UNITED STATES

 

SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, D.C. 20549 - 0001

 

 

FORM 10-Q

 

(Mark One)

 

 

FOR THE QUARTER ENDED JUNE 30, 2002

 

or

 

 

COMMISSION FILE NUMBER 000-30271

 

PEC SOLUTIONS, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

 

 

Registrant's telephone number, including area code: (703) 679-4900

 

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

 

As of August 14, 2002, 26,463,982 of the registrant's Common Stock, par value $.01 per share, were outstanding.

 

 

PEC SOLUTIONS, INC.

QUARTERLY REPORT ON FORM 10-Q FOR THE SIX MONTHS ENDED JUNE 30, 2002

 

TABLE OF CONTENTS

 

PART I.  FINANCIAL INFORMATION

Item 1. Financial Statements:

Consolidated Balance Sheets - June 30, 2002 and December 31, 2001

Consolidated Statements of Income - Three and six months ended June 30, 2002 and 2001

Consolidated Statements of Cash Flows -- Six months ended June 30, 2002 and 2001

Notes to Consolidated Financial Statements

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Item 3. Qualitative and Quantitative Disclosure about Market Risk

PART II. OTHER INFORMATION

Items 1 -- 6

Signatures

 

2

 

PART I: FINANCIAL INFORMATION

 

ITEM 1: FINANCIAL STATEMENTS

 

PEC SOLUTIONS, INC.

CONSOLIDATED BALANCE SHEETS

(DOLLARS IN THOUSANDS)

 

		AS OF JUNE 30, 2002			AS OF DEC. 31, 2001
		(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents		$	34,240		$	30,436
Short-term investments		19,523			31,105
Accounts receivable, net		42,895			36,423
Other current assets		3,204			4,134
Total current assets		99,862			102,098
Property and equipment, net		17,815			6,497
Investments		21,147			13,762
Goodwill		14,113			12,565
Intangibles, net		6,938			2,969
Other assets		3,675			3,817
Total assets		$	163,550		$	141,708
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued expenses		$	6,873		$	4,020
Advance payments on contracts		1,211			1,290
Retirement plan contribution payable		1,141			—
Accrued payroll		4,061			7,018
Accrued vacation		2,988			2,185
Other current liabilities		2,800			3,958
Total current liabilities		19,074			18,471
Long-term liabilities:
Supplemental retirement program liability		990			949
Deferred rent payable		1,118			923
Long-term lease obligation		13,939			2,883
Other long-term liabilities		32			54
Total long-term liabilities		16,079			4,809
Total liabilities		35,153			23,280
Commitments and contingencies
Stockholders’ equity:
Undesignated capital stock, 10,000,000 shares authorized		—			—
Common stock, $0.01 par value, 75,000,000 shares authorized, 26,292,064 and 26,109,649 shares issued and outstanding, respectively		263			261
Additional paid-in capital		85,164			83,582
Retained earnings		43,311			34,585
Accumulated other comprehensive income (loss)		(341		)	—
Total stockholders’ equity		128,397			118,428
Total liabilities and stockholders’ equity		$	163,550		$	141,708

 

See notes to consolidated financial statements.

 

3

 

PEC SOLUTIONS, INC.

CONSOLIDATED STATEMENTS OF INCOME

(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)

 

		THREE MONTHS ENDED						SIX MONTHS ENDED
		JUNE 30, 2002			JUNE 30, 2001			JUNE 30, 2002			JUNE 30, 2001
		(UNAUDITED)
Revenues		$	42,761		$	27,134		$	80,992		$	49,054
Operating costs and expenses:
Direct costs		25,511			14,261			48,430			26,058
General and administrative expenses		8,090			5,722			15,521			11,090
Sales and marketing expenses		1,462			1,136			3,041			2,032
Goodwill and intangible amortization		213			180			381			360
Total operating costs and expenses		35,276			21,299			67,373			39,540
Operating income		7,485			5,835			13,619			9,514
Other income, net		464			441			967			909
Income before income taxes		7,949			6,276			14,586			10,423
Provision for income taxes		3,104			2,585			5,696			4,294
Net income		$	4,845		$	3,691		$	8,890		$	6,129
Earnings per share:
Basic		$	0.18		$	0.16		$	0.34		$	0.27
Diluted		$	0.16		$	0.14		$	0.30		$	0.24
Weighted average shares used in computing earnings per share:
Basic		26,261			22,658			26,214			22,565
Diluted		29,787			26,386			29,847			26,074

 

See notes to consolidated financial statements.

 

4

 

PEC SOLUTIONS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(DOLLARS IN THOUSANDS)

 

		SIX MONTHS ENDING
		JUNE 30, 2002			JUNE 30, 2001
		(UNAUDITED)
Cash flows from operating activities:
Net income		$	8,890		$	6,129
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		643			527
Amortization of goodwill		—			360
Amortization of intangibles		381			—
Deferred rent payable		195			229
Deferred income taxes		(241		)	(137		)
Loss from investment in building		49			—
Changes in operating assets and liabilities:
Accounts receivable, net		(6,472		)	(12,421		)
Other current assets		1,062			(62		)
Other assets		72			(32		)
Accounts payable and accrued expenses		2,853			378
Advance payments on contracts		(78		)	(231		)
Retirement plan contribution payable		1,141			565
Accrued payroll		(2,957		)	428
Accrued vacation		803			502
Other current liabilities		(1,158		)	976
Supplemental retirement program liability		41			109
Other long-term liabilities		—			(10		)
Net cash provided (used) by operating activities		5,224			(2,690		)
Cash flows from investing activities:
Purchases of property and equipment		(908		)	(520		)
Net sales of short-term investments		11,397			637
Investment in affiliate		—			(1,500		)
Purchase of assets		(5,852		)	—
Capitalized software		(14		)	(431		)
Purchases of long-term investments		(7,437		)	—
Net cash used by investing activities		(2,814		)	(1,814		)
Cash flows from financing activities:
Proceeds from issuance of common stock		1,415			441
Common stock offering costs		—			(58		)
Payments on capital lease obligations		(21		)	—
Net cash provided by financing activities		1,394			383
Net increase (decrease) in cash		3,804			(4,121		)
Cash and cash equivalents at beginning of period		30,436			14,655
Cash and cash equivalents at end of period		$	34,240		$	10,534
Income taxes paid		$	4,678		$	3,820
Interest paid		$	6		$	2

 

See notes to consolidated financial statements.

 

5

 

PEC SOLUTIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2002

(UNAUDITED)

1. Financial Statements

 

The accompanying consolidated financial statements, except for the December 31, 2001 balance sheet, are unaudited and have been prepared in accordance with accounting standards generally accepted in the United States for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally in the United States have been omitted. In the opinion of management, all adjustments, consisting of normally recurring accruals, considered necessary for a fair presentation, have been included. It is suggested that these condensed financial statements be read in conjunction with the Company's audited financial statements for the years ended December 31, 2000 and 2001 and for each of the three years in the period ended December 31, 2001 included on Form 10-K, as filed with the Securities and Exchange Commission. The results of operations for the six months ended June 30, 2002, are not necessarily indicative of the operating results to be expected for the full year.

 

2. Accounts Receivable

 

Accounts receivable consist of the following as of:

 

		JUNE 30, 2002			DECEMBER 31, 2001
		(DOLLARS IN THOUSANDS)
Billed accounts receivable		$	36,493		$	33,337
Unbilled accounts receivable		7,937			4,701
Progress payments		(1,211		)	(1,290		)
		43,219			36,748
Allowance for doubtful accounts		(324		)	(325		)
Accounts receivable, net		$	42,895		$	36,423

 

Unbilled accounts receivable comprise recognized recoverable costs and accrued profits on contracts for which billings had not been presented to clients as of the balance sheet date. Management anticipates the collection of these amounts within 90 days of the balance sheet date. Payments to the Company on contracts with agencies and departments of the U.S. Government are subject to adjustment upon audit by the U.S. Government. All years subsequent to 1997 are subject to U.S. Government audit. Management believes the effect of audit adjustments, if any, on periods not yet audited, will not have a material effect on the financial statements.

 

3. Net Income Per Share

 

Basic and diluted earnings per share for the three months and six months ended June 30, 2002 and 2001 were determined as follows:

 

		THREE MONTHS ENDED JUNE 30, 2001								SIX MONTHS ENDED JUNE 30, 2001
		(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
		NET INCOME			SHARES		PER SHARE			NET INCOME			SHARES		PER SHARE
Basic EPS		$	3,691		22,658,042		$	0.16		$	6,129		22,565,252		$	0.27
Effect of dilutive options		—			3,727,965		(0.02		)	—			3,509,042		(0.03		)
Diluted EPS		$	3,691		26,386,007		$	0.14		$	6,129		26,074,294		$	0.24

 

		THREE MONTHS ENDED JUNE 30, 2002								SIX MONTHS ENDED JUNE 30, 2002
		(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
		NET INCOME			SHARES		PER SHARE			NET INCOME			SHARES		PER SHARE
Basic EPS		$	4,845		26,261,322		$	0.18		$	8,890		26,214,090		$	0.34
Effect of dilutive options		—			3,525,761		(0.02		)	—			3,632,803		(0.04		)
Diluted EPS		$	4,845		29,787,083		$	0.16		$	8,890		29,846,893		$	0.30

 

6

 

4. Acquisitions

 

On June 14, 2002, the Company acquired the contracts and employees of Vector Research, Inc. (“Vector”) for $5.7

million cash plus the assumption of $0.1 million in accrued liabilities.  Vector was a provider of technology development and engineering services to the federal government.  The purchase price has been allocated as follows, goodwill of $1.5 million and intangibles consisting of customer contracts and relationships of $4.3 million.  Intangibles are being amortized over 4 years.  The fair value of the assets acquired has been based on preliminary estimates and may be revised at a later date, based upon the completion of valuation studies.  The operating results of Vector have been included in the consolidated results of the Company from the date of acquisition.

 

5. Goodwill and Intangible Assets

 

In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations and No. 142, Goodwill and Other Intangible Assets.  SFAS No. 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method.  Under SFAS No. 142, goodwill and intangible assets with indefinite lives will no longer be amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment. Separable intangible assets that are not deemed to have indefinite lives will continue to be amortized over their useful lives but with no maximum life.  The Company has adopted the provisions of SFAS No. 142 effective January 1, 2002.

 

Upon the adoption of FAS 142, the Company discontinued the amortization of goodwill.  The following table presents a reconciliation of net income and earnings per share adjusted for the exclusion of goodwill:

 

		Three Months Ended						Six Months Ended
		(Dollars in thousands, except for per share amounts)
		June 30, 2002			June 30, 2001			June 30, 2002			June 30, 2001
Reported net income		$	4,845		$	3,691		$	8,890		$	6,129
Add:  Goodwill amortization		—			180			—			360
Adjusted net income		$	4,845		$	3,871		$	8,890		$	6,489
Reported basic earnings per share		$	0.18		$	0.16		$	0.34		$	0.27
Add:  Goodwill amortization		—			0.01			—			0.02
Adjusted basic earnings per share		$	0.18		$	0.17		$	0.34		$	0.29
Reported diluted earnings per share		$	0.16		$	0.14		$	0.30		$	0.24
Add:  Goodwill amortization		—			0.01			—			0.01
Adjusted diluted earnings per share		$	0.16		$	0.15		$	0.30		$	0.25

 

The Company only has one reporting unit.  Nonamortizable intangible assets at June 30, 2002, consist only of goodwill of $14,113,000.  The Company’s amortizable intangible assets include customer contracts and related relationships.  The gross carrying amount of the customer relationships at June 30, 2002 was $7,375,000 with accumulated amortization of $437,443.  Goodwill increased by $1,452,000 during the quarter ended June 30, 2002 as it related to the asset purchase of Vector.  In accordance with the provisions of SFAS No. 142, the Company performed the appropriate transitional impairment tests related to its stated goodwill and determined that there is no transitional impairment loss.  Also in accordance with the provisions of SFAS No. 142, the Company reassessed the useful lives of all intangible assets and determined that no adjustments were necessary.

 

Amortization expense for the three and six months ended June 30, 2002 was $213,000 and $381,000, respectively.  Intangibles are amortized on a straight line basis.  Estimated amortization expense for each of the five succeeding calendar years based on the intangible assets as of June 30, 2002 is as follows:

 

 

7

 

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

OVERVIEW

 

PEC Solutions is a professional services firm specializing in high-end solutions that help government organizations capitalize on the Internet and other advanced technologies. We migrate paper-intensive procedures to web-enabled processes using eGovernment solutions that help our clients enhance their productivity and improve the services they offer to the public. As a total solutions provider, we address the full technology lifecycle, including formulating technology strategies, creating business solutions, performing long-term operational management and continuing enhancement of the solution.

