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SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

(Mark One)

Commission File Number: 000-24193

ATLANTIC DATA SERVICES, INC.

One Batterymarch Park, Quincy, Massachusetts 02169
(Address of Principal Executive Offices) (Zip Code)
(617) 770 – 3333
(Registrant’s Telephone Number, Including Area Code)

Securities Registered Pursuant to Section 12(b) of the Act: None.

Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, $.01 par value
(Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 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. Yes [ X ] 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 the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [   ] No [ X ].

The aggregate market value of the voting common equity held by non-affiliates of the Company was approximately $7,300,000 on September 30, 2002 based on the last reported sale price of the Company’s Common Stock on The NASDAQ National Market on September 30, 2002 of $1.70 per share. There were 13,045,245 shares of Common Stock issued and outstanding as of September 30, 2002.

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ATLANTIC DATA SERVICES, INC.

ANNUAL REPORT ON FORM 10-K
FOR THIS FISCAL YEAR ENDED MARCH 31, 2003

FORWARD LOOKING STATEMENTS

This Report includes forward-looking statements, which are made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. You can identify these forward-looking statements when you see us using words such as “expect,” “anticipate,” “believe,” “intend,” “may,” “predict,” and other similar expressions. These forward-looking statements cover, among other items: events, conditions and financial trends that may affect our future plans of operation, business strategy, growth of operations and financial position, including statements regarding revenue and earnings or loss per share projections, concentration of revenues among a limited number of customers, expected capital expenditures for fiscal 2004 and sufficiency of cash to meet working capital and capital expenditure requirements for 2004. Any forward-looking statements are not guarantees of future performance and are necessarily subject to a number of risks and uncertainties, some of which are beyond our control. These risks and uncertainties include, among others: variability of our quarterly operating results due to, among other things, the number, size and scope of customer projects commenced and completed during a quarter, changes in employee utilization rates and changes in average billing rates; our dependence on the financial services industry; general economic uncertainty; concentration of revenues and our dependence on major customers; risks associated with fixed price contracts; our dependence on key personnel; intense competition in the IT consulting industry; and risks associated with potential acquisitions. Because of these risks and uncertainties, the forward-looking events discussed in this Report might not transpire.

PART I

ITEM 1: BUSINESS

A.     General

Atlantic Data Services, Inc. (“We” or “ADS”), provides information technology (“IT”) strategy consulting and systems integration services to the financial services industry. We offer rapid, cost-effective IT solutions to the business challenges faced by financial services companies through our in-depth financial services experience, technological expertise and project management skills. Our service offerings are organized around four practice areas: Customer Relationship Management (“CRM”), Conversions and Consolidations, IT Strategy and Consulting, and e-Business. We were incorporated in Massachusetts on March 25, 1980.

The business challenges created by deregulation and consolidation, coupled with the need to maintain existing systems and incorporate new technologies, have forced banks to turn to third party IT providers for assistance in developing IT solutions to meet their changing needs. Because of the critical importance of their IT systems, many banks seek to engage IT service providers who have in-depth knowledge of their systems and business processes and who can assume responsibility for project management and delivery. IT service providers working with banks must possess extensive experience in the financial services industry and be fluent in both traditional legacy systems and newer technologies. However, there is a shortage of professionals who have this combination of skills. While many banks are concluding that using outside specialists enables them to develop better IT solutions in less time and to reduce implementation risks, most IT consulting firms do not have the specialized knowledge of the financial services industry necessary to assist banks in rapidly and cost-effectively meeting their business challenges.

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We enable our customers to leverage their existing IT systems and personnel to compete more effectively, to rapidly assimilate changing technologies and to meet their evolving business needs in a timely and cost-effective manner. We work closely with our customers’ management and IT personnel from the diagnostic and strategic planning stages through project completion. Our IT professionals have extensive experience in the diverse technical environments, legacy hardware platforms, programming languages, and software used by banks, as well as newer technologies, including client/server applications and the Internet. In addition, we have developed proprietary tools and methodologies designed to reduce the risks inherent in complex systems implementations. We work closely with our customers to determine the appropriate resources and staffing to assign to their projects and deploy our staff from throughout the United States to meet a customer’s needs.

Practice Areas

We offer and deliver our services through four practice areas that address the major areas of interest and activity of our customers. These four practice areas are:

CRM. We understand that a key success factor for financial services organizations is the acquisition, servicing and growth of profitable customer relationships. Our goal is to help our clients become more customer-focused so they can maintain and grow market share in the competitive financial services marketplace. Our approach is to assist our clients by delivering a practical plan for transforming the enterprise to support their customer-oriented business strategy. Then as each initiative is launched, our requirements documentation services team can assist in the translation of business needs into formal requirements for the project team – assuring that the solution delivers business results. As an independent services firm, our team of experts can also assist in the acquisition of best of breed tools and solutions. We also recognize that high-performance customer information is the foundation of any CRM program. Our customer information teams can provide everything from diagnostic services to complete systems integration to assure that this valuable asset supports our customer’s CRM program. Our approach with every engagement is to focus on business objectives and return-on-investment, and to deliver value at every step.

