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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 1999
COMMISSION FILE NUMBER 000-30422
PREDICTIVE SYSTEMS, INC.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 7371 13-3808483
(State of (Primary Standard Industrial I.R.S. Employer
Incorporation) Classification Code) Identification Number)
417 Fifth Avenue, 11th Floor
New York, New York 10016
(212) 659-3400
(Address, Including Zip Code, and Telephone Number,
Including Area Code, of Registrant's Principal Executive Offices)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK PAR VALUE $0.001 PER SHARE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 of 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of voting stock held by non-affiliates of the
registrant as of March 1, 2000 was $276,854,232.75 (based on the last reported
sale price on the NASDAQ National Market on that date).
The number of shares outstanding of the registrant's common stock as of
March 1, 2000 was 23,429,200.
DOCUMENTS INCORPORATED BY REFERENCE
The following documents (or parts thereof) are incorporated by reference into
the following parts of this Form 10-K: None
PART 1
Item 1. Business
Recent Developments
On March 6, 2000 we filed a Registration Statement on Form S-1
(Registration No. 333-31770). You should review the Registration Statement and
the amendments for more information about this offering.
Overview
We are a network consulting company focused on the design, performance,
management and security of complex computing networks. We utilize our
proprietary consulting methodology, BusinessFirst, to translate our clients'
strategic business objectives into sound technology solutions. Using our
BusinessFirst methodology, we demonstrate the business value of technology
solutions in specific and measurable terms, thereby enabling our clients to
incorporate objective and quantifiable analysis into their technology
investment decisions.
As an independent service provider, we provide our clients with unbiased
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. In
addition to these services, we have developed an innovative service model
through which we deliver our clients packaged service products, otherwise
referred to as productized services. Our service products are characterized by
pre-defined service offerings that have pre-defined deliverables, a pre-defined
pricing model and are implemented using a pre-defined methodology. In contrast
to our project outsource and collaborative consulting services which provide
our clients with services that are customized for, and therefore unique to,
each engagement, our service products are typically provided with little or no
modification.
Our consultants are organized into the following practice areas, which
cover the four cornerstones of network computing: network and systems
management; internetwork design and engineering; performance management; and
information security. This structure enables our consultants to gain in-depth
expertise and become intimately familiar with the best practices and
methodologies identified within each of those disciplines.
Industry Background
The effective communication and management of information has become
critical to success in today's competitive and rapidly changing global business
environment. Network infrastructures that once were viewed as sources of
competitive advantage are now being recognized as competitive necessities for
businesses in a broad range of industries. This shift is driven primarily by
the following factors:
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
solutions that integrate a variety of systems and technologies from multiple
vendors. The rapid pace of change in networking
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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 $12.1 billion in 1998 to $25.5 billion
by 2003. There are many third-party service providers, including network
equipment vendors, systems integrators, value-added resellers and network
consulting companies, seeking to capitalize on this growth.
However, 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 network consulting company focused on the design, performance,
management and security of complex computing networks. We utilize our
proprietary consulting methodology, BusinessFirst, to translate our clients'
strategic business objectives into sound technology solutions. We believe that
our success to date has been largely attributable to the following key
characteristics of our service offerings:
Quantifiable Business Analysis. Using our BusinessFirst methodology, we
can demonstrate the business value of technology solutions in specific and
measurable terms, thereby enabling our clients to incorporate objective and
quantifiable analysis into their technology investment decisions. We utilize
widely accepted principles of risk analysis and mitigation used by the
insurance and financial services industries to assess our client's technology
environment. We provide our clients with a detailed analysis of the financial
benefit of a project by quantifying factors such as business risks, total cost
of ownership and operational efficiency. As a result, our clients can gain a
clear understanding of the benefits that they will derive from their network
technology investments and a measure of certainty about how their technology
investments will be translated into quantifiable improvements to their business
processes.
Flexible and Innovative Service Delivery Methodologies. We provide our
clients with a flexible service delivery model that is designed to enhance
their ability to cost-effectively leverage our expertise. We are engaged by our
clients in one of three ways: on a project outsource basis, on a collaborative
consulting basis or through the purchase of pre-defined service offerings,
otherwise known as service products. 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'
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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. When engaged on a collaborative consulting basis, we
extend our clients' internal technical capabilities with our consultants. This
enables our clients to utilize our extensive expertise and to access our
methodologies while they retain overall responsibility for the project.
Collaborative consulting services are typically billed on a time and expense
basis, and typically do not entail fixed-cost, fixed-time or fixed-service
commitments. Our service products are pre-defined service offerings that we
believe address the needs that are common to many of our clients. These service
products are characterized by pre-defined deliverables, pre-defined pricing and
are provided with little or no modification.
In-Depth Network Computing Expertise. Our consultants are organized into
practice areas which cover the four cornerstones of network computing: network
and systems management; internetwork design and engineering; performance
management; and information security. This enables our consultants to gain
in-depth expertise and become intimately familiar with the best practices
within each of those disciplines. More importantly, it enables us to leverage
the knowledge base within each practice group to provide our clients with
cross-functional teams of consultants that are better equipped to address their
varying networking needs in a coordinated and efficient manner.
Strategy
Our goal is to become the leading provider of services for the design,
performance, management and security of complex networks. To achieve this goal,
we intend to pursue the following strategies:
Continue to Evolve Our BusinessFirst Methodology. The evolution and
enhancement of our BusinessFirst methodology is critical to our ability to
leverage and share knowledge across engagements and to further improve our
ability to deliver predictable, high-quality services to our clients on time
and on budget. We have a dedicated team of consultants that is focused on
continuously enhancing and refining our BusinessFirst methodology by
incorporating the best practices identified over numerous engagements. We
believe that this enables us to consistently deliver high-quality network
technology solutions.
Expand and Enhance Our Service Product Offerings. We intend to continue to
enhance and expand our innovative service product offerings. These service
offerings provide our clients with a pre-defined set of deliverables that
require minimal customization and are characterized by an objective and
quantifiable value proposition and return on investment justification.
Moreover, our service products enable us to increase our margin opportunities
by improving the efficiency of our sales and service delivery model. These
products also enable us to market and sell our services through indirect
channels. For example, BellSouth offers our E-Readiness Assessment service
product to their customers in the nine-state BellSouth region.
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
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.
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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. Last
year, we acquired Network Resource Consultants and Company B.V. in The
Netherlands in order to further expand our European presence. We currently
offer our services through a network of offices in eight states throughout the
United States and in England and The Netherlands. 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.
BusinessFirst Methodology
BusinessFirst is a proprietary methodology that governs our organization
and client engagements. Our BusinessFirst methodology enables us to better
understand the business objectives that drive the need for technology solutions
and provide our clients with pre-defined services on a fixed-time, fixed-price
basis. We begin each engagement by helping our clients clarify their business
requirements in specific terms. We then undertake a thorough assessment of our
client's existing business processes and technology infrastructure. Based on
this assessment, we formulate an analysis of the requirements to translate
their technology investments into measurable business objectives. Once we
formulate a requirements analysis, we draw upon our broad expertise to design a
solution that leverages our clients' existing technology infrastructure to
maximize their return on investment. We believe that our BusinessFirst
methodology bridges the gap in the marketplace between management consulting
firms and technical staff augmentation services and enables us to translate
business objectives into leading-edge technology solutions.
Services
Our consultants are organized into four practice areas. Although many of
our consultants are cross-skilled in a variety of technologies and many
technologies span multiple practice areas, each practice area represents an
aspect of network technology important enough to warrant specialization.
These practice areas are:
o network and systems management;
o internetwork design and engineering;
o performance management; and
o information security.
Our consultants have extensive experience with a wide variety of
technologies and vendors. For some clients, our consultants are involved in
both technology and vendor selection. Other clients have already selected the
technology, vendor or both. Regardless, we offer our clients a completely
objective, vendor-neutral approach. Our knowledge of advanced technologies and
leading vendors is a significant part of our value proposition to our clients.
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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:
Service Description
- - -------------------------------------- ---------------------------------------------------------
Service Definition and Service Level Highlights a client's service level commitments and
Agreement Workshop assists in the development of a rational, long-term plan
for meeting and exceeding those commitments.
Rapid Restart Assessment Determines the readiness of a client's network
operations center and provides short-term and long-term
recommendations for addressing its deficiencies.
Network Operation Center Assists clients in evaluating and selecting network and
Architecture and Implementation systems management technologies appropriate for their
network operations centers. Configures and implements
the selected technology and trains clients' operations
staff.
Process and Procedure Development Designs, implements and documents the processes and
procedures required to operate a network operations
center.
Automation, Correlation and Root Automates repetitive management tasks associated with
Cause Analysis Technology operating a network.
Development
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Internetwork Design and Engineering. Our internetwork design and
engineering practice focuses on designing and implementing network solutions in
support of our clients' strategic business initiatives. We have created a team
of seasoned professionals who use their specialized technical skills,
real-world industry experience and methodologies to solve the problems
associated with building and maintaining network foundations. With core
competencies in the areas of backbone technology, local area network switching,
Internet Protocol, or IP, management and design, asynchronous transfer mode, or
ATM, and remote access, our versatile team contributes both technical depth and
breadth to client engagements.
The following table lists some of the services provided by our
internetwork design and engineering practice area:
Service Description
- - ----------------------------------- ----------------------------------------------------------
Advanced Technology Planning and Assists clients in planning and integrating advanced
Migration technologies into their business-critical networks. The
services include technology briefings, vendor/product
selection, solution design and integration planning and
comprehensive testing.
Network Deployment Services Implements network technology into clients' existing
networks. Services include project management, vendor
coordination, technology installations and training.
Remote Access and Virtual Private Designs and deploys secure, high-performance remote
Network access and virtual private network solutions to allow
clients, their employees, supply-chain partners and other
business partners to access information remotely.
Network Audit Services Audits clients' network infrastructure to evaluate its
design and performance, document the configuration,
analyze its compliance to prescribed standards and
develop an action plan to meet strategic objectives.
Internet Protocol Management Designs and implements Internet Protocol address
Solutions schemes required for a client to connect to the Internet.
The service also implements management technologies
to administer the Internet Protocol addresses used
within an organization.
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Performance Management. Our performance management practice leverages
proven methodologies and our extensive experience to help our clients optimize
their networks. We use sophisticated tools and techniques to gather, organize
and warehouse network performance data. This data may subsequently be used for
a number of related performance analysis applications, including capacity
planning, response time management and network simulation modeling. Consultants
in our performance management practice area are experts in applicable
technologies, including core competencies in remote monitoring, or RMON, data
warehousing and discrete event simulation modeling.
The following table lists some of the services provided by our performance
management practice area:
Service Description
- - ----------------------------- --------------------------------------------------------------
Network Baselining Collects data in order to establish a baseline of network
resource utilization. The baseline is then used as a
comparison against future trends.
Application Impact Analysis Analyzes how an application uses network resources to
predict response times that users will experience when
the application is deployed. Recommends improvements
that enable the application to maximize network
resources.
Network Usage-Based Billing Assists clients' transition from a flat-rate billing model to
Services a usage-based billing model for buying network
services.
Capacity Planning Assists clients in understanding the capacity and
network resource constraints that exist within their
network with sufficient advance warning to enable them
to add capacity before user performance is affected.
Response Time Management Monitors and analyzes end-user application response
times to ensure that they remain within the service level
commitments.
Network Simulation Modeling Models a network environment so that new configuration
and new application deployment scenarios can be
simulated before going into production.
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Information Security. Our information security practice is focused on
ensuring that the confidentiality, integrity and availability of our clients'
networks are protected. Our information security consultants have practical
experience with a wide array of advanced security technologies, as well as the
social and procedural aspects of security. By translating the complexities of
information security into understandable terms such as risks, costs and
benefits, we enable our clients to make clear and informed decisions about
protecting their information assets.
The following table lists some of the services provided by our information
security practice area:
Service Description
- - ----------------------------------- -----------------------------------------------------------
Information Security Requirements Assesses clients' physical security environment, the
Analysis technical controls for accessing information assets and
employee security awareness. Highlights deficiencies
and makes recommendations to migrate clients to
industry-specific best practices.
Asset and Risk Analysis Identifies critical assets, determines susceptibility to
risks and quantifies the impact of such risks.
Recommends a risk mitigation plan to prioritize
corrective actions.
Information Security Policy Assists customers to create a comprehensive
Development information security policy that clearly states
requirements for employee behavior, technical security
systems and the physical controls needed to protect the
client's information assets.
Security System Design and Designs and implements security systems using custom
Implementation configured products to enforce the specific information
security policy of each client.
Incident Response and Digital Provides critical response team services in the event of
Forensics Services a security breach. Restores the operational integrity of
the systems, maintains evidence, provides forensic and
investigative services and facilitates changes to prevent
a recurrence of the breach.
Information Security Assessments Verifies the implementation and effectiveness of clients'
security policies by reviewing and testing their policies,
employee awareness, perimeter security and response
team readiness.
Service Products
Through our collective experience, we gain insights into the common needs
of our clients. When we determine that a need is both urgent and pervasive, we
standardize our services into a solution referred to as a service product. Our
service products are pre-defined service offerings that are replicable from one
project to another and have a pre-defined set of service deliverables, a
pre-defined pricing model and are implemented using a pre-defined methodology.
In contrast to our project outsource and collaborative consulting services
which provide our clients with services that are customized for, and therefore
unique to, each engagement, our service products are typically provided with
little or no modification.
Our service products offer a number of advantages as compared to custom
consulting engagements. These include:
o efficient delivery of our services over and over again using a
replicable methodology;
o ability to gain broad market penetration because our productized services
are well-defined and can be more easily sold by our sales force and
through third-party sales channels;
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o ability to more effectively articulate the business benefit of our
services based on observing the impact that our service products have for
other clients; and
o a more flexible pricing strategy that is based on the business benefit to
our clients and not the cost to deliver our services.
Our current service products include:
Information Security Requirements Analysis. This service product is
designed to discover information security weaknesses in our clients' networks
and systems. It provides our clients with the ability to understand where they
are vulnerable to a security threat and both the likelihood and potential cost
of each threat. Our certified security experts assess a client's physical,
administrative and technical security. They then present a report to management
explaining how the security weaknesses that they have found could impact the
client's business and propose strategies for addressing these weaknesses.
Network Assessment. This service product provides a cost-effective expert
analysis of a client's existing network environment. It provides a report that
helps the client to understand the performance and reliability characteristics
of its network and provides specific recommendations for improvements to the
network along with an analysis of the business benefits that can be achieved
through the recommended improvements.
Application Impact Study. This service product provides clients with the
information they need to understand how the deployment of a new application
will impact an existing network. Our consultants use a combination of
sophisticated analysis tools and methodologies to thoroughly understand how an
application uses network resources. They then issue a report on the
application's performance and its impact on the client's network. Clients can
then determine if they need to enhance their network in order to ensure that
their critical applications perform to their requirements.
Network Management Assessment. This service product provides an evaluation
of a client's current network management systems. Our consultants analyze both
a client's network management technology and its service level agreements. They
then provide the client with a tactical and strategic roadmap that enables the
client to implement network management solutions that support the client's
business objectives.
Network Modeling. This service product allows clients to ask "what if"
questions about planned changes in their network before the changes are
implemented. Using a combination of sophisticated software tools and our own
methodology, we build a model of the network environment. We can then simulate
changes in the environment such as adding applications or changing equipment,
and observe the impact. Clients can then use this analysis to optimally plan
changes in their network.
E-Readiness Assessment. This service product provides our enterprise
clients with a comprehensive assessment of their network infrastructure's
readiness to support busness-to-business or business-to-consumer electronic
commerce over the Internet. The e-readiness assessment includes an evaluation
of their network design, a network management systems analysis, a performance
and capacity planning check and a review of information security policies,
procedures and systems. The client receives a report detailing gaps in the
network infrastructure that could adversely impact e-business transactions and
a priortized list of suggested infrastructure enhancements.
E-Business Risk Analysis. This service product helps our financial
services clients to measure, monitor and control risks arising from doing
business over the Internet. Using risk categories that are recognized by
industry regulators, the E-Business Risk Analysis provides a quantitative
profile of network infrastructure-related risks and a range of suggested
mitigation alternatives.
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Clients
We provide professional network services to a variety of clients across a
broad range of industries including:
Bear Stearns Deutsche Bank ICG Primus Telecom
Bell Atlantic DLJdirect ING Barings Furman Selz PSINet
BellSouth EMC INTELSAT Qwest
Bose Enron Communications Mary Kay Cosmetics Raytheon
British Telecom Exodus Communications MCI Worldcom SIAC
Cable & Wireless Fidelity Investments Navisite State Street Bank
Cignal Global Comm. First Union Norfolk Southern Teligent
Cisco Fleet Bank Pepsi Union Bank of California
Comdisco homeruns.com Pershing UUNET
CTC Communications iBEAM Broadcasting Pfizer
Representative Client Case Studies
The following case studies are representative of some of the network consulting
services that we have provided to our clients.
UUNET. UUNET, the Internet services division of MCI WorldCom, is a global
leader in Internet communications solutions to businesses worldwide. UUNET has
built its reputation on providing high-quality services such as Internet access,
web hosting, remote access and other value-added networking services. To ensure
its ability to provide clients with the highest levels of service, UUNET
constructed one of the most rigorously-engineered and widely deployed
Internet-protocol networks in the world. UUNET currently offers service to more
that 70,000 businesses in 114 countries throughout North America, Europe and
Asia Pacific. UUNET selected us to develop its next-generation Internet-based
service offering, Virtual Private Networking.
Virtual Private Networks, or VPNs, provide secure, encrypted connections
over the public Internet that allow businesses to communicate privately without
having to build separate private networks. While UUNET's own network systems
engineers are among the most experienced in the world, they wanted an
independent assessment of their VPN system design. We worked with UUNET to
develop a comprehensive VPN solution, including network management, service
provisioning and fulfillment, and network security. We also worked successfully
with UUNET to ensure that the VPN was scalable across UUNET's global network,
both in terms of functionality, ease of deployment and ease of operation.
Finally, we helped develop and document the processes and procedures necessary
to efficiently operate the service.
The success of UUNET's VPN service has led to other collaborations with us,
including the development of UUNET's Internet-based fax service and branded
dial-up Internet access service.
