> FINANCIAL HIGHLIGHTS
DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS AS OF 6.30
1994 1995 1996 1997 1998
Revenue $ 4,069 $7,095 $ 13,863 $ 27,374 $ 46,317
Loss from operations (1,431) (893) (1,982) (5,114) (6,712)
Net loss (1,477) (979) (2,386) (6,245) (6,517)
Gross margin 2,440 4,392 7,428 13,715 22,458
Operating profit before client acquisition
costs 36 2,050 4,117 6,592 11,146
Pro forma basic and diluted net loss
per share (0.59) (0.41)
Shares used in computing pro forma basic
and diluted net loss per share 10,533 15,722
Total assets 2,019 4,134 117,228 200,435 376,009
Payroll tax funds invested -- -- 106,339 177,626 332,667
NINETY EIGHT 3 PROBUSINESS SERVICES, INC.
> MANAGEMENT'S DISCUSSION AND ANALYSIS
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. The following discussion also should be
read in conjunction with the Financial Statements and Notes thereto included
elsewhere in this Annual Report.
OVERVIEW
ProBusiness Services, Inc. is a leading provider of employee administrative
services for large employers. The Company's primary service offerings are
payroll processing, payroll tax filing, benefits administration, including the
enrollment and processing of flexible benefits plans and COBRA programs, and
human resources software. 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 1994, the Company has
experienced significant growth of its revenue, client base and average client
size. Revenue increased from $13.9 million in fiscal 1996 to $46.3 million in
fiscal 1998. From June 30, 1996, to June 30, 1998, the client base for payroll
processing services increased from 310 to 510 clients, while the average size of
the Company's payroll clients increased from approximately 620 employees to
approximately 1,100 employees. The number of checks that the Company processed
for its payroll clients increased from 2.9 million to 4.3 million for the
quarters ended June 30, 1997 and 1998, respectively. As of June 30, 1998, the
Company provided services to approximately 1,400 clients. 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 size of
its clients, the introduction of new features and other services, and a high
retention rate of existing payroll clients (approximately 92% for fiscal 1998).
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
three to twelve months or longer, and the implementation process generally takes
an additional three to nine months or longer. In addition, the Company's revenue
is 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 tax funds.
Further, the Company's operating expenses are typically higher as a percentage
of revenue in the first and second 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 expects this pattern to continue. 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
June 30, 1998, the company had an accumulated deficit of approximately
$25.5 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, and, to a lesser extent, amortization of capitalized software development
costs. General and administrative expenses consist primarily of personnel costs,
professional fees and other overhead costs for finance and corporate services.
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.
In January 1997, the Company acquired all of the outstanding capital stock
of BeneSphere Administrators, Inc. for an initial purchase price of $3.1
million, with up to an additional $4.5 million to be paid in quarterly
installments, beginning April 1998 through January 2000, if certain financial
performance conditions are met. As of June 30, 1998, and in connection with the
financial performance conditions, $2.2 million of the $4.5 million additional
purchase price had been earned. In May 1996, the Company acquired substantially
all of the business and assets of Dimension Solutions for a purchase price of
$1.3 million. In connection with the acquisition of Dimension Solutions, the
Company recorded a one-time charge of $711,000 in fiscal 1996 relating to the
purchase of in-process technology.
NINETY EIGHT 19 PROBUSINESS SERVICES, INC.
> MANAGEMENT'S DISCUSSION AND ANALYSIS
The following table sets forth certain financial data as a percentage of revenue
for the periods indicated:
STATEMENTS OF OPERATIONS DATA
RESULTS OF OPERATIONS AS OF 6.30
1996 1997 1998
Revenue 100.0% 100.0% 100.0%
OPERATING EXPENSES:
Cost of providing services 46.4 49.9 51.5
General and administrative expenses 14.8 15.6 14.5
Research and development expenses 9.1 10.4 9.9
Client acquisition costs 38.9 42.8 38.6
Acquisition of in-process technology 5.1 -- --
- ------------------------------------------------------------------------------------------------
Total operating expenses 114.3 118.7 114.5
- ------------------------------------------------------------------------------------------------
Loss from operations (14.3) (18.7) (14.5)
Interest expense (3.4) (4.3) (1.2)
Other income 0.5 0.2 1.6
- ------------------------------------------------------------------------------------------------
Net loss (17.2)% (22.8)% (14.1)%
- ------------------------------------------------------------------------------------------------
REVENUE
Revenue increased 69.2% in fiscal 1998 and increased 97.5% in fiscal 1997,
primarily due to increases in the number and average size of the Company's
payroll and tax clients, and, to a lesser extent, the introduction of the
Company's benefits administration services in January 1997 which were included
in the Company's results for the full year in fiscal 1998. Interest income
earned on payroll tax funds invested was $11.5 million, $5.9 million and $1.9
million in fiscal 1998, 1997 and 1996, respectively. The increases were
primarily the result of higher average daily payroll tax fund balances.
COST OF PROVIDING SERVICES
Cost of providing services increased 74.7% in fiscal 1998 and 112.3% in
fiscal 1997 and increased as a percentage of revenue to 51.5% in fiscal 1998,
compared with 49.9% in fiscal 1997 and 46.4% in fiscal 1996. The increases in
absolute dollars were primarily due to the year-over-year increase in clients
serviced. The increases as a percentage of revenue in fiscal 1998 and fiscal
1997 were primarily due to building management infrastructure in the Company's
benefits operations and opening the Company's production facility in Irvine,
California in fiscal 1998.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased 57.1% in fiscal 1998 and
108.5% in fiscal 1997. The increases in absolute dollars were primarily due to
the hiring of additional management and administrative personnel to support the
Company's growth, and, to a lesser extent, to costs associated with the
Company's benefits administration services which were introduced in January 1997
and included in general and administrative expenses for the full year in fiscal
1998.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased 61.4% in fiscal 1998 and 126.0%
in fiscal 1997. Research and development expenses as a percentage of revenue
represented 9.9% in fiscal 1998 compared with 10.4% in fiscal 1997 and 9.1% in
fiscal 1996. The increases in absolute dollars were primarily a result of
increases in personnel and equipment to develop enhancements and new features to
the Company's existing services. Research and development expenses decreased as
a percentage of revenue in fiscal 1998 due in part to higher revenue and an
increase in the amount of expenses capitalized. Capitalized software
development costs were $3.9 million, $1.4 million and $645,000 for fiscal 1998,
1997 and 1996, respectively.
CLIENT ACQUISITION COSTS
Client acquisition costs increased 52.6% in fiscal 1998 and 117.3% in
fiscal 1997. The increases in absolute dollars were primarily due to the
expanded sales and implementation force for payroll and stand-alone tax services
and expenses related to the Company's benefits administration services
introduced in January 1997 and included in client acquisition costs for the full
year in fiscal 1998.
NINETY EIGHT 20 PROBUSINESS SERVICES, INC.
INTEREST EXPENSE
Interest expense decreased 53.2% in fiscal 1998 and increased 151.6% in
fiscal 1997. The decrease in interest expense in fiscal 1998 was primarily due
to the repayment of subordinated debt and repayment of borrowings under the
Company's secured revolving line of credit with proceeds from the Company's
initial public offering in September 1997. The increase in interest expense in
fiscal 1997 was primarily due to increased borrowing under the Company's line of
credit, the issuance of promissory notes to certain investors in October and
December 1995 and an increased amount of capitalized equipment leases.
OTHER INCOME
Other income increased as a percentage of revenue to 1.6% in fiscal 1998
from 0.2% in fiscal 1997. The increase in other income as a percentage of
revenue was due to higher cash and investment balances resulting from the
Company's initial public offering in September 1997 when compared to the same
period the prior year.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has financed its operations primarily through
a combination of sales of equity securities, private debt and bank borrowings,
and, to a lesser extent, equipment leases. Prior to its initial public offering
of common stock, the Company raised approximately $23.4 million in private sales
of equity securities and raised approximately $27.0 million from the initial
public offering in September 1997.
At June 30, 1998, the Company had approximately $13.8 million of cash and
cash equivalents and a $20.0 million secured revolving line of credit, which
expires in December 2000. At June 30, 1998, the Company had no outstanding
borrowings under the line of credit.
Net cash provided by operating activities for fiscal 1998 was $3.6 million
and net cash used in operating activities for fiscal 1997 and 1996 was $4.1
million and $202,000, respectively. Net cash provided by operating activities in
fiscal 1998 was primarily the result of increases in accrued liabilities,
depreciation and deferred revenue, and decreases in other assets in fiscal 1998,
partially offset by an increase in prepaid expenses and other current assets.
Net cash used in operating activities in fiscal 1997 was primarily the result of
an increase in net losses and, to a lesser extent, increases in accounts
receivable and other assets, partially offset by depreciation and amortization
and an increase in accrued liabilities.
Net cash used in investing activities was $14.3 million, $4.7 million and
$3.3 million for fiscal 1998, 1997 and 1996, respectively. Net cash used in
investing activities in fiscal 1998 resulted primarily from (i) capital
expenditures for equipment, furniture and fixtures to support the Company's
increased personnel, (ii) the move of the Company's corporate headquarters in
early fiscal 1998 and (iii) the establishment of the Company's Irvine production
facility in early fiscal 1998. In addition, the Company capitalized software
development costs of $3.9 million, $1.4 million and $645,000 in fiscal 1998,
1997 and 1996, respectively. The Company expects to make additional capital
expenditures for furniture, equipment and fixtures to support the continued
growth of its operations. In addition, the Company anticipates that it will
continue to expend funds for software development in the future.
Net cash provided by financing activities was $19.5 million, $9.8 million
and $6.7 million for fiscal 1998, 1997 and 1996, respectively. Net cash provided
by financing activities for fiscal 1998 related primarily to $27.0 million of
net proceeds from the Company's initial public offering of common stock and
$959,000 from the exercise of warrants. The increase was partially offset by the
payment of $3.9 million of outstanding subordinated debt and the net repayment
of $4.8 million of borrowings under the Company's secured revolving line of
credit. Net cash provided by financing activities for fiscal 1997 was primarily
a result of $9.9 million of net proceeds from the issuance of preferred stock in
March 1997. Net cash provided by financing activities for fiscal 1996 was
primarily the result of $4.0 million from subordinated debt and net proceeds of
$2.5 million from borrowings under line-of-credit agreements.
The Company believes that existing cash 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. On August 12, 1998, the Company filed a
Registration Statement with the Securities and Exchange Commission relating to
the registration for public offering of common stock with a proposed maximum
aggregate offering price of up to $110,000,000. The Company may also utilize
cash to acquire or invest in complementary businesses or to obtain the right to
use complementary technologies, although the Company does not have any pending
plans to do so. The Company may sell additional equity or debt securities or
obtain additional credit facilities.
NINETY EIGHT 21 PROBUSINESS SERVICES, INC.
> MANAGEMENT'S DISCUSSION AND ANALYSIS
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
OPERATING LOSSES; NEED TO COMMIT TO EXPENSES IN ADVANCE OF REVENUE
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 June 30, 1998, the Company had an accumulated deficit
of approximately $25.5 million. The establishment of new client relationships
involves lengthy and extensive sales and implementation processes. The sales
process generally takes three to 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. The Company has made
acquisitions of businesses in the past and intends to pursue acquisitions in the
future. In connection with acquisitions, the Company has in the past incurred
and will likely incur in the future costs associated with adding personnel,
integrating technology, increasing overhead to support the acquired businesses,
acquiring in-process technology and amortization expenses related to intangible
assets. Any future acquisitions could have a material adverse effect on the
Company's business, financial condition and results of operations.
SEASONALITY; FLUCTUATIONS 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 second 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 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 administration 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
While the Company has no current agreements or negotiations underway with
respect to any acquisition of, or investment in, businesses that provide
complementary services or technologies to those of the Company, the Company
intends to make additional acquisitions of, and investments in, such businesses.
There can be no assurance that any future acquisition will be completed or that,
if completed, will be effectively assimilated into the Company's business.
NINETY EIGHT 22 PROBUSINESS SERVICES, INC.
In addition, future acquisitions could result in the issuance of dilutive equity
securities, the incurrence of debt or contingent liabilities, and amortization
expenses related to goodwill and other intangible assets, any of which could
have a material adverse effect on the Company's business, financial condition
and results of operations. Furthermore, there can be no assurance that any
strategic investment will succeed. The initial cost of such an investment or the
failure of such an investment to succeed could have a material adverse effect on
the Company's business, financial condition and results of operations.
RISKS ASSOCIATED WITH PAYROLL TAX FILING SERVICE AND BENEFITS ADMINISTRATION
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
results of operations.
The Company's benefits administration 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 administration services are also dependent upon
government regulations which are subject to continuous changes that could reduce
or eliminate the need for benefits administration 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 results of operations.
INVESTMENT RISKS
The Company invests funds, including payroll tax funds transferred to it by
clients, until the Company remits the funds to tax authorities when due. The
Company typically invests these funds in short-term financial instruments such
as overnight U.S. government direct and agency obligations repurchase
agreements, commercial paper rated A1 and/or P1 and money market funds with an
underlying credit quality of AA or better. These investments are 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 investing these 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
NINETY EIGHT 23 PROBUSINESS SERVICES, INC.
> MANAGEMENT'S DISCUSSION AND ANALYSIS
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. In addition, there can be no assurance that the
Company would have sufficient funds to meet any such swap payment obligations. 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 results of operations.
MANAGEMENT OF GROWTH
The Company's business has grown significantly in size and complexity over
the past four years. The Company's number of employees has increased from 325 at
the end of fiscal 1997 to 500 at the end of fiscal 1998. 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 intends to open a satellite sales and implementation center in New
Jersey by the end of calendar 1998 and may open additional sales offices in the
future. In addition, the Company intends to move its benefits administration
center from its current location in Bellevue, Washington to another location
there, and the Company has leased additional office space to be built adjacent
to its Pleasanton headquarters. There can be no assurance that the Company will
be able to establish such facilities on a timely basis. The Company's growth may
depend to some extent on its ability to successfully complete strategic
acquisitions or investments to expand or complement its existing business. There
can be no assurance that suitable acquisitions or investments can be identified,
consummated or successfully integrated into the Company's operations. Any
inability to manage growth effectively could have a material adverse effect on
the Company's business, financial condition and 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 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 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
administration services are conducted solely in Bellevue, Washington, and no
benefits
NINETY EIGHT 24 PROBUSINESS SERVICES, INC.
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. 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 which 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 results of operations.
RISKS 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. By the end of calendar
1998, the Company intends to open a satellite sales and implementation center in
New Jersey to service the eastern United States. The Company may open additional
sales offices in the future. Due to the time required to sell and implement the
Company's services and the fixed costs associated with opening a new center, any
revenue associated with a new center will be significantly lower than the costs
associated with it, potentially for a significant period of time. Growth and
geographic expansion have resulted in new and increased responsibilities for
management personnel and have placed and continue to place a significant 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 results of operations.
In addition, an increase in the Company's operating expenses from its planned
expansion will have a material adverse effect on the Company's business,
financial condition and results of operations if revenue does not increase to
support such expansion.
IMPACT OF 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" requirements by the end of 1999. Significant uncertainty
exists in the software industry concerning the potential effects associated with
such compliance issues.
The Company has conducted a preliminary review of its internal computer
systems to identify the systems that could be affected by the Year 2000 issue
and to develop a plan to make its systems Year 2000 compliant. Based on this
preliminary review, the Company has discovered certain failures to comply with
Year 2000 requirements. The Company is taking action to correct the noncomplying
features of its systems, and the Company believes that its internal software
systems will be Year 2000 compliant by 2000. There can be no assurance, however,
that the Company's systems will be fully Year 2000 compliant in a timely manner,
and a failure by the Company to make its internal systems Year 2000 compliant
could have a material adverse effect on the Company's business, financial
condition and results of operations. The Company has not determined an estimate
of the costs required to correct the noncomplying features, and the Company does
not currently have a contingency plan in the event that it is unable to make its
systems Year 2000 compliant. Additionally, the costs of making such systems Year
2000 compliant could have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company believes that its current products are, and future products
will be, fully Year 2000 compliant. The Company's past software products, many
of which are currently used by clients, are not Year 2000 compliant. The Company
has begun the process of transitioning existing clients to its Year 2000
compliant products; however, there can be no assurance that the Company will be
successful in providing all of its clients with Year 2000 compliant products by
2000. Any failure by the Company to transition its clients to Year 2000
compliant products could have a material adverse effect on the Company's
business, financial condition and results of operations. In addition, there can
be no assurance that Year 2000 errors or defects will not be discovered in the
Company's current and future products.
NINETY EIGHT 25 PROBUSINESS SERVICES, INC.
> MANAGEMENT'S DISCUSSION AND ANALYSIS
The Company is not assessing the Year 2000 compliance of its clients'
systems or the possible effects on its operations of the Year 2000 compliance of
its clients' systems. Due to the substantial integration between the Company's
computer systems and its clients' systems, the failure by the Company's clients
to have Year 2000 compliant systems could have a material adverse effect on the
Company's business, financial condition and results of operations. The Company
is assessing the possible effects on its operations of the Year 2000 readiness
of key suppliers and subcontractors. The Company's reliance on 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 Year 2000 issues could have a material adverse effect on the Company's
business, financial condition and results of 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 results of operations.
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 Year 2000 compliant and
to transition its clients to a Year 2000 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.
NINETY EIGHT 26 PROBUSINESS SERVICES, INC.
> BALANCE SHEETS
ASSETS
DOLLARS IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS AS OF 6.30
1997 1998
CURRENT ASSETS:
Cash and cash equivalents $ 5,047 $ 13,771
Accounts receivable, net of allowance
of $365,000 at June 30, 1997 and
$420,000 at June 30, 1998 2,476 2,612
Prepaid expenses and other current assets 643 2,122
- ------------------------------------------------------------------------------
8,166 18,505
Payroll tax funds invested 177,626 332,667
- ------------------------------------------------------------------------------
Total current assets 185,792 351,172
Equipment, furniture and fixtures, net 7,623 13,958
Other assets 7,020 10,879
- ------------------------------------------------------------------------------
Total assets $ 200,435 $ 376,009
- ------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
DOLLARS IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS AS OF 6.30
1997 1998
CURRENT LIABILITIES:
Accounts payable $ 1,089 $ 1,750
Accrued liabilities 4,984 10,403
Deferred revenue 1,279 2,139
Current portion of capital lease obligations 773 890
- ------------------------------------------------------------------------------
8,125 15,182
Payroll tax funds collected but unremitted 177,626 332,667
- ------------------------------------------------------------------------------
Total current liabilities 185,751 347,849
Note payable to stockholder 250 --
Long-term debt 8,667 --
Capital lease obligations, less current portion 1,898 1,414
Commitments
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value; authorized:
5,000,000 shares; issued and outstanding:
3,228,034 shares at June 30, 1997 3 --
Common stock, $.001 par value; authorized:
60,000,000 shares; issued and outstanding:
2,295,416 shares at June 30, 1997 and
17,114,855 shares at June 30, 1998 2 17
Additional paid-in capital 23,904 53,286
Accumulated deficit (18,952) (25,469)
Notes receivable from stockholders (1,088) (1,088)
- ------------------------------------------------------------------------------
Total stockholders' equity 3,869 26,746
- ------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 200,435 $ 376,009
- ------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES.
NINETY EIGHT 27 PROBUSINESS SERVICES, INC.
> STATEMENTS OF OPERATIONS
DOLLARS IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS AS OF 6.30
1996 1997 1998
Revenue $ 13,863 $ 27,374 $ 46,317
OPERATING EXPENSES:
Cost of providing services 6,435 13,659 23,859
General and administrative expenses 2,054 4,282 6,727
Research and development expenses 1,257 2,841 4,585
Client acquisition costs 5,388 11,706 17,858
Acquisition of in-process technology 711 -- --
- ------------------------------------------------------------------------------------------------------------------------------
Total operating expenses 15,845 32,488 53,029
- ------------------------------------------------------------------------------------------------------------------------------
Loss from operations (1,982) (5,114) (6,712)
Interest expense (473) (1,190) (557)
Other income 69 59 752
- ------------------------------------------------------------------------------------------------------------------------------
Net loss $ (2,386) $ (6,245) $ (6,517)
- ------------------------------------------------------------------------------------------------------------------------------
Historical basic and diluted net loss per share (Note 1) $ (4.91)
- ------------------------------------------------------------------------------------------------------------------------------
Shares used in computing historical basic and diluted net loss per share (Note 1) 486
- ------------------------------------------------------------------------------------------------------------------------------
Pro forma basic and diluted net loss per share (Note 1) $ (0.59) $ (0.41)
- ------------------------------------------------------------------------------------------------------------------------------
Shares used in computing pro forma basic and diluted net loss per share (Note 1) 10,533 15,722
SEE ACCOMPANYING NOTES.
NINETY EIGHT 28 PROBUSINESS SERVICES, INC.
> STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
DOLLARS IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS
----------PREFERRED STOCK---------- ----------COMMON STOCK----------
ADDITIONAL ADDITIONAL
PAID-IN PAID-IN
SHARES AMOUNT CAPITAL SHARES AMOUNT CAPITAL
Balance at June 30, 1995 2,613,301 $ 2 $ 11,682 20,142 $ -- $ 3
Issuance of Series E preferred
stock at $7.94 per share, net
of issuance costs 40,000 -- 317 -- -- --
Exercise of stock options -- -- -- 1,802,334 2 365
Issuance of preferred stock
warrants -- -- 200 -- -- --
Net loss -- -- -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1996 2,653,301 2 12,199 1,822,476 2 368
Issuance of Series F preferred
stock at $17.40 per share, net
of issuance costs 574,733 1 9,850 -- -- --
Exercise of stock options -- -- -- 472,940 -- 1,166
Issuance of preferred stock
warrants -- -- 321 -- -- --
Net loss -- -- -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1997 3,228,034 3 22,370 2,295,416 2 1,534
Issuance of common stock in
connection with initial
public offering, net of
offering costs -- -- -- 4,312,500 4 27,005
Conversion of preferred
stock into common stock (3,288,034) (3) (22,370) 9,684,102 10 22,363
Exercise of warrants -- -- -- 415,725 1 958
Exercise of stock options -- -- -- 236,998 -- 317
Issuance of stock under
employee stock purchase plan -- -- -- 170,114 -- 1,060
Issuance of warrants -- -- -- -- -- 49
Net loss -- -- -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1998 -- $-- $ -- 17,114,855 $ 17 $ 53,286
- -----------------------------------------------------------------------------------------------------------------------------------
NOTES TOTAL
RECEIVABLE STOCKHOLDERS'
ACCUMULATED FROM EQUITY
DEFICIT STOCKHOLDERS (DEFICIT)
Balance at June 30, 1995 $ (10,321) $ -- $ 1,366
Issuance of Series E preferred
stock at $7.94 per share, net
of issuance costs -- -- 317
Exercise of stock options -- -- 367
Issuance of preferred stock
warrants -- -- 200
Net loss (2,386) -- (2,386)
- ------------------------------------------------------------------------------------
Balance at June 30, 1996 (12,707) -- (136)
Issuance of Series F preferred
stock at $17.40 per share, net
of issuance costs -- -- 9,851
Exercise of stock options -- (1,088) 78
Issuance of preferred stock
warrants -- -- 321
Net loss (6,245) -- (6,245)
- ------------------------------------------------------------------------------------
Balance at June 30, 1997 (18,952) (1,088) 3,869
Issuance of common stock in
connection with initial
public offering, net of
offering costs -- -- 27,009
Conversion of preferred
stock into common stock -- -- --
Exercise of warrants -- -- 959
Exercise of stock options -- -- 317
Issuance of stock under
employee stock purchase plan -- -- 1,060
Issuance of warrants -- -- 49
Net loss (6,517) -- (6,517)
- ------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 1998 $ (25,469) $ (1,088) $ 26,746
- ------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES.