 

We derive substantially all of our revenues from fees for consulting services. We generate these fees from various types of contracts, including time and materials contracts, fixed-price contracts and cost-reimbursable contracts. During the three months and six months ended June 30, 2002, revenues from these contract types were approximately 61%, 20% and 19%, and 60%, 20% and 20% respectively, of total revenues. We typically issue invoices monthly to manage outstanding accounts receivable balances. We recognize revenues on time and materials contracts as the services are provided. We recognize revenues on fixed-price contracts using the percentage of completion method as services are performed over the life of the contract, based on the costs we incur in relation to the total estimated costs. We recognize and make provisions for any anticipated contract losses at the time we know and can estimate them. Fixed-price contracts are attractive to clients and, while subject to increased risks, provide opportunities for increased margins. We recognize revenues on cost-reimbursable contracts as services are provided. These revenues are equal to the costs incurred in  providing these services plus a proportionate amount of the fee earned. We have historically recovered all of our costs on cost-reimbursable contracts, which means we have lower risk and our margins are lower on these contracts.

 

Our historical revenue growth is attributable to various factors, including an increase in the size and number of projects for existing and new clients. Existing clients from the previous year generated approximately 93% and 95% of our revenues in the three months and six months ended June 30, 2002. As of June 30, 2002, we had 1,293 personnel.

 

In the three months and six months ended June 30, 2002, we derived approximately 30% and 32% respectively, of our revenues through relationships with prime contractors, who contract directly with the end-client and subcontract with us. In most of these engagements, we retain full responsibility for the end-client relationship and direct and manage the activities of our contract staff.

 

Our most significant expense is direct costs, which consist primarily of project personnel salaries and benefits, and direct expenses incurred to complete projects. Our direct costs as a percentage of revenues are also related to the utilization rate of our consulting personnel. We manage utilization by frequently monitoring project requirements and timetables. The number of consulting personnel assigned to a project will vary according to the size, complexity, duration and demands of the project.

 

General and administrative expenses consist primarily of costs associated with our executive management, finance and administrative groups, human resources, unassigned consulting personnel, personnel training, occupancy costs, depreciation and amortization, travel and all other branch and corporate costs.

 

Sales and marketing expenses include the costs of sales and marketing personnel and costs associated with marketing and bidding on future projects.

 

Other income consists primarily of interest income earned on our cash, cash equivalents and marketable securities.

 

8

 

Results of Operations

 

The following table sets forth certain financial data as a percentage of revenues for the periods indicated.

 

		THREE MONTHS ENDED						SIX MONTHS ENDED
		JUNE 30, 2002			JUNE 30, 2001			JUNE 30, 2002			JUNE 30, 2001
		(DOLLARS IN THOUSANDS)
Statement of Income:
Revenues		$	42,761		$	27,134		$	80,992		$	49,054
Direct costs		25,511			14,261			48,430			26,058
Gross profit (a)		17,250			12,873			32,562			22,996
Other operating costs and expenses:
General and administrative expenses		8,090			5,722			15,521			11,090
Sales and marketing expenses		1.462			1,136			3,041			2,032
Goodwill and intangible amortization		213			180			381			360
Total other operating costs and expenses		9,765			7,038			18,943			13,482
Operating income		7,485			5,835			13,619			9,514
Other income, net		464			441			967			909
Income before income taxes		7,949			6,276			14,586			10,423
Provision for income taxes		3,104			2,585			5,696			4,294
Net income		$	4,845		$	3,691		$	8,890		$	6,129
As a Percentage of Revenues:
Revenues		100.0		%	100.0		%	100.0		%	100.0		%
Direct costs		59.7			52.6			59.8			53.1
Gross profit (a)		40.3			47.4			40.2			46.9
Other operating costs and expenses:
General and administrative expenses		18.9			21.1			19.2			22.6
Sales and marketing expenses		3.4			4.2			3.7			4.2
Goodwill and intangible amortization		0.5			0.6			0.5			0.7
Total other operating costs and expenses		22.8			25.9			23.4			27.5
Operating income		17.5			21.5			16.8			19.4
Other income, net		1.1			1.6			1.2			1.8
Income before income taxes		18.6			23.1			18.0			21.2
Provision for income taxes		7.3			9.5			7.0			8.7
Net income		11.3		%	13.6		%	11.0		%	12.5		%

 

(a)  Gross profit represents revenues less direct costs, which consist primarily of project personnel salaries and benefits and direct expenses incurred to complete projects.

