SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT

[X]	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 1999

or

[   ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                TO

Commission File Number 0-27607

CYSIVE, INC.

(Registrant’s telephone number, including area code): (703) 742-0865

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 PER SHARE

     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 registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K.  [X]

      As of February 17, 2000, there were 11,634,474 shares of Common Stock outstanding. The aggregate value of the shares of Common Stock of the Registrant issued and outstanding on such date, excluding 7,365,350 shares held by all affiliates of the Registrant, was approximately $465.6 million.

DOCUMENTS INCORPORATED BY REFERENCE

      List hereunder the following documents incorporated by reference and the Part of the Form 10-K into which the document is incorporated:

      (1)  Portions of the definitive Proxy Statement for the Annual Meeting of the Shareholders to be held on April 24, 2000 are incorporated by reference into Part III, Items 10 - 13 of this Form 10-K.

ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION

      Certain statements contained in this Annual Report on Form 10-K, including information with respect to the Company’s future business plans, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other comparable terminology are intended to identify forward-looking statements. These factors may cause our actual results to differ materially from a forward-looking statement. There are a number of important factors that could cause the results of the Company to differ materially from those indicated by such forward-looking statements. These factors include those set forth in Part I “Business — Risk Factors.”

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PART I

Item 1.  Business

Overview

      Cysive is a leading software engineering firm that designs and builds complex, highly customized systems supporting large scale e-businesses. E-businesses are companies that conduct a significant portion of their business through electronic commerce channels which are integrated with their existing internal systems, such as accounting, billing, manufacturing and inventory control. Since commencing operations in 1994, we have used advanced Internet technologies to build our customers’ e-business capabilities. We design software systems which can handle high volumes of customer transactions, operate reliably on a 24/7 basis and expand to meet the growth requirements of large scale e-businesses. Due to the advanced technologies necessary to complete our projects, we employ software engineers with an average of nine years of experience who use a well-defined process to deliver reliable and secure custom systems on a timely basis.

      Given our technology expertise, we target corporate customers who require highly complex systems to meet the growth demanded by their e-business strategies. For example, our software engineers, in collaboration with Cisco Systems, Inc., built Cisco’s Internetworking Products Center, or IPC. The IPC is one of the world’s largest Internet commerce sites and accounted for approximately 60% of Cisco’s fiscal 1999 total revenues of $12.2 billion. In addition to Cisco, we have built systems for customers including Classified Ventures, Inc., Equifax Secure, Inc., First Union Corporation, medibuy.com, Inc., Sylvan Prometric and UUNet Technologies, Inc. Our industry leadership is reflected in the quality of our customer base and our high revenue per software engineer as compared to our competitors.

Industry Background

      In the mid-1990s, a first wave of commercial Internet usage achieved widespread adoption. The Internet brought technology standardization to business through a common set of protocols, languages and applications, such as HTTP, HTML and web browsers. Although many companies comprehended the magnitude of potential technological and communications advancements provided by the Internet, they lacked the resources to implement Internet-based technologies. The immediate objective for most companies at this time was to establish an Internet presence. These companies used the Internet to communicate with customers and launched their web sites as colorful online marketing brochures. With little ability to automate business processes or execute transactions, these sites were maintained separately from the enterprise systems at the core of the business which, in turn, had not been designed to communicate with the standards-based software of the Internet. Simple, small-scale functions such as customer inquiries to the web sites were handled through text-based scripts, such as CGI and Perl, which had neither the structure nor the capability of a software program, but sufficed for this early-stage environment. As a result, many of today’s Internet professional services providers focus on providing strategy, design and technology services to enable companies to build an initial presence on the Internet rather than the specialized technology expertise required to create successful e-businesses which are capable of accommodating rapid growth.

      Today, we believe a second wave is beginning, spearheaded by the companies whose use of the Internet has evolved from a marketing orientation to a business, or transactional, orientation. For these companies, the web site has quickly evolved from a simple marketing tool into an advanced software application at the core of their businesses. International Data Corporation estimates worldwide Internet services spending to increase from $16.5 billion in 1999 to $100.7 billion by 2004. Many companies are building their information technology systems to transact directly, seamlessly and instantaneously with customers, suppliers, partners and distributors around the world. These e-business capabilities are rapidly creating new markets, communications channels and revenue growth opportunities, while enabling companies to reduce costs, improve operating efficiencies, shorten cycle times and improve communications.

      To truly automate all of the functions associated with an e-business transaction, companies cannot simply link Internet customers directly to their existing internal systems. These existing systems were designed for a defined number of specifically trained employees. In addition, each system typically was built to provide a very

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      To integrate the existing internal systems, an advanced technology approach is necessary in which the business logic, or all of the business procedures and rules, is built into a set of core software applications that bridges these existing systems with the Internet. These core software applications handle all of the business functions that previously could only be executed by specially trained personnel, including preferred customer discounting, credit approval, product configuration, pricing, billing, accounting, inventory control and order and delivery scheduling. A successful e-business system must present business functions to customers in a simple format, yet provide comprehensive access to all of the information and transactional capabilities the business has to offer. In addition, the software systems that integrate the Internet with the existing internal systems must be carefully designed to handle extremely large volumes of Internet traffic and ensure 24/7 reliability. These types of systems require software engineering expertise in areas like: load balancing to spread traffic across servers; caching to make data access immediate; thread and connection pooling to optimally use system resources; and data conversion to convert data into usable Internet formats. These systems use a component-based design which is flexible and extensible to meet the needs of the business as it grows.

      Advantages achieved by e-businesses that were the first to conduct business on the Internet will be lost if their transactional systems cannot handle increased user demand. Therefore, we believe a greater portion of future corporate Internet spending will be in the implementation and integration of advanced Internet systems. Companies like Cysive that have the Internet technology expertise, a defined, repeatable and rigorous process and a proven track record in building e-business systems will drive business on the Internet.

The Cysive Solution

      Cysive engineers and deploys advanced systems that enable our customers to transact business electronically. To build the e-business systems demanded by our customers, we emphasize the following key elements:

Advanced E-business Systems

      The core of our business is to design and build complex, highly customized systems based on Internet technologies. Our expertise lies in building the systems driving large scale e-businesses. For example, Cysive built the software application for First Union Corporation’s online automated account stand-in system which is accessible through multiple channels by First Union’s more than 16 million retail and corporate customers. When First Union’s mainframe-based systems become overloaded, this system stands-in for all online channels, including interactive voice response and the Internet. We believe our ability to successfully deploy truly large scale systems is a key point of differentiation in our market. Furthermore, the knowledge and confidence gained from building customized systems critical to our customers’ businesses generates a high level of repeat business from our customers. For example, in 1999, 74% of our customers were customers in prior years. In addition, our focus on the latest, most advanced technology helps us to recruit highly experienced software engineers who desire a culture and environment that takes pride in implementing the newest technologies.

Highly Experienced Software Engineers

      The integration of existing and emerging technologies required to build our customers’ e-business systems is highly complex and requires expertise across a broad array of technologies. Our software engineers must have extensive knowledge in advanced technologies like XML, Java, C++, Distributed Objects, like CORBA and DCom, and Relational and Object Database Management Systems. In addition, they must have experience interfacing with older system technologies. As a result, we employ software engineers with proven technology expertise and many years of experience. Our software engineers have an average of nine years of experience. Furthermore, 90% of our software engineers have technical undergraduate degrees and 51% have advanced degrees. This significant level of experience enhances our teams’ productivity and enables us to

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SWAT Team Approach

      The high productivity of our experienced software engineers enables us to build extensive e-business systems with Software and Technologies, or SWAT, teams that are comprised of a small number of engineers. For example, with a team of only six software engineers, we built Cisco Systems’ Internetworking Product Center, which, according to Cisco, generated approximately 60% of Cisco’s fiscal 1999 total revenues. We believe smaller teams increase efficiency, enhance the ability of a team to share ideas, expertise and project development information and reduce the margin for error. As a result, we believe that by using our SWAT teams, we shorten the delivery time of a project and increase the likelihood of success, reducing the overall project cost to the customer. Through this approach, we are able to focus our customers on the total value of the project, rather than on hourly billing rates. In addition, our efficient, SWAT team approach allows us to quickly redeploy teams once a project is completed and to grow our business without having to add large numbers of software engineers. As a result of our high levels of productivity, we consistently generate revenue per software engineer in excess of $350,000.

Rigorous Development Process

      For every project undertaken, our software engineers adhere to the Cysive development process. This approach begins with a comprehensive assessment of a customer’s needs followed by the development of a series of milestones comprised of three distinct phases: analysis; design and development; and testing and deployment. A well-defined process helps us to mitigate risk, ensure consistent quality and build e-business systems more rapidly. The Cysive development process also ensures that our customers have the flexibility to continuously modify their projects as their needs evolve. By streamlining our processes and producing noticeable efficiencies, the Cysive development process helps to build customer confidence and consequently generate greater repeat business.

Sophisticated Knowledge Management

      We have spent considerable resources to stay apprised of the latest technologies and methods for implementing these technologies. Our technology group leads our efforts in research and development, training and information exchange. In addition, we have developed the Cysive Technology Pipeline, a proprietary, intranet-based part of our knowledge base. Through the Technology Pipeline, our highly experienced software engineers review, learn and employ the latest and most advanced technologies before they are used on critical client projects. Our Technology Pipeline is part of a larger centralized knowledge base which our software engineers access through our intranet and use to share their project experiences. Together, the technology group and our knowledge base help to disseminate our accumulated project experience to all employees, enhance the reusability of processes and accelerate the professional development of our software engineers by keeping them abreast of new technologies.

Thorough Quality Assurance Process

      We adhere to a thorough quality assurance process to identify and manage risk. To distribute knowledge across our company and to help maintain objectivity within each project, we use a project manager from outside of a given project team to serve as the quality assurance supervisor who monitors and evaluates a project’s development. The supervisor is responsible for a monthly review meeting and report focused on the scope, schedule and cost of the project. As a result, all project managers are subject to as well as oversee the quality assurance process. In addition to risk management, our quality assurance approach facilitates the sharing of ideas and technologies among project managers, enables us to grow our business while maintaining high levels of quality and allows us to make objective, value-added recommendations to our customers during the course of a project.

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Cysive Growth Strategy

      Our objective is to strengthen our position as a leading e-business engineering firm. The key elements of our growth strategy are to:

Attract and Retain Highly Experienced Software Engineers

      Attracting and retaining qualified software engineers is critical to our growth. We identify and attract seasoned software engineers through a broad range of sources, including internal referrals, other technology companies and technical associations, the Internet and advertisements in technical periodicals. We place a strong emphasis on hiring software engineers who have several years of industry experience and proven technical expertise. To ensure that we hire qualified software engineers, we employ a seven-step recruiting process that incorporates multiple examinations to evaluate a candidate’s technical qualifications. Our focus on complex projects, coupled with our exacting recruiting standards, has created a culture that fosters proven competence with advanced technologies and helps us to attract and retain highly qualified personnel. For example, in 1999, we hired 44% of our new software engineers based on internal referrals. We believe that our attrition rate of less than 5% is well below the industry average.

Expand Existing and Establish New Customer Relationships

      Our ability to further penetrate our existing customer base and establish relationships with new customers is essential to our growth. Because our strategy revolves around delivering highly customized e-business systems for our customers’ critical business applications, we approach the customer relationship from a long-term perspective. We target corporate customers who are investing significant resources on Internet-focused business strategies that require complex technology systems. While further penetration of our existing customer base is important, we aggressively seek new customer relationships through our direct sales efforts, new marketing activities, referral-driven sales and strategic technology partnerships.

Expand Cysive’s Brand Recognition

      Our reputation and track record with customers are key to our success. To augment the reputation and track record that we have established from successfully implementing many e-business systems, we have launched an aggressive marketing campaign aimed at chief executive officers, chief information officers and electronic commerce managers to build brand recognition and generate sales leads. Our success in communicating the Cysive brand will drive our visibility with potential customers, industry partners and prospective employees.

Enhance Our Geographic Presence

      Continued geographic expansion gives us access to a broader base of highly qualified software engineers and customers. We plan to establish a local presence in several of the key technology markets to increase our visibility with and ability to evaluate a larger number of potential software engineers. Decreasing the travel burden placed on our software engineers should significantly enhance our ability to hire and retain people with the skill level we desire and help us to maintain our low attrition rates. Moreover, a broader geographic presence will help us to service our existing customers better and to establish new relationships. In addition, we intend to capitalize on local offices to enhance our regional marketing efforts. We have offices in the metropolitan areas of Washington, D.C., San Jose, CA, Atlanta, GA, Chicago, IL, Los Angeles, CA and Dallas, TX, and have opened a sales office in New York, NY.

Continue to Build and Deploy Advanced Technologies

      Deployment of advanced technologies is essential to our ability to deliver customized e-business systems. The core systems that our software engineers build for our customers serve as the foundation for future application developments and, therefore, need to be reliable and secure. These systems must also be able to sustain rapid growth without requiring significant modification. These systems cannot be developed solely by using packaged applications but instead require the integration of an array of existing and new technologies.

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The Cysive Development Process

      Cysive uses a multi-phase development process that simplifies the management of and reduces the risks associated with project development. Our development approach starts with a comprehensive assessment that identifies the scope, design, schedule and cost of building a customer’s e-business system. After this initial assessment, the project consists of incremental milestones that produce deliverables over a time period which typically spans eight to 16 weeks. These milestones allow for a controlled, customized and repeatable process that reduces costs and ensures delivery. Within each milestone, our development process comprises three phases: analysis, design and development, and testing and deployment. Throughout each milestone, Cysive project managers perform routine quality assurance reviews to ensure we deliver the system on time, on budget and with the appropriate functionality.

Comprehensive Initial Assessment

      The Cysive assessment evaluates the customer’s e-business strategy and gives an immediate, clear and concise understanding of the e-business system needed to meet our customer’s business objectives. We provide a system blueprint that details the high level design, including the system’s key components and processes, and the requirements, including every function and interaction the new system will deliver. We also produce a detailed project plan with our recommendations for the organization, process, schedule, staffing and cost of the project. The assessment determines the project milestones required for successful delivery. Each milestone has an inventory of specific related functions, and within each milestone, we complete the three phases of the Cysive development process. By building, testing and deploying the system in milestone increments, we ensure timely and accurate delivery of the system. Moreover, the milestones can often be completed in parallel, significantly reducing the time to market of the system.

The Development Process: Analysis Phase

      The analysis phase produces detailed requirements and system design specifications to ensure smooth, predictable project execution. As part of this phase, we deliver the following:

	•	Requirements Specification: We produce a detailed description of functional needs as well as non-functional requirements, including performance, reliability and security requirements.
	•	High Level Object Model: We develop a model that highlights the software components of the system, its business functions and interrelationships.
	•	Updated Project Plan: We update the schedule, tasks, resource requirements and organization chart in the project plan.
	•	Technical and Software Design Specification: We specify software partitioning, other products, protocols and deployment options.
	•	Frameworks and Graphical User Interface Prototypes: We partially develop the system that provides an early demonstration of its functionality and conduct end-to-end testing to reduce risk.

The Development Process: Design and Development Phase

      During the design and development phase, we refine the system and write and test the source code. As part of this phase, we deliver the following:

	•	Design Documentation: We provide sequence diagrams and a greater level of detail to the object model developed in the prior phase.
	•	Source Code Written: We write the code to implement each business function in the system.

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	•	Testing: We begin with unit testing, followed by incremental integration and regression testing.
	•	Functional System Demonstration: As we complete each milestone, a demonstration of the systems’ functionality becomes available for review.

The Development Process: Testing and Deployment Phase

      The final phase of the Cysive development process starts during the analysis phase when the project team evaluates and selects the best testing tools for a customer’s system test. A three-step testing process begins with:

	•	System Test and User Acceptance Planning: We detail the processes for conducting the system test, define how and when performance and stress testing will be conducted, detail reporting and tracking of software defects and outline test team member roles.
	•	System Test: The system test requires completion of all milestones, integration and regression testing. The system test team works together with the development team to identify any defects in the software, make appropriate fixes and execute additional test cycles until all defects are eliminated.
	•	User Acceptance Test/ Pilot: The last step in the testing phase includes final testing of the software and release to a subset of the user community. The pilot process develops a core group of users to debug the system in its actual production environment and to help accelerate training when made available to a broader user community.
	•	System Deployment: After final testing, we deploy the system and monitor its performance through feedback from future milestones of the project.