BT Syncordia Solutions. BT Syncordia Solutions, a division of British
Telecom, is Europe's second largest provider of managed and outsourced network
solutions. BT Syncordia manages the infrastructure of more than 27,000 clients
in 46 countries. BT Syncordia-managed networks carry a significant portion of
the commercial banking transactions in the United Kingdom. In order to meet the
availability requirements of its customers, BT Syncordia turned to us to help it
design and build a world-class network operations center.
We used our BusinessFirst methodology and extensive technical experience to
design and build a network operations center for BT Syncordia. We integrated
sophisticated network management
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tools that could manage BT Syncordia's multi-vendor network and easily
incorporate changes due to increases in network traffic, introduction of new
services and increases in customer base. We also instituted processes and
procedures that enabled BT Syncordia's operations staff to act rapidly to
identify and resolve network performance issues.
Union Bank of California. Union Bank of California has been a leader in
the development of on-line banking products and services. Its early entry into
the on-line banking arena has allowed it to effectively utilize the Internet to
conduct a significant amount of banking transactions each day. Critical to the
continued success and growth of Union Bank of California's on-line presence is
the security of its networks. Union Bank of California has turned to us to
address its network security requirements.
Even though Union Bank of California had designed and implemented
sophisticated security technology solutions, it enlisted our help to validate
its security program and to assist it in highlighting deficiencies or
vulnerabilities in its existing security program. We performed a thorough
assessment of its perimeter defenses, encryption strategy, authentication
techniques, and operational processes and procedures. Our efforts helped Union
Bank of California make necessary changes to its infrastructure, security
systems and operational policies that significantly improved the security of
their Internet banking and other on-line initiatives. We also created an ongoing
review process to ensure continued, optimal security.
Sales and Marketing
We have developed direct and indirect sales channels for the sale of our
services. To facilitate our direct sales effort we have developed the
infrastructure necessary to capture and track the major sales indicators
through the sales cycle. Additionally, a significant amount of time and effort
has been and will continue to be invested in the development of tools, training
materials and training for sales and technical personnel. Our service products
have provided us with an opportunity to develop strategic third-party
relationships with hardware, software service and telecommunications providers
in order to expand our sales channel. As a result, we are developing an
indirect sales channel through relationships with third-party strategic
partners. We have 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.
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 December 31, 1999, we had 416 full-time employees.
Recruiting. Our success is dependent in part on attracting and retaining
talented and motivated personnel at all levels. Accordingly, we invest
significant resources in our recruiting efforts. We have a proactive recruiting
philosophy and believe in a broad-based model for attracting candidates.
Generally, we hire technical consultants according to profiles that fit into
one of our four practice areas.
Corporate Culture. Our corporate culture is shaped by our view of
employees as investors because they choose to invest their talents, skills,
time and energy into our organization. This mindset is critical to our ability
to attract and retain professional staff at a time when information
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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.
14
We pursue the registration of our trademarks in the United States and
England. We may not be able to secure adequate protection of our trademarks in
the United States and other countries. We currently have applied for trademark
registrations in the United States and England for the PREDICTIVE SYSTEMS and
BUSINESSFIRST marks, and further, a trademark application in the United States
for the Predictive logo. The United States Patent and Trademark Office has
raised preliminary objections to the registration of the BUSINESSFIRST mark and
the Predictive logo on a number of grounds, including likelihood of confusion
with pre-existing trademarks. We have responded to these objections and are
awaiting the decisions on our responses. We have not, however, received any
objections from third parties asserting likelihood of confusion claims with
respect to our trademarks. Nonetheless, we may not be able to obtain trademark
registrations in the United States or England, or both, for one or more of
these trademarks, in which case we would be unable to fully enforce any
statutory trademark rights against third parties for these trademarks, and/or
we may decide to replace these trademarks with new trademarks. This could have
a material adverse effect on our business, financial condition and results of
operations. Effective trademark protection may not be available in all the
countries in which we conduct business. Policing unauthorized use of our marks
is also difficult and expensive. In addition, it is possible that our
competitors have adopted or will adopt product or service names similar to
ours, thereby impeding our ability to build brand identity and possibly leading
to customer confusion.
We cannot be certain that our services and the finished products that we
deliver do not or will not infringe valid patents, copyrights, trademarks or
other intellectual property rights held by third parties. We may be subject to
legal proceedings and claims from time to time relating to the intellectual
property of others in the ordinary course of our business. We may incur
substantial expenses in defending against these third-party infringement
claims, regardless of their merit. Successful infringement claims against us
may result in substantial monetary liability or may materially disrupt the
conduct of our business.
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 our common stock 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
15
During the year ended December 31, 1999, Qwest Communications and Bear
Stearns accounted for 16.8% and 14.0%, respectively, of our revenues. Our five
largest clients accounted for 45.8% of our revenues for the year ended December
31, 1999. 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.
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 short notice. If a major client or a number of small
clients terminate our contracts or significantly reduce or modify their
business relationships with us, 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; and
o the timing and extent of training.
16
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 year ended December 31, 1999, fixed-price projects accounted for 35.0%
of our revenue. 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.
17
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, 1999, our staff increased from
approximately 123 to approximately 416 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.
If we are unable to integrate our recent acquisition of Network Resource
Consultants and Company and any other future acquisitions, our business may be
disrupted
We recently acquired Network Resource Consultants and Company B.V., a
network consulting company based in The Netherlands. The integration of this
and other future acquisitions presents us with significant financial,
managerial and operational challenges. We may not be able to meet these
challenges effectively. To the extent our management is required to devote
significant time and attention to integrating the technology, operations and
personnel of acquired businesses, we may not be able to properly serve our
current clients or attract new clients. Any difficulties in integrating
acquisitions could disrupt our ongoing business, distract our management and
employees, increase our expenses and otherwise adversely affect our business.
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
18
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 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, in
particular Ronald G. Pettengill, Jr., our Chairman and Chief Executive Officer,
and Robert L. Belau, our President. 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
addition, in August 1999, we acquired Network Resource Consultants and Company,
a network consulting company based in The Netherlands. 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;
19
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.
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);
20
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.
Year 2000 problems present technological risks which may be costly to correct
and which may disrupt our business
Year 2000 problems could cause us, or our clients, to experience
operational difficulties and incur expenses. We are not aware of any material
Year 2000 problems that have harmed or threaten to harm our business, but we
cannot assure you that no such problems will emerge. Our failure to timely fix
or replace our internal systems or material third-party software, hardware or
services as a result of a material Year 2000 problem could result in lost
revenues and other business interruptions, any of which could materially and
adversely effect us. Any significant Year 2000 problem could also require us to
incur significant unanticipated expenses to remedy these problems and could
divert management from other tasks of operating our business, which would harm
our business, results of operations and financial condition. Please see "Item
7--Management's Discussion and Analysis of Financial Condition and Results of
Operations--Year 2000" for more detailed information regarding the Year 2000
issue.
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 not be able to obtain trademark protection for some of our important
trademarks, which would significantly impair our ability to prevent others from
using those trademarks and may require us to replace them with new trademarks
The United States Patent and Trademark Office has raised objections to the
registration of our "BUSINESSFIRST" and Predictive logo trademarks, including
likelihood of confusion with pre-existing trademarks. We have responded to
these objections and are awaiting decisions on our responses. We have not,
however, received any objections from third parties asserting likelihood of
confusion claims with respect to our trademarks. Nonetheless, we may not be
able to obtain trademark registrations in the United States or England, where
we presently have pending trademark applications for our "PREDICTIVE SYSTEMS"
and "BUSINESSFIRST" marks, for one or more of these trademarks, in which case
we will be unable to enforce any statutory trademark rights against third
parties for these trademarks, and/or we must decide to replace such trademarks
with new trademarks.
21
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.
Risks Related to the Public Trading of our Common Stock
Our stock price is likely to be highly volatile and could drop unexpectedly
The market price of our common stock is highly volatile and may fluctuate
substantially. As a result, investors in our common stock may experience a
decrease in the value of their common stock regardless of our operating
performance or prospects. In addition, the stock market has, from time to time,
experienced significant price and volume fluctuations that have affected the
market prices for the securities of technology companies. In the past, following
periods of volatility in the market price of a particular company's securities,
securities class action litigation was often brought against that company. Many
technology-related companies have been subject to this type of litigation. We
may also become involved in this type of litigation. Litigation is often
expensive and diverts management's attention and resources.
We are controlled by a small group of our existing stockholders, whose
interests may differ from other stockholders
As of March 1, 2000, our directors, executive officers and affiliates
beneficially owned approximately 66.4% of the outstanding shares of our common
stock (and, assuming the consummation of the offering described in "-- Recent
Developments," will beneficially own approximately 55.8% of our common stock).
Accordingly, these stockholders 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.
Shares eligible for public sale could adversely affect our stock price
The market price of our common stock could decline as a result of sales by
our existing stockholders of shares of common stock in the market, or the
perception that these sales could occur. In addition, we have a significant
number of shares that are subject to outstanding options. The exercise of these
options and the subsequent sale of the underlying common stock could cause a
further decline in our stock price. These sales also might make it difficult for
us to sell equity securities in the future at a time and at a price that we deem
appropriate.
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 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 will
also be available to you on the Commission's Internet site (http://www.sec.gov).
Item 2. Properties
Our principal executive offices are located in approximately 32,000 square
feet of office space in New York, New York with an option for an additional
32,000 square feet available by March 2001. We also lease office space in
California, Georgia, Massachusetts, New Jersey, North Carolina, Texas, Virginia,
England and The Netherlands.
We believe that our existing facilities are adequate for our current needs
and that additional space will be available as needed.
Item 3. Legal Proceedings
Except as set forth below, we are not a party to any material legal
proceedings.
In an action entitled Art Eckert vs. Predictive Systems, Inc., in October
1999, a former employee commenced an action against us in New York Supreme
Court (Putnam County) seeking damages for various claims relating to his
employment. The former employee is claiming damages totaling approximately $16
million. In December of 1999, we filed a motion to dimiss one of the claims.
The former employee has opposed our motion and filed an amended complaint
containing the same claims in slightly different form. We believe that these
claims are without merit and intend to continue to vigorously defend ourselves
against them.
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
22
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Market Information
Our common stock has been quoted on the Nasdaq National Market under the
symbol PRDS since our initial public offering on October 27, 1999. The
following table sets forth, for the period indicated, the high and low sale
prices per share of the common stock as reported on the Nasdaq National Market.
High Low
----------- ---------
Fourth Quarter 1999 (since October 27, 1999) .......... $ 68.00 $ 28.00
On March 21, 2000, the last sale price of our common stock reported on the
Nasdaq National Market was $55.00 per share.
Holders
As of March 1, 2000, we had approximately 95 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 securities since January
1, 1999:
1. On March 5, 1999, we issued 6,512,316 shares of our Series A Convertible
Preferred Stock for an aggregate amount of $18,565,225.44 in a private
placement to six accredited investors in reliance upon the exemption from
registration provided by Section 4(2) of the Securities Act of 1933, as
amended.
2. On March 5, 1999, we issued warrants to purchase 15% of the number of
shares registered in our initial public offering (consummated in November
1999) at the initial public offering price for an aggregate amount of
$1,000 in a private placement to two accredited investors in reliance upon
the exemption from registration provided by Section 4(2) of the Securities
Act.
3. On August 12, 1999, we issued 1,062,814 shares of our common stock to two
persons in exchange for all of the outstanding capital stock of Network
Resource Consultants and Company, B.V. in reliance upon the exemption from
registration provided by Section 4(2) of the Securities Act.
4. On September 16, 1999, we issued 1,242,000 shares of our common stock to
Cisco Systems, Inc., an accredited investor, in a private placement for an
aggregate amount of $14,904,000 in reliance upon the exemption from
registration provided by Section 4(2) of the Securities Act.
5. On September 22, 1999, we issued 94,867 and 18,133 shares of common stock
to General Atlantic Partners 57, L.P. and GAP Coinvestment Partners II,
L.P., both accredited investors, in a private placement for an aggregate
amount of $1,356,000 in reliance upon the exemption from registration
provided by Section 4(2) of the Securities Act.
23
Item 6. Selected Consolidated Financial Data
The selected consolidated balance sheet data as of December 31, 1998 and
1999 and the selected consolidated statements of operations data for the years
ended December 31, 1997, 1998 and 1999 have been derived from our audited
consolidated financial statements included elsewhere in this Report. The
selected consolidated balance sheet data as of December 31, 1996 and 1997 and
the selected consolidated statements of operations data for the year ended
December 31, 1996 have been derived from our consolidated audited financial
statements not included in this Report. The selected consolidated balance
sheet as of December 31, 1995 and the selected consolidated statement of
operations data for the period from February 10, 1995 (inception) to December
31, 1995 are derived from our unaudited consolidated financial statements not
included in this 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 Report.
Period from
February 10,
1995 (inception)
to December 31, Year Ended December 31,
------------------ -----------------------------------------------
1995 1996 1997 1998 1999
------------------ ----------- ---------- ---------- ----------
(unaudited) (in thousands, except per share data)
Statement of Operations Data:
Revenues:
Professional services. .................. $ 2,090 $ 6,819 $16,897 $23,858 $50,698
Hardware and software sales ............. 161 1,287 1,190 2,065 2,047
-------- -------- ------- ------- -------
Total revenues ......................... 2,251 8,106 18,087 25,923 52,745
Cost of revenues:
Professional services ................... 981 3,382 9,590 12,861 25,699
Hardware and software purchases ......... 161 970 817 1,699 1,766
-------- -------- ------- ------- -------
Total cost of revenues ................. 1,142 4,352 10,407 14,560 27,465
-------- -------- ------- ------- -------
Gross profit ............................. 1,109 3,754 7,680 11,363 25,280
Expenses:
Sales and marketing ..................... 220 386 1,082 3,433 8,478
General and administrative .............. 535 1,683 4,390 8,184 16,809
Depreciation and amortization ........... 63 142 321 568 1,083
Noncash compensation expense ............ -- -- -- -- 48
-------- -------- ------- ------- -------
Operating profit (loss) .................. 291 1,543 1,887 (822) (1,138)
Other income (expense):
Interest income ......................... 5 31 27 58 944
Other income ............................ -- 8 4 1 76
Interest expense ........................ -- -- (36) (324) (157)
-------- -------- ------- ------- -------
Income (loss) before income tax provision
(benefit) ............................... 296 1,582 1,882 (1,087) (275)
Income tax provision (benefit) ........... 146 719 871 (460) 682
-------- -------- ------- ------- -------
Net income (loss) ........................ $ 150 $ 863 $1,011 $ (627) $ (957)
======== ======== ======= ======= =======
Net income (loss) per share--
Basic ................................... $ 0.04 $ 0.20 $ 0.22 $(0.11) $(0.08)
======== ======== ======= ======= =======
Diluted ................................. $ 0.01 $ 0.07 $ 0.08 $(0.11) $(0.08)
======== ======== ======= ======= =======
Weighted average shares outstanding--
Basic ................................... 4,245 4,269 4,382 6,015 12,138
======== ======== ======= ======= =======
Diluted ................................. 10,396 11,586 12,765 6,015 12,138
======== ======== ======= ======= =======
24
Please see Note 4 to our consolidated financial statements for an
explanation of the number of shares used in per share computations for 1999,
1998 and 1997.
December 31,
--------------------------------------------------------
1995 1996 1997 1998 1999
------------- -------- -------- --------- ----------
(unaudited) (in thousands)
Balance Sheet Data:
Cash and cash equivalents .......... $ 270 $ 638 $ 420 $ -- $ 89,634
Marketable securities .............. -- -- -- -- 2,018
Working capital .................... 661 1,178 1,679 2,365 102,092
Total assets ....................... 1,180 3,629 6,870 13,677 117,423
Total stockholders' equity ......... 192 1,061 2,072 2,026 108,502
25
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 Report.
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 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 $1.0 million. 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:
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
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 assets acquired which have been
allocated to workforce, customer lists and goodwill. The intangible assets are
being amortized over a period of 5 years.
26
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 of approximately $75.1 million after deducting underwriters discounts
and commissions, and expenses, payable by us.
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:
Year Ended December 31,
------------------------------------
1997 1998 1999
---------- ------------ --------
Revenues:
Professional services .................. 93.4% 92.0% 96.1%
Hardware and software sales ............ 6.6 8.0 3.9
------ ----- -----
Total revenues ....................... 100.0 100.0 100.0
Cost of revenues:
Professional services .................. 53.0 49.6 48.7
Hardware and software sales ............ 4.5 6.6 3.4
------ ----- -----
Total cost of revenues ............... 57.5 56.2 52.1
Gross Profit ............................ 42.5 43.8 47.9
Expenses:
Sales and marketing .................... 6.0 13.2 16.1
General and administrative ............. 24.3 31.6 31.8
Depreciation and amortization .......... 1.8 2.2 2.1
Noncash compensation expense ........... -- -- 0.1
Operating profit (loss) ................. 10.4 ( 3.2) ( 2.2)
Other income (expense) .................. ( 0.0) ( 1.0) 1.7
------ ----- -----
Income (loss) before income tax provision
(benefit) .............................. 10.4 ( 4.2) ( 0.5)
Income tax provision (benefit) .......... 4.8 ( 1.8) 1.3
------ ----- -----
Net income (loss) ....................... 5.6% ( 2.4)% ( 1.8)%
====== ===== =====
Years Ended December 31, 1998 and 1999
Revenues. Substantially all of our revenues are derived from fees for
professional services. Revenues increased 103.5% from $25.9 million in 1998 to
$52.7 million in 1999. Revenues from professional services increased 112.5%
from $23.9 million in 1998 to $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 decreased from
27
$2.1 million in 1998 to $2.0 million in 1999. 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 from approximately 149 at
December 31, 1998 to approximately 302 at December 31, 1999.
Gross Profit. Gross profit increased 122.5% from $11.4 million in 1998 to
$25.3 million in 1999. As a percentage of revenues, gross profit increased from
43.8% in 1998 to 47.9% in 1999. This increase in gross profit was due to
efficiencies in completing fixed-price, fixed-time projects, higher utilization
rates and an increase in average billing rates. Cost of revenues increased from
$14.6 million in 1998 to $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 146.9% from $3.4 million in
1998 to $8.5 million in 1999. As a percentage of revenues, sales and marketing
expenses increased from 13.2% in 1998 to 16.1% in 1999. 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 105.4% from $8.2 million in 1998 to $16.8 million in 1999. As a
percentage of revenues, general and administrative expense increased from 31.6%
in 1998 to 31.8% in 1999. The increase in absolute dollars was primarily due to
an increase of $3.9 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
90.7% from $568,000 in 1998 to $1.1 million in 1999. This increase was due to
purchases of additional equipment to support our growth and amortization of
intangible assets of $327,000.
