U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDING June 30, 2001.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
____________________ TO ____________________.
COMMISSION FILE NUMBER: 333-84045
PREDICTIVE SYSTEMS, INC.
---------------------------------
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 13-3808483
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(State or other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
417 FIFTH AVENUE, NEW YORK, NEW YORK 10016
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(Address of Principal Executive Offices) (Zip Code)
(212) 659-3400
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(Registrant's Telephone Number, Including Area Code)
Check whether the registrant: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
As of August 9, 2001, there were 36,252,089 shares of the registrant's common
stock, $.001 par value per share, outstanding.
INDEX
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
Page
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PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets as of June 30, 2001
(unaudited) and December 31, 2000 ........................ 1
Consolidated Statements of Operations for the three and six
months ended June 30, 2001 and 2000 (unaudited) ....... 2
Consolidated Statement of Cash Flows for the six months
ended June 30, 2001 and 2000 (unaudited) ............... 3
Notes to Consolidated Financial Statements (unaudited) ... 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS ..................... 7
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK .................................................... 16
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS ........................................ 16
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS ................ 17
ITEM 3. DEFAULTS UPON SENIOR SECURITIES .......................... 17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ...... 17
ITEM 5. OTHER INFORMATION ........................................ 17
ITEM 6. EXHIBITS AND REPORT ON FORM 8-K .......................... 17
ITEM 7. SIGNATURES ............................................... 17
PART 1. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, 2001 December 31, 2000
-------------------- --------------------
(unaudited)
ASSETS
Current assets
Cash and cash equivalents $ 58,952,613 $ 80,058,791
Investment in marketable securities, at market value 2,011,140 3,794,100
Accounts receivable - net of allowance for
doubtful accounts of $1,487,378 and $1,292,491, respectively 16,884,641 22,454,109
Unbilled work in process 3,850,401 5,055,471
Inventory held for resale 3,500,000 --
Related party receivables 3,352,336 4,115,043
Receivables from employees and stockholders 219,142 423,074
Prepaid expenses and other current assets 3,428,917 2,335,192
-------------------- --------------------
Total current assets 92,199,190 118,235,780
Property and equipment - net of accumulated
depreciation and amortization of $4,693,895 and $3,363,265, respectively 11,633,453 10,403,523
Intangible assets - net of accumulated amortization of $15,913,489 and $3,238,598,
respectively 105,702,699 115,441,166
Long-term investments in related parties 1,000,000 2,000,000
Other assets 349,670 248,068
-------------------- --------------------
Total assets $ 210,885,012 $ 246,328,537
==================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 3,885,785 $ 3,062,164
Accrued compensation 3,305,016 3,096,492
Accrued expenses and other current liabilities 11,927,845 9,418,105
Current portion of capital lease obligations 109,724 137,734
Deferred income 3,885,146 2,890,130
-------------------- --------------------
Total current liabilities 23,113,516 18,604,625
-------------------- --------------------
Noncurrent liabilities
Capital lease obligations 88,808 151,965
Deferred rent 539,224 530,589
Deferred income tax liability 3,347,072 3,347,072
-------------------- --------------------
Total noncurrent liabilities 3,975,104 4,029,626
-------------------- --------------------
Total liabilities 27,088,620 22,634,251
-------------------- --------------------
Commitments and contingencies
Stockholders' equity
Common stock, $.001 par value, 200,000,000 shares authorized,
36,201,816 and 34,903,696 shares issued and outstanding 36,202 34,904
Additional paid-in capital 229,468,317 227,753,713
Deferred compensation (506,529) (694,280)
Accumulated deficit (45,150,843) (3,517,572)
Accumulated other comprehensive (loss) income (50,755) 117,521
-------------------- --------------------
Total stockholders' equity 183,796,392 223,694,286
-------------------- --------------------
Total liabilities and stockholders' equity $ 210,885,012 $ 246,328,537
==================== ====================
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 (UNAUDITED)
Three Months Ended June 30 Six Months Ended June 30
--------------------------- ---------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
Revenues:
Professional services $ 17,841,371 $ 22,067,108 $ 38,199,215 $ 40,968,389
Hardware and software sales 491,831 1,307,860 892,911 1,451,733
------------ ------------ ------------ ------------
Total revenues 18,333,202 23,374,968 39,092,126 42,420,122
------------ ------------ ------------ ------------
Cost of revenues:
Professional services 12,868,216 11,168,771 28,079,225 20,874,591
Hardware and software purchases 896,031 999,745 1,178,859 1,107,956
------------ ------------ ------------ ------------
Total cost of revenues 13,764,247 12,168,516 29,258,084 21,982,547
------------ ------------ ------------ ------------
Gross profit 4,568,955 11,206,452 9,834,042 20,437,575
------------ ------------ ------------ ------------
Sales and marketing 4,729,089 3,125,963 9,288,641 5,776,785
General and administrative 12,054,038 6,425,231 23,938,900 11,865,354
Depreciation and amortization 953,284 438,423 1,719,779 713,260
Intangibles amortization 6,300,112 213,177 12,674,891 426,354
Restructuring and other charges 3,663,817 -- 4,304,765 --
Loss on long-term investment in related party -- -- 1,000,000 --
Noncash compensation expense 107,969 19,039 218,236 38,078
------------ ------------ ------------ ------------
Operating expenses 27,808,309 10,221,833 53,145,212 18,819,831
------------ ------------ ------------ ------------
Operating (loss) profit (23,239,354) 984,619 (43,311,170) 1,617,744
Other income (expense):
Interest income 752,403 1,956,704 1,858,089 3,221,335
Other expense (75,669) (1,631) (53,784) (11,117)
Interest expense (83,744) (13,837) (126,406) (31,826)
------------ ------------ ------------ ------------
(Loss) income before income tax provision (22,646,364) 2,925,855 (41,633,271) 4,796,136
Income tax provision -- 1,261,909 -- 2,103,650
------------ ------------ ------------ ------------
Net (loss) income $(22,646,364) $ 1,663,946 $(41,633,271) $ 2,692,486
============ ============ ============ ============
Net (loss) income per share: Basic $ (0.63) $ 0.07 $ (1.17) $ 0.11
============ ============ ============ ============
Net (loss) income per share: Diluted $ (0.63) $ 0.05 $ (1.17) $ 0.08
============ ============ ============ ============
Weighted average shares outstanding: Basic 35,952,843 25,525,718 35,697,095 24,489,787
============ ============ ============ ============
Weighted average shares outstanding: Diluted 35,952,843 34,158,073 35,697,095 33,913,534
============ ============ ============ ============
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 (UNAUDITED)
Six Months Ended June 30
---------------------------------------------
2001 2000
-------------------- --------------------
Cash flows from operating activities:
Net (loss) income $ (41,633,271) $ 2,692,486
Adjustments to reconcile net (loss) income to net cash used in operating
activities:
Noncash compensation expense 218,236 38,078
Deferred income taxes -- (569,775)
Depreciation and amortization 14,394,670 1,139,614
Bad debt expense 1,434,179 238,521
Loss on long-term investment in related party 1,000,000 --
Write-off of software inventory 500,000 --
Noncash component of restructuring and other charges 1,231,050 --
(Increase) decrease in-
Accounts receivable 4,897,996 (5,798,765)
Unbilled work in process 1,205,070 (776,008)
Inventory held for resale (3,500,000) --
Income taxes (335,085) --
Prepaid expenses and other assets (1,651,371) (194,723)
Increase (decrease) in-
Accounts payable 823,621 (196,477)
Accrued expenses and other current liabilities 3,031,527 644,944
Deferred income 995,016 (342,649)
Income taxes -- 2,822,730
Deferred rent 8,635 289,714
-------------------- --------------------
Net cash used in operating activities (17,379,727) (12,310)
-------------------- --------------------
Cash flows from investing activities:
Proceeds from sale or redemption (purchase) of marketable securities, net 1,797,802 (463,905)
(Payments to) repayments from employees, net (537) 116,859
Loans to stockholders -- (280,216)
Adjustments to purchase price for fiscal 2000 acquisitions (1,961,302) --
Purchase of property and equipment, net (5,118,216) (4,450,939)
-------------------- --------------------
Net cash used in investing activities (5,282,253) (5,078,201)
-------------------- --------------------
Cash flows from financing activities:
Principal payments on capital leases (91,167) --
Proceeds from sale of stock through ESPP 204,312 1,305,702
Proceeds from sale of common stock, net of expenses -- 40,054,296
Proceeds from exercise of stock options 1,625,774 1,412,914
-------------------- --------------------
Net cash provided by financing activities 1,738,919 42,772,912
-------------------- --------------------
Effects of exchange rates (183,117) (110,311)
-------------------- --------------------
Net (decrease) increase in cash (21,106,178) 37,572,090
Cash and cash equivalents - beginning of period 80,058,791 89,633,634
-------------------- --------------------
Cash and cash equivalents - end of period $ 58,952,613 $ 127,205,724
==================== ====================
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 23,251 $ 14,543
==================== ====================
Taxes $ 280,349 $ --
==================== ====================
Supplemental disclosures on noncash investing and financing activities:
Noncash adjustment to purchase price for fiscal 2000 acquisitions $ 937,457 $ --
==================== ====================
The accompanying notes to consolidated financial statements are
an integral part of these consolidated statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(1) BASIS OF PRESENTATION
The consolidated financial statements and accompanying financial
information as of June 30, 2001 and for the three and six months ended
June 30, 2001 and 2000 are unaudited and, in the opinion of management,
include all adjustments (consisting only of normal recurring
adjustments) which the Company considers necessary for a fair
presentation of the financial position of the Company at such dates and
the operating results and cash flows for those periods. The financial
statements included herein have been prepared in accordance with
generally accepted accounting principles and the instructions of Form
10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information
and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles
have been condensed or omitted. These financial statements should be
read in conjunction with the Company's audited financial statements for
the year ended December 31, 2000. Results for interim periods are not
necessarily indicative of results for the entire year.
(2) ACQUISITIONS
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 and transaction
expenses of $1,085,417, of which approximately $853,000 were paid as of
June 30, 2001. 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 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. In 2001, the Company recorded an
additional $342,000 to the purchase price for the closing of certain
offices and a reduction in workforce in connection with the Company's
acquisition plan. This amount consisted of $301,000 for severance
benefits for 16 employees laid-off and $41,000 for exit costs related
to real estate. As of June 30, 2001, $204,000 of severance benefits
remained unpaid and is reflected in accrued expenses and other current
liabilities. 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.
On December 14, 2000, the Company acquired Global Integrity Corporation
("Global Integrity") in a transaction accounted for as a purchase.
Global Integrity provides information security services to Fortune 500
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
paid upon the closing of the transaction and transaction expenses of
$1,830,162, of which all have been paid as of June 30, 2001. The
Company also issued options to purchase 551,048 shares of common stock
to employees of Global Integrity in exchange for their Global Integrity
options. These options had a fair value of $2,271,434 and were
accounted for as additional purchase price. Additionally, the Global
Integrity 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 $4,313,033 and recorded intangible
assets of approximately $81.3 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 $63.0 million. Additionally, the Company recognized a
deferred income tax liability of $7,308,222 related to the
nondeductibility of certain acquired identifiable intangibles. In 2001,
the Company recorded an additional $2.4 million to the purchase price
for the closing of certain offices and a reduction in workforce in
connection with the Company's acquisition plan. This amount consisted
of $185,000 for severance benefits for 15 employees laid-off and $2.2
million for exit costs related to real estate. As of June 30, 2001,
$1.6 million remained unpaid for severance benefits and exit costs.
Such amount is reflected in accrued expenses and other current
liabilities. 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 Integrity have been included in the results of
operations of the Company since the date of acquisition.
The following unaudited information presents the pro forma results of
operations for the Company for the three and six months ended June 30,
2000 as if the acquisitions of Synet and Global Integrity had occurred
on the first day of these periods.
Three Months Ended Six Months Ended
June 30, 2000 June 30, 2000
-------------------- --------------------
(unaudited) (unaudited)
Revenues $ 29,857,555 $ 58,141,551
Net loss $ (4,472,793) $ (9,550,535)
Per Share Information:
Net loss per share - Basic and Diluted $ (0.14) $ (0.30)
Weighted average shares outstanding -
Basic and Diluted $ 32,295,820 $ 31,456,164
(3) NET (LOSS) INCOME PER SHARE
Basic net (loss) income per share is computed by dividing net (loss)
income available to common stockholders by the weighted average number
of shares outstanding. Diluted net (loss) income per share reflects the
potential dilution that would occur if securities or other contracts to
issue common stock were exercised or converted into common stock,
unless they are antidilutive.
The following table reconciles the numerator and denominator for the
calculation:
Three Months Ended Six Months Ended
June 30 June 30
--------------------------- ---------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
(unaudited) (unaudited)
Numerator -
Net (loss) income $(22,646,364) $ 1,663,946 $(41,633,271) $ 2,692,486
------------ ------------ ------------ ------------
Denominator -
Denominator for basic earnings
per share - weighted average
shares outstanding 35,952,843 25,525,718 35,697,095 24,489,787
============ ============ ============ ============
Effect of dilutive securities -
Incremental shares for assumed
conversion of options -- 8,632,355 -- 9,423,747
------------ ------------ ------------ ------------
Denominator for diluted earnings
per share - weighted average
shares outstanding 35,952,843 34,158,073 35,697,095 33,913,534
============ ============ ============ ============
Net (loss) income per share -
Basic $ (0.63) $ 0.07 $ (1.17) $ 0.11
Diluted $ (0.63) $ 0.05 $ (1.17) $ 0.08
============ ============ ============ ============
(4) COMPREHENSIVE (LOSS) INCOME
The Company adopted Statement of Financial Accounting Standards No.
130, "Reporting Comprehensive Income," which established standards for
reporting and displaying comprehensive income and its components. The
components of comprehensive (loss) income are as follows:
Three Months Ended Six Months Ended
June 30 June 30
--------------------------- ---------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
(unaudited) (unaudited)
Net (loss) income $(22,646,364) $ 1,663,946 $(41,633,271) $ 2,692,486
Unrealized (loss) gain on
investments (6,972) (19,413) 14,842 (32,433)
Foreign currency translation
adjustment 97,028 (120,180) (183,117) (110,311)
------------ ------------ ------------ ------------
Comprehensive (loss) income $(22,556,308) $ 1,524,353 $(41,801,546) $ 2,549,742
============ ============ ============ ============
(5) RESTRUCTURING AND OTHER CHARGES
In February 2001, the Company's management foresaw the need to lower
the operating costs of the business given its near-term revenue
projections. Therefore, the Company established a plan that included
the following: (1) a reduction in its workforce for both domestic and
international operations related to professional consultant employees
that had been underutilized for several months and also to employees
that held various management, sales and administrative positions deemed
to be duplicative functions; (2) the closing of several domestic and
international regional offices located in geographic areas that no
longer cost justified remaining open; and (3) the discontinuance of
electronic equipment leases and other expenses related to the reduction
in workforce.
