**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**Form 10-Q**

 
| **(Mark  One)** |   |
|-----------------|--------|

 
| **x** | **Quarterly Report Pursuant to  Section 13 or 15(d) of The Securities Exchange Act of 1934** |
|-------|----------------------------------------------------------------------------------------------|

 

**For TheQuarter Ended March 31, 2002**

 

**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 Registrant as Specified in itsCharter)

 

| **DELAWARE**                                                                       |   | **54-1339972**                        |
|------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State  or other jurisdiction of incorporation or organization)                    |   | (I.R.S.  Employer Identification No.) |
|                                                                               |   |                                  |
| **12750 FAIR  LAKES CIRCLE, FAIRFAX, VA**                                          |   | **22033**                             |
| (Address  of principal executive offices)                                          |   | (Zip  Code)                           |
|                                                                               |
| Registrant’s telephone  number, including area code: ** (703) 679-4900** |

 

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

 

Asof May 10, 2002, 26,262,049 of the registrant’s Common Stock, par value $.01per share, were outstanding.

 

 

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**PECSOLUTIONS, INC.**

**QUARTERLYREPORT ON FORM 10-Q FOR THE THREE MONTHS ENDED MARCH 31, 2002**

 

**TABLEOF CONTENTS**

 
| Item 1. Financial Statements:                                                                              |
|------------------------------------------------------------------------------------------------------------|
| Consolidated Balance  Sheets — March 31, 2002 and December 31, 2001                                   |
| Consolidated Statements  of Income — Three months ended March 31, 2002 and 2001                       |
| Consolidated  Statements of Cash Flows — Three months ended March 31, 2002 and 2001                   |
| Notes to  Consolidated Financial Statements                                                                |
| Item  2. Management’s Discussion and Analysis of Financial Condition and Results  of  Operations |
| Item  3. Qualitative and Quantitative Disclosure about Market Risk                                         |
| PART II. OTHER INFORMATION                                                                                 |
| Items  1 – 6                                                                                          |
| Signatures                                                                                                 |

 

2

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**PART I: FINANCIAL INFORMATION**

 

**ITEM 1:         FINANCIALSTATEMENTS**

 

**PECSOLUTIONS, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(DOLLARSIN THOUSANDS)**

 
|                                                                                                                                 |   | **As of  March 31,  2002** |    | **As of  December 31,  2001** |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------|---------|-------------------------------|--------|
|                                                                                                                                 |   | **(Unaudited)**            |    |                          |   |
| **ASSETS**                                                                                                                           |   |                       |    |                          |   |
| Current assets:                                                                                                                      |   |                       |    |                          |   |
| Cash and cash equivalents                                                                                                            |   | $                          | 31,383  |                          | $      | 30,436 |   |
| Short-term investments                                                                                                               |   | 26,421                     |    | 31,105                        |   |
| Accounts receivable, net                                                                                                             |   | 39,512                     |    | 36,423                        |   |
| Other current assets                                                                                                                 |   | 3,762                      |    | 4,134                         |   |
| Total current assets                                                                                                                 |   | 101,078                    |    | 102,098                       |   |
|                                                                                                                                 |   |                       |    |                          |   |
| Property and equipment, net                                                                                                          |   | 9,579                      |    | 6,497                         |   |
| Investments                                                                                                                          |   | 19,133                     |    | 13,762                        |   |
| Goodwill                                                                                                                             |   | 12,565                     |    | 12,565                        |   |
| Intangibles, net                                                                                                                     |   | 2,801                      |    | 2,969                         |   |
| Other assets                                                                                                                         |   | 4,094                      |    | 3,817                         |   |
| Total assets                                                                                                                         |   | $                          | 149,250 |                          | $      | 141,708 |   |
|                                                                                                                                 |   |                       |    |                          |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                        |   |                       |    |                          |   |
|                                                                                                                                 |   |                       |    |                          |   |
| Current liabilities:                                                                                                                 |   |                       |    |                          |   |
| Accounts payable and accrued expenses                                                                                                |   | $                          | 5,398   |                          | $      | 4,020 |   |
| Advance payments on contracts                                                                                                        |   | 938                        |    | 1,290                         |   |
| Retirement plan contribution payable                                                                                                 |   | 402                        |    | —                        |   |
| Accrued payroll                                                                                                                      |   | 3,134                      |    | 7,018                         |   |
| Accrued vacation                                                                                                                     |   | 2,766                      |    | 2,185                         |   |
| Other current liabilities                                                                                                            |   | 5,459                      |    | 3,958                         |   |
| Total current liabilities                                                                                                            |   | 18,097                     |    | 18,471                        |   |
| Long-term liabilities:                                                                                                               |   |                       |    |                          |   |
| Supplemental retirement program liability                                                                                            |   | 952                        |    | 949                           |   |
| Deferred rent payable                                                                                                                |   | 1,020                      |    | 923                           |   |
| Long-term lease obligation                                                                                                           |   | 5,980                      |    | 2,883                         |   |
| Other long-term liabilities                                                                                                          |   | 29                         |    | 54                            |   |
| Total long-term liabilities                                                                                                          |   | 7,981                      |    | 4,809                         |   |
| Total liabilities                                                                                                                    |   | 26,078                     |    | 23,280                        |   |
|                                                                                                                                 |   |                       |    |                          |   |
| Commitments and contingencies                                                                                                        |   |                       |    |                          |   |
|                                                                                                                                 |   |                       |    |                          |   |
| Stockholders’ equity:                                                                                                           |   |                       |    |                          |   |
| Undesignated capital stock, 10,000,000 shares authorized                                                                             |   | —                     |    | —                        |   |
| Common stock, $0.01 par value, 75,000,000 shares authorized,  26,212,003 and 26,109,649 shares issued and  outstanding, respectively |   | 262                        |    | 261                           |   |
| Additional paid-in capital                                                                                                           |   | 84,450                     |    | 83,582                        |   |
| Retained earnings                                                                                                                    |   | 38,624                     |    | 34,585                        |   |
| Accumulated other comprehensive income (loss)                                                                                        |   | (164                       | )       | —                        |   |
| Total stockholders’ equity                                                                                                      |   | 123,172                    |    | 118,428                       |   |
| Total liabilities and stockholders’ equity                                                                                      |   | $                          | 149,250 |                          | $      | 141,708 |   |

 

Seenotes to consolidated financial statements.

 

3

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**PEC SOLUTIONS,INC.**

**CONSOLIDATED STATEMENTS OF INCOME**

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

 
|                                                            |   | **Three Months Ended** |   |
|-----------------------------------------------------------------|--------|------------------------|--------|
|                                                            |   | **March 31,  2002**    |   | **March 31,  2001** |   |
|                                                            |   | **(Unaudited)**        |   |
| Revenues                                                        |   | $                      | 38,231 |   | $ | 21,920 |   |
| Operating costs and expenses:                                   |   |                   |   |   |   |
| Direct costs                                                    |   | 22,918                 |   | 11,798 |   |
| General and administrative expenses                             |   | 7,431                  |   | 5,368 |   |
| Sales and marketing expenses                                    |   | 1,579                  |   | 895 |   |
| Goodwill and intangible amortization                            |   | 168                    |   | 180 |   |
| Total operating costs and expenses                              |   | 32,096                 |   | 18,241 |   |
| Operating income                                                |   | 6,135                  |   | 3,679 |   |
| Other income, net                                               |   | 503                    |   | 468 |   |
| Income before income taxes                                      |   | 6,638                  |   | 4,147 |   |
| Provision for income taxes                                      |   | 2,592                  |   | 1,709 |   |
| Net income                                                      |   | $                      | 4,046  |   | $ | 2,438 |   |
| Earnings per share:                                             |   |                   |   |   |   |
| Basic                                                           |   | $                      | 0.15   |   | $ | 0.11 |   |
| Diluted                                                         |   | $                      | 0.14   |   | $ | 0.10 |   |
| Weighted average shares used  in  computing earnings per share: |   |                   |   |   |   |
| Basic                                                           |   | 26,166                 |   | 22,472 |   |
| Diluted                                                         |   | 29,879                 |   | 25,536 |   |

 

Seenotes to consolidated financial statements.

 

4

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**PECSOLUTIONS, INC.**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(DOLLARSIN THOUSANDS)**

 
|                                                                               |   | **Three Months Ending** |   |
|------------------------------------------------------------------------------------|--------|-------------------------|--------|
|                                                                               |   | **March 31,  2002**     |   | **March 31,****2001** |   |
|                                                                               |   | **(Unaudited)**         |   |
| Cash flows from operating activities:                                              |   |                    |   |   |   |
| Net income                                                                         |   | $                       | 4,046  |   | $ | 2,438 |   |
| Adjustments to reconcile net income to  net cash provided by operating activities: |   |                    |   |   |   |
| Depreciation and amortization                                                      |   | 299                     |   | 272 |   |
| Amortization of goodwill                                                           |   | —                  |   | 180 |   |
| Amortization of intangibles                                                        |   | 168                     |   | — |   |
| Deferred rent payable                                                              |   | 97                      |   | 108 |   |
| Deferred income taxes                                                              |   | (105                    | )      | (48 | ) |
| Loss from investment in building                                                   |   | 29                      |   | — |   |
| Changes in operating assets and liabilities:                                       |   |                    |   |   |   |
| Accounts receivable, net                                                           |   | (3,089                  | )      | (5,265 | ) |
| Other current assets                                                               |   | 439                     |   | (164 | ) |
| Other assets                                                                       |   | (211                    | )      | (3 | ) |
| Accounts payable and accrued expenses                                              |   | 1,378                   |   | (259 | ) |
| Advance payments on contracts                                                      |   | (352                    | )      | (523 | ) |
| Retirement plan contribution payable                                               |   | 402                     |   | 282 |   |
| Accrued payroll                                                                    |   | (3,884                  | )      | (61 | ) |
| Accrued vacation                                                                   |   | 581                     |   | 337 |   |
| Other current liabilities                                                          |   | 1,524                   |   | 1,802 |   |
| Supplemental retirement program liability                                          |   | 3                       |   | 23 |   |
| Other long-term liabilities                                                        |   | (25                     | )      | (5 | ) |
| Net cash provided (used) by operating activities                                   |   | 1,300                   |   | (886 | ) |
| Cash flows from investing activities:                                              |   |                    |   |   |   |
| Net sales (purchases) of short-term investments                                    |   | 4,522                   |   | (1,045 | ) |
| Purchases of property and equipment                                                |   | (202                    | )      | (188 | ) |
| Capitalized software                                                               |   | (113                    | )      | (177 | ) |
| Purchase of long-term investments                                                  |   | (5,400                  | )      | — |   |
| Net cash used by investing activities                                              |   | (1,193                  | )      | (1,410 | ) |
| Cash flows from financing activities:                                              |   |                    |   |   |   |
| Proceeds from issuance of common stock                                             |   | 863                     |   | 155 |   |
| Payments on capital lease obligations                                              |   | (23                     | )      | — |   |
| Net cash provided by financing activities                                          |   | 840                     |   | 155 |   |
| Net increase (decrease) in cash                                                    |   | 947                     |   | (2,141 | ) |
| Cash and cash equivalents at beginning of period                                   |   | 30,436                  |   | 14,655 |   |
| Cash and cash equivalents at end of period                                         |   | $                       | 31,383 |   | $ | 12,514 |   |
|                                                                               |   |                    |   |   |   |
| Income taxes paid                                                                  |   | $                       | 138    |   | $ | 100 |   |
| Interest paid                                                                      |   | $                       | 1      |   | $ | 1 |   |
| Non-cash transactions:                                                             |   |                    |   |   |   |
| Additions to construction-in-process and long-term lease obligation                |   | $                       | 3,097  |   | $ | — |   |

 

Seenotes to consolidated financial statements.

 

5

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**PECSOLUTIONS, INC.**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**MARCH31, 2002**

**(UNAUDITED)**

 

1. Financial Statements

 

Theaccompanying consolidated financial statements, except for the December 31,2001 balance sheet, are unaudited and have been prepared in accordance withaccounting standards generally accepted in the United States for interimfinancial information and the instructions to Form 10-Q and Article 10 ofRegulation S-X. Accordingly, certain information and footnote disclosuresnormally included in financial statements prepared in accordance withaccounting principles generally in the United States have been omitted. In theopinion of management, all adjustments, consisting of normally recurringaccruals, considered necessary for a fair presentation, have been included. Itis suggested that these financial statements be read in conjunction with theCompany’s audited financial statements as of December 31, 2000 and 2001 and foreach of the three years in the period ended December 31, 2001 included in theCompany’s 2001 Form 10-K, as filed with the Securities and Exchange Commission.The results of operations for the three months ended March 31, 2002, are notnecessarily indicative of the operating results to be expected for the fullyear.

 

2. Accounts Receivable

 

Accountsreceivable consist of the following as of:

 
|                            |   | **March 31,  2002**        |   | **December 31,  2001** |   |
|---------------------------------|--------|----------------------------|--------|------------------------|--------|
|                            |   | **(Dollars in thousands)** |   |
| Billed accounts receivable      |   | $                          | 34,419 |                   | $      | 33,337 |   |
| Unbilled accounts receivable    |   | 6,355                      |   | 4,701                  |   |
| Progress payments               |   | (938                       | )      | (1,290                 | )      |
|                            |   | 39,836                     |   | 36,748                 |   |
| Allowance for doubtful accounts |   | (324                       | )      | (325                   | )      |
| Accounts receivable, net        |   | $                          | 39,512 |                   | $      | 36,423 |   |

 

Unbilledaccounts receivable comprise recognized recoverable costs and accrued profits oncontracts for which billings had not been presented to clients as of thebalance sheet date. Management anticipates the collection of these amountswithin 90 days of the balance sheet date. Payments to the Company on contractswith agencies and departments of the U.S. Government are subject to adjustmentupon audit by the U.S. Government. All years subsequent to 1997 are subject toU.S. Government audit. Management believes the effect of audit adjustments, ifany, on periods not yet audited, will not have a material effect on thefinancial statements.

 

3. Net Income Per Share

 

Basicand diluted earnings per share for the three months ended March 31, 2002 and2001 were determined as follows:

 
|                       |          | **Three Months Ended March 31, 2002**                    |          | **Three Months Ended March 31, 2001** |       |
|----------------------------|---------------|----------------------------------------------------------|---------------|---------------------------------------|------------|
|                       |          | **(Dollars in thousands, except for per share amounts)** |          |
|                       |          | **Net****Income**                                        |          |                                  |       |   |   | **Net  Income** |   |   |   |   |   |
| **Shares**                 | **Per Share** | **Shares**                                               | **Per Share** |
| Basic EPS                  |          | $                                                        | 4,046         |                                  | 26,166,351 |   | $ | 0.15 |   | $ | 2,438 |   | 22,472,154 |   | $ | 0.11 |   |
| Effect of dilutive options |          | —                                                   |          | 3,712,736                             |       | (0.01 | ) | — |   | 3,064,115 |   | (0.01 | ) |
| Diluted EPS                |          | $                                                        | 4,046         |                                  | 29,879,087 |   | $ | 0.14 |   | $ | 2,438 |   | 25,536,269 |   | $ | 0.10 |   |

 

4. Goodwill and Intangible Assets

 

In June 2001, the FinancialAccounting Standards Board issued Statement of Financial Accounting Standards(SFAS) No. 141, *Business Combinations*andNo. 142, *Goodwill and Other IntangibleAssets*.  SFAS No. 141requires all business combinations initiated after June 30, 2001 to beaccounted for using the purchase method. Under SFAS No. 142, goodwill and intangible assets with indefinite liveswill no longer be amortized but are reviewed annually (or more frequently ifimpairment 

 

6

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indicators arise) for impairment. Separableintangible assets that are not deemed to have indefinite lives will continue tobe amortized over their useful lives but with no maximum life.  The Company has adopted the provisions ofSFAS No. 142 effective January 1, 2002.

