<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDING SEPTEMBER 30, 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: 333-84045
PREDICTIVE SYSTEMS, INC
- - --------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 13-3808483
---------------------------------- ---------------------------------------
(State or other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
145 HUDSON STREET, NEW YORK, NEW YORK 10013
- - --------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(212) 219-4400
- - --------------------------------------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Check whether the registrant: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes[X] No [ ]
As of September 30, 1999, there were 12,277,764 shares of the registrant's
common stock, $.001 par value per share, outstanding.
<PAGE>
INDEX
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
PAGE
NUMBER
<S> <C> <C>
PART I. FINANCIAL INFORMATION................................................................ 3
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Unaudited)........................................................ 3
Consolidated Balance Sheets at December 31, 1998 and September 30, 1999 3
Consolidated Statements of Operations for the
three and nine months ended September 30, 1998 and 1999 4
Consolidated Statements of Cash Flows for the nine months ended
September 30, 1998 and 1999 5
Notes to Consolidated Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS................................. 9
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.................... 17
PART II. OTHER INFORMATION.................................................................... 26
ITEM 1. LEGAL PROCEEDINGS................................................................ 26
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS........................................ 26
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.................................................. 26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............................. 26
ITEM 5. OTHER INFORMATION................................................................ 27
ITEM 6. EXHIBITS AND REPORT ON FORM 8-K.................................................. 27
ITEM 7. SIGNATURES....................................................................... 28
</TABLE>
2
<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, 1998 September 30, 1999
----------------- ------------------
(unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ - $ 14,423,612
Accounts receivable - net of allowance for
doubtful accounts of $141,489 and $528,068, respectively 8,806,184 15,994,556
Unbilled work in process 1,062,824 523,507
Notes receivable - employees 55,100 63,936
Notes receivable - stockholders 515,000 -
Due from related party 916,948 -
Prepaid income taxes 342,829 777,313
Other current assets 386,453 855,237
----------------- ------------------
Total current assets 12,085,338 32,638,161
PROPERTY AND EQUIPMENT - net of accumulated depreciation
and amortization of $947,735 and $1,565,321, respectively 1,356,634 2,379,569
INTANGIBLES - net of amortization of $113,694 - 4,149,843
OTHER ASSETS 235,047 272,871
----------------- ------------------
Total assets $ 13,677,019 $ 39,440,444
----------------- ------------------
----------------- ------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Cash overdraft $ 475,610 $ -
Short-term borrowings 5,598,000 -
Accounts payable and accrued expenses 2,803,686 5,104,613
Deferred income tax liability 185,000 80,668
Deferred income 445,414 179,002
Dividends payable 61,250 -
Income taxes payable - 93,466
Current portion of capitalized lease obligations 151,027 154,639
----------------- ------------------
Total current liabilities 9,719,987 5,612,388
----------------- ------------------
NON CURRENT LIABILITIES:
Deferred rent 70,957 49,863
Capital lease obligations 446,018 355,448
Deferred income tax liability 714,146 84,642
Other long term liabilities - 4,891
----------------- ------------------
Total liabilities 10,951,108 6,107,232
----------------- ------------------
MANDATORY REDEEMABLE CONVERTIBLE PREFERRED STOCK
($.001 par value, 5% cumulative, 4,200,000 and 0 shares issued
and outstanding) 700,000 -
STOCKHOLDERS' EQUITY:
Convertible preferred stock ($.001 par value, 20,000,000 shares
authorized, 6,512,316 shares issued and outstanding) - 6,512
Common stock ($.001 par value, 200,000,000 shares authorized,
7,900,200 and 15,132,864 shares issued and
7,900,200 and 12,277,764 shares outstanding) 7,900 15,133
Additional paid-in capital 682,270 41,413,614
Treasury stock, 2,855,100 shares - (8,398,753)
Deferred compensation - (275,711)
Retained earnings 1,335,741 515,806
Accumulated other comprehensive income - 56,611
----------------- ------------------
Total stockholders' equity 2,025,911 33,333,212
----------------- ------------------
Total liabilities and stockholders' equity $ 13,677,019 $ 39,440,444
----------------- ------------------
----------------- ------------------
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these consolidated balance sheets.
3
<PAGE>
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
1998 1999 1998 1999
----------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
REVENUES:
Professional services $ 6,701,139 $ 13,624,347 $ 15,636,359 $ 34,902,634
Hardware and software sales 234,191 465,108 764,449 1,752,809
----------- ------------ ------------ ------------
Total Revenues 6,935,330 14,089,455 16,400,808 36,655,443
COST OF REVENUES:
Professional services 3,308,127 7,004,648 8,487,404 17,250,593
Hardware and software purchases 228,978 299,027 666,798 1,330,916
----------- ------------ ------------ ------------
Total cost of revenues 3,537,105 7,303,675 9,154,202 18,581,509
----------- ------------ ------------ ------------
Gross profit 3,398,225 6,785,780 7,246,606 18,073,934
SALES AND MARKETING 1,031,631 2,423,927 2,287,338 5,833,224
GENERAL AND ADMINISTRATIVE 2,231,358 4,709,994 5,818,169 12,086,419
DEPRECIATION AND AMORTIZATION 123,435 341,330 352,783 653,465
NONCASH COMPENSATION EXPENSE -- 19,039 -- 28,914
----------- ------------ ------------ ------------
Operating profit (loss) 11,801 (708,510) (1,211,684) (528,088)
OTHER INCOME (EXPENSE):
Interest income 14,099 31,409 26,761 100,983
Other income 20 19,013 55 55,895
Interest expense (98,991) (25,046) (165,620) (134,124)
----------- ------------ ------------ ------------
Loss before income tax provision (benefit) (73,071) (683,134) (1,350,488) (505,334)
INCOME TAX PROVISION (BENEFIT) 46,242 (55,214) (494,638) 305,851
----------- ------------ ------------ ------------
Net loss $ (119,313) $ (627,920) $ (855,850) $ (811,185)
----------- ------------ ------------ ------------
----------- ------------ ------------ ------------
NET LOSS PER SHARE
BASIC and DILUTED $ (0.02) $ (0.06) $ (0.16) $ (0.09)
----------- ------------ ------------ ------------
----------- ------------ ------------ ------------
WEIGHTED AVERAGE SHARES OUTSTANDING
BASIC and DILUTED 6,835,867 10,389,157 5,367,889 9,441,071
----------- ------------ ------------ ------------
----------- ------------ ------------ ------------
</TABLE>
The accompanying notes to consolidated financial statements are
an integral part of these consolidated statements.
