<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 MARCH 31, 2000
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)
417 FIFTH AVENUE, NEW YORK, NEW YORK 10016
- --------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(212) 659-3400
- --------------------------------------------------------------------------------
(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 March 31, 2000, there were 25,259,490 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. CONSOLIDATED FINANCIAL STATEMENTS ............................................. 3
Consolidated Balance Sheets at
March 31, 2000 (unaudited) and December 31, 1999............................... 3
Consolidated Statements of Operations for the
three months ended March 31, 2000 and 1999 (unaudited)......................... 4
Consolidated Statements of Cash Flows for the
three months ended March 31, 2000 and 1999 (unaudited)......................... 5
Notes to Consolidated Financial Statements (unaudited)......................... 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS............................................ 8
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK.................................................................... 12
PART II. OTHER INFORMATION.......................................................................... 20
ITEM 1. LEGAL PROCEEDINGS.............................................................. 20
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS...................................... 20
ITEM 3. DEFAULTS UPON SENIOR SECURITIES................................................ 20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................ 20
ITEM 5. OTHER INFORMATION.............................................................. 20
ITEM 6. EXHIBITS AND REPORT ON FORM 8-K................................................ 20
ITEM 7. SIGNATURES..................................................................... 20
</TABLE>
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<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, 2000 December 31, 1999
-------------- -----------------
(unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 88,797,758 $ 89,633,634
Investment in marketable securities at market value - 2,018,060
Stock subscription receivable 40,740,000 -
Accounts receivable - net of allowance for
doubtful accounts of $653,997 and $568,344, respectively 19,061,729 16,257,304
Unbilled work in process 317,686 289,120
Notes receivable - employees 68,229 116,859
Notes receivable - stockholders 571,464 -
Deferred tax asset 2,184,194 842,606
Prepaid expenses and other current assets 1,110,311 1,219,717
------------ ------------
Total current assets 152,851,371 110,377,300
PROPERTY AND EQUIPMENT - net of accumulated
depreciation and amortization of $1,978,548 and $1,703,711, respectively 6,368,588 2,884,105
GOODWILL-net of accumulated amortization of $540,048 and $326,871, respectively 3,723,489 3,936,666
OTHER ASSETS 249,086 224,740
------------ ------------
Total assets $163,192,534 $117,422,811
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 4,071,769 $ 2,322,065
Accrued expenses 3,979,310 4,714,861
Current portion of capital lease obligations 177,630 183,193
Income taxes payable 199,574 -
Deferred income 1,111,158 1,064,721
------------ ------------
Total current liabilities 9,539,441 8,284,840
NONCURRENT LIABILITIES
Capital lease obligations 246,185 284,037
Deferred rent 103,388 49,863
Deferred income tax liability 361,447 299,851
Other long-term liabilities 2,850 2,498
------------ ------------
Total liabilities 10,253,311 8,921,089
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $.001 par value, 200,000,000 shares authorized,
25,259,490 and 23,429,200 shares issued and outstanding 25,259 23,429
Additional paid-in capital 151,795,924 108,404,681
Deferred compensation (237,633) (256,672)
Retained earnings 1,398,165 369,625
Accumulated other comprehensive loss (42,492) (39,341)
------------ ------------
Total stockholders' equity 152,939,223 108,501,722
------------ ------------
Total liabilities and stockholders' equity $163,192,534 $117,422,811
============ ============
</TABLE>
The accompanying notes to financial statements
are an integral part of these consolidated balance sheets.