 

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

 

|                                |   | **Three Months Ended**                                   |   |
|-------------------------------------|--------|----------------------------------------------------------|--------|
|                                |   | **(Dollars in thousands, except for per share amounts)** |   |
|                                |   | **March 31, 2002**                                       |   | **March 31, 2001** |   |
| Reported net income                 |   | $                                                        | 4,046  |   | $ | 2,438 |   |
| Add:  Goodwill amortization    |   | —                                                   |   | 180 |   |
| Adjusted net income                 |   | $                                                        | 4,046  |   | $ | 2,618 |   |
|                                |   |                                                     |   |   |   |
| Reported basic earnings per share   |   | $                                                        | 0.15   |   | $ | 0.11 |   |
| Add:  Goodwill amortization    |   | —                                                   |   | 0.01 |   |
| Adjusted basic earnings per share   |   | $                                                        | 0.15   |   | $ | 0.12 |   |
|                                |   |                                                     |   |   |   |
| Reported diluted earnings per share |   | $                                                        | 0.14   |   | $ | 0.10 |   |
| Add:  Goodwill amortization    |   | —                                                   |   | — |   |
| Adjusted diluted earnings per share |   | $                                                        | 0.14   |   | $ | 0.10 |   |

 

The Company only has onereporting unit.  Nonamortized intangibleassets consist only of goodwill of $12,565,363.  The Company’s amortizable intangible assets include customercontracts and related relationships. The gross carrying amount of the customer relationships at March 31,2002 was $3,025,000 with accumulated amortization of $224,075.  There have been no changes in the carryingamount of goodwill for the quarter ended March 31, 2002.  In accordance with the provisions of SFAS No.142, the Company performed the appropriate transitional impairment tests relatedto its stated goodwill and determined that there is no transitional impairmentloss.  Also in accordance with theprovisions of SFAS No. 142, the Company reassessed the useful lives of allintangible assets and determined that no adjustments were necessary.

 

There were no intangibles at March 31, 2001.  Intangibles are amortized on a straight-linebasis.

 

Amortization expense for the three months ended March31, 2001 was $168,000.  Estimatedamortization expense for each of the five succeeding calendar years based onthe intangible assets as of March 31, 2002 is as follows:

 

| **Year ending December 31,** |   | **Amount**                 |   |
|------------------------------|--------|----------------------------|--------|
|                         |   | **(dollars in thousands)** |   |
| 2002                         |   | $                          | 672    |   |
| 2003                         |   | 672                        |   |
| 2004                         |   | 672                        |   |
| 2005                         |   | 672                        |   |
| 2006                         |   | 281                        |   |
|                              |        |                            |        |  |

 

5.  Recent Pronouncements

 

In August 2001, FAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Asset*s was issued. This statement provides guidance on the accounting for the impairment ordisposal of long-lived assets and was adopted by the Company on January 1,2002.   There were no adjustments to thefinancial statements related to impairment or disposal of long-lived assets.

 

7

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**ITEM 2.          MANAGEMENT’SDISCUSSION AND ANALYSIS OF 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 revenues from feesfor consulting services. We generate these fees from contracts with variouspayment arrangements, including time and materials contracts, fixed-pricecontracts and cost-reimbursable contracts. During the three months ended March31, 2002, revenues from these contract types were approximately 59%, 20% and21%, respectively, of total revenues. We typically issue invoices monthly tomanage outstanding accounts receivable balances. We recognize revenues on timeand materials contracts as the services are provided. We recognize revenues onfixed-price contracts using the percentage of completion method as services areperformed over the life of the contract, based on the costs we incur inrelation to the total estimated costs. We recognize and make provisions for anyanticipated contract losses at the time we know and can estimate them.Fixed-price contracts are attractive to clients and, while subject to increasedrisks, provide opportunities for increased margins. We recognize revenues oncost-reimbursable contracts as services are provided. These revenues are equalto the costs incurred in providing these services plus a proportionate amountof the fee earned. We have historically recovered all of our costs oncost-reimbursable contracts, which means we have lower risk and our margins arelower on these contracts.

 

Our historical revenue growth is attributable tovarious factors, including an increase in the size and number of projects forexisting and new clients. Existing clients from the previous year generatedapproximately 97% of our revenues in the three months ended March 31 2002. Asof March 31, 2002, we had 1,236  personnel.

 

In the three months ended March 31, 2002, we derivedapproximately 35% of our revenues through relationships with prime contractors,who contract directly with the end-client and subcontract with us. In most ofthese engagements, with the exception of the EDS (NMCI) subcontract, we retainfull responsibility for the end-client relationship and direct and manage theactivities of our contract staff.

