EXHIBIT 99.1
CLEMCO, INC. AND SUBSIDIARY
Consolidated Financial Statements
December 31, 1998 and 1997
With Independent Auditors' Report Thereon
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Clemco, Inc.:
We have audited the accompanying consolidated balance sheets of Clemco, Inc.
and subsidiary (collectively, the "Company") as of December 31, 1998 and
1997, and the related consolidated statements of operations, shareholders'
deficit, and cash flows for each of the years in the three-year period ended
December 31, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated 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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Clemco,
Inc. and subsidiary as of December 31, 1998 and 1997, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 1998 in conformity with generally accepted
accounting principles.
/S/ KPMG LLP
Atlanta, Georgia
March 19, 1999, except as to
note 13, which is as of
April 27, 1999
CLEMCO, INC. AND SUBSIDIARY
Consolidated Balance Sheets
December 31, 1998 and 1997
ASSETS (NOTE 5) 1998 1997
----------------- -----------------
Current assets:
Cash and cash equivalents $ 2,133,406 763,152
Trade accounts receivable, net of allowance for
doubtful accounts of $8,981 in 1998 and
$2,200 in 1997 228,074 334,405
Unbilled costs and accrued earnings on uncompleted
contracts (note 3) 241,361 15,755
Other current assets 93,676 67,200
----------------- -----------------
Total current assets 2,696,517 1,180,512
Property and equipment, net (note 2) 376,323 272,480
Goodwill, net of accumulated amortization of
$532,382 in 1998 and $409,524 in 1997 81,904 204,762
Other assets 23,132 630
----------------- -----------------
$ 3,177,876 1,658,384
================= =================
2
LIABILITIES AND SHAREHOLDERS' DEFICIT 1998 1997
----------------- -----------------
Current liabilities:
Obligation to financial institution (note 4) $ 149,720 --
Current installments of long-term debt and obligations
under capital leases (note 5) 123,528 93,696
Accounts payable 179,846 35,874
Obligation under consulting agreement (note 10(b)) 144,633 --
Billings in excess of costs and accrued earnings on
uncompleted contracts (note 3) 712,116 362,943
Deferred revenue 38,499 --
Other accrued expenses (note 7) 179,100 296,063
----------------- -----------------
Total current liabilities 1,527,442 788,576
Long-term debt and obligations under capital leases,
excluding current installments (note 5) 71,293 149,472
Obligation under consulting agreement (note 10(b)) -- 177,928
----------------- -----------------
Total liabilities 1,598,735 1,115,976
----------------- -----------------
Series A convertible preferred stock, no par value (unaccrued liquidation
preference of $1,811,999 at December 31, 1998);
redeemable; authorized 3,000,000 shares; 2,936,508 shares
issued and outstanding (note 8) 1,803,599 1,646,443
Series B convertible preferred stock, no par value (unaccrued
liquidation preference of $1,877,086 at December 31, 1998);
redeemable; authorized 2,097,585 shares; 1,979,938 shares issued
and outstanding (note 8) 1,868,384 1,705,854
Series C convertible preferred stock, no par value (unaccrued
liquidation preference of $500,000 at December 31, 1998);
redeemable; authorized 416,667 shares; 416,667 shares issued
and outstanding at December 31, 1998 (note 8) 500,000 --
Series D convertible preferred stock, no par value (unaccrued
liquidation preference of $3,265,137 at December 31, 1998);
redeemable; authorized 5,103,743 shares; 3,015,848 shares
issued and outstanding at December 31, 1998 (note 8) 3,250,000 --
Shareholders' deficit (note 9):
Common stock, no par value. Authorized 50,000,000 shares;
5,283,300 shares and 5,264,550 shares issued and
outstanding at December 31, 1998 and 1997, respectively 504,785 502,910
Additional paid-in capital 126,100 30,000
Accumulated deficit (6,387,060) (3,242,799)
----------------- -----------------
(5,756,175) (2,709,889)
Less note receivable from employee for common stock (86,667) (100,000)
----------------- -----------------
Total shareholders' deficit (5,842,842) (2,809,889)
Commitments and contingencies (notes 9 and 10)
----------------- -----------------
$ 3,177,876 1,658,384
================= =================
See accompanying notes to consolidated financial statements.
