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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K405
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the year ended December 31, 2000
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Commission file number 000-30422
PREDICTIVE SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 7371 13-3808483
(State of incorporation) (Primary Standard Industrial (I.R.S. Employer
Classification Code) Identification Number)
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417 Fifth Avenue, 11th Floor
New York, New York 10016
(212) 659-3400
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock Par
Value $0.001 Per Share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 of 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. |X| Yes |_| No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |X|
The aggregate market value of voting stock held by non-affiliates of the
registrant as of March 16, 2001 was $45,022,127 (based on the last reported
sale price on the NASDAQ National Market on that date).
The number of shares outstanding of the registrant's common stock as of
March 16, 2001 was 35,640,109.
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DOCUMENTS INCORPORATED BY REFERENCE
The following documents (or parts thereof) are incorporated by reference
into the following parts of this Form 10-K: Portions of the Registrant's
Definitive Proxy Statement for the 2001 Annual Meeting of Stockholders are
incorporated by reference into Part III of this Report.
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TABLE OF CONTENTS
Page
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PART I
Item 1. Business. ........................................... 3
Item 2. Properties .......................................... 21
Item 3. Legal Proceedings. .................................. 21
Item 4. Submission of Matters to a Vote of Security Holders. 21
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters................................. 22
Item 6. Selected Consolidated Financial Data ................ 23
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations. ................ 24
Item 7A. Quantitative and Qualitative Disclosures about
Market Risk. ...................................................... 33
Item 8. Financial Statements and Supplementary Data. ........ 34
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure ................. 34
PART III
Item 10. Directors and Executive Officers of the Registrant. . 35
Item 11. Executive Compensation. ............................. 35
Item 12. Security Ownership of Certain Beneficial Owners and
Management.......................................... 35
Item 13. Certain Relationships and Related Transactions. ..... 35
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K......................................... 35
SIGNATURES. ....................................................... 39
INDEX TO EXHIBITS. ................................................ S-1
2
PART I
Item 1. Business
From time to time, we may, through our management, make forward-looking
public statements in press releases or other communications, such as
statements concerning then expected future revenues or earnings or alliances,
product development, and commercialization, as well as other estimates
relating to future operations. Forward-looking statements may be in reports
filed under the Securities Exchange Act of 1934, as amended, in press
releases, or in oral statements made with the approval of an authorized
executive officer. The words or phrases "believe," "will likely result," "are
expected to," "will continue," "is anticipated," "estimate," or similar
expressions are intended to identify "forward-looking statements" within the
meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A
of the Securities Act of 1933, as enacted by the Private Securities Litigation
Reform Act of 1995.
We wish to caution readers not to place undue reliance on these forward-
looking statements which speak only as of the date on which they are made.
Various factors including those set forth under the section entitled "Risk
Factors," could affect our financial or other performance, and could cause our
actual results for future periods to differ materially from any opinions or
statements expressed with respect to future periods or events in any current
statement.
We will not undertake and specifically decline any obligation to publicly
release the result of any revisions which may be made to any forward-looking
statements to reflect events or circumstatnces after the date of such
statements or to reflect the occurrence of anticipated or unanticipated events
which may cause management to reevaluate such forward-looking statements.
Overview
We are a leading independent network infrastructure consulting company
focused on helping service providers and global enterprises harness the power
of network technology. Specifically, we design, manage and secure network and
technology infrastructures that continuously deliver measurable business
results for our clients. Our BusinessFirst(TM) approach ensures that our
solutions not only meet clients' business goals, but also deliver quantifiable
results. With BusinessFirst, we can offer fixed-price, fixed-time engagements
that baseline a client's environment, prioritize a client's goals and deliver
business-driven solutions.
We use two complementary approaches to network infrastructure solutions. Our
Consulting Services division gives clients a comprehensive range of offerings
that deliver both breadth and depth of expertise across six practices. In
addition, we deliver managed security services to clients through our Global
Integrity(TM) Managed Services division which allow our clients to outsource
their network security needs and are generally provided on an annual
subscription basis.
Industry Background
As an independent service provider, we provide our clients with unbiased
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 based on
and measured against mutually agreed upon service offerings 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. Our consultants are organized into the following practice
areas, which cover the cornerstones of network technology: network design and
engineering; network and systems management; integrated customer service;
performance management; Global Integrity information security; and business
integration services. This structure enables our consultants to gain in-depth
expertise and become intimately familiar with the best practices and
methodologies identified within each of those disciplines.
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
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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:
o the migration from mainframe and client/server technologies to Internet-
based computing environments among most industries;
o the demand for real-time exchange of critical, time-sensitive information
within organizations and among their external constituents; and
o 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 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 information, conduct retail transactions and
access online sources of entertainment. Business and consumer trends will
continue to positively impact the number of users who access, and the data
traffic carried over, the Internet.
The growth in network-dependent activities requires complex network
infrastructure solutions that integrate a variety of 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 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. Consequently, the demand for network
consulting and integration services has grown dramatically. International Data
Corporation, a market research organization, estimates that the worldwide
market for these services will grow from $15.6 billion in 1999 to $32.8
billion by 2004. 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, we believe that few have the requisite focus and expertise to
address the complex, multi-faceted issues surrounding today's networks, and
many are limited by the fact that they:
o are primarily motivated by distributing their own products and often lack
the skills to implement multi-vendor solutions;
o are focused on traditional mainframe computing environments and derive a
large percentage of their revenue from reselling hardware and software
products; or
o 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 consulting and technical expertise in the
design, implementation, management and security of complex networks.
The Predictive Solution
We are a leading network infrastructure consulting company, committed to
building fast, reliable and secure networks and providing efficient, effective
customer-based infrastructure management solutions for our clients. We are
dedicated to understanding both prevalent and cutting-edge technologies to
provide us with relevant and specific technical knowledge. We believe that our
success to date has been largely attributable to the following key
characteristics of our service offerings:
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Quantitative Business Analysis. Using our proprietary quantifiable Business
Analysis 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
tangible and measurable improvements to their business processes.
Fixed-Price, Fixed-Time Engagement Model. We provide our clients with a
service delivery model that is designed to enhance their ability to cost-
effectively leverage our expertise. When engaged on a project outsource basis,
we work with our clients to mutually define a fixed scope of work at the
beginning of the project that is tailored to the clients' specific needs and
therefore, modified from engagement to engagement. We then deliver the
services for a fixed fee, in a fixed period of time with a fixed set of
deliverables.
In-Depth Network Infrastructure Expertise. Our consultants are organized
into practice areas which cover the cornerstones of network infrastructure:
network design and engineering; network and systems management; integrated
customer service; performance management; Global Integrity information
security; and business integration services. 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 needs in a coordinated and efficient manner.
Strategy
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 who 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 Systems 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 invest heavily in the training and
development of our consultants.
Further Increase Our Industry Expertise. We intend to continue to expand
the scope of our industry expertise in order to further penetrate the markets
in which we serve. 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 electronic commerce industries. In
each of these markets, we employ industry experts, pursue targeted sales and
marketing opportunities and develop industry-specific service offerings. We
intend to expand into other industries 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 offices in 12
states throughout the United States and in England, Germany, The Netherlands
and Japan. We intend to continue to pursue strategic acquisitions to gain
access to new geographic markets, additional talented professionals, and
network management tools and methodologies.
Establish Additional and Broaden Existing Strategic Relationships. We have
developed a number of strategic relationships, including alliances with Cisco
Systems and BellSouth. Under these relationships, our partners recommend or
directly resell our services to their clients, including our service products
and our consulting services on a project outsource basis. We intend to
continue to expand the scope of these
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relationships and to develop new strategic alliances to further broaden the
indirect sales channel for our services.
Services
For our Consulting Services division, consultants are organized into six
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 six practice areas are:
o network design and engineering;
o network and systems management;
o integrated customer service;
o performance management;
o Global Integrity information security; and
o business integration services.
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 Design and Engineering. Our network design and engineering practice
is dedicated to helping our clients plan, implement and operate mission-
critical global networks. We have created a team of seasoned professionals
from three major industry training grounds - service providers, network
equipment vendors and Fortune 500 end users. Using their specialized technical
skills and real-world industry experience, our network consultants innovate
network solutions that provide our clients with a measurable competitive
advantage.
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The following table lists some of the services provided by our network
design and engineering practice area:
Service Description
- ------------------------------------------------- -------------------------------------------------
Design, Planning and Implementation.............. Design and implement core backbones and campus
networks. The services include core backbone
design, campus network design, disaster recovery
strategies, protocol transition services and
project management.
Advanced Technology Migration.................... Assists clients in planning new network services
or upgrading existing services. The services
include technology impact studies, technology
evaluation and testing, failure analysis,
performance analysis and network management
analysis.
Multiservice Assessments......................... Assesses ability of clients' network
infrastructure to support a multiservice or
converged (voice/video/data) network. Evaluate
potential convergence solutions and perform
detailed technology and cost-benefit analyses
before recommending a particular solution to a
client.
Addressing, DNS and Routing...................... Designs and implements Internet Protocol address
schemes required for a client to connect to the
Internet. The service also implements management
technologies to administer the Internet Protocol
addresses used within an organization.
Virtual Private Network and Access Solutions..... 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 and Systems Management. Our network and systems management practice
focuses on designing and implementing reliable and continuously available
management systems for large-scale, 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.
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The following table lists some of the services provided by our network and
systems management practice area:
Service Description
- ------------------------------------------------- -------------------------------------------------
Enterprise Management Assessment................. Provides a comprehensive overview of a client's
enterprise management center with the goal of
consolidation, integration and simplicity of
operations. Develops recommendations to align the
enterprise management center with the needs of
the client's organization.
IT Management Center Engineering................. Assists clients in developing and deploying
enterprise management centers. Develops technical
specifications, working prototypes and then
implements the solution.
Event Correlation and Root Cause Analysis........ Provides methodology and tools for quickly and
efficiently pinpointing the location of the core
problems behind network faults so that they can
be resolved.
IT Service Definition/Measurement................ Establishes service definitions and instruments
the measurement of service level agreements
within the enterprise structure.
Technology and Process Integration............... Designs and documents the processes and
procedures required to operate technology
infrastructure.
Acute Problem Diagnosis and Triage............... Identifies root causes and provides resolution
for acute network performance problems.
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Integrated Customer Service. Our integrated customer service practice helps
organizations build proactive, customer-focused service centers that handle
all types of customer inquiries and drive service management. Our solutions
combine a variety of management disciplines, including call and problem
management and customer fulfillment, asset management, knowledge management
and service management.
The following table lists some of the services provided by our integrated
customer service practice area:
Service Description
- ------------------------------------------------- -------------------------------------------------
Call Center/Help Desk Assessment................. Assesses a clients' Call Center and/or IT Help
Desk. Identifies and prioritizes solutions that
will lower costs and enable clients to
effectively support technology.
Asset Management Assessment...................... Assess clients' asset management systems.
Analyzes current documentation and reports and
makes recommendations that enable clients to
effectively manage IT assets throughout the
lifecycle.
Rapid Analysis and Planning Session.............. 1-2 day working session with key personnel and
Predictive consultants to discuss issues and
develop solutions to specific infrastructure
management issues.
E-Infrastructure Management Architect Design..... Evaluates client's current infrastructure
management process and technology and delivers an
infrastructure architect blueprint. Produces an
e-infrastructure management architecture and
transition plan.
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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.
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.
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.
Network Modeling................................. Models a network environment so that new
configuration and new application deployment
scenarios can be simulated before going into
production.
Application Impact Studies....................... Analyzes how an application uses network
resources 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...................... Assists clients' transition from a flat-rate
billing model to a usage-based billing model for
buying network services.
Acute Problem Diagnosis and Triage............... Identifies root causes and provides resolution
for acute network performance problems.
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Global Integrity Information Security. Our Global Integrity Information
Security practice is focused on protecting the confidentiality, integrity and
availability of all data and systems on our clients' networks. 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.
The following table lists some of the services provided by our Global
Integrity Information Security practice area:
Service Description
- ------------------------------------------------- -------------------------------------------------
Assessment....................................... Verifies the implementation and effectiveness of
clients' security policies by reviewing and
testing their policies, employee awareness,
perimeter security and response team readiness.
Ethical Hacking.................................. Attacks a client's network infrastructure and
applications in order to determine how they might
be penetrated by a hacker.
Infrastructure Security.......................... Design and implement security systems using
custom configured products to enforce clients'
specific information security policies.
Product Testing.................................. Perform comprehensive testing on a product in
order to gauge its security.
Forensics........................................ Provides a response team which contains damage
and repels attacks. Restores operational
consistency of the client's systems, maintains
evidence, provides forensic and investigative
services to locate the source of the problem and
facilitate changes to the security systems to
prevent recurrence of the problem.
Business Integration Services. Our Business Integration Services practice
integrates sound business knowledge and methodologies with the technical depth
of our other services to achieve meaningful results. Our business integration
services consultants have in-depth knowledge of specific industries and
combine this knowledge with business process skills in order to maximize the
benefits that our clients realize from their technology infrastructure.
The following table lists some of the services provided by business
integration services practice area:
Service Description
- ------------------------------------------------- -------------------------------------------------
Business Process and Workflow Assessment......... Allows clients to document, review and approve
the business and technical processes needed to
achieve their strategic business goals. Provides
a set of tactical recommendations that provide a
strategic roadmap.
Business Continuity Planning..................... Integrates the business, operations and
information technology interests of clients to
ensure a successful business continuity planning
program.
Enterprise Management Business Impact Analysis... Provides a statistical model that illustrates the
business costs, in lost revenue, productivity or
labor costs to recover from network outages or
service interruptions. This model clearly
quantifies the business impact of investments in
technology solutions.
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Managed Security Services
Our Global Integrity managed services division provides sophisticated,
adaptive managed security services. These services include:
o Monitoring - monitoring firewalls and intrusion detection systems for
suspicious activity;
o Response - responding to crisis' when a client is under siege, applying
cyberforensic techniques to identify perpetrators and delivering cyber
litigation support for prosecution;
o Threat Advisory (ISAC) - our Information Sharing and Analysis Centers
(ISAC) provide industry-specific bureau, and corporate forums for
collecting, analyzing, and distributing cutting-edge information about
threats, vulnerabilities and attacks; and
o Intelligence - our Open Source Intelligence (OSI) program provides
client-specific in-formation impacting brand, operations and security
posture;
Clients
We have provided professional network services to a variety of clients
across a broad range of industries, including:
Bear Stearns CSFBdirect Worldcom
Bell Atlantic CTC Communications Navisite
BellSouth Deutsche Bank Pepsi
British Telecom Exodus Communications Pershing
Cable & Wireless Fidelity Investments Pfizer
Cignal Global Comm. First Union Qwest
Cisco Fleet Bank SIAC
Comdisco iBEAM Broadcasting UUNET
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. We have
developed a number of strategic relationships, including alliances with Cisco
Systems and BellSouth. Under these relationships, our partners recommend or
directly resell our services to their clients, including our consulting
services on a project outsource basis. For example, we serve as BellSouth's
preferred provider of network consulting for their business customers.