Quality Assurance

      Cysive’s thorough quality assurance process mitigates risk and addresses critical issues as they arise to ensure that we deploy our customers’ e-business systems successfully and on schedule. The mandatory process involves monthly two-day evaluations conducted by a senior level software engineer who serves as a supervisor to a project team. To distribute knowledge across our company and to help maintain objectivity within each project, we use a project manager from outside of a given project team to serve as the quality assurance supervisor who monitors and evaluates a project’s development. This supervisor is responsible for a monthly review meeting and report focused on the scope, schedule and cost of the project. This senior level supervisor evaluates the status reports, assists in the resolution of technical problems and ensures adherence to the development process. In addition, the supervisor is responsible for continually assessing a customer’s internal processes and helps to make objective, value-added recommendations to our customers. This process imposes a discipline to our projects that helps to shorten time-to-deployment cycles by as much as one to three months. In addition to ensuring a high quality deliverable, the quality assurance process helps to give our software engineers valuable project experience. By making every one of our senior software engineers responsible for quality assurance, the process facilitates the sharing of knowledge and helps us to maintain high levels of quality as we scale the business. In addition, throughout the quality assurance process, project documentation and data are continually fed into our knowledge base.

Knowledge Management

      We spend considerable resources implementing practices by which we stay apprised of the latest technologies and the methods for applying these technologies which we refer to as our knowledge management process.

Technology Group

      Our technology group leads our efforts in research and development, training and information exchange. Members of the technology group serve as practice leaders for our software engineers in the latest technologies, languages, tools and environments. Accordingly, their primary job is to continually lead the

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Knowledge Base

      Over the past two years, Cysive has spent significant resources building an extensive knowledge base. The knowledge base, which our software engineers access from remote locations via a secure corporate intranet, is the central repository for detailed information on every customer project Cysive conducts. For each system being built, the knowledge base contains a project file detailing customer information, a description of the project including the requirements analysis, project plans, system designs and quality assurance reviews, and a list of the technology products utilized on the project. Finally, the knowledge base also contains relevant white papers, technical tips and technology articles that may be of interest to our software engineers.

      This knowledge base, which enables us to leverage and reapply our accumulated experience, is a critical resource for both our software engineers and management. Using the knowledge base’s powerful search and display tools, users can quickly traverse information links to related information and documents. As a result, our software engineers can readily reference plans and specifications from prior projects. This real-time access to information enables our software engineers to condense the delivery time and to mitigate the potential problems of a project by identifying those techniques and products that have already been successfully employed in similar systems. In addition, by providing information on project progress and customer needs, the knowledge base helps management prepare for customer meetings and project reviews.

      A key component of the knowledge base is the Cysive Technology Pipeline, which is our repository of evaluations of technologies, tools and products. Prior to use on a customer project, all products are carefully evaluated. The Technology Pipeline contains reviews of over 174 products in 30 technology categories. While the Technology Pipeline is an invaluable resource for our software engineers, it is also an important method by which we conduct training and development. The evaluation process that we employ involves all of our software engineers. While between projects, our software engineers, under the direction of our technology team, work on one or more of the seven stages we have outlined in the evaluation of a product. Having our software engineers conduct these evaluations affords them the opportunity to continually work with a variety of new technologies. A product can then be used on a customer project once it has successfully completed all of the stages of the Cysive evaluation process. Initial implementation of new technologies are generally performed by the software engineers who were part of the technology’s evaluation team. In this manner, we ensure that our customers receive both a proven technology and a team of software engineers with expertise to deliver that technology.

Culture

      We continue to build our corporate culture around a common set of values based on excellence, discipline and results. Our software engineers understand that we hire only high caliber technical people because our customers demand a high level of execution. We believe we have instilled in our software engineers the sense of challenge as well as pride in having helped to build some of the most technically complex systems in today’s e-business environment. By growing our business internally, we have been able to instill this value set to all of our professionals on an individual basis. Our culture contributes to our low attrition rate of less than 5%.

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      While we focus on excellence and quality, we also foster and maintain a culture based on innovation, challenge and teamwork to attract and retain the level of software engineer we demand. In addition, we attempt to create an environment that promotes cooperative relationships and encourages teamwork. To ensure rapid deployment of our software engineers, we promote flexibility, speed and open communication. In addition, to ensure continued development of our technical staff, we place a high priority on training. We conduct training in a number of important ways by:

	•	requiring time for training, so that our software engineers have the opportunity to assess and master emerging technologies;
	•	mandating an initial two-week boot camp for new employees;
	•	conducting two annual company meetings centered around technical themes;
	•	sending our software engineers to conferences after which they are required to write white papers for internal distribution;
	•	providing training in preparation for three levels of technical certification;
	•	purchasing reference materials for our software engineers who in return write reviews of the materials; and
	•	offering ongoing internal technology seminars.

Recruiting

      Cysive’s continued success and growth depends on our ability to attract and retain high caliber technical talent. We have a stringent recruiting process that ensures the technical capability of all of our hires. Given the importance of recruiting to our company, every professional within Cysive is dedicated to our recruiting efforts, from our 12 technical recruiting experts to our software engineers, management and sales and marketing staff.

      We target software engineers with extensive experience and demonstrated expertise working throughout the technology development lifecycle, from analysis and design through the development, testing and deployment of complex technical solutions. Only software engineers with this depth and range of technology expertise possess the skills required to design and build e-business systems that integrate advanced Internet-based technologies with multiple existing internal systems.

      We employ a seven-step hiring process. After initially seeking and identifying candidates who meet our rigorous standards, our recruiting experts conduct an initial phone interview with technical questions to screen for high caliber talent. Candidates then take an hour-long technical test and proceed to a project manager-level technical screen, face-to-face interviews with a regional director, project manager and software engineers and a discussion with a senior executive officer. We maintain a detailed candidate pipeline that tracks all steps of the process. The capability to analyze this data by skill level, years of experience, region, salary, source, recruiter, visa status and time-to-close allows us to constantly monitor and improve our recruiting efforts.

      To attract potential software engineers, we target multiple functional areas. We have a number of recruiting efforts aimed at the local, regional and national markets to help us identify the industry’s most seasoned technical talent. We have built a reference database which is comprised of internal referrals from our software engineers and which accounted for 44% of our new hires in 1999. We also research and identify companies and technical associations with suitable technical talent and employ advanced Internet search capabilities to identify potential candidates. Finally, we advertise in technical and trade periodicals that appeal to software engineers.

Sales and Marketing

      Our sales efforts are targeted at corporate customers who are investing significant resources in their e-business strategies and consequently require complex technology systems to meet the growth of these strategies. We have a sales force of 17 professionals that covers three geographic regions: east, central and west. In each region, we have a senior regional sales manager and a supporting team of account managers. By

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      Given our successful completion of several high profile e-business systems, many sales leads result from referrals. In addition, our sales force actively generates leads through a combination of direct mail, targeted events with industry thought leaders and cooperative marketing with industry partners. To augment our sales efforts, we also have a separate marketing effort comprised of four professionals. Cysive’s marketing group focuses on two key objectives. First, we focus on building brand recognition at a national level to drive business growth and support our recruiting efforts. Second, we focus on developing and cultivating leads for the sales force amongst our target audience of chief executive officers, chief information officers and electronic commerce managers. To achieve these objectives, we employ a consistent communication strategy based on standards for our logo, corporate identity, visual elements and messages across all marketing channels. In addition, to enhance our brand reputation and credibility, we utilize:

	•	a public relations program focused on building awareness and recognition through industry and business press, industry analysts and major industry forums;
	•	a comprehensive web site focused on customer case studies and testimonials;
	•	national and regional advertising;
	•	on-site marketing programs at customer projects to enhance visibility within the customer environment; and
	•	seminars to increase the visibility of our executives and provide lead generation opportunities.