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 expense changed from ($265,000) in 1998 to
income of $863,000 in 1999. This decrease 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 NRCC.
Years Ended December 31, 1997 and 1998
Revenues. Revenues increased 43.3% from $18.1 million in 1997 to $25.9
million in 1998. Revenues from professional services increased 41.2% from $16.9
million in 1997 to $23.9 million in 1998. This increase was primarily due to an
increase in the number of professional services projects and an increase in the
size of these projects. Revenues from hardware and software sales increased
73.6% from $1.2 million in 1997 to $2.1 million in 1998. During 1998, Bear
Stearns accounted for 21.0% of revenues. The number of our billable consultants
increased from approximately 98 at December 31, 1997 to approximately 149 at
December 31, 1998.
28
Gross Profit. Gross profit increased 48.0% from $7.7 million in 1997 to
$11.4 million in 1998. As a percentage of revenues, gross profit increased from
42.5% in 1997 to 43.8% in 1998. This increase in gross profit was due to
efficiencies in completing fixed-price, fixed-time projects, partially offset
by lower utilization rates and a decrease in average billing rates. Cost of
revenues increased from $10.4 million in 1997 to $14.6 million in 1998. This
increase in cost of revenues was due primarily to an increase in compensation
and benefits paid to consultants.
Sales and Marketing Expenses. Sales and marketing expenses increased
217.4% from $1.1 million in 1997 to $3.4 million in 1998. As a percentage of
revenues, sales and marketing expenses increased from 6.0% in 1997 to 13.2% in
1998. This increase was primarily due to an increase of $1.6 million in
compensation and benefits paid due to the hiring of additional personnel, an
increase of $591,000 due to increased sales and marketing efforts, and an
increase of $142,000 in commissions paid because of the increase in revenues.
General and Administrative Expenses. General and administrative expenses
increased 86.4% from $4.4 million in 1997 to $8.2 million in 1998. As a
percentage of revenues, general and administrative expense increased from 24.3%
in 1997 to 31.6% in 1998. This increase was due to an increase of $1.4 million
in recruiting and professional development and other administrative costs, an
increase of $1.3 million in compensation and benefits costs, and an increase of
$1.1 million in facilities and equipment costs.
Depreciation and Amortization. Depreciation and amortization increased
76.9% from $321,000 in 1997 to $568,000 in 1998. This increase was due to
purchases of additional equipment to support our growth.
Other Income (Expense). Other expense increased from ($5,000) in 1997 to
($265,000) in 1998. This increase was primarily due to an increase in interest
expense related to an increase in short-term borrowings.
Income Taxes. The income tax provision was $871,000 on pre-tax income of
$1.9 million in 1997. In 1998 the income tax benefit was ($460,000) on pre-tax
losses of $1.1 million. The effective tax rate was 46.3% and 42.3% for 1997 and
1998, respectively. The differences in the effective tax rate resulted from a
greater amount of non-tax deductible expenses during 1997.
29
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, 1999 and
the percentage of our revenues represented by each item in the respective
quarters. In the opinion of management, all necessary adjustments, consisting
only of normal recurring adjustments, have been included in the amounts stated
below to present fairly the unaudited quarterly results when read in
conjunction with our financial statements and notes. The unaudited results of
operations for any quarter are not necessarily indicative of results for any
future period.
Quarter Ended
---------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31,
1998 1998 1998 1998
------------ ------------ ----------- ----------
(in thousands)
Revenues:
Professional services .............. $ 3,798 $ 5,137 $ 6,702 $ 8,221
Hardware and software sales ........ 78 452 233 1,302
------- ------- ------- -------
Total revenues .................... 3,876 5,589 6,935 9,523
Cost of Revenues:
Professional services .............. 2,387 2,792 3,308 4,374
Hardware and software purchases 65 373 229 1,032
------- ------- ------- -------
Total cost of revenues ............ 2,452 3,165 3,537 5,406
------- ------- ------- -------
Gross profit ........................ 1,424 2,424 3,398 4,117
Expenses:
Selling and marketing .............. 484 771 1,032 1,146
General and administrative ......... 1,722 1,865 2,231 2,366
Depreciation and amortization ...... 108 121 123 216
Noncash compensation expense........ -- -- -- --
------- ------- ------- -------
Operating profit (loss) ............. (890) (333) 12 389
Other income (expense) .............. (22) (32) (85) (126)
------- ------- ------- -------
Income (loss) before income tax
provision (benefit) ................ (912) (365) (73) 263
Income tax provision (benefit) ...... (390) (150) 46 34
------- ------- ------- -------
Net income (loss) ................... $ (522) $ (215) $ (119) $ 229
======= ======= ======= =======
Percentage of Total Revenues
-----------------------------------------------------
Revenues:
Professional services .............. 98.0% 91.9% 96.6% 86.3%
Hardware and software sales ........ 2.0 8.1 3.4 13.7
------- ------- ------- -------
Total revenues .................... 100.0 100.0 100.0 100.0
Cost of Revenues:
Professional services .............. 61.5 50.0 47.7 45.9
Hardware and software purchases 1.7 6.6 3.3 10.9
------- ------- ------- -------
Total cost of revenues ............ 63.2 56.6 51.0 56.8
------- ------- ------- -------
Gross profit ........................ 36.8 43.4 49.0 43.2
Expenses:
Selling and marketing .............. 12.5 13.8 14.9 12.0
General and administrative ......... 44.5 33.4 32.1 24.8
Depreciation and amortization ...... 2.8 2.2 1.8 2.3
Noncash compensation expense........ -- -- -- --
------- ------- ------- -------
Operating profit (loss) ............. (23.0) ( 6.0) 0.2 4.1
Other income (expense) .............. ( 0.5) ( 0.5) ( 1.3) ( 1.3)
------- ------- ------- -------
Income (loss) before income tax
provision (benefit) ................ (23.5) ( 6.5) ( 1.1) 2.8
Income tax provision (benefit) ...... (10.1) ( 2.7) 0.6 0.4
------- ------- ------- -------
Net income (loss) ................... (13.4)% ( 3.8)% ( 1.7)% 2.4%
======= ======= ======= =======
30
Quarter Ended
--------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31,
1999 1999 1999 1999
------------ ------------ ------------- -------------
(in thousands)
Revenues:
Professional services .............. $ 9,887 $ 11,391 $ 13,624 $ 15,796
Hardware and software sales ........ 478 810 465 294
-------- -------- -------- --------
Total revenues .................... 10,365 12,201 14,089 16,090
Cost of Revenues:
Professional services .............. 4,849 5,397 7,005 8,448
Hardware and software purchases 426 606 299 435
-------- -------- -------- --------
Total cost of revenues ............ 5,275 6,003 7,304 8,883
-------- -------- -------- --------
Gross profit ........................ 5,090 6,198 6,785 7,207
Expenses:
Selling and marketing .............. 1,589 1,820 2,424 2,645
General and administrative ......... 3,469 3,908 4,710 4,722
Depreciation and amortization ...... 144 168 341 430
Noncash compensation expense........ 5 5 19 19
-------- -------- -------- --------
Operating profit (loss) ............. (117) 297 (709) (609)
Other income (expense) .............. (28) 26 25 840
-------- -------- -------- --------
Income (loss) before income tax
provision (benefit) ................ (145) 323 (684) 231
Income tax provision (benefit) ...... (49) 410 (56) 377
-------- -------- -------- --------
Net income (loss) ................... $ (96) $ (87) $ (628) $ (146)
======== ======== ======== ========
Revenues:
Professional services .............. 95.4% 93.4% 96.7% 98.2%
Hardware and software sales ........ 4.6 6.6 3.3 1.8
-------- -------- -------- --------
Total revenues .................... 100.0 100.0 100.0 100.0
Cost of Revenues:
Professional services .............. 46.8 44.2 49.7 52.5
Hardware and software purchases 4.1 5.0 2.1 2.7
-------- -------- -------- --------
Total cost of revenues ............ 50.9 49.2 51.8 55.2
-------- -------- -------- --------
Gross profit ........................ 49.1 50.8 48.2 44.8
Expenses:
Selling and marketing .............. 15.3 14.9 17.3 16.4
General and administrative ......... 33.5 32.0 33.4 29.4
Depreciation and amortization ...... 1.4 1.4 2.4 2.7
Noncash compensation expense........ 0.0 0.0 0.1 0.1
-------- -------- -------- --------
Operating profit (loss) ............. ( 1.1) 2.5 ( 5.0) ( 3.8)
Other income (expense) .............. ( 0.3) 0.2 0.1 5.2
-------- -------- -------- --------
Income (loss) before income tax
provision (benefit) ................ ( 1.4) 2.7 ( 4.9) 1.4
Income tax provision (benefit) ...... ( 0.5) 3.4 ( 0.4) 2.3
-------- -------- -------- --------
Net income (loss) ................... ( 0.9)% ( 0.7)% ( 4.5)% ( 0.9)%
======== ======== ======== ========
31
We have historically experienced significant quarterly fluctuations in our
revenues and results of operations and expect these fluctuations to continue.
Factors causing these variations include the number, timing, scope and
contractual terms of client projects, delays incurred in the performance of
such projects, accuracy of estimates of resources and time required to complete
ongoing projects, and general economic conditions. In addition, our future
revenues and operating results may fluctuate as a result of changes in pricing
in response to customer demand and competitive pressures, the ratio of
fixed-price contracts versus time-and-expense contracts and the timing of
collection of accounts receivable. A high percentage of our operating expenses,
particularly personnel and rent, are relatively fixed in advance of any
particular quarter. As a result, unanticipated variations in the number and
timing of our projects or in employee utilization rates may cause significant
variations in operating results in any particular quarter, and could result in
losses. Any significant shortfall of revenues in relation to our expectations,
any material reduction in utilization rates for our consultants, an
unanticipated termination of a major project, a client's decision not to pursue
a new project or proceed to succeeding stages of a current project, or the
completion during a quarter of several major customer projects could require us
to pay underutilized employees and have a material adverse effect on our
business, results of operations and financial condition.
Our quarterly operating results are also subject to certain seasonal
fluctuations. We have in the past recruited new consultants in the first and
second quarters who have not conducted billable services until later in the
year. Demand for our services may be lower in the fourth quarter due to reduced
activity during the holiday season and fewer working days for those customers
that curtail operations during this period. These and other seasonal factors
may contribute to fluctuations in our operating results from quarter to
quarter.
Liquidity and Capital Resources
Since inception, we have financed our operations through the sale of
equity securities and cash flow from operations. As of December 31, 1999, we
had approximately $89.6 million in cash and cash equivalents and $2.0 million
in marketable securities.
Cash used in operating activities decreased from $3.7 million for 1998 to
$2.6 million for 1999. A significant use of cash resulted from an increase in
accounts receivable, partially offset by an increase in accounts payable and
accrued expenses and other current liabilities.
Cash used in operating activities was $3.7 million in 1998, and $1.2
million in 1997. The increase in the use of cash resulted from the net loss in
1998, an increase in accounts receivable and unbilled work in process during
1998 partially offset by an increase in accounts payable and accrued expenses
and other current liabilities at December 31, 1998.
Cash provided by financing activities was $95.0 million for 1999, $5.4
million for 1998 and $1.4 million for 1997. 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 General Atlantic Partners
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 and 1997 resulted from short-term borrowings.
Our capital expenditures were $2.2 million for 1999, $687,000 for 1998 and
$357,000 for 1997. Capital expenditures were made to purchase computer
equipment, office furniture and for leasehold improvements.
We have a demand loan facility, secured by a lien on all of our assets,
under which we may borrow up to the lesser of $5.0 million or 80.0% of our
accounts receivable. Amounts outstanding under the facility bear interest at a
rate of 11.25% per annum. At December 31, 1999, there were no amounts
outstanding under the facility.
Year 2000
Many currently installed computer systems and software products are coded
to accept or recognize only two-digit entries in the date code field. These
systems may recognize a date using
32
"00" as the year 1900 rather than the year 2000. As a result, it has been
necessary to update the computer systems and/or software used by many companies
and governmental agencies to comply with Year 2000 requirements or risk system
failure or miscalculations causing disruptions of normal business activities.
Most reports to date, however, are that computer systems are functioning
normally and the compliance and remediation work accomplished leading up to the
Year 2000 was effective to prevent material problems. Computer experts have
warned, however, that there may still be residual consequences.
We are exposed to the risk that the systems on which we depend to conduct
our operations are not Year 2000 compliant and we cannot assure you that any
Year 2000 problems will not result in disruptions.
Based on initial reports, we believe that our information technology
systems, which include our hardware and software, and our non-information
technology systems, which include the telephone systems and other office
equipment we use internally, are Year 2000 compliant.
In addition, to date, we have not experienced any significant problems
relating to the Year 2000 compliance of our major distributors, suppliers and
vendors. However, we cannot assure you that these distributors, suppliers or
vendors will not experience a Year 2000 problem in the future. In the event
that any of them experience a Year 2000 problem and we are unable to locate an
acceptable alternative, our business would be harmed.
Although our initial reports have not identified any material Year 2000
problems affecting our material third-party vendors, it is possible that
certain Year 2000 problems may have residual consequences or that our
third-party vendors were mistaken in certifying that their systems are Year
2000 compliant. If we fail to fix our internal systems or to fix or replace
material third-party software, hardware or services on a timely basis, we may
suffer lost revenues, increased operating costs and other business
interruptions, any of which could have a material adverse effect on our
business, results of operations and financial condition. Moreover, if we fail
to adequately address Year 2000 compliance issues, we may be subject to claims
of mismanagement and related litigation, which would be costly and
time-consuming to defend.
Although initial reports are that computer systems are functioning
normally, we cannot assure you that governmental agencies, utility companies,
Internet access companies, third-party service providers and others outside our
control will not develop Year 2000 problems. If those entities fail to be Year
2000 compliant, there may be a systemic failure beyond our control, such as a
prolonged Internet, telecommunications or electrical failure, which could have
a material adverse effect on our business, results of operations and financial
condition.
Based on our assessment of our Year 2000 readiness, we do not anticipate
being required to implement any material aspects of a contingency plan to
address Year 2000 readiness of our critical operations.
Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivatives
and Hedging Activities." This statement establishes accounting and reporting
standards of derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. This statement is
effective for all quarters of fiscal years beginning after June 15, 2000. We do
not expect the adoption of this standard to have a material effect on our
results of operations, financial position or cash flows.
33
Forward-Looking Statements; Market Data
Many statements made in this Report under the Sections "Item 1 - Business",
"Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations" and elsewhere are forward-looking statements that are
not based on historical facts. Because these forward looking-statements involve
risks and uncertainties, there are important factors that could cause actual
results to differ materially from those expressed or implied by these
forward-looking statements, including those discussed under "Item 1 - Business -
Risk Factors."
This Report contains market data related to our business and the
network consulting and integration services industry. This market data includes
projections that are based on a number of assumptions. If these assumptions
turn out to be incorrect, actual results may differ from the projections based
on these assumptions. As a result, our markets may not grow at the rates
projected by these data, or at all. The failure of these markets to grow at
these projected rates may have a material adverse effect on our business,
results of operations and financial condition, and the market price of our
common stock.
The forward-looking statements made in this Report relate only to events
as of the date on which the statements are made. We undertake no obligation to
update any forward-looking statement to reflect events or circumstances after
the date on which the statement is made or to reflect the occurrence of
unanticipated events.
34
Item 7A. Quantitive 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. Financial Statements and Supplementary Data
Reference is made to the financial statements listed under the heading
"(a)(1) Consolidated Financial Statements" of Item 14 hereof, which financial
statements are incorporated herein by reference in response to this Item 8.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
35
PART III
Item 10. Directors and Executive Officers of the Registrant
The following table sets forth our executive officers, directors and key
employees, their ages and the positions they hold:
Name Age Position
- - ------------------------------------ ----- --------------------------------------------------
Ronald G. Pettengill, Jr. .......... 41 Chairman of the Board and Chief Executive Officer
Robert L. Belau .................... 36 President and Director
Gerard E. Dorsey ................... 53 Chief Financial Officer
Thomas R. Joseph ................... 32 Vice President, General Manager North America
Carl D. Humes ...................... 34 Vice President, Global Operations
Gregory D. Nicastro ................ 40 Vice President, Services Strategy
Neeraj Sethi ....................... 36 Vice President, Finance
R. Kevin Holt ...................... 46 Vice President, Human Resources
John Wright ........................ 36 Managing Director, Europe
Gary N. Papilsky ................... 28 Vice President and General Counsel
Peter L. Bloom (1) ................. 42 Director
Donald J. Duffy (1) ................ 32 Director
Braden R. Kelly (2) ................ 29 Director
Eric Meyer (2) ..................... 39 Director
Inder Sidhu ........................ 39 Director
William L. Smith ................... 42 Director
William W. Wyman (2) ............... 62 Director
- - ------------
(1) Member of the compensation committee
(2) Member of the audit committee
Ronald G. Pettengill, Jr. co-founded Predictive in February 1995 and has
been Chairman of the Board and Chief Executive Officer since that time. Prior
to founding Predictive, Mr. Pettengill was Senior Vice President of Network
Operations at Allerion, Inc., a systems integration and network control center
design, operation and service delivery firm, from 1992 to 1995. From 1990 to
1992, Mr. Pettengill was the Director of Technical Services at Network
Management, Inc., which provided consulting services to assist Fortune 500
companies migrate from mainframe to network-based client/server environments.
Prior to working at Network Management, Mr. Pettengill was the Network Manager
at Bear, Stearns & Co. Inc.
Robert L. Belau co-founded Predictive in February 1995 and has been
President and a Director since that time. Prior to founding Predictive, Mr.
Belau was Director of Sales at Allerion, and also managed the definition,
productization and pricing of its network management outsourcing services, from
1993 to 1995. From 1987 to 1993, Mr. Belau was the Director of Sales at Network
Management. Mr. Belau is the step-brother of Eric Meyer, one of our directors.
Gerard E. Dorsey has been Chief Financial Officer since September 1999.