Companies can contact BellSouth as the single point of accountability for
their e-business needs, reducing the investment in time and resources needed
to implement effective solutions. We intend to continue to expand the scope of
these relationships and to develop new strategic alliances to further broaden
the indirect sales channel for our services.
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 February 28, 2001, we had 610 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.
Corporate Culture. Our dynamic 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 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
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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 Systems 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 an employee stock
purchase plan.
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, 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 still
evolving. 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. 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
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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.
Risk Factors
An investment in our company 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 trading price of our common stock could decline.
Risks Related to Our Financial Condition and Business Model
Our limited operating history, particularly in light of our recent growth,
makes it difficult for you to evaluate our business and to predict our future
success
We commenced operations in February 1995 and therefore have only a limited
operating history for you to evaluate our business. Because of our limited
operating history, recent growth and the fact that many of our competitors
have longer operating histories, we believe that the prediction of our future
success is difficult. 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. 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 revenues are generated from a small number of clients, our
revenues are difficult to predict and the loss of one client could
significantly reduce our revenues
During the year ended December 31, 2000, BellSouth accounted for 10.2% of
our revenues. Our five largest clients accounted for 37.8% of our revenues for
the year ended December 31, 2000. For the year ended December 31, 1999, our
five largest clients accounted for 45.8% of our revenues. Recently, a number
of our clients have significantly reduced their information technology and
network consulting expenditures. If one of our major clients discontinues or
significantly reduces the use of our services, we may not generate sufficient
revenues to offset this loss of revenues and our net income will decrease. In
addition, the non-payment or late payment of amounts due from a major client
could adversely affect us.
We may not be able to hire a Chief Executive Officer, which could interrupt
our business and adversely affect our growth
Recently, our Chief Executive Officer, Ronald G. Pettengill, Jr., announced
that he was leaving the company. Accordingly, we are engaged in finding his
successor. Our business may suffer if we encounter delays in hiring Mr.
Pettengill's replacement. In addition, there may be only a limited number of
persons with the requisite skills to serve as our Chief Executive Officer and
it may become increasingly difficult to hire such a person. If we are unable
to hire a Chief Executive Officer, or if we cannot successfully integrate a
new Chief Executive Officer into our senior management team, then our ability
to manage our company, effectively deliver our services and carry out our
business plan may be impaired.
Our clients may terminate their contracts with us on short notice
Our services are often delivered pursuant to short-term arrangements and
most clients can reduce or cancel their contracts for our services without
penalty and with little or no notice. If a major client or a
14
number of small clients terminate our contracts or significantly reduce or
modify their business relationships with us, we may not be able to replace the
shortfall in revenues. Consequently, you should not predict or anticipate our
future revenues based upon the number of clients we have currently or the
number and size of our existing projects.
Our operating results may vary from quarter to quarter in future periods, and
as a result, we may fail to meet the expectations of our investors and
analysts, which may cause our stock price to fluctuate or decline
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:
o the loss of key employees;
o the development and introduction of new service offerings;
o reductions in our billing rates;
o the miscalculation of resources required to complete new or ongoing
projects;
o the utilization of our workforce;
o the ability of our clients to meet their payments obligations to us; and
o 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. In addition, our operating results may
be below the expectations of public market analysts or investors in some
future quarter. If this occurs, the price of our common stock is likely to
decline.
We derive a substantial portion of our revenues from fixed-price projects,
under which we assume greater financial risk if we fail to accurately estimate
the costs of the projects
We derive a substantial portion of our revenues from fixed-price projects.
For the years ended December 31, 2000 and 1999, fixed-price projects accounted
for 43.2% and 35.0% 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 a decrease in net income. 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 these periods equal to the
amount by which our revenues were previously overstated.
Our operating results may fluctuate due to seasonal factors which could result
in greater than expected losses
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 reduces our margins and operating
income. Accordingly, we may report greater than expected losses for these
periods.
15
Our long sales cycle makes our revenues difficult to predict and could cause
our quarterly operating results to be below the expectations of public market
analysts and investors
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 reduce our revenues for a quarter and cause our
quarterly operating results to be below the expectations of public market
analysts or investors. If this occurs, the price of our common stock is likely
to decline.
We may need to raise additional capital to grow our business, which we may not
be able to do
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.
As a result, we may not be able to generate sufficient cash from our
operations to meet additional working capital requirements, support additional
capital expenditures or take advantage of acquisition opportunities.
Accordingly, we may need to raise additional capital in the future. 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 ability to operate and grow our business could be impeded.
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 December 31, 2000, our staff increased from
approximately 123 to approximately 691 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. We may not be
able to do so successfully.
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.
Competition in the network consulting industry is intense, and therefore we
may lose projects to our competitors
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. In addition,
competition could result in lower billing rates and gross margins and could
require us to increase our spending on sales and marketing.
We face competition from systems integrators, value added resellers, network
services firms, telecommunications providers, and network equipment and
computer systems vendors. These competitors may be able to respond more
quickly to new or emerging technologies and changes in client requirements or
devote greater resources to the expansion of their market share.
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.
16
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 will suffer.
Our acquisitions of Synet Service Corporation and Global Integrity Corporation
may not result in the benefits we anticipate from a combined company
We recently consummated our acquisition of Synet Service Corporation and
Global Integrity Corporation. The integration of Synet and Global Integrity
into our operations presents us with significant financial, managerial and
operational challenges and may:
o divert management attention form running our existing business;
o require us to expend resources integrating different technologies and
cultures; and
o strain our financial reporting systems and procedures.
The acquisitions may not result in the benefits we anticipate from the
combined company and may underperform relative to our expectations, including
with respect to increased business opportunities and economies of scale, and
the retention of personnel from the acquired companies. Moreover, the
acquisitions will require us to amortize additional goodwill in our financial
statements, leading to an adverse effect on our operating results.
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 have an adverse effect on client satisfaction
and our operating results
Acquisitions, including those already consummated, involve a number of
risks, including:
o adverse effects on our reported operating results due to accounting
charges associated with acquisitions;
o increased expenses, including compensation expense resulting from newly
hired employees; and
o 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.
Competition for experienced personnel is intense and our inability to retain
key personnel could interrupt our business and adversely affect our growth
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 may impair our ability to effectively
deliver our services and manage our company, and to carry out our business
plan. In addition, competition for qualified personnel in the network
consulting industry is intense and we may not be successful in attracting and
retaining these personnel. There may be only a limited number of persons with
the requisite skills to serve in these positions and it may become
increasingly difficult to hire these persons. Our business will suffer if we
encounter delays in hiring additional personnel.
17
Our international expansion efforts, which are a key part of our growth
strategy, may not be successful
We expect to expand our international operations and international sales and
marketing efforts. In January 1999, we commenced operations in England. In
August 1999, we acquired Network Resource Consultants and Company, a network
consulting company based in The Netherlands. Additionally, Synet Services
Corporation, acquired in October 2000, has a German subsidiary and Global
Integrity Corporation, acquired in December 2000, has existing operations in
England and Japan. 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, 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.
We anticipate that we will face the following challenges internationally:
o the burden and expense of complying with a wide variety of foreign laws
and regulatory requirements;
o potentially adverse tax consequences;
o longer payment cycles and problems in collecting accounts receivable;
o technology export and import restrictions or prohibitions;
o tariffs and other trade barriers;
o difficulties in staffing and managing foreign operations;
o cultural and language differences;
o fluctuations in currency exchange rates; and
o seasonal reductions in business activity during the summer months in
Europe.
If we do not appropriately anticipate changes and adapt our practices to
meet these challenges, our growth could be impeded and our results of
operations could suffer.
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. As a result
of the complexities inherent in today's computing environments, we face
significant challenges in remaining abreast of such changes and product
introductions. If we cannot keep pace with these changes, we will not be able
to meet our clients' increasingly sophisticated network management needs and
our services will become less competitive.
Our future success will depend on our ability to:
o keep pace with continuing changes in industry standards, information
technology and client preferences;
o respond effectively to these changes; and
o develop new services or enhance our existing services.
We may be unable 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.
18
If the use of large-scale, complex networks does not continue to grow, we may
not be able to successfully increase or maintain our client base and revenues
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 may not grow and our revenues may
decline.
We may not successfully penetrate the managed services market
In March 2001, we entered into the managed services market. This is a new
market for us and one in which we have not had significant experience.
Entering into this market requires a material financial commitment by us. Our
efforts in this new market may not be successful. Accordingly, we may lose
some or all of the resources we invest in this new market.
If the Internet does not grow and continue to develop as a viable business
tool, demand for our services and our revenues may decline
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:
o inadequate development of the necessary infrastructure;
o lack of development of complementary products (such as high speed modems
and high speed communication lines);
o implementation of competing technology;
o delays in the development or adoption of new standards and protocols
required to handle increased levels of Internet activity; or
o governmental regulation.
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, there will be a significant decline in
the need for our services and our revenues will decline.
Risks Related to Intellectual Property Matters and Potential Legal Liability
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 have to defend against intellectual property infringement claims, which
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. As a result, we may
be subject to legal proceedings
19
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.
Because our services are often critical to our clients' operations, we may be
subject to significant claims if our services do not meet our clients
expectations
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.
Our stock price is likely to be highly volatile and could drop unexpectedly
The market price of our common stock is highly volatile, has fluctuated
substantially and may continue to do so. 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.
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 48.7% 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.
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.
Additional Information
We file annual, quarterly and special reports, proxy statements and other
information with the Commission. You may read and copy all or any portion of
any reports, statements or other information in Predictive's 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 are also available to you on the Commission's
Internet site (http://www.sec.gov).
20
Item 2. Properties
Our principal executive offices are located in New York, New York. We also
lease office space in California, Colorado, Florida, Georgia, Illinois,
Massachusetts, Minneapolis, New Hampshire, New Jersey, North Carolina, Texas,
Virginia, England, Germany, The Netherlands and Japan.
We believe that our existing facilities are adequate for our current needs
and that additional space will be available as needed.
Item 3. Legal Proceedings
Except as set forth below, we are not a party to any material legal
proceedings.
On October 29, 1999, Art Eckert ("Plaintiff") filed an action against
Predictive in which he alleged that Predictive was in breach of an employment
agreement between Plaintiff and Predictive. Plaintiff also alleged that
Predictive fraudulently induced Plaintiff to enter into this purported
employment agreement. Plaintiff seeks to recover damages in excess of $3.2
million with respect to the claim for breach of contract, and damages in
excess of $6.0 million with respect to the claim for fraudulent inducement.
Predictive filed a motion to dismiss the claim for fraudulent inducement on
December 13, 1999. Plaintiff amended the complaint, essentially adding
allegations with respect to the claim for fraudulent inducement, and opposing
Predictive's motion.
By Decision and Order filed on July 11, 2000, Judge S. Barrett Hickman, in
New York Supreme Court, Putnam County, denied Predictive's motion to dismiss
the claim for fraudulent inducement. The case is in the discovery phase and
Predictive intends to defend it vigorously.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 2000.
21
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Market Information
Our common stock has been quoted on the Nasdaq National Market under the
symbol PRDS since our initial public offering on October 27, 1999. The
following table sets forth, for the period indicated, the high and low sale
prices per share of the common stock as reported on the Nasdaq National
Market.
High Low
------ ------
Fourth Quarter 1999 (since October 27, 1999) ................ 68.000 28.000
First Quarter 2000 .......................................... 89.000 42.375
Second Quarter 2000 ......................................... 48.125 25.125
Third Quarter 2000 .......................................... 40.500 14.875
Fourth Quarter 2000 ......................................... 23.3125 6.8125
First Quarter 2001........................................... 9.1875 2.0313
On March 30, 2001, the last sale price of our common stock reported on the
Nasdaq National Market was $2.0313 per share.
Holders
As of March 16, 2001, we had approximately 84 holders of record of our
common stock.
Dividends
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.
Recent Sales of Unregistered Securities
We have sold and issued the following unregistered securities since January
1, 2000:
1. On October 16, 2000, we issued 1,922,377 shares of common stock at
$11.00 per share and options to purchase 242,459 shares of common
stock to the former stockholders and option holders of Synet Service
Corporation in connection with our acquisition of Synet in reliance
upon the exemption from registration provided by Section 4(2) of the
Securities Act.
2. On December 14, 2000, we issued 5,240,275 shares of common stock at
$8.15 per share, and options to purchase 551,048 shares of common
stock to the former stockholders and option holders of Global
Integrity Corporation in connection with our acquisition of Global
Integrity in reliance upon the exemption from registration provided
by Section 4(2) of the Securities Act.
22
Item 6. Selected Consolidated Financial Data
The selected consolidated balance sheet data as of December 31, 2000 and
1999 and the selected consolidated statements of operations data for the years
ended December 31, 2000, 1999 and 1998 have been derived from our audited
consolidated financial statements included elsewhere in this annual report.
The selected consolidated balance sheet data as of December 31, 1998, 1997 and
1996 and the selected consolidated statements of operations data for the years
ended December 31, 1997 and 1996 have been derived from our consolidated
audited financial statements not included in this annual report.
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 annual report.
Year Ended December 31,
--------------------------------------------------
2000 1999 1998 1997 1996
-------- ------- ------- ------- -------
(in thousands, except per share data)
Statement of Operations Data:
Revenues:
Professional services ......................................... $ 85,325 $50,698 $23,858 16,897 6,819
Hardware and software sales ................................... 2,950 2,047 2,065 1,190 1,287
-------- ------- ------- ------- -------
Total revenues ............................................. 88,275 52,745 25,923 18,087 8,106
Cost of Revenues:
Professional services ......................................... 47,420 25,699 12,861 9,590 3,382
Hardware and software purchases ............................... 2,201 1,766 1,699 817 970
-------- ------- ------- ------- -------
Total cost of revenues ..................................... 49,621 27,465 14,560 10,407 4,352
-------- ------- ------- ------- -------
Gross profit ................................................... 38,654 25,280 11,363 7,680 3,754
Operating Expenses:
Sales and marketing ........................................... 12,290 8,478 3,433 1,082 386
General and administrative .................................... 27,309 16,308 8,132 4,331 1,677
Depreciation and amortization ................................. 1,657 756 568 321 142
Intangibles amortization ...................................... 2,912 327 -- -- --
Bad debt expense .............................................. 4,922 501 52 59 6
Noncash compensation expense .................................. 158 48 -- -- --
-------- ------- ------- ------- -------
Operating (loss) profit ........................................ (10,594) (1,138) (822) 1,887 1,543
Other income (expense):
Interest income ............................................... 7,261 944 58 27 31
Other income .................................................. (268) 76 1 4 8
Interest expense .............................................. (191) (157) (324) (36) --
-------- ------- ------- ------- -------
(Loss) income before income tax provision (benefit) ............ (3,792) (275) (1,087) 1,882 1,582
Income tax provision (benefit) ................................. 95 682 (460) 871 719
-------- ------- ------- ------- -------
Net (loss) income .............................................. $ (3,887) $ (957) $ (627) $ 1,011 $ 863
======== ======= ======= ======= =======
Net (loss) income per share --
Basic ......................................................... $ (0.15) $ (0.08) $ (0.11) $ 0.22 $ 0.20
======== ======= ======= ======= =======
Diluted ....................................................... $ (0.15) $ (0.08) $ (0.11) $ 0.08 $ 0.07
======== ======= ======= ======= =======
Weighted average shares outstanding
Basic ......................................................... 26,274 12,138 6,015 4,382 4,269
======== ======= ======= ======= =======
Diluted ....................................................... 26,274 12,138 6,015 12,765 11,586
======== ======= ======= ======= =======
23
Please see Note 4 to our consolidated financial statements for an
explanation of the number of shares used in per share computations for 2000,
1999, 1998, 1997 and 1996.