Conversions and Consolidations. The financial services industry continues to undergo tremendous change and reorganization. We have been a leading solution provider in hundreds of conversions, consolidations and migrations, deploying the financial services expertise necessary to contribute to our customers’ successes. As a core competency, we provide the requisite project management skills to help our customers tackle the business and technological challenges before them, and to exceed the goals of their original strategic objectives. The financial industry experience resident on our consulting staff enables us to provide our clients with both the business insight and operational expertise to guarantee successful business integrations.

IT Strategy and Consulting. Firms in every segment of financial services are facing unprecedented pressure to innovate and change. In the face of competition from new and traditional rivals, financial institutions must simultaneously develop or acquire new products and services, improve the level of personalized service provided to customers, and significantly improve operating efficiency. We provide the operational insight and major project discipline to complete these strategic initiatives successfully. We leverage our industry knowledge and technology expertise to help clients identify, design and implement business solutions that produce measurable improvements. Not only are new capabilities implemented, but operational performance efficiencies are also achieved, resulting in a client’s improved bottom line.

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e-Business. ADS defines e-Business as the transformation of key business processes using Internet technologies. We believe that successful e-Business is all about operational efficiency, return on investment, and execution. We bring over twenty years of in-depth banking, project management, and systems integration experience to assist clients in realizing their e-Business potential. Our banking and system integration experience enables us to identify innovative opportunities to achieve operational efficiency through e-Business; our project management expertise ensures execution within fiscal and scheduling constraints; and the combination of this efficiency and execution results in a favorable return on investment for our clients. Our e-Business services fall into three main categories: strategy, design, and implementation. Combining our technology and financial industry expertise, we work with our customers to create systems that build virtual bridges between buyers, suppliers, customers, and financial institutions for swift and reliable transactions.

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B.     Customers

Our customers consist primarily of banks and other financial services companies located in the United States and Canada. The following is a list of representative customer during fiscal 2003:

We have derived and expect to continue to derive a significant portion of our revenues from a relatively limited number of customers. For example, our five largest customers in fiscal 2003, Citizens Financial Corporation, Zions Bancorporation, FleetBoston Financial Corporation, IntraNet Inc., a TSA Company and Capital One Services, Inc. accounted for approximately 41.7%, 32.5%, 9.0%, 6.9% and 1.8%, respectively, of revenues. In fiscal 2002, FleetBoston Financial Corporation, Citizens Financial Corporation, Zions Bancorporation, IntraNet, Inc., a TSA Company and National City Corporation accounted for approximately 24.7%, 23.8%, 21.6%, 7.3% and 4.1%, respectively, of revenues. Because a significant portion of our revenues are derived from services related to deregulation and consolidation activities in the financial services industry, changes in the regulatory environment or a reduction in consolidation activity have in the past, and may in the future, have a material adverse effect on our business, financial condition and results of operations. In addition, the loss of a major customer or termination of a major project as a result of an acquisition of a customer by an organization to which we do not currently provide services could have a material adverse effect on our business, financial condition and results of operations.

Although our largest customers have varied from period to period, we anticipate that our results of operations will continue to significantly depend upon revenues from a small number of customers. We cannot assure you that our major customers will continue to purchase our services at current levels, if at all, or that we would be able to replace revenues from lost customers with revenues from other customers. The loss of, or a significant reduction in revenues from, any of our major customers could materially adversely affect our business, financial condition and results of operations.

C.     Sales and Marketing

We market and sell our services directly through our professional sales and marketing staff and senior management operating principally from our offices in Quincy, Massachusetts. As of March 31, 2003, we had 9 persons engaged in sales and marketing activities.

Our senior business development representatives are assigned to a limited number of customers to foster an in-depth understanding of each customer’s individual needs and build a long-term customer relationship. We attempt to develop customer relationships through a carefully coordinated effort between our sales and professional services staff. Initial sales calls are made at the customer’s senior management level and followed up by detailed presentations targeted to their specific needs.

We employ a variety of business development and marketing techniques to communicate directly with current and prospective customers, including targeted print and direct mail advertisements, participation in financial services industry trade shows and conferences, and our web site. In addition, we maintain relationships with key industry research groups such as TowerGroup, American Bankers Association, and the Bank Administration Institute.

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As part of our sales and marketing strategy, we intend, from time to time, to partner with other IT consulting firms, including in some instances our competitors, and to explore relationships with certain third party software providers to the financial services market.

D.     Employees

As of March 31, 2003, we had 89 full time employees, of which 61 were project personnel, 19 employees were in finance and administration and 9 were in sales and marketing. None of our employees are subject to a collective bargaining agreement. We believe relations with our employees are good.