3
CLEMCO, INC. AND SUBSIDIARY
Consolidated Statements of Operations
Years ended December 31, 1998, 1997, and 1996
1998 1997 1996
--------------- --------------- --------------
Revenues (note 12) $ 1,785,976 1,287,844 1,716,682
Salaries, wages, and benefits 2,316,536 1,933,547 1,387,042
Other operating expenses 1,968,757 1,581,439 720,950
Depreciation and amortization 245,851 221,235 210,058
--------------- --------------- --------------
Operating loss (2,745,168) (2,448,377) (601,368)
Interest expense (110,043) (63,836) (23,472)
Other income (expense), net 30,636 6,480 (1,378)
--------------- --------------- --------------
Loss before income taxes (2,824,575) (2,505,733) (626,218)
Income tax benefit (note 6) -- -- 93,377
--------------- --------------- --------------
Net loss (2,824,575) (2,505,733) (532,841)
Accretion of discount on convertible preferred stock (319,686) (168,794) --
--------------- --------------- --------------
Net loss attributable to common stock $ (3,144,261) (2,674,527) (532,841)
=============== =============== ==============
Net loss per common share - basic and diluted (0.60) (0.53) (0.12)
=============== =============== ==============
Shares used in the calculation of net loss per common
share - basic and diluted 5,268,424 5,042,998 4,546,703
=============== =============== ==============
See accompanying notes to consolidated financial statements.
4
CLEMCO, INC. AND SUBSIDIARY
Consolidated Statements of Shareholders' Deficit
Years ended December 31, 1998, 1997, and 1996
NOTE RECEIVABLE
COMMON STOCK ADDITIONAL FROM TOTAL
------------------------ PAID-IN ACCUMULATED EMPLOYEE FOR SHAREHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT COMMON STOCK EQUITY (DEFICIT)
------------ ---------- ---------- ------------- ----------- ---------------
Balance at December 31, 1995 4,500,000 $ 350,000 -- (35,431) -- 314,569
Issuance of common stock to employee in --
exchange for note receivable from employee 500,000 100,000 -- -- (100,000) --
Net loss -- -- -- (532,841) -- (532,841)
------------ ---------- ---------- ------------- ----------- -------------
Balance at December 31, 1996 5,000,000 450,000 -- (568,272) (100,000) (218,272)
Issuance of common stock award to employee 264,550 52,910 -- -- -- 52,910
Issuance of preferred stock purchase warrants -- -- 30,000 -- -- 30,000
Accretion of discount on convertible
preferred stock -- -- -- (168,794) -- (168,794)
Net loss -- -- -- (2,505,733) -- (2,505,733)
------------ ---------- ---------- ------------- ----------- -------------
Balance at December 31, 1997 5,264,550 502,910 30,000 (3,242,799) (100,000) (2,809,889)
Exercise of stock options 18,750 1,875 -- -- -- 1,875
Accretion of discount on convertible
preferred stock -- -- -- (319,686) -- (319,686)
Payment on note receivable from employee -- -- -- -- 13,333 13,333
Issuance of common stock purchase warrants -- -- 96,100 -- -- 96,100
Net loss -- -- -- (2,824,575) -- (2,824,575)
============ ========== ========== ============= =========== =============
Balance at December 31, 1998 5,283,300 $ 504,785 126,100 (6,387,060) (86,667) (5,842,842)
============ ========== ========== ============= =========== =============
See accompanying notes to consolidated financial statements.
5
CLEMCO, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years ended December 31, 1998, 1997, and 1996
1998 1997 1996
------------------ ------------------ ----------------
Cash flows from operating activities:
Net loss $ (2,824,575) (2,505,733) (532,841)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 245,851 221,235 210,058
Compensation expense resulting from common stock award -- 52,910 --
Deferred income taxes -- -- (71,227)
Noncash interest expense 64,100 30,000 --
Loss on disposal of property and equipment 5,430 -- --
(Increase) decrease in:
Trade accounts receivable 106,331 (182,219) 282,817
Unbilled costs and accrued earnings on uncompleted contracts (225,606) 166,418 (177,165)
Other assets (48,978) (12,282) (3,727)
Increase (decrease) in:
Accounts payable and other accrued expenses 63,061 97,077 121,942
Deferred revenue 38,499 -- --
Billings in excess of costs and accrued earnings on
uncompleted contracts 349,173 267,095 (10,083)
------------------ ------------------ ----------------
Net cash used in operating activities (2,226,714) (1,865,499) (180,226)
------------------ ------------------ ----------------
Cash flows used in investing activities - capital expenditures (176,112) (122,968) (78,233)
------------------ ------------------ ----------------
Cash flows from financing activities:
Borrowing from financial institution 149,720 -- --
Borrowings (repayments) of note payable to bank -- (80,000) 80,000
Payments of obligation under consulting agreement (33,295) (22,592) (29,023)
Proceeds from borrowings under long-term debt 450,000 670,000 250,000
Proceeds from repayment of note receivable from employee 13,333 -- --
Principal repayments on long-term debt and obligations under
capital leases (104,501) (74,951) (64,964)
Proceeds from stock options exercised 1,875 -- --
Proceeds from sale of Series A convertible preferred stock -- 1,247,131 --
Proceeds from sale of Series B convertible preferred stock -- 1,000,000 --
Proceeds from sale of Series C convertible preferred stock 500,000 -- --
Proceeds from sale of Series D convertible preferred stock 2,795,948 -- --
------------------ ------------------ ----------------
Net cash provided by financing activities 3,773,080 2,739,588 236,013
------------------ ------------------ ----------------
Increase (decrease) in cash and cash equivalents 1,370,254 751,121 (22,446)
Cash and cash equivalents at beginning of year 763,152 12,031 34,477
------------------ ------------------ ----------------
Cash and cash equivalents at end of year $ 2,133,406 763,152 12,031
================== ================== ================
Supplemental disclosures of cash flow information:
Cash paid during the year for interest $ 110,325 23,696 20,664
================== ================== ================
Significant noncash financing activities:
Capital expenditures financed under capital lease obligations $ 56,154 93,667 --
================== ================== ================
Accretion of discount on convertible preferred stock $ 319,686 168,794 --
================== ================== ================
Issuance of common stock warrant for professional services $ 32,000 -- --
================== ================== ================
Issuance of Series A convertible preferred stock in
satisfaction of notes payable, including accrued interest $ -- 253,425 --
================== ================== ================
Issuance of Series B convertible preferred stock in
satisfaction of notes payable, including accrued interest $ -- 682,947 --
================== ================== ================
Issuance of Series D convertible preferred stock in
satisfaction of notes payable, including accrued interest $ 454,052 -- --
================== ================== ================
Issuance of common stock to employee in exchange for note
receivable $ -- -- 100,000
================== ================== ================
See accompanying notes to consolidated financial statements.
6
CLEMCO, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(1) BUSINESS, BASIS OF PRESENTATION, AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
(A) BUSINESS AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Clemco,
Inc. and its wholly owned subsidiary, Conduit Software, Inc.
(collectively, the "Company"). Significant intercompany accounts and
transactions have been eliminated in consolidation. Clemco, Inc. was
incorporated in the State of Georgia on August 25, 1994 for the
purpose of acquiring the common stock of Information Management, Inc.
On April 30, 1997, the Articles of Incorporation of Information
Management, Inc. were amended to change its name to Conduit Software,
Inc.
The Company develops and markets human resource software applications
and products and provides services to a variety of commercial
businesses. The market for human resource software applications and
products is characterized by significant risk as a result of rapid
changes in technology, fierce competition from companies with
significantly greater financial resources than the Company, and
frequent new product introductions. Changing technology, increasing
competition, or other developments in the market for the Company's
applications and products could have an adverse effect on the
Company's financial position and results of operations.
(B) REVENUE RECOGNITION
The Company's revenues are derived primarily from licensing software
and providing services to customers under fixed price and
time-and-materials customer contracts. Revenues from fixed-price
contracts are recognized using the percentage-of-completion method,
measured by the percentage of labor hours incurred to date to
estimated total labor hours for each contract. Provisions for
estimated losses on uncompleted contracts are made in the period in
which such losses are determined. Revenues derived from contracts to
provide services on a time-and-materials basis are recognized as the
related services are performed.
The asset "unbilled costs and accrued earnings on uncompleted
contracts" represents revenues recognized in excess of amounts billed.
The liability "billings in excess of costs and accrued earnings on
uncompleted contracts" represents billings in excess of revenues
recognized.
(C) CASH AND CASH EQUIVALENTS
Cash and cash equivalents includes amounts on deposit with a
commercial bank. The Company classifies all highly liquid investments
with original maturities of three months or less as cash and cash
equivalents.
7
CLEMCO, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(D) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, less accumulated
depreciation and amortization. Depreciation is provided using the
straight-line method over the estimated useful lives of the related
assets as follows:
Computer equipment 5 years
Furniture, fixtures, and office equipment 5-7 years
Software 3 years
Amortization of assets held under capital leases is included in
depreciation and amortization. Assets held under capital leases are
amortized using the straight-line method over the estimated useful
life of the asset or the lease term, whichever is shorter.
(E) GOODWILL
Goodwill represents the excess of the cost over the fair value of the
assets acquired related to Clemco, Inc.'s 1994 acquisition of
Information Management, Inc. Goodwill is being amortized using the
straight-line method over a period of five years. The carrying value
of goodwill is reviewed by the Company for impairment which is
recognized when the expected undiscounted future net cash flows
derived from the business that resulted in such goodwill is less than
the carrying value of the goodwill. If the Company's review indicates
a potential impairment, the Company uses fair value in determining the
amount that should be recognized.
(F) INCOME TAXES
The Company uses the asset and liability method of accounting for
income taxes. Under the asset and liability method, deferred income
tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and
their respective tax bases and net operating loss and tax credit
carryforwards. Deferred income tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be
recovered or settled. The effect on deferred income tax assets and
liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
(G) USE OF ESTIMATES
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities and
the disclosure of contingent assets and liabilities as of the date of
the consolidated financial statements and revenues and expenses for
the reporting period to prepare these consolidated financial
statements in conformity with generally accepted accounting
principles. Actual results could differ from those estimates.
8
CLEMCO, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(H) STOCK COMPENSATION PLANS
The Company accounts for its stock option plan in accordance with the
provisions of Statement of Financial Accounting Standards No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION ("SFAS No. 123"), which
encourages entities to recognize as compensation expense over the
vesting period the fair value of all stock-based awards on the date of
grant. Alternatively, SFAS No. 123 allows entities to continue to
apply the provisions of Accounting Principles Board ("APB") Opinion
No. 25 and provide pro forma disclosures for employee stock option
grants as if the fair-value-based method defined in SFAS No. 123 had
been applied. The Company has elected to continue to apply the
provisions of APB Opinion No. 25 and provide the pro forma disclosures
required by SFAS No. 123.
(I) COMPREHENSIVE INCOME
No statements of comprehensive income have been included in the
accompanying financial statements since the Company has no "other
comprehensive income" to report.
(J) NET LOSS PER SHARE OF COMMON STOCK
On December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128, EARNINGS PER SHARE ("SFAS 128"), which
prescribes the calculation methodology and financial reporting
requirements for basic and diluted earnings per share. Basic earnings
(loss) per common share available to common shareholders are based on
the weighted-average number of common shares outstanding. Diluted
earnings (loss) per common share available to common shareholders are
based on the weighted-average number of common shares outstanding and
dilutive potential common shares, such as dilutive stock options. The
computation of potential common shares was antidilutive in each of the
periods presented; therefore, the amounts reported for basic and
diluted are the same.
(K) INDUSTRY SEGMENT
On January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION. The Company operates and manages
its business in one segment, that being a software and services
company that develops, markets, and supports human resource software
applications to a variety of commercial businesses.
9
CLEMCO, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(2) PROPERTY AND EQUIPMENT
Property and equipment consist of the following at December 31, 1998 and
1997:
1998 1997
----------- ------------
Computer equipment $ 301,998 159,308
Furniture, fixtures, and office equipment 175,450 146,120
Software 176,639 123,322
----------- ------------
654,087 428,750
Less accumulated depreciation and amortization 277,764 156,270
----------- ------------
$ 376,323 272,480
=========== ============
Property and equipment includes assets held under capital lease
arrangements at December 31, 1998 and 1997 as follows:
1998 1997
----------- ------------
Assets held under capital leases $ 151,819 95,665
Less accumulated amortization 45,707 15,266
----------- ------------
$ 106,112 80,399
=========== ============
(3) COSTS AND ACCRUED EARNINGS ON UNCOMPLETED CONTRACTS
Costs and accrued earnings on uncompleted contracts at December 31, 1998
and 1997 are summarized as follows:
1998 1997
-------------- -------------
Cumulative costs incurred and accrued
earnings on uncompