SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

(Mark One)
x	Quarterly Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934
For The Quarter Ended March 31, 2003
Or
o	Transition Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934

 

Commission File Number 000-30271

 

 

PEC SOLUTIONS, INC.

(Exact Name of Registrant as Specified in its Charter)

 

DELAWARE		54-1339972
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
12730 FAIR LAKES CIRCLE, FAIRFAX, VA		22033
(Address of principal executive offices)		(Zip Code)
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

 

Indicate by check mark whether the registrant is an acclelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes ý  No o

 

As of May 14, 2003, 27,043,423 of the registrant’s Common Stock, par value $.01 per share, were outstanding.

 

 

PEC SOLUTIONS, INC.

QUARTERLY REPORT ON FORM 10-Q FOR THE THREE MONTHS ENDED MARCH 31, 2003

 

TABLE OF CONTENTS

 

Item 1. Financial Statements:

Consolidated Balance Sheets — March 31, 2003 and December 31, 2002

Consolidated Statements of Income — Three months ended March 31, 2003 and 2002

Consolidated Statements of Cash Flows — Three months ended March 31, 2003 and 2002

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 March 31, 2003			As of December 31, 2002
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	26,366		$	21,176
Short-term investments		32,120			35,551
Accounts receivable, net		50,011			52,974
Other current assets		2,425			3,452
Total current assets		110,922			113,153
Property and equipment, net		27,804			27,967
Investments		30,470			26,790
Goodwill		16,932			16,932
Intangibles, net		3,487			3,700
Other assets		3,811			3,749
Total assets		$	193,426		$	192,291
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued expenses		$	5,213		$	8,415
Advance payments on contracts		1,766			1,070
Retirement plan contribution payable		647			—
Accrued payroll		3,485			6,836
Accrued vacation		3,198			2,562
Other current liabilities		1,813			935
Total current liabilities		16,122			19,818
Long-term liabilities:
Supplemental retirement program liability		1,055			966
Deferred rent payable		1,459			1,341
Long-term lease obligation		22,886			22,822
Total long-term liabilities		25,400			25,129
Total liabilities		41,522			44,947
Commitments and contingencies
Stockholders’ equity:
Undesignated capital stock, 10,000,000 shares authorized		—			—
Common stock, $0.01 par value, 75,000,000 shares authorized, 27,030,780 and 26,792,565 shares issued and outstanding, respectively		270			268
Additional paid-in capital		92,390			91,071
Retained earnings		59,396			56,046
Accumulated other comprehensive loss		(152		)	(41		)
Total stockholders’ equity		151,904			147,344
Total liabilities and stockholders’ equity		$	193,426		$	192,291

 

See notes to consolidated financial statements.

 

3

 

PEC SOLUTIONS, INC.

CONSOLIDATED STATEMENTS OF INCOME

(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)

 

		Three Months Ended
		March 31, 2003			March 31, 2002
		(Unaudited)
Revenues		$	43,466		$	38,231
Operating costs and expenses:
Direct costs		26,971			22,918
General and administrative expenses		9,159			7,431
Sales and marketing expenses		1,447			1,579
Amortization of intangibles		213			168
Total operating costs and expenses		37,790			32,096
Operating income		5,676			6,135
Other income (loss), net		(23		)	503
Income before income taxes		5,653			6,638
Provision for income taxes		2,162			2,592
Net income		$	3,491		$	4,046
Earnings per share:
Basic		$	0.13		$	0.15
Diluted		$	0.12		$	0.14
Weighted average shares used in computing earnings per share:
Basic		26,935			26,166
Diluted		29,925			29,879

 

See notes to consolidated financial statements.

 

4

 

PEC SOLUTIONS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(DOLLARS IN THOUSANDS)

 

		Three Months Ending
		March 31, 2003			March 31, 2002
		(Unaudited)
Cash flows from operating activities:
Net income		$	3,491		$	4,046
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		665			299
Amortization of intangibles		213			168
Amortization of bond premium and discounts, net		(79		)	(69		)
Deferred rent		118			97
Deferred income taxes		(172		)	(105		)
(Gain) loss from investment in building		(237		)	29
Non-cash charge related to building		64			—
Changes in operating assets and liabilities:
Accounts receivable, net		2,962			(3,089		)
Other current assets		1,313			439
Other assets		(94		)	(211		)
Accounts payable and accrued expenses		(3,202		)	1,378
Advance payments on contracts		696			(352		)
Retirement plan contribution payable		647			402
Accrued payroll		(3,351		)	(3,884		)
Accrued vacation		636			581
Other current liabilities		842			1,524
Supplemental retirement program liability		86			3
Other long-term liabilities		—			(25		)
Net cash provided by operating activities		4,598			1,231
Cash flows from investing activities:
Purchases of property and equipment		(420		)	(202		)
Purchases of short-term investments		(8,035		)	(18,398		)
Proceeds from sale of short-term investments		11,414			22,981
Capitalized software		—			(113		)
Purchase of long-term investments		(5,000		)	(5.400		)
Proceeds from sale of long-term investments		1,271			8
Distribution from building investment		310			—
Net cash used by investing activities		(460		)	(1,124		)
Cash flows from financing activities:
Proceeds from issuance of common stock		1,052			863
Payments on note payable and capital lease obligations		—			(23		)
Net cash provided by financing activities		1,115			840
Net increase in cash		5,190			947
Cash and cash equivalents at beginning of period		21,176			30,436
Cash and cash equivalents at end of period		$	26,366		$	31,383
Income taxes paid		$	2		$	138
Interest paid		$	660		$	1
Non-cash transactions:
Common stock repurchased and retired in exchange for shares in cashless exercise of stock options		$	197		$	7

 

See notes to consolidated financial statements.

 

5

 

PEC SOLUTIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2003

(UNAUDITED)

 

1.  Financial Statements

 

The accompanying consolidated financial statements, except for the December 31, 2002 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 financial statements be read in conjunction with the Company’s audited financial statements as of December 31, 2001 and 2002 and for each of the three years in the period ended December 31, 2002 included in the Company’s 2002 Form 10-K/A, as filed with the Securities and Exchange Commission. The results of operations for the three months ended March 31, 2003, are not necessarily indicative of the operating results to be expected for the full year.

 

2.  Stock-based Compensation

 

The Company has a Stock Option and Incentive Plan, which is described more fully in Note 8. FAS No. 123, “Accounting for Stock-Based Compensation,” as amended by FAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure, an Amendment of FASB Statement No. 123,” requires companies to (i) recognize as expense the fair value of stock-based awards, or (ii) continue to apply the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issues to Employees” and related Interpretations (“APB 25”), and provide pro forma net income and earnings per share disclosures for employee stock option grants as if the fair-value-based method defined in FAS No. 123 had been applied.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of FASB Statement No. 123.” SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair market value based method of accounting for stock-based compensation. The Company does not presently expect to make such a voluntary change. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. These amended disclosure requirements are applicable for financial statements issued for interim periods beginning after December 15, 2002.

 

The Company uses the Black-Scholes option-pricing model to determine the pro forma impact under SFAS No. 123 to the Company’s net income and earnings per share. The model utilizes certain information, such as the interest rate on a risk-free security maturing generally at the same time as the option being valued, and requires certain assumptions, such as the expected amount of time an option will be outstanding until it is exercised or it expires, to calculate the fair value of stock options granted.

 

This information and the assumptions used for March 31, 2003 and 2002 for the Company’s stock option plan are summarized as follows:

 

 

The Company continues to apply the provisions of APB 25 and provide the pro forma disclosures in accordance with the provisions of FAS Nos. 123 and 148. Under APB 25, the Company has not recorded in net income any stock-based employee compensation cost associated with the Company’s stock option plan, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant.

 

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to its stock option plan:

 

6

 

 

 

3.  Accounts Receivable

 

Accounts receivable consist of the following as of:

 

		March 31, 2003			December 31, 2002
		(Dollars in thousands)
Billed accounts receivable		$	42,163		$	45,411
Unbilled accounts receivable:
Amounts currently billable		5,872			5,856
Revenues recorded in excess of contract value or funding		4,064			3,099
Progress payments		(1,766		)	(1,070		)
		50,333			53,296
Allowance for doubtful accounts		(322		)	(322		)
Accounts receivable, net		$	50,011		$	52,974

 

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. Revenues recorded in excess of contract value or funding are billable upon receipt of contractual amendments.  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 1998 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.

