OUR GROWTH STRATEGY

The two components of our strategy for growth are organic new business development and completing strategically targeted acquisitions.

Organic New Business Development

Leverage Our Longstanding Client Relationships to Cross-Sell Our Broad Range of Services

We plan to continue expanding the volume and scope of the Company’s technicalservices we provide to our existing clients. We believe our high level of client satisfaction and deep knowledge of our clients’ business processes enhance our ability to cross-sell our broad range of professional services businessincluding, but not limited to, information technology, engineering and integration, advanced scientific research, systems and mission assurance, program acquisition and advisory services, and program and personnel security management.

Expand Our Client Base

We believe that the federal government’s increasing reliance on outsourcing and the increased emphasis on national security and homeland security have increased our market opportunity. We have a longstanding heritage of supporting the federal government in the areas of information technology, systems engineering, security and program management support. We intend to leverage this broad experience to expand our client base to include organizations within the federal government for which we have not historically worked. In addition, we intend to continue strategic hiring to expand the breadth of our expertise into new areas of the federal government or new technologies.

Pursue Strategic Acquisitions

Our industry remains fragmented and we believe industry consolidation will continue. We will continue to selectively review acquisition candidates with the Department of Defensecomplementary skills and other governmental agencies is obtained through competitive procurementmarket focus to enhance our internal growth and through follow-on services relatedstrategically position ourselves to existing business. In certain instances, however, the Company acquires such service contracts because of special professional competency or proprietary knowledge in specific subjectcapitalize on anticipated high growth areas.

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Government ContractsEXISTING CONTRACT PROFILES

DirectAs of December 31, 2005, we had more than 200 active contract engagements, each employing one of three types of price structures: cost-plus-fee, time and indirect contracts with government defensematerial, and intelligence agencies comprise the majorityfixed-price. The following table summarizes our revenue from each type of the Company’s business base. During 2003, 51%contract as a percentage of the Company’s contracts were cost-reimbursement, 33% were time-and-materials, and 16% were firm fixed-price. Followingour total revenue for each year ended December 31,

The following are briefsummary descriptions of theour various types of contracts the Company receives from the government.contract types:

Cost-reimbursementCost-plus-fee contracts. Cost-plus-fee contracts provide for payment of allowable incurred costs, to the extent prescribed in the contract, plus a profit component. These contracts establish an estimate of total cost for the purpose of obligating funds and establishing a ceiling that the contractorwe may not exceed without the approval of the contracting officer. Cost-reimbursementCost-plus-fee contracts are suitable for use when uncertainties involved in contract performance do not permit costs to be estimated with sufficient accuracy to use a fixed-price contract. Cost-reimbursementCost-plus-fee contracts covered by the Federal Acquisition Regulation require an audit of actual costs and provide for upward or downward adjustments if actual recoverable costs differ from billed recoverable costs. If our costs exceed the ceiling or are not allowable under the terms of the contract or applicable regulations, we may not be able to recover those costs. Approximately 47% of our current cost-plus-fee contracts contain ceilings on various categories of expenses. Therefore, if we incur expenses in excess of these ceilings, we will not be fully reimbursed by the government.

Time-and-materials (T&M)Time and material (“T&M”) contracts. T&M contracts provide for acquiring services on the basis of direct labor hours at specified fixed hourly rates. A T&M contractcontracts may also provide for acquiring materials, including, if appropriate, material handling costs. Profit margins on T&M contracts fluctuate based on the difference between negotiated billing rates and actual labor and overhead costs directly charged or allocated to such contracts. We assume the risk that a contract’s costs of performance may exceed the negotiated hourly rates.

Firm fixed-priceFixed-price contracts. Fixed-price contracts provide for delivery of products or services for a price that is negotiated in advance on the basis of the contractor’s cost experience. The price is not subject to any adjustment unless there is a change in the scope of work. Profit margins increase to the extent that costs are below the contracted amounts. If the costs exceed the estimates, profit margins decrease and a loss may be realized on the contract.

CLIENTS

Revenue derived from the U.S. government and its prime contractors represented approximately 99%, 100%, and 99% of our total revenue for the years ended December 31, 2005, 2004, 2003, respectively. The U.S. Government is expected to continue to account for substantially all of our revenue for the foreseeable future.

Our federal government clients typically exercise independent contracting authority, and even offices or divisions within an agency or department may directly, or through a prime contractor, use our services as a separate client so long as that client has independent decision-making and contracting authority within its organization. We consider each office or division within an agency or department, which directly or through a prime contractor, engages us, to be a separate client.

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Approximately 20% of our revenue for fiscal year 2005 came from one prime contract from NASA, which has a potential nine-year and four-month total contract term if all options are exercised. In addition, the Homeland Security Group’s contract with one Department of Defense customer generated 11% of the Company’s revenue and 44% of the Company’s operating income for the year ended December 31, 2005.

Contract BacklogBACKLOG

We define backlog to include funded and unfunded orders for services under existing signed contracts, assuming the exercise of all priced options relating to those contracts. We define funded backlog to be the portion of backlog for which funding currently is appropriated and obligated to us under a contract or other authorization for payment signed by an authorized purchasing authority, less the amount of revenue we have previously recognized.

The Company’sfollowing table summarizes our funded backlog, of orders, based on remainingour unfunded contract value, believedvalues and our total estimated backlog (in millions) for each year ended December 31,:

We currently expect to be firm as of December 31, 2003 wasrecognize approximately $171$120.0 million of which approximately $170.4 million was attributable to the Analex segment and $0.6 million was attributable to the ABS segment. The portion of therevenue during 2006 from our total backlog expected to be realized within 2004 is $56 million. Funded backlog as of December 31, 2003 was approximately $19.3 million, of which approximately $0.6 million was attributable to the ABS segment. We expect to consume all of the funded backlog during 2004.2005. Included in the backlog approximationestimate are amounts from future years of government contracts under which the government has the right, but not the obligation, to exercise an option for the Companyus to perform services.

CompetitionCOMPETITION

In general, the industry in which the Company operateswe operate includes a large number of competitors of varying sizes. Competition within the information technology and government contracting arenas is intense. The Company maintainsWe maintain a primary commitment to itsour current direct and indirect government clients, while we are also intensifying itsour business development efforts to win additional government clients. The Company isWe are continuing efforts to diversify itsour defense and intelligence client base.base by offering a broad-range of services such as information technology, engineering and integration, advanced scientific research, systems and mission assurance, program acquisition and advisory services, and program and personnel security management.

The Analex segmentWe generally competescompete against federal systems integrators such as Booz Allen Hamilton, Lockheed Martin, Northrop Grumman, Anteon International Corporation, CACI International Inc., Computer Sciences Corporation, and Science Applications International Corporation, among others, including a varietynumber of small and medium sized, privately-held government contractors offering information technology and systems engineering services to the U.S. government. In addition, the Systems Engineering Group competeswe compete against large aerospace contractors such as Boeing and Lockheed Martin and other small and medium sized privately held firms in the provision of launch related services. Selection isContract awards are based primarily on a combination of the price of services and evaluation of technical capability, as well as past performance, quality of service and responsiveness to client requirements.

Within the Analex segment, the Company believes that the Homeland Security Group has a competitive advantage in its skilled engineers and customer relationships within the intelligence community and in its expertise and experience with independent verification and validation of space launch vehicles. However, larger government contractors can provide a breadth of professional offerings that the smaller Homeland Security Group may not be able to match. The Company also believes that the Systems Engineering Group has a competitive advantage in space launch support, especially in the expendable launch vehicle support segment, arising from the Company’s work on the ELVIS contract. Given the Company’s size, larger government contractors operating in this business area may be able to provide a breadth of service offerings beyond the Company’s capabilities.

The ABS segment’s main competition comes from individual research professionals and research groups at academic institutions seeking government funded research work. ABS competes for research grants on the basis of scientific expertise, past research activity and past performance under previous research grants. In the event that any technologies or products are developed based on ABS’ research, ABS will likely compete against a variety of large and small biotechnology and pharmaceutical businesses.

EmployeesEMPLOYEES

As of December 31, 2003, the Company (including its subsidiaries)2005, we employed approximately 5521,100 people including full time, part timefull-time, part-time and casual employees. Of the 5521,100 employees, 48 are members of unions, and we believe employee relations are believed by management to be generally good. In October 2002,On November 1, 2005, the Company entered into a three-yearrenewed its Collective Bargaining Agreement with the International Brotherhood of Teamsters now representing approximately 3738 employees on the NASA ELVIS contract at Vandenberg Air Force Base in California. In February 2003, the Company entered into a three-yearThe renewal extends this Collective Bargaining Agreement

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through November 1, 2009. In February 2006, we renewed our Collective Bargaining Agreement for three years with the International Brotherhood of Electrical Workers now representing approximately 1110 employees on the NASA ELVIS contract at the Kennedy Space Center in Florida.

General InformationGENERAL INFORMATION

Raw materials, patents, licenses, trademarks, franchises and concessions are not material to the operation of the Company’s businessour operations. We did not engage in significant internally sponsored research and the Company’s business is not seasonal. The Company derivesdevelopment. We typically experience lower staff utilization rates in our fiscal third and fourth quarters. These lower utilization rates are primarily attributable to our employees taking seasonal leave. We derive no revenuesrevenue from foreign operations.

Recent DevelopmentsRECENT DEVELOPMENTS

On March 4, 2003,April 1, 2005, we acquired ComGlobal Systems, Inc, a software engineering and information technology firm, specializes in C4I programs for the military. Its largest customer is the U.S. Navy’s Tomahawk Cruise Missile Program. ComGlobal is now a wholly-owned subsidiary of Analex began trading on the American Stock Exchange under the symbol “NLX”.and reported as a part of our Homeland Security Group.

On July 18, 2003, the Company entered into a Subordinated Note and Series A Convertible Preferred Stock Purchase Agreement (together with the First Amendment thereto dated September 30, 2003 and the Second Amendment thereto dated November 4, 2003, the “Pequot Purchase Agreement”) with Pequot Private Equity Fund III, L.P., a Delaware limited partnership, and Pequot Offshore Private Equity Partners III, L.P., a Cayman Islands limited partnership (“Pequot”). Details of the terms of the securities sold to Pequot pursuant to the Pequot Purchase Agreement are contained inItem 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Accounting treatment of these securities is discussed inItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.AVAILABLE INFORMATION

Available Information

The Company filesWe file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). The public may read and copy any materials the Company fileswe file with the SEC at the SEC’s Public Reference Room at 450 Fifth100 F Street, NW,NE, Room 1580, Washington, DC 20549. The public may also obtain information on the operation offrom the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site at http://www.sec.gov that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC, including the Company. The Companyus. We also providesprovide a link to certain of itsour most recent filings with the SEC at the Company’sour Internet site at http://www.analex.com. The information contained on the Company’sour Internet site is not part of this Annual Report.

Item 2.    Properties

The Company owns no real property. As of December 31, 2003, the Company leased a total of 68,373 square feet of office space at various locations in Virginia, Maryland, Colorado and Ohio. These leases expire between December 2004 and September 2006. (See Note 13 of the Notes to Consolidated Financial Statements.)