4
<PAGE>
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------------------------
1998 1999
------------ -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (855,850) $ (811,185)
Adjustments to reconcile net loss to
net cash used in operating activities -
Noncash compensation expense - 28,914
Deferred income taxes (556,469) (733,836)
Depreciation and amortization 352,783 653,465
Provision for doubtful accounts 102,226 386,579
(Increase) decrease in -
Accounts receivable (946,130) (7,252,802)
Unbilled work in process (787,725) 539,317
Prepaid income taxes 60,926 (434,484)
Other current assets (107,132) (385,013)
Other assets (31,710) (37,824)
Increase (decrease) in -
Accounts payable and accrued expenses 273,913 1,165,127
Deferred income (27,124) (283,909)
Deferred rent 47,651 (21,094)
Income taxes payable - 1,133,251
Other long-term liabilities - (264,259)
------------ -------------
Net cash used in operating activities (2,474,641) (6,317,753)
------------ -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments to employees (30,591) (57,714)
Repayments from employees - 48,878
Payments to stockholders (515,000) -
Repayments from stockholders - 515,000
Payments to related party (675,520) (478,078)
Repayments from related party - 1,395,026
Cash received from acquisition of NRCC - 163,768
Purchase of property and equipment (504,706) (1,431,207)
------------ -------------
Net cash (used in) provided by investing activities (1,725,817) 155,673
------------ -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Common shares repurchased to treasury - (8,398,753)
Cash overdraft (501,958) (475,610)
Proceeds from short-term borrowings 13,983,000 4,351,000
Repayments of short-term borrowings (10,168,000) (9,949,000)
Payment of preferred dividends - (70,000)
Proceeds from sale of preferred stock - 18,566,225
Proceeds from sale of common stock, net of expense - 16,260,000
Proceeds from exercise of stock options 616,000 245,219
------------ -------------
Net cash provided by financing activities 3,929,042 20,529,081
------------ -------------
Effects of exchange rates - 56,611
Net (decrease) increase in cash (271,416) 14,423,612
CASH AND CASH EQUIVALENTS, beginning of period 420,456 -
------------ -------------
CASH AND CASH EQUIVALENTS, end of period $ 149,040 $ 14,423,612
------------ -------------
------------ -------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for -
Interest $ 165,620 $ 182,884
------------ -------------
------------ -------------
Taxes $ 5,345 $ 440,993
------------ -------------
------------ -------------
SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTION:
Dividends declared on mandatory redeemable convertible preferred stock $ 26,250 $ 8,750
------------ -------------
------------ -------------
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these consolidated statements.
5
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(1) BASIS OF PRESENTATION
The consolidated financial statements and accompanying financial
information as of September 30, 1998 and 1999 and for the three and nine
months ended September 30, 1999 are unaudited and, and in the opinion of
management, include all adjustments (consisting only of normal recurring
adjustments) which the Company considers necessary for a fair presentation
of the financial position of the Company at such dates and the operating
results and cash flows for those periods. The financial statements included
herein have been prepared in accordance with generally accepted accounting
principles and the instructions of Form 10-Q and Rule 10-01 of Regulation
S-X. Accordingly, certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted. These
financial statements should be read in conjunction with the Company's
audited financial statements for the year ended December 31,1998, which
were included as part of the Company's Form S-1 declared effective by the
Securities and Exchange Commission on October 26, 1999.
Results for interim periods are not necessarily indicative of results for
the entire year.
(2) NET LOSS PER SHARE
Basic earnings per share is computed by dividing income (loss) available
to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted earnings per share reflects the
potential dilution that would occur if securities or other contracts to
issue common stock were exercised or converted into common stock, unless
they are antidilutive. No consideration was given for these types of
securities as the effect of their conversion was antidilutive for all
periods presented.
The calculation of loss per share is as follows:
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months ended September 30,
-------------------------------- -------------------------------
1998 1999 1998 1999
---- ---- ---- ----
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Numerator -
Net Loss $(119,313) $ (627,920) $ (855,850) $ (811,185)
Preferred stock dividends (8,750) -- (26,250) (8,750)
--------- ------------ ----------- -----------
Numerator for basic and
diluted earnings per
share - net loss
available to common
stockholders (128,063) (627,920) (882,100) (819,935)
--------- ------------ ----------- -----------
--------- ------------ ----------- -----------
Denominator -
Weighted average shares -
basic and diluted 6,835,867 10,389,157 5,367,889 9,441,071
--------- ------------ ----------- -----------
--------- ------------ ----------- -----------
Net loss per share -
basic and diluted $ (0.02) $ (0.06) $ (0.16) $ (0.09)
--------- ------------ ----------- -----------
--------- ------------ ----------- -----------
</TABLE>
6
<PAGE>
(3) COMPREHENSIVE INCOME
The Company adopted Statement of Financial Accounting Standards No. 130.
"Reporting Comprehensive Income," which established standards for
reporting and displaying comprehensive income and its components in a
financial statement that is displayed with the same prominence as other
financial statements. The components of comprehensive income are as
follows:
<TABLE>
<CAPTION>
Three Months Ended September 30,
-------------------------------------------------
1998 1999
---------------------- -------------------------
(unaudited)
<S> <C> <C>
Net Loss $(119,313) $(627,920)
Foreign currency translation adjustment - 72,310
---------------------- -------------------------
Comprehensive Loss $(119,313) $(555,610)
</TABLE>
(4) ACQUISITION
On August 12, 1999, the Company acquired Network Resource Consultants and
Company B. V. ("NRCC") in a transaction accounted for as a purchase. In
connection with this transaction, the Company exchanged 1,062,814 shares of
its common stock in exchange for all of the outstanding stock of NRCC. The
Company acquired net assets of approximately $88,000 and recorded
intangible assets of approximately $4.3 million which represent the excess
of purchase price over the fair value of assets acquired.
The following information presents the pro forma results of operations for
the Company for the periods ending September 30, 1998 and 1999 as if the
acquisition of NRCC had occurred on the first day of the fiscal years
presented.
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months ended September 30,
-------------------------------- -------------------------------
1998 1999 1998 1999
---- ---- ---- ----
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenues $ 7,334,900 $ 14,089,455 $ 17,690,377 $ 37,654,968
Operating loss (149,832) (807,993) (1,666,711) (906,678)
Net loss (213,122) (687,610) (1,124,337) (1,033,935)
PER SHARE INFORMATION:
Net loss per share -
basic and diluted (0.03) (0.06) (0.17) (0.10)
Weighted average common shares
Outstanding -
basic and diluted 7,898,681 10,861,518 6,430,703 10,307,067
</TABLE>
(5) SUBSEQUENT EVENT
On October 27, 1999, the Company sold 4,000,000 shares of common stock at
an initial public offering price of $18 per share and began trading on the
Nasdaq National Market under the symbol PRDS. On November 1, 1999, the
Company received net proceeds of approximately $67.0 million, after
deducting underwriting discounts and commissions. The
7
<PAGE>
Company has granted underwriters a 30 day option to purchase up to an
additional 600,000 shares of common stock at $18 per share to cover
over-allotments.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS RELATING TO
FUTURE EVENTS AND FUTURE PERFORMANCE OF THE COMPANY WITHIN THE MEANING OF
SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934, INCLUDING, WITHOUT LIMITATION, STATEMENTS REGARDING THE
COMPANY'S EXPECTATIONS, BELIEFS, INTENTIONS OR FUTURE STRATEGIES THAT ARE
SIGNIFIED BY THE WORDS "EXPECTS", "ANTICIPATES", "INTENDS", "BELIEVES" OR
SIMILAR LANGUAGE. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED
IN SUCH FORWARD-LOOKING STATEMENTS. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN
THIS DOCUMENT ARE BASED ON INFORMATION AVAILABLE TO THE COMPANY ON THE DATE
HEREOF, AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY FORWARD LOOKING
STATEMENTS. THE COMPANY CAUTIONS INVESTORS THAT ITS BUSINESS AND FINANCIAL
PERFORMANCE ARE SUBJECT TO SUBSTANTIAL RISKS AND UNCERTAINTIES. IN EVALUATING
THE COMPANY'S BUSINESS, PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE
INFORMATION SET FORTH BELOW UNDER THE CAPTION "RISK FACTORS" IN ADDITION TO THE
OTHER INFORMATION SET FORTH HEREIN AND ELSEWHERE IN THE COMPANY'S OTHER PUBLIC
FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION.