Prior to joining us, Mr. Dorsey was Senior Vice President-Finance, Chief
Financial Officer and Secretary of Intelligroup, Inc., a professional
information technology consulting services company, from 1998 to 1999. From
1995 to 1998, Mr. Dorsey was Senior Vice President-Finance and Chief Financial
Officer of Ariel Corporation, a data communications company. Prior to joining
Ariel Corporation, from 1991 until 1995, Mr. Dorsey was Chief Financial Officer
of Information Management Technologies Corporation, a printing and office
services outsourcing company. From 1987 until 1990, Mr. Dorsey was Treasurer of
Loral Corporation.
Thomas R. Joseph has been Vice President, General Manager North America
since April 1999. Prior to that Mr. Joseph held various positions with us, most
recently as National Vice President of Business Development, from 1996 to 1999.
From 1994 to 1996, Mr. Joseph was a Global Accounts Manager at Metropolitan
Fiber Systems, a competitive access provider.
36
Carl D. Humes has been Vice President, Global Operations since April 1999.
Prior to that Mr. Humes served as Regional Vice President of Technical Services
for our Mid-Atlantic region since 1996. From 1995 to 1996, Mr. Humes was a
consultant at Booz-Allen & Hamilton, a strategic consulting firm. Prior to
that, Mr. Humes was an officer in the United States Navy, and served on a
nuclear submarine and at the White House Office of Emergency Operations.
Gregory D. Nicastro has been Vice President, Services Strategy since April
1999. Prior to that, Mr. Nicastro served as Vice President of Marketing since
1997. Prior to joining us, Mr. Nicastro founded ActingExec, a marketing
consulting firm, in 1995. From July 1995 to October 1995, Mr. Nicastro was
Director of Systems Marketing at 3Com Corporation. From 1988 to 1995, Mr.
Nicastro served as National Account Sales Manager at Sun Microsystems.
Neeraj Sethi has been Vice President, Finance since 1995. Prior to joining
us, Mr. Sethi was Assistant Vice President for Global Expense Management at
Bankers Trust from 1992 to 1995. From 1989 to 1992, Mr. Sethi was Controller
and Financial Analyst at Network Management.
R. Kevin Holt has been Vice President, Human Resources since March 1999.
Prior to joining us, Mr. Holt was a Managing Partner at USWeb/CKS (formerly
USWeb). Prior to the merger of USWeb/CKS and Gray Peak Technologies, Mr. Holt
served as Vice President and Director of Recruiting at Gray Peak, a high-end
network solutions provider. From October 1995 until September 1997, Mr. Holt
served as the Eastern Division Recruiting Manager at Sprint-Paranet, a global
network solutions provider. Previously, Mr. Holt was the Founder and President
of Metropolitan Search, a contingency and retained search and consulting
company.
John Wright has been Managing Director, Europe since January 1999. Prior
to joining us, Mr. Wright founded Visia Management Consultants, a strategic
consulting company, in 1997. From 1996 to 1997, Mr. Wright served as Director,
Business Development at Global Village, a communications software firm. From
1987 to 1996, Mr. Wright served in various roles at Gandalf Digital
Communications, including, most recently, Director of Indirect Channels.
Gary N. Papilsky has been Vice President and General Counsel since October
1999. Prior to joining us, Mr. Papilsky was an attorney with Brobeck, Phleger &
Harrison LLP, a law firm specializing in emerging growth technology companies,
from 1998 to 1999. From 1996 to 1998, Mr. Papilsky was an attorney with the law
firm of Sonnenschein Nath & Rosenthal.
Peter L. Bloom has been a director of Predictive since March 1999. Mr.
Bloom is a managing member of General Atlantic Partners, LLC, a private equity
investment firm that focuses exclusively on Internet and information technology
investments on a global basis, and has been at General Atlantic since 1995.
From 1982 to 1995, Mr. Bloom served in various roles at Salomon Brothers,
including as Managing Director of Salomon's U.S. Technology Division. Mr. Bloom
is a Director of Bindview Development Corporation and a Special Advisor to the
Board of Directors of E*TRADE Group, Inc.
Donald J. Duffy has been a director of Predictive since its inception in
February 1995. Mr. Duffy is a co-founder of Meyer, Duffy & Associates, Inc.,
and Meyer Duffy Ventures, firms that invest in early stage networking and
Internet technology companies. Mr. Duffy has been at Meyer, Duffy & Associates
since 1994. From 1992 to 1994, Mr. Duffy was a Vice President at Oak Hall
Capital Advisors, a money management firm.
Braden R. Kelly has been a director of Predictive since June 1999. Mr.
Kelly is a principal at General Atlantic Partners, LLC, and has been with
General Atlantic since 1995. Mr. Kelly is a director of HEALTHvision, Inc., a
provider of comprehensive Internet solutions to the healthcare industry. From
1993 to 1994, Mr. Kelly served as a Financial Analyst at Morgan Stanley &
Company.
Eric Meyer has been a director of Predictive since its inception in
February 1995. Mr. Meyer is a co-founder of Meyer, Duffy & Associates and Meyer
Duffy Ventures, firms that invest in early stage networking and Internet
technology companies. Mr. Meyer has been at Meyer, Duffy & Associates since
1994. From 1992 to 1994 Mr. Meyer served as a Vice President at Oak Hall
Capital Advisors. Mr. Meyer is the step-brother of Robert L. Belau, our
President and one of our directors.
37
Inder Sidhu has been a director of Predictive since September 1999. Mr.
Sidhu has been the Vice President of Worldwide Professional Services at Cisco
since December 1998. From 1995 to 1998, Mr. Sidhu served in various executive
management positions in the Sales and Business Development organizations at
Cisco. From 1991 to 1995 Mr. Sidhu was a consultant at McKinsey & Company.
Prior to that, Mr. Sidhu led a network management group at 3Com Corporation.
William L. Smith has been a director of Predictive since March 2000. Mr.
Smith has been with BellSouth since 1979, most recently serving since January
2000 as its Executive Vice President of Network Planning and Chief Technology
Officer, where he is responsible for, among other things, strategic planning of
BellSouth's telecommunications infrastructure, as well as its product
development, Internet, entertainment and long distance units. From February 1998
to December 1999 he served as Vice President - Network Strategic Planning for
BellSouth Telecommunications, BellSouth's domestic telephone unit. Prior to that
he served as President of BellSouth's Internet unit from December 1997 through
January 1998 and from September 1996 to November 1997 as Executive Director -
Product Commercialization Unit. From January 1995 to August 1996, he served as
Assistant Vice President - Data Services Unit for BellSouth.
William W. Wyman has been a director of Predictive since September 1999.
Since 1995, Mr. Wyman has been a business advisor and counselor on a broad
range of issues to a number of corporate chief executives of financial
services, information services, forest products and software companies. From
1984 to 1995, Mr. Wyman was a partner at Oliver, Wyman & Company, a firm which
specializes in management consulting to large financial institutions and which
he co-founded. Mr. Wyman is a director of SS&C Technologies and U.S.
Timberlands. He also serves as a trustee of the Dartmouth Hitchcock Medical
Center and on the Boards of Advisors of The Sprout Group, a venture capital
fund associated with Donaldson, Lufkin & Jenrette, and Legend Capital, a
leveraged buyout firm associated with Castle Harlan Investments.
Classified Board of Directors
Our board of directors is divided into three classes of directors serving
staggered three year terms. Upon expiration of the term of a class of directors,
the directors in that class will be elected for three-year terms at the annual
meeting of stockholders in the year in which their term expires. Messrs.
Pettengill, Belau and Duffy are our Class I directors whose terms expire at the
2000 annual meeting of stockholders. Messrs. Bloom, Meyer and Wyman are our
Class II directors whose terms expire at the 2001 annual meeting of
stockholders. Messrs. Kelly, Sidhu and Smith are our Class III directors whose
terms expire at the 2002 annual meeting of stockholders. These provisions, when
coupled with the provision of our amended and restated certificate of
incorporation authorizing the board of directors to fill vacant directorships or
increase the size of the board of directors, may delay a stockholder from
removing incumbent directors and simultaneously gaining control of the board of
directors by filling the vacancies with its own nominees.
Board Committees
The audit committee reports to the board of directors regarding the
appointment of our independent public accountants, the scope and results of our
annual audits, compliance with our accounting and financial policies and
management's procedures and policies relative to the adequacy of our internal
accounting controls. The members of the audit committee are Messrs. Meyer,
Kelly and Wyman who were appointed in May 1999, June 1999 and September 1999,
respectively. Prior to that time, the responsibilities of the audit committee
were handled by the entire board of directors.
The compensation committee reviews and makes recommendations to the board
of directors regarding our compensation policies and all forms of compensation
to be provided to our executive officers and directors. In addition, the
compensation committee reviews bonus and stock compensation arrangements for
all of our other employees. The members of the compensation committee are
Messrs. Duffy and Bloom, who were appointed in May 1999. Prior to that time,
the responsibilities of the compensation committee were handled by the entire
board of directors.
Compensation Committee Interlocks and Insider Participation
No interlocking relationships exist between our board of directors or
compensation committee and the board of directors or compensation committee of
any other company, nor has any interlocking relationship existed in the past
with the exception of the following:
o Mr. Pettengill served, through September 1999, and Messrs. Belau, Duffy and
Meyer currently serve, on the board of directors of Tribeca Software, a
network management software company; Messrs. Pettengill and Belau served,
through September 1999, as executive officers of Tribeca, and Mr. Meyer
currently serves as an executive officer of Tribeca. Please see "Certain
Relationships and Related Transactions-- Tribeca Software" for information
about our relationship with Tribeca.
38
o Messrs. Pettengill and Meyer serve on the board of directors of
Riversoft Ltd., a network management software company. We act as a
reseller for Riversoft's software. To date, our revenues from sales of
Riversoft's software have not been material.
o Our directors have engaged in various other transactions with us. For
information about these transactions please see "Certain Relationships and
Transactions--Relationship with Cisco," "--Sale of Common Stock," "--Sales
of Series A Convertible Preferred Stock and Warrants," "--Share
Redemption," "--Meyer, Duffy & Associates," "--Loans to Officers" and
"--Option Grants."
Director Compensation
We do not currently compensate our directors for attending meetings of the
board of directors or committee meetings of the board of directors, but we do
reimburse directors for their reasonable travel expenses incurred in connection
with attending these meetings. Each of Messrs. Bloom, Duffy, Kelly and Meyer
were granted options to purchase 25,000 shares of our common stock at a price of
$4.00 per share in May 1999. Messrs. Sidhu and Wyman were granted options to
purchase 25,000 shares of our common stock at a price of $11.05 per share in
September 1999. Mr. Smith was granted options to purchase 25,000 shares of our
common stock at a price of $60.50 per share in March 2000. These options vest
over a period of four years.
Under the automatic option grant program of the 1999 Stock Incentive Plan,
which is described below under "--1999 Stock Incentive Plan," each individual
who first joins the board of directors after November 1, 1999 as a non-employee
member of the board of directors will also receive an option grant for 25,000
shares of our common stock at the time of his or her commencement of service on
the board of directors. In addition, at each annual meeting of stockholders,
beginning with the 2001 annual meeting, each individual who is to continue to
serve as a non-employee member of the board of directors will receive an option
to purchase 2,500 shares of our common stock.
Item 11. Executive Compensation
The following table sets forth the total compensation paid or accrued
during the fiscal years ended December 31, 1999 and 1998 to our Chief Executive
Officer and to each of our most highly compensated executive officers, other
than the Chief Executive Officer, whose salary and bonus for 1999 exceeded
$100,000.
Summary Compensation Table
Long-Term
Annual Compensation Compensation Awards
---------------------- --------------------
Shares Underlying All Other
Name and Principal Position Year Salary $ Bonus $ Options Compensation
- - --------------------------------------------- ------ ---------- ---------- -------------------- ----------------
Ronald G. Pettengill, Jr. ................... 1999 $195,833 $75,000 200,000 $ 12,157(1)
Chief Executive Officer 1998 175,000 50,000 60,000 8,447(1)
Robert L. Belau ............................. 1999 195,833 75,000 200,000 9,839(1)
President 1998 175,000 50,000 60,000 8,899(1)
Thomas R. Joseph ............................ 1999 150,000 99,000 100,000 6,600(2)
Vice President, General Manager 1998 112,500 190,000 270,000 3,000(2)
North America
Carl D. Humes ............................... 1999 150,000 64,000 60,000 6,000(2)
Vice President, Global Operations .......... 1998 112,500 190,000 270,000 3,000(2)
Gregory D. Nicastro ......................... 1999 154,700 50,000 -- --
Vice President, Strategic Services ......... 1998 140,000 14,000 -- --
Neeraj Sethi ................................ 1999 170,000 70,000 70,000 5,000
Vice President, Finance 1998 135,167 55,000 -- --
R. Kevin Holt ............................... 1999 110,833 100,000 130,000 --
Vice President, Human Resources 1998 -- -- -- --
- - ------------
(1) We paid a monthly car allowance and automobile insurance premiums for each
of Messrs. Pettengill and Belau during the years ended December 31, 1999
and 1998.
(2) We paid a monthly car allowance effective July 1998 for each of Messrs.
Joseph and Humes during the years ended December 31, 1999 and 1998.
39
Option Grants in Last Fiscal Year
The following table sets forth grants of stock options for the year ended
December 31, 1999 to our Chief Executive Officer and to each of our most highly
compensated executive officers, other than the Chief Executive Officer, whose
salary and bonus for such fiscal year exceeded $100,000. Mr. Nicastro was not
granted stock options in the year ended December 31, 1999. We have never
granted any stock appreciation rights. The potential realizable value is
calculated based on the term of the option at its time of grant. It is
calculated assuming that the fair market value of common stock on the date of
grant appreciates at the indicated annual rate compounded annually for the
entire term of the option and that the option is exercised and sold on the last
day of its term for the appreciated stock price. These numbers are calculated
based on the requirements of the Securities and Exchange Commission and do not
reflect our estimate of future stock price growth. The percentage of total
options granted to employees in the last fiscal year is based on options to
purchase an aggregate of 3,686,990 shares of common stock granted under our
option plans.
Potential Realizable Value
Number of Percent of at Assumed Annual Rates
Securities Total Options of Stock Price Appreciation
Underlying Granted to Exercise for Option Term
Options Employees Price Per Expiration ------------------------------
Name Granted In 1999 Share ($) Date 5% 10%
- - ----------------------------------- ------------ --------------- ----------- ------------ -------------- --------------
Ronald G. Pettengill, Jr. ......... 200,000 5.4% $ 4.00 5/11/09 $19,522,400 $30,089,115
Robert L. Belau ................... 200,000 5.4 4.00 5/11/09 19,522,400 30,089,115
Thomas R. Joseph .................. 100,000 2.7 6.50 7/1/09 9,511,200 14,794,557
Carl D. Humes ..................... 60,000 1.6 6.50 7/1/09 5,416,400 8,034,304
Neeraj Sethi ...................... 70,000 1.9 2.50 4/1/09 6,937,840 10,636,190
R. Kevin Holt ..................... 130,000 3.5 2.50 3/1/09 12,255,533 17,927,659
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option
Values
The following table sets forth information concerning the value realized
upon exercise of options during 1999 and the number and value of unexercised
options held by each of our named executive officers at December 31, 1999. The
last reported sale price of our common stock on December 31, 1999 was $65.50
per share. Accordingly, the values set forth below have been calculated on the
basis of the fair market value on December 31, 1999 less the applicable
exercise price per share, multiplied by the number of shares underlying the
options.
Options at In-the-Money Options
Fiscal Year-End at Fiscal Year-End
------------------------------ -----------------------------
Number of Securities
Shares Underlying Unexercised Value of Unexercised
Acquired on Value ------------------------------ -----------------------------
Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
- - ----------------------------------- ------------- ---------- ------------- --------------- ------------- --------------
Ronald G. Pettengill, Jr. ......... -- -- 830,000 150,000 $53,510,000 $ 9,225,000
Robert L. Belau ................... -- -- 830,000 150,000 53,510,000 9,225,000
Thomas R. Joseph .................. -- -- 270,000 190,000 17,370,030 11,667,500
Carl D. Humes ..................... -- -- 270,000 150,000 17,332,500 9,307,500
Gregory D. Nicastro ............... -- -- 84,000 252,000 5,397,000 16,191,000
Neeraj Sethi ...................... -- -- 120,000 130,000 7,722,500 8,265,000
R. Kevin Holt ..................... -- -- 32,500 97,500 2,047,500 6,142,500
Employment Agreements
We have entered into executive employment agreements with Ronald G.
Pettengill, Jr., our Chairman and Chief Executive Officer, and Robert L. Belau,
our President. Each employment
40
agreement provides for an initial annual base salary of $200,000. Each
employment agreement also provides for a 1999 performance-based bonus, which
totalled $75,000, and bonuses in all subsequent years at the discretion of our
Board of Directors. Under the agreements, each executive also received options
to purchase 100,000 shares of our common stock at a price of $4.00 per share,
which vest over 3 years. Additionally, each executive received options to
purchase an additional 100,000 shares of our common stock at a price of $4.00
per share which vest after 4 years. These additional options will vest
immediately upon the achievement of certain gross revenues thresholds.
Each employment agreement expires on May 11, 2002, subject to extension or
earlier termination. Each employment agreement provides that if Messrs.
Pettengill and Belau are terminated by us without cause or if they terminate
their employment agreements for good reason, they will be entitled to their
base salary and health coverage until the later of the expiration date of their
employment agreements or one year from the date of termination. Additionally,
all stock options granted to them will immediately vest.
Under the agreements, good reason includes:
o a material breach of the agreements by us;
o a material change in the executive's duties and responsibilities;
o a change in the executive's reporting relationship;
o a relocation of our executive offices further than 75 miles from its
current location; or
o a change of control.
Each employment agreement prohibits Messrs. Pettengill and Belau from
competing with us, or soliciting our customers or employees, for a period of
one year from the date of their termination of employment.
We have also entered into an employment agreement with R. Kevin Holt, our
Vice President of Human Resources, John Wright, Managing Director Europe, and
Gerard E. Dorsey, our Chief Financial Officer. Mr. Holt's agreement provides
for an initial annual base salary of $130,000 and for a 1999 performance-based
bonus, which totaled $100,000, and bonuses in all subsequent years based upon
the achievement of certain hiring goals. Under the agreement, Mr. Holt received
options to purchase 130,000 shares of our common stock at a price of $2.50 per
share, which vest over four years.