December 31,
-------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- ------- ------ ------
(in thousands)
Balance Sheet Data:
Cash and cash equivalents ........................ $ 80,059 $ 89,634 $ -- $ 420 $ 638
Marketable securities ............................ 3,794 2,018 -- -- --
Working capital .................................. 104,869 102,092 2,365 1,679 1,178
Total assets ..................................... 251,454 117,250 13,677 6,870 3,629
Total stockholders' equity ....................... 223,694 108,502 2,026 2,072 1,061
Item 7. 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 notes to those statements and other financial information
appearing elsewhere in this annual report.
Forward-Looking Statements
From time to time, we may, through our management, make forward-looking
public statements in press releases or other communications, such as
statements concerning then expected future revenues or earnings or alliances,
product development, and commercialization, as well as other estimates
relating to future operations. Forward-looking statements may be in reports
filed under the Securities Act of 1934, as amended, in press releases, or in
oral statements made with the approval of an authorized executive officer. The
words or phrases "believe," "will likely result," "are expected to," "will
continue," "is anticipated," "estimate," or similar expressions are intended
to identify "forward-looking statements" within the meaning of Section 21E of
the Securities Exchange Act of 1934 and Section 27A of the Securities Act of
1933, as enacted by the Private Securities Litigation Reform Act of 1995.
We wish to caution readers not to place undue reliance on these forward-
looking statements which speak only as of the date on which they are made.
Various factors including those set forth under the section entitled "Risk
Factors," could affect our financial or other performance, and could cause our
actual results for future periods to differ materially from any opinions or
statements expressed with respect to future periods or events in any current
statement.
We will not undertake and specifically decline any obligation to publicly
release the result of any revisions which may be made to any forward-looking
statements to reflect events or circumstances after the date of such
statements or to reflect the occurrence of anticipated or unanticipated events
which may cause management to reevaluate such forward-looking statements.
Overview
Substantially all of our revenues are derived from professional services. We
provide network consulting services to our clients on either a project
outsource or collaborative consulting basis. We derive revenues from these
services on both a fixed-price, fixed-time basis and on a time-and-expense
basis. We use our BusinessFirst approach 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 in excess of $500,000. 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
24
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 under utilization 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 under
utilization include:
o the reduction in size, delay in commencement, interruption or termination
of one or more significant projects;
o the completion during a quarter of one or more significant projects;
o the miscalculation of resources required to complete new or ongoing
projects; and
o the timing and extent of training, weather related shut-downs, vacations
and holidays.
Our cost of revenues consists of costs associated with our professional
services and hardware and software purchases. Costs of revenues associated
with professional services include compensation and benefits for our
consultants and project-related travel expenses. Costs of hardware and
software purchases consist of acquisition costs of third-party hardware and
software resold.
On August 12, 1999, we acquired Network Resource Consultants and Company
B.V. for an aggregate purchase price of approximately $4.3 million. The
purchase price was paid in the form of 1,062,814 shares of our common stock in
exchange for all of the outstanding capital stock of Network Resource
Consultants and Company. The acquisition was accounted for as a purchase and
resulted in intangible assets of approximately $4.3 million representing the
excess purchase price over the fair value of the net tangible assets acquired.
The intangible assets are being amortized over a period of 5 years.
On September 16, 1999, we completed the sale of 1,242,000 shares of our
common stock to Cisco at $12.00 per share for net proceeds of approximately
$14.2 million.
On September 22, 1999, we completed the sale of 94,867 and 18,133 shares of
our common stock to General Atlantic Partners 57, L.P., and GAP Coinvestment
Partners II, L.P., respectively, at $12.00 per share for net proceeds of
approximately $1.4 million.
In November 1999, we consummated the initial public offering of 4.6 million
shares of our common stock, at $18.00 per share, which resulted in net
proceeds to us of approximately $75.1 million after deducting underwriter
discounts and commissions, and other expenses paid by us.
In April 2000, we consummated a follow-on public offering for 3.8 million
shares of our common stock, of which 1.0 million shares were sold by us, while
the reminder were sold by our stockholders, resulting in net proceeds to us of
approximately $39.8 million after deducting underwriter discounts and
commissions, and other expenses paid by us.
On October 16, 2000, we acquired Synet Service Corporation for an aggregate
purchase price, valued at the time of the transaction, of approximately $32.3
million. The purchase price was paid in the form of 1,922,377 shares of our
common stock, options to purchase 242,459 shares of our common stock and $9.0
million in cash, including certain transaction expenses, in exchange for all of
the outstanding capital stock of Synet. The acquisition was accounted for as a
purchase and resulted in intangible assets of approximately $33.4 million
representing customer lists, workforce and the excess of the purchase price over
the fair value of the net tangible assets acquired. The intangible assets are
being amortized over a period of 3- 5 years.
On December 14, 2000, we acquired Global Integrity Corporation for an
aggregate purchase price, valued at the time of the transaction of
approximately $78.2 million. The purchase price was paid in the form of
5,240,275 shares of our common stock, options to purchase 551,048 shares of
common stock and $31.5 million in cash, including certain transaction expenses
in exchange for all of the outstanding capital stock of Global. The
acquisition was accounted for as a purchase and resulted in intangible assets
of approximately
25
$81.1 million representing customer lists, workforce, tradenames, developed
technology and the excess of the purchase price over the fair value of the net
tangible assets acquired. The intangible assets are being amortized over a
period of 3-5 years.
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.
Results of Operations
The following table sets forth certain financial data for the periods
indicated expressed as a percentage of total revenues:
December 31,
----------------------
2000 1999 1998
----- ----- -----
(in thousands)
Revenues:
Professional services ............................... 96.7% 96.1% 92.0%
Hardware and software sales ......................... 3.3 3.9 8.0
----- ----- -----
Total revenues..................................... 100.0 100.0 100.0
Cost of Revenues:
Professional services ............................... 53.7 48.7 49.6
Hardware and software purchases ..................... 2.5 3.4 6.6
----- ----- -----
Total cost of revenues............................. 56.2 52.1 56.2
----- ----- -----
Gross profit.......................................... 43.8 47.9 43.8
Operating Expenses:
Sales and marketing ................................. 13.9 16.1 13.2
General and administrative .......................... 30.9 30.9 31.4
Depreciation and amortization ....................... 1.9 1.4 2.2
Intangibles amortization ............................ 3.3 0.6 --
Bad debt expense .................................... 5.6 1.0 0.2
Noncash compensation expense ........................ 0.2 0.1 --
----- ----- -----
Operating loss........................................ (12.0) (2.2) (3.2)
Other income (expense)................................ 7.7 1.7 (1.0)
----- ----- -----
Loss before income tax provision (benefit)............ (4.3) (0.5) (4.2)
Income tax provision (benefit)........................ 0.1 1.3 (1.8)
----- ----- -----
Net loss.............................................. (4.4)% (1.8)% (2.4)%
===== ===== =====
Years Ended December 31, 2000 and 1999
Revenues. Substantially all of our revenues are derived from fees for
professional services. Revenues increased 67.6% to $88.3 million in 2000 from
$52.7 million in 1999. Revenues from professional services increased 68.3% to
$85.3 million in 2000 from $50.7 million in 1999. This increase was primarily
due to an increase in the number of professional services projects and an
increase in the size of the projects. Revenues from hardware and software
sales increased to $2.9 million in 2000 from $2.0 million in 1999. During
2000, BellSouth accounted for 10.2% of our revenues. The number of our
billable consultants increased from approximately 302 at December 31, 1999 to
approximately 520 at December 31, 2000.
Gross Profit. Gross profit increased 52.9% to $38.7 million in 2000 from
$25.3 million in 1999. As a percentage of revenues, gross profit decreased to
43.8% in 2000 from 47.9% in 1999. The increase in gross profit absolute
dollars was due to efficiencies in completing fixed-price, fixed-time projects
and an increase in average billing rates, offset by lower utilization rates.
Cost of revenues increased to $49.6 million in 2000
26
from $27.5 million in 1999. This increase in cost of revenues was due to an
increase in compensation and benefits paid to consultants, which was directly
related to increased revenue.
Sales and Marketing Expenses. Sales and marketing expenses consist
primarily of compensation and benefits, travel expenses and promotional
expenses. Sales and marketing expenses increased 45.0% to $12.3 million in
2000 from $8.5 million in 1999. As a percentage of revenues, sales and
marketing expenses decreased to 13.9% in 2000 from 16.1% in 1999. This
increase in absolute dollars was primarily due to an increase of $1.3 million
in compensation and benefits paid due to the hiring of additional personnel,
an increase of $1.3 million in marketing expenses and an increase of
$1.2 million in commissions paid.
General and Administrative Expenses. General and administrative expenses
increased 67.5% to $27.3 million in 2000 from $16.3 million in 1999. As a
percentage of revenues, general and administrative expenses were 30.9% in 2000
and 30.9% in 1999. The increase in absolute dollars was primarily due to an
increase of $5.7 million in recruiting and professional development and other
administrative costs, an increase of $2.7 million in facilities and equipment
costs and an increase of $2.6 million in compensation and benefits costs.
Depreciation and Amortization. Depreciation and amortization increased
119.2% to $1.7 million in 2000 from $756,000 in 1999. This increase was due to
purchases of additional equipment to support our growth.
Intangibles Amortization. Amortization of intangibles increased 790.5% to
$2.9 million in 2000 from $327,000 in 1999. In 2000, amount consisted of
$853,000 amortization of intangibles relating to our acquisition of Network
Resource Consultants and Company, $1.4 million amortization of Synet intangibles
related to the acquisition of Synet in October 2000 and $650,000 amortization of
Global intangibles related to the acquisition of Global in December 2000. In
1999, amortization was solely related to the Network Resource Consultants and
Company intangibles.
Bad Debt Expense. Bad debt expense increased 882.4% to $4.9 million in 2000
from $501,000 in 1999. This increase is primarily due to accounts receivable
write-offs of $4.0 million related to ICG, Inc., North Point Communications
and Digital Broadband Communications, Inc. On November 14, 2000, ICG, Inc.
filed for federal bankruptcy protection, which creates significant uncertainty
regarding our ability to collect the outstanding accounts receivables due from
them of $3.6 million. In addition, payments received in 2000 by us from ICG
may be subject to a challenge under federal bankruptcy laws. On December 27,
2000, Digital Broadband filed for federal bankruptcy protection, which creates
significant uncertainty regarding our ability to collect the outstanding
accounts receivables due from them of $15,000. On January 16, 2001, North
Point filed for federal bankruptcy protection, which creates significant
uncertainty regarding our ability to collect the outstanding accounts
receivables due from them of $350,000. The remaining increase represents
additional provision charged to expense, which was directly related to
increased revenue and trade accounts receivable balances.
Noncash Compensation Expense. During 1999, we granted options to purchase
shares of common stock at exercises prices that were less than the fair market
value of the underlying shares of common stock. During 2000, related to the
acquisitions of Synet and Global, we issued Predictive options to Synet and
Global option holders for the unvested portion of their Synet and Global
options, respectively. These transactions resulted in noncash compensation
expense of approximately $158,000 for the year ended December 31, 2000. The
remaining noncash compensation expense beyond 2000 is currently estimated to
be $694,000.
Other Income (Expense). Other income increased 688.2% to $6.8 million in
2000 from $863,000 in 1999. This increase was primarily due to an increase of
$6.3 million in interest income related to net proceeds from our initial and
follow-on public offerings, which proceeds were invested in interest-bearing
cash equivalents and marketable securities.
Income Taxes. Income tax provision was $95,000 on pre-tax losses of $3.8
million for 2000. In 1999, the income tax provision was $682,000 on pre-tax
losses of $275,000. The effective tax rate was 2.5% and 248.3% during 2000 and
1999, respectively. The change in the effective tax rates primarily relates to
the provision for a valuation allowance against net operating losses of our
subsidiaries as well as non-deductible
27
amortization expense of the intangibles resulting from the acquisitions of
Network Resource Consultants and Company, Synet and Global.
Years Ended December 31, 1999 and 1998
Revenues. Revenues increased 103.5% to $52.7 million in 1999 from $25.9
million in 1998. Revenues from professional services increased 112.5% to $50.7
million in 1999 from $23.9 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 the projects. Revenues from hardware and software sales decreased
to $2.0 million in 1999 from $2.1 million in 1998. During 1999, Qwest
Communications and Bear Stearns accounted for 16.8% and 14.0%, respectively,
of our revenues. The number of our billable consultants increased to
approximately 302 at December 31, 1999 from approximately 149 at December 31,
1998.
Gross Profit. Gross profit increased 122.5% to $25.3 million in 1999 from
$11.4 million in 1998. As a percentage of revenues, gross profit increased to
47.9% in 1999 from 43.8% 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. Cost of revenues
increased to $27.5 million in 1999 from $14.6 million in 1998. This increase
in cost of revenues was due to an increase in compensation and benefits paid
to consultants, which was directly related to increased revenue.
Sales and Marketing Expenses. Sales and marketing expenses increased 146.9%
to $8.5 million in 1999 from $3.4 million in 1998. As a percentage of
revenues, sales and marketing expenses increased to 16.1% in 1999 from 13.2%
in 1998. This increase was primarily due to an increase of $3.7 million in
compensation and benefits paid due to the hiring of additional personnel, and
an increase of $1.1 million in commissions paid.
General and Administrative Expenses. General and administrative expenses
increased 100.5% to $16.3 million in 1999 from $8.1 million in 1998. As a
percentage of revenues, general and administrative expense decreased to 30.9%
in 1999 from 31.4% in 1998. The increase in absolute dollars was primarily due
to an increase of $3.5 million in recruiting and professional development and
other administrative costs, an increase of $3.3 million in compensation and
benefits costs, and an increase of $1.4 million in facilities and equipment
costs.
Depreciation and Amortization. Depreciation and amortization increased
33.1% to $756,000 in 1999 from $568,000 in 1998. This increase was due to
purchases of additional equipment to support our growth.