E.     Intellectual Property Rights

Our success is dependent upon certain proprietary methodologies and software tools, including our Engagement Management Methodology and Conversion Productivity Tool that we use in providing services to customers. Our business also includes developing custom software for various customers. Ownership of such software is generally assigned to the customer, and we retain no right, title or interest in it.

We rely on a combination of trade secret, nondisclosure and other contractual arrangements and copyright and trademark laws to protect our proprietary rights. We currently hold no patents or registered copyrights. We generally enter into confidentiality agreements with our outside consultants, customers and potential customers and limit access to and distribution of our proprietary information. While we do not usually enter into confidentiality agreements with our employees, such employees are generally required to sign confidentiality agreements in connection with specific customer engagements. There is no assurance that these steps will be adequate to deter misappropriation of our proprietary information or of our customers or that we will be able to detect unauthorized use of, and take appropriate steps to enforce, our intellectual property rights.

In the future, litigation may be necessary to enforce and protect our trade secrets, copyrights and other intellectual property or proprietary rights. We may also be subject to litigation alleging claimed infringement or litigation to determine the scope and validity of the intellectual property or proprietary rights of others. Although we are not aware that our services, trademarks or other proprietary rights infringe upon the proprietary rights of others, there is no assurance that third parties will not assert infringement claims against us or that such claims will not result in a material adverse effect on our business, financial condition and results of operations. Any litigation concerning our use of technology could result in substantial cost to us in defending such actions and/or divert our attention from operations, either of which could have a material adverse effect on our business, financial condition or results of operations.

F.     Competition

The IT and systems integration market, especially in the financial services industry, includes a large number of competitors and is subject to rapid technological and market changes. We compete for customer projects and experienced personnel with a number of companies having significantly greater financial, technical and marketing resources and revenues. Many of these competitors also have greater name recognition in the financial services industry. Our competitors operate in a variety of market segments, including systems consulting and integration, application software, professional services (such as computer equipment companies like International Business Machines Corporation), multinational professional service firms, and general management consulting firms (such as Accenture, Computer Sciences Corporation and Electronic Data Systems Corporation). In addition, the custom software development market is highly fragmented with numerous firms, many of which focus on their respective local markets. We also face competition from internal IT departments of our customers.

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We expect to experience increasing competition from companies offering established integration services and new service offerings and technologies. In addition, current and potential competitors may make strategic acquisitions or establish cooperative relationships among themselves or with others, thereby increasing their ability to expand or increase their service offerings to address the needs of our existing or prospective customers. Accordingly, it is possible that new competitors or alliances among current and new competitors may emerge and rapidly gain significant market share. Increased competition could result in lower utilization rates, billing rate reductions, fewer customer engagements, reduced gross margins, and loss of market share for us, any of which could materially adversely affect our business, financial condition and results of operations.

We believe the principal competitive factors in our market are: knowledge of the financial services industry, responsiveness to customer needs, quality of service, project management capability, technical expertise and price. We believe we compete favorably in most of these areas and excel in the depth of industry knowledge and experience we bring to our financial services customers. We believe our ability to compete also depends in part on factors outside of our control, including the ability of our competitors to attract, motivate and retain project managers and other personnel.

To be successful in the future, we must respond promptly and effectively to customer demands, technological changes and competitors’ innovations. Our competitors may be able to respond more quickly to new and emerging technologies and changes in service offerings to prospective customers. There is no assurance that we will be able to compete successfully with existing or new competitors or that competition will not have a material adverse effect on our business, financial condition and results of operations.

ITEM 2: PROPERTIES

Our headquarters and administrative, sales and marketing operations are in Quincy, Massachusetts in a leased facility, which currently consists of 27,325 square feet. At December 31, 2003, our lease arrangement provides that the amount of leased space will be reduced to 16,376 square feet. At April 1, 2005, our lease arrangement provides that the amount of space will be further reduced to 14,836 square feet. The lease expires on March 31, 2010.

ITEM 3: LEGAL PROCEEDINGS

On June 4, 2003, ADS and each of its directors were served with a complaint filed as a purported class action lawsuit in Massachusetts state court by two of the Company’s stockholders on behalf of all other stockholders of the Company. The complaint alleges, among other things, that ADS and its directors have breached or may have breached fiduciary duties owed to ADS stockholders in connection with its May 5, 2003 announcement that ADS had received from certain of its directors and stockholders a preliminary expression of interest to engage in a going private transaction. We believe that the action is without merit and intend to contest it vigorously. Otherwise, we are not a party to any litigation that we believe could have a material adverse effect on our business, financial condition, cash flows and results of operations.

ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of our security holders during the fourth quarter of the year ended March 31, 2003.

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PART II

ITEM 5: MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Price Range of Common Stock

The Company’s stock is currently traded on The NASDAQ National Market (“NASDAQ”) under the symbol “ADSC.” The following table sets forth, on a per share basis for the periods shown, the high and low bid information of our common stock as reported on NASDAQ. Such information reflects inter-dealer prices, without retail markup, markdown or commission and may not represent the price of actual transactions.

As of June 13, 2003, there were approximately 126 stockholders of record.