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<PAGE>
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
<TABLE>
<CAPTION>
Three Months Ended March 31,
2000 1999
------------ -----------
<S> <C> <C>
REVENUES:
Professional services $ 18,901,279 $ 9,887,442
Hardware and software sales 143,873 477,467
------------ -----------
Total revenues 19,045,152 10,364,909
------------ -----------
COST OF REVENUES:
Professional services 9,705,820 4,849,321
Hardware and software purchases 108,211 425,956
------------ -----------
Total cost of revenues 9,814,031 5,275,277
------------ -----------
Gross profit 9,231,121 5,089,632
------------ -----------
SALES AND MARKETING 2,650,822 1,589,171
GENERAL AND ADMINISTRATIVE 5,440,122 3,469,033
DEPRECIATION AND AMORTIZATION 488,014 143,827
NONCASH COMPENSATION EXPENSE 19,039 4,625
------------ -----------
Operating profit (loss) 633,124 (117,024)
OTHER INCOME (EXPENSE):
Interest income 1,264,631 45,173
Other (expense) income (9,486) 12,750
Interest expense (17,989) (86,233)
------------ -----------
INCOME (LOSS) BEFORE INCOME TAX PROVISION (BENEFIT) 1,870,280 (145,334)
Income tax provision (benefit) 841,740 (48,850)
------------ -----------
Net income (loss) $ 1,028,540 $ (96,484)
============ ===========
NET INCOME (LOSS) PER SHARE: BASIC $ 0.04 $ (0.01)
============ ===========
NET INCOME (LOSS) PER SHARE: DILUTED $ 0.03 $ (0.01)
============ ===========
WEIGHTED AVERAGE SHARES OUTSTANDING: BASIC 23,453,839 8,379,660
============ ===========
WEIGHTED AVERAGE SHARES OUTSTANDING: DILUTED 33,331,117 8,379,660
============ ===========
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
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<PAGE>
PREDICTIVE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------------------
2000 1999
----------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 1,028,540 $ (96,484)
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Noncash compensation expense 19,039 4,625
Deferred income taxes (218,740) (48,850)
Depreciation and amortization 488,014 143,827
Provision for doubtful accounts 85,653 126,504
Unrealized gain on marketable securities (13,020) -
(Increase) decrease in-
Accounts receivable (2,890,078) (700,864)
Unbilled work in process (28,566) (692,115)
Income taxes 1,213,322 49,699
Prepaid expenses and other current assets 109,406 (27,835)
Other assets (24,346) 23,323
Increase (decrease) in-
Accounts payable 1,749,704 (484,068)
Accrued expenses and other currrent liabilities (809,038) (36,430)
Deferred income 46,437 (401,820)
Deferred rent 53,525 (21,744)
Other long-term liabilities 352 -
------------ -----------
Net cash provided by (used in) operating activities 810,204 (2,162,232)
------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of marketable securities (120,765,541) -
Proceeds from sale or redemption of marketable securities 122,783,601 -
Common shares repurchased to treasury - (8,398,753)
Payments to employees 48,630 -
Repayments from employees - 35,000
Loans to stockholders (571,464) -
Repayments from stockholders - 515,000
Payments to related party - (333,307)
Repayments from related party - 1,075,979
Purchase of property and equipment (3,802,735) (207,544)
------------ -----------
Net cash used in investing activities (2,307,509) (7,313,625)
------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash overdraft - (475,610)
Proceeds from short-term borrowings - 4,351,000
Repayments of short-term borrowings - (9,949,000)
Payment of preferred dividends - (70,000)
Proceeds from sale of preferred stock - 18,564,755
Proceeds from exercise of stock options 651,560 50,000
------------ -----------
Net cash provided by financing activities 651,560 12,471,145
------------ -----------
Effects of exchange rates 9,869 -
------------ -----------
Net (decrease) increase in cash (835,876) 2,995,288
CASH AND CASH EQUIVALENTS - beginning of period 89,633,634 -
------------ -----------
CASH AND CASH EQUIVALENTS - end of period $ 88,797,758 $ 2,995,288
============ ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 14,543 $ 79,990
============ ===========
Taxes $ - $ 27,540
============ ===========
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
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<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(1) BASIS OF PRESENTATION
The consolidated financial statements and accompanying financial
information as of March 31, 2000 and for the three months ended March 31,
2000 and 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,
1999. Results for interim periods are not necessarily indicative of
results for the entire year.
(2) NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed by dividing net income
(loss) available to common stockholders by the weighted average number of
shares outstanding. Diluted net income (loss) per share reflects the
potential dilution that would occur if securities or other contracts to
issue common stock were exercised or converted into common stock, unless
they are antidilutive.
