UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDING March 31, 2003.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
____________________ TO ____________________.
COMMISSION FILE NUMBER: 000-30422
PREDICTIVE SYSTEMS, INC.
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(Exact Name of Registrant as Specified in its Charter)
DELAWARE 13-3808483
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(State or other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
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)
Check whether the registrant: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of May 12, 2003, there were 38,099,978 shares of the registrant's common
stock, $.001 par value per share, outstanding.
INDEX
PREDICTIVE SYSTEMS, INC.
Page
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PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets as of March 31, 2003
(unaudited) and December 31, 2002 ........................ 1
Consolidated Statements of Operations for the three
months ended March 31, 2003 (unaudited) and 2002
(unaudited)............................................... 2
Consolidated Statements of Cash Flows for the three months
ended March 31, 2003 (unaudited) and 2002
(unaudited)............................................... 3
Notes to Consolidated Financial Statements (unaudited) ... 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS ..................... 11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK .................................................... 25
ITEM 4. CONTROLS AND PROCEDURES................................... 25
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS ........................................ 26
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS ................ 26
ITEM 3. DEFAULTS UPON SENIOR SECURITIES .......................... 26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ...... 26
ITEM 5. OTHER INFORMATION ........................................ 26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ......................... 26
ITEM 7. SIGNATURES ............................................... 28
PART 1. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
PREDICTIVE SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
March 31, 2003 December 31, 2002
-------------- -----------------
(unaudited)
ASSETS
Current assets
Cash and cash equivalents $ 17,630,779 $ 19,464,669
Restricted cash 849,710 1,364,781
Accounts receivable - net of allowance for
doubtful accounts of $1,224,389 and $1,722,078, respectively 3,617,047 3,805,602
Related party receivables 242,814 548,704
Unbilled revenues 1,648,569 1,922,870
Work in process - hardware and software -- 237,984
Receivables from employees and stockholders 21,174 14,793
Refundable income taxes 218,540 282,913
Prepaid expenses and other current assets 964,858 1,654,809
------------- -------------
Total current assets 25,193,491 29,297,125
Property and equipment - net of accumulated
depreciation and amortization of $583,641 and $722,118, respectively 299,726 306,343
Goodwill 1,669,801 1,669,801
Restricted cash 504,000 504,000
Other assets 445,850 432,678
------------- -------------
Total assets $ 28,112,868 $ 32,209,947
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 920,269 $ 619,842
Accrued expenses and other current liabilities 3,053,561 5,579,670
Deferred revenue 726,346 1,373,691
Current portion of capital lease obligations 42,901 48,969
------------- -------------
Total current liabilities 4,743,077 7,622,172
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Noncurrent liabilities
Capital lease obligations -- 8,610
Deferred rent 118,674 113,344
------------- -------------
Total noncurrent liabilities 118,674 121,954
------------- -------------
Total liabilities 4,861,751 7,744,126
------------- -------------
Commitments and contingencies
Stockholders' equity
Common stock, $.001 par value, 200,000,000 shares authorized,
38,171,687 and 37,633,856 shares issued and outstanding, respectively 38,172 37,634
Additional paid-in capital 230,822,618 230,560,837
Deferred compensation (166,883) (14,238)
Accumulated deficit (207,673,085) (206,316,789)
Accumulated other comprehensive income 230,295 198,377
------------- -------------
Total stockholders' equity 23,251,117 24,465,821
------------- -------------
Total liabilities and stockholders' equity $ 28,112,868 $ 32,209,947
============= =============
The accompanying notes are an integral part of these
consolidated financial statements.
PREDICTIVE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended March 31,
-------------------------------
2003 2002
------------ ------------
Revenues:
Professional services $ 7,474,692 $ 14,105,923
Reimbursed expenses 159,262 401,161
Hardware and software sales 629,096 523,483
------------ ------------
Total revenues 8,263,050 15,030,567
------------ ------------
Costs of revenues (excluding noncash compensation
expense of $21,777 and $18,814, respectively)
Professional services 4,889,311 10,171,336
Reimbursed expenses 159,262 401,161
Hardware and software 416,280 493,159
------------ ------------
Total cost of revenues 5,464,853 11,065,656
------------ ------------
Gross profit 2,798,197 3,964,911
------------ ------------
Sales and marketing (excluding noncash charges for stock-based
compensation and services of $18,723 and $3,618, respectively) 1,034,687 2,742,051
General and administrative (excluding noncash charges for stock-based
compensation and services of $65,824 and $13,187, respectively) 2,674,271 6,441,038
Depreciation and amortization 62,310 774,402
Intangibles amortization -- 980,250
Restructuring and other charges 324,270 933,502
Noncash charges for stock-based compensation and services 106,324 35,619
------------ ------------
Total operating expenses 4,201,862 11,906,862
------------ ------------
Operating loss (1,403,665) (7,941,951)
Other income (expense):
Interest income 53,782 148,834
Other expense, net (2,339) (445,568)
Interest expense (4,074) (13,586)
------------ ------------
Loss before cumulative effect of change in
accounting principle (1,356,296) (8,252,271)
Cumulative effect of change in accounting principle -- (23,307,626)
------------ ------------
Net loss $ (1,356,296) $(31,559,897)
============ ============
Basic and diluted loss per common share before
cumulative effect of change in accounting principle $ (0.04) $ (0.22)
Cumulative effect of change in accounting principle -- (0.63)
------------ ------------
Basic and diluted net loss per common share $ (0.04) $ (0.85)
============ ============
Basic and diluted weighted average common
shares outstanding 38,147,677 36,980,895
============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
PREDICTIVE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended March 31,
-------------------------------
2003 2002
------------ ------------
Cash flows from operating activities:
Net loss $ (1,356,296) $(31,559,897)
Adjustments to reconcile net loss to net cash used in operating activities:
Noncash charges for stock-based compensation and services 106,324 35,619
Depreciation and amortization 62,310 1,754,652
Cumulative effect of change in accounting principle -- 23,307,626
Decrease (increase) in -
Restricted cash 515,070 (554,657)
Accounts receivable 494,445 654,553
Unbilled revenues 274,300 (570,647)
Advances under system integrator agreement -- 465,750
Refundable income taxes 64,373 (31,181)
Prepaid expenses and other current assets 927,936 428,035
Other assets (13,180) (228,457)
Increase (decrease) in -
Accounts payable 300,427 (1,452,486)
Accrued expenses and other current liabilities (2,526,100) (2,110,608)
Deferred revenue (647,344) 104,057
Deferred rent and other long-term liabilities 5,330 34,829
------------ ------------
Net cash used in operating activities (1,792,405) (9,722,812)
------------ ------------
Cash flows from investing activities:
Purchase of marketable securities, net -- (1,343)
Loans to employees, net (6,381) (12,802)
Purchase of property and equipment, net (55,693) (491,510)
------------ ------------
Net cash used in investing activities (62,074) (505,655)
------------ ------------
Cash flows from financing activities:
Proceeds from issuance of restricted stock to officers 525 --
Principal payments on capital lease obligations (14,677) (21,532)
Proceeds from exercise of stock options 2,823 738,916
------------ ------------
Net cash (used in) provided by financing activities (11,329) 717,384
------------ ------------
Effects of exchange rates 31,918 392,670
------------ ------------
Net decrease in cash and cash equivalents (1,833,890) (9,118,413)
Cash and cash equivalents - beginning of period 19,464,669 41,277,867
------------ ------------
Cash and cash equivalents - end of period $ 17,630,779 $ 32,159,454
============ ============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 4,074 $ 13,586
============ ============
Taxes $ 28,517 $ 33,098
============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
PREDICTIVE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(1) BASIS OF PRESENTATION
Interim Financial Statements
The consolidated financial statements and accompanying financial information as
of March 31, 2003 and for the three months ended March 31, 2003 and 2002 are
unaudited and, in the opinion of management, include all adjustments (consisting
only of normal recurring adjustments) which Predictive Systems, Inc. (the
"Company" or "Predictive") considers necessary for a fair presentation of the
financial position of the Company at such dates and the operating results and
cash flows for those periods. The financial statements included herein have been
prepared in accordance with generally accepted accounting principles in the
United States of America and the instructions of Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles in the United States of America have been
condensed or omitted. These financial statements should be read in conjunction
with the Company's financial statements contained in its Annual Report on Form
10-K for the year ended December 31, 2002. Results for interim periods are not
necessarily indicative of results for the entire year.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Recently Issued Accounting Pronouncements
In July 2001, the FASB issued Statement of Financial Accounting Standard No.
