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UNITED STATES SECURITIES AND EXCHANGE
COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
Commission file number 000-30422
PREDICTIVE SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 13-3808483
(State of incorporation) (I.R.S. Employer
Identification Number)
--------------------
19 West 44th Street, 9th Floor
New York, New York 10036
(212) 659-3400
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
http://www.predictive.com
(Registrant's URL)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock Par
Value $0.001 Per Share
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. |X| Yes |_| No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). |_| Yes |X| No
The aggregate market value of voting stock held by non-affiliates of the
registrant as of the last business day of the registrant's most recently
completed second fiscal quarter was $8,282,944 (based on the last reported sale
price on the NASDAQ SmallCap Market on that date).
The number of shares outstanding of the registrant's common stock as of March
27, 2003 was 38,158,107.
DOCUMENTS INCORPORATED BY REFERENCE
The following documents (or parts thereof) are incorporated by reference into
the following parts of this Form 10-K: Portions of the Registrant's Definitive
Proxy Statement for the 2003 Annual Meeting of Stockholders, or if no such proxy
statement is filed with the Securities and Exchange Commission by April 30,
2003, an amendment to this Annual Report on Form 10K, are incorporated by
reference into Part III of this Report.
1
TABLE OF CONTENTS
Page
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PART I
Item 1. Business. ........................................... 4
Item 2. Properties .......................................... 16
Item 3. Legal Proceedings. .................................. 17
Item 4. Submission of Matters to a Vote of Security Holders. 17
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters................................. 18
Item 6. Selected Consolidated Financial Data ................ 20
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations. ................ 21
Item 7A. Quantitative and Qualitative Disclosures about
Market Risk. ........................................ 39
Item 8. Financial Statements and Supplementary Data. ........ 39
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure ................. 75
PART III
Item 10. Directors and Executive Officers of the Registrant. . 76
Item 11. Executive Compensation. ............................. 76
Item 12. Security Ownership of Certain Beneficial Owners and
Management.......................................... 76
Item 13. Certain Relationships and Related Transactions. ..... 76
Item 14. Controls and Procedures .............................. 76
Item 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K......................................... 76
SIGNATURES. ....................................................... 79
2
FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995 that
involve risks, uncertainties and assumptions that, if they never materialize or
if they prove incorrect, could cause our results to differ materially from those
expressed or implied by such forward-looking statements. All statements other
than statements of historical fact are statements that could be deemed
forward-looking, including statements pertaining to: our revenue, earnings, cash
flow and liquidity; our strategy relating to network technologies; the
industries in which we operate; our product development plans and investments;
future acquisitions; international operations; cost savings arising from our
restructurings; and legal proceedings and litigation matters. You can identify
these and other forward-looking statements by the use of words such as "may,"
"will," "should," "expects," "plans," "anticipates," "believes," "estimates,"
"predicts," "intends," "potential," "continue" or the negative of such terms, or
other comparable terminology. Forward-looking statements also include the
assumptions underlying or relating to any of the foregoing statements. Our
actual results could differ materially from those anticipated in these
forward-looking statements as a result of various factors, including those set
forth in this Annual Report under the heading "Risk Factors." All
forward-looking statements included in this document are based on information
available to us on the date hereof. We will not undertake and specifically
decline any obligation to update any forward-looking statements.
3
PART I
Item 1. Business
Overview
We are a leading independent network infrastructure and security
consulting company focused on helping global enterprises and service providers
harness the power of network technology. Specifically, we build, optimize, and
secure high-performance infrastructures that deliver measurable results by
increasing operational efficiency, mitigating risk, and empowering our Fortune
1000 clients' business initiatives. Our BusinessFirst(TM) approach ensures that
we deliver measurable, sustainable results to clients that allow them to benefit
from our collective, in-depth experience. With BusinessFirst, we prioritize a
client's goals and deliver business-driven solutions. Our expertise spans a
multitude of disciplines including enterprise management, performance, network
design, and management and information security. We believe that this range of
services along with our business-oriented approach is unique in the industry.
As an independent service provider, we provide our clients with
unbiased expertise that enables the design, implementation and management of
optimal technology solutions. We provide our services on either a project
outsource or collaborative consulting basis. Our project outsource services are
based on and measured against mutually agreed upon service offerings and provide
our clients with certainty of costs, delivery time and project scope. Our
collaborative consulting services enable our clients to utilize our extensive
expertise in order to extend their internal capabilities and to access our
methodologies. Our service offerings cover the cornerstones of network
technology: network design and engineering; enterprise management (including
network management, asset management, performance management and service
management); and information security. This structure enables us to gain
in-depth expertise and become familiar with the best practices and methodologies
identified within each of those disciplines.
Industry Background
Over the past few years, a number of trends have emerged that begin to
push the envelope of the current iteration of corporate networks. The developing
concept of "pervasive computing," based heavily on personal digital assistants
(PDAs), Web-enabled phones, and other appliance-type devices, coupled with the
increasing adoption of the concept that computer networks should be viewed as a
utility, have begun to push the limits of the current generation of security and
network management models.
Whereas networks have traditionally been built around the notion of
physical environments, in which users and data were often co-located, we believe
future networks are likely to be more "transparent"; that is, networks will be
architected around the location of data and applications, as opposed to
individual users or machines. In addition, organizations must adapt their
current security models to be more flexible and configurable, without
compromising the strength of the security provided. This new concept of
"transparent networking" creates a new set of issues for large corporations:
o Networks must support wireless clients of a heterogeneous nature.
o Networks must support users in geographically disparate locations, all
around the world.
o Corporations must be able to centrally manage and maintain network
components that are in physically distant locations, and that may be
run by third-parties.
o Service level agreements (SLAs) must be adapted and strengthened to
apply to highly distributed control environments.
o Customer environments must be able to create highly-personalized client
experiences, and networks must be able to support those abstract
personalized experiences in the physical network.
o Organizations must have the ability to control and manage large numbers
of assets in widespread environments.
o Organizations must develop, deploy, and manage highly-flexible,
dynamically-configurable, and strong security models that fit the
transparent environment.
However, we believe that few firms have the requisite focus and
expertise to address these issues, and that many are limited by the fact that
they:
o are primarily motivated by distributing their own products and often
lack the skills to implement multi-vendor solutions;
o do not have the breadth of capabilities in networking, security and
enterprise management to address the issues raised by transparent
networking;
o are focused on traditional mainframe computing environments and derive
a large percentage of their revenue from reselling hardware and
software products; or
o only augment businesses' in-house capabilities with hourly rate-based
teams of technical personnel.
4
The Predictive Solution
We are a leading network infrastructure and security consulting company
that builds, optimizes, and secures high-performance infrastructures that
deliver measurable results by increasing operational efficiency, mitigating risk
and empowering our Fortune 1000 clients' business initiatives. Predictive
Systems' BusinessFirst(TM) approach is the core value that underpins everything
we do, motivating our consultants to understand each client's business and to
design and build network infrastructures that support and enhance that business.
We employ our BusinessFirst approach on all engagements in order to ensure that
our network technology and security solutions not only meet our clients'
business objectives, but also bring tangible business benefits. BusinessFirst
reflects our inherent belief that a client's infrastructure is a
mission-critical asset. We are dedicated to understanding both prevalent and
cutting-edge technologies to provide us with relevant and specific technical
knowledge. We believe that our success to date has been largely attributable to
the following key characteristics of our service offerings:
Business-driven, Results-Oriented Approach. Using our proprietary
Business Analysis methodology, Operational Risk capabilities, Business Process
Engineering teams and our structured Program and Project Management teams, we
can demonstrate the business value of technology solutions in specific and
measurable terms, thereby enabling our clients to incorporate objective and
quantifiable analysis into their technology investment decisions. We provide our
clients with a detailed analysis of the financial benefit of a project by
quantifying factors such as business risks, total cost of ownership and
operational efficiency. As a result, our clients can gain a clear understanding
of the benefits that they will derive from their network technology and security
investments and a measure of certainty about how their technology investments
will be translated into tangible and measurable improvements to their business
processes.
Fixed-Price, Fixed-Time Engagement Model. We provide our clients with a
service delivery model that is designed to enhance their ability to
cost-effectively leverage our expertise. When engaged on a project outsource
basis, we work with our clients to mutually define a fixed scope of work at the
beginning of the project that is tailored to the clients' specific needs and
therefore, modified from engagement to engagement. We then deliver the services
for a fixed fee, in a fixed period of time with a fixed set of deliverables.
