- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE PERIOD ENDED SEPTEMBER 30, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
------------------------
PROBUSINESS SERVICES, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 94-2976066
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
4125 HOPYARD ROAD
PLEASANTON, CA 94588
(Address of principal executive offices)
(925) 737-3500
(Registrant's telephone number, including area code)
------------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES /X/ NO / /
As of November 8, 1999, there were 23,257,029 shares of the Registrant's
Common Stock outstanding.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PROBUSINESS SERVICES, INC.
INDEX
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED):
Condensed Consolidated Balance Sheets as of
September 30, 1999 and June 30, 1998...................... 3
Condensed Consolidated Statements of Operations for the
Three months ended September 30, 1999 and 1998............ 4
Condensed Consolidated Statement of Stockholders' Equity for
the
Three months ended September 30, 1999..................... 5
Condensed Consolidated Statements of Cash Flows for the
Three months ended September 30, 1999 and 1998............ 6
Notes to Condensed Consolidated Financial Statements........ 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................. 9
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISK..... 18
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS........................................... 19
ITEM 2. CHANGES IN SECURITIES....................................... 19
ITEM 3. DEFAULTS UPON SENIOR SECURITIES............................. 19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......... 19
ITEM 5. OTHER INFORMATION........................................... 19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................ 19
SIGNATURES.................................................. 20
2
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
PROBUSINESS SERVICES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS)
SEPTEMBER 30, 1999 JUNE 30, 1999
------------------- --------------
ASSETS
Current assets:
Cash and cash equivalents................................. $ 61,466 $ 73,575
Accounts receivable, net of allowances.................... 6,258 4,599
Prepaid expenses and other current assets................. 3,107 3,777
-------- --------
70,831 81,951
Payroll tax funds invested................................ 710,595 580,452
-------- --------
Total current assets........................................ 781,426 662,403
Equipment, furniture and fixtures, net...................... 33,835 31,024
Other assets................................................ 18,057 16,997
-------- --------
Total assets................................................ $833,318 $710,424
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued liabilities, current portion of
capital lease obligations and deferred revenue.......... $ 28,436 $ 29,894
Payroll tax funds collected but unremitted................ 710,595 580,452
-------- --------
Total current liabilities................................... 739,031 610,346
Capital lease obligations, less current portion............. 511 548
Stockholders' equity........................................ 93,776 99,530
-------- --------
Total liabilities and stockholders' equity.................. $833,318 $710,424
======== ========
See notes to condensed consolidated financial statements.
3
PROBUSINESS SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED
SEPTEMBER 30
-------------------
1999 1998
-------- --------
Revenue..................................................... $20,954 $14,255
Operating expenses:
Cost of providing services................................ 11,148 7,711
General and administrative................................ 3,395 2,565
Research and development.................................. 3,353 1,916
Client acquisition costs.................................. 10,058 6,456
------- -------
Total operating expenses.................................. 27,954 18,648
Loss from operations........................................ (7,000) (4,393)
Interest expense............................................ (129) (230)
Interest income and other, net.............................. 969 186
------- -------
Net loss.................................................... $(6,160) $(4,437)
======= =======
Basic and diluted net loss per share........................ $ (0.27) $ (0.24)
======= =======
Shares used in computing basic and diluted net loss per
share..................................................... 22,864 18,148
======= =======
See notes to condensed consolidated financial statements.
4
PROBUSINESS SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
NOTES
COMMON STOCK ADDITIONAL RECEIVABLE TOTAL
--------------------- PAID-IN ACCUMULATED FROM STOCKHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT STOCKHOLDERS EQUITY
---------- -------- ---------- ----------- ------------ -------------
Balances at June 30, 1999....... 22,942,362 $23 $148,284 $(47,896) $(881) $99,530
Exercise of stock options....... 54,663 -- 406 -- -- 406
Net loss and comprehensive
loss.......................... -- -- -- (6,160) -- (6,160)
---------- --- -------- -------- ----- -------
Balances at September 30,
1999.......................... 22,997,025 $23 $148,690 $(54,056) $(881) $93,776
========== === ======== ======== ===== =======
See notes to condensed consolidated financial statements.
5
PROBUSINESS SERVICES, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
THREE MONTHS ENDED
SEPTEMBER 30,
-------------------
1999 1998
-------- --------
OPERATING ACTIVITIES
Net loss.................................................... $ (6,160) $(4,437)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 2,479 1,275
Other................................................... -- 83
Changes in operating assets and liabilities:
Accounts receivable, net.............................. (1,659) (465)
Prepaid expenses and other current assets............. 670 (91)
Other assets.......................................... 156 726
Accounts payable, accrued liabilities, current portion
of capital lease obligations and deferred revenue... (1,187) 991
-------- -------
Net cash used in operating activities....................... (5,701) (1,918)
-------- -------
INVESTING ACTIVITIES
Purchases of equipment, furniture and fixtures.............. (4,991) (2,105)
Capitalization of software development costs................ (1,515) (1,025)
Notes receivable from stockholders.......................... 0
-------- -------
Net cash used in investing activities....................... (6,506) (3,130)
-------- -------
FINANCING ACTIVITIES
Repayments under note payable............................... -- (8)
Proceeds from notes receivable from stockholder............. -- 153
Principal payments on capital lease obligations............. (308) (261)
Net proceeds from issuance of common stock.................. 406 81,328
-------- -------
Net cash provided by financing activities................... 98 81,212
-------- -------
Net increase (decrease) in cash and cash equivalents........ (12,109) 76,164
Cash and cash equivalents, beginning of period.............. 73,575 13,946
-------- -------
Cash and cash equivalents, end of period.................... $ 61,466 $90,110
======== =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest.................. $ 129 $ 305
======== =======
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING
ACTIVITIES:
Purchase of equipment, furniture and fixtures under
capital leases.......................................... $ -- $ 215
======== =======
See notes to condensed consolidated financial statements.
6
PROBUSINESS SERVICES, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
ProBusiness Services, Inc., ("ProBusiness" or the "Company") has prepared
its interim condensed consolidated financial statements without audit, pursuant
to the rules and regulations of the Securities and Exchange Commission (the
"SEC"). Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations.
The information included in this report should be read in conjunction with
the Company's audited consolidated financial statements and notes thereto
included in the Company's 1999 Annual Report on Form 10-K. The condensed
consolidated balance sheet as of June 30, 1999 has been prepared from the
audited consolidated financial statements of the Company.
In the opinion of management, the accompanying unaudited interim condensed
consolidated financial statements reflect all adjustments (consisting only of
normal recurring adjustments) necessary to summarize fairly the consolidated
financial position, results of operations and cash flows for such periods. The
results for the interim period ended September 30, 1999 are not necessarily
indicative of the results that may be expected for the fiscal year ending
June 30, 2000 or for any future periods.
2. BASIC AND DILUTED NET LOSS PER SHARE
Shares used in computing basic and diluted net income (loss) per share are
based on the weighted average shares outstanding in each period. Basic net
income (loss) per share excludes any dilutive effects of stock options. Diluted
net income (loss) per share includes the dilutive effect of the assumed exercise
of stock options using the treasury stock method. However, the effect of
outstanding stock options has been excluded from the calculation of diluted net
loss per share as their inclusion would be antidilutive. If the Company had
reported net income, the calculation of diluted net income per share would have
included the shares used in the computation of net loss per share as well as an
additional 1,096,000 and 1,374,000 common equivalent shares related to
outstanding stock options and warrants not included above (using the treasury
stock method) for the first quarter of fiscal 2000 and 1999, respectively.
3. SEGMENT INFORMATION
The Company's Chief Operating Decision Maker who is the President and Chief
Executive Officer, evaluates performance based on a measure of consolidated
gross margin, operating profit before client acquisition costs and profit or
loss from operations. The accounting policies of the reportable segment are the
same as those described in the Company's Annual Report on Form 10-K for the year
ended June 30, 1999. The Company's condensed consolidated statements of
operations disclose the financial information of its reportable segment in
accordance with Statement of Financial Accounting Standards ("SFAS") SFAS No.
131 "Disclosures about Segments of an Enterprise."
4. RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133") and in June 1999, the FASB
issued SFAS No. 137, "Accounting for Derivative and Hedging Activities-Deferral
of the Effective Date of FASB Statement No. 133" ("SFAS 137"). SFAS 133
established methods of accounting for derivative financial instruments and
hedging activities related to those instruments as well as other hedging
activities. SFAS 137 deferred for one year the effective date of SFAS 133. The
Company is required to adopt this statement in fiscal 2001 and has not
determined the
7
PROBUSINESS SERVICES, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
4. RECENTLY ISSUED ACCOUNTING STANDARDS (Continued)
effect, if any, that adoption will have on its consolidated financial position
or consolidated results of operations.
5. BUSINESS COMBINATIONS
In April 1999, the Company acquired Clemco, Inc. ("Conduit Parent"), the
parent and sole stockholder of Conduit Software, Inc., a provider of employee
relationship management applications. The merger was accounted for using the
pooling of interests method of accounting and as such the Company's historical
financial results for all dates and periods prior to the merger have been
restated to reflect the merger. In connection with the acquisition, the Company
issued 1,714,973 shares of its common stock to Conduit Parent's stockholders in
exchange for all of the outstanding common and preferred stock of Conduit
Parent. All outstanding options and warrants to purchase Conduit Parent's
capital stock were converted into options and warrants to purchase 82,987 shares
of ProBusiness common stock. In connection with the business combination, the
Company incurred direct transaction costs of approximately $3,500,000, which
consisted primarily of fees for investment banking, legal and accounting
services incurred in conjunction with the merger. Of this, $2,926,000 was paid
before September 30, 1999. The balance of $574,000 is included in current
liabilities on the consolidated balance sheet and is anticipated to be paid
within 12 months. The Company's consolidated results of operations include
adjustments to conform the presentation and accounting policies of Conduit
Parent to ProBusiness' accounting policies.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS
AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM
THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS. POTENTIAL RISKS AND
UNCERTAINTIES INCLUDE, AMONG OTHERS, THOSE SET FORTH UNDER "OVERVIEW" AND
"ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS" INCLUDED IN THIS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS. THE FOLLOWING DISCUSSION ALSO SHOULD BE READ IN CONJUNCTION WITH THE
FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED ELSEWHERE IN THIS QUARTERLY
REPORT.
OVERVIEW
ProBusiness Services, Inc. is a leading provider of employee outsourced
administrative services for large employers. The Company's primary service
offerings are payroll processing, payroll tax filing, benefits administration,
human resources software and self-service applications. The Company's
proprietary PC-based payroll system offers the cost-effective benefits of
outsourcing and high levels of client service, while providing the flexibility,
control, customization and integration of an in-house system.
The Company derives its revenue from fees charged to clients for services
and income earned from investing payroll tax funds. Since 1997, the Company has
experienced significant growth of its revenue, client base and average client
size. Revenue increased from $27.7 million in fiscal 1997 to $70.1 million in
fiscal 1999. From September 30, 1997 to September 30, 1999, the client base for
payroll processing services increased from approximately 425 clients to
approximately 570 clients, while the average size of the Company's payroll
clients increased from approximately 900 employees to approximately 1,600
employees. The Company's revenue growth is primarily due to continued growth in
its client base, the introduction of its payroll tax service in fiscal 1996, an
increase in the average number of employees of its clients, the introduction of
new features and other services, and a high retention rate of existing payroll
clients (approximately 90% for fiscal 1999). The Company does not anticipate it
will sustain this rate of growth in the future.
The establishment of new client relationships involves lengthy and extensive
sales and implementation processes. The sales process generally takes six to
twelve months or longer, and the implementation process generally takes an
additional three to nine months or longer. The Company has experienced
significant operating losses since its inception and expects to incur
significant operating losses in the future due to continued client acquisition
costs, investments in research and development and costs associated with
expanding sales efforts and operations in new geographic regions. As of
September 30, 1999, the Company had an accumulated deficit of $54.1 million.
There can be no assurance that the Company will achieve or sustain profitability
in the future.
The Company's cost of providing services consists primarily of ongoing
account management, tax and benefits administration operations and production
costs. General and administrative expenses consist primarily of personnel costs,
professional fees, and other overhead costs for finance, corporate services and
information technology. Research and development expenses consist primarily of
personnel costs. Client acquisition costs consist of sales and implementation
expenses and, to a lesser extent, marketing expenses.
9
RESULTS OF OPERATIONS
The following table sets forth certain financial data as a percentage of
revenue for the periods indicated:
QUARTER ENDED
SEPTEMBER 30,
-----------------------
1999 1998
-------- --------
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Revenue.................................................... 100.0 % 100.0 %
Operating expenses:
Cost of providing services............................... 53.2 % 54.1 %
General and administrative............................... 16.2 % 18.0 %
Research and development................................. 16.0 % 13.4 %
Client acquisition costs................................. 48.0 % 45.3 %
----- -----
Total operating expenses................................... 133.4 % 130.8 %
Loss from operations....................................... (33.4)% (30.8)%
Interest expense........................................... (0.6)% (1.6)%
Interest income and other, net............................. 4.6 % 1.3 %
----- -----
Net loss................................................... (29.4)% (31.1)%
===== =====
REVENUE. Revenue increased 47.0% in the first quarter of fiscal 2000 when
compared with the same period of fiscal 1999, primarily due to increases in the
number and average size of the Company's payroll and tax clients. Interest
income earned on payroll tax funds invested was $5.4 million and $3.2 million
for first quarter of fiscal 2000 and 1999, respectively. The increase was
primarily attributable to higher average daily payroll tax fund balances.
COST OF PROVIDING SERVICES. Cost of providing services increased 44.6% in
the first quarter of fiscal 2000 when compared with the same period of fiscal
1999 and decreased as a percentage of revenue to 53.2% in the first quarter of
fiscal 2000 from 54.1% in the first quarter of fiscal 1999. The increase in
absolute dollars was primarily due to increased personnel in operations such as
account management, production and payroll tax service resulting from an
increase in the client base.
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased
32.4% in the first quarter of fiscal 2000 when compared with the same period of
fiscal 1999 and decreased as a percentage of revenue to 16.2% in the first
quarter of fiscal 2000 from 18.0% in the first quarter of fiscal 1999. The
increase in absolute dollars was primarily due to increased investment in the
Company's information technology infrastructure and the hiring of additional
management and administrative personnel to support the Company's growth. The
decrease as a percentage of revenue resulted from a higher revenue base.
RESEARCH AND DEVELOPMENT. Research and development expenses increased 75.0%
in the first quarter of fiscal 2000 when compared with the same period of fiscal
1999 and increased as a percentage of revenue to 16.0% in the first quarter of
fiscal 2000 from 13.4% in the first quarter of fiscal 1999. The increases in
both absolute dollars and percentage of revenue were primarily a result of
increases in personnel costs related to expansion of web development, the
accelerated development of Golden Gate, the Company's next-generation,
fully-integrated product and to costs related to the development of enhancements
to and new features for the Company's existing services. Capitalized software
development costs were $1.5 million and $1.0 for the first quarter of fiscal
2000 and 1999, respectively. In the first quarter of fiscal 2000, capitalized
software costs primarily included costs incurred for the development of Golden
Gate. The
10
Company believes that software development costs are essential to technology and
product leadership and expects such costs to continue to be significant, both in
absolute dollars and as a percentage of revenue.
CLIENT ACQUISITION COSTS. Client acquisition costs increased 55.8% in the
first quarter of fiscal 2000 when compared with the same period of fiscal 1999
and increased as a percentage of revenue to 48.0% in the first quarter of fiscal
2000 from 45.3% in the first quarter of fiscal 1999. The increases in both
absolute dollars and percentage of revenue were primarily attributable to
additional investments made to capture market share by expanding the Company's
sales, implementation and marketing workforce for payroll and national tax
services.
INTEREST EXPENSE. Interest expense decreased 43.9% in the first quarter of
fiscal 2000 when compared with the same period of fiscal 1999 and decreased as a
percentage of revenue to 0.6% in the first quarter of fiscal 2000 from 1.6% in
the first quarter of fiscal 1999. The decrease in absolute dollars was primarily
attributable to a decrease in bank fees.
INTEREST INCOME AND OTHER, NET. Other income increased 421.0% in the first
quarter of fiscal 2000 when compared with the same period of fiscal 1999 and
increased as a percentage of revenue to 4.6% in the first quarter of fiscal 2000
from 1.3% in the first quarter of fiscal 1999. The increases in interest income
was primarily due to higher cash and investment balances resulting from the
Company's follow-on public offering in September 1998.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1999, the Company's principal sources of liquidity included
$61.5 million of cash and cash equivalents and a secured $20 million revolving
line of credit which expires in December 2000. There were no outstanding
borrowings under the line of credit as of September 30, 1999.
Net cash used in operating activities was $5.7 million and $1.9 million for
the first three months of fiscal 2000 and 1999, respectively. The net cash used
in operating activities for the first three months of fiscal 2000 was primarily
attributable to the first quarter net loss and an increase in net accounts
receivable and decreases in accounts payable, accrued liabilities and deferred
revenue, partially offset by depreciation and amortization and decreases in
prepaid expenses and other assets.
Net cash used in investing activities was $6.5 million and $3.1 million for
the first three months of fiscal 2000 and 1999, respectively. The increase in
net cash used in investing activities related primarily to purchases of
equipment, furniture and fixtures and an increase in capitalization of software
development costs.
Net cash provided by financing activities was $98,000 and $81.2 million for
the first three months of fiscal 2000 and 1999, respectively. The decrease in
net cash provided by financing activities for first three months of fiscal 2000
related primarily to $80.7 million of net proceeds from the Company's follow-on
public offering of common stock in September 1998.
The Company believes that existing cash and cash equivalent balances,
amounts available under its current credit facility and anticipated cash flows
from operations will be sufficient to meet its working capital and capital
expenditure requirements for at least the next 12 months.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
OPERATING LOSSES; NEED TO COMMIT TO EXPENSE IN ADVANCE OF REVENUES. The Company
has experienced significant operating losses since its inception and expects to
incur significant operating losses in the future due to continued client
acquisition costs, investments in research and development and costs associated
with expanding its sales efforts and operations to new geographic regions. As of
September 30, 1999, the Company had an accumulated deficit of $54.1 million. The
establishment of new client relationships involves lengthy and extensive sales
and implementation processes. The sales process generally takes six to
11
twelve months or longer, and the implementation process generally takes an
additional three to nine months or longer. In connection with the acquisition of
each new client, the Company incurs substantial client acquisition costs, which
consist primarily of sales and implementation expenses and, to a lesser extent,
marketing expenses. The Company's ability to achieve profitability will depend
in part upon its ability to attract and retain new clients, offer new services
and features and achieve market acceptance of new services. There can be no
assurance that the Company will achieve or sustain profitability in the future.
Failure to achieve or sustain profitability in the future could have a material
adverse effect on the Company's business, financial condition and consolidated
results of operations.
SEASONALITY; FLUCTUATION IN QUARTERLY RESULTS. The Company's business is
characterized by significant seasonality. As a result, the Company's revenue has
been subject to significant seasonal fluctuations, with the largest percentage
of annual revenue being realized in the third and fourth fiscal quarters,
primarily due to new clients beginning services in the beginning of the tax year
(the Company's third fiscal quarter) and higher interest income earned on
payroll tax funds invested. Further, the Company's operating expenses are
typically higher as a percentage of revenue in the first and third fiscal
quarters as the Company increases personnel to acquire new clients and to
implement and provide services to such new clients, a large percentage of which
begin services in the third quarter.
The Company's quarterly operating results have in the past varied and will
in the future vary significantly depending on a variety of factors, including
the number and size of new clients starting services, the decision of one or
more clients to delay or cancel implementation or ongoing services, interest
rates, seasonality, the ability of the Company to design, develop and introduce
new services and features for existing services on a timely basis, costs
associated with strategic acquisitions and alliances or investments in
technology, the success of any such strategic acquisition, alliance or
investment, costs to transition to new technologies, expenses incurred for
geographic expansion, risks associated with payroll tax and benefits
administrative services, price competition, a reduction in the number of
employees of its clients and general economic factors. Revenue from new clients
typically represents a significant portion of quarterly revenue in the third and
fourth fiscal quarters. A substantial majority of the Company's operating
expenses, particularly personnel and related costs, depreciation and rent, is
relatively fixed in advance of any particular quarter. The Company's agreements
with its clients generally do not have significant penalties for cancellation.
As a result, any decision by a client to delay or cancel implementation of the
Company's services or the Company's underutilization of personnel may cause
significant variations in operating results in a particular quarter and could
result in losses for such quarter. As the Company secures larger clients, the
time required for implementing the Company's services increases, which could
contribute to larger fluctuations in revenue. Interest income earned from
investing payroll tax funds, which is a significant portion of the Company's
revenue, is vulnerable to fluctuations in interest rates. In addition, the
Company's business may be affected by shifts in the general condition of the
economy, client staff reductions, strikes, acquisitions of its clients by other
companies and other downturns. There can be no assurance that the Company's
future revenue and results of operations will not vary substantially. It is
possible that in some future quarter the Company's results of operations will be
below the expectations of public market analysts and investors. In either case,
the market price of the Company's common stock could be materially adversely
affected.
RISKS ASSOCIATED WITH STRATEGIC ACQUISITIONS AND INVESTMENTS. In April 1999,
the Company acquired Conduit Parent, a leading provider of Employee Relationship
Management applications, in a transaction accounted for using the pooling of
interests method of accounting. There can be no assurance that this acquisition
will be effectively assimilated into the Company's business. The integration of
Conduit Parent will place a burden on the Company's management. Such integration
is subject to risks commonly encountered in making such acquisitions, including,
among others, loss of key personnel of the acquired company, the difficulty
associated with assimilating the personnel and operations of the acquired
company, the potential disruption of the Company's ongoing business, the
maintenance of uniform standards, controls, procedures and policies, and the
impairment of the Company's reputation and relationships with
12
employees and clients. There can be no assurance that the Company will be
successful in overcoming these risks or any other problems encountered in
connection with its acquisition of Conduit Parent.
The Company has no other current agreements or negotiations under way other
than those described above with respect to any acquisition of, or investment in,
businesses that provide complementary services or technologies to those of the
Company. The Company has in the past and intends in the future to make
additional acquisitions of, and investments in, such businesses. In addition,
future acquisitions could result in the issuance of dilutive equity securities,
the incurrence of debt or contingent liabilities. Furthermore, there can be no
assurance that any strategic acquisition or investment will succeed. Any future
acquisitions or investments could have a material adverse effect on the
Company's business, financial condition and consolidated results of operations.
RISKS ASSOCIATED WITH PAYROLL TAX SERVICE AND BENEFITS ADMINISTRATIVE
SERVICES. The Company's payroll tax filing service is subject to various risks
resulting from errors and omissions in filing client tax returns and paying tax
liabilities owed to tax authorities on behalf of clients. The Company's clients
transfer to the Company contributed employer and employee tax funds. The Company
processes the data received from the client and remits the funds along with a
tax return to the appropriate tax authorities when due. Tracking, processing and
paying such tax liabilities is complex. Errors and omissions have occurred in
the past and may occur in the future in connection with such service. The
Company is subject to large cash penalties imposed by tax authorities for late
filings or underpayment of taxes. To date, such penalties have not been
significant. However, there can be no assurance that any liabilities associated
with such penalties will not have a material adverse effect on the Company's
business, financial condition and results of operations. There can be no
assurance that the Company's reserves or insurance for such penalties will be
adequate. In addition, failure by the Company to make timely or accurate tax
return filings or pay tax liabilities when due on behalf of clients may damage
the Company's reputation and could adversely affect its relationships with
existing clients and its ability to gain new clients.
The Company's payroll tax filing service is also dependent upon government
regulations, which are subject to continual changes. Failure by the Company to
implement these changes into its services and technology in a timely manner
would have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, since a significant portion of
the Company's revenue is derived from interest earned from investing on
collected but unremitted payroll tax funds, changes in policies relating to
withholding federal or state income taxes or reduction in the time allowed for
taxpayers to remit payment for taxes owed to government authorities would have a
material adverse effect on the Company's business, financial condition and
consolidated results of operations.
The Company's benefits administrative services are subject to various risks
resulting from errors and omissions in processing and filing COBRA or other
benefit plan forms in accordance with governmental regulations and the
respective plans. The Company processes data received from employees and
employers and is subject to penalties for any late or misfiled plan forms. There
can be no assurance the Company's reserves or insurance for such penalties will
be adequate. In addition, failure to properly file plan forms would have a
material adverse effect on the Company's reputation, which could adversely
affect its relationships with existing clients and its ability to gain new
clients. The Company's benefits administrative services are also dependent upon
government regulations, which are subject to continuous changes that could
reduce or eliminate the need for benefits administrative services. The Company
has access to confidential information and to client funds. As a result, the
Company is subject to potential claims by its clients for the actions of the
Company's employees arising from damages to the client's business or otherwise.
There can be no assurance that the Company's fidelity bond and errors and
omissions insurance will be adequate to cover any such claims. Such claims could
have a material adverse effect on the Company's business, financial condition
and consolidated results of operations.
INVESTMENT RISKS. The Company invests funds, including payroll tax funds
transferred to it by clients in short-term financial instruments such as
overnight repurchase agreements, commercial paper and money market funds, which
are subject to credit risks and interest rate fluctuations. These investments
are
13
exposed to several risks, including credit risks from the possible inability of
the borrowers to meet the terms of their obligations under the financial
instruments. The Company would be liable for any losses on such investments.
Interest income earned from the investment of client tax funds represents a
significant portion of the Company's revenues. As a result, the Company's
business, financial condition and results of operations are significantly
impacted by interest rate fluctuations. The Company enters into interest rate
swap agreements to minimize the impact of interest rate fluctuations. There can
be no assurance, however, that the Company's swap agreements will protect the
Company from all interest rate risks. Under certain circumstances, if interest
rates rise, the Company would have payment obligations under its interest rate
swap agreements, which may not be offset by interest earned by the Company on
deposited funds. A payment obligation under the Company's swap agreements could
have a material adverse effect on the Company's business, financial condition
and results of operations. A default by the Company under its swap agreements
could result in acceleration and setoff by the bank of all outstanding contracts
under the swap agreement and could result in cross-defaults of other debt
agreements of the Company, any of which could have a material adverse effect on
the Company's business, financial condition and consolidated results of
operations.
MANAGEMENT OF GROWTH. The Company's business has grown significantly in size
and complexity over the past five years. This growth has placed, and is expected
to continue to place, significant demands on the Company's management, systems,
internal controls and financial and physical resources. In order to meet such
demands, the Company intends to continue to hire new employees, open new offices
to attract clients in new geographic regions, increase expenditures on research
and development, and invest in new equipment and make other capital
expenditures. In addition, the Company expects that it will need to develop
further its financial and managerial controls and reporting systems and
procedures to accommodate any future growth. Failure to expand any of the
foregoing areas in an efficient manner could have a material adverse effect on
the Company's business, financial condition and results of operations. The
Company established facilities for sales and implementation in New Jersey and in
Georgia and moved their administrative services center from Bellevue to Bothell
Washington during fiscal 1999. Any inability to manage growth effectively could
have a material adverse effect on the Company's business, financial condition
and consolidated results of operations.
SUBSTANTIAL COMPETITION. The market for the Company's services is intensely
competitive, subject to rapid change and significantly affected by new service
introductions and other market activities of industry participants. The Company
primarily competes with several public and private payroll service providers,
such as Automatic Data Processing, Inc., Ceridian Corporation and
Paychex, Inc., as well as smaller, regional competitors. Many of these companies
have longer operating histories, greater financial, technical, marketing and
other resources, greater name recognition and a larger number of clients than
the Company. In addition, certain of these companies offer more services or
features than the Company and have processing facilities located throughout the
United States. The Company also competes with in-house employee services
departments and, to a lesser extent, banks and local payroll companies. With
respect to benefits administrative services, the Company competes with insurance
companies, benefits consultants and other local benefits outsourcing companies.
The Company may also compete with marketers of related products and services
that may offer payroll or benefits administrative services in the future. The
Company has experienced, and expects to continue to experience, competition from
new entrants into its markets. Increased competition, the failure of the Company
to compete successfully, pricing pressures, loss of market share and loss of
clients could have a material adverse effect on the Company's business,
financial condition and consolidated results of operations.
RISKS ASSOCIATED WITH THE DEVELOPMENT AND INTRODUCTION OF NEW OR ENHANCED
SERVICES; RISKS OF SOFTWARE DEFECTS. The technologies in which the Company has
invested to date are rapidly evolving and have short life cycles, which requires
the Company to anticipate and rapidly adapt to technological changes. In
addition, the Company's industry is characterized by increasingly sophisticated
and varied needs of clients, frequent new service and feature introductions and
emerging industry standards. The introduction of
14
services embodying new technologies and the emergence of new industry standards
and practices can render existing services obsolete and unmarketable. The
Company's future success will depend, in part, on its ability to develop or
acquire advanced technologies, enhance its existing services with new features,
add new services that address the changing needs of its clients, and respond to
technological advances and emerging industry standards and practices on a timely
and cost-effective basis. Several of the Company's competitors invest
substantially greater amounts in research and development than the Company,
which may allow them to introduce new services or features before the Company.
Even if the Company is able to develop or acquire new technologies in a timely
manner, it may incur substantial costs in developing or acquiring such
technologies and in deploying new services and features to its clients,
including costs associated with acquiring in-process technology, amortization
expenses related to intangible assets and costs of additional personnel. If the
Company is unable to develop or acquire and successfully introduce new services
and new features of existing services in a timely or cost-effective manner, the
Company's business, financial condition and results of operations could be
materially adversely affected. Application software used by the Company may
contain defects or failures when introduced or when new versions or enhancements
are released. The Company has in the past discovered software defects in certain
of its applications, in some cases only after its systems have been used by
clients. There can be no assurance that future defects will not be discovered in
existing or new applications or releases. Any such occurrence could have a
material adverse effect upon the Company's business, financial condition and
consolidated results of operations.
DEPENDENCE ON THIRD-PARTY PROVIDERS. The Company depends on third-party courier
services to deliver paychecks to clients. The Company does not have any formal
written agreements with any of the courier services that it uses. Such courier
services have been in the past and may be in the future unable to pick up or
deliver the paychecks from the Company to its clients in a timely manner for a
variety of reasons, including employee strikes, storms or other adverse weather
conditions, earthquakes or other natural disasters, logistical or mechanical
failures or accidents. Failure by the Company to deliver client paychecks in a
timely manner could damage the Company's reputation and have a material adverse
effect on the Company's business, financial condition and consolidated results
of operations.
DISASTER RECOVERY; RISK OF LOSS OF CLIENT DATA. The Company currently conducts
substantially all of its payroll and payroll tax processing at the Company's
headquarters in Pleasanton, California, and divides the payroll printing and
finishing between its Pleasanton and Irvine, California, facilities. The Irvine
facility serves both as an alternative processing center and a back-up payroll
center. The Company's benefits administrative services are conducted solely in
Bothell, Washington, and no benefits administration back-up facility exists. The
Company establishes for each payroll client a complete set of payroll data at
the Pleasanton processing center, as well as at the client's site. In the event
of a disaster in Pleasanton, clients would have the ability to process payroll
checks based on the data they have on site if necessary. In addition, the
Company has developed business continuity plans for each of the Company's
mission critical business units. There can be no assurance that the Company's
disaster recovery procedures are sufficient or that the payroll data recovered
at the client site would be sufficient to allow the client to calculate and
produce payroll in a timely fashion.
The Company's operations are dependent on its ability to protect its
computer systems against damage from a major catastrophe (such as an earthquake
or other natural disaster), fire, power loss, security breach,
telecommunications failure or similar event. No assurance can be given that the
precautions that the Company has taken to protect itself from or minimize the
impact of such events will be adequate. Any damage to the Company's data
centers, failure of telecommunications links or breach of the security of the
Company's computer systems could result in an interruption of the Company's
operations or other loss that may not be covered by the Company's insurance. Any
such event could have a material adverse effect on the Company's business,
financial condition and consolidated results of operations.
DEPENDENCE ON KEY PERSONNEL. The Company's success will depend on the
performance of the Company's senior management and other key employees. The loss
of the services of any senior management or other
15
key employee could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company generally does not
enter into employment or noncompetition agreements with its employees. If one or
more of the Company's key employees resigns from the Company to join a
competitor or to form a competitor, the loss of such personnel and any resulting
loss of existing or potential clients to any such competitor could have a
material adverse effect on the Company's business, financial condition and
results of operations. In the event of the loss of any key personnel, there can
be no assurance that the Company would be able to prevent the unauthorized
disclosure or use of its technical knowledge, practices, procedures or client
lists by a former employee or that such disclosure or use would not have a
material adverse effect on the Company's business, financial condition and
consolidated results of operations.
NEED TO ATTRACT AND RETAIN EXPERIENCED PERSONNEL. The Company's success depends
to a significant degree on its ability to attract and retain experienced
employees. There is substantial competition for experienced personnel, which the
Company expects to continue. Many of the companies with which the Company
competes for experienced personnel have greater financial and other resources
than the Company. The Company has in the past and may in the future experience
difficulty in recruiting sufficient numbers of qualified personnel. In
particular, the Company's ability to find and train implementation employees is
critical to the Company's ability to achieve its growth objectives. The
inability to attract and retain experienced personnel as required could have a
material adverse effect on the Company's business, financial condition and
consolidated results of operations.
RISK ASSOCIATED WITH GEOGRAPHIC EXPANSION. A substantial majority of the
Company's revenue historically has been derived from clients located in the
western United States. The Company's ability to achieve significant future
revenue growth will in large part depend on its ability to gain new clients
throughout the United States. Growth and geographic expansion have resulted in
new and increased responsibilities for management personnel and have placed and
continue to place a strain on the Company's management and operating and
financial systems. The Company will be required to continue to implement and
improve its systems on a timely basis and in such a manner as is necessary to
accommodate the increased number of transactions and clients and the increased
size of the Company's operations. Any failure to implement and improve the
Company's systems or to hire and retain the appropriate personnel to manage its
operations would have a material adverse effect on the Company's business,
financial condition and consolidated results of operations.
YEAR 2000 COMPLIANCE. Many currently installed computer systems and software
products are coded to accept only two-digit entries in the date code field.
Beginning in 2000, these date code fields will need to accept four-digit entries
in order to distinguish 21st century dates from 20th century dates. As a result,
computer systems and/or software used by many companies will need to be upgraded
to comply with Year 2000 ("Y2K") requirements by the end of 1999. Significant
uncertainty exists in the software industry concerning the potential effects
associated with such compliance issues. To address this issue we have a Y2K
project team to ensure that the daily operations and functionality of the
Company will not be adversely affected by the Y2K issue.
The Company believes that software applications used for providing payroll,
tax and HR services at the Company are Y2K compliant. Currently clients
representing 99.8% of revenue are processing on the Company's Y2K compliant
applications. The remaining clients are scheduled to be processing on Y2K
products by November 1999. There can be no assurance that Y2K errors or defects
will not be discovered in the Company's current and future products.
The Company has engaged a representative sample of its client base to
participate in the application testing process and validate the output; however,
the Company is not assessing the Y2K compliance of its clients' systems or the
possible effects on its operations of the Y2K compliance of its clients'
systems.
The Company has assessed Y2K compliance status with regards to its
internally developed software, third-party software, hardware, facilities,
vendors and suppliers. All remediation efforts related to mission
16
critical software, hardware, vendors, suppliers and facilities have been
completed. The Company's reliance on third-party suppliers and subcontractors,
and therefore on the proper functioning of their information systems and
software, means that failure by such suppliers and subcontractors to address Y2K
issues could have a material adverse effect on the Company's business, financial
condition and consolidated results of operations.
Our Y2K compliance is dependent on key third parties also being Y2K
compliant on a timely basis; we cannot assure that the systems of certain of our
key third parties (for example, phone service providers, banks, etc.), upon
which we rely, will be converted in a timely manner, or that their failure to
convert would not have an adverse effect on our systems. In a worst-case
scenario, if one or more of our significant systems or key third parties were
not Y2K compliant by the end of 1999, this could potentially delay both clients'
payroll processing and transmission of tax payments to the local, state or
federal tax authorities. Failure by the Company to process payroll timely or
make timely or accurate tax return filings or pay tax liabilities when due on
behalf of clients may damage the Company's reputation and could have a material
adverse effect on the Company's business, financial condition and consolidated
results of operations.
The Company has a business continuity plan in place in case of an event
(including disruption due to Y2K issues) that may affect our mission critical
operations. As in other businesses, many of our business processes are dependent
upon third-party providers. We have contracts in place with alternative vendors
for mission critical suppliers such as telecommunications, delivery services and
production supplies. In addition, the Company maintains a back-up generator in
case of disruption of electrical service, and multiple fuel suppliers have been
contracted. There can be no assurance that the business continuity plans in
place will be adequate.
The costs for Y2K compliance have not been specifically identified within
the Company. However, the costs associated with Y2K compliance have not been,
and are not expected to be, material to our operations.
LIMITATIONS ON PROTECTION OF INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS. The
Company's success is dependent in part upon its proprietary software technology.
The Company has no patents, patent applications or registered copyrights. The
Company relies on a combination of contract, copyright and trade secret laws to
establish and protect its proprietary technology. The Company distributes its
services under software license agreements that grant clients licenses to use
the Company's services and contain various provisions protecting the Company's
ownership and the confidentiality of the underlying technology. The Company
generally enters into confidentiality and/or license agreements with its
employees and existing and potential clients and limits access to and
distribution of its software, documentation and other proprietary information.
There can be no assurance that the steps taken by the Company in this regard
will be adequate to deter misappropriation or independent third-party
development of the Company's technology. There can be no assurance that the
Company's services and technology do not infringe any existing patents,
copyrights or other proprietary rights of others, or that third parties will not
assert infringement claims in the future. If any such claims are asserted and
upheld, the costs of defense could be substantial and any resulting liability to
the Company could have a material adverse effect on the Company's business,
financial condition and consolidated results of operations.
POSSIBLE VOLATILITY OF STOCK PRICE. The market price of the Company's common
stock is likely to be highly volatile and could be subject to wide fluctuations
in response to quarterly variations in operating results, announcements of
technological innovations or new services by the Company or its competitors,
market conditions in the information services industry, changes in financial
estimates by securities analysts or other events or factors, many of which are
beyond the Company's control. In addition, the stock market has experienced
significant price and volume fluctuations that have particularly affected the
market prices of equity securities of many technology and services companies and
that often have been unrelated to the operating performance of such companies.
These broad market fluctuations may adversely affect the market price of the
Company's common stock.
17
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
There have been no material changes in the Company's market risk during the
three month period ended September 30, 1999. For additional information on
market risk see "Additional Factors That May Affect Future Results--Investment
Risks" contained on page 14 of this quarterly report and page 7 of the Company's
1999 Annual Report to Stockholders under the heading "Additional Factors That
May Affect Future Results--Investment Risks" (which is incorporated by reference
into Part II, Item 7A of the Company's Annual Report on Form 10-K for the year
ended June 30, 1999.)
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS. Forward-looking statements
contained in this annual report are subject to the safe harbor created by the
Private Securities Litigation Reform Act of 1995 and are highly dependent upon a
variety of important factors that could cause actual results to differ
materially from those reflected in such forward-looking statements. When used in
this document and documents referenced herein, the words "intend," "anticipate,"
"believe," "estimate" and "expect" and similar expressions as they relate to the
Company are included to identify such forward-looking statements. These
forward-looking statements include statements regarding the demand for
outsourcing employee administrative services; the Company's expansion of its
client base; the Company's intention to increase its direct sales force; the
development of a comprehensive and fully integrated suite of employee
administrative services; the Company's ability to offer additional services; the
initiation or completion of any strategic acquisition, investment or alliance;
the Company's ability to extend its technology leadership; the Company's ability
to attract and retain new clients; market acceptance of any new services offered
by the Company; the Company's ability to minimize the impact of interest rate
fluctuations; the Company's ability to develop its financial and managerial
controls and systems; the opening of additional facilities; the sufficiency of
the Company's back-up facilities and disaster recovery procedures; the Company's
ability to develop or acquire new technologies; the Company's ability to attract
and retain experienced employees; the ability of the Company to make its
internal system Y2K compliant and to transition its clients to a Y2K compliant
system; the Company's ability to maintain a high payroll client retention rate
and the Company's ability to increase its national presence. These
forward-looking statements are based largely on the Company's current
expectations and are subject to a number of risks and uncertainties, including,
without limitation, those identified under "Additional Factors That May Affect
Future Results" and elsewhere in this annual report and other risks and
uncertainties indicated from time to time in the Company's filings with the
Securities and Exchange Commission. Actual results could differ materially from
these forward-looking statements. In addition, important factors to consider in
evaluating such forward-looking statements include changes in external market
factors, changes in the Company's business or growth strategy or an inability to
execute its strategy due to changes in its industry or the economy generally,
the emergence of new or growing competitors and various other competitive
factors. In light of these risks and uncertainties, there can be no assurance
that the forward-looking statements contained in this annual report will in fact
occur.
18
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There are no material pending legal proceedings.
ITEM 2. CHANGES IN SECURITIES
(b) On September 25, 1998, the Company commenced a secondary public offering
(the "Secondary Offering"), which consisted of 3,191,250 shares of its
Common Stock at $27.00 per share pursuant to a registration statement (No.
333-60745) declared effective by the Securities and Exchange Commission on
September 25, 1998. As of July 1, 1999 $73.6 million of the Company's net
proceeds from the offering were invested in short-term financial
instruments. During the period July 1, 1999 to September 30, 1999
approximately $12.1 million of the proceeds was used for working capital. At
October 1, 1999, approximately $61.5 million of the net offering proceeds
from the Secondary Offering were invested in short-term financial
instruments.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(b) Exhibits.
See exhibit list following signature page.
(c) On May 12, 1999, the Company filed a report on form 8-K for announcing that
on April 27, 1999, the Company completed the acquisition of Conduit Parent.
On July 12, 1999, the Company filed on Form 8-K/A an amendment to the Form
8-K previously filed on May 12, 1999, for the required financial statement
disclosure.
19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: November 15, 1999
PROBUSINESS SERVICES, INC.
(Registrant)
/s/ THOMAS H. SINTON
--------------------------------------
PRESIDENT AND CHIEF EXECUTIVE OFFICER
/s/ STEVEN E. KLEI
--------------------------------------
SENIOR VICE PRESIDENT, FINANCE AND
CHIEF FINANCIAL OFFICER
20