**UNITED STATES**

 

**SECURITIES AND EXCHANGECOMMISSION**

 

**WASHINGTON,D.C. 20549 - 0001**

 

**FORM 10-Q**

 

| **(Mark One)**                           |
|------------------------------------------|
|                                     |   |
|                                     | **ý** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                     |   |
| **FOR THE  QUARTER ENDED JUNE 30, 2003** |
|                                     |   |
| **or**                                   |
|                                     |   |
|                                     | **o** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**COMMISSIONFILE NUMBER 000-30271**

 

 

**PEC SOLUTIONS, INC.**

(EXACT NAME OF REGISTRANTAS 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 telephonenumber, 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 theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter 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 registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).Yes  ý   No o

 

As of August 14, 2003, 27,153,292 of theregistrant’s Common Stock, par value $.01 per share, were outstanding.

 

 

----

 

**PECSOLUTIONS, INC.**

**QUARTERLYREPORT ON FORM 10-Q FOR THE SIX MONTHS ENDED JUNE 30, 2003**

 

**TABLE OFCONTENTS**

 
| PART I.  FINANCIAL INFORMATION                                                                 |
|-----------------------------------------------------------------------------------------------------|
| Item 1. Financial Statements:                                                                       |
| Consolidated Balance Sheets - June 30, 2003 and December 31, 2002                                   |
| Consolidated Statements of Income - Three  and six months ended June 30, 2003 and 2002              |
| Consolidated Statements of Cash Flows — Six  months ended June 30, 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                                                                                          |

 

3

----

 

**PART I: FINANCIAL INFORMATION**

 

**ITEM 1: FINANCIAL STATEMENTS**

 

**PECSOLUTIONS, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(DOLLARSIN THOUSANDS)**

 
|                                                                                                                                 |   | **AS OF  JUNE 30,  2003** |    | **AS OF  DEC. 31,  2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------|---------|---------------------------|--------|
|                                                                                                                                 |   | **(Unaudited)**           |    |
| **ASSETS**                                                                                                                           |   |                      |    |                      |   |
| Current assets:                                                                                                                      |   |                      |    |                      |   |
| Cash and cash  equivalents                                                                                                           |   | $                         | 36,343  |                      | $      | 21,176 |   |
| Short-term investments                                                                                                               |   | 30,054                    |    | 35,551                    |   |
| Accounts receivable, net                                                                                                             |   | 46,644                    |    | 52,974                    |   |
| Other current assets                                                                                                                 |   | 3,130                     |    | 3,452                     |   |
| Total current assets                                                                                                                 |   | 116,171                   |    | 113,153                   |   |
|                                                                                                                                 |   |                      |    |                      |   |
| Property and equipment,  net                                                                                                         |   | 27,413                    |    | 27,967                    |   |
| Investments                                                                                                                          |   | 32,299                    |    | 26,790                    |   |
| Goodwill                                                                                                                             |   | 16,932                    |    | 16,932                    |   |
| Intangibles, net                                                                                                                     |   | 3,275                     |    | 3,700                     |   |
| Other assets                                                                                                                         |   | 4,061                     |    | 3,749                     |   |
| Total assets                                                                                                                         |   | $                         | 200,151 |                      | $      | 192,291 |   |
|                                                                                                                                 |   |                      |    |                      |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                        |   |                      |    |                      |   |
|                                                                                                                                 |   |                      |    |                      |   |
| Current liabilities:                                                                                                                 |   |                      |    |                      |   |
| Accounts payable and  accrued expenses                                                                                               |   | $                         | 6,608   |                      | $      | 8,415 |   |
| Advance payments on  contracts                                                                                                       |   | 598                       |    | 1,070                     |   |
| Retirement plan  contribution payable                                                                                                |   | 1,112                     |    | —                    |   |
| Accrued payroll                                                                                                                      |   | 4,124                     |    | 6,836                     |   |
| Accrued vacation                                                                                                                     |   | 3,266                     |    | 2,562                     |   |
| Other current  liabilities                                                                                                           |   | 843                       |    | 935                       |   |
| Total current  liabilities                                                                                                           |   | 16,551                    |    | 19,818                    |   |
|                                                                                                                                 |   |                      |    |                      |   |
| Long-term liabilities:                                                                                                               |   |                      |    |                      |   |
| Supplemental retirement  program liability                                                                                           |   | 1,275                     |    | 966                       |   |
| Deferred rent payable                                                                                                                |   | 1,578                     |    | 1,341                     |   |
| Long-term lease  obligation                                                                                                          |   | 22,950                    |    | 22,822                    |   |
| Total long-term  liabilities                                                                                                         |   | 25,803                    |    | 25,129                    |   |
| Total liabilities                                                                                                                    |   | 42,354                    |    | 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, 27,132,673 and 26,792,565 shares issued  and outstanding, respectively |   | 271                       |    | 268                       |   |
| Additional paid-in  capital                                                                                                          |   | 93,637                    |    | 91,071                    |   |
| Retained earnings                                                                                                                    |   | 64,034                    |    | 56,046                    |   |
| Accumulated other  comprehensive loss                                                                                                |   | (145                      | )       | (41                       | )      |
| Total stockholders’  equity                                                                                                     |   | 157,797                   |    | 147,344                   |   |
| Total liabilities and  stockholders’ equity                                                                                     |   | $                         | 200,151 |                      | $      | 192,291 |   |

 

See notes to consolidatedfinancial statements.

 

4

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**PECSOLUTIONS, INC.**

**CONSOLIDATED STATEMENTS OF INCOME**

**(AMOUNTSIN THOUSANDS, EXCEPT PER SHARE DATA)**

 
|                                                           |   | **THREE MONTHS ENDED** |   | **SIX MONTHS ENDED** |   |
|----------------------------------------------------------------|--------|------------------------|--------|----------------------|--------|
|                                                           |   | **JUNE 30,  2003**     |   | **JUNE 30,  2002**   |   | **JUNE 30,  2003** |   | **JUNE 30,  2002** |   |
|                                                           |   | **(Unaudited)**        |   |
| Revenues                                                       |   | $                      | 44,265 |                 | $      | 42,761 |   | $ | 87,731 |   | $ | 80,992 |   |
| Operating costs and  expenses:                                 |   |                   |   |                 |   |   |   |   |   |
| Direct costs                                                   |   | 25,711                 |   | 25,511               |   | 52,682 |   | 48,430 |   |
| General and  administrative expenses                           |   | 9,074                  |   | 8,090                |   | 18,233 |   | 15,521 |   |
| Sales and marketing  expenses                                  |   | 1,635                  |   | 1,462                |   | 3,082 |   | 3,041 |   |
| Goodwill and intangible  amortization                          |   | 212                    |   | 213                  |   | 425 |   | 381 |   |
| Total operating costs  and expenses                            |   | 36,632                 |   | 35,276               |   | 74,422 |   | 67,373 |   |
| Operating income                                               |   | 7,633                  |   | 7,485                |   | 13,309 |   | 13,619 |   |
| Investment and other  income                                   |   | 540                    |   | 469                  |   | 1,177 |   | 973 |   |
| Interest expense                                               |   | (662                   | )      | (5                   | )      | (1,322 | ) | (6 | ) |
| Income before income  taxes                                    |   | 7,511                  |   | 7,949                |   | 13,164 |   | 14,586 |   |
| Provision for income  taxes                                    |   | 2,873                  |   | 3,104                |   | 5,035 |   | 5,696 |   |
| Net income                                                     |   | $                      | 4,638  |                 | $      | 4,845 |   | $ | 8,129 |   | $ | 8,890 |   |
| Earnings per share:                                            |   |                   |   |                 |   |   |   |   |   |
| Basic                                                          |   | $                      | 0.17   |                 | $      | 0.18 |   | $ | 0.30 |   | $ | 0.34 |   |
| Diluted                                                        |   | $                      | 0.16   |                 | $      | 0.16 |   | $ | 0.27 |   | $ | 0.30 |   |
| Weighted average shares  used in computing earnings per share: |   |                   |   |                 |   |   |   |   |   |
| Basic                                                          |   | 27,047                 |   | 26,261               |   | 26,991 |   | 26,214 |   |
| Diluted                                                        |   | 29,491                 |   | 29,787               |   | 29,720 |   | 29,847 |   |

 

See notes to consolidatedfinancial statements.

 

5

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**PECSOLUTIONS, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(DOLLARSIN THOUSANDS)**

 
|                                                                                               |   | **SIX MONTHS  ENDING** |   |
|----------------------------------------------------------------------------------------------------|--------|------------------------|--------|
|                                                                                               |   | **JUNE 30,  2003**     |   | **JUNE 30,  2002** |   |
|                                                                                               |   | **(Unaudited)**        |   |
| Cash flows from  operating activities:                                                             |   |                   |   |   |   |
| Net income                                                                                         |   | $                      | 8,129  |   | $ | 8,890 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities:                 |   |                   |   |   |   |
| Depreciation and  amortization                                                                     |   | 1,441                  |   | 643 |   |
| Amortization of  intangibles                                                                       |   | 425                    |   | 381 |   |
| Amortization of bond  premium and discounts, net                                                   |   | 52                     |   | 65 |   |
| Deferred rent                                                                                      |   | 237                    |   | 195 |   |
| Deferred income taxes                                                                              |   | (310                   | )      | (241 | ) |
| (Gain) loss from  investment in building                                                           |   | (471                   | )      | 49 |   |
| Non-cash charge related  to building                                                               |   | 128                    |   | — |   |
| Changes in operating  assets and liabilities:                                                      |   |                   |   |   |   |
| Accounts receivable, net                                                                           |   | 6,329                  |   | (6,472 | ) |
| Other current assets                                                                               |   | 531                    |   | 1,062 |   |
| Other assets                                                                                       |   | (184                   | )      | 72 |   |
| Accounts payable and  accrued expenses                                                             |   | (1,807                 | )      | 2,853 |   |
| Advance payments on  contracts                                                                     |   | (472                   | )      | (78 | ) |
| Retirement plan  contribution payable                                                              |   | 1,112                  |   | 1,141 |   |
| Accrued payroll                                                                                    |   | (2,712                 | )      | (2,957 | ) |
| Accrued vacation                                                                                   |   | 704                    |   | 803 |   |
| Other current  liabilities                                                                         |   | 42                     |   | (1,158 | ) |
| Supplemental retirement  program liability                                                         |   | 308                    |   | 41 |   |
| Net cash provided by  operating activities                                                         |   | 13,482                 |   | 5,289 |   |
| Cash flows from  investing activities:                                                             |   |                   |   |   |   |
| Purchases of property  and equipment                                                               |   | (722                   | )      | (908 | ) |
| Purchases of short-term  investments                                                               |   | (21,818                | )      | (61,234 | ) |
| Proceeds from sale of  short-term investments                                                      |   | 27,160                 |   | 72,566 |   |
| Purchase of assets                                                                                 |   | —                 |   | (5,852 | ) |
| Capitalized software                                                                               |   | (193                   | )      | (14 | ) |
| Purchases of long-term  investments                                                                |   | (7,079                 | )      | (13,743 | ) |
| Proceeds from sale of  long-term investments                                                       |   | 1,628                  |   | 6,306 |   |
| Distributions from  building investment                                                            |   | 413                    |   | — |   |
| Net cash used by  investing activities                                                             |   | (611                   | )      | (2,879 | ) |
| Cash flows from  financing activities:                                                             |   |                   |   |   |   |
| Proceeds from issuance  of common stock                                                            |   | 2,296                  |   | 1,415 |   |
| Payments on capital  lease obligations                                                             |   | —                 |   | (21 | ) |
| Net cash provided by  financing activities                                                         |   | 2,296                  |   | 1,394 |   |
| Net increase in cash                                                                               |   | 15,167                 |   | 3,804 |   |
| Cash and cash  equivalents at beginning of period                                                  |   | 21,176                 |   | 30,436 |   |
| Cash and cash  equivalents at end of period                                                        |   | $                      | 36,343 |   | $ | 34,240 |   |
| Income taxes paid                                                                                  |   | $                      | 3,059  |   | $ | 4,678 |   |
| Interest paid                                                                                      |   | $                      | 1,322  |   | $ | 6 |   |
| Non-cash transactions:                                                                             |   |                   |   |   |   |
| Common stock repurchased  and retired in exchange for shares in cashless exercise of stock options |   | $                      | 197    |   | $ | 175 |   |

 

See notes to consolidatedfinancial statements.

 

6

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**PECSOLUTIONS, INC.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**JUNE 30,2003**

**(UNAUDITED)**

**1. Financial Statements**

 

The accompanying consolidated financialstatements, except for the December 31, 2002 balance sheet, are unaudited andhave been prepared in accordance with accounting standards generally acceptedin the United States for interim financial information and the instructions toForm 10-Q and Article 10 of Regulation S-X. Accordingly, certain informationand footnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally in the United States have beenomitted. In the opinion of management, all adjustments, consisting of normallyrecurring accruals, considered necessary for a fair presentation, have beenincluded. It is suggested that these condensed financial statements be read inconjunction with the Company’s audited financial statements for the years endedDecember 31, 2001 and 2002 and for each of the three years in the period endedDecember 31, 2002 included in the Company’s 2002 Form 10-K/A, as filed with theSecurities and Exchange Commission. The results of operations for the sixmonths ended June 30, 2003, are not necessarily indicative of the operatingresults to be expected for the full year.

 

**2.Stock-based Compensation**

 

In December 2002, the FASB issued SFASNo. 148, “Accounting for Stock-Based Compensation—Transition andDisclosure, an amendment of FASB Statement No. 123.” SFAS No. 148provides alternative methods of transition for a voluntary change to the fairmarket value based method of accounting for stock-based compensation. TheCompany does not presently expect to make such a voluntary change. In addition,SFAS No. 148 amends the disclosure requirements of SFAS No. 123 torequire prominent disclosures in both annual and interim financial statementsabout the method of accounting for stock-based employee compensation and theeffect of the method used on reported results. These amended disclosurerequirements are applicable for financial statements issued for interim periodsbeginning after December 15, 2002, and have been included below.

 

The Company uses the Black-Scholesoption-pricing model to determine the pro forma impact under SFAS No. 123to the Company’s net income and earnings per share. The model utilizes certaininformation, such as the interest rate on a risk-free security maturinggenerally at the same time as the option being valued, and requires certainassumptions, such as the expected amount of time an option will be outstandinguntil it is exercised or it expires, to calculate the fair value of stockoptions granted.

 

This information and the assumptions used forthe six months ended June 30, 2003 and 2002 for the Company’s stock option andstock purchase plans are summarized as follows:

 
|                                                 |   | **STOCK  OPTION PLAN**       |   | **STOCK  PURCHASE PLAN** |   |
|------------------------------------------------------|--------|------------------------------|--------|--------------------------|--------|
|                                                 |   | **FOR THE SIX MONTHS ENDED** |   |
|                                                 |   | **JUNE 30,  2003**           |   | **JUNE 30,  2002**       |   | **JUNE 30,  2003** |   | **JUNE 30,  2002** |   |
|                                                 |   |                         |   |                     |   |   |   |   |   |
| Volatility                                           |   | 47.62                        | %      | 52.69                    | %      | 47.62 | % | 52.69 | % |
| Risk-free  interest rate                             |   | 3.54                         | %      | 4.86                     | %      | 0.98 | % | 1.75 | % |
| Dividend yield                                       |   | 0                            | %      | 0                        | %      | 0 | % | 0 | % |
| Expected lives                                       |   | 10 years                     |   | 10 years                 |   | 0.50 years |   | 0.50 years |   |
|                                                 |   |                         |   |                     |   |   |   |   |   |
| Weighted  average fair value per share at grant date |   | $                            | 7.88   |                     | $      | 4.39 |   | $ | 1.85 |   | $ | 2.99 |   |
|                                                      |        |                              |        |                          |        |  |  |  |  |  |  |  |  |

 

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

 

7

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The following table illustrates the effect onnet income and earnings per share if the Company had applied the fair valuerecognition provisions of SFAS No. 123 to its stock option and stockpurchase plans:

 

|                                        |   | **FOR THE THREE MONTHS ENDED**                    |   | **FOR THE SIX MONTHS ENDED** |   |
|---------------------------------------------|--------|---------------------------------------------------|--------|------------------------------|--------|
|                                        |   | **JUNE 30, 2003**                                 |   | **JUNE 30, 2002**            |   | **JUNE 30, 2003** |   | **JUNE 30, 2002** |   |
|                                        |   | **(In thousands, except for per share  amounts)** |   |
| Net income, as  reported                    |   | $                                                 | 4,638  |                         | $      | 4,845 |   | $ | 8,129 |   | $ | 8,890 |   |
| Pro forma  compensation expense, net of tax |   | (618                                              | )      | (594                         | )      | (1,148 | ) | (1,084 | ) |
|                                        |   |                                              |   |                         |   |   |   |   |   |
| Pro forma net  income                       |   | $                                                 | 4,020  |                         | $      | 4,251 |   | $ | 6,981 |   | $ | 7,806 |   |
|                                        |   |                                              |   |                         |   |   |   |   |   |
| Net income  (loss) per share:               |   |                                              |   |                         |   |   |   |   |   |
| Basic—as  reported                     |   | $                                                 | 0.17   |                         | $      | 0.18 |   | $ | 0.30 |   | $ | 0.34 |   |
| Basic—pro forma                        |   | $                                                 | 0.15   |                         | $      | 0.16 |   | $ | 0.26 |   | $ | 0.30 |   |
| Diluted—as  reported                   |   | $                                                 | 0.16   |                         | $      | 0.16 |   | $ | 0.27 |   | $ | 0.30 |   |
| Diluted—pro  forma                     |   | $                                                 | 0.14   |                         | $      | 0.14 |   | $ | 0.23 |   | $ | 0.26 |   |

 

**3. Accounts Receivable**

 

Accounts receivable consist of the followingas of:

 
|                                                      |   | **JUNE 30, 2003**          |   | **DECEMBER 31, 2002** |   |
|-----------------------------------------------------------|--------|----------------------------|--------|-----------------------|--------|
|                                                      |   | **(Dollars in thousands)** |   |
| Billed accounts  receivable                               |   | $                          | 39,608 |                  | $      | 45,411 |   |
| Unbilled accounts  receivable:                            |   |                       |   |                  |   |
| Amounts currently  billable                               |   | 3,439                      |   | 5,856                 |   |
| Revenues recorded in  excess of contract value or funding |   | 4,507                      |   | 3,099                 |   |
| Progress payments                                         |   | (598                       | )      | (1,070                | )      |
|                                                      |   | 46,956                     |   | 53,296                |   |
| Allowance for doubtful  accounts                          |   | (312                       | )      | (322                  | )      |
| Accounts receivable, net                                  |   | $                          | 46,644 |                  | $      | 52,974 |   |

 

Unbilled accounts receivable compriserecognized recoverable costs and accrued profits on contracts for whichbillings had not been presented to clients as of the balance sheet date.Revenues recorded in excess of contract value or funding are billable uponreceipt of contractual amendments.  Management anticipatesthe 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. Allyears subsequent to 2000 are subject to U.S. Government audit. Managementbelieves the effect of audit adjustments, if any, on periods not yet audited,will not have a material effect on the financial statements.

 

During the sixmonths ended June 30, 2003, the Company had one customer that accounted formore that 10% of revenue.  EDS (NavyMarine Corps Intranet) accounted for 11.7% of revenue, or $10.3 million.  At June 30, 2003, there was $6.3 milliondue  from EDS.  At June 30, 2003 there was $6.3 million due on a subcontract forthe Company’s biometric identification system. The Company is working with the prime contractor to receive full paymenton this receivable, and expects to receive full payment.  During the six months ended June 30, 2002,the Company had one customer that accounted for more than 10% of revenue.  EDS (Navy Marine Corps Intranet) accountedfor 19.6% of revenue, or $15.9 million. At June 30, 2002, there was $19.4 million due from EDS.

 

**4. Net Income Per Share**

 

Basic and diluted earnings per share for the three months andsix months ended June 30, 2003 and 2002 were determined as follows:

 
|                        |   | **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 |   |

 
|                        |   | **THREE MONTHS ENDED JUNE 30, 2003**                      |   | **SIX MONTHS ENDED JUNE 30, 2003** |       |
|-----------------------------|--------|-----------------------------------------------------------|--------|------------------------------------|------------|
|                        |   | **(Dollars in thousands, except for per share  amounts)** |   |
|                        |   | **NET  INCOME**                                           |   | **SHARES**                         |       | **PER SHARE** |   | **NET  INCOME** |   | **SHARES** |   | **PER SHARE** |   |
| Basic EPS                   |   | $                                                         | 4,638  |                               | 27,047,227 |   | $ | 0.17 |   | $ | 8,129 |   | 26,991,481 |   | $ | 0.30 |   |
| Effect of dilutive  options |   | —                                                    |   | 2,443,813                          |       | (0.01 | ) | — |   | 2,728,290 |   | (0.03 | ) |
| Diluted EPS                 |   | $                                                         | 4,638  |                               | 29,491,040 |   | $ | 0.16 |   | $ | 8,129 |   | 29,719,771 |   | $ | 0.27 |   |

 

8

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**5. Goodwill and Intangible Assets**

 

The Company has recognized goodwill relatedto its acquisitions of Viking Technology, Inc. (“Viking”), Troy Systems, Inc.(“Troy”) and Vector.  The Company onlyhas one reporting unit.  Nonamortizedintangible assets consist only of goodwill of $16.9 million.  The Company’s amortizable intangible assetsinclude customer contracts and related relationships purchased in theacquisitions of Troy on November 20, 2001 and Vector on June 14, 2002.  The intangibles related to the Troyacquisition totaled $3.0 million and are amortized on a straight-line basisover a 4.5-year period.  The intangibleson the Vector purchase totaled $1.5 million and are being amortized on astraight-line basis over an 8.4-year period. Total accumulated amortization as of June 30, 2003 was $1.3 million.  In accordance with the provisions of SFASNo. 142, the Company performed the appropriate annual impairment tests duringthe three months ended March 31, 2003 related to its stated goodwill, anddetermined that there was no impairment loss, and therefore no change was madeto the carrying amount of goodwill.

 

Intangibles are amortized on a straight-linebasis.  Estimated annual amortizationexpense for each of the five following calendar years is as follows:

 
| **Year ending December 31,** |   | **Amount**                  |   |
|------------------------------|--------|-----------------------------|--------|
|                         |   | **(Dollars in  thousands)** |   |
| 2003                         |   | $                           | 851    |   |
| 2004                         |   | 851                         |   |
| 2005                         |   | 851                         |   |
| 2006                         |   | 851                         |   |
| 2007                         |   | 296                         |   |
|                              |        |                             |        |  |

 

**6. Investments**

 

The Companyhas an ownership interest in an unconsolidated and affiliated company that ownsan office building that the Company leases. For the three months and six months ended June 30, 2003, the Companyrecorded income of $234,000 and $471,000, respectively.  It also received cash distributions of  $103,000 and $413,000, respectively from theinvestment.  For the three months andsix months ended June 30, 2002, the Company recorded losses of $20,000 and$49,000, respectively. There were no cash distributions for the three or sixmonths ended June 30, 2002.

 

**7.  Other Comprehensive Gain (Loss)**

 

Othercomprehensive gain (loss), consisting of unrealized gains (losses) onsecurities was $7,000 and $(111,000), respectively, for the three months andsix months ended June 30, 2003 and $(177,000) and  $(341,000), respectively, for the three months and six monthsended June 30, 2002.

 

**8.  Contingencies**

 

On or afterMarch 18, 2003, several purported class action complaints were filed againstthe Company and certain of its officers in the United States District Court forthe Eastern District of Virginia.  Thecomplaints allege that between October 22, 2002 and March 14, 2003, the defendantsmade, or were aware of false and misleading statements which had the effect ofinflating the market price of the Company’s common stock, in violation ofSections 10(b) and 20(a) of the Securities Exchange Act of 1934.  The complaints do not specify the amount ofdamages sought.  Management believesthat the plaintiffs’ claims are without merit, and intends to defend the casesvigorously.  In addition, astockholder’s legal counsel sent a letter of demand that the Board of Directorsinvestigate the same charges addressed in the class action suites.  The Board is addressing this request.

 

**9.  Recent Pronouncements**

 

InNovember 2002, the FASB’s Emerging Issues Task Force, or EITF, finalizedEITF Issue 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF 00-21addresses how to determine whether an arrangement involving multipledeliverables contains more than one unit of accounting. It also addresses howarrangement consideration should be measured and allocated to the separateunits of accounting in an arrangement. EITF 00-21 does not apply todeliverables in arrangements to the extent the accounting for such deliverablesare within the scope of other existing higher-level authoritative accountingliterature. We must adopt the provisions of EITF 00-21 for new contractsentered into on or after July 1, 2003. We have already adopted theprovisions of EITF 00-21 and the adoption has not had a material impact on ourfinancial position, results of operations or cash flows.

 

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In November 2002, FASB Interpretation No. 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others, an Interpretation of FASB StatementsNo. 5, 57, and 107 and Rescission of FASB Interpretation No. 34,” (“FIN45”) was issued. FIN 45 clarifies the requirements of SFAS No. 5,“Accounting for Contingencies,” relating to guarantors’ accounting for, anddisclosure of, the issuance of certain types of guarantees. The disclosureprovisions of FIN 45 are applicable to interim or annual periods that end afterDecember 15, 2002, and did not have an impact on the June 30, 2003financial statements. The provisions for initial recognition and measurementunder FIN 45 are effective on a prospective basis for guarantees that areissued or modified after December 31, 2002. The initial recognition andmeasurement provisions under FIN 45 did not have any impact on our financialstatements.

 

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) whetherconsolidation is required under the “controlling financial interest” model ofAccounting Research Bulletin No. 51 (ARB 51), “Consolidated FinancialStatements” 51 (or other existing authoritative guidance) or, alternatively,(2) whether the variable interest model under FIN 46 should be used toaccount for existing and new entities. At this time, we do not have anyentities that would be covered under FIN 46.

 

On May 31,2003, the Financial Accounting Standards Board (FASB) issued FASB Statement No.150 (FAS 150), “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity”.  FAS 150 improves the accounting for certain financial instrumentsthat, under previous guidance, issuers could account for as equity and requiresthat those instruments be classified as liabilities (or assets in certaincircumstances) in statements of financial position.  FAS 150 also requires disclosures about alternative ways ofsettling the instruments and the capital structure of entities—all of whoseshares are mandatorily redeemable. FAS 150 is generally effective for allfinancial instruments entered into or modified after May 31, 2003, andotherwise is effective at the beginning of the first interim period beginningafter June 15, 2003.  The adoption ofFAS 150 will not have any impact on our financial statements.

 

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**OVERVIEW**

 

PEC Solutions is a professional services firmspecializing in high-end solutions that help government organizationscapitalize on the Internet and other advanced technologies. We migratepaper-intensive procedures to web-enabled processes using eGovernment solutionsthat help our clients enhance their productivity and improve the services theyoffer to the public. As a total solutions provider, we address the fulltechnology lifecycle, including formulating technology strategies, creatingbusiness solutions, performing long-term operational management and continuingenhancement of the solution.

 

We derive substantially all of our revenuesfrom fees for consulting services. We generate these fees from various types ofcontracts, including time and materials contracts, fixed-price contracts andcost-reimbursable contracts. During the three months and six months ended June30, 2003, revenues from these contract types were approximately 57%, 25% and18%, and 61%, 20% and 19% respectively, of total revenues. We typically issueinvoices monthly to manage outstanding accounts receivable balances. Werecognize revenues on time and materials contracts as the services areprovided. We recognize revenues on fixed-price contracts using the percentageof 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. Werecognize and make provisions for any anticipated contract losses at the timewe know and can estimate them. Fixed-price contracts are attractive to clientsand, while subject to increased risks, provide opportunities for increasedmargins. We recognize revenues on cost-reimbursable contracts as services areprovided. These revenues are equal to the costs incurred in  providing these services plus aproportionate amount of the fee earned. We have historically recovered all ofour costs on cost-reimbursable contracts, which means we have lower risk andour margins are lower on these contracts.

 

Our historical revenue growth is attributableto various factors, including an increase in the size and number of projectsfor existing and new clients. Existing clients from the previous year generatedapproximately 96% of our revenues in the three months and six months ended June30, 2003. As of June 30, 2003, we had 1,270 personnel.

 

In the three months and six months ended June30, 2003, we derived approximately 24% and 25%, respectively, of our revenuesthrough relationships with prime contractors, who contract directly with theend-client and subcontract with us. In most of these engagements, we retainfull responsibility for the end-client relationship and direct and manage theactivities of our contract staff.

 

Our most significant expense is direct costs,which consist primarily of project personnel salaries and benefits, and directexpenses incurred to complete projects. Our direct costs as a percentage of revenuesare also related to the utilization rate of our consulting personnel. We manageutilization by frequently monitoring project requirements and timetables. Thenumber of consulting personnel assigned to a project will vary according to thesize, complexity, duration and demands of the project.

 

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

 

Sales and marketing expenses include thecosts of sales and marketing personnel and costs associated with marketing andbidding on future projects.

 

Investment and other income consist primarilyof interest income earned on our cash, cash equivalents and marketablesecurities, as well as, income from the investment in our corporateheadquarters building.

 

Interest expense is primarily related to thecorporate headquarters building.

 

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**Results of Operations**

 

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

 
|                                      |   | **THREE MONTHS ENDED**     |   | **SIX MONTHS ENDED** |   |
|-------------------------------------------|--------|----------------------------|--------|----------------------|--------|
|                                      |   | **JUNE 30,  2003**         |   | **JUNE 30,  2002**   |   | **JUNE 30,  2003** |   | **JUNE 30,  2002** |   |
|                                      |   | **(Dollars in thousands)** |   |
| Statement of Income:                      |   |                       |   |                 |   |   |   |   |   |
| Revenues                                  |   | $                          | 44,265 |                 | $      | 42,761 |   | $ | 87,731 |   | $ | 80,992 |   |
| Direct costs                              |   | 25,711                     |   | 25,511               |   | 52,682 |   | 48,430 |   |
| Gross profit (a)                          |   | 18,554                     |   | 17,250               |   | 35,049 |   | 32,562 |   |
| Other operating costs  and expenses:      |   |                       |   |                 |   |   |   |   |   |
| General and  administrative expenses      |   | 9,074                      |   | 8,090                |   | 18,233 |   | 15,521 |   |
| Sales and marketing  expenses             |   | 1,635                      |   | 1,462                |   | 3,081 |   | 3,041 |   |
| Goodwill and intangible  amortization     |   | 212                        |   | 213                  |   | 426 |   | 381 |   |
| Total other operating  costs and expenses |   | 10,921                     |   | 9,765                |   | 21,740 |   | 18,943 |   |
| Operating income                          |   | 7,633                      |   | 7,485                |   | 13,309 |   | 13,619 |   |
| Investment and other  income              |   | 540                        |   | 469                  |   | 1,177 |   | 973 |   |
| Interest expense                          |   | (662                       | )      | (5                   | )      | (1,322 | ) | (6 | ) |
| Income before income  taxes               |   | 7,511                      |   | 7,949                |   | 13,164 |   | 14,586 |   |
| Provision for income  taxes               |   | 2,873                      |   | 3,104                |   | 5,035 |   | 5,696 |   |
| Net income                                |   | $                          | 4,638  |                 | $      | 4,845 |   | $ | 8,129 |   | $ | 8,890 |   |
| As a Percentage of  Revenues:             |   |                       |   |                 |   |   |   |   |   |
|                                      |   |                       |   |                 |   |   |   |   |   |
| Revenues                                  |   | 100.0                      | %      | 100.0                | %      | 100.0 | % | 100.0 | % |
| Direct costs                              |   | 58.1                       |   | 59.7                 |   | 60.1 |   | 59.8 |   |
| Gross profit (a)                          |   | 41.9                       |   | 40.3                 |   | 39.9 |   | 40.2 |   |
| Other operating costs  and expenses:      |   |                       |   |                 |   |   |   |   |   |
| General and  administrative expenses      |   | 20.5                       |   | 18.9                 |   | 20.8 |   | 19.2 |   |
| Sales and marketing  expenses             |   | 3.7                        |   | 3.4                  |   | 3.5 |   | 3.7 |   |
| Goodwill and intangible  amortization     |   | 0.5                        |   | 0.5                  |   | 0.5 |   | 0.5 |   |
| Total other operating  costs and expenses |   | 24.7                       |   | 22.8                 |   | 24.8 |   | 23.4 |   |
| Operating income                          |   | 17.2                       |   | 17.5                 |   | 15.1 |   | 16.8 |   |
| Investment and other  income              |   | 0.2                        |   | 1.1                  |   | 1.4 |   | 1.2 |   |
| Interest expense                          |   | (0.4                       | )      | (0.0                 | )      | (1.5 | ) | (0.0 | ) |
| Income before income  taxes               |   | 17.0                       |   | 18.6                 |   | 15.0 |   | 18.0 |   |
| Provision for income  taxes               |   | 6.5                        |   | 7.3                  |   | 5.7 |   | 7.0 |   |
| Net income                                |   | 10.5                       | %      | 11.3                 | %      | 9.3 | % | 11.0 | % |

 

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(a)  Gross profit representsrevenues less direct costs, which consist primarily of project personnelsalaries and benefits and direct expenses incurred to complete projects.

 

**RESULTS OF OPERATIONS FOR THE THREE MONTHSENDED JUNE 30, 2003 COMPARED WITH THE THREE MONTHS ENDED JUNE 30, 2002**

 

REVENUES. For the three months ended June 30,2003, our total revenues increased by 3.5%, or $1.5 million over the sameperiod last year. The increase in revenues primarily reflects an increase inthe volume of services to existing clients and services to new clients.  Services to new clients representapproximately 4% of revenues.  Revenueswere adversely impacted by the late passage and signing of the Federal civilianagency budgets.  We also saw a reductionin revenue from the EDS (Navy Marine Corps Intranet) contract during thecurrent period versus last year, as the program went from its initialengineering phase into a production phase.

 

DIRECT COSTS. For the three months ended June30, 2003, direct costs increased by 0.8%, or $0.2 million, over the same periodlast year.  Direct costs decreased as apercentage of revenues for the period ended June 30, 2003, to 58.1% as comparedto 59.7% in the same period last year as a result of a change in contract mix.

 

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GROSS PROFIT. Gross profit increased by 7.6%to $18.6 million in the three months ended June 30, 2003 from $17.3 million inthe three months ended June 30, 2002. Gross profit as a percentage of revenuesincreased to 41.9% in the three months ended June 30, 2003 from 40.3% in thethree months ended June 30, 2002, as a result of increased utilization andchange in contract mix.

 

GENERAL AND ADMINISTRATIVE EXPENSES. Generaland administrative expenses increased 12.2% to $9.1 million in the three monthsended June 30, 2003 from $8.1 million in the three months ended June 30, 2002.Facility costs increased in the current quarter over last year due to theopening of our new headquarters office in Fairfax, Virginia and an office inWashington, D.C.  Our total general andadministrative headcount decreased to 125 personnel as of June 30, 2003compared to 128 personnel as of June 30, 2002.

 

SALES AND MARKETING. Sales and marketingexpenses increased 11.8% to $1.6 million in the three months ended June 30,2003 from $1.5 million in the three months ended June 30, 2002. This increasewas due to an increase in our marketing efforts.

 

AMORTIZATION OF INTANGIBLES.  For the three months ended June 30, 2003 andJune 30, 2002, we incurred $213 thousand of amortization of expense related tothe $4.5 million of intangibles we recorded in connection with the value ofcontracts and customer relationships acquired in the November 2001 acquisitionof Troy, and the June 2002 acquisition of Vector.

 

INVESTMENT AND OTHER INCOME.  For the three months ended June 30, 2003, weearned $306 thousand of interest income and net gains on sales ofsecurities.  We also had a $ 234thousand gain from our investment in our corporate headquarters building.  For the three months ended June 30, 2002, wehad $489 thousand of interest income and net losses on sales ofsecurities.  We also had a $20 thousandloss from the investment in our corporate headquarters building.  Interest income was less in 2003 due toreduced interest rates.  The increase inthe gain from the investment in our corporate headquarters building was aresult of the building going into operation in December 2002.

 

INTEREST EXPENSE.   For the three months ended June 30, 2003, we incurred interestexpense of $662 thousand principally related to our corporate headquartersbuilding.  For the three months endedJune 30, 2002, we incurred $5 thousand of interest expense, there was nointerest expense related to the corporate headquarters building during thisperiod of time.

 

OPERATING INCOME. Operating income increased4.3% to $7.6 million in the three months ended June 30, 2003 from $7.5 millionin the three months ended June 30, 2002. This increase was due primarily toincreased revenues and lower direct cost mix.

 

**RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDEDJUNE 30, 2003 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 2002**

 

REVENUES. For the six months ended June 30,2003, our total revenues increased by 8.3%, or $87.7 million over the sameperiod last year. The increase in revenues primarily reflects an increase inthe volume of services to existing clients and services to new clients.Services to new clients represent approximately 4% of revenues.  We saw a reduction in revenue from the EDS(Navy Marine Corps Intranet) contract during the current period versus lastyear as the program went from its initial engineering phase into a productionphase.  Although revenue increased, thegrowth was limited by the late passage and signing of the Federal civilianagency budgets.

 

DIRECT COSTS. For the six months ended June30, 2003, direct costs increased by 8.8%, or $4.3 million, over the same periodlast year.  Direct costs increased as apercentage of revenues for the period ended June 30, 2003, to 60.1% as comparedto 59.8% in the same period last year. This increase was attributable primarily to the delays related to thepassage and signing of the Federal civilian agency budgets and the associatedlack of new project startups during this period.  New project startups normally allow for the recovery of increasesin labor costs, which for us go into effect January 1st of eachyear.

 

GROSS PROFIT. Gross profit increased by 7.6%to $35.0 million in the six months ended June 30, 2003 from $32.6 million inthe six months ended June 30, 2002. Gross profit as a percentage of revenuesdecreased to 39.9% in the six months ended June 30, 2003 from 40.2% in the sixmonths ended June 30, 2002, as direct costs grew at a faster rate thanrevenues.  As previously indicatedrevenues were impacted by the late passage and signing of the Federal civilianagency budgets.

 

GENERAL AND ADMINISTRATIVE EXPENSES. Generaland administrative expenses increased 17.5% to $18.2 million in the six monthsended June 30, 2003 from $15.5 million in the six months ended June 30, 2002.Facility costs increased in the current period over last year due to theopening of new headquarters office in Fairfax, Virginia and an office inWashington, D.C.  Our total general andadministrative headcount decreased to 125 employees as of June 30, 2003compared to 128 employees as of June 30, 2002.

 

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SALES AND MARKETING. Sales and marketingexpenses increased 1.3% to $3.1 million in the six months ended June 30, 2003from $3.0 million in the six months ended June 30, 2021. This increase was dueto an increase in our marketing efforts.

 

AMORTIZATION OF INTANGIBLES.  For the six months ended June 30, 2003 andJune 30, 2002, we incurred $426 thousand and $381 thousand, respectively, ofamortization of expense related to the $3.0 million of intangibles we recordedin connection with the value of contracts and customer relationships acquiredin the November 2001 acquisition of Troy, and $1.5 million of intangibles inconnection with the value of contracts and customer relationships acquired inthe June 2002 acquisition of Vector.

 

INVESTMENT AND OTHER INCOME.  For the six months ended June 30, 2003, weearned $706 thousand of interest income and net gains on sales ofsecurities.  We also had a $ 471 thousandgain from our investment in our corporate headquarters building.  For the six months ended June 30, 2002, wehad $1.0 million of interest income and net losses on sales of securities.  We also had a $49 thousand loss from theinvestment in our corporate headquarters building.  Interest income was less in 2003 due to reduced interestrates.  The increase in the gain fromthe investment in our corporate headquarters building was a result of the buildinggoing into operation in December 2002.

 

INTEREST EXPENSE.   For the six months ended June 30, 2003, we incurred interestexpense of $1.3 million principally related to our corporate headquartersbuilding.  For the six months ended June30, 2002, we incurred $6 thousand of interest expense, there was no interestexpense related to the corporate headquarters building during this period oftime.

 

OPERATING INCOME. Operating income decreased2.3% to $13.3 million in the six months ended June 30, 2002 from $13.6 millionin the six months ended June 30, 2002, due to the factors discussed above,including the late passage and signing of the Federal civilian agency budgets.

 

Our revenues and operating results may besubject to significant variation from quarter to quarter depending on a numberof factors, including the progress of contracts, revenues earned on contracts,the number of billable days in a quarter, the timing of the pass-through ofother direct costs, the commencement and completion of contracts during anyparticular quarter, the schedule of the government agencies for awardingcontracts, the term of each contract that we have been awarded and generaleconomic conditions. Because a significant portion of our expenses, such aspersonnel and facilities costs, are fixed in the short term, successfulcontract performance and variation in the volume of activity as well as in thenumber of contracts commenced or completed during any quarter may causesignificant variations in operating results from quarter to quarter.

 

The federal government’s fiscal year endsSeptember 30. If a budget for the next fiscal year has not been approved bythat date, our clients may have to suspend engagements that we are working onuntil a budget has been approved. Such suspensions may cause us to realizelower revenues in the fourth quarter of the year. Further, a change inPresidential administrations and in senior government officials may affect therate at which the federal government purchases technology, although we have notseen an impact with the 2001 change  inadministration.

 

As a result of the factors above,period-to-period comparisons of our revenues and operating results may not bemeaningful. You should not rely on these comparisons as indicators of futureperformance as no assurances can be given that quarterly results will notfluctuate, causing a material adverse effect on our operating results andfinancial condition.

 

**Liquidityand Capital Resources**

 

Net cash provided by operating activities was$13.5 million for the six months ended June 30, 2003. Cash provided byoperating activities was primarily from net income, adjusted for workingcapital changes, which were principally decreases in accounts receivable.

 

Net cash used by investing activities was$0.6 million for the six months ended June 30, 2003. During the six monthsended June 30, 2003, we purchased $0.7 million of property and equipment and$5.4 million of net long-term investments, invested $0.2 in capitalizedsoftware, while selling $ 5.3 million of net short-term investments andreceiving $0.4 million of distributions from the investment in our buildingjoint venture.

 

Net cash provided by financing activities was$2.3 million from the sale of common stock to employees upon the exercise oftheir stock options and purchase of stock through the employee stock purchaseplan for the six months ended June 30, 2003.

 

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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 anticipatepaying any cash dividends in the foreseeable future.

 

We maintain a $10.0 million line of creditwith Bank of America, bearing interest at the LIBOR Rate plus 250 basis pointsper annum, which expires on June 30, 2005. As of June 30, 2003, we had noborrowings outstanding under the line of credit. As of June 30, 2002, we hadoutstanding $2.8 million in letters of credit in lieu of rent deposits.

 

Under some of our fixed-price contracts, wereceive advance payments for work to be performed in future months. If we donot perform the work, the unearned portion of these advances will be returnedto our clients. At June 30, 2003, our accounts receivable turnover rate, net ofadvance payments on contracts, was approximately four times a year.

 

**RecentAccounting 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 multipledeliverables contains more than one unit of accounting. It also addresses howarrangement consideration should be measured and allocated to the separateunits of accounting in an arrangement. EITF 00-21 does not apply todeliverables in arrangements to the extent the accounting for such deliverablesare within the scope of other existing higher-level authoritative accountingliterature. We must adopt the provisions of EITF 00-21 for new contractsentered into on or after July 1, 2003. We have already adopted theprovisions of EITF 00-21 and the adoption has not had a material impact on ourfinancial position, results of operations or cash flows.

 

In November 2002, FASB Interpretation No. 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others, an Interpretation of FASB StatementsNo. 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, anddisclosure of, the issuance of certain types of guarantees. The disclosureprovisions of FIN 45 are applicable to interim or annual periods that end afterDecember 15, 2002, and did not have an impact on the June 30, 2003financial statements. The provisions for initial recognition and measurementunder FIN 45 are effective on a prospective basis for guarantees that areissued or modified after December 31, 2002. The initial recognition andmeasurement provisions under FIN 45 did not have any impact on our financialstatements.

 

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 consolidationis required under the “controlling financial interest” model of AccountingResearch Bulletin No. 51 (ARB 51), “Consolidated Financial Statements” 51(or other existing authoritative guidance) or, alternatively, (2) whetherthe variable interest model under FIN 46 should be used to account for existingand new entities. At this time, we do not have any entities that would becovered under FIN 46.

 

On May 31,2003, the Financial Accounting Standards Board (FASB) issued FASB Statement No.150 (FAS 150), “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity”.  FAS 150 improves the accounting for certain financial instrumentsthat, under previous guidance, issuers could account for as equity and requiresthat those instruments be classified as liabilities (or assets in certaincircumstances) in statements of financial position.  FAS 150 also requires disclosures about alternative ways ofsettling the instruments and the capital structure of entities—all of whoseshares are mandatorily redeemable. FAS 150 is generally effective for allfinancial instruments entered into or modified after May 31, 2003, andotherwise is effective at the beginning of the first interim period beginningafter June 15, 2003.  The adoption ofFAS 150 will not have any impact on our financial statements.

 

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**SPECIALNOTE REGARDING FORWARD LOOKING STATEMENTS**

 

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

 

**ITEM 3.QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK**

 

We invest our cash in a variety of financialinstruments, including U.S. Treasury and Agency obligations, money marketinstruments of domestic and foreign issuers denominated in U.S. dollars ofcommercial paper, bankers’ acceptances, certificates of deposit, euro-dollartime deposits and variable rate issues, corporate note and bonds, asset-backedsecurities, repurchase agreements, municipal notes and bonds and auction ratepreferred securities.

 

Investments in both fixed and floating rateinterest earning instruments carry a degree of interest rate risk. Fixedsecurities may have their fair market value adversely impacted because of arise in interest rates, while floating rare securities may produce less incomethan expected if interest rates fall. Due in part to these factors, theCompany’s future investment income may fall short of expectations because ofchanges in interest rates or the Company may suffer losses in principal ifforced to sell securities which have seen a decline in market value because ofchanges in interest rates.  A 10% changein interest rates could have approximately a $150,000 impact on our interestincome.

 

Our investments are made in accordance withan investment policy approved by the Board of Directors. Under this policy, noinvestment securities can have maturities exceeding two years and the averageduration of the portfolio cannot exceed twelve months.

 

**ITEM  4. Controls and Procedures**

 

Ourmanagement, under the supervision and with the participation of David C.Karlgaard, our Chief Executive Officer, and Stuart R. Lloyd, our ChiefFinancial Officer, performed an evaluation of the effectiveness of the designand operation of our disclosure controls and procedures as of the end thequarter covered by this report.  Basedon that evaluation, Messrs. Karlgaard and Lloyd concluded that our disclosurecontrols and procedures were effective. There have been no significant changes in our internal controls or inother factors that could significantly affect internal controls subsequent to theirevaluation.

 

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**PART II – OTHER INFORMATION**

 

**ITEM 1.LEGAL PROCEEDINGS**

 

On or afterMarch 18, 2003, several purported class action complaints were filed against usand certain of our officers in the United States District Court for the EasternDistrict of Virginia.  The complaintsallege that between October 22, 2002 and March 14, 2003, the defendants made,or were aware of false and misleading statements which had the effect ofinflating the market price of our stock, in violation of Sections 10(b) and20(a) of the Securities Exchange Act of 1934. The complaints do not specify the amount of damages sought.  We believe that the plaintiffs’ claims arewithout merit, and we intend to defend the cases vigorously.  In addition, a stockholder’s legal counselsent a letter of demand that the Board of Directors investigate the samecharges addressed in the class actions suits. The Board is addressing this request.

 

**ITEM 2. CHANGES IN SECURITIES AND USE OFPROCEEDS**

 

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

 

The primarypurposes 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 publicmarkets. We have used the net proceeds from this offering for general corporatepurposes, including working capital. We have also used a portion of the netproceeds to acquire three businesses that are complementary to ours, and mayuse the remaining proceeds for this purpose.

 

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

 

Managementwill have broad discretion in the allocation of the remaining net proceeds fromthe sale of stock.  We have no currentplans, agreements or commitments for, and are not currently engaged in anynegotiations with respect to, any such transaction. Pending their use, theproceeds 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 OFSECURITY HOLDERS**

 

(a) The Company held its Annual Meeting of Stockholders on May 21, 2003 (the“Annual Meeting”).

 

(b) n/a

 

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

 

(i) The election of three directors to serve until the 2006 annual meetingof stockholders, and until their successors are elected and duly qualified,with 98.9% of the Common Stock present and voting at the meeting voting for Dr.David C. Karlgaard, Mr. R. Jerry Grossman and Mr. B. Gary Dando as follows:

 

17

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| **NOMINEE**        |   | **FOR**    |   | **AGAINST  OR WITHHELD** |
|--------------------|--------|------------|--------|--------------------------|
| David C. Karlgaard |   | 25,717,900 |   | 296,236                  |
| R. Jerry Grossman  |   | 25,717,900 |   | 296,236                  |
| B. Gary Dando      |   | 25,717,900 |   | 296,236                  |

 

(ii) The ratification of the appointment ofPricewaterhouseCoopers LLP as our independent auditors for the year endedDecember 31, 2003 was ratified by 99.4% of the shares of Common Stock presentand voting at the meeting. (Votes for: 25,847,563; votes against or withheld:102,555; abstain: 64,018; broker non-votes: 0).

 

**ITEM 5. OTHER INFORMATION**

 

None

 

18

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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             |
|                |   |                                                                                                   |
| 10.4.1              |   | Key Executive Severence Plan between  Registrant and David C. Karlgaard, dated July 23, 2003           |
|                |   |                                                                                                   |
| 10.5*               |   | Employment Agreement between the Registrant  and Paul G. Rice, dated January 1, 2000                   |
|                |   |                                                                                                   |
| 10.5.1              |   | Key Executive Severence Plan between  Registrant and Paul G. Rice, dated July 23, 2003                 |
|                |   |                                                                                                   |
| 10.6*               |   | Employment Agreement between the Registrant  and Alan H. Harbitter, dated January 1, 2000              |
|                |   |                                                                                                   |
| 10.6.1              |   | Key Executive Severence Plan between  Registrant and Alan H. Harbitter, dated July 23, 2003            |
|                |   |                                                                                                   |
| 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.            |
|                |   |                                                                                                   |

 

19

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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                                                                                                               |
|       |   |                                                                                                                                         |
| 10.24***** |   | Amendment to Bank of America Promissory  Note                                                                                                |
|       |   |                                                                                                                                         |
| 10.25***** |   | Amendment to Bank of America Revolving Note                                                                                                  |
|       |   |                                                                                                                                         |
| 10.26      |   | Amended and Restated Bank of America  Revolving Credit Note                                                                                  |
|       |   |                                                                                                                                         |
| 10.27      |   | Amended and Restated Bank of America  Financing and Security Agreement                                                                       |
|       |   |                                                                                                                                         |
| 10.28      |   | Key Executive Severance Plan between  Registrant and Christos Bratiotis, dated July 23, 2003                                                 |
|       |   |                                                                                                                                         |
| 10.29      |   | Key Executive Severance Plan between  Registrant and John T. Forbus, dated July 23, 2003                                                     |
|       |   |                                                                                                                                         |
| 10.30      |   | Key Executive Severance Plan between  Registrant and Charles E. Owlett, dated July 23, 2003  (to be filed with September 30, 2003 Form 10-Q) |
|       |   |                                                                                                                                         |
| 21.1****   |   | Subsidiaries of PEC Solutions, Inc.                                                                                                          |

 

----

*******                              **Incorporatedherein by reference to the Company’s Registration Statement on Form S-1, No.333-95331.

 

********                       **Incorporatedherein by reference to the Company’s Annual Report on Form 10K/A filed on April19, 2001.

 

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

 

**********         **Incorporatedherein by reference to the Company’s Annual Report on Form 10-K filed on March29, 2002.

 

***********  **Incorporatedherein by reference to the Company’s Quarterly Report Form 10Q/A filed on May14, 2003.

 

(b) None

 

20

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**SIGNATURES**

 

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

 

 
|                  | BY: /s/ STUART R. LLOYD                                       |
|-----------------------|---------------------------------------------------------------|
| DATE: AUGUST 14, 2003 | STUART R. LLOYD                                               |
|                  | CHIEF FINANCIAL OFFICER,  SENIOR  VICE PRESIDENT AND DIRECTOR |
|                  | (PRINCIPAL FINANCIAL AND  ACCOUNTING OFFICER)                 |

 

21

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