Dividend Policy

We do not intend to pay cash dividends in the foreseeable future. The payment of any future dividends will be at the discretion of our Board of Directors and will depend upon, among other things, future earnings, operations, capital requirements of the Company, business conditions and contractual restrictions on payment of dividends, if any.

Equity Compensation Plan Information

All equity compensation plans have been approved by security holders.

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ITEM 6: SELECTED CONSOLIDATED FINANCIAL DATA

The selected consolidated financial data presented below as of and for the fiscal years ended March 31, 2003, 2002, 2001, 2000 and 1999 have been derived from our audited consolidated financial statements. This data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” our Consolidated Financial Statements and related notes thereto, and other financial information appearing elsewhere in this Form 10-K. All amounts are in thousands, except per share data.

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FORWARD LOOKING STATEMENTS

This Report includes forward-looking statements, which are made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. You can identify these forward-looking statements when you see us using words such as “expect,” “anticipate,” “believe,” “intend,” “may,” “predict,” and other similar expressions. These forward-looking statements cover, among other items: events, conditions and financial trends that may affect our future plans of operation, business strategy, growth of operations and financial position, including statements regarding revenue and earnings or loss per share projections, concentration of revenues among a limited number of customers, expected capital expenditures for fiscal 2004 and sufficiency of cash to meet working capital and capital expenditure requirements for 2004. Any forward-looking statements are not guarantees of future performance and are necessarily subject to a number of risks and uncertainties, some of which are beyond our control. These risks and uncertainties include, among others: variability of our quarterly operating results due to, among other things, the number, size and scope of customer projects commenced and completed during a quarter, changes in employee utilization rates and changes in average billing rates; our dependence on the financial services industry; general economic uncertainty; concentration of revenues and our dependence on major customers; risks associated with fixed price contracts; our dependence on key personnel; intense competition in the IT consulting industry; and risks associated with potential acquisitions. Because of these risks and uncertainties, the forward-looking events discussed in this Report might not transpire.

ITEM 7: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

ADS provides information technology (“IT”) strategy consulting and systems integration services to the financial services industry. We offer rapid, cost-effective IT solutions to the business challenges faced by financial services companies through our in-depth financial services experience, technological expertise and project management skills. Our service offerings are organized around four practice areas: Customer Relationship Management (“CRM”), Conversions and Consolidations, IT Strategy and Consulting, and e-Business.

On May 5, 2003, we announced that we received a preliminary expression of interest to engage in a going private transaction from a group consisting of two current members of management who are also Directors of the Company, one outside Director and another entity affiliated with one of our outside Directors (collectively, the “Principals”). The Board of Directors has appointed an Independent Committee of the Board to consider the proposal and enter into negotiations with the Principals regarding the proposal.

Our revenues are derived primarily from professional fees billed to customers on a time and materials basis or, in certain limited instances, on a fixed price basis. Included in revenues are reimbursable contract-related travel expenses, which are separately billed to customers. Substantially all of our contracts, other than fixed price contracts, are terminable by the customer following limited notice and without significant penalty to the customer. Revenues from fixed price contracts represented approximately 1.4% and 2.2% of our revenues for the fiscal years ended March 31, 2003 and 2002, respectively.

We have derived, and expect to continue to derive, a significant portion of our revenues from a relatively limited number of customers. Revenues from our five largest customers in fiscal 2003, 2002 and 2001 were 91.9%, 81.5% and 65.4%, respectively, as a percentage of revenues. In the near and intermediate term, we expect that this heavy concentration of revenues will continue. In fiscal 2003, Citizens

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Financial Corporation, Zions Bancorporation, FleetBoston Financial Corporation, IntraNet Inc., a TSA Company and Capital One Services, Inc. accounted for approximately 41.7%, 32.5%, 9.0%, 6.9% and 1.8%, respectively, of revenues. In fiscal 2002, FleetBoston Financial Corporation, Citizens Financial Corporation, Zions Bancorporation, IntraNet, Inc., a TSA Company and National City Corporation accounted for approximately 24.7%, 23.8%, 21.6%, 7.3% and 4.1%, respectively, of revenues. In fiscal 2001, FleetBoston Financial Corporation, Citizens Banking Corporation (MI), Brokat Financial Systems, NBT Bancorp and Corillian Corporation accounted for approximately 27.2%, 12.5%, 9.2%, 8.3% and 8.2%, respectively, of revenues. Because a significant portion of our revenues are derived from services related to deregulation and consolidation activities in the financial services industry, changes in the regulatory environment or a reduction in consolidation activity have in the past, and could in the future, have a material adverse effect on our business, financial condition and results of operations. In addition, the loss of a major customer or termination of a major project as a result of an acquisition of a customer by an organization to which we do not currently provide services, or for any other reason, could have a material adverse effect on our business, revenues and profitability.