Substantially all of our revenues are derived from
professional services. We provide network consulting services to our clients on
either a project outsource or collaborative consulting basis. We derive revenues
from these services on both a fixed-price, fixed-time basis and on a
time-and-expense basis. We use our BusinessFirst methodology to estimate and
propose prices for our fixed-price projects. The estimation process accounts for
standard billing rates particular to each project, the client's technology
environment, the scope of the project, and the project's timetable and overall
technical complexity. A member of our senior management team must approve all of
our fixed-price proposals. For these contracts, we recognize revenue using a
percentage-of-completion method primarily based on costs incurred. We make
provisions for estimated losses on uncompleted contracts on a
contract-by-contract basis and recognize such provisions in the period in which
the losses are determined. Professional services revenues for time-and-expense
based projects are recognized as services are performed. Any payments received
in advance of services performed are recorded as deferred revenue. Our clients
are generally able to reduce or cancel their use of our professional services
without penalty and with little or no notice. We also derive limited revenues
from the sale of hardware and software. We sell hardware and software only when
specifically requested by a client. We expect revenues from the sale of hardware
and software to continue to decline on a percentage basis.
Since we recognize professional services revenues only when
our consultants are engaged on client projects, the utilization of our
consultants is important in determining our
9
<PAGE>
operating results. In addition, a substantial majority of our operating
expenses, particularly personnel and related costs, depreciation and rent, are
relatively fixed in advance of any particular quarter. As a result, any
underutilization of our consultants may cause significant variations in our
operating results in any particular quarter and could result in losses for such
quarter. Factors which could cause underutilization include:
- the reduction in size, delay in commencement,
interruption or termination of one or more
significant projects;
- the completion during a quarter of one or more
significant projects;
- the miscalculation of resources required to complete
new or ongoing projects; and
- the timing and extent of training, weather related
shut-downs, vacations and holidays.
Our cost of revenues consist of costs associated with our
professional services and hardware and software purchases. Costs of revenues
associated with professional services include compensation and benefits for our
consultants and project-related travel expenses. Costs of hardware and software
purchases consist of acquisition costs of third-party hardware and software
resold.
On August 12, 1999, we acquired Network Resource Consultants
and Company B.V. for an aggregate purchase price of approximately $4.3 million.
The purchase price was paid in the form of 1,062,814 shares of our common stock
in exchange for all of the outstanding capital stock of Network Resource
Consultants and Company. The acquisition was accounted for as a purchase and
resulted in intangible assets of approximately $4.3 million representing the
excess purchase price over the fair value of the net assets acquired. The
intangible assets will be amortized over a period of 5 years.
We plan to continue to expand our operations by hiring
additional consultants and other employees, and adding new offices, systems and
other infrastructure. The resulting increase in operating expenses will have a
material adverse effect on our operating results if our revenues do not increase
to support such expenses. Based on all of the foregoing, we believe that our
quarterly revenue and operating results are likely to vary significantly in the
future and that period-to-period comparisons of our operating results are not
necessarily meaningful and should not be relied on as indications of future
performance.
RESULTS OF OPERATIONS
Nine Months Ended September 30, 1998 and 1999
REVENUES. Substantially all of our revenues are derived
from fees for professional services. Revenues increased 123.5% from $16.4
million in the nine months ended September 30, 1998 to $36.7 million in the
nine months ended September 30, 1999. Revenues from professional services
increased 123.2% from $15.6 million in the nine months ended September 30,
1998 to $34.9 million in the nine months ended September 30, 1999. This
increase was primarily due to an increase in the number of professional
services projects and an increase in the
10
<PAGE>
size of the projects. Revenues from hardware and software sales increased
129.3% from $764,000 in the nine months ended September 30, 1998 to $1.8
million in the nine months ended September 30, 1999. During the nine months
ended September 30, 1999, Bear Stearns & Co. Inc. and Qwest Communication,
Inc. accounted for 18.1% and 16.7%, respectively, of our revenues. The number
of our billable consultants increased from 133 at September 30, 1998 to 263
at September 30, 1999.
GROSS PROFIT. Gross profit increased 149.4% from $7.2 million
in the nine months ended September 30, 1998 to $18.1 million in the nine months
ended September 30, 1999. As a percentage of revenues, gross profit increased
from 44.2% in the nine months ended September 30, 1998 to 49.3% in the nine
months ended September 30, 1999. This increase in gross profit was due to
efficiencies in completing fixed-price, fixed-time projects, higher utilization
rates and an increase in average billing rates. Cost of revenues increased from
$9.2 million in the nine months ended September 30, 1998 to $18.6 million in the
nine months ended September 30, 1999. This increase in cost of revenues was due
primarily to an increase in compensation and benefits paid to consultants.
SALES AND MARKETING EXPENSES. Sales and marketing expenses
consist primarily of compensation and benefits, travel expenses and promotional
expenses. Sales and marketing expenses increased 155.0% from $2.3 million in
the nine months ended September 30, 1998 to $5.8 million in the nine months
ended September 30, 1999. As a percentage of revenues, sales and marketing
expenses increased from 13.9% in the nine months ended September 30, 1998 to
15.9% in the nine months ended September 30, 1999. This increase was
primarily due to an increase of $2.6 million in compensation and benefits
paid due to the hiring of additional personnel, an increase of $750,000 in
commissions paid to direct sales employees reflecting the increase in our
revenues and an increase of $225,000 due to increased sales and marketing
efforts.
GENERAL AND ADMINISTRATIVE EXPENSES. General and
administrative expenses increased 107.7% from $5.8 million in the nine months
ended September 30, 1998 to $12.1 million in the nine months ended September 30,
1999. As a percentage of revenues, general and administrative expense decreased
from 35.5% in the nine months ended September 30, 1998 to 33.0% in the nine
months ended September 30, 1999. The increase in absolute dollars was primarily
due to an increase of $3.2 million in recruiting and professional development
and other administrative costs due to the continued investment in our in-house
recruiting organization, an increase of $1.9 million in compensation and benefit
costs, and an increase of $1.2 million in facilities and equipment costs
reflecting the continued investment in our infrastructure.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization
increased 85.2% from $353,000 in the nine months ended September 30, 1998 to
$653,000 in the nine months ended September 30, 1999. This increase was due to
purchases of additional computer equipment to support our growth and
amortization of intangibles of $114,000 associated with acquisition of Network
Resource Consultants and Company.