Our employment agreement with Mr. Holt expires on January 23, 2001,
subject to earlier termination. Mr. Holt's agreement provides that if he is
terminated by us without cause or if he terminates his employment with us for
good reason, he will be entitled to receive his base salary until the earlier
of six months after the date of his termination or the date he accepts new
employment. Under the agreement, good reason includes:
o a reduction in Mr. Holt's base salary;
o a relocation of Mr. Holt's office further than 50 miles from his current
office; or
o a material reduction in job duties.
Our agreement prohibits Mr. Holt from competing with us, soliciting our
employees or permitting his name to be used in connection with a competing
business for a period of six months from the date of the termination of his
employment.
Our agreement with Mr. Wright provides for an initial base salary of
[British Pounds]71,200, approximately $114,000 at an exchange rate of 1.60, plus
a bonus based on our performance. Under the agreement, Mr. Wright received
options to purchase 80,000 shares of our common stock at a price of $2.50 per
share, which vest over four years. We agreed to contribute an amount equal to
5% of Mr. Wright's base salary to a pension plan. The employment agreement
prohibits Mr. Wright from competing with us and soliciting our employees for a
period of 6 and 12 months, respectively, from the termination of his
employment. The agreement is in effect until terminated by either party by
giving at least 3 months notice to the other party.
41
Our agreement with Mr. Dorsey provides for an initial base salary of
$210,000 and an annual bonus of up to a maximum of $75,000. Under the
agreement, Mr. Dorsey received options to purchase 175,000 shares of our common
stock at a price of $11.05 per share, which vest over 4 years. Our agreement
further provides that Mr. Dorsey will receive an automobile allowance of $650
per month. The agreement prohibits Mr. Dorsey from competing with us and
soliciting our employees for a period of one year from the termination of his
employment. The agreement has an initial term of three years, and renews
automatically for successive one year periods unless written notice is given by
either party. Our employment agreement with Mr. Dorsey expires on September 24,
2002, subject to extension or earlier termination. Mr. Dorsey's agreement
provides that if he is terminated by us without cause or if he terminates his
employment agreement with us for good reason, he will be entitled to receive
his base salary until the earlier of twelve months after the date of his
termination or the date he accepts new employment. Under terms of this
agreement good reason includes if Mr. Dorsey terminates his employment within
30 days after a change in control of Predictive. If Mr. Dorsey is terminated by
us without cause or if he terminates his employment agreement with us for good
reason, any unvested options will vest immediately.
1999 Stock Incentive Plan
The 1999 Stock Incentive Plan is intended to serve as the successor equity
incentive program to our 1998 Stock Option/Stock Issuance Plan and our 1998
California Stock Option/Stock Issuance Plan. The 1999 Plan became effective
upon its adoption by the board of directors on September 14, 1999 and was
approved by our stockholders on that date.
6,655,600 shares of common stock have been authorized for issuance under
the 1999 Plan. This share reserve consists of the shares which were available
for issuance under the predecessor plans on the effective date of the 1999 Plan
plus an additional increase of 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 predecessor plans were incorporated into the
1999 Plan upon the date of our initial public offering, and no further option
grants may be made under those plans. The incorporated options will continue to
be governed by their existing terms, unless our compensation committee extends
one or more features of the 1999 Plan to those options. However, except as
otherwise noted below, the outstanding options under the predecessor plans
contain substantially the same terms and conditions summarized below for the
discretionary option grant program under the 1999 Plan.
The 1999 Plan has five separate programs:
o the discretionary option grant program under which eligible individuals
in our employ or service (including officers, non-employee board members
and consultants) may be granted options to purchase shares of our common
stock;
o the stock issuance program under which these individuals may be issued
shares of our common stock directly, with the purchase of such shares or
as a bonus tied to the performance of services;
o the salary investment option grant program under which executive officers
and other highly compensated employees may elect to apply a portion of
their base salary to the acquisition of special below-market stock option
grants;
o the automatic option grant program under which option grants are
automatically made at periodic intervals to eligible non-employee board
members; and
42
o the director fee option grant program under which non-employee board
members may elect to apply a portion of their retainer fee to the
acquisition of special below-market stock option grants.
The discretionary option grant and stock issuance programs are
administered by our compensation committee. This committee determines which
eligible individuals are to receive option grants or stock issuances, the time
or times when such option grants or stock issuances are to be made, the number
of shares subject to each such grant or issuance, the exercise or purchase
price for each such grant or issuance, the status of any granted option as
either an incentive stock option or a non-statutory stock option under the
federal tax laws, the vesting schedule to be in effect for the option grant or
stock issuance and the maximum term for which any granted option is to remain
outstanding. The committee also selects the executive officers and other highly
compensated employees who may participate in the salary investment option grant
program in the event that program is activated for one or more calendar years.
Neither the compensation committee nor the board exercises any administrative
discretion with respect to option grants made under the salary investment
option grant program or under the automatic option grant or director fee option
grant program for the non-employee board members.
The exercise price for the options may be paid in cash or in shares of our
common stock valued at fair market value on the exercise date. The option may
also be exercised through a same-day sale program without any cash outlay by
the optionee. In addition, the compensation committee may allow a participant
to pay the option exercise price or direct issue price (and any associated
withholding taxes incurred in connection with the acquisition of shares) with a
full-recourse, interest-bearing promissory note.
In the event that we are acquired, whether by merger or asset sale or
board-approved sale by the stockholders of more than 50% of our voting stock,
each outstanding option under the discretionary option grant program which is
not to be assumed by the successor corporation or otherwise continued will
automatically accelerate in full, and all unvested shares under the
discretionary option grant and stock issuance programs will immediately vest,
except to the extent our repurchase rights with respect to those shares are to
be assigned to the successor corporation or otherwise continued in effect. The
compensation committee may grant options under the discretionary option grant
program which will accelerate in the acquisition even if the options are
assumed or which will accelerate if the optionee's service is subsequently
terminated. The compensation committee may grant options and issue shares which
accelerate in connection with a hostile change in control effected through a
successful tender offer for more than 50% of our outstanding voting stock or by
proxy contest for the election of board members) or the options and shares may
accelerate upon a subsequent termination of the individual's service.
Options currently outstanding under the plan may be assumed by the
successor corporation in an acquisition; such options are not by their terms
subject to acceleration at the time of an acquisition or a change in control or
upon the termination of the optionee's service following any such transaction.
Stock appreciation rights may be issued under the discretionary option
grant program which will provide the holders with the election to surrender
their outstanding options for an appreciation distribution from us equal to the
fair market value of the vested shares subject to the surrendered option less
the aggregate exercise price payable for such shares. This appreciation
distribution may be made in cash or in shares of our common stock. There are
currently no outstanding stock appreciation rights under the predecessor plans.
The compensation committee has the authority to cancel outstanding options
under the discretionary option grant program (including options incorporated
from predecessor plans) in return for the grant of new options for the same or
different number of option shares with an exercise price per share based upon
the fair market value of the common stock on the new grant date.
In the event the compensation committee elects to activate the salary
investment option grant program for one or more calendar years, each of our
executive officers and other highly
43
compensated employees selected for participation may elect to reduce his or her
base salary for that calendar year by a specified dollar amount not less than
$5,000 nor more than $50,000. In return, the individual will automatically be
granted, on the first trading day in the calendar year for which the salary
reduction is to be in effect, a non-statutory option to purchase that number of
shares of common stock determined by dividing the salary reduction amount by
two-thirds of the fair market value per share of our common stock on the grant
date. The option exercise price will be equal to one-third of the fair market
value of the option shares on the grant date. As a result, the fair market
value of the option shares on the grant date less the exercise price payable
for those shares will be equal to the salary reduction amount. The option will
become exercisable in a series of 12 equal monthly installments over the
calendar year for which the salary reduction is to be in effect and will be
subject to full and immediate vesting in the event of an acquisition or change
in control.
Under the automatic option grant program, each individual who first joins
our board after our initial public offering as a non-employee board member will
automatically be granted an option for 25,000 shares of our common stock at the
time of his or her commencement of board service. In addition, on the date of
each annual stockholders meeting, beginning with the 2001 meeting, each
individual who has served as a non-employee board member since the last annual
stockholders meeting will receive an option grant to purchase 2,500 shares of
our common stock. Each automatic grant will have an exercise price equal to the
fair market value per share of our common stock on the grant date and will have
a maximum term of 10 years, subject to earlier termination following the
optionee's cessation of board service. Each option will be immediately
exercisable, subject to our right to repurchase any unvested shares, at the
original exercise price, at the time of the board member's cessation of
service. The options will vest, and our repurchase right will lapse, with
respect to, the initial 25,000-share option grant in a series of four (4) equal
successive annual installments upon the optionee's completion of each year of
service over the four (4)-year period measured from the grant date. However,
each such outstanding option will immediately vest upon an acquisition or
change in control or the death or disability of the optionee while serving as a
board member. Each 2,500-share option grant will be fully vested on grant.
If the director fee option grant program is put into effect in the future,
then each non-employee board member may elect to apply all or a portion of any
cash retainer fee for the year to the acquisition of a below-market option
grant. The option grant will automatically be made on the first trading day in
January in the year for which the non-employee board member would otherwise be
paid the cash retainer fee in the absence of his or her election. The option
will have an exercise price per share equal to one-third of the fair market
value of the option shares on the grant date, and the number of shares subject
to the option will be determined by dividing the amount of the retainer fee
applied to the program by two-thirds of the fair market value per share of our
common stock on the grant date. As a result, the fair market value of the
option shares on the grant date less the exercise price payable for those
shares will be equal to the portion of the retainer fee applied to that option.
The option will become exercisable in a series of twelve equal monthly
installments over the calendar year for which the election is in effect.
However, the option will become immediately exercisable for all the option
shares upon the death or disability of the optionee while serving as a board
member.
Limited stock appreciation rights will automatically be included as part
of each grant made under the automatic option grant, director fee option grant
and salary investment option grant programs and may be granted to one or more
officers as part of their option grants under the discretionary option grant
program. Options with this limited stock appreciation right may be surrendered
to us upon the successful completion of a hostile tender offer for more than
50% of our outstanding voting stock. In return for the surrendered option, the
optionee will be entitled to a cash distribution from us in an amount per
surrendered option share equal to the highest price per share of our common
stock paid in connection with the tender offer less the exercise price payable
for such share.
The board may amend or modify the 1999 Plan at any time, subject to any
required stockholder approval. The 1999 Plan will terminate no later than
September 14, 2009.
44
Employee Stock Purchase Plan
Our Employee Stock Purchase Plan was adopted by the board on September 14,
1999 and approved by our stockholders on that date. The plan became effective
on October 27, 1999. The plan is designed to allow our eligible employees and
those of our participating subsidiaries to purchase shares of our common stock,
at semi-annual intervals, through periodic payroll deductions. A total of
750,000 shares of our common stock may be issued under the plan.
The 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.
Individuals who are eligible employees on the start date of any offering
period may enter the plan on that start date or on any subsequent semi-annual
entry date (generally May 1 or November 1 each year). Individuals who become
eligible employees after the start date of the offering period may join the
plan on any subsequent semi-annual entry date within that period.
A participant may contribute up to 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 our common stock
on the participant's entry date into the offering period or the fair market
value on the semi-annual purchase date. The first purchase date will occur on
the last business day in April 2000. In no event, however, may any participant
purchase more than 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 our common stock on any semi-annual purchase date be
less than the fair market value on the first day of the offering period, then
the current offering period will automatically end and a new offering period
will begin, based on the lower fair market value.
The board may at any time amend or modify the plan. The plan will
terminate no later than the last business day in October 2009.
45
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth information with respect to beneficial
ownership of our common stock, as of March 1, 2000:
o each person known by us to beneficially own more than 5% of our common
stock;
o each executive officer named in the Summary Compensation Table;
o each of our directors;
o all of our executive officers and directors as a group; and
o the selling stockholders.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and includes voting or investment power with
respect to the securities. Unless otherwise indicated, the address for those
listed below is c/o Predictive Systems, Inc., 145 Hudson Street, New York, New
York 10013. Except as indicated by footnote, and subject to applicable community
property laws, the persons named in the table have sole voting and investment
power with respect to all shares of common stock shown as beneficially owned by
them. The number of shares of common stock outstanding used in calculating the
percentage for each listed person includes the shares of common stock underlying
options held by such persons that are exercisable within 60 days of March 15,
2000, but excludes shares of common stock underlying options held by any other
person. Percentage of beneficial ownership is based on 23,429,200 shares of
common stock outstanding as of March 15, 2000.
Shares+ Percent+
------------ ---------
Ronald G. Pettengill, Jr. (1) ................. 2,312,333 9.5%
Robert L. Belau (2) ........................... 2,738,333 11.3
Gerard R. Dorsey .............................. -- --
R. Kevin Holt (3) ............................. 32,500 *
Carl D. Humes (4) ............................. 270,000 1.1
Thomas R. Joseph (5) .......................... 270,000 1.1
Gregory D. Nicastro (6) ....................... 168,000 *
Gary N. Papilsky .............................. 1,000 *
Neeraj Sethi (7) .............................. 197,500 *
John Wright (8) ............................... 20,000 *
Peter L. Bloom (9) ............................ 6,886,256 29.4
Donald J. Duffy (10) .......................... 2,638,150 11.2
Braden R. Kelly (11) .......................... -- --
Eric Meyer (12) ............................... 3,121,150 13.2
Inder Sidhu (13) .............................. 1,242,000 5.3
William L. Smith .............................. -- --
William W. Wyman (14) ......................... -- --
Cisco Systems, Inc. (15) ...................... 1,242,000 5.3
General Atlantic Partners, LLC (16) ........... 6,880,006 29.4
Meyer, Duffy & Associates, L.P. (17) .......... 1,800,000 7.7
Putnam Investments, Inc. (18) ................. 1,388,787 5.9
Other selling stockholders ....................
All directors and executive officers as a group
(17 persons) (19) ............................ 17,445,322 66.4
- - ------------
* Indicates less than one percent of the common stock.
+ On March 6, 2000, we filed a Registration Statement on Form S-1 (Registration
No. 33-31770), registering the sale of 1,000,000 shares of common stock by us
and 2,800,000 shares of common stock by various selling stockholders (plus an
additional 570,000 shares of common stock to be sold pursuant to the
underwriters' exercise of the over-allotment option by some of the selling
stockholders). We expect this transaction to be consummated in the second
quarter 2000. If this public offering is consummated, the share numbers and
percentages in this table will change. You should review the Registration
Statement and the amendments to it for more information about that offering.
46
(1) Includes (a) 863,333 shares issuable upon the exercise of currently
exercisable options (b) 1,439,000 shares of common stock held by Tao
Partners Limited Partnership and (c) 10,000 shares held by The Pettengill
Family Foundation. Mr. Pettengill and his wife are the sole stockholders
of Julcon, Inc., the general partner of Tao Partners Limited Partnership.
Mr. Pettengill disclaims beneficial ownership of the shares held by The
Pettengill Family Foundation.
(2) Includes (a) 863,333 shares issuable upon the exercise of currently
exercisable options (b) 126,000 shares of common stock held by The Belau
Family Trust and (c) 10,000 shares held by The Belau Family Foundation.
Mr. Belau disclaims beneficial ownership of the shares held by The Belau
Family Foundation.
(3) Includes 32,500 shares issuable upon the exercise of currently exercisable
options.
(4) Includes 270,000 shares issuable upon the exercise of currently
exercisable options.
(5) Includes (a) 250,000 shares issuable upon the exercise of currently
exercisable options and (b) 20,000 shares issuable upon the exercise of
currently exerciseable stock options held by The Joseph Family Trust. Mr.
Joseph disclaims beneficial ownership of the securities held by The Joseph
Family Trust.
(6) Includes 168,000 shares issuable upon the exercise of currently
exercisable options.
(7) Includes 167,500 shares issuable upon the exercise of currently
exercisable options.
(8) Includes 20,000 shares issuable upon the exercise of currently exercisable
options.
(9) Includes (a) 6,250 shares issuable upon the exercise of currently
exercisable options, (b) 5,350,441 shares owned by General Atlantic
Partners 54, (c) 349,918 shares owned by General Atlantic Partners 57, and
(d) 1,179,647 shares owned by GAP Coinvestment Partners II. The general
partner of General Atlantic Partners 54 and General Atlantic Partners 57
is General Atlantic Partners, LLC and the managing members of General
Atlantic Partners, LLC are also the general partners of GAP Coinvestment
Partners II. Peter L. Bloom is a managing member of General Atlantic
Partners, LLC. Mr. Bloom disclaims beneficial ownership of these
securities except to the extent of his economic interest in General
Atlantic Partners, LLC, and GAP Coinvestment Partners II. The address of
Mr. Bloom is c/o General Atlantic Partners, LLC, 3 Pickwick Plaza,
Greenwich, Connecticut 06830.
10) Includes (a) 186,250 shares issuable upon the exercise of currently
exercisable options, (b) 510,960 shares of common stock held by MD
Strategic, L.P., (c) 1,800,000 shares of common stock held by Meyer, Duffy
& Associates, L.P., and (d) 140,940 shares of common stock held by PVII,
L.P. Mr. Duffy is a general partner of each of MD Strategic, L.P., Meyer,
Duffy & Associates, L.P. and PVII, L.P. Mr. Duffy disclaims beneficial
ownership of these securities except to the extent of his economic
interest in MD Strategic L.P., Meyer, Duffy & Associates, L.P. and PVII,
L.P. The address of Mr. Duffy is c/o of Meyer, Duffy & Associates, Inc.,
237 Park Avenue, New York, New York 10017.
(11) Mr. Kelly is a limited partner of GAP Coinvestment Partners II. Mr. Kelly
disclaims beneficial ownership of the securities held by GAP Coinvestment
Partners II except to the extent of his economic interest in those
securities. The address of Mr. Kelly is c/o General Atlantic Partners,
LLC, 3 Pickwick Plaza, Greenwich, Connecticut 06830.