In-Depth Network Infrastructure and Security Expertise. Our consultants
are organized into disciplines that span the cornerstones of network
infrastructure and security: network design and engineering; Global Integrity
Security; network and systems management; integrated customer service and
performance management. This enables our consultants to gain in-depth expertise
and become intimately familiar with the best practices within each of those
disciplines. More importantly, it enables us to leverage the knowledge base
within each practice group to provide our clients with cross-functional teams of
consultants that are better equipped to address their varying needs in a
coordinated and efficient manner.
Strategy
Continue to Attract and Retain Highly Qualified Consultants. We intend
to continue to attract and retain highly qualified consultants by providing them
with a rich environment and culture in which to work, and by offering them
attractive professional development and compensation opportunities. We generally
recruit consultants who have significant technical expertise and offer them the
ability to accelerate their career development by working with sophisticated
technologies in complex, multi-vendor environments. We have established a formal
training program which is designed to improve the skills and productivity of our
consultants. We intend to continue to promote our corporate culture with stated
values and invest in the training and development of our consultants.
Further Increase Our Industry Expertise. We intend to continue to
expand the scope of our industry expertise in order to further penetrate the
markets in which we serve. We believe our expertise in specific industries
considerably enhances our ability to help companies within those industries gain
competitive advantage by improving the performance, utility and security of
their networks. We have significant experience within the financial services,
telecommunication services, oil/gas and Internet and electronic commerce
industries. In each of these markets, we employ industry experts, pursue
targeted sales and marketing opportunities and develop industry-specific service
offerings. We intend to expand into other industries which we believe will be
well suited to our services.
Cross-Sell into Existing Accounts and Deepen Existing Relationships.
Over the years, we have cultivated and grown client relationships with many of
the largest companies in the world. In many cases, however, these relationships
may only be based on a small subset of services currently (or previously)
contracted to Predictive. However, we believe that these clients would be
receptive to a broader range of services to address a number of their technology
infrastructure needs.
Establish Additional and Broaden Existing Strategic Relationships. We
have developed a number of strategic relationships, including alliances with
Cisco Systems, InfoVista , Micromuse, SMARTS and Symantec, and. Under these
relationships, our partners recommend or directly resell our services to their
clients. We intend to continue to expand the scope of these relationships and to
develop new strategic alliances to further broaden the indirect sales channel
for our services.
5
Services
Our service offerings are grouped into three major areas: Networking,
Enterprise Management, and Information Security. Our consultants are further
organized into different disciplines. Although many of our consultants are
cross-skilled in a variety of technologies and many technologies span multiple
disciplines, each discipline represents an aspect of network technology
important enough to warrant specialization.
These five disciplines are:
o network design and engineering;
o network and systems management;
o integrated customer service;
o performance management; and
o Global Integrity Security.
Our consultants have extensive experience with a wide variety of
technologies and vendors. For some clients, our consultants are involved in both
technology and vendor selection. Other clients have already selected the
technology, vendor or both. Regardless, we offer our clients a completely
objective, vendor-neutral approach. Our knowledge of advanced technologies and
leading vendors is a significant part of our value proposition to our clients.
Network Design and Engineering. Our network design and engineering
discipline is dedicated to helping our clients plan, implement and operate
business networks and network services. Our real-world experience and
cross-discipline collaboration produces network systems that are cost-effective,
manageable, scalable and secure. This enables our clients to use technology to
gain a major competitive advantage and a tangible return on investment.
The following table lists some of the services provided by our network
design and engineering discipline area:
Service Description
- ------------------------------------------------- -------------------------------------------------
Network Operations Assessments................... Assess the ability of an organization's network to
support its business strategy. Includes an analysis
of the network's performance, capacity, security,
availability and disaster scenarios.
Virtual Private Network and Access Solutions..... Designs and deploys secure, high-performance
remote access and virtual private network
solutions to allow clients, their employees,
supply-chain partners and other business partners
to access information remotely.
Advanced Technology Evaluation/Migration......... Helps clients choose the right technologies to meet
their business objectives and maximize their
competitive advantage in planning new network
services or upgrading existing ones. The services
include technology impact studies, technology
evaluation and testing, and failure and performance
analyses.
Wireless LAN Services........................... Assess, design and implement wireless LAN
architecture for corporate environments. The
services include requirements gathering, site
surveys, technology and product selection, wireless
LAN implementation, development of security policies
and architecture and integration of management
capabilities.
Network Design, Planning and Implementation...... Design and implement core backbones and campus
networks. The services include core optical backbone
design, campus network design, wireless network
design, IP addressing, DNS and DHCP design, protocol
transition services, project management and
implementation planning, staging/prototyping
services, and implementation team services.
Complex Network Troubleshooting.................. Address network performance and outage issues to get
the network running at optimum levels in the
shortest time possible.
6
Network and Systems Management. Our network and systems management
discipline combines proven methodologies, front-line strategies, and extensive
hands-on experience in advising world-class organizations how to architect and
implement enterprise management centers. The result is a system that delivers
the functionality, reliability, diagnostics and manageability essential to help
our clients' organizations meet their competitive challenges.
The following table lists some of the services provided by our network
and systems management discipline:
Service Description
- ------------------------------------------------- -------------------------------------------------
Enterprise Management Assessment................. Provides a comprehensive overview of a client's
enterprise management center with the goal of
consolidation, integration and simplicity of
operations. Develops recommendations to align the
enterprise management center with the needs of
the client's organization.
NOC "Pitstop"................................... Performs a diagnostic assessment of a client's
network management capabilities and existing Network
Operations Center. Provides a roadmap to achieving
business goals, as well as an actionable project
plan for improving performance metrics.
IT Management Center Engineering................. Assists clients in developing and deploying
enterprise management centers. Develops technical
specifications, working prototypes and then
implements the solution.
Event Correlation and Root Cause Analysis........ Provides methodology and tools for quickly and
efficiently pinpointing the location of the core
problems behind network faults so that they can
be resolved.
IT Service Definition/Measurement................ Establishes service definitions and instruments
for the measurement of service level agreements
within the enterprise structure.
Integrated Customer Service. Our integrated customer service discipline
helps organizations build proactive, customer-focused service centers that
handle all types of customer inquiries and drive service management. Our
solutions bring together a variety of management disciplines, including problem
management and asset management and service level management.
The following table lists some of the services provided by our
integrated customer service discipline:
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Service Description
- ------------------------------------------------- -------------------------------------------------
Call Center/Help Desk Assessment................. Assesses a clients' Call Center and/or IT Help
Desk. Identifies and prioritizes solutions that
will lower costs and enable clients to
effectively support technology.
Asset Management Assessment...................... Assess clients' asset management systems.
Analyzes current documentation and reports
and makes recommendations that enable clients to
effectively manage IT assets throughout the
lifecycle.
Rapid Analysis and Planning (RAP) Session........ 1-2 day working session with key personnel and
Predictive consultants to discuss issues and
develop solutions to specific infrastructure
management issues.
Asset Management Design and Implementation....... Design of an asset management solution that meets
client's business needs and facilitates the
management and inventory of IT assets. Includes
the implementation of that solution, and development
of a set of performance measurements to ensure that
solution continues to benefit the business.
Performance Management. Our performance management discipline leverages
proven methodologies and our extensive experience to help our clients optimize
their networks. We use sophisticated tools and techniques to gather, organize
and warehouse network performance data. This data may subsequently be used for a
number of related performance analysis applications, including capacity
planning, response time management and network simulation modeling. Consultants
in our performance management discipline are experts in applicable technologies,
including core competencies in remote monitoring, or RMON, data warehousing and
discrete event simulation modeling.
The following table lists some of the services provided by our
performance management discipline:
Service Description
- ------------------------------------------------- -------------------------------------------------
Network Baselining............................... Provides a snapshot of the current network
environment. The baseline can be used as a
comparison point as events change.
Capacity Planning................................ Projects network and system resource requirements
necessary to support business needs.
Application Impact Studies....................... Analyzes how an application uses network
resources to predict response times that users
will experience when the application is deployed
across the network. Recommends improvements that
enable the application to maximize network
resources.
Network Triage................................... Identifies root causes and provides resolution
for acute network performance problems.