Intangibles Amortization. During August 1999, we acquired Network Resource
Consultants and Company. This acquisition resulted in amortization of intangible
assets of $327,000 in 1999.
Bad Debt Expense. Bad debt expense increased 863.5% to $501,000 in 1999
from $52,000 in 1998. This increase was due to additional provision charged to
expense, which was directly related to increased revenue and trade accounts
receivable balances.
Noncash Compensation Expense. During 1999, we granted options to purchase
shares of common stock at exercises prices that were less than the fair market
value of the underlying shares of common stock. This resulted in noncash
compensation expense of approximately $48,000 for the year ended December 31,
1999. The remaining noncash compensation expense beyond 1999 is currently
estimated to be $257,000.
Other Income (Expense). Other income (expense) changed to income of $863,000
in 1999 from expense of ($265,000) in 1998. This change was primarily due to an
increase of $886,000 in interest income related to net proceeds from our initial
public offering, which proceeds were invested in interest-bearing cash
equivalents and marketable securities.
Income Taxes. Income tax expense was $682,000 on pre-tax losses of $275,000
for 1999. In 1998, the income tax benefit was ($460,000) on pre-tax losses of
$1.1 million. The effective tax rate was 248.3% and 42.3% during 1999 and
1998, respectively. The change in the effective tax rates primarily relates to
the provision for a valuation allowance against net operating losses of our
foreign subsidiaries as well as non-deductible amortization expense of the
intangibles resulting from the acquisition of Network Resource Consultants and
Company.
28
Quarterly Results of Operations
The following table sets forth unaudited quarterly statement of operations
data for each of the eight quarters in the period ended December 31, 2000 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
-------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31,
2000 2000 2000 2000
-------- -------- --------- --------
Revenues:
Professional services ............................................... $18,901 $22,067 $23,754 $ 20,603
Hardware and software sales ......................................... 144 1,308 913 585
------- ------- ------- --------
Total revenues..................................................... 19,045 23,375 24,667 21,188
Cost of Revenues:
Professional services ............................................... 9,706 11,169 12,137 14,408
Hardware and software sales ......................................... 108 1,000 669 424
------- ------- ------- --------
Total cost of revenues............................................. 9,814 12,169 12,806 14,832
------- ------- ------- --------
Gross profit.......................................................... 9,231 11,206 11,861 6,356
Operating Expenses:
Selling and marketing ............................................... 2,651 3,126 3,169 3,344
General and administrative .......................................... 5,378 6,310 6,877 8,744
Depreciation and amortization ....................................... 275 439 453 490
Intangibles amortization ............................................ 213 213 213 2,273
Bad debt expense .................................................... 62 114 77 4,669
Noncash compensation expense ........................................ 19 19 19 101
------- ------- ------- --------
Operating profit (loss)............................................... 633 985 1,053 (13,265)
Other income.......................................................... 1,237 1,941 2,068 1,556
------- ------- ------- --------
Income (loss) before income tax provision (benefit)................... 1,870 2,926 3,121 (11,709)
Income tax provision (benefit)........................................ 842 1,262 1,339 (3,348)
------- ------- ------- --------
Net income (loss)..................................................... $ 1,028 $ 1,664 $ 1,782 $ (8,361)
======= ======= ======= ========
Percentage of Total Revenues
-------------------------------------------
Revenues:
Professional services ............................................... 99.2% 94.4% 96.3% 97.2%
Hardware and software sales ......................................... 0.8 5.6 3.7 2.8
------- ------- ------- --------
Total revenues..................................................... 100.0 100.0 100.0 100.0
Cost of Revenues:
Professional services ............................................... 50.9 47.8 49.2 68.0
Hardware and software sales ......................................... 0.6 4.3 2.7 2.0
------- ------- ------- --------
Total cost of revenues............................................. 51.5 52.1 51.9 70.0
------- ------- ------- --------
Gross profit.......................................................... 48.5 47.9 48.1 30.0
Operating Expenses:
Selling and marketing ............................................... 13.9 13.4 12.9 15.8
General and administrative .......................................... 28.3 26.9 27.9 41.3
Depreciation and amortization ....................................... 1.5 1.9 1.8 2.3
Intangibles amortization ............................................ 1.1 0.9 0.9 10.7
Bad debt expense .................................................... 0.3 0.5 0.3 22.0
Noncash compensation expense ........................................ 0.1 0.1 0.1 0.5
------- ------- ------- --------
Operating profit (loss)............................................... 3.3 4.2 4.2 (62.6)
Other income (expense)................................................ 6.5 8.3 8.4 7.3
------- ------- ------- --------
Income (loss) before income tax provision (benefit)................... 9.8 12.5 12.6 (55.3)
Income tax provision (benefit)........................................ 4.4 5.4 5.4 (15.8)
------- ------- ------- --------
Net income (loss)..................................................... 5.4% 7.1% 7.2% (39.5)%
======= ======= ======= ========
29
Quarter Ended
-------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31,
1999 1999 1999 1999
-------- -------- --------- --------
Revenues:
Professional services ............................................... $ 9,887 $11,391 $13,624 15,796
Hardware and software sales ......................................... 478 810 465 294
------- ------- ------- -------
Total revenues..................................................... 10,365 12,201 14,089 16,090
Cost of Revenues:
Professional services ............................................... 4,849 5,397 7,005 8,448
Hardware and software sales ......................................... 426 606 299 435
------- ------- ------- -------
Total cost of revenues............................................. 5,275 6,003 7,304 8,883
------- ------- ------- -------
Gross profit.......................................................... 5,090 6,198 6,785 7,207
Operating Expenses:
Selling and marketing ............................................... 1,589 1,820 2,424 2,645
General and administrative .......................................... 3,342 3,690 4,604 4,672
Depreciation and amortization ....................................... 144 168 227 217
Intangibles amortization ............................................ -- -- 114 213
Bad debt expense .................................................... 127 218 106 50
Noncash compensation expense ........................................ 5 5 19 19
------- ------- ------- -------
Operating profit (loss)............................................... (117) 297 (709) (609)
Other income (expense)................................................ (28) 26 25 840
------- ------- ------- -------
Income (loss) before income tax provision (benefit)................... (145) 323 (684) 231
Income tax provision (benefit)........................................ (49) 410 (56) 377
------- ------- ------- -------
Net income (loss)..................................................... $ (96) $ (87) $ (628) $ (146)
======= ======= ======= =======
Percentage of Total Revenues
-------------------------------------------
Revenues:
Professional services ............................................... 95.4% 93.4% 96.7% 98.2%
Hardware and software sales ......................................... 4.6 6.6 3.3 1.8
------- ------- ------- -------
Total revenues..................................................... 100.0 100.0 100.0 100.0
Cost of Revenues:
Professional services ............................................... 46.8 44.2 49.7 52.5
Hardware and software sales ......................................... 4.1 5.0 2.1 2.7
-------- -------- --------- --------
Total cost of revenues............................................. 50.9 49.2 51.8 55.2
------- ------- ------- -------
Gross profit.......................................................... 49.1 50.8 48.2 44.8
Operating Expenses:
Selling and marketing ............................................... 15.3 14.9 17.2 16.5
General and administrative .......................................... 32.3 30.2 32.7 29.0
Depreciation and amortization ....................................... 1.4 1.4 1.6 1.4
Intangibles amortization ............................................ -- -- 0.8 1.3
Bad debt expense .................................................... 1.2 1.8 0.8 0.3
Noncash compensation expense ........................................ -- -- 0.1 0.1
------- ------- ------- -------
Operating profit (loss)............................................... (1.1) 2.5 (5.0) (3.8)
Other income (expense)................................................ (0.3) 0.2 0.1 5.2
------- ------- ------- -------
Income (loss) before income tax provision (benefit)................... (1.4) 2.7 (4.9) 1.4
Income tax provision (benefit)........................................ (0.5) 3.4 (0.4) 2.3
------- ------- ------- -------
Net income (loss)..................................................... (0.9)% (0.7)% (4.5)% (0.9)%
======= ======= ======= =======
30
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 flows from operations. As of December 31, 2000, we had
approximately $80.1 million in cash and cash equivalents and $3.8 million in
marketable securities.
Cash used in operating activities decreased to $2.0 million for 2000 from
$2.6 million for 1999. A significant use of cash resulted from an increase in
accounts receivable and unbilled work in progress partially offset by a decrease
in accounts payable.
Cash used in operating activities was $2.6 million in 1999 and $3.7 million
in 1998. A significant use of cash resulted from an increase in accounts
receivable partially offset by an increase in accrued expenses and other current
liabilities.
Cash used in investing activities was $53.8 million in 2000, $2.7 million in
1999 and $2.1 million in 1998. Our capital expenditures were $7.0 million for
2000, $2.2 million for 1999 and $687,000 for 1998. Capital expenditures were
made to purchase computer equipment, office furniture and for leasehold
improvements. In 2000, a significant use of cash resulted from $43.3 million
net cash paid in the acquisitions of Synet and Global and $2.0 million in
long-term investments.
Cash provided by financing activities was $46.0 million for 2000, $95.0
million for 1999 and $5.4 million for 1998. Cash provided by financing
activities for 2000 resulted from the receipt of approximately $39.8 million
in net proceeds from the sale of our common stock in a follow-on offering,
$3.6 million in proceeds from exercise of stock options and $2.6 million in
proceeds from the sale of our common stock in connection with our employee
stock purchase plan. Cash provided by financing activities for 1999 resulted
from the receipt of approximately $75.1 million in net proceeds from the sale
of our common stock in our initial public offering, the receipt of
approximately $18.6 million in net proceeds related to the sale of preferred
stock and the receipt of approximately $15.5 million in net proceeds from the
sale of common stock to Cisco and partnerships affiliated with General
Atlantic Partners, LLC prior to the initial public offering, offset partially
by the repayment of short-term borrowings and repurchase of treasury stock.
Cash provided by financing activities for 1998 resulted from short-term
borrowings.
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 December 31, 2000, there were no amounts
outstanding under the facility.
31
Recent Accounting Pronouncements
In December 1999, the SEC issued Staff Accounting Bulletin No. 101 ("SAB
101"), "Revenue Recognition in Financial Statements." SAB 101 provides
guidance on the recognition, presentation, and disclosure of revenue in
financial statements filed with the SEC. SAB 101 does not supersede any
existing authoritative literature. We adopted the principles of SAB 101 during
2000, the effect of which was not material to our results of operations or
financial position.
In March 2000, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions
Involving Stock Compensation, an Interpretation of APB No. 25." FIN 44
provides guidance on certain aspects of applying APB No. 25. FIN 44 is
effective July 1, 2000, but is also effective for certain events that have
occurred after December 15, 1998 or January 12, 2000. We adopted the
principles of FIN 44 during 2000, the effect of which was not material to our
results of operations or financial position.
Disclosure Regarding Private Securities Litigation Reform Act of 1995
From time to time, the Company, through its management, may make forward-
looking public statements in press releases or other communications, such as
statements concerning then expected future revenues or earnings or alliances,
product development, and commercialization, as well as other estimates
relating to future operations. Forward-looking statements may be in reports
filed under the Securities Exchange Act of 1934, as amended, in press
releases, or in oral statements made with the approval of an authorized
executive officer. The words or phrases "believe," "will likely result," "are
expected to," "will continue," "is anticipated," "estimate," or similar
expressions are intended to identify "forward-looking statements" within the
meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A
of the Securities Act of 1933, as enacted by the Private Securities Litigation
Reform Act of 1995.
The Company wishes to caution readers not to place undue reliance on these
forward-looking statements which speak only as of the date on which they are
made. Various factors including those set forth under the section entitled
"Risk Factors," could affect the Company's financial or other performance, and
could cause the Company's actual results for future periods to differ
materially from any opinions or statements expressed with respect to future
periods or events in any current statement.
The Company will not undertake and specifically declines any obligation to
publicly release the result of any revisions which may be made to any forward-
looking statements to reflect events or circumstances after the date of such
statements or to reflect the occurrence of anticipated or unanticipated events
which may cause management to reevaluate such forward-looking statements.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Currency Rate Fluctuations.
Our results of operations, financial position and cash flows are not
materially affected by changes in the relative values of non-U.S. currencies
to the U.S. dollar. We do not use derivative financial instruments to limit
our foreign currency risk exposure.
Market Risk.
Our accounts receivable are subject, in the normal course of business, to
collection risks. We regularly assess these risks and have established
policies and business practices to protect against the adverse effects of
collection risks. As a result, we do not anticipate any material losses in
this area.
Interest Rate Risks.
We do not currently have any outstanding indebtedness. In addition, our
investments are classified as cash and cash equivalents with original
maturities of three months or less. Therefore, we are not exposed to material
market risk arising from interest rate changes, nor do such changes affect the
value of investments as recorded by us.
32
Item 8. Financial Statements and Supplementary Data
Reference is made to the financial statements listed under the heading
"(a)(1) Consolidated Financial Statements" of Item 14 hereof, which financial
statements are incorporated herein by reference in response to this Item 8.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
33
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required by this item is incorporated by reference from the
information under the captions "Election of Directors" and "Executive
Compensation, Management and Other Information" contained in our definitive
proxy statement to be filed no later than April 30, 2001, in connection with
the solicitation of proxies for our annual meeting of stockholders to be held
May 16, 2001 (the "Proxy Statement").
Item 11. Executive Compensation
The information required by this item is incorporated by reference from the
information under the caption "Executive Compensation, Management and Other
Information" contained in the Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is incorporated by reference from the
information under the caption "Security Ownership of Certain Beneficial Owners
and Management" contained in the Proxy Statement.
Item 13. Certain Relationships and Related Transactions
The information required by this item is incorporated by reference from the
information under the caption "Certain Transactions" contained in the Proxy
Statement.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Consolidated Financial Statements.
The following consolidated financial statements of Predictive Systems, Inc.
and Subsidiaries and the Report of Independent Public Accountants thereon are
included in Item 8 above:
Page
----
Report of Independent Public Accountants ................................ F-2
Consolidated Balance Sheets as of December 31, 2000 and 1999. ........... F-3
Consolidated Statements of Operations for the Years Ended December 31,
2000, 1999 and 1998.................................................... F-4
Consolidated Statements of Stockholders' Equity and Comprehensive Income
for the Years Ended December 31, 2000, 1999 and 1998................... F-5
Consolidated Statements of Cash Flows for the Years Ended December 31,
2000, 1999 and 1998.................................................... F-7
Notes to Consolidated Financial Statements. ............................. F-9
(a) (2) Financial Statement Schedule.
Page
----
Schedule II -- Schedule of Valuation and Qualifying Accounts............. S-2
34
(a) (3) Exhibits.
The following Exhibits are incorporated herein by reference or are filed
with this report as indicated below.
Number Description
------ -----------
3.1* Amended and Restated Certificate of Incorporation.
3.2** Amended and Restated By-laws.
4.1*** Specimen common stock certificate.