Customers

      The following is a representative list of our customers for 1999 and the current year.

CareerPath.com, Inc.

      In 1999, our five largest customers represented 64.5% of our revenues: Sylvan Prometric, 27.8%; Equifax Secure, Inc., 11.4%; Classified Ventures, Inc., 9.9%; Cisco Systems, Inc., 8.1%; and CareerPath.com, Inc. 7.3%. The volume of work that we perform for a specific customer is likely to vary from period to period, and a significant customer in one period may not use our services in a subsequent period. In addition, a failure to collect a large account receivable from any of these customers could significantly reduce our assets and adversely affect our business, financial condition and results of operations.

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Competition

      The e-business engineering market is intensely competitive and faces rapid technological change. We expect the competition to continue and intensify, which could result in price reductions, reduced profitability and loss of current or future customers. Our competitors fall into four major categories:

	•	internal information technology departments of current and potential customers;
	•	Internet professional services providers, such as Proxicom, Inc., Scient Corporation and Viant Corporation;
	•	large information technology consulting services providers, such as Andersen Consulting LLP, Electronic Data Systems Corporation, International Business Machines Corporation and PricewaterhouseCoopers LLP; and
	•	traditional information technology services providers, such as Sapient Corporation.

      Many of our competitors have longer operating histories and customer relationships, greater financial, technical, marketing and public relations resources, larger customer bases and greater brand or name recognition than we have. Our competitors may be able to respond more quickly to technological developments and changes in customer needs. This may place us at a disadvantage in responding to our competitors’ pricing strategies, technological advances, advertising campaigns, strategic partnerships and other initiatives. In addition, there are low barriers to entry into our business because the costs to provide information technology services are relatively low. We do not own any technologies that preclude or inhibit competitors from entering our industry. Therefore, we expect to continue to face additional competition from new entrants into our industry.

      We believe that the principal competitive factors in our business are:

	•	advanced technical knowledge;
	•	the reputation and experience of professionals delivering services;
	•	customer value and service;
	•	the success and reliability of the delivered system; and
	•	the ability to attract and retain highly skilled, experienced professionals.

      We believe that we presently compete favorably with respect to each of these factors. The market for our services is evolving, however, and we may be unable to compete successfully in the future.

Employees

      As of February 17, 2000, we had 183 employees, of whom 114 were software engineers. Of these 114 software engineers, 31, or 27%, are working in the United States under an H-1B visa. Moreover, 22 of our software engineers who are working under H-1B visas have applied for permanent residency with the U.S. Immigration and Naturalization Service. We believe our relationship with our employees is good. None of our employees is represented by a union.

Intellectual Property Rights

      Our proprietary knowledge base and other intellectual property rights that we develop for our customers are an integral part of our business. While ownership of custom work product is generally retained by the customer, we retain a royalty-free license to use some or all of the applications, processes and intellectual property developed in connection with customer projects. This information is accessible on our knowledge base only to our employees via our secure corporate intranet. We enter into confidentiality agreements with our employees, generally require that our software engineers and customers enter into similar agreements and limit access to and distribution of our knowledge base. The steps we have taken in this regard may not be adequate to deter misappropriation of our proprietary information, and we may be unable to detect unauthorized use and take appropriate steps to enforce our intellectual property rights.

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Risk Factors

      An investment in our common stock involves risks. You should carefully consider the risks described below and the other information in this Annual Report on Form 10-K including our financial statements and the related notes. The trading price of our common stock could decline due to any of these risks.

Because we rely on highly trained and experienced personnel to design and build complex systems for our customers, our inability to attract and retain qualified employees would impair our ability to provide our services to existing and new customers

      Our future success depends in large part on our ability to attract and retain highly trained and experienced software engineers as well as recruiters, other technical personnel and sales and marketing professionals of various experience levels. If we fail to attract and retain these personnel, we may be unable to complete existing projects or bid for new projects of similar size, which could reduce our revenues. While attracting and retaining experienced software engineers is critical to our business and growth strategy, maintaining our current level of software engineer experience, averaging nine years, may be particularly difficult. Skilled software engineers are in short supply, and this shortage is likely to continue for some time. As a result, competition for these people is intense, and the industry attrition rate for them is high. Additionally, we plan to open new offices in a number of geographic markets to attract and retain new employees. Our failure to open new offices or to open them in areas which experienced software engineers would find attractive could limit our ability to attract and retain qualified personnel. Moreover, even if we are able to grow and expand our employee base, the resources required to attract and retain these employees may adversely affect our operating margins.

In 1999, we derived 64.5% of our revenues from our five largest customers, and we expect to continue to rely on a limited number of customers for a significant portion of our revenues; as a result, the loss of or a significant reduction in the work performed for any of them could result in reduced revenues and earnings

      We currently derive and expect to continue to derive a significant portion of our revenues from a limited number of customers. As a result, the loss of or significant reduction in the work performed for any significant customer could reduce our revenues. In 1999, our five largest customers represented 64.5% of our revenues: Sylvan Prometric, 27.8%; Equifax Secure, Inc., 11.4%; Classified Ventures, Inc., 9.9%; Cisco Systems, Inc., 8.1%; and CareerPath.com, Inc. 7.3%. The volume of work that we perform for a specific customer is likely to vary from period to period, and a significant customer in one period may not use our services in a subsequent period. In addition, a failure to collect a large account receivable from any of these customers could significantly reduce our assets and profitability.

Because the number of our customers, employees and offices has grown rapidly since January 1, 1998 and we expect this growth rate to continue, we may have difficulty managing our growth effectively, which could adversely affect the quality of our services and reduce our earnings

      We have grown rapidly and expect to continue to grow rapidly by both hiring new employees and serving new businesses and geographic markets. We plan to open new offices in 2000. Our growth has placed and will continue to place a significant strain on our management and operating and financial systems. In addition, our management has limited experience managing a business of our current size. Our employee base grew from 42 on January 1, 1998 to 183 on February 17, 2000. As a result, our personnel, systems, procedures and controls may be inadequate to support our future operations. Our current growth rate may not be sustainable for the long-term.

Because our customers retain us on a project-by-project basis, rather than under long-term contracts, we may be unable to accurately predict our revenues, which may adversely affect our operating margins

      Our operating expenses, including employee salaries, rent and administrative expenses, are relatively fixed and cannot be reduced on short notice to compensate for unanticipated variations in the number or size of projects in progress. Because we incur costs based on our expectations of future revenues, our failure to predict

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Our quarterly revenues and operating results are likely to fluctuate significantly, causing our stock price to decline

      Our quarterly revenues and operating results have varied in the past and are likely to vary significantly from quarter to quarter. This fluctuation may cause our operating results to be below the expectations of securities analysts and investors, and the price of our stock may fall. Factors that could cause quarterly fluctuations include:

	•	the loss of a significant customer or project;
	•	our employee utilization rate, including our ability to transition employees quickly from completed or terminated projects to new projects;
	•	the introduction of new services or changes in pricing policies by us or our competitors;
	•	our ability to manage costs, including employee costs and support services costs; and
	•	costs related to the expected opening or expansion of our offices.

      In any given quarter, most of our revenues have been attributable to a limited number of customers and we expect this to continue. As a result, the cancellation or deferral of even a small number of projects in a particular quarter could significantly reduce our revenues, which would hurt our quarterly financial performance. In addition, a substantial portion of our costs are relatively fixed and based upon anticipated revenues. A failure to book an expected order in a given quarter or the need to provide training to our employees on new technologies as occurred in the fourth quarter of 1997 and the first half of 1998 would not be offset by a corresponding reduction in costs and could adversely affect our operating results. As a result of these factors, we believe that period-to-period comparisons of our revenues and operating results are not necessarily meaningful.

We depend on our Chief Executive Officer, and his loss may adversely affect our ability to attract and retain customers, maintain a cohesive culture and compete effectively

      We believe that our success depends on the continued employment of our Chief Executive Officer, Nelson A. Carbonell, Jr. If Mr. Carbonell were unable or unwilling to continue in his present position, he would be very difficult to replace and our business could be adversely affected. Mr. Carbonell is particularly important to our business in providing strategic direction, managing our operations and creating and maintaining a cohesive culture. He has also been involved in establishing and expanding customer relationships.

Approximately 27% of our current software engineers are not U.S. citizens and may be forced to leave Cysive when their temporary visas expire, and we may be unable to attract and retain additional foreign nationals due to limits imposed on the number of visas issued by the U.S. government

      We depend on software engineers who, although residing in the United States, are not U.S. citizens, and the loss of a significant number of these personnel would make it difficult to serve our customers and grow our business. These software engineers are permitted to work in the United States for up to six years under temporary H-1B visas. Most of our software engineers working under H-1B visas were originally sponsored by former employers and, as a result, hold visas which expire in less than six years from their date of employment by Cysive. As of February 17, 2000, 31, or 27%, of our software engineers were working under H-1B visas. The U.S. Immigration and Naturalization Service limits the number of new H-1B visas issued in each fiscal year, and if this limit is reached, our supply of potential software engineers will be limited. Further, we have extended offers to employees of other companies who are working under H-1B visas in the United States. We cannot employ these H-1B workers until the U.S. Immigration and Naturalization Service approves a separate

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Competition from larger, more established competitors with greater financial resources and from new entrants could result in price reductions, reduced profitability and loss of current or future customers

      The e-business engineering market is intensely competitive and faces rapid technological change. We expect competition to continue and intensify, which could result in price reductions, reduced profitability and the loss of current or future customers. Our competitors fall into four major categories:

	•	internal information technology departments of current and potential customers;
	•	Internet professional services providers, such as Proxicom, Inc., Scient Corporation and Viant Corporation;
	•	large information technology consulting services providers, such as Andersen Consulting LLP, Electronic Data Systems Corporation, International Business Machines Corporation and PricewaterhouseCoopers LLP; and
	•	traditional information technology services providers, such as Sapient Corporation.

      Many of our competitors have longer operating histories and customer relationships, greater financial, technical, marketing and public relations resources, larger customer bases and greater brand or name recognition than we have. Our competitors may be able to respond more quickly to technological developments and changes in customer needs. This ability may place us at a disadvantage in responding to our competitors’ pricing strategies, technological advances, advertising campaigns, strategic partnerships and other initiatives. In addition, there are low barriers to entry into our business because the costs to provide information technology services are relatively low. We do not own any technologies that preclude or inhibit competitors from entering our industry. Therefore, we expect to continue to face additional competition from new entrants into our industry.

We enter into non-compete agreements with some of our customers, which reduces the number of our potential customers and sources of revenues

      A substantial portion of our business involves the development of software applications for specific projects. Ownership of customer-specific software is generally retained by the customer, although we retain rights to some of the applications, processes and other intellectual property developed in connection with projects. We sometimes agree, however, not to reuse this customer-specific software when building systems for a customer’s competitors. In addition, we occasionally agree not to build any type of system for a customer’s competitors for limited periods of time, which have been as long as two years. These non-compete agreements reduce the number of our potential customers and our sources of revenues.

Our business is technology driven, and if we have difficulty responding to changing technology, industry standards and customer preferences, we could lose customers, which would reduce our revenues

      We have derived and expect to continue to derive a substantial portion of our revenues from creating e-business systems that are based upon the latest, most advanced technologies and are capable of adapting to future technologies. Our success depends on our ability to offer services that stay at the forefront of continuing changes in technology, evolving industry standards and changing customer preferences. Our failure to create e-business systems that use these technologies could cause us to lose current and potential business opportunities, resulting in reduced revenues. Additionally, to the extent technology becomes standardized or simplified, there may be less demand for our services.

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If we fail to meet our customers’ expectations, we could damage our reputation and have difficulty attracting new business or be sued

      Our projects are complex and critical to our customers. As a result, if we fail or are unable to meet a customer’s expectations, we could damage our reputation. This could adversely affect our ability to attract new business from that customer or others. If we fail to perform adequately on a project, a customer could sue us for damages. Our contracts generally limit our liability for damages that may arise from negligent acts, errors, mistakes or omissions in rendering services to our customers. However, we cannot be sure that these contractual provisions will protect us from liability for damages if we are sued. Furthermore, our general liability insurance coverage may not continue to be available on reasonable terms or in sufficient amounts to cover one or more large claims, or the insurer may disclaim coverage as to any future claim.

Currently, our business depends on integrating Internet-related technology into our customers’ businesses, and, as a result, our business will suffer if use of the Internet as a means for commerce declines

      If commerce on the Internet does not continue to grow or grows slower than expected, the need for our e-business enabling services could decline, resulting in fewer projects and reduced revenues. Consumers and businesses may reject the Internet as a viable commercial medium for a number of reasons, including:

	•	actual or perceived lack of security of information;
	•	lack of access and ease of use;
	•	congestion of Internet traffic or other usage delays;
	•	inconsistent quality of service;
	•	increases in access costs to the Internet;
	•	evolving government regulation;
	•	uncertainty regarding intellectual property ownership;
	•	costs associated with the obsolescence of existing infrastructure; and
	•	economic viability of the Internet commerce model.

Some of our customers are small or have little or no operating history, raising the possibility that they may lack sufficient cash flow to pay our fees

      We believe that an increasing portion of our future revenues could be derived from emerging companies, like our current customer LeapIT.com, formed specifically to conduct business over the Internet. These companies often have little or no earnings or cash flow, and their businesses are more likely to fail than those of more mature companies. As a result, they may be unable to pay our fees in a timely fashion or at all.

Because our business of software engineering involves creating and using intellectual property, misappropriation of and disputes regarding intellectual property could harm our reputation, adversely affect our competitive position and cost us money

      If third parties infringe or misappropriate our trade secrets, trademarks or other proprietary information, or if disputes arise with customers concerning intellectual property we create for them and/or license from them, our reputation, competitive position and relationships with customers could be damaged. We could be required to spend significant amounts of time and financial resources to defend our company, and our managerial resources could be diverted.

Item 2.  Properties

      On November 15, 1999, we executed a lease for a new principal headquarters in Reston, VA that expires in April 2010. We anticipate to occupy this new space in March, 2000. We also have offices in the metropolitan areas of Chicago, IL, San Jose, CA, Atlanta, GA and plan to open offices in the metropolitan areas of Los Angeles, CA and Dallas, TX. We do not own any real estate. Other than our headquarters in

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Item 3.  Legal Proceedings

      Except as set forth below, we are not a party to any material pending legal proceedings. Our former outside counsel, Mr. John Newman, filed a Bill of Complaint against us on December 15, 1999 in the Virginia Circuit Court for Fairfax County (Chancery No. 164139). Mr. Newman is seeking a judicial declaration that an unvested option to purchase 11,250 shares of our stock granted to him in April 1999 did not terminate upon the termination of his representation of Cysive on October 14, 1999, but rather contends this option became immediately exercisable under a change in control provision in our 1994 Stock Option Plan as a result of our initial public offering on October 15, 1999. Mr. Newman is also seeking an unspecified award of compensation and/or additional stock options as alleged additional compensation for legal services he performed for us at what he now claims were discounted rates. Management denies the alleged factual and legal bases of Mr. Newman’s claims and is defending the matter vigorously, including the assertion of counterclaims for breach of fiduciary duty and defamation against Mr. Newman. No scheduling order has been entered in the case nor has a trial date been set. Although we do not expect this case to have a material adverse effect on our business, operating income or financial condition, an adverse judgment could have a material adverse effect on the operating results reported by us for the period in which any adverse judgment might occur.

Item 4.  Submission of Matters to a Vote of Security Holders

      None

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PART II

Item 5.  Market for Registrant’s Common Equity and Related Stockholder Matters

(a)(1)  Market Price of Common Stock

      Cysive’s Common Stock has been quoted on the Nasdaq National Market System under the symbol “CYSV” since Cysive’s initial public offering on October 15, 1999. The following table sets forth for the period indicated the high and low sale prices for Cysive’s Common Stock:

      On February 17, 2000, the last reported sale price of Cysive’s Common Stock was $109.63 per share. As of February 17, 2000, there were approximately 58 holders of record of the Common Stock.

(a)(2)  Recent Sales of Unregistered Securities

      From January 1, 1999 through December 31, 1999, the Registrant issued and sold an aggregate of 1,379,798 shares of its common stock to employees, consultants and directors for aggregate consideration of approximately $1.1 million pursuant to the exercise of stock options granted under its Amended and Restated 1994 Stock Incentive Plan.

      No underwriters were involved in any of the foregoing sales of securities. Such sales were made in reliance upon an exemption from the registration provisions of the Securities Act set forth in Rule 701 of the Securities Act relative to options to purchase common stock. All of the foregoing securities are deemed restricted securities for the purposes of the Securities Act.

(b)  Use of Proceeds.

      There has been no change to the information previously provided by the Company in its Registration Statement on Form S-1 (Registration No. 333-85651), which was declared effective on October 14, 1999.

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Item 6.  Selected Financial Data

      The following selected financial data should be read together with the financial statements and the related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Annual Report on Form 10-K. The balance sheet data at December 31, 1995, 1996, 1997, 1998, 1999 and the statement of operations data for each of the years in the five-year period ended December 31, 1999 have been derived from Cysive’s financial statements for these years, which have been audited by Ernst & Young LLP, independent auditors.

      Through September 30, 1999, we operated as an S corporation under the Internal Revenue Code. Under the provisions of the tax code, our stockholders included their pro rata share of our income in their personal income tax returns. Accordingly, we were not subject to federal and most state income taxes through September 30, 1999. In connection with our initial public offering, our stockholders elected to rescind the S corporation election effective on October 1, 1999, and we are now subject to federal and state income taxes.

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Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

      You should read the following discussion together with “Selected Financial Data” and our financial statements and the related notes included elsewhere in this Annual Report of Form 10K.

Overview

      We design and build complex, highly customized systems supporting large scale e-businesses. Prior to 1997, we built large scale, distributed systems using approaches and technologies that are the foundations for current Internet applications. At that time, our advanced technology focus required a sales effort led by technology savvy project managers. In late 1996 and early 1997, our technology group evaluated and developed software prototypes using key Internet technologies such as Java, XML and CORBA. After successfully deploying our first e-business system in mid-1997, we began to target customers who were making significant investments in their e-business applications. As a result, there was a fundamental shift in our business strategy away from general purpose distributed systems to customized e-business applications. As part of this strategy, in the fourth quarter of 1997 and the first half of 1998, we spent considerable resources to accomplish two specific goals. Our first goal was to train all of our software engineers with advanced Internet technologies that had been researched and prototyped by our technology group. Our second goal was to deploy a direct sales force capable of selling e-business applications. These initiatives significantly impacted our results of operations for these three quarters. Specifically, the generation of a sales pipeline of e-business applications and the deployment of our sales force affected our revenues and sales and marketing expenses. In addition, the completion of two of our largest distributed systems combined with the extensive training of our software engineers caused our utilization rates and gross margins to decline during these quarters. As reflected in our latest results, these investments positioned us to emerge in the second half of 1998 as a leading e-business engineering firm.

      We derive our revenues from software engineering services which are provided primarily on a time and materials basis. Revenues are recognized and billed monthly by multiplying the number of hours expended by our software engineers in the performance of the contract by the established billing rates. Our customers reimburse us for direct expenses allocated to a project such as airfare, lodging and meals. Consequently, these direct reimbursements are excluded from revenues.

      Our financial results may fluctuate from quarter-to-quarter based on factors such as the number of projects, the amount and timing of our customers’ expenditures, employee utilization rates, hourly billing rates and general economic conditions. Revenues from a few large customers may constitute a significant portion of our total revenues in a particular quarter or year. For example, in 1998, our five largest customers represented 65.3% of our revenues, and in 1999 our five largest customers represented 64.5% of our revenues. The following table identifies these customers and the percentage of our revenues derived from each.

      Revenues from any given customer will vary from period to period. We expect, however, that significant customer concentration will continue for the foreseeable future. To the extent that any significant customer uses less of our services or terminates its relationship with us, our revenues may decline substantially. We attempt to mitigate our revenue concentration issues by contractual wind-down provisions and by rapid redeployment of our software engineers.

      The number of Cysive employees increased from 19 as of January 1, 1996 to 167 as of December 31, 1999. We actively recruit software engineers and support staff and expect the total number of employees to

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      General and administrative expenses consist primarily of compensation and benefits for our management, finance and administration, human resources, information technology, recruiting and the non-billable portion of our quality assurance and regional management personnel. In addition, general and administrative expenses include:

	•	depreciation and amortization;
	•	general operating expenses such as telephones, office supplies, travel, outside professional services and training and facilities costs; and
	•	allocated costs related to the administration of the quality review function, including maintaining our knowledge base, researching new technologies and writing technical reviews.

We expect general and administrative expenses to increase as we add additional personnel, expand our information systems, open new offices, increase our recruiting efforts and incur additional costs related to the growth of our business and operations as a public company.

      Sales and marketing expenses consist primarily of salaries, commissions, benefits, marketing programs and travel costs associated with our sales and marketing efforts. We sell our services through a direct sales force organized by geographic region. We expect sales and marketing expenses to increase as we continue to build a direct sales force and expand our marketing programs.

      Stock compensation expense for 1999 relates to grants of options to purchase 3,505,135 shares of common stock at an exercise price below the fair market value of the common stock on the date of grant, resulting in a non-cash compensation charge of $28.5 million. Stock compensation expense of $14.9 million was recorded in 1999. The remaining balance of $13.6 million will be amortized as follows:

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Results of Operations

      The following table presents, for the periods indicated, the relative composition of revenues and selected statements of operations data as a percentage of revenues:

Year Ended December 31, 1999 Compared to Year Ended December 31, 1998

      Revenues. Revenues increased $16.1 million, or 176.4%, to $25.3 million in 1999 from $9.1 million in 1998. This increase in revenues primarily reflected the direct sales model established in mid-1998, the benefits of which were not fully realized until early 1999. In addition to a much larger customer base in 1999, the average project size increased substantially for several of our major customers. Our headcount of billable software engineers increased from 40 at December 31, 1998 to 102 at December 31, 1999.

      Direct Costs. Direct costs increased $5.2 million, or 137.8%, to $8.9 million in 1999 from $3.7 million in 1998. As a percentage of revenues, direct costs decreased to 35.2% in 1999 from 40.9% in 1998. This decrease as a percentage of revenues was primarily attributable to an increase in our average utilization rate in 1999 to 88% from 71% in 1998. Our lower utilization rate in 1998 resulted primarily from the completion of two of our largest distributed systems and the extensive training of all of our software engineers during the first half of 1998. The benefit of our higher utilization in 1999, however, was partially offset by an increase in our wage rates.

      Gross Profit. Gross profit increased $11.0 million, or 203.1%, to $16.4 million in 1999 from $5.4 million in 1998. Because our revenue growth exceeded the rate that direct costs increased, the gross margin increased to 64.8% in 1999 from 59.1% in 1998.

      General and Administrative. General and administrative expenses increased $4.5 million, or 165.2%, to $7.2 million in 1999 from $2.7 million in 1998. This increase was due primarily to the addition and expansion of office space, the increase in our recruiting and corporate administrative staffs and the build up of infrastructure to support our increased headcount. As a percentage of revenues, general and administrative expenses decreased to 28.6% in 1999 from 29.8% in 1998. This decrease was due primarily to our ability to allocate our costs over a greater revenue base, particularly with respect to depreciation and amortization.

      Sales and Marketing. Sales and marketing expenses increased $3.7 million, or 201.0%, to $5.5 million in 1999 from $1.8 million in 1998. As a percentage of revenues, sales and marketing expenses increased to 21.7% in 1999 from 20.0% in 1998. This increase was primarily due to the significant expansion of our direct sales force in 1999. During 1999, we increased the number of our direct sales professionals to 13 from five in 1998. Additionally, we launched our marketing programs directed at building brand recognition.

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      Stock Compensation. We recorded $14.9 million in stock compensation in 1999. This expense represents the difference between the deemed fair market value of the underlying vested stock options and their exercise price. This amount was significantly larger than the stock compensation amount in previous years and was primarily related to a revaluation of our deemed fair market value in conjunction with our public offering.

      Operating Income (Loss). Operating income decreased $12.0 million to a loss of $11.2 million in 1999 from income of $782,000 in 1998. Excluding the impact of the stock compensation expense in 1999, operating income would have increased $2.8 million, or 360.4%, to $3.6 million in 1999 from $782,000 in 1998. Similarly, excluding the impact of the stock compensation expense in 1999, the operating margin would have increased to 14.3% in 1999 from 8.5% in 1998.

      Other Income, Net. Net other income increased $418,000 to $432,000 in 1999 from $14,000 in 1998 primarily due to interest income from the initial public offering proceeds.

      Income (Loss) before Taxes. Income before taxes decreased $11.6 million to a loss of $10.8 million in 1999 from income of $796,000 in 1998. This change was primarily due to the stock compensation expense in 1999. As a result, the loss before taxes margin was 42.6% in 1999 compared to an income before taxes margin of 8.7% in 1998. Excluding the impact of the stock compensation expense, income before taxes would have increased $3.3 million, or 412.4%, to $4.1 million in 1999 from $796,000 in 1998. Similarly, excluding the impact of the stock compensation expense in 1999, the income before taxes margin would have increased to 16.1% in 1999 from 8.7% in 1998.

      Income Tax Benefit. We recorded a $4.4 million net tax benefit in 1999. This benefit resulted primarily from the stock compensation expenses recorded in 1999. We will realize this benefit upon exercise of any non-qualified stock options in future periods.

      Net Income (Loss). Net income decreased $7.2 million to a loss of $6.4 million in 1999 from net income of $796,000 in 1998 due to the stock compensation expense recorded in 1999. In addition, we had no tax expense in 1998 due to our election to be treated as an S corporation for tax purposes. Excluding the impact of the stock compensation expense and the tax benefit from the S corporation to C corporation conversion in 1999 and treating the periods presented as if we were a C corporation with an effective tax rate of approximately 40% net income would have increased $1.9 million, or 394.7%, to $2.4 million in 1999 from $489,000 in 1998. Similarly, excluding the impact of the stock compensation expense, the net income margin would have increased to 9.6% in 1999 from 5.3% in 1998.

Year Ended December 31, 1998 Compared to Year Ended December 31, 1997

      Revenues. Revenues increased $1.4 million, or 18.6%, to $9.1 million in 1998 from $7.7 million in 1997. This increase in revenues reflected a larger number of customers, which totaled 23 in 1998 as compared to 15 in 1997. In addition, our higher revenues were a result of our ability to increase our billing rates in 1998 as we more fully migrated our business model to e-business applications. The benefits of this larger customer base and our higher billing rates, however, were offset in part by two factors. First, our business model shifted, affecting the fourth quarter of 1997 and the first two quarters of 1998. Second, we completed projects in early 1998 for our two largest customers in 1997. As discussed above, we made significant investments in our direct sales force, the benefits of which were not realized until the second half of 1998. Consequently, while we ended 1998 with a greater number of customers, most of their associated projects did not start until the second half of the year.

      Direct Costs. Direct costs increased $944,000, or 33.7%, to $3.7 million in 1998 from $2.8 million in 1997. As a percentage of revenues, direct costs increased to 40.9% in 1998 from 36.3% in 1997. This significant increase as a percentage of revenues was primarily due to our low utilization rates in the first half of 1998 which correlated with the completion of two large scale distributed systems and our efforts to train all of our software engineers. The average utilization rate decreased to 70.5% in 1998 from 79.9% in 1997.

      Gross Profit. Gross profit increased $487,000, or 9.9%, to $5.4 million in 1998 from $4.9 million in 1997. Because direct costs increased at a higher rate than our revenue growth, the gross margin decreased to 59.1% in 1998 from 63.7% in 1997.

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      General and Administrative. General and administrative expenses decreased $29,000, or 1.0%, to $2.7 million in 1998 from $2.8 million in 1997. As a percentage of revenues, general and administrative expenses decreased to 29.8% in 1998 from 35.7% in 1997. This decrease as a percentage of revenues was primarily attributable to our ability to allocate our costs over a greater revenue base. The benefits of this operating leverage were partially offset by the opening of a new office in the metropolitan area of San Jose, CA in May 1998 and the expansion of our Reston, VA office in August 1998.

      Sales and Marketing. Sales and marketing expenses increased $1.1 million, or 139.8%, to $1.8 million in 1998 from $761,000 in 1997. As a percentage of revenues, sales and marketing expenses increased to 20.0% in 1998 from 9.9% in 1997. This increase was primarily due to the significant expansion of our direct sales force in the first half of 1998. In addition, at the end of 1998 we hired a dedicated marketing staff and implemented a more extensive marketing program.

      Stock Compensation. Stock compensation reflects non-qualified stock options granted at exercise prices below fair market value, which vested upon the achievement of select performance goals at the end of 1998.

      Operating Income (Loss). Operating income decreased $617,000, or 44.1%, to $782,000 in 1998 from $1.4 million in 1997. As a result of the above factors, the operating margin decreased to 8.5% in 1998 from 18.1% in 1997.

      Other Income, Net. Net other income decreased $9,000, or 40.2%, to $14,000 in 1998 from $23,000 in 1997. This decrease was primarily due to the interest expense we incurred from borrowings under our line of credit during 1998 to support our internal growth.

      Net Income (Loss). Net income decreased $626,000, or 44.0%, to $796,000 in 1998 from $1.4 million in 1997. As a result of the above factors, the net margin decreased to 8.7% in 1998 from 18.4% in 1997.

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Quarterly Results of Operations

      The following table presents unaudited quarterly financial data for the periods indicated. We derived this data from our unaudited financial statements, and in our opinion, they include all adjustments, which consist only of normal recurring adjustments, necessary to present fairly the financial results for the periods. Our quarterly operating results have varied significantly in the past and will continue to do so in the future due to a number of factors including, but not limited to, changes in average billing rates, utilization rates and personnel additions, as well as the timing of expenses. Accordingly, our results for any given quarter or series of quarters are not necessarily indicative of our results for any future period. However, our quarterly operating results may represent trends which aid in understanding our business.

      Revenues. Revenues declined from the quarter ended March 31, 1998 through the quarter ended June 30, 1998 because the utilization rates decreased from 57% to 52% which was partially offset by a billing rate increase of $27.00 average per hour over the same period. From the quarter ended June 30, 1998 through the quarter ended December 31, 1999, revenues increased primarily as a result of increases in billable software engineers from 31 to 102 and increases in utilization rates from 52% to 88%.

      Operating expenses. General and administrative expenses as a percentage of revenues generally declined during the periods shown, reflecting greater operating leverage from spreading these expenditures over a larger revenue base. Increases in the second and fourth quarters relate to our annual technical offsite meeting held in the second quarter and our annual company meeting held in the fourth quarter. Beginning in the first quarter of 1998 through the second quarter of 1999, the sales and marketing expenses as a percentage of revenues increased due to the expansion of our direct sales force and the establishment of a marketing function. Stock compensation expense beginning in the quarter ended September 30, 1998 through the quarter ended December 31, 1999 represented the vesting of options granted at a value below fair market value.

Liquidity and Capital Resources

      On October 15, 1999, we completed an initial public offering of 3,000,000 shares of our common stock. After deducting expenses, we received approximately $46.3 million in proceeds from this transaction. On October 22, 1999, we received an additional $4.0 million in proceeds when the underwriters exercised their over-allotment option for an additional 252,500 shares of our common stock.

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      In September 1999, we renewed our line of credit with Merrill Lynch Business Financial Services Inc. under which we are entitled to draw up to $2.5 million in borrowings. We intend to use any borrowings under the line of credit for working capital purposes. The interest rate on amounts borrowed under the line of credit is calculated using the 30-day dealer commercial paper rate as quoted in The Wall Street Journal, plus 2.65% per annum. The credit facility expires in September 2000. Any borrowings under the line of credit will be secured by all of our assets. The line of credit requires our financial ratios to be in compliance with the debt covenants. At December 31, 1999, we had no outstanding borrowings under the line of credit.