 

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2002 COMPARED WITH THE THREE MONTHS ENDED JUNE 30, 2001

 

REVENUES. For the three months ended June 30, 2002, our total revenues increased by 57.6%, or $15.6 million over the same period last year. The increase in revenues primarily reflects an increase in the volume of services to existing clients and services to new clients. Services to new clients represent approximately 7% of revenues.

 

DIRECT COSTS. For the three months ended June 30, 2002, direct costs increased by 78.9%, or $11.3 million, over the same period last year. The increase was due primarily to an increase in project personnel to 1,165 as of June 30, 2002 as compared to 742 as of June 30, 2001. Direct costs increased as a percentage of revenues for the period ended June 30, 2002, to 59.7% as compared to 52.6% in the same period last year, due to normal fluctuations in labor and other direct costs and the impact of the Troy acquisition.

 

9

 

GROSS PROFIT. Gross profit increased by 34.0% to $17.3 million in the three months ended June 30, 2002 from $12.9 million in the three months ended June 30, 2001. Gross profit as a percentage of revenues decreased to 40.3% in the three months ended June 30, 2002 from 47.4% in the three months ended June 30, 2001, as direct costs grew at a faster rate than revenues due to normal fluctuations in labor and other direct costs and the impact of the Troy acquisition.

 

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased 41.4% to $8.1 million in the three months ended June 30, 2002 from $5.7 million in the three months ended June 30, 2001. Facility costs increased in the current quarter over last year due to the opening of new offices in Fairfax, Virginia. Our total general and administrative headcount increased to 128 employees as of June 30, 2002 compared to 90 employees as of June 30, 2001, consistent with our plans.

 

SALES AND MARKETING. Sales and marketing expenses increased 28.7% to $1.5 million in the three months ended June 30, 2002 from $1.1 million in the three months ended June 30, 2001. This increase was due to an increase in our marketing efforts.

 

AMORTIZATION OF GOODWILL. As a result of the adoption of FAS 142, effective January 1, 2002, we incurred no goodwill amortization expense in the three months ended June 30, 2002.  In the three months ended June 30, 2001, we incurred $180 of amortization expense related to the $3.6 million of goodwill we recorded in connection with the acquisition of Viking.

 

AMORTIZATION OF INTANGIBLES.  For the three months ended June 30, 2002, we incurred $213 thousand of amortization of expense related to the $3.0 million of intangibles we recorded in connection with the value of contracts and customer relationships acquired in the November 2001 acquisition of Troy, and $4.4 million of intangibles in connection with the value of contracts and customer relationships acquired in the June 2002 acquisition of Vector.  There were no intangibles at June 30, 2001, and therefore, no amortization.

 

OPERATING INCOME. Operating income increased 28.3% to $7.5 million in the three months ended June 30, 2002 from $5.8 million in the three months ended June 30, 2001. This increase was due primarily to increased revenues.

 

RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2002 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 2001

 

REVENUES. For the six months ended June 30, 2002, our total revenues increased by 65.1%, or $31.9 million over the same period last year. The increase in revenues primarily reflects an increase in the volume of services to existing clients and services to new clients. Services to new clients represent approximately 5% of revenues.

 

DIRECT COSTS. For the six months ended June 30, 2002, direct costs increased by 85.9%, or $22.4 million, over the same period last year. The increase was due primarily to an increase in project personnel to 1,165 as of June 30, 2002 as compared to 742 as of June 30, 2001. Direct costs increased as a percentage of revenues for the period ended June 30, 2002, to 59.8% as compared to 53.1% in the same period last year, due to normal fluctuations in labor and other direct costs and the impact of the Troy acquisition.

 

GROSS PROFIT. Gross profit increased by 41.6% to $32.6 million in the six months ended June 30, 2002 from $23.0 million in the six months ended June 30, 2001. Gross profit as a percentage of revenues decreased to 40.2% in the six months ended June 30, 2002 from 46.9% in the six months ended June 30, 2001, as direct costs grew at a faster rate than revenues due to normal fluctuations in labor and other direct costs and the impact of the Troy acquisition.

 

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased 40.0% to $15.5 million in the six months ended June 30, 2002 from $11.1 million in the six months ended June 30, 2001. Facility costs increased in the current period over last year due to the opening of new offices in Fairfax, Virginia. Our total general and administrative headcount increased to 128 employees as of June 30, 2002 compared to 90 employees as of June 30, 2001, consistent with our plans.

 

10

 

SALES AND MARKETING. Sales and marketing expenses increased 49.7% to $3.0 million in the six months ended June 30, 2002 from $2.0 million in the six months ended June 30, 2001. This increase was due to an increase in our marketing efforts.

 

AMORTIZATION OF GOODWILL. As a result of the adoption of FAS 142, effective January 1, 2002, we incurred no goodwill amortization expense in the six months ended June 30, 2002.  In the six months ended June 30, 2001, we incurred $360 thousand of amortization expense related to the $3.6 million of goodwill we recorded in connection with the acquisition of Viking.

 

AMORTIZATION OF INTANGIBLES.  For the six months ended June 30, 2002, we incurred $381 thousand of amortization of expense related to the $3.0 million of intangibles we recorded in connection with the value of contracts and customer relationships acquired in the November 2001 acquisition of Troy, and $4.4 million of intangibles in connection with the value of contracts and customer relationships acquired in the June 2002 acquisition of Vector.  There were no intangibles at June 30, 2001, and therefore, no amortization.

 

OPERATING INCOME. Operating income increased 43.2% to $13.6 million in the six months ended June 30, 2002 from $9.5 million in the six months ended June 30, 2001. This increase was due primarily to increased revenues.

 

Our revenues and operating results may be subject to significant variation from quarter to quarter depending on a number of factors, including the progress of contracts, revenues earned on contracts, the number of billable days in a quarter, the timing of the pass-through of other direct costs, the commencement and completion of contracts during any particular quarter, the schedule of the government agencies for awarding contracts, the term of each contract that we have been awarded and general economic conditions. Because a significant portion of our expenses, such as personnel and facilities costs, are fixed in the short term, successful contract performance and variation in the volume of activity as well as in the number of contracts commenced or completed during any quarter may cause significant variations in operating results from quarter to quarter.

 

The federal government's fiscal year ends September 30. If a budget for the next fiscal year has not been approved by that date, our clients may have to suspend engagements that we are working on until a budget has been approved. Such suspensions may cause us to realize lower revenues in the fourth quarter of the year. Further, a change in Presidential administrations and in senior government officials may affect the rate at which the federal government purchases technology, although we have not seen an impact with the 2001 change  in administration.

 

As a result of the factors above, period to period comparisons of our revenues and operating results may not be meaningful. You should not rely on these comparisons as indicators of future performance as no assurances can be given that quarterly results will not fluctuate, causing a material adverse effect on our operating results and financial condition.

 

Liquidity and Capital Resources

 

Prior to the IPO and follow-on offering, we funded our operations primarily through cash generated from operations and the sale of common stock to employees. Net cash provided by operating activities was $5.2 million for the six months ended June 30, 2002. Cash provided by operating activities was primarily from net income, adjusted for working capital changes, which were principally decreases in accounts receivable.

 

Net cash used by investing activities was $2.8 million for the six months ended June 30, 2002. During the six months ended June 30, 2002, we purchased $0.9 million of property and equipment. We had $11.4 million of net sales of short-term investments, $7.4 million of net purchases of long-term investments and invested $5.9 million in the assets of Vector.

 

Net cash provided by financing activities was $1.4 million from the sale of common stock to employees upon the exercise of their stock options or stock purchase plan for the six months ended June 30, 2002.

 

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We expect to retain future earnings, if any, for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. We believe that our current cash position is adequate for our short-term and long-term working capital and capital expenditure needs.

 

We maintain a $6.0 million line of credit with Bank of America, bearing interest at the LIBOR Rate plus 250 basis points per annum, which expires on April 30, 2003. As of June 30, 2002, we had no borrowings outstanding under the line of credit. As of June 30, 2002, we had outstanding $2.99 million in letters of credit in lieu of rent deposits.

 

Under some of our fixed-price contracts, we receive advance payments for work to be performed in future months. If we do not perform the work, the unearned portion of these advances will be returned to our clients. At June 30, 2002, our accounts receivable turnover rate, net of advance payments on contracts, was approximately four times a year.

 

We have invested $3.0 million in an affiliated company, which is building our new office building in Fairfax, Virginia.  We are required to make an additional $1.5 million investment at the time of occupancy of the facility.  We have a 48% minority interest in this company and are not obligated to guarantee the non-recourse mortgage obligation, nor are we involved in the management of the construction of the building or the management of the owner-lessor.  In accordance with Emerging Issues Task Force Issue No. 97-10 The Effect of Lessee Involvement in Asset Construction, the Company is considered to be the owner of the property (for accounting purposes).  Accordingly, the Company recorded construction costs incurred to date of $13.9 million as construction-in-process with an offsetting long-term lease obligation as of June 30, 2002.  It is anticipated that the total construction-in-process costs will be approximately $25 to $30 million at the completion of construction, which is expected to be December 1, 2002.