4.2 See Exhibits 3.1 and 3.2 for provisions of the Amended and Restated Certificate of Incorporation and Amended and
Restated By-laws of the Registrant defining the rights of holders of Common Stock of the Registrant.
10.1*** 1999 Stock Incentive Plan.
10.2*** 1999 Employee Stock Purchase Plan.
10.3 Synet Service Corporation 1996 Stock Option Plan.
10.3.1 Global Integrity Corporation 1998 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.
10.7 Amended and Restated Registration Rights Agreement, dated December 14, 2000.
10.8*** Secured Promissory Note, dated August 31, 1998, in favor of Brown Brothers Harriman & Co.
10.9*** Agreement of Lease, dated June 25, 1999, by and between the Registrant and Polestar Fifth Property Associates LLC.
10.10+ Development and License Agreement, dated July 29, 1998, by and between Bear Stearns & Company, Inc. and the
Registrant.
10.11 Professional Services Agreement, dated November 7, 2000 by and between the Registrant and Bear, Sterns & Co., Inc.
10.12 Professional Services Agreement, dated March 1, 2000 by and between the Registrant and RiverSoft Inc.
10.14+ Systems Integration Consulting Services Agreement, dated May 21, 1998, by and between LCI International Telecom Corp.
dba Qwest Communications Corporation and the Registrant.
10.15*** Amendment No. 1 to Consulting Services Agreement dated June 21, 1999, to Systems Integration Consulting Services
Agreement, dated May 21, 1998, by and between LCI International Telecom Corp. dba Qwest Communications Corporation and
the Registrant.
10.16 Technical Services Agreement, dated November 17, 2000 by and between Science Applications International Corporation
and Global Integrity Corporation.
10.17 Assignment and Cross License Agreement, dated December 6, 2000 by and between Science Applications International
Corporation and Global Integrity Corporation.
10.19*** Investor's Rights Agreement, dated September 16, 1999, by and between Cisco Systems, Inc. and the Registrant.
10.20+ Professional Services Subcontract, dated May 14, 1999, by and between Cisco Systems, Inc. and the Registrant.
10.21 Employment and Non-Competition Agreement, dated October 16, 2000 by and between the Registrant and Bart Greenwood.
10.22 Service Agreement, dated January 1, 2001 by and between the Registrant and Eammon Kearns.
10.23*** Employment Agreement, dated September 21, 1999 by and between Gerard Dorsey and the Registrant.
10.24++ Software Development and Service Agreement, effective January 15, 2001, by and between the Registrant and BellSouth
Telecommunications, Inc.
21.1 List of Subsidiaries.
23.1 Consent of Arthur Andersen LLP.
35
- ---------------
* Incorporated by reference to Exhibit 3.2 of Predictive's Registration
Statement on Form S-1, No. 333-84045 ("Registration Statement No. 333-
84045").
** Incorporated by reference to Exhibit 3.4 of Registration Statement No.
333-84045.
*** Incorporated by reference to the identically numbered exhibit of
Registration Statement No. 333-84045.
+ Non-confidential portions of this Exhibit were filed as the identically
numbered exhibit of Registration Statement No. 333-84045, which non-
confidential portions are incorporated herein by reference. Confidential
treatment was granted for certain portions of this Exhibit pursuant to
Rule 406 promulgated under the Securities Act. Confidential portions of
this Exhibit have been filed separately with the Securities and Exchange
Commission.
++ Confidential treatment to be requested for certain portions of this
Exhibit pursuant to Rule 406 promulgated under the Securities Act.
Confidential portions of this Exhibit have been filed separately with the
Securities and Exchange Commission.
(b) Reports on Form 8-K
The Company filed two reports on Form 8-K during the fourth quarter ended
December 31, 2000. Information regarding the items reported on is as follows:
October 31, 2000
The Company announced the completion of the acquisition of Synet Service
Corporation.
December 27, 2000
The Company announced the completion of the acquisition of Global Integrity
Corporation.
36
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, as amended, the
Registrant has duly caused this Report 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 March, 2001.
PREDICTIVE SYSTEMS, INC.
By: Ronald G. Pettengill, Jr.
---------------------------------
Name: Ronald G. Pettengill, Jr.
Title: Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Report has been signed by the following persons in the
capacities indicated.
Signature Title(s) Date
--------- -------- ----
/s/ Ronald G. Pettengill, Jr. Chief Executive Officer March 29, 2001
------------------------------------- (principal executive officer)
Ronald G. Pettengill, Jr.
/s/ Robert L. Belau President and Director March 29, 2001
-------------------------------------
Robert L. Belau
/s/ Gerard E. Dorsey Chief Financial Officer (principal March 29, 2001
------------------------------------- financial and accounting officer)
Gerard E. Dorsey
/s/ Peter L. Bloom Director March 29, 2001
-------------------------------------
Peter L. Bloom
/s/ Braden R. Kelly Director March 29, 2001
-------------------------------------
Braden R. Kelly
/s/ Eric Meyer Director March 29, 2001
-------------------------------------
Eric Meyer
/s/ Inder Sidhu Director March 29, 2001
-------------------------------------
Inder Sidhu
/s/ William L. Smith Director March 29, 2001
-------------------------------------
William L. Smith
/s/ William W. Wyman Chairman of the Board of Directors March 29, 2001
-------------------------------------
William W. Wyman
37
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Public Accountants........................................................... F-2
Consolidated Balance Sheets as of December 31, 2000 and 1999....................................... F-3
Consolidated Statements of Operations for the Years Ended December 31, 2000, 1999 and 1998......... F-4
Consolidated Statements of Stockholders' Equity and Comprehensive Income for the Years
Ended December 31, 2000, 1999 and 1998............................................................. F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 2000, 1999 and 1998......... F-7
Notes to Consolidated Financial Statements......................................................... F-9
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Predictive Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Predictive
Systems, Inc. (a Delaware corporation) (the "Company") and subsidiaries as of
December 31, 2000 and 1999, and the related consolidated statements of
operations, stockholders' equity and comprehensive income and cash flows for
each of the three years in the period ended December 31, 2000. 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 auditing standards generally accepted
in the United States. 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. and
subsidiaries as of December 31, 2000 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2000 in conformity with accounting principles generally accepted in
the United States.
/s/ ARTHUR ANDERSEN LLP
-----------------------
New York, New York
February 7, 2001
F-2
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
------------
2000 1999
---- ----
ASSETS
CURRENT ASSETS:
Cash and cash equivalents............................................................ $ 80,058,791 $ 89,633,634
Marketable securities................................................................ 3,794,100 2,018,060
Accounts receivable--net of allowance for doubtful accounts of $1,292,491 and
$568,344, respectively............................................................. 22,454,109 15,330,018
Unbilled work in process............................................................. 5,055,471 289,120
Related party receivables............................................................ 4,115,043 927,286
Receivables from employees and stockholders.......................................... 423,074 116,859
Refundable income taxes.............................................................. -- 669,896
Deferred tax asset................................................................... 5,125,792 75,541
Prepaid expenses and other current assets............................................ 2,335,192 1,144,176
------------ ---------
Total current assets................................................................. 123,361,572 110,204,590
Property and equipment -- net of accumulated depreciation and amortization of
$3,363,265 and $1,703,711, respectively............................................ 10,403,523 2,884,105
Intangible assets, net of accumulated amortization of $3,238,598 and
$326,871, respectively............................................................. 115,441,166 3,936,666
Long-term investments in related parties............................................. 2,000,000 --
Other assets......................................................................... 248,068 224,740
------------ ------------
Total assets......................................................................... $251,454,329 $117,250,101
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable..................................................................... $ 3,062,164 $ 2,322,065
Accrued compensation................................................................. 3,096,492 2,005,859
Accrued expenses and other current liabilities....................................... 8,976,557 2,536,292
Current portion of capital lease obligations......................................... 137,734 183,193
Current portion of notes payable..................................................... 16,000 --
Income taxes payable................................................................. 313,267 --
Deferred income...................................................................... 2,890,130 1,064,721
------------ ------------
Total current liabilities............................................................ 18,492,344 8,112,130
NONCURRENT LIABILITIES:
Capital lease obligations............................................................ 151,965 284,037
Deferred rent........................................................................ 530,589 49,863
Deferred income tax liability........................................................ 8,585,145 299,851
Other long-term liabilities.......................................................... -- 2,498
------------ ------------
Total liabilities.................................................................... 27,760,043 8,748,379
------------ ------------
COMMITMENTS AND CONTINGENCIES (Note 12)
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value, 10,000,000 shares authorized, 0 shares issued
and outstanding.................................................................... -- --
Common stock, $.001 par value, 200,000,000 shares authorized,
34,903,696 and 23,429,200 shares issued and outstanding............................ 34,904 23,429
Additional paid-in capital........................................................... 227,753,713 108,404,681
Deferred compensation................................................................ (694,280) (256,672)
Retained earnings (accumulated deficit) ............................................. (3,517,572) 369,625
Accumulated other comprehensive income (loss)........................................ 117,521 (39,341)
------------ ------------
Total stockholders' equity........................................................... 223,694,286 108,501,722
------------ ------------
Total liabilities and stockholders' equity........................................... $251,454,329 $117,250,101
============ ============
The accompanying notes to consolidated financial statements are an
integral part of these consolidated balance sheets.
F-3
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For The Years Ended December 31,
--------------------------------
2000 1999 1998
---- ---- ----
Revenues:
Professional services............................... $ 85,325,305 $50,698,035 $23,857,780
Hardware and software sales......................... 2,949,961 2,046,810 2,065,348
------------ ----------- -----------
Total revenues...................................... 88,275,266 52,744,845 25,923,128
------------ ----------- -----------
Cost of Revenues:
Professional services............................... 47,420,520 25,698,926 12,861,272
Hardware and software purchases..................... 2,200,748 1,765,746 1,698,356
------------ ----------- -----------
Total cost of revenues.............................. 49,621,268 27,464,672 14,559,628
------------ ----------- -----------
Gross profit........................................ 38,653,998 25,280,173 11,363,500
Operating Expenses:
Sales and marketing................................. 12,290,414 8,477,692 3,433,751
General and administrative.......................... 27,309,249 16,308,363 8,132,209
Depreciation and amortization....................... 1,657,311 756,019 567,761
Intangibles amortization............................ 2,911,727 326,871 --
Bad debt expense.................................... 4,921,556 501,141 52,277
Noncash compensation expense........................ 157,557 47,953 --
------------ ----------- -----------
Operating loss...................................... (10,593,816) (1,137,866) (822,498)
Other Income (Expense):
Interest income..................................... 7,260,536 943,898 57,976
Other (expense) income ............................. (268,314) 76,309 1,555
Interest expense.................................... (190,519) (157,210) (324,591)
------------ ----------- -----------
Loss before income tax
provision (benefit)................................. (3,792,113) (274,869) (1,087,558)
Income tax provision (benefit)...................... 95,084 682,497 (460,258)
------------ ----------- -----------
Net loss............................................ $ (3,887,197) $ (957,366) $ (627,300)
============ =========== ===========
Net loss per share --
Basic and Diluted................................... $(0.15) $(0.08) $(0.11)
============ =========== ===========
Weighted average common shares outstanding--
Basic and Diluted................................... 26,273,946 12,137,560 6,015,433
============ =========== ===========
The accompanying notes to consolidated financial statements are an
integral part of these consolidated statements.
F-4
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
Convertible
Preferred Stock Common Stock Additional
----------------------- ----------------------- Paid-in
Shares Par Value Shares Par Value Capital
------ --------- ------ --------- ----------
Balance at December 31, 1997...................... -- $-- 4,408,200 $4,408 $69,762
Net loss....................................... -- -- -- -- --
Exercise of options............................ -- -- 3,492,000 3,492 612,508
Preferred stock dividends...................... -- -- -- -- --
---------- ------- ---------- ------- ------------
Balance at December 31, 1998...................... -- -- 7,900,200 7,900 682,270
Comprehensive loss
Net loss....................................... -- -- -- -- --
Unrealized gains on investments................ -- -- -- -- --
Foreign currency translation adjustment........ -- -- -- -- --
Total comprehensive loss.......................... -- -- -- -- --
Preferred stock dividends...................... -- -- -- -- --
Issuance of preferred stock.................... 6,512,316 6,512 -- -- 18,559,713
Common stock repurchased to
treasury, 2,855,100 shares................... -- -- -- -- --
Issuance of common stock, net of
offering expenses of $750,000................ -- -- 1,355,000 1,355 15,508,645
Issuance of common stock in
connection with the acquisition of NRCC...... -- -- 1,062,814 1,063 4,250,193
Issuance of common stock in initial
public offering, net of offering
expenses, including the
reissuance of 2,855,100 shares
of treasury stock............................ -- -- 1,744,900 1,745 66,737,265
Conversion of preferred stock to
common stock................................. (6,512,316) (6,512) 10,712,316 10,712 695,800
Exercise of options............................ -- -- 653,970 654 300,065
Income tax benefit relating to
exercise of options.......................... -- -- -- -- 1,366,105
Recognition of deferred compensation........... -- -- -- -- 304,625
Noncash compensation expense................... -- -- -- -- --
---------- ------- ---------- ------- ------------
Balance at December 31, 1999...................... -- -- 23,429,200 23,429 108,404,681
Comprehensive loss
Net loss....................................... -- -- -- -- --
Unrealized loss on investments................. -- -- -- -- --
Foreign currency translation adjustment........ -- -- -- -- --
Total comprehensive loss -- -- -- -- --
Issuance of common stock in connection with
Employee Stock Purchase Plan................... -- -- 192,723 193 2,571,958
Issuance of common stock in secondary offering,
net of offering expenses of $917,000......... -- -- 1,000,000 1,000 39,823,079
Issuance of common stock and options in
connection with the acquisition of Synet..... -- -- 1,922,377 1,923 22,729,425
Issuance of common stock and options in
connection with the acquisition of Global
Integrity.................................... -- -- 5,240,275 5,240 45,057,627
Exercise of options............................ -- -- 3,119,121 3,119 3,928,871
Income tax benefit relating to
exercise of options.......................... -- -- -- -- 5,238,072
Noncash compensation expense................... -- -- -- -- --
---------- ------- ---------- ------- ------------
Balance at December 31, 2000...................... -- $ -- 34,903,696 $34,904 $227,753,713
========== ======= ========== ======= ============
The accompanying notes to consolidated financial statements are an
integral part of these consolidated statements.
F-5
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME -- (Continued)
Retained Accumulated
Earnings Other Total
Treasury Deferred (Accumulated Comprehensive Stockholders'
Stock Compensation Deficit) Income (Loss) Equity
----- ------------ -------- -------------
Balance at December 31, 1997............... $ -- $ -- $ 1,998,041 $ -- $ 2,072,211
Net loss................................ -- -- (627,300) -- (627,300)
Exercise of options..................... -- -- -- -- 616,000
Preferred stock dividends............... -- -- (35,000) -- (35,000)
----------- --------- ----------- -------- ------------
Balance at December 31, 1998............ -- -- 1,335,741 -- 2,025,911
Comprehensive loss
Net loss................................ -- -- (957,366) (957,366)
Unrealized gains on investments......... -- -- -- 1,426 1,426
Foreign currency translation
adjustment............................ -- -- -- (40,767) (40,767)
----------- --------- ----------- -------- ------------
Total comprehensive loss................ (996,707)
============
Preferred stock dividends............... -- -- (8,750) -- (8,750)
Issuance of preferred stock............. -- -- -- -- 18,566,225
Common stock repurchased to
treasury, 2,855,100 shares............ (8,398,753) -- -- -- (8,398,753)
Issuance of common stock, net of
offering expenses of $750,000......... -- -- -- -- 15,510,000
Issuance of common stock in
connection with the acquisition of
NRCC.................................. -- -- -- -- 4,251,256
Issuance of common stock in initial
public offering, net of offering
expenses, including the
reissuance of 2,855,100 shares
of treasury stock..................... 8,398,753 -- -- -- 75,137,763
Conversion of preferred stock to
common stock.......................... -- -- -- -- 700,000
Exercise of options..................... -- -- -- -- 300,719
Income tax benefit relating to
exercise of options................... -- -- -- -- 1,366,105
Recognition of deferred
compensation.......................... -- (304,625) -- -- --
Noncash compensation expense............ -- 47,953 -- -- 47,953
----------- --------- ----------- -------- ------------
Balance at December 31, 1999............... -- (256,672) 369,625 (39,341) 108,501,722
Comprehensive loss
Net loss................................ -- -- (3,887,197) -- (3,887,197)
Unrealized loss on investments.......... -- -- -- (11,670) (11,670)
Foreign currency translation
adjustment............................ -- -- -- 168,532 168,532
------------
Total comprehensive loss................ (3,730,335)
============
Issuance of common stock in connection
with the Employee Stock Purchase Plan. -- -- -- -- 2,572,151
Issuance of common stock in
secondary offering, net of offering
expenses of $917,000.................. -- -- -- -- 39,824,079
Issuance of common stock and options
in connection with the acquisition
of Synet.............................. -- (474,308) -- -- 22,257,040
Issuance of common stock and options
in connection with the acquisition of
Global Integrity...................... -- (120,857) -- -- 44,942,010
Exercise of options..................... -- -- -- -- 3,931,990
Income tax benefit relating to
exercise of options................... -- -- -- -- 5,238,072
Noncash compensation expense............ -- 157,557 -- -- 157,557
----------- --------- ----------- -------- ------------
Balance at December 31, 2000............ $ -- $(694,280) $(3,517,572) $117,521 $223,694,286
=========== ========= =========== ======== ============
The accompanying notes to consolidated financial statements are an
integral part of these consolidated statements.
F-6
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31,
--------------------------------
2000 1999 1998
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss............................................................. $ (3,887,197) $ (957,366) $ (627,300)
Adjustments to reconcile net loss to net cash used in
operating activities--
Noncash compensation expense......................................... 157,557 47,953 --
Deferred income taxes................................................ (462,297) (674,836) (540,469)
Depreciation and amortization........................................ 4,569,038 1,082,890 567,761
Gain on sale of property and equipment............................... (3,023) -- --
Bad debt expense..................................................... 4,921,556 501,141 52,277
(Increase) decrease in--
Accounts receivable.................................................. (6,307,431) (6,728,666) (4,660,591)
Unbilled work in process............................................. (1,740,325) 773,704 (883,420)
Related party receivables............................................ (3,187,757) (901,446) --
Income taxes......................................................... 762,802 1,039,038 1,220
Prepaid expenses and other current assets............................ (300,372) (749,493) (215,378)
Other assets......................................................... 24,833 10,307 32,267
(Decrease) increase in--
Accounts payable..................................................... (233) 885,107 1,096,032
Accrued expenses and other current liabilities....................... 3,673,829 2,737,184 1,053,276
Deferred income...................................................... (665,116) 601,810 412,459
Deferred rent........................................................ 480,726 (21,094) 47,651
Other long-term liabilities.......................................... (2,498) (266,652) --
------------ ----------- ------------
Net cash used in operating activities................................ (1,965,908) (2,620,419) (3,664,215)
------------ ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of marketable securities.................................... (8,011,356) (3,118,060) --
Proceeds from sale or redemption of marketable securities............ 6,223,646 1,101,426 --
Payments to employees................................................ (76,308) (110,637) (26,950)
Repayments from employees............................................ 64,647 48,878 25,221
Payments to stockholders............................................. -- -- (515,000)
Repayments from stockholders......................................... -- 515,000 --
Payments to related party............................................ -- (478,078) (916,948)
Repayments from related party........................................ -- 1,395,026 --
Settlement of notes receivable, net.................................. 283,493
Cash received from acquisition of NRCC............................... -- 163,768 --
Purchase of property and equipment................................... (7,040,497) (2,194,847) (686,823)
Sale of property and equipment....................................... 27,500 -- --
Net cash paid in acquisitions of Global Integrity and Synet.......... (43,282,258) -- --
Long-term investments in related parties............................. (2,000,000) -- --
------------ ----------- ------------
Net cash used in investing activities................................ (53,811,133) (2,677,524) (2,120,500)
------------ ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash overdraft....................................................... -- (475,610) (69,741)
Common shares repurchased to treasury................................ -- (8,398,753) --
Proceeds from short-term borrowings.................................. -- 4,351,000 19,643,000
Repayments of short-term borrowings.................................. -- (9,949,000) (14,825,000)
Payment of preferred dividends....................................... -- (70,000) --
Proceeds from sale of preferred stock................................ -- 18,566,225 --
Proceeds from sale of common stock, net of expenses.................. -- 15,510,000 --
Proceeds from public offerings, net of expenses,
including reissuance of treasury stock............................. 39,824,079 75,137,763 --
Proceeds from exercise of stock options.............................. 3,637,436 300,719 616,000
Proceeds from issuance of common stock in connection
with Employee Stock Purchase Plan.................................. 2,572,151 -- --
------------ ----------- ------------
Net cash provided by financing activities............................ 46,033,666 94,972,344 5,364,259
------------ ----------- ------------
Effects of exchange rates............................................ 168,532 (40,767) --
Net (decrease) increase in cash...................................... (9,574,843) 89,633,634 (420,456)
CASH AND CASH EQUIVALENTS, beginning of period....................... 89,633,634 -- 420,456
------------ ----------- ------------
CASH AND CASH EQUIVALENTS, end of period............................. $ 80,058,791 $89,633,634 $ --
============ =========== ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for--
Interest............................................................. $ 190,519 $ 234,768 $ 262,539
============ =========== ============
Taxes................................................................ $ 109,440 $ 442,420 $ --
============ =========== ============
The accompanying notes to consolidated financial statements are an
integral part of these consolidated balance sheets.
F-7
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS -- (Continued)
DETAILS OF ACQUISITIONS (Note 3):
Fair value of assets acquired........................ $127,608,072 $ 5,051,683 $ --
Liabilities assumed.................................. (15,980,009) (800,427) --
Less fair value of equity issued..................... (67,199,050) (4,251,256) --
Less remaining accrued transaction expenses.......... (1,133,662)
------------ ----------- --------
Cash paid.......................................... 43,295,351 -- --
Less cash acquired................................... (13,093) (163,768) --
------------ ----------- --------
Net cash paid (received)........................... $ 43,282,258 $ (163,768) $ --
============ =========== ========
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING
AND FINANCING TRANSACTIONS:
Stock and options issued for acquisition............. $ 67,199,050 $ 4,251,256 $ --
============ =========== ========
Tax benefits of stock option exercises............... $ 5,238,072 $ 1,366,105 $ --
============ =========== ========
Borrowings under capital leases...................... $ -- $ -- $238,050
============ =========== ========
Dividends declared on mandatory redeemable
convertible preferred stock.......................... $ -- $ 8,750 $ 35,000
============ =========== ========
Services provided to Global Integrity prior to
acquisition date................................... $ 555,500 $ -- $ --
============ =========== ========
The accompanying notes to consolidated financial statements are an
integral part of these consolidated statements.
F-8
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
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 security of complex computing networks. Services are currently
provided through the Company's offices and wholly-owned subsidiaries located
throughout the United States and its wholly-owned subsidiaries in England, which
was formed in the first quarter of 1999, the Netherlands, which was acquired in
the third quarter of 1999, and in Germany, which was acquired in the fourth
quarter of 2000 through the acquisition of Synet.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation --
The consolidated financial statements include the accounts of all wholly-owned
subsidiaries. All significant intercompany accounts and transactions have been
eliminated in consolidation.
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 --
Revenues 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. Included in unbilled work in process as of December 31, 2000 and 1999 is
$4,193,223 and $132,323, respectively, related to fixed-price contracts.
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 debt and equity securities with
a maturity of three months or less at the time of purchase to be cash
equivalents.
Marketable Securities --
The Company accounts for marketable securities in accordance with the provisions
of Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities."
Management determines the appropriate classification of its investments in
equity securities at the time of purchase and reevaluates such determinations at
each balance sheet date. All marketable securities are classified as
available-for-sale and are available to support current operations or take
advantage of other investment opportunities. These securities are stated at
estimated fair value based upon market quotes. Unrealized gains and losses, net
of taxes, are computed on the basis of specific identification and are recorded
as a component of other comprehensive income. Unrealized gains and losses in
fiscal years 2000, 1999 and 1998 are immaterial.
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.
F- 9
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: -- (Continued)
Intangibles --
Intangible assets principally include customer lists, workforce, developed
technology, tradenames and the excess of purchase price over the fair value of
identifiable net assets acquired (goodwill). The intangible assets are amortized
on a straight-line basis over their estimated useful lives ranging from three to
five years.
The Company assesses the recoverability of goodwill by determining whether the
amortization of the goodwill balance over its remaining life can be recovered
through forecasted future operations. Impairment is evaluated by comparing
future cash flows (undiscounted and without interest charges) expected to result
from the use or sale of the asset and its eventual disposition, to the carrying
amount of the asset.
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. For the year ended December
31, 2000, the Company wrote-off trade accounts receivable of approximately
$3,996,000 as a result of three customers filing for federal bankruptcy
protection, which created significant uncertainty regarding the Company's
ability to collect these outstanding trade accounts receivable balances.
For the year ended December 31, 2000, approximately 10% of sales were from one
customer who is a related party (Note 7). For the year ended December 31, 1999,
approximately 31% of sales were from two customers. For the year ended December
31, 1998, approximately 20% of sales were from one customer. The amounts due
from these customers at December 31, 2000 and 1999 were approximately $2,843,901
and $4,146,181, respectively.
Foreign Currency Translation --
The financial statements of foreign subsidiaries, where the local currency is
the functional currency, are translated into U.S. dollars using exchange rates
in effect at period end for assets and liabilities and average rates during each
reporting period for results of operations and cash flows. Adjustments resulting
from translation of financial statements are reflected as a separate component
of stockholders' equity.
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. (Note 10)
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) available
to common stockholders by the weighted average number of shares outstanding.
Diluted net income (loss) per 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 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 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 --
The Company observes the provisions of SFAS No. 123 "Accounting for Stock-Based
Compensation" ("SFAS 123"), and elected to continue the accounting set forth in
Accounting Principles Board No. 25 "Accounting for Stock Issued to Employees"
("APB 25") and to provide the necessary pro forma disclosures as if the fair
value method had been applied. (Note 11)
F-10
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: -- (Continued)
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.
Comprehensive Income --
The Company observes SFAS No. 130, "Reporting Comprehensive Income" ("SFAS
130"). The standard requires that comprehensive income, which includes net
income as well as certain changes in assets and liabilities recorded in
stockholders' equity, be reported in the financial statements. The adoption of
SFAS 130 increased the reporting disclosures but had no impact on the results of
operations or financial position of the Company.
Segment Reporting --
SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information" 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. 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.
Recently Issued Accounting Pronouncements --
In December 1999, the SEC issued Staff Accounting Bulletin No. 101 ("SAB 101"),
"Revenue Recognition in Financial Statements." SAB 101 provides guidance on the
recognition, presentation, and disclosure of revenue in financial statements
filed with the SEC. SAB 101 does not supersede any existing authoritative
literature. The Company has adopted the principles of SAB 101 during 2000, the
effect of which was not material to the Company's results of operations or
financial position.
In March 2000, The Financial Accounting Standards Board ("FASB") issued
Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions Involving
Stock Compensation, an Interpretation of APB No. 25." FIN 44 provides guidance
on certain aspects of applying APB No. 25. FIN 44 is effective July 1, 2000, but
is also effective for certain events that have occurred after December 15, 1998
or January 12, 2000. The Company has adopted the principles of FIN 44 during
2000, the effect of which was not material to the Company's results of
operations or financial position.
Reclassification --
Certain items have been reclassified in the prior year to conform to the current
year presentation.
(3) ACQUISITIONS:
On August 12, 1999, the Company acquired Network Resource Consultants and
Company B.V. ("NRCC") in a transaction accounted for as a purchase. In
connection with this transaction, the Company exchanged 1,062,814 shares of its
common stock at a fair value of $4.3 million in exchange for all of the
outstanding stock of NRCC. The Company acquired net tangible assets of
approximately $88,000 and recorded intangible assets of approximately $4.3
million, which represented the excess of the purchase price over the fair value
of the net tangible assets acquired. The intangible assets are being amortized
on a straight-line basis over a period of five years. The results of operations
of NRCC have been included in the results of operations of the Company since the
date of acquisition.
A preliminary summary of the purchase price allocation is as follows:
Cash and cash equivalents................................... $ 163,768
Accounts receivable, net.................................... 322,149
Prepaid expenses and other current assets................... 83,771
Property and equipment...................................... 218,458
Goodwill.................................................... 4,263,537
Accounts payable and accrued expenses....................... (285,801)
Deferred income............................................. (17,497)
Due to shareholder.......................................... (269,150)
Income taxes payable........................................ (127,979)
----------
$4,351,256
On October 16, 2000, the Company acquired Synet Service Corporation ("Synet") in
a transaction accounted for as a purchase. Synet is a network and systems
management consulting firm that works with organizations to improve the
availability and reliability of e-commerce applications and network
infrastructure. The consideration for the acquisition consisted of an aggregate
of 1,922,377 shares of common stock at a fair value of $11.00 per share, par
value $0.001 per share, $9,000,000 cash paid upon closing of the transaction,
$1,053,164 cash paid to fund operating needs of the Company prior to the closing
of the transaction and transaction expenses of $1,085,417, of which $575,186
were paid prior to December 31, 2000. Approximately 522,000 shares were
accounted for as stock options until a related note was repaid in December 2000,
at which time the shares were considered to
F-11
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(3) ACQUISITIONS: -- (Continued)
be issued for accounting purposes. The Company also issued options to purchase
242,459 shares of common stock to employees of Synet in exchange for their Synet
options. These options had a fair value of $1,110,893 and were accounted for as
additional purchase price. The Company acquired net tangible assets of $169,482
and recorded intangible assets of approximately $33.4 million, which represented
customer lists, workforce and excess of the purchase price over the fair value
of the net tangible assets of approximately $30.4 million. Additionally, the
Company recognized a deferred income tax liability of $1,184,620 related to the
nondeductibility of certain acquired identifiable intangibles. Goodwill and the
intangible assets are being amortized on a straight-line basis over periods of
three to five years. The results of operations of Synet have been included in
the results of operations of the Company since the date of acquisition.
A preliminary summary of the purchase price allocation is as follows:
Accounts receivable, net...................................... $ 1,342,856
Unbilled work in process...................................... 599,700
Prepaid expenses and other current assets..................... 408,022
Related party receivable...................................... 487,493
Property and equipment........................................ 138,240
Goodwill...................................................... 30,391,595
Workforce..................................................... 1,766,000
Customer lists................................................ 1,200,000
Other assets.................................................. 85,854
Accounts payable.............................................. (540,329)
Accrued expenses and other current liabilities................ (904,129)
Notes payable................................................. (220,000)
Deferred income............................................... (175,061)
Deferred income tax liability................................. (1,184,620)
-----------
$33,395,621
On December 14, 2000, the Company acquired Global Integrity Corporation
("Global") in a transaction accounted for as a purchase. Global provides
information security services to Fortune and Global 1000 companies. The
consideration for the acquisition consisted of an aggregate of 5,240,275 shares
of common stock at a fair value of $8.15 per share, par value $0.001 per share,
$31,460,270 cash and transaction expenses of $1,830,162, of which $1,206,731
were paid prior to December 31, 2000. The Company also issued options to
purchase 551,048 shares of common stock to employees of Global in exchange for
their Global options. These options had a fair value of $2,233,769 and were
accounted for as additional purchase price. Additionally, the Global
stockholders and optionholders have the right to earn up to an additional
$14,012,500 in value (to be paid in cash to stockholders and additional options
to optionholders) upon the achievement of certain revenue milestones by the
acquired business. The Company acquired net tangible assets of $4,482,032 and
recorded intangible assets of approximately $81.1 million, which represented
customer lists, workforce, tradenames, developed technology and excess of the
purchase price over the fair value of the net tangible assets of approximately
$62.8 million. Additionally, the Company recognized a deferred income tax
liability of $7,308,222 related to the nondeductibility of certain acquired
identifiable intangibles. Goodwill and the intangible assets are being amortized
on a straight-line basis over periods of three to five years. The results of
operations of Global have been included in the results of operations of the
Company since the date of acquisition.
A preliminary summary of the purchase price allocation is as follows:
Cash and cash equivalents.................................. $ 13,093
Accounts receivable, net................................... 4,395,359
Unbilled work in process................................... 2,981,826
Prepaid expenses and other current assets.................. 539,402
Property and equipment..................................... 2,200,000
Goodwill................................................... 62,760,632
Workforce.................................................. 2,890,000
Customer lists............................................. 3,307,000
Developed technology....................................... 9,574,000
Tradenames................................................. 2,527,000
Accounts payable........................................... (200,003)
Accrued expenses and other current liabilities............. (2,374,779)
Income taxes payable....................................... (126,680)
Deferred income............................................ (2,315,464)
Deferred income tax liability.............................. (7,938,944)
-----------
$78,232,442
F-12
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(3) ACQUISITIONS: -- (Continued)
The following unaudited information presents the pro forma results of operations
for the Company for the years ending December 31, 2000 and 1999 as if the
acquisitions of NRCC, Synet and Global had occurred on the first day of the
earliest year presented.
Year Ended December 31,
2000 1999
---- ----
(unaudited) (unaudited)
Revenues...................... $120,191,561 $ 81,413,609
Operating loss................ (32,957,809) (30,260,518)
Net loss...................... $(26,238,969) $(28,089,548)
Per Share Information:
Net loss per share --
Basic and diluted............. $(0.80) $ (1.42)
Weighted Average Shares
Outstanding --
Basic and diluted............. 32,890,544 19,853,019
(4) NET INCOME (LOSS) PER SHARE:
As discussed in Note 2, net income (loss) per share is calculated in accordance
with SFAS 128. The following table reconciles the numerator and denominator for
the calculation -
Year Ended December 31,
-----------------------
2000 1999 1998
---- ---- ----
Numerator -
Net loss.................................................... $(3,887,197) $(957,366) $(627,300)
Preferred stock dividends................................... -- (8,750) (35,000)
----------- ----------- ----------
Numerator for basic and diluted earnings per share - net
loss available to common stockholders....................... (3,887,197) (966,116) (662,300)
=========== =========== ==========
Denominator -
Denominator for basic and diluted earnings per share -
weighted average shares..................................... 26,273,946 12,137,560 6,015,433
=========== =========== ==========
Basic and diluted loss per share............................ $(0.15) $ (0.08) $ (0.11)
=========== =========== ==========
The conversion of outstanding options was not considered for any year presented
as the effect would be anti-dilutive.
(5) PROPERTY AND EQUIPMENT:
The components of property and equipment are as follows -
December 31,
------------
2000 1999
---- ----
Computer equipment................................. $ 7,243,960 $ 2,487,334
Office furniture................................... 1,266,794 810,822
Leasehold improvements............................. 5,256,034 1,289,660
----------- -----------
13,766,788 4,587,816
Less - Accumulated depreciation and amortization... (3,363,265) (1,703,711)
----------- -----------
$10,403,523 $ 2,884,105
=========== ===========
Depreciation and amortization expense related to property and equipment
aggregated $1,657,311, $756,019 and $567,761, respectively, for the years ending
December 31, 2000, 1999 and 1998.
F-13
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(6) INTANGIBLE ASSETS:
The components of intangible assets are as follows -
December 31,
------------
2000 1999
---- ----
Workforce........................................... $ 4,656,000 $ --
Customer lists...................................... 4,507,000 --
Developed technology................................ 9,574,000 --
Tradenames.......................................... 2,527,000 --
Goodwill............................................ 97,415,764 4,263,537
------------ ----------
118,679,764 4,263,537
Less - Accumulated depreciation and amortization.... (3,238,598) (326,871)
------------ ----------
$115,441,166 $3,936,666
============ ==========
Amortization expense related to intangibles was $2,911,727 and $326,871,
respectively, for the years ending December 31, 2000 and 1999.
(7) 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 pro rata distribution to shareholders
accounted for at historical cost. In connection with the spin-off the Company
sold certain assets with minimal book value to the software development company
and received a note for approximately $130,000 for the sale of certain software.
Additionally, the Company provided a $1,000,000 line of credit to that company
bearing interest at 8%. As of December 31, 1998, $916,948 was due from this
company, which was fully repaid during 1999. Since then no balance is due from
this company and the line of credit no longer exists.
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 during 1999.
Two of the Company's customers, Cisco Systems and BellSouth, each have one seat
on the Company's Board of Directors. Additionally, in September 1999, the
Company sold 1,242,000 shares of common stock to Cisco for $12.00 per share.
During 2000 and 1999, the Company recorded revenues of $4.3 million and $2.2
million, respectively, from services performed for Cisco Systems, and $9.0
million and $1.2 million, respectively, from services performed for BellSouth.
As of December 31, 2000 and 1999, amounts due from Cisco were $1,021,142 and
$584,474, respectively, and from Bell South were $2,843,901 and $342,812,
respectively. Such amounts are included in related party receivables.
On October 6, 2000, the Company purchased 1,000,000 shares of Series A Preferred
Stock in Digital Mojo Corporation ("Digital Mojo"), which the Company has
recorded as a long-term investment in related party. Digital Mojo has 3,800,000
shares of Series A Preferred Stock and 8,100,000 shares of common stock
outstanding, giving the Company an 8.4% interest on an as converted basis. The
Series A Preferred Stock has certain antidilution rights, but converts initially
on a one for one basis into common stock. The Series A Preferred Stock has a
liquidation preference equal to $1.00 per share plus a 10% cumulative dividend.
The Company also received certain registration rights with respect to the shares
purchased. During 2000, the Company recorded revenues of $337,530 from services
performed for Digital Mojo.
On December 22, 2000, the Company purchased a $1,000,000 12% Convertible
Promissory Note (the "Note") of Paradigm4, Inc. ("Paradigm4") which the Company
has recorded as a long-term investment in related party. The Note is payable 90
days from the date of purchase. The Company received a stock purchase warrant
(the "warrant") to purchase up to 0.7692% of the outstanding shares of Paradigm4
on a fully diluted basis at a price equal to $.01 per share. The warrant is
exercisable immediately and expires on December 22, 2005. The Company also
received a second stock purchase warrant (the "second warrant") to purchase up
to 2.3077% of the outstanding shares of Paradigm4 on a fully diluted basis at a
price equal to $.01 per share. The second warrant is exercisable in the event
that a qualified financing does not take place prior to March 22, 2001 and
expires on March 22, 2006. In the event that a bona fied offer to wholly repay
the Note is made prior to March 22, 2001, the percentage of the outstanding
capital stock on a fully diluted basis that can be purchased with the second
warrant shall be reduced to 0.7692%. During 2000, the Company recorded revenues
of $350,750 from services performed for Paradigm4. As of December 31, 2000, the
amount due from Paradigm4 for services was $250,000. Such amount has been
included in related party receivables.
Receivables from employees and stockholders represent short term lending to such
parties entered into in the normal course of business.
The Company's management believes that these transactions were entered into on a
basis that approximates fair value.
F-14
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(8) DEBT:
The Company has a demand loan facility, secured by a lien on all of the
Company's assets, under which we may borrow up to the lesser of $5,000,000 or
80.0% of accounts receivable. Amounts outstanding under the facility bear
interest at a rate of 11.25% per annum. At December 31, 2000 and 1999, there
were no amounts outstanding under the facility.
(9) 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
2004. 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
----
2001................................................ $ 160,068
2002................................................ 92,241
2003................................................ 60,127
2004................................................ 1,124
Less -- Amount representing interest................ (23,861)
------------------------------------ ---------
Present value of net minimum lease payments......... 289,699
Less -- Current portion............................. (137,734)
----------------------- ---------
$ 151,965
=========
(10) INCOME TAXES:
The components of the Company's provision (benefit) for income taxes for the
years ended December 31, 2000, 1999 and 1998 are as follows --
Year Ended December 31,
-----------------------
2000 1999 1998
---- ---- ----
Current income tax provision:
Federal.................................................. $ 42,950 $ 988,715 $ --
State.................................................... 459,807 368,618 80,211
Foreign.................................................. 54,624 -- --
--------- ---------- ---------
557,381 1,357,333 80,211
Deferred income tax benefit:
Federal.................................................. (356,081) (507,059) (407,182)
State.................................................... (106,216) (167,777) (133,287)
--------- ---------- ---------
(462,297) (674,836) (540,469)
--------- ---------- ---------
Total income tax provision (benefit)..................... $ 95,084 $ 682,497 $(460,258)
========= ========== =========
The following table indicates the significant elements contributing to the
difference between the Federal statutory rate and the Company's effective tax
rate --
Year Ended December 31,
-----------------------
2000 1999 1998
---- ---- ----
Federal statutory rate..................................... (34.0)% (34.0)% (34.0)%
State taxes, net of Federal effect......................... 6.2 73.1 (6.6)
Non-deductible amortization................................ 22.6 40.3 --
Meals and entertainment.................................... 3.1 27.6 --
Reversal of income tax receivable.......................... 6.3 -- --
Adjustment to cash to accrual basis liability.............. -- (56.4) --
Valuation allowance........................................ -- 206.0 --
Other...................................................... (1.7) (8.3) (1.7)
----- ----- -----
2.5% 248.3% (42.3)%
===== ===== ======
F-15
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(10) INCOME TAXES: -- (Continued)
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 approximately $1,667,000. Effective
October 16, 2000, Synet converted from a cash basis to an accrual basis taxpayer
as of the acquisition date. The conversion from the cash basis to accrual basis
required the recognition of a deferred tax liability of approximately $352,000
which was recognized as an acquired liability. Other major components of the
deferred tax assets and (liabilities) as of December 31, 2000 and 1999 are as
follows:
December 31,
------------
2000 1999
---- ----
Intangibles............................................ $ (8,492,842) --
Bad debt reserve....................................... 452,554 $ 223,741
Depreciation........................................... (38,507) 62,200
Change from cash to accrual basis liability............ (682,560) (724,202)
Deferred rent.......................................... 192,003 --
Deferred revenue....................................... (435,460) --
Accrued vacation....................................... 87,498 --
Net operating loss carryforwards....................... 27,282,518 824,322
Valuation allowance.................................... (21,846,203) (639,230)
Other, net............................................. 21,646 28,859
------------ ---------
Total deferred income tax liability.................... $ (3,459,353) $(224,310)
============ =========
At December 31, 2000 the Company had available net operating loss carryforwards
of approximately $68,377,000 to reduce future period's taxable income. These
loss carryforwards begin to expire in 2012. Included in the net operating loss
carryforward at December 31, 2000 is approximately $65,771,000 related to the
exercise of nonqualified stock options and disqualifying dispositions credited
to additional paid-in capital. The Company has applied a valuation allowance of
approximately $52,643,000 related to the nonqualified stock options and
disqualified dispositions which will be credited to additional paid-in capital
upon utilization of tax carryforwards. The tax effect of the $13,128,000 loss
($5,238,072) for which a valuation has not been recognized, has been credited to
additional paid-in capital.
At December 31, 2000, the Company's subsidiaries in England and The Netherlands
had available net operating losses of $2,035,134, the tax benefits of which have
been fully reserved for by a valuation allowance because of the uncertainty of
their realizability.
(11) 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 accrued dividends at 5% per year,
commencing March 1, 1997. Each share was convertible, subject to
certain adjustments, into 1 share of common stock, at the option of the
holder. 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.
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
were converted into common shares on a 1 to 1 ratio on the date of the
initial public offering.
In connection with the issuance of the 1999 Preferred Shares to General
Atlantic Partners 54, L.P. and GAP Coinvestment Partners II, L.P.,
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 was required to be delivered within
20 business days following the first filing of the Company's
registration statement on Form S-1. These warrants expired without any
common stock purchases.
Following is a summary of transactions involving the Company's common stock:
Subsequent to the conversion of the 1995 Preferred Shares, the Company
repurchased 2,855,100 shares of common stock at a purchase price of
approximately $2.94 per share.
On August 12, 1999, the Company issued 1,062,814 shares of common stock
to two persons in exchange for all of the outstanding capital stock of
NRCC.
F-16
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(11) STOCKHOLDERS' EQUITY: -- (Continued)
On September 16, 1999, the Company sold 1,242,000 shares of its common
stock to Cisco Systems, Inc. at a price of $12.00 per share. In
connection with this transaction, the Company entered into an
Investor's Rights Agreement with Cisco Systems, Inc. pursuant to which
the Company granted Cisco Systems, Inc. certain registration rights.