NONCASH COMPENSATION EXPENSE. During the nine months ended
September 30, 1999, we granted options to purchase shares of common stock at
exercises prices that were less than the fair market value of the underlying
shares of common stock. This will result in noncash
11
<PAGE>
compensation expense over the period that these specific options vest. We
estimate this expense will be approximately $48,000 for the year ended December
31, 1999. During the nine months ended September 30, 1999, we recorded $29,000
of noncash compensation expense related to these options. The remaining noncash
compensation expense beyond 1999 is currently estimated to be $257,000.
OTHER INCOME (EXPENSE). Other expense decreased from $139,000
in the nine months ended September 30, 1998 to $23,000 of income in the nine
months ended September 30, 1999. This decrease was primarily due to a decrease
in interest expense related to short term borrowings, and increased interest
income and other non-operating income.
INCOME TAXES. The income tax benefit was ($495,000) on pre-tax
losses of $1.4 million for the nine months ended September 30, 1998. For the
nine months ended September 30, 1999, the income tax provision was $306,000
on U.S. pre-tax income of $590,000. The U.S. effective tax rate was 36.6% and
51.8% during the nine months ended September 30, 1998 and 1999, respectively.
The differences in the effective tax rates relates to the provision for a
valuation allowance against net operating losses of our foreign subsidiaries
and non-tax deductible expenses, including amortization of intangibles of
$114,000, and non-cash compensation expenses of $29,000 for the nine months
ended September 30, 1999.
Three Months Ended September 30, 1998 and 1999
REVENUES. Revenues increased 103.2% from $6.9 million in the
three months ended September 30, 1998 to $14.1 million in the three months ended
September 30, 1999. Revenues from professional services increased 103.3% from
$6.7 million in the three months ended September 30, 1998 to $13.6 million in
the three months ended September 30, 1999. This increase was primarily due to an
increase in the number of professional services projects and an increase in the
size of the projects. Revenues from hardware and software sales increased 98.6%
from $234,000 in the three months ended September 30, 1998 to $465,000 in the
three months ended September 30, 1999. During the three months ended September
30, 1999, Bear Stearns & Co. Inc. and Qwest Communication, Inc. accounted for
10.1% and 16.1%, respectively, of our revenues. The number of our billable
consultants increased from 133 at September 30, 1998 to 263 at September 30,
1999.
GROSS PROFIT. Gross profit increased 99.7% from $3.4 million
in the three months ended September 30, 1998 to $6.8 million in the three months
ended September 30, 1999. As a percentage of revenues, gross profit decreased
from 49.0% in the three months ended September 30, 1998 to 48.2% in the three
months ended September 30, 1999. This decrease in gross profit was due to a
decrease in the utilization rate in our foreign subsidiaries due to the European
summer holidays and a large number of newly hired consultants in the U.S. for
projects starting in the fourth quarter. Cost of revenues increased from $3.5
million in the three months ended September 30, 1998 to $7.3 million in the
three months ended September 30, 1999. This increase in cost of revenues was due
primarily to an increase in compensation and benefits paid to consultants.
SALES AND MARKETING EXPENSES. Sales and marketing expenses
increased 135.0% from $1.0 million in the three months ended September 30,
1998 to $2.4 million in the three
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months ended September 30, 1999. As a percentage of revenues, sales and
marketing expenses increased from 14.9% in the three months ended September
30, 1998 to 17.2% in the three months ended September 30, 1999. This increase
was primarily due to an increase of $875,000 in compensation and benefits
paid due to the hiring of additional personnel, an increase of $300,000 in
commissions paid to direct sales employees reflecting the increase in our
revenues and an increase of $225,000 due to increased sales and marketing
efforts.
GENERAL AND ADMINISTRATIVE EXPENSES. General and
administrative expenses increased 111.1% from $2.2 million in the three months
ended September 30, 1998 to $4.7 million in the three months ended September 30,
1999. As a percentage of revenues, general and administrative expenses increased
from 32.2% in the three months ended September 30, 1998 to 33.4% in the three
months ended September 30, 1999. The increase was primarily due to an increase
of $1.6 million in recruiting and professional development and other
administrative costs due to the continued investment in our in-house recruiting
organization, an increase of $600,000 in compensation and benefit costs, and an
increase of $225,000 in facilities and equipment costs reflecting the continued
investment in our infrastructure.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization
increased 176.5% from $123,000 in the three months ended September 30, 1998 to
$341,000 in the three months ended September 30, 1999. This increase was due to
purchases of additional computer equipment to support our growth and
amortization of intangibles of $114,000 associated with the acquisition of
Network Resource Consultants and Company.
NONCASH COMPENSATION EXPENSE. During the three months ended
September 30, 1999, we granted options to purchase shares of common stock at
exercises prices that were less than the fair market value of the underlying
shares of common stock. This will result in noncash compensation expense over
the period that these specific options vest. We estimate that this expense will
be approximately $48,000 for the year ended December 31, 1999. During the three
months ended September 30, 1999, we recorded $19,000 of noncash compensation
expense related to these options. The remaining noncash compensation expense
beyond 1999 is currently estimated to be $257,000.
OTHER INCOME (EXPENSE). Other expense decreased from $85,000
in the three months ended September 30, 1998 to $25,000 of income in the three
months ended September 30, 1999. This decrease was primarily due to a decrease
in interest expense related to short term borrowings, and increased interest
income and other non-operating income.
INCOME TAXES. Provision for income taxes was $46,000 on
pre-tax losses of $73,000 for the three months ended September 30, 1998. For the
three months ended September 30, 1999, the income tax benefit was $55,000 on
U.S. pre-tax losses of $236,000. The difference in the effective tax rates
relates to the provision for a valuation allowance against net operating
losses of our foreign subsidiaries and an increase in expenses not deductible
for tax purposes.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our operations through borrowings
under short-term credit facilities, the sale of equity securities and cash flows
from operations. At
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September 30, 1999, we had approximately $14.4 million in cash and cash
equivalents. On November 1, 1999, we completed the initial public offering of
4,000,000 shares of our common stock and received net proceeds of approximately
$67.0 million, after deducting underwriting discounts and commissions.
Net cash used in operating activities was $6.3 million for the nine
months ended September 30, 1999. Significant uses of cash resulted from an
increase in accounts receivable offset by an increase in accounts payable and
accrued expenses.
Net cash provided by financing activities was $20.5 million for the
nine months ended September 30, 1999. During the nine months ended September 30,
1999, we sold preferred and common stock in private placements for aggregate net
proceeds of approximately $34.2 million. During the nine months ended September
30, 1999, we redeemed 2,855,100 shares of our common stock at a purchase price
of $2.94 per share for an aggregate payment of approximately $8.4 million.
During the nine months ended September 30, 1999, we repaid approximately $9.9
million of short-term borrowings.
Our capital expenditures were $1.4 million for the nine months ended
September 30, 1999. Capital expenditures were made to purchase computer
equipment and office furniture and for leasehold improvements.
We have a demand loan facility, secured by a lien on all our assets,
under which we may borrow up to the lesser of $5.0 million or 80.0% of eligible
accounts receivable. Amounts outstanding under the facility bear interest at a
rate of 11.25% per annum. At September 30, 1999, there were no amounts
outstanding under the facility.
We believe that our existing cash, cash equivalents and marketable
securities will be sufficient to meet our anticipated needs for working
capital and capital expenditures at least for the next twelve months. If cash
generated from operations is insufficient to satisfy our liquidity
requirements, we may seek to sell additional equity or debt securities or to
obtain a credit facility. The sale of additional equity or convertible debt
securities could result in dilution to our stockholders. The incurrence of
indebtedness would result in increased fixed obligations and could result in
operating covenants that would restrict our operations. We cannot assure you
that financing will be available in amounts or on terms acceptable to us, if
at all.
IMPACT OF THE YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are
coded to accept or recognize only two-digit entries in the date code field.
These systems may recognize a date using "00" as the year 1900 rather than the
year 2000. As a result, it is necessary to update the computer systems and/or
software used by many companies and governmental agencies to comply with Year
2000 requirements or risk system failure or miscalculations causing disruptions
of normal business activities.
We are exposed to the risk that the systems on which we depend to
conduct our operations are not Year 2000 compliant.
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STATE OF READINESS. We are in the process of determining the Year 2000
readiness of our information technology systems, which include our hardware and
software, and our non-information technology systems, which include the
telephone systems and other office equipment we use internally. Our assessment
plan consists of the following steps:
- evaluating our date dependent code, software and
hardware and evaluating external dependencies;
- quality assurance testing of our internally-developed
proprietary software;
- contacting third-party vendors and licensors of
material hardware, software and services that we use;
- contacting vendors of material non-information
technology systems that we use;
- formulating repair or replacement requirements and
implementing corrective measures; and
- evaluating the need for, and preparing and
implementing, if required, a contingency plan.
To date, we have determined the following through our
assessment:
- We have checked our internally developed software and
systems for date dependent code, and all material
files and systems are Year 2000 compliant. We believe
that the recently installed code is also Year 2000
compliant;
- We have contacted the vendors of material hardware
and software components of our information technology
systems, and they have informed us that the products
we use are currently Year 2000 compliant;
- Commercial software, including financial reporting
software, upon which we depend is either Year 2000
compliant or will be upgraded to be compliant in the
normal course of business through upgrades or
installation of software patches;
- Substantially all hardware we use in our network
operations and all of the hardware we use in our
office operations have been certified as Year 2000
compliant by its vendors;
- Our telephone system and mail systems are certified
as Year 2000 compliant; and
- Our landlords and third-party advertising sales
representative and servicing organizations have not
yet provided us with Year 2000 compliance
information.
While we have assessed the Year 2000 readiness of each of our material
internal systems, we will not conduct an end-to-end system test until the end of
November 1999. Accordingly, we cannot yet assess whether our internal system, as
a whole, is Year 2000 compliant.
COSTS. We estimate that the total cost for our Year 2000 compliance
efforts will be approximately $250,000. Most of these expenses relate to the
operating costs associated with time spent by our employees in Year 2000
compliance matters. If we encounter unexpected
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difficulties, or we are unable to obtain compliance information from material
third parties, we may need to spend additional amounts to ensure that our
systems are Year 2000 compliant.
RISKS. Although we have received compliance information from our
material third-party vendors, we have not received compliance information
from all of our third-party vendors. In addition, it is possible that our
third-party vendors were mistaken in certifying that their systems are Year
2000 compliant. In addition, we will not conduct an end-to-end system test
until the end of November 1999. If we fail to fix our internal systems or to
fix or replace material third-party software, hardware or services on a
timely basis, we may suffer lost revenues, increased operating costs and
other business interruptions, any of which could have a material adverse
effect on our business, results of operations and financial condition.
Moreover, if we fail to adequately address Year 2000 compliance issues, we
may be subject to claims of mismanagement and related litigation, which would
be costly and time-consuming to defend.
In addition, we cannot assure you that governmental agencies, utility
companies, Internet access companies, third-party service providers and others
outside our control will be Year 2000 compliant. If those entities fail to be
Year 2000 compliant, there may be a systemic failure beyond our control, such as
a prolonged Internet, telecommunications or electrical failure, which could have
a material adverse effect on our business, results of operations and financial
condition.
CONTINGENCY PLAN. As discussed above, we are engaged in an ongoing Year
2000 assessment and have developed no contingency plans to address the
worst-case scenario that might occur if technologies we depend upon actually are
not Year 2000 compliant. We will take into account our Year 2000 simulation
testing results and the responses we receive from all third-party vendors and
service providers in determining the need for and nature and extent of any
contingency plans. We intend to develop any required contingency plan by the end
of November 1999.
FORWARD-LOOKING STATEMENTS
The Year 2000 discussion above is provided as a "Year 2000
Readiness Disclosure" as defined in the Year 2000 Information and Readiness
Disclosure Act of 1998 (Public Law 105-271, 112 Stat. 2386) enacted on October
19, 1998 and contains forward-looking statements. These statements are based on
management's best current estimates, which were derived from a number of
assumptions about future events, including the continued availability of
resources, representations received form third parties and other factors.
However, we cannot assure you that these estimates will be achieved, and our
actual results could differ materially from those anticipated. Specific factors
that might cause material differences include:
- the ability to identify and remediate all relevant
systems;
- results of Year 2000 testing;
- adequate resolution of Year 2000 issues by
governmental agencies, businesses and other third
parties who are our outsourcing service providers,
suppliers, and vendors;
- unanticipated system costs; and
- our ability to implement adequate contingency plans.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
RISKS RELATED TO OUR FINANCIAL CONDITION AND BUSINESS MODEL
OUR LIMITED OPERATING HISTORY, PARTICULARLY IN LIGHT OF OUR RECENT GROWTH, MAKES
IT DIFFICULT FOR YOU TO EVALUATE OUR BUSINESS AND TO PREDICT OUR FUTURE SUCCESS
We commenced operations in February 1995 and therefore have only a
limited operating history for you to evaluate our business. Because of our
limited operating history, recent growth and the fact that many of our
competitors have longer operating histories, we believe that the prediction of
our future success is difficult. You should evaluate our chances of financial
and operational success in light of the risks, uncertainties, expenses, delays
and difficulties associated with operating a new business, many of which are
beyond our control. You should not rely on our historical results of operations
as indications of future performance. The uncertainty of our future performance
and the uncertainties of our operating in a new and expanding market increase
the risk that the value of your investment will decline.
BECAUSE MOST OF OUR REVENUES ARE GENERATED FROM A SMALL NUMBER OF CLIENTS, OUR
REVENUES ARE DIFFICULT TO PREDICT AND THE LOSS OF ONE COULD SIGNIFICANTLY REDUCE
OUR REVENUES
During the nine months ended September 30, 1999, each of Bear Stearns
and Qwest Communications accounted for 18.1% and 16.7%, respectively, of our
revenues. Our five largest clients accounted for 50.3% of our revenues for the
nine months ended September 30, 1999. For the year ended December 31, 1998, our
five largest clients accounted for 54.9% of our revenues. If one of our major
clients discontinues or significantly reduces the use of our services, we may
not generate sufficient revenues to offset this loss of revenues and our net
income will decrease. In addition, the non-payment or late payment of amounts
due from a major client could adversely affect us.