143, "Accounting for Asset Retirement Obligations" (SFAS 143), which is
effective for fiscal years beginning after June 15, 2002. SFAS 143 requires,
among other things, the accounting and reporting of legal obligations associated
with the retirement of long-lived assets that result from the acquisition,
construction, development or normal operation of a long-lived asset. The Company
adopted this pronouncement as of January 1, 2003, the effect of which was not
material to its consolidated results of operations or financial position.
In April 2002, the FASB issued Statement of Financial Accounting Standard No.
145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" (SFAS 145). This statement
eliminates the automatic classification of gain or loss on an extinguishment of
debt as an extraordinary item of income and requires that such gain or loss be
evaluated for extraordinary classification under the criteria of Accounting
Principles Board No. 30, "Reporting Results of Operations." This statement also
requires sales-leaseback accounting for certain lease modifications that have
economic effects that are similar to sales-leaseback transactions, and makes
various other technical corrections to existing pronouncements. The Company
adopted this pronouncement as of January 1, 2003, the effect of which was not
material to its consolidated results of operations or financial position.
In July 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities" (SFAS 146). SFAS 146 will supersede EITF No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS
146 requires that costs associated with an exit or disposal plan be recognized
when incurred rather than at the date of commitment to an exit or disposal
plan. SFAS 146 is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. The Company adopted this pronouncement
effective January 1, 2003. The adoption of this pronouncement did not have a
material impact on the Company's consolidated results of operations or financial
position.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness to Others" which elaborates on the disclosures to be made by a
guarantor in its interim and annual financial statements about its obligations
under certain guarantees that it has issued. It also clarifies that a guarantor
is required to recognize, at the inception of a guarantee, a liability for the
fair value of the obligation undertaken in issuing the guarantee. The initial
recognition and measurement provisions of this Interpretation are applicable on
a prospective basis to guarantees issued or modified after December 31, 2002.
The disclosure requirements in this Interpretation are effective for financial
statements of interim or annual periods ending after December 15, 2002. The
Company has provided information regarding commitments and contingencies
relating to guarantees in Note 11. The Company adopted the initial recognition
and measurement provisions of this Interpretation January 1, 2003. The adoption
of these provisions did not have a material impact on the Company's consolidated
results of operations or financial position.
In December 2002, the FASB issued Statement of Financial Accounting Standard No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an
amendment of FASB Statement No. 123" (SFAS 148). SFAS 148 amends Statement of
Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation"
(SFAS 123) to provide alternative methods to account for the transition from the
intrinsic value method of recognition of stock-based employee compensation in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees", to the fair value recognition provisions under SFAS
123. The Company adopted the recognition provisions of SFAS 123 as of January 1,
2002 pursuant to the prospective method of adoption required by SFAS 123. SFAS
148 provides two additional methods of transition and will no longer permit the
SFAS 123 prospective method to be used for fiscal years beginning after December
15, 2003. In addition, SFAS 148 amends the disclosure requirements of SFAS 123
to require prominent disclosure in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the pro
forma effects had the fair value recognition provisions of SFAS 123 been used
for all periods presented. The Company has adopted the annual disclosure
provisions of SFAS 148. The adoption of SFAS 148 did not have a significant
impact on the Company's consolidated results of operations or financial
position.
In April 2003, the FASB issued Statement of Financial Accounting Standard No.
149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities" (SFAS 149). SFAS 149 amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives), and for
hedging activities under Statement of Financial Accounting Standard No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). This
statement is effective for contracts entered into or modified after June 30,
2003 and for hedging relationships after June 30, 2003. All provisions of SFAS
149 should be applied prospectively. The adoption of SFAS 149 will not have a
significant impact on the Company's consolidated results of operations or
financial position.
Stock-Based Compensation
In October 2002, the Company adopted the fair value provisions of Statement of
Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation"
(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, the Company was required to apply the fair value method of accounting to
all equity instruments issued to employees on or after January 1, 2002. The fair
value method is not 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 were or
are modified subsequent to January 1, 2002. Therefore, the cost related to
stock-based employee compensation included in the determination of the net loss
for the three months ended March 31, 2003 and 2002 is less than that which would
have been recognized if the fair-value-based method had been applied to all
awards since their date of grant. The following table illustrates the effect on
net loss and net loss per common share if the fair-value-based method had been
applied to all outstanding and unvested awards in each period.
Three Months Ended March 31,
-------------------------------
2003 2002
------------ ------------
Net loss - as reported $ (1,356,296) $(31,559,897)
Add: Stock-based employee
compensation expense included
in reported net loss, net of related
tax effects 106,324 35,619
Deduct: Total stock-based employee
compensation expense determined
under fair-value-based method
for all awards, net of related tax effects (283,643) (2,248,368)
------------ ------------
Net loss - proforma $ (1,533,615) $(33,772,646)
============ ============
Basic and diluted net loss per common share - as
reported $ (0.04) $ (0.85)
============ ============
Basic and diluted net loss per common share - proforma $ (0.04) $ (0.91)
============ ============
(3) NET LOSS PER SHARE
Basic net loss per share is computed by dividing net loss by the weighted
average number of common shares outstanding. Diluted net loss per share reflects
the potential dilution that would occur if securities or other contracts to
issue common stock were exercised or converted into common stock, unless they
are anti-dilutive.
Potential common shares of 8,853,221 and 11,308,784 representing outstanding
options as of March 31, 2003 and 2002, respectively, were not considered in the
calculation of diluted net loss per common share for the respective three month
period ended March 31, 2003 and 2002 as the effect would be anti-dilutive.
(4) COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss) for the three months ended March
31, 2003 and 2002 are as follows:
Three Months Ended
March 31,
-------------------------------
2003 2002
------------ ------------
(unaudited)
Net loss $ (1,356,296) $(31,559,897)
Unrealized loss on investments -- (1,343)
Foreign currency translation adjustment 31,918 392,670
------------ ------------
Comprehensive loss $ (1,324,378) $(31,168,570)
============ ============
(5) BUSINESS CONCENTRATIONS AND CREDIT RISK
Financial instruments, which subject the Company to concentrations of credit
risk, consist primarily of cash and cash equivalents and accounts receivable.
The Company maintains cash and cash equivalents with various financial
institutions. The Company performs periodic evaluations of the relative credit
standing of these institutions. The Company's clients are primarily concentrated
in the United States. The Company generally does not require collateral and
establishes an allowance for doubtful accounts based upon factors surrounding
the credit risk of customers, historical trends and other information. For the
three months ended March 31, 2003, the Company reversed bad debt expense of
$350,000 based on the Company's collection of certain receivables whose
collection had been considered doubtful due to their age.
For the three months ended March 31, 2003 and 2002, approximately 6.7% and 15.4%
of revenues before reimbursed expenses, respectively, were from BellSouth who is
a related party (Note 7). Pfizer accounted for approximately 19.1% and 12.3% of
revenues before reimbursed expenses for the three months ended March 31, 2003
and 2002, respectively. There were no other customers that accounted for more
than 10% of revenues before reimbursed expenses for the three months ended March
31, 2003 and 2002. The amounts due from BellSouth at March 31, 2003 and December
31, 2002 were $214,087 and $524,977, respectively. The amounts due from Pfizer
at March 31, 2003 and December 31, 2002 were $183,299 and $341,832,
respectively. For the three months ended March 31, 2003 and 2002, the Company's
five largest customers accounted for approximately 47.7% and 43.3% of revenues
before reimbursed expenses, respectively.
(6) GOODWILL AND INTANGIBLE ASSETS
On January 1, 2002, the Company adopted the provisions of Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS 142).
SFAS 142 requires that upon adoption, amortization of goodwill and indefinite
lived intangible assets cease, and instead, the carrying value of goodwill and
indefinite lived intangible assets be evaluated for impairment on at least an
annual basis. SFAS 142 also requires the goodwill of each reporting unit to be
tested for impairment as of the beginning of the fiscal year in which this
statement is initially applied. The Company's reporting units utilized for
evaluating the recoverability of goodwill are the same as its operating
segments. The Company evaluated goodwill and its tradename intangible asset for
impairment as of January 1, 2002 and determined that an impairment of
$23,307,626 existed at that date. This impairment charge has been reflected as a
cumulative effect of a change in accounting principle in the consolidated
statement of operations for the three months ended March 31, 2002. An
independent third party valuation specialist using a combined income and market
approach determined the fair value of the Company's reporting units. The
impairment charge resulted from a continued decline in the Company's revenues
and a reduction in the expected future cash flows to be generated from
operations.
There were no changes in the carrying value of goodwill during the three months
ended March 31, 2003.