(12) Includes (a) 186,250 shares issuable upon the exercise of currently
exercisable options, (b) 510,960 shares of common stock held by MD
Strategic, L.P., (c) 1,800,000 shares of common stock held by Meyer, Duffy
& Associates, L.P., and (d) 140,940 shares of common stock held by PVII,
L.P. Mr. Meyer is a general partner of each of MD Strategic L.P., Meyer,
Duffy & Associates, L.P. and PVII, L.P. Mr. Meyer disclaims beneficial
ownership of these securities except to the extent of his economic
interest in MD Strategic L.P., Meyer, Duffy & Associates, L.P. and PVII,
L.P. The address of Mr. Meyer is c/o Meyer, Duffy & Associates, Inc., 237
Park Avenue, New York, New York 10017.
47
(13) Includes 1,242,000 shares of common stock owned by Cisco. Mr. Sidhu is the
Vice President of Worldwide Professional Services at Cisco. The address of
Mr. Sidhu is c/o Cisco Systems, Inc., 170 West Tasman Drive, San Jose,
California 95134-1706.
(14) The address of Mr. Wyman is 4 North Balch Street, Hanover, New Hampshire
03755.
(15) The address of Cisco is 170 West Tasman Drive, San Jose, California
95134-1706.
(16) Includes (a) 5,350,441 shares owned by General Atlantic Partners 54, (b)
349,918 shares owned by General Atlantic Partners 57, and (c) 1,179,647
shares owned by GAP Coinvestment Partners II. General Atlantic Partners,
LLC is the general partner of General Atlantic Partners 54 and General
Atlantic Partners 57 and the managing members of General Atlantic
Partners, LLC are also the general partners of GAP Coinvestment Partners
II. Therefore, General Atlantic Partners, LLC may vote and dispose of the
shares owned by these entities. The address of General Atlantic Partners,
LLC is 3 Pickwick Plaza, Greenwich, Connecticut 06830.
(17) The address of Meyer, Duffy & Associates, L.P. is c/o Meyer, Duffy &
Associates, Inc., 237 Park Avenue, New York, New York 10017.
(18) Includes (a) 1,223,687 shares held by Putnam Investment Management, Inc.
("PIM") and (b) 165,100 shares held by The Putnam Advisory Company, Inc.
("PAC"). PIM and PAC are wholly- owned subsidiaries of Putnam Investments,
Inc., a wholly-owned subsidiary of Marsh & McLennan Companies, Inc. Of the
1,223,687 shares held by PIM, 1,115,897 shares are held by Putnam OTC &
Emerging Growth Fund. The address of Putnam Investments, Inc. is One Post
Office Square, Boston, Massachusetts 02109.
(19) Includes 2,768,000 shares issuable upon the exercise of currently
exercisable options.
48
Item 13. Certain Relationships and Related Transactions
Relationship with Cisco
In September 1999, we sold 1,242,000 shares of our common stock to Cisco
for $12.00 per share. In connection with the investment, we have agreed to
nominate a person designated by Cisco to our Board of Directors so long as
Cisco owns more than 750,000 shares of our common stock. Additionally, we
provide network consulting services to Cisco pursuant to an existing agreement
negotiated by the parties in an arms-length transaction. This agreement expires
in May 2003 and governs the terms and conditions that apply to all consulting
services performed by us for Cisco and for customers of Cisco. This agreement
provides that if we give more favorable rates to another client we will inform
Cisco and Cisco will have the right to terminate this agreement. In fiscal 1998
and 1999, revenues from Cisco were $35,190 and $2,240,229, respectively. Inder
Sidhu, one of our directors, is the Vice President of Worldwide Professional
Services at Cisco.
Sale of Common Stock
In September 1999, we sold 94,867 and 18,133 shares of our common stock to
General Atlantic Partners 57 and GAP Coinvestment Partners II, respectively,
for $12.00 per share. Peter L. Bloom and Braden R. Kelly, our directors, are,
respectively, a managing member and a principal of General Atlantic Partners,
LLC. General Atlantic Partners, LLC is the general partner of General Atlantic
Partners 57 and the managing members of General Atlantic Partners, LLC are also
the general partners of GAP Coinvestment Partners II.
Tribeca Software
In March 1998, we made a pro rata distribution of all of the outstanding
shares of our former subsidiary, Tribeca Software, Inc., to our stockholders.
Of the 1,501,700 then outstanding shares of Tribeca, we distributed the
following amounts to our officers, directors and 5% stockholders and their
affiliates:
Number of Shares
Name of Stockholder of Tribeca
- - ---------------------------------------- -----------------
Ronald G. Pettengill, Jr. .............. 234,000
Robert L. Belau ........................ 250,000
Belau Irrevocable Family Trust ......... 10,000
Neeraj Sethi ........................... 13,000
Donald J. Duffy ........................ 25,000
Eric Meyer ............................. 42,500
MD Strategic, L.P. ..................... 85,000
PVII, L.P. ............................. 32,000
Boyce Meyer Trust(1). .................. 200,000
- - ------------
(1) Boyce Meyer was the father of Eric Meyer and the stepfather of Robert L.
Belau.
Subsequent to this transaction, Tribeca purchased from us, and we assigned
to Tribeca, network management software and other assets, including computer
and office equipment. As payment for these assets, Tribeca gave us a demand
note in the amount of $130,000, which accrued interest at 8% per annum.
Additionally, we gave Tribeca a $1,000,000 line of credit at an interest rate
of 8% per annum. In March 1999, Tribeca paid us the full amounts due under the
demand note and line of credit and the line of credit was terminated. The
largest amount outstanding under the line of credit was $988,800.
From March 1998 through June 1999, we performed payroll, accounting and
other administrative services for Tribeca for a fee of $7,000 per month.
Additionally, Tribeca leases office space and
49
equipment from us for approximately $8,000 per month as of January 1, 2000,
which monthly payment had been approximately $12,000 through December 31, 1999.
We believe that these transactions were on terms that are no less favorable
than those that could be obtained from unaffiliated third parties.
Ronald G. Pettengill, Jr., our Chairman and Chief Executive Officer, was a
director of Tribeca until September 1999 and owns shares of Tribeca's common
stock. Robert L. Belau, our President, and Donald J. Duffy and Eric Meyer, our
directors, are directors of Tribeca and own shares of common stock of Tribeca.
Additionally, Messrs. Pettengill and Belau served as executive officers of
Tribeca until September 1999 and Mr. Meyer has served as Tribeca's interim
Chief Executive Officer since September 1999.
Sale of Series A Convertible Preferred Stock and Warrants
In March 1999, we sold 6,512,316 shares of series A convertible preferred
stock and warrants to purchase the number of shares of our common stock that
equaled 15% of the number of shares registered in our initial public offering,
at $18.00 per share, to six accredited investors for an aggregate purchase
price of approximately $18.6 million. General Atlantic Partners 54, L.P.
purchased 5,350,441 shares and GAP Coinvestment Partners II purchased 1,112,765
shares. Peter L. Bloom and Braden R. Kelly, our directors, are respectively a
managing member and a principal of General Atlantic Partners, LLC. General
Atlantic Partners, LLC is the general partner of General Atlantic Partners 54
and the managing members of General Atlantic Partners, LLC are also the general
partners of GAP Coinvestment Partners II. The purchase price for the series A
convertible preferred stock was $2.85 per share. On the closing of our initial
public offering, the series A convertible preferred stock converted into
6,512,316 shares of our common stock. The warrants have terminated and are no
longer exercisable.
Share Redemption
As a condition of the March 1999 sale of series A convertible preferred
stock and warrants, we were required to repurchase approximately $8.4 million
of our common stock. Accordingly, we made an offer to each of our stockholders
to repurchase their shares at a price of $2.94 per share. Subsequently, in
March 1999, we repurchased a total of 2,855,100 shares of common stock from 31
of our stockholders who elected to sell shares for an aggregate purchase price
of approximately $8.4 million. Of these, we purchased the following amounts
from our officers, directors and 5% stockholders and their affiliates:
Number of Shares Aggregate
Name of Stockholder Redeemed Consideration
- - ----------------------------------- ------------------ --------------
Ronald G. Pettengill, Jr. ......... 534,000 $1,570,850
Robert L. Belau ................... 480,000 1,412,000
Neeraj Sethi ...................... 48,000 141,200
Donald J. Duffy ................... 210,000 617,750
Eric Meyer ........................ 282,000 829,550
MD Strategic, L.P. ................ 119,040 350,176
Predictive Ventures, L.P. ......... 300,000 882,500
PVII, L.P. ........................ 33,060 97,251
Eric Meyer and Donald J. Duffy, our directors, are general partners of MD
Strategic, Predictive Ventures and PVII.
Meyer, Duffy & Associates
We had an agreement with Meyer, Duffy & Associates, Inc. pursuant to which
they provided us with consulting and advisory services regarding capital
raising and strategic partnerships. Eric Meyer and Donald J. Duffy, our
directors, serve as co-managing Directors of Meyer, Duffy & Associates. We
50
paid Meyer, Duffy & Associates a retainer fee of $5,000 per month in connection
with these services through March 31, 1999, the date that the agreement
terminated. Additionally, in August 1998, we loaned Meyer, Duffy & Associates,
L.P., in connection with the exercise of options, $300,000 at an interest rate
of 7% per annum. Meyer, Duffy & Associates, L.P. repaid this loan in March
1999. Messrs. Meyer and Duffy are the general partners of Meyer, Duffy &
Associates, L.P.
Loans to Officers
In August 1998, in connection with the exercise of options, we loaned each
of Ronald G. Pettengill, Jr., our Chairman and Chief Executive Officer and
Robert L. Belau, our President, $97,500 at an interest rate of 7% per annum.
Messrs. Pettengill and Belau repaid those loans in March 1999. In addition to
these loans, from time to time, we have advanced loans to Messrs. Pettengill
and Belau. As of December 31, 1998 the amounts outstanding under these advances
for Messrs. Pettengill and Belau was $15,000 and $13,402, respectively, which
represents the largest amounts outstanding under these advances during fiscal
1998. There are currently no advances outstanding. We may in the future make
loans to our officers.
Option Grants
We granted each of Messrs. Bloom, Duffy, Kelly and Meyer, our non-employee
directors, options to purchase 25,000 shares of our common stock at a price of
$4.00 per share. We granted each of Messrs. Sidhu and Wyman, our non-employee
directors, options to purchase 25,000 shares of our common stock at a price of
$11.05 per share. Further, in 1999, we granted to Messrs. Pettengill, Belau,
Dorsey, Joseph, Humes, Holt, Sethi, Wright and Papilsky options to purchase
200,000; 200,000; 175,000; 100,000; 60,000; 130,000; 70,000; 80,000 and 50,000,
respectively. Additionally, in March 2000, we granted Mr. Smith, one of our
non-employee directors, options to purchase 25,000 shares of our common stock at
a price of $60.50 per share. Please see "Executive Compensation--Employment
Agreements." For additional information regarding the grant of stock options to
executive officers and directors, please see "Directors and Executive Officers
of the Registrant--Director Compensation," "Executive Compensation" and
"Security Ownership of Certain Beneficial Owners and Management."
Relationship with BellSouth
We provide network consulting services to BellSouth pursuant to an existing
agreement negotiated by the parties in an arms-length transaction. This
agreement expires in May 2001 and governs the terms and conditions that apply to
all consulting services performed by us for BellSouth and for BellSouth's
customers. In fiscal 1999, revenue from BellSouth was $1,229,881. William L.
Smith, one of our directors, is Executive Vice President of Network Planning and
Chief Technology Officer of BellSouth.
We have adopted a policy that all transactions with officers, directors,
5% stockholders and their affiliates be entered into only if they are approved
by a majority of the disinterested independent directors, are on terms no less
favorable to us than could be obtained from unaffiliated parties and are
reasonably expected to benefit us.
51
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) Consolidated Financial Statements.
The following consolidated financial statements of Predictive
Systems, Inc. and Subsidiaries and the Report of Independent Public
Accountants thereon are included in Item 8 above:
Page
-----
Report of Independent Public Accountants ............................................. F-2
Consolidated Balance Sheets as of December 31, 1998 and 1999 ......................... F-3
Consolidated Statements of Operations for the Years Ended December 31, 1997, 1998 and
1999 ................................................................................ F-4
Consolidated Statements of Stockholders' Equity and Comprehensive Income for the Years
Ended December 31, 1997, 1998 and 1999 .............................................. F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1998 and
1999 ................................................................................ F-6
Notes to Consolidated Financial Statements ........................................... F-7
(a)(2) Financial Statement Schedules.
All financial statement schedules required by Item 14(a)(2) have
been omitted because they are inapplicable or because the required
information has been included in the Consolidated Financial Statements or
Notes thereto.
(a)(3) Exhibits.
The following Exhibits are incorporated herein by reference or are
filed with this report as indicated below.
Number Description
- - ------------- ----------------------------------------------------------------------------------------
3.1# Amended and Restated Certificate of Incorporation.
3.2## Amended and Restated By-laws.
4.1+ Specimen common stock certificate.
4.2 See Exhibits 3.1 and 3.2 for provisions of the Amended and Restated Certificate of
Incorporation and Amended and Restated By-laws of the Registrant defining the rights of
holders of Common Stock of the Registrant.
4.3+ Stock Purchase Warrant, dated March 5, 1999, by and between General Atlantic Partners
54, L.P. and the Registrant.
4.4+ Stock Purchase Warrant, dated March 5, 1999, by and between GAP Coinvestment
Partners II, L.P. and the Registrant.
10.1+ 1999 Stock Incentive Plan.
10.2+ 1999 Employee Stock Purchase Plan.
10.4+ Employment Agreement, dated May 11, 1999, by and between Ronald Pettengill and the
Registrant.
10.5+ Employment Agreement, dated May 11, 1999, by and between Robert Belau and the
Registrant.
10.6+ Employment Agreement, dated January 22, 1999, by and between Kevin Holt and the
Registrant.
10.7+ Registration Rights Agreement, dated March 5, 1999.
10.8+ Secured Promissory Note, dated August 31, 1998, in favor of Brown Brothers Harriman &
Co.
10.9+ Agreement of Lease, dated June 25, 1999, by and between the Registrant and Polestar
Fifth Property Associates LLC.
10.10** Development and License Agreement, dated July 29, 1998, by and between Bear, Stearns
& Co. Inc. and the Registrant.
10.10.1@ Statements of Work, by and between Bear, Stearns & Co. Inc. and the Registrant, entered
into pursuant to the Development and License Agreement included as Exhibit 10.10.
10.12** Consulting Services Agreement, dated October 15, 1998, by and between First Union
Corporation and the Registrant.
10.12.1@ Statement of Work, by and between First Union Corporation and the Registrant, entered
into pursuant to the Consulting Services Agreement included as Exhibit 10.12.
10.13** Strategic Partnering Agreement, dated July 30, 1999, by and between Cabletron Systems
Inc. and the Registrant.
10.14** Systems Integration Consulting Services Agreement, dated May 21, 1998, by and between
LCI International Telecom Corp. dba Qwest Communications Corporation and the
Registrant.
10.15+ Amendment No. 1 to Consulting Services Agreement dated June 21, 1999, to Systems
Integration Consulting Services Agreement, dated May 21, 1998, by and between LCI
International Telecom Corp. dba Qwest Communications Corporation and the Registrant.
10.15.1@ Statements of Work, by and between Qwest Communications Corporation and the Registrant, entered
into pursuant to the Consulting Services Agreement included as Exhibit 10.14, as amended
by Amendment No. 1 thereto, included as Exhibit 10.15.
10.16+ Stock and Warrant Purchase Agreement, dated March 5, 1999, by and among General
Atlantic Partners 54, L.P., GAP Coinvestment Partners II, L.P., the Other Purchasers
named therein and the Registrant.
10.17+ Service Agreement, dated January 1, 1999, by and between John Wright and Predictive
Limited.
10.18+ Common Stock Purchase Agreement, dated September 16, 1999, by and between Cisco
Systems, Inc. and the Registrant.
10.19+ Investor's Rights Agreement, dated September 16, 1999, by and between Cisco Systems,
Inc. and the Registrant.
10.20** Professional Services Subcontract, dated May 14, 1999, by and between Cisco Systems,
Inc. and the Registrant.
52
Number Description
- - ----------- -----------------------------------------------------------------------------------
10.20.1@ Statements of Work, by and between Cisco Systems and the Registrant, entered into pursuant
to the Professional Services Subcontract included as Exhibit 10.20.
10.21+ Common Stock Purchase Agreement, dated September 22, 1999, by and among General
Atlantic Partners 57, L.P., GAP Coinvestment Partners II, L.P. and the Registrant.
10.22+ Amendment No. 1 to the Registration Rights Agreement, dated March 5, 1999, dated
September 22, 1999.
10.23+ Employment Agreement, dated September 21, 1999 by and between Gerard Dorsey and
the Registrant.
10.24+ Amendment No. 1 to Common Stock Purchase Agreement, dated September 27, 1999, by
and between Cisco Systems, Inc. and the Registrant.
10.25@ Master Professional Services Agreement, dated May 14, 1999, by and between
BellSouth MNS, Inc. and the Registrant.
10.25.1@ Statements of Work, by and between BellSouth MNS, Inc. and the Registrant, entered into
pursuant to the Master Professional Services Agreement included as Exhibit 10.25.
10.26++ Service Agreement, dated February 1, 2000, by and between Cisco Systems, Inc. and the Registrant.
21.1 List of Subsidiaries
23.1 Consent of Arthur Andersen LLP
27.1 Financial Data Schedule.
- - ------------
# 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.
++ Incorporated by reference to the identically numbered exhibit of
Registration Statement No. 333-31770.
** 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.
@ Non-confidential portions of this Exhibit were filed as the identically
numbered Exhibit of Registration Statement No.333-31770, which
non-confidential portions are incorporated herein by reference. Confidential
treatment was 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 Registrant did not file any reports on Form 8-K during the quarter
ended December 31, 1999.
53
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, 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 28th day of March, 2000.
PREDICTIVE SYSTEMS, INC.
By: Ronald G. Pettengill, Jr.
-------------------------------
Name: Ronald G. Pettengill, Jr.
Title: Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Report has been signed by the following persons in the capacities
indicated.
Signature Title(s) Date
- - ------------------------------- -------------------------------------------------- --------------
/S/ Ronald G. Pettengill, Jr. Chief Executive Officer and Chairman of the March 28, 2000
- - --------------------------- Board of Directors (principal executive officer)
Ronald G. Pettengill, Jr.