The following table reconciles the numerator and denominator for the
calculation:
Three Months Ended
March 31,
----------------------------
2000 1999
---- ----
(unaudited)
Numerator -
Net income (loss) $1,028,540 $ (96,484)
Preferred stock dividends -- (8,750)
---------- -----------
Numerator for basic and
diluted earnings per
share - net income (loss)
available to common
stockholders $1,028,540 $ (105,234)
========== ===========
Denominator -
Weighted average shares -
Basic 23,453,839 8,379,660
Diluted 33,331,117 8,379,660
========== =========
Net income (loss) per share -
Basic $ 0.04 $ (0.01)
Diluted $ 0.03 $ (0.01)
========= ==========
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<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. The
components of comprehensive income are as follows:
Three Months Ended March 31,
----------------------------
2000 1999
---- ----
(unaudited)
Net income (loss) $1,028,540 $(96,484)
Unrealized loss on investments $ (13,020) --
Foreign currency translation adjustment 9,869 --
---------- --------
Comprehensive income (loss) $1,025,389 $(96,484)
========== ========
(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 represented the
excess of the 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 March 31, 2000 and 1999 as if the
acquisition of NRCC had occurred on the first day of the periods
presented:
Three Months Ended
March 31,
------------------------------
2000 1999
---- ----
Revenues $19,045,152 $10,814,695
Operating income (loss) 633,124 (263,940)
Net income (loss) $ 1,028,540 $ (267,923)
PER SHARE INFORMATION:
Net income (loss) per share -
Basic $0.04 $(0.03)
Diluted $0.03 $(0.03)
Weighted Average Shares
Outstanding -
Basic 23,453,839 9,442,474
Diluted 33,331,117 9,442,474
(5) SUBSEQUENT EVENT
In April 2000, we consummated a follow-on public offering for 3.8 million
shares of our common stock, of which 1.0 million shares were sold by the
Company, while the remainder were sold by certain stockholders, resulting
in net proceeds to the Company of approximately $40 million after
deducting underwriter discounts and commissions and expenses payable by
us.
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<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 in excess of $1.0 million. For these contracts, we
recognize revenue using a percentage-of-completion method primarily based on
costs incurred. We make provisions for estimated losses on uncompleted contracts
on a contract-by-contract basis and recognize such provisions in the period in
which the losses are determined. Professional services revenues for
time-and-expense based projects are recognized as services are performed. Any
payments received in advance of services performed are recorded as deferred
revenue. Our clients are generally able to reduce or cancel their use of our
professional services without penalty and with little or no notice. We also
derive limited revenues from the sale of hardware and software. We sell hardware
and software only when specifically requested by a client. We expect revenues
from the sale of hardware and software to continue to decline on a percentage
basis.
Since we recognize professional services revenues only when
our consultants are engaged on client projects, the utilization of our
consultants is important in determining our operating results. In addition, a
substantial majority of our operating expenses, particularly personnel and
related costs, depreciation and rent, are relatively fixed in advance of any
particular quarter. As a result, any underutilization of our consultants may
cause significant variations in our operating results in any particular quarter
and could result in losses for such quarter. Factors which could cause
underutilization include:
- 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
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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 are being amortized over a period of 5 years.
On September 16, 1999, we completed the sale of 1,242,000
shares of our common stock to Cisco Systems, Inc. at $12.00 per share for net
proceeds of approximately $14.2 million. On September 22, 1999, we completed the
sale of 94,867 and 18,133 shares of our common stock to General Atlantic
Partners 57, L.P. and GAP Coinvestment Partners 11, L.P., respectively, at
$12.00 per share for net proceeds of approximately $1.4 million.
In November 1999, we consummated the initial public offering
of 4.6 million shares of our common stock at $18.00 per share, which resulted in
net proceeds of approximately $75.1 million after deducting underwriter
discounts and commissions, and expenses as payable by us.
In April 2000, we consummated a follow-on public offering for
3.8 million shares of our common stock, of which 1.0 million shares were offered
by the Company resulting in net proceeds of approximately $40.0 million after
deducting underwriter discounts and commissions, and expenses as payable by us.
We plan to continue to expand our operations by hiring
additional consultants, and adding new offices and systems. 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
Three Months Ended March 31, 2000 and 1999
REVENUES. Substantially all of our revenues are derived from
fees for professional services. Revenues increased 84% to $19.0 million in the
three months ended March 31, 2000 from $10.4 million in the three months ended
March 31, 1999. Revenues from professional services increased 91% to $18.9
million in the three months ended March 31, 2000 from $9.9 million in the three
months ended March 31, 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. During the three months ended March 31, 2000, Qwest Communication,
Inc. accounted for 15.4% of our revenues. The number of our billable consultants
increased to 337 at March 31, 2000 from 160 at March 31, 1999.