 

Recent Accounting Pronouncements

 

None

 

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SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

 

The matters discussed in this Form 10-Q include forward-looking statements that involve risks or uncertainties. While forward-looking statements are sometimes presented with numerical specificity, they are based on various assumptions made by management regarding future circumstances over many of which we have little or no control. Forward-looking statements may be identified by words including “anticipate,” “believe,” “estimate,” “expect” and similar expressions. We caution readers that forward-looking statements, including without limitation, those relating to our future business prospects, revenues, working capital, liquidity, and income, are subject to certain risks and uncertainties that would cause actual results to differ materially from those indicated in the Forward-Looking Statements. Factors that could cause actual results to differ from Forward-Looking Statements include the concentration of our revenues from government clients, risks involved in contracting with the government, difficulties we may have in attracting, retaining and managing professional and administrative staff, fluctuations in quarterly results, risks related to acquisitions, risks related to competition and our ability to continue to win and perform efficiently on contracts, and other risks and factors identified from time to time in our reports filed with the SEC, including those identified under the section entitled “Risk Factors” in our Registration Statement on Form 10-K (SEC File No. 000-30271) as amended which hereby is incorporated by reference. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected.

 

ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK

 

We invest our cash in a variety of financial instruments, including U.S. Treasury and Agency obligations, money market instruments of domestic and foreign issuers denominated in U.S. dollars of commercial paper, bankers' acceptances, certificates of deposit, euro-dollar time deposits and variable rate issues, corporate note and bonds, asset-backed securities, repurchase agreements, municipal notes and bonds and auction rate preferred securities.

 

Investments in both fixed and floating rate interest earning instruments carry a degree of interest rate risk. Fixed securities may have their fair market value adversely impacted because of a rise in interest rates, while floating rare securities may produce less income than expected if interest rates fall. Due in part to these factors, the Company's future investment income may fall short of expectations because of changes in interest rates or the Company may suffer losses in principal if forced to sell securities which have seen a decline in market value because of changes in interest rates.

 

Our investments are made in accordance with an investment policy approved by the Board of Directors. Under this policy, no investment securities can have maturities exceeding one year and the average duration of the portfolio can not exceed six months.

 

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PART II -- OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

None

 

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

 

In April 2000, we commenced and completed a firm commitment underwritten initial public offering of 3,000,000 shares of our common stock at a price of $9.50 per share. The shares were registered with the Securities and Exchange Commission pursuant to a registration statement on Form S-1 (No. 333-95331), which was declared effective on April 19, 2000. The public offering was underwritten by a syndicate of underwriters led by Donaldson, Lufkin & Jenrette Securities Corporation; Chase Securities Inc.; Legg Mason Wood Walker, Incorporated; and DLJDIRECT Inc. as their representatives. After deducting underwriting discounts and commissions of approximately $2 million and expenses of approximately $0.9 million, we received net proceeds of $25.6 million.

 

The primary purposes of this offering were to create a public market for our common stock, to improve the incentive mechanism for our professionals through stock options, to obtain additional equity capital and to facilitate future access to public markets. We have used the net proceeds from this offering for general corporate purposes, including working capital. We have also used a portion of the net proceeds to acquire three businesses that are complementary to ours, and may use the remaining proceeds for this purpose.

 

On August 28, 2000, we acquired all of the outstanding capital stock of Viking for $2 million cash plus the assumption of debt in a business combination accounted for as a purchase. Viking is a provider of integrated software and advanced technology solutions for state and local law enforcement, fire and emergency medical service agencies. On November 20, 2001, we acquired all of the outstanding capital stock of Troy for $15.3 million cash plus common stock valued at $3.0 million (103,065 shares).  Troy derives revenue from system development, networking, engineering, integration services, and information systems security and its primary customer is the federal government.  On June 14, 2002, we acquired the assets of Vector Security, Inc, which consisted of their contracts with federal government agencies, for $5.7 million cash.  Vector provided technology development and engineering services to the federal government.