Cost of revenues consists primarily of salaries and employee benefits for personnel dedicated to customer assignments, fees paid to subcontractors for work performed in connection with customer assignments, and reimbursable contract-related travel expenses incurred in connection with the delivery of our services. Customer project margins and personnel utilization percentages are the most significant variables in determining our income from continuing operations. We manage our personnel utilization rates by monitoring personnel needs and generally adjust personnel levels based on specific project requirements. The number of staff assigned to particular projects may vary widely depending on the size, duration, and degree of completion and complexity of each engagement. Delays in project completion and in implementation may result in periods when personnel are not assigned to active projects and, accordingly, result in lower average utilization rates during such periods, which could have a materially adverse effect on our operating results. In addition, we must maintain appropriate numbers of senior professionals both to oversee existing engagements and for business development activities.

Sales and marketing expenses consist primarily of salaries, employee benefits, travel expenses and promotional costs. General and administrative expenses consist primarily of expenses associated with our management, finance and administrative groups, including recruiting, training, depreciation and amortization, and occupancy costs.

First Quarter Outlook

For the first quarter of fiscal 2004, we anticipate that revenue will be in the $4.1 to $4.4 million range, with net loss in the range of ($.01) to ($.03) per share. The Company had previously projected revenue of $4.7 to $5.0 million and net income of $.01 to $.03 per share. Revenue is lower than projected because the Company did not enter into certain contracts it expected to sign.

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Results of Operations

The following table sets forth, for the periods indicated, certain financial data as a percentage of revenues:

Variability of Operating Results

Variations in our revenues and operating results have occurred from quarter to quarter, and on an annual basis, and may continue to occur as a result of a number of factors. Revenues and operating results can depend on:

•		the number, size and scope of customer projects commenced and completed during a quarter,
•		changes in employee utilization rates,
•		changes in average billing rates,
•		the number of working days in a quarter,
•		the timing of introduction of new service offerings, both by us and our competitors,
•		changes in pricing, both by us and our competitors,
•		loss of a significant customer,
•		increased competition from our competitors,
•		loss of key personnel,
•		other factors that adversely impact the financial services industry,
•		general economic conditions,
•		potential acquisitions and our ability to successfully integrate the acquired business or technologies into our existing business and operations, and
•		our ability to develop and introduce new service offerings, improve existing service offerings and develop and maintain the skills necessary to keep pace with changing technologies.

The timing of revenues is difficult to forecast because our sales cycle is relatively long, ranging from one to six months for new projects with existing customers and three to six months for new customers, and

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may depend on factors such as the size and scope of projects or other factors that adversely impact the financial services industry and general economic conditions. In addition, the relatively long length of our sales cycle may negatively impact the operating results for any particular quarter as a result of increased sales and marketing expenses without associated increases in revenues in the particular quarter. Furthermore, many of our projects are, and may be in the future, terminable without customer penalty. An unanticipated termination of a major project or loss of a major customer could require us to maintain or terminate underutilized employees, resulting in a higher than expected number of unassigned persons or higher than expected severance expenses.

Year Ended March 31, 2003 Compared to Year Ended March 31, 2002

Revenues

Revenues increased 6.4% for the year ended March 31, 2003 compared to the year ended March 31, 2002, to $21.7 million from $20.4 million. This increase was predominately due to an increase in the volume of services delivered to customers, offset in part by a 2.2% decrease in the average billing rate from $139 per hour for fiscal 2002 to $136 per hour for fiscal 2003.

Cost of Revenues

Cost of revenues decreased 9.6% to $12.2 million in fiscal 2003 compared to $13.5 million in fiscal 2002, representing 56.3% and 66.3% of revenues, respectively. The dollar decrease in cost of revenues was primarily due to a decrease in the average number of billable personnel from 90 for fiscal 2002 to 75 for fiscal 2003. The percentage decrease was due to an increase in the utilization rate from 71.0% for the year ended March 31, 2002 to 86.2% for the year ended March 31, 2003.

Sales and Marketing

Sales and marketing expenses decreased 51.5% to $1.6 million in fiscal 2003 compared to $3.3 million in fiscal 2002, representing 7.6% and 16.1% of revenues, respectively. The overall dollar decrease resulted primarily from a decrease in our sales and marketing group from an average of 16 employees for fiscal 2002 to an average of 8 employees for fiscal 2003. The percentage decrease is the result of decreased expenses as well as an increase in the revenue on which the percentage is calculated.

General and Administrative

General and administrative expenses decreased 7.4% to $5.0 million in fiscal 2003 compared to $5.4 million in fiscal 2002, representing 22.9% and 26.4% of revenues, respectively. The dollar decrease is primarily due to a decrease in compensation expenses as a result of a reduction in the average number of general and administrative personnel from 21 employees for fiscal 2002 to 19 for fiscal 2003. The percentage decrease is the result of decreased expenses as well as an increase in the revenue on which the percentage is calculated.

Restructuring Expense

In April of fiscal 2002, we reduced our headcount by 35 employees, resulting in a pre-tax restructuring expense of $925,000.

