AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 29, 1999
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM S-1
REGISTRATION STATEMENT
UNDER THE SECURITIES ACT OF 1933
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PREDICTIVE SYSTEMS, INC.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 7371 13-3808483
(State or Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employer Identification Number)
Incorporation or Organization) Classification Code Number)
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145 HUDSON STREET
NEW YORK, NEW YORK 10013
(212) 219-4400
(Address, Including Zip Code, and Telephone Number,
Including Area Code, of Registrant's Principal Executive Offices)
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RONALD G. PETTENGILL, JR. ROBERT L. BELAU
CHIEF EXECUTIVE OFFICER PRESIDENT
PREDICTIVE SYSTEMS, INC.
145 HUDSON STREET
NEW YORK, NEW YORK 10013
(212) 219-4400
(Name, Address, Including Zip Code, and Telephone Number,
Including Area Code, of Agents for Service)
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Copies to:
ALEXANDER D. LYNCH, ESQ. PETER B. TARR, ESQ.
BABAK YAGHMAIE, ESQ. JOSEPH E. MULLANEY III, ESQ.
BROBECK, PHLEGER & HARRISON LLP HALE AND DORR LLP
1633 BROADWAY, 47(TH) FLOOR 60 STATE STREET
NEW YORK, NEW YORK 10019 BOSTON, MASSACHUSETTS 02109
(212) 581-1600 (617) 526-6000
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. / /
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. / / ______
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / / ______
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / / ______
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. / /
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CALCULATION OF REGISTRATION FEE
PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AGGREGATE OFFERING AMOUNT OF
SECURITIES TO BE REGISTERED PRICE(1) REGISTRATION FEE
Common Stock, par value $.001 per share................................................. $52,000,000 $14,456
(1) Estimated pursuant to Rule 457(o) under the Securities Act of 1933, as
amended, solely for the purpose of computing the amount of the registration
fee.
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(A), MAY
DETERMINE.
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THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION
IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL SECURITIES, AND WE ARE NOT
SOLICITING OFFERS TO BUY THESE SECURITIES, IN ANY STATE WHERE THE OFFER OR SALE
IS NOT PERMITTED.
SUBJECT TO COMPLETION, DATED JULY 29, 1999.
PREDICTIVE SYSTEMS, INC.
SHARES
COMMON STOCK
Predictive Systems, Inc. is offering shares of its common stock.
This is our initial public offering, and no public market currently exists for
our shares. We have applied to have the shares we are offering approved for
quotation on the Nasdaq National Market under the symbol "PRDS." We anticipate
that the initial public offering price will be between $ and $ per share.
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INVESTING IN OUR COMMON STOCK INVOLVES RISKS.
SEE "RISK FACTORS" BEGINNING ON PAGE 8.
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PER SHARE TOTAL
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Public Offering Price.......................................... $ $
Underwriting Discounts and Commissions......................... $ $
Proceeds to Predictive......................................... $ $
THE SECURITIES AND EXCHANGE COMMISSION AND STATE SECURITIES REGULATORS HAVE
NOT APPROVED OR DISAPPROVED THESE SECURITIES, OR DETERMINED IF THIS PROSPECTUS
IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
We have granted the underwriters a 30-day option to purchase up to an
additional shares of common stock to cover over-allotments. BancBoston
Robertson Stephens Inc. expects to deliver the shares of common stock to
purchasers on , 1999.
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BANCBOSTON ROBERTSON STEPHENS
BEAR, STEARNS & CO. INC.
DONALDSON, LUFKIN & JENRETTE
FIRST UNION CAPITAL MARKETS CORP.
THE DATE OF THIS PROSPECTUS IS , 1999.
[COLOR ARTWORK TO BE PROVIDED]
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE
HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION DIFFERENT FROM THAT
CONTAINED IN THIS PROSPECTUS. WE ARE OFFERING TO SELL, AND SEEKING OFFERS TO
BUY, SHARES OF COMMON STOCK ONLY IN JURISDICTIONS WHERE OFFERS AND SALES ARE
PERMITTED. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS ACCURATE ONLY AS OF
THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF DELIVERY OF THIS
PROSPECTUS OR OF ANY SALE OF OUR COMMON STOCK. IN THIS PROSPECTUS, REFERENCES TO
THE "COMPANY," "PREDICTIVE," "WE," "US" AND "OUR" REFER TO PREDICTIVE SYSTEMS,
INC. AND ITS SUBSIDIARIES.
UNTIL , 1999 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS THAT BUY, SELL OR TRADE OUR COMMON STOCK, WHETHER OR NOT PARTICIPATING
IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS REQUIREMENT IS
IN ADDITION TO THE DEALERS' OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
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TABLE OF CONTENTS
PAGE
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Prospectus Summary......................................................................................... 4
Risk Factors............................................................................................... 8
Forward-Looking Statements................................................................................. 15
Use of Proceeds............................................................................................ 16
Dividend Policy............................................................................................ 16
Capitalization............................................................................................. 17
Dilution................................................................................................... 18
Selected Consolidated Financial Data....................................................................... 19
Management's Discussion and Analysis of Financial Condition and Results of Operations...................... 21
Business................................................................................................... 30
Management................................................................................................. 42
Certain Transactions....................................................................................... 52
Principal Stockholders..................................................................................... 54
Description of Capital Stock............................................................................... 56
Shares Eligible for Future Sale............................................................................ 59
Underwriting............................................................................................... 61
Legal Matters.............................................................................................. 63
Experts.................................................................................................... 63
Where You Can Find More Information........................................................................ 63
Index to Financial Statements.............................................................................. F-1
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"PREDICTIVE SYSTEMS," "BUSINESSFIRST" and the Predictive logo are trademarks
of Predictive. All other trademarks and service marks used in this prospectus
are the property of their respective owners.
3
PROSPECTUS SUMMARY
YOU SHOULD READ THE FOLLOWING SUMMARY TOGETHER WITH THE MORE DETAILED
INFORMATION AND OUR CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES
APPEARING ELSEWHERE IN THIS PROSPECTUS.
PREDICTIVE SYSTEMS, INC.
OUR BUSINESS
We are a network consulting company focused on the design, performance,
management and security of complex business-critical computing networks. We
utilize our proprietary consulting methodology, BusinessFirst, to translate our
clients' strategic business objectives into sound technology solutions. Using
our BusinessFirst methodology, we demonstrate the business value of technology
solutions in specific and measurable terms, thereby enabling our clients to
incorporate objective and quantifiable analysis into their technology investment
decisions. As a result, our clients can gain a clear understanding of the
benefits that they will derive from their network technology investments and a
measure of certainty regarding how their technology investments will be
translated into quantifiable improvements to their business processes.
OUR SERVICES
As an independent service provider, we provide our clients with unbiased and
vendor-neutral expertise that enables the design, implementation and management
of optimal technology solutions. We provide our services on either a project
outsource or collaborative consulting basis. Our project outsource services are
primarily based and measured against pre-defined deliverables and provide our
clients with certainty of costs, delivery time and project scope. Our
collaborative consulting services enable our clients to utilize our extensive
expertise in order to extend their internal capabilities and to access our
methodologies. In addition to these services, we have developed an innovative
service model through which we deliver our clients packaged service products, or
productized services. These services consist of pre-defined, fixed-price
deliverables that are replicated from our best practices. We believe that this
unique approach to network services further differentiates us from our
competitors.
Our consultants are organized into the following practice areas, which cover
the four cornerstones of network computing: network and systems management;
internetwork design and engineering; performance management; and information
security. This structure enables our consultants to gain in-depth expertise and
become intimately familiar with the best practices within each of those
disciplines.
OUR MARKET
We believe we are well-positioned to capitalize on global trends impacting
communications technology, primarily the acceptance and growth of the Internet
and private intranets. As a result of these trends, the demand for network
consulting services has grown dramatically. International Data Corporation
estimates that the worldwide market for these services will grow from $12.1
billion in 1998 to $25.5 billion by 2003. Although there are many third-party
service providers attempting to address this growing market, including network
equipment vendors, systems integrators, value-added resellers and network
consulting companies, few have the requisite focus and expertise to address the
complex, multi-faceted issues surrounding today's business-critical networks.
4
OUR STRATEGY
Our goal is to become the leading provider of services for the design,
performance, management and security of complex networks. To achieve this goal,
we intend to pursue the following strategies:
- continue to evolve our BusinessFirst methodology;
- expand and enhance our productized service offerings;
- continue to attract and retain highly qualified consultants;
- further increase our industry expertise; and
- expand in existing and new geographic markets.
OUR CLIENTS
We provide our services to a broad range of clients in many industries,
including communications services, financial services, network technology and
professional services. Our client base includes leaders such as Allied Signal,
Ascend, AT&T, Bank of America, Bear, Stearns, Bloomberg, British Telecom, Cisco
Systems, Lucent Technologies, Nortel Networks, Pfizer, PricewaterhouseCoopers,
Qwest and Raytheon.
OUR HISTORY
We were organized in Delaware in February 1995. Since our inception, we have
expanded our service offerings, evolved our technology expertise and developed
the scope of our business to address the most critical network technology needs
of the broad client base we serve. We have continued to grow our client base by
expanding geographically, and we have supported this client base by attracting
and retaining talented professionals at all levels. As of June 30, 1999, our
employee base had grown to 280 full-time employees.
Our principal executive offices are located at 145 Hudson Street, New York,
New York 10013. Our telephone number is (212) 219-4400. In addition, we maintain
offices in eight other locations, including Atlanta, Georgia; Boston,
Massachusetts; Dallas, Texas; Florham Park, New Jersey; Herndon, Virginia;
Pleasanton, California; Santa Cruz, California; and London, England.
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Except as otherwise noted, all information in this prospectus:
- reflects the automatic conversion of all of our outstanding shares of
series A convertible preferred stock into an aggregate of 6,512,316 shares
of common stock upon the completion of this offering; and
- assumes no exercise of the underwriters' over-allotment option.
5
THE OFFERING
Common stock offered by Predictive........... shares
Common stock to be outstanding after this shares
offering...................................
Use of proceeds.............................. For general corporate purposes, including
working capital. We may also use a portion of
the proceeds for acquisitions of
complementary businesses or technologies.
Please see "Use of Proceeds."
Proposed Nasdaq National Market symbol....... PRDS
The number of shares outstanding after this offering is based on our shares
of common stock outstanding as of March 31, 1999 and gives effect to the
conversion of all outstanding shares of series A convertible preferred stock
into 6,512,316 shares of common stock automatically on the closing of this
offering. This information excludes:
- 8,586,600 shares subject to options outstanding as of March 31, 1999 at a
weighted average exercise price of $1.14 per share; and
- shares subject to warrants outstanding as of March 31, 1999 at
an exercise price per share equal to the initial public offering price of
our common stock; and
- additional shares reserved for issuance under our stock option
plan.
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SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following tables summarize the financial data for our business. You
should read this information with the discussion in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and our consolidated
financial statements and related notes included elsewhere in this prospectus.
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
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1996 1997 1998 1998 1999
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(UNAUDITED)
STATEMENT OF OPERATIONS DATA:
Revenues............................... $ 8,106 $ 18,087 $ 25,923 $ 3,877 $ 10,365
Cost of revenues....................... 4,352 10,407 14,560 2,452 5,275
Gross profit........................... 3,754 7,680 11,363 1,425 5,090
Operating profit (loss)................ 1,543 1,887 (822) (890) (112)
Net income (loss)...................... $ 863 $ 1,011 $ (627) $ (520) $ (91)
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NET INCOME (LOSS) PER SHARE:
Basic.................................. $ 0.20 $ 0.22 $ (0.11) $ (0.12) $ (0.01)
Diluted................................ 0.07 0.08 (0.11) (0.12) (0.01)
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING:
Basic.................................. 4,269 4,382 6,015 4,463 8,380
Diluted................................ 11,586 12,765 6,015 4,463 8,380
The following table is a summary of our balance sheet at March 31, 1999. The
pro forma adjusted data give effect to:
- the conversion of 6,512,316 shares of our Series A convertible preferred
stock into 6,512,316 shares of common stock and the reissuance of treasury
stock in connection with this conversion; and
- the sale of shares of common stock at an assumed initial public
offering price of $ per share, after deducting underwriting
discounts and commissions and estimated offering expenses payable by us.
MARCH 31, 1999
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PRO FORMA
ACTUAL AS ADJUSTED
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BALANCE SHEET DATA:
Cash and cash equivalents................................................................. $ 2,995 $
Working capital........................................................................... 12,261
Total assets.............................................................................. 16,631
Total stockholders' equity................................................................ 12,842
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RISK FACTORS
THIS OFFERING INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD CAREFULLY CONSIDER
THE RISKS DESCRIBED BELOW BEFORE YOU DECIDE TO BUY OUR COMMON STOCK. IF ANY OF
THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS, RESULTS OF OPERATIONS OR
FINANCIAL CONDITION WOULD LIKELY SUFFER. IN THIS CASE, THE MARKET PRICE OF OUR
COMMON STOCK COULD DECLINE, AND YOU COULD LOSE ALL OR PART OF YOUR INVESTMENT.
RISKS RELATED TO OUR FINANCIAL CONDITION AND BUSINESS MODEL
OUR LIMITED OPERATING HISTORY MAKES EVALUATING OUR BUSINESS DIFFICULT
We commenced operations in February 1995. Accordingly, you can only evaluate
our business based on our limited operating history. You should evaluate our
chances of financial and operational success in light of the risks,
uncertainties, expenses, delays and difficulties associated with operating a new
business, many of which are beyond our control. As a result of our limited
operating history, rapid growth and the emerging nature of the markets in which
we compete, we believe that quarter-to-quarter comparisons of our results of
operations for preceding quarters are not necessarily meaningful. You should not
rely on our historical results of operations as indications of future
performance. The uncertainty of our future performance and the uncertainties of
our operating in a new and expanding market increase the risk that the value of
your investment will decline.
BECAUSE MOST OF OUR REVENUE IS GENERATED FROM A SMALL NUMBER OF CLIENTS, OUR
REVENUES ARE DIFFICULT TO PREDICT AND THE LOSS OF ONE COULD SIGNIFICANTLY REDUCE
OUR REVENUES
Our five largest clients accounted for 62.8% of our revenues for the three
months ended March 31, 1999. For the year ended December 31, 1998, our five
largest clients accounted for 54.9% of our revenues. If one of our major clients
discontinues or significantly reduces the use of our services, our business,
results of operations and financial condition could materially suffer. In
addition, the non-payment or late payment of amounts due from a major client
could have a material adverse effect on our business, results of operations and
financial condition.
OUR CLIENTS MAY TERMINATE THEIR CONTRACTS WITH US ON SHORT NOTICE, WHICH COULD
ADVERSELY AFFECT OUR OPERATING RESULTS
Our services are often sold pursuant to short-term arrangements and most
clients can reduce or cancel their contracts for our services without penalty
and with little or short notice. If a major client or a number of small clients
terminate our contracts or significantly reduce or modify their business
relationships with us, our business, results of operations and financial
condition will be materially adversely affected. Consequently, you should not
predict or anticipate our future revenue based upon the number of clients we
have currently or the number and size of our existing projects.
OUR OPERATING RESULTS MAY FLUCTUATE FROM QUARTER TO QUARTER WHICH MAY NEGATIVELY
IMPACT OUR STOCK PRICE
Our operating results have varied from quarter to quarter. Our operating
results may continue to vary as a result of a variety of factors. These factors
include:
- the loss of key employees;
- the development and introduction of new service offerings;
- reductions in billing rates;
- the miscalculation of resources required to complete new or ongoing
projects;
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- the utilization of our workforce; and
- the timing and extent of training.
Many of these factors are beyond our control. Accordingly, you should not
rely on quarter-to-quarter comparisons of our results of operations as an
indication of our future performance.
IF WE FAIL TO ACCURATELY ESTIMATE COSTS IN FIXED-PRICE PROJECTS, OUR OPERATING
RESULTS MAY SUFFER
We derive a substantial portion of our revenues from fixed-price projects.
For the year ending December 31, 1998 and the three months ended March 31, 1999,
fixed-price projects accounted for 26.0% and 37.0% of our revenue, respectively.
We assume greater financial risks on a fixed-price project than on a
time-and-expense based project. If we miscalculate the resources or time we need
for these fixed-price projects, the costs of completing these projects may
exceed the price, which could result in a loss on the project and materially
adversely affect our operating results. Further, the average size of our
contracts has increased in recent quarters, resulting in a corresponding
increase in our exposure to the financial risks of fixed-price engagements. We
recognize revenues from fixed-price projects based on our estimate of the
percentage of each project completed in a reporting period. To the extent our
estimates are inaccurate, the revenues and operating profits, if any, that we
report for periods during which we are working on a fixed-price project may not
accurately reflect the final results of the project and we would be required to
record an expense for such period equal to the amount by which our revenues were
previously overstated.
OUR OPERATING RESULTS MAY FLUCTUATE DUE TO SEASONAL FACTORS
Our results of operations may experience seasonal fluctuations as businesses
typically spend less on network management services during the summer and
year-end vacation and holiday periods. Additionally, as a large number of our
employees take vacation during these periods, our utilization rates during these
periods tend to be lower, which adversely affects our margins and results of
operations. If in future quarters our results of operations fall below the
expectations of stock market analysts and investors, the market price of our
stock is likely to fall.
OUR LONG SALES CYCLE MAKES OUR REVENUE DIFFICULT TO PREDICT
The timing of our revenues is difficult to predict because of the length and
variance of the time required to complete a sale. Before hiring us for a
project, our clients often undertake an extensive review process and may require
approval at various levels within their organization. Any delay due to a long
sales cycle could have a material adverse affect on our business, results of
operations and financial condition.
WE MAY NOT BE ABLE TO OBTAIN SUFFICIENT FUNDS TO GROW OUR BUSINESS
Our future liquidity and capital requirements are difficult to predict
because they depend on numerous factors, including the success of our existing
and new service offerings and competing technological and market developments.
We may need to raise additional funds in order to meet additional working
capital requirements, support additional capital expenditures or take advantage
of acquisition opportunities. Our ability to obtain additional financing will be
subject to a number of factors, including market conditions, our operating
performance and investor sentiment. These factors may make the timing, amount,
terms and conditions of additional financing unattractive for us. If we are
unable to raise additional funds when needed, our growth could be impeded.
9
RISKS RELATED TO OUR STRATEGY AND MARKET
WE MAY HAVE DIFFICULTY MANAGING OUR EXPANDING OPERATIONS, WHICH MAY HARM OUR
BUSINESS
A key part of our strategy is to grow our business, however, our rapid
growth has placed a significant strain on our managerial and operational
resources. From January 1, 1997 to June 30, 1999, our staff increased from
approximately 123 to approximately 280 employees. To manage our growth, we must
continue to improve our financial and management controls, reporting systems and
procedures, and expand and train our work force. If we fail to do so, our
business, financial condition or results of operations may be materially
adversely affected.
WE MAY NOT BE ABLE TO HIRE AND RETAIN QUALIFIED NETWORK SYSTEMS CONSULTANTS
WHICH COULD AFFECT OUR ABILITY TO COMPETE EFFECTIVELY
Our continued success depends on our ability to identify, hire, train and
retain highly qualified network management consultants. These individuals are in
high demand and we may not be able to attract and retain the number of highly
qualified consultants that we need. If we cannot retain, attract and hire the
necessary consultants, our ability to grow, complete existing projects and bid
for new projects will be adversely affected and our business, results of
operations and financial condition will suffer.
COMPETITION COULD HARM OUR BUSINESS
Our market is intensely competitive, highly fragmented and subject to rapid
technological change. We expect competition to intensify and increase over time.
We may lose projects to our competitors, which could adversely affect our
business, results of operations and financial condition.
We face competition from systems integrators, value added resellers, local
and regional network services firms, telecommunications providers, and network
equipment and computer systems vendors. Many of these competitors have:
- longer operating histories;
- greater name recognition;
- larger established client relationships; and
- significantly greater financial, technical and personnel resources.
Additionally, our competitors have in the past and may in the future form
alliances with various network equipment vendors that may give them an advantage
in implementing networks using that vendor's equipment.
We also compete with internal information technology departments of current
and potential clients. To the extent that current or potential clients decide to
satisfy their needs internally, our business, results of operations and
financial condition will be materially adversely effected.
IF WE ARE UNABLE TO INTEGRATE OUR ACQUISITIONS, OUR BUSINESS MAY BE DISRUPTED
Integrating future acquisitions presents us with significant financial,
managerial and operational challenges. We may not be able to meet these
challenges effectively. To the extent our management is required to devote
significant time and attention to integrating the technology, operations and
personnel of acquired businesses, we may not be able to properly serve our
current clients or attract new clients. Any difficulties in integrating
acquisitions could disrupt our ongoing business, distract our management and
employees, increase our expenses and otherwise adversely affect our business.
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IF WE ARE UNABLE TO FIND SUITABLE ACQUISITION CANDIDATES, OUR GROWTH COULD BE
IMPEDED
A component of our growth strategy is the acquisition of, or investment in,
complementary businesses, technologies, services or products. Our ability to
identify and invest in suitable acquisition and investment candidates on
acceptable terms is crucial to this strategy. We may not be able to identify,
acquire or make investments in promising acquisition candidates on acceptable
terms. Moreover, in pursuing acquisition and investment opportunities, we may be
in competition with other companies having similar growth and investment
strategies. Competition for these acquisitions or investment targets could also
result in increased acquisition or investment prices and a diminished pool of
businesses, technologies, services or products available for acquisition or
investment.
OUR ACQUISITION STRATEGY COULD SUBJECT US TO SIGNIFICANT RISKS, ANY OF WHICH
COULD HARM OUR BUSINESS
Acquisitions involve a number of risks, including:
- adverse effects on our reported operating results due to accounting
charges associated with acquisitions;
- increased expenses, including compensation expense resulting from newly
hired employees; and
- potential disputes with the sellers of acquired businesses, technologies,
services or products.
Client dissatisfaction or performance problems with an acquired business,
technology, service or product could also have a material adverse impact on our
reputation as a whole. In addition, any acquired business, technology, service
or product could significantly underperform relative to our expectations. For
all these reasons, our pursuit of an overall acquisition and investment strategy
or any individual acquisition or investment could have a material adverse effect
on our business, results of operations and financial condition.
IF WE ARE UNABLE TO RETAIN KEY PERSONNEL, OUR BUSINESS AND GROWTH WILL SUFFER
Our future success depends, in significant part, upon the continued service
and performance of our senior management and other key personnel. Losing the
services of any of these individuals would impair our ability to effectively
deliver our services and manage our company. These problems would negatively
affect our business, results of operations and financial condition, as well as
our ability to grow.
OUR INTERNATIONAL EXPANSION EFFORTS MAY NOT BE SUCCESSFUL
We expect to expand our international operations and international sales and
marketing efforts. Recently, we commenced operations in England. We have had
limited experience in marketing, selling and distributing our services
internationally. We may not be able to maintain and expand our international
operations or successfully market our services internationally. Failure to do so
may negatively affect our business, results of operations and financial
condition, as well as our ability to grow.
OUR BUSINESS MAY SUFFER IF WE FAIL TO ADAPT APPROPRIATELY TO THE CHALLENGES
ASSOCIATED WITH OPERATING INTERNATIONALLY
Operating internationally may require us to modify the way we conduct our
business and deliver our services in these markets. If we do not appropriately
anticipate changes and adapt our practices, our business, results of operations
and financial condition could materially suffer. We anticipate that we will face
the following challenges internationally:
- the burden and expense of complying with a wide variety of foreign laws
and regulatory requirements;
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- potentially adverse tax consequences;
- longer payment cycles and problems in collecting accounts receivable;
- technology export and import restrictions or prohibitions;
- tariffs and other trade barriers;
- difficulties in staffing and managing foreign operations;
- political and economic instability;
- cultural and language differences;
- fluctuations in currency exchange rates; and
- seasonal reductions in business activity, especially during the summer
months in Europe and other parts of the world.
IF WE DO NOT KEEP PACE WITH TECHNOLOGICAL CHANGES, OUR SERVICES MAY BECOME LESS
COMPETITIVE AND OUR BUSINESS WILL SUFFER
Our market is characterized by rapidly changing technologies, frequent new
product and service introductions and evolving industry standards. If we cannot
keep pace with these changes our services may become less competitive and our
business will suffer. To achieve our goals, we need to keep pace with continuing
changes in industry standards, information technology and client preferences. We
may be unable, for technological or other reasons, to develop and introduce new
services or enhancements to existing services in a timely manner or in response
to changing market conditions or client requirements. This would materially
adversely affect our business, results of operations and financial condition.
THE MARKET FOR OUR SERVICES DEPENDS ON THE CONTINUED GROWTH OF LARGE-SCALE,
COMPLEX NETWORKS
To date, a majority of our revenues have been from network management
services related to large-scale, complex networks. We believe that we will
continue to derive a majority of our revenues from providing network design,
performance, management and security services. As a result, our future success
is highly dependent on the continued growth and acceptance of large-scale,
complex computer networks and the continued trend among our clients to use
third-party service providers. If the growth of the use of enterprise networks
does not continue or declines, our business, results of operations and financial
condition could materially suffer.
WE ARE DEPENDENT ON THE INTERNET GROWING AND CONTINUING TO DEVELOP AS A VIABLE
BUSINESS TOOL
The growing demand for network management services has been driven in part
by the growth of the Internet. The Internet may not prove to be a viable
commercial marketplace because of:
- inadequate development of the necessary infrastructure;
- lack of development of complementary products (such as high speed modems
and high speed communication lines);
- implementation of competing technology;
- delays in the development or adoption of new standards and protocols
required to handle increased levels of Internet activity;
- governmental regulation; or
- other reasons.
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This would materially adversely affect our business, results of operations
and financial condition. Moreover, critical issues concerning the use of the
Internet remain unresolved and may affect the growth of the use of such
technologies to solve business problems. If the Internet fails to grow or grows
more slowly as a viable business tool than anticipated, our business, results of
operations and financial condition would be materially adversely affected.
YEAR 2000 PROBLEMS MAY DISRUPT OUR BUSINESS
Year 2000 problems could require us, or our clients, to experience delays
and incur unanticipated expenses. Our failure to correct a material Year 2000
problem could have a material adverse effect on our business, results of
operations and financial condition. We may experience operations difficulties
because of undetected errors or defects in the technology we use in our internal
systems. Also, failure to provide Year 2000 compliant solutions to our clients
could have a material adverse effect on our business, results of operations and
financial condition. Additionally, our clients' and future clients' purchasing
patterns, specifically in the fourth quarter of 1999, may be affected by Year
2000 issues as companies expend significant resources to correct or replace
their current systems for Year 2000 compliance.
RISKS RELATED TO LEGAL UNCERTAINTY
UNAUTHORIZED USE OF OUR INTELLECTUAL PROPERTY BY THIRD PARTIES MAY DAMAGE OUR
BRAND
We regard our copyrights, trade secrets and other intellectual property as
critical to our success. Unauthorized use of our intellectual property by third
parties may damage our brand and our reputation. We rely on trademark and
copyright law, trade secret protection and confidentiality and/or license and
other agreements with our employees, customers, partners and others to protect
our intellectual property rights. However, we do not have any patents or patent
applications pending and existing trade secret, trademark and copyright laws
afford us only limited protection. Despite our precautions, it may be possible
for third parties to obtain and use our intellectual property without our
authorization. The laws of some foreign countries are also uncertain or do not
protect intellectual property rights to the same extent as do the laws of the
United States.
WE MAY NOT BE ABLE TO PROTECT SOME OF OUR INTELLECTUAL PROPERTY THROUGH
TRADEMARK PROTECTION, WHICH WOULD IMPAIR OUR ABILITY TO PREVENT OTHERS FROM
USING OUR INTELLECTUAL PROPERTY
The trademark offices in the United States and England have raised
objections to the registration of our "PREDICTIVE SYSTEMS," "BUSINESSFIRST" and
Predictive logo trademarks, including likelihood of confusion with pre-existing
trademarks and descriptiveness. We have responded to these objections and are
awaiting the trademark offices' decisions on our responses. We have not,
however, received any objections from third parties asserting likelihood of
confusion claims with respect to our trademarks. Nonetheless, we may not be able
to obtain trademark registrations in the United States or England, or both, for
one or more of these trademarks, in which case we would be unable to fully
enforce our statutory trademark rights against third parties for these
trademarks, and/or we must decide to replace such trademarks with new
trademarks. This could have a material adverse effect on our business, financial
condition and results of operations.
DEFENDING AGAINST INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS COULD BE EXPENSIVE
AND, IF WE ARE NOT SUCCESSFUL, COULD DISRUPT OUR BUSINESS
We cannot be certain that our services, the finished products that we
deliver or materials provided to us by our clients for use in our finished
products do not or will not infringe valid patents, copyrights, trademarks or
other intellectual property rights held by third parties. We may be subject to
legal proceedings and claims from time to time relating to the intellectual
property of others in the ordinary course of our business. We may incur
substantial expenses in defending against these third-party
13
infringement claims, regardless of their merit. Successful infringement claims
against us may result in substantial monetary liability or may materially
disrupt the conduct of our business.
WE MAY BE SUBJECT TO CLAIMS IF OUR SERVICES HARM OUR CLIENTS' BUSINESSES
Many of our projects are critical to the operations of our clients'
businesses. If we cannot complete these projects to our clients' expectations,
we could materially harm our clients' operations. This could damage our
reputation, subject us to increased risk of litigation or result in our having
to provide additional services to a client at no charge. Although we carry
general liability insurance coverage, our insurance may not cover all potential
claims to which we are exposed or may not be adequate to indemnify us for all
liability that may be imposed. The successful assertion of one or more
significant claims against us could have a material adverse effect on our
business, results of operations and financial condition.
RISKS RELATED TO THIS OFFERING
WE WILL HAVE DISCRETION AS TO THE USE OF THE PROCEEDS OF THIS OFFERING, WHICH WE
MAY NOT USE EFFECTIVELY
Our management will have significant flexibility in applying the net
proceeds of this offering and may use the proceeds in ways with which
stockholders disagree. We may not be able to invest these funds effectively.
OUR STOCK PRICE IS LIKELY TO BE HIGHLY VOLATILE AND COULD DROP UNEXPECTEDLY
Following this offering, the market price of our common stock is likely to
be highly volatile and may fluctuate substantially. As a result, investors in
our common stock may experience a decrease in the value of their common stock
regardless of our operating performance or prospects. In addition, the stock
market has, from time to time, experienced significant price and volume
fluctuations that have affected the market prices for the securities of
technology companies. In the past, following periods of volatility in the market
price of a particular company's securities, securities class action litigation
was often brought against that company. Many technology-related companies have
been subject to this type of litigation. We may also become involved in this
type of litigation. Litigation is often expensive and diverts management's
attention and resources, which could have a material adverse effect upon our
business, financial condition and results of operations.
WE ARE CONTROLLED BY A SMALL GROUP OF OUR EXISTING STOCKHOLDERS, WHOSE INTERESTS
MAY DIFFER FROM OTHER STOCKHOLDERS
Our directors, executive officers and affiliates currently beneficially own
approximately 79.1% of the outstanding shares of our common stock, and after the
offering will beneficially own approximately % of the outstanding shares of
our common stock. Accordingly, these stockholders will have significant
influence in determining the outcome of any corporate transaction or other
matter submitted to the stockholders for approval, including mergers,
acquisitions, consolidations and the sale of all or substantially all of our
assets, and also the power to prevent or cause a change in control. The
interests of these stockholders may differ from the interests of the other
stockholders.
SHARES ELIGIBLE FOR PUBLIC SALE AFTER THIS OFFERING COULD ADVERSELY AFFECT OUR
STOCK PRICE
The market price of our common stock could decline as a result of sales by
our existing stockholders of shares of common stock in the market after this
offering, or the perception that these sales could occur. These sales also might
make it difficult for us to sell equity securities in the future at a time and
at a price that we deem appropriate.
14
OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY INHIBIT A TAKEOVER THAT STOCKHOLDERS
MAY CONSIDER FAVORABLE
Provisions in our charter and bylaws may have the effect of delaying or
preventing a change of control or changes in our management that stockholders
consider favorable or beneficial. If a change of control or change in management
is delayed or prevented, the market price of our common stock could decline.
YOU WILL SUFFER IMMEDIATE AND SUBSTANTIAL DILUTION
The initial public offering price per share will significantly exceed the
net tangible book value per share of $ . Accordingly, investors purchasing
shares in this offering will suffer immediate and substantial dilution of their
investment.
FORWARD-LOOKING STATEMENTS
Many statements made in this prospectus under the captions "Prospectus
Summary", "Risk Factors", "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business" and elsewhere are
forward-looking statements that are not based on historical facts. Because these
forward looking-statements involve risks and uncertainties, there are important
factors that could cause actual results to differ materially from those
expressed or implied by these forward-looking statements, including those
discussed under "Risk Factors."
The forward-looking statements made in this prospectus relate only to events
as of the date on which the statements are made. We undertake no obligation to
update any forward-looking statement to reflect events or circumstances after
the date on which the statement is made or to reflect the occurrence of
unanticipated events.
15
USE OF PROCEEDS
The net proceeds we will receive from the sale of the shares of common stock
offered by us are estimated to be $ million, assuming an initial public
offering price of $ per share, after deducting the underwriting discounts and
commissions and estimated offering expenses payable by us. If the underwriters'
over-allotment option is exercised in full, we estimate that the net proceeds
will be $ million.
The primary purposes of this offering are to obtain additional equity
capital, create a public market for our common stock, and facilitate future
access to public markets. We expect to use the net proceeds of this offering for
general corporate purposes, including working capital. A portion of the net
proceeds may also be used for the acquisition of complementary businesses or
technologies. Pending such uses, we will invest the net proceeds of this
offering in investment grade, interest-bearing securities.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our common stock. We
currently intend to retain future earnings, if any, to finance the expansion of
our business. As a result, we do not intend to pay cash dividends in the
foreseeable future.
16
CAPITALIZATION
The following table sets forth our capitalization as of March 31, 1999:
- on an actual basis;
- on a pro forma basis after giving effect to the automatic conversion of
our series A convertible preferred stock into common stock and the
reissuance of treasury stock in connection with this conversion; and
- on a pro forma as adjusted basis to reflect our sale of shares of common
stock at an assumed initial public offering price of $ per share,
after deducting underwriting discounts and commissions and the estimated
offering expenses payable by us. Please see "Use of Proceeds."
You should read this information together with our consolidated financial
statements and related notes appearing elsewhere in this prospectus.
MARCH 31, 1999
-------------------------------------
PRO FORMA AS
ACTUAL PRO FORMA ADJUSTED
--------- ----------- -------------
(IN THOUSANDS, EXCEPT SHARE DATA)
Long term debt.............................................................. $ -- $ -- $ --
Stockholders' equity:
Convertible preferred stock, $.001 par value, 20,000,000 shares
authorized, 6,512,316 issued and outstanding, actual; 10,000,000
authorized, none issued and outstanding, pro forma and pro forma as
adjusted................................................................ 7 -- --
Common stock, $.001 par value, 50,000,000 shares authorized, 12,400,200
issued and 9,545,100 outstanding, actual; (200,000,000 authorized,
16,057,416 issued and outstanding, pro forma; issued and outstanding,
pro forma as adjusted).................................................. 12 19
Additional paid-in capital.................................................. 19,986 11,587
Treasury stock.............................................................. (8,399) -- --
Retained earnings........................................................... 1,236 1,236
--------- ----------- -------------
Total stockholders' equity................................................ 12,842 12,842
--------- ----------- -------------
Total capitalization.................................................... $ 12,842 $ 12,842 $
--------- ----------- -------------
--------- ----------- -------------
The number of shares of common stock to be outstanding after this offering
is based on the number of shares outstanding as of March 31, 1999. It does not
include:
- 8,586,600 shares subject to options outstanding as of March 31, 1999 at a
weighted average exercise price of $1.14 per share;
- shares subject to warrants outstanding as of March 31, 1999 at an
exercise price per share equal to the initial public offering price of our
common stock; and
- additional shares that could be issued under our stock option
plans.
17
DILUTION
Our pro forma net tangible book value as of March 31, 1999 was approximately
$ million, or $ per share of common stock. Pro forma net tangible book
value per share is determined by dividing the amount of our total tangible
assets less total liabilities by the pro forma number of shares of stock
outstanding at that date, assuming conversion of all outstanding shares of our
series A convertible preferred stock into common stock. Dilution in net tangible
book value per share represents the difference between the amount per share paid
by purchasers of shares of common stock in this offering and the net tangible
book value per share of common stock immediately after the completion of this
offering.
After giving effect to the issuance and sale of the shares of common stock
offered by us and after deducting the estimated underwriting discounts and
commissions and offering expenses payable by us, our pro forma net tangible book
value as of March 31, 1999 would have been $ , or $ per share. This
represents an immediate increase in pro forma net tangible book value of $
per share to existing stockholders and an immediate dilution of $ per share
to new investors purchasing shares in this offering. If the initial public
offering price is higher or lower, the dilution to the new investors will be
greater or less, respectively. The following table illustrates this per share
dilution.
Assumed initial public offering price per share.............................. $
Pro forma net tangible book value per share at March 31, 1999.............. $
Pro forma increase attributable to new investors...........................
---------
Pro forma net tangible book value per share after this offering..............
---------
Pro forma dilution per share to new investors................................ $
---------
---------
The following table summarizes, on a pro forma basis, as of March 31, 1999,
the differences between the number of shares of common stock purchased from us,
the aggregate cash consideration paid to us and the average price per share paid
by existing stockholders and new investors purchasing shares of common stock in
this offering. The calculation below is based on an assumed initial public
offering price of $ per share, before deducting the estimated underwriting
discounts and commissions and offering expenses payable by us:
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------------- -------------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------------ ----------- ------------- ----------- ------------
Existing stockholders.......... 16,057,416 % $ 11,606,172 % $ 0.72
New investors..................
------------ ----- ------------- -----
Total...................... 100.0% $ 100.0%
------------ ----- ------------- -----
------------ ----- ------------- -----
This discussion and table assume no exercise of any stock options and
warrants outstanding as of March 31, 1999. As of March 31, 1999, there were
options outstanding to purchase a total of 8,586,600 shares of common stock with
a weighted average exercise price of $1.14 per share and warrants exercisable
into shares of common stock at an exercise price per share equal to the
offering price of our common stock in this offering. To the extent that any of
these options are exercised, there will be further dilution to new investors.
Please see "Capitalization."
18
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated balance sheet data as of December 31, 1997 and
1998 and the selected consolidated statement of operations data for the years
ended December 31, 1996, 1997 and 1998 have been derived from our audited
consolidated financial statements included elsewhere in this prospectus. The
selected consolidated balance sheet data as of March 31, 1999 and the
consolidated statements of operations for the three months ended March 31, 1998
and 1999 have been derived from unaudited consolidated financial statements
included elsewhere in this prospectus. The selected consolidated balance sheet
data as of December 31, 1996 has been derived from our consolidated audited
financial statements not included in this prospectus. The selected consolidated
balance sheet as of December 31, 1995 and the selected consolidated statement of
operations data for the period from February 10, 1995 (inception) to December
31, 1995 are derived from our unaudited consolidated financial statements not
included in this prospectus.
The unaudited consolidated financial statements include all adjustments,
consisting only of normal recurring adjustments, which, in the opinion of
management, are necessary for the fair presentation of our consolidated
financial position and the consolidated results of operations for those periods.
Results of operations for the three months ended March 31, 1999 are not
necessarily indicative of the results that may be expected for the entire year
or for any future period.
The selected consolidated financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements and the
notes to those statements included elsewhere in this prospectus.
PERIOD FROM
FEBRUARY 10,
1995
(INCEPTION) THREE MONTHS ENDED
TO DECEMBER 31, YEAR ENDED DECEMBER 31, MARCH 31,
--------------- -------------------------------- --------------------
1995 1996 1997 1998 1998 1999
--------------- ---------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE
(UNAUDITED) DATA) (UNAUDITED)
STATEMENT OF OPERATIONS DATA:
Revenues:
Professional services............. $ 2,090 $ 6,819 $ 16,897 $ 23,858 $ 3,798 $ 9,887
Hardware and software sales....... 161 1,287 1,190 2,065 79 478
--------------- ---------- --------- --------- --------- ---------
2,251 8,106 18,087 25,923 3,877 10,365
Cost of Revenues:
Professional services............. 981 3,382 9,590 12,861 2,387 4,849
Hardware and software purchases... 161 970 817 1,699 65 426
--------------- ---------- --------- --------- --------- ---------
Total cost of revenues............ 1,142 4,352 10,407 14,560 2,452 5,275
Gross profit...................... 1,109 3,754 7,680 11,363 1,425 5,090
Sales and marketing................. 220 386 1,082 2,618 484 1,589
General and administrative.......... 535 1,683 4,390 8,999 1,722 3,469
Depreciation and amortization....... 63 142 321 568 109 144
--------------- ---------- --------- --------- --------- ---------
Operating profit (loss)........... 291 1,543 1,887 (822) (890) (112)
Other Income (Expense):
Interest income................... 5 31 27 58 3 46
Other income...................... -- 8 4 1 -- 12
Interest expense.................. -- -- (36) (324) (25) (86)
--------------- ---------- --------- --------- --------- ---------
Income (loss) before provision
(benefit) for income taxes...... 296 1,582 1,882 (1,087) (912) (140)
Income tax provision (benefit)...... 146 719 871 (460) (392) (49)
--------------- ---------- --------- --------- --------- ---------
Net income (loss)................. $ 150 $ 863 $ 1,011 $ (627) $ (520) $ (91)
--------------- ---------- --------- --------- --------- ---------
--------------- ---------- --------- --------- --------- ---------
19
PERIOD FROM
FEBRUARY 10,
1995
(INCEPTION) THREE MONTHS ENDED
TO DECEMBER 31, YEAR ENDED DECEMBER 31, MARCH 31,
--------------- -------------------------------- --------------------
1995 1996 1997 1998 1998 1999
--------------- ---------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE
(UNAUDITED) DATA) (UNAUDITED)
Net income (loss) per share:
Basic............................. $ 0.04 $ 0.20 $ 0.22 $ (0.11) $ (0.12) $ (0.01)
--------------- ---------- --------- --------- --------- ---------
--------------- ---------- --------- --------- --------- ---------
Diluted........................... $ 0.01 $ 0.07 $ 0.08 $ (0.11) $ (0.12) $ (0.01)
--------------- ---------- --------- --------- --------- ---------
--------------- ---------- --------- --------- --------- ---------
Weighted average common shares
outstanding:
Basic............................. 4,245 4,269 4,382 6,015 4,463 8,380
--------------- ---------- --------- --------- --------- ---------
--------------- ---------- --------- --------- --------- ---------
Diluted........................... 10,396 11,586 12,765 6,015 4,463 8,380
--------------- ---------- --------- --------- --------- ---------
--------------- ---------- --------- --------- --------- ---------
Please see note 3 to our consolidated financial statements for an
explanation of the number of shares used in per share computations. Upon the
closing of this offering, each share of our series A preferred stock will
convert into one share of our common stock. On a pro forma basis, basic and
diluted loss per share, had each share of our series A preferred stock been
immediately converted into common stock at the time of issuance, would have been
$(0.01) for the three months ended March 31, 1999.
THREE MONTHS
DECEMBER 31, ENDED MARCH 31,
---------------------------------------------- -----------------
1995 1996 1997 1998 1999
------------- --------- --------- --------- -----------------
(UNAUDITED) (IN THOUSANDS) (UNAUDITED)
BALANCE SHEET DATA:
Cash and cash equivalents.............................. $ 270 $ 638 $ 420 $ -- $ 2,995
Working capital........................................ 661 1,178 1,679 2,365 12,261
Total assets........................................... 1,180 3,629 6,870 13,677 16,631
Total stockholders' equity............................. 192 1,061 2,072 2,026 12,842
20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR FINANCIAL
STATEMENTS AND THE NOTES TO THOSE STATEMENTS AND OTHER FINANCIAL INFORMATION
APPEARING ELSEWHERE IN THIS PROSPECTUS.
OVERVIEW
Substantially all of our revenues are derived from professional services. We
provide network consulting services to our clients on both a fixed-price,
fixed-time basis and on a time-and-expense basis. We use our BusinessFirst
methodology to estimate and propose prices for our fixed-price projects. The
estimation process accounts for standard billing rates particular to each
project, the client's technology environment, the scope of the project, and the
project's timetable and overall technical complexity. A member of our senior
management team must approve all of our fixed-price proposals. For these
contracts, we recognize revenue using a percentage-of-completion method
primarily based on costs incurred. We make provisions for estimated losses on
uncompleted contracts on a contract-by-contract basis and recognize such
provisions in the period in which the losses are determined. Professional
services revenues for time-and-expense based projects are recognized as services
are performed. Any payments received in advance of services performed are
recorded as deferred revenue. Our clients are generally able to reduce or cancel
their use of our professional services without penalty and with little or no
notice. We also derive limited revenues from the sale of hardware and software.
We sell hardware and software only when specifically requested by a client. We
expect revenues from the sale of hardware and software to continue to decline on
a percentage basis.
Since we recognize professional services revenues only when our consultants
are engaged on client projects, the utilization of our consultants is important
in determining our operating results. In addition, a substantial majority of our
operating expenses, particularly personnel and related costs, depreciation and
rent, are relatively fixed in advance of any particular quarter. As a result,
any underutilization of our consultants may cause significant variations in our
operating results in any particular quarter and could result in losses for such
quarter. Factors which could cause underutilization include:
- the reduction in size, delay in commencement, interruption or termination
of one or more significant projects;
- the completion during a quarter of one or more significant projects;
- the miscalculation of resources required to complete new or ongoing
projects; and
- the timing and extent of training, weather related shut-downs, vacations
and holidays.
In addition, we plan to continue to expand our operations by hiring
additional consultants and other employees, and adding new offices, systems and
other infrastructure. The resulting increase in operating expenses will have a
material adverse effect on our operating results if our revenues do not increase
to support such expenses. Based on all of the foregoing, we believe that our
quarterly revenue and operating results are likely to vary significantly in the
future and that period-to-period comparisons of our operating results are not
necessarily meaningful and should not be relied on as indications of future
performance.
21
RESULTS OF OPERATIONS
The following table sets forth certain financial data for the periods
indicated expressed as a percentage of total revenues:
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------- ------------------------
1996 1997 1998 1998 1999
--------- --------- --------- ----------- -----------
Revenues:
Professional services........................................... 84.1% 93.4% 92.0% 98.0% 95.4%
Hardware and software sales..................................... 15.9 6.6 8.0 2.0 4.6
--------- --------- --------- ----------- -----------
Total revenues................................................ 100.0 100.0 100.0 100.0 100.0
Costs of revenues:
Professional services........................................... 41.7 53.0 49.6 61.5 46.8
Hardware and software sales..................................... 12.0 4.5 6.6 1.7 4.1
--------- --------- --------- ----------- -----------
Total cost of revenues........................................ 53.7 57.5 56.2 63.2 50.9
Gross Profit...................................................... 46.3 42.5 43.8 36.8 49.1
Expenses:
Sales and marketing............................................. 4.8 6.0 10.1 12.5 15.3
General and administrative...................................... 20.8 24.3 34.7 44.5 33.5
Depreciation and amortization................................... 1.7 1.8 2.2 2.8 1.4
Operating income (loss)........................................... 19.0 10.4 (3.2) (23.0) (1.1)
Other income (expense)............................................ 0.5 0.0 (1.0) (0.5) (0.3)
--------- --------- --------- ----------- -----------
Net income (loss) before income tax provision (benefit)........... 19.5 10.4 (4.2) (23.5) (1.4)
Income tax provision (benefit).................................... 8.9 4.8 (1.8) (10.1) (0.5)
--------- --------- --------- ----------- -----------
Net income (loss)................................................. 10.6% 5.6% (2.4)% (13.4)% (0.9)%
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
THREE MONTHS ENDED MARCH 31, 1998 AND 1999
REVENUES. Substantially all of our revenues are derived from fees for
professional services. Revenues increased 167.4% from $3.9 million in the three
months ended March 31, 1998 to $10.4 million in the three months ended March 31,
1999. Revenues from professional services increased 160.3% from $3.8 million in
the three months ended March 31, 1998 to $9.9 million in the three months ended
March 31, 1999. Revenues from hardware and software sales increased 508.5% from
$79,000 in the three months ended March 31, 1998 to $478,000 in the three months
ended March 31, 1999. This increase was primarily due to an increase in the
number of professional services projects and an increase in the size of these
projects. During the three months ended March 31, 1999, each of Bear, Stearns &
Co. Inc. and Qwest Communications, Inc. accounted for 24.0% and 17.4%,
respectively, of our revenues. The number of our billable consultants increased
from approximately 104 at March 31, 1998 to approximately 160 at March 31, 1999.
GROSS PROFIT. Gross profit increased 257.3% from $1.4 million in the three
months ended March 31, 1998 to $5.1 million in the three months ended March 31,
1999. As a percentage of revenues, gross profit increased from 36.7% in the
three months ended March 31, 1998 to 49.1% in the three months ended March 31,
1999. Cost of revenues increased from $2.3 million in the three months ended
March 31, 1998 to $4.8 million in the three months ended March 31, 1999. This
increase in gross profit was due to efficiencies in completing fixed-price,
fixed-time projects, higher utilization rates and an increase in average billing
rates.
22
SALES AND MARKETING EXPENSES. Sales and marketing expenses consist
primarily of compensation and benefits, travel expenses and promotional
expenses. Sales and marketing expenses increased 228.3% from $484,000 in the
three months ended March 31, 1998 to $1.6 million in the three months ended
March 31, 1999. As a percentage of revenues, sales and marketing expenses
increased from 12.5% in the three months ended March 31, 1998 to 15.3% in 1999.
This increase was due to increased sales and marketing efforts, hiring of
additional personnel and an increase in commissions paid.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 101.4% from $1.7 million in the three months ended March 31, 1998 to
$3.5 million in the three months ended March 31, 1999. As a percentage of
revenues, general and administrative expense decreased from 44.4% in the three
months ended March 31, 1998 to 33.5% in the three months ended March 31, 1999.
The increase in absolute dollars was due to an increase in our facilities and
equipment, compensation and benefits, recruiting and professional development,
and other administrative costs.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
32.5% from $109,000 in the three months ended March 31, 1998 to $144,000 in the
three months ended March 31, 1999. This increase was due to purchases of
additional equipment to support our growth.
OTHER INCOME (EXPENSE). Other expense increased from $22,000 in the three
months ended March 31, 1998 to $27,000 in the three months ended March 31, 1999.
This increase was primarily due to an increase in interest expense related to
short term borrowings.
INCOME TAXES. The income tax benefit was ($392,000) on pre-tax losses of
$912,000 for the three months ended March 31, 1998. For the three months ended
March 31, 1999, the income tax benefit was $(49,000) on pre-tax losses of
$140,000. The effective tax rate was 43.0% and 35.0% during the three months
ended March 31, 1998 and 1999, respectively. The difference in the effective tax
rates relates to certain non-tax deductible expenses which were greater during
the three months ended March 31, 1999.
YEARS ENDED DECEMBER 31, 1997 AND 1998
REVENUES. Revenues increased 43.3% from $18.1 million in 1997 to $25.9
million in 1998. Revenues from professional services increased 41.2% from $16.9
million in 1997 to $23.9 million in 1998. Revenues from hardware and software
sales increased 73.6% from $1.2 million in 1997 to $2.1 million in 1998. This
increase was primarily due to an increase in the number of professional services
projects and an increase in the size of these projects. During 1998, Bear,
Stearns & Co. Inc. accounted for 21.0% of revenues. The number of our billable
consultants increased from approximately 98 at December 31, 1997 to
approximately 149 at December 31, 1998.
GROSS PROFIT. Gross profit increased 48.0% from $7.7 million in 1997 to
$11.4 million in 1998. As a percentage of revenues, gross profit increased from
42.5% in 1997 to 43.8% in 1998. Cost of revenues increased from $10.4 million in
1997 to $14.6 million in 1998. This increase in gross profit was due to
efficiencies in completing fixed-price, fixed-time projects, higher utilization
rates and an increase in average billing rates.
SALES AND MARKETING EXPENSES. Sales and marketing expenses increased 142.0%
from $1.1 million in 1997 to $2.6 million in 1998. As a percentage of revenues,
sales and marketing expenses increased from 6.0% in 1997 to 10.1% in 1998. This
increase was due to increased sales and marketing efforts, hiring of additional
personnel and commissions paid because of the increase in revenues.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 105.0% from $4.4 million in 1997 to $9.0 million in 1998. As a
percentage of revenues, general and administrative expense increased from 24.3%
in 1997 to 34.7% in 1998. This increase was due to an increase in facilities and
equipment, compensation and benefits, recruiting and professional development,
and other administrative costs.
23
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
76.9% from $321,000 in 1997 to $568,000 in 1998. This increase was due to
purchases of additional equipment to support our growth.
OTHER INCOME (EXPENSE). Other expense increased from $(5,000) in 1997 to
$(265,000) in 1998. This increase was primarily due to an increase in interest
expense related to an increase in short term borrowings.
INCOME TAXES. The income tax provision was $871,000 on pre-tax income of
$1.9 million in 1997. In 1998 the income tax benefit was ($460,000) on pre-tax
losses of $1.1 million. The effective tax rate was 46.3% and 42.3% for 1997 and
1998, respectively. The differences in the effective tax rate resulted from a
greater amount of non-tax deductible expenses during 1997.
YEARS ENDED DECEMBER 31, 1996 AND 1997
REVENUES. Revenues increased 123.1% from $8.1 million in 1996 to $18.1
million in 1997. Revenues from professional services increased 147.8% from $6.8
million in 1996 to $16.9 million in 1997. Revenues from hardware and software
sales decreased 7.6% from $1.3 million in 1996 to $1.2 million in 1997. The
increase in professional services was primarily due to an increase in the number
of professional services projects and an increase in the size of these projects.
During 1997, each of Bear, Stearns & Co. Inc. and Unisys Corporation accounted
for 20.6% and 19.7% of revenues, respectively. The number of our billable
consultants increased from approximately 42 at December 31, 1996 to
approximately 98 at December 31, 1997.
GROSS PROFIT. Gross profit increased 104.6% from $3.8 million in 1996 to
$7.7 million in 1997. As a percentage of revenues, gross profit decreased from
46.3% in 1996 to 42.5% in 1997. Cost of revenues increased from $4.4 million in
1996 to $10.4 million 1997. This increase in gross profit was due to
efficiencies in completing fixed-price, fixed-time projects, higher utilization
rates and an increase in average billing rates.
SALES AND MARKETING EXPENSES. Sales and marketing expenses increased 180.3%
from $386,000 in 1996 to $1.1 million in 1997. As a percentage of revenues,
sales and marketing expenses increased from 4.8% in 1996 to 6.0% in the 1997.
This increase sales and marketing efforts, hiring of additional personnel was
due to increased commissions paid because of the increase in revenues.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 160.8% from $1.7 million in 1996 to $4.4 million in 1997. As a
percentage of revenues, general and administrative expense increased from 20.8%
1996 to 24.3% in 1997. This increase was due to an increase in facilities and
equipment, compensation and benefits, recruiting and professional development,
and other administrative costs.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
125.8% from $142,000 in 1996 to $321,000 in 1997. This increase was due to
purchases of additional equipment to support our growth.
OTHER INCOME (EXPENSE). Other income (expense) decreased from $39,000 in
1996 to $(5,000) in 1997, due to an increase in interest expense as a result of
short term borrowings during 1997.
INCOME TAXES. The income tax provision was $719,000 on pre-tax income of
$1.6 million in 1996. In 1997, the income tax provision was $871,000 on pre-tax
income of $1.9 million. The effective tax rate was 45.4% and 46.3% in 1997 and
1998, respectively. The increase in the effective tax rate above the federal and
state statutory rates reflects certain non-tax deductible expenses.
24
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth unaudited quarterly statement of operations
data for each of the seven quarters in the period ended March 31, 1999 and the
percentage of our revenues represented by each item in the respective quarters.
In the opinion of management, all necessary adjustments, consisting only of
normal recurring adjustments, have been included in the amounts stated below to
present fairly the unaudited quarterly results when read in conjunction with our
financial statements and notes. The unaudited results of operations for any
quarter are not necessarily indicative of results for any future period.
QUARTER ENDED
------------------------------------------------------------------------------
SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31,
1997 1997 1998 1998 1998 1998 1999
--------- -------- --------- -------- --------- -------- ---------
(IN THOUSANDS)
Revenues:
Professional services............ $4,692 $3,918 $3,798 $5,137 $6,702 $8,221 $9,887
Hardware and software sales...... 139 406 79 452 233 1,301 478
--------- -------- --------- -------- --------- -------- ---------
Total revenues................. 4,831 4,324 3,877 5,589 6,935 9,522 10,365
Cost of Revenues:
Professional services............ 2,658 2,269 2,387 2,792 3,308 4,374 4,849
Hardware and software
purchases...................... 92 245 65 373 229 1,032 426
--------- -------- --------- -------- --------- -------- ---------
Total cost of revenues......... 2,750 2,514 2,452 3,165 3,537 5,406 5,275
--------- -------- --------- -------- --------- -------- ---------
Gross profit....................... 2,081 1,810 1,425 2,424 3,398 4,116 5,090
Expenses:
Selling and marketing............ 312 372 484 640 651 843 1,589
General and administrative....... 1,292 1,303 1,722 1,996 2,612 2,669 3,469
Depreciation and amortization.... 86 104 109 121 123 215 144
--------- -------- --------- -------- --------- -------- ---------
Operating profit (loss)............ 391 31 (890) (333) 12 389 (112)
Other income (expense)............. (7) (14) (22) (32) (85) (126) (28)
--------- -------- --------- -------- --------- -------- ---------
Net income (loss) before income
tax provision (benefit)........ 384 17 (912) (365) (73) 263 (140)
Income tax provision (benefit)... 178 8 (392) (150) 46 36 (49)
--------- -------- --------- -------- --------- -------- ---------
Net income (loss)................ $ 206 $ 9 $ (520) $ (215) $ (119) $ 227 $ (91)
--------- -------- --------- -------- --------- -------- ---------
--------- -------- --------- -------- --------- -------- ---------
PERCENTAGE OF TOTAL REVENUES
------------------------------------------------------------------------------
Revenues:
Professional services............ 97.1% 90.6% 98.0% 91.9% 96.6% 86.3% 95.4%
Hardware and software sales...... 2.9 9.4 2.0 8.1 3.4 13.7 4.6
--------- -------- --------- -------- --------- -------- ---------
Total revenues................. 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Cost of Revenues:
Professional services............ 55.0 52.5 61.5 50.0 47.7 45.9 46.8
Hardware and software
purchases...................... 1.9 5.6 1.7 6.6 3.3 10.9 4.1
--------- -------- --------- -------- --------- -------- ---------
Total cost of revenues......... 56.9 58.1 63.2 56.6 51.0 56.8 50.9
--------- -------- --------- -------- --------- -------- ---------
Gross profit....................... 43.1 41.9 36.8 43.4 49.0 43.2 49.1
Expenses:
Selling and marketing............ 6.5 8.6 12.5 11.5 9.4 8.9 15.3
General and administrative....... 26.7 30.2 44.5 35.7 37.6 27.9 33.5
Depreciation and amortization.... 1.8 2.4 2.8 2.2 1.8 2.3 1.4
--------- -------- --------- -------- --------- -------- ---------
Operating profit (loss)............ 8.1 0.7 (23.0) (6.0) 0.2 4.1 (1.1)
Other income (expense)............. (0.2) (0.3) (0.5) (0.5) (1.3) (1.3) (0.3)
--------- -------- --------- -------- --------- -------- ---------
Net income (loss) before income
tax provision (benefit)........ 7.9 0.4 (23.5) (6.5) (1.1) 2.8 (1.4)
Income tax provision (benefit)... 3.7 0.2 (10.1) (2.7) 0.6 0.4 (0.5)
--------- -------- --------- -------- --------- -------- ---------
Net income (loss)................ 4.3% 0.2% (13.4)% (3.8)% (1.7)% 2.4% (0.9)%
--------- -------- --------- -------- --------- -------- ---------
--------- -------- --------- -------- --------- -------- ---------
25
We have historically experienced significant quarterly fluctuations in our
revenues and results of operations and expect these fluctuations to continue.
Factors causing these variations include the number, timing, scope and
contractual terms of client projects, delays incurred in the performance of such
projects, accuracy of estimates of resources and time required to complete
ongoing projects, and general economic conditions. In addition, our future
revenues and operating results may fluctuate as a result of changes in pricing
in response to customer demand and competitive pressures, the ratio of
fixed-price contracts versus time-and-expense contracts and the timing of
collection of accounts receivable. A high percentage of our operating expenses,
particularly personnel and rent, are relatively fixed in advance of any
particular quarter. As a result, unanticipated variations in the number and
timing of our projects or in employee utilization rates may cause significant
variations in operating results in any particular quarter, and could result in
losses. Any significant shortfall of revenues in relation to our expectations,
any material reduction in utilization rates for our consultants, an
unanticipated termination of a major project, a client's decision not to pursue
a new project or proceed to succeeding stages of a current project, or the
completion during a quarter of several major customer projects could require us
to pay underutilized employees and have a material adverse effect on our
business, results of operations and financial condition.
Our quarterly operating results are also subject to certain seasonal
fluctuations. We have in the past recruited new consultants in the first and
second quarters who have not conducted billable services until later in the
year. Demand for our services may be lower in the fourth quarter due to reduced
activity during the holiday season and fewer working days for those customers
that curtail operations during this period. These and other seasonal factors may
contribute to fluctuations in our operating results from quarter to quarter.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our operations through the sale of equity
securities and cash flow from operations. As of March 31, 1999, we had
approximately $3.0 million in cash and cash equivalents.
Cash used in operating activities increased from $206,000 for the three
months ended March 31, 1998 to $2.2 million for the three months ended March 31,
1999. Significant uses of cash resulted from an increase in accounts receivable
and unbilled work in progress, a reduction in accounts payable, accrued expenses
and deferred income, partially offset by a reduction in the net loss.
Cash (used in) provided by operating activities was $(3.7) million in 1998,
$(1.2) million in 1997 and $700,000 in 1996. The increase in the use of cash
resulted from the net loss in 1998, an increase in accounts receivable and
unbilled work in progress during 1998 partially offset by an increase in
accounts payable and accrued expenses at December 31, 1998.
Cash provided by financing activities was $12.5 million for the three months
ended March 31, 1999, $5.4 million for 1998, $1.4 million for 1997 and $5,000
for 1996. Cash provided by financing activities for the three months ended March
31, 1999 resulted from the proceeds of $18.6 million related to the sale of
preferred stock offset partially by the repayment of short term borrowings. Cash
provided by financing activities for 1998 and 1997 resulted from short term
borrowings.
Our capital expenditures were $209,000 for the three months ended March 31,
1999, $687,000 for 1998, $357,000 for 1997 and $315,000 for 1996. Capital
expenditures were made to purchase computer equipment and office furniture and
for leasehold improvements.
We have a demand loan facility, secured by a lien on all of our assets,
under which we may borrow up to the lesser of $5.0 million or 80.0% of our
accounts receivable. Amounts outstanding under the facility bear interest at a
rate of 11.25% per annum. At March 31, 1999, there were no amounts outstanding
under the facility.
26
We believe that the net proceeds from this offering, together with our
current cash and cash equivalents, will be sufficient to meet our working
capital needs for at least the next 12 months.
IMPACT OF THE YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are coded to
accept or recognize only two-digit entries in the date code field. These systems
may recognize a date using "00" as the year 1900 rather than the year 2000. As a
result, it is necessary to update the computer systems and/or software used by
many companies and governmental agencies to comply with Year 2000 requirements
or risk system failure or miscalculations causing disruptions of normal business
activities.
We are exposed to the risk that the systems on which we depend to conduct
our operations are not Year 2000 compliant.
STATE OF READINESS. We are in the process of determining the Year 2000
readiness of our information technology systems, which include our hardware and
software, and our non-information technology systems, which include the
telephone systems and other office equipment we use internally. Our assessment
plan consists of the following steps:
- evaluating our date dependent code, software and hardware and evaluating
external dependencies;
- quality assurance testing of our internally-developed proprietary
software;
- contacting third-party vendors and licensors of material hardware,
software and services that we use;
- contacting vendors of material non-information technology systems that we
use;
- formulating repair or replacement requirements and implementing corrective
measures; and
- evaluating the need for, and preparing and implementing, if required, a
contingency plan.
To date, we have determined the following through our assessment:
- We have checked our internally developed software and systems for date
dependent code, and all material files and systems are Year 2000
compliant. We believe that the recently installed code is also Year 2000
compliant;
- We have contacted the vendors of material hardware and software components
of our information technology systems, and they have informed us that the
products we use are currently Year 2000 compliant;
- Commercial software, including financial reporting software, upon which we
depend is either Year 2000 compliant or will be upgraded to be compliant
in the normal course of business through upgrades or installation of
software patches;
- Substantially all hardware we use in our network operations and all of the
hardware we use in our office operations have been certified as Year 2000
compliant by its vendors;
- Our telephone system and mail systems are certified as Year 2000
compliant; and
- Our landlords and third-party advertising sales representative and
servicing organizations have not yet provided us with Year 2000 compliance
information.
While we have assessed the Year 2000 readiness of each of our material
internal systems, we will not conduct an end-to-end system test until August
1999. Accordingly, we cannot yet assess whether our internal system, as a whole,
is Year 2000 compliant. In addition, we will continue to attempt to obtain
verification from all remaining distributors, suppliers and vendors that their
systems are Year 2000 compliant. We intend to complete our assessment, and the
replacement or remediation of any non-Year 2000 compliant technologies, by the
end of the third quarter of 1999.
27
COSTS. We estimate that the total cost for our Year 2000 compliance efforts
will be approximately $250,000. Most of these expenses relate to the operating
costs associated with time spent by our employees in Year 2000 compliance
matters. If we encounter unexpected difficulties, or we are unable to obtain
compliance information from material third parties, we may need to spend
additional amounts to ensure that our systems are Year 2000 compliant.
RISKS. Although we have received compliance information from our material
third-party vendors, we have not received compliance information from all of our
third-party vendors. In addition, it is possible that our third-party vendors
were mistaken in certifying that their systems are Year 2000 compliant. In
addition, we will not conduct an end-to-end system test until August 1999. If we
fail to fix our internal systems or to fix or replace material third-party
software, hardware or services on a timely basis, we may suffer lost revenues,
increased operating costs and other business interruptions, any of which could
have a material adverse effect on our business, results of operations and
financial condition. Moreover, if we fail to adequately address Year 2000
compliance issues, we may be subject to claims of mismanagement and related
litigation, which would be costly and time-consuming to defend.
In addition, we cannot assure you that governmental agencies, utility
companies, Internet access companies, third-party service providers and others
outside our control will be Year 2000 compliant. If those entities fail to be
Year 2000 compliant, there may be a systemic failure beyond our control, such as
a prolonged Internet, telecommunications or electrical failure, which could have
a material adverse effect on our business, results of operations and financial
condition.
CONTINGENCY PLAN. As discussed above, we are engaged in an ongoing Year
2000 assessment and have developed no contingency plans to address the
worst-case scenario that might occur if technologies we depend upon actually are
not Year 2000 compliant. We will take into account our Year 2000 simulation
testing results and the responses we receive from all third-party vendors and
service providers in determining the need for and nature and extent of any
contingency plans. We intend to develop any required contingency plan by the end
of September 1999.
FORWARD-LOOKING STATEMENTS
The Year 2000 discussion above is provided as a "Year 2000 Readiness
Disclosure" as defined in the Year 2000 Information and Readiness Disclosure Act
of 1998 (Public Law 105-271, 112 Stat. 2386) enacted on October 19, 1998 and
contains forward-looking statements. These statements are based on management's
best current estimates, which were derived from a number of assumptions about
future events, including the continued availability of resources,
representations received form third parties and other factors. However, we
cannot assure you that these estimates will be achieved, and our actual results
could differ materially from those anticipated. Specific factors that might
cause material differences include:
- the ability to identify and remediate all relevant systems;
- results of Year 2000 testing;
- adequate resolution of Year 2000 issues by governmental agencies,
businesses and other third parties who are our outsourcing service
providers, suppliers, and vendors;
- unanticipated system costs; and
- our ability to implement adequate contingency plans.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standard Board, or FASB, issued
Statement of Financial Accounting Standards, or SFAS, No. 131, "Disclosures
About Segments of an Enterprise and Related
28
Information." This statement establishes standards for the way public business
enterprises report information about operating segments in annual financial
statements and requires that those enterprises report selected information about
operating segments in interim financial reports issued to shareholders. This
statement is effective for financial statements for periods beginning after
December 15, 1997 and need not be applied to interim periods in the initial year
of application. Comparative information for earlier years presented is to be
restated. We do not operate in more than one segment. Our chief operating
decision maker allocates resources and assesses the performance associated with
its business on a single-segment basis.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivatives and
Hedging Activities." This statement establishes accounting and reporting
standards of derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. This statement is
effective for all quarters of fiscal years beginning after June 15, 1999. We do
not expect the adoption of this standard to have a material effect on our
results of operations, financial position or cash flows.
29
BUSINESS
OVERVIEW
We are a network consulting company focused on the design, performance,
management and security of complex business-critical computing networks. We
utilize our proprietary consulting methodology, BusinessFirst, to translate our
clients' strategic business objectives into sound technology solutions. Using
our BusinessFirst methodology, we demonstrate the business value of technology
solutions in specific and measurable terms, thereby enabling our clients to
incorporate objective and quantifiable analysis into their technology investment
decisions.
As an independent service provider, we provide our clients with unbiased and
vendor-neutral expertise that enable the design, implementation and management
of optimal technology solutions. We provide our services on either a project
outsource or collaborative consulting basis. Our project outsource services are
based and measured against pre-defined deliverables and provide our clients with
certainty of costs, delivery time and project scope. Our collaborative
consulting services enable our clients to utilize our extensive expertise in
order to extend their internal capabilities and to access our methodologies. In
addition to these services, we have developed an innovative service model
through which we deliver our clients packaged service products, or productized
services. These services consist of pre-defined, fixed-price deliverables that
are replicated from our best practices.
Our consultants are organized into the following practice areas, which cover
the four cornerstones of network computing: network and systems management;
internetwork design and engineering; performance management; and information
security. This structure enables our consultants to gain in-depth expertise and
become intimately familiar with the best practices within each of those
disciplines.
INDUSTRY BACKGROUND
The effective communication and management of information has become
critical to success in today's competitive and rapidly changing global business
environment. Network infrastructures that once were viewed as sources of
competitive advantage are now being recognized as competitive necessities for
businesses in a broad range of industries. This shift is driven primarily by the
following factors:
- the migration from mainframe and client/server technologies to
Internet-based computing environments among most industries;
- the demand for real-time exchange of critical, time-sensitive information
within organizations and among their external constituents; and
- the widespread adoption of the Internet among consumers.
As a result of these factors, current and emerging network hardware and
software companies are rapidly developing sophisticated technologies for
business users to accommodate mission-critical applications, such as electronic
commerce, supply chain management, web hosting, customer relationship management
and global marketing. In addition to business use of networks, consumers are
increasingly accessing networks, via the Internet, to communicate, store and
publish bandwidth-intensive information, conduct retail transactions and access
online sources of entertainment. Business and consumer trends will continue to
positively impact the number of users accessing the Internet and virtual private
networks and the data traffic carried over these networks.
The growth in network-dependent activities requires complex network
solutions that integrate legacy systems and technologies from multiple vendors.
The rapid pace of change in networking technology has further increased the
complexity of designing and implementing these network solutions. As competing
hardware and software companies develop applications to more effectively and
efficiently manage increasing volumes of information, rapid adoption of new
technologies is required for
30
businesses to remain competitive. Accordingly, the demand for experienced
professionals that can assist businesses in designing, implementing, managing
and monitoring complex network solutions has increased dramatically.
As a result of demand for professionals with networking expertise, it has
become increasingly difficult for businesses to attract and retain dedicated
internal information technology resources. In response, many businesses are
focusing on their core competencies and outsourcing their network management
needs to third-party service providers. As a result, the demand for network
consulting and integration services has grown dramatically. International Data
Corporation estimates that the worldwide market will grow for these services
from $12.1 billion in 1998 to $25.5 billion by 2003. There are many third-party
service providers, including network equipment vendors, systems integrators,
value-added resellers and network consulting companies, seeking to capitalize on
this growth.
However, few have the requisite focus and expertise to address the complex,
multi-faceted issues surrounding today's business-critical networks, and many
are limited by the fact that they:
- are primarily motivated by distributing their own products and often lack
the skills to implement multi-vendor solutions;
- are focused on legacy computing environments and derive a large percentage
of their revenue from reselling hardware and software products; or
- only augment businesses' in-house capabilities with hourly rate-based
teams of technical personnel.
As a result, a significant opportunity exists for a service provider that
can offer businesses high-end, vendor neutral consulting and technical expertise
in the design, implementation, management and security of complex networks.
THE PREDICTIVE SOLUTION
We are a network consulting company focused on the design, performance,
management and security of complex, business-critical computing networks. We
utilize our proprietary consulting methodology, BusinessFirst, to translate our
clients' strategic business objectives into sound technology solutions. We
believe that our success to date has been largely attributable to the following
key characteristics of our service offering:
QUANTIFIABLE BUSINESS ANALYSIS. Using our BusinessFirst methodology, we can
demonstrate the business value of technology solutions in specific and
measurable terms, thereby enabling our clients to incorporate objective and
quantifiable analysis into their technology investment decisions. We utilize
widely accepted principles of risk analysis and mitigation used by the insurance
and financial services industries to assess our client's technology environment.
We provide our clients with a detailed analysis of the financial benefit of a
project by quantifying factors such as business risks, total cost of ownership
and operational efficiency. As a result, our clients can gain a clear
understanding of the benefits that they will derive from their network
technology investments and a measure of certainty about how their technology
investments will be translated into quantifiable improvements to their business
processes.
FLEXIBLE AND INNOVATIVE SERVICE DELIVERY METHODOLOGIES. We provide our
clients with a flexible service model that is designed to enhance their ability
to cost-effectively leverage our expertise. We are typically engaged by our
clients on either a project outsource or collaborative consulting basis. Our
project outsource services are primarily based and measured against pre-defined
deliverables and provide our clients with certainty of costs, delivery time and
project scope. Our collaborative consulting services enable our clients to
utilize our extensive expertise in order to extend their internal capabilities
and to access our methodologies. In addition to these services, we have
developed an innovative service delivery model through which we offer our
clients packaged service products, or productized services.
31
These services consist of pre-defined, fixed-price deliverables that are
replicated from our best practices. We believe that this unique approach to
network services further differentiates us from our competitors.
IN-DEPTH NETWORK COMPUTING EXPERTISE. Our consultants are organized into
practice areas which cover the four cornerstones of network computing: network
and systems management; internetwork design and engineering; performance
management; and information security. This enables our consultants to gain
in-depth expertise and become intimately familiar with the best practices within
each of those disciplines. More importantly, it enables us to leverage the
knowledge base within each practice group to provide our clients with
cross-functional teams of consultants that are better equipped to address their
varying networking needs in a coordinated and efficient manner.
VENDOR-NEUTRAL APPROACH. As an independent service provider, we offer our
clients unbiased and vendor-neutral expertise that enables the design,
implementation and management of optimal technology solutions. We capitalize on
our extensive experience across complex, multi-vendor network environments to
provide our clients with end-to-end network services utilizing best-of-breed
technologies.
STRATEGY
Our goal is to become the leading provider of services for the design,
performance, management and security of complex networks. To achieve this goal,
we intend to pursue the following strategies:
CONTINUE TO EVOLVE OUR BUSINESSFIRST METHODOLOGY. The evolution and
enhancement of our BusinessFirst methodology is critical to our ability to
leverage and share knowledge across engagements and to further improve our
ability to deliver predictable, high-quality services to our clients on time and
on budget. We have a dedicated team of consultants that is focused on
continuously enhancing and refining our BusinessFirst methodology by
incorporating best practices identified over numerous engagements. We believe
that this enables us to consistently deliver high-quality network technology
solutions.
EXPAND AND ENHANCE OUR PRODUCTIZED SERVICE OFFERINGS. We intend to continue
to enhance and expand our innovative productized service offerings. These
service offerings provide our clients with a pre-defined set of deliverables
that are characterized by an objective and quantifiable value proposition and
return on investment justification. Moreover, our productized services enable us
to increase our margin opportunities by improving the efficiency of our sales
and service delivery model. These products also enable us to market and sell our
services through indirect channels. For example, we recently entered into an
agreement with Cabletron under which Cabletron has agreed to market and sell our
productized service offerings, which will initially include our Information
Security Requirements Analysis product and will expand to other productized
service offerings. We intend to enter into other strategic relationships which
will enable us to further expand our market penetration by leveraging our
strategic partners' distribution channels to market and sell these services.
CONTINUE TO ATTRACT AND RETAIN HIGHLY QUALIFIED CONSULTANTS. We intend to
continue to attract and retain highly qualified consultants by providing them
with a rich environment and culture to work in, and by offering them attractive
professional development and compensation opportunities. We generally recruit
consultants that have significant technical expertise and offer them the ability
to accelerate their career development by working with sophisticated
technologies in complex, multi-vendor environments. We have established a formal
training program, Predictive University, which is designed to improve the skills
and productivity of our consultants. We intend to continue to build our
nationwide recruiting organization, promote our corporate culture with stated
values, and to invest heavily in the training and development of our
consultants.
32
FURTHER INCREASE OUR INDUSTRY EXPERTISE. We intend to continue to expand
the scope of our industry expertise in order to further penetrate our vertical
markets. We believe our expertise in specific industries considerably enhances
our ability to help companies within those industries gain competitive advantage
by improving the performance and utility of their networks. We have significant
experience within the financial services, communication services, and Internet
and e-commerce industries. In each of our vertical industry groups, we employ
industry experts, pursue targeted sales and marketing opportunities and develop
industry-specific service offerings. We intend to expand into other vertical
markets which we believe will be well suited to our services.
EXPAND IN EXISTING AND NEW GEOGRAPHIC MARKETS. We intend to expand our
presence in the geographic markets we currently serve and to enter new markets.
We believe that building a critical mass of highly-qualified consultants and
establishing a multi-national presence through both internal growth and
acquisitions will provide us with a substantial competitive advantage. We
currently offer our services through a network of nine offices located
throughout the United States and in London, England. We intend to pursue
strategic acquisitions to gain access to new geographic markets, additional
talented professionals, and network management tools and methodologies.
BUSINESSFIRST METHODOLOGY
BusinessFirst is a proprietary methodology that governs our organization and
client engagements. Our BusinessFirst methodology enables us to better
understand the business objectives that drive the need for technology solutions
and provide our clients with pre-defined deliverables on a fixed-time,
fixed-price basis. We begin each engagement by helping our clients clarify their
business requirements in specific terms. We then undertake a thorough assessment
of our client's existing business processes and technology infrastructure. Based
on this assessment, we formulate an analysis of the requirements to translate
their technology investments into measurable business objectives. Once we
formulate a requirements analysis, we draw upon our broad, vendor-neutral
expertise to design a solution that leverages our clients' existing technology
infrastructure to maximize their return on investment. We believe that our
BusinessFirst methodology bridges the gap in the marketplace between management
consulting firms and technical staff augmentation services and enables us to
translate business objectives into leading-edge technology solutions.
SERVICES
Our consultants are organized into four practice areas. Although many of our
consultants are cross-skilled in a variety of technologies and many technologies
span multiple practice areas, each practice area represents an aspect of network
technology important enough to warrant specialization.
These practice areas are:
- network and systems management;
- internetwork design and engineering;
- performance management; and
- information security.
Our consultants have extensive experience with a wide variety of
technologies and vendors. For some clients, our consultants are involved in both
technology and vendor selection. Other clients have already selected the
technology, vendor or both. Regardless, we offer our clients a completely
objective, vendor-neutral approach. Our knowledge of advanced technologies and
leading vendors is a significant part of our value proposition to our clients.
NETWORK AND SYSTEMS MANAGEMENT. Our network and systems management practice
focuses on designing and implementing reliable and continuously available
management systems for large-scale,
33
highly-complex networks. The fundamental tenet of this practice area is that
proactive management is an essential element of any network design and
engineering effort. Our network management consultants develop systems and
processes that are able to identify, isolate and resolve network failures,
sometimes before they occur.
The following table lists some of the services provided by our network and
systems management practice area:
SERVICE DESCRIPTION
- -------------------------------------------- --------------------------------------------------------------------
Service Definition and Service Level Highlights a client's service level commitments and assists in the
Agreement Workshop development of a rational, long-term plan for meeting and exceeding
those commitments.
Rapid Restart Assessment Determines the readiness of a client's network operations center and
provides short-term and long-term recommendations for addressing its
deficiencies.
Network Operation Center Architecture and Assists clients in evaluating and selecting network and systems
Implementation management technologies appropriate for their network operations
centers. Configures and implements the selected technology and
trains clients' operations staff.
Process and Procedure Development Designs, implements and documents the processes and procedures
required to operate a network operations center.
Automation, Correlation and Root Cause Automates repetitive management tasks associated with operating a
Analysis Technology Development network, including event filtering, extraneous event suppression and
automated root cause analysis.
INTERNETWORK DESIGN AND ENGINEERING. Our internetwork design and
engineering practice focuses on designing and implementing network solutions in
support of our clients' strategic business initiatives. We have created a team
of seasoned professionals who use their specialized technical skills, real-world
industry experience and methodologies to solve the problems associated with
building and maintaining network foundations. With core competencies in the
areas of backbone technology, local area network switching, Internet Protocol,
or IP, management and design, asynchronous transfer mode, or ATM, and remote
access, our versatile team contributes both technical depth and breadth to
client engagements.
34
The following table lists some of the services provided by our internetwork
design and engineering practice area:
SERVICE DESCRIPTION
- -------------------------------------------- --------------------------------------------------------------------
Advanced Technology Planning and Migration Assists clients in planning and integrating advanced technologies
into their business-critical networks. The services include
technology landscape briefings, vendor/ product selection, solution
design and integration planning and comprehensive testing.
Network Deployment Services Implements network technology into clients' existing networks.
Services include project management, vendor coordination, technology
installations and training.
Remote Access and Virtual Private Network Designs and deploys secure, high-performance remote access and
virtual private network solutions to allow clients, their employees,
supply-chain partners and other business partners to access
information remotely.
Network Audit Services Audits clients' network infrastructure to evaluate its design and
performance, document the configuration, analyze its compliance to
prescribed standards and develop an action plan to meet strategic
objectives.
Internet Protocol Management Solutions Designs and implements Internet Protocol address schemes required
for a client to connect to the Internet. The service also implements
management technology to administer the Internet Protocol addresses
used within an organization.
PERFORMANCE MANAGEMENT. Our performance management practice leverages
proven methodologies and our extensive experience to help our clients optimize
their networks. We use sophisticated tools and techniques to gather, organize
and warehouse network performance data. This data may subsequently be used for a
number of related performance analysis applications, including capacity
planning, response time management and network simulation modeling. Consultants
in our performance management practice area are experts in applicable
technologies, including core competencies in remote monitoring, or RMON, data
warehousing and discrete event simulation modeling.
35
The following table lists some of the services provided by our performance
management practice area:
SERVICE DESCRIPTION
- -------------------------------------------- --------------------------------------------------------------------
Network Baselining Collects data in order to establish a baseline of network resource
utilization. The baseline is then used as a comparison against
future trends.
Application Impact Analysis Analyzes how an application uses network resource to predict
response times that users will experience when the application is
deployed. Recommends improvements that enable the application to
maximize network resources.
Network Usage-Based Billing Services Assists clients' transition from a flat-rate billing model to a
usage-based billing model for buying network services.
Capacity Planning Assists clients in understanding the capacity and network resource
constraints that exist within their network with sufficient advance
warning to enable them to add capacity before user performance is
affected.
Response Time Management Monitors and analyzes end-user application response times to ensure
that they remain within the service level commitments.
Network Simulation Modeling Models a network environment so that new configuration and new
application deployment scenarios can be simulated before going into
production.
INFORMATION SECURITY. Our information security practice is focused on
ensuring that the confidentiality, integrity and availability of our clients'
networks are protected. Our information security consultants have practical
experience with a wide array of advanced security technologies, as well as the
social and procedural aspects of security. By translating the complexities of
information security into understandable terms such as risks, costs and
benefits, we enable our clients to make clear and informed decisions about
protecting their information assets.
36
The following table lists some of the services provided by our information
security practice area:
SERVICE DESCRIPTION
- -------------------------------------------- --------------------------------------------------------------------
Information Security Requirements Analysis Assesses clients' physical security environment, the technical
controls for accessing information assets and employee security
awareness. Highlights deficiencies and makes recommendations to
migrate clients to industry-specific best practices.
Asset and Risk Analysis Identifies critical assets, determines susceptibility to risks and
quantifies the impact of such risks. Recommends a risk mitigation
plan to prioritize corrective actions.
Information Security Policy Development Assists customers to create a comprehensive information security
policy that clearly states requirements for employee behavior,
technical security systems and the physical controls needed to
protect the client's information assets.
Security System Design and Implementation Designs and implements security systems using custom configured
products to enforce the specific information security policy of each
client.
Incident Response and Digital Forensics Provides critical response team services in the event of a security
Services breach. Restores the operational integrity of the systems, maintains
evidence, provides forensic and investigative services and
facilitates changes to prevent a recurrence of the breach.
Information Security Assessments Verifies the implementation and effectiveness of clients' security
policies by reviewing and testing their policies, employee
awareness, perimeter security and response team readiness.
PRODUCTIZED SERVICES
Using our BusinessFirst methodology, we have standardized our replicable
best practice offerings into productized services that have the following
attributes:
- a defined value proposition;
- a defined set of deliverables;
- a defined return on investment analysis;
- a defined delivery methodology; and
- a flexible pricing strategy.
We believe that our productized services are an innovative approach to
meeting our clients' growing need for cost certainty and guaranteed
deliverables. These productized services also enable us to leverage our best
practices into highly-replicable margin opportunities and to expand our market
penetration through third-party sales channels.
Our current productized services include:
INFORMATION SECURITY REQUIREMENTS ANALYSIS. This product is designed to
discover information security weaknesses and to provide our clients with the
ability to correct them. Our certified security
37
experts assess a client's physical, administrative and technical security. They
then present a report to management explaining how the security weaknesses that
they have found could impact the client's business and proposing strategies for
addressing these weaknesses.
NETWORK ASSESSMENT. This product provides a cost-effective expert analysis
of a client's existing network environment using proven tools and methodologies.
They then provide a report that helps the client to understand its network and
provides specific recommendations for improvements to and upgrades of the
client's existing network. This analysis is designed to provide clients with the
analysis they need to assess the business benefits that can be achieved by
improving their networks.
APPLICATION IMPACT STUDY. This product provides clients with the
information they need in order to plan the deployment of applications, and for
correcting mismatched networks and applications. Our network systems engineers
use a combination of commercial, public and privately developed software tools
to perform the application impact study. They then issue a report on the
application's performance and its impact on the client's network. Clients can
then determine if they need to enhance their network in order to ensure that
their mission critical applications perform to their requirements.
NETWORK USAGE INFORMATION. This product provides clients with a system to
collect and analyze actual network usage, allowing clients to bill for network
system costs. Our network systems engineers use industry proven tools and
methodologies to assess the client's requirements, implement the systems and
customize the solution for the client's specific business goals.
ENTERPRISE MANAGEMENT ASSESSMENT. This product provides an evaluation of a
client's current enterprise network management architecture. Our network systems
engineers analyze both a client's enterprise network management architecture and
its business objectives for its technology solution. They then provide the
client with a tactical and strategic roadmap that enables the client to
implement network solutions that support the client's business objectives.
NETWORK MODELING. This product provides clients with an understanding of
the performance capabilities of their current network environment. This
tool-based analysis examines network traffic flows, utilization trends,
application response times and general performance statistics of a client's
network environment. We then present the client with a detailed analysis of
their networks performance capabilities and a "what if" analysis tool that
allows them to determine the impact of usage upon their network. Clients can
then use this analysis and tool to predict network performance and evaluate the
need to upgrade their networks.
YEAR 2000 COMPLIANCE ASSESSMENT. This product identifies network
infrastructure that is at risk because of Year 2000 problems and the impact
these risks can have on a client's business. Our network systems engineers
analyze a client's network infrastructure devices and enterprise management
applications to determine the potential risk based on vendor specifications.
They then develop a plan for remediation to minimize the Year 2000 risk to a
client's business.
38
CLIENTS
We provide professional network services to a variety of clients across a
broad range of vertical industries including:
COMMUNICATIONS FINANCIAL SERVICES NETWORK TECHNOLOGY OTHER
SERVICES Bank of America Adaptec Allied Signal
AT&T Bear, Stearns Ascend Communications Houghton Mifflin
Bell Atlantic Bloomberg Analog Devices Mary Kay Cosmetics
Bell South Cigna Cabletron Merck
British Telecom Citigroup Cisco Systems Norfolk Southern
Cable & Wireless DLJdirect Data General Pepsi
Cignal Global Comm. Deutsche Bank IBM Pfizer
Cox Communications Fidelity Lucent Technologies Raytheon
Enron Communications First Union Nortel Networks Siemens Energy
iBEAM Broadcasting Fleet Bank PROFESSIONAL SERVICES Staples
ICG Netcom ING Baring Furman Selz AT&T Solutions
Intelsat J.P. Morgan CSC
MCI/Worldcom Morgan Stanley GE Capital
Navisite Pershing Law Plus
Pacific Bell State Street Bank Lockheed Martin
Primus Telecom. State Farm McKinsey & Company
PSINet SWIFT PricewaterhouseCoopers
Qwest Union Bank of Unisys
Teligent California
UUNet Wells Fargo
SALES AND MARKETING
We have developed direct and indirect sales channels for the sale of our
services. To facilitate our direct sales effort we have developed the
infrastructure necessary to capture and track the major sales indicators through
the sales cycle. Additionally, a significant amount of time and effort has been
and will continue to be invested in the development of tools, training materials
and training for sales and technical personnel. Our productized services have
provided us with an opportunity to develop strategic third-party relationships
with hardware, software service and telecommunications providers in order to
expand our sales channel. As a result, we are developing an indirect sales
channel through relationships with third-party strategic partners. We have
entered into an agreement with Cabletron under which Cabletron has agreed to
market and sell our productized services. We intend to pursue similar agreements
with other strategic partners in order to broaden our indirect sales channel.
HUMAN RESOURCES
We seek to attract, train, retain and deliver the highest level of technical
talent. We believe that our proactive approach gives us a strong competitive
edge in the marketplace and a scalable, consistently high standard of service
delivery. As of June 30, 1999, we had 280 full-time employees.
RECRUITING. Our success is dependent in part on attracting and retaining
talented and motivated personnel at all levels. Accordingly, we invest
significant resources in our recruiting efforts. We have a proactive recruiting
philosophy and believe in a broad-based model for attracting candidates.
Generally, we hire technical consultants according to profiles that fit into one
of our four practice areas.
CORPORATE CULTURE. Our corporate culture is shaped by our view of employees
as investors because they choose to invest their talents, skills, time and
energy into our organization. This mindset is critical
39
to our ability to attract and retain professional staff at a time when
information technology professionals are in high demand. We have instituted a
very competitive benefits package for all employees and have developed policies
that ensure that we continue to address our employees' professional development
and satisfaction. We strive to maintain our relaxed and supportive workplace
despite our rapid growth and expansion.
PROFESSIONAL DEVELOPMENT. We believe that our investment in our employees
must mirror our employees' investment in and commitment to us. Integral to this
goal is the establishment of a career development plan for each of our
employees, which is created and agreed upon by management and the employee. We
provide our consultants with the opportunity to obtain extensive subject matter
expertise in their practice area and to work in collaborative multi-discipline
projects. We have also established Predictive University, a training program
that leverages both our in-house captured knowledge programs, as well as
selected outside certification programs.
COMPENSATION. We believe that linking employee compensation to our success
through performance-based incentive programs encourages a high level of
involvement from each team member and increases our employee retention. We
provide a highly competitive compensation package that consists of a combination
of base salary, performance-based incentives and company stock options.
COMPETITION
The network management consulting industry is comprised of many
participants, is highly competitive and is subject to rapid technological
change. We face intense competition from systems integrators, value added
resellers, local and regional network services firms, telecommunications
providers, network equipment and computer systems vendors. Many of our
competitors have greater name recognition, longer operating histories, more
relationships with large and established clients and greater financial,
technical and managerial resources. Furthermore, we expect that our competitors
may in the future form alliances with other technology vendors, which may give
them an advantage in managing networks that use that vendor's equipment.
Most of our current clients and prospective clients have internal
information technology departments and could choose to satisfy their network
management needs through internal resources rather than by outsourcing them to
third-party service providers such as ourselves. The decision by clients or
prospective clients to rely on their own information technology departments
could have a material adverse affect on our business, results of operations and
financial condition. Moreover, as the domestic and global markets for
information technology services continue to grow, we expect to face stiff
competition from new entrants into the network management consulting industry.
We believe that the principal competitive factors in the network management
market are the ability to attract and retain qualified personnel, quality and
breadth of services offered, price and reliability of services provided and the
strength of client relationships. We believe we compete favorably with respect
to all of these factors. We believe we distinguish ourselves from our
competitors through our expertise in managing complex, multi-vendor networks and
our ability to provide clients with cost certainty and guaranteed deliverables.
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
We regard our copyrights, trade secrets and other intellectual property as
critical to our success. Unauthorized use of our intellectual property by third
parties may damage our brand and our reputation. We rely on trademark and
copyright law, trade secret protection and confidentiality and/or license and
other agreements with our employees, customers, partners and others to protect
our intellectual property rights. Despite our precautions, it may be possible
for third parties to obtain and use our intellectual property without our
authorization. Furthermore, the validity, enforceability and scope of protection
of intellectual property in Internet-related industries is uncertain and still
evolving.
40
The laws of some foreign countries do not protect intellectual property to the
same extent as do the laws of the United States.
We pursue the registration of our trademarks in the United States and
England. We may not be able to secure adequate protection of our trademarks in
the United States and other countries. We currently have applied for trademark
registrations in the United States and England for the PREDICTIVE SYSTEMS and
BUSINESSFIRST marks, and further, a trademark application in the United States
for the Predictive logo. The trademark offices in the United States and England
have raised preliminary objections to the registration of the trademarks
described above on a number of grounds, including likelihood of confusion with
pre-existing trademarks and descriptiveness. We have responded to these
objections and are awaiting the trademark offices' decisions on our responses.
We have not, however, received any objections from third parties asserting
likelihood of confusion claims with respect to our trademarks. Nonetheless, we
may not be able to obtain trademark registrations in the United States or
England, or both, for one or more of these trademarks, in which case we would be
unable to fully enforce our statutory trademark rights against third parties for
these trademarks, and/or we may decide to replace these trademarks with new
trademarks. This could have a material adverse effect on our business, financial
condition and results of operations. Effective trademark protection may not be
available in all the countries in which we conduct business. Policing
unauthorized use of our marks is also difficult and expensive. In addition, it
is possible that our competitors have adopted or will adopt product or service
names similar to ours, thereby impeding our ability to build brand identity and
possibly leading to customer confusion.
We cannot be certain that our services and the finished products that we
deliver do not or will not infringe valid patents, copyrights, trademarks or
other intellectual property rights held by third parties. We may be subject to
legal proceedings and claims from time to time relating to the intellectual
property of others in the ordinary course of our business. We may incur
substantial expenses in defending against these third-party infringement claims,
regardless of their merit. Successful infringement claims against us may result
in substantial monetary liability or may materially disrupt the conduct of our
business.
FACILITIES
Our principal executive offices are currently located in approximately
15,000 square feet of office space in New York, New York. Additionally, in June
1999 we entered into an agreement to lease approximately 32,000 square feet of
office space in another facility in New York, New York, with an option for an
additional 32,000 square feet available by March 2001. We expect to move our
principal executive offices to the new facilities in December 1999. We also
lease office space in:
- Atlanta, Georgia;
- Boston, Massachusetts;
- Dallas, Texas;
- Florham Park, New Jersey;
- Herndon, Virginia;
- Pleasanton, California;
- Santa Cruz, California; and
- London, England.
We believe that our existing facilities are adequate for our current needs
and that additional space will be available as needed.
LEGAL PROCEEDINGS
We are not a party to any legal proceedings.
41
MANAGEMENT
The following table sets forth our executive officers, directors and key
employees, their ages and the positions they hold:
NAME AGE POSITION
- ----------------------------------------------------- --- -----------------------------------------------------
Ronald G. Pettengill, Jr............................. 40 Chairman of the Board and Chief Executive Officer
Robert L. Belau...................................... 36 President and Director
Thomas R. Joseph..................................... 32 Vice President, General Manager North America
Carl D. Humes........................................ 33 Vice President, Global Operations
Gregory D. Nicastro.................................. 39 Vice President, Strategic Services
Neeraj Sethi......................................... 36 Vice President, Finance
R. Kevin Holt........................................ 45 Vice President, Human Resources
John Wright.......................................... 36 Managing Director, Europe
Peter L. Bloom (1)................................... 41 Director
Donald J. Duffy (1).................................. 32 Director
Braden R. Kelly (2).................................. 28 Director
Eric Meyer (2)....................................... 38 Director
- ------------------------
(1) Member of the compensation committee
(2) Member of the audit committee
RONALD G. PETTENGILL, JR. co-founded Predictive in February 1995 and has
been Chairman of the Board and Chief Executive Officer since that time. Prior to
founding Predictive, Mr. Pettengill was Senior Vice President of Network
Operations at Allerion, Inc., a systems integration and network control center
design, operation and service delivery firm, from 1992 to 1995. From 1990 to
1992, Mr. Pettengill was the Director of Technical Services at Network
Management, Inc., which provided consulting services to assist Fortune 500
companies migrate from mainframe to network-based client/ server environments.
Prior to working at Network Management, Mr. Pettengill was the Network Manager
at Bear, Stearns & Co. Inc.
ROBERT L. BELAU co-founded Predictive in February 1995 and has been
President and a Director since that time. Prior to founding Predictive, Mr.
Belau was Director of Sales at Allerion, and also managed the definition,
productization and pricing of its network management outsourcing services, from
1993 to 1995. From 1987 to 1993, Mr. Belau was the Director of Sales at Network
Management. Mr. Belau is the step-brother of Eric Meyer, one of our directors.
THOMAS R. JOSEPH has been Vice President, General Manager North America
since April 1999. Prior to that he held various positions with us, most recently
as National Vice President of Business Development, from 1996 to 1999. From 1994
to 1996, Mr. Joseph was a Global Accounts Manager at Metropolitan Fiber Systems,
a competitive access provider.
CARL D. HUMES has been Vice President, Global Operations since April 1999.
Prior to that he served as Region Vice President of Technical Services for our
Mid-Atlantic region since 1996. From 1995 to 1996, Mr. Humes was a consultant at
Booz-Allen & Hamilton, a strategic consulting firm. Prior to that, Mr. Humes was
an officer in the United States Navy, and served on a nuclear submarine and at
the White House Office of Emergency Operations.
GREGORY D. NICASTRO has been Vice President, Strategic Services since April
1999. Prior to that, Mr. Nicastro served as Vice President of Marketing since
1997. Prior to joining us, Mr. Nicastro founded ActingExec, a marketing
consulting firm, in 1995. From July 1995 to October 1995,
42
Mr. Nicastro was Director of Systems Marketing at 3Com Corporation. From 1988 to
1995, Mr. Nicastro served as National Account Sales Manager at Sun Microsystems.
NEERAJ SETHI has been Vice President of Finance since 1995. Prior to joining
us, Mr. Sethi was Assistant Vice President for Global Expense Management at
Bankers Trust from 1992 to 1995. From 1989 to 1992, Mr. Sethi was Controller and
Financial Analyst at Network Management.
R. KEVIN HOLT has been Vice President of Human Resources since March 1999.
Prior to joining us, Mr. Holt was a Managing Partner at USWeb/CKS (formerly
USWeb). Prior to the merger of USWeb/ CKS and Gray Peak Technologies, Mr. Holt
served as Vice President and Director of Recruiting at Gray Peak, a high-end
network solutions provider. From October 1995 until September 1997, Mr. Holt
served as the Eastern Division Recruiting Manager at Sprint-Paranet, a global
network solutions provider. Previously, Mr. Holt was the Founder and President
of Metropolitan Search, a contingency and retained search and consulting
company.
JOHN WRIGHT has been Managing Director, Europe since January 1999. Prior to
joining us, Mr. Wright founded Visia Management Consultants, a strategic
consulting company, in 1997. From 1996 to 1997, Mr. Wright served as Director,
Business Development at Global Village, a communications software firm. From
1987 to 1996, Mr. Wright served in various roles at Gandalf Digital
Communications, including, most recently, Director of Indirect Channels.
PETER L. BLOOM has been a director of Predictive since March 1999. Mr. Bloom
is a managing member of General Atlantic Partners, LLC, a private equity firm
that invests globally in software, services, Internet and related information
technology companies, and has been at General Atlantic since 1995. From 1982 to
1995, Mr. Bloom served in various roles at Salomon Brothers, including as
Managing Director of Salomon's U.S. Technology Division. Mr. Bloom is a Director
of Bindview Development Corporation and a Special Advisor to the Board of
Directors of E*TRADE Securities, Inc.
DONALD J. DUFFY has been a director of Predictive since its inception in
February 1995. Mr. Duffy is a co-founder of Meyer, Duffy & Associates, Inc., and
is a Managing Member of MD Ventures. Mr. Duffy is a director of Bikers Dream
Inc., a publicly traded company. Mr. Duffy has been at Meyer, Duffy & Associates
and MD Ventures since 1994. From 1992 to 1994, Mr. Duffy was a Vice President at
Oak Hall Capital Advisors, a money management firm.
BRADEN R. KELLY has been a director of Predictive since June 1999. Mr. Kelly
is an associate at General Atlantic Partners, LLC, and has been with General
Atlantic since 1995. Mr. Kelly is a director of HEALTHvision, Inc., a provider
of comprehensive Internet solutions to the healthcare industry. From 1993 to
1994, Mr. Kelly served as a Financial Analyst at Morgan Stanley & Company.
ERIC MEYER has been as a director of Predictive since its inception in
February 1995. Mr. Meyer is a co-founder of Meyer, Duffy & Associates and is a
Managing Member of MD Ventures. Mr. Meyer has been at Meyer, Duffy & Associates
and MD Ventures since 1994. From 1992 to 1994 Mr. Meyer served as a Vice
President at Oak Hall Capital Advisors. Mr. Meyer is the step-brother of Robert
L. Belau, our President and one of our directors.
CLASSIFIED BOARD OF DIRECTORS
Prior to the completion of the offering, our board of directors will be
divided into three classes of directors serving staggered three-year terms. As a
result, approximately one-third of the board of directors will be elected each
year. These provisions, when coupled with the provision of our amended and
restated certificate of incorporation authorizing the board of directors to fill
vacant directorships or increase the size of the board of directors, may delay a
stockholder from removing incumbent directors and simultaneously gaining control
of the board of directors by filling the vacancies with its own nominees.
43
BOARD COMMITTEES
The audit committee reports to the board of directors regarding the
appointment of our independent public accountants, the scope and results of our
annual audits, compliance with our accounting and financial policies and
management's procedures and policies relative to the adequacy of our internal
accounting controls. The audit committee currently consists of Messrs. Meyer and
Kelly.
The compensation committee reviews and makes recommendations to the board of
directors regarding our compensation policies and all forms of compensation to
be provided to our executive officers and directors. In addition, the
compensation committee reviews bonus and stock compensation arrangements for all
of our other employees. The current members of the compensation committee are
Messrs. Duffy and Bloom. No interlocking relationships exist between our board
of directors or compensation committee and the board of directors or
compensation committee of any other company, nor has any interlocking
relationship existed in the past with the exception of Messrs. Pettengill,
Belau, Duffy and Meyer serving on the Board of Directors of Tribeca Software,
Inc. and Messrs. Pettengill and Meyer serving on the Board of Directors of
Riversoft Ltd.
DIRECTOR COMPENSATION
We do not currently compensate our directors for attending meetings of the
board of directors or committee meetings of the board of directors, but we do
reimburse directors for their reasonable travel expenses incurred in connection
with attending these meetings.
Under the automatic option grant program of the 1999 Stock Incentive Plan,
which is described below under "--1999 Stock Incentive Plan," each individual
who first joins the board of directors after the closing of this offering as a
non-employee member of the board of directors will also receive an option grant
for 25,000 shares of our common stock at the time of his or her commence of
service on the board of directors. In addition, at each annual meeting of
stockholders, beginning with the 2001 annual meeting, each individual who is to
continue to serve as a non-employee member of the board of directors will
receive an option to purchase 2,500 shares of our common stock.
44
EXECUTIVE COMPENSATION
The following table sets forth the total compensation paid or accrued during
the fiscal year ended December 31, 1998 to our Chief Executive Officer and to
each of our most highly compensated executive officers, other than the Chief
Executive Officer, whose salary and bonus for such fiscal year exceeded
$100,000.
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
AWARDS
ANNUAL COMPENSATION -----------------
---------------------- SHARES UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION SALARY $ BONUS $ OPTIONS COMPENSATION
- ------------------------------------------------------- ---------- ---------- ----------------- -------------
Ronald G. Pettengill, Jr............................... $ 175,000 $ 50,000 60,000 $ 8,447(1)
Chief Executive Officer
Robert L. Belau........................................ 175,000 50,000 60,000 8,899(1)
President
Thomas R. Joseph....................................... 112,500 190,000 270,000 3,000(2)
Vice President of North America
Carl D. Humes.......................................... 112,500 190,000 270,000 3,000(2)
Vice President, Technical Services
Gregory D. Nicastro.................................... 140,000 14,000 -- --
Vice President, Strategic Services
Neeraj Sethi........................................... 135,167 55,000 -- --
Vice President, Finance
- ------------------------
(1) We paid a monthly car allowance and automobile insurance premiums for each
of Messrs. Pettengill and Belau during the year ended December 31, 1998.
(2) We paid a monthly car allowance effective July 1998 for each of Messrs.
Joseph and Humes during the year ended December 31, 1998.
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth grants of stock options for the year ended
December 31, 1998 to our Chief Executive Officer and to each of our most highly
compensated executive officers, other than the Chief Executive Officer, whose
salary and bonus for such fiscal year exceeded $100,000. We have never granted
any stock appreciation rights. The potential realizable value is calculated
based on the term of the option at its time of grant. It is calculated assuming
that the fair market value of common stock on the date of grant appreciates at
the indicated annual rate compounded annually for the entire term of the option
and that the option is exercised and sold on the last day of its term for the
appreciated stock price. These numbers are calculated based on the requirements
of the Securities and Exchange Commission and do not reflect our estimate of
future stock price growth. The percentage of total
45
options granted to employees in the last fiscal year is based on options to
purchase an aggregate of shares of common stock granted under our option
plan.
POTENTIAL REALIZABLE
VALUE
AT ASSUMED ANNUAL
PERCENT OF RATES
NUMBER OF TOTAL OF STOCK PRICE
SECURITIES OPTIONS APPRECIATION
UNDERLYING GRANTED TO EXERCISE FOR OPTION TERM
OPTIONS EMPLOYEES PRICE PER EXPIRATION ----------------------
NAME GRANTED IN 1998 SHARE ($) DATE 5% 10%
- ------------------------------------------- ----------- ------------- ----------- ----------- ---------- ----------
Ronald G. Pettengill, Jr................... 60,000 2.5% $ 1.25 1/1/08 $ 47,167 $ 119,531
Robert L. Belau............................ 60,000 2.5 1.25 1/1/08 47,167 119,531
Thomas R. Joseph........................... 150,000 6.2 1.25 1/1/08 117,918 298,827
120,000 4.9 1.50 8/1/08 113,201 286,874
Carl D. Humes.............................. 150,000 6.2 1.25 1/1/08 117,918 298,827
120,000 4.9 1.50 8/1/08 113,201 286,874
- ------------------------
(1) There was no public market for this common stock on December 31, 1998. The
fair market value on December 31, 1998 was determined by the board of
directors to be $1.50 per share.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
The following table sets forth information concerning the value realized
upon exercise of options during 1998 and the number and value of unexercised
options held by each of our named executive officers at December 31, 1998. There
was no public trading market for the common stock as of December 31, 1998.
Accordingly, the values set forth below have been calculated on the basis of the
fair market value on December 31, 1998 as determined by our board of directors
of $1.50 per share, less the applicable exercise price per share, multiplied by
the number of shares underlying the options.
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS
SHARES FISCAL YEAR-END AT FISCAL YEAR-END
ACQUIRED ON VALUE -------------------------- --------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ----------------------------------------- ----------- ---------- ----------- ------------- ----------- -------------
Ronald G. Pettengill, Jr................. 585,000 $ 779,805 780,000 -- $ 515,220 --
Robert L. Belau.......................... 585,000 779,805 780,000 -- 515,220 --
Thomas R. Joseph......................... -- -- 210,000 150,000 82,530 $ 15,000
Carl D. Humes............................ -- -- 210,000 150,000 82,530 15,000
Gregory D. Nicastro...................... -- -- -- 336,000 -- 84,000
Neeraj Sethi............................. 135,000 179,955 90,000 90,000 35,010 22,500
EMPLOYMENT AGREEMENTS
We have entered into executive employment agreements with Ronald G.
Pettengill, Jr., our Chairman and Chief Executive Officer, and Robert L. Belau,
our President. Each employment agreement provides for an initial annual base
salary of $200,000. Each employment agreement also provides for initial
performance based bonuses of $25,000 upon the closing of this offering and up to
an additional $50,000 upon the achievement of certain gross revenue thresholds
in the 1999 fiscal year. Under the agreements, each executive also received
options to purchase 100,000 shares of our common stock at a price of $4.00 per
share, which vest over 3 years. Additionally, each executive received options to
purchase an additional 100,000 shares of our common stock at a price of $4.00
per share which vest after 4 years. These additional options will vest
immediately upon the achievement of certain gross revenues thresholds.
Each employment agreement expires on May 11, 2002, subject to earlier
termination or extension. Each employment agreement provides that if Messrs.
Pettengill and Belau are terminated by us without
46
cause or if they terminate their employment agreements for good reason, they
will be entitled to their base salary and health coverage until the later of the
expiration date of their employment agreements or one year from the date of
termination. Additionally, all stock options granted to them will immediately
vest.
Under the agreements, good reason includes:
- a material breach of the agreements by us;
- a material change in the executives duties and responsibilities;
- a change in the executive's reporting relationship;
- a relocation of our executive offices further than 75 miles from its
current location; or
- a change of control.
Each employment agreement prohibits Messrs. Pettengill and Belau from
competing with us, or soliciting our customers or employees, for a period of one
year from the date of their termination of employment.
We have also entered into an employment agreement with R. Kevin Holt, our
Vice President of Human Resources. This agreement provides for an initial annual
base salary of $130,000 and for an initial performance based bonus of up to
$120,000 upon the achievement of certain hiring goals, hiring processes and
marketing goals in the fiscal year ending December 31, 1999. Under the
agreement, Mr. Holt received options to purchase 130,000 shares of our common
stock at a price of $2.50 per share, which vest over 4 years.
Our employment agreement with Mr. Holt expires on January 23, 2001, subject
to earlier termination. Mr. Holt's agreement provides that if he is terminated
by us without cause or if he terminates his employment with us for good reason,
he will be entitled to receive his base salary until the earlier of six months
after the date of his termination or the date he accepts new employment. Under
the agreement, good reason includes:
- a reduction in Mr. Holt's base salary;
- a relocation of Mr. Holt's office further than 50 miles from his current
office; or
- a material reduction in job duties.
Our agreement prohibits Mr. Holt from competing with us, soliciting our
employees or permitting his name to be used in connection with a competing
business for a period of six months from the date of the termination of his
employment.
1999 STOCK INCENTIVE PLAN
The 1999 Stock Incentive Plan is intended to serve as the successor equity
incentive program to our 1998 Stock Option/Stock Issuance Plan and our 1998
California Stock Option/Stock Issuance Plan. The 1999 Plan became effective upon
its adoption by the board of directors on , 1999. It will be
approved by the stockholders prior to the date of this offering.
shares of common stock have been authorized for issuance under
the 1999 Plan. This share reserve consists of the shares which were available
for issuance under the predecessor plans on the effective date of the 1999 Plan
plus an additional increase of shares. The share reserve will
automatically be increased on the first trading day of January each calendar
year, beginning in January 2001, by a number of shares equal to 1% of the total
number of shares of common stock outstanding on the last trading day of the
immediately preceding calendar year, but no such annual increase will exceed
shares. However, in no event may any one participant in the 1999 Plan
47
receive option grants or direct stock issuances for more than shares in
the aggregate per calendar year.
Outstanding options under the predecessor plans will be incorporated into
the 1999 Plan upon the date of this offering, and no further option grants will
be made under those plans. The incorporated options will continue to be governed
by their existing terms, unless our compensation committee extends one or more
features of the 1999 Plan to those options. However, except as otherwise noted
below, the outstanding options under the predecessor plans contain substantially
the same terms and conditions summarized below for the discretionary option
grant program under the 1999 Plan.
The 1999 Plan has five separate programs:
- the discretionary option grant program under which eligible individuals in
our employ or service (including officers, non-employee board members and
consultants) may be granted options to purchase shares of our common
stock;
- the stock issuance program under which these individuals may be issued
shares of our common stock directly, with the purchase of such shares or
as a bonus tied to the performance of services;
- the salary investment option grant program under which executive officers
and other highly compensated employees may elect to apply a portion of
their base salary to the acquisition of special below-market stock option
grants;
- the automatic option grant program under which option grants will
automatically be made at periodic intervals to eligible non-employee board
members; and
- the director fee option grant program under which non-employee board
members may elect to apply a portion of their retainer fee to the
acquisition of special below-market stock option grants.
The discretionary option grant and stock issuance programs will be
administered by our compensation committee. This committee will determine which
eligible individuals are to receive option grants or stock issuances, the time
or times when such option grants or stock issuances are to be made, the number
of shares subject to each such grant or issuance, the exercise or purchase price
for each such grant or issuance, the status of any granted option as either an
incentive stock option or a non-statutory stock option under the federal tax
laws, the vesting schedule to be in effect for the option grant or stock
issuance and the maximum term for which any granted option is to remain
outstanding. The committee will also select the executive officers and other
highly compensated employees who may participate in the salary investment option
grant program in the event that program is activated for one or more calendar
years. Neither the compensation committee nor the board will exercise any
administrative discretion with respect to option grants made under the salary
investment option grant program or under the automatic option grant or director
fee option grant program for the non-employee board members.
The exercise price for the options may be paid in cash or in shares of our
common stock valued at fair market value on the exercise date. The option may
also be exercised through a same-day sale program without any cash outlay by the
optionee. In addition, the compensation committee may allow a participant to pay
the option exercise price or direct issue price (and any associated withholding
taxes incurred in connection with the acquisition of shares) with a
full-recourse, interest-bearing promissory note.
In the event that we are acquired, whether by merger or asset sale or
board-approved sale by the stockholders of more than 50% of our voting stock,
each outstanding option under the discretionary option grant program which is
not to be assumed by the successor corporation or otherwise continued will
automatically accelerate in full, and all unvested shares under the
discretionary option grant and
48
stock issuance programs will immediately vest, except to the extent our
repurchase rights with respect to those shares are to be assigned to the
successor corporation or otherwise continued in effect. The compensation
committee may grant options under the discretionary option grant program which
will accelerate in the acquisition even if the options are assumed or which will
accelerate if the optionee's service is subsequently terminated. The
compensation committee may grant options and issue shares which accelerate in
connection with a hostile change in control effected through a successful tender
offer for more than 50% of our outstanding voting stock or by proxy contest for
the election of board members) or the options and shares may accelerate upon a
subsequent termination of the individual's service.
Options currently outstanding under the may be assumed by the
successor corporation in an acquisition; such options are not by their terms
subject to acceleration at the time of an acquisition or a change in control or
upon the termination of the optionee's service following any such transaction.
Stock appreciation rights may be issued under the discretionary option grant
program which will provide the holders with the election to surrender their
outstanding options for an appreciation distribution from us equal to the fair
market value of the vested shares subject to the surrendered option less the
aggregate exercise price payable for such shares. This appreciation distribution
may be made in cash or in shares of our common stock. There are currently no
outstanding stock appreciation rights under the predecessor plans.
The compensation committee has the authority to cancel outstanding options
under the discretionary option grant program (including options incorporated
from predecessor plans) in return for the grant of new options for the same or
different number of option shares with an exercise price per share based upon
the fair market value of the common stock on the new grant date.
In the event the compensation committee elects to activate the salary
investment option grant program for one or more calendar years, each of our
executive officers and other highly compensated employees selected for
participation may elect to reduce his or her base salary for that calendar year
by a specified dollar amount not less than $5,000 nor more than $50,000. In
return, the individual will automatically be granted, on the first trading day
in the calendar year for which the salary reduction is to be in effect, a
non-statutory option to purchase that number of shares of common stock
determined by dividing the salary reduction amount by two-thirds of the fair
market value per share of our common stock on the grant date. The option
exercise price will be equal to one-third of the fair market value of the option
shares on the grant date. As a result, the fair market value of the option
shares on the grant date less the exercise price payable for those shares will
be equal to the salary reduction amount. The option will become exercisable in a
series of 12 equal monthly installments over the calendar year for which the
salary reduction is to be in effect and will be subject to full and immediate
vesting in the event of an acquisition or change in control.
Under the automatic option grant program, each individual who first joins
our board after the effective date of this offering as a non-employee board
member will automatically be granted an option for 25,000 shares of our common
stock at the time of his or her commencement of board service. In addition, on
the date of each annual stockholders meeting, beginning with the 2001 meeting,
each individual who has served as a non-employee board member since the last
annual stockholders meeting will receive an option grant to purchase 2,500
shares of our common stock. Each automatic grant will have an exercise price
equal to the fair market value per share of our common stock on the grant date
and will have a maximum term of 10 years, subject to earlier termination
following the optionee's cessation of board service. Each option will be
immediately exercisable, subject to our right to repurchase any unvested shares,
at the original exercise price, at the time of the board member's cessation of
service. The options will vest, and our repurchase right will lapse, with
respect to, the initial 25,000-share option grant in a series of four (4) equal
successive annual installments upon the
49
optionee's completion of each year of service over the four (4)-year period
measured from the grant date. However, each such outstanding option will
immediately vest upon an acquisition or change in control or the death or
disability of the optionee while serving as a board member. Each 2,500-share
option grant will be fully vested on grant.
If the director fee option grant program is put into effect in the future,
then each non-employee board member may elect to apply all or a portion of any
cash retainer fee for the year to the acquisition of a below-market option
grant. The option grant will automatically be made on the first trading day in
January in the year for which the non-employee board member would otherwise be
paid the cash retainer fee in the absence of his or her election. The option
will have an exercise price per share equal to one-third of the fair market
value of the option shares on the grant date, and the number of shares subject
to the option will be determined by dividing the amount of the retainer fee
applied to the program by two-thirds of the fair market value per share of our
common stock on the grant date. As a result, the fair market value of the option
shares on the grant date less the exercise price payable for those shares will
be equal to the portion of the retainer fee applied to that option. The option
will become exercisable in a series of twelve equal monthly installments over
the calendar year for which the election is in effect. However, the option will
become immediately exercisable for all the option shares upon the death or
disability of the optionee while serving as a board member.
Limited stock appreciation rights will automatically be included as part of
each grant made under the automatic option grant, director fee option grant and
salary investment option grant programs and may be granted to one or more
officers as part of their option grants under the discretionary option grant
program. Options with this limited stock appreciation right may be surrendered
to us upon the successful completion of a hostile tender offer for more than 50%
of our outstanding voting stock. In return for the surrendered option, the
optionee will be entitled to a cash distribution from us in an amount per
surrendered option share equal to the highest price per share of our common
stock paid in connection with the tender offer less the exercise price payable
for such share.
The board may amend of modify the 1999 Plan at any time, subject to any
required stockholder approval. The 1999 Plan will terminate no later than
, 2009.
EMPLOYEE STOCK PURCHASE PLAN
Our Employee Stock Purchase Plan was adopted by the board on ,
1999 and will be approved by the stockholders prior to the date of this
offering. The plan will become effective immediately upon the execution of the
underwriting agreement for this offering. The plan is designed to allow our
eligible employees and those of our participating subsidiaries to purchase
shares of our common stock, at semi-annual intervals, through periodic payroll
deductions. A total of shares of our common stock will be issued under the
plan.
The plan will have a series of successive offering periods, each with a
maximum duration of 24 months. The initial offering period will begin on the day
the underwriting agreement is executed in connection with this offering and will
end on the last business day in October 2001. The next offering period will
begin on the first business day in November 2001, and subsequent offering
periods will be set by our compensation committee.
Individuals who are eligible employees on the start date of any offering
period may enter the plan on that start date or on any subsequent semi-annual
entry date (generally May 1 or November 1 each year). Individuals who become
eligible employees after the start date of the offering period may join the plan
on any subsequent semi-annual entry date within that period.
A participant may contribute up to % of his or her cash earnings through
payroll deductions and the accumulated payroll deductions will be applied to the
purchase of shares on the participant's behalf on each semi-annual purchase date
(the last business day in January and July each year). The
50
purchase price per share will be 85% of the lower of the fair market value of
our common stock on the participant's entry date into the offering period or the
fair market value on the semi-annual purchase date. The first purchase date will
occur on the last business day in April 2000. In no event, however, may any
participant purchase more than shares, nor may all participants in the
aggregate purchase more than shares on any one semi-annual purchase date.
Should the fair market value of our common stock on any semi-annual purchase
date be less than the fair market value on the first day of the offering period,
then the current offering period will automatically end and a new offering
period will begin, based on the lower fair market value.
The board may at any time amend or modify the plan. The plan will terminate
no later than the last business day in October 2009.
51
CERTAIN TRANSACTIONS
TRIBECA SOFTWARE
In March 1998, we distributed all of the outstanding shares of our former
subsidiary, Tribeca Software, Inc., to our stockholders. As part of this
transaction, Tribeca purchased from us, and we assigned to Tribeca, network
management software and other assets. As payment for these assets, Tribeca gave
us a demand note in the amount of $130,000, which accrued interest at 8% per
annum. Additionally, we gave Tribeca a $1,000,000 line of credit at an interest
rate of 8% per annum. As of March 31, 1999, $174,276 was due from Tribeca.
Subsequent to this date, Tribeca paid us the full amounts due under the demand
note and the line of credit and the line of credit was terminated.
We have in the past performed administrative and other services for Tribeca
for which we did not receive any payment. Additionally, Tribeca leases office
space and equipment from us for approximately $12,000 per month. We also act as
a reseller for Tribeca's software. In 1998, sales of Tribeca's software
accounted for approximately $100,000 of our revenues.
Ronald G. Pettengill, Jr., our Chairman and Chief Executive Officer, Robert
L. Belau, our President, and Donald Duffy and Eric Meyer, our directors, are
directors of Tribeca and own shares of common stock of Tribeca. Additionally,
Messrs. Pettengill and Belau serve as executive officers of Tribeca.
SALE OF SERIES A PREFERRED STOCK AND WARRANTS
In March 1999, we sold 6,512,316 shares of series A convertible preferred
stock and warrants to purchase 15% of the number of shares registered in this
offering at the initial public offering price to a number of investors for an
aggregate purchase price of approximately $18.6 million. General Atlantic
Partners 54, L.P., one of our 5% stockholders, purchased 5,350,441 shares. On
the closing of this offering, the series A convertible preferred stock will
automatically convert into 6,512,316 shares of common stock.
SHARE REDEMPTION
In March 1999, we made an offer to redeem a number of shares from our
stockholders. Subsequently, we redeemed a total of 2,855,100 shares of common
stock from a number of stockholders for an aggregate purchase price of
approximately $8.4 million. Of these, we purchased the following amounts from
our officers, directors and 5% stockholders and their affiliates:
NUMBER OF SHARES AGGREGATE
NAME OF STOCKHOLDER REDEEMED CONSIDERATION
- --------------------------------------------------------------------------------- ---------------- -------------
Ronald G. Pettengill, Jr......................................................... 534,000 $ 1,570,850
Robert L. Belau.................................................................. 480,000 1,412,000
Neeraj Sethi..................................................................... 48,000 141,200
Donald J. Duffy.................................................................. 210,000 617,750
Eric Meyer....................................................................... 282,000 829,550
MD Strategic, L.P................................................................ 119,040 350,176
PV4, L.P......................................................................... 300,000 882,500
PVII, L.P........................................................................ 33,060 $ 97,251
Eric Meyer and Donald Duffy, each, a director of ours, are general partners
of MD Strategic, PV4 and PVII.
52
MEYER, DUFFY & ASSOCIATES
We had an agreement with Meyer, Duffy & Associates, Inc. pursuant to which
Meyer Duffy & Associates provides us with consulting and advisory services. Eric
Meyer and Donald Duffy, each one of our directors, serve as co-managing
Directors of Meyer, Duffy & Associates. We paid Meyer, Duffy & Associates a
retainer fee of $5,000 per month in connection with these services through March
31, 1999. Additionally, in August 1998, we loaned Meyer, Duffy & Associates, in
connection with the exercise of options, $300,000 at an interest rate of 7% per
annum. Meyer, Duffy & Associates repaid this loan in March 1999.
LOAN TO OFFICERS
In August 1998, in connection with the exercise of options, we loaned each
of Ronald G. Pettengill, Jr., our Chairman and Chief Executive Officer and
Robert L. Belau, our President, $97,500 at an interest rate of 7% per annum.
Messrs. Pettengill and Belau repaid those loans in March 1999. In addition to
these loans, from time to time, we have advanced loans to Messrs. Pettengill and
Belau. As of December 31, 1998 the amounts outstanding under these advances for
Messrs. Pettengill and Belau was $15,000 and $13,402, respectively. There are
currently no advances outstanding.
OPTION GRANTS
We granted each of our non-employee directors options to purchase 25,000
shares of our common stock at a price of $4.00 per share. Additionally, in 1999,
we granted to Messrs. Pettengill, Belau and Holt options to purchase 200,000,
200,000 and 130,000, respectively. Please see "Management-- Employment
Agreements." For additional information regarding the grant of stock options to
executive officers and directors, please see "Management--Director
Compensation," "--Executive Compensation," "--1999 Stock Incentive Plan" and
"Principal Stockholders."
AGREEMENTS WITH UNDERWRITERS
We provide network consulting services to Bear, Stearns & Co. Inc.,
Donaldson, Lufkin & Jenrette and First Union Capital Markets Corp. pursuant to
agreements they have entered into with us. The terms of these agreements were
negotiated by parties in arms-length transactions and were entered into prior to
our selection of the underwriters of this offering. In fiscal 1998, revenues
derived from Bear, Stearns, Donaldson, Lufkin & Jenrette and its affiliates, and
First Union equalled $5.4 million, $162, 689 and $50,000, respectively. For the
three months ended March 31, 1999, revenues derived from Bear, Stearns and
Donaldson, Lufkin & Jenrette and its affiliates equalled $2.5 million and
$368,803, respectively. We may provide network consulting services to other
underwriters in this offering after the date of this prospectus.
It is our current policy that all transactions with officers, directors, 5%
stockholders and their affiliates be entered into only if they are approved by a
majority of the disinterested independent directors, are on terms no less
favorable to us than could be obtained from unaffiliated parties and are
reasonably expected to benefit us.
53
PRINCIPAL STOCKHOLDERS
The following table sets forth information with respect to beneficial
ownership of our common stock, as of June 30, 1999 and as adjusted to reflect
the sale of common stock offered by us in this offering for:
- each person known by us to beneficially own more than 5% of our common
stock;
- each executive officer named in the Summary Compensation Table;
- each of our directors; and
- all of our executive officers and directors as a group.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and includes voting or investment power with
respect to the securities. Unless otherwise indicated, the address for those
listed below is c/o Predictive Systems, Inc., 145 Hudson Street, New York, New
York 10013. Except as indicated by footnote, and subject to applicable community
property laws, the persons named in the table have sole voting and investment
power with respect to all shares of common stock shown as beneficially owned by
them. The number of shares of common stock outstanding used in calculating the
percentage for each listed person includes the shares of common stock underlying
options held by such persons that are exercisable within 60 days of June 30,
1999, but excludes shares of common stock underlying options held by any other
person. Percentage of beneficial ownership is based on 16,122,966 shares of
common stock outstanding as of June 30, 1999, and shares of common stock
outstanding after completion of this offering.
PERCENTAGE OF COMMON STOCK
BENEFICIALLY OWNED
----------------------------
SHARES BENEFICIALLY PRIOR TO AFTER
NAME OF BENEFICIAL OWNER OWNED OFFERING OFFERING(1)
- ----------------------------------------------------------------- ------------------------ ----------- ---------------
Ronald G. Pettengill, Jr. (2).................................... 2,229,000 13.1% %
Robert L. Belau (3).............................................. 2,655,000 15.7
Thomas R. Joseph (4)............................................. 240,000 1.5
Carl D. Humes (4)................................................ 240,000 1.5
Gregory D. Nicastro (5).......................................... 84,000 *
Neeraj Sethi (6)................................................. 150,000 *
Peter L. Bloom (7)............................................... 6,463,206 40.1
Donald J. Duffy (8).............................................. 2,631,894 16.1
Braden R. Kelly (7).............................................. -- --
Eric Meyer (8)................................................... 3,114,894 19.1
General Atlantic Partners LLC (7)................................ 6,463,206 40.1
Meyer Duffy and Associates, L.P (9).............................. 1,800,000 11.2
All directors and executive officers as a group (12 persons)
(10)........................................................... 15,356,100 82.0
- ------------------------
* Indicates less than one percent of the common stock.
(1) Assumes that the underwriters' over-allotment option to purchase up to an
additional shares from Predictive is not exercised.
(2) Includes (a) 780,000 shares issuable upon the exercise of currently
exercisable options and (b) 150,000 shares of common stock held by The Conor
G. Pettengill Trust and 150,000 shares held by The Julia G. Pettengill
Trust.
54
(3) Includes (a) 780,000 shares issuable upon the exercise of currently
exercisable options and (b) 126,000 shares of common stock held by The Belau
Family Trust.
(4) Includes 240,000 shares issuable upon the exercise of stock options which
are exercisable within 60 days of June 30, 1999.
(5) Includes 84,000 shares issuable upon the exercise of stock options which are
exercisable within 60 days of June 30, 1999.
(6) Includes 120,000 shares issuable upon the exercise of stock options which
are exercisable within 60 days of June 30, 1999.
(7) Includes 5,350,441 shares owned by General Atlantic Partners 54, L.P. and
1,112,765 shares owned by GAP Coinvestment Partners II, L.P. General
Atlantic Partners 54 and GAP Coinvestment Partners also hold warrants to
purchase 15% of the number of shares to be sold in this offering at the
initial public offering price. The general partner of General Atlantic
Partners 54 is General Atlantic Partners, LLC and the managing members of
General Atlantic Partners are also the general partners of GAP Coinvestment
Partners. Peter L. Bloom is a managing member of General Atlantic Partners
and Braden R. Kelly is an associate of General Atlantic Partners. Each of
Messrs. Bloom and Kelly disclaim beneficial ownership of these securities
except to the extent of his pecuniary interest. The address of Messrs.
Bloom, Kelly and General Atlantic Partners is c/o General Atlantic Partners,
3 Pickwick Plaza, Greenwich, Connecticut 06830.
(8) Includes (a) 180,000 shares issuable upon the exercise of currently
exercisable options, (b) 510,960 shares of common stock held by MD
Strategic, L.P., (c) 1,800,000 shares of common stock held by Meyer, Duffy
and Associates, L.P. and (d) 140,934 shares of common stock held by PVII,
L.P. Messrs. Duffy and Meyer are the general partners of each of MD
Strategic, L.P., Meyer, Duffy Associates, L.P. and PVII, L.P. Each of
Messrs. Duffy and Meyer disclaim beneficial ownership of these securities
except to the extent of his pecuniary interest. The address of Messrs. Duffy
and Meyer is c/o of Meyer, Duffy & Associates, Inc., 237 Park Avenue, New
York, New York 10017.
(9) The address of Meyer, Duffy and Associates, L.P. is c/o of Meyer, Duffy &
Associates, Inc., 237 Park Avenue, New York, New York 10017
(10) Includes 2,604,000 shares of common stock issuable upon the exercise of
stock options which are exercisable within 60 days of June 30, 1999
55
DESCRIPTION OF CAPITAL STOCK
GENERAL
Our amended and restated certificate of incorporation, which will become
effective upon the closing of this offering, authorizes the issuance of up to
200,000,000 shares of common stock, par value $.001 per share, and 10,000,000
shares of preferred stock, par value $.001 per share, the rights and preferences
of which may be established from time to time by our board of directors. As of
June 30, 1999, 16,122,966 shares of common stock were outstanding. As of June
30, 1999, we had 63 stockholders.
COMMON STOCK
Under our amended and restated certificate of incorporation, holders of our
common stock are entitled to one vote for each share held of record on all
matters submitted to a vote of the stockholders, including the election of
directors. They do not have cumulative voting rights. Subject to preferences
that may be applicable to any then-outstanding preferred stock, holders of our
common stock are entitled to receive ratably dividends, if any, as may be
declared by the board of directors out of legally available funds. In case of a
liquidation, dissolution or winding up of Predictive, the holders of common
stock will be entitled to share ratably in the net assets legally available for
distribution to shareholders after payment of all of our liabilities and any
preferred stock then outstanding. Holders of common stock have no preemptive or
conversion rights or other subscription rights. There are no redemption or
sinking fund provisions applicable to the common stock. The rights, preferences
and privileges of holders of common stock are subject to the rights of the
holders of shares of any series of preferred stock that we may designate and
issue in the future. After the closing of this offering, there will be no shares
of preferred stock outstanding.
PREFERRED STOCK
Under our amended and restated certificate of incorporation, our board of
directors has the authority, without further action by the stockholders, to
issue from time to time, shares of preferred stock in one or more series. The
board of directors may fix the number of shares, designations, preferences,
powers and other special rights of the preferred stock. The preferences, powers,
rights and restrictions of different series of preferred stock may differ. The
issuance of preferred stock could decrease the amount of earnings and assets
available for distribution to holders of common stock or affect adversely the
rights and powers, including voting rights, of the holders of common stock. Such
issuance may also have the effect of delaying, deferring or preventing a change
in control of Predictive. We have no current plans to issue any shares of
preferred stock.
REGISTRATION RIGHTS
In March 1999, we entered into a registration rights agreement with some of
our stockholders, including: General Atlantic Partners; Ronald G. Pettengill,
Jr., our Chief Executive Officer; Robert L. Belau, our President; Eric Meyer and
Donald Duffy, each, one of our directors; and Meyer, Duffy and Associates.
Under the terms of the agreement, at any time after the first anniversary of
the effective date of this offering, each of General Atlantic Partners and GAP
Coinvestment Partners may, on two occasions only, require us to register for
sale all or any portion of the shares of common stock issuable upon conversion
of the preferred shares held by them. We are also obligated to register some
shares of common stock held by parties to the registration rights agreement if
they request to be included in the registration. Further, if we become eligible
to file registration statements on Form S-3, some parties to the registration
rights agreement may require us to file a registration statement on Form S-3
under the Securities Act with respect to some shares of common stock held by
them. We are also obligated to
56
register some shares of common stock held by parties to the registration rights
agreement if they request to be included in the registration. In addition,
holders of common stock who are parties to the registration rights agreement
will be entitled to require us to register some of their common stock when we
register stock of other stockholders. This type of registration right is known
as a "piggyback" registration right.
The foregoing registration rights are subject to certain conditions and
limitations, including:
- The right of the underwriters in any underwritten offering to limit the
number of shares of common stock held by stockholders with registration
rights to be included in any demand, S-3 or piggyback registration; and
- Our right to delay for up to 90 days the filing or effectiveness of a
registration statement pursuant to a demand for registration if the board
of directors of determines that the registration would not be in our best
interest at that time.
We are generally required to bear all of the expenses of all registrations,
except underwriting discounts and commissions. Registration of any of the shares
of common stock held by stockholders with registration rights would result in
those shares becoming freely tradable without restriction under the Securities
Act immediately after effectiveness of the registration. We have agreed to
indemnify the holders of registration rights in connection with demand, S-3 and
piggyback registration under the terms of our amended and restated registration
rights agreement.
ANTI-TAKEOVER EFFECTS OF DELAWARE LAW AND OUR AMENDED AND RESTATED CERTIFICATE
OF INCORPORATION AND BYLAWS
Provisions of our amended and restated certificate of incorporation and
amended and restated bylaws, which are summarized in the following paragraphs,
may have an anti-takeover effect and may delay, defer or prevent a tender offer
or takeover attempt that a stockholder might consider in its best interest,
including those attempts that might result in a premium over the market price
for the shares held by stockholders.
CLASSIFIED BOARD OF DIRECTORS
Our board of directors is divided into three classes of directors serving
staggered three-year terms. As a result, approximately one-third of the board of
directors will be elected each year. These provisions, when coupled with the
provision of our amended and restated certificate of incorporation authorizing
the board of directors to fill vacant directorships or increase the size of the
board of directors, may delay a stockholder from removing incumbent directors
and simultaneously gaining control of the board of directors by filling the
vacancies created by such removal with its own nominees.
STOCKHOLDER ACTION; SPECIAL MEETING OF STOCKHOLDERS
Our amended and restated certificate of incorporation eliminates the ability
of stockholders to act by written consent. It further provides that special
meetings of our stockholders may be called only by the chairman of the board of
directors or a majority of the board of directors.
ADVANCE NOTICE REQUIREMENTS FOR STOCKHOLDER PROPOSALS AND DIRECTOR NOMINATIONS
Our amended and restated by-laws provide that stockholders seeking to bring
business before an annual meeting of stockholders, or to nominate candidates for
election as directors at an annual meeting of stockholders, must provide timely
notice thereof in writing. To be timely, a stockholder's notice must be received
at our principal executive offices not less than 60 days nor more than 90 days
prior to the anniversary date of the immediately preceding annual meeting of
stockholders. In the event
57
that the annual meeting is called for a date that is not within thirty (30) days
before or after the anniversary date, in order to be timely, notice from the
stockholder must be received no later than the tenth day following the date on
which notice of the annual meeting was mailed to stockholders or made public,
whichever occurred earlier. In the case of a special meeting of stockholders
called for the purpose of electing directors, notice by the stockholder in order
to be timely must be received not later than the close of business on the tenth
day following the day on which notice was mailed or public disclosure of the
date of the special meeting was made, whichever first occurs. Our amended and
restated by-laws also specify certain requirements as to the form and content of
a stockholder's notice. These provisions may preclude stockholders from bringing
matters before an annual or special meeting of stockholders or from making
nominations for directors at these meetings.
AUTHORIZED BUT UNISSUED SHARES
The authorized but unissued shares of common stock and preferred stock are
available for future issuance without stockholder approval. These additional
shares may be utilized for a variety of corporate purposes, including future
public offerings to raise additional capital, corporate acquisitions and
employee benefit plans. The existence of authorized but unissued shares of
common stock and preferred stock could render more difficult or discourage an
attempt to obtain control of us by means of a proxy contest, tender offer,
merger or otherwise.
The Delaware General Corporation Law provides generally that the affirmative
vote of a majority of the shares entitled to vote on any matter is required to
amend a corporation's certificate of incorporation or bylaws, unless a
corporation's certificate of incorporation or bylaws, as the case may be,
requires a greater percentage. Our amended and restated certificate of
incorporation imposes supermajority vote requirements in connection with various
business combination transactions and the amendment of various provisions of our
amended and restated certificate of incorporation and amended and restated
bylaws, including those provisions relating to the classified board of
directors, action by written consent and special meetings by stockholders.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for our common stock will be American Stock
Transfer & Trust Company, New York, New York.
LISTING
We intend to apply to list our common stock on the Nasdaq National Market
under the trading symbol "PRDS."
58
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has not been any public market for our common
stock, and we cannot predict the effect, if any, that market sales of shares of
common stock or the availability of shares of common stock for sale will have on
the market price of the common stock prevailing from time to time. Nevertheless,
sales of substantial amounts of our common stock in the public market, or the
perception that such sales could occur, could adversely affect the market price
of the common stock and could impair our future ability to raise capital through
the sale of its equity securities.
Upon completion of this offering, we will have an aggregate of shares
of common stock outstanding, assuming no exercise of the underwriters'
over-allotment option and no exercise of outstanding options or warrants. Of the
outstanding shares, the shares sold in this offering will be freely
tradable, except that any shares held by our "affiliates," as defined in Rule
144 promulgated under the Securities Act of 1933, may only be sold in compliance
with the limitations described below. The remaining 16,122,966 shares of common
stock will be deemed "restricted securities" as defined under Rule 144.
Restricted securities may be sold in the public market only if registered or if
they qualify for an exemption from registration under Rules 144, 144(k) or 701
promulgated under the Securities Act, which rules are summarized below. Subject
to the lock-up agreements described below and the provisions of Rules 144,
144(k) and 701, additional shares will be available for sale in the public
market as follows:
NUMBER OF SHARES DATE
- ----------------- ------------------------------------------------------------------------
After the date of this prospectus
After 90 days from the date of this prospectus
After 180 days from the date of this prospectus (subject, in some
cases), to volume limitations
In general, under Rule 144, as currently in effect, a person, including an
affiliate, who has beneficially owned shares for at least one year is entitled
to sell, within any three-month period commencing 90 days after the date of this
prospectus, a number of shares that does not exceed the greater of (1) 1% of the
then outstanding shares of common stock (approximately shares immediately
after this offering) or (2) the average weekly trading volume in the common
stock during the four calendar weeks preceding the date on which notice of such
sale is filed, subject to certain restrictions. In addition, a person who is not
deemed to have been an affiliate of Predictive at any time during the 90 days
preceding a sale and who has beneficially owned the shares proposed to be sold
for at least two years would be entitled to sell such shares under Rule 144(k)
without regard to the requirements described above. To the extent that shares
were acquired from an affiliate of ours, that person's holding period for the
purpose of selling under Rule 144 commences on the date of transfer from the
affiliate. Notwithstanding the foregoing, to the extent the shares were acquired
through the cashless exercise of a stock option or a warrant, that person's
holding period for effecting a sale under Rule 144 commences on the date of the
option or warrant grant. In general, under Rule 701 of the Securities Act as
currently in effect, any of our employees, consultants or advisors who purchased
our shares in connection with a compensatory stock or option plan or other
written agreement is eligible to resell such shares after the effective date of
this offering in reliance on Rule 144, but without compliance with certain
restrictions, including the holding period in Rule 144.
As of the date of this prospectus, options to purchase a total of 9,644,650
shares of common stock are outstanding, of which 4,961,000 are currently
exercisable (without regard to the 180-day lock up period). Promptly after the
closing of this offering, we intend to file a registration statement to register
for resale all shares of common stock issued or issuable under its 1999 employee
stock purchase plan
59
and not otherwise freely transferable. Accordingly, shares covered by that
registration statement will be eligible for sale in the public markets, unless
those options are subject to vesting restrictions.
Our directors and officers and certain of our stockholders who hold
shares and options in the aggregate have agreed that they will not sell,
directly or indirectly, any shares of common stock (other than shares of common
stock purchased as part of the directed share program in connection with this
offering) without the prior written consent of BancBoston Robertson Stephens
Inc. for a period of 180 days from the date of this prospectus.
We have agreed not to sell or otherwise dispose of any shares of our common
stock during the 180 day period following the date of the prospectus, except we
may issue, and grant options to purchase, shares of common stock under our stock
option plan.
Following this offering, under certain circumstances and subject to certain
conditions, holders of 6,463,206 shares of our outstanding common stock will
have certain demand registration rights with respect to their shares of common
stock (subject, in certain cases, to the 180-day lock-up arrangement described
above) to require us to register their shares of common stock under the
Securities Act, and they will have certain rights to participate in any future
registration of securities by us. Additionally, holders of 7,413,900 shares of
our outstanding common stock will have some rights to participate in any future
registrations of securities by us. See "Description of Capital
Stock-Registration Rights."
60
UNDERWRITING
The underwriters named below, acting through their representatives,
BancBoston Robertson Stephens Inc., Bear, Stearns & Co. Inc., Donaldson, Lufkin
& Jenrette Securities Corporation and First Union Capital Markets Corp., have
severally agreed with us, subject to the terms and conditions of the
underwriting agreement, to purchase from us the number of shares of common stock
set forth opposite their names below. The underwriters are committed to purchase
and pay for all of the shares if any are purchased.
NUMBER OF
UNDERWRITER SHARES
- --------------------------------------------------------------------------------- ----------
BancBoston Robertson Stephens Inc................................................
Bear, Stearns & Co. Inc..........................................................
Donaldson, Lufkin & Jenrette Securities Corporation..............................
First Union Capital Markets Corp.................................................
----------
Total........................................................................
----------
----------
We have been advised that the underwriters propose to offer the shares of
common stock to the public at the public offering price located on the cover
page of this prospectus and to dealers at that price less a concession of not in
excess of $ per share, of which $ may be reallowed to other dealers.
After the initial public offering, the public offering price, concession and
reallowance to dealers may be reduced by the representatives. No reduction in
this price will change the amount of proceeds to be received by us as indicated
on the cover page of this prospectus.
OVER-ALLOTMENT OPTION. We have granted to the underwriters an option,
exercisable during the 30-day period after the date of this prospectus, to
purchase up to additional shares of common stock at the same price per
share as we will receive for the shares that the underwriters have
agreed to purchase. To the extent that the underwriters exercise this option,
each of the underwriters will have a firm commitment to purchase approximately
the same percentage of additional shares that the number of shares of common
stock to be purchased by it shown in the above table represents as a percentage
of the shares offered by this prospectus. If purchased, the additional
shares will be sold by the underwriters on the same terms as those on which the
shares are being sold. We will be obligated, under this option, to sell
shares to the extent the option is exercised. The underwriters may exercise the
option only to cover over-allotments made in connection with the sale of the
shares of common stock offered by this prospectus.
The following table shows the per share and total underwriting discounts and
commissions to be paid by us to the underwriters. This information is presented
assuming either no exercise or full exercise by the underwriters of their
over-allotment option.
WITHOUT WITH
PER OVER-ALLOTMENT OVER-ALLOTMENT
SHARE OPTION OPTION
--------- ----------------- -----------------
Assumed public offering price........................... $ $ $
Underwriting discounts and commissions..................
Proceeds, before expenses, to us........................
The expenses of the offering payable by us are estimated at $ . BancBoston
Robertson Stephens Inc. expects to deliver the shares of common stock to
purchasers on , 1999.
61
INDEMNITY. The underwriting agreement contains covenants of indemnity among
the underwriters and us against certain civil liabilities, including liabilities
under the Securities Act and liabilities arising from breaches of representation
and warranties contained in the underwriting agreement.
FUTURE SALES. Each of our executive officers, directors and other
significant stockholders of record has agreed with the representatives, for a
period of 180 days after the date of this prospectus, not to offer to sell,
contract to sell or otherwise sell, dispose of, loan, pledge or grant any rights
with respect to any shares of common stock, any options or warrants to purchase
any shares of common stock, or any securities convertible into or exchangeable
for shares of common stock owned as of the date of this prospectus or acquired
directly from us by these holders or with respect to which they have or may
acquire the power of disposition, without the prior written consent of
BancBoston Robertson Stephens Inc. However, BancBoston Robertson Stephens Inc.
may, in its sole discretion and at any time without notice, release all or any
portion of the securities subject to lock-up agreements. There are no agreements
between the representatives and any of our stockholders providing consent by the
representatives to the sale of shares prior to the expiration of the 180-day
lock-up period. In addition, we have generally agreed that, during the 180-day
lock-up period, we will not, without the prior written consent of BancBoston
Robertson Stephens Inc., (a) consent to the disposition of any shares held by
stockholders prior to the expiration of the 180-day lock-up period or (b) issue,
sell, contract to sell or otherwise dispose of, any shares of common stock, any
options or warrants to purchase any shares of common stock, or any securities
convertible into, exercisable for or exchangeable for shares of common stock,
other than our sale of shares in the offering, our issuance of common stock upon
the exercise of currently outstanding options and warrants, and our issuance of
incentive awards under our stock incentive plan. Please see "Shares Eligible for
Future Sale."
DIRECT SHARES. We have requested that the underwriters reserve up to ten
percent of the shares of common stock for sale at the initial public offering
price to directors, officers, employees and other individuals designated by us.
The underwriters have informed us that they do not intend to confirm sales
to any accounts over which they exercise discretionary authority.
NO PRIOR PUBLIC MARKET. Prior to this offering, there has been no public
market for the common stock. Consequently, the initial public offering price for
the common stock offered by this prospectus will be determined through
negotiations between us and the representatives. Among the factors to be
considered in these negotiations are prevailing market conditions, our financial
information, market valuations of other companies that we and the
representatives believe to be comparable to us, estimates of our business
potential, the present state of our development and other factors deemed
relevant.
STABILIZATION. The representatives have advised us that, under Regulation M
under the Securities Exchange Act, some participants in the offering may engage
in transactions, including stabilizing bids, syndicate covering transactions or
the imposition of penalty bids, that may have the effect of stabilizing or
maintaining the market price of the common stock at a level above that which
might otherwise prevail in the open market. A "stabilizing bid" is a bid for or
the purchase of the common stock on behalf of the underwriters for the purpose
of fixing or maintaining the price of the common stock. A "syndicate covering
transaction" is the bid for or purchase of the common stock on behalf of the
underwriters to reduce a short position incurred by the underwriters in
connection with the offering. A "penalty bid" is an arrangement permitting the
representatives to reclaim the selling concession otherwise accruing to an
underwriter or syndicate member in connection with the offering if the common
stock originally sold by the underwriter or syndicate member is purchased by the
representatives in a syndicate covering transaction and has therefore not been
effectively placed by the underwriter or syndicate member. The representatives
have advised us that these transactions may be effected on the Nasdaq National
Market or otherwise and, if commenced, may be discontinued at any time.
OTHER AGREEMENTS. We provide network consulting services to some of the
underwriters. Please see "Certain Transactions--Agreements with Underwriters."
62
LEGAL MATTERS
The validity of the common stock offered will be passed upon for us by
Brobeck, Phleger & Harrison LLP, New York, New York. The Brobeck investment fund
and attorneys at Brobeck hold in the aggregate 49,110 shares of series A
preferred stock, which will automatically convert into 49,110 shares of common
stock upon the closing of this offering, and 1,000 shares of common stock.
Various legal matters in connection with this offering will be passed upon for
the underwriters by Hale and Dorr LLP, Boston, Massachusetts.
EXPERTS
The financial statements of Predictive Systems, Inc. as of December 31, 1997
and 1998 and for each of the three years in the period ended December 31, 1998
included in this prospectus and elsewhere in the registration statement have
been audited by Arthur Andersen LLP, independent public accountants, as
indicated in their reports thereto and are included herein in reliance upon the
authority of said firm as experts in giving said reports.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 (including exhibits and schedules thereto) under the
Securities Act with respect to the common stock to be sold in this offering.
This prospectus, which constitutes a part of the registration statement, does
not contain all of the information set forth in the registration statement or
the exhibits and schedules which are part of the registration statement. For
further information with respect to Predictive and the common stock, reference
is made to the registration statement and the exhibits and schedules thereto.
You may read and copy all or any portion of the registration statement or
any reports, statements or other information in Predictive files in the
Commission's public reference room at Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C., 20549 and at the regional offices of the
Commission located at Seven World Trade Center, 13th Floor, New York, New York
10048 and 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. You can
request copies of these documents upon payment of a duplicating fee, by writing
to the Commission. Please call the Commission at 1-800-SEC-0330 for further
information on the operation of the public reference rooms. Predictive's
Commission filings, including the registration statement, will also be available
to you on the Commission's Internet site (http://www.sec.gov).
We intend to furnish our stockholders with annual reports containing
financial statements audited by our independent auditors and to make available
to our stockholders quarterly reports containing unaudited financial data for
the first three quarters of each fiscal year.
63
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARY
INDEX TO FINANCIAL STATEMENTS
PAGE
-----
Report of Independent Public Accountants................................................................... F-2
Balance Sheets as of December 31, 1997 and 1998 and March 31, 1999 (Unaudited)............................. F-3
Statements of Operations for the Years Ended December 31, 1996, 1997 and 1998 and the Three Months Ended
March 31, 1998 and 1999 (Unaudited)...................................................................... F-4
Statements of Stockholders' Equity for the Years Ended December 31, 1996, 1997 and 1998 and the Three
Months Ended March 31, 1999 (Unaudited).................................................................. F-5
Statements of Cash Flows for the Years Ended December 31, 1996, 1997 and 1998 and the Three Months Ended
March 31, 1998 and 1999 (Unaudited)...................................................................... F-6
Notes to Financial Statements.............................................................................. F-8
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The financial statements included herein have been adjusted to give effect
to the increase in the authorized number of common shares to 200,000,000 and to
decrease the authorized number of preferred shares to 10,000,000. We expect to
be in a position to render the following report upon the effectiveness of such
events assuming that from May 12, 1999 to the effective date of such events, no
other events will have occurred that would effect the financial statements or
the notes thereto.
ARTHUR ANDERSEN LLP
/s/ Arthur Andersen LLP
New York, New York
May 12, 1999
To Predictive Systems, Inc.:
We have audited the accompanying balance sheets of Predictive Systems, Inc.
(a Delaware corporation) (the "Company") as of December 31, 1997 and 1998, and
the related statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Predictive Systems, Inc. as
of December 31, 1997 and 1998, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1998 in
conformity with generally accepted accounting principles.
F-2
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
--------------------- MARCH 31,
1997 1998 1999
--------- ---------- -----------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................................. $ 420,456 $ -- $2,995,288
Accounts receivable--net of allowance for doubtful accounts of $79,613,
$141,489 and $267,993, respectively..................................... 4,197,870 8,806,184 9,380,544
Unbilled work in process.................................................. 179,404 1,062,824 1,754,939
Notes receivable--employees............................................... 53,371 55,100 20,100
Notes receivable--stockholders............................................ -- 515,000 --
Due from related party.................................................... -- 916,948 174,276
Prepaid income taxes...................................................... 344,049 342,829 293,130
Other current assets...................................................... 276,609 386,453 414,288
--------- ---------- -----------
Total current assets.................................................... 5,471,759 12,085,338 15,032,565
PROPERTY AND EQUIPMENT--net of accumulated depreciation and amortization of
$485,510, $947,735 and $1,089,007, respectively........................... 893,988 1,356,634 1,386,212
DEFERRED TAX ASSET.......................................................... 237,322 -- --
OTHER ASSETS................................................................ 267,314 235,047 211,724
--------- ---------- -----------
Total assets............................................................ $6,870,383 $13,677,019 1$6,630,501
--------- ---------- -----------
--------- ---------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Cash overdraft............................................................ $ 545,351 $ 475,610 $ --
Short-term borrowings..................................................... 780,000 5,598,000 --
Accounts payable and accrued expenses..................................... 654,378 2,803,686 2,283,188
Deferred income tax liability............................................. 1,676,937 185,000 302,797
Deferred income........................................................... 32,955 445,414 43,594
Dividends payable......................................................... 26,250 61,250 --
Current portion of capital lease obligation............................... 76,982 151,027 142,180
--------- ---------- -----------
Total current liabilities............................................... 3,792,853 9,719,987 2,771,759
--------- ---------- -----------
NONCURRENT LIABILITIES:
Deferred rent............................................................. 23,306 70,957 49,213
Capital lease obligation.................................................. 282,013 446,018 419,726
Deferred income tax liability............................................. -- 714,146 547,499
--------- ---------- -----------
Total liabilities....................................................... 4,098,172 10,951,108 3,788,197
--------- ---------- -----------
MANDATORY REDEEMABLE CONVERTIBLE PREFERRED STOCK ($.001 par value, 5%
cumulative, 4,200,000, 4,200,000 and 0 shares issued and outstanding)..... 700,000 700,000 --
STOCKHOLDERS' EQUITY:
Convertible preferred stock ($.001 par value, 10,000,000 shares
authorized, 0, 0 and 6,512,316 shares issued and outstanding)........... -- -- 6,512
Common stock ($.001 par value, 200,000,000 shares authorized, 4,408,200,
7,900,200 and 12,400,200 shares issued and 4,408,200, 7,900,200 and
9,545,100 shares outstanding)........................................... 4,408 7,900 12,400
Additional paid-in capital................................................ 69,762 682,270 19,986,013
Treasury stock, 2,855,100 shares.......................................... -- -- (8,398,753)
Retained earnings......................................................... 1,998,041 1,335,741 1,236,132
--------- ---------- -----------
Total stockholders' equity.............................................. 2,072,211 2,025,911 12,842,304
--------- ---------- -----------
Total liabilities and stockholders' equity.............................. $6,870,383 $13,677,019 1$6,630,501
--------- ---------- -----------
--------- ---------- -----------
The accompanying notes to consolidated financial statements are an
integral part of these consolidated balance sheets.
F-3
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------------------ --------------------------
1996 1997 1998 1998 1999
------------ ------------- ------------- ------------ ------------
(UNAUDITED)
REVENUES:
Professional services.................... $ 6,818,678 $ 16,897,456 $ 23,857,780 $ 3,798,188 $ 9,887,442
Hardware and software sales.............. 1,287,649 1,189,617 2,065,348 78,471 477,467
------------ ------------- ------------- ------------ ------------
Total revenues......................... 8,106,327 18,087,073 25,923,128 3,876,659 10,364,909
COST OF REVENUES:
Professional services.................... 3,381,505 9,590,306 12,861,272 2,386,992 4,849,321
Hardware and software purchases.......... 970,479 816,935 1,698,356 65,115 425,956
------------ ------------- ------------- ------------ ------------
Total cost of revenues................. 4,351,984 10,407,241 14,559,628 2,452,107 5,275,277
------------ ------------- ------------- ------------ ------------
Gross profit........................... 3,754,343 7,679,832 11,363,500 1,424,552 5,089,632
SALES AND MARKETING........................ 386,000 1,081,889 2,618,743 484,075 1,589,171
GENERAL AND ADMINISTRATIVE................. 1,683,574 4,390,476 8,999,494 1,722,508 3,469,033
DEPRECIATION AND AMORTIZATION.............. 142,134 320,908 567,761 108,534 143,827
------------ ------------- ------------- ------------ ------------
Operating profit (loss)................ 1,542,635 1,886,559 (822,498) (890,565) (112,399)
OTHER INCOME (EXPENSE):
Interest income.......................... 31,540 26,575 57,976 3,098 46,173
Other income............................. 7,613 3,849 1,555 -- 12,750
Interest expense......................... -- (35,545) (324,591) (24,762) (86,233)
------------ ------------- ------------- ------------ ------------
Income (loss) before income tax
provision (benefit).................. 1,581,788 1,881,438 (1,087,558) (912,229) (139,709)
INCOME TAX PROVISION (BENEFIT)............. 718,678 870,504 (460,258) (391,994) (48,850)
------------ ------------- ------------- ------------ ------------
Net income (loss)...................... $ 863,110 $ 1,010,934 $ (627,300) $ (520,235) $ (90,859)
------------ ------------- ------------- ------------ ------------
------------ ------------- ------------- ------------ ------------
NET INCOME (LOSS) PER SHARE
BASIC.................................... $ 0.20 $ 0.22 $ (0.11) $ (0.12) $ (0.01)
------------ ------------- ------------- ------------ ------------
------------ ------------- ------------- ------------ ------------
DILUTED.................................. $ 0.07 $ 0.08 $ (0.11) $ (0.12) $ (0.01)
------------ ------------- ------------- ------------ ------------
------------ ------------- ------------- ------------ ------------
WEIGHTED AVERAGE SHARES OUTSTANDING--
BASIC.................................... 4,269,000 4,382,417 6,015,433 4,463,133 8,379,660
------------ ------------- ------------- ------------ ------------
------------ ------------- ------------- ------------ ------------
DILUTED.................................. 11,586,130 12,764,610 6,015,433 4,463,133 8,379,660
------------ ------------- ------------- ------------ ------------
------------ ------------- ------------- ------------ ------------
The accompanying notes to consolidated financial statements are an
integral part of these consolidated statements.
F-4
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
CONVERTIBLE
COMMON STOCK PREFERRED STOCK ADDITIONAL TOTAL
---------------------- ---------------------- PAID-IN TREASURY RETAINED STOCKHOLDERS'
SHARES PAR VALUE SHARES PAR VALUE CAPITAL STOCK EARNINGS EQUITY
--------- ----------- --------- ----------- ---------- ---------- --------- ------------
Balance at December 31,
1995........................ 4,269,000 $ 4,269 -- $ -- $ 37,901 $ -- $ 150,247 $ 192,417
Exercise of options......... 30,000 30 -- -- 4,970 -- -- 5,000
Net income.................. -- -- -- -- -- -- 863,110 863,110
--------- ----------- --------- ----------- ---------- ---------- --------- ------------
Balance at December 31,
1996........................ 4,299,000 4,299 -- -- 42,871 -- 1,013,357 1,060,527
Exercise of options......... 109,200 109 -- -- 26,891 -- -- 27,000
Preferred stock dividends... -- -- -- -- -- -- (26,250) (26,250)
Net income.................. -- -- -- -- -- -- 1,010,934 1,010,934
--------- ----------- --------- ----------- ---------- ---------- --------- ------------
Balance at December 31,
1997........................ 4,408,200 4,408 -- -- 69,762 -- 1,998,041 2,072,211
Exercise of options......... 3,492,000 3,492 -- -- 612,508 -- -- 616,000
Preferred stock dividends... -- -- -- -- -- -- (35,000) (35,000)
Net loss.................... -- -- -- -- -- -- (627,300) (627,300)
--------- ----------- --------- ----------- ---------- ---------- --------- ------------
Balance at December 31,
1998........................ 7,900,200 7,900 -- -- 682,270 -- 1,335,741 2,025,911
Preferred stock dividends... -- -- -- -- -- -- (8,750) (8,750)
Conversion of preferred to
common stock.............. 4,200,000 4,200 -- -- 695,800 -- -- 700,000
Common stock repurchased to
treasury, 2,855,100
shares.................... -- -- -- -- -- (8,398,753) -- (8,398,753)
Issuance of stock........... -- -- 6,512,316 6,512 18,558,243 -- -- 18,564,755
Exercise of options......... 300,000 300 -- -- 49,700 -- -- 50,000
Net loss.................... -- -- -- -- -- -- (90,859) (90,859)
--------- ----------- --------- ----------- ---------- ---------- --------- ------------
Balance at March 31, 1999
(unaudited)................. 12,400,200 $ 12,400 6,512,316 $ 6,512 $19,986,013 $(8,398,753) $1,236,132 $12,842,304
--------- ----------- --------- ----------- ---------- ---------- --------- ------------
--------- ----------- --------- ----------- ---------- ---------- --------- ------------
The accompanying notes to consolidated financial statements are an
integral part of these consolidated statements.
F-5
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
----------------------------------- ----------------------
1996 1997 1998 1998 1999
---------- ---------- ----------- ---------- ----------
(UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)...................................... $ 863,110 $1,010,934 $ (627,300) $ (520,235) $ (90,859)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities--
Deferred income taxes................................ 463,229 838,572 (540,469) (391,994) (48,850)
Depreciation and amortization........................ 142,134 320,908 567,761 108,534 143,827
Provision for doubtful accounts...................... 20,840 99,308 102,196 55,110 126,504
(Increase) decrease in--
Accounts receivable................................ (1,197,039) (2,718,335) (4,710,510) 430,779 (700,864)
Unbilled work in process........................... (300,190) 204,978 (883,420) (41,317) (692,115)
Prepaid income taxes............................... (133,133) (210,916) 1,220 1,226 49,699
Other current assets............................... (190,084) (44,401) (215,378) 29,905 (27,835)
Other assets....................................... (77,851) (127,283) 32,267 (12,024) 23,323
Increase (decrease) in--
Accounts payable and accrued expenses.............. 575,628 (61,916) 2,149,308 131,532 (520,498)
Deferred income.................................... 494,948 (464,493) 412,459 4,996 (401,820)
Deferred rent...................................... 16,462 (7,269) 47,651 (2,399) (21,744)
---------- ---------- ----------- ---------- ----------
Net cash provided by (used in) operating
activities..................................... 678,054 (1,159,913) (3,664,215) (205,887) (2,161,232)
---------- ---------- ----------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Common shares repurchased to treasury.................. -- -- -- -- (8,398,753)
(Payments to) repayments from employees................ -- (53,371) (1,729) (13,042) 35,000
(Payments to) repayments from stockholders............. -- -- (515,000) -- 515,000
(Payments to) repayments from related party............ -- -- (916,948) (176,261) 742,672
Purchase of computer equipment, office furniture, and
leasehold improvements............................... (315,189) (356,782) (686,823) (187,139) (208,544)
---------- ---------- ----------- ---------- ----------
Net cash used in investing activities............ (315,189) (410,153) (2,120,500) (376,442) (7,314,625)
---------- ---------- ----------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash overdraft......................................... -- 545,351 (69,741) (184,048) (475,610)
Proceeds from short-term borrowings.................... -- 2,452,000 19,643,000 4,082,000 4,351,000
Repayments of short-term borrowings.................... -- (1,672,000) (14,825,000) (3,715,000) (9,949,000)
Payment of preferred dividends......................... -- -- -- -- (70,000)
Proceeds from sale of preferred stock.................. -- -- -- -- 18,564,755
Proceeds from exercise of stock options................ 5,000 27,000 616,000 -- 50,000
---------- ---------- ----------- ---------- ----------
Net cash provided by financing activities........ 5,000 1,352,351 5,364,259 182,952 12,471,145
---------- ---------- ----------- ---------- ----------
Net increase (decrease) in cash.................. 367,865 (217,715) (420,456) (399,377) 2,995,288
CASH AND CASH EQUIVALENTS, beginning of period........... 270,306 638,171 420,456 420,456 --
---------- ---------- ----------- ---------- ----------
CASH AND CASH EQUIVALENTS, end of period................. $ 638,171 $ 420,456 $ -- $ 21,079 $2,995,288
---------- ---------- ----------- ---------- ----------
---------- ---------- ----------- ---------- ----------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for--
Interest............................................. $ 366 $ 35,545 $ 262,539 $ 24,762 $ 79,990
---------- ---------- ----------- ---------- ----------
---------- ---------- ----------- ---------- ----------
Taxes................................................ $ 409,683 $ 260,000 $ -- $ -- $ 27,540
---------- ---------- ----------- ---------- ----------
---------- ---------- ----------- ---------- ----------
SUPPLEMENTAL DISCLOSURES OF NONCASH TRANSACTIONS:
Borrowings under capital leases........................ $ 409,683 $ 335,669 $ 238,050 $ -- $ --
---------- ---------- ----------- ---------- ----------
---------- ---------- ----------- ---------- ----------
Dividends declared on mandatory redeemable convertible
preferred stock...................................... $ -- $ 26,250 $ 35,000 $ -- $ --
---------- ---------- ----------- ---------- ----------
---------- ---------- ----------- ---------- ----------
The accompanying notes to consolidated financial statements are an
integral part of these consolidated statements.
F-6
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) OWNERSHIP AND OPERATIONS:
Predictive Systems, Inc. (the "Company"), was incorporated under the laws of
the State of Delaware on February 10, 1995. The Company was formerly 100% owned
by Predictive Holdings, Inc. (the "Parent"). During the first quarter of 1999
the Parent was merged with and into the Company and the Parent was concurrently
dissolved. The financial statements and footnotes reflect the combined
operations and financial position of the Company and the Parent for all periods
presented.
The Company provides network consulting services for the design,
performance, management and securities of complex business-critical computing
network. Services are currently provided through the Company's offices located
throughout the United States and its wholly-owned subsidiary in England which
was formed in the first quarter of 1999.
The Company is proposing an initial public offering of up to
shares of common stock including overallotment. See "Risk Factors" in the
accompanying prospectus.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
UNAUDITED INTERIM FINANCIAL STATEMENTS--
The accompanying balance sheet as of March 31, 1999 and statements of
operations, stockholders' equity and cash flows for the three months ended March
31, 1998 and 1999 included herein have been prepared by the Company and are
unaudited. The information furnished in the unaudited financial statements
referred to above includes all adjustments which are, in the opinion of
management, necessary for a fair presentation of such financial statements. The
results of operations for the three months ended March 31, 1999 are not
necessarily indicative of the results to be expected for the entire fiscal year.
USE OF ESTIMATES--
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
REVENUE AND COST RECOGNITION--
Revenue for time-and-material contracts are recognized as the services are
rendered. Revenues for fixed-price contracts are recognized as services are
rendered on the percentage-of-completion method of accounting based on the ratio
of costs incurred to total estimated costs. Unbilled work in process represent
costs incurred and estimated earnings, production, and other client-reimbursable
costs. Provisions for estimated losses on uncompleted contracts are made in the
period in which such losses are determined. The Company acts as a reseller of
certain hardware and software and sales revenue is recognized when these
products are shipped to the customer.
Deferred income represents prepayments from customers that are recorded as
liabilities for future services to be performed. Income is recognized upon
performance of these related services.
CASH EQUIVALENTS--
The Company considers all short-term marketable equity securities with a
maturity of three months or less at the time of purchase to be cash equivalents.
F-7
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
PROPERTY AND EQUIPMENT--
Computer equipment and office furniture are carried at their cost basis and
depreciated using the straight-line method over their estimated useful lives,
ranging from three to seven years. Leasehold improvements are amortized over the
lesser of their estimated useful lives or the life of the lease. Expenditures
for maintenance and repairs are charged to operations as incurred and major
expenditures for renewals and betterments are capitalized and depreciated over
their useful lives.
BUSINESS CONCENTRATIONS AND CREDIT RISK--
Financial instruments, which subject the Company to concentrations of credit
risk, consist primarily of cash and cash equivalents and trade accounts
receivable. The Company maintains cash and cash equivalents with various
financial institutions. The Company performs periodic evaluations of the
relative credit standing of these institutions. The Company's clients are
primarily concentrated in the United States. The Company performs ongoing credit
evaluations, generally does not require collateral and establishes an allowance
for doubtful accounts based upon factors surrounding the credit risk of
customers, historical trends and other information. To date, such losses have
been within management's expectations.
For the year ended December 31, 1996, approximately 80% of sales were from
six customers. For the year ended December 31, 1997, approximately 64% of sales
were from four customers. For the year ended December 31, 1998, approximately
21% of sales were from one customer. The amounts due from these customers at
December 31, 1997 and 1998 were approximately $2,357,000 and $2,931,000,
respectively.
INCOME TAXES--
The Company accounts for income taxes under Statement of Financial
Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes" ("SFAS
109"). SFAS 109 requires the recognition of deferred tax assets and liabilities
for the expected future tax consequences of events that have been included in
the financial statements or tax returns. Under this method, deferred tax assets
and liabilities are determined based on the differences between the financial
statement and the tax basis of assets and liabilities using enacted tax rates in
effect for the year in which the differences are expected to reverse. The
Company converted from a cash basis to an accrual basis taxpayer on January 1,
1998.
NET INCOME (LOSS) PER SHARE--
The Company computes net income (loss) per share in accordance with SFAS No.
128, "Earnings per Share" ("SFAS 128"). Under the provisions of SFAS 128, basic
net income (loss) per share is computed by dividing net income (loss) by the
weighted average number of shares outstanding. Diluted net income (loss) per
common share ("Diluted EPS") is computed by dividing net income (loss) by the
weighted average number of common shares and dilutive common share equivalents
outstanding.
ACCOUNTING FOR LONG-LIVED ASSETS--
The Company accounts for long-lived assets in accordance with the provisions
of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of" ("SFAS No. 121"). This statement
establishes financial accounting and reporting standards for the impairment of
long-lived assets, certain identifiable intangibles, and goodwill related to
those assets to be held and used, and for long-lived assets and certain
identifiable intangibles to be disposed of. SFAS 121 requires, among other
things, that an entity review its long-lived assets and certain related
F-8
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
intangibles for impairment whenever changes in circumstances indicate that the
carrying amount of an asset may not be fully recoverable. The Company does not
believe that any such changes have taken place.
STOCK-BASED COMPENSATION--
In 1996, the Company adopted the provisions of SFAS No. 123 "Accounting for
Stock-Based Compensation" ("SFAS No. 123"), and elected to continue the
accounting set forth in Accounting Principles Board No. 25 "Accounting for Stock
Issued to Employees" ("APB No. 25") and to provide the necessary pro forma
disclosures as if the fair value method had been applied (Note 7).
FAIR VALUE OF FINANCIAL INSTRUMENTS--
The carrying amounts of cash and cash equivalents, accounts and other
receivables, and accounts payable approximate fair value due to the short-term
maturity of these instruments. The carrying amounts of outstanding borrowings
approximate fair value.
NEW ACCOUNTING PRONOUNCEMENTS--
In June 1997, the Financial Accounting Standard Board ("FASB") issued SFAS
No. 131, "Disclosures About Segments of an Enterprise and Related Information."
This statement establishes standards for the way public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to shareholders. This statement is
effective for financial statements for periods beginning after December 15, 1997
and need not be applied to interim periods in the initial year of application.
Comparative information for earlier years presented is to be restated. The
Company does not believe it operates in more than one segment. The chief
operating decision maker allocates resources and assesses the performance
associated with its business on a single-segment basis.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivatives and
Hedging Activities", which establishes accounting and reporting standards of
derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. This statement is effective for all
quarters of fiscal years beginning after June 15, 1999. The Company does not
expect the adoption of this standard to have a material effect on the Company's
results of consolidated operations, financial position or cash flows.
F-9
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) NET INCOME (LOSS) PER SHARE:
As discussed in Note 2, net income (loss) per share is calculated in
accordance with SFAS No. 128. The following table reconciles the numerator and
denominator for the calculation--
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------------------ --------------------------
1996 1997 1998 1998 1999
------------- ------------- ------------ ------------ ------------
(UNAUDITED)
Numerator--
Net income (loss)...................... $ 863,110 $ 1,010,934 $ (627,300) $ (520,235) $ (90,859)
Preferred stock dividends.............. -- (26,250) (35,000) (8,750) (8,750)
------------- ------------- ------------ ------------ ------------
Numerator for basic earnings per
share--net income (loss) available
to common stockholders............. 863,110 984,684 (662,300) (528,985) (99,609)
------------- ------------- ------------ ------------ ------------
------------- ------------- ------------ ------------ ------------
Effect of dilutive securities-- preferred
stock dividend......................... -- 26,250 -- -- --
------------- ------------- ------------ ------------ ------------
Numerator for diluted earnings per
share--net income (loss) available to
common stockholders after assumed
conversions............................ $ 863,110 $ 1,010,934 $ (662,300) $ (528,985) $ (99,609)
------------- ------------- ------------ ------------ ------------
------------- ------------- ------------ ------------ ------------
Denominator--
Denominator for basic earnings per
share--weighted average shares....... 4,269,000 4,382,417 6,015,433 4,463,133 8,379,660
------------- ------------- ------------ ------------ ------------
------------- ------------- ------------ ------------ ------------
Effect of dilutive securities--
Incremental shares for assumed
conversions of preferred stock....... 4,200,000 4,200,000 -- -- --
Incremental shares for assumed
conversions of options............... 3,117,130 4,182,193 -- -- --
------------- ------------- ------------ ------------ ------------
Dilutive potential common shares....... 7,317,130 8,382,193 -- -- --
------------- ------------- ------------ ------------ ------------
------------- ------------- ------------ ------------ ------------
Denominator for diluted earnings per
share--adjusted weighted average shares
and assumed conversions................ 11,586,130 12,764,610 6,015,433 4,463,133 8,379,660
------------- ------------- ------------ ------------ ------------
------------- ------------- ------------ ------------ ------------
Basic earnings per share from net income
(loss)................................. $ 0.20 $ 0.22 $ (0.11) $ (0.12) $ (0.01)
------------- ------------- ------------ ------------ ------------
------------- ------------- ------------ ------------ ------------
Diluted earnings per share from net
income (loss).......................... $ 0.07 $ 0.08 $ (0.11) $ (0.12) $ (0.01)
------------- ------------- ------------ ------------ ------------
------------- ------------- ------------ ------------ ------------
The following table summarizes the weighted average of securities
outstanding which are excluded from the loss per share calculation for the year
ended December 31, 1998 and the three months ended
F-10
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) NET INCOME (LOSS) PER SHARE: (CONTINUED)
March 31, 1998 and 1999, respectively. Preferred stock is reflected on an "if
converted" basis. See Note 7.
THREE MONTHS ENDED
MARCH 31,
DECEMBER 31, ----------------------
1998 1998 1999
------------ ---------- ----------
(UNAUDITED)
Mandatory redeemable convertible preferred............ 4,200,000 4,200,000 3,126,667
Convertible preferred................................. -- -- 1,881,336
Stock options......................................... 2,396,092 4,653,263 3,570,871
------------ ---------- ----------
6,596,092 8,853,263 8,578,874
------------ ---------- ----------
------------ ---------- ----------
(4) PROPERTY AND EQUIPMENT:
The components of computer equipment, office furniture, and leasehold
improvements are as follows--
DECEMBER 31,
-------------------------- MARCH 31,
1997 1998 1999
------------ ------------ ------------
(UNAUDITED)
Computer equipment.................................. $ 646,026 $ 1,243,472 $ 1,376,481
Office furniture.................................... 341,901 630,722 640,315
Leasehold improvements.............................. 391,571 430,172 458,423
------------ ------------ ------------
1,379,498 2,304,366 2,475,219
Less--Accumulated depreciation and amortization..... (485,510) (947,735) (1,089,007)
------------ ------------ ------------
$ 893,988 $ 1,356,631 $ 1,386,212
------------ ------------ ------------
------------ ------------ ------------
Depreciation and amortization expense aggregated $142,134, $320,908,
$567,761, $108,534 (unaudited) and $143,827 (unaudited), respectively, for the
years ending December 31, 1996, 1997 and 1998 and for the three months ended
March 31, 1998 and 1999.
(5) DEBT:
The Company has a secured demand loan under which it may borrow up to
$5,000,000, but not more than 80% of the Company's eligible accounts receivable,
as defined. At December 31, 1998, the balance outstanding on this demand loan
was $5,598,000 as the lender has informally extended the Company's ability to
borrow under this demand loan. The interest rate on the demand loan was 11.25%
at December 31, 1998. During the first quarter of 1999, the balance outstanding
on the demand loan was paid in full.
F-11
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) CAPITAL LEASE OBLIGATIONS:
The Company has entered into various leases for computer equipment, office
furniture, and leasehold improvements. These leases have been capitalized using
interest rates ranging from 7.88% to 18.83% and expire on various dates through
2003. Depreciation on the capitalized assets has been included in depreciation
expense in the accompanying statements of operations.
The future minimum lease payments required under the above mentioned capital
leases for the twelve months ended December 31, are as follows--
YEAR
- ---------------------------------------------------------------------------------
1999............................................................................. $ 211,951
2000............................................................................. 209,297
2001............................................................................. 155,655
2002............................................................................. 87,812
2003............................................................................. 55,697
Less--Amount representing interest............................................... (123,367)
-----------
Present value of net minimum lease payments...................................... 597,045
Less--Current portion............................................................ (151,027)
-----------
$ 446,018
-----------
-----------
(7) STOCKHOLDERS' EQUITY:
PREFERRED STOCK--
Since inception, the Company has issued two types of preferred stock. The
following is a discussion of each of these issuances--
In 1995, the Company issued 4,200,000 shares of mandatory redeemable
convertible preferred stock (the "1995 Preferred Shares") at a price of
$0.17 per share. The shares accrue dividends at 5% per year, commencing
March 1, 1997. Each share is convertible, subject to certain adjustments,
into 1 share of common stock, at the option of the holder. The shares
automatically convert upon successful completion of an initial public
offering yielding gross proceeds of at least $10.0 million and at an initial
public offering price of not less than $0.83 per share. Commencing March 1,
1998, the Company was able to redeem the 1995 Preferred Shares. Commencing
March 1, 2001, if not previously redeemed, the Company was required to
redeem the 1995 Preferred Shares in three equal annual installments.
During the quarter ended March 31, 1999, the holders of the 1995
Preferred Shares exercised their conversion rights and converted all
outstanding shares into 4,200,000 shares of common stock. In connection with
the conversion, the Company paid $70,000 of accumulated dividends on the
1995 Preferred Shares.
Subsequent to the conversion of the 1995 Preferred Shares, the Company
redeemed 2,855,100 shares of common stock at a purchase price of
approximately $2.94 per share.
On March 5, 1999, the Company sold 6,512,316 shares of convertible
preferred stock (the "1999 Preferred Shares") to General Atlantic Partners
54, L.P. (5,350,441 shares), GAP Coinvestment Partners II, LP (1,112,765
shares), and other investors (49,110 shares) resulting in net proceeds of
approximately $18,600,000. The 1999 Preferred Shares are convertible to
common shares on a 1 to 1 ratio at any time at the option of the holder,
subject to certain adjustments. The shares will automatically convert (i)
prior to the closing of the proposed initial public offering
F-12
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) STOCKHOLDERS' EQUITY: (CONTINUED)
yielding net proceeds of at least $25 million and resulting in a market
capitalization of at least $100 million or (ii) upon the conversion of at
least 67% of all 1999 Preferred Shares.
In connection with the issuance of the 1999 Preferred Shares to General
Atlantic Partners 54, L.P. and GAP Coinvestment Partners II, warrants were
issued to purchase shares of common stock equal to 15% of the number of
shares sold in the proposed initial public offering at a price equal to the
initial price to the public. In order to exercise the warrants, a notice of
exercise must be delivered within 20 business days following the first
filing of the Company's registration statement on Form S-1.
The Company will record the value of these warrants, as determined by
using the Black-Scholes model, as a dividend to these shareholders. The
dividend will decrease equity but will have no effect on reported net income
(loss). The dividend will be recorded at the time of the initial public
offering as the actual value of the warrants cannot be determined until that
date.
STOCK OPTIONS--
In 1998, the Company adopted its Stock Option/Stock Issuance Plans (the
"Option Plans"). Prior to this time, options issued were not issued in
connection with a plan. The Option Plans are each divided into two separate
equity programs, the Option Grant Program and the Stock Issuance Program. Under
the Option Grant Program, the Company may issue either incentive stock options
or nonqualified stock options. Under the Stock Issuance Program the Company may
issue shares of common stock either through the purchase of such shares or as a
bonus for services rendered. To date, no shares have been issued under the Stock
Issuance Programs. Awards under either program may be granted to such directors,
employees and consultants of the Company as the Board of Directors selects in
its discretion. A combined total of shares of common stock has been
reserved for issuance under the two Option Plans.
A summary of the activity under the Option Grant Programs is as follows--
1996 1997 1998 MARCH 31, 1999
---------------------- ---------------------- ---------------------- ----------------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE SHARES PRICE
--------- ----------- --------- ----------- --------- ----------- --------- -----------
Outstanding at beginning of
period............................ 4,386,000 $ 0.17 5,916,000 $ 0.33 9,471,600 $ 0.61 8,397,600 $ 1.02
Granted............................. 1,560,000 0.78 3,856,800 1.04 2,427,000 1.41 585,000 2.36
Exercised........................... (30,000) 0.17 (109,200) 0.25 (3,492,000) 0.18 (300,000) 0.17
Forfeited........................... -- -- (192,000) 0.83 (9,000) 0.83 (96,000) 0.86
--------- ----- --------- ----- --------- ----- --------- -----
Outstanding at end of period........ 5,916,000 $ 0.33 9,471,600 $ 0.61 8,397,600 $ 1.02 8,586,600 $ 1.14
--------- ----- --------- ----- --------- ----- --------- -----
--------- ----- --------- ----- --------- ----- --------- -----
Options exercisable at end of
period............................ 3,588,000 $ 0.27 5,700,300 $ 0.42 4,586,250 $ 0.80 4,580,250 $ 0.85
--------- ----- --------- ----- --------- ----- --------- -----
--------- ----- --------- ----- --------- ----- --------- -----
Weighted average fair value of
options granted during period..... $ 0.17 $ 0.23 $ 0.26 $ 0.47
F-13
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) STOCKHOLDERS' EQUITY: (CONTINUED)
The following table summarizes information about stock options outstanding
at December 31, 1998--
WEIGHTED OPTIONS
OPTIONS AVERAGE EXERCISABLE
OUTSTANDING AT REMAINING AT
DECEMBER 31, CONTRACTUAL DECEMBER 31,
EXERCISE PRICES 1998 LIFE 1998
- ------------------------------------------------- -------------- ----------- -------------
$0.17............................................ 789,000 6.20 years 789,000
0.50............................................ 240,000 7.00 years 240,000
0.83............................................ 3,040,800 7.83 years 2,557,800
1.25............................................ 2,788,800 8.61 years 912,450
1.50............................................ 1,539,000 9.59 years 87,000
-------------- -------------
8,397,600 4,586,250
-------------- -------------
-------------- -------------
The Company has elected to follow APB No. 25 in accounting for its employee
stock options. Accordingly, no compensation cost has been recognized for Option
Plans. Had the determination of compensation costs been based on the fair value
at the grant dates for awards under the Option Plans, consistent with the method
of SFAS No. 123, the Company's income (loss) and basic and diluted income (loss)
per share would have been reduced to the following pro forma amounts--
The fair value of all of our option grants is estimated on the date of grant
using the Black-Scholes model with the following weighted-average assumptions
used for grants in 1996, 1997, 1998 and the three months ended March 31, 1999--
- weighted-average risk free interest rates of 6.29%, 6.28%, 5.51% and
5.36%, respectively;
- expected dividend yields of 0%;
- expected lives of 4 years; and
- expected volatility of 0%.
THREE
MONTHS
YEAR ENDED DECEMBER 31, ENDED
--------------------------------------- MARCH 31,
1996 1997 1998 1999
---------- ------------ ------------- -----------
(UNAUDITED)
Net income (loss):
As reported.......................... $ 863,110 $ 1,010,934 $ (627,300) $ (90,959)
Pro forma............................ 830,967 774,427 (1,006,406) (259,225)
Basic net income (loss) per share:
As reported.......................... $ 0.20 $ 0.22 $ (0.11) $ (0.01)
Pro forma............................ $ 0.19 $ 0.18 $ (0.17) $ (0.03)
Diluted net income (loss) per share:
As reported.......................... $ 0.07 $ 0.08 $ (0.11) $ (0.01)
Pro forma............................ $ 0.07 $ 0.06 $ (0.17) $ (0.03)
F-14
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) INCOME TAXES:
The components of the Company's provision (benefit) for income taxes for the
years ended December 31, 1996, 1997 and 1998 and the three months ended March
31, 1998 and 1999 are as follows--
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
----------------------------------- -----------------------
1996 1997 1998 1998 1999
---------- ---------- ----------- ----------- ----------
(UNAUDITED)
Current income tax provision--
Federal.......................................... $ 185,521 $ 35,864 $ -- $ -- $ --
State............................................ 94,450 18,802 80,211 -- --
---------- ---------- ----------- ----------- ----------
279,971 54,666 80,211 -- --
---------- ---------- ----------- ----------- ----------
Deferred income tax provision (benefit)--
Federal.......................................... 331,790 578,823 (407,182) (302,937) (38,691)
State............................................ 131,439 259,749 (133,287) (89,057) (10,159)
---------- ---------- ----------- ----------- ----------
463,229 838,572 (540,469) (391,994) (48,850)
---------- ---------- ----------- ----------- ----------
$ 743,200 $ 893,238 $ (460,258) $ (391,994) $ (48,850)
---------- ---------- ----------- ----------- ----------
---------- ---------- ----------- ----------- ----------
The following table indicates the significant elements contributing to the
difference between the Federal statutory rate and the Company's effective tax
rate--
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------- --------------------
1996 1997 1998 1998 1999
--------- --------- --------- --------- ---------
(UNAUDITED)
Federal statutory rate................................. 34.0% 34.0% (34.0)% (34.0)% (34.0)%
State taxes net of Federal effect...................... 6.6 6.6 (6.6) (6.6) (6.6)
Other.................................................. 4.8 5.7 (1.7) (2.4) 5.6
--------- --------- --------- --------- ---------
45.4% 46.3% (42.3)% (43.0)% (35.0)%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
On January 1, 1998, the Company converted from a cash basis to an accrual
basis taxpayer. The conversion from the cash basis to accrual basis required the
recognition of a deferred tax liability of
F-15
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) INCOME TAXES: (CONTINUED)
approximately $1,667,000. Other major components of the deferred tax assets and
(liabilities) as of December 31, 1997, 1998 and March 31, 1999 (unaudited) are
as follows--
DECEMBER 31,
---------------------------- MARCH 31,
1997 1998 1999
------------- ------------- -------------
(UNAUDITED)
Bad debt reserve................................. $ 32,486 $ 57,529 $ 108,966
Prepaid expenses................................. (66,407) -- --
Accounts receivable.............................. (1,739,221) -- --
Unbilled receivables............................. (72,946) -- --
Accounts payable and accrued expenses............ 255,872 -- --
Depreciation..................................... 14,231 100,124 75,800
Section 481 A. adjustment........................ -- (1,249,974) (1,131,855)
Net operating loss carryforwards................. 227,732 174,474 76,602
Other, net....................................... (91,362) 18,701 20,191
------------- ------------- -------------
Total deferred taxes, net.................... $ (1,439,615) $ (899,146) $ (850,296)
------------- ------------- -------------
------------- ------------- -------------
At December 31, 1998, the Company had available net operating loss
carryforwards of approximately $390,000 to reduce future period's taxable
income. These loss carryforwards begin to expire in 2012.
(9) RELATED PARTIES:
During 1998 the Company started a software development company which had
previously been consolidated with the Company. In March 1998, the software
development company was spun off through a distribution of all of its
outstanding shares to the Company's stockholders. In connection with the
spin-off the Company sold certain assets to the software development company for
approximately $130,000 and provided a $1,000,000 line of credit bearing interest
at 8%. As of December 31, 1998 and March 31, 1999, $916,948 and $174,276,
respectfully, was due from this company.
(10) NOTES RECEIVABLE--STOCKHOLDERS:
In August 1998, the Company loaned certain stockholders approximately
$515,000 in connection with the exercise of stock options. The stockholders
signed notes payable to the Company in exchange for the loans which had interest
rates of 7%. All amounts due under these notes were paid in full in March 1999.
(11) COMMITMENTS AND CONTINGENCIES:
OPERATING LEASES--
The Company has entered into non-cancelable operating leases for office
space with terms ranging from approximately six months to five years, with an
option to renew two of these leases for an additional five years. These leases
provide for minimum annual lease payments and additional operating expense
charges, as well as rent concessions for two locations, which are being
amortized over five years, the term of the lease.
F-16
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) COMMITMENTS AND CONTINGENCIES: (CONTINUED)
The future minimum lease payments required under the above mentioned
operating leases for the year ended December 31, are as follows--
YEAR
- --------------------------------------------------------------------------------
1999............................................................................ $ 857,708
2000............................................................................ 723,319
2001............................................................................ 690,309
2002............................................................................ 437,821
2003............................................................................ 211,934
------------
Total minimum lease payments................................................ $ 2,921,091
------------
------------
Rent expense was approximately $202,568, $457,825 and $736,120 for the years
ended December 31, 1996, 1997 and 1998, respectively. Rent expense totaled
approximately $144,954 (unaudited) and $241,461 (unaudited) for the three months
ended March 31, 1998 and 1999, respectively.
PENSION PLAN--
The Company has a 401(k) plan with discretionary matching contributions for
its employees. The Company did not make any contributions to the 401(k) plan
during 1996, 1997 or 1998.
LITIGATION--
The Company is involved, from time to time, in legal proceedings incurred in
the normal course of business. In the opinion of management and its counsel,
none of these proceedings would have a material effect on the financial position
or results of operations of the Company.
(12) SUBSEQUENT EVENT:
Subsequent to year-end the Company amended and restated its certificate of
incorporation to increase its authorized common stock to 200,000,000 shares and
decrease its authorized preferred stock to 10,000,000 shares.
F-17
[LOGO]
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the costs and expenses, other than the
underwriting discounts and commissions, payable by the registrant in connection
with the issuance and distribution of the common stock being registered. All
amounts are estimates except the SEC registration fee, the NASD filing fee and
the Nasdaq National Market listing fee.
AMOUNT TO
BE PAID
----------
SEC registration fee.............................................................. $ 14,456
NASD filing fee................................................................... 5,700
Nasdaq National Market listing fee................................................
Legal fees and expenses...........................................................
Accounting fees and expenses......................................................
Printing and engraving............................................................
Blue sky fees and expenses (including legal fees)................................. 12,500
Transfer Agent and Registrar fees and expenses.................................... 15,000
Miscellaneous.....................................................................
----------
Total......................................................................... $
----------
----------
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Registrant's Amended and Restated Certificate of Incorporation in effect
as of the date hereof (the "Certificate") provides that, except to the extent
prohibited by the Delaware General Corporation Law, as amended (the "DGCL"), the
Registrant's directors shall not be personally liable to the Registrant or its
stockholders for monetary damages for any breach of fiduciary duty as directors
of the Registrant. Under the DGCL, the directors have a fiduciary duty to the
Registrant which is not eliminated by this provision of the Certificate and, in
appropriate circumstances, equitable remedies such as injunctive or other forms
of nonmonetary relief will remain available. In addition, each director will
continue to be subject to liability under the DGCL for breach of the director's
duty of loyalty to the Registrant, for acts or omissions which are found by a
court of competent jurisdiction to be not in good faith or involving intentional
misconduct, for knowing violations of law, for actions leading to improper
personal benefit to the director, and for payment of dividends or approval of
stock repurchases or redemptions that are prohibited by the DGCL. This provision
also does not affect the directors' responsibilities under any other laws, such
as the Federal securities laws or state or Federal environmental laws. The
Registrant has applied for liability insurance for its officers and directors.
Section 145 of the DGCL empowers a corporation to indemnify its directors
and officers and to purchase insurance with respect to liability arising out of
their capacity or status as directors and officers, provided that this provision
shall not eliminate or limit the liability of a director: (i) for any breach of
the director's duty of loyalty to the corporation or its stockholders, (ii) for
acts or omissions not in good faith or which involve intentional misconduct or a
knowing violation of law, (iii) arising under Section 174 of the DGCL, or (iv)
for any transaction from which the director derived an improper personal
benefit. The DGCL provides further that the indemnification permitted thereunder
shall not be deemed exclusive of any other rights to which the directors and
officers may be entitled under the corporation's bylaws, any agreement, a vote
of stockholders or otherwise. The Certificate eliminates the personal liability
of directors to the fullest extent permitted by Section 102(b)(7) of the DGCL
and provides that the Registrant may fully indemnify any person who was or is a
party or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding
II-1
(whether civil, criminal, administrative or investigative) by reason of the fact
that such person is or was a director or officer of the Registrant, or is or was
serving at the request of the Registrant as a director or officer of another
corporation, partnership, joint venture, trust, employee benefit plan or other
enterprise, against expenses (including attorney's fees), judgments, fines and
amounts paid in settlement actually and reasonably incurred by such person in
connection with such action, suit or proceeding.
At present, there is no pending litigation or proceeding involving any
director, officer, employee or agent as to which indemnification will be
required or permitted under the Certificate. The Registrant is not aware of any
threatened litigation or proceeding that may result in a claim for such
indemnification.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
The Registrant has sold and issued the following securities since January 1,
1996:
1. On March 5, 1999, the Registrant issued 6,512,316 shares of Series A
Convertible Preferred Stock for an aggregate amount of $18,565,225.44.
2. On March 5, 1999, the Registrant issued warrants to purchase 15% of the
number of shares registered in its initial public offering at the initial
public offering price for an aggregate amount of $1,000.
3. The Registrant from time to time has granted stock options to employees,
directors and consultants in reliance upon exemption from registration
pursuant to either (i) Section 4(2) of the Securities Act of 1933, as
amended (the "Securities Act"), or (ii) Rule 701 promulgated under the
Securities Act. The following table sets forth certain information
regarding such grants:
NUMBER OF EXERCISE
SHARES PRICES
---------- -------------
January 1, 1996 to December 31, 1996........................................ 1,560,000 $ 0.50-$0.83
January 1, 1997 to December 31, 1997........................................ 3,856,800 $ 0.83-$1.25
January 1, 1998 to December 31, 1998........................................ 2,427,000 $ 1.25-$1.50
January 1, 1999 to present.................................................. 2,000,835 $ 1.50-$4.00
No underwriters were involved in connection with the sales of securities
referred to in this Item 15.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits.
NUMBER DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
1.1* Form of underwriting agreement.
3.1 Certificate of incorporation.
3.2* Form of amended and restated certificate of incorporation to be in effect upon the closing of the
offering.
3.3 By-laws.
3.4* Form of amended and restated by-laws to be in effect upon the closing of this offering.
4.1* Specimen common stock certificate.
4.2 See Exhibits 3.1, 3.2, 3.3 and 3.4 for provisions of the Certificate of Incorporation and By-laws of the
Registrant defining the rights of holders of Common Stock of the Registrant.
II-2
NUMBER DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
4.3 Stock Purchase Warrant, dated March 5, 1999, by and between General Atlantic Partners 54, L.P. and the
Registrant.
4.4 Stock Purchase Warrant, dated March 5, 1999, by and between Gap Coinvestment Partners II, L.P. and the
Registrant.
5.1* Opinion of Brobeck, Phleger & Harrison LLP.
10.1* 1999 Stock Incentive Plan.
10.4 Employment Agreement, dated May 11, 1999, by and between Ronald Pettengill and the Registrant.
10.5 Employment Agreement, dated May 11, 1999, by and between Robert Belau and the Registrant.
10.6 Employment Agreement, dated January 22, 1999, by and between Kevin Holt and the Registrant.
10.7 Registration Rights Agreement, dated March 5, 1999.
10.8 Secured Promissory Note, dated August 31, 1998, in favor of Brown Brothers Harriman & Co.
23.1 Consent of Arthur Andersen LLP.
23.2* Consent of Brobeck, Phleger & Harrison LLP (included in Exhibit 5.1).
24.1 Powers of attorney (please see Signature Page).
27.1 Financial Data Schedule.
- ------------------------
* To be supplied by amendment.
(b) Financial Statement Schedules.
Schedule II-Valuation and Qualifying Accounts
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the financial
statements or notes thereto.
ITEM 17. UNDERTAKINGS
The undersigned Registrant hereby undertakes to provide to the underwriters
at the closing specified in the underwriting agreement, certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act of 1933,
the information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant pursuant to Rule 424 (b)(1) or (4), or
497(h) under the Securities Act of 1933, shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act of
1933, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and this offering of such securities at that time shall be
deemed to be the initial BONA FIDE offering thereof.
II-3
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act, and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of counsel the matter has
been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
II-4
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized in the City of New York,
State of New York, on this 29th day of July, 1999.
PREDICTIVE SYSTEMS, INC.
BY: /S/ RONALD G. PETTENGILL, JR.
-----------------------------------------
Name: Ronald G. Pettengill, Jr.
Title: Chief Executive Officer
POWER OF ATTORNEY
We, the undersigned directors and/or officers of Predictive Systems, Inc.
(the "Company"), hereby severally constitute and appoint Ronald Pettengill,
Chief Executive Officer, and Robert Belau, President, and each of them
individually, with full powers of substitution and resubstitution, our true and
lawful attorneys, with full powers to them and each of them to sign for us, in
our names and in the capacities indicated below, the Registration Statement on
Form S-1 filed with the Securities and Exchange Commission, and any and all
amendments to said Registration Statement (including post-effective amendments),
and any registration statement filed pursuant to Rule 462(b) under the
Securities Act of 1933, as amended, in connection with the registration under
the Securities Act of 1933, as amended, of equity securities of the Company, and
to file or cause to be filed the same, with all exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
connection therewith, as fully to all intents and purposes as each of them might
or could do in person, and hereby ratifying and confirming all that said
attorneys, and each of them, or their substitute or substitutes, shall do or
cause to be done by virtue of this Power of Attorney.
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Registration Statement has been signed by the following persons in the
capacities indicated on July 29, 1999:
SIGNATURE TITLE(S) DATE
- ------------------------------ --------------------------- -------------------
/s/ RONALD G. PETTENGILL, Chief Executive Officer and July 29, 1999
JR. Chairman of the Board of
- ------------------------------ Directors (principal
Ronald G. Pettengill, Jr. executive officer)
/s/ ROBERT L. BELAU President and Director July 29, 1999
- ------------------------------
Robert L. Belau
/s/ NEERAJ SETHI Vice President, Finance July 29, 1999
- ------------------------------ (principal financial and
Neeraj Sethi accounting officer)
II-5
SIGNATURE TITLE(S) DATE
- ------------------------------ --------------------------- -------------------
/s/ PETER L. BLOOM Director July 29, 1999
- ------------------------------
Peter L. Bloom
/s/ DONALD J. DUFFY Director July 29, 1999
- ------------------------------
Donald J. Duffy
/s/ BRADEN R. KELLY Director July 29, 1999
- ------------------------------
Braden R. Kelly
/s/ ERIC MEYER Director July 29, 1999
- ------------------------------
Eric Meyer
II-6
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Predictive Systems, Inc.
We have audited in accordance with generally accepted auditing standards,
the financial statements of Predictive Systems, Inc. included in this
registration statement and have issued our report thereon dated May 12, 1999.
Our audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The schedule of valuation and qualifying accounts
is the responsibility of the Company's management and is presented for purposes
of complying with the Securities and Exchange Commissions rules and is not part
of the basic financial statements. This schedule has been subjected to the
auditing procedures applied in the audit of the basic financial statements and,
in our opinion, fairly states in all material respects the financial data
required to be set forth therein in relation to the basic financial statements
taken as a whole.
ARTHUR ANDERSEN LLP
/s/ Arthur Andersen LLP
New York, New York
May 12, 1999
S-1
SCHEDULE II
PREDICTIVE SYSTEMS, INC.
SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
BALANCE AT CHARGED TO
BEGINNING OF COSTS AND BALANCE AT
YEAR EXPENSES DEDUCTIONS END OF YEAR
------------- ------------- ------------- -------------
For the fiscal year ended December 31, 1996
Allowance for doubtful accounts.................................. $ 9 $ 21 $ -- $ 30
----- ----- ----- -----
----- ----- ----- -----
For the fiscal year ended December 31, 1997
Allowance for doubtful accounts.................................. $ 30 $ 99 $ (49) $ 80
----- ----- ----- -----
----- ----- ----- -----
For the fiscal year ended December 31, 1998
Allowance for doubtful accounts.................................. $ 80 $ 102 $ (41) $ 141
----- ----- ----- -----
----- ----- ----- -----
S-2
INDEX TO EXHIBITS
NUMBER DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
1.1* Form of underwriting agreement.
3.1 Certificate of incorporation.
3.2* Form of amended and restated certificate of incorporation to be in effect upon the closing of the
offering.
3.3 By-laws.
3.4* Form of amended and restated by-laws to be in effect upon the closing of this offering.
4.1* Specimen common stock certificate.
4.2 See Exhibits 3.1, 3.2, 3.3 and 3.4 for provisions of the Certificate of Incorporation and By-laws of the
Registrant defining the rights of holders of Common Stock of the Registrant.
4.3 Stock Purchase Warrant, dated March 5, 1999, by and between General Atlantic Partners 54, L.P. and the
Registrant.
4.4 Stock Purchase Warrant, dated March 5, 1999, by and between Gap Coinvestment Partners II, L.P. and the
Registrant.
5.1* Opinion of Brobeck, Phleger & Harrison LLP.
10.1* 1999 Stock Incentive Plan.
10.4 Employment Agreement, dated May 11, 1999, by and between Ronald Pettengill and the Registrant.
10.5 Employment Agreement, dated May 11, 1999, by and between Robert Belau and the Registrant.
10.6 Employment Agreement, dated January 22, 1999, by and between Kevin Holt and the Registrant.
10.7 Registration Rights Agreement, dated March 5, 1999.
10.8 Secured Promissory Note, dated August 31, 1998, in favor of Brown Brothers Harriman & Co.
23.1 Consent of Arthur Andersen LLP.
23.2* Consent of Brobeck, Phleger & Harrison LLP (included in Exhibit 5.1).
24.1 Powers of attorney (please see Signature Page).
27.1 Financial Data Schedule.
- ------------------------
* To be supplied by amendment.