Global Integrity Services. Our Global Integrity Services business unit
enables our clients to manage risk by understanding, prioritizing and mitigating
their security-related business risks with our comprehensive set of information
protection services. We help clients by assessing, designing, and implementing
secure revenue-enhancing electronic business solutions, cost saving networks,
wireless solutions and a variety of other services, all of which rely on a
secure infrastructure to save money or expand revenues.
8
The following table lists some of the services provided by our Global
Integrity Services business unit:
Service Description
- ------------------------------------------------- -------------------------------------------------
TrustCheck(TM) Assessment........................ Provides a consistent, quantitative measure of
information security for an organization, technical
infrastructure or application. Pinpoints
vulnerabilities and develops a specific ranking
that compares the client's security to its industry
peers.
Ethical Hacking.................................. Attacks a client's network infrastructure and
applications in order to determine how they might
be penetrated by a hacker.
Security Architecture Design and Implementation.. Design and implement secure networks, systems and applications
to be deployed throughout a client's infrastructure
using sophisticated technologies.
Application Security Assessment and Design....... Review the design and implementation of sensitive
applications to ensure that proper security controls
are included.
Incident Response and Digital Forensics.......... Development of a program and procedures for
responding and reacting to security incidents.
Includes training on evidence handling and forensic
analysis of data, development of procedures for
interacting with law enforcement and media, as well
as development of procedures for recovering systems
as quickly as possible. Services also include on-
site forensics support for Predictive clients.
GlobalSecure(TM) Management and Monitoring
Services......................................... Services include the remote monitoring and management
of firewalls and intrusion detection systems. Powered
by our partner, Riptech, these services provide 24x7
vigilance of a client's security systems to ensure
that attacks, incidents, and other security issues
are detected and acted upon as quickly as possible.
Security Intelligence Services................... A subscription service which provides clients with
information into the trends and evolution of the
threat. These services include distribution of daily
alerts regarding vulnerabilities in IT systems,
threats to physical security and high-level trends
in the threat model, pulled from various sources,
both public and private.
Clients
We have provided professional network and security services to a
variety of clients across a broad range of industries, including:
AIG Citigroup McDonald's
AT&T Devon Energy Pfizer
Bear Stearns Cox Communications Rabobank
BellSouth JPMorgan Chase Time
Cable & Wireless Maher Terminals Verizon
Sales and Marketing
We have developed direct and indirect sales channels for the sale of
our services. To facilitate our direct sales effort we have developed the
infrastructure necessary to capture and track the major sales indicators through
the sales cycle. Additionally, a significant amount of time and effort has been
and will continue to be invested in the development of tools, training materials
and training for sales and technical personnel. We have developed a number of
strategic relationships, including alliances with Cisco Systems, InfoVista ,
Micromuse, SMARTS and Symantec. Under these relationships, our partners
recommend or directly resell our services to their clients, including our
consulting services on a project outsource basis. We intend to continue to
expand the scope of these relationships and to develop new strategic alliances
to further broaden the indirect sales channel for our services.
9
Human Resources
We seek to attract, train, retain and deliver the highest level of
technical talent. We believe that our proactive approach gives us a strong
competitive edge in the marketplace and a scalable, consistently high standard
of service delivery. As of March 15, 2003, we had 200 full-time employees.
Competition
The network infrastructure and security consulting industry is
comprised of many participants, is highly competitive and is subject to rapid
technological change. We face intense competition from systems integrators,
value added resellers, network services firms, security consulting firms,
telecommunications providers, network equipment and computer systems vendors.
Many of our competitors have greater name recognition, longer operating
histories, more relationships with large and established clients and greater
financial, technical and managerial resources. Furthermore, we expect that our
competitors may in the future form alliances with other technology vendors,
which may give them an advantage in managing networks that use that vendor's
equipment.
Most of our current clients and prospective clients have internal
information technology departments and could choose to satisfy their network
management needs through internal resources rather than by outsourcing them to
third-party service providers such as ourselves. The decision by clients or
prospective clients to rely on their own information technology departments
could have a material adverse affect on our business, results of operations and
financial condition. Moreover, as the domestic and global markets for
information technology services continue to grow, we expect to face stiff
competition from new entrants into the network management consulting industry.
We believe that the principal competitive factors in the network
infrastructure and security consulting market are the ability to attract and
retain qualified personnel, quality and breadth of services offered, price and
reliability of services provided and the strength of client relationships. We
believe we compete favorably with respect to all of these factors. We believe we
distinguish ourselves from our competitors through our expertise in managing
complex, multi-vendor networks and our ability to provide clients with cost
certainty and guaranteed deliverables.
Intellectual Property and Proprietary Rights
We regard our copyrights, trade secrets and other intellectual property
as critical to our success. Unauthorized use of our intellectual property by
third parties may damage our brand and our reputation. We rely on trademark and
copyright law, trade secret protection and confidentiality and/or license and
other agreements with our employees, customers, partners and others to protect
our intellectual property rights. Despite our precautions, it may be possible
for third parties to obtain and use our intellectual property without our
authorization. Furthermore, the validity, enforceability and scope of protection
of intellectual property in Internet-related industries is still evolving. The
laws of some foreign countries do not protect intellectual property to the same
extent as do the laws of the United States.
We pursue the registration of our trademarks in the United States and
England. We may not be able to secure adequate protection of our trademarks in
the United States and other countries. Effective trademark protection may not be
available in all the countries in which we conduct business. Policing
unauthorized use of our marks is also difficult and expensive. In addition, it
is possible that our competitors have adopted or will adopt product or service
names similar to ours, thereby impeding our ability to build brand identity and
possibly leading to customer confusion.
We cannot be certain that our services and the finished products that
we deliver do not or will not infringe valid patents, copyrights, trademarks or
other intellectual property rights held by third parties. We may be subject to
legal proceedings and claims from time to time relating to the intellectual
property of others in the ordinary course of our business. We may incur
substantial expenses in defending against these third-party infringement claims,
regardless of their merit. Successful infringement claims against us may result
in substantial monetary liability or may materially disrupt the conduct of our
business.
International Operations
We currently have offices in the United Kingdom and the Netherlands. The
scope of our international operations includes service delivery and sales and
marketing. Geographic revenue classification is based on the country in which
the sale is invoiced. Revenue for the fiscal year ended December 31, 2002 was
82% North America and 18% international, 89% North America and 11% international
for the comparable period in 2001 and 91% North America and 9% international for
the comparable period in 2000.
10
Risk Factors
An investment in our company involves a high degree of risk. You should
carefully consider the risks described below before you decide to buy our common
stock. If any of the following risks actually occur, our business, results of
operations or financial condition would likely suffer. In this case, the trading
price of our common stock could decline.
Risks Related to Our Financial Condition and Business Model
Our limited operating history 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 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 volatile market increase the risk
that the value of your investment will decline.
Adverse market conditions, particularly those affecting the professional
services industry, may impair our operating results
Our results depend on market conditions affecting the technology
industry in general and the telecommunications and enterprise sectors in
particular. Adverse market conditions in the sectors in which we operate could
delay buying decisions or cause projects to be deferred, reduced in scope or
discontinued. These sectors are experiencing a drastic downturn. We can not
predict how long this contraction will last, or the timing or strength of a
recovery, if any. If market conditions and corporate spending in these sectors
do not improve, our business, financial condition and operating results will
continue to suffer.
We have lost money from operations in the past and expect to incur additional
losses for the foreseeable future, which could impact our stock price and
liquidity.
Our net loss for the 12 months ended December 31, 2002 was $61.9
million. As of December 31, 2002, our accumulated deficit was $206.3 million. We
expect to generate significant net losses for the foreseeable future and may
never achieve profitability. If we do not achieve profitability, our stock price
may decline. In addition, 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.
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 year ended December 31, 2002, BellSouth and Pfizer accounted
for approximately 15.0% and 13.7%, respectively of revenues before reimbursed
expenses. Our five largest clients accounted for approximately 45.4% of revenues
before reimbursed expenses for the year ended December 31, 2002. For the year
ended December 31, 2001, our five largest clients accounted for approximately
40.6% of our revenues before reimbursed expenses. 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 loss
will increase. In addition, the non-payment or late payment of amounts due from
a major client could adversely affect us. As of December 31, 2002, the accounts
receivable from BellSouth and Pfizer were approximately $524,977 and $341,832,
respectively, which related to work performed in October through December 2002.
We believe that we will continue to depend on a small number of large customers
for a significant portion of our revenues.
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 no 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.
11
Our operating results may vary from quarter to quarter in future periods, and as
a result, we may fail to meet the expectations of our investors and analysts,
which may cause our stock price to fluctuate or decline
Our operating results have varied from quarter to quarter. Our
operating results may continue to vary as a result of a variety of factors.
These factors include:
o the loss of key employees;
o the development and introduction of new service offerings;
o reductions in our billing rates;
o the miscalculation of resources required to complete new or
ongoing projects;
o the utilization of our workforce;
o the ability of our clients to meet their payments obligations
to us; and
o 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 our own expectations or 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 years ended December 31, 2002 and 2001, fixed-price projects
accounted for 37.0% and 48.2% of revenues before reimbursed expenses,
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 an increase in
net loss. We recognize revenues from fixed-price projects based on our estimate
of the percentage of each project completed in a reporting period. To the extent
our estimates are inaccurate, the revenues and operating profits, if any, that
we report for periods during which we are working on a fixed-price project may
not accurately reflect the final results of the project and we would be required
to record an expense for these periods equal to the amount by which our revenues
were previously overstated.
Our operating results may fluctuate due to seasonal factors, which could result
in greater than expected losses
Our results of operations may experience seasonal fluctuations as
businesses typically spend less on network management services during the summer
and year-end vacation and holiday periods. Additionally, as a large number of
our employees take vacation during these periods, our utilization rates during
these periods tend to be lower, which reduces our margins and operating income.
Accordingly, we may report greater than expected losses for these periods.
Our long sales cycle makes our revenues difficult to predict and could cause our
quarterly operating results to be below the expectations of public market
analysts and investors
The timing of our revenues is difficult to predict because of the
length and variance of the time required to complete a sale. Before hiring us
for a project, our clients often undertake an extensive review process and may
require approval at various levels within their organization. Any delay due to a
long sales cycle could reduce our revenues for a quarter and cause our quarterly
operating results to be below the expectations of public market analysts or
investors. If this occurs, the price of our common stock is likely to decline.
We may need to raise additional capital to grow our business, which we may not
be able to do
Our future liquidity and capital requirements are difficult to predict
because they depend on numerous factors, including the success of our existing
and new service offerings and competing technological and market developments.
As a result, we may not be able to generate sufficient cash from our operations
to meet additional working capital requirements, support additional capital
expenditures or take advantage of acquisition opportunities. Accordingly, we may
need to raise additional capital in the future. Our ability to obtain additional
financing will be subject to a number of factors, including market conditions,
our operating performance and investor sentiment. These factors may make the
timing, amount, terms and conditions of additional financing unattractive for
us. If we are unable to raise additional funds when needed, our ability to
operate and grow our business could be impeded.
12
Risks Related to Our Strategy and Market
We may have difficulty managing the fluctuations in the demand for our services,
which could have adverse effects on our business
Our business has recently experienced lower revenues due to decreased
customer demand for our services. Since December 31, 2000, to scale back our
operations and to reduce our expenses in response to this reduced demand for our
services, we have decreased our headcount to 236 employees as of December 31,
2002 from approximately 691 employees as of December 31, 2000. While this action
has positively impacted our results of operations, there are several risks
inherent in our efforts to transition to a smaller workforce. Reducing the size
of our workforce could have adverse effects on our business by reducing our pool
of technical talent, making it more difficult for us to respond to customers,
limiting our ability to provide increased services quickly if and when the
demand for our services increases, and limiting our ability to hire and retain
key personnel. A key part of our strategy going forward is to grow our business.
In order to achieve this growth, demand for our services must increase. If the
opportunity to grow our business arises, we may need to modify our financial and
management controls, reporting systems and procedures and to train our work
force. We may not be able to do so successfully, causing our earnings to be
lower than they might otherwise be.
Our management team has experienced significant turnover, which 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. Neeraj
("Berry") Sethi was appointed our Chief Financial Officer in August 2002 and
Shawn Kreloff was appointed our Executive Vice President of Sales and Business
Development in September 2002. In addition, in connection with our recent
reductions in staff, many members of our senior management team have either
departed, or been redeployed and given new responsibilities. If the
restructuring of our senior management team does not lead to the results we
expect, our ability to effectively deliver our services, manage our company and
carry out our business plan may be impaired.
We may not be able to hire and retain qualified network systems and security
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 and security 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 and security 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, security consulting firms, telecommunications providers,
and network equipment and computer systems vendors. These competitors may be
able to respond more quickly to new or emerging technologies and changes in
client requirements or devote greater resources to the expansion of their market
share.
Additionally, our competitors have in the past and may in the future
form alliances with various network equipment vendors that may give them an
advantage in implementing networks using that vendor's equipment.
We also compete with internal information technology departments of
current and potential clients. To the extent that current or potential clients
decide to satisfy their needs internally, our business will suffer.
If we 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 and security
needs and our services will become less competitive.
Our future success will depend on our ability to:
o keep pace with continuing changes in industry standards,
information technology and client preferences;
o respond effectively to these changes; and
o develop new services or enhance our existing services.
13
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. We may experience difficulties or delays in
our development efforts with respect to new services or enhancements, and may
not ultimately be successful in developing them. Any significant delay in
releasing new services or enhancements could adversely affect our reputation,
give a competitor a first-to-market or cause a competitor to achieve greater
market share.
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, including those already consummated, involve a number of
risks, including:
o adverse effects on our reported operating results due to
accounting charges associated with acquisitions;
o increased expenses, including compensation expense resulting
from newly hired employees; and
o potential disputes with the sellers of acquired businesses,
technologies, services or products.
Client dissatisfaction or performance problems with an acquired
business, technology, service or product could also have a material adverse
impact on our reputation as a whole. In addition, any acquired business,
technology, service or product could significantly underperform relative to our
expectations.
Competition for experienced personnel is intense and our inability to retain key
personnel could interrupt our business and adversely affect our growth
Our future success depends, in significant part, upon the continued
service and performance of our senior management and other key personnel. 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 and security
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 business may suffer if we fail to adapt appropriately to the challenges
associated with operating internationally
We operate internationally in The United Kingdom and The Netherlands.
Operating internationally may require us to modify the way we conduct our
business and deliver our services in these markets. We anticipate that we will
face the following challenges internationally:
o the burden and expense of complying with a wide variety of
foreign laws and regulatory requirements;
o potentially adverse tax consequences;
o longer payment cycles and problems in collecting accounts
receivable;
o technology export and import restrictions or prohibitions;
o tariffs and other trade barriers;
o difficulties in staffing and managing foreign operations;
o cultural and language differences;
14
o fluctuations in currency exchange rates; and
o seasonal reductions in business activity during the summer
months in Europe.
If we do not appropriately anticipate changes and adapt our practices
to meet these challenges, our growth could be impeded and our results of
operations could suffer.
If 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
and security 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.
The war with Iraq and continued threats of terrorism may harm our business and
negatively impact the U.S. and global economy.
The economic uncertainty resulting from the unpredictability of
military action and other responses associated with the war with Iraq may
negatively impact consumer as well as business confidence in the near term. In
addition, the continued threat of terrorism and heightened security measures in
response to this threat have caused and may continue to cause significant
disruptions to commerce throughout the world. To the extent that this economic
uncertainty and these continued disruptions result in a general decrease in
corporate spending on information technology, our business, revenues and results
of operations could be harmed. We are unable to predict whether the war with
Iraq, threats of terrorism or the response thereto will result in any long-term
commercial disruptions or if such activities or responses will have a long-term
adverse effect on our business, strategy, results of operations or financial
condition.
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 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 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 protracted and costly 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 and
materially disrupt the conduct of our business. We may also be required to
obtain a license from a third party or cease activities utilizing a third
party's proprietary rights.
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.
15
Our stock price is likely to be highly volatile and could drop unexpectedly
The market price of our common stock is highly volatile, has fluctuated
substantially and may continue to do so. 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 are currently involved in this type of litigation.
Litigation is often expensive and diverts management's attention and resources.
Due to the fact that our stock price had not met the $1.00 minimum price
requirement of the Nasdaq National Market, our common stock is no longer listed
on the Nasdaq National Market, which may adversely impact the liquidity of your
shares.
Our common stock is currently listed on the Nasdaq SmallCap Market. The
trading volume of our common stock listed on the Nasdaq SmallCap Market has been
significantly less than the historical volume when our common stock was listed
on the Nasdaq National Market, and accordingly, there may not be significant
liquidity if and when you desire to sell your shares. This lack of liquidity may
result in holders not being able to purchase or sell shares as quickly and
inexpensively as they have done historically, and may impact the trading price
of our common stock.
The Nasdaq SmallCap Market also maintains a $1.00 minimum price
requirement. On March 27, 2003, the price of our common stock was $0.28. We have
until July 21, 2003 to regain compliance with the minimum bid requirement,
subject to possible extension if we meet certain requirements to extend such
compliance period. There is no assurance we will meet the required criteria, or
that this compliance period will be extended in the event we do not. If we are
delisted from the Nasdaq SmallCap Market, we may be unable to have our common
stock listed or quoted on any other organized market. Even if our common stock
is quoted or listed on another organized market, an active trading market may
not develop, and our ability to raise financing will be materially and adversely
affected.
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 28.9% 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.
Available Information
Our reports filed with Securities and Exchange Commission, including
our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports
on Form 8-K and amendments to reports filed pursuant to Sections 13(a) and 15(d)
of the Securities Exchange Act of 1934, as amended, are available on our website
at http://www.predictive.com, when such reports are available on the Securities
and Exchange Commission website.
Item 2. Properties
Our principal executive offices are located in New York, New York. We
also lease office space in California, Georgia, Minnesota, New Jersey, Virginia,
England and The Netherlands.
We believe that our existing facilities are adequate for our current
needs and that additional space will be available as needed.
16
Item 3. Legal Proceedings
Except as set forth below, we are not a party to any material legal
proceedings.
Certain investment bank underwriters, and certain of our directors and
officers have been named in a putative class action for violation of the federal
securities laws in the United States District Court for the Southern District of
New York, captioned In Predictive Systems, Inc. Initial Public Offering
Securities Litigation, 01 Civ. 10059 (SAS). This is one of a number of cases
challenging underwriting practices in the initial public offerings ("IPOs") of
more than 300 companies. These cases have been coordinated for pretrial
proceedings as In re Initial Public Offering Securities Litigation, 21 MC 92
(SAS). Plaintiffs generally allege that certain underwriters engaged in
undisclosed and improper underwriting activities, namely the receipt of
excessive brokerage commissions and customer agreements regarding post-offering
purchases of stock in exchange for allocations of IPO shares. Plaintiffs also
allege that various investment bank securities analysts issued false and
misleading analyst reports. The complaint against the Company claims that the
purported improper underwriting activities were not disclosed in the
registration statements for our IPO and Secondary Offering and seeks unspecified
damages on behalf of a purported class of persons who purchased the Company's
securities or sold put options during the time period from October 27, 1999 to
December 6, 2000. On February 19, 2003, the Court issued an Opinion and Order
denying our motion to dismiss certain of the claims in the complaint. We believe
we have meritorious defenses against the allegations in the complaint and intend
to defend the case vigorously.
On or about November 13, 2002, ICG Communications filed a claim against
the Company in the Federal Bankruptcy Court alleging that approximately $4.3
million in payments that the Company received from ICG within the 90 days
preceding ICG's bankruptcy filing were voidable as preferential transfers under
section 547 of the United States Bankruptcy Code. On March 27, 2003 the Company
and ICG reached an agreement to settle this claim for $350,000. This agreement
is subject to bankruptcy court approval.
In February 28, 2003, Brian Mulvey, a former employee of the Company,
and his wife Nancy Mulvey, filed a lawsuit in the Superior Court of New Jersey
against the Company and four of our managers. The Mulveys have alleged that
during Brian Mulvey's employment with the Company, he was subjected to age
discrimination, sexual harassment and other such conduct. Nancy Mulvey is
Brian's Mulvey's wife, but was never employed with the Company. Plaintiffs seek
an unspecified amount of compensatory damages, emotional distress damages,
punitive damages, attorneys' fees and costs. We deny the allegations of the
complaint and plan to vigorously defend the case.
Item 4. Submission of Matters to a Vote of Security Holders
We held our 2002 Annual Meeting of Stockholders on December 10, 2002. At that
meeting, the stockholders approved the following proposals: (i) the election of
Inder Sidhu and William L. Smith as Class III directors to serve on the Board of
Directors until the 2005 Annual Meeting of Stockholders, (ii) the amendment of
our 1999 Stock Incentive Plan to (a) increase the maximum number of options or
shares that may be granted to one person in any calendar year to 2,000,000 from
500,000; and (b) increase the number of options issued to non-employee Board
members upon their initial appointment to the Board and upon the date of each
Annual Meeting of Stockholders to 75,000 and 10,000 shares, respectively, from
25,000 and 2,500 shares, respectively, (iii) the amendment of our 1999 Employee
Stock Purchase Plan to increase the number of shares of our common stock that
may be issued thereunder from 750,000 shares up to a maximum of 1,150,000
shares, and (iv) the ratification of the Board of Directors' decision to select
Deloitte & Touche LLP as our independent public accountants for the year ending
December 31, 2002.
There were 31,129,857 votes cast for, 557,654 votes cast against and 0
abstentions in connection with the election of Inder Sidhu as a Class III
Director. There were 29,950,795 votes cast for, 1,736,716 votes cast against and
0 abstentions in connection with the election of William L. Smith as a Class III
Director.. There were 27,572,086 votes cast for, 4,111,980 votes cast against
and 3,445 abstentions in connection with the approval of an amendment to our
1999 Stock Incentive Plan to (a) increase the maximum number of options or
shares that may be granted to one person in any calendar year to 2,000,000 from
500,000; and (b) increase the number of options issued to non-employee Board
members upon their initial appointment to the Board and upon the date of each
Annual Meeting of Stockholders to 75,000 and 10,000 shares, respectively, from
25,000 and 2,500 shares, respectively. There were 30,017,428 votes cast for,
1,667,313 votes cast against and 2,770 abstentions in connection with the
approval of an amendment to our 1999 Employee Stock Purchase Plan to increase
the number of shares of common stock that may be issued thereunder from 750,000
shares up to a maximum of 1,150,000 shares. There were 31,659,515 votes cast
for, 21,701 votes cast against and 6,295 abstentions in connection with
ratification of the Board of Director's decision to select Deloitte & Touche LLP
as our independent public accountants for the year ending December 31, 2002.
17
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Market Information
Our common stock has been quoted on the Nasdaq SmallCap Market under
the symbol PRDS since December 13, 2002 and on the Nasdaq National Market under
the symbol PRDS from our initial public offering on October 27, 1999 to December
12, 2002. The following table sets forth, for the period indicated, the high and
low sale prices per share of the common stock as reported on the Nasdaq National
Market and Nasdaq SmallCap Market.
High Low
----- -----
First Quarter 2001 ................................. 9.19 2.00
Second Quarter 2001 ................................. 5.40 1.19
Third Quarter 2001 ................................. 4.00 0.70
Fourth Quarter 2001 ................................. 2.08 0.70
First Quarter 2002 ................................. 2.58 1.25
Second Quarter 2002 ................................. 1.55 0.31
Third Quarter 2002 ................................. 0.37 0.13
Fourth Quarter 2002 ................................. 0.56 0.18
On March 27 , 2003, the last sale price of our common stock reported on
the Nasdaq SmallCap Market was $0.28 per share.
The Company maintains the 1999 Stock Incentive Plan (the "1999 Plan"), and the
1999 Employee Stock Purchase Plan (the "Purchase Plan"), pursuant to which it
may grant equity awards to eligible persons. The following table sets forth
information about equity awards under the Company's plans as of the close of the
fiscal year ended December 31, 2002.
(a) (b) (c)
Number of
Securities to be Weighted- Number of Securities
Issued upon Average Exercise Remaining Available for
Exercise of Price of Future Issuance under
Outstanding Outstanding Equity Compensation
Options, Options, Plans (Excluding
Warrants and Warrants and Securities
Plan Category Rights Rights Reflected in Column (a))
- ------------------------------------------- ------ ------ ------------------------
Equity compensation plans approved
by security holders..................... 7,715,836 $0.89 13,140,506 (1)/(2)
Equity compensation plans not
approved by security holders (3)........ 1,298,730 $0.33 0
Total.............................
(1) The 1999 Plan incorporates an evergreen formula pursuant to which on each
January 1, the aggregate number of shares reserved for issuance under the
1999 Plan will increase by a number of shares equal to 1% of the
outstanding shares on the day preceding (December 31), but no such annual
increase will exceed 500,000 shares.
(2) Of these shares, 698,535 shares remain available for purchase under the
Purchase Plan.
(3) There remained outstanding as of December 31, 2002 59,959 stock options
under the 1996 Synet Stock Option Plan and 2,625 stock options under the
Global Integrity 1998 Stock Incentive Plan with a weighted average exercise
price of $2.70 and $7.62 per share, respectively. The Company assumed the
options under these plans in connection with its acquisition of Synet
Service Corporation and Global Integrity Corporation, respectively, in the
fourth quarter of 2000. No further awards will be made under either option
plan. Statistics regarding these plans are not included in the above table.
Holders
As of March 27, 2003, we had approximately 136 holders of record of our
common stock.
18
Dividends
We have never declared or paid any cash dividends on our common stock.
We currently intend to retain future earnings, if any, to finance the expansion
of our business. As a result, we do not intend to pay cash dividends in the
foreseeable future.
Recent Sales of Unregistered Securities
On September 19, 2002, we sold 238,095 shares of our common stock to
Shawn Kreloff, one of our officers, at a price of $0.21 per share for total
proceeds of $49,999.95 in reliance upon the exemption from registration provided
by Section 4(2) of the Securities Act.
19
Item 6. Selected Consolidated Financial Data
The selected consolidated balance sheet data as of December 31, 2002
and 2001 and the selected consolidated statements of operations data for the
years ended December 31, 2002, 2001 and 2000 have been derived from our audited
consolidated financial statements included elsewhere in this annual report. The
selected consolidated balance sheet data as of December 31, 2000, 1999 and 1998
and the selected consolidated statements of operations data for the years ended
December 31, 1999 and 1998 have been derived from our consolidated audited
financial statements not included in this annual report.
The selected consolidated financial data set forth below should be read
in conjunction with Management's Discussion and Analysis of Financial Condition
and Results of Operations and the consolidated financial statements and the
notes to those statements included elsewhere in this annual report.
Year Ended December 31,
--------------------------------------------------
2002 2001 2000 1999 1998
-------- ------- ------- ------- -------
(in thousands, except per share data)
Statement of Operations Data:
Revenues:
Professional services ......................................... $ 44,891 $ 66,217 $ 85,325 $ 50,698 $ 23,858
Reimbursed expenses ........................................... 1,253 1,872 2,921 1,054 398
Hardware and software sales ................................... 3,816 1,991 2,950 2,047 2,065
-------- ------- ------- ------- -------
Total revenues ............................................. 49,960 70,080 91,196 53,799 26,321
Cost of Revenues:
Professional services ......................................... 31,685 50,518 47,420 25,699 12,861
Reimbursed expenses............................................ 1,253 1,872 2,921 1,054 398
Hardware and software.......................................... 3,419 2,090 2,201 1,766 1,699
-------- ------- ------- ------- -------
Total cost of revenues ..................................... 36,357 54,480 52,542 28,519 14,958
-------- ------- ------- ------- -------
Gross profit ................................................... 13,603 15,600 38,654 25,280 11,363
Operating Expenses:
Sales and marketing ........................................... 8,027 15,830 12,290 8,478 3,433
General and administrative .................................... 20,372 42,058 32,231 16,809 8,184
Depreciation and amortization ................................. 1,708 2,873 1,657 756 568
Intangibles amortization ...................................... 1,961 21,933 2,912 327 --
Loss on equipment.............................................. -- 443 -- -- --
Impairment of goodwill and intangibles......................... 9,305 60,485 -- -- --
Impairment of property and equipment........................... 4,510 -- -- -- --
Restructuring and other charges................................ 7,468 14,672 -- -- --
Loss on long-term investments in related parties............... -- 2,000 -- -- --
Noncash charges for stock-based compensation and services...... 329 276 158 48 --
-------- ------- ------- ------- -------
Operating loss ................................................. (40,077) (144,970) (10,594) (1,138) (822)
Other income(expense):
Interest income ............................................... 411 2,565 7,261 944 58
Other income (expense) ........................................ 1,123 (51) (268) 76 1
Interest expense .............................................. (35) (52) (191) (157) (324)
-------- ------- ------- ------- -------
Loss before income tax provision (benefit) and cumulative
effect of change in accounting principle....................... (38,578) (142,508) (3,792) (275) (1,087)
Income tax provision (benefit) ................................. 40 (1,635) 95 682 (460)
-------- ------- ------- ------- -------
Loss before cumulative effect of change in accounting principle. (38,618) (140,873) (3,887) (957) (627)
Cumulative effect of change in accounting principle............. (23,308) -- -- -- --
-------- ------- ------- ------- -------
Net loss........................................................ $(61,926) $(140,873) $ (3,887) $ (957) $ (627)
======== ======= ======= ======= =======
Basic and diluted loss per common share before cumulative
effect of change in accounting principle....................... $ (1.03) $ (3.91) $ (0.15) $ (0.08) $ (0.11)
Cumulative effect of change in accounting principle............. (0.63) -- -- -- --
-------- ------- ------- ------- -------
Basic and diluted net loss per common share..................... $ (1.66) $ (3.91) $ (0.15) $ (0.08) $ (0.11)
======== ======= ======= ======= =======
Basic and diluted weighted average common shares outstanding.... 37,331 36,008 26,274 12,138 6,015
======== ======= ======= ======= =======
20
See Note 4 to our consolidated financial statements for an explanation
of the number of shares used in per share computations.
December 31,
-------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- ------- ------ ------
(in thousands)
Balance Sheet Data:
Cash and cash equivalents ........................ $ 19,465 $ 41,278 $ 80,059 $ 89,634 $ --
Marketable securities ............................ -- -- 3,794 2,018 --
Working capital .................................. 21,675 41,262 99,631 102,092 2,365
Total assets ..................................... 32,210 102,493 246,329 117,250 13,677
Total stockholders' equity ....................... 24,466 84,937 223,694 108,502 2,026
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion of our financial condition and results of
operations should be read in conjunction with our consolidated financial
statements and related notes thereto included elsewhere in this Annual Report on
Form 10-K. This discussion contains forward-looking statements, which involve
risks and uncertainties. Our actual results could differ materially from those
anticipated in these forward-looking statements for many reasons, including the
risks described in "Risk Factors" starting on page 11 and elsewhere in this
Annual Report.
Overview
The principal source of our revenues is fees from professional
services. We provide network and security 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 also provide managed security services to our
clients. We derive revenues from these services on a subscription basis. We use
our BusinessFirst approach 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 $500,000. For these contracts, we recognize revenue using a
percentage-of-completion method primarily based on hours 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. Revenues for
subscription-based contracts are recognized on a straight-line basis over the
period of service. 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 revenues from the sale of hardware and software.
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 under utilization 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 under
utilization include:
o the reduction in size, delay in commencement, interruption or
termination of one or more significant projects;
o the completion during a quarter of one or more significant
projects;
o the miscalculation of resources required to complete new or
ongoing projects; and
o the timing and extent of training, weather related shut-downs,
vacations and holidays.
Our cost of revenues consists of costs associated with our professional
services and hardware and software purchases. Costs of revenues associated with
professional services include compensation and benefits for our consultants and
project-related travel expenses that are not reimbursed by our clients. Costs of
hardware and software purchases consist of acquisition costs of third-party
hardware and software that is resold.
21
Given the continuing uncertainty in the professional network consulting
services marketplace, 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.
On August 12, 1999, we acquired Network Resource Consultants and
Company B.V. ("NRCC") 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 NRCC. 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 tangible assets acquired. Subsequent to the acquisition and
until the adoption of SFAS 142 on January 1, 2002, goodwill was being amortized
on a straight-line basis over a period of five years. In December 2002, our
subsidiary in Germany, which is included in our International Consulting
reporting unit, filed for bankruptcy. The provisions of SFAS 142 required that
we review goodwill associated with our International Consulting reporting unit
as a result of the bankruptcy filing. Based on the analysis of goodwill
associated with the International Consulting reporting unit it was determined
that impairment existed at December 31, 2002. As a result we have reduced
goodwill for our International Reporting Unit which was recorded in connection
with the acquisition of NRCC by approximately $561,000 for the year ended
December 31, 2002.
On September 16, 1999, we completed the sale of 1,242,000 shares of our
common stock to Cisco at $12.00 per share for net proceeds of approximately
$14.2 million.
On September 22, 1999, we completed the sale of 94,867 and 18,133
shares of our common stock to General Atlantic Partners 57, L.P., and GAP
Coinvestment Partners II, L.P., respectively, at $12.00 per share for net
proceeds of approximately $1.4 million.
On November 1, 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 to us of approximately $75.1 million after deducting underwriter
discounts and commissions, and other expenses paid by us.
On April 5, 2000, we consummated a follow-on public offering for 3.8
million shares of our common stock at $43.00 per share, of which 1.0 million
shares were sold by us, while the reminder were sold by our stockholders,
resulting in net proceeds to us of approximately $39.8 million after deducting
underwriter discounts and commissions, and other expenses paid by us.
On October 16, 2000, we acquired Synet Service Corporation ("Synet")
for an aggregate purchase price, valued at the time of the transaction, of
approximately $33.4 million. The purchase price was paid in the form of
1,922,377 shares of our common stock, options to purchase 242,459 shares of our
common stock and $9.0 million in cash, including certain transaction expenses,
in exchange for all of the outstanding capital stock of Synet. The acquisition
was accounted for as a purchase and resulted in intangible assets of
approximately $33.4 million representing customer lists, workforce and the
excess of the purchase price over the fair value of the net tangible assets
acquired. During 2001, we adjusted the purchase price by $23,000 for the closing
of certain offices and a reduction in workforce in connection with the
acquisition plan and to adjust the final purchase price allocation. In the third
quarter of fiscal 2001, we reviewed goodwill and the intangible assets for
impairment due to revenue declines in this business in relation to prior periods
and forecasted earnings and to the overall deterioration of market conditions in
the enterprise sector. As a result of this review, an impairment loss of $18.2
million was recognized for the difference between the estimated value of Synet
based on future discounted cash flows and the carrying amount of its assets and
liabilities, including goodwill. Subsequent to the acquisition and until the
adoption of Statement of Financial Accounting Standards No. 142, "Goodwill and
Intangible Assets," (SFAS 142) on January 1, 2002, goodwill and the intangible
assets were being amortized on a straight-line basis over periods of three to
five years. Upon adoption of SFAS 142, we evaluated goodwill for impairment and
determined that impairment existed as of January 1, 2002. Of the impairment
charge recorded, approximately $7.0 million pertained to goodwill associated
with the acquisition of Synet. Such impairment charge is included in the
cumulative effect of change in accounting principle. Given the continuing
decline in our revenues and market capitalization and the overall deterioration
of market conditions in the enterprise sector, we also reviewed our long-lived
assets for impairment during 2002 in accordance with the provisions of Statement
of Financial Accounting Standards No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" (SFAS 144). Based on this review, we recognized
an impairment charge to reduce the carrying value of our finite lived intangible
assets, of which approximately $517,000 pertained to intangibles recorded in
connection with the acquisition of Synet.
22
On December 14, 2000, we acquired Global Integrity Corporation ("Global
Integrity") for an aggregate purchase price, valued at the time of the
transaction, of approximately $78.3 million. The purchase price was paid in the
form of 5,240,275 shares of our common stock, options to purchase 551,048 shares
of common stock and $31.5 million in cash, including certain transaction
expenses in exchange for all of the outstanding capital stock of Global
Integrity. The acquisition was accounted for as a purchase and resulted in
intangible assets of approximately $81.1 million representing customer lists,
workforce, trade names, developed technology and the excess of the purchase
price over the fair value of the net tangible assets acquired. During 2001, we
adjusted the purchase price by $3.3 million for the closing of certain offices
and a reduction in workforce in connection with the acquisition plan and to
adjust the final purchase price allocation. In the third quarter of fiscal 2001,
we reviewed goodwill and the intangible assets for impairment due to revenue
declines in this business in relation to prior periods and forecasted earnings
and to the overall deterioration of market conditions in the enterprise sector.
As a result of this review, an impairment loss of $42.3 million was recognized
for the difference between the estimated value of Global Integrity based on
future discounted cash flows and the carrying amount of its assets and
liabilities, including goodwill. Subsequent to the acquisition and until the
adoption of SFAS 142 on January 1, 2002, goodwill and the intangible assets were
being amortized on a straight-line basis over periods of three to five years.
Upon adoption of SFAS 142, we evaluated goodwill and our tradename intangible
for impairment and determined that impairment existed as of January 1, 2002. Of
the impairment charge recorded, approximately $16.3 million pertained to
goodwill and tradenames associated with the acquisition of Global Integrity.
Such impairment charge is included in the cumulative effect of change in
accounting principle. Given the continuing decline in our revenues and market
capitalization and the overall deterioration of market conditions in the
enterprise sector, we also reviewed our long-lived assets for impairment during
2002 in accordance with the provisions of SFAS 144. Based on this review, we
recognized an impairment charge to reduce the carrying value of our finite lived
intangible assets, of which approximately $8.2 million pertained to intangibles
recorded in connection with the acquisition of Global Integrity.
In February 2001, our management foresaw the need to lower the
operating costs of the business given its near-term revenue projections.
Therefore, we established a plan that included the following: (1) a reduction in
our workforce for both domestic and international operations related to
professional consultant employees that had been underutilized for several months
and also to employees that held various management, sales and administrative
positions deemed to be duplicative functions; (2) the closing of several
domestic and international regional offices located in geographic areas that no
longer cost justified remaining open; and (3) the discontinuance of electronic
equipment leases and other expenses related to the reduction in workforce.
For the year ended December 31, 2001, we recorded restructuring charges
of $9.3 million in connection with our 2001 restructuring plan. Such charges
consisted of $3.4 million in severance benefits and other related expenses for a
reduction in headcount of 251 employees and $5.9 million in exit costs related
to real estate and electronic equipment.
In December 2001, we formed a strategic alliance with an unaffiliated
third party (the "Alliance Partner") to outsource the monitoring services
provided by our Managed Security Services division. As a result of this
alliance, we established a restructuring plan that included the following: (1) a
reduction of our workforce; (2) the write-off of equipment and software
development costs associated with our security operations center which was no
longer needed as a result of the outsourcing; and (3) non-recoverable costs
incurred to convert clients to the Alliance Partner.
For the year ended December 31, 2001, we reduced headcount by 12
employees and recorded restructuring charges of $4.4 million in connection with
the outsourcing of our monitoring services. Such charges consisted of $315,000
in severance benefits, $798,000 in non-recoverable costs to convert clients to
the Alliance Partner and other related charges, and $3.3 million for the
write-off of equipment and software development costs associated with our
security operations center, which was no longer needed as a result of the
outsourcing.
In 2002, we reversed $433,000 of the restructuring charges previously
accrued in 2001 in connection with the outsourcing of our monitoring services.
Of this amount, $150,000 was received from the sale of equipment previously
written-off and an additional $283,000 was reversed for accruals, which were no
longer considered necessary.
In January 2002, our management foresaw the need to continue to lower
the operating costs of the business given continuing difficult market
conditions. Therefore, we established a 2002 restructuring plan that included
the following: (1) a reduction in our workforce for both domestic and
international operations related to professional consultant employees that had
been underutilized for several months and also to employees that held various
management, sales and administrative positions deemed to be duplicative
functions; (2) the closing of additional domestic regional offices located in
geographic areas that no longer cost justified remaining open; and (3) the
discontinuance of electronic equipment leases and other expenses related to the
reduction in workforce.
For the year ended December 31, 2002, we recorded restructuring charges
of $5.9 million in connection with our 2002 restructuring plan. Such charges
consisted of $3.3 million in severance benefits and other related expenses for a
reduction in headcount of 156 employees, $2.3 million in exit costs related to
real estate and electronic equipment leases for the closing of domestic offices,
and an increase to previously accrued exit costs in the amount of $181,000
resulting from favorable and unfavorable settlements and changes to subtenant
assumptions for leased domestic offices.
In December 2002, our subsidiary in Germany, Predictive AG, filed for
bankruptcy resulting in the termination of the German operations. As a result,
we recorded a restructuring charge equal to the net assets of Predictive AG in
the amount of $284,000 and recorded an additional $25,000 in legal costs
associated with the bankruptcy.
23
Critical Accounting Policies and Estimates
This discussion and analysis of our financial condition and results of
operations are based on our consolidated financial statements that have been
prepared under generally accepted accounting principles. The preparation of
financial statements in conformity with generally accepted accounting principles
requires our management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenue and expenses during the reporting period. Actual results
could materially differ from those estimates. We have disclosed all significant
accounting policies in Note 2 to the consolidated financial statements included
in this Annual Report on Form 10-K. The consolidated financial statements and
the related notes thereto should be read in conjunction with the following
discussion of our critical accounting policies. Our critical accounting policies
and estimates are:
o Revenue recognition
o Valuation of goodwill, intangible assets and other long-lived
assets
o Stock based compensation
o Income taxes
Revenue Recognition: We currently recognize revenue from professional
services. As described below, significant management judgments and estimates
must be made and used in determining the amount of revenue recognized in any
given accounting period. Material differences may result in the amount and
timing of our revenue for any given accounting period depending upon judgments
made or estimates utilized by management.
We recognize revenue for fixed price contracts in accordance with AICPA
Statement of Position 81-1, "Accounting for Performance of Construction Type and
Certain Production Type Contracts." When reliable estimates are available for
the costs and efforts necessary to complete the consulting services and those
services do not include contractual milestones or other acceptance criteria, we
recognize revenue under the percentage of completion method based upon input
measures, such as direct labor hours. When such estimates are not available, we
defer all revenue recognition until we have completed the contract and have no
further obligations to the customer. Periodically we may encounter changes in
the number of hours or other costs estimated to complete a project. When such
circumstances occur, we make adjustments to the cost and profitability estimates
for the contract in the period in which the changes become known. If such
revisions indicate a loss will be incurred on the contract, we record the entire
loss at such time. Under each arrangement, revenues are recognized when an
agreement has been signed and the customer acknowledges an unconditional
obligation to pay, the services have been delivered, there are no uncertainties
surrounding customer acceptance, the fees are fixed and determinable, and
collection is considered probable.
Goodwill and Indefinite Lived Intangibles: Goodwill consists of the
excess purchase price over the fair value of identifiable net assets of acquired
businesses. Indefinite lived intangibles consist of our tradename intangible.
The carrying value of goodwill and indefinite lived intangibles are evaluated
for impairment on an annual basis. We also review goodwill and indefinite lived
intangibles for impairment whenever events or changes in circumstances indicate
that their carrying amount may be impaired. If the carrying value of goodwill
exceeds its implied value an impairment loss is recognized for an amount equal
to the excess of the carrying value over the implied value. If the carrying
amount of an indefinite lived intangible asset exceeds its fair value, an
impairment loss shall be recognized in an amount equal to that excess. Our
reporting units utilized for evaluating the recoverability of goodwill and the
indefinite lived intangibles are the same as our operating segments. Upon
adoption of Statement of Financial Accounting Standards No. 142, "Goodwill and
Other Intangible Assets" (SFAS 142), we evaluated goodwill and our tradename
intangible for impairment as required by that statement and determined that an
impairment of $23.3 million existed at January 1, 2002. This impairment has been
recorded in the financial statements as a cumulative effect of a change in
accounting principle. An independent third party valuation specialist using a
combination income and market approach determined the estimated fair value of
our reporting units and our tradename intangible at January 1, 2002. In December
2002, our German subsidiary, which is included in our International Consulting
reporting unit, filed for bankruptcy. The provisions of SFAS 142 required that
we review goodwill associated with our International Consulting reporting unit
for impairment as a result of the bankruptcy filing. Based on this review by an
independent third party valuation specialist using a combined income and market
approach it was determined that an impairment of $561,000 existed at December
31, 2002 related to the goodwill of the International Consulting reporting unit.
Long-Lived Assets: Long-lived assets, including finite lived intangible
assets, are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of the asset or asset group may not be
recoverable. An impairment loss is recognized if the carrying amount of a
long-lived asset group is not recoverable. The carrying amount of a long-lived
asset group is not recoverable if it exceeds the sum of the undiscounted cash
flows expected to result from the use and eventual disposition of the asset
group. An impairment loss is measured as the amount by which the carrying amount
of a long-lived asset group exceeds its fair value. Given the projected
operating performance over the remaining useful lives of the finite lived
intangible assets and other long-lived assets for the US Consulting and Managed
Security Services reporting units, it was determined that the carrying values of
these assets were not recoverable. As a result, we recorded an impairment charge
during 2002 related to finite lived intangibles and property and equipment of
$8.7 million and $4.5 million, respectively. The fair values of the asset groups
were determined based on the discounted cash flows expected to be generated from
such asset groups over the estimated remaining useful life of the principle
asset in each group.
24
Stock-Based Compensation: In October 2002, we adopted the fair value
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" (SFAS 123). Prior to the adoption of SFAS 123, we
accounted for our stock-based compensation arrangements with our employees using
the intrinsic value method in accordance with the provisions of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB
25), and complied with the disclosure provisions of SFAS 123. SFAS 123
established a fair-value-based method of accounting for stock-based compensation
plans. Pursuant to the transition provisions of SFAS 123, we are required to
apply the fair value method of accounting to all option grants issued or
modified on or after January 1, 2002. The fair value method will not be applied
to stock option awards granted in fiscal years prior to 2002. Such awards will
continue to be accounted for under the intrinsic value method pursuant to APB
25, except to the extent that prior years' awards are modified subsequent to
January 1, 2002. As a result of adoption of SFAS 123, we recorded an additional
charge to noncash charges for stock based compensation and services of
approximately $210,000 for the year ended December 31, 2002. The Black-Scholes
option-pricing model was used to determine the estimated fair value of stock
options issued and modified during 2002. The use of this model required
management to make certain estimates for values of variables used by the model.
Management estimated the values for stock price volatility, the expected life of
the equity instruments and the risk free rate based on information that was
available to management at the time the Black-Scholes option-pricing
calculations were performed.
Income Taxes: Operating losses in prior periods have generated
significant state and federal tax net operating losses, or NOL carryforwards.
Generally accepted accounting principles in the United States require that we
record a valuation allowance against the deferred tax asset associated with this
NOL if it is "more likely than not" that we will not be able to utilize it to
offset future taxes. Due to our history of unprofitable operations and our
expected losses for the foreseeable future, we have recorded a valuation
allowance equal to 100% of these deferred tax assets. It is possible, however,
that we could be profitable in the future at levels which would cause management
to conclude that it is more likely than not that we will realize all or a
portion of the NOL carryforward. Upon reaching such a conclusion, we would
record the estimated net realizable value of the deferred tax asset at that time
and would then provide for income taxes at a rate equal to our combined federal
and state effective rates. Subsequent revisions to the estimated net realizable
value of the deferred tax asset could cause our provision for income taxes to
vary significantly from period to period, although our cash tax payments would
remain unaffected until the benefit of the NOL is utilized.
Results of Operations
The following table sets forth certain financial data for the periods
indicated expressed as a percentage of total revenues:
December 31,
--------------------------------
2002 2001 2000
-------- -------- ---------
Revenues:
Professional services ............................................... 89.9% 94.5% 93.6%
Reimbursed expenses.................................................. 2.5 2.7 3.2
Hardware and software sales ......................................... 7.6 2.8 3.2
------- ------- -------
Total revenues..................................................... 100.0 100.0 100.0
Cost of Revenues:
Professional services ............................................... 63.4 72.0 52.0
Reimbursed expenses.................................................. 2.5 2.7 3.2
Hardware and software .............................................. 6.9 3.0 2.4
------- ------- -------
Total cost of revenues............................................. 72.8 77.7 57.6
------- ------- -------
Gross profit.......................................................... 27.2 22.3 42.4
Operating Expenses:
Selling and marketing ............................................... 16.0 22.6 13.5
General and administrative .......................................... 40.8 60.0 35.4
Depreciation and amortization ....................................... 3.4 4.1 1.8
Intangibles amortization ............................................ 3.9 31.3 3.2
Loss on equipment.................................................... -- 0.6 --
Impairment of goodwill and intangibles............................... 18.6 86.3 --
Impairment of property and equipment................................. 9.0 -- --
Restructuring and other charges...................................... 14.9 20.9