 

Our most significant expense is direct costs, whichconsist primarily of project personnel salaries and benefits, and directexpenses incurred to complete projects. Our direct costs as a percentage ofrevenues 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 tothe size, complexity, duration and demands of the project.

 

General and administrative expenses consist primarilyof costs associated with our executive management, finance and administrativegroups, human resources, unassigned consulting personnel, personnel training,occupancy costs, depreciation and amortization, travel and all other branch andcorporate costs.

 

Sales and marketing expenses include the costs ofsales and marketing personnel and costs associated with marketing and biddingon future projects.

 

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

 

 

8

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Results of Operations

 

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

 
|                                     |   | **Three Months Ended**     |   |
|------------------------------------------|--------|----------------------------|--------|
|                                     |   | **March 31,  2002**        |   | **March 31,  2001** |   |
|                                     |   | **(Dollars in thousands)** |   |
| Statement of Income:                     |   |                       |   |   |   |
| Revenues                                 |   | $                          | 38,231 |   | $ | 21,920 |   |
| Direct costs                             |   | 22,918                     |   | 11,798 |   |
| Gross profit (a)                         |   | 15,313                     |   | 10,122 |   |
| Other operating costs and expenses:      |   |                       |   |   |   |
| General and administrative expenses      |   | 7,431                      |   | 5,368 |   |
| Sales and marketing expenses             |   | 1,579                      |   | 895 |   |
| Goodwill and intangible amortization     |   | 168                        |   | 180 |   |
| Total other operating costs and expenses |   | 9,178                      |   | 6,443 |   |
| Operating income                         |   | 6,135                      |   | 3,679 |   |
| Other income, net                        |   | 503                        |   | 468 |   |
| Income before income taxes               |   | 6,638                      |   | 4,147 |   |
| Provision for income taxes               |   | 2,592                      |   | 1,709 |   |
| Net income                               |   | $                          | 4,046  |   | $ | 2,438 |   |
|                                     |   |                       |   |   |   |
| As a Percentage of Revenues:             |   |                       |   |   |   |
|                                     |   |                       |   |   |   |
| Revenues                                 |   | 100.0                      | %      | 100.0 | % |
| Direct costs                             |   | 60.0                       |   | 53.8 |   |
| Gross profit (a)                         |   | 40.0                       |   | 46.2 |   |
| Other operating costs and expenses:      |   |                       |   |   |   |
| General and administrative expenses      |   | 19.4                       |   | 24.5 |   |
| Sales and marketing expenses             |   | 4.1                        |   | 4.1 |   |
| Amortization of goodwill                 |   | 0.4                        |   | 0.8 |   |
| Total other operating costs and expenses |   | 23.9                       |   | 29.4 |   |
| Operating income                         |   | 16.1                       |   | 16.8 |   |
| Other income, net                        |   | 1.3                        |   | 2.1 |   |
| Income before income taxes               |   | 17.4                       |   | 18.9 |   |
| Provision for income taxes               |   | 6.8                        |   | 7.8 |   |
| Net income                               |   | 10.6                       | %      | 11.1 | % |

 

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(a)               Gross profitrepresents revenues less direct costs, which consist primarily of projectpersonnel salaries and benefits and direct expenses incurred to complete projects.

 

 

**Results of Operations for The Three Months Ended March 31,2002 Compared with The Three Months Ended March 31, 2001**

 

*Revenues.*For the three months ended March 31, 2002, our total revenuesincreased by 74.4%, or $16.3 million over the same period last year. Theincrease in revenues primarily reflects an increase in the volume of servicesto existing clients and services to new clients, which represents approximately3% of revenues.

 

*DirectCosts.* For the three months ended March 31, 2002, direct costsincreased by 94.3%, or $11.1 million, over the same period last year. Theincrease was due primarily to an increase in project personnel to 1,097 as ofMarch 31, 2002 as compared to 627 as of March 31, 2001. Direct costs increasedas a percentage of revenues for the period ended March 31, 2002, to 60.0% ascompared to 53.8% in the same period last year, due to normal fluctuations inlabor and other direct costs and lower margins on the Troy contracts.

 

*GrossProfit*. Gross profit increased by 51.3% to $15.3 million inthe three months ended March 31, 2002 from $10.1 million in the three monthsended March 31, 2001. Gross profit as a percentage of revenues decreased to40.0% in the three months ended March 31, 2002 from 46.2% in the three monthsended March 31, 2001, as direct costs grew at a faster rate than revenues dueto normal fluctuations in labor and other direct costs and the lower margins onthe Troy contracts.

 

*Generaland Administrative Expenses*. General and administrativeexpenses increased 38.4% to $7.4 million in the three months ended March 31,2002 from $5.4 million in the three months ended March 31, 2001. Facility costsincreased in the current quarter over last year due to the opening of newoffices in Alexandria, Fairfax and Norfolk, Virginia, Colombia, Maryland, SanAntonio, Texas, San Diego, California, Trevose, Pennsylvania and Honolulu,Hawaii. Our total general and administrative headcount increased to 139employees as of March 31, 2002 compared to 81 employees as of March 31, 2001, consistentwith our plans.

 

9

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*Salesand Marketing*. Sales and marketing expenses increased 76.4%to $1.6 million in the three months ended March 31, 2002 from $0.9 million inthe three months ended March 31, 2001. This increase was due to an increase inour marketing and proposal efforts during the quarter.

 

*Amortizationof Goodwill*. As a result of the adoption of FAS 142,effective January 1, 2002, we incurred no goodwill amortization expense in thethree months ended March 31, 2002.  Inthe three months ended March 31, 2001, we incurred $180 thousand related to the$3.6 million of goodwill we recorded in connection with the acquisition ofViking.

 

*Amortizationof Intangibles*.  Forthe three months ended March 31, 2002, we incurred $168 thousand ofamortization expense related to the $3.0 million of intangibles we recorded inconnection with the value of contracts and customer relationships acquired inthe November 2001 acquisition of Troy.  There were no intangibles at March 31, 2001, and therefore, noamortization.

 

*OperatingIncome*. Operating income increased 66.7% to $6.1 million inthe three months ended March 31, 2002 from $3.7 million in the three monthsended March 31, 2001. This increase was due primarily to increased revenues.

 

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

 

The federal government’s fiscal year ends September30. 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 abudget has been approved. Such suspensions may cause us to realize lowerrevenues in the fourth quarter of the year. Further, a change in Presidentialadministrations and in senior government officials may negatively affect therate at which the federal government purchases technology, although we have notseen a negative impact with the current change in administration.

 

As a result of the factors above, period to periodcomparisons of our revenues and operating results may not be meaningful. Youshould not rely on these comparisons as indicators of future performance as noassurances can be given that quarterly results will not fluctuate, causing amaterial adverse effect on our operating results and financial condition.

 

Liquidity and CapitalResources

 

Net cash provided by operating activities was $1.3million for the three months ended March 31, 2002. Cash provided by operatingactivities was primarily from net income, adjusted for working capital changes,principally an increase in accounts receivable and a decrease in accruedpayroll.  The Company began semi-monthlypayrolls in January 2002.  Previouslypayments were on a monthly basis.

 

Net cash used by investing activities was $1.2 millionfor the three months ended March 31, 2002. During the three months ended March31, 2002, we purchased $0.2 million of property and equipment and $5.4 millionof long-term investments, while selling $4.5 million of short-term investmentsand incurred $0.1 million for capitalized software development costs.

 

Net cash provided by financing activities was $0.8million principally from the sale of common stock to employees upon theexercise of their stock options and purchase of stock through the employeestock purchase plan for the three months ended March 31, 2002.

 

We expect to retain future earnings, if any, for usein the operation and expansion of our business and do not anticipate paying anycash dividends in the foreseeable future.

 

We believe that our current cash position is adequatefor our short-term and long-term working capital and capital expenditure needs.

 

We maintain a $6.0 million line of credit with Bank ofAmerica, bearing interest at the one-month LIBOR rate plus 250 basis points perannum and expiring on April 30, 2003. As of March 31, 2002, we had no borrowings outstanding under the line ofcredit. We have $2.99 million outstanding in letters of credit in lieu of rentdeposits.

 

10

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Under some of our fixed-price contracts, we receiveadvance payments for work to be performed in future months. If we do notperform the work, the unearned portion of these advances will be returned toour clients. At March 31, 2002, our accounts receivable turnover rate, net ofadvance payments on contracts, was approximately four times a year.

 

We have invested $3.0 million in an affiliatedcompany, which is building our new office building in Fairfax, Virginia.  We are required to make an additional $1.5million investment at the time of occupancy of the facility.  We have a 48% minority interest in thiscompany and are not obligated to guarantee the non-recourse mortgageobligation, nor are we involved in the management of the construction of the buildingor the management of the owner-lessor. In accordance with Emerging Issues Task Force Issue No. 97-10 *The Effect of Lessee Involvement in AssetConstruction*, the Company is considered to be the owner of theproperty (for accounting purposes). Accordingly, the Company recorded construction costs incurred to date of$6.0 million as construction-in-process with an offsetting long-term leaseobligation as of March 31, 2002.  It isanticipated that the total construction-in-process costs will be approximately$25 to $30 million at the completion of construction, which is expected to beDecember 1, 2002.

 

Recent AccountingPronouncements

 

None

 

 

**SPECIALNOTE REGARDING FORWARD LOOKING STATEMENTS**

 

The matters discussed in this Form 10-Q includeforward-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 our reportsfiled with the SEC, including those identified under the section entitled “RiskFactors” in our Annual Report on Form 10-K (SEC File No. 000-30271) as amendedwhich hereby is incorporated by reference. Should one or more of these risks oruncertainties materialize, or should underlying assumptions prove incorrect,actual results may vary materially from those anticipated, estimated orprojected.

 

 

**ITEM 3.          QUALITATIVEAND 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. dollarsconsisting of commercial paper, bankers’ acceptances, certificates of deposit,euro-dollar time deposits and variable rate issues, corporate note and bonds,asset-backed securities, repurchase agreements, municipal notes and bonds andauction rate preferred securities.

 

Investments in both fixed and floating rate interestearning instruments carry a degree of interest rate risk. Fixed securities mayhave their fair market value adversely impacted because of a rise in interestrates, while floating rate securities may produce less income than expected ifinterest rates fall. Due in part to these factors, the Company’s futureinvestment income may fall short of expectations because of changes in interestrates or the Company may suffer losses in principal if forced to sellsecurities which have seen a decline in market value because of changes ininterest rates.  A 10% change ininterest rates could have approximately a $150,000 impact on our interestincome.

 

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

 

11

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**PART II — OTHER INFORMATION**

 

**ITEM 1.          LEGALPROCEEDINGS**

 

None

 

**ITEM 2.          CHANGES IN SECURITIES AND USE OF PROCEEDS**

 

In April 2000, we commenced and completed a firmcommitment 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 primary purposes of this offering were to create apublic market for our common stock, to improve the incentive mechanism for ourprofessionals through stock options, to obtain additional equity capital and tofacilitate future access to public markets. We have used the net proceeds fromthis offering for general corporate purposes, including working capital. Wehave also used a portion of the net proceeds to acquire two businesses that arecomplementary to ours, and may use the remaining proceeds for this purpose.

 

On August 28, 2000, we acquired all of the outstandingcapital stock of Viking for $2 million cash plus the assumption of debt in abusiness combination accounted for as a purchase. Viking is a provider ofintegrated software and advanced technology solutions for state and local lawenforcement, fire and emergency medical service agencies. On November 20, 2001,we acquired all of the outstanding capital stock of Troy for $15.3 million cashplus common stock valued at $3.0 million (103,065 shares).  Troy derives revenue from systemdevelopment, networking, engineering, integration services, and informationsystems security and its primary customer is the federal government.

 

Management will have broad discretion in theallocation of the remaining net proceeds from the sale of stock.  We have no current plans, agreements orcommitments for, and are not currently engaged in any negotiations with respectto, any such transaction. Pending their use, the proceeds of this offering havebeen 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                                                                         |
|       |   |                                                                                                   |
| 21.1****   |   | Subsidiaries of PEC Solutions,  Inc.                                                                   |

 

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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)Reports on Form 8-K

 

(1)          We filed anamended Current Report on Form 8-K/A on February 1, 2002 and March 12, 2002,reporting under Item 2 the acquisition of Troy Systems, Inc.

 

**Signatures**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Company hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized..

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

 

 

May 10, 2002

 

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