Item 3.    Legal Proceedings

The Company was served on October 9, 2003 with a complaint filed by Swales & Associates, Inc. in the Maryland Circuit Court for Prince George’s County alleging breach of contract and other claims relating to Swales’ termination as a subcontractor under the Company’s ELVIS contract with NASA. Management believes that the allegation is without merit and is vigorously contesting the complaint. Management believes and will assert that it validly exercised its contractual right to terminate the subcontract for Analex’s convenience and that termination of Swales occurred only after NASA was informed of Swales’ cost overruns and negotiations with Swales failed to yield an acceptable alternative. The Company will assert that Swales entered into the subcontract after it had hired incumbent ELVIS personnel at cost-prohibitive rates, knowing that its actual costs would greatly exceed the subcontract’s funding limitations. Under the complaint, Swales is seeking damages in excess of $4.0 million. Management believes that any liability that may ultimately result from the resolution of this matter will not have a material adverse effect on the financial position or results of operations of the Company.

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

(a)  The Company held a Special Meeting of Stockholders on December 9, 2003.

(b)  At the Special Meeting, the Company’s stockholders approved (i) the Pequot Transaction and (ii) amendments to the Company’s Certificate of Incorporation to increase the Company’s authorized capital stock from 35,000,000 shares, consisting of 30,000,000 shares of Common Stock and 5,000,000 shares of preferred stock, par value $0.02 per share (“Preferred Stock”), to 100,000,000 shares consisting of 65,000,000 shares of Common Stock and 35,000,000 shares of Preferred Stock.

The following votes were cast with respect to each of the matters voted on at the Special Meeting:

PART II1A. Risk Factors

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

Prior to March 3, 2003, the Company’s common stock was traded over the counter (OTC) and quoted on the OTC Bulletin Board under the symbol “ANLX”. On March 4, 2003, the common stock was listed on the American Stock Exchange and began trading under the symbol “NLX”.

The range of high and low bid quotations for the Common Stock, as reported by the American Stock Exchange and the OTC Bulletin Board, for each quarterly period during 2003, 2002, and 2001 is shown below. The prices presented below reflect inter-dealer prices without retail mark-ups, mark-downs or commissions, and may not reflect actual transactions.

As of March 25, 2004, there were approximately 2,054 shareholders of record of the Company’s Common Stock. No cash dividends were paid to common shareholders during 2003 or during the past three fiscal years, and no dividends are expected to be declared during 2004 for common shareholders. The ability of the Company to pay dividends on its Common Stock requires the consent of Bank of America, N.A. under the Company’s credit agreement with Bank of America, and the consent of the holders of at least a majority of the outstanding shares of Series A Preferred Stock pursuant to the Certificate of Designations.

Pequot Transaction

Pursuant to the Pequot Purchase Agreement dated July 18, 2003, the Company agreed to:

In addition, on July 18, 2003, the Company entered into a Securities Repurchase Agreement (together with the First Amendment thereto dated September 30, 2003 and the Second Amendment thereto dated November 4, 2003, the “Stout Repurchase Agreement”) with Company’s former Chairman Jon M. Stout, certain members of Mr. Stout’s immediate family including former Company director Shawna Stout, and certain entities controlled by Mr. Stout and his family (collectively, the “Stout Parties”), pursuant to which the Company agreed to purchase an aggregate of 2,625,451 shares of Common Stock and warrants and options exercisable to purchase an aggregate of 1,209,088 shares of Common Stock from the Stout Parties for aggregate consideration of $9,166,844.

The transactions contemplated by the Pequot Purchase Agreement and the Stout Repurchase Agreement were consummated simultaneously at closing (the “Closing”) which occurred on December 9, 2003. The Closing occurred immediately following the approval by the Company’s stockholders of the Pequot Transaction. Because the consummation of the transactions under each of the Pequot Purchase Agreement and the Stout Repurchase Agreement were conditioned upon each other, they constituted a single transaction to be voted upon by the stockholders. The transactions contemplated by the Pequot Purchase Agreement and the Stout Repurchase Agreement are collectively referred to herein as the “Pequot Transaction.” The Series A Preferred Stock, the Convertible Notes and the related warrants sold and issued to Pequot in December 2003 are collectively referred to as the “Pequot Instruments”.

The proceeds from the sale of the Convertible Notes were used to repurchase the securities from the Stout Parties and pay expenses incurred by the Company in connection with the Pequot Transaction. Subsequent to year end, the Company used a portion of the proceeds from the sale of the Series A Preferred Stock to pay in full the outstanding promissory note issued to the Department of Justice under a Settlement Agreement between the former Analex Corporation and the Department of Justice. Remaining proceeds from the sale of the Series A Preferred Stock will be used to finance all or a portion of the cost of future acquisitions by the Company.

Discussed below is a summary of the key terms of the Pequot Instruments. Accounting treatment of these instruments is discussed in further detail inItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. A substantial portion of the face value of these instruments is allocated to the Company’s equity account on its balance sheet, subject to annual accretion over the next four years.To Our Business

Series A Preferred StockWe depend on contracts with U.S. federal government agencies, particularly clients within the Department of Defense and NASA, for substantially all of our revenue, and if our relationships with these agencies were impaired, our business could be materially adversely affected.

The Series A Preferred Stock bears a cumulative annual dividend of 6%, payable quarterly in cash or, if the Company’s available cash for operations does not meet specified levels or such payment would result in an event

of default under the Company’s senior credit facility, in additional shares of Series A Preferred Stock. Due to non-cash accounting accretion related to the Series A Preferred Stock, the annual charges taken on the Company’s statement of operations are expected to be substantially larger than the 6% dividend. Holders of Series A Preferred Stock are entitled to vote together with all other classes and series of voting stock of the Company on all actions to be taken by the stockholders of the Company. In addition, as long as 50% of the Series A Preferred Stock originally issued remains outstanding, the Company may not take numerous actions without obtaining the written consent of the holders of a majority of the Series A Preferred Stock.

Upon any liquidation, dissolution or winding up of the Company, holders of the Series A Preferred Stock are entitled to receive, out of the Company’s assets available for shareholder distributions and prior to distributions to junior securities (including the Common Stock), an amount equal to the Series A Purchase Price plus any accrued but unpaid dividends thereon.

The Series A Preferred Stock is convertible into Common Stock at any time at the election of its holders, initially at a ratio of one share of Common Stock for every share of Series A Preferred Stock. The Series A Preferred Stock will automatically convert into Common Stock if, any time following 18 months after the Closing, the average closing price of the Common Stock over a 20 consecutive trading day period exceeds 2.5 times the conversion price then in effect ($2.23 as of December 31, 2003) for the Series A Preferred Stock. In addition, the Series A Preferred Stock held by holders that do not accept an offer by the Company to purchase the Series A Preferred Stock for at least 2.5 times the conversion price then in effect also will automatically convert into Common Stock. The Series A Preferred Stock will also automatically convert into Common Stock upon the agreement of the holders of a majority of the Series A Preferred Stock.

Holders of the Series A Preferred Stock may require the Company to redeem their shares in four equal quarterly installments any time on or after the fourth anniversary of the Closing at the Series A Purchase Price, as adjusted for stock splits, stock dividends and similar events, plus accrued but unpaid dividends.

Convertible Notes

The Convertible Notes mature on December 9, 2007. The Convertible Notes bear interest at an annual rate of 7%, payable quarterly in cash or, if the Company’s available cash for operations does not meet specified levels or such payment would result in an event of default under the Company’s senior credit facility, such interest will be accrued and added to the outstanding principal. Due to non-cash accretion related to the Convertible Notes, the annual charges taken on the Company’s statement of operations are expected to be substantially larger than the 7% interest charge.

Prior to the date which is 18 months after the Closing, the Convertible Notes may not be prepaid without the consent of the holders of a majority of the outstanding principal amount of the Convertible Notes. Any time following 18 months after the Closing, the Company, at its sole option, may prepay the Convertible Notes. Such prepayment will be made, at the option of the Convertible Note holders, either in cash in an amount equal to the outstanding principal plus the net present value of interest to maturity discounted at 7% per annum or by conversion of the principal into shares of Series A Preferred Stock and the payment of interest in cash or in shares of Series A Preferred Stock. Holders of the Convertible Notes may convert the outstanding principal and accrued interest on the Notes into Series A Preferred Stock at any time. The conversion price for the Convertible Notes is 135% of the Series A Purchase Price, subject to adjustment for stock splits, stock dividends and similar events. The Company may cause the automatic conversion of the Convertible Notes into Common Stock if, any time following 18 months after the Closing, the average closing price for the Common Stock over a 20 consecutive trading day period exceeds 2.5 times the Series A Purchase Price.

The Company’s obligations under the Convertible Notes are secured by a lien on substantially all of the assets of the Company and its subsidiaries and are guaranteed by the Company’s subsidiaries. Such obligations are subordinated to the rights of the Company’s present and future senior secured lenders.

Warrants

The Warrants are exercisable at any time before the tenth anniversary of the Closing. The Preferred Warrants are exercisable to purchase one share of Common Stock for every five shares of Common Stock issued or issuable upon conversion of the Series A Preferred Stock. The Note Warrants are exercisable to purchase one share of Common Stock for every five shares of Common Stock issued or issuable upon conversion of the Convertible Notes. The initial exercise price of the Warrants is $3.28 representing a 47% premium to the Series A Purchase Price.

Item 6.    Selected Consolidated Financial Data

The following selected consolidated financial data as of December 31, 2003, 2002 and 2001, for the six months ended December 31, 2000 and 1999 and for the fiscal years ended June 30, 2000 and 1999 have been takenRevenue derived from the consolidated financial statements of the Company. This data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the consolidated financial statements and the related notes thereto included elsewhere in this Report.

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

The following discussion and analysis should be read in conjunction with the “Selected Consolidated Financial Data”, and the consolidated financial statements and related notes included elsewhere in this Form 10-K.

Overview

Analex specializes in developing intelligence, system engineering and bio-defense services in support of our nation’s security. All of our sales are generated using written contractual arrangements. The contracts require us to deliver technical services to the intelligence community, analyze and support defense systems, design, develop and test aerospace systems according to the specifications provided by our customers. In the case of ABS, the contracts require us to develop medial defenses and treatments for infectious agents such as anthrax and smallpox used in biological warfare and terrorism.

Sales to U.S. federal government agencies and their prime contractors represented approximately 98%99%, 100% and 99% of our total revenues duringrevenue for the twelve monthsfiscal years ended December 31, 2005, 2004 and 2003, and 2002.respectively. The Department of Defense, our principal U.S. government customer, accounted for approximately 44%69%, 55% and 52%42% of our revenues inrevenue for the twelve monthsfiscal years ended December 31, 2005, 2004 and 2003, respectively. NASA generated 30%, 44% and 2002, respectively. With the acquisition of the former Analex Corporation in November 2001, NASA became our largest customer, generating 53% and 45%57% of our revenuesrevenue for the twelve monthsfiscal years ended December 31, 20032005, 2004 and 2002,2003, respectively. Approximately 17% of our revenues20%, 28% and 72% of our operating income for fiscal year 2003 came from one prime contract with an agency within the Department of Defense. Approximately 30% of our revenuesrevenue for the fiscal yearyears ended December 31, 2005, 2004 and 2003, respectively, came from one prime contract with NASA, which has a potential nine-yearwill continue until September 2011 if the remaining option is exercised in 2008. In the event that the remaining option term is not exercised, we will not be able to recognize the full value of the contract awarded. In addition, the Homeland Security Group’s contract with one Department of Defense customer generated 11%, 16% and four-month contract term if all options are exercised.17% of our revenue for the fiscal years ended December 31, 2005, 2004 and 2003, respectively, and 44%, 62% and 72% of our operating income for the fiscal years ended December 31, 2005, 2004 and 2003, respectively. We expect that federal government contracts will continue to be the source of substantially all of our revenuesrevenue for the foreseeable future.