The aggregate amortization expense for intangible assets was $980,250 for the
three months ended March 31, 2002.
(7) RELATED PARTIES
In June 2002, the Company entered into a consulting agreement with Meyer Capital
Partners LLC to assist management of the Company in the analysis, valuation and
screening process of potential merger and/or acquisition opportunities. A
director of the Company is the managing member of Meyer Capital Partners LLC. In
2003, the Company granted Meyer Capital Partners LLC options to purchase 40,000
shares of the Company's common stock pursuant to the terms of the consulting
agreement. The fair value of these options has been recorded as consulting
expense during 2003. For the three months ended March 31, 2003, the Company
recognized expense of $30,000 for consulting services. As of March 31, 2003 and
December 31, 2002, the amount due to Meyer Capital Partners LLC was $10,000.
Such amount is included in accounts payable and accrued expenses and other
current liabilities, respectively.
The Company provides network consulting services to Cisco Systems, Inc.
("Cisco") pursuant to a consulting services agreement. This agreement provides
that if the Company gives more favorable rates to another client it will inform
Cisco and Cisco will have the right to terminate this agreement. One of the
Company's directors is also an officer of Cisco. Additionally, in September
1999, the Company sold 1,242,000 shares of common stock to Cisco for $12.00 per
share. For the three months ended March 31, 2002, the Company recognized
revenues of approximately $15,000 from services performed for Cisco. For the
three months ended March 31, 2003 no revenues were recognized from services
performed for Cisco. As of March 31, 2003 and December 31, 2002, amounts due
from Cisco were $5,447 and $447, respectively. Such amounts are included in
related party receivables.
The Company provides network consulting services to BellSouth Corporation
("BellSouth") pursuant to a consulting services agreement. One of the Company's
directors is also an officer of BellSouth. For the three months ended March 31,
2003 and 2002, the Company recognized revenues of approximately $544,000 and
$2,263,000, respectively, from services performed for BellSouth. As of March 31,
2003 and December 31, 2002, amounts due from BellSouth were $214,087 and
$524,977, respectively. Such amounts are included in related party receivables.
The Company and Science Applications International Corporation ("SAIC") provide
network and security consulting services to each other pursuant to existing
agreements. For the three months ended March 31, 2003 and 2002, revenues from
SAIC were approximately $2,000 and $77,000, respectively. For the three months
ended March 31, 2002, the Company purchased approximately $4,000 in consulting
services from SAIC. There were no purchases of consulting services from SAIC for
the three months ended March 31, 2003. Additionally, SAIC provided the Company
with various services relating to alarm, telecommunications and IT support
functions and the Company rented certain of its office space from SAIC. For the
three months ended March 31, 2002, the Company paid approximately $272,000 for
such services and the rental of office space. Of the amounts paid for the three
months ended March 31, 2002, approximately $175,000 was expensed. The remaining
amounts paid in 2002 were accrued in 2001 in connection with the Company's
acquisition plan. There were no amounts paid or expensed for the three months
ended March 31, 2003. In addition, the Company and SAIC license certain of their
respective intellectual property to the other. As of March 31, 2003 and December
31, 2002, amounts due from SAIC were $23,280. Such amount is included in related
party receivables. On April 10, 2003, the Company agreed to sell certain
business units to SAIC (See Note 12).
Receivables from employees and stockholders represent short term lending to such
parties entered into in the normal course of business.
(8) STOCKHOLDERS' EQUITY
Pursuant to the terms of their employment agreements, in January 2003, the
Company issued to two executives of the Company 375,000 and 150,000 shares of
restricted stock (the "Restricted Stock"), respectively, at a price of $0.001
per share. The Restricted Stock was issued under the terms and conditions set
forth in the 1999 Plan and a stock purchase agreement, and is subject to a
repurchase right by the Company at the per share purchase price paid by the
executive, which repurchase right shall lapse as to 25% of the Restricted Stock
on the first anniversary of January 2, 2003, and in thirty-six equal monthly
installments thereafter as long as the executive is employed by the Company. The
repurchase rights lapse in full in the event of a change in control of the
Company in which the 1999 Plan is not assumed by the acquirer. During the three
months ended March 31, 2003, the Company recognized compensation expense of
$11,125 and at March 31, 2003 has recorded deferred compensation of $166,883
related to these restricted stock issuances.
(9) RESTRUCTURING AND OTHER CHARGES
In December 2001, the Company formed a strategic alliance with an unaffiliated
third party (the "Alliance Partner") to outsource the monitoring services
provided by its Managed Security Services division. As a result of this
alliance, the Company established a restructuring plan that included the
following: (1) a reduction of the Company's workforce; (2) the write-off of
equipment and software development costs associated with the Company's security
operations center which was no longer needed as a result of the outsourcing; and
(3) nonrecoverable costs incurred to convert clients to the Alliance Partner.
In January 2002, the Company's management foresaw the need to continue to lower
the operating costs of the business given continuing difficult market conditions
in the enterprise sector. Therefore, the Company established a 2002
restructuring plan that included the following: (1) a reduction in its 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.
In December 2002, the Company's subsidiary in Germany, Predictive AG, filed for
bankruptcy resulting in the termination of the German operations. As a result,
the Company recorded a restructuring charge equal to the net assets of
Predictive AG in the amount of $284,266 and recorded an additional $25,000 in
legal costs associated with the bankruptcy. As of March 31, 2003 and December
31, 2002, restructuring charges of $25,000 in connection with the Predictive AG
bankruptcy remained unpaid and are included in accrued expenses and other
current liabilities on the accompanying consolidated balance sheet.
In January 2003, the Company's management foresaw the need to continue to lower
the operating costs of the business given continuing difficult market
conditions. Therefore, the Company has established a 2003 restructuring plan for
a further reduction in its workforce for both domestic and international
operations related to the professional consultant employees that had been
underutilized for several months.
For the three months ended March 31, 2003, the Company recorded restructuring
charges of $333,821 in connection with its 2003 restructuring plan and $26,000
in connection with its 2002 restructuring plan. Such charges pertained to
severance benefits and other related expenses for a reduction in headcount of 46
employees. These charges were offset by a reduction to previously accrued exit
costs in the amount of $35,551 resulting from the favorable settlement of a
leased domestic office. For the three months ended March 31, 2002, the Company
recorded restructuring charges of $933,502 in connection with its 2002
restructuring plan. Such charges consisted of $818,717 in severance benefits and
other related expenses for a reduction in headcount of 47 employees and $264,785
in exit costs related to real estate and electronic equipment for the closing of
domestic offices. These charges were offset by $150,000 received from the
disposition of equipment previously written-off in connection with the
outsourcing of the Company's monitoring division. These charges have been
reflected as operating expenses of the Company. As of March 31, 2003 and
December 31, 2002, restructuring charges, exclusive of the charges recorded in
connection with the Predictive AG bankruptcy, of $1,057,585 and $2,488,767,
respectively, remained unpaid in connection with the Company's restructuring
activities and are included in accrued expenses and other current liabilities on
the accompanying consolidated balance sheet. The restructuring charges recorded
in connection with the 2003 restructuring plan were recognized as incurred in
accordance with the provisions of SFAS 146 whereas the restructuring charges
recorded in connection with the 2002 restructuring plan and the outsourcing of
the Company's monitoring division were recognized at the date of commitment to
an exit or disposal plan in accordance with EITF No. 94-3.
A summary of the restructuring and other charges for the three months ended
March 31, 2003 and 2002 is as follows:
Balance as Restructuring Balance as
of 12/31/02 Expense Cash of 3/31/03
---------------------------------------------------------------------
Severance and other related costs $ 582,993 $ 359,821 $ 747,554 $ 195,260
Exit costs 1,905,774 (35,551) 1,007,898 862,325
Predictive AG bankruptcy 25,000 --- --- 25,000
---------------------------------------------------------------------
$ 2,513,767 $ 324,270 $ 1,755,452 $ 1,082,585
=====================================================================
Balance as Restructuring Balance as
of 12/31/01 Expense Cash of 3/31/02
---------------------------------------------------------------------
Severance and other related costs $ 17,320 $ 818,717 $ 118,385 $ 717,652
Exit costs 1,115,996 264,785 839,544 541,237
Outsourcing monitoring services 722,224 (150,000) 186,439 385,785
---------------------------------------------------------------------
$ 1,855,540 $ 933,502 $ 1,144,368 $ 1,644,674
=====================================================================
(10) INDUSTRY SEGMENT INFORMATION
The Company's reportable segments are US Consulting, International Consulting,
and Managed Security Services. Revenues and cash flows in the US Consulting and
International Consulting segments are generated by providing the following
services: network design and engineering, network and systems management,
integrated customer service, performance management, information security, and
business integration services. Revenues and cash flows in the Managed Security
Services segment are generated by providing the following services: response,
threat advisory through Information Sharing and Analysis Centers, remote
monitoring and management of firewalls, and providing of Open Source
Intelligence programs.
The accounting policies for the segments are the same as those described in the
"Summary of Significant Accounting Policies," included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2002. The Company evaluates
the performance of its segments based on their operating income (loss), which
represents segment revenues less direct costs of operation, excluding the
allocation of corporate expenses. Identifiable assets of the operating segments
principally consist of net accounts receivable, unbilled revenues and
work-in-process hardware and software. Accounts receivable and unbilled revenues
for US Consulting and Managed Security Services are managed on a combined basis.
All other identifiable assets not attributable to industry segments are included
in corporate assets. The Company does not track expenditures for property and
equipment on a segment basis. The table below presents information on the
revenues and operating income (loss) for each segment for the three months ended
March 31, 2003 and 2002, and items which reconcile segment operating income
(loss) to the Company's reported loss before cumulative effect of change in
accounting principle.
Three Months Ended March 31,
-------------------------------
2003 2002
------------ ------------
Revenues:
US Consulting $ 6,318,301 $ 10,865,134
International Consulting 1,277,449 2,214,234
Managed Security Services 667,300 1,951,199
------------ ------------
Total revenues 8,263,050 15,030,567
------------ ------------
Operating income (loss):
US Consulting 1,276,078 (111,191)
International Consulting 219,411 (62,846)
Managed Security Services 252,404 11,936
------------ ------------
Total operating income (loss) 1,747,893 (162,101)
------------ ------------
Corporate expenses:
Sales and marketing (434,395) (321,970)
General and administrative (2,224,259) (4,734,107)
Depreciation and amortization (62,310) (774,402)
Intangibles amortization -- (980,250)
Restructuring and other charges (324,270) (933,502)
Noncash charges for stock-based
compensation and services (106,324) (35,619)
Interest income 53,782 148,834
Other expense, net (2,339) (445,568)
Interest expense (4,074) (13,586)
------------ ------------
Total corporate expenses (3,104,189) (8,090,170)
------------ ------------
Loss before cumulative effect of change
in accounting principle $ (1,356,296) $ (8,252,271)
============ ============
The table below presents information on the revenues for our geographic
locations for the three months ended March 31, 2003 and 2002:
Three Months Ended March 31,
------------------------------
2003 2002
----------- -----------
Revenues:
North America $ 6,985,601 $12,816,333
Europe 1,277,449 2,214,234
----------- -----------
Total revenues $ 8,263,050 $15,030,567
=========== ===========
(11) COMMITMENTS AND CONTINGENCIES
Litigation
Except as set forth below, the Company is not a party to any material legal
proceedings.
Certain investment bank underwriters, the Company, and certain of the Company's
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 the Company's motion to dismiss certain of the claims in the complaint.
The Company believes it has meritorious defenses against the allegations in the
complaint and intends to defend the case vigorously.
In February 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 its 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. The Company denies the allegations of the complaint
and plans to vigorously defend the case.
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. The Company and ICG reached an
agreement to settle this claim for $350,000 in March 2003. This agreement is
subject to bankruptcy court approval.
Guarantees
In the normal course of business, the Company enters into contracts in which it
makes representations and warranties regarding the performance of its services
and that its services will not infringe on third party intellectual property
rights. Historically, there have been no significant losses related to such
representations and warranties and the Company expects these losses to be
minimal in the future.
The Company is required under the terms of certain lease agreements to provide
letters of credit. The credit facility agreement used to provide these financial
guarantees places restrictions on the Company's cash and cash equivalents. Cash
of $835,275 and $1,350,346, respectively, at March 31, 2003 and December 31,
2002 was pledged as collateral under this agreement. In August 2002, the Company
was required under the terms of a customer contract to provide a letter of
credit for the value of services to be performed. The credit facility agreement
used to provide this financial guarantee places restrictions on the Company's
cash and cash equivalents until the services are rendered to the customer. The
services are expected to be fully rendered by June 30, 2003. Cash of $518,435 as
of March 31, 2003 and December 31, 2002 was pledged as collateral under this
agreement.
(12) SUBSEQUENT EVENTS
On April 9, 2003, the Company and International Network Services Inc. ("INS"), a
leading provider of global network consulting and security services, announced a
definitive agreement under which INS will acquire the Company. Pursuant to the
terms of the agreement and pending shareholder approval, a wholly-owned
subsidiary of INS will merge with and into the Company. The Company will
continue operations as a wholly-owned subsidiary of INS. The total cash
consideration is expected to be $19,186,700. The $19,186,700 aggregate
consideration will be increased if and to the extent the Company's net assets at
closing determined in accordance with the merger agreement exceed the estimate
of net assets at closing as set forth in the merger agreement by more than
$1,250,000, and will be decreased if and to the extent the Company's net assets
at closing determined in accordance with the merger agreement are less than the
estimate of net assets at closing as set forth in the merger agreement by more
than $1,250,000. The estimate of net assets at closing set forth in the merger
agreement is $15,386,700. Pursuant to the merger agreement, certain proposed
actions regarding the Company's operations require the prior written consent of
INS. The merger agreement also requires that the Company pay INS a fee of
$600,000 should the merger agreement be terminated under certain circumstances.
On April 10, 2003, the Company entered into an Asset Purchase Agreement with
Science Applications International Corporation ("SAIC"), whereby the Company
agreed to sell to SAIC its Information Sharing and Analysis Centers and Open
Source Intelligence services business in exchange for 4,192,220 shares of its
common stock currently held by SAIC. Consummation of the asset sale is subject
to various conditions, including the receipt of certain third party consents.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS RELATING TO FUTURE EVENTS AND
FUTURE PERFORMANCE OF THE COMPANY WITHIN THE MEANING OF SECTION 27A OF THE
SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934,
INCLUDING, WITHOUT LIMITATION, STATEMENTS REGARDING THE COMPANY'S EXPECTATIONS,
BELIEFS, INTENTIONS OR FUTURE STRATEGIES THAT ARE SIGNIFIED BY THE WORDS
EXPECTS, ANTICIPATES, INTENDS, BELIEVES OR SIMILAR LANGUAGE. ACTUAL RESULTS
COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN SUCH FORWARD-LOOKING
STATEMENTS. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS DOCUMENT ARE BASED
ON INFORMATION AVAILABLE TO THE COMPANY ON THE DATE HEREOF, AND THE COMPANY
ASSUMES NO OBLIGATION TO UPDATE ANY FORWARD LOOKING STATEMENTS. THE COMPANY
CAUTIONS INVESTORS THAT ITS BUSINESS AND FINANCIAL PERFORMANCE ARE SUBJECT TO
SUBSTANTIAL RISKS AND UNCERTAINTIES. IN EVALUATING THE COMPANY'S BUSINESS,
PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE INFORMATION SET FORTH BELOW
UNDER THE CAPTION "RISK FACTORS" IN ADDITION TO THE OTHER INFORMATION SET FORTH
HEREIN AND ELSEWHERE IN THE COMPANY'S OTHER PUBLIC FILINGS WITH THE SECURITIES
AND EXCHANGE COMMISSION.
OVERVIEW
On April 9, 2003, we announced a definitive agreement under which International
Network Services Inc. ("INS"), a leading provider of global network consulting
and security services, will acquire us. Pursuant to the terms of the agreement
and pending shareholder approval, a wholly-owned subsidiary of INS will merge
with and into us. We will continue operations as a wholly-owned subsidiary of
INS. The total cash consideration is expected to be $19,186,700. The $19,186,700
aggregate consideration will be increased if and to the extent our net assets at
closing determined in accordance with the merger agreement exceed the estimate
of net assets at closing as set forth in the merger agreement by more than
$1,250,000, and will be decreased if and to the extent our net assets at closing
determined in accordance with the merger agreement are less than the estimate of
net assets at closing as set forth in the merger agreement by more than
$1,250,000. The estimate of net assets at closing set forth in the merger
agreement is $15,386,700. Pursuant to the merger agreement, certain proposed
actions regarding our operations require the prior written consent of INS. The
merger agreement also requires that we pay INS a fee of $600,000 should the
merger agreement be terminated under certain circumstances.