 

During the quarter ended March 31, 2003, the Company had two customers that each accounted for more that 10% of revenue.  For the quarter EDS (Navy Marine Corps Intranet) accounted for 13%, or $5.7 million, and from the Special Project Division of the Drug Enforcement Agency accounted for 11%, or $4.7 million.  At March 31, 2003, there was $5.0 million due from EDS and $3.7 million due from the Special Project Division of the Drug Enforcement Agency.  At March 31, 2003 there was $6.3 million due from a subcontract for the Company’s biometric identification system.  As discussed in the Company’s 2002 10-K/A filing, the prime contractor has indicated that they would like to reduce the amount due by $3.7 million, but the Company believes there is no basis for a reduction and expects to receive full payment.  During the quarter ended March 31, 2002, the Company had two customers that each accounted for more than 10% of revenue.  For the quarter EDS (Navy Marine Corps Intranet) accounted for 20%, or $7.6 million, and from the Special Project Division of the Drug Enforcement Agency accounted for 11%, or $4.0 million.  At March 31, 2002 there was $6.2 million due from EDS and $2.7 million due form the Special Project Division of the Drug Enforcement Agency.

 

4.  Net Income Per Share

 

Basic and diluted earnings per share for the three months ended March 31, 2003 and 2002 were determined as follows:

 

		Three Months Ended March 31, 2003								Three Months Ended March 31, 2002
		(Dollars in thousands, except for per share amounts)
		Net Income								Net Income
					Shares		Per Share						Shares		Per Share
Basic EPS		$	3,491		26,934,667		$	0.13		$	4,046		26,166,351		$	0.15
Effect of dilutive options		—			2,990,474		(0.01		)	—			3,712,736		(0.01		)
Diluted EPS		$	3,491		29,925,141		$	0.12		$	4,046		29,879,087		$	0.14

 

7

 

5.  Goodwill and Intangible Assets

 

The Company has recognized goodwill related to its acquisitions of Viking Technology, Inc. (Viking), Troy Systems, Inc. (Troy) and Vector Research, Inc. (Vector).  The Company only has one reporting unit.  Nonamortized intangible assets consist only of goodwill of $16.9 million.  The Company’s amortizable intangible assets include customer contracts and related relationships purchased in the acquisitions of Troy on November 20, 2001 and Vector on June 14, 2002.  The intangibles related to the Troy acquisition totaled $3.0 million and are amortized on a straight-line basis over a 4.5-year period.  The intangibles on the Vector purchase totaled $1.5 million and are being amortized on a straight-line basis over an 8.4-year period.   Total accumulated amortization as of March 31, 2003 was $1.0 million.  There have been no changes in the carrying amount of goodwill for the quarter ended March 31, 2003.  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 months ended March 31, 2003 and 2002 was $213,000 and $168,000, respectively.  Estimated amortization expense for each of the five succeeding calendar years based on the intangible assets as of March 31, 2003 is as follows:

 

 

6.  Investments

 

The Company has an ownership interest in an unconsolidated and affiliated company that owns an office building that the Company leases.  For the three months ended March 31, 2003, the Company  recorded income of $237,000 and received  cash distributions of $310,000 from the investment.  For the three months ended March 31, 2002, the Company recorded a loss of $29,000  and there were no cash distributions.

 

7.  Other Comprehensive Loss

 

Other comprehensive loss, consisting of unrealized gains (losses) on securities was $(111,000) for the three months ended March 31, 2003 and $(164,000) for the three months ended March 31, 2002.

 

8.  Contingencies

 

On or after March 18, 2003, several purported class action complaints were filed against us and certain of our officers in the United States District Court for the Eastern District of Virginia.  The complaints allege that between October 22, 2002 and March 14, 2003, the defendants made, or were aware of false and misleading statements which had the effect of inflating the market price of our stock, in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934.  The complaints do not specify the amount of damages sought.  We believe that the plaintiffs’ claims are without merit, and we intend to defend the cases vigorously.  In addition, a stockholder’s legal counsel sent a letter of demand that the Board investigate the same charges addressed in the class action suites.

 

9.  Recent Pronouncements

 

In November 2002, the FASB’s Emerging Issues Task Force, or EITF, finalized EITF Issue 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF 00-21 addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. It also addresses how arrangement consideration should be measured and allocated to the separate units of accounting in an arrangement. EITF 00-21 does not apply to deliverables in arrangements to the extent the accounting for such deliverables are within the scope of other existing higher-level authoritative accounting literature. The Company must adopt the provisions of EITF 00-21 for new contracts entered into on or after July 1, 2003. The Company has already adopted the provisions of EITF 00-21 and the adoption has not had a material impact on the Company’s financial position, results of operations, or cash flows.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of FASB Statement No. 123.” SFAS No. 148 provides alternative methods of transition for a voluntary change to

 

8

 

the fair market value based method of accounting for stock-based compensation. The Company does not presently expect to make such a voluntary change. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results and have been reflected in Note 2, Stock Based Compensation. These amended disclosure requirements are applicable for financial statements issued for interim periods beginning after December 15, 2002.

 

In November 2002, FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an Interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34,” (“FIN 45”) was issued. FIN 45clarifies the requirements of SFAS No. 5, “Accounting for Contingencies,” relating to guarantors’ accounting for, and disclosure of, the issuance of certain types of guarantees. The disclosure provisions of FIN 45 are applicable to interim or annual periods that end after December 15, 2002, and did not have an impact on the March 31, 2003 financial statements. The provisions for initial recognition and measurement under FIN 45 are effective on a prospective basis for guarantees that are issued or modified after December 31, 2002. The initial recognition and measurement provisions under FIN 45 did not have any impact on the Company’s financial statements.

 

On January 17, 2003, the Financial Accounting Standards Board (FASB or the “Board”) issued FASB Interpretation No. 46, (FIN 46), “Consolidation of Variable Interest Entities”. The provisions will be the guidance that determines (1) whether consolidation is required under the “controlling financial interest” model of Accounting Research Bulletin No. 51 (ARB 51), “Consolidated Financial Statements” 51 (or other existing authoritative guidance) or, alternatively, (2) whether the variable interest model under FIN 46 should be used to account for existing and new entities. At this time, the Company does not have any entities that would be covered under FIN 46.

 

 

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 contracts with various payment arrangements, including time and materials contracts, fixed-price contracts and cost-reimbursable contracts. During the three months ended March 31, 2003, revenues from these contract types were approximately 57%, 23% and 20%, respectively, of total revenues. During the three months ended March 31, 2002, revenues from these contract types were approximately 59%, 20% and 21%, 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.  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 95% of our revenues in the three months ended March 31 2003. As of March 31, 2003, we had 1,315 personnel.

 

In the three months ended March 31, 2003, we derived approximately 27% of our revenues through relationships with prime contractors, which contract directly with the end-client and subcontract with us. In most of these engagements, with the exception of the EDS (NMCI) subcontract, 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.

 

9

 

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 (loss) consists primarily of interest income earned on our cash, cash equivalents and marketable securities, and income from our investment in the limited liability corporation that owns the corporate headquarters office building and the interest expense associated with that building.

 

Results of Operations

 

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

 

		Three Months Ended
		March 31, 2002			March 31, 2002
		(Dollars in thousands)
Statement of Income:
Revenues		$	43,466		$	38,231
Direct costs		26,971			22,918
Gross profit (a)		16,495			15,313
Other operating costs and expenses:
General and administrative expenses		9,159			7,431
Sales and marketing expenses		1,447			1,579
Goodwill and intangible amortization		213			168
Total other operating costs and expenses		10,819			9,178
Operating income		5,676			6,135
Other income (loss), net		(23		)	503
Income before income taxes		5,653			6,638
Provision for income taxes		2,162			2,592
Net income		$	3,491		$	4,046
As a Percentage of Revenues:
Revenues		100.0		%	100.0		%
Direct costs		62.0			60.0
Gross profit (a)		38.0			40.0
Other operating costs and expenses:
General and administrative expenses		21.1			19.4
Sales and marketing expenses		3.3			4.1
Amortization of goodwill		0.5			0.4
Total other operating costs and expenses		24.9			23.9
Operating income		13.1			16.1
Other income, net		(0.1		)	1.3
Income before income taxes		13.0			17.4
Provision for income taxes		5.0			6.8
Net income		8.0		%	10.6		%

 

(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 March 31, 2003 Compared with The Three Months Ended March 31, 2002

 

Revenues.  Our total revenues increased by 13.7%, or $5.2 million, for the three months ended March 31, 2003, 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

 

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new clients, which represents approximately 5% of revenues.

 

Direct Costs. Our direct costs increased by 17.7%, or 4.1 million, for the three months ended March 31, 2003, over the same period last year.  Direct costs increased as a percentage of revenues for the period ended March 31, 2003, to 62.0% as compared to 60.0% in the same period last year.  This increase was attributable primarily to the delays related to the passage and signing of the Federal civilian budgets and the associated lack of new project startups during the quarter.  New project startups normally allow for the recovery of increases in labor costs, which for us go into effect January 1^st of each year.

 

Gross Profit. Gross profit increased by 7.7% to $16.5 million in the three months ended March 31, 2003 from $15.3 million in the three months ended March 31, 2002. Gross profit as a percentage of revenues decreased to 38.0% in the three months ended March 31, 2003 from 40.0% in the three months ended March 31, 2002, as direct costs increased at a faster rate than revenues.  As previously indicated revenues were impacted by the late passage and signing of the Federal civilian budgets.

 

General and Administrative Expenses. General and administrative expenses increased 23.3% to $9.2 million in the three months ended March 31, 2003 from $7.4 million in the three months ended March 31, 2002. Facility costs increased in the current quarter over last year due to the opening of our new headquarters office in Fairfax, VA and an office in Washington, DC.  Our total general and administrative headcount decreased to 123 employees as of March 31, 2003 compared to 139 employees as of March 31, 2002.

 

Sales and Marketing. Sales and marketing expenses decreased 8.4% to $1.4 million in the three months ended March 31, 2003, from $1.6 million in the three months ended March 31, 2002. This decrease was due to a decrease in our marketing and proposal efforts during the quarter related to the delay in the passage of the Federal civilian budgets in 2003.

 

Amortization of Intangibles.  For the three months ended March 31, 2003, we incurred $213,000 of amortization expense related to the $4.5 million of intangibles we recorded in connection with the value of contracts and customer relationships acquired in the November 2001 acquisition of Troy, and the June 2002 acquisition of Vector.   For the three months ended March 31, 2002, we incurred $168,000 of amortization 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.

 

Operating Income. Operating income decreased 7.5% to $5.7 million in the three months ended March 31, 2003 from $6.1 million in the three months ended March 31, 2002, due to the factors discussed above.

 

Other income (loss).  Other income (loss) decreased to a loss ($23,000) in the three months ended March 31, 2003 from income of $503,000 in the three months ended March 31, 2002.  The decrease was principally related to the $660,000 interest expense created by the accounting treatment of the monthly lease payments on our headquarters building.

 

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 negatively affect the rate at which the federal government purchases technology, although we have not seen a negative impact with the current 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

 

Net cash provided by operating activities was $4.6 million for the three months ended March 31, 2003. Cash provided by operating activities was primarily from net income, adjusted for working capital changes, principally a decrease in accounts receivable and a decreases in accounts payable, accrued expenses and accrued payroll.

 

Net cash used by investing activities was $0.5 million for the three months ended March 31, 2003. During the three months ended March 31, 2003, we purchased $0.4 million of property and equipment and $3.7 million of net long-term investments, while

 

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selling $3.4 million of net short-term investments and receiving $0.3 million of distributions from the investment in our building joint venture.

 

Net cash provided by financing activities was $1.1 million principally from the sale of common stock to employees upon the exercise of their stock options and purchase of stock through the employee stock purchase plan for the three months ended March 31, 2003.

 

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 one-month LIBOR rate plus 250 basis points per annum and expiring on June 30, 2003.  We are in the process of renewing this line of credit.  As of March 31, 2003, we had no borrowings outstanding under the line of credit. We have $2.98 million outstanding 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 March 31, 2003, our accounts receivable turnover rate, net of advance payments on contracts, was approximately four times a year.

 

Recent Accounting Pronouncements

 

In November 2002, the FASB’s Emerging Issues Task Force, or EITF, finalized EITF Issue 00-21. “Revenue Arrangements with Multiple Deliverables.” EITF 00-21 addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. It also addresses how arrangement consideration should be measured and allocated to the separate units of accounting in an arrangement. EITF 00-21 does not apply to deliverables in arrangements to the extent the accounting for such deliverables are within the scope of other existing higher-level authoritative accounting literature.  We must adopt the provisions of EITF 00-21 for new contracts entered into on or after July 1, 2003. We have already adopted the provisions of EITF 00-21 and the adoption has not had a material impact on our financial position, results of operations, or cash flows.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of FASB Statement No. 123.” SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair market value based method of accounting for stock-based compensation. We do not presently expect to make such a voluntary change. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. These amended disclosure requirements are applicable for financial statements issued for interim periods beginning after December 15, 2002, and reflected in the notes to the financial statements.

 

In November 2002, FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an Interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34,” (“FIN 45”) was issued. FIN 45 clarifies the requirements of SFAS No. 5, “Accounting for Contingencies,” relating to guarantors’ accounting for, and disclosure of, the issuance of certain types of guarantees. The disclosure provisions of FIN 45 are applicable to interim or annual periods that end after December 15, 2002, and did not have an impact on the March 31, 2003 financial statements. The provisions for initial recognition and measurement under FIN 45 are effective on a prospective basis for guarantees that are issued or modified after December 31, 2002.  The initial recognition and measurement provisions under FIN 45 did not have any  impact on our financial statements.

 

On January 17, 2003, the Financial Accounting Standards Board (FASB or the “Board”) issued FASB Interpretation No. 46, (FIN 46), Consolidation of Variable Interest Entities. The provisions will be the guidance that determines (1) whether consolidation is required under the “controlling financial interest” model of Accounting Research Bulletin No. 51 (ARB 51), Consolidated Financial Statements 51 (or other existing authoritative guidance) or, alternatively, (2) whether the variable interest model under FIN 46 should be used to account for existing and new entities. At this time, we do not have any entities that would be covered under FIN 46.

 

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-

 

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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 Annual Report on Form 10-K/A (SEC File No. 000-30271) 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 consisting of commercial paper, bankers’ acceptances, certificates of deposit, euro-dollar time deposits and variable rate issues, corporate notes 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 rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations because of changes in interest rates or we may suffer losses in principal if we are forced to sell securities which have seen a decline in market value because of changes in interest rates.  A 10% change in interest rates could have approximately a $150,000 impact on our interest income.

 

Our investments are made in accordance with an investment policy approved our Board of Directors. Under this policy, no investment securities can have maturities exceeding two years and the average duration of the portfolio cannot exceed twelve months.

 

ITEM  4.  Controls and Procedures

 

Our management, under the supervision and with the participation of David C. Karlgaard, our Chief Executive Officer, and Stuart R. Lloyd, our Chief Financial Officer, performed an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures within 90 days before the filing date of this quarterly report.  Based on that evaluation, Messrs. Karlgaard and Lloyd concluded that our disclosure controls and procedures were effective.  There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to their evaluation.

 

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PART II — OTHER INFORMATION

 

ITEM 1.          LEGAL PROCEEDINGS

 

On or after March 18, 2003, several purported class action complaints were filed against us and certain of our officers in the United States District Court for the Eastern District of Virginia.  The complaints allege that between October 22, 2002 and March 14, 2003, the defendants made, or were aware of false and misleading statements which had the effect of inflating the market price of our stock, in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934.  The complaints do not specify the amount of damages sought.  We believe that the plaintiffs’ claims are without merit, and we intend to defend the cases vigorously.  In addition, a stockholder’s legal counsel sent a letter of demand that the Board investigate the same charges addressed in the class actions suits.

 

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 two 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 was 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 derived 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, 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

 

None

 

ITEM 5.          OTHER INFORMATION

 

None

 

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ITEM 6           (A) 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 Building IV 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.
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 L.C. and PEC Solutions, Inc.
10.21***		Bank of America Promissory Note
10.22***		Bank of America Revolving Note
10.23		Amendment to Bank of America Promissory Note
10.24		Amendment to Bank of America Revolving Note
21.1****		Subsidiaries of PEC Solutions, Inc.
99.1		Certification of Principal Executive Officer Pursuant to 18 U.S.C. 1350
99.2		Certification of Principal Financial Officer Pursuant to 18 U.S.C. 1350

 

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*		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 10-K/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.

 

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(b)   None

 

Signatures

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

		BY:	/s/ STUART R. LLOYD
			Stuart R. Lloyd
			Chief Financial Officer, Senior Vice President and Director (Principal Financial and Accounting Officer)

 

May 14, 2003

 

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Certifications

 

I, David C. Karlgaard, certify that:

 

1.                                       I have reviewed this quarterly report on Form 10-Q of PEC Solutions, Inc.;

 

2.                                       Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3.                                       Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4.                                       The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

 

b)                                     Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c)                                      Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures abased on our evaluation as of the Evaluation Date;

 

5.                                       The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

 

a)                                      All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weakness in internal controls; and

 

b)                                     Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6.                                       The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

May 14, 2003	By:	/s/  DAVID C. KARLGAARD
		Name: David C. Karlgaard
		Title: President, Chief Executive Officer and Chairman (Principal Executive Officer)

 

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I, Stuart R. Lloyd, certify that:

 

1.                                       I have reviewed this quarterly report on Form 10-Q of PEC Solutions, Inc.;

 

2.                                       Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3.                                       Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4.                                       The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b)                                     Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c)       Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures abased on our evaluation as of the Evaluation Date;

 

5.                                       The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

 

a)                                      All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weakness in internal controls; and

 

b)                                     Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6.                                       The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

May 14, 2003	By:	/s/  STUART R. LLOYD
		Name: Stuart R. Lloyd
		Title: Chief Financial Officer, Senior Vice President and Director (Principal Financial and Accounting Officer)

 

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