In fiscal year 2003, a majority of our revenues If we were generated as a prime contractor tosuspended or debarred from contracting with the federal government. We intend to focus on retaining and increasing the percentage of our business as prime contractor because it provides us with stronger client relationships.The following table shows our revenues as prime contractor and as subcontractor as a percentage of our total revenues for the following periods:

We have two reportable segments: (1) Analex, which is engaged in professional services related to information technology and systems engineering for the U.S. government primarily NASA andgenerally, the Department of Defense, NASA or any significant agency in the intelligence community, if our reputation or relationship with government agencies were impaired, or if the government otherwise ceased doing business with us or significantly decreased

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the amount of business it does with us, our business, operating results, financial condition and (2) Advanced Biosystems (ABS),business prospects could be materially adversely affected.

Changes in the spending priorities of the federal government can materially adversely affect our business.

Our business depends upon continued federal government expenditures on defense, intelligence, aerospace and other programs that we support. Our contracts with the U.S. government are subject to the availability of funds through annual appropriations. These contracts may be terminated by the government for its convenience at any time, and generally do not require the purchase of a fixed quantity of services or products. Reductions in the U.S. government defense, intelligence or aerospace spending could adversely affect our operating results. Any reductions in the U.S. government spending on specific defense, intelligence, or aerospace-related programs or contracts can have a material adverse effect on our business and revenue in the future. A significant change in the spending priorities of the federal government could cause it and its many agencies to reduce their purchases under contracts, to exercise their right to terminate contracts at any time without penalty, or not to exercise options to renew contracts. Any such actions could cause our actual results to differ materially in an adverse manner from those anticipated. Among the factors that could adversely affect our business are:

The failure by Congress to approve budgets in a timely manner could cause the federal agencies we support to delay or reduce spending and that could cause us to lose revenue.

On an annual basis, Congress must approve budgets that govern spending by each of the federal agencies we support. In the past, when Congress was unable to agree on budget priorities, and was therefore unable to pass the annual budget on a timely basis, Congress has enacted a continuing resolution. A continuing resolution allows government agencies to operate at spending levels approved in the previous budget cycle. When government agencies must operate on the basis of a continuing resolution it may delay funding we expect to receive from clients for work we are already performing and will likely result in any new initiatives being delayed, and in some cases being cancelled.

The adoption of new procurement laws or regulations could reduce the amount of services that are outsourced by the federal government and could cause us to lose future revenue.

New legislation, procurement regulations, or union pressure could cause federal agencies to adopt restrictive procurement practices regarding the use of third party service providers. For example, the American Federation of Government Employees, the largest federal employee union, strongly endorses legislation that may restrict the procedure by which services are outsourced to government contractors. If such legislation were to be enacted, it would likely reduce the amount of services that could be outsourced by the federal government, which could materially reduce our future revenue.

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The Office of Management and Budget process for ensuring that government agencies would properly support capital planning initiatives, including information technology investments, could reduce or delay federal information technology spending and cause us to lose revenue.

The Office of Management and Budget, or OMB, supervises spending by federal agencies, including enforcement of the Government Performance Results Act. This Act requires, among other things, that federal agencies make an adequate business justification to support capital planning initiatives, including all information technology investments. The factors considered by OMB include, among others, whether the proposed information technology investment is engagedexpected to achieve an appropriate return on investment, whether related processes are contemporaneously reviewed, whether inter-operability with existing systems and the capacity for these systems to share data across government has been considered, and whether existing off-the-shelf products are being utilized to the extent possible. If our clients do not adequately justify proposed information technology investments to the OMB, the OMB may refuse funding for their new or continuing information technology investments, and we may lose revenue as a result.

The loss of a key executive could impair our relationships with government clients and disrupt the management of our business.

We believe that our success depends on the continued contributions of the members of our senior management. We rely on our senior management to generate business and execute programs successfully. In addition, the relationships and reputation that many members of our senior management team have established and maintain with government personnel contribute to our ability to maintain good client relations and to identify new business opportunities. Although we have stock and bonus incentives for senior management, we do not have any employment agreements providing for a specific term of employment with any member of our senior management (with the exception of Mr. Sterling E. Phillips, our Chief Executive Officer). The loss of any member of our senior management could impair our ability to identify new business opportunities, secure new contracts, maintain good client relations, and successfully manage our business.

We face intense competition from many competitors that have greater resources than we do, which could result in biomedical researchprice reductions, reduced profitability, and loss of market share.

We operate in highly competitive markets and generally encounter intense competition. If we are unable to successfully compete for medical defenses against toxic agents capablenew business or win recompetitions of being used as bioterrorist weapons,existing business, our revenue growth and operating margins may decline. Many of our competitors are larger and have greater financial, technical, marketing, and public relations resources, larger client bases, and greater brand or name recognition than we do. Larger competitors include federal systems integrators such as anthraxSRA International, CACI International Inc., ManTech Corporation, Computer Sciences Corporation and smallpox. The Analex segment consistsScience Applications International Corporation, divisions of two business groups: the Homeland Security Group and the Systems Engineering Group. The Homeland Security Group provides information technology services, systems integration, hardware and software engineering and independent quality assurance in support of the U.S. intelligence community and Department of Defense. The Systems Engineering Group provides engineering, information technology and program management support to NASA, the Department of Defense, and major aerospacelarge defense contractors such as General Dynamics Corporation, Lockheed Martin Corporation, and Northrop Grumman. The following table showsGrumman Corporation, and consulting firms such as Booz Allen Hamilton. Our larger competitors may be able to compete more effectively for very large-scale government contracts. Our larger competitors also may be able to provide clients with different or greater capabilities or benefits than we can provide in areas such as technical qualifications, past performance on large-scale contracts, geographic presence, the ability to provide a broader range of services without creating conflicts of interest or intra-organizational conflicts of interest, price, and the availability of key professional personnel. Our competitors also have established or may establish relationships among themselves or with third parties, including through joint ventures, teaming arrangements or mergers and acquisitions, to increase their ability to address client needs. Accordingly, it is possible that new competitors or alliances among competitors may continue to emerge.

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We may not receive the full amount authorized under contracts and we may not accurately estimate our revenues from each of these segments as a percentagebacklog.

Although some of our total revenuesfederal government contracts require performance over a number of years, Congress appropriates funds for these contracts for only one year at a time. As a result, our contracts typically are only partially funded at any point during their term, and all or some of the past three years:work intended to be performed under the contracts will remain unfunded pending subsequent Congressional appropriations and the obligation of additional funds to the contract by the procuring agency. Nonetheless, in calculating the amount of our backlog, we include amounts from future years of government contracts under which the government has the right, but not the obligation, to exercise an option for us to perform services. Our backlog of orders, based on remaining contract value, believed to be firm as of December 31, 2005 was approximately $291.7 million. However, because we may not receive the full amount we expect under a contract, our estimate of our backlog may be inaccurate and we may post results that differ materially in an adverse manner from those anticipated.

Percent of Revenues by SegmentWe derive significant revenue from contracts awarded through a competitive bidding process, which can impose substantial costs upon us, and we will fail to maintain our current and projected revenue if we fail to compete effectively.

We derive significant revenue from federal government contracts that are awarded through a competitive bidding process. We expect that most of the government business we seek in the foreseeable future will be awarded through competitive bidding. Competitive bidding imposes substantial costs and presents a number of risks. Such risks include, but are not limited to

OurTo the extent we engage in competitive bidding and are unable to win particular contracts, we not only incur substantial costs in the bidding process that would negatively affect our operating results, but we may be precluded from operating in the market for services that are provided under those contracts for a number of years. Even if we win a particular contract through competitive bidding, our profit margins may be depressed as a result of the costs incurred through the bidding process.

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

We provide services to the federal government under three types of contracts: cost-plus-fees, time-and-materials,cost-plus-fee, time-and-material, and fixed price contracts.fixed-price. For the fiscal year ended December 31, 2005, 42% of our contracts were cost-plus-fee, 34% were time-and-material, and 24% were fixed-price. Each of these types of contracts, to differing degrees, involves the risk that we could underestimate our cost of fulfilling the contract. In the event that the

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assumptions we use to formulate our pricing for the work prove to be inaccurate, we may lose money on the contract, which would adversely affect our operating results.

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

The following table showsfederal government audits and reviews our revenues from eachperformance on contracts, pricing practices, cost structure, and compliance with applicable laws, regulations, and standards. Like most government contractors, our contracts are audited and reviewed on a continual basis. An audit of these typesour work, including an audit of work performed by companies we may acquire or subcontractors we have engaged or may engage, could result in a substantial adjustment to our previously reported operating results. For example, any costs which were originally reimbursed could subsequently be disallowed. In this case, cash we have already collected may need to be refunded and operating margins may be reduced. If a government audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines, and suspension or debarment from doing business with U.S. federal government agencies. In addition, we could suffer serious harm to our reputation if allegations of impropriety were made against us, whether or not true.

Failure to maintain strong relationships with other contractors could result in a decline in our revenue.

Approximately 27%, 32% and 43% of our revenue for the years ended December 31, 2005, 2004 and 2003, respectively, were generated as a subcontractor to various prime contractors to the federal government. Although we intend to focus on retaining and increasing the percentage of our total revenuesbusiness as prime contractor because it provides us with stronger client relationships, we may not succeed in doing so. If not, we will continue to depend on relationships with these and other contractors for a significant portion of our revenue in the past three years:foreseeable future. Our business, prospects, financial condition or operating results could be adversely affected if these and other contractors eliminate or reduce their subcontracts with us, either because they choose to establish relationships with our competitors or because they choose to directly offer services that compete with our business, or if the government terminates or reduces these other contractors’ programs or does not award them new contracts.

We must continue to recruit and retain qualified skilled employees.

Our objectiveAn integral part of our future success is to grow sales organically and through acquisitions. In order to assist in accomplishing this objective, we havedependent upon our continued to increase our sales, general and administrative expenditures so as to increase our efforts in new business development andability to provide employees who have advanced information technology and technical services skills and who have excellent customer relationships within the necessary infrastructuredefense, aerospace and intelligence communities. As described below, many of these employees are required by our federal government clients to support rapid growthhave security clearances of various levels issued by the appropriate agency. These employees are in great demand and are likely to remain a limited resource in the

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foreseeable future. If we are unable to recruit and retain a sufficient number of these highly skilled employees, especially those requiring security clearances, our ability to maintain and grow our business could be adversely affected. In addition, some of our contracts contain provisions requiring us to commit to staff a program with certain personnel the customer considers key to our successful performance under the contract. In the event we are unable to provide these key personnel or acceptable substitutions, the client may terminate the contract, and we may not be able to recover its costs in the event the contract is terminated.

Our business is dependent upon obtaining and maintaining required security clearances.