As of June 30, 2001, 138 employees were laid-off. The Company recorded
restructuring charges of $3,275,033, of which $1,620,852 remained
unpaid as of June 30, 2001. Such charges consisted of $1,683,473 in
severance benefits, $1,458,614 in exit costs related to real estate and
electronic equipment, and $132,946 in other related expenses. These
charges have been reflected as operating expenses of the Company.
In June 2001, the Company wrote-off approximately $1,030,000 related to
internal software management tools that no longer suited the business
needs of the Company.
(6) EFFECTS OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133 ("SFAS 133"), "Accounting
for Derivative Instruments and Hedging Activities." SFAS 133
establishes accounting and reporting standards requiring that every
derivative instrument be recorded in the balance sheet as either an
asset or liability measured at its fair value. SFAS 133 requires that
changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. SFAS 133 is
effective for fiscal years beginning after June 15, 1999. In July 1999,
the FASB approved SFAS No. 137, "Accounting for Derivative Instruments
and Hedging Activities-Deferral of the Effective Date of SFAS 133",
which amends SFAS 133 to be effective for all fiscal quarters of all
fiscal years beginning after June 15, 2000. As the Company currently
does not engage in derivative instruments or hedging activities, the
adoption of this accounting principle did not have a material impact on
the Company's financial position or results of operations.
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 141, Business Combinations ("SFAS
141") and No. 142, Goodwill and Other Intangible Assets ("SFAS 142").
SFAS 141 requires all business combinations initiated after June 30,
2001 to be accounted for using the purchase method. Under SFAS 142,
goodwill and intangible assets with indefinite lives are no longer
amortized but are reviewed annually (or more frequently if impairment
indicators arise) for impairment. Separable intangible assets that are
not deemed to have indefinite lives will continue to be amortized over
their useful lives (but with no maximum life). The amortization
provisions of SFAS 142 apply to goodwill and intangible assets acquired
after June 30, 2001. With respect to goodwill and intangible assets
acquired prior to July 1, 2001, the Company is required to adopt SFAS
142 effective January 1, 2002. The Company is currently evaluating the
effect that adoption of the provisions of SFAS 142 that are effective
January 1, 2002 will have on its results of operations and financial
position.
(7) SUBSEQUENT EVENTS
In August 2001, the Company laid-off approximately 63 employees in
connection with the restructuring plan. These employees consisted
primarily of field consultants and sales personnel. The Company also
closed additional domestic offices located in geographic areas that no
longer cost justified remaining open. The Company will record
restructuring charges for severance payments of approximately $600,000
and exit costs related to real estate of approximately $2.9 million.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS RELATING TO FUTURE
EVENTS AND FUTURE PERFORMANCE OF THE COMPANY WITHIN THE MEANING OF SECTION 27A
OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF
1934, INCLUDING, WITHOUT LIMITATION, STATEMENTS REGARDING THE COMPANY'S
EXPECTATIONS, BELIEFS, INTENTIONS OR FUTURE STRATEGIES THAT ARE SIGNIFIED BY THE
WORDS "EXPECTS", "ANTICIPATES", "INTENDS", "BELIEVES" OR SIMILAR LANGUAGE.
ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN SUCH
FORWARD-LOOKING STATEMENTS. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS
DOCUMENT ARE BASED ON INFORMATION AVAILABLE TO THE COMPANY ON THE DATE HEREOF,
AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY FORWARD LOOKING STATEMENTS.
THE COMPANY CAUTIONS INVESTORS THAT ITS BUSINESS AND FINANCIAL PERFORMANCE ARE
SUBJECT TO SUBSTANTIAL RISKS AND UNCERTAINTIES. IN EVALUATING THE COMPANY'S
BUSINESS, PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE INFORMATION SET
FORTH BELOW UNDER THE CAPTION "RISK FACTORS" IN ADDITION TO THE OTHER
INFORMATION SET FORTH HEREIN AND ELSEWHERE IN THE COMPANY'S OTHER PUBLIC FILINGS
WITH THE SECURITIES AND EXCHANGE COMMISSION.
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 methodology to estimate and propose prices for our fixed-price
projects. The estimation process accounts for standard billing rates particular
to each project, the client's technology environment, the scope of the project
and the project's timetable and overall technical complexity. A member of our
senior management team must approve all of our fixed-price proposals 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 underutilization of our consultants may cause significant variations in our
operating results in any particular quarter and could result in losses for such
quarter. Factors which could cause underutilization include:
- the reduction in size, delay in commencement, interruption
or termination of one or more significant projects;
- the completion during a quarter of one or more significant
projects;
- the miscalculation of resources required to complete new or
ongoing projects; and
- the timing and extent of training, weather related
shut-downs, vacations and holidays.
Our cost of revenues consist 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.
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 offered by the Company
resulting in net proceeds of approximately $39.8 million after deducting
underwriter discounts and commissions, and expenses as payable by us.
On October 16, 2000, we acquired Synet Service Corporation for an aggregate
purchase price 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 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 the customer lists, workforce and excess of the purchase price over
the fair value of the net tangible assets acquired. During 2001, the Company
adjusted the purchase price for $342,000 for the closing of certain offices and
a reduction in workforce in connection with the acquisition plan. 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 of approximately $78.3 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 in exchange for all of the
outstanding capital stock of Global Integrity. The acquisition was accounted for
as a purchase and resulted in intangible assets of approximately $81.3 million
representing the customer lists, workforce, tradenames, developed technology and
excess of the purchase price over the fair value of the net tangible assets
acquired. During 2001, the Company adjusted the purchase price for $2.4 million
for the closing of certain offices and a reduction in workforce in connection
with the acquisition plan. The intangible assets are being amortized over a
period of 3-5 years.
Given the decline in revenue related to the service provider customer base,
coupled with the continuing uncertainty in the professional network consulting
services marketplace, 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
Three Months Ended June 30, 2001 and 2000
REVENUES. Revenues decreased 21.6% to $18.3 million in the three months ended
June 30, 2001 from $23.4 million in the three months ended June 30, 2000.
Revenues from professional services decreased 19.1% to $17.8 million in the
three months ended June 30, 2001 from $22.1 million in the three months ended
June 30, 2000. This decrease was primarily due to the severe contraction in
spending by telecom service providers in both domestic and international
operations and difficult market conditions in the enterprise sector. Revenues
from hardware and software sales decreased 62.4% to $492,000 in the three months
ended June 30, 2001 from $1.3 million in the three months ended June 30, 2000.
This decrease was primarily due to a decline in client requests for hardware and
software in connection with professional services projects. During the three
months ended June 30, 2001, BellSouth Corporation accounted for 20.2% of our
revenues. The number of our billable consultants increased to 416 as of June 30,
2001 from 377 as of June 30, 2000.
GROSS PROFIT. Gross profit decreased 59.2% to $4.6 million in the three months
ended June 30, 2001 from $11.2 million in the three months ended June 30, 2000.
As a percentage of revenues, gross profit decreased to 24.9% in the three months
ended June 30, 2001 from 47.9% in the three months ended June 30, 2000. This
decrease in gross profit is a result of a decrease in utilization of the related
consultants in addition to the write-off of $500,000 of software inventory which
was no longer deemed to be saleable. Excluding the impact of this write-off,
gross margin was 27.6% for the three months ended June 30, 2001. Cost of
revenues increased 13.1% to $13.8 million in the three months ended June 30,
2001 from $12.2 million in the three months ended June 30, 2000. This increase
in cost of revenues was due primarily to an increase in compensation and
benefits paid to consultants in addition to the $500,000 write-off of software
inventory.
SALES AND MARKETING EXPENSES. Sales and marketing expenses increased 51.3% to
$4.7 million in the three months ended June 30, 2001 from $3.1 million in the
three months ended June 30, 2000. As a percentage of revenues, sales and
marketing expenses increased to 25.8% in the three months ended June 30, 2001
from 13.4% in the three months ended June 30, 2000. The increase in absolute
dollars was primarily due to an increase of $191,000 in commissions paid, an
increase of $1.4 million in compensation and benefits paid due to the hiring of
additional personnel and the acquisitions of Synet and Global Integrity, and an
increase of $25,000 in sales and marketing efforts.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 87.6% to $12.1 million in the three months ended June 30, 2001 from
$6.4 million in the three months ended June 30, 2000. As a percentage of
revenues, general and administrative expenses increased to 65.7% in the three
months ended June 30, 2001 from 27.5% in the three months ended June 30, 2000.
The increase in absolute dollars was primarily due to an increase of $1.8
million in compensation and benefits costs due to the continued investment in
our domestic organization and European corporate staff, an increase of $798,000
in facilities and equipment leases reflecting the continued investment in our
infrastructure, an increase of $917,000 in bad debt expense, and an increase of
$2.2 million in professional services and other administrative costs.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased 117.4% to
$953,000 in the three months ended June 30, 2001 from $438,000 in the three
months ended June 30, 2000. This increase was due to purchases of additional
computer equipment to support our growth offset by write-offs of leasehold
improvements in connection with the restructuring plan.
INTANGIBLES AMORTIZATION. Amortization of intangibles increased to $6.3 million
for the three months ended June 30, 2001 from $213,000 for the three months
ended June 30, 2000. For the three months ended June 30, 2001, the amount
consisted of $213,000 amortization of intangibles related to the acquisition of
Network Resource Consultants and Company B.V. ("NRCC") in August 1999, $1.7
million amortization of intangibles related to the acquisition of Synet in
October 2000 and $4.4 million amortization of intangibles related to the
acquisition of Global Integrity in December 2000. For the three months ended
June 30, 2000, amortization was solely related to intangibles as a result of the
NRCC acquisition.
RESTRUCTURING AND OTHER CHARGES. For the three months ended June 30, 2001, the
Company laid-off 68 employees in connection with its restructuring plan. These
employees consisted primarily of employees who
held certain administrative and management positions deemed to be duplicative
functions. Amounts recognized as restructuring charges are $1.1 million in
severance benefits, $1.5 million in exit costs related to real estate and
electronic equipment, and $133,000 in other related expenses related to the
reduction in force. Additionally, included in this financial statement caption
for the three months ended June 30, 2001, is $1,030,000 related to the write-off
of internal software management tools that no longer suit the business needs of
the Company.
NONCASH COMPENSATION EXPENSE. During 1999, the Company 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 resulting in deferred
compensation. During 2000, related to the acquisition of Synet and Global
Integrity, the Company issued options to Synet and Global Integrity
optionholders in exchange for their Synet and Global Integrity options,
respectively. The unvested portion of the Synet and Global Integrity options
resulted in deferred compensation. These transactions result in noncash
compensation expense over the period that these specific options vest. During
the three months ended June 30, 2001 and 2000, the Company recorded
approximately $108,000 and $19,000, respectively, of noncash compensation
expenses related to these options.
OTHER INCOME (EXPENSE). Other income decreased to $593,000 in the three months
ended June 30, 2001 from $1.9 million in the three months ended June 30, 2000.
This decrease was primarily due to a decrease in interest income as a result of
the utilization of cash and cash equivalents to fund current operating needs,
the Synet and Global Integrity acquisitions, and a general decline in interest
rates.
INCOME TAXES. For the three months ended June 30, 2001 the benefit for income
taxes was fully offset by valuation allowances. For the three months ended June
30, 2000, the income tax provision was $1.3 million on pre-tax income of
approximately $2.9 million. The difference in the effective tax rates relates to
the provision for a valuation allowance against net operating losses and an
increase in expenses not deductible for tax purposes.
Six Months Ended June 30, 2001 and 2000
REVENUES. Revenues decreased 7.8% to $39.1 million in the six months ended June
30, 2001 from $42.4 million in the six months ended June 30, 2000. Revenues from
professional services decreased 6.8% to $38.2 million in the six months ended
June 30, 2001 from $41.0 million in the six months ended June 30, 2000. This
decrease was primarily due to the severe contraction in spending by telecom
service providers in both domestic and international operations and difficult
market conditions in the enterprise sector. Revenues from hardware and software
sales decreased to $893,000 in the six months ended June 30, 2001 from $1.5
million in the six months ended June 30, 2000. This decrease was primarily due
to a decline in client requests for hardware and software in connection with
professional services projects. During the six months ended June 30, 2001,
BellSouth Corporation accounted for 19.1% of our revenues. The number of our
billable consultants increased to 416 as of June 30, 2001 from 377 as of June
30, 2000.
GROSS PROFIT. Gross profit decreased 51.9% to $9.8 million in the six months
ended June 30, 2001 from $20.4 million in the six months ended June 30, 2000. As
a percentage of revenues, gross profit decreased to 25.2% in the six months
ended June 30, 2001 from 48.2% in the six months ended June 30, 2000. This
decrease in gross profit is a result of a decrease in utilization of the related
consultants in addition to the write-off of $500,000 of software inventory which
was deemed to be no longer saleable. Excluding the impact of this write-off,
gross margin was 26.4% for the six months ended June 30, 2001. Cost of revenues
increased 33.1% to $29.3 million in the six months ended June 30, 2001 from
$22.0 million in the six months ended June 30, 2000. This increase in cost of
revenues was due primarily to an increase in compensation and benefits paid to
consultants in addition to the $500,000 write-off of software inventory.
SALES AND MARKETING EXPENSES. Sales and marketing expenses increased 60.8% to
$9.3 million in the six months ended June 30, 2001 from $5.8 million in the six
months ended June 30, 2000. As a percentage of revenues, sales and marketing
expenses increased to 23.8% in the six months ended June 30, 2001 from 13.6% in
the six months ended June 30, 2000. The increase in absolute dollars was
primarily due to an increase of $659,000 in commissions paid, an increase of
$2.5 million in compensation and benefits paid due to the hiring of additional
personnel and the acquisitions of Synet and Global Integrity, and an increase of
$375,000 in sales and marketing efforts.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 101.8% to $23.9 million in the six months ended June 30, 2001 from
$11.9 million in the six months ended June 30, 2000. As a
percentage of revenues, general and administrative expenses increased to 61.2%
in the six months ended June 30, 2001 from 28.0% in the six months ended June
30, 2000. The increase in absolute dollars was primarily due to an increase of
$4.3 million in compensation and benefits costs due to the continued investment
in our domestic organization and European corporate staff, an increase of $2.1
million in facilities and equipment leases reflecting the continued investment
in our infrastructure, an increase of $1.5 million in bad debt expense, and an
increase of $4.1 million in professional services and other administrative
costs.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased 141.1% to
$1.7 million in the six months ended June 30, 2001 from $713,000 in the six
months ended June 30, 2000. This increase was due to purchases of additional
computer equipment to support our growth offset by write-offs of leasehold
improvements in connection with the restructuring plan.
INTANGIBLES AMORTIZATION. Amortization of intangibles increased to $12.7 million
for the six months ended June 30, 2001 from $426,000 for the six months ended
June 30, 2000. For the six months ended June 30, 2001, the amount consisted of
$426,000 amortization of intangibles related to the acquisition of NRCC in
August 1999, $3.5 million amortization of intangibles related to the acquisition
of Synet in October 2000 and $8.8 million amortization of intangibles related to
the acquisition of Global Integrity in December 2000. For the six months ended
June 30, 2000, amortization was solely related to intangibles as a result of the
NRCC acquisition.
RESTRUCTURING AND OTHER CHARGES. For the six months ended June 30, 2001, the
Company laid-off 138 employees in connection with its restructuring plan. These
employees consisted of field consultants that were under performing as well as
employees who held certain administrative and management positions deemed to be
duplicative functions. Amounts recognized as restructuring charges included $1.7
million in severance benefits, $1.5 million in exit costs related to real estate
and electronic equipment, and $133,000 in other related expenses related to the
reduction in force. Additionally, included in the financial statement caption
for the six months ended June 30, 2001 is $1,030,000 related to the write-off of
internal software management tools that no longer suit the business needs of the
Company.
LOSS ON LONG-TERM INVESTMENT IN RELATED PARTY. On March 22, 2001, Paradigm4,
Inc. filed for federal bankruptcy protection. This action created significant
uncertainty regarding the Company's investment in Paradigm4. As a result, the
Company has recognized a loss on its $1.0 million investment in Paradigm4 for
the six months ended June 30, 2001.
NONCASH COMPENSATION EXPENSE. During 1999, the Company 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 resulting in deferred
compensation. During 2000, related to the acquisition of Synet and Global
Integrity, the Company issued options to Synet and Global Integrity
optionholders in exchange for their Synet and Global Integrity options,
respectively. The unvested portion of their Synet and Global Integrity options
resulted in deferred compensation. These transactions result in noncash
compensation expense over the period that the specific options vest. During the
six months ended June 30, 2001 and 2000, the Company recorded approximately
$218,000 and $38,000, respectively, of noncash compensation expenses related to
these options.
OTHER INCOME (EXPENSE). Other income decreased to $1.7 million in the six months
ended June 30, 2001 from $3.2 million in the six months ended June 30, 2000.
This decrease was primarily due to a decrease in interest income as a result of
the utilization of cash and cash equivalents to fund current operating needs,
the Synet and Global Integrity acquisitions, and a general decline in interest
rates.
INCOME TAXES. For the six months ended June 30, 2001 the benefit for income
taxes was fully offset by valuation allowances. For the six months ended June
30, 2000, the income tax provision was $2.1 million on pre-tax income of
approximately $4.8 million. The difference in the effective tax rates relates to
the provision for a valuation allowance against net operating losses and an
increase in expenses not deductible for tax purposes.
LIQUIDITY AND CAPITAL RESOURCES. Since inception, we have financed our
operations through borrowings under short-term credit facilities, the sale of
equity securities and cash flows from operations. As of June 30, 2001, we had
approximately $59.0 million in cash and cash equivalents and $2.0 million in
marketable securities.
Net cash used in operating activities was $17.4 million for the six months ended
June 30, 2001 due to losses generated in operations and an increase in accrued
expenses.
Net cash used in investing activities was $5.3 million for the six months ended
June 30, 2001. Cash used in investing activities resulted from capital
expenditures of approximately $5.1 million and adjustments to purchase
price of $2.0 million as a result of the acqusition plan. Capital expenditures
consisted of $1.2 million of costs incurred in connection with the development
of software to be used for internal purposes and $3.9 million related to
purchases of computer equipment in connection with the expansion of our
operations in Germany and the continued investment in our infrastructure.
Cash provided by financing activities was $1.7 million for the six months ended
June 30, 2001. Cash provided by financing activities resulted from the receipt
of proceeds from the exercise of options and the sale of stock in connection
with the Company's Employee Stock Purchase Plan.
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 $10.0 million or 80.0% of our accounts
receivable. Amounts outstanding under the facility bear interest at the lender's
base rate which was 6.75% as of June 30, 2001. As of June 30, 2001, there were
no amounts outstanding under the facility.
We believe that our existing cash, cash equivalents and marketable securities
will be sufficient to meet our anticipated needs for working capital and capital
expenditures at least for the next twelve months. If cash generated from
operations is insufficient to satisfy our liquidity requirements, we may seek to
sell additional equity or debt securities or to obtain a credit facility. The
sale of additional equity or convertible debt securities could result in
dilution to our stockholders. The incurrence of indebtedness would result in
increased fixed obligations and could result in operating covenants that would
restrict our operations. We cannot assure you that financing will be available
in amounts or on terms acceptable to us, if at all.
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.
Adverse market conditions, particularly those affecting the
professional services industry, may impair our operating results
Our results depend to a large extent on market conditions affecting the
technology industry in general and the telecommunications and enterprise sectors
in particular. Adverse market conditions in the sectors in which we operate
could delay buying decisions or cause projects to be deferred, reduced in scope
or discontinued. These sectors have experienced a drastic downturn in the past
twelve months. If market conditions and corporate spending continue to worsen in
these sectors, our operating results will continue to suffer.
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 six months ended June 30, 2001, BellSouth Corporation
accounted for 19.1% of our revenues. Our five largest clients accounted for
41.6% of our revenues for the six months ended June 30, 2001. For the year ended
December 31, 2000, our five largest clients accounted for 37.8% of our revenues.
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 loss will increase. In addition, the non-payment or late
payment of amounts due from a major client could adversely affect us. As of June
30, 2001, the accounts receivable from BellSouth Corporation was approximately
$3.3 million, which related to work performed in February 2001 through June
2001.
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 market conditions in the sectors in which we operate;
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 six months ended June 30, 2001 and the year ended December 31,
2000, fixed-price projects accounted for 48.5% and 43.2% 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. This
unpredictability is often compounded by uncertain market conditions. 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 operations, which may harm our
business
A key part of our strategy is to grow our business; however, our rapid
growth has placed a significant strain on our managerial and operational
resources. From January 1, 1997 to June 30, 2001, our staff increased from
approximately 123 to approximately 596 employees. Since such time, as a result
of market conditions and other factors, we have decreased our staff to 539
employees as of August 1, 2001. As a result of this reduction, the remaining
employees have been charged with additional responsibilities. 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.
Our management team has experienced significant turnover which 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. Andrew
Zimmerman has recently been appointed our Chief Executive Officer, and our
President has recently resigned. In addition, in connection with our recent
reduction in staff, many members of our senior management team have either
departed, or been redeployed and given new responsibilities. If the
restructuring of our senior management team does not lead to the results we
expect, our ability to effectively deliver our services, manage our company, and
carry out our business plan may be impaired.
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.
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 Service
Corporation, acquired in October 2000, has a German subsidiary, whose operations
we have significantly increased, 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 security services market
In December 2000, we entered into the managed security 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. To date we have made a substantial infrastructure investment in order to
serve this market. We cannot assure you that our efforts in this new market will
be successful. Accordingly, we may lose some or all of the resources we invest
in this new market.
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 45% 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE 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.
PART II. OTHER INFORMATION
ITEM 1. 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 the
Company in which he alleged that the Company was in breach of an employment
agreement between Plaintiff and the Company. Plaintiff also 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 opposing 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
Predictive intends to defend it vigorously.
By Decision and Order dated July 16, 2001, Judge Hickman denied Plaintiff's
motion to amend his complaint to add a new cause of action for breach of an
implied covenant of good faith and fair dealing.
This matter is set for trial on May 6, 2002.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On October 27, 1999, the SEC declared effective the Registration Statement on
Form S-1, SEC Registration Number 333-84045 for our public offering of common
stock in the United States (the "Offering"). We realized net proceeds of
approximately $67.0 million from the Offering. Since that time we have used the
proceeds for the following: $11.1 million for the acquisition of Synet; $33.3
million for the acquisition of Global Integrity; and $21.1 million to fund
current operating needs.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our 2001 Annual Meeting of Stockholders on May 22, 2000. At that
meeting, the stockholders approved the following proposals: (i) the election of
Peter L. Bloom, Eric Meyer and William W. Wyman as Class II directors to serve
on the Board of Directors, (ii) the ratification of the Board of Directors'
decision to select Arthur Andersen LLP as our independent public accountants for
the year ending December 31, 2001 and (iii) the approval of an amendment to our
1999 Stock Incentive Plan to increase the number of shares of common stock
reserved for issuance under the plan by 14,000,000 shares to an aggregate of
21,004,637 shares.
There were 31,569,766 votes cast for, 40,386 votes cast against and 0abstentions
in connection with the election of Peter L. Bloom as a Class II Director. There
were 31,362,682 votes cast for, 247,470 votes cast against and 0 abstentions in
connection with the election of Eric Meyer as a Class II Director. There were
27,467,585 votes cast for, 4,142,567 votes cast against and 0 abstentions in
connection with the election of William W. Wyman as a Class II Director. The
remainder of our Board of Directors remains as previously reported. There were
31,552,721 votes cast for, 55,671 votes cast against and 1,760 abstentions in
connection with ratification of the Board of Director's decision to select
Arthur Andersen LLP as our independent public accountants for the year ending
December 31, 2001. There were 17,741,501 votes cast for, 8,241,071 votes cast
against and 59,611 abstentions in connection with the approval of an amendment
to our 1999 Stock Incentive Plan to increase the number of shares of common
stock reserved for issuance under the plan by 14,000,000 shares to an aggregate
of 21,004,637 shares.
ITEM 5. OTHER INFORMATION
NONE
ITEM 6. EXHIBITS AND REPORT ON FORM 8-K
(a) The following exhibit is filed as part of this report:
10.1 Employment Agreement, dated as of June 15, 2001, by and
between the Registrant and Andrew Zimmerman.
(b) The Company filed two reports on Form 8-K during the first
quarter ended June 30, 2001. Information regarding the items
reported on is as follows:
April 3, 2001
The Company announced that Ronald G. Pettengill had
resigned as Chairman and Chief Executive Officer of
the Company.
June 28, 2001
The Company announced that Andrew Zimmerman has been
elected Chief Executive Officer of the Company.
ITEM 7. SIGNATURES
Pursuant to the requirements of the Securities Exchange Act, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
PREDICTIVE SYSTEMS, INC.
(Registrant)
Date: August 14, 2001 /s/ ANDREW ZIMMERMAN
--------------------------------------------------------------------------------
Name: Andrew Zimmerman
Title: Chief Executive Officer
(principal executive officer)
Date: August 14, 2001 /s/ GERARD E. DORSEY
--------------------------------------------------------------------------------
Name: Gerard E. Dorsey
Title: Chief Financial Officer
(principal accounting and financial officer)