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Write-Down of Investment

On September 8, 2000, we made a $3 million preferred stock investment, representing a minority interest in S2 Systems, Inc., a software solutions provider in the banking and diversified financial services markets. This investment was stated at cost. During the quarter ended September 30, 2001, we determined that our investment was permanently impaired and it was written-down to zero.

Interest Income, Net

Interest income, net decreased 34.6% to $681,000 in fiscal 2003 compared to $1.04 million for fiscal 2002. This decrease was principally due to average interest rate decreases of approximately 37.0%, offset in part by a 4.6% increase in the average balances of cash and cash equivalents and short-term investments. Interest expense is immaterial.

Provision for Income Taxes

The provision for income taxes from continuing operations increased $2.6 million to $1.3 million in fiscal 2003 compared to a $(1.3) million tax benefit in fiscal 2002. The provision was established due to profitability. The benefit was the result of the Economic Stimulus Act, which allowed a company to carryback losses for five years to recover taxes previously paid. The tax benefit was initiated in Q4 2002 and was net of a provision for taxes in Q1 2002 of $.4 million, which was to establish a valuation allowance for deferred taxes. We established the valuation allowance because we believe it is more likely than not that the deferred tax asset will not be realizable.

Due to varying state and local income tax rates and depending on our levels of profitability, our effective tax rate may vary from period to period, depending on the states in which we do business.

Discontinued Operations

On March 29, 2002, we announced our decision to discontinue the operations of Cool Springs Associates, Inc. d/b/a EarningsInsights (“EI”). Consequently, we incurred a charge of $1.9 million, net of income tax benefit, relating to the write-off of EI assets and an accrual for estimated losses during the phase-out period.

The disposition of the EI operation represented the disposal of a business segment under APB No. 30. Accordingly, results of this operation have been classified as discontinued, and interim quarterly periods have been restated. For the fiscal year ended March 31, 2002, EI incurred a $797,000 loss, net of income tax benefit.

For the year ended March 31, 2003, we had income on the disposal of business (net of tax) of $71,000. This was because actual disposal costs were less than those estimated in fiscal 2002.

Year Ended March 31, 2002 Compared to Year Ended March 31, 2001

Revenues

Revenues decreased 40.2% for the year ended March 31, 2002 compared to the year ended March 31, 2001, to $20.4 million from $34.1 million. This decrease was predominately due to a 46.6% decrease in volume of services delivered to customers due to the continued IT spending freeze, offset in part by a 14.9% increase in the average billing rate from $121 per hour for fiscal 2001 to $139 per hour for fiscal 2002.

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Cost of Revenues

Cost of revenues decreased 43.3% to $13.5 million in fiscal 2002 compared to $23.9 million in fiscal 2001, representing 66.3% and 70.0% of revenues, respectively. The dollar decrease in cost of revenues was primarily due to a decrease in the average number of billable personnel from 150 for fiscal 2001 to 90 for fiscal 2002. The decrease in cost of revenues as a percentage of revenues is due to the increase in the average billing rate.

Sales and Marketing

Sales and marketing expenses decreased 32.4% to $3.3 million in fiscal 2002 compared to $4.9 million in fiscal 2001, representing 16.1% and 14.2% of revenues, respectively. The overall dollar decrease resulted primarily from a decrease in our sales and marketing group from an average of 21 employees for fiscal 2001 to an average of 16 employees for fiscal 2002. The increase in sales and marketing expense as a percentage of revenues is due to the significant reduction in revenue from the prior year.

General and Administrative

General and administrative expenses decreased 22.2% to $5.4 million in fiscal 2002 compared to $6.9 million in fiscal 2001, representing 26.4% and 20.3% of revenues, respectively. The dollar decrease is primarily due to a decrease in compensation expenses as a result of a reduction in the average number of general and administrative personnel from 28 employees for fiscal 2001 to 21 for fiscal 2002. The percentage change is primarily due to the significant reduction in revenue from the prior year.

Restructuring Expense

In April of fiscal 2002, we reduced our headcount by 35 employees, resulting in a pre-tax restructuring expense of $925,000. In January of fiscal 2001, we also reduced our headcount by 28 employees resulting in a pre-tax restructuring expense of $337,000.

Write-Down of Investment

On September 8, 2000, we made a $3 million preferred stock investment, representing a minority interest in S2 Systems, Inc., a software solutions provider in the banking and diversified financial services markets. This investment was stated at cost. During the quarter ended September 30, 2001, we determined that our investment was permanently impaired and it was written-down to zero.

Interest Income, Net

Interest income, net decreased $1.1 million to $1.0 million in fiscal 2002 compared to $2.1 million for fiscal 2001. This decrease was principally due to interest rate decreases and lower cash balances. Interest expense is immaterial.