/s/ Robert L. Belau President and Director March 28, 2000
- - ----------------------------
Robert L. Belau
/s/ Gerard E. Dorsey Chief Financial Officer (principal financial and March 28, 2000
- - ---------------------------- accounting officer)
Gerard E. Dorsey
/s/ Peter L. Bloom Director March 28, 2000
- - ---------------------------
Peter L. Bloom
/s/ Donald J. Duffy Director March 28, 2000
- - ---------------------------
Donald J. Duffy
/s/ Braden R. Kelly Director March 28, 2000
- - ---------------------------
Braden R. Kelly
/s/ Eric Meyer Director March 28, 2000
- - ---------------------------
Eric Meyer
Director March 28, 2000
- - ---------------------------
Inder Sidhu
/s/ William L. Smith Director March 28, 2000
- - ----------------------------
William L. Smith
/s/ William W. Wyman Director March 28, 2000
- - ----------------------------
William W. Wyman
54
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
Page
-----
Report of Independent Public Accountants ............................................. F-2
Consolidated Balance Sheets as of December 31, 1998 and 1999 ......................... F-3
Consolidated Statements of Operations for the Years Ended December 31, 1997, 1998 and
1999 ................................................................................ F-4
Consolidated Statements of Stockholders' Equity and Comprehensive Income for the Years
Ended December 31, 1997, 1998 and 1999 .............................................. F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1998 and
1999 ................................................................................ F-6
Notes to Consolidated Financial Statements ........................................... F-7
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Predictive Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Predictive
Systems, Inc. (a Delaware corporation) (the "Company") and subsidiaries as of
December 31, 1998 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, 1999. 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 accounting 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, 1998 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1999 in conformity with accounting standards generally accepted in
the United States.
/s/ ARTHUR ANDERSEN LLP
----------------------------------------
Arthur Andersen LLP
New York, New York
February 10, 2000
F-2
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
---------------------------------
1998 1999
-------------- ----------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ...................................................... $ -- $ 89,633,634
Marketable securities .......................................................... -- 2,018,060
Accounts receivable--net of allowance for doubtful accounts of $141,489 and
$568,344, respectively ........................................................ 8,806,184 16,257,304
Unbilled work in process ....................................................... 1,062,824 289,120
Notes receivable--employees .................................................... 55,100 116,859
Notes receivable--stockholders ................................................. 515,000 --
Due from related party ......................................................... 916,948 --
Refundable income taxes ........................................................ 342,829 842,606
Prepaid expenses and other current assets ...................................... 386,453 1,219,717
----------- ------------
Total current assets .......................................................... 12,085,338 110,377,300
Property and equipment -- net of accumulated depreciation and amortization of
$947,735 and $1,703,711, respectively........................................... 1,356,634 2,884,105
Intangible assets, net of accumulated amortization of $326,871................... -- 3,936,666
Other assets .................................................................... 235,047 224,740
----------- ------------
Total assets .................................................................. $13,677,019 $117,422,811
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Cash overdraft ................................................................. $ 475,610 $ --
Short-term borrowings .......................................................... 5,598,000 --
Accounts payable ............................................................... 1,255,661 2,322,065
Accrued compensation ........................................................... 668,321 2,005,859
Accrued expenses and other current liabilities ................................. 879,704 2,709,002
Current portion of capital lease obligaions .................................... 151,027 183,193
Deferred income tax liability .................................................. 185,000 --
Deferred income ................................................................ 445,414 1,064,721
Dividends payable .............................................................. 61,250 --
----------- ------------
Total current liabilities ..................................................... 9,719,987 8,284,840
NONCURRENT LIABILITIES:
Capital lease obligations ...................................................... 446,018 284,037
Deferred rent .................................................................. 70,957 49,863
Deferred income tax liability .................................................. 714,146 299,851
Other long-term liabilities .................................................... -- 2,498
----------- ------------
Total liabilities ............................................................. 10,951,108 8,921,089
----------- ------------
COMMITMENTS AND CONTINGENCIES (Note 11)
Mandatory redeemable convertible preferred stock, $.001 par value, 5%
cumulative, 4,200,000 and 0 shares issued and outstanding ...................... 700,000 --
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value, 10,000,000 shares authorized, 0 shares issued
and outstanding ................................................................ -- --
Common stock, $.001 par value, 50,000,000 and 200,000,000 shares authorized,
7,900,200 and 23,429,200 shares issued and outstanding ......................... 7,900 23,429
Additional paid-in capital ...................................................... 682,270 108,404,681
Deferred compensation ........................................................... -- (256,672)
Retained earnings ............................................................... 1,335,741 369,625
Accumulated other comprehensive loss ............................................ -- (39,341)
----------- ------------
Total stockholders' equity .................................................... 2,025,911 108,501,722
----------- ------------
Total liabilities and stockholders' equity .................................... $13,677,019 $117,422,811
=========== ============
The accompanying notes to consolidated financial statements are an
integral part of these consolidated balance sheets.
F-3
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31,
------------------------------------------------
1997 1998 1999
-------------- -------------- --------------
Revenues:
Professional services ................... $16,897,456 $23,857,780 $50,698,035
Hardware and software sales ............. 1,189,617 2,065,348 2,046,810
----------- ----------- -----------
Total revenues ........................ 18,087,073 25,923,128 52,744,845
Cost of Revenues:
Professional services ................... 9,590,306 12,861,272 25,698,926
Hardware and software purchases ......... 816,935 1,698,356 1,765,746
----------- ----------- -----------
Total cost of revenues ................ 10,407,241 14,559,628 27,464,672
----------- ----------- -----------
Gross profit .......................... 7,679,832 11,363,500 25,280,173
Sales and marketing ...................... 1,081,889 3,433,751 8,477,692
General and administrative ............... 4,390,476 8,184,486 16,809,504
Depreciation and amortization ............ 320,908 567,761 1,082,890
Noncash compensation expense ............. -- -- 47,953
----------- ----------- -----------
Operating profit (loss) ............... 1,886,559 (822,498) (1,137,866)
Other Income (Expense):
Interest income ......................... 26,575 57,976 943,898
Other income ............................ 3,849 1,555 76,309
Interest expense ........................ (35,545) (324,591) (157,210)
----------- ----------- -----------
Income (loss) before income tax
provision (benefit) .................. 1,881,438 (1,087,558) (274,869)
Income tax provision
(benefit) ............................... 870,504 (460,258) 682,497
----------- ----------- -----------
Net income (loss) ..................... $1,010,934 $ (627,300) $ (957,366)
=========== =========== ===========
Net income (loss) per share --
Basic ................................... $ 0.22 $ (0.11) $ (0.08)
=========== =========== ===========
Diluted ................................. $ 0.08 $ (0.11) $ (0.08)
=========== =========== ===========
Weighted average shares outstanding--
Basic ................................... 4,382,417 6,015,433 12,137,560
=========== =========== ===========
Diluted ................................. 12,764,610 6,015,433 12,137,560
=========== =========== ===========
The accompanying notes to consolidated financial statements are an
integral part of these consolidated statements.
F-4
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
Convertible
Preferred Stock Common Stock Additional
---------------------------- ------------------------- Paid-in
Shares Par Value Shares Par Value Capital
--------------- ----------- ------------ ----------- ---------------
Balance at December 31, 1996 .............. -- $ -- 4,299,000 $ 4,299 $ 42,871
Net income ............................... -- -- -- -- --
Exercise of options ...................... -- -- 109,200 109 26,891
Preferred stock dividends ................ -- -- -- -- --
---------- --------- --------- ------- ------------
Balance at December 31, 1997 .............. -- -- 4,408,200 4,408 69,762
Net loss ................................. -- -- -- -- --
Exercise of options ...................... -- -- 3,492,000 3,492 612,508
Preferred stock dividends ................ -- -- -- -- --
---------- --------- --------- ------- ------------
Balance at December 31, 1998 .............. -- -- 7,900,200 7,900 682,270
Comprehensive loss
Net loss ................................ -- -- -- -- --
Unrealized gains on investments ......... -- -- -- -- --
Foreign currency translation
adjustment .............................. -- -- -- -- --
Total comprehensive loss ................
Preferred stock dividends ............... -- -- -- -- --
Issuance of preferred stock ............. 6,512,316 6,512 -- -- 18,559,713
Common stock repurchased to
treasury, 2,855,100 shares .............. -- -- -- -- --
Issuance of common stock, net of
offering expenses of $750,000 ........... -- -- 1,355,000 1,355 15,508,645
Issuance of common stock in
connection with the acquisition of
NRCC .................................... -- -- 1,062,814 1,063 4,250,193
Issuance of common stock in initial
public offering, net of offering
expenses, including the
reissuance of 2,855,100 shares
of treasury stock ....................... -- -- 1,744,900 1,745 66,737,265
Conversion of preferred stock to
common stock ............................ (6,512,316) (6,512) 10,712,316 10,712 695,800
Exercise of options ..................... -- -- 653,970 654 300,065
Income tax benefit relating to
exercise of options ..................... -- -- -- -- 1,366,105
Recognition of deferred
compensation ............................ -- -- -- -- 304,625
Noncash compensation expense ............ -- -- -- -- --
---------- --------- ---------- ------- ------------
Balance at December 31, 1999 .............. -- $ -- 23,429,200 $23,429 $108,404,681
========== ========= ========== ======= ============
Accumulated
Other Total
Treasury Deferred Retained Comprehensive Stockholders'
Stock Compensation Earnings Income (Loss) Equity
--------------- -------------- ------------- --------------- ---------------
Balance at December 31, 1996 .............. $ -- $ -- $1,013,357 $ -- $ 1,060,527
Net income ............................... -- -- 1,010,934 -- 1,010,934
Exercise of options ...................... -- -- -- -- 27,000
Preferred stock dividends ................ -- -- (26,250) -- (26,250)
------------- ---------- ---------- --------- ------------
Balance at December 31, 1997 .............. -- -- 1,998,041 -- 2,072,211
Net loss ................................. -- -- (627,300) -- (627,300)
Exercise of options ...................... -- -- -- -- 616,000
Preferred stock dividends ................ -- -- (35,000) -- (35,000)
------------- ---------- ---------- --------- ------------
Balance at December 31, 1998 .............. -- -- 1,335,741 -- 2,025,911
Comprehensive loss
Net loss ................................ -- -- (957,366) (957,366)
Unrealized gains on investments ......... -- -- -- 1,426 1,426
Foreign currency translation
adjustment .............................. -- -- -- (40,767) (40,767)
------------
Total comprehensive loss ................ (996,707)
============
Preferred stock dividends ............... -- -- (8,750) -- (8,750)
Issuance of preferred stock ............. -- -- -- -- 18,566,225
Common stock repurchased to
treasury, 2,855,100 shares .............. (8,398,753) -- -- -- (8,398,753)
Issuance of common stock, net of
offering expenses of $750,000 ........... -- -- -- -- 15,510,000
Issuance of common stock in
connection with the acquisition of
NRCC .................................... -- -- -- -- 4,251,256
Issuance of common stock in initial
public offering, net of offering
expenses, including the
reissuance of 2,855,100 shares
of treasury stock ....................... 8,398,753 -- -- -- 75,137,763
Conversion of preferred stock to
common stock ............................ -- -- -- -- 700,000
Exercise of options ..................... -- -- -- -- 300,719
Income tax benefit relating to
exercise of options ..................... -- -- -- -- 1,366,105
Recognition of deferred
compensation ............................ -- (304,625) -- -- --
Noncash compensation expense ............ -- 47,953 -- -- 47,953
------------- ---------- ---------- --------- ------------
Balance at December 31, 1999 .............. $ -- $ (256,672) $ 369,625 $ (39,341) $108,501,722
============= ========== ========== ========= ============
The accompanying notes to consolidated financial statements are an
integral part of these consolidated statements.
F-5
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
---------------------------------------------------
1997 1998 1999
--------------- ---------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ................................................. $ 1,010,934 $ (627,300) $ (957,366)
Adjustments to reconcile net income (loss) to net cash used in
operating activities--
Noncash compensation expense ...................................... -- -- 47,953
Deferred income taxes ............................................. 838,572 (540,469) (674,836)
Depreciation and amortization ..................................... 320,908 567,761 1,082,890
Provision for doubtful accounts ................................... 99,308 102,196 469,000
Unrealized gain on sale of marketable securities .................. -- -- 1,426
(Increase) decrease in--
Accounts receivable .............................................. (2,718,335) (4,710,510) (7,597,971)
Unbilled work in process ......................................... 204,978 (883,420) 773,704
Income taxes ..................................................... (210,916) 1,220 866,328
Prepaid expenses and other current assets ........................ (44,401) (215,378) (749,493)
Other assets ..................................................... (127,283) 32,267 10,307
(Decrease) increase in--
Accounts payable ................................................. (168,844) 1,096,032 885,107
Accrued expenses and other current liabilities ................... 106,928 1,053,276 2,909,894
Deferred income .................................................. (464,493) 412,459 601,810
Deferred rent .................................................... (7,269) 47,651 (21,094)
Other long-term liabilities ...................................... -- -- (266,652)
------------ ------------- ------------
Net cash used in operating activities ............................ (1,159,913) (3,664,215) (2,618,993)
------------ ------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of marketable securities ................................. -- -- (3,118,060)
Proceeds from sale or redemption of marketable securities ......... -- -- 1,100,000
Payments to employees ............................................. (57,151) (26,950) (110,637)
Repayments from employees ......................................... 3,780 25,221 48,878
Payments to stockholders .......................................... -- (515,000) --
Repayments from stockholders ...................................... -- -- 515,000
Payments to related party ......................................... -- (916,948) (478,078)
Repayments from related party ..................................... -- -- 1,395,026
Cash received from acquisition of NRCC ............................ -- -- 163,768
Purchase of property and equipment ................................ (356,782) (686,823) (2,194,847)
------------ ------------- ------------
Net cash used in investing activities ............................ (410,153) (2,120,500) (2,678,950)
------------ ------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash overdraft .................................................... 545,351 (69,741) (475,610)
Common shares repurchased to treasury ............................. -- -- (8,398,753)
Proceeds from short-term borrowings ............................... 2,452,000 19,643,000 4,351,000
Repayments of short-term borrowings ............................... (1,672,000) (14,825,000) (9,949,000)
Payment of preferred dividends .................................... -- -- (70,000)
Proceeds from sale of preferred stock ............................. -- -- 18,566,225
Proceeds from sale of common stock, net of expenses ............... -- -- 15,510,000
Proceeds from initial public offering, net of expenses,
including reissuance of treasury stock ........................... -- -- 75,137,763
Proceeds from exercise of stock options ........................... 27,000 616,000 300,719
------------ ------------- ------------
Net cash provided by financing activities ........................ 1,352,351 5,364,259 94,972,344
------------ ------------- ------------
Effects of exchange rates ......................................... -- -- (40,767)
Net (decrease) increase in cash .................................. (217,715) (420,456) 89,633,634
CASH AND CASH EQUIVALENTS, beginning of period ..................... 638,171 420,456 --
------------ ------------- ------------
CASH AND CASH EQUIVALENTS, end of period ........................... $ 420,456 $ -- $ 89,633,634
============ ============= ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for-- ...................................
Interest ......................................................... $ 35,545 $ 262,539 $ 234,768
============ ============= ============
Taxes ............................................................ $ 260,000 $ -- $ 442,420
============ ============= ============
SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING TRANSACTIONS:
Stock issued for acquisition ...................................... $ -- $ -- $ 4,251,256
============ ============= ============
Tax benefits of stock option exercises $ -- $ -- $ 1,366,105
============ ============= ============
Borrowings under capital leases ................................... $ 335,669 $ 238,050 $ --
============ ============= ============
Dividends declared on mandatory redeemable convertible preferred
stock ............................................................ $ 26,250 $ 35,000 $ 8,750
============ ============= ============
The accompanying notes to consolidated financial statements are an
integral part of these consolidated statements.
F-6
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 securities of complex computing networks. Services
are currently provided through the Company's offices located throughout the
United States and its wholly-owned subsidiaries in England, which was formed in
the first quarter of 1999, and in The Netherlands, which was acquired in the
third quarter of 1999.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
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, 1998 and 1999 is $1,032,390 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.
Property and Equipment --
Computer equipment and office furniture are carried at their cost basis
and depreciated using the straight-line method over their estimated useful
lives, ranging from three to seven years. Leasehold improvements are amortized
over the lesser of their estimated useful lives or the life of the lease.
Expenditures for maintenance and repairs are charged to operations as incurred
and major expenditures for renewals and betterments are capitalized and
depreciated over their useful lives.
Business Concentrations and Credit Risk --
Financial instruments, which subject the Company to concentrations of
credit risk, consist primarily of cash and cash equivalents and trade accounts
receivable. The Company maintains cash and cash equivalents with various
financial institutions. The Company performs periodic evaluations
F-7
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: -- (Continued)
of the relative credit standing of these institutions. The Company's clients
are primarily concentrated in the United States. The Company performs ongoing
credit evaluations, generally does not require collateral and establishes an
allowance for doubtful accounts based upon factors surrounding the credit risk
of customers, historical trends and other information. To date, such losses
have been within management's expectations.
For the year ended December 31, 1997, approximately 60% of sales were from
four customers. For the year ended December 31, 1998, approximately 20% of
sales were from one customer. For the year ended December 31, 1999,
approximately 31% of sales were from two customers. The amounts due from these
customers at December 31, 1998 and 1999 were approximately $2,931,000 and
$4,146,181, respectively.
Income Taxes --
The Company accounts for income taxes under Statement of Financial
Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes" ("SFAS
109"). SFAS 109 requires the recognition of deferred tax assets and liabilities
for the expected future tax consequences of events that have been included in
the financial statements or tax returns. Under this method, deferred tax assets
and liabilities are determined based on the differences between the financial
statement and the tax basis of assets and liabilities using enacted tax rates
in effect for the year in which the differences are expected to reverse. The
Company converted from a cash basis to an accrual basis taxpayer on January 1,
1998. (Note 9)
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 adopted 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).
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 adopted SFAS No. 130, "Reporting Comprehensive Income." 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 No. 130 increased
the reporting disclosures but had no impact on the results of operations or
financial position of the Company.
F-8
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: -- (Continued)
Segment Reporting --
In June 1997, the Financial Accounting Standard Board ("FASB") issued SFAS
No. 131, "Disclosures About Segments of an Enterprise and Related Information."
This statement establishes standards for the way public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to shareholders. 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.
(3) ACQUISITION:
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 in exchange for all of the outstanding stock of NRCC. The Company
acquired net 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 assets acquired.
The following information presents the pro forma results of operations for
the Company for the years ending December 31, 1998 and 1999 as if the
acquisition of NRCC had occurred on the first day of the years presented.
Year Ended December 31,
1998 1999
---------------- ----------------
Revenues ............... $ 27,812,053 $ 53,997,772
Operating loss ......... (1,413,386) (1,518,687)
Net loss ............... $ (1,313,630) $ (1,394,550)
Per Share Information:
Net loss per share --
Basic ............... $ (0.19) $ (0.11)
Diluted ............. $ (0.19) $ (0.11)
Weighted Average Shares
Outstanding --
Basic ............... 7,078,247 12,786,896
Diluted ............. 7,078,247 12,786,896
F-9
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(4) NET INCOME (LOSS) PER SHARE:
As discussed in Note 2, net income (loss) per share is calculated in
accordance with SFAS 128. The following table reconciles the numerator and
denominator for the calculation --
Year Ended December 31,
-----------------------------------------------
1997 1998 1999
------------- -------------- --------------
Numerator --
Net income (loss) ........................................ $1,010,934 $ (627,300) $ (957,366)
Preferred stock dividends ................................ (26,250) (35,000) (8,750)
----------- ---------- -----------
Numerator for basic earnings per share -- net
income (loss) available to common
stockholders .......................................... 984,684 (662,300) (966,116)
=========== ========== ===========
Effect of dilutive securities -- preferred stock
dividend.................................................. 26,250 -- --
----------- ---------- -----------
Numerator for diluted earnings per share -- net
income (loss) available to common
stockholders after assumed conversions ................... $1,010,934 $ (662,300) $ (966,116)
=========== ========== ===========
Denominator --
Denominator for basic earnings per share --
weighted average shares ................................ 4,382,417 6,015,433 12,137,560
=========== ========== ===========
Effect of dilutive securities --
Incremental shares for assumed conversions of
preferred stock ........................................ 4,200,000 -- --
Incremental shares for assumed conversions of
options ................................................ 4,182,193 -- --
----------- ---------- -----------
Dilutive potential common shares ......................... 8,382,193 -- --
=========== ========== ===========
Denominator for diluted earnings per share --
adjusted weighted average shares and assumed
conversions .............................................. 12,764,610 6,015,433 12,137,560
=========== ========== ===========
Basic earnings per share from net income (loss) ........... $ 0.22 $ (0.11) $ (0.08)
=========== ========== ===========
Diluted earnings per share from net income (loss) ......... $ 0.08 $ (0.11) $ (0.08)
=========== ========== ===========
(5) PROPERTY AND EQUIPMENT:
The components of property and equipment are as follows --
December 31,
-------------------------------
1998 1999
------------- ---------------
Computer equipment ........................................ $1,243,475 $ 2,487,334
Office furniture .......................................... 630,722 810,822
Leasehold improvements .................................... 430,172 1,289,660
---------- ------------
2,304,369 4,587,816
Less -- Accumulated depreciation and amortization ......... (947,735) (1,703,711)
---------- ------------
$1,356,634 $ 2,884,105
========== ============
Depreciation and amortization expense related to property and equipment
aggregated $320,908, $567,761 and $756,019, respectively, for the years ending
December 31, 1997, 1998 and 1999.
F-10
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(6) 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. At December 31, 1999 no balance is
due from this company and the line of credit no longer exists.
Two of the Company's customers, Cisco Systems and BellSouth, each have one
seat on the Company's Board of Directors. During 1999, the Company recorded
revenues of $2.2 million and $1.2 million from services performed for Cisco
Systems and BellSouth, respectively.
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.
The Company's management believes that these transactions were entered into
on a basis that approximates fair value.
(7) SHORT-TERM BORROWINGS:
The Company has a secured demand loan under which it may borrow up to
$5,000,000, but not more than 80% of the Company's eligible accounts
receivable, as defined. At December 31, 1998, the balance outstanding on this
demand loan was $5,598,000 as the lender has informally extended the Company's
ability to borrow under this demand loan. The interest rate on the demand loan
was 11.25% at December 31, 1998. During the first quarter of 1999, the balance
outstanding on the demand loan was paid in full. No amounts were outstanding
under this loan as of December 31, 1999.
(8) 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
----
2000 ................................................ $ 225,698
2001 ................................................ 160,068
2002 ................................................ 92,241
2003 ................................................ 60,127
2004 ................................................ 1,124
Less -- Amount representing interest ................ (72,028)
----------
Present value of net minimum lease payments ......... 467,230
Less -- Current portion ............................. (183,193)
----------
$ 284,037
==========
F-11
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(9) INCOME TAXES:
The components of the Company's provision (benefit) for income taxes for
the years ended December 31, 1997, 1998 and 1999 are as follows --
Year Ended December 31,
------------------------------------------
1997 1998 1999
---------- ------------- -------------
Current income tax provision:
Federal ..................................... $ 26,882 $ -- $ 988,715
State ....................................... 5,050 80,211 368,618
-------- ---------- ---------
31,932 80,211 1,357,333
Deferred income tax provision (benefit):
Federal ..................................... 578,823 (407,182) (507,059)
State ....................................... 259,749 (133,287) (167,777)
-------- ---------- ---------
838,572 (540,469) (674,836)
-------- ---------- ---------
Total income tax provision (benefit) ......... $870,504 $ (460,258) $ 682,497
======== ========== ==========
The following table indicates the significant elements contributing to the
difference between the Federal statutory rate and the Company's effective tax
rate --
Year Ended December 31,
------------------------------------------
1997 1998 1999
---------- ------------- -------------
Federal statutory rate ......................... 34.0% (34.0)% (34.0)%
State taxes, net of Federal effect ............. 6.6 ( 6.6) 73.1
Non-deductible amortization .................... -- -- 40.3
Meals and entertainment ........................ -- -- 27.6
Adjustment to cash to accrual basis liability .. -- -- (56.4)
Valuation allowance ............................ -- -- 206.0
Other .......................................... 5.7 ( 1.7) ( 8.3)
----- ----- -----
46.3% (42.3)% 248.3%
===== ===== =====
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. Other
major components of the deferred tax assets and (liabilities) as of December
31, 1998 and 1999 are as follows:
December 31,
-------------------------------
1998 1999
--------------- -------------
Bad debt reserve ............................ $ 57,529 $ 223,741
Depreciation ................................ 100,124 62,200
Change from cash to accrual basis liability (1,249,974) (724,202)
Net operating loss carryforwards ............ 174,474 824,322
Valuation allowance ......................... -- (639,230)
Other, net .................................. 18,701 28,859
------------ ----------
Total deferred income taxes, net ......... $ (899,146) $ (224,310)
============ ==========
At December 31, 1998 and 1999 the Company had available net operating loss
carryforwards of approximately $390,000 and $2,125,000 to reduce future
period's taxable income. These loss carryforwards begin to expire in 2012.
During 1999, the Company's subsidiaries in England and The Netherlands
incurred net operating losses, the tax benefits of which have been fully
reserved for by a valuation allowance because of the uncertainty of their
realizability.
F-12
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(10) 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.
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 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 converted into common
shares on a 1 to 1 ratio on the date of the initial public offering.
Effective September 14, 1999, the Company is authorized to issue 10,000,000
shares of Preferred Stock, par value $.001 per share.
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.
On September 14, 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 57, 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.
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
F-13
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(10) STOCKHOLDERS' EQUITY: -- (Continued)
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.
As of December 31, 1999 a combined total of 1,903,870 shares of common stock
has been reserved for issuance under the Option Plan.
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.
6,655,600 shares of common stock have been authorized for issuance under
the 1999 Plan. This share reserve consists of the shares which were available
for issuance under the predecessor 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.
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.
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.
F-14
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(10) STOCKHOLDERS' EQUITY: -- (Continued)
A summary of the Company's stock option activity is as follows --
Year Ended December 31,
---------------------------------------------------------------------------------
1997 1998 1999
------------------------- --------------------------- -------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------- ---------- --------------- ---------- -------------- ---------
Outstanding at beginning of
period ...................... 5,916,000 $ 0.33 9,471,600 $ 0.61 8,397,600 $ 1.02
Granted ...................... 3,856,800 1.04 2,427,000 1.41 3,686,990 7.25
Exercised .................... (109,200) 0.25 (3,492,000) 0.18 (653,970) 0.46
Forfeited .................... (192,000) 0.83 (9,000) 0.83 (673,710) 2.36
--------- ------ ---------- ------ --------- ------
Outstanding at end of period . 9,471,600 $ 0.61 8,397,600 $ 1.02 10,756,910 $ 3.11
========= ====== ========== ====== ========== ======
Options exercisable at end of
period ...................... 5,700,300 $ 0.42 4,586,250 $ 0.80 5,259,270 $ 1.02
========= ====== ========== ====== ========== ======
Weighted average fair value of
options granted during period $ 0.23 $ 0.26 $ 4.31
The following table summarizes information about stock options outstanding
at December 31, 1999 --
Options Weighted Options
Outstanding at Average Exercisable at
December 31, Remaining December 31,
Exercise Prices 1999 Contractual Life 1999
- - ----------------- ---------------- ------------------ ---------------
$0.17............ 330,000 5.20 years 330,000
0.50 ........... 240,000 6.00 years 240,000
0.83 ........... 2,890,800 6.82 years 2,724,300
1.25 ........... 2,628,300 7.61 years 1,390,800
1.50 ........... 1,282,000 8.62 years 442,520
2.50 ........... 775,500 9.23 years 20,000
4.00 ........... 1,184,960 9.43 years 106,000
6.50 ........... 375,750 9.52 years --
10.20 ........... 179,500 9.67 years --
11.05 ........... 727,850 9.76 years 5,650
15.00 ........... 19,000 9.82 years --
45.06 ........... 84,250 9.92 years --
66.50 ........... 39,000 10.00 years --
--------- ---------
10,756,910 5,259,270
========== =========
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 income (loss) and basic and diluted income (loss) per share would
have been reduced to the pro forma amounts in the table below.
The fair value of all of our option grants is estimated on the date of
grant using the Black-Scholes model with the following weighted-average
assumptions used for grants in 1997, 1998 and 1999.
o weighted-average risk free interest rates of 6.28%, 5.51% and 5.79%,
respectively;
o expected dividend yields of 0%;
F-15
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(10) STOCKHOLDERS' EQUITY: -- (Continued)
o expected lives of 4 years; and
o expected volatility of 73.17%.
Year Ended December 31,
-------------------------------------------------
1997 1998 1999
--------------- -------------- --------------
Net income (loss):
As reported ................................. $ 1,010,934 $ (627,300) $ (957,366)
Pro forma ................................... 774,427 (1,006,406) (1,980,145)
Basic net income (loss) per share:
As reported ................................. $ 0.22 $ (0.11) $ (0.08)
Pro forma ................................... $ 0.18 $ (0.17) $ (0.16)
Diluted net income (loss) per share: .........
As reported ................................. $ 0.08 $ (0.11) $ (0.08)
Pro forma ................................... $ 0.06 $ (0.17) $ (0.16)
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. This amount will be recognized as noncash compensation expense
over the vesting period of the options (4 years). For the year ended December
31, 1999, $47,953 of the deferred compensation was amortized to expense and has
been reflected as noncash compensation expense in the accompanying statements
of operations.
(11) 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
----
2000 ................................... $ 2,942,309
2001 ................................... 2,109,118
2002 ................................... 1,521,564
2003 ................................... 1,311,518
2004 ................................... 1,067,054
2005 and thereafter .................... 5,126,059
-----------
Total minimum lease payments ......... $14,077,622
===========
Rent expense was approximately $457,825, $736,120 and $1,311,411 for the
years ended December 31, 1997, 1998 and 1999, respectively.
Pension Plan --
The Company has a 401(k) plan with discretionary matching contributions
for its employees. The Company did not make any contributions to the 401(k)
plan during 1997, 1998 or 1999.
F-16
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(11) COMMITMENTS AND CONTINGENCIES: -- (Continued)
Litigation --
The Company is involved, from time to time, in legal proceedings incurred
in the normal course of business. In the opinion of management and its counsel,
none of these proceedings would have a material effect on the financial
position or results of operations of the Company.
F-17
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
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 10, 2000. Our audit was made for the purpose of forming an opinion on
the basic financial statements taken as a whole. The schedule of valuation and
qualifying accounts is the responsibility of the Company's management and is
presented for purposes of complying with the Securities and Exchange Commissions
rules and is not part of the basic financial statements. This schedule has been
subjected to the auditing procedures applied in the audit of the basic financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth therein in relation to the basic
financial statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP
-------------------------
Arthur Andersen LLP
New York, New York
February 10, 2000
S-1
Schedule II
PREDICTIVE SYSTEMS, INC.
SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Balance at Charged to
Beginning of Costs and Balance at End
Year Expenses Deductions of Year
-------------- ----------- ------------ ---------------
For the fiscal year ended December 31, 1997
Allowance for doubtful accounts .......... $ 30 $ 99 $ (49) $ 80
For the fiscal year ended December 31, 1998
Allowance for doubtful accounts .......... $ 80 $102 $ (41) $141
For the fiscal year ended December 31, 1999
Allowance for doubtful accounts .......... $141 $469 $ (42) $568
S-2
INDEX TO EXHIBITS
Number Description
- - -------------- -----------
1.1* Form of underwriting agreement.
3.1# Amended Restated Certificate of Incorporation.
3.2## Amended and Restated By-laws.
4.1+ Specimen common stock certificate.
4.2 See Exhibits 3.1 and 3.2 for provisions of the Amended and Restated Certificate of
Incorporation and Amended and Restated By-laws of the Registrant defining the rights
of holders of Common Stock of the Registrant.
4.3+ Stock Purchase Warrant, dated March 5, 1999, by and between General Atlantic
Partners 54, L.P. and the Registrant.
4.4+ Stock Purchase Warrant, dated March 5, 1999, by and between GAP Coinvestment
Partners II, L.P. and the Registrant.
10.1+ 1999 Stock Incentive Plan.
10.2+ 1999 Employee Stock Purchase Plan.
10.4+ Employment Agreement, dated May 11, 1999, by and between Ronald Pettengill and the
Registrant.
10.5+ Employment Agreement, dated May 11, 1999, by and between Robert Belau and the
Registrant.
10.6+ Employment Agreement, dated January 22, 1999, by and between Kevin Holt and the
Registrant.
10.7+ Registration Rights Agreement, dated March 5, 1999.
10.8+ Secured Promissory Note, dated August 31, 1998, in favor of Brown Brothers Harriman
& Co.
10.9+ Agreement of Lease, dated June 25, 1999, by and between the Registrant and Polestar
Fifth Property Associates LLC.
10.10** Development and License Agreement, dated July 29, 1998, by and between Bear,
Stearns & Co. Inc. and the Registrant.
10.10.1@ Statements of Work, by and between Bear, Stearns & Co. Inc. and the Registrant, entered
into pursuant to the Development and License Agreement inluded as Exhibit 10.10.
10.12** Consulting Services Agreement, dated October 15, 1998, by and between First Union
Corporation and the Registrant.
10.12.1@ Statement of Work, by and between First Union Corporation and the Registrant, entered
into pursuant to the Consulting Services Agreement included as Exhibit 10.12.
10.13** Strategic Partnering Agreement, dated July 30, 1999, by and between Cabletron
Systems Inc. and the Registrant.
10.14** Systems Integration Consulting Services Agreement, dated May 21, 1998, by and
between LCI International Telecom Corp. dba Qwest Communications Corporation and
the Registrant.
10.15+ Amendment No. 1 to Consulting Services Agreement dated June 21, 1999, to Systems
Integration Consulting Services Agreement, dated May 21, 1998, by and between LCI
International Telecom Corp. dba Qwest Communications Corporation and the Registrant.
10.15.1@ Statements of Work, by and between Qwest Communications Corporation and the Registrant, entered
into pursuant to the Consulting Services Agreement included as Exhibit 10.14, as amended by
Amendment No. 1 thereto, included as Exhibit 10.15.
10.16+ Stock and Warrant Purchase Agreement, dated March 5, 1999, by and among General
Atlantic Partners 54, L.P., GAP Coinvestment Partners II, L.P., the Other Purchasers
named therein and the Registrant.
10.17+ Service Agreement, dated January 1, 1999, by and between John Wright and Predictive
Limited.
10.18+ Common Stock Purchase Agreement, dated September 16, 1999, by and between
Cisco Systems, Inc. and the Registrant.
10.19+ Investor's Rights Agreement, dated September 16, 1999, by and between Cisco
Systems, Inc. and the Registrant.
10.20** Professional Services Subcontract, dated May 14, 1999, by and between Cisco
Systems, Inc. and the Registrant.
10.20.1@ Statements of Work, by and between Cisco System and the Registrant, entered into pursuant
to the Professional Services Subcontract included as Exhibit 10.20.
10.21+ Common Stock Purchase Agreement, dated September 22, 1999, by and among
General Atlantic Partners 57, L.P., GAP Coinvestment Partners II, L.P. and the
Registrant.
Number Description
- - ------------- -----------
10.22+ Amendment No. 1 to the Registration Rights Agreement, dated March 5, 1999, dated
September 22, 1999.
10.23+ Employment Agreement, dated September 21, 1999 by and between Gerard Dorsey and
the Registrant.
10.24+ Amendment No. 1 to Common Stock Purchase Agreement, dated September 27, 1999,
by and between Cisco Systems, Inc. and the Registrant.
10.25@ Master Professional Services Agreement, dated May 14, 1999, by and between
BellSouth MNS, Inc. and the Registrant.
10.25.1@ Statements of Work, by and between BellSouth MNS, Inc. and the Registrant, entered into
pursuant to the Master Professional Services Agreement included as Exhibit 10.25.
10.26++ Service Agreement, dated February 1, 2000, by and between Cisco Systems, Inc. and the Registrant.
21.1 List of Subsidiaries.
23.1 Consent of Arthur Andersen LLP
27.1 Financial Data Schedule.
- - ------------
# 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.
++ Incorporated by reference to the identically numbered exhibit of
Registration Statement No. 333-31770.
** 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.
@ Non-confidential portions of this Exhibit were filed as the identically
numbered Exhibit of Registration Statement No. 333-31770, which
non-confidential portions are incorporated herein by reference. Confidential
treatment was 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.