OUR CLIENTS MAY TERMINATE THEIR CONTRACTS WITH US ON SHORT NOTICE
Our services are often delivered pursuant to short-term arrangements
and most clients can reduce or cancel their contracts for our services without
penalty and with little or short notice. If a major client or a number of small
clients terminate our contracts or significantly reduce or modify their business
relationships with us, we may not be able to replace the shortfall in revenues.
Consequently, you should not predict or anticipate our future revenues based
upon the number of clients we have currently or the number and size of our
existing projects.
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OUR OPERATING RESULTS MAY VARY FROM QUARTER TO QUARTER IN FUTURE PERIODS, AND AS
A RESULT, WE MAY FAIL TO MEET THE EXPECTATIONS OF OUR INVESTORS AND ANALYSTS,
WHICH MAY CAUSE OUR STOCK PRICE TO FLUCTUATE OR DECLINE
Our operating results have varied from quarter to quarter. Our
operating results may continue to vary as a result of a variety of factors.
These factors include:
- the loss of key employees;
- the development and introduction of new service
offerings;
- reductions in our billing rates;
- the miscalculation of resources required to complete
new or ongoing projects;
- the utilization of our workforce; and
- the timing and extent of training.
Many of these factors are beyond our control. Accordingly, you should
not rely on quarter-to-quarter comparisons of our results of operations as an
indication of our future performance. In addition, our operating results may be
below the expectations of public market analysts or investors in some future
quarter. If this occurs, the price of our common stock is likely to decline.
WE DERIVE A SUBSTANTIAL PORTION OF OUR REVENUES FROM FIXED-PRICE PROJECTS, UNDER
WHICH WE ASSUME GREATER FINANCIAL RISK IF WE FAIL TO ACCURATELY ESTIMATE THE
COSTS OF THE PROJECTS
We derive a substantial portion of our revenues from fixed-price
projects. For the year ending December 31, 1998 and the nine months ended
September 30, 1999, fixed-price projects accounted for 26.0% and 36.8% of our
revenue, respectively. We assume greater financial risks on a fixed-price
project than on a time-and-expense based project. If we miscalculate the
resources or time we need for these fixed-price projects, the costs of
completing these projects may exceed the price, which could result in a loss on
the project and a decrease in net income. Further, the average size of our
contracts has increased in recent quarters, resulting in a corresponding
increase in our exposure to the financial risks of fixed-price engagements. We
recognize revenues from fixed-price projects based on our estimate of the
percentage of each project completed in a reporting period. To the extent our
estimates are inaccurate, the revenues and operating profits, if any, that we
report for periods during which we are working on a fixed-price project may not
accurately reflect the final results of the project and we would be required to
record an expense for these periods equal to the amount by which our revenues
were previously overstated.
OUR OPERATING RESULTS MAY FLUCTUATE DUE TO SEASONAL FACTORS WHICH COULD RESULT
IN GREATER THAN EXPECTED LOSSES
Our results of operations may experience seasonal fluctuations as
businesses typically spend less on network management services during the summer
and year-end vacation and holiday periods. Additionally, as a large number of
our employees take vacation during these periods, our utilization rates during
these periods tend to be lower, which reduces our margins and operating income.
Accordingly, we may report greater than expected losses for these periods.
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OUR LONG SALES CYCLE MAKES OUR REVENUES DIFFICULT TO PREDICT AND COULD CAUSE OUR
QUARTERLY OPERATING RESULTS TO BE BELOW THE EXPECTATIONS OF PUBLIC MARKET
ANALYSTS AND INVESTORS
The timing of our revenues is difficult to predict because of the
length and variance of the time required to complete a sale. Before hiring us
for a project, our clients often undertake an extensive review process and may
require approval at various levels within their organization. Any delay due to a
long sales cycle could reduce our revenues for a quarter and cause our quarterly
operating results to be below the expectations of public market analysts or
investors. If this occurs, the price of our common is likely to decline.
RISKS RELATED TO OUR STRATEGY AND MARKET
WE MAY HAVE DIFFICULTY MANAGING OUR EXPANDING OPERATIONS, WHICH MAY HARM OUR
BUSINESS
A key part of our strategy is to grow our business; however, our rapid
growth has placed a significant strain on our managerial and operational
resources. From January 1, 1997 to September 30, 1999, our staff increased from
approximately 123 to approximately 365 employees. To manage our growth, we must
continue to improve our financial and management controls, reporting systems and
procedures, and expand and train our work force. We may not be able to do so
successfully.
WE MAY NOT BE ABLE TO HIRE AND RETAIN QUALIFIED NETWORK SYSTEMS CONSULTANTS,
WHICH COULD AFFECT OUR ABILITY TO COMPETE EFFECTIVELY
Our continued success depends on our ability to identify, hire, train
and retain highly qualified network management consultants. These individuals
are in high demand and we may not be able to attract and retain the number of
highly qualified consultants that we need. If we cannot retain, attract and hire
the necessary consultants, our ability to grow, complete existing projects and
bid for new projects will be adversely affected.
COMPETITION IN THE NETWORK CONSULTING INDUSTRY IS INTENSE, AND THEREFORE WE MAY
LOSE PROJECTS TO OUR COMPETITORS
Our market is intensely competitive, highly fragmented and subject to
rapid technological change. We expect competition to intensify and increase over
time. We may lose projects to our competitors, which could adversely affect our
business, results of operations and financial condition. In addition,
competition could result in lower billing rates and gross margins and could
require us to increase our spending on sales and marketing.
We face competition from systems integrators, value added resellers,
local and regional network services firms, telecommunications providers, and
network equipment and computer systems vendors. These competitors may be able to
respond more quickly to new or emerging technologies and changes in client
requirements or devote greater resources to the expansion of their market share.
Additionally, our competitors have in the past and may in the future
form alliances with various network equipment vendors that may give them an
advantage in implementing networks using that vendor's equipment.
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We also compete with internal information technology departments of
current and potential clients. To the extent that current or potential clients
decide to satisfy their needs internally, our business will suffer.
IF WE ARE UNABLE TO INTEGRATE OUR RECENT ACQUISITION OF NETWORK RESOURCE
CONSULTANTS AND COMPANY AND ANY FUTURE ACQUISITIONS, OUR BUSINESS MAY BE
DISRUPTED
We recently acquired Network Resource Consultants and Company, a
network consulting company based in The Netherlands. The integration of this and
future acquisitions presents us with significant financial, managerial and
operational challenges. We may not be able to meet these challenges effectively.
To the extent our management is required to devote significant time and
attention to integrating the technology, operations and personnel of acquired
businesses, we may not be able to properly serve our current clients or attract
new clients. Any difficulties in integrating acquisitions could disrupt our
ongoing business, distract our management and employees, increase our expenses
and otherwise adversely affect our business.
IF WE ARE UNABLE TO FIND SUITABLE ACQUISITION CANDIDATES, OUR GROWTH COULD BE
IMPEDED
A component of our growth strategy is the acquisition of, or investment
in, complementary businesses, technologies, services or products. Our ability to
identify and invest in suitable acquisition and investment candidates on
acceptable terms is crucial to this strategy. We may not be able to identify,
acquire or make investments in promising acquisition candidates on acceptable
terms. Moreover, in pursuing acquisition and investment opportunities, we may be
in competition with other companies having similar growth and investment
strategies. Competition for these acquisitions or investment targets could also
result in increased acquisition or investment prices and a diminished pool of
businesses, technologies, services or products available for acquisition or
investment.
OUR ACQUISITION STRATEGY COULD HAVE AN ADVERSE EFFECT ON CLIENT SATISFACTION AND
OUR OPERATING RESULTS
Acquisitions involve a number of risks, including:
- adverse effects on our reported operating results due
to accounting charges associated with acquisitions;
- increased expenses, including compensation expense
resulting from newly hired employees; and
- potential disputes with the sellers of acquired
businesses, technologies, services or products.
Client dissatisfaction or performance problems with an acquired
business, technology, service or product could also have a material adverse
impact on our reputation as a whole. In addition, any acquired business,
technology, service or product could significantly underperform relative to our
expectations.
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COMPETITION FOR EXPERIENCED PERSONNEL IS INTENSE AND OUR INABILITY TO RETAIN KEY
PERSONNEL COULD INTERRUPT OUR BUSINESS AND ADVERSELY AFFECT OUR GROWTH
Our future success depends, in significant part, upon the continued
service and performance of our senior management and other key personnel, in
particular Ronald G. Pettengill, Jr., our Chairman and Chief Executive Officer,
and Robert L. Belau, our President. Losing the services of any of these
individuals would impair our ability to effectively deliver our services and
manage our company, and to carry out our business plan. In addition, competition
for qualified personnel in the network consulting industry is intense and we may
not be successful in attracting and retaining these personnel. There may be only
a limited number of persons with the requisite skills to serve in these
positions and it may become increasingly difficult to hire these persons. Our
business will suffer if we encounter delays in hiring additional personnel.
OUR INTERNATIONAL EXPANSION EFFORTS, WHICH ARE A KEY PART OF OUR GROWTH
STRATEGY, MAY NOT BE SUCCESSFUL
We expect to expand our international operations and international
sales and marketing efforts. Recently, we commenced operations in England. In
addition, in August 1999, we acquired Network Resource Consultants and Company,
a network consulting company based in The Netherlands. We have had limited
experience in marketing, selling and distributing our services internationally.
We may not be able to maintain and expand our international operations or
successfully market our services internationally. Failure to do so may
negatively affect our business, as well as our ability to grow.
OUR BUSINESS MAY SUFFER IF WE FAIL TO ADAPT APPROPRIATELY TO THE CHALLENGES
ASSOCIATED WITH OPERATING INTERNATIONALLY
Operating internationally may require us to modify the way we
conduct our business and deliver our services in these markets.
We anticipate that we will face the following challenges
internationally:
- the burden and expense of complying with a wide
variety of foreign laws and regulatory requirements;
- potentially adverse tax consequences;
- longer payment cycles and problems in collecting
accounts receivable;
- technology export and import restrictions or
prohibitions;
- tariffs and other trade barriers;
- difficulties in staffing and managing foreign
operations;
- cultural and language differences;
- fluctuations in currency exchange rates; and
- seasonal reductions in business activity during the
summer months in Europe.
If we do not appropriately anticipate changes and adapt our practices
to meet these challenges, our growth could be impeded and our results of
operations could suffer.
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IF WE DO NOT KEEP PACE WITH TECHNOLOGICAL CHANGES, OUR SERVICES MAY BECOME LESS
COMPETITIVE AND OUR BUSINESS WILL SUFFER
Our market is characterized by rapidly changing technologies, frequent
new product and service introductions and evolving industry standards. As a
result of the complexities inherent in today's computing environments, we face
significant challenges in remaining abreast of such changes and product
introductions. If we cannot keep pace with these changes, we will not be able to
meet our clients' increasingly sophisticated network management needs and our
services will become less competitive.
Our future success will depend on our ability to:
- keep pace with continuing changes in industry
standards, information technology and client
preferences;
- respond effectively to these changes; and
- develop new services or enhance our existing
services.
We may be unable to develop and introduce new services or enhancements
to existing services in a timely manner or in response to changing market
conditions or client requirements.
IF THE USE OF LARGE-SCALE, COMPLEX NETWORKS DOES NOT CONTINUE TO GROW, WE MAY
NOT BE ABLE TO SUCCESSFULLY INCREASE OR MAINTAIN OUR CLIENT BASE AND REVENUES
To date, a majority of our revenues have been from network management
services related to large-scale, complex networks. We believe that we will
continue to derive a majority of our revenues from providing network design,
performance, management and security services. As a result, our future success
is highly dependent on the continued growth and acceptance of large-scale,
complex computer networks and the continued trend among our clients to use
third-party service providers. If the growth of the use of enterprise networks
does not continue or declines, our business may not grow and our revenues may
decline.
IF THE INTERNET DOES NOT GROW AND CONTINUE TO DEVELOP AS A VIABLE BUSINESS TOOL,
DEMAND FOR OUR SERVICES AND OUR REVENUES MAY DECLINE
The growing demand for network management services has been driven in
part by the growth of the Internet. The Internet may not prove to be a viable
commercial marketplace because of:
- inadequate development of the necessary
infrastructure;
- lack of development of complementary products (such
as high speed modems and high speed communication
lines);
- implementation of competing technology;
- delays in the development or adoption of new
standards and protocols required to handle increased
levels of Internet activity; or
- governmental regulation.
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Moreover, critical issues concerning the use of the Internet remain
unresolved and may affect the growth of the use of such technologies to solve
business problems. If the Internet fails to grow or grows more slowly as a
viable business tool than anticipated, there will be a significant decline in
the need for our services and our revenues will decline.
YEAR 2000 PROBLEMS PRESENT TECHNOLOGICAL RISKS WHICH MAY BE COSTLY TO CORRECT
AND WHICH MAY DISRUPT OUR BUSINESS
Year 2000 problems could cause us, or our clients, to experience
operational difficulties and incur expenses. Although we have received
compliance information from our material third-party vendors, we have not
received compliance information from all of our third-party vendors. In
addition, it is possible that our third-party vendors were mistaken in
certifying that their systems are Year 2000 compliant. Furthermore, we will not
conduct an end-to-end system test until the end of November 1999. If we fail to
fix our internal systems or to fix or replace material third-party software,
hardware or services on a timely basis, we may suffer lost revenues, increased
operating costs and other business interruptions, any of which would materially
and adversely affect us. Moreover, if we fail to adequately address Year 2000
compliance issues, we may be subject to claims of mismanagement and related
litigation, which would be costly and time-consuming to defend.
In addition, we cannot assure you that governmental agencies, utility
companies, Internet access companies, third-party service providers and others
outside our control will be Year 2000 compliant. If those entities fail to be
Year 2000 compliant, there may be a systemic failure beyond our control, such as
a prolonged Internet, telecommunications or electrical failure, which could
materially disrupt our ability to deliver our services.
RISKS RELATED TO INTELLECTUAL PROPERTY MATTERS AND POTENTIAL LEGAL LIABILITY
UNAUTHORIZED USE OF OUR INTELLECTUAL PROPERTY BY THIRD PARTIES MAY DAMAGE OUR
BRAND
We regard our copyrights, trade secrets and other intellectual property
as critical to our success. Unauthorized use of our intellectual property by
third parties may damage our brand and our reputation. We rely on trademark and
copyright law, trade secret protection and confidentiality and/or license and
other agreements with our employees, customers, partners and others to protect
our intellectual property rights. However, we do not have any patents or patent
applications pending and existing trade secret, trademark and copyright laws
afford us only limited protection. Despite our precautions, it may be possible
for third parties to obtain and use our intellectual property without our
authorization. The laws of some foreign countries are also uncertain or do not
protect intellectual property rights to the same extent as do the laws of the
United States.
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WE MAY NOT BE ABLE TO OBTAIN TRADEMARK PROTECTION FOR SOME OF OUR IMPORTANT
TRADEMARKS, WHICH WOULD SIGNIFICANTLY IMPAIR OUR ABILITY TO PREVENT OTHERS FROM
USING THOSE TRADEMARKS AND MAY REQUIRE US TO REPLACE THEM WITH NEW TRADEMARKS
The trademark offices in the United States and England have raised
objections to the registration of our "PREDICTIVE SYSTEMS," "BUSINESSFIRST" and
Predictive logo trademarks, including likelihood of confusion with pre-existing
trademarks and descriptiveness. We have responded to these objections and are
awaiting the trademark offices' decisions on our responses. We have not,
however, received any objections from third parties asserting likelihood of
confusion claims with respect to our trademarks. Nonetheless, we may not be able
to obtain trademark registrations in the United States or England, or both, for
one or more of these trademarks, in which case we will be unable to fully
enforce our statutory trademark rights against third parties for these
trademarks, and/or we must decide to replace such trademarks with new
trademarks.
WE MAY HAVE TO DEFEND AGAINST INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS, WHICH
COULD BE EXPENSIVE AND, IF WE ARE NOT SUCCESSFUL, COULD DISRUPT OUR BUSINESS
We cannot be certain that our services, the finished products that we
deliver or materials provided to us by our clients for use in our finished
products do not or will not infringe valid patents, copyrights, trademarks or
other intellectual property rights held by third parties. As a result, we may be
subject to legal proceedings and claims from time to time relating to the
intellectual property of others in the ordinary course of our business. We may
incur substantial expenses in defending against these third-party infringement
claims, regardless of their merit. Successful infringement claims against us may
result in substantial monetary liability or may materially disrupt the conduct
of our business.
BECAUSE OUR SERVICES ARE OFTEN CRITICAL TO OUR CLIENTS' OPERATIONS, WE MAY BE
SUBJECT TO SIGNIFICANT CLAIMS IF OUR SERVICES DO NOT MEET OUR CLIENTS
EXPECTATIONS
Many of our projects are critical to the operations of our clients'
businesses. If we cannot complete these projects to our clients' expectations,
we could materially harm our clients' operations. This could damage our
reputation, subject us to increased risk of litigation or result in our having
to provide additional services to a client at no charge. Although we carry
general liability insurance coverage, our insurance may not cover all potential
claims to which we are exposed or may not be adequate to indemnify us for all
liability that may be imposed.
OUR STOCK PRICE IS LIKELY TO BE HIGHLY VOLATILE AND COULD DROP UNEXPECTEDLY
The market price of our common stock is likely to be highly volatile
and may fluctuate substantially. As a result, investors in our common stock may
experience a decrease in the value of their common stock regardless of our
operating performance or prospects. In addition, the stock market has, from time
to time, experienced significant price and volume fluctuations that have
affected the market prices for the securities of technology companies. In the
past, following periods of volatility in the market price of a particular
company's securities, securities class action litigation was often brought
against that company. Many technology-related companies have been subject to
this type of litigation. We may also become involved in this
24
<PAGE>
type of litigation. Litigation is often expensive and diverts management's
attention and resources.
WE ARE CONTROLLED BY A SMALL GROUP OF OUR EXISTING STOCKHOLDERS, WHOSE INTERESTS
MAY DIFFER FROM OTHER STOCKHOLDERS
Our directors, executive officers and affiliates currently beneficially
own approximately 67.0% of the outstanding shares of our common stock.
Accordingly, these stockholders will have significant influence in determining
the outcome of any corporate transaction or other matter submitted to the
stockholders for approval, including mergers, acquisitions, consolidations and
the sale of all or substantially all of our assets, and also the power to
prevent or cause a change in control. The interests of these stockholders may
differ from the interests of the other stockholders.
OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY INHIBIT A TAKEOVER THAT STOCKHOLDERS
MAY CONSIDER FAVORABLE
Provisions in our charter and bylaws may have the effect of delaying or
preventing a change of control or changes in our management that stockholders
consider favorable or beneficial. If a change of control or change in management
is delayed or prevented, the market price of our common stock could decline.
25
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
No material legal proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On August 12, 1999 the Registrant issued 1,062,814 shares of
common stock to two persons in exchange for all of the outstanding
capital stock of Network Resource Consultants and Company, B.V. in
reliance upon the exemption from registration provided by Section
4(2) of the Securities Act.
On September 15, 1999, the Registrant issued 1,242,000 shares
of common stock to Cisco Systems, Inc., an accredited investor, in
a private placement for an aggregate amount of $14,904,000 in
reliance upon the exemption from registration provided by Section
4(2) of the Securities Act.
On September 22, 1999, the Registrant issued 94,867 and 18,133
shares of common stock to General Atlantic Partners 57, L.P. and
GAP Coinvestment Partners II, L.P., both accredited investors, in
a private placement for an aggregate amount of $1,356,000 in
reliance upon the exemption from registration provided by Section
4(2) of the Securities Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
In September 1999, in a Written Consent in Lieu of a Special
Meeting of the Stockholders of the Company, a majority of the
holders of the then outstanding shares of common stock of the
Company (which majority included the majority of holders of the
preferred stock of the Company, voting on an as-converted basis)
approved:
(1) the adoption of the Amended and Restated Certificate of
Incorporation of the Company;
(2) the adoption of the Amended and Restated By-Laws of the
Company;
(3) the adoption of the 1999 Employee Stock Purchase Plan,
including the reservation of 750,000 shares thereunder; and
(4) the adoption of the 1999 Stock Incentive Plan, including
the reservation of an additional 2,345,597 shares thereunder.
26
<PAGE>
ITEM 5. OTHER INFORMATION
NONE
ITEM 6. EXHIBITS AND REPORT ON FORM 8-K
(a) The following exhibits are filed as part of this report:
27.1 Financial Data Schedule
(b) The Company did not file any reports on Form 8-K during
the three months ended September 30, 1999.
27
<PAGE>
ITEM 7. SIGNATURES
Pursuant to the requirements of the Securities Exchange Act,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PREDICTIVE SYSTEMS, INC.
(Registrant)
Date: November 15, 1999 /s/ RONALD G. PETTENGILL, JR.
-----------------------------------------
Name: Ronald G. Pettengill, Jr.
Title: Chief Executive Officer
(principal executive officer)
Date: November 15, 1999 /s/ GERARD E. DORSEY
------------------------------------------
Name: Gerard E. Dorsey
Title: Chief Financial Officer
(principal accounting and financial officer)
28
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<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JUL-01-1999
<PERIOD-END> SEP-30-1999
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