Many of our federal government contracts require our employees to maintain various levels of security clearances, and we are required to maintain certain facility security clearances complying with federal agencies’ requirements. Obtaining and maintaining security clearances for employees involves a lengthy process, and it is difficult to identify, recruit and retain employees who already hold security clearances. If our employees are unable to obtain or retain security clearances or if our employees who hold security clearances leave us, the client whose work requires cleared employees could terminate the contract or decide not to renew it upon its expiration. In addition, we expect that many of the contracts on which we will bid will require us to demonstrate our ability to obtain facility security clearances and perform work with employees who hold specified types of security clearances. To the extent we are not able to obtain facility security clearances or engage employees with the required security clearances for a particular contract, we may not be able to bid on or win new contracts, or effectively re-bid on expiring contracts.

Employee or subcontractor misconduct, including security breaches, could result in the loss of clients and our suspension or disbarment from organic growthcontracting with the federal government.

We may not be able to prevent our employees or subcontractors from engaging in misconduct, fraud or other improper activities that could adversely affect our business and reputation. Misconduct could include the failure to comply with federal government procurement regulations, regulations regarding the protection of classified information and legislation regarding the pricing of labor and other costs in government contracts. Many of the systems we develop involve managing and protecting information involved in national security and other sensitive government functions. A security breach in one of these systems could prevent us from acquisitions.having access to such critically sensitive systems. The precautions we take to prevent and detect this activity may not be effective, and we could face unknown risks or losses. As a result of employee or subcontractor misconduct, we could face fines and penalties, loss of security clearance and suspension or debarment from contracting with the federal government, which could materially adversely affect our business, operating results and financial condition.

If our subcontractors fail to perform their contractual obligations, our performance as a prime contractor and our ability to obtain future business could be materially and adversely impacted and our actual results could differ materially in an adverse manner from those anticipated.

Our ABS segment, focusing on biodefense research, is dependentperformance of government contracts regularly involves the issuance of subcontracts to other companies upon continued fundingwhich we rely to perform all or a portion of its research efforts from various governmental agencies. New sources of funding for ABS have been identified, however, these new contracts are at a substantially decreased level of effort and shorter duration than our previous contracts. At this time,the work we are uncertainobligated to deliver to our clients. There is a risk that we may have disputes from time to time with our subcontractors, including disputes regarding the quality and timeliness of the work performed. A failure by one or more of our subcontractors to satisfactorily deliver on a timely basis the agreed-upon supplies and/or perform the agreed-upon services may materially and adversely impact our ability to continueperform our obligations as a prime contractor. A subcontractor’s performance deficiency could result in the government terminating our contract for default. A default termination could expose us to obtain funding sourcesliability for ABS. Management is exploring optionsexcess costs of re-procurement by the government and have a material adverse effect on our ability to compete for divestiture of ABS.future contracts and task orders. Such problems with subcontractors could materially adversely affect our business, operating results and financial condition.

In addition,15

Federal government contracts contain provisions giving government customers a variety of rights that are unfavorable to us, including the ability to terminate a contract at any time for convenience.

Federal government contracts contain provisions and are subject to laws and regulations that provide government clients with rights and remedies not typically found in commercial contracts. These rights and remedies allow government clients, among other things, under certain conditions, to:

If a government customer terminates one of our keycontracts for convenience, we may recover only our incurred or committed costs, settlement expenses, and profit on work completed prior to the termination. If a federal government customer were to unexpectedly terminate, cancel, or decline to exercise an option to renew with respect to one or more of our significant contracts or suspend or debar us from doing business with government agencies, our revenue and operating results would be materially adversely affected.

We must comply with a variety of laws and regulations, and our failure to comply could cause our actual results to differ materially in an adverse manner from those anticipated.

We must observe laws and regulations relating to the formation, administration and performance of federal government contracts which affect how we do business with our clients and may impose added costs on our business. For example, the Federal Acquisition Regulation and the industrial security regulations of the Department of Defense and related laws include provisions that:

Our failure to comply with these or other laws and regulations could result in contract termination, loss of security clearances, suspension or debarment from contracting with the federal government, civil fines and damages and criminal prosecution and penalties, any of which could materially adversely affect our business, operating results and financial condition.

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We may have difficulty identifying and executing acquisitions on favorable terms; and if we undertake acquisitions, they could be expensive, increase our costs or liabilities, and disrupt our business.

One of our strategies following the Pequot Transaction in December 2003 is to pursue growth through acquisitions. We planhave completed a limited number of acquisitions in our history. We intend to selectively acquire companiesbusinesses that complement or expand our current capabilities. These businesses are especially in demand in the current market, and enhance our existingother prospective purchasers who have substantially greater resources than we do may offer to acquire such businesses andupon such economic terms that are currently reviewing potential targets.hard for us to match. We anticipatemay not be able to acquire candidates at prices that we will needconsider appropriate or to obtain additional financing through salefinance acquisitions on terms that are satisfactory to us. We may desire to use our common stock as consideration in acquisitions, and therefore any decline in the market price of equity and debt securitiesour common stock or any unwillingness of owners of businesses we wish to fundacquire to accept our acquisitions.

The Company’s backlog of orders, based on remaining contract value, believed to be firmcommon stock as of December 31, 2003 was approximately $171 million, of which approximately $170.4 million was attributable to the Analex segment and $0.6 million was attributable to ABS. The portionpart of the total backlog expected to be realized within 2004 is $56 million. Funded backlog as of December 31, 2003 was approximately $19.3 million, of which approximately $0.6 million was attributable to the ABS segment. We expect to consume all of the funded backlog during 2004. Included in the backlog approximation are amounts from future years of government contracts under which the government has the right to exercise an option for the Company to perform services.

All of our U.S. Government contracts are subject to audit and various cost controls, and include standard provisions for termination for the convenience of the U.S. Government. Multi-year U.S. Government contracts and related orders are subject to cancellation if funds for contract performance for any subsequent year become unavailable.

Critical Accounting Policies

The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require the Company to make estimates and assumptions. The Company’s significant accounting policies are described in Note 2 to the consolidated financial statements. The Company believes that the following critical accounting policies require significant management judgments, estimates and assumptions in the preparation of the consolidated financial statements.

Revenues

The Company’s contracts with the government are typically cost plus fee, time and materials, or fixed-price contracts. Revenues result from work performed on these contracts by the Company’s employees and from pass-through of costs for material and work performed by subcontractors. Revenues on cost-type contracts are recorded as contract-allowable costs are incurred and fees earned. Revenues for time and materials contracts are recorded on the basis of contract-allowable labor hours worked multiplied by the contract defined billing rates, plus the cost of materials used in performance on the contract. Profits on time and material contracts result from the difference between the cost of services performed and the contract defined billing rates for these services. Revenues on certain fixed-price service contracts are recorded each period based on a monthly amount for services provided. Revenues on other fixed-price contracts are recorded as costs are incurred, using the percentage-of-completion method of accounting. Profits on fixed-price contracts result from the difference between the incurred costs and the revenue earned. In the normal course of business, the Company may be party to claims and disputes resulting from modifications and change orders and other contract matters. Claims for additional contract compensation are recognized when realization is probable and estimable.

Long-Lived Assets

In assessing the recoverability of long-lived assets, including goodwill and other intangibles, the Company must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or the Company’s related assumptions change in the future, the Company may be required to record impairment charges not previously recorded for these assets.

Contingencies

From time to time, the Company is subject to proceedings, lawsuits and other claims related to labor and other matters. The Company is required to assess the likelihood of any adverse judgments or outcomes to these contingencies as well as potential ranges of probable losses and establish reserves accordingly. The amount of reserves required, if any, may change in future periods due to new developments in each matter or changes in approach to a matter such as a change in settlement strategy.

Results of Operations

Comparison of Year Ended December 31, 2003 to

the Year Ended December 31, 2002

Revenues by Segment

Percentage Revenue Growth Year Over Year by Segment

Revenues for the year ended December 31, 2003 were approximately $66.1 million, an 11.5% increase from the $59.3 million in revenues for the year ended December 31, 2002. Revenues for the Homeland Security Group grew by $2.1 million, or 8%, while revenues for the Systems Engineering Group grew by $7.7 million, or 28%. This growth was offset by a decline in revenues in ABS of $3.0 million, or 44%. The net revenues growth of approximately $6.8 million is primarily due to a full year of revenues generated within the Systems Engineering Group by the NASA ELVIS contract that began July 1, 2002, which amounted to an $11.2 million increase in revenues from 2002 to 2003. This increase was offset by a decline of $4.0 million in the Systems Engineering Group due to reduced efforts on the MRDOC contract. Revenues for the Homeland Security Group increased by $2.1 million, or 8%, due to growth in services provided to the intelligence community and related agencies. In addition, revenues at ABS declined by $3.0 million due to a reduction in research activity as contracts were

completed. New sources of funding for ABS have been identified, however, these new contracts are at a substantially decreased level of effort and shorter duration than our previous contracts. At this time, we are uncertain ofpurchase price could adversely affect our ability to continuecomplete acquisitions or require us to obtain funding sources for ABS. Ifuse more of our cash or incur additional financing to do so.

After an appropriate acquisition candidate has been identified, we may not be able to successfully negotiate the terms of the acquisition, finance the acquisition or, if the acquisition occurs, successfully integrate the acquired business into our existing business. Negotiations of potential acquisitions and the integration of acquired business operations could disrupt our business by diverting management attention away from day-to-day operations. Acquisitions of businesses or other material operations may require additional debt or equity financing, resulting in additional leverage or dilution of equity ownership. We may also not realize cost efficiencies or synergies that we anticipated when selecting our acquisition candidates. Acquisition candidates may have liabilities or adverse operating issues that we fail to discover through our due diligence investigation prior to the acquisition. Any costs, liabilities, or disruptions associated with any future acquisitions we may pursue could adversely affect our operating results. To the extent we are unable to obtain funding, the resultpursue our acquisition strategy, we will be a continued decrease in revenues and operating profit. Increases or decreases in revenue are predominantly attributablerequired to changes in the volume of services provided. As a government contractor, costs billedrely exclusively on internal growth to the government are prescribed by the Federal Acquisition Regulation and include recovery of allowable costs such as labor, fringe benefits, overhead and general and administrative expenses plus a reasonable fee.

Costs of revenue for the year ended December 31, 2003 were approximately $55.8 million, an increase of approximately 11% from the prior year. The increase is primarily due to the costs of revenue within the Systems Engineering Group associated with the ELVIS contract, which were approximately $19.2 million for 2003 compared to $8.8 million for 2002. This was offset by a decline in the costs of revenue of ABS of $2.5 million due to reduced research staff and a reduction of $3.7 million due to declining efforts on the MRDOC contract. Costs of revenue as a percentage of revenues declined from 2002 to 2003. For the year ended December 31, 2003, costs of revenues were approximately 84% and approximately 85% for the year ended December 31, 2002.

Selling, general and administrative expenses totaled approximately $6.3 million, or 9.6% of revenues, for the year ended December 31, 2003, compared with approximately $5.0 million, or 8.5% of revenues, for the year ended December 31, 2002. The $1.3 million, or 25%, increase is due to various factors including the addition of senior business development staff members and increased general and administrative expenses such as corporate insurance, legal fees, shareholder communications expenses, recruiting expenses, and board of director fees.expand our business.

