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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549 - 0001
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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 THE THREE MONTHS ENDED MARCH 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 000-30271
PEC SOLUTIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 54-1339972
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) 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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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to the
filing requirements for the past 90 days. Yes [ ] No [ ]
As of May 12, 2000, 22,219,295 of the registrant's Common Stock, par
value $.01 per share, were outstanding.
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PEC SOLUTIONS, INC.
QUARTERLY REPORT ON FORM 10-Q FOR THE THREE MONTHS ENDED MARCH 31, 2000
<TABLE>
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TABLE OF CONTENTS
PAGE
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Financial Statements:
Unaudited Balance Sheets -- March 31, 2000 and December 31, 1999......................... 3
Unaudited Statements of Income -- Three months ended March
31, 2000 and 1999................................................................. 4
Unaudited Statements of Cash Flows -- Three months ended March 31, 2000
and 1999......................................................................... 5
Notes to Financial Statements............................................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations.......................................................................... 8
Item 3. Qualitative and Quantitative Disclosure about Market Risk......................17
PART II. OTHER INFORMATION
Items 1 -- 6.............................................................................18
Signatures...............................................................................20
</TABLE>
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PART I: FINANCIAL INFORMATION
ITEM 1: UNAUDITED FINANCIAL STATEMENTS
PEC SOLUTIONS, INC.
UNAUDITED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
AS OF AS OF
MAR. 31, DEC. 31,
2000 1999
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(UNAUDITED)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents...................................... $11,446 $7,981
Accounts receivable, net....................................... 12,165 13,241
Other current assets........................................... 990 924
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Total current assets...................................... 24,601 22,146
Property and equipment, net......................................... 1,598 1,507
Other assets........................................................ 968 747
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Total assets.............................................. $27,167 $24,400
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses.......................... $2,316 $2,425
Advanced payments on contracts................................ 1,114 1,473
Dividends payable.............................................. - 413
Retirement plan contribution payable........................... 248 -
Accrued payroll................................................ 2,617 3,249
Accrued vacation............................................... 1,171 903
Other current liabilities...................................... 490 373
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Total current liabilities................................. 7,956 8,836
Supplemental retirement program liability........................... 336 281
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Total liabilities........................................ 8,292 9,117
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Commitments and contingencies:
Stockholders' equity
Undesignated capital stock, 10,000,000 shares
authorized............................................... - -
Common stock, $0.01 par value, 75,000,000 shares...............
authorized, 19,186,920 and 17,706,372 shares
issued and outstanding, respectively...................... 192 177
Additional paid-in capital..................................... 2,765 601
Retained earnings.............................................. 15,918 14,505
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Total stockholders' equity................................. 18,875 15,283
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Total liabilities and stockholders' equity................. $27,167 $24,400
======= =======
</TABLE>
See notes to financial statements (unaudited).
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PEC SOLUTIONS, INC.
UNAUDITED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
---------------------------
MARCH 31, MARCH 31,
2000 1999
<S> <C> <C>
Revenues........................................ $15,582 $11,813
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Operating costs and expenses:
Direct costs............................... 8,903 6,989
General and administrative expenses........ 3,941 2,895
Sales and marketing expenses............... 540 475
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Total operating costs and expenses.... 13,384 10,359
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Operating income................................ 2,198 1,455
Other income, net............................... 115 47
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Income before income taxes...................... 2,313 1,502
Provision for income taxes...................... 900 570
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Net income...................................... $1,413 $932
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Earnings per share:
Basic...................................... $0.08 $0.05
----- -----
Diluted.................................... $0.06 $0.04
----- -----
Weighted average shares used in
computing earnings per share:
Basic...................................... 18,257 17,156
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Diluted.................................... 23,442 23,645
</TABLE>
See notes to financial statements (unaudited).
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PEC SOLUTIONS, INC.
UNAUDITED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
QUARTERS ENDING
-------------------------
MARCH 31, MARCH 31,
2000 1999
<S> <C> <C>
Cash flows from operating activities:
Net income........................................................... 1,413 932
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation.................................................... 139 179
Changes in operating assets and liabilities:
Accounts receivable, net........................................ 1,076 572
Other current assets............................................ (66) (8)
Other assets.................................................... (59) (127)
Accounts payable and accrued expenses........................... (109) 113
Advance payments on contracts................................... (359) (66)
Retirement plan contribution payable............................ 248 (1,024)
Accrued payroll................................................. (632) (588)
Accrued vacation................................................ 268 197
Other current liabilities....................................... 117 359
Supplemental retirement program liability....................... 55 41
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Net cash provided by operating activities................... 2,091 580
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Cash flows from investing activities:
Purchases of property and equipment............................. (230) (140)
Proceeds from sale of property and equipment.......................... 0 6
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Net cash used in investing activities....................... (230) (134)
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Cash flows from financing activities:
Dividends paid.................................................. (413) (348)
Proceeds from issuance of common stock.......................... 2,179 38
Repurchases of common stock..................................... 0 (1,262)
Common stock offering costs..................................... (162) 0
Notes payable................................................... 0 597
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Net cash provided (used) by financing activities.......... 1,604 (975)
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Net increase in cash...................................................... 3,465 (529)
Cash and cash equivalents at beginning of period.......................... 7,981 5,367
Cash and cash equivalents at end of period................................ $ 11,446 $4,838
======== ======
Income taxes paid......................................................... 171 75
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Interest paid............................................................. 0 11
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</TABLE>
See notes to financial statements (unaudited).
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PEC SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 2000
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
1. FINANCIAL STATEMENTS
The accompanying unaudited financial statements have been prepared in
accordance with accounting standards generally accepted in the United States for
interim financial information and the instructions to Form 10-Q and Article 10
of Regulation S-X. Accordingly, certain information and footnote disclosures
normally included in financial statements prepared in accordance with accounting
principles generally in the United States have been omitted. In the opinion
of management, all adjustments, consisting of normally recurring accruals,
considered necessary for a fair presentation have been included. It is
suggested that these condensed financial statements be read in conjunction
with the Company's audited financial statements for the years ended December
31, 1998 and 1999 and for each of the three years in the period ended
December 31, 1999 included on Form S-1, as amended, as filed with the
Securities and Exchange Commission. The results of operations for the three
months ended March 31, 2000, are not necessarily indicative of the operating
results to be expected for the full year.
2. INITIAL PUBLIC OFFERING
The Company completed an initial public offering of common stock during
April 2000. The Company sold 3,000,000 shares of common stock generating $25,605
in proceeds to the Company, net of offering expenses.
3. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following as of:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
2000 1999
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(Dollars in thousands, unaudited)
<S> <C> <C>
Billed accounts receivable $ 11,304 $ 11,854
Unbilled accounts receivable 2,028 2,225
Progress payments (973) (645)
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12,358 13,434
Allowance for doubtful accounts (193) (193)
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Accounts receivable, net $ 12,165 $ 13,241
=========== ===========
</TABLE>
Unbilled accounts receivable comprise recognized recoverable costs and
accrued profits on contracts for which billings had not been presented to
clients as of the Balance Sheet date. Management anticipates the collection of
these amounts within 90 days of the Balance Sheet date. Payments to the Company
on contracts with agencies and departments of the U.S. Government are subject to
adjustment upon audit by the U.S. Government. All years subsequent to 1995 are
subject to U.S. Government audit. Management believes the effect of audit
adjustments, if any, on periods not yet audited, will not have a material effect
on the financial statements.
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4. NET INCOME PER SHARE
Basic and diluted earnings per share for the three months ended March 31,
1999 and 2000 were determined as follows:
<TABLE>
<CAPTION>
Three Months Ended March 31, 1999
------------------------------------------
Net Shares Per Share
Income
--------- ---------- -------------
<S> <C> <C> <C>
Basic EPS $ 932 17,155,774 $0.05
Effect of dilutive options --- 6,489,433 (0.01)
========= ========== =============
Diluted EPS $ 932 23,645,207 $0.04
========= ========== =============
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended March 31, 2000
------------------------------------------
Net Shares Per Share
Income
--------- ---------- -------------
<S> <C> <C> <C>
Basic EPS $ 1,413 18,257,334 $0.08
Effect of dilutive options --- 5,184,255 (0.02)
--------- ---------- -------------
Diluted EPS $ 1,413 23,441,589 $0.06
========= ========== =============
</TABLE>
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
PEC Solutions is a professional services firm specializing in high-end
solutions that help government organizations capitalize on the Internet and
other advanced technologies. We migrate paper-intensive procedures to
web-enabled processes using eGovernment solutions that help our clients enhance
their productivity and improve the services they offer to the public. As a total
solutions provider, we address the full technology lifecycle, including
formulating technology strategies, creating business solutions, performing
long-term operational management and continuing enhancement of the solution.
We derive substantially all of our revenues from fees for consulting
services. We generate these fees from contracts with various payment
arrangements, including time and materials contracts, fixed-price contracts and
cost-reimbursable contracts. During the three months ended March 31, 2000,
revenues from these contract types were approximately 62%, 26% and 12%,
respectively, of total revenues. We typically issue invoices monthly to manage
outstanding accounts receivable balances. We recognize revenues on time and
materials contracts as the services are provided. We recognize revenues on
fixed-price contracts using the percentage of completion method as services are
performed over the life of the contract, based on the costs we incur in relation
to the total estimated costs. We recognize and make provisions for any
anticipated contract losses at the time we know and can estimate them.
Fixed-price contracts are attractive to clients and, while subject to increased
risks, provide opportunities for increased margins. We recognize revenues on
cost-reimbursable contracts as services are provided. These revenues are equal
to the costs incurred in providing these services plus a proportionate amount of
the fee earned. We have historically recovered all of our costs on
cost-reimbursable contracts, which means we have lower risk and our margins are
lower on these contracts.
Our historical revenue growth is attributable to various factors, including
an increase in the size and number of projects for existing and new clients.
Existing clients from the previous year generated approximately [96%] of our
revenues in the three months ended March 31, 2000. As of March 31, 2000, we had
439 employees.
In the three months ended March 31, 2000, we derived approximately 41% of
our revenues through relationships with prime contractors, who contract directly
with the end-client and subcontract with us. In most of these engagements, we
retain full responsibility for the end-client relationship and direct and manage
the activities of our contract staff.
Our most significant expense is direct costs, which consist primarily of
project personnel salaries and benefits, and direct expenses incurred to
complete projects. Our direct costs as a percentage of revenues are also related
to the utilization rate of our consulting employees. We manage utilization by
frequently monitoring project requirements and timetables. The number of
consulting employees assigned to a project will vary according to the size,
complexity, duration and demands of the project.
General and administrative expenses consist primarily of costs associated
with our executive management, finance and administrative groups, human
resources, unassigned consulting employees, employee training, occupancy costs,
depreciation and amortization, travel, and all other branch and corporate costs.
Sales and marketing expenses include the costs of sales and marketing
personnel and costs associated with marketing and bidding on future projects.
Other income consists primarily of interest income earned on our cash, cash
equivalents and marketable securities.
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RESULTS OF OPERATIONS
The following table sets forth certain financial data as a percentage of
revenues for the quarters indicated.
<TABLE>
<CAPTION>
QUARTERS ENDED
---------------------------------------------
MARCH 31, 2000 MARCH 31, 1999
(Dollars in thousands)
<S> <C> <C>
STATEMENT OF INCOME:
Revenues..................................................... $15,582 $11,813
Direct Costs................................................. 8,903 6,989
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Gross Profit (a)............................................. 6,679 4,824
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Other operating costs and expenses:
General and administrative expenses.......................... 3,941 2,895
Sales and marketing expenses................................. 540 475
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Total other operating costs and expenses............. 4,481 3,370
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Operating Income............................................. 2,198 1,455
Other income, net............................................ 115 47
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Income before income taxes................................... 2,313 1,502
Provision for income taxes................................... 900 570
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Net income................................................... $ 1,413 $ 932
======= =======
AS A PERCENTAGE OF REVENUES:
Revenues..................................................... 100.0% 100.0%
Direct costs................................................. 57.1 59.2
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Gross profit (a)............................................. 42.9 40.8
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Other operating costs and expenses:
General and administrative expenses..................... 25.3 24.5
Sales and marketing expenses............................ 3.5 4.0
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Total other operating costs and expenses............ 28.8 28.5
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Operating income............................................. 14.1 12.3
Other income, net............................................ 0.8 0.4
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Income before income taxes................................... 14.9 12.7
Provision for income taxes................................... 5.8 4.8
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Net income................................................... 9.1% 7.9%
======= =======
</TABLE>
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(a) Gross profit represents revenues less direct costs, which consist primarily
of project personnel salaries and benefits and direct expenses incurred to
complete projects.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2000 COMPARED WITH
THE THREE MONTHS ENDED MARCH 31, 1999
REVENUES. Revenues increased 31.9% to $15.6 million in the three months
ended March 31, 2000 from $11.8 million in the three months ended March 31,
1999. The increase in revenues primarily reflects an increase in the volume of
services to existing clients.
DIRECT COSTS. Direct costs increased 27.4% to $8.9 million in the three
months ended March 31, 2000 from $7.0 in the three months ended March 31, 1999.
The increase was due primarily to an increase in project personnel to 381 as of
March 31, 2000 as compared to 332 as of March 31, 1999. Direct costs decreased
as a percentage of revenues to 57.1%
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in the three months ended March 31, 2000 from 59.2% in the three months ended
March 31, 1999 due to normal fluctuations in labor and other direct costs.
GROSS PROFIT. Gross profit increased 38.5% to $6.7 million in the three
months ended March 31, 2000 from $4.8 million in the three months ended March
31, 1999. Gross profit as a percentage of revenues increased to 42.9% in the
three months ended March 31, 2000 from 40.8% in the three months ended March 31,
1999 as direct costs grew at a slower rate than revenues due to normal
fluctuations in labor and other direct costs.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 36.1% to $3.9 million in 2000 from $2.9 million in the three months
ended March 31, 1999. Facility costs increased in the quarter due to the opening
of our new offices in Fairfax, Virginia. Our total general and administrative
headcount increased to 58 employees as of March 31, 2000 compared to 44
employees as of March 31, 1999.
SALES AND MARKETING. Sales and marketing expenses were $0.5 million in
the three months ended March 31, 2000 an increase of 13.7% from the three
months ended March 31, 1999. This increase was due to an increase in our
marketing efforts.
OPERATING INCOME. Operating income increased 51.1% to $2.2 million in the
three months ended March 31, 2000 from $1.5 million in the three months ended
March 31, 1999. This increase was due primarily to increased revenues and
decreased costs as a percent of revenues.
Our revenues and operating results may be subject to significant variation
from quarter to quarter depending on a number of factors, including the progress
of contracts, revenues earned on contracts, the number of billable days in a
quarter, the timing of the pass-through of other direct costs, the commencement
and completion of contracts during any particular quarter, the schedule of the
government agencies for awarding contracts, the term of each contract that we
have been awarded and general economic conditions. For example, revenues in the
first quarter of 1999 were lower than the fourth quarter of 1998 due to two
fewer billable days in the first quarter, and the inclusion in the fourth
quarter's revenues of a larger than usual amount of other direct costs to be
passed through to clients. Because a significant portion of our expenses, such
as personnel and facilities costs, are fixed in the short term, successful
contract performance and variation in the volume of activity as well as in the
number of contracts commenced or completed during any quarter may cause
significant variations in operating results from quarter to quarter.
The federal government's fiscal year ends September 30. If a budget for the
next fiscal year has not been approved by that date, our clients may have to
suspend engagements that we are working on until a budget has been approved.
Such suspensions may cause us to realize lower revenues in the fourth quarter of
the year. Further, a change in Presidential administrations and in senior
government officials may negatively affect the rate at which the federal
government purchases technology.
As a result of the factors above, period to period comparisons of our
revenues and operating results may not be meaningful. You should not rely on
these comparisons as indicators of future performance as no assurances can be
given that quarterly results will not fluctuate, causing a material adverse
effect on our operating results and financial condition.
LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations since inception primarily through cash
generated from operations and the sale of common stock to employees. Net cash
provided by operating activities was $2.1 million for the three months ended
March 31, 2000. Cash provided by operating activities was primarily from net
income, adjusted for working capital changes.
Net cash used by investing activities was $0.2 million for the three months
ended March 31, 2000. During the three months ended March 31, 2000, we purchased
$0.2 million of property and equipment.
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Net cash provided by financing activities was $1.6 million for the three
months ended March 31, 2000. During the three months ended March 31, 2000, we
sold $2.2 million of common stock, while paying $0.4 million in dividends. We
also incurred $0.2 million for the April 2000 offering of common stock.
Although dividends have been paid in prior years, after the April 2000
offering of common stock, we expect to retain future earnings, if any, for
use in the operation and expansion of our business and do not anticipate
paying any further cash dividends in the foreseeable future. Under the terms
of our stock option agreement and plan, we have purchased shares of stock
from employees upon their termination of employment. We intend to terminate
these terms and will no longer acquire shares from terminating employees
following the offering.
We believe that our current cash position is adequate for our short-term
working capital and capital expenditure needs. We believe that subsequent to
this offering, our cash position will be adequate for our anticipated long-term
working capital and capital expenditure needs.
We maintain a $2.7 million line of credit with Bank of America, which
bears interest at the bank's prime rate and expires on April 30, 2001. We
expect to renew our line of credit when it expires. As of March 31, 2000, we
had no borrowings outstanding under the line of credit. We did have
outstanding $1.25 million in letters of credit in lieu of rent deposits.
Under some of our fixed-price contracts, we receive advance payments for
work to be performed in future months. If we do not perform the work, the
unearned portion of these advances will be returned to our clients. By the
end of the first quarter of 2000, our accounts receivable turn over rate, net
of advance payments on contracts, was approximately five times a year. This
rate has improved over the last eight quarters, thus increasing our cash
flow. At this collection rate management believes cash generated through
operations will be sufficient to fund short and long-term cash needs.
YEAR 2000 COMPLIANCE
Although we have not experienced any significant failures or problems in
connection with the Year 2000 date change in either our software or the systems
we have developed for our clients, our clients may still experience significant
problems that may require them to divert significant resources to remediation
instead of to new eGovernment solutions. This could delay our ability to
generate new business and additional revenues.
Furthermore, undiscovered Year 2000 problems may also affect software or
code that we develop or third-party software products that are incorporated into
the information systems solutions we create for our clients. Our clients license
software directly from third parties, and we do not guarantee that the software
licensed from these suppliers is Year 2000 compliant. However, if we fail to
provide our clients Year 2000 compliant information systems solutions we could
suffer financial loss, harm to our reputation and liability to others and could
seriously harm our business, financial condition and operating results.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities. SFAS 133,
as amended, is effective for quarters of fiscal years beginning after June 15,
2000. Currently, we do not use derivative financial instruments. As a result,
we do not expect SFAS 133 to have a material impact on our results of
operations or financial position.
In December 1999, the SEC released Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements." The bulletin establishes more
clearly defined revenue recognition criteria than previously existing
accounting pronouncements. This bulletin became effective for the Company for
the quarter ended March 31, 2000. The Company has evaluated the full impact
of this bulletin to determine the impact on its financial position and
results of operations. This bulletin did not have a material effect on the
Company's results of operations.
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
The matters discussed in this Form 10-Q include forward-looking
statements that involve risks or uncertainties. While forward-looking
statements are sometimes presented with numerical specificity, they are based
on various assumptions made by management regarding future circumstances over
many of which the Company has little or no control. Forward-looking
statements may be identified by words including "anticipate," "believe,"
"estimate," "expect" and similar expressions. The Company cautions readers
that forward-looking statements, including without limitation, those relating
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to the Company's future business prospects, revenues, working capital,
liquidity, and income, are subject to certain risks and uncertainties that
would cause actual results to differ materially from those indicated in the
Forward-Looking Statements. Factors that could cause actual results to differ
from Forward-Looking Statements include the concentration of the Company's
revenues from government clients, risks involved in contracting with the
government, difficulties the Company may have in attracting, retaining and
managing professional and administrative staff, fluctuations in quarterly
results, risks related to acquisitions, risks related to competition and the
Company's ability to continue to win and perform efficiently on contracts,
and other risks and factors identified from time to time in the Company's
reports filed with the SEC, including those identified under the section
entitled "Risk Factors" in the Conpany's Registration Statement on Form S-1
(SEC File No. 333-95331) which hereby is incorporated by reference. Should
one or more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual results may vary materially from those
anticipated, estimated or projected.
RISK FACTORS
SUBSTANTIALLY ALL OF OUR REVENUES WOULD BE THREATENED IF OUR RELATIONSHIPS
WITH AGENCIES OF THE FEDERAL GOVERNMENT WERE HARMED
Our largest clients are agencies of the federal government. If the
federal government in general, or any significant government agency, uses less
of our services or terminates its relationship with us, our revenues could
decline substantially, and our business could be seriously harmed. During the
three months ended March 31, 2000, contracts with the federal government and
contracts with prime contractors of the federal government accounted for
approximately 94% of our revenues. During that same period, our ten largest
clients, all agencies of the federal government, generated approximately 65% of
our revenues, with the top five clients accounting for 41% of our revenues. We
believe that federal government contracts are likely to continue to account for
a significant portion of our revenues for the foreseeable future. The volume of
work that we perform for a specific client, however, is likely to vary from year
to year, and a significant client in one year may not use our services as
extensively, or at all, in a subsequent year.
OUR GOVERNMENT CONTRACTS MAY BE TERMINATED PRIOR TO THEIR COMPLETION, AND
IF WE DO NOT REPLACE THEM, OUR OPERATING RESULTS MAY BE HARMED
We derive substantially all of our revenues from government contracts
that typically are awarded through competitive processes and span a one year
base period and one or more option years. The unexpected termination or
nonrenewal of one or more of our significant contracts could result in
significant revenue shortfalls. Our clients generally have the right not to
exercise the option periods. In addition, our contracts typically contain
provisions permitting an agency to terminate the contract on short notice, with
or without cause. Following termination, if the client requires further services
of the type provided in the contract, there is frequently a competitive
rebidding process. We may not win any particular rebid or be able to
successfully bid on new contracts to replace those that have been terminated.
Even if we do win the rebid, we may experience revenue shortfalls in periods
where we anticipated revenues from the contract rather than its termination and
subsequent rebidding. These revenue shortfalls could harm operating results for
those periods.
OUR LACK OF LONG-TERM CONTRACTS WITH CLIENTS AND OUR RELATIVELY FIXED
OPERATING EXPENSES EXPOSE US TO GREATER RISK OF INCURRING LOSSES
Our clients retain us on an engagement-by-engagement basis, rather than
under long-term contracts. We incur costs based on our expectations of future
revenues. Our operating expenses are relatively fixed and cannot be reduced on
short notice to compensate for unanticipated variations in the number or size of
engagements in progress. These factors make it difficult for us to predict our
revenues and operating results. If we fail to predict our revenues accurately,
it may seriously harm our financial condition and results of operation.
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A REDUCTION IN OR THE TERMINATION OF OUR SERVICES COULD LEAD TO
UNDERUTILIZATION OF OUR EMPLOYEES AND COULD HARM OUR OPERATING RESULTS
Our employee compensation expenses are relatively fixed. Therefore, if
a client defers, modifies or cancels an engagement or chooses not to retain us
for additional phases of a project, our operating results will be harmed unless
we can rapidly redeploy our employees to other engagements in order to minimize
underutilization.
FAILING TO MAINTAIN STRONG RELATIONSHIPS WITH PRIME CONTRACTORS COULD
RESULT IN A DECLINE IN OUR REVENUES
We derived approximately 41% of our revenues during the three months
ended March 31, 2000 through our relationships with prime contractors, which, in
turn, have contractual relationships with end-clients. One of our prime
contractors, Unisys, accounted for 24% of our revenues during the three months
ended March 31, 2000. We expect to continue to depend on these relationships for
a material portion of our revenues in the foreseeable future. If any of these
prime contractors eliminate or reduce their engagements with us, or have their
engagements eliminated or reduced by their end-clients, we will lose a source of
revenues, which, if not replaced, will adversely affect our operating results.
WE MUST RECRUIT AND RETAIN QUALIFIED PROFESSIONALS TO SUCCEED IN OUR LABOR
INTENSIVE BUSINESS
Our future success depends in large part on our ability to recruit and
retain qualified professionals skilled in complex information technology
services and solutions, including encryption and other security systems. Such
personnel are in great demand and are likely to remain a limited resource in the
foreseeable future. Competition for qualified professionals is intense. Any
inability to recruit and retain a sufficient number of these professionals could
hinder the growth of our business.
WE MAY LOSE MONEY ON FIXED PRICE CONTRACTS IF WE MISCALCULATE THE RESOURCES
WE NEED TO COMPLETE THE CONTRACT
We derived approximately 26% of our revenues in the three months ended
March 31, 2000 from fixed-price contracts. We anticipate a material portion of
our future engagements will continue to be contracted at a fixed price. Unlike
time and materials contracts, for which we are reimbursed based on our actual
expenditures of resources, fixed-price contracts require us to price our
contracts by predicting our expenditures in advance. If we miscalculate the
resources we need to complete fixed-price engagements, our operating results
could be seriously harmed because we are not compensated for the higher costs.
The risk that we may miscalculate the resources we need is higher because we
work with complex technologies in compressed time frames.
WE COULD LOSE REVENUES AND CLIENTS AND EXPOSE OUR COMPANY TO LIABILITY IF
WE FAIL TO MEET CLIENT EXPECTATIONS
We create, implement and maintain technology solutions that are often
critical to our clients' operations. If our technology solutions or other
applications have significant defects or errors or fail to meet our clients'
expectations, we may:
- lose revenues due to adverse client reaction;
- be required to provide additional remediation services to a client at
no charge;
- receive negative publicity, which could damage our reputation and
adversely affect our ability to attract or retain clients; and
- suffer claims for substantial damages against us, regardless of our
responsibility for the failure.
While many of our contracts limit our liability for damages that may arise from
negligent acts, errors, mistakes or omissions in rendering services to our
clients, we cannot be sure that these contractual provisions will protect us
from
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<PAGE>
liability for damages if we are sued. Furthermore, our general liability
insurance coverage may not continue to be available on reasonable terms or in
sufficient amounts to cover one or more large claims, or the insurer may
disclaim coverage as to any future claim. The successful assertion of any large
claim against us could seriously harm our business. Even if not successful, such
claims could result in significant legal and other costs and may be a
distraction to management.
SECURITY BREACHES IN SENSITIVE GOVERNMENT SYSTEMS COULD RESULT IN THE LOSS
OF CLIENTS AND NEGATIVE PUBLICITY
Many of the systems we develop involve managing and protecting
information involved in law enforcement and other sensitive government
functions. A security breach in one of these systems could cause serious harm to
our business, could result in negative publicity and could prevent us from
having further access to such critically sensitive systems or other similarly
sensitive areas for other governmental clients. Losses that we could incur from
such a security breach could exceed the policy limits that we have for "errors
and omissions" or product liability insurance.
IF WE CANNOT OBTAIN THE NECESSARY SECURITY CLEARANCES, WE MAY NOT BE ABLE
TO PERFORM CLASSIFIED WORK FOR THE GOVERNMENT AND OUR REVENUES MAY SUFFER
Government contracts require us, and some of our employees, to maintain
security clearances. If we lose or are unable to obtain security clearances, the
client can terminate the contract or decide not to renew it upon its expiration.
As a result, to the extent we cannot obtain the required security clearances for
our employees working on a particular engagement, we may not derive the revenue
anticipated from the engagement, which, if not replaced with revenue from other
engagements, could seriously harm our operating results.
WE DEPEND ON OUR SENIOR MANAGEMENT TEAM, AND THE LOSS OF ANY MEMBER MAY
ADVERSELY AFFECT OUR ABILITY TO OBTAIN AND MAINTAIN CLIENTS
We believe that our success will depend on the continued employment of
our senior management team, including David Karlgaard, our Chief Executive
Officer, Paul Rice, our Chief Operating Officer and Alan Harbitter, our Chief
Technology Officer. We have key man life insurance policies that cover Messrs.
Karlgaard and Rice up to $1 million and Mr. Harbitter up to $500,000. This
dependence is particularly important to our business because personal
relationships are a critical element of obtaining and maintaining client
engagements. If one or more members of our senior management team was unable or
unwilling to continue in their present positions, such persons would be
difficult to replace and our business could be seriously harmed. Furthermore,
clients or other companies seeking to develop in-house capabilities may hire
away some of our key employees. Employee defections to clients or competitors
would not only result in the loss of key employees but could also result in the
loss of a client relationship or a new business opportunity. Any losses of
client relationships could seriously harm our business.
WE MAY NOT BE ABLE TO SUCCESSFULLY IDENTIFY, MANAGE AND INTEGRATE FUTURE
ACQUISITIONS, WHICH MAY HARM OUR OPERATING RESULTS
We may use a portion of the proceeds from this offering to acquire
companies or businesses that are complementary to ours. However, we have no
immediate plans or current agreements to acquire any additional companies or
businesses, and we cannot assure you that we will identify appropriate
acquisition candidates. If we do identify an appropriate acquisition candidate,
we cannot assure you that we would be able to successfully negotiate the terms
of an acquisition, finance the acquisition or integrate the acquired business
into our existing business. Negotiations of potential acquisitions and the
integration of an acquired business could disrupt our business by diverting
management away from day-to-day operations. Further, failure to successfully
integrate any acquisition may cause significant operating inefficiencies and
adversely affect our profitability. Consummating a merger could require us to
raise additional funds through additional equity or debt financing. Additional
equity financing could result in further dilution of the per share
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<PAGE>
value of your stock. Additional debt financing could force us to accept
contractual limitations that could harm our ability to grow.
AUDITS OF OUR GOVERNMENT CONTRACTS MAY RESULT IN A REDUCTION IN REVENUE WE
RECEIVE FROM THOSE CONTRACTS OR MAY RESULT IN CIVIL OR CRIMINAL PENALTIES THAT
COULD HARM OUR REPUTATION
Federal government agencies routinely audit government contracts. These
agencies review a contractor's performance on its contract, pricing practices,
cost structure and compliance with applicable laws, regulations and standards.
An audit could result in a substantial adjustment to our revenues because any
costs found to be improperly allocated to a specific contract will not be
reimbursed, while improper costs already reimbursed must be refunded. If a
government audit uncovers improper or illegal activities, we may be subject to
civil and criminal penalties and administrative sanctions, including termination
of contracts, forfeiture of profits, suspension of payments, fines and
suspension or debarment from doing business with federal government agencies. In
addition, we could suffer serious reputational harm if allegations of
impropriety were made against us.
WE MAY BE LIABLE FOR PENALTIES UNDER A VARIETY OF PROCUREMENT RULES AND
REGULATIONS, AND CHANGES IN GOVERNMENT REGULATIONS COULD SLOW OUR GROWTH OR
REDUCE OUR PROFITABILITY
We must comply with and are affected by federal government regulations
relating to the formation, administration and performance of government
contracts. These regulations affect how we do business with our clients and may
impose added costs on our business. Any failure to comply with applicable laws
and regulations could result in contract termination, price or fee reductions or
suspension or debarment from contracting with the federal government. Further,
the federal government may reform its procurement practices or adopt new
contracting methods relating to the GSA schedule or other government-wide
contract vehicles. If we are unable to successfully adapt to those changes, our
business could be seriously harmed.
OUR FAILURE TO ADEQUATELY PROTECT OUR CONFIDENTIAL INFORMATION AND
PROPRIETARY RIGHTS MAY HARM OUR COMPETITIVE POSITION.
While our employees execute confidentiality agreements, we cannot
guarantee that this will be adequate to deter misappropriation of our
confidential information. In addition, we may not be able to detect unauthorized
use of our intellectual property in order to take appropriate steps to enforce
our rights. If third parties infringe or misappropriate our copyrights,
trademarks or other proprietary information, our competitive position could be
seriously harmed. In addition, other parties may assert infringement claims
against us or claim that we have violated their intellectual property rights.
Such claims, even if not true, could result in significant legal and other costs
and may be a distraction to management. While we have applied for trademarks for
PEC.com, PEC, PEC Solutions, Web-enabling Government and the related symbols and
designs, we cannot assure you that these trademarks will be granted.
RISKS RELATED TO THE EGOVERNMENT SOLUTIONS MARKET COMPETITION COULD RESULT
IN PRICE REDUCTIONS, REDUCED PROFITABILITY AND LOSS OF MARKET SHARE
Competition in the market for eGovernment solutions is intense. If we
are unable to differentiate our services from those of our competitors, our
revenue growth and operating margins may decline. Many of our competitors are
larger and have greater financial, technical, marketing and public relations
resources, larger client bases and greater brand or name recognition than us.
Our larger competitors may be able to provide clients with additional benefits,
including reduced prices. We may be unable to meet those prices, which may cause
us to lose business and market share. Alternatively, we could decide to meet the
lower prices, which could harm our profitability. If we fail to compete
successfully, our business could be seriously harmed.
Our current competitors include, and may in the future include, the
following:
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<PAGE>
- information technology services providers and large government
contractors such as American Management Systems, Andersen Consulting,
Booz-Allen & Hamilton, Computer Sciences Corporation, Electronic Data
Systems, KPMG, PricewaterhouseCoopers, Science Applications
International Corporation and Unisys; and
- Internet professional services providers.
Current and potential competitors also have established or may
establish cooperative relationships among themselves or with third parties to
increase their ability to address client needs. Accordingly, it is possible that
new competitors or alliances among competitors may emerge and rapidly acquire
significant market share. In addition, some of our competitors may develop
services that are superior to, or have greater market acceptance than, the
services that we offer.
OUR BUSINESS WILL BE HARMED IF GOVERNMENT AGENCIES ARE UNWILLING TO REPLACE
OR SUPPLEMENT EXPENSIVE LEGACY SYSTEMS.
Government agencies have spent substantial resources over an extended
period of time to develop computer systems and to train their personnel to use
them. These agencies may be reluctant to abandon or supplement these legacy
systems with Internet and other advanced technology systems because of the cost
of developing them or the additional cost of re-training their personnel. Such
reluctance would make it more difficult to acquire new engagements which would
harm our business prospects.
OUR GROWTH WILL BE HARMED IF A VIABLE MARKET FOR EGOVERNMENT SERVICES IS
NOT SUSTAINED
We cannot be certain that a viable government market for Internet and
other advanced technology services will be sustainable. If this market is not
sustained and we are unable to refocus our services on the private sector market
or other in-demand technologies, our growth would be negatively affected.
Although government agencies have recently increased focus on and
funding for technology initiatives, we cannot be certain that these initiatives
will continue in the future. Budget cutbacks or political changes could result
in a change of focus or reductions in funding for technology initiatives, which,
in turn, could seriously harm our revenues.
UNDISCOVERED YEAR 2000 PROBLEMS COULD NEGATIVELY AFFECT OUR CLIENTS'
SYSTEMS, WHICH COULD HARM OUR REVENUES AND OUR REPUTATION
Although we have not experienced any significant failures or problems
in connection with the Year 2000 date change in either our software or the
systems we have developed for our clients, our clients may still experience
significant problems that may require them to divert significant resources to
remediation instead of to eGovernment solutions. This could delay our ability to
generate new business and additional revenues.
Furthermore, undiscovered Year 2000 problems may also affect software
or code that we develop or third-party software products that are incorporated
into the information systems solutions we create for our clients. Our clients
license software directly from third parties, and we do not guarantee that the
software licensed from these suppliers is Year 2000 compliant. However, any
failure on our part to provide Year 2000 compliant information systems solutions
to our clients could result in financial loss, harm to our reputation and
liability to others and could seriously harm our business, financial condition
and operating results.
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<PAGE>
RISKS RELATED TO THE OWNERSHIP OF OUR COMMON STOCK OUR QUARTERLY REVENUES
AND OPERATING RESULTS COULD BE VOLATILE AND MAY CAUSE OUR STOCK PRICE TO
FLUCTUATE
Our quarterly revenues and operating results may fluctuate
significantly in the future. In particular, if the Federal government does not
adopt a budget for its fiscal year beginning on October 1, Federal agencies may
be forced to suspend our contracts due to a lack of funding. Consequently, we
may realize lower revenues in the quarter ending December 31. Further, the rate
at which the Federal government procures technology may be negatively affected
following changes in Presidential administrations and in senior government
officials. As a result, our operating results could be volatile and difficult to
predict and period-to-period comparisons of our operating results may not be a
good indication of our future performance.
A significant portion of our operating expenses, such as personnel and
facilities costs, are fixed in the short term. Therefore, any failure to
generate revenues according to our expectations in a particular quarter could
result in reduced income in the quarter. In addition, our quarterly operating
results may not meet the expectations of securities analysts or investors, which
in turn may have an adverse effect on the market price of our common stock.
WE HAVE VARIOUS MECHANISMS IN PLACE THAT MAY PREVENT A CHANGE IN CONTROL
THAT STOCKHOLDERS MAY CONSIDER FAVORABLE
Our certificate of incorporation and bylaws may discourage, delay or
prevent a change in control of PEC Solutions that stockholders may consider
favorable. Our certificate of incorporation and bylaws:
- authorize the issuance of blank check capital stock that
could be issued by our board of directors to thwart a
takeover attempt;
- classify the board of directors into staggered, three-year
terms, which may lengthen the time required to gain control
of our board of directors;
- prohibit cumulative voting in the election of directors,
which would otherwise allow holders of less than a majority
of the stock to elect some directors;
- require super-majority voting to effect amendments to
provisions of our bylaws concerning the number of directors;
- limit who may call special meetings of stockholders;
- prohibit stockholder action by written consent, requiring
all actions to be taken at a meeting of the stockholders;
- establish advance notice requirements for nominating
candidates for election to the board of directors or for
proposing matters that can be acted upon by stockholders at
stockholder meetings; and
- require that vacancies on the board of directors, including
newly-created directorships, be filled only by a majority
vote of directors then in office.
In addition, Section 203 of the Delaware General Corporation Law may
discourage, delay or prevent a change in control by prohibiting PEC Solutions
from engaging in a business combination with an interested stockholder for a
period of three years after the person becomes an interested stockholder. See
"Description of Our Capital Stock--Anti-Takeover Effects of Our Certificate of
Incorporation and Bylaws and Delaware General Corporation Law."
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
None
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<PAGE>
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Between January 1, 2000 and March 31, 2000, we sold an aggregate of
1,480,548 shares of common stock at purchase prices ranging from $0.78 to
$3.05 per share, for an aggregate consideration of $1,800,466 upon exercise
of stock options granted under our stock option agreement and our
nonqualified stock option plan.
In April 2000, we commenced and completed a firm commitment underwritten
initial public offering of 3,000,000 shares of our common stock at a price of
$9.50 per share. The shares were registered with the Securities and Exchange
Commission pursuant to a registration statement on Form S-1 (No. 333-95331),
which was declared effective on April 19, 2000. The public offering was
underwritten by a syndicate of underwriters led by Donaldson, Lufkin & Jenrette
Securities Corporation; Chase Securities Inc.; Legg Mason Wood Walker,
Incorporated; and DLJDIRECT Inc. as their representatives. After deducting
underwriting discounts and commissions of approximately $2 million and expenses
of approximately $1 million, we received net proceeds of $25.6 million.
The primary purposes of this offering were to create a public market for
our common stock, to improve the incentive mechanism for our professionals
through stock options, to obtain additional equity capital and to facilitate
future access to public markets. We expect to use the net proceeds from this
offering for general corporate purposes, including working capital. Management
will have broad discretion in the allocation of the net proceeds. We may also
use a portion of the net proceeds to acquire businesses that are complementary
to ours. We have no current plans, agreements or commitments for, and are not
currently engaged in any negotiations with respect to, any such transaction.
Pending their use, the proceeds of this offering have been invested in
short-term, investment grade, interest-bearing securities.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
On January 25, 2000, holders of 15,815,868 shares of our common stock, a
majority of our outstanding stock, approved, by written consent in lieu of a
meeting, in accordance with Section 228 of the Delaware General Corporation
Law, the adoption of the PEC SOLUTIONS 2000 STOCK INCENTIVE PLAN.
ITEM 5. OTHER INFORMATION
None
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<PAGE>
ITEM 6 (A) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------- -------------------
<S> <C>
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 January 1, 2000
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.
27* Financial Data Schedule
</TABLE>
* Filed herewith
All other exhibits incorporated herein by reference to the Company's
Registration Statement on Form S-1, No. 333-41517.
(b) Reports on Form 8-K
None.
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<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
COMPANY HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED.
BY: /s/ STUART R. LLOYD
-----------------------------------------------
Stuart R. Lloyd
CHIEF FINANCIAL OFFICER, SENIOR VICE PRESIDENT AND
DIRECTOR (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)
May [ ], 2000
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20
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 11,446
<SECURITIES> 0
<RECEIVABLES> 12,358
<ALLOWANCES> (193)
<INVENTORY> 0
<CURRENT-ASSETS> 24,601
<PP&E> 4,045
<DEPRECIATION> (2,447)
<TOTAL-ASSETS> 27,167
<CURRENT-LIABILITIES> 7,956
<BONDS> 0
0
0
<COMMON> 192
<OTHER-SE> 18,683
<TOTAL-LIABILITY-AND-EQUITY> 27,167
<SALES> 15,582
<TOTAL-REVENUES> 15,582
<CGS> 8,903
<TOTAL-COSTS> 13,384
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 2,313
<INCOME-TAX> 900
<INCOME-CONTINUING> 1,413
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,413
<EPS-BASIC> $0.08
<EPS-DILUTED> $0.06
</TABLE>