 

Management will have broad discretion in the allocation of the remaining net proceeds from the sale of stock.  We have no current plans, agreements or commitments for, and are not currently engaged in any negotiations with respect to, any such transaction. Pending their use, the proceeds of this offering have been invested in short-term, investment grade, interest-bearing securities.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None

 

ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS

 

(a)  The Company held its Annual Meeting of Stockholders on May 22, 2002

(the “Annual Meeting”).

 

(b)  n/a

 

(c)  The following matters were voted upon at the Annual Meeting:

 

(i)  To elect three directors to serve until the 2005 annual meeting of stockholders, and until their successors are elected and duly qualified, with 99.5% of the Common Stock present and voting at the meeting voting for Dr. Harbitter, Mr. Lloyd and Ms. Owlett as follows:

 

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NOMINEE		FOR		AGAINST OR WITHHELD
Alan H. Harbitter		24,522,450		114,442
Stuart R. Lloyd		24,522,450		114,442
Sharon M. Owlett		24,522,450		114,442

 

(ii) To ratify the appointment of PricewaterhouseCoopers LLP as our independent auditors for the year ended December 31, 2002 was ratified by 99.5% of the shares of Common Stock present and voting at the meeting. (Votes for: 24,519,487; votes against or withheld: 112,227; abstain: 4,963; broker non-votes: 0).

 

ITEM 5. OTHER INFORMATION

 

None

 

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ITEM 6 (A) EXHIBITS

 

EXHIBIT NUMBER		EXHIBIT DESCRIPTION
3.1*		Certificate of Incorporation
3.2*		By-Laws
10.1*		Office Lease Agreement between Building IV Associates L.P. and the Registrant
10.2*		Amendment No. 1 to Office Lease Agreement between  Building IV Associates L.P. and the Registrant
10.3*		Office Lease Agreement between Building V Associates L.P. and the Registrant
10.4*		Employment Agreement between the Registrant and David C. Karlgaard, dated January 1, 2000
10.5*		Employment Agreement between the Registrant and Paul G. Rice, dated January 1, 2000
10.6*		Employment Agreement between the Registrant and Alan H. Harbitter, dated January 1, 2000
10.7*		Employment Agreement between the Registrant and Stuart R. Lloyd, dated December 31, 1998
10.8*		2000 Stock Incentive Plan
10.9*		1995 Nonqualified Stock Option
10.10*		1987 Stock Option Agreement, as amended
10.11*		Nonqualified Executive Supplemental Retirement Program Agreement dated December 1998
10.12*		2000 Employee Stock Option Plan
10.13*		Amended and Restated Loan Agreement between the Registrant and NationsBank, N.A.
10.14**		Amendment No. 2 to Office Lease Agreement between Building IV Associates L.P. and PEC Solutions, Inc.
10.15**		Amendment No. 3 to Office Lease Agreement between BuildingIV Associates L.P. and PEC Solutions, Inc.
10.16**		Office Lease Agreement between Building VI L.C. and PEC Solutions, Inc.
10.17***		First Amendment to Lease Agreement between Building VI L.C.  and PEC Solutions, Inc.

 

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10.18***		Second Amendment to Lease Agreement between Building VI L.C. and PEC Solutions, Inc.
10.19***		Operating Agreement between Building VI Investment L.C. And PEC Solutions, Inc.
10.20***		First Amendment to Operating Agreement between Building VI Investment L.C. and PEC Solutions, Inc.
10.21***		Bank of America Financing and Security Agreement
10.22***		Bank of America Promissory Note
10.23***		Bank of America Revolving Note
21.1****		Subsidiaries of PEC Solutions, Inc.

 

*                             Incorporated herein by reference to the Company's Registration Statement on Form S-1, No. 333-95331.

 

**                      Incorporated herein by reference to the Company's Annual Report on Form 10K/A filed on April 19, 2001.

 

***               Incorporated herein by reference to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2001, filed August 13, 2001.

 

****        Incorporated herein by reference to the Company’s Annual Report on Form 10-K filed on March 29, 2002.

 

(b)  None

 

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SIGNATURES

 

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED THEREUNTO DULY AUTHORIZED.

 

 

	BY: /s/ STUART R. LLOYD
DATE: AUGUST 14, 2002	STUART R. LLOYD
	CHIEF FINANCIAL OFFICER, SENIOR
	VICE PRESIDENT AND DIRECTOR
	(PRINCIPAL FINANCIAL AND
	ACCOUNTING OFFICER)

 

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