Operating Income by Segment

Percentage of Operating Income by Segment

Percentage Growth of Operating Income Year Over Year by Segment

The Company had operating income of approximately $3.6 million for the year ended December 31, 2003, comparedWe may need to operating income of approximately $3.5 million for the year ended December 31, 2002. This $0.06 million increase is primarily attributableraise additional capital to operating income within the Systems Engineering Group generated by the ELVIS contract, which approximated a $0.9 million increase over the prior year offset by a decrease of $0.4 million in operating income generated by the MRDOC contract. The Homeland Security Group experienced increased operating income of $0.3 million,fund future acquisitions or 11%, duebe unable to growth in services provided to the intelligence community and related agencies. In addition, ABS experienced a decrease in operating income of $0.5 million for 2003 compared to 2002 due to declining revenues and a one-time charge to write down intangible assets related to patent development. Also contributing to decreased operating income was increased selling, general and administrative expenses as noted above.

The Company had interest expense of $0.5 million for the year ended December 31, 2003, compared to interest expense of $1.0 million for the year ended December 31, 2002. The decrease is primarily due to the removal of guarantee fees associated with the Bank of America Credit Agreement. In addition, during 2003, the Company began accounting for the accretion of non-cash interest charges on its Convertible Notes issued under the Pequot Transaction. This accretion charge amounted to approximately $120,500. On a full year basis, the accretion component of interest expense is expected to be $1.9 million, assuming that the Convertible Notes are not converted to common shares.

The Company had amortization expense of $0.5 million for the year ended December 31, 2003, compared to amortization expense of $0.3 million for the year ended December 31, 2002. The increase in amortization expense is due to the non-compete agreement entered into with Jon Stout, which was entered into under the Pequot Transaction, and amortization expense related to intangible assets established with the award of the ELVIS contract.

Income tax expense for the year ended December 31, 2003 was $0.3 million compared with $0.1 million in the prior year. The Company’s effective tax rate did not change significantly from 2002 to 2003. In both years, the Company’s provision for income taxes was limited to state taxes and alternative minimum tax as the Company has been able to utilize its net operating loss carryforwards to offset taxable income. The Company consumed all net operating loss carryforwards during 2003 and will experience an increase in income tax expense in 2004.

Net income amounted to $2.7 million, or 4% of revenues, an increase of $390,000, or 17%, over the $2.4 million net income last year.

Dividends accrued with respect to 2003 amounted to $56,700, with anraise such additional non-cash accretion charge of approximately $236,300. On a full year basis, the Company expects that cash dividends on the preferred stock will amount to $0.9 million and the non-cash accretion charge will amount to $3.8 million, assuming that the preferred stock is not converted to common shares. Net income available to common shareholders for 2003 amounted to $2.5 million after the dividends on and accretion of Series A Preferred Stock.

Results of Operations

Comparison of Year Ended December 31, 2002 to

the Year Ended December 31, 2001

Accounting Treatment of The Pequot Transactioncapita.

In July 2003, we entered into a stock purchase agreement with Pequot with respect to the sale of our Series A Preferred Stock, Convertible Notes, Preferred Warrants and Note Warrants to the Pequot funds (the “Pequot Purchase Agreement”). On December 9, 2003, pursuant to the Pequot Purchase Agreement, the Company (i) issued and sold to Pequot an aggregate of 6,726,457 shares of the Company’s Series A Preferred Stock, par value $0.02 per share, (the “Series A Preferred Stock”) for a purchase price of $2.23 per share (the “Series A Purchase Price”), representing an aggregate consideration of approximately $15,000,000; (ii) issued and sold to the Pequot $10,000,000 in aggregate principal amount of the Company’s Secured Subordinated Convertible Promissory Notes (the “Convertible Notes”), the initial conversion price of which is $3.01 (representing 135% of the Series A Purchase Price); and (iii) issued to Pequot Preferred Warrants and Note Warrants, the initial exercise price of which is $3.28 (representing a 47% premium to the Series A Purchase Price). The Series A Preferred Stock, the Convertible Notes and the related warrants are collectively referred to hereinafter as the “Pequot Instruments.”

Series A Preferred Stock

The Company determined the initial carrying value of the Series A Preferred Stock by a two-step allocation process: first to the Preferred Warrants; and second, to an embedded conversion option. First the Company allocated the proceeds from the sale of the Series A Preferred Stock between the Series A Preferred Stock and the Preferred Warrants based on their relative fair values, which resulted in recording a discount on the Series A Preferred Stock. The value of the Preferred Warrants was determined using the Black-Scholes option pricing model. The Preferred Warrants were valued using the exercise price of $3.28 pursuant to the Pequot Purchase Agreement, the stock price as of the date of the date of the Closing of $4.04, a risk free rate of 2.80%, a volatility of 94.80%, and an expected life of four years. The risk free rate was equal to the four-year U.S. Treasury rate, as the period to the earliest redemption date of the Series A Preferred Stock is four years from December 9, 2003 (the “Closing date”). The volatility was based on an average of three measurements: the actual volatility in the Company’s stock price over the four years prior to the Closing date; the actual volatility in the Company’s stock price from the date of the acquisition of the former Analex Corporation, November 3, 2001 to the Closing date; and the actual volatility in the Company’s stock price from the listing date on the American Stock Exchange, March 4, 2003, to the Closing date.

Second, in accordance with EITF No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, after allocating the Series A Preferred Stock proceeds as described above, the Company calculated the embedded conversion price and used it to measure the intrinsic value of the embedded conversion option.

This value was determined by calculating the number of shares of common stock into which the Series A Preferred Stock is convertible. The value allocated to the Series A Preferred Stock (after value was allocated to the Preferred Warrants) was then divided by the number of shares of common stock into which the Series A Preferred Stock is convertible. The result, $1.66, was then compared to the current fair value of $4.04, the Company’s stock price as of the Closing date. Since the conversion price was less than the fair value as of the Closing date, a beneficial conversion feature exists. The difference between the conversion price and the fair value as of the Closing date was multiplied by the total number of shares of common stock into which the Series A Preferred Stock is convertible. The result was a beneficial conversion of approximately $11.1 million. The amount of the beneficial conversion was recorded as additional paid in capital, resulting in a further discount on the Series A Preferred Stock. The table below details the accounting treatment of the Series A Preferred Stock.

Allocation of Series A Preferred Stock Proceeds

The discount on the Series A Preferred Stock created as a result of the allocation of fair value to the Preferred Warrants and the beneficial conversion charge will be accreted to the Series A Preferred Stock over a four-year period to the earliest redemption date. Issuance costs of $622,600 are recorded as an additional discount and will be accreted to the Series A Preferred Stock over the four-year period to the earliest redemption date.

The Series A Preferred Stock accrues dividends at 6% per annum payable quarterly in cash. Therefore, the Company will accrue the dividends payable each quarter, which is $225,000. Both the accretion of and dividends on the Series A Preferred Stock will reduce net income attributable to common shareholders. As a result, in the absence of acquisitions that might add substantial incremental earnings, the net income to common shareholders for 2004 is likely to be a loss.

The annual cash dividend payable on the Series A Preferred Stock amounts to $900,000 and the annual non-cash accretion amounts to $3,750,000. The total expected annual charge related to the Series A Preferred Stock, thus, amounts to $4,650,000. For 2003, since the Series A Preferred Stock was only issued on December 9, 2003, the total charge amounted to $236,300.

If the holders of the Series A Preferred Stock were to convert their shares into common shares, there would be a one-time, non-cash charge to write-off the unamortized discount related to the Series A Preferred Stock. The unamortized discount is comprised of the amount allocated to the fair value of the Preferred Warrants, the discount on the preferred stock due to beneficial conversion and issuance costs, less any accretion and amortization taken. At December 31, 2003, that amount was $14,763,700.

Convertible Notes

The Company determined the initial carrying value of the Convertible Notes by a two-step allocation process: first to the Note Warrants; and, second, to an embedded conversion option.

First, the Company allocated the proceeds from the sale of the Convertible Notes between the Convertible Notes and the Note Warrants based on their relative fair values, which resulted in the recording of a discount on the Convertible Notes. The value of the Note Warrants was determined using the Black-Scholes option pricing model. The Note Warrants were valued using the exercise price of $3.28 as stated in the agreement, the stock price as of the date of the date of the Closing of $4.04, a risk free rate of 2.80%, a volatility of 94.80%, and an expected life of four years. The risk free rate was equal to the four-year U.S. Treasury rate, as the Convertible Notes mature in four years. The volatility was based on an average of three measurements: the actual volatility in the Company’s stock price over the four years prior to the Closing date; the actual volatility in the Company’s stock price from the date of the acquisition of the former Analex Corporation, November 3, 2001 to the Closing date; and the actual volatility in the Company’s stock price from the listing date on the American Stock Exchange, March 4, 2003, to the Closing date.

Second, after allocating the Convertible Notes proceeds, the Company calculated the embedded conversion price and used it to measure the intrinsic value of the embedded conversion option. This was determined by calculating the number of shares of common stock into which the Convertible Notes were convertible. The value allocated to the Convertible Notes (after value was allocated to the Warrants) was then divided by the number of shares of common stock into which the Convertible Debt is convertible. The result, $1.66, was then compared to the current fair value of $4.04, the Company’s stock price as of the Closing date. Since the conversion price was less than the current fair value, a beneficial conversion feature exists. The difference between the conversion price and the current fair value was multiplied by the total number of shares of common stock into which the Convertible Notes are convertible. The result was a beneficial conversion of approximately $5.3 million. The amount of the beneficial conversion was recorded as additional paid in capital, resulting in a further discount on the Convertible Notes. The table below details the accounting treatment of the Convertible Notes.

The discount on the Convertible Notes created as a result of the allocation of fair value to the Note Warrants will be amortized to interest expense over the four-year period to the maturity of the Convertible Notes using the effective yield method. Issuance costs of $415,000 are recorded as deferred financings costs and will be amortized to interest expense over the four-year period to the maturity of the Convertible Notes.

The Convertible Notes accrue interest at 7% per annum, which is payable quarterly in cash.

The annual interest payable on the Convertible Notes amounts to $700,000 and the annual non-cash interest and accretion charges amount to $1,911,900. The total expected annual charge related to the Convertible Notes, thus, amounts to $2,611,900. For 2003, since the Convertible Notes were only issued on December 9, 2003, the total charge amounted to $113,900.

If the holders of the Convertible Notes were to convert the notes into common shares, there would be a one-time, non-cash charge to write-off the unamortized discount related to the Convertible Notes. The unamortized discount is comprised of the amount allocated to the fair value of the Note Warrants, the discount on the convertible notes due to beneficial conversion and issuance costs, less any accretion and amortization taken. At December 31, 2003, that amount was $7,527,100.

Stout Repurchase Agreement

The Stout Repurchase Agreement provided for the Stout Non-Competition Agreement between the Company and Jon Stout. The $600,000 consideration to be paid under the Stout Non-Competition Agreement was recognized as a liability as of the Closing date and will be paid quarterly over the three-year life of the agreement.

Also, included in the Stout Repurchase Agreement was the repurchase of certain warrants and stock options. The Company estimated the fair value of the warrants as of the Closing date using a fair value option pricing model and determined that the amount the Stout Parties are receiving to purchase warrants is less than the fair value as of the Closing date. Therefore, the Company did not incur any additional compensation expense related to the purchase of the warrants. However, as the Company also purchased certain stock options held by the Stout Parties, the Company incurred compensation expense as a result of the purchase of stock options from the Stout Parties of $95,800, which is equal to the amount paid to purchase the stock options.

Impact of Pequot Transaction on Shareholder’s Equity

The following table shows the changes in Shareholder’s Equity due to the Pequot Transaction.

Capital Resources and Liquidity

The working capital at December 31, 2003 increased by approximately $16.4 million from December 31, 2002, primarily due to cash provided by the Pequot Transaction along with the Company’s continued profitability. Proceeds of the Pequot Transaction were $25 million, of which $9.4 million was used to fund the activities pursuant to the Stout Repurchase Agreement. The working capital at December 31, 2002 increased by approximately $1.4 million from December 31, 2001, primarily due to increased profitability generated by the Company’s purchase of the former Analex Corporation and the award of the ELVIS contract.

In the twelve months ended December 31, 2003, the Company recorded net income of $2.7 million and EBITDA (as defined below) of $4.1 million, after add-backs for interest of $0.5 million, taxes of $0.3 million, depreciation of $0.1 million and amortization of $0.5 million. In the twelve months ended December 31, 2002, the Company recorded net income of $2.4 million and EBITDA of $3.9 million, after add-backs for interest of $1.0 million, taxes of $0.1 million, depreciation of $0.1 million and amortization of $0.3 million.

While weWe expect that the proceeds from the Pequot Transaction, the borrowing availability under our credit facility, together with cash provided by operations, will be sufficient to fund our working capital needs for normal operations for at least the next twelve months,months. However, we anticipate that we will need to obtain additional financing either through sale of equity orand debt securities or from our credit facility to fund our acquisitions.

In We may seek additional funds by incurring additional indebtedness, issuing additional equity securities, or by other means. There is no assurance that additional financing could be obtained when we need it. If additional financing is raised through sale of our equity securities, there could be a significant dilutive effect on the absenceownership interests and voting rights of acquisitions, given the substantial charges associatedour existing stockholders and warrant and option holders. Currently, we have no agreements, arrangements or understandings with the Convertible Notes and the Series A Preferred Stock, it is possible that the Company mightrespect to acquisition of any entity or business. We may also need to renegotiate its covenants under its bank lineobtain additional financing over the next twelve months if our current plans or projections prove to be inaccurate or our expected cash flows prove to be insufficient to fund our operations because of credit during 2004 in order the remain in compliance with the terms of its credit facility. The Company’s expectation, however, is that acquisitions will be consummated and therefore, we do not consider it a material risk.

lower-than-expected revenues, unanticipated expenses or other unforeseen difficulties. Our ability to obtain additional financing will depend on a number of factors, including market conditions, our operating performance and investor interests.interest. These factors may make the timing, amount, terms and conditions of any financing unattractive. If additional financing is raised through sale of our common stock, it may result in significant dilution to our existing stockholders.

InOur substantial convertible preferred stock and debt could adversely affect our financial and operating flexibility.

On December 9, 2003, we sold to Pequot $10 million in aggregate principal amount of Series A Convertible Notes.Notes (“Series A Convertible Note”). The Series A Convertible Notes bear interest at an annual rate of 7%. They are secured by a lien on substantially all of the assets of the Company and its subsidiaries and are guaranteed by the Company’s subsidiaries. The Convertible Notes will mature on December 9, 2007. On December 9, 2003, we also issued for $15 million, 6,726,457 shares of Series A Convertible Preferred Stock (“Series A Preferred Stock”) and 1,345,291 Common Stock Warrants exercisable at $3.28 per share. The indebtedness incurred with respect toSeries A Preferred Stock accrues dividends at 6% per annum payable quarterly in cash. In

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May 2004, we issued in aggregate principal amount of $12 million of convertible secured senior subordinated promissory notes (“Series B-1 Notes”) and 857,142 Common Stock Warrants exercisable at $4.32 per share. In September 2004, the Series B-1 Notes were converted into 3,428,571 shares of Series B Convertible NotesPreferred Stock (“Series B-1 Preferred Stock”). In April 2005, the Company issued for $25 million, an additional 7,142,856 shares of Series B Convertible Preferred Stock (“Series B-2 Preferred Stock”) and 1,785,713 Common Stock Warrants exercisable at $4.29 per share. All Series B Convertible Preferred Stock accrues dividends at 6% per annum payable quarterly in cash. Our quarterly preferred stock dividend expense is material in relation to our ability to service the debt from our operating cash flow and our ability to repay the debt in full at maturity. Thereapproximately $800,000. No assurance can be no assurancegiven that sufficient funds will be available to meet our operating needs, or to repaypay the Convertible Notesdividends on the Series A Preferred Stock, the Series B Preferred Stock, or to redeem the Series A Convertible Note, the Series A Preferred Stock and the Series B Preferred Stock in accordance with their respective terms. In connection with the acquisition of ComGlobal, we amended our credit agreement with Bank of America. Our revolving credit facility with Bank of America was increased to $40 million. We drew down $22 million from the credit facility on April 1, 2005 in connection with our acquisition of ComGlobal. As of December 31, 2005, the Company had an outstanding balance under its credit facility with Bank of America of approximately $27.6 million. The balance outstanding on our revolving credit facility is serviced by our operating cash flows. This may affect our ability to repaymeet the Convertible Notes at maturity may also be adversely affected by the right of the holdersinterest and dividend obligations of the Series A Preferred Stock to contemporaneously require the Company to redeem their shares ofand Series A Preferred Stock.B instruments.

EBITDA consists of earnings before interest expense, interestOur debt instruments contain numerous financial and other income, income taxes, depreciation and amortization. EBITDA does not represent funds available for the Company’s discretionary use and is not intended to represent cash flow from operations. EBITDA should also not be construed as a substitute for operating income or a better measure of liquidity than cash flow from operating activities, which are determined in accordance with accounting principles generally accepted in the U.S. EBITDA excludes componentsoperational covenants that are significant in understanding and assessing the Company’s results of operations and cash flows. EBITDA is considered to be relevant and useful information, which is often reported and widely used by analysts, investors and other interested parties. Accordingly, the Company is disclosing this information to permit a more comprehensive analysis of the Company’s operating performance, as an additional meaningful measure of performance and liquidity, and to provide additional information with respect to the Company’s ability to meet future debt service, capital expenditure and working capital requirements.

Net cash provided by operating activities was $2.7 million during the twelve months ended December 31, 2003, compared to $1.3 million for the prior year. The increased net cash provided by operating activities resulted from a decreased accounts receivable balance due to a reduction in days outstanding, offset by a decrease in accounts payables due to the timing of certain trade payments. Net cash provided by operating activities was $1.3 million during the twelve months ended December 31, 2002, compared to a net use of cash from operating activities of $0.4 million for the prior year. The increased net cash provided by operating activities resulted primarily from increased net income in 2002 compared to 2001.further limit our operational flexibility.

Net cash used in investing activities during the twelve months ended December 31, 2003 was $1.0 million. Net cash used in investing activities in this period was primarily related to the Jon Stout Non-Competition Agreement totaling $0.6 million as an intangible asset related to the Pequot Transaction. In addition, fixed asset purchases of $0.4 million were made. Net cash used in investing activities during the twelve months ended December 31, 2002 was $0.2 million. Net cash used in investing activities in this period was for fixed asset purchases and legal fees associated with the filing of patent applications for ABS.

Net cash provided by financing activities in 2003 amounted to $12.3 million compared to net cash used by financing activities in 2002 of $0.8 million. This increase is primarily attributable to the Pequot Transaction. For 2003, the Company generated a net increase in cash and equivalents of $12.9 million compared to a net increase of $0.2 million in 2002. Net cash used by financing activities in 2002 amounted to $0.8 million compared to net cash provided by financing activities in 2001 of $6.5 million. In 2002 the Company paid down net bank debt of $1.0 million compared to net bank borrowings of $2.3 million and net proceeds from the issuance of common stock of $3.9 million in 2001 associated with the acquisition of the former Analex Corporation. For 2002, the Company generated a net increase in cash and equivalents of $0.2 million compared to a net decrease of $0.2 million in 2001.

Interest expense of $519,800 consists of cash and non-cash expense. Cash interest expense was $405,900 and non-cash interest expense which is generated by amortization of the Convertible Debt discount was $113,900.

Effective November 2001, the Company acquired Analex, a professional services and program management firm whose principal customers are NASA and the U.S. intelligence community, for approximately $13,898,000. The purchase price was satisfied with cash payments of $6,510,000, 3,520,339 shares of Common Stock valued at $4,664,000, the issuance of promissory notes of $1,773,000, non-compete arrangements for which consideration was $892,000, and the satisfaction of other certain liabilities of Analex.

The fair value of the assets acquired and liabilities assumed approximated their book value of $6,092,400 and $5,730,000, respectively. The Company incurred financial, legal and accounting costs associated with the Analex purchase of approximately $570,000. During 2002, certain contingencies were finalized including the settlement of the Analex closing balance sheet requirements and the award of the ELVIS contract.

On November 2, 2001, to finance the acquisition of Analex, the Company entered into a Credit AgreementOur credit facility with Bank of America which provides the Company with a $4,000,000 Revolving Credit Facility through November 2, 2006 and a five-year $3,500,000 Term Loan. The Revolving Credit Facility has an annual renewal occurring April 30 of each year. The principal amount of the Term Loan is amortized in sixty equal monthly payments of $58,333. In August 2002, the credit limit on the Revolving Credit Facility was increased to $8,000,000. At December 31, 2003, there was no outstanding balance on the Revolving Credit Facility while the outstanding balance on the Term Loan was $2.0 million. Interest on each of the facilities is at the LIBOR Rate plus an applicable margin. The Credit Facility and Term Loan are secured by the accounts receivable and other assets of the Company.

Upon the Closing of the Pequot Transaction, Bank of America and the Company entered into a modification of the Credit Agreement amendingcontains financial covenant requirements. The Company must maintain a Total Funded Debtcovenants setting forth certain maximum ratios for total funded debt to EBITDA ratio of no greater than 4.0 to 1.0 from Closing until September 30, 2004, and no greater than

3.5 to 1.0 October 1, 2004 and thereafter. In addition, the Company must maintain a Fixed Charge Coverage Ratio of no less than 1.05 to 1.0 from Closing until December 31, 2003, of no less than 1.1 to 1.0 from January 1, 2004 until September 30, 2004, of no less than 1.2 to 1.0 October 1, 2004 and thereafter. As of December 31, 2003, the Company was in compliance with each of these covenants.minimum ratios for fixed charge coverage. The credit agreementfacility also restricts our ability to dispose of properties, incur additional indebtedness, pay dividends (except to holders of the Series A and Series B Preferred Stock pursuant to the certificate of designation)Stock) or other distributions, create liens on assets, enter into sale andcertain leaseback transactions, make investments, loans or advances, engage in mergers or consolidations, and engage in transactions with affiliates. The credit facility is generally secured by all the assets of our business.

Our ability to comply with the financial covenants in our credit agreement will be affected by our financial performance our ability to complete an acquisition as well as events beyond our control, including prevailing economic, financial and industry conditions. The breach of any of the covenants in our credit agreements could result in a default, which would permit Bank of America to declare all amounts borrowed thereunder, together with accrued and unpaid interest, to be due and payable. If we are unable to repay our indebtedness, Bank of America could proceedexercise its security rights against our accounts receivable and other assets which are the collateral securing the indebtedness. In

We cannot predict the absenceresults of acquisitions, givenlegal proceedings which may arise from time to time in the substantial charges associatedordinary course of business or in relation to our acquisition activities.

From time to time we are involved in legal proceedings arising in the ordinary course of our business. We cannot predict the nature, extent and timing of such legal proceedings. Furthermore, we cannot predict whether the outcome of such legal proceedings could have a material adverse effect on our operating results or cash flows.

We were served on October 9, 2003 with a complaint filed by Swales & Associates, Inc. (“Swales”) alleging breach of contract and other claims relating to Swales’ termination as a subcontractor under the Company’s ELVIS contract with NASA. We entered into a Settlement Agreement dated July 22, 2004 with Swales. Under the terms of the Settlement Agreement, we paid $1,000,000 to Swales in July 2004. Included in the $1,000,000 settlement is approximately $320,000 for work performed by Swales prior to termination. This amount was billed to NASA and we received payment. Legal fees are expected to be approximately $290,000. We have received an opinion from legal counsel that the unreimbursed amount of the settlement payment, together with legal fees and expenses incurred in connection with the litigation, are costs that are reimbursable under the ELVIS contract with NASA. Therefore, we established a receivable of approximately $1.0 million related to the expected reimbursement of these costs. In May 2005, we received oral customer feedback that the costs were allowable

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and allocable to the contract, but the reasonableness of these costs still needed to be assessed by NASA. Based on the opinion of legal counsel and management’s assessment of relevant facts, we believed and continue to believe that the costs incurred are allowable, allocable and reasonable. During the quarter ended December 31, 2005, we met with NASA procurement personnel who indicated to us that prior NASA communications with respect to allowability and allocability should not be relied upon. While we continue to believe that the full amount is allowable, allocable and reasonable, and therefore should be recoverable under the ELVIS contract with NASA, we have concluded that a reserve of $500,000 is appropriate as of December 31, 2005. We intend to continue to use all reasonable efforts to recover the full amount of our costs from NASA.

We were served on April 29, 2005 with a complaint filed by H&K Strategic Business Solutions, LLC (“HKSBS”) in Virginia Circuit Court alleging breach of contract and other claims relating to a Corporate Acquisition Agreement between the parties, dated February 10, 2004, which we terminated on February 14, 2005. Under the complaint, HKSBS is seeking damages of $830,000 together with legal fees and expenses. This matter is scheduled for trial on March 20 and 21, 2006, and in the event that HKSBS prevails, we could be held liable for up to the full amount of the damages sought; and that result could have a material adverse effect on our operating results and cash flows. We have filed a counter-claim against HKSBS seeking reimbursement of prior retainer payments made to HKSBS of approximately $110,000, plus certain legal fees.

Risks Related to Our Common Stock

It is likely that we will continue to report net losses to common shareholders due to certain non-cash accretions arising from our financing instruments.

It is likely that we will continue to report net losses to common shareholders due to non-cash accretions related to the outstanding Series A Convertible NotesNote, Series A Preferred Stock and Series B Preferred Stock. An aggregate of 3,428,571 shares of Series B Preferred Stock were issued and sold in connection with our acquisition of Beta Analytics, Inc (“BAI”) in 2004. An aggregate of 7,142,856 shares of Series B Preferred Stock were issued in connection with our acquisition of ComGlobal in April 2005. Pursuant to the U.S. Generally Accepted Accounting Principles, accounting for the Series A Convertible Note, the Series A Preferred Stock and Series B Preferred Stock and related Warrants (collectively, the “Financing Instruments”) will include cash and non-cash charges each year for as long as the Financing Instruments remain outstanding and are not converted into our common stock. We incur quarterly non-cash interest and accretion charges of approximately $2.0 million on our outstanding Financing Instruments and cash charges of approximately $1.0 million. In addition, a significant portion of these charges are not tax deductible.

Investors, whose interests may not be aligned with yours, will have the ability to exercise significant influence over the Company, which could result in actions of which you or other stockholders may not approve.

Using the method of calculation in accordance with the SEC rules on beneficial ownership, General Electric Pension Trust (“GEPT”) and New York Life Capital Partners II, LP (“NYL”) together with Pequot Private Equity Fund III, L.P and Pequot Offshore Private Equity Partners III, L.P (collectively, “Pequot,” and together with GEPT and NYL, the “Investors”) currently beneficially hold approximately 29%, 23%, and 52% of our outstanding voting securities, respectively. Pursuant to the provisions of an Amended and Restated Stockholders’ Agreement dated May 28, 2004, the Investors together with certain other principal stockholders, have agreed to vote their securities for a nine-person board comprised of the CEO, two (2) directors designated by a Pequot Majority in Interest (as defined in the Amended and Restated Stockholders’ Agreement), one (1) non-employee director designated by our CEO and reasonably acceptable to the Investors, and five (5) independent directors nominated by our Nominating Committee. In the event that we fail to redeem the Series A Preferred Stock or the

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Series B Preferred Stock and such failure continues for a period of nine (9) consecutive months, Pequot or the Investors, if required after September 15, 2008, as the case may be, will have the right to designate additional members to the Board as is necessary for the members of the Board designated by Pequot or the Investors, as the case may be, to constitute a majority of the Board. In addition, for as long as 50% of the Series A Preferred Stock originally issued remains outstanding or 25% of the Series B Preferred Stock originally issued remains outstanding, we may not take numerous actions without obtaining the written consent of the holders of a majority of the Series A Preferred Stock or the Series B Preferred Stock.

Holders of our Preferred Stock have such a significant ownership interests that it could deter any third party from making an offer to buy our company.

The significant ownership interest and significant influence of the Investors as a whole could effectively deter a third party from making an offer to acquire our company, which might involve a premium over the current stock price or other benefits for stockholders, or otherwise prevent changes in the control or management of our company. Both the Series A Preferred Stock and the Series B Preferred Stock bear a cumulative annual dividend of 6%. If our available cash for operations does not meet certain specified levels or if the cash dividend payment on the Series A Preferred Stock or the Series B Preferred Stock will result in an event of default under our credit facility, dividends will be paid in additional shares of Series A Preferred Stock or Series B Preferred Stock, as the case may be, causing our Investors’ ownership interest to be even higher. There are also no restrictions, in the form of a standstill agreement or otherwise, on the ability of the Investors or its affiliates to purchase additional securities of our Company and thereby further consolidate their ownership interest.

A substantial number of shares are eligible for sale in the near future, which could cause our Common Stock price to decline significantly.

Future sales of our Common Stock in the public market could lower our stock price and impair our ability to raise funds in any new stock offerings. As of December 31, 2005, we had approximately 16.3 million outstanding shares of Common Stock that were subject to dilution by:

Sales of a substantial amount of Common Stock in the public market, or the perception that these sales may occur, could adversely affect the market price of our Common Stock prevailing from time to time in the public market and could impair our ability to raise funds in additional stock offerings.

The price of our Common Stock could be volatile.

Our Common Stock is listed on the American Stock Exchange and has experienced, and may experience in the future, significant price and volume fluctuations which could adversely affect the market price of our Common Stock without regard to our operating performance. In addition, the trading price of our Common Stock could be subject to significant fluctuations in response to actual or anticipated variations in our quarterly

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operating results announcements by us or our competitors, factors affecting the defense, intelligence and/or aerospace industries generally, changes in national or regional economic conditions, changes in securities analysts’ estimates for our competitors’ or industry’s future performance or general market conditions. The market price of our Common Stock could also be affected by general market price declines or market volatility in the future or future declines or volatility in the prices of stocks for companies in our industry.

As a result of the preferential rights of Series A and Series B Preferred Stock, holders of Common Stock may receive no payment at all upon a liquidation of our Company.

Upon any liquidation, dissolution or winding up of our Company, holders of Series A Preferred Stock and Series B Preferred Stock are entitled to receive, out of our assets available for stockholder distributions and prior to distributions to junior securities (including our Common Stock), an amount equal to, in the case of Series A Preferred Stock, the Series A Preferred Stock purchase price plus any accrued but unpaid dividends, and in the case of Series B Preferred Stock, the Series B Preferred Stock purchase price plus any accrued but unpaid dividends. No distribution upon liquidation may be made to the holders of Common Stock until the holders of the Series A Preferred Stock and Series B Preferred Stock have been paid their liquidation preferences. As a result, it is possible that, upon liquidation, all amounts available for the Company might needholders of our equity would be paid to renegotiatethe holders of the Series A Preferred Stock and Series B Preferred Stock, and that the holders of Common Stock would not receive any payment.

Item 2.    Properties

As of December 31, 2005, we own real property with approximately 4,300 square feet. This property, the former corporate headquarters of BAI, is located in Upper Marlboro, Maryland. This property is currently under contract for sale, although there is no assurance that the sale will close. We also leased a total of approximately 153,000 square feet of office space, including approximately 28,500 square feet at our new corporate headquarters located at 2677 Prosperity Ave., Suite 400, Fairfax, VA 22031. In addition to our headquarters and operations in Virginia, we lease facilities in Maryland, Florida, Colorado, Ohio, Nevada and California. These leases expire at various dates through 2012. (See Note 12 of the Notes to Consolidated Financial Statements.)

Item 3.    Legal Proceedings

We were served on October 9, 2003 with a complaint filed by Swales & Associates, Inc. (“Swales”) alleging breach of contract and other claims relating to Swales’ termination as a subcontractor under our ELVIS contract with NASA. We entered into a Settlement Agreement dated July 22, 2004 with Swales. Under the terms of the Settlement Agreement, we paid $1,000,000 to Swales in July 2004. Included in the $1,000,000 settlement is approximately $320,000 for work performed by Swales prior to termination. This amount was billed to NASA and we received payment. Legal fees are expected to be approximately $290,000. We have received an opinion from legal counsel that the unreimbursed amount of the settlement payment, together with legal fees and expenses incurred in connection with the litigation, are costs that are reimbursable under the ELVIS contract with NASA. Therefore, we established a receivable of approximately $1.0 million related to the expected reimbursement of these costs. In May 2005, we received oral customer feedback that the costs were allowable and allocable to the contract, but the reasonableness of these costs still needed to be assessed by NASA. Based on the opinion of legal counsel and management’s assessment of relevant facts, we believed and continue to believe that the costs incurred are allowable, allocable and reasonable. During the quarter ended December 31, 2005, we met with NASA procurement personnel who indicated to us that prior NASA communications with respect to allowability and allocability should not be relied upon. While we continue to believe that the full amount is allowable, allocable and reasonable, and therefore should be recoverable under the ELVIS contract with NASA, we have concluded that a reserve of $500,000 is appropriate as of December 31, 2005. We intend to continue to use all reasonable efforts to recover the full amount of our costs from NASA.

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On April 29, 2005 we were served with a compliant filed by H&K Strategic Business Solutions, LLC (“HKSBS”) in Virginia Circuit Court alleging breach of contract relating to a Corporate Acquisition Agreement between the parties, dated February 10, 2004 that we terminated on February 14, 2005. Under the complaint, HKSBS is seeking damages of $830,000 together with legal fees and expenses. We believe the complaint is without merit, however, we cannot predict the outcome of the proceeding at this time. We have filed a counter-claim against HKSBS seeking reimbursement of prior retainer payments made to HKSBS of approximately $110,000, plus certain legal fees. This matter is scheduled for trial on March 20 and 21, 2006. In the event that HKSBS prevails, we could be held liable for up to the full amount of the damages sought; and that result could have a material adverse effect on our operating results and cash flows.

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

We held our Annual Meeting of Stockholders on May 19, 2005. Results of the meeting can be found in Item 4 of our Form 10-Q for the fiscal quarter ended June 30, 2005, filed with the Securities and Exchange Commission on August 2, 2005, and the same is being incorporated by reference herein.

PART II

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

Our Common Stock is listed on the American Stock Exchange and trades under the symbol “NLX”.

The range of the high and low sales prices for the Common Stock, as reported on the American Stock Exchange, for each quarterly period during 2005 and 2004 are shown below. The prices presented below reflect inter-dealer prices without retail mark-ups, mark-downs or commissions, and may not reflect actual transactions.

As of March 7, 2006, there were approximately 2,400 shareholders of record of our common stock. No cash dividends were paid to common shareholders during 2005 or during the past three fiscal years, and no dividends are expected to be declared during 2006 for common shareholders. Our ability to pay dividends on our common stock requires the consent of the holders of the Series A Preferred Stock and Series B Preferred Stock and Bank of America, N.A., as required under our credit agreement with them.

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Item 6.    Selected Consolidated Financial Data

The following selected consolidated financial data as of December 31, 2005, 2004, 2003, 2002 and 2001 have been taken from our consolidated financial statements. This data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the consolidated financial statements and the related notes thereto included elsewhere in this Report.

See Item 7 “Management’s Discussion and Analysis” for an explanation of events that materially affect comparability.

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

The following discussion and analysis should be read in conjunction with the “Selected Consolidated Financial Data”, and the consolidated financial statements and related notes included elsewhere in this Form 10-K.

FORWARD-LOOKING STATEMENTS

Certain matters contained in the following discussion and analysis concerning our operations, cash flows, financial position, economic performance, and financial condition, including in particular, the likelihood of our success in growing our business through acquisitions or otherwise, the realization of sales from backlog, and the sufficiency of capital to meet our working capital needs, include forward-looking statements within the meaning

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of Section 27A of the Securities Act and Section 21E of the Exchange Act. Forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results, level of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. In some cases, you can identify these statements by forward-looking words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “should,” “will,” “would” or similar words. We believe that it is important to communicate our future expectations to our investors. However, there are events in the future that we may not be able to predict accurately or control. Our actual results could differ materially in an adverse manner from those anticipated in these forward-looking statements for many reasons, and as a result of many factors, including those identified in the Risk Factors section of this Form 10-K

Readers of this report should not place undue reliance on these forward-looking statements, which apply only as of the date of the filing of this Form 10-K. We assume no obligation to update any such forward-looking statements.

INTRODUCTION

This management’s discussion and analysis of financial condition and results of operations is intended to provide readers with an understanding of our past performance, financial condition and future prospects. We will discuss and provide our analysis of the following:

OVERVIEW OF BUSINESS

We are a leading provider of mission-critical professional services to the U.S. government. We specialize in providing intelligence, systems engineering and security services in support of our nation’s security. Analex focuses on developing innovative technical approaches for the intelligence community, analyzing and supporting defense systems, designing, developing and testing aerospace systems and providing a full range of security support services to the U.S. government. We specialize in the following professional services:

Information Technology Services.Our information technology services focus on design, development, test, integration and support of software and networks for mission critical systems. We develop radar, modeling and simulation and system software, all in support of collecting, testing, and analyzing data from various intelligence systems. We also provide the military with program management, systems engineering and software development services, including the development of command, control, communications, computers and intelligence (“C4I”) programs.

Aerospace Engineering Services.Our aerospace engineering services focus on engineering associated with the development, support and operations of space launch vehicles and facilities as well as independent verification and validation services. We provide services in the design and testing of expendable launch vehicles for the Department of Defense (“DoD”) and intelligence community. Our highly specialized expertise includes test, analysis and independent validation and verification support in areas such as structural dynamics, trajectory and performance, thermal system performance, and range safety. Our solutions enable the simulation of a realistic operational environment so that satellites and related systems can be tested prior to deployment. We also perform verification and validation of test results to ensure the reliability of the data.

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Security and Intelligence Support Services.Our security and intelligence support services focus on analysis support and threat assessments, counterintelligence, information, network and facilities security, technology protection and security education and training.

Our principal customer is the U.S. government. Revenue generated from contracts to federal government agencies and their prime contractors represented approximately 99%, 100% and 99% of our total revenue for the years ended December 31, 2005, 2004 and 2003, respectively. Our principal U.S. government customer is the DoD, which, directly or through its covenantsprime contractors, accounted for approximately 69%, 55%, and 42%, of our revenue for the years ended December 31, 2005, 2004, and 2003, respectively. NASA is also a significant customer, generating 30%, 44%, and 57% of our revenue for the years ended December 31, 2005, 2004 and 2003, respectively. For fiscal years ended December 31, 2005, 2004 and 2003, approximately 11%, 16% and 17%, respectively, of our revenue and 44%, 62% and 72%, respectively, of our operating income came from one prime contract with an agency within the Department of Defense. For fiscal years ended December 31, 2005, 2004 and 2003 approximately 20%, 28% and 30%, respectively, of our revenue came from one prime contract with NASA, which will continue until September 2011, if the remaining contract option is exercised in 2008. We expect that federal government contracts will continue to be the source of substantially all of our revenue for the foreseeable future.

We provide our services through one reportable segment, comprised of two strategic business units, our Homeland Security Group (“HSG’) and our Systems Engineering Group (“SEG”). HSG accounted for approximately 69.9% of our revenue for the year ended December 31, 2005. HSG provides information technology services, aerospace engineering services and security and intelligence support services to the agencies within the intelligence community such as the National Reconnaissance Office (“NRO”), the Missile Defense Agency and the National Security Agency. HSG also provides services to the DoD, and major aerospace contractors, such as Lockheed Martin and Northrop Grumman. We expect that our Homeland Security Group will continue to benefit from the country’s shifting priorities towards national defense and homeland security and emphasis on enhanced intelligence capabilities.

SEG accounted for approximately 30.1% of our revenue for the year ended December 31, 2005. SEG provides aerospace engineering services and information technology services, including program management support, primarily to NASA and major aerospace contractors in support of the development of space-based systems. SEG also supports the operation of terrestrial assets and the launch of unmanned rockets by NASA under its bankour Expendable Launch Vehicle Integrated Support (“ELVIS”) contract. Specific capabilities of the Systems Engineering Group include expendable launch vehicle engineering, space systems development, and ground support for space operations.

On April 1, 2005, we acquired ComGlobal Systems, Incorporated (“ComGlobal”). ComGlobal, a software engineering and information technology firm, specializes in C4I programs for the military. Its largest customer is the U.S. Navy’s Tomahawk Cruise Missile Program. ComGlobal is a wholly-owned subsidiary of Analex and is reported as a part of our Homeland Security Group.

On May 28, 2004, we acquired Beta Analytics, Inc. (“BAI”). BAI’s services cover a range of life-cycle protection and physical security services specifically in the areas of information protection, physical security, intelligence threat assessment and analysis, technology protection, security management and security education and training. BAI is a wholly-owned subsidiary of Analex and is reported as a part of our Homeland Security Group.

During the second quarter of 2004, we concluded that our then wholly-owned subsidiary, Advanced Biosystems, Inc. (“ABS”), did not fit with our long-term strategic plan and decided to divest ABS. ABS was engaged in biomedical research for broad-spectrum defenses against toxic agents capable of being used as bioterrorist weapons, such as anthrax and smallpox. We disposed of ABS on November 16, 2004. Therefore, the

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results of operations of ABS are reported as discontinued operations, net of applicable income taxes, for all periods presented. Historically, we reported ABS as a separate business segment.

We generate a majority of our revenue as a prime contractor to the federal government. Our objective is to focus on retaining and increasing the percentage of our business as a prime contractor because we believe it provides us with stronger client relationships. The following table summarizes our revenue as a prime contractor and as subcontractor as a percentage of our total revenue for the years ended December 31,:

All of our U.S. government contracts are subject to audit and various cost controls, and include standard provisions for termination at any time at the convenience of the U.S. government. Multi-year U.S. government contracts and related orders are subject to cancellation if funding for contract performance for any subsequent year becomes unavailable.

SELECTED KEY METRICS EVALUATED BY MANAGEMENT

We manage and assess the performance of our business by evaluating a variety of metrics. Selected key metrics are discussed below.

Revenue Growth

Our revenue growth during 2005 was driven primarily by strategic acquisitions. Our total revenue growth rate was 49.5% for 2005, compared to 51.5% for 2004. Organic growth decelerated in 2005 as certain customers experienced funding reductions to help offset the cost of the continuing war in Iraq. We have recently begun to make incremental investments in a centralized business development team and new processes that we believe will improve future organic revenue growth.

Contract Backlog

Future growth is dependent upon the strength of our target markets, our ability to identify opportunities, and our ability to successfully bid and win new contracts. Our success can be measured in part based upon the growth of our backlog. The following table summarizes our contract backlog as of December 31,:

Our total backlog of over $291.7 million as of December 31, 2005 represented a 52% increase over the backlog as of December 31, 2004. We currently expect to recognize revenue during fiscal 2006 from approximately 41% of our total backlog as of December 31, 2005.

Contract mix

Contract profit margins are generally affected by the type of contracts we have. We can typically earn higher profits on fixed-price and time-and-material contracts than cost-plus-fee contracts. Thus, an important part

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of growing our operating income is to increase the amount of services delivered under fixed-price and time and material contracts. The following table summarizes our historical contract mix, measured as a percentage of total revenue, for the years ended December 31,:

While our government clients typically determine what type of contract will be awarded to us, where we have the opportunity to influence the type of contract awarded, we will pursue time-and-material and fixed-price contracts for the reasons discussed above.

Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”)

We believe EBITDA is useful in evaluating our results because it excludes certain non-cash expenses that are not directly related to our core operating performance. EBITDA is calculated by adding net interest expense, income taxes, discontinued operations, depreciation and amortization to net income. EBITDA for the years ended December 31, 2005, 2004 and 2003 was $13.1 million, $8.0 million and $4.1 million, respectively. EBITDA, as a percentage of revenue, the years ended December 31, 2005, 2004 and 2003 was 9.3%, 8.5% and 6.6%, respectively.

EBITDA, or earnings before interest, taxes, depreciation and amortization, is a non-GAAP financial measure under applicable SEC rules. Generally, a non-GAAP financial measure is a numerical measure of a Company’s performance, financial position or cash flows that either excludes or includes amounts that are not normally excluded or included in the most directly comparable measure calculated and presented in accordance with U.S. generally accepted accounting principles. EBITDA should not be considered as a substitute either for net income, as an indicator of our operating performance, or for cash flow, as measures of our liquidity. In addition, because all companies do not calculate EBITDA identically, our presentation of EBITDA may not be comparable to other similarly titled measures of other companies.

Days Sales Outstanding

Days sales outstanding, or DSO, is a measure of how efficiently we manage the billing and collection of our accounts receivable, our most significant working capital requirement. For the fiscal quarter ended December 31, 2005 our DSO was 75 days. This represents an increase over the approximately 60 days we have historically experienced. Timing issues related to certain contract actions arising during the fourth quarter are primarily responsible for this increase. We believe these contract actions have been addressed and expect our DSO to trend more towards historical levels.

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RESULTS OF OPERATIONS AND RELATED INFORMATION

The following table sets forth some items from our consolidated statements of operations, and these items expressed as a percentage of revenue, for the periods indicated.