      Cash and cash equivalents were $612,000 at December 31, 1998 and $2.4 million at December 31, 1999. Investments, which reflect the application of our net proceeds from our initial public offering, were $45.0 million at December 31, 1999. Net cash provided by operating activities was $731,000 and $674,000 for the years ended December 31, 1998 and 1999. Capital expenditures of $249,000 and $526,000 for the years ended December 31, 1998 and 1999 were used primarily for computer equipment, office equipment and leasehold improvements related to our growth.

      Through September 30, 1999, we operated as an S corporation. Accordingly, our stockholders included their pro rata share of our income in their personal income tax returns, and we were not subject to federal and most state income taxes during the periods prior to that time. Our stockholders elected to rescind the S corporation election effective on October 1, 1999. We paid $2.8 million to our stockholders on December 30, 1999 as an S corporation distribution, and this distribution was funded through operating income. We owe an additional $231,000 to these stockholders of unpaid S corporation distributions that we expect to pay out of cash from operating activities in 2000.

      We anticipate that the net proceeds from this offering, together with proceeds from our initial public offering, existing sources of liquidity and funds generated from operations, should be adequate to fund our currently anticipated cash needs through at least the next 18 months. To the extent we are unable to fund our operations from cash flows, we may need to obtain financing from external sources in the form of either additional equity or indebtedness. There can be no assurance that additional financing will be available at all, or that, if available, the financing will be obtainable on favorable terms.

Year 2000 Readiness Disclosure

      Our business operations were not adversely affected by any year 2000 issues. Prior to the end of 1999, we acted to ensure that our products and critical internal business systems were year 2000 compliant.

      We have funded the costs to become year 2000 compliant from operating cash flows and have not separately accounted for these costs in the past. To date, these costs have not been material. However, we may incur significant costs if unanticipated year 2000 compliance problems arise. These unanticipated costs, or our failure to correct any unanticipated year 2000 problems in a timely manner, could have a material adverse effect on our business, financial condition, results of operations and prospects for growth.

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk.

      Cysive is exposed to interest rate risk related to its borrowings under the credit facility with Merrill Lynch & Co., Inc. There were no borrowings outstanding under the credit facility as of December 31, 1999.

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Item 8.  Financial Statements and Supplementary Data.

Index to Financial Statements

26

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

Board of Directors

      We have audited the accompanying balance sheets of Cysive, Inc. as of December 31, 1998 and 1999, and the related statements of operations, stockholders’ equity, 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 auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Cysive, Inc. at December 31, 1998 and 1999, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States.

	/s/ ERNST & YOUNG LLP

McLean, Virginia

27

CYSIVE, INC.

BALANCE SHEETS

See accompanying notes.

28

CYSIVE, INC.

STATEMENTS OF OPERATIONS

See accompanying notes.

29

CYSIVE, INC.

STATEMENTS OF STOCKHOLDERS’ EQUITY

See accompanying notes.

30

CYSIVE, INC.

STATEMENTS OF CASH FLOWS

See accompanying notes.

31

CYSIVE, INC.

NOTES TO FINANCIAL STATEMENTS

Note 1 — Organization

      Cysive, Inc. (the “Company” or “Cysive”) is a leading software engineering firm that designs and builds complex, highly customized systems supporting large scale e-businesses. Since commencing operations in 1994, Cysive has used advanced Internet technologies to build its customers’ e-business capabilities. Cysive designs software systems which can handle high volumes of transactions, operate reliably on a 24/7 basis and expand to meet the growth requirements of large scale e-business. The Company operates in one business segment.

      On October 15, 1999, the Company completed its initial public offering (“IPO”) and issued 3,000,000 shares of common stock at $17.00 per share. Subsequently on October 22, 1999, an additional 252,500 shares at $17.00 per share were sold as the underwriters exercised their over-allotment option related to the IPO.

Note 2 — Summary of Significant Accounting Policies

Revenue Recognition

      The Company derives substantially all of its revenues from time and materials contracts. On these contracts, revenues are computed by multiplying the number of project personnel hours expended in the performance of the contract by the contract billing rates plus other directly billable costs. Reserves for possible losses on contracts, if any, are recognized in full when determined. Any prepayments by clients are recorded as deferred revenue and are recognized as services are provided. Reimbursable project costs are excluded from revenue as the Company incurs these costs on behalf of its customers.

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, the 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.

Cash and Cash Equivalents

      For purposes of the statements of cash flows, the Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents.

Investments

      The Company classifies its investments as available-for-sale. Investments in securities that are classified as available-for-sale and have readily determinable fair values are measured at fair market value in the balance sheets. Any unrealized gains or losses, net of taxes, are reported as a separate component of stockholders’ equity, if deemed material. Realized gains and losses and declines in market value judged to be other than temporary are included in investment income. Interest and dividends are included in investment income. As of December 31, 1998 and 1999, there are no material unrealized gains or losses on investments. At December 31, 1999 the investments consisted of short-term municipal and commercial bonds.

Concentration of Credit Risk

      Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, accounts receivable and certain investments. The cash is held by several financial institutions. For accounts receivable, the Company performs ongoing credit evaluations of its customers’ financial condition and generally does not require collateral. The Company maintains reserves for credit losses

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NOTES TO FINANCIAL STATEMENTS — (Continued)

which, historically, have been within management’s expectations. The carrying amount of the receivables approximates their fair value. Investments are evaluated to determine whether any unrealized losses have occurred and any losses are booked at the time the loss occurs.

Furniture, Fixtures and Equipment

      Furniture, fixtures and equipment are stated at historical cost, net of accumulated depreciation and amortization. Repairs and maintenance are charged to operations as incurred, while significant improvements are capitalized. Furniture, fixtures and equipment are depreciated or amortized over their estimated useful life, on the straight-line basis, using the following useful lives:

Income Taxes

      For the period from October 1, 1999 through December 31, 1999, the Company provided for income taxes in accordance with the liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.

      Prior to October 1, 1999, the Company and its shareholders elected to be treated as an S corporation under the Internal Revenue Code. Under the provisions of the tax code, the Company’s shareholders included their pro rata share of the Company’s income in their personal income tax returns. Accordingly, the Company was not subject to federal and most state income taxes during the historical periods prior to October 1, 1999. The Company has paid out substantially all of the undistributed balance of cumulative income taxed or taxable to these stockholders as of December 31, 1999.

      In connection with the S corporation to C corporation conversion, the Company recorded a deferred tax benefit of $4.8 million for the cumulative differences between the financial reporting and income tax basis of certain assets and liabilities at October 1, 1999.

Stock-Based Compensation

      The Company accounts for its stock-based compensation in accordance with Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” (“APB 25”) using the intrinsic value method. The Company has made pro forma disclosures required by Statement of Financial Accounting Standards No. 123 (“SFAS 123”) “Accounting for Stock Based Compensation” using the fair value method.

Earnings (Loss) Per Share

      Basic earnings (loss) per share is calculated using the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is calculated using the weighted average number of common and dilutive common equivalent shares outstanding during the period, using the treasury stock method for options.

Significant Customers

      For the year ended December 31, 1997, three customers individually represented 50%, 17% and 10% of the Company’s revenues. For the year ended December 31, 1998, three customers individually represented

33

NOTES TO FINANCIAL STATEMENTS — (Continued)

20%, 18% and 13% of the Company’s revenues. For the year ended December 31, 1999, three customers individually represented 28%, 11% and 10% of the Company’s revenues.

Advertising Costs

      All advertising and promotion costs are expensed as incurred. During the years ended December 31, 1997, 1998 and 1999, the Company expensed $88,000, $194,000 and $1.3 million, respectively, as advertising costs.

Reclassifications

      Certain amounts in the prior years financial statements have been reclassified to conform to the current year presentation.

Note 3 — Investments

      The following is a summary of the estimated fair value of available-for-sale securities at December 31, 1999:

      Gross unrealized holding gains and losses for the year ended December 31, 1999 were not material. Gross realized gains and losses for the year ended December 31, 1999 were not material. For purposes of determining gross realized gains and losses, the cost of securities sold is based upon specific identification.

      Investments are generally comprised of variable rate securities that provide for optional or early redemption within twelve months and the contractual maturities are generally greater than twelve months.

Note 4 — Furniture, Fixtures and Equipment

      Major classes of furniture, fixtures and equipment consist of the following: