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
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:
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
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.
The following table lists some of the services provided by our network design and engineering practice area:
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.
The following table lists some of the services provided by our network and systems management practice area:
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:
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:
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:
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:
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
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
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
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.
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.
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.
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.
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
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).
Item 2.
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.
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.
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.
PART II
Item 5.
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.
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.
Item 6.
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.
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.
Item 7.
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
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
$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:
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
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
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.
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.
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.
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.
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.
Item 8.
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.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
PART III
Item 10.
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.
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.
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.
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.
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:
(a) (2) Financial Statement Schedule.
(a) (3) Exhibits.
The following Exhibits are incorporated herein by reference or are filed with this report as indicated below.
- --------------- * 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.
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.
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.
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
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
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
The accompanying notes to consolidated financial statements are an integral part of these consolidated balance sheets.
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes to consolidated financial statements are an integral part of these consolidated statements.
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
The accompanying notes to consolidated financial statements are an integral part of these consolidated statements.
The accompanying notes to consolidated financial statements are an integral part of these consolidated statements.
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes to consolidated financial statements are an integral part of these consolidated balance sheets.
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS -- (Continued)
The accompanying notes to consolidated financial statements are an integral part of these consolidated statements.
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)
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
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
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 -
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.
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.
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 --
The following table indicates the significant elements contributing to the difference between the Federal statutory rate and the Company's effective tax rate --
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:
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.
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.
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 --
The following table summarizes information about stock options outstanding at December 31, 2000 --
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.
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.
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.
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)
S-2
INDEX TO EXHIBITS
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