Provision (Benefit) for Income Taxes

The provision (benefit) for income taxes from continuing operations decreased $1.5 million to a $(1.3) million tax benefit in fiscal 2002 compared to a $250,000 provision in fiscal 2001. The benefit was the result of the passage of the Economic Stimulus Act which allowed a company to carry-back losses for five years to recover taxes previously paid. That tax benefit was initiated in Q4 2002 and was net of a provision for taxes in Q1 2002 of $.4 million which was to establish a valuation allowance for deferred taxes. Management established the valuation allowance because it is more likely than not that the deferred tax asset will not be realizable.

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Discontinued Operations

On March 29, 2002, we announced our decision to discontinue the operations of EI. Consequently, we incurred a charge of $1.9 million, net of income tax benefit, relating to the write-off of EI assets and an accrual for estimated losses during the phase-out period.

The disposition of the EI operation represented the disposal of a business segment under APB No. 30. Accordingly, results of this operation have been classified as discontinued, and interim quarterly periods have been restated. For the fiscal year ended March 31, 2002, EI incurred a $797,000 loss, net of income tax benefit.

Liquidity and Capital Resources

We have no long-term debt and continue to operate primarily debt-free. Working capital increased to $37.7 million at March 31, 2003 compared to $35.2 million at March 31, 2002. This increase was primarily due to our profitability for fiscal 2003. Our days sales in accounts receivable at March 31, 2003 was 48 compared to 49 days at March 31, 2002. While we believe that the risk with respect to collection of accounts receivable is minimized by the creditworthiness of our customers, primarily banks and other financial institutions, and our credit and collection policies, there can be no assurance that we will not encounter collection problems in the future.

Capital expenditures were approximately $16,000 for the fiscal year 2003. The expenditures were used primarily for computer and other equipment, software and, to a lesser extent, furniture and fixtures. For fiscal 2004, capital expenditures are expected to be approximately $100,000, and will be used primarily for computers and other equipment.

On May 5, 2003, we announced that we received a preliminary expression of interest to engage in a going private transaction from a group consisting of two current members of management who are also Directors of the Company, one outside Director and another entity affiliated with one of our outside Directors (collectively, the “Principals”). The Board of Directors has appointed an Independent Committee of the Board to consider the proposal and enter into negotiations with the Principals regarding the proposal.

We expect that existing cash and cash equivalent balances, together with cash provided from operations, will be sufficient to meet our working capital and capital expenditure requirements for at least the next twelve months.

To date, inflation has not had a material impact on our financial results.

We lease our facilities and other equipment under operating leases. Rent expense recognized under these leases during the fiscal years ended March 31, 2003, 2002 and 2001 totaled approximately $648,000, $627,000 and $639,000, respectively. Future minimum lease payments due under noncancelable operating leases are as follows:

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There were no capital leases outstanding as of March 31, 2003.

Recent Accounting Pronouncements

In June 2001, the FASB issued SFAS No. 143, “Accounting for Obligations Associated with the Retirement of Long-Lived Assets.” SFAS No. 143 provides the accounting requirements for retirement obligations associated with tangible long-lived assets. SFAS No. 143 is effective for financial statements for fiscal years beginning after June 15, 2002. The Company does not expect that the adoption of SFAS No. 143 will have a material impact on the Company’s financial statements.

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This statement requires recording costs associated with exit or disposal activities at their fair values when a liability has been incurred. Under previous guidance, certain exit costs were accrued upon management’s commitment to an exit plan, which is generally before an actual liability has been incurred. This statement is effective for exit or disposal activities initiated after December 31, 2002. The adoption of this statement did not have a material impact on the Company’s financial statements.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” which amended SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based compensation. It also amends the disclosure provisions to require prominent disclosure, in both annual and interim financial statements, about the effects on reported net income of an entity’s accounting policy decisions with respect to stock-based employee compensation. The provisions of SFAS No. 148 are to be applied to financial statements for fiscal years ending after December 15, 2002. Reference is made to the “Stock-Based Compensation” section of Note 2 of Item 8 for disclosure of the Company’s stock-based compensation accounting policies and the effect of those polices on reported net income. The adoption of SFAS No. 148 did not have an impact on the Company’s financial position or results of operations.

In November 2002, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. (“FIN”) 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FIN 34.” The Interpretation requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken by issuing the guarantee. The Interpretation also requires additional disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees it has issued. The accounting requirements for the initial recognition of guarantees became applicable on a prospective basis for guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for all guarantees outstanding, regardless of when they were issued or modified as of December 15, 2002. The

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adoption of FIN 45 did not have a material effect on the Company’s consolidated financial statements. The Company has the following guarantee:

To the extent permitted under Massachusetts law and the Company’s Second Amended and Restated Articles of Organization and to the extent provided for in the Company’s corporate by-laws, the Company will indemnify its officers and directors for certain events or occurrences while the director or officer is or was serving at our request in such capacity. The maximum potential amount of future payments the Company could be required to make under these indemnification obligations is unlimited; however, the Company has a Directors and Officers liability insurance policy that limits its exposure and enables the Company to recover a portion of any future amounts paid, provided that such insurance policy provides coverage. As these indemnification obligations were in effect prior to December 31, 2002 these obligations were grandfathered under the provisions of FIN 45. Accordingly, the Company has not accrued a liability for these agreements as of March 31, 2003.

In May 2003, the FASB issued SFAS 150, “Accounting For Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (“SFAS 150”), which establishes standards for how an issuer of financial instruments classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS 150 requires that an issuer classify a financial instrument that is within the scope of SFAS 150 as a liability (or an asset in some circumstances) if, at inception, the monetary value of the obligation is based solely or predominantly on a fixed monetary amount known at inception, variations in something other than the fair value of the issuer’s equity shares or variations inversely related to changes in the fair value of the issuer’s equity shares. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company does not expect the adoption of this statement to have a material impact on its financial statements.

Critical Accounting Policies

We believe the following represent our critical accounting policies:

Revenue Recognition

The Company primarily derives its revenue by providing consulting services on a time and materials basis and, to a lesser extent, on a fixed price basis. In fiscal 2003, 98.6% of our revenue from consulting services was provided under time and materials billing arrangements. Under both time and materials and fixed price arrangements, revenue is recognized as the consulting services are performed over the term of the arrangement. Deferred revenue represents cash collected and/or billings in advance of the performance of services.

Income Taxes

We recognize deferred tax assets and liabilities for the expected consequences of temporary differences between the financial statement basis and tax basis of our assets and liabilities. A deferred tax valuation allowance is established if, in management’s opinion, it is more likely than not that all or a portion of our deferred tax assets will not be realized.

At March 31, 2003, a full valuation allowance has been provided for our deferred tax assets. If we achieve sustained profitability, some or all of this valuation allowance would be reversed to income.

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Accounts Receivable

We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history and the customer’s current credit worthiness, as determined by our review of their current credit information. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Since our accounts receivable are concentrated in a relatively few number of customers, a significant change in the liquidity or financial position of any one of these customers could have a material adverse impact on the collectibility of our accounts receivables and our business, financial condition and results of operations.

Valuation of Long-Lived Assets

We periodically evaluate long-lived assets for potential impairment under SFAS 144. We will perform these evaluations whenever events or changes in circumstances suggest that the carrying value of an asset or group of assets is not recoverable. Indicators of potential impairment include:

•		a significant change in the manner in which an asset is used;
•		a significant decrease in the market value of an asset; and
•		a significant adverse change in our business or our industry.

If we believe an indicator of potential impairment exists, we test to determine whether the impairment recognition criteria of SFAS 144 has been met. In evaluating long-lived assets for potential impairment, we make several significant estimates and judgments, including:

•		estimating future cash flows associated with the asset or group of assets; and
•		determining an appropriate discount rate to use in the analysis.

Use of different estimates and judgments could yield materially different results in our analysis, and could result in significant different asset impairment charges.

Marketable Securities

We invest in marketable securities as part of our strategy to invest excess cash and achieve income therefrom. On a quarterly basis we review the fair market value of these marketable securities in comparison to historical cost.

If the fair market value of a marketable security is less than our carrying value, we consider all available evidence in assessing when and if the value of the investment can be expected to recover to at least its historical cost. This evidence would include:

•		a lack of any substantial company-specific adverse events causing declines in value; and
•		overall financial condition and liquidity of the issuer of the securities.

If our review indicates that the decline in value is “other than temporary,” we write-down our investment to the then current market value and record an impairment charge in our statements of operations. The determination of whether an unrealized loss is “other than temporary” requires significant judgment, and can have a material impact on our reported results.

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk from changes in interest rates due to investments in instruments made for non-trading purposes. The interest rate risk relates primarily to our portfolio of short-term investment grade securities. As of March 31, 2003 we did not, nor do we intend to, use derivative financial instruments for speculative trading purposes.

The majority of our sales are denominated in U.S. dollars and take place in North America.

We believe that interest rate risk and foreign currency exchange rate risk are both immaterial to the Company.

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ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Consolidated Financial Statements

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REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of
Atlantic Data Services, Inc:

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Atlantic Data Services, Inc. and its subsidiary (the “Company”) at March 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 2003 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and the financial statement schedule are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

PricewaterhouseCoopers LLP

Boston, Massachusetts
May 5, 2003, except for the fourth paragraph of Note 14 for which the date is June 4, 2003

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ATLANTIC DATA SERVICES, INC.

Consolidated Balance Sheets
(in thousands, except share data)

The accompanying notes are an integral part of these consolidated financial statements.

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ATLANTIC DATA SERVICES, INC.

Consolidated Statements of Operations
(in thousands, except per share data)

The accompanying notes are an integral part of these consolidated financial statements.

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ATLANTIC DATA SERVICES, INC.

Consolidated Statements of Stockholders’ Equity
(in thousands, except share data)

The accompanying notes are an integral part of these consolidated financial statements.

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ATLANTIC DATA SERVICES, INC.

Consolidated Statements of Cash Flows
(in thousands)