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PEC SOLUTIONS, INC. FISCAL YEAR 2004 FORM 10-K Table of Contents
PART III

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934

Commission File No. 000-30271

PEC SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)

Registrant's telephone number, including area code: (703) 679-4900
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.01 par value
(Title of Each Class)

        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 such filing requirements for the past 90 days. Yes ý    No o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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

        The aggregate market value of voting stock held by non-affiliates of the registrant was $153,686,841 based upon the closing price on the Nasdaq National Market on the last business day of the registrant's most recently completed second fiscal quarter (June 30, 2004).

        Number of shares of Common Stock outstanding as of February 28, 2005 was: 27,592,993 shares

Documents Incorporated By Reference:

        Part III—Proxy Statement for the 2005 Annual Meeting of Stockholders on May 25, 2005. Such proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the Registrant's fiscal year ended December 31, 2004.

PEC SOLUTIONS, INC.
FISCAL YEAR 2004
FORM 10-K
Table of Contents

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PART I

Item 1. Business.

Overview

        PEC Solutions, Inc. (www.pec.com) is a professional services firm providing high-end solutions that help government clients harness the power of the Internet and other advanced technologies to improve mission performance. We specialize in Web-Enabling Government® by providing secure, interoperable technology solutions for clients in homeland security, law enforcement, intelligence, defense, and civilian agencies within the Federal Government and at state and local levels. 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.

        Our clients have included every cabinet-level department of the Federal Government as well as numerous additional entities at the federal, state and local levels. This group includes a cross-section of defense, civil, law enforcement, intelligence and judicial government organizations. Our largest clients include the U.S. Postal Service; the Department of Homeland Security; the Department of Veterans Affairs; the Department of Justice; agencies of the Department of Defense including the Air Force; and the intelligence community.

        PEC Solutions, Inc. was originally incorporated under the laws of the Commonwealth of Virginia as Performance Engineering Corporation ("PEC") on June 25, 1985. On January 1, 2000, PEC was reincorporated under the laws of Delaware as PEC Solutions, Inc.

Industry Background

        Government has emerged in recent years as one of the leading purchasers of advanced technology solutions. The Federal Government's 2005 approved budget allocates $59.7 billion for information technology spending. According to Government Electronics and Information Technology Association (GEITA), a trade group that tracks Federal Government spending trends, the Federal Government will spend $72.9 billion on information technology by 2010, up from $56.3 billion in 2005. This represents a five-year compound annual growth rate of 3.6 percent.

Efforts to Improve Homeland Security and Mount Counter-Terrorism Programs will Continue to Stimulate Government Technology Spending

        We believe that the events of September 11, 2001, resulted in escalating priorities relating to the needs of the nation's law enforcement infrastructure, and in the broader areas of national defense and homeland security. The President's 2005 budget provides continued strong support for federal information technology spending in this area. Much of the spending focuses on homeland security and e-Government. We believe that high-end technology solutions providers, with strong legacy practices and client bases in the agencies and government verticals relating to homeland security, law enforcement, intelligence, and defense, could experience increases in demand as the Federal market moves forward.

Government Reform is Driving Growth in Advanced Technology Spending

        We believe that political pressures and budgetary constraints are forcing government agencies at all levels to improve their processes and services and to operate more like commercial enterprises. Organizations throughout the Federal, state and local governments are investing heavily in information technology to improve effectiveness, enhance productivity, and extend new services in order to deliver increasingly responsive and cost-effective public services. Government's increased focus on infrastructure consolidation, information sharing, and intelligence reform will have a positive impact on

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the IT services industry. We believe that Internet technologies provide an ideal solution to meet government's needs.

        Changes over the mid to late 1990's in Federal Government contract procurement and compliance regulations have streamlined the government's buying practices, resulting in a more commercial approach to the procurement and management of technologies and services. As a result, procurement lead times have decreased and government buyers now have greater flexibility to purchase services on the basis of distinguishing corporate capabilities and successful past performance. Federal Government entities now are able to award contracts based on factors other than price alone, if they judge that the Government would receive a greater value. In addition, the General Services Administration's (GSA) extension of basic government-wide contract vehicles for procuring technology components and services, the GSA Schedules, makes purchasing technology services easier and faster. Federal Government buyers can now order services directly from pre-approved providers instead of using a time-consuming bid solicitation process. We believe that these changes have improved our ability to successfully pursue business in the government market. There are currently no proposed changes to government procurement regulations that we believe will materially affect our business in the immediate future.

Government's Need to Outsource Technology Programs

        Government organizations rely heavily on outside contractors to provide skilled resources to accomplish technology programs. We believe that this reliance will continue to intensify due to political and budgetary pressures in many government agencies and due to the difficulties government faces in recruiting and retaining highly skilled technology professionals in a competitive labor market. INPUT, a research firm that tracks government trends, estimates that outsourcing will rise 55% from 2004 to 2009 due to the retirement of Federal IT professionals. In concert with its transition to more commercial practices, government is increasingly outsourcing technology programs as a means of simplifying the implementation and management of the technology, so that government workers can focus on their mission.

Technology Services Providers in the Government Sector

        Engagements in the government market can be broadly classified into four categories based on the type of services provided. Many companies provide a mix of services across these categories.

        First, at the low end, providing information technology staff augmentation at low hourly rates typically involves placing staff in client facilities. These engagements typically exhibit low operating margins and slow growth.

        Second, large-scale systems integration and outsourcing engagements typically involve assuming responsibility for acquiring, assembling and operating large inventories of equipment and software. Major portions of these engagements involve reselling commodity technologies at highly competitive fixed unit prices. These engagements typically exhibit moderate growth, but low operating margins.

        Third, large-scale systems development engagements involve providing full-service solutions that combine hardware, software development, system engineering and operations. These engagements typically exhibit moderate growth and operating margins.

        Fourth, at the high end, engagements involving high-value management consulting and development and integration of complex systems in core mission areas use specialized or emerging technologies such as the Internet and advanced security. These engagements typically exhibit strong growth and operating margins.

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Challenges in the Government Technology Services Sector

        Technology services providers face a unique combination of challenges when providing services to government clients. These include:

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Substantial government investments in legacy systems that are not readily adaptable to evolving technologies;



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Extremely large volumes of data collected and retained in government databases;



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Large and widely dispersed workforces, often consisting of tens of thousands of knowledge workers located in hundreds of sites throughout the United States and the world;



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Heightened security concerns due to the need to protect individual privacy and extraordinarily sensitive information; and



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Complex management needs that require a combination of strategic planning capabilities, government domain expertise, public sector procurement savvy, and cutting-edge technology skills.

Our Solution

        We are a high-end technology solutions provider that addresses the needs and particular challenges of the evolving government market by combining the following key elements in our solutions:

Total Solutions Provider Capabilities

        As a total solutions provider, we address the full technology lifecycle through our deep technical capabilities and extensive government domain knowledge. We possess a wide range of the specialized skills needed for government technology engagements including: strategic technology consulting; program management; system architectural design; network engineering; applications development; and systems integration, deployment and operational support. We relieve our clients of the details of the application and management of technologies so they can focus on their core competencies and mission. Our mission-critical solutions integrate an organization's back-office processes and legacy systems with customized applications, and enhance the interoperability and accessibility of critical enterprise data.

Extensive Government Domain Experience

        Our founders, who have worked together for more than 20 years in the government marketplace, have substantial technical and management backgrounds. Our management maintains close working relationships with our clients and an active role in our projects, resulting in consistent contract performance and broad recognition of our managers. Our consulting staff is knowledgeable in the government sector application of technology management policy formulation, acquisition strategy, business process re-engineering and best-value procurement methods.

Deep Technology Expertise

        We have expertise in the critical underlying infrastructure technologies necessary to support fully Web-based enterprises, including security, intranets, applications development and enterprise management. We have direct experience with the legacy automation architectures found in government agencies, allowing us to craft solutions that take advantage of the substantial investments our clients have in legacy systems. Our employees have experience with emerging technologies, Web-enabling tools and vendors such as Microsoft, Oracle, Cisco, IBM/Lotus, IBM/Tivoli, Entrust and Linux.

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Reusable Solution Sets

        For portions of our business, we develop reusable solution sets that can be reapplied to requirements commonly encountered in our markets. We develop the software code and components comprising these reusable solution sets based on our government domain expertise. These solutions enable us to give our clients the benefit of our knowledge and experience in addressing complex mission challenges and to develop and implement solutions more quickly and efficiently. We focus our efforts on customizing solutions to meet our clients' specific needs and to deliver reliable solutions based on components that have been tested and perfected through repeated use.

The PEC Philosophy—Flexibility and Objectivity

        We retain the maximum possible flexibility in the systems and components that we use in our solutions by maintaining both strong established product credentials and substantial hands-on experience with emerging products. We focus on providing strategic and high-end technical service contributions to large programs, while assisting our clients to assemble, contract with and manage the vendors of commodity program elements. By remaining independent of specific vendors, we are able to work with providers that best serve the interests of our clients.

Our Strategy

        Our strategy is to continue to grow by capitalizing on our leadership position in the government technology solutions market. Our strategies for obtaining this objective include:

Maintaining Our Technology Leadership Position

        We will continue to focus on high-end engagements that require specialized knowledge of emerging technologies. We intend to maintain our technology leadership by recruiting employees who will add to our inventory of technology skills and by refining the skills and capabilities of our existing staff through training, certification and hands-on laboratory experimentation. We seek to work closely with our technology partners to share expertise and innovations and to stay well ahead of competitors in the practical aspects of applying and integrating emerging technologies.

Increasing Federal Government Market Penetration and Diversification

        We endeavor to capitalize on our long-term relationships with government clients and our reputation within the government market to cross-sell our full range of services to our existing client base and to expand into organizations in the Federal Government for which we have not already performed services. We pursue these opportunities through a continued active sales and marketing effort and by continuing to promote the success stories stemming from our aggressive application of government technology solutions. We also strive to leverage our relationships with our technology providers and their sales resources to obtain new Federal Government clients.

Enhancing the PEC Solutions Brand and Culture

        We continue to operate a program to build the identity and awareness of the PEC Solutions brand in order to improve our visibility in the marketplace and to attract the best and brightest employees. We seek to hire and retain outstanding professionals, provide incentives to achieve corporate goals, and maintain a culture that fosters innovation. We will continue to emphasize professional development and training of our employees. We maintain an active internal communications program to promote a team culture and foster high employee morale. We also continue to emphasize our corporate technology infrastructure to facilitate the sharing of knowledge among our employees.

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Expanding Our Presence in State and Local Government and Selected Commercial Markets

        We attempt to leverage our domain expertise and deep technology skills for providing services to state and local governments. We also explore available opportunities to expand our business of Web-enabling private sector organizations that operate in highly regulated industries and that have significant interactions with the government agencies with which we work. We believe our existing solution sets, such as case management systems, criminal suspect booking stations, and land and financial records automation, are applicable to projects at the state and local levels, as well as at private sector organizations.

Undertaking a Disciplined Acquisition Program

        We are seeking to broaden our capabilities and client base and extend our presence in both the defense and Federal civilian markets by acquiring select businesses. Acquired businesses will perform similar technical work for organizations outside our current client base or will support solution sets that are consistent with and extend our Web-enabling strategy.

Our Services

        As a provider of government technology solutions, we offer a variety of services across the full technology lifecycle. These services include:

Strategy and Design

        We help clients develop the operational vision for integrated mission solutions, and formulate the business and execution plans for realizing imaginative, integrated and aggressive technology solutions. We develop sophisticated enterprise architectures—the technology blueprints and systematic guidance that allow enterprises to incrementally develop, migrate to, and operate large-scale systems. By re-engineering government processes, we move organizations to an e-Government environment. We perform economic analyses to weigh the costs of technology investment against the operational benefits expected from such technology implementation. We provide support to organizations that are executing programs to privatize large-scale information systems operations, or are undertaking far-reaching changes in their business models, such as migrating from appropriated to fee-for-service financial models.

Solutions Development and Implementation

        We develop, engineer and integrate computer hardware, commercial software, reusable solution sets, custom-built applications and networks to create integrated business solutions for our clients. Our emphasis on Internet technology allows us to combine leading-edge technologies with disciplined and effective system development methodologies. Our methods are designed to ensure that the technology fits with business processes and that users realize process improvement. We distinguish ourselves by addressing the core technical and business challenges in migrating large government enterprises to integrated e-Government solutions. We build:

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INTEGRATED MISSION APPLICATIONS.    We integrate complex back-office business applications and legacy systems with customized mission applications using the information-sharing capabilities of open architectures. We also design, develop and install complex custom application systems that implement knowledge management repositories and tera-byte data warehousing systems allowing government agencies to mine the vast storehouses of records that they collect and maintain.



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LARGE-SCALE INTRANET INFRASTRUCTURES.    We deploy and manage complex international network infrastructures: intranets and extranets that deliver the performance,

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reliability and flexibility needed to support the diverse needs of Web-enabled organizations with thousands of widely dispersed knowledge workers.

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BIOMETRIC IDENTIFICATION SYSTEMS.    We develop and deploy biometric solution sets that help Federal agencies collect and process biometric identification from individuals—such as digital fingerprints, mugshots, and identifying features—for law enforcement and civilian government applicant purposes. This information is then either electronically processed into or vetted against key law enforcement and national security databases.



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LEADING-EDGE AUTHENTICATION AND ENCRYPTION SECURITY APPLICATIONS.    We apply advanced security technologies such as public key infrastructure to manage data encryption systems; biometric authentication to identify individuals by their physical characteristics; and strong encryption to protect sensitive information in highly decentralized systems against unauthorized access and compromised integrity.



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AUTOMATED ENTERPRISE MANAGEMENT SYSTEMS.    We develop and deploy processes and automated tools for our clients to centrally manage and operate complex national networks of workstations and servers at reduced cost.

Ongoing Systems Management and Enhancement

        We provide long-term, ongoing support for our solutions including the operation, management and enhancement actions necessary to keep solutions up-to-date with evolving business processes and technologies. We use sophisticated tools to reduce the burden and costs of maintaining large complex intranets, and to enhance whole systems without the need to deploy engineers and field service technicians to the operating locations of an enterprise. We operate highly automated enterprise technology management processes that support integration, configuration management, software distribution and user support, and allow clients to outsource the responsibilities for maintaining their technology infrastructures and applications. The results are reduced operating costs for our clients and improved performance and reliability.

Recent Developments

        On December 30, 2004, NCS Pearson paid us approximately $4.1 million of the approximately $6.3 million that they owed us. On February 3, 2005, we filed a motion in the United States District Court for the District of Minnesota, asking the court to lift the stay on the original claim. For more discussion on this matter see Item 3 "Legal Proceedings."

        On February 25, 2005, in anticipation of the implementation of SFAS 123R "Share-Based Payment", we accelerated the vesting of all out-of-the money stock options. Therefore these options will not be expensed in future periods after the implementation of SFAS 123R. It is estimated that this will reduce the amount of compensation expenses we would otherwise have been obligated to recognize in connection with these options by approximately $8.4 million before taxes. This amount is $1.1 million less than indicated in our 8-K filing on March 3, 2005. The reduction in estimated potential expense was due to a recalculation of the Black-Sholes methodology. For more discussion on this matter, see Footnote 1 "Stock-Based Compensation" to the financial statements.

Sales and Marketing

        Our marketing efforts are focused on creating awareness of opportunities in government technology innovation, establishing PEC Solutions as a leader in this new category, and building the PEC Solutions' brand.

        We market and sell our services through multiple channels by using our business development staff, leveraging existing client relationships, capitalizing on our task order contracts, responding to

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competitive solicitations, attending marketing events and engaging in other public relations activities. We employ marketing research services to identify and track potential contract opportunities. We also cultivate relationships with leading-edge technology vendors, such as Microsoft and IBM, and prime contractors, such as EDS, to identify and obtain project leads consistent with our capabilities.

        We employ a team selling approach, whereby our business developers collaborate with our service delivery professionals and management to identify prospects, conduct sales and manage client relationships. We allocate business developers to each of our business units who pursue new clients and programs across their market segments. Each current client is assigned to a relationship manager who is responsible for ensuring client satisfaction and successful project performance, and identifying new business opportunities with the client.

Culture, People and Recruiting

        We have developed a corporate culture that promotes excellence in job performance, respect for the ideas and judgment of our colleagues and recognition of the value of the unique skills and capabilities of our professional staff. We seek to attract highly qualified and ambitious staff. We strive to establish an environment in which all employees can make their best personal contribution and have the satisfaction of being part of a unique team. We believe that we have successfully attracted and retained highly skilled employees because of the quality of our work environment, the professional challenge of our assignments, and the financial and career advancement opportunities we make available to our staff.

        We occupy state-of-the-art facilities that are conducive to highly technical and collaborative work, while providing individual privacy. In our solutions centers, we configure large networks of leading-edge equipment and software, and provide our engineers and developers with advanced tools to evaluate and apply new technologies. We believe that the location, environment and amenities provided by our new Fair Lakes campus facility contributes to our ability to attract and retain highly skilled employees.

        As of December 31, 2004, we had 1,991 personnel (including those employed by our subsidiary entities). Of our total personnel, 1,810 were consulting and service delivery professionals, and 181 were management and administrative personnel performing corporate marketing, human resources, finance, accounting, legal, internal information systems and administrative functions. Twenty-six of our personnel are represented by a collective bargaining unit. As of February 28, 2005, comparative numbers were 1,938, 1,735 and 183, respectively.

        In addition to standard company benefits, we provide:

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Tuition reimbursement for employees pursuing advanced academic degrees;



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Professional training programs;



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Financial incentives for employees obtaining product competency certifications;



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A bonus program;



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Spot cash awards to reward specific employee accomplishments; and



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Stock option grants based on job performance.

        We invest heavily in technical staff recruiting resources and hiring programs. Each of our business units is staffed with a dedicated recruiter, and we aggressively use a variety of recruiting methods, including advertising, job fairs, open houses and Internet-based career placement services. We also offer substantial awards and recognition to our current employees for referrals, which has been particularly effective in identifying and recruiting talented staff.

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        We have developed an active and effective college recruiting program that draws on management staff and recent college hires from across our company to attract graduating students with strong academic backgrounds in our core disciplines. We currently target colleges and universities in Washington, D.C., Maryland, and Virginia with this program, and perform on-campus recruiting during the spring and fall recruiting seasons at five universities.

Competition

        Our current competitors include, and may in the future include, the following:

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Information technology services providers and large government contractors such as Accenture, Booz-Allen & Hamilton, Computer Sciences Corporation, Electronic Data Systems, Bearing Point, International Business Machines, Science Applications International Corporation, Unisys, Lockheed Martin and Northrop Grumman; and



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Internet professional services providers.

        Many of our competitors have long operating histories and strong client relationships, greater financial, technical, marketing and public relations resources, larger client bases and greater brand or name recognition than we have.

        We believe that the major competitive factors in our market relate to a company's distinctive technical capabilities, successful past contract performance, reputation for quality and key management and business development staff. Under best-value procurement methods, price is an important, but secondary, factor in the selection of a technology service provider.

Intellectual Property Rights

        Our success is dependent, in part, upon our proprietary processes, components and other intellectual property rights. We do not have any patents or patent applications pending. We rely on a combination of trade secret, nondisclosure and other contractual agreements, and copyright and trademark laws, to protect our proprietary rights. Existing trade secret and copyright laws afford us only limited protection. We enter into confidentiality agreements with our employees and our contractors and limit access to and distribution of our proprietary information. There can be no assurance that the steps we have taken in this regard will be adequate to deter misappropriation of our proprietary information or that we will be able to detect unauthorized use and take appropriate steps to enforce our intellectual property rights.

        A portion of our business involves the development of software applications for specific client engagements. Although ownership of client-specific software is generally retained by the client, we retain some rights to the applications, processes and intellectual property developed in connection with client engagements. We generally retain full-rights when licensing our public safety software applications.

Backlog

        Our current funded backlog is approximately $124 million. Our contracts typically are funded incrementally, and therefore the funded backlog only represents that portion of the contract value. Funding occurs as work progresses. The Federal civilian budget normally is signed before the end of the calendar year. The 2004 and 2005 federal civilian budgets were not signed until the end of January 2004 and December 2004, respectively, which adversely effected the funding of contracts. Our average contract/task performance period runs between 10 to 12 months. Our backlog is typically subject to large variations from quarter to quarter as existing contracts/tasks are renewed or new contracts are awarded. Additionally, all Federal Government contracts, whether or not funded, may be terminated at the convenience of the government.

Environmental Issues

        We have not incurred any costs associated with environmental issues.

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Risk Factors

Risk Factors Related to Our Business

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 would decline substantially, and our business would be seriously harmed. During 2004, contracts with the Federal Government and contracts with prime contractors of the Federal Government accounted for approximately 97% of our revenues. During that same period, our ten largest clients, all agencies of the Federal Government, generated approximately 52% of our revenues, with the top five clients accounting for 34% 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.

Major changes to the Government's fundamental organization could negatively impact revenues.

        The establishment of the Department of Homeland Security, the largest reorganization of the Federal Government since 1947, required new and enhanced oversight of technology spending programs at the numerous and disparate agencies being rolled into the new organization. Any future reorganization, or delays in technology spending that might result as the reorganization is implemented, could adversely impact company revenues.

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 non-renewal 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 re-bidding process. We may not win any particular re-bid or be able to successfully bid on new contracts to replace those that have been terminated. Even if we do win the re-bid, we may experience revenue shortfalls in periods where we anticipated revenues from the contract rather than its termination and subsequent re-bidding. 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 generally 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 re-deploy 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 22% of our revenues during 2004 through our relationships with prime contractors, which, in turn, have contractual relationships with end-clients. 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 16% of our revenues in 2004 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.

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:

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Lose revenues due to adverse client reaction;



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Be required to provide additional remediation services to a client at no charge;



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Receive negative publicity, which could damage our reputation and adversely affect our ability to attract or retain clients; and



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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 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.

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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 President, and Alan Harbitter, our Chief Operating Officer. 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 were 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 public offerings and operations to acquire companies or businesses that are complementary to ours. However, we have no 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 value of our 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 revenues 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

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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.

Changes to Federal Government procurement rules and regulations could impact revenues.

        While the government procurement changes of the mid-1990s generally benefited companies servicing the Federal Government (such as government agencies being able to award outsourcing contracts based on "best value" over lowest price), any future changes that sought to limit or reduce government outsourcing, for example, bringing more technology systems work "in-house," could have a negative impact on company revenues.

Continued involvement in Iraq, or other nations, could impact Federal Government spending on our civilian and defense programs.

        Although our work focuses primarily on our clients' mission-critical programs, continued involvement in Iraq or a war in another country could change the Federal Government's spending priorities for domestic and military programs. Spending on our clients' programs could also be negatively impacted by Congress's unwillingness to pass the necessary appropriation bills required to pay for a war effort.

Risks Factors Related to the Government Technology Solutions Market.

Competition could result in price reductions, reduced profitability and loss of market share.

        Competition in the market for government technology 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, business

14

development 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:

•

Information technology services providers and large government contractors such as Accenture, Booz-Allen & Hamilton, Computer Sciences Corporation, Electronic Data Systems, Bearing Point, International Business Machines, Science Applications International Corporation, Unisys, Lockheed Martin and Northrop Grumman; 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.

New acquisitions could result in reduced profitability.

        If PEC continues to diversify its business by acquiring companies with margins lower than PEC's, our operating margins may decline. Cost-plus contracts are a staple of the defense industry, and are normally associated with lower profit margins.

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 government technology 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.

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

15

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.

Our officers and directors own 51.3% of our stock and can control matters submitted to stockholders for their approval.

        Our directors and executive officers directly or indirectly own, in the aggregate, 51.3% of our outstanding common stock. As a result, these stockholders will be able to exercise control over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may also have the effect of delaying or preventing a change in control of PEC Solutions.

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 us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder.

Website Access to Reports

        Our filings with the U.S. Securities and Exchange Commission (the "SEC") and other information, including our Ethics Policy, can be found on the PEC Solutions Website (www.pec.com). Information on our Website does not constitute part of this report.

        We make available free of charge, on or through our Internet Website, as soon as reasonably practicable after they are electronically filed or furnished to the SEC, our Annual Reports on

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Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act of 1934.

Item 2. Properties.

        Our operations occupy approximately 431,000 square feet of space located in Arlington, Fairfax and Falls Church, Virginia; Baltimore, Columbia, Lanham and Rockville, Maryland; Washington, D.C.; San Diego, California; San Antonio, Texas; Trevose, Pennsylvania; Montgomery, Alabama; Denver and Colorado Springs, Colorado; O'Fallon, Illinois; Dayton, Ohio; and Sierra Vista, Arizona. We also have employees working at client sites throughout the United States. The large majority of the space is office space, all of which is leased. For lease commitment information, reference is made to Note 15 in the accompanying consolidated financial statements. Existing facilities are considered to be generally suitable and adequate for our present needs. We have a 48% equity interest in the limited liability company that owns our newest building in Fairfax, Virginia. Future contracts may require us to lease additional office space in other cities located in the United States.

Item 3. Legal Proceedings.

        On and after March 18, 2003, several purported class action complaints were filed against us and certain of our officers in the United States District Court for the Eastern District of Virginia. The complaints allege that between October 22, 2002 and March 14, 2003, the defendants made, or were aware of, false and misleading statements which had the effect of inflating the market price of the Company's common stock, in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The complaints were consolidated into a single class action on September 13, 2003. The class action was dismissed by the District Court on January 28, 2004. The plaintiffs filed an appeal with the U.S. Court of Appeals for the Fourth Circuit on September 30, 2004. Oral arguments on the appeal were held on December 2, 2004, and we are awaiting the appellate court's decision. In addition, shortly after the class action complaints were filed, a stockholder's legal counsel sent a letter of demand that the Board of Directors investigate the same charges addressed in the class action suit. In late 2003 the Board concluded, after its investigation and based on its business judgment, to reject the demand letter.

        On September 11, 2003, we instituted a lawsuit in the United States District Court for the District of Minnesota against NCS Pearson, Inc. for improperly withholding payment of funds owed to us under a subcontract. We were seeking recovery of $6.3 million in unpaid receivables plus interest and costs. On November 4, 2004, the District Court granted defendant's motion to stay the proceedings pending the outcome of dispute resolution procedures among NCS Pearson, PEC, and the government. The judge stated that NCS Pearson and PEC possessed a commonality of position against the Government and indicated that adjudication of PEC's claim was premature at that time. We appealed the stay to the U.S. Court of Appeals for the Eight Circuit. After the appeal was filed in December 2004, NCS Pearson settled its dispute with the Government, and subsequently paid us approximately $4.1 million. On February 3, 2005, we filed a motion in the District Court, asking the judge to lift the stay and reopen our case against NCS Pearson. A hearing on the matter was held on February 18, 2005 and we are awaiting the judge's decision. On March 1, 2005, the Eighth Circuit granted our motion to hold the appeal in abeyance until it is determined whether the proceedings will resume at the District court level.

Item 4. Submission of Matters To a Vote of Security Holders.

        None

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PART II

Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

        At March 2, 2005, we had approximately 6,300 holders of record of our common stock. We had 27,592,993 shares of common stock outstanding. Our stock began trading on the Nasdaq National Market on April 20, 2000 under the symbol "PECS". The following high and low sale prices indicated for our common stock are as reported on the Nasdaq National Market during each of the quarters indicated.

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

Recent Sales of Unregistered Securities or Issuer Repurchases of Registered Securities

        None

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Item 6. Selected Financial Data.

        Our selected consolidated financial data for the years ended December 31, 2000, 2001, 2002, 2003 and 2004 have been derived from our audited consolidated financial statements. The 2002, 2003 and 2004 information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and the related notes thereto appearing elsewhere in this Annual Report on Form 10-K. Certain reclassifications have been made to the prior period financial statements to conform to the presentation used in our December 31, 2004, consolidated financial statements.

(a)

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

(b)

Per share amounts for all periods presented have been adjusted to reflect the 3 for 1 stock split in January 2000 and the 2 for 1 stock split in March 2000.

(c)

See footnote 3. "Goodwill and Intangibles" of the financial statements to see the impact of acquisitions on the financial results.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

        This Management's Discussion and Analysis of Financial Condition and Results of Operation section includes "forward-looking statements," within the meaning of the Federal Private Securities Litigation Reform Act of 1995. While forward-looking statements sometimes are presented with numerical specificity, they are based on various assumptions made by management regarding future circumstances over many of which we have little or no control. Forward-looking statements may be identified by words including "anticipate," "believe," "estimate," "expect" and similar expressions. We caution readers that forward-looking statements, including without limitation, those relating to future business prospects, revenues, working capital, liquidity, and income, are subject to certain risks and uncertainties that would cause actual results to differ materially from those indicated in the forward-looking statements. Factors that could cause actual results to differ from forward-looking statements include the concentration of our revenues from the U.S. Government and its agencies and departments (the "Government"), risks involved in contracting with government clients, difficulties we may have in attracting, retaining and managing professional and administrative staff, fluctuations in quarterly results, risks related to acquisitions, risks related to competition and our ability to continue to win and perform

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efficiently on government contracts, and other risks and factors identified from time to time in the reports we file with the U.S. Securities and Exchange Commission ("SEC"), including those identified under the caption "Risk Factors" in this Annual Report on Form 10-K. 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.

Overview

        We are 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 e-Government 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.

        As part of our growth strategy, we have completed acquisitions of Viking Technology, Inc. ("Viking") on August 28, 2000; Troy Systems, Inc. ("Troy") on November 20, 2001; the contracts and employees of Vector Research, Inc. ("Vector") on June 15, 2002; Integrated Information Technology Corporation ("IITC") on May 28, 2004; and AC Technologies, Inc. ("ACT") on September 9, 2004. These business combinations were accounted for as purchases. See "Acquisitions."

        In 2004, our revenues were adversely affected by the late passage and signing of both the 2004 and 2005 Federal civilian budgets.

        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 2004, revenues from these contract types were approximately 63%, 16%, and 21%, respectively, of total revenues. We expect this approximate mix of business to continue in 2005. 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 when known or identified. However, if the contract has a service element, revenues are recognized on a straight-line basis over the term of the contract. In certain arrangements, we enter into contracts that include the delivery of a combination of two or more of our service offerings. Typically, such multiple-element arrangements incorporate the design, development or modification of systems and an ongoing obligation to manage, staff, maintain, host or otherwise run solutions and systems provided to the client. Such contracts are divided into separate units of accounting and the total arrangement fee is allocated to each unit based on its relative fair value. Revenue is recognized separately, and in accordance with our revenue recognition policy, for each element. Fixed-price contracts are attractive to clients, and while subject to increased risks, provide opportunities for increased margins. We recognize revenue 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. While our margins are lower on cost-reimbursable contracts, we have historically recovered all of our costs on these contracts, which means we have lower risk.

        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 fiscal year generated in excess of 98% of our revenues in 2004, approximately 93% of our revenues in 2003, and approximately 86% of our revenues in 2002. We manage our client development efforts through each of our strategic service groups, each having specific client responsibility and focus. As of December 31,

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2004, we had 1,991 personnel and on February 28, 2005 we had 1,931 personnel (including those employed by our subsidiary entities).

        In 2004, we derived approximately 22% of our revenue through relationships with prime contractors, which 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.

        During 2004, we had no customers that accounted for more than 10% of our total revenue.

        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, public reporting costs, 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, and income from our investment in our corporate headquarters building.

Acquisitions

        On June 15, 2002, we acquired the contracts and employees of Vector for $5.7 million cash plus the assumption of $0.1 million in accrued liabilities. Vector was a provider of technology development and engineering services to the Federal Government. The excess of purchase price over fair value of the net assets was approximately $4.3 million. At the time of the acquisition, Vector had 41 personnel.

        On May 28, 2004, we acquired all of the outstanding common shares of IITC for $34.0 million in a business combination accounted for as a purchase. IITC derives revenue from providing satellite communication engineering and information technology solutions to the Federal Government. The excess of purchase price over the fair value of the net assets was approximately $30.2 million. At the time of the acquisition, IITC had 271 personnel.

        On September 9, 2004, we acquired all of the outstanding common shares of ACT for $51.4 million in a business combination accounted for as a purchase. ACT derives revenue from providing software engineering and networking services to the Federal Government. The excess of purchase price over the fair value of the net assets was approximately $45.7 million. At the time of the acquisition, ACT had 364 personnel.

Critical Accounting Policies and Significant Estimates

        The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires that management make estimates and assumptions affecting the assets and liabilities (including contingent assets and liabilities) reported at the date of the consolidated financial statements and the revenues and expenses reported for the periods presented. Actual amounts could differ from those estimates. Management bases its estimates on historical experience, current data, information related to performance, and on various other assumptions that are believed to be reasonable under the

21

circumstances. Those measurements that are most affected by management's estimates of future events are:

•

Revenue recognition.  Our revenue is derived primarily from contracts with the Federal Government. In 2002, 2003 and 2004, 21%, 24%, 16% of our contracts were fixed-priced contracts. Revenues on fixed-price contracts are recognized using the percentage-of-completion method of accounting. Such revenues are recorded based on the percentage of costs incurred in the applicable reporting period compared to the most recent estimates of total costs to complete each contract. Estimating future costs and, therefore, revenues and profits, is a process requiring a high degree of management judgment. In the event of a change in total estimated contract cost or profit, the cumulative effect of such change is recorded in the period the change in estimate occurs. We recognize and make provisions for any anticipated contract losses when known or identified. However, if the contract has a service element, revenues are recognized on a straight-line basis over the term of the contract. In certain arrangements, we enter into contracts that include the delivery of a combination of two or more of our service offerings. Typically, such multiple-element arrangements incorporate the design, development or modification of systems and an ongoing obligation to manage, staff, maintain, host or otherwise run solutions and systems provided to the client. Such contracts are divided into separate units of accounting and the total arrangement fee is allocated to each unit based on its relative fair value. Revenue is recognized separately, and in accordance with our revenue recognition policy, for each element.



•

Depreciation and amortization periods for long-lived assets, including property and equipment and intangibles.  In accordance with SFAS No. 144, "Accounting for the Impairment of Long-Lived Assets," we review our long-lived assets, including property and equipment and identifiable intangibles, whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. To determine the recoverability of long-lived assets, we evaluate the probability that future estimated undiscounted net cash flows will be less than the carrying amount of the assets. If the future estimated undiscounted net cash flows will be less than the carrying amount of the long-lived assets, then such assets are written down to their fair value. We have not identified any events or circumstances that indicate the carrying value of long-lived assets may not be fully recoverable.



•

Realization values of various assets such as receivables and goodwill.  The allowance for doubtful accounts reflects management's best estimate of probable losses based on historical experience, known troubled accounts and other currently available information. Allowances are established for specific receivables when deemed appropriate. Goodwill is tested for impairment on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the goodwill below its carrying value. We completed our annual impairment test and concluded goodwill was not impaired. If actual market conditions are less favorable than those we have projected, or if an event occurs, or circumstances change that would more likely than not reduce the fair value of the goodwill below its carrying value, we may be required to recognize goodwill impairment charges.

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Results of Operations

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