On April 10, 2003, we entered into an Asset Purchase Agreement with Science
Applications International Corporation ("SAIC"), whereby we agreed to sell to
SAIC our Information Sharing and Analysis Centers and Open Source Intelligence
services business in exchange for 4,192,220 shares of our common stock currently
held by SAIC. Consummation of the asset sale is subject to various conditions,
including the receipt of certain third party consents.
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.
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.
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) nonrecoverable costs incurred to convert
clients to the Alliance Partner.
In January 2002, our management foresaw the need to continue to lower the
operating costs of the business given continuing difficult market conditions in
the enterprise sector. 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.
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
$284,266 and recorded an additional $25,000 in legal costs associated with the
bankruptcy.
In January 2003, our management foresaw the need to continue to lower the
operating costs of the business given continuing difficult market conditions.
Therefore, we established a 2003 restructuring plan for a further reduction in
our workforce for both domestic and international operations related to the
professional consultant employees that had been underutilized for several
months.
For the three months ended March 31, 2003, we recorded restructuring charges of
$333,821 in connection with our 2003 restructuring plan and $26,000 in
connection with our 2002 restructuring plan. Such charges pertained to severance
benefits and other related expenses for a reduction in headcount of 46
employees. These charges were offset by a reduction to previously accrued exit
costs in the amount of $35,551 resulting from the favorable settlement of a
leased domestic office. For the three months ended March 31, 2002, we recorded
restructuring charges of $933,502 in connection with our 2002 restructuring
plan. Such charges consisted of $818,717 in severance benefits and other related
expenses for a reduction in headcount of 47 employees and $264,785 in exit costs
related to real estate and electronic equipment for the closing of domestic
offices. These charges were offset by $150,000 received from the disposition of
equipment previously written-off in connection with the outsourcing of our
monitoring division. The restructuring charges recorded in connection with the
2003 restructuring plan were recognized as incurred in accordance with the
provisions of SFAS 146 whereas the restructuring charges recorded in connection
with the 2002 restructuring plan and the outsourcing of our monitoring division
were recognized at the date of commitment to an exit or disposal plan in
accordance with EITF No. 94-3.
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 the Company's Annual Report on Form 10-K for the year ended December 31,
2002. 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 during the period ended March 31, 2002. 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.
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. There were no impairment charges recorded
for the three months ended March 31, 2003 and 2002.
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. The Black-Scholes option-pricing model is used to determine the
estimated fair value of stock options issued and modified. The use of this model
requires management to make certain estimates for values of variables used by
the model. Management estimates the values for stock price volatility, the
expected life of the equity instruments and the risk free rate based on
information that is available at the time the Black-Scholes option-pricing
calculations are 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 of America 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
Three Months Ended March 31, 2003 and 2002
REVENUES. Our principal source of revenues is fees from professional services.
Total revenues decreased 45.0% to $8.3 million for the three months ended March
31, 2003 from $15.0 million for the three months ended March 31, 2002. Revenues
from professional services decreased 47.0% to $7.5 million for the three months
ended March 31, 2003 from $14.1 million for the three months ended March 31,
2002. This decrease was primarily due to difficult market conditions affecting
the technology industry in general and the telecommunications and enterprise
sector in particular. These sectors are experiencing a drastic downturn and that
downturn has adversely impacted our ability to secure new business. Reimbursed
expenses decreased 60.3% to $159,000 for the three months ended March 31, 2003
from $401,000 for the three months ended March 31, 2002. This decrease was
primarily attributable to the nature of the customer contracts in addition to
the overall decline in professional services revenues. Revenues from hardware
and software sales increased 20.2% to $629,000 for the three months ended March
31, 2003 from $523,000 for the three months ended March 31, 2002. This increase
was primarily due to one contract where the client requested us to supply all
hardware and software associated with a professional services project that
commenced in June 2002. For the three months ended March 31, 2003 and 2002,
approximately 6.7% and 15.4%, respectively, of revenues before reimbursed
expenses were from Bell South who is a related party. Pfizer accounted for
approximately 19.1% and 12.3%, respectively, of revenues before reimbursed
expenses for the three months ended March 31, 2003 and 2002. There were no other
customers that accounted for more than 10.0% of revenues before reimbursed
expenses for the three months ended March 31, 2003 and 2002. The number of our
billable consultants decreased from approximately 306 at March 31, 2002 to
approximately 140 at March 31, 2003 mainly due to our 2002 and 2003
restructuring activities, which are discussed below.
Revenues generated from our operating segments for the three months ended March
31, 2003 as compared to the three months ended March 31, 2002 were as follows:
Three months ended March 31,
------------------------------
2003 2002 Change % Change
------------ ------------ ------------ ----
US Consulting $ 6,318,000 $ 10,865,000 $ (4,547,000) (41.8)%
International Consulting 1,278,000 2,215,000 (937,000) (42.3)%
Managed Security Services 667,000 1,951,000 (1,284,000) (65.8)%
------------ ------------ ------------ ----
$ 8,263,000 $ 15,031,000 $ (6,768,000) (45.0)%
============ ============ ============ ====
The decrease in revenues in our US Consulting segment was primarily due to
difficult market conditions affecting the technology industry in general and the
telecommunications and enterprise sector in particular. These sectors are
experiencing a drastic downturn and that downturn has adversely impacted our
ability to secure new business. The decrease in our International Consulting
segment revenues was primarily attributable to a large customer contract for
which services were performed in the first quarter of 2002. This contract
generated approximately $743,000 in revenue for our international operations for
the three months ended March 31, 2002. The decrease in revenues in our Managed
Security Services segment was primarily attributable to the recognition of
non-recurring revenues for the three months ended March 31, 2002 associated with
the strategic alliance to outsource our monitoring services.
GROSS PROFIT. Gross profit decreased 29.4% to $2.8 million for the three months
ended March 31, 2003 from $4.0 million for the three months ended March 31,
2002. As a percentage of revenues, gross profit increased to 33.9% for the three
months ended March 31, 2003 from 26.4% for the three months ended March 31,
2002. Gross profit on professional services for the three months ended March 31,
2003 was $2.6 million or 34.6% compared to $3.9 million or 27.9% for the three
months ended March 31, 2002. The increase in gross profit as a percentage of
professional services revenues is primarily a result of a reduction in billable
headcount of 105 since March 31, 2002 resulting from our restructuring
activities in addition to an improvement in utilization. Gross profit on
hardware and software sales for the three months ended March 31, 2003 was
$213,000 or 33.8% compared to $30,000 or 5.8% for the three months ended March
31, 2002. The increase in gross profit as a percentage of hardware and software
sales is a result of a professional services project with a higher resale margin
for certain hardware and software products resold. Costs of revenues decreased
50.6% to $5.5 million for the three months ended March 31, 2003 from $11.1
million for the three months ended March 31, 2002. Costs of revenues
attributable to professional services decreased 51.9% to $4.9 million for the
three months ended March 31, 2003 from $10.2 million for the three months ended
March 31, 2002. This decrease in cost of revenues was due primarily to a
decrease in compensation and benefits paid to consultants as a result of a
reduction in billable headcount of 105 since March 31, 2002 resulting from our
restructuring activities and an average 10% salary reduction for all US
employees which was implemented in July 2002. Costs of revenues attributable to
hardware and software sales decreased 15.6% to $416,000 for the three months
ended March 31, 2003 from $493,000 for the three months ended March 31, 2002.
Such costs were lower despite an increase in revenues for the three months ended
March 31, 2003 compared to the three months ended March 31, 2002 as a result of
a professional services project with a higher resale margin for certain hardware
and software products resold.
Cost of revenues and gross profit associated with our operating segments for the
three months ended March 31, 2003 as compared to the three months ended March
31, 2002 were as follows:
Three months ended March 31,
------------------------------
2003 2002 Change % Change
------------ ------------ ------------ ----
Cost of Revenues:
US Consulting $ 4,287,000 $ 8,645,000 $ (4,358,000) (50.4)%
International Consulting 694,000 1,266,000 (572,000) (45.2)%
Managed Security Services 484,000 1,155,000 (671,000) (58.1)%
------------ ------------ ------------ ----
$ 5,465,000 $ 11,066,000 $ (5,601,000) (50.6)%
============ ============ ============ ====
Gross Profit:
US Consulting $ 2,031,000 $ 2,220,000 $ (189,000) (8.5)%
International Consulting 584,000 949,000 (365,000) (38.5)%
Managed Security Services 183,000 796,000 (613,000) (77.0)%
------------ ------------ ------------ ----
$ 2,798,000 $ 3,965,000 $ (1,167,000) (29.4)%
============ ============ ============ ====
Gross Profit Margin:
US Consulting 32.1% 20.4%
International Consulting 45.7% 42.8%
Managed Security Services 27.4% 40.8%
The decrease in cost of revenues for our US Consulting, International Consulting
and Managed Security Services operating segments was due primarily to a decrease
in compensation and benefits paid to consultants as a result of reductions in
billable headcount of 81, 18 and 6, respectively, since March 31, 2002 resulting
from our restructuring activities and an average 10% salary reduction for all US
employees which was implemented in July 2002. Gross margin improved for the US
Consulting and International Consulting operating segments due to these
reductions in cost and an overall improvement in utilization. Gross margin
declined for the Managed Security Services segment as a result of the
recognition of higher margin non-recurring revenues for the three months ended
March 31, 2002 associated with the strategic alliance to outsource our
monitoring services.
SALES AND MARKETING EXPENSES. Sales and marketing expenses decreased 62.3% to
$1.0 million for the three months ended March 31, 2003 from $2.7 million for the
three months ended March 31, 2002. As a percentage of revenues, sales and
marketing expenses decreased to 12.5% for the three months ended March 31, 2003
from 18.2% for the three months ended March 31, 2002. The decrease in absolute
dollars was primarily due to a decrease of $829,000 in compensation and benefits
paid due to a reduction in headcount of 26 since March 31, 2002 resulting from
our restructuring activities and an average 10% salary reduction for all US
employees which was implemented in July 2002, and a decrease of $601,000 in
commissions paid as a result of declining revenues for professional services and
the merging of the sales forces for US Consulting and Managed Security Services
in the first quarter of 2002. We also reduced sales commission rates effective
January 1, 2003. The remaining $277,000 decrease in sales and marketing expenses
was a result of decreased expenditures for marketing and selling efforts, such
as conferences and mailings, and an overall decline in travel costs as part of
our cost reduction measures undertaken in 2002.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased 58.5% to $2.7 million for the three months ended March 31, 2003 from
$6.4 million for the three months ended March 31, 2002. As a percentage of
revenues, general and administrative expenses decreased to 32.4% for the three
months ended March 31, 2003 from 42.9% for the three months ended March 31,
2002. The decrease in absolute dollars was primarily due to a decrease of
$666,000 in compensation and benefits costs as a result of a reduction in
headcount of 24 since March 31, 2002 resulting from our restructuring activities
and an average 10% salary reduction for all US employees which was implemented
in July 2002, a decrease of $535,000 in travel and entertainment and training
costs also resulting from reductions in headcount, a decrease of $350,000 in bad
debt expense, a decrease of $477,000 in outside professional services as a
result of nonrecurring computer consulting fees incurred subsequent to the
completion of the implementation of a fully integrated accounting system in
2002, nonrecurring search fees for sales account managers and nonrecurring human
resource consulting fees which were incurred in 2001 and ceased immediately
after the first quarter of 2002, and a decrease of $1.5 million in facilities
and equipment leases resulting from our restructuring activities. Such
restructuring activities included a reduction in our leased space from 11
locations, or approximately 90,642 square feet, at March 31, 2002 to 6
locations, or approximately 44,032 square feet, at March 31, 2003. Additional
reductions in general and administrative expenses of $592,000 were attributable
to a reduction in office supplies and telecommunications expense as part of our
cost reduction measures undertaken in 2002, including reductions in both
headcount and leased space as discussed above, and lower insurance premiums due
to reductions in our directors and officers insurance for 2003. These decreases
were offset by an increase in general and administrative expense of $350,000 in
connection with the agreement to settle the ICG bankruptcy claim.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization decreased 92.0% to
$62,000 for the three months ended March 31, 2003 from $774,000 for the three
months ended March 31, 2002. The decrease was attributable to a reduction in the
carrying value of property and equipment in 2002 due to the write-off of
approximately $497,000 of property and equipment resulting from our
restructuring activities. The impact on depreciation and amortization expense as
a result of these write-offs was approximately $51,000. Additionally, as a
result of our operating performance, the corresponding decline in our market
capitalization, the general economic environment, and our forecasted operating
results for the foreseeable future, we evaluated the carrying value of the
long-lived assets of our US Consulting and Managed Security Services reporting
units for impairment during June of 2002 in accordance with the provisions of
SFAS 144. Based on this review, we recorded an impairment charge during 2002
related to the write-off of the property and equipment for our US Consulting and
Managed Security Services reporting units of $4.2 million and $286,000,
respectively. The impact on depreciation and amortization expense as a result of
the impairment charge was approximately $439,000. Finally, our expenditures for
property and equipment decreased for the three months ended March 31, 2003 to
$56,000 from $492,000 for the three months ended March 31, 2002 as a result of
our cost reduction efforts undertaken in 2002. We recorded additional
depreciation expense in 2002 for capitalized software that was placed in service
on January 1, 2002 of approximately $222,000.
INTANGIBLES AMORTIZATION. Effective January 1, 2002 we were required to adopt
SFAS 142, "Goodwill and Other Intangible Assets" (SFAS 142). SFAS 142 requires
that upon adoption, amortization of goodwill and indefinite lived intangibles
cease, and instead the carrying value of goodwill and indefinite lived
intangibles be evaluated for impairment on at least an annual basis. For the
three months ended March 31, 2002, intangibles amortization of $980,000 was
recorded for intangible assets with finite lives only. Such intangible assets
were comprised of customer lists and developed technology. As a result of our
operating performance, the corresponding decline in our market capitalization,
the general economic environment, and our forecasted operating results for the
foreseeable future, we evaluated the carrying value of the long-lived assets of
our US Consulting and Managed Security Services reporting units for impairment
during June of 2002. Based on this evaluation, it was determined that the
carrying values of these assets were not recoverable and as such we recorded an
impairment charge during 2002 to write-off the net book value of our finite
lived intangible assets, consisting of customers lists and developed technology.
As such, no amortization expense for finite lived intangible assets has been
recorded since June 30, 2002.
RESTRUCTURING AND OTHER CHARGES. In January 2003, our management foresaw the
need to lower the operating costs of the business given continuing difficult
market conditions. Therefore, we established a 2003 restructuring plan for a
further reduction in our workforce for both domestic and international
operations related to the professional consultant employees that had been
underutilized for several months. In January 2002, our management foresaw the
need 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 three months ended March 31, 2003, we recorded
restructuring charges of $334,000 in connection with our 2003 restructuring plan
and $26,000 in connection with our 2002 restructuring plan. Such charges
pertained to severance benefits and other related expenses for a reduction in
headcount of 46 employees. These charges were offset by a reduction to
previously accrued exit costs in the amount of $36,000 resulting from the
favorable settlement of a leased domestic office. For the three months ended
March 31, 2002, we recorded restructuring charges of $934,000 in connection with
our 2002 restructuring plan. Such charges consisted of $819,000 in severance
benefits and other related expenses for a reduction in headcount of 47 employees
and $265,000 in exit costs related to real estate and electronic equipment for
the closing of domestic offices. These charges were offset by $150,000 received
from the disposition of equipment previously written-off in connection with the
outsourcing of our monitoring division. The restructuring charges recorded in
connection with the 2003 restructuring plan were recognized as incurred in
accordance with the provisions of SFAS 146 whereas the restructuring charges
recorded in connection with the 2002 restructuring plan and the outsourcing of
our monitoring division were recognized at the date of commitment to an exit or
disposal plan in accordance with EITF No. 94-3.
NONCASH CHARGES FOR STOCK-BASED COMPENSATION AND SERVICES. During 1999, we
granted options to purchase shares of common stock at exercises prices that were
less than the fair market value of the underlying shares of common stock,
resulting in deferred compensation. During 2000, in connection with our
acquisitions of Synet and Global Integrity, we issued options to Synet and
Global Integrity option holders in exchange for their Synet and Global Integrity
options, respectively. The unvested portion of the Synet and Global Integrity
options resulted in deferred compensation. These transactions resulted in
noncash charges for stock-based compensation and services over the period that
these specific options vest. For the three months ended March 31, 2003 and 2002,
we recorded approximately $4,000 and $36,000, respectively, of noncash charges
for stock-based compensation and services related to these options. The decrease
in expense attributable to these options is a result of the cancellation of
options as a result of reductions in headcount, mainly resulting from our
restructuring activities. In October 2002, we adopted 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" (APB25), 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 were required to apply the fair value
method of accounting to all option grants issued on or after January 1, 2002.
Such noncash charge for 2002 options was recorded in the fourth quarter of 2002.
As a result of our option exchange program subsequent to the adoption of SFAS
123 under which 4,085,860 options were exchanged for options to purchase
3,139,424 shares of our common stock, we recorded an additional charge to
noncash charges for stock-based compensation and services of $91,000 for the
three months ended March 31, 2003. In January 2003 we issued to two of our
executives 375,000 and 150,000 shares of restricted stock, respectively, at a
price of $0.001 per share. For the three months ended March 31, 2003, we
recognized compensation expense of $11,000 related to these restricted stock
issuances.
OTHER INCOME (EXPENSE). Other income in the three months ended March 31, 2003
primarily consisted of interest income. Other expense in the three months ended
March 31, 2002 primarily consisted of foreign currency exchange rate losses
related to the settlement of transactions between our foreign subsidiaries.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. Upon adoption of SFAS 142
in 2002, we recorded a noncash charge of $23.3 million for the three months
ended March 31, 2002 to reduce the carrying value of our goodwill and other
indefinite lived intangible assets, primarily consisting of acquired tradenames.
LIQUIDITY AND CAPITAL RESOURCES. We have financed our operations through the
sale of equity securities and cash flows from operations. As of March 31, 2003,
we had approximately $17.6 million in cash and cash equivalents and $1.4 million
in restricted cash backing letters of credit issued pursuant to certain
operating real estate and equipment lease agreements and a customer contract.
Net cash used in operating activities decreased to $1.8 million for the three
months ended March 31, 2003 from $9.7 million for the three months ended March
31, 2002. This decrease was primarily attributable to a reduction in the
operating loss for the three months ended March 31, 2003 as compared to the
three months ended March 31, 2002. We experienced a decrease in accrued expenses
and other current liabilities for the three months ended March 31, 2003 of
approximately $2.5 million. Such decrease was primarily attributable to
approximately $1.4 million paid in connection with severance and office lease
related liabilities recorded in connection with our restructuring plans,
including approximately $967,000 in lease termination fees for office space
abandoned in 2002. The remaining decrease related to the pay-down of previously
accrued liabilities for commissions, subcontractor expenses and accounting fees
incurred in the latter part of 2002. This net outflow of cash for the three
months ended March 31, 2003 was offset by net inflows of cash resulting from the
release of $515,000 in restricted cash due to the satisfaction of letter of
credit obligations pursuant to certain real estate lease agreements and a
decrease in accounts receivable and unbilled revenues of approximately $494,000
and $274,000, respectively. The decrease in accounts receivable and unbilled
revenues was primarily attributable to increased collection efforts and
declining revenues due to difficult market conditions affecting the technology
industry in general and the telecommunications and enterprise sector in
particular. These sectors are experiencing a drastic downturn and that downturn
has adversely impacted our ability to secure new business.
Net cash used in investing activities was $62,000 and $506,000, respectively,
for the three months ended March 31, 2003 and 2002. Capital expenditures were
$56,000 for the three months ended March 31, 2003 and primarily consisted of
purchases of computer equipment. Capital expenditures were $492,000 for the
three months ended March 31, 2002. Such capital expenditures consisted of
purchases of approximately $305,000 for computer equipment, office furniture,
and leasehold improvements in connection with the investment in our
infrastructure and approximately $187,000 of costs incurred in connection with
the development of software to be used for internal purposes. The decline in the
use of cash for capital expenditures for the three months ended March 31, 2003
as compared to the three months ended March 31, 2002 was attributable to our
cost reduction efforts undertaken beginning in 2002.
Net cash used in financing activities was $11,000 for the three months ended
March 31, 2003. Net cash provided by financing activities was $717,000 for the
three months ended March 31, 2002. Cash provided by financing activities for the
three months ended March 31, 2003 and 2002 primarily resulted from the receipt
of proceeds from the exercise of options of $3,000 and $739,000, respectively,
offset by payments made under capital lease obligations of $15,000 and $22,000,
respectively. Additionally, for the three months ended March 31, 2003 we
generated approximately $1,000 in proceeds from the issuance of restricted stock
to two officers.
We are required under the terms of certain lease agreements to provide letters
of credit. The credit facility agreement used to provide these financial
guarantees places restrictions on our cash and cash equivalents. Cash of
$835,000 and $1.4 million, respectively, at March 31, 2003 and December 31, 2002
was pledged as collateral under this agreement. In August 2002, we were required
under the terms of a customer contract to provide a letter of credit for the
value of services to be performed. The credit facility agreement used to provide
this financial guarantee places restrictions on our cash and cash equivalents
until the services are rendered to the customer. The services are expected to be
fully rendered by June 30, 2003. Cash of $518,000 as of March 31, 2003 and
December 31, 2002 was pledged as collateral under this agreement.
We believe that our existing cash and cash equivalents will be sufficient to
meet our anticipated needs for working capital and capital expenditures for at
least the next twelve months. If cash on hand and cash generated from operations
is insufficient to satisfy our liquidity requirements, we may seek to sell
additional equity or debt securities or to obtain credit facilities. The sale of
additional equity or convertible debt securities could result in dilution to our
stockholders. The incurrence of indebtedness would result in increased fixed
obligations and could result in operating covenants that would restrict our
operations. We cannot assure you that financing will be available in amounts or
on terms acceptable to us, if at all.
Through March 31, 2003, we have not entered into any off balance sheet
arrangements or transactions with unconsolidated entities or other persons.
Recent Accounting Pronouncements
In July 2001, the FASB issued Statement of Financial Accounting Standard No.
143, "Accounting for Asset Retirement Obligations" (SFAS 143), which is
effective for fiscal years beginning after June 15, 2002. SFAS 143 requires,
among other things, the accounting and reporting of legal obligations associated
with the retirement of long-lived assets that result from the acquisition,
construction, development or normal operation of a long-lived asset. We adopted
this pronouncement as of January 1, 2003, the effect of which was not material
to our consolidated results of operations or financial position.
In April 2002, the FASB issued Statement of Financial Accounting Standard No.
145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" (SFAS 145). This statement
eliminates the automatic classification of gain or loss on an extinguishment of
debt as an extraordinary item of income and requires that such gain or loss be
evaluated for extraordinary classification under the criteria of Accounting
Principles Board No. 30, "Reporting Results of Operations." This statement also
requires sales-leaseback accounting for certain lease modifications that have
economic effects that are similar to sales-leaseback transactions, and makes
various other technical corrections to existing pronouncements. We adopted this
pronouncement as of January 1, 2003, the effect of which was not material to our
consolidated results of operations or financial position.
In July 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities" (SFAS 146). SFAS 146 will supersede EITF No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS
146 requires that costs associated with an exit or disposal plan be recognized
when incurred rather than at the date of a commitment to an exit or disposal
plan. SFAS 146 is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. We adopted this pronouncement effective
January 1, 2003. The adoption of this pronouncement did not have a material
impact on our consolidated results of operations or financial position.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness to Others" which elaborates on the disclosures to be made by a
guarantor in its interim and annual financial statements about its obligations
under certain guarantees that it has issued. It also clarifies that a guarantor
is required to recognize, at the inception of a guarantee, a liability for the
fair value of the obligation undertaken in issuing the guarantee. The initial
recognition and measurement provisions of this Interpretation are applicable on
a prospective basis to guarantees issued or modified after December 31, 2002.
The disclosure requirements in this Interpretation are effective for financial
statements of interim or annual periods ending after December 15, 2002. We have
provided information regarding commitments and contingencies relating to
guarantees in Note 11 to our consolidated financial statements. We adopted the
initial recognition and measurement provisions of this Interpretation January 1,
2003. The adoption of these provisions did not have a material impact on our
consolidated results of operations or financial position.
In December 2002, the FASB issued Statement of Financial Accounting Standard No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an
amendment of FASB Statement No. 123" (SFAS 148). SFAS 148 amends Statement of
Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation"
(SFAS 123) to provide alternative methods to account for the transition from the
intrinsic value method of recognition of stock-based employee compensation in
accordance with Accounting Principles Board Opinion No. 25 "Accounting for Stock
Issued to Employees" to the fair value recognition provisions under SFAS 123.
The Company adopted the recognition provisions of SFAS 123 as of January 1, 2002
pursuant to the prospective method of adoption required by SFAS 123. SFAS 148
provides two additional methods of transition and will no longer permit the SFAS
123 prospective method to be used for fiscal years beginning after December 15,
2003. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to
require prominent disclosure in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the pro
forma effects had the fair value recognition provisions of SFAS 123 been used
for all periods presented. We have adopted the annual disclosure provisions of
SFAS 148. The adoption of SFAS 148 did not have a significant impact on our
consolidated results of operations or financial position.
In April 2003, the FASB issued Statement of Financial Accounting Standard No.
149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities" (SFAS 149). SFAS 149 amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives), and for
hedging activities under Statement of Financial Accounting Standard No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). This
statement is effective for contracts entered into or modified after June 30,
2003 and for hedging relationships after June 30, 2003. All provisions of SFAS
149 should be applied prospectively. The adoption of SFAS 149 will not have a
significant impact on our consolidated results of operations or financial
position.
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 Proposed Merger with INS
The per share consideration to be received by our stockholders in the merger is
subject to adjustment
On April 8, 2003, we executed a merger agreement to be acquired by INS. Under
the terms of the merger agreement, each outstanding share of our common stock
will be converted into cash. The amount of cash to be received per share will
equal $19,186,700, divided by the number of shares of our common stock and "in
the money" options outstanding at the closing of the merger. The $19,186,700
aggregate consideration will be increased if and to the extent our net assets at
closing, determined in accordance with the provisions of the merger agreement,
exceed our estimate of our net assets at closing set forth in the merger
agreement by more than $1,250,000, and will be decreased if and to the extent
our net assets at closing, determined in accordance with the provisions of the
merger agreement, are less than our estimate of our net assets at closing set
forth in the merger agreement by more than $1,250,000. Our estimate of our net
assets at closing set forth in the merger agreement is $15,386,700.
Our failure to complete the proposed merger with INS could adversely affect our
business
The merger is subject to approval by our stockholders and various other
conditions, including the retention of certain of our customers and employees
and the clearance by the SEC of our proxy statement related to the merger, and
there can be no assurance the merger will be successfully completed. In the
event the merger is not completed, we believe our business will face significant
difficulties, including:
o a reduced client pipeline and a reduced ability to close
sales;
o our ability to attract and retain employees;
o possibly strained relationships with our existing clients and
strategic partners;
o the potential payment of a termination fee to INS;
o a reduced market price of our common stock to the extent that
the current market price reflects a market assumption that the
merger will be completed; and
o bearing the costs related to the merger, such as legal,
accounting and other fees, which must be paid even if the
merger is not completed.
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 three months ended March 31, 2003 was $1.4 million. As of
March 31, 2003, our accumulated deficit was $207.7 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
For the three months ended March 31, 2003, BellSouth and Pfizer accounted for
approximately 6.7% and 19.1% of revenues before reimbursed expenses,
respectively. Our five largest clients accounted for approximately 47.7% of
revenues before reimbursed expenses for the three months ended March 31, 2003.
For the year ended December 31, 2002, our five largest clients accounted for
approximately 45.4% 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 March 31, 2003, the
accounts receivable from BellSouth and Pfizer was approximately $214,087 and
$183,299, respectively, which related to work performed in January through March
2003. 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.
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 three months ended March 31, 2003 and the year ended December 31, 2002,
fixed-price projects accounted for 43.8% and 37.0% 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
In the event the merger with INS does not close, we will need adequate capital
to fund our operations. Our future liquidity and capital requirements are
difficult to predict because they depend on numerous factors, including the
success of our existing and new service offerings and competing technological
and market developments. As a result, we may not be able to generate sufficient
cash from our operations to meet additional working capital requirements,
support additional capital expenditures or take advantage of acquisition
opportunities. Accordingly, we may need to raise additional capital in the
future. Our ability to obtain additional financing will be subject to a number
of factors, including market conditions, our operating performance and investor
sentiment. These factors may make the timing, amount, terms and conditions of
additional financing unattractive for us. If we are unable to raise additional
funds when needed, our ability to operate and grow our business could be
impeded.
Risks Related to Our Strategy and Market
We may have difficulty managing 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 184 employees as of March 31, 2003 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 if the merger with INS
does not close is to grow our business. In order to achieve this growth, demand
for our services must increase. If the merger with INS does not close and 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 ability to close the INS merger, and if the merger is not completed 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. 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 merger with INS does not close and 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.
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.
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 our merger with INS does not close and we are unable to find suitable
acquisition candidates, our growth could be impeded
A component of our growth strategy if the merger with INS does not close 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 impact our ability to close the merger with INS, interrupt our
business and adversely affect our growth
Our ability to close the merger with INS, and our future success otherwise,
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 close the merger, effectively deliver our
services and manage our company, and to carry out our business plan.
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;
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.
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 27.3% 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.
Approval of the merger with INS requires the affirmative vote of a majority of
shares of our common stock outstanding on the record date for the special
meeting of stockholders during which the merger will be considered. Stockholders
who beneficially own an aggregate of 28.4% of our outstanding shares of common
stock as of the date of execution of the merger agreement have previously
delivered voting agreements to INS whereby such holders have agreed to vote
their shares in favor of the merger. Accordingly, holders of a significant
percentage of our outstanding common stock have already committed to voting for
the merger and will greatly influence whether the merger is approved.
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Currency Rate Fluctuations.
Our results of operations, financial position and cash flows are not materially
affected by changes in the relative values of non-U.S. currencies to the U.S.
dollar. We do not use derivative financial instruments to limit our foreign
currency risk exposure.
Market Risk.
Our accounts receivable are subject, in the normal course of business, to
collection risks. We regularly assess these risks and have established policies
and business practices to protect against the adverse effects of collection
risks. As a result, we do not anticipate any material losses in this area.
Interest Rate Risks.
We do not currently have any outstanding indebtedness, with the exception of
capital leases. In addition, our investments are classified as cash and cash
equivalents with original maturities of three months or less. Therefore, we are
not exposed to material market risk arising from interest rate changes, nor do
such changes affect the value of investments as recorded by us.
ITEM 4. CONTROLS AND PROCEDURES
Based on their evaluation of the company's disclosure controls and procedures as
of a date within 90 days of the filing of this Report, the Chief Executive
Officer and Chief Financial Officer have concluded that such controls and
procedures are effective to ensure that information required to be disclosed by
us in reports we file or submit under the Securities Exchange Act of 1934, as
amended, is recorded, processed, summarized and reported within the time periods
specified by the rules and forms of the Securities and Exchange Commission.
There were no significant changes in the company's internal controls or in other
factors that could significantly affect such controls subsequent to the date of
their evaluation. We have not identified any significant deficiencies or
material weaknesses in our internal controls and therefore no corrective actions
were taken.
PART II. OTHER INFORMATION
ITEM 1. 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.
In February 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.
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.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
NONE.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
NONE.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE.
ITEM 5. OTHER INFORMATION
The Audit Committee of the Board of Directors approved the categories of all
non-audit services performed by the Company's independent accountants, which for
the quarter ended March 31, 2003 consisted of transaction advisory services in
connection with the Company's merger with INS and sale of assets to SAIC.
ITEM 6. EXHIBITS AND REPORT ON FORM 8-K
(a) The following exhibits are filed as part of this report:
99.1 Certification under Section 906 of the Sarbanes-Oxley Act.
(b) The Company filed no reports on Form 8-K during the three months ended
March 31, 2003 and three reports filed after March 31, 2003 through the date
hereof. Information regarding the items reported on is as follows:
April 9, 2003. The Company announced that it entered into an Agreement and Plan
of Merger with International Network Services, Inc.
April 11, 2003. The Company announced that it entered into an Asset Purchase
Agreement for the sale of Security Intelligence Services business.
April 24, 2003. The Company announced its financial results for the fiscal
quarter ended March 31, 2003.
ITEM 7. SIGNATURES
Pursuant to the requirements of the Securities Exchange Act, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
PREDICTIVE SYSTEMS, INC.
(Registrant)
Date: May 15, 2003 /s/ ANDREW ZIMMERMAN
------------------------------------------------------
Name: Andrew Zimmerman
Title: Chief Executive Officer
(principal executive officer)
Date: May 15, 2003 /s/ NEERAJ SETHI
------------------------------------------------------
Name: Neeraj Sethi
Title: Chief Financial Officer
(principal accounting and financial officer)
CERTIFICATION PURSUANT TO RULE 13A-14 OR 15D-14 OF THE SECURITIES
EXCHANGE ACT OF 1934, AS ADOPTED PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002
I, Andrew Zimmerman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Predictive Systems,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Dated: May 15, 2003
By: /s/ Andrew Zimmerman
Name: Andrew Zimmerman
Title: Chief Executive Officer
CERTIFICATION PURSUANT TO RULE 13A-14 OR 15D-14 OF THE SECURITIES
EXCHANGE ACT OF 1934, AS ADOPTED PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002
I, Neeraj Sethi, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Predictive Systems,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Dated: May 15, 2003
By: /s/ Neeraj Sethi
Name: Neeraj Sethi
Title: Chief Financial Officer