NINETY EIGHT 29 PROBUSINESS SERVICES, INC.
> STATEMENTS OF CASH FLOWS
DOLLARS IN THOUSANDS AS OF 6.30
1996 1997 1998
OPERATING ACTIVITIES
Net loss $(2,386) $ (6,245) $ (6,517)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation and amortization 1,146 2,574 4,285
Acquisition of in-process technology 711 -- --
Change in operating assets and liabilities:
Accounts receivable, net (,521) (1,002) (136)
Prepaid expenses and other current assets (214) (254) (1,479)
Other assets 201 (1,782) 1,577
Accounts payable 360 438 661
Accrued liabilities 650 1,990 4,338
Deferred revenue (149) 174 860
- ---------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities (202) (4,107) 3,589
INVESTING ACTIVITIES
Acquisition of BeneSphere Administrators,Inc., net of cash acquired -- (245) --
Additional consideration paid in connection with the acquisition of
BeneSphere Administrators, Inc. -- -- (1,127)
Purchase of equipment, furniture and fixtures (2,682) (2,775) (9,353)
Capitalization of software development costs (645) (1,409) (3,858)
Notes receivable from stockholders -- (295) --
- ---------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (3,327) (4,724) (14,338)
FINANCING ACTIVITIES
Borrowings under bank line-of-credit agreements 5,934 24,727 6,874
Repayments of borrowings under line-of-credit agreements (3,478) (23,831) (11,632)
Repayments under long-term debt -- -- (3,909)
Proceeds from note payable 4,000 -- --
Repayments under note payable -- (534) --
Proceeds from notes payable to stockholders 250 275 --
Repayments under notes payable to stockholders (227) (275) (250)
Principal payments on capital lease obligations (128) (454) (955)
Proceeds from issuance of preferred stock -- 9,851 --
Proceeds from issuance of common stock 367 78 29,345
- ---------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 6,718 9,837 19,473
- ---------------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 3,189 1,006 8,724
Cash and cash equivalents, at beginning of year 852 4,041 5,047
- ---------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, at end of year $ 4,041 $ 5,047 $ 13,771
- ---------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 377 $ 1,507 $ 552
- ---------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Purchase of equipment, furniture and fixtures under capital leases $ 210 $ 2,644 $ 588
- ---------------------------------------------------------------------------------------------------------------------
Issuance of warrants $ 200 $ 161 $ 49
- ---------------------------------------------------------------------------------------------------------------------
Notes receivable from stockholders issued in connection
with stock option exercises $ -- $ 1,088 $ --
- ---------------------------------------------------------------------------------------------------------------------
ACQUISITION OF DIMENSION SOLUTIONS, INC.
Issuance of Series E preferred stock $ 317 $ -- $ --
Liabilities assumed 947 -- --
- ---------------------------------------------------------------------------------------------------------------------
$ 1,264 $ -- $ --
- ---------------------------------------------------------------------------------------------------------------------
ACQUISITION OF BENESPHERE ADMINISTRATORS, INC.
Issuance of warrants $ -- $ 160 $ --
Liabilities assumed -- 2,445 --
Note payable to BeneSphere Administrators, Inc. -- 250 --
- ---------------------------------------------------------------------------------------------------------------------
$ -- $ 2,855 $ --
- ---------------------------------------------------------------------------------------------------------------------
BeneSphere contingent consideration $ -- $ -- $ 2,208
- ---------------------------------------------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES
NINETY EIGHT 30 PROBUSINESS SERVICES, INC.
> NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
OPERATIONS
ProBusiness Services, Inc. (the "Company") provides employee administrative
services for large employers. The Company's primary service offerings are
payroll processing, payroll tax filing, human resources software and benefits
administration, including the enrollment and processing of flexible benefit
plans and COBRA programs.
On May 23, 1996, the Company acquired substantially all of the business and
assets of Dimension Solutions, Inc. ("Dimension Solutions") for approximately
$1,300,000. The transaction was recorded under the purchase method of
accounting, and the results of operations of Dimension Solutions have been
included in the financial statements of the Company beginning May 24, 1996.
On January 1, 1997, the Company acquired all of the outstanding stock of
BeneSphere Administrators, Inc. ("BeneSphere"), a Washington corporation. The
transaction was recorded under the purchase method of accounting, and the
results of operations of BeneSphere have been included in the financial
statements of the Company beginning January 2, 1997 (Note 10).
PAYROLL PROCESSING AND PAYROLL TAX FILING SERVICES
In connection with its payroll tax filing services, the Company collects
funds from clients for payment of payroll taxes, holds such funds in financial
institutions until payment is due (such funds being segregated from the
Company's other accounts), remits such funds to the appropriate taxing
authorities, and files related federal, state and local tax returns, coupons, or
other required payroll tax data ("payroll tax filings"). For such services, the
Company derives its payroll tax filing service revenue from fees charged and
from interest income it receives on payroll tax funds temporarily held pending
remittance on behalf of its clients to taxing authorities ("collected but
unremitted payroll tax funds"). These collected but unremitted payroll tax funds
and the related liability to clients for such funds are included in the
accompanying balance sheets as current assets and current liabilities. The
amount of funds held under these arrangements with customers may vary
significantly during the year. The Company invests collected but unremitted
payroll tax funds in various financial instruments which consisted of overnight
U.S. government, agency and mortgage backed repurchase agreements ($40,965,000),
money market funds ($134,520,000) and cash and cash equivalents ($2,141,000) at
June 30, 1997, and of overnight U.S. government, agency and mortgage backed
repurchase agreements ($279,801,000), money market funds ($50,076,000) and cash
and cash equivalents ($2,790,000) at June 30, 1998. As a result of the types of
financial instruments in which the Company invests, the carrying amount of such
investments approximates fair value. The Company's collected but unremitted
payroll tax fund investments are held primarily with one custodial financial
institution. Interest income earned on collected but unremitted payroll tax
funds, which is classified as revenue, amounted to approximately $1,896,000,
$5,925,000, and $11,521,000 for fiscal 1996, 1997 and 1998, respectively.
The Company's payroll tax filing service is subject to various risks
resulting from errors and omissions in the payment of payroll taxes and related
payroll tax filings. The Company processes data received from clients and remits
funds along with any required payroll tax filings 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 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 or results of
operations. At June 30, 1997 and 1998, the Company had accrued approximately
$586,000 and $971,000, respectively, for potential tax penalties. There can be
no assurance that the Company's accruals or insurance for such penalties will be
adequate. In addition, failure by the Company to make timely or accurate payroll
tax payments or filings when due may damage the Company's reputation and
adversely affect its relationships with existing clients and its ability to gain
new clients.
The Company's payroll tax service is also dependent upon government
regulations, which are subject to continuous changes. Failure by the Company to
implement these changes into its services and technology in a timely manner
could 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 the investment of
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 of taxes owed to government authorities could have a
material adverse effect on the Company's business, financial condition and
results of operations.
NINETY EIGHT 31 PROBUSINESS SERVICES, INC.
> NOTES TO FINANCIAL STATEMENTS
The Company's benefits administration 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 accruals 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 administration services are also dependent upon
government regulations which are subject to continuous changes that could reduce
or eliminate the need for benefits administration 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 results of operations.
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. The Company currently conducts
substantially all of its payroll and payroll tax processing and production at
the Company's headquarters in Pleasanton, California. 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 which 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 results of operations.
INTEREST RATE SWAP AGREEMENTS
During fiscal 1998, the Company entered into various interest rate swap
agreements with a financial institution. The purpose of these agreements is to
convert a portion of the interest the Company earns from collected but
unremitted payroll tax funds from a floating to a fixed rate basis. The Company
considers these agreements to be for "other than trading purposes" and has
accounted for these agreements on an accrual basis, with each net payment or
receipt due or owed under each agreement recognized in earnings during the
period to which the payment or receipt relates, with no recognition on the
balance sheet of the fair value of the agreements. At June 30, 1998, the
aggregate fair value of these agreements was $432,000.
These agreements, with fixed interest rates between 5.736% and 5.905%, each
have a term of two years, one of which has a cancellation option after one year,
and expire at various dates through April 2000. Interest is paid or received
based upon the difference in the fixed interest rate and the contractual
floating rate option times the contractual notional balance. The actual notional
balance varies on a monthly basis due to fluctuations in projected holdings of
collected but unremitted payroll tax funds. At June 30, 1998, the notional
balance was $204,700,000 and the average monthly notional balance for the
remaining term of the agreements was $242,000,000. The agreements require
collateral if interest rates increase and certain other conditions are met as
defined in the agreements. At June 30, 1998, no collateral was required.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities and the reported amounts of
revenues and expenses during the period. Such estimates include, but are not
limited to, provisions for doubtful accounts and penalties and interest relating
to payroll tax processing and estimates regarding the recoverability of
capitalized software. Actual results could differ from these estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of
three months or less at the time of purchase to be cash equivalents. Cash and
cash equivalents have a carrying amount which approximates fair value. The
Company's cash, cash equivalents and payroll tax funds invested are held
primarily with two financial institutions.
EQUIPMENT, FURNITURE AND FIXTURES
Equipment, furniture and fixtures are stated at cost, net of accumulated
depreciation and amortization. Depreciation of equipment, furniture and
fixtures is computed using the straight-line method over the estimated useful
lives of the assets which range from three to seven years. Leasehold
improvements and assets under capital leases are amortized over the shorter
of the life of the asset or the term of the lease.
NINETY EIGHT 32 PROBUSINESS SERVICES, INC.
REVENUE RECOGNITION
Revenue from payroll processing and payroll tax filing services under
client contracts is recognized as the services are performed. Interest income
earned on unremitted payroll tax funds invested is recognized as earned.
The Company's sales are primarily to customers in the United States. Credit
evaluations are performed as necessary and the Company does not require
collateral from customers.
SOFTWARE DEVELOPMENT COSTS
The Company accounts for software development costs in accordance with
Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of
Computer Software to Be Sold, Leased or Otherwise Marketed."
The Company capitalizes software development costs incurred after
establishing technological feasibility of the product prior to the general
release of the service using the product. Costs incurred in connection with the
enhancement of the Company's existing products or after the general release of
the service using the product are expensed in the current period and included in
the research and development costs within the statement of operations. The
Company amortizes the capitalized software development costs using the greater
of the straight-line basis over the estimated product life, which is generally a
36-month period, or the ratio of current revenue to the total of current revenue
and anticipated future revenue over the life of the related product. Such
amortization is included in cost of providing services within the statement of
operations.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for employee stock options in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25") and has adopted the "disclosure only" alternative as
described in FAS No. 123, "Accounting for Stock-Based Compensation" ("FAS 123")
(Note 7).
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued FAS
No. 130, "Reporting Comprehensive Income" ("FAS 130"), and FAS No. 131,
"Disclosure about Segments of an Enterprise and Related Information" ("FAS
131"). The Company is required to adopt these statements in fiscal 1999. FAS 130
establishes new standards for reporting and displaying comprehensive income and
its components. FAS 131 requires disclosure of certain information regarding
operating segments, products and services, geographic areas of operation and
major customers. The Company has not reached a conclusion as to the appropriate
segments, if any, it will be required to report to comply with the provisions of
FAS 131. Adoption of these statements is not expected to have a significant
impact on the Company's financial position, results of operations or cash flows.
In June 1998, the FASB issued FAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("FAS 133"). The Company is required to
adopt FAS 133 in fiscal 2000. FAS 133 established methods of accounting for
derivative financial instruments and hedging activities related to those
instruments as well as other hedging activities. The Company has not yet
determined what the effect of FAS 133 will be on the operations and financial
position of the Company.
RECLASSIFICATIONS
Certain prior year balances have been reclassified to conform to the
current year presentation.
BASIC AND DILUTED NET LOSS PER SHARE (HISTORICAL AND PRO FORMA)
Historical net loss per share is presented under the requirements of FAS
No. 128, "Earnings per Share" ("FAS 128"). FAS 128 replaced the previously
reported primary and fully diluted earnings per share with basic and diluted
earnings per share. Unlike primary earnings per share, basic earnings per share
excludes any dilutive effects of options, warrants, convertible securities and
shares subject to repurchase. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share. Common stock equivalent
shares from convertible preferred stock and from stock options and warrants are
not included in the calculation of diluted net loss per share as the effect is
anti-dilutive. All net loss per share amounts for all periods have been
presented to conform to the FAS 128 requirements.
In February 1998, Staff Accounting Bulletin No. 98 ("SAB 98") was issued
and amends the existing Securities and Exchange Commission ("SEC") staff
guidance primarily to give effect to FAS 128. Under SAB 98, certain shares of
convertible preferred stock, options and warrants to purchase shares of common
stock, issued at prices below the per share price of shares sold in the
Company's initial public offering in September 1997 and previously included in
the computations of shares used in computing net loss per share pursuant to
previous staff accounting bulletins have now been excluded from the computation.
Pro forma net loss per share has been computed as described above and also
gives effect, under SEC guidance, to the conversion of preferred stock to common
stock not included above that automatically converted upon completion of the
Company's initial public offering, using the if-converted method.
NINETY EIGHT 33 PROBUSINESS SERVICES, INC.
> NOTES TO FINANCIAL STATEMENTS
A reconciliation of shares used in the calculation of historical and pro
forma basic and diluted net loss per share follows:
DOLLARS IN THOUSANDS EXCEPT SHARE AND PER SHARE INFORMATION AS OF 6.30
1996 1997 1998
Historical:
Net loss $ (2,386) $ (6,245) $ (6,517)
- -----------------------------------------------------------------------------------------------------------------------
Weighted average shares of common stock outstanding used in computing
basic and diluted net loss per share 486 1,999 13,596
- -----------------------------------------------------------------------------------------------------------------------
Basic and diluted net loss per share $ (4.91) $ (3.12) $ (0.48)
- -----------------------------------------------------------------------------------------------------------------------
Pro forma:
Net loss $ (6,245) $ (6,517)
- -----------------------------------------------------------------------------------------------------------------------
Shares used in computing basic and diluted net loss per share (from above) 1,999 13,596
Pro forma adjustment to reflect the effect of the conversion of preferred
stock from the date of issuance 8,534 2,126
- -----------------------------------------------------------------------------------------------------------------------
Weighted average shares used in computing pro forma basic and diluted
net loss per share 10,533 15,722
- -----------------------------------------------------------------------------------------------------------------------
Pro forma basic and diluted net loss per share $ (0.59) $ (0.41)
- -----------------------------------------------------------------------------------------------------------------------
If the Company had reported net income, the calculation of diluted earnings
per share (historical and pro forma) would have included the shares used in the
computation of historical and pro forma net loss per share as well as an
additional 356,000, 466,000 and 797,000 common equivalent shares related to the
outstanding options and warrants not included above (determined using the
treasury stock method) for fiscal 1996, 1997 and 1998, respectively.
2. EQUIPMENT, FURNITURE AND FIXTURES
Equipment, furniture and fixtures consist of the following:
DOLLARS IN THOUSANDS AS OF 6.30
1997 1998
Equipment and leasehold improvements $ 9,981 $ 18,172
Furniture and fixtures 1,973 3,239
- ---------------------------------------------------------------------------------------------------
11,954 21,411
Less accumulated depreciation and amortization (4,331) (7,453)
- ---------------------------------------------------------------------------------------------------
$ 7,623 $ 13,958
- ---------------------------------------------------------------------------------------------------
Equipment, furniture and fixtures include amounts for assets acquired under
capital leases, principally production, office and computer equipment, of
$3,515,000 and $3,863,000 at June 30, 1997 and 1998, respectively. Accumulated
amortization of these assets was $854,000 and $1,712,000 at June 30, 1997 and
1998, respectively.
NINETY EIGHT 34 PROBUSINESS SERVICES, INC.
3. LONG-TERM DEBT
LINE OF CREDIT AGREEMENTS
As of June 30, 1998, the Company executed an Amended and Restated Loan and
Security Agreement with a financial institution. The agreement provides for
borrowings that are limited to the lesser of $20,000,000 or the sum of five
times the Company's average monthly net collections, as defined in the
agreement, plus the lesser of five times the Company's average monthly
collections of the interest on tax investment funds as defined in the agreement
or $5,000,000, plus $1,500,000. The agreement superseded all previous
line-of-credit agreements and amendments thereto with the financial institution
that existed as of June 30, 1997.
At June 30, 1998, no borrowings were outstanding under the agreement and
the amount available for borrowing under the agreement was approximately
$20,000,000. Borrowings outstanding under the agreement bear interest at the
bank's prime rate plus 1% (9.5% at June 30, 1998) and are collateralized by
substantially all of the Company's assets not otherwise encumbered. The
financial covenants of the agreement require the Company to maintain minimum net
worth and earnings to debt service ratios. The agreement expires on December 31,
2000, and is subject to automatic and continuous renewal unless termination
notice is given by either party in accordance with the agreement. All borrowings
outstanding at June 30, 1997 totaling $4,758,000, under the previous agreements,
were paid in September 1997 with the proceeds from the Company's initial public
offering.
SUBORDINATED NOTES PAYABLE
In October 1995 and December 1995, the Company issued $1,100,000 and
$2,900,000, respectively of subordinated notes payable to investors. The
subordinated notes and interest accrued thereon were repaid in their entirety in
September 1997 with proceeds from the Company's initial public offering.
NOTE PAYABLE TO STOCKHOLDER
A $250,000 subordinated note payable to a stockholder was assumed in the
acquisition of Dimension Solutions. The note was repaid in fiscal 1998.
4. LEASE OBLIGATIONS
The Company leases its facilities and various equipment under noncancelable
operating leases which expire at various dates through 2010. The Company is also
obligated under a number of capital equipment leases expiring at various dates
through 2003. The future minimum lease payments under capital and operating
leases subsequent to June 30, 1998 are summarized as follows:
DOLLARS IN THOUSANDS FOR THE YEARS ENDING 6.30
CAPITAL LEASES OPERATING LEASES
1999 $1,180 $ 3,476
2000 1,029 4,067
2001 297 4,434
2002 158 4,402
2003 158 4,186
Thereafter -- 25,710
- -------------------------------------------------------------------------------------
Total minimum lease payments 2,822 $46,275
- -------------------------------------------------------------------------------------
Less amounts representing interest 518
- -------------------------------------------------------------------
Present value of net minimum capital lease obligations 2,304
Less current portion 890
- -------------------------------------------------------------------
$1,414
- -------------------------------------------------------------------
Rent expense was approximately $707,000, $1,487,000 and $3,028,000 for
fiscal 1996, 1997 and 1998, respectively.
NINETY EIGHT 35 PROBUSINESS SERVICES, INC.
> NOTES TO FINANCIAL STATEMENTS
5. INCOME TAXES
As of June 30, 1998, the Company had federal and state net operating loss
carryforwards of approximately $17,200,000 and $1,200,000, respectively. The
Company also had federal and state research and development tax credit
carryforwards of approximately $1,057,000 and $442,000, respectively. The
federal net operating loss and credit carryforwards will expire at various dates
beginning with the fiscal year ending 1999 through 2013, if not utilized. The
state net operating loss carryforwards will expire at various dates beginning
with the fiscal 1999 through 2003, if not utilized. The state credit
carryforwards do not expire.
Utilization of the net operating losses and credits may be subject to a
substantial annual limitation due to the ownership change limitations provided
by the Internal Revenue Code of 1986, as amended (the "Code"), and similar state
provisions. The annual limitation may result in the expiration of net operating
losses and credits before utilization.
Significant components of the Company's deferred tax assets and liabilities
are as follows:
DOLLARS IN THOUSANDS AS OF 6.30
1997 1998
Deferred tax assets:
Net operating loss carryforwards $ 4,965 $ 5,951
Research and development credit carryforwards 650 1,499
Depreciation 428 1,010
Accrued liabilities and allowances 330 2,147
- ---------------------------------------------------------------------------------------
Gross deferred tax assets 6,373 10,607
Less valuation allowance (5,988) (9,224)
- ---------------------------------------------------------------------------------------
Deferred tax assets 385 1,383
Deferred tax liabilities:
Capitalized software development costs (313) (1,338)
Other (72) (45)
- ---------------------------------------------------------------------------------------
Gross deferred tax liabilities (385) (1,383)
- ---------------------------------------------------------------------------------------
Net deferred taxes $ -- $ --
- ---------------------------------------------------------------------------------------
A valuation allowance has been established and, accordingly, no benefit has
been recognized for the Company's net operating losses and other deferred tax
assets. The Company believes that, based on a number of factors, the available
objective evidence creates sufficient uncertainty regarding the realizability of
the deferred tax assets such that a full valuation allowance has been recorded.
These factors include the Company's history of net losses since its inception
and expected near-term future losses. The Company will continue to assess the
realizability of the deferred tax assets based on actual and forecasted
operating results. The net valuation allowance increased by $2,391,000 and
$3,236,000, respectively during fiscal 1997 and 1998.
6. STOCKHOLDERS' EQUITY
In September 1997, the Company completed its initial public offering of
common stock. The offering consisted of 3,750,000 shares of common stock issued
to the public at $7.33 per share. Upon the closing of the initial public
offering, all outstanding shares of preferred stock were converted into common
stock.
In October 1997, the underwriters exercised an option to purchase an
additional 562,500 shares of common stock at the initial public offering price
of $7.33 per share to cover over-allotments in connection with the initial
public offering.
NINETY EIGHT 36 PROBUSINESS SERVICES, INC.
WARRANTS
The following table represents a summary of warrants outstanding as of
June 30, 1998:
EXERCISE PRICE NUMBER OF SHARES
DATE ISSUED EXPIRATION PER SHARE JUNE 30, 1998
April 1996 April 2001 $ 2.65 28,500
October 1996 October 2001 2.65 28,500
November 1996 September 2002 2.65 67,500
January 1997 January 2002 6.00 75,000
July 1997 July 2002 6.00 30,000
- ---------------------------------------------------------------------------
229,500
- ---------------------------------------------------------------------------
In connection with the Company's initial public offering, the Company
issued 367,288 shares of common stock upon the exercise of warrants, a portion
of which were exercised pursuant to a net exercise provision, for total proceeds
of $923,000. In addition, during fiscal 1998, the Company issued 48,437 shares
of common stock upon exercise of warrants, a portion of which were exercised
pursuant to net exercise provisions, for a total of $36,000. All other warrants
noted as exercised above were exercised pursuant to net exercise provisions.
STOCK SPLIT
On July 23, 1998, the Board of Directors approved a three-for-two split of
its $.001 par value common stock in the form of a 50 percent distribution to
stockholders of record as of July 31, 1998. As a result of the stock split,
authorized and outstanding common shares increased 50 percent and capital in
excess of par was reduced by the par value of the additional common shares
issued. The rights of the holders of these securities were not otherwise
modified. All references in the financial statements to number of shares, per
share amounts, stock option data and market prices of the Company's common stock
have been restated for the effect of the stock split.
7. STOCK OPTION AND STOCK PURCHASE PLANS
STOCK OPTION PLANS
The Company's 1989 Stock Option Plan (the "1989 Plan") provided for the
granting to employees (including officers and employee directors) of "incentive
stock options" within the meaning of the Code and for the granting to employees,
directors and consultants of nonstatutory stock options. In February 1997, the
Board of Directors of the Company increased the shares available for future
grants under the 1989 Plan by 2,063,649 for a total of 4,480,872. Options
granted under the 1989 Plan before the effective date of the amendment and
restatement to the 1996 Plan in September, 1997, described below, remain
outstanding in accordance with their terms, but no further options were granted
under the 1989 Plan after the effective date of the amendment and restatement to
the 1996 Plan.
In 1996, the Company established the 1996 Executive Stock Option Plan
("Executive Plan") which provides for stock options to employees and
consultants. Under the Executive Plan, the Board of Directors may grant
nonstatutory stock options to employees and consultants and incentive stock
options to employees only. The Company has reserved 1,125,000 shares of common
stock for exercise of stock options under the Executive Plan. The grant of
incentive stock option to an employee who owns stock representing more than 10%
of the voting power of all classes of stock of the Company must be no less than
110% of the fair market value per share on the date of grant. Fair market value
is determined by the Board of Directors. For all other employees the options
must be no less than 100% of the fair market value per share on the date of
grant. All nonstatutory stock options granted are at a price that is determined
by the Board of Directors. The options generally expire ten years from the date
of grant and are exercisable as determined by the Board of Directors.
In November 1996, the Board of Directors and stockholders approved,
effective upon the initial public offering, an amendment and restatement of the
Executive Plan to rename the 1996 Executive Stock Option Plan to the 1996 Stock
Option Plan (the "1996 Plan") and authorized an increase in the number of shares
reserved for issuance under the 1996 Plan of any unused or canceled shares under
the 1989 Plan, and an annual increase equal to the lesser of (a) 375,000 shares,
(b) 2% of the outstanding shares of common stock on such date or (c) a lesser
amount determined by the Board. The 1996 Plan provides for grants to employees
(including officers and employee directors) of incentive stock options and for
the granting to employees, directors and consultants of nonqualified stock
options. Notes receivable for the purchase of common stock are included in
stockholders' equity (deficit).
NINETY EIGHT 37 PROBUSINESS SERVICES, INC.
> NOTES TO FINANCIAL STATEMENTS
A summary of the activity under the 1989 and 1996 Plans is set forth below:
-------OUTSTANDING OPTIONS--------
WEIGHTED AVERAGE
EXERCISE PRICE
NUMBER OF SHARES PER SHARE
Outstanding at June 30, 1995 1,528,344 $ 0.17
Granted 1,583,895 0.29
Exercised (1,802,334) 0.22
Canceled (345,703) 0.22
- ------------------------------------------------------------------------------
Outstanding at June 30, 1996 964,202 0.27
Granted 994,005 4.83
Exercised (472,940) 2.39
Canceled (171,603) 2.51
- ------------------------------------------------------------------------------
Outstanding at June 30, 1997 1,313,664 2.67
Granted 907,875 11.82
Exercised (236,998) 1.34
Canceled (184,125) 7.12
- ------------------------------------------------------------------------------
Outstanding at June 30, 1998 1,800,416 $ 6.97
- ------------------------------------------------------------------------------
As of June 30, 1998, options to purchase 414,884 shares of common stock
were vested and exercisable at an average exercise price of $2.03 per share and
options to purchase 1,277,510 shares were available for future grant. As of June
30, 1998, options to purchase approximately 317,000 shares of common stock had
been exercised which are subject to repurchase.
The weighted-average fair value of options granted during fiscal 1996, 1997
and 1998 was $0.06, $1.01 and $6.98 per share, respectively.
The following table summarizes information concerning currently outstanding
and exercisable options at June 30, 1998:
--------------OUTSTANDING OPTIONS--------------- --------EXERCISABLE--------
WEIGHTED AVERAGE
REMAINING WEIGHTED AVERAGE WEIGHTED AVERAGE
EXERCISE PRICE SHARES CONTRACTUAL LIFE EXERCISE PRICE SHARES EXERCISE PRICE
$ 0.13 -- $0.26 399,084 7.10 $ 0.26 231,235 $ 0.25
$ 0.83 -- $4.83 399,707 8.41 $ 4.02 141,932 $ 3.75
$ 5.83 -- $6.00 620,250 9.03 $ 5.91 40,967 $ 5.86
$12.08 --$31.17 381,375 9.57 $ 18.84 750 $ 19.33
- --------------------------------------------------------------------------------------------------------------
1,800,416 414,884
- --------------------------------------------------------------------------------------------------------------
STOCK-BASED COMPENSATION
As permitted under FAS 123, the Company has elected to continue to follow
APB 25 in accounting for stock-based awards to employees. Under APB 25, the
Company has not recognized any compensation expense with respect to such awards,
since the exercise price of the stock options awarded are equal to the fair
market value of the underlying security on the grant date.
Disclosure of information regarding net loss and net loss per share is
required by FAS 123, which also requires that the information be determined on
an "as adjusted" basis as if the Company had accounted for its stock-based
awards to employees granted subsequent to June 30, 1995, under the fair value
method of FAS 123. The fair value of the Company's stock-based awards to
employees was estimated as of the date of the grant using a Black-Scholes option
pricing model. Limitations on the effectiveness of the Black-Scholes option
valuation model are that it was developed for use in estimating the fair value
of traded options which have no vesting restrictions and are fully transferable
and
NINETY EIGHT 38 PROBUSINESS SERVICES, INC.
that the model requires the use of highly subjective assumptions including
expected stock price volatility. Because the Company's stock-based awards to
employees have characteristics significantly different from those of traded
options and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its
stock-based awards to employees. The Company has plans which award employees
stock options. These plans are discussed in the note above. The fair value of
the Company's stock-based awards to employees was estimated using the following
weighted-average assumptions:
AS OF 6.30
1996 1997 1998
Expected life (in years) 3 2 2
Expected volatility 0.001 0.001 0.746
Risk-free interest rate 6.2% 6.2% 5.5%
Expected dividend yield 0.0% 0.0% 0.0%
For disclosure purposes, the adjusted estimated fair value of the Company's
stock-based awards to employees is amortized over the vesting period for
options. The Company's adjusted information follows:
DOLLARS IN THOUSANDS EXCEPT FOR PER SHARE INFORMATION AS OF 6.30
1996 1997 1998
Net loss, as reported $ (2,386) $ (6,245) $ (6,517)
- --------------------------------------------------------------------------------
Net loss, as adjusted $ (2,403) $ (6,355) $ (7,427)
- --------------------------------------------------------------------------------
Historical net loss per share, as reported $ (4.91) $ (3.12) $ (0.48)
- --------------------------------------------------------------------------------
Historical net loss per share, as adjusted $ (4.94) $ (3.18) $ (0.55)
- --------------------------------------------------------------------------------
Pro forma net loss per share, as reported $ (0.59) $ (0.41)
- --------------------------------------------------------------------------------
Pro forma net loss per share, as adjusted $ (0.60) $ (0.47)
- --------------------------------------------------------------------------------
Because FAS 123 is applicable only to the Company's stock-based awards
granted subsequent to June 30, 1995, its effect will not be fully reflected
until approximately fiscal 1999.
1997 EMPLOYEE STOCK PURCHASE PLAN
The Company's 1997 Employee Stock Purchase Plan (the "Purchase Plan") was
adopted by the Board of Directors in November 1996 and amended in August 1997,
for which employees who work a minimum of 20 hours per week and for five months
in any calendar year are eligible. There were 750,000 shares of common stock
authorized for issuance under the Purchase Plan with an annual increase to be
added on each anniversary date of the adoption of the Purchase Plan equal to the
lesser of (a) 225,000 shares, (b) 1.5% of the outstanding shares on such date or
(c) a lesser amount determined by the Board of Directors. As of June 30, 1998,
170,114 shares had been issued for the first purchase. Under the Purchase Plan,
the Company's employees, subject to certain restrictions, may purchase shares of
common stock at the lesser of 85 percent of the fair market value at either the
beginning of each two-year offering period or the end of each six-month purchase
period within the two-year offering period. Plan purchases are limited to 10% of
each employee's compensation.
8. EMPLOYEE BENEFIT PLAN
The Company maintains a tax-deferred savings plan under section 401(k) of
the Code (the "Plan") for the benefit of certain qualified employees. Employees
may elect to contribute to the Plan, through payroll deductions of up to 18% of
their compensation, subject to certain limitations. The Company, at its
discretion, may make additional contributions. The Company did not make any
contributions to the Plan in fiscal 1996, 1997 or 1998.
NINETY EIGHT 39 PROBUSINESS SERVICES, INC.
> NOTES TO FINANCIAL STATEMENTS
9. BALANCE SHEET DETAIL
Other assets consist of the following:
DOLLARS IN THOUSANDS AS OF 6.30
1997 1998
Capitalized software development costs $ 1,716 $ 5,247
Deferred financing costs 1,043 --
Prepaid lease expense 161 133
Notes receivable from employees 376 422
Goodwill and other intangible assets 2,627 4,493
Deposits and other 1,097 584
- ------------------------------------------------------------------------------
$ 7,020 $ 10,879
- ------------------------------------------------------------------------------
Accumulated amortization for capitalized software development costs was
approximately $475,000 and $802,000 at June 30, 1997 and 1998, respectively.
Accumulated amortization for goodwill and other intangible assets was
approximately $80,000 and $384,000 at June 30, 1997 and 1998, respectively.
In January 1997, the Company advanced $250,000 in the form of a note
receivable from a stockholder who is also an executive officer. The note is due
in January 2001, bears interest at 6.10% and is full recourse.
Accrued liabilities consist of the following:
DOLLARS IN THOUSANDS AS OF 6.30
1997 1998
Accrued expenses $ 2,773 $ 4,408
Accrued tax penalties 586 971
Accrued payroll and related expenses 1,361 3,322
Accrued acquisition costs 144 --
Accrued BeneSphere contingent consideration (Note 10) -- 1,081
Other 120 621
- ------------------------------------------------------------------------------
$ 4,984 $ 10,403
- ------------------------------------------------------------------------------
10. BUSINESS ACQUISITIONS
In January 1997, the Company acquired all of the outstanding stock of
BeneSphere. The purchase price consisted of $500,000 in cash, of which $250,000
was paid upon closing and $250,000 was paid in April 1997, warrants to purchase
75,000 shares of the Company's common stock at a price of $6.00 per share and
with an estimated fair value of $160,000, the assumption of $2,445,000 of
BeneSphere's liabilities (including acquisition costs) plus additional
contingent consideration based on BeneSphere's revenues in excess of certain
base amounts, as defined in the agreement, over the next two calendar years
following the acquisition which cannot exceed $4,500,000. The contingent
consideration is payable in cash in four quarterly payments beginning April 1,
1998 for the calendar year 1997 payment and April 1, 1999 for the calendar year
1998 payment. Interest shall accrue at a rate of 9% per annum on all earned but
unpaid balances.
NINETY EIGHT 40 PROBUSINESS SERVICES, INC.
A summary of the purchase price allocation is as follows:
DOLLARS IN THOUSANDS
Current and other assets $ 517
Goodwill 2,278
Customer list 310
- ---------------------------------------------------------------------------
Total purchase price allocation $ 3,105
- ---------------------------------------------------------------------------
Goodwill arising from the acquisition is being amortized on a straight-line
basis over 20 years.
In January 1998, the Company accrued an additional $2,208,000 of contingent
consideration and recorded goodwill in the same amount related to the BeneSphere
acquisition as described above. As of June 30, 1998, the Company had made two
quarterly payments relating to the contingent consideration and had a remaining
outstanding balance of $1,081,000 which is classified as accrued liabilities.
11. SUBSEQUENT EVENTS
PUBLIC OFFERING
On July 23, 1998, the Board of Directors authorized the Company to proceed
with a public offering of the Company's common stock.
NINETY EIGHT 41 PROBUSINESS SERVICES, INC.
> REPORT OF INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND STOCKHOLDERS
PROBUSINESS SERVICES, INC.
We have audited the accompanying balance sheets of ProBusiness Services,
Inc. as of June 30, 1997 and 1998 and the related statements of operations,
stockholders' equity (deficit), and cash flows for each of the three years in
the period ended June 30, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of ProBusiness Services, Inc.
at June 30, 1997 and 1998 and the results of its operations and its cash flows
for each of the three years in the period ended June 30, 1998 in conformity with
generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
July 23,1998 ERNST & YOUNG, LLP WALNUT CREEK, CALIFORNIA
NINETY EIGHT 42 PROBUSINESS SERVICES, INC.
> QUARTERLY FINANCIAL DATA (UNAUDITED)
DOLLARS IN THOUSANDS
--------------------------QUARTER ENDED------------------------
1997 1998
SEPTEMBER 30 DECEMBER 31 MARCH 31 JUNE 30
Revenue $ 9,227 $ 10,325 $ 13,611 $ 13,154
Operating expenses:
Cost of providing services 5,019 5,772 6,424 6,644
General and administrative expenses 1,768 1,600 1,693 1,666
Research and development expenses 1,110 1,020 1,213 1,242
Client acquisition costs 3,978 4,092 5,569 4,219
- ---------------------------------------------------------------------------------------------------------------
Total operating expenses 11,875 12,484 14,899 13,771
- ---------------------------------------------------------------------------------------------------------------
Loss from operations (2,648) (2,159) (1,288) (617)
Interest expense (255) (119) (87) (96)
Other income 26 234 242 250
- ---------------------------------------------------------------------------------------------------------------
Net loss $ (2,877) $ (2,044) $ (1,133) $ (463)
- ---------------------------------------------------------------------------------------------------------------
DOLLARS IN THOUSANDS
--------------------------QUARTER ENDED------------------------
1996 1997
SEPTEMBER 30 DECEMBER 31 MARCH 31 JUNE 30
Revenue $ 4,675 $ 5,524 $ 8,427 $ 8,748
Operating expenses:
Cost of providing services 2,288 2,950 3,907 4,514
General and administrative expenses 622 869 1,441 1,350
Research and development expenses 625 683 732 801
Client acquisition costs 2,215 2,413 3,664 3,414
- ---------------------------------------------------------------------------------------------------------------
Total operating expenses 5,750 6,915 9,744 10,079
- ---------------------------------------------------------------------------------------------------------------
Loss from operations (1,075) (1,391) (1,317) (1,331)
Interest expense (215) (305) (380) (290)
Other income 11 1 2 45
- ---------------------------------------------------------------------------------------------------------------
Net loss $ (1,279) $ (1,695) $ (1,695) $ (1,576)
- ---------------------------------------------------------------------------------------------------------------
STOCK SUMMARY BY QUARTER
------FISCAL 1998------
HIGH LOW
First Quarter (from September 19,1997) $ 12.92 $ 7.67
Secound Quarter 15.33 12.08
Third Quarter 20.00 14.00
Fourth Quarter 32.58 17.33
- ---------------------------------------------------------------------------
NINETY EIGHT 43 PROBUSINESS SERVICES, INC.