On September 22, 1999, the Company sold 94,867 and 18,133 shares of its
common stock to General Atlantic Partners 54, L.P. and GAP Coinvestment
Partners II, L.P., respectively, at a price of $12.00 per share.
On October 27, 1999, the Company sold 4,600,000 shares of common stock
at an initial public offering price of $18.00 per share and began
trading on the Nasdaq National Market under the symbol PRDS. The net
proceeds of the offering were approximately $75.1 million after
deducting underwriting discounts, commissions, and other offering
expenses.
In April 2000, the Company consummated a follow-on public offering for
3,800,000 shares of its common stock, of which 1,000,000 shares were
sold by the Company, while the remainder were sold by certain
stockholders, resulting in net proceeds to the Company of approximately
$39.8 million after deducting underwriter discounts, commissions and
other offering expenses payable by the Company.
On October 16, 2000, in connection with the acquisition of Synet the
Company issued 1,922,377 shares of common stock at $11.00 per share
less 521,765 shares which were accounted for as stock options until a
related note was repaid in December 2000, at which time the shares were
issued. The Company also issued options to purchase 242,459 shares of
common stock to the former stockholders and optionholders of Synet.
On December 14, 2000, in connection with the acquisition of Global the
Company issued 5,240,275 shares of common stock at $8.15 per share and
options to purchase 551,048 shares of common stock to the former
stockholders and optionholders of Global.
Stock Options --
In 1998, the Company adopted its Stock Option/Stock Issuance Plan (the "Option
Plan"). Prior to this time, options issued were not issued in connection with a
plan. The Option Plan is 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.
The 1999 Stock Incentive Plan (the "1999 Plan"), adopted and effective on
September 14, 1999, is intended to serve as the successor equity incentive
program to the Option Plan. The Company has authorized 6,655,600 shares of
common stock for issuance under the 1999 Plan. This share reserve consists of
the shares which were available for issuance under the predecessor plan on the
effective date of the 1999 Plan plus an additional increase of 2,345,597 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 500,000 shares. However, in no event may any one
participant in the 1999 Plan receive option grants or direct stock issuances for
more than 500,000 shares in the aggregate per calendar year.
Outstanding options under the Option Plan were incorporated into the 1999 Plan
upon the date of the initial public offering, and no further option grants may
be made under the plan. The incorporated options will continue to be governed by
their existing terms, unless the Company extends one or more features of the
1999 Plan to those options.
The Employee Stock Purchase Plan (the "Employee Plan") was adopted and approved
by the Company on September 14, 1999. The plan, effective on October 27, 1999,
is designed to allow eligible employees, as defined, to purchase shares of
common stock, at semi-annual intervals, through periodic payroll deductions. A
total of 750,000 shares of common stock may be issued under this plan. As of
December 31, 2000, 192,723 shares were issued in connection with the Employee
Plan.
The Employee Plan has a series of successive offering periods, each with a
maximum duration of 24 months. The initial offering period began on October 27,
1999 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. The Employee Plan
will terminate no later than the last business day in October 2009.
Individuals who are eligible employees on the start date of any offering period
may enter the Employee 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
Employee Plan on any subsequent semi-annual entry date within that period.
F-17
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(11) STOCKHOLDERS' EQUITY: -- (Continued)
A participant may contribute up to 10% 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 purchase price per
share will be 85% of the lower of the fair market value of the 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 500 shares, nor may all participants in the aggregate purchase more
than 187,500 shares on any one semi-annual purchase date. Should the fair market
value of the 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.
A summary of the Company's stock option activity is as follows --
Year Ended December 31,
-----------------------
2000 1999 1998
---- ---- ----
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Outstanding at beginning of
period.......................... 10,756,910 $ 3.11 8,397,600 $1.02 9,471,600 $0.61
Granted......................... 4,421,735 18.63 3,686,990 7.25 2,427,000 1.41
Exercised....................... (3,119,121) 1.26 (653,970) 0.46 (3,492,000) 0.18
Forfeited....................... (1,092,167) 17.70 (673,710) 2.36 (9,000) 0.83
----------- ------ ---------- ----- ---------- -----
Outstanding at end of period 10,967,357 $8.44 10,756,910 $3.11 8,397,600 $1.02
=========== ===== ========== ===== ========== =====
Options exercisable at end of
period........................ 4,112,602 $2.68 5,259,270 $1.02 4,586,250 $0.80
=========== ===== ========== ===== ========== =====
Weighted average fair value of
options granted during period
$11.42 $4.31 $0.26
The following table summarizes information about stock options outstanding at
December 31, 2000 --
Total Weighted Options Weighted
Outstanding Weighted Average Exercisable at Average
Range of at December 31, Average Contractual Life December 31, Exercise
Exercise Prices 2000 Exercise Price (in yrs) 2000 Price
- --------------- ----------- -------------- ---------------- -------------- ------------
$ 0.01 13,750 $ 0.01 9.79 13,750 $ 0.01
$ 0.50-1.25 3,595,510 $ 0.99 3.88 2,759,510 $ 0.95
$ 1.50-2.11 740,495 $ 1.51 5.77 394,495 $ 1.52
$ 2.50-3.15 766,212 $ 2.56 7.95 128,863 $ 2.61
$ 4.00-4.09 973,526 $ 4.00 8.13 413,484 $ 4.01
$ 6.50-8.81 1,738,182 $ 7.68 9.57 124,779 $ 6.51
$10.20-15.00 1,250,309 $ 11.70 8.69 224,446 $ 10.93
$16.07-22.00 912,358 $ 18.99 9.53 -- $ --
$29.06-35.94 603,265 $ 30.21 9.39 7,281 $ 29.06
$45.06-65.50 373,750 $ 49.51 8.93 45,994 $ 50.49
---------- --------- ----------
10,967,357 7.07 4,112,602
F-18
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(11) STOCKHOLDERS' EQUITY: -- (Continued)
The Company has elected to follow APB 25 in accounting for its employee stock
options. Had the determination of compensation costs been based on the fair
value at the grant dates consistent with the method of SFAS 123, the Company's
loss and basic and diluted loss per share would have been reduced to the pro
forma amounts in the table below.
The fair value of all option grants is estimated on the date of grant using the
Black-Scholes model with the following weighted-average assumptions used for
grants in 2000, 1999 and 1998.
o weighted-average risk free interest rates of 5.97%, 5.79% and 5.51%,
respectively;
o expected dividend yields of 0%;
o expected lives of 4 years; and
o expected volatility of 76.15%, 73.17% and 73.17%, respectively.
Year Ended December 31,
-----------------------
2000 1999 1998
---- ---- ----
Net loss:
As reported..................................... $(3,887,197) $ (957,366) $ (627,300)
Pro forma....................................... $(9,692,565) $ (1,980,145) $ (1,006,406)
Basic and diluted net loss per share:
As reported..................................... $ (0.15) $ (0.08) $ (0.11)
Pro forma....................................... $ (0.37) $ (0.16) $ (0.17)
Deferred Compensation --
During 1999, the Company granted stock options with exercise prices which were
less than the fair market value of the underlying shares of common stock at the
date of grant. As a result, the Company recorded deferred compensation of
$304,625. In connection with the acquisition of Synet and Global, the Company
granted stock options to employees of Synet and Global which had exercise prices
that were less than the fair market value of the underlying shares of common
stock at the date of grant. As a result, the Company recorded deferred
compensation of $474,308 and $120,857, respectively. These amounts will be
recognized as noncash compensation expense over the vesting period of the
options (approximately 4 years). For the years ended December 31, 2000 and 1999,
$157,557 and $47,953, respectively, of the deferred compensation was amortized
to expense and has been reflected as noncash compensation expense in the
accompanying statements of operations.
F-19
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(12) COMMITMENTS AND CONTINGENCIES:
Operating Leases --
The Company has entered into non-cancelable operating leases for office space
with terms ranging from approximately one month to ten 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 the terms
of the leases.
The future minimum lease payments required under the above mentioned operating
leases for the year ended December 31, are as follows --
Year
2001............................................. $ 3,556,259
2002............................................. 2,983,481
2003............................................. 2,754,977
2004............................................. 2,520,392
2005............................................. 2,163,539
2006 and thereafter.............................. 4,228,696
------------------- -----------
Total minimum lease payments.................. $18,207,344
============================ ===========
Rent expense was approximately $2,421,069, $1,311,411 and $736,120 for the years
ended December 31, 2000, 1999 and 1998, 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
2000, 1999 or 1998.
Employment Agreements --
The Company has entered into employment agreements with certain executives of
the Company. Commitments under these agreements provide for payments of $955,000
for fiscal years 2001, 2002 and 2003, respectively.
Litigation --
Except as set forth below, we are not a party to any material legal proceedings.
On October 29, 1999, Art Eckert ("Plaintiff") filed an action against the
Company in which he alleged that the Company was in breach of an employment
agreement between Plaintiff and the Company. Plaintiff alleged that the Company
fraudulently induced Plaintiff to enter into this purported employment
agreement. Plaintiff seeks to recover damages in excess of $3.2 million with
respect to the claim for breach of contract, and, damages in excess of $6.0
million with respect to the claim for fraudulent inducement. The Company filed a
motion to dismiss the claim for fraudulent inducement on December 13, 1999.
Plaintiff amended the complaint, essentially adding allegations with respect to
the claim for fraudulent inducement, and opposed the Company's motion.
By Decision and Order filed on July 11, 2000, Judge S. Barrett Hickman, in New
York Supreme Court, Putnam County, denied the Company's motion to dismiss the
claim for fraudulent inducement. The case is in the discovery phase and the
Company intends to defend it vigorously.
The Company does not believe that this action will have a material adverse
effect on its business, results of operations, or financial position.
(13) SUBSEQUENT EVENTS:
On March 22, 2001, Paradigm4 filed for federal bankruptcy protection thereby
creating significant uncertainty regarding the Company's ability to collect an
outstanding trade receivable due of $250,000 as of December 31, 2000. In
addition, this action has created significant uncertainty regarding the
Company's $1.0 million investment in Paradigm4.
The Company does not believe that this action will have a material adverse
impact on its business, results of operations, or financial position.
F-20
INDEPENDENT AUDITORS' REPORT
To Predictive Systems, Inc.:
We have audited in accordance with accounting standards generally accepted
in the United States, the financial statements of Predictive Systems, Inc.
included in this filing on Form 10-K and have issued our report thereon dated
February 7, 2001. 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
Commission's rules and 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.
/s/ ARTHUR ANDERSEN LLP
Arthur Andersen LLP
New York, New York
February 7, 2001
S-1
Schedule II -- Schedule of Valuation and Qualifying Accounts (in thousands)
Balance at Charged to Balance at
Beginning of Costs and End of
Year Expenses Deduction the Year
For the fiscal year
ended December 31, 1998
Allowance for doubtful
accounts............... $130 $ 52 $ (41) $ 141
For the fiscal year
ended December 31, 1999
Allowance for doubtful
accounts............... $141 $ 501 $ (74) $ 568
For the fiscal year
ended December 31, 2000
Allowance for doubtful
accounts............... $568 $4,922 $(4,198) $1,292
S-2
INDEX TO EXHIBITS
Number Description
------ -----------
3.1* Amended and Restated Certificate of Incorporation.
3.2** Amended and Restated By-laws.
4.1*** Specimen common stock certificate.
4.2 See Exhibits 3.1 and 3.2 for provisions of the Amended and Restated Certificate of Incorporation and Amended and
Restated By-laws of the Registrant defining the rights of holders of Common Stock of the Registrant.
10.1*** 1999 Stock Incentive Plan.
10.2*** 1999 Employee Stock Purchase Plan.
10.3 Synet Service Corporation 1996 Stock Option Plan.
10.3.1 Global Integrity Corporation 1998 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.
10.7 Amended and Restated Registration Rights Agreement, dated December 14, 2000.
10.8*** Secured Promissory Note, dated August 31, 1998, in favor of Brown Brothers Harriman & Co.
10.9*** Agreement of Lease, dated June 25, 1999, by and between the Registrant and Polestar Fifth Property Associates LLC.
10.10+ Development and License Agreement, dated July 29, 1998, by and between Bear Stearns & Company, Inc. and the
Registrant.
10.11 Professional Services Agreement, dated November 7, 2000 by and between the Registrant and Bear, Sterns & Co., Inc.
10.12 Professional Services Agreement, dated March 1, 2000 by and between the Registrant and RiverSoft Inc.
10.14+ Systems Integration Consulting Services Agreement, dated May 21, 1998, by and between LCI International Telecom Corp.
dba Qwest Communications Corporation and the Registrant.
10.15*** Amendment No. 1 to Consulting Services Agreement dated June 21, 1999, to Systems Integration Consulting Services
Agreement, dated May 21, 1998, by and between LCI International Telecom Corp. dba Qwest Communications Corporation and
the Registrant.
10.16 Technical Services Agreement, dated November 17, 2000 by and between Science Applications International Corporation
and Global Integrity Corporation.
10.17 Assignment and Cross License Agreement, dated December 6, 2000 by and between Science Applications International
Corporation and Global Integrity Corporation.
10.19*** Investor's Rights Agreement, dated September 16, 1999, by and between Cisco Systems, Inc. and the Registrant.
10.20+ Professional Services Subcontract, dated May 14, 1999, by and between Cisco Systems, Inc. and the Registrant.
10.21 Employment and Non-Competition Agreement, dated October 16, 2000 by and between the Registrant and Bart Greenwood.
10.22 Service Agreement, dated January 1, 2001 by and between the Registrant and Eammon Kearns.
10.23*** Employment Agreement, dated September 21, 1999 by and between Gerard Dorsey and the Registrant.
10.24++ Software Development and Service Agreement, effective January 15, 2001, by and between the Registrant and BellSouth
Telecommunications, Inc.
21.1 List of Subsidiaries.
23.1 Consent of Arthur Andersen LLP.
S-3
- ---------------
* Incorporated by reference to Exhibit 3.2 of Predictive's Registration
Statement on Form S-1, No. 333-84045 ("Registration Statement No. 333-
84045").
** Incorporated by reference to Exhibit 3.4 of Registration Statement No.
333-84045.
*** Incorporated by reference to the identically numbered exhibit of
Registration Statement No. 333-84045.
+ Non-confidential portions of this Exhibit were filed as the identically
numbered exhibit of Registration Statement No. 333-84045, which non-
confidential portions are incorporated herein by reference. Confidential
treatment was granted for certain portions of this Exhibit pursuant to
Rule 406 promulgated under the Securities Act. Confidential portions of
this Exhibit have been filed separately with the Securities and Exchange
Commission.
++ Confidential treatment to be requested for certain portions of this
Exhibit pursuant to Rule 406 promulgated under the Securities Act.
Confidential portions of this Exhibit have been filed separately with the
Securities and Exchange Commission.
S-4