject to Congressional appropriations. Although multi-year contracts may be authorized in connection with major procurements, Congress generally appropriates funds on a fiscal year basis, even though a program may continue for many years. Consequently, programs are often only partially funded initially, and additional funds are committed only as Congress makes further appropriations.

All contracts with the U.S. government contain provisions, and are subject to laws and regulations, that give the government rights and remedies not typically found in commercial contracts, including rights that allow the government to:

	•		terminate existing contracts for convenience, which affords the U.S. government the right to terminate the contract in whole or in part anytime it wants for any reason or no reason, as well as for default;
	•		reduce or modify contracts or subcontracts, if its requirements or budgetary constraints change;
	•		cancel multi-year contracts and related orders, if funds for contract performance for any subsequent year become unavailable;
	•		claim rights in products and systems produced by its contractor;
	•		adjust contract costs and fees on the basis of audits completed by its agencies;
	•		suspend or debar a contractor from doing business with the U.S. government; and
	•		control or prohibit the export of products.

Generally, government contracts are subject to oversight audits by government representatives. Provisions in these contracts permit termination, in whole or in part, without prior notice, at the government’s convenience or upon contractor default under the contract. Compensation in the event of a termination, if any, is limited to work completed at the time of termination. In the event of termination for convenience, the contractor may receive a certain allowance for profit on the work performed.

Environmental Matters

Our operations may include the use and disposal of hazardous materials. The Company never takes title to any hazardous materials used in its operations. 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 substantial 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.

Available Information

Our headquarters is located at 2677 Prosperity Avenue, Suite 300, Fairfax, VA, 22031. Our website address is www.Horne.com. The information contained on our website is not incorporated by reference into this Annual Report. All reports we filed electronically with the Securities and Exchange Commission (SEC), including our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, and other information and amendments to those reports filed electronically (if applicable), are accessible at no cost on our website as soon as reasonably practicable after such reports have been filed or furnished to the SEC. These filings are also accessible on the SEC’s Web site at www.sec.gov. The public may read and copy any materials we filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information from the Public Reference Room by calling the SEC at 1-800-SEC-0330.

Item 1A. Risk Factors.

We are subject to several risk factors that could have a direct and material impact on the operations of the Company and the market price of our common stock. These risk factors are described below.

Increased corporate overhead structure combined with a reduced operating base may impact our ability to operate.

We have made a significant investment in our corporate structure to provide the organizational capabilities to expand our business both organically and through acquisitions. This investment has increased our on-going cost structure and may impair our ability to earn a net profit. This increase in organizational structure has occurred at the same time that we have disposed of our second largest operating subsidiary thereby putting additional cost burdens on our remaining subsidiaries.

If we are unable to grow our business, we may incur significant operating losses. If we were to incur significant operating losses, that may impact the Company’s ability to continue operations. We are actively monitoring our cost structure to ensure that we are prudently incurring expenses and we are actively pursuing growth opportunities for all of our businesses.

Continued losses in our Security Solutions segment may require the Company to consider strategic alternatives.

The Company has incurred significant losses within this segment over the past three years due to factors including raw material price increases, multi-year fixed-price contracts bid under lower cost structures than currently exist, and management issues. The failure of this unit to deliver improved performance may require the Company to evaluate strategic alternatives related to this subsidiary.

Continued poor financial performance may require the Company to seek alternative financing.

Given our operating losses, we may not be able to renew our line of credit that expires in April 2007. We are currently in default of a financial net worth covenant under that line that could restrict future borrowings. This situation may cause us to seek additional sources of financing including using second tier lenders that may increase our cost of borrowing.

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, the contract is terminated for convenience by the customer, or our inability to find qualified employees or subcontractors to complete the work.

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 Security Solutions segment 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.

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; and
	•		Changes in policy or budgetary measures that adversely affect government contracts in general.

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.

We depend on contracts with U.S. federal government agencies or with prime contractors of such agencies for substantially all of our revenue, and if our relationships with these agencies were harmed, our business could be threatened.

We receive more than 90% of our revenue in any given year from contracts with U.S. federal government agencies or with prime contractors of such agencies. We believe that federal government contracts will continue to be the source of substantially all of our revenue for the foreseeable future. For this reason, any issue that compromises our relationship with agencies of the federal government or their prime contractors could cause serious harm to our business.

Our failure to comply with complex procurement laws and regulations could cause us to lose business and subject us to a variety of penalties.

We must comply with laws and regulations relating to the formation, administration, and performance of federal government contracts, which effect how we do business with our government clients and may impose added costs on our business. Among the most significant regulations are:

	•		The Federal Acquisition Regulation, and agency regulations analogous or supplemental to the Federal Acquisition Regulation, which comprehensively regulate the formation, administration, and performance of government contracts, including provisions relating to the avoidance of conflicts of interest and intra-organizational conflicts of interest;
	•		The Truth in Negotiations Act, which requires certification and disclosure of all cost and pricing data in connection with some contract negotiations;

	•		The Procurement Integrity Act, which requires evaluation of ethical conflicts surrounding procurement activity and establishing certain employment restrictions for individuals who participate in the procurement process;
	•		The Cost Accounting Standards, which impose accounting requirements that govern our right and method to reimbursement under some cost-based government contracts;
	•		Laws, regulations, and executive orders restricting the use and dissemination of information classified for national security purposes and the exportation of specified products, technologies, and technical data;
	•		Laws surrounding lobbying activities a corporation may engage in to support corporate interests; and
	•		Compliance with anti-trust laws.

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

Item 1B. Unresolved Staff Comments.

None.

There were approximately 100 stockholders of record on March 15, 2007. A significant number of the outstanding shares are beneficially owned by individuals or entities registered in a street name. The Company believes there are approximately 8,500 beneficial owners of its common stock as of March 15, 2007.

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

2004 Non-Statutory Stock Option Plan

The Company’s 2004 Non-Statutory Stock Option Plan was adopted by the Board of Directors on March 11, 2004 and approved by the shareholders in March 2004. The plan was intended to advance the interests of the Company by inducing individuals, and eligible entities, and 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 $.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 authorized under this plan was increased to 30,000,000.

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.

The amendments to the Stock Option Plan have not been approved by the shareholders.

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

The financial information above is reflective of the operations since 2002. Prior to April 2003, the predecessor company of Spectrum Sciences & Software Holdings Corp. Silva Bay International, Inc., was a non-reporting entity that had no financial activity. The information shown above for the year 2002 is for SSSI, which the Company acquired on April 3, 2003. The above data includes the results of the 2005 acquisitions of CEECO and Horne Engineering subsequent to their respective dates of acquisition. The above data excludes the results of M&M, which the Company acquired in 2005 and disposed of in 2006.

The Company uses certain measures of performance that are not required by, or presented in accordance with generally accepted accounting principles (GAAP). These non-GAAP financial measures are EBITDA less stock option expense 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 less stock option expense represents net income before interest, taxes, depreciation and amortization, and stock option expense for employees and directors. We use this measure to facilitate operating performance comparisons from period to period. We believe this measure facilitates company-to-company comparisons by backing out 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 this measure to evaluate and price potential acquisition candidates. We have excluded stock option expense to employees and directors due to the magnitude of the option awards in 2004 and 2005 that were a result of actions of a different Board of Directors and executive management. The compensation philosophy of that Board and management is no longer applicable to our Company, and we expect our stock option compensation expense, in the foreseeable future, to be significantly lower than the 2004 and 2005 levels.

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

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 may affect the Company’s performance. These factors include 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. 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 provides a variety of goods and services through its wholly owned subsidiaries — SSSI, CEECO, and Horne Engineering. The provision of such goods and services 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.

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 accounting principles generally accepted in the United States of America. 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 varies by segment. The Security Solutions segment uses percentage of completion, our Repair and Overhaul segment uses the completed contract method of revenue recognition, and our Service segment primarily uses cost plus on reimbursable time-and-materials contracts. The revenue on these contracts is recognized as costs are incurred. The Service segment does have a limited number of short-term fixed-price contracts where revenue is recognized as milestones are achieved. Although the Repair and Overhaul segment uses the completed contract method of revenue recognition, there is no material difference in the results of using completed contract versus percentage of completion due to the short-term nature of their contracts.

Security Solution’s 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 towards 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, through its Services segment, 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 has recognized 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 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.

Allowance for Bad Debts

We evaluate our accounts receivable through a continuous process of assessing our portfolio on an individual and overall basis. The majority of our contracts are with United States Government entities and as such we have minimal risk of collectability. The few contracts we have with non-governmental entities we review on a contract by contract basis. Our allowance for bad debts has been and is less than .1% of our outstanding receivables at any time.

Net Operating Loss Carry-Forwards

We have not recognized the benefit in our financial statements with respect to the approximately $44 million net operating loss carry-forward for federal income tax purposes as of December 31, 2006. 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. 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 price over the fair value of net 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.

Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements,” to define fair value, establish a framework for measuring fair value in accordance with generally accepted accounting principles, and expand disclosures about fair value measurements. SFAS No. 157 will be effective for fiscal years beginning after November 15, 2007, thus it will start affecting the Company on January 1, 2008, the beginning of the Company’s 2008 fiscal year. The Company is assessing the impact the adoption of SFAS No. 157 will have on the Company’s consolidated financial position and results of operations.

In February 2006, the FASB issued FAS 155, “Accounting for Certain Hybrid Financial Instruments,” which clarifies when certain financial instruments and features of financial instruments must be treated as derivatives and reported on the balance sheet at fair value with changes in fair value reported in net income. We will implement FAS 155 beginning with financial instruments acquired on or after January 1, 2007, which is the effective date of FAS 155. We do not expect the adoption of FAS 155 to have a material impact on our financial position at our date of adoption. However, FAS 155 may affect future income recognition for certain financial instruments that contain certain embedded derivatives as any changes in their fair values will be recognized in net income each period.

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin 108, “Considering the Effects on Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” (“SAB 108”). SAB 108 requires registrants to quantify errors using both the income statement method (that is, iron curtain method) and the rollover method and requires adjustment if either method indicates a material error. If a correction in the current year relating to prior year errors is material to the current year, then the prior year financial in