GROSS PROFIT. Gross profit increased 81% to $9.2 million in
the three months ended March 31, 2000 from $5.1 million in the three months
ended March 31, 1999. As a percentage of revenues, gross profit decreased to
48.5% in the three months ended March 31, 2000 from 49.1% in the three months
ended March 31, 1999. This decrease in gross profit margin was due to a
reduction in the utilization rate to 77% for the three months ended March 31,
2000 from 86% for the three months ended March 31, 1999, partially offset by an
increase in average billing rates. Cost of revenues increased to $9.8 million in
the three months ended March 31, 2000 from $5.3 million in the three months
ended March 31, 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
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<PAGE>
expenses. Sales and marketing expenses increased 67% to $2.7 million in the
three months ended March 31, 2000 from $1.6 million in the three months ended
March 31, 1999. As a percentage of revenues, sales and marketing decreased to
13.9% in the three months ended March 31, 2000 from 15.3% in the three months
ended March 31, 1999. The increase in absolute dollars was primarily due to an
increase of $650,000 in compensation and benefits paid due to the hiring of
additional personnel, an increase of $336,000 in commissions paid due to an
increase in revenues and an increase of $75,000 in sales and marketing efforts.
GENERAL AND ADMINISTRATIVE EXPENSES. General and
administrative expenses increased 57% to $5.4 million in the three months ended
March 31, 2000 from $3.5 million in the three months ended March 31, 1999. As a
percentage of revenues, general and administrative expense decreased to 28.6% in
the three months ended March 31, 2000 from 33.5% in the three months ended March
31, 1999. The increase in absolute dollars was primarily due to an increase of
$903,000 in recruiting and professional development and other administrative
costs due to the continued investment in our in-house recruiting organization,
an increase of $650,000 in compensation and benefit costs, and an increase of
$418,000 in facilities and equipment costs reflecting the continued investment
in our infrastructure.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization
increased 239% to $488,000 in the three months ended March 31, 2000 from
$144,000 in the three months ended March 31, 1999. This increase was due to
purchases of additional computer equipment to support our growth and
amortization of intangibles of $213,000 associated with acquisition of Network
Resource Consultants and Company.
NONCASH COMPENSATION EXPENSE. During 1999, we granted options
to purchase shares of common stock at exercise 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.
During the three months ended March 31, 2000, we recorded approximately $19,000
of noncash compensation expense related to these options compared to $5,000 for
the three months ended March 31, 1999.
OTHER INCOME (EXPENSE). Other income increased from $1.2
million in the three months ended March 31, 2000 to $28,000 of other (expense)
in the three months ended March 31, 1999. This increase was primarily due to an
increase in interest income related to net proceeds from our initial public
offering, which proceeds were invested in interest-bearing cash equivalents and
marketable securities.
INCOME TAXES. For the three months ended March 31, 2000, the
income tax provision was $842,000 on pre-tax income of $1.9 million. The income
tax benefit was $49,000 on pre-tax losses of $145,000 for the three months ended
March 31, 1999. The U.S. effective tax rate was 45% and 34% during the three
months ended March 31, 2000 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 $213,000 for the three months
ended March 31, 2000.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our operations through the
sale of equity securities and cash flows from operations. As of March 31, 2000,
we had approximately $88.8 million in cash and cash equivalents. On April 4,
2000, we completed a follow-on public offering of 1.0 million shares of our
common stock and received net proceeds of approximately $40.7 million.
Net cash provided by operating activities was $810,000 for the
three months ended March 31, 2000.
Net cash used in investing activities was $2.3 million for the
three months ended March 31, 2000. During the three months ended March 31, 2000,
our capital expenditures were $3.8 million. Capital expenditures of $3.0 million
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<PAGE>
related to leasehold improvements for our new corporate office and the remaining
$800,000 related to purchases of computer equipment and office furniture.
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 March 31, 2000, 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.
YEAR 2000
Many currently installed computer systems and software
products are coded to accept or recognize only two-digit entries in the date
code field. These systems may recognize a date using "00" as the year 1900
rather than the year 2000. As a result, it has been necessary to update the
computer systems and/or software used by any companies and governmental agencies
to comply with Year 2000 requirements or risk system failure or miscalculations
causing disruptions of normal business activities. Most reports to date,
however, are that computer systems are functioning normally and the compliance
and remediation work accomplished leading up to the Year 2000 was effective to
prevent material problems. Computer experts have warned, however, that there may
still be residual consequences.
We are exposed to the risk that the systems on which we depend
to conduct our operations are not Year 2000 compliant and we cannot assure you
that any Year 2000 problems will not result in disruptions.
Based on initial reports, we believe that our information
technology systems, which include our hardware and software, and our
non-information technology systems, which include the telephone systems and
other office equipment we use internally, are Year 2000 compliant.
In addition, to date, we have not experienced any significant
problems relating to the Year 2000 compliance of our major distributors,
suppliers and vendors. However, we cannot assure you that these distributors,
suppliers or vendors will not experience a Year 2000 problem in the future. In
the event that any of them experience a Year 2000 problem and we are unable to
locate an acceptable alternative, our business would be harmed.
Although our initial reports have not identified any material
Year 2000 problems affecting our material third-party vendors, it is possible
that certain Year 2000 problems may have residual consequences or that our
third-party vendors were mistaken in certifying that their systems are Year 2000
compliant. If we fail to fix our internal systems or to fix or replace material
third-party software, hardware or services on a timely basis, we may suffer lost
revenues, increased operating costs and other business interruptions, any of
which could have a material adverse effect on our business, results of
operations and financial condition. Moreover, if we fail to adequately address
Year 2000 compliance issues, we may be subject to claims of mismanagement and
related litigation, which would be costly and time-consuming to defend.
Although initial reports are that computer systems are
functioning normally, we cannot assure you that governmental agencies, utility
companies, Internet access companies, third-party service providers and other
outside our control will not develop Year 2000 problems. If those entities fail
to be Year 2000 compliant, there may be a systematic failure beyond our control,
such as a prolonged Internet, telecommunications or electrical failure, which
could have a material adverse effect on our business, results of operations and
financial condition.
Based on our assessment of our Year 2000 readiness, we do not
anticipate being required to implement any material aspects of a contingency
plan to address Year 2000 readiness of our critical operations.
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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.
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 client could significantly
reduce our revenues
During the three months ended March 31, 2000, Qwest
Communications accounted for 15.4% of our revenues. Our five largest clients
accounted for 39.4% of our revenues for the three months ended March 31, 2000.
For the the year ended December 31, 1999, our five largest clients accounted for
45.8% of our revenues. If one of our major clients discontinues or significantly
reduces the use of our services, we may not generate sufficient revenues to
offset this loss of revenues and our net 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 ended December 31, 1999 and the three months
ended March 31, 2000, fixed-price projects accounted for 35.0% and 36.0% of our
revenue, respectively. We assume greater financial risks on a fixed-price
project than on a time-and-expense based project. If we miscalculate the
resources or time we need for these fixed-price projects, the costs of
completing these projects may exceed the price, which could result in a loss on
the project and a decrease in net income. Further, the average size of our
contracts has increased in recent quarters, resulting in a corresponding
increase in our exposure to the financial risks of fixed-price engagements. We
recognize revenues from fixed-price projects based on our estimate of the
percentage of each project completed in a reporting period. To the extent our
estimates are inaccurate, the revenues and operating profits, if any, that we
report for periods during which we are working on a fixed-price project may not
accurately reflect the final results of the project and we would be required to
record an expense for these periods equal to the amount by which our revenues
were previously overstated.
Our operating results may fluctuate due to seasonal factors which could result
in greater than expected losses
Our results of operations may experience seasonal fluctuations
as businesses typically spend less on network management services during the
summer and year-end vacation and holiday periods. Additionally, as a large
number of our employees take vacation during these periods, our utilization
rates during these periods tend to be lower, which reduces our margins and
operating income. Accordingly, we may report greater than expected losses for
these periods.
Our long sales cycle makes our revenues difficult to predict and could cause our
quarterly operating results to be below the expectations of public market
analysts and investors
The timing of our revenues is difficult to predict because of
the length and variance of the time required to complete a sale. Before hiring
us for a project, our clients often undertake an extensive review process and
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may require approval at various levels within their organization. Any delay due
to a long sales cycle could reduce our revenues for a quarter and cause our
quarterly operating results to be below the expectations of public market
analysts or investors. If this occurs, the price of our common stock is likely
to decline.
We may need to raise additional capital to grow our business, which we may not
be able to do
Our future liquidity and capital requirements are difficult to predict because
they depend on numerous factors, including the success of our existing and new
service offerings and competing technological and market developments. As a
result, we may not be able to generate sufficient cash from our operations to
meet additional working capital requirements, support additional capital
expenditures or take advantage of acquisition opportunities. Accordingly, we may
need to raise additional capital in the future. Our ability to obtain additional
financing will be subject to a number of factors, including market conditions,
our operating performance and investor sentiment. These factors may make the
timing, amount, terms and conditions of additional financing unattractive for
us. If we are unable to raise additional funds when needed, our ability to
operate and grow our business could be impeded.
Risks Related to Our Strategy and Market
We may have difficulty managing our 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 March 31, 2000, our staff
increased from approximately 123 to approximately 452 employees. To manage our
growth, we must continue to improve our financial and management controls,
reporting systems and procedures, and expand and train our work force. We may
not be able to do so successfully.
We may not be able to hire and retain qualified network systems consultants
which could affect our ability to compete effectively
Our continued success depends on our ability to identify,
hire, train and retain highly qualified network management consultants. These
individuals are in high demand and we may not be able to attract and retain the
number of highly qualified consultants that we need. If we cannot retain,
attract and hire the necessary consultants, our ability to grow, complete
existing projects and bid for new projects will be adversely affected.
Competition in the network consulting industry is intense, and therefore we may
lose projects to our competitors
Our market is intensely competitive, highly fragmented and
subject to rapid technological change. We expect competition to intensify and
increase over time. We may lose projects to our competitors, which could
adversely affect our business, results of operations and financial condition. In
addition, competition could result in lower billing rates and gross margins and
could require us to increase our spending on sales and marketing.
We face competition from systems integrators, value added
resellers, network services firms, telecommunications providers, and network
equipment and computer systems vendors. These competitors may be able to respond
more quickly to new or emerging technologies and changes in client requirements
or devote greater resources to the expansion of their market share.
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Additionally, our competitors have in the past and may in the
future form alliances with various network equipment vendors that may give them
an advantage in implementing networks using that vendor's equipment.
We also compete with internal information technology
departments of current and potential clients. To the extent that current or
potential clients decide to satisfy their needs internally, our business will
suffer.
If we are unable to integrate our recent acquisition of Network Resource
Consultants and Company and any other future acquisitions, our business may be
disrupted
We recently acquired Network Resource Consultants and Company
B.V., a network consulting company based in The Netherlands. The integration of
this and other future acquisitions presents us with significant financial,
managerial and operational challenges. We may not be able to meet these
challenges effectively. To the extent our management is required to devote
significant time and attention to integrating the technology, operations and
personnel of acquired businesses, we may not be able to properly serve our
current clients or attract new clients. Any difficulties in integrating
acquisitions could disrupt our ongoing business, distract our management and
employees, increase our expenses and otherwise adversely affect our business.
If we are unable to find suitable acquisition candidates, our growth could be
impeded
A component of our growth strategy is the acquisition of, or
investment in, complementary businesses, technologies, services or products. Our
ability to identify and invest in suitable acquisition and investment candidates
on acceptable terms is crucial to this strategy. We may not be 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.
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
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Executive Officer, and Robert L. Belau, our President. Losing the services of
any of these individuals may impair our ability to effectively deliver our
services and manage our company, and to carry out our business plan. In
addition, competition for qualified personnel in the network consulting industry
is intense and we may not be successful in attracting and retaining these
personnel. There may be only a limited number of persons with the requisite
skills to serve in these positions and it may become increasingly difficult to
hire these persons. Our business will suffer if we encounter delays in hiring
additional personnel.
Our international expansion efforts, which are a key part of our growth
strategy, may not be successful
We expect to expand our international operations and
international sales and marketing efforts. In January 1999, we commenced
operations in England. In addition, in August 1999, we acquired Network Resource
Consultants and Company, a network consulting company based in The Netherlands.
We have had limited experience in marketing, selling and distributing our
services internationally. We may not be able to maintain and expand our
international operations or successfully market our services internationally.
Failure to do so may negatively affect our business, as well as our ability to
grow.
Our business may suffer if we fail to adapt appropriately to
the challenges associated with operating internationally
Operating internationally may require us to modify the way we
conduct our business and deliver our services in these markets.
We anticipate that we will face the following challenges internationally:
- 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.
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.
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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.
Moreover, critical issues concerning the use of the Internet
remain unresolved and may affect the growth of the use of such technologies to
solve business problems. If the Internet fails to grow or grows more slowly as a
viable business tool than anticipated, there will be a significant decline in
the need for our services and our revenues will decline.
Year 2000 problems present technological risks which may be costly to correct
and which may disrupt our business
Year 2000 problems could cause us, or our clients, to
experience operational difficulties and incur expenses. We are not aware of any
material Year 2000 problems that have harmed or threaten to harm our business,
but we cannot assure you that no such problems will emerge. Our failure to
timely fix or replace our internal systems or material third-party software,
hardware or services as a result of a material Year 2000 problem could result in
lost revenues and other business interruptions, any of which could materially
and adversely effect us. Any significant Year 2000 problem could also require us
to incur significant unanticipated expenses to remedy these problems and could
divert management from other tasks of operating our business, which would harm
our business, results of operations and financial condition. Please see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Year 2000" for more detailed information regarding the Year 2000
issue.
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Risks Related to Intellectual Property Matters and Potential Legal Liability
Unauthorized use of our intellectual property by third parties may damage our
brand
We regard our copyrights, trade secrets and other intellectual
property as critical to our success. Unauthorized use of our intellectual
property by third parties may damage our brand and our reputation. We rely on
trademark and copyright law, trade secret protection and confidentiality and/or
license and other agreements with our employees, customers, partners and others
to protect our intellectual property rights. However, we do not have any patents
or patent applications pending and existing trade secret, trademark and
copyright laws afford us only limited protection. Despite our precautions, it
may be possible for third parties to obtain and use our intellectual property
without our authorization. The laws of some foreign countries are also uncertain
or do not protect intellectual property rights to the same extent as do the laws
of the United States.
We may not be able to obtain trademark protection for some of our important
trademarks, which would significantly impair our ability to prevent others from
using those trademarks and may require us to replace them with new trademarks
The United States Patent and Trademark Office has raised
objections to the registration of our "BUSINESSFIRST" and Predictive logo
trademarks, including likelihood of confusion with pre-existing trademarks. We
have responded to these objections and are awaiting decisions on our responses.
We have not, however, received any objections from third parties asserting
likelihood of confusion claims with respect to our trademarks. Nonetheless, we
may not be able to obtain trademark registrations in the United States or
England, where we presently have pending trademark applications for our
"PREDICTIVE SYSTEMS" and "BUSINESSFIRST" marks, for one or more of these
trademarks, in which case we will be unable to enforce any statutory trademark
rights against third parties for these trademarks, and/or we must decide to
replace such trademarks with new trademarks.
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.
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Our stock price is likely to be highly volatile and could drop unexpectedly
The market price of our common stock is highly volatile and
may fluctuate substantially. As a result, investors in our common stock may
experience a decrease in the value of their common stock regardless of our
operating performance or prospects. In addition, the stock market has, from time
to time, experienced significant price and volume fluctuations that have
affected the market prices for the securities of technology companies. In the
past, following periods of volatility in the market price of a particular
company's securities, securities class action litigation was often brought
against that company. Many technology-related companies have been subject to
this type of litigation. We may also become involved in this type of litigation.
Litigation is often expensive and diverts management's attention and resources.
We are controlled by a small group of our existing stockholders, whose interests
may differ from other stockholders
Our directors, executive officers and affiliates currently
beneficially own approximately 55.8% 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.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Except as set forth below, we are not a party to any material legal proceedings.
In an action entitled Art Eckert vs. Predictive Systems,
Inc., in October 1999, a former employee commenced an action against us in New
York Supreme Court (Putnam County) seeking damages for various claims relating
to his employment. The former employee is claiming damages totaling
approximately $16 million. In December of 1999, we filed a motion to dismiss one
of the claims. The former employee has opposed our motion and filed an amended
complaint containing the same claims in slightly different form. We believe that
these claims are without merit and intend to continue to vigorously defend
ourselves against them.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
NONE
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE
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 March 31, 2000.
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: May 12, 2000 /s/ RONALD G. PETTENGILL, JR.
-----------------------------------------
Name: Ronald G. Pettengill, Jr.
Title: Chief Executive Officer
(principal executive officer)
Date: May 12, 2000 /s/ GERARD E. DORSEY
------------------------------------------
Name: Gerard E. Dorsey
Title: Chief Financial Officer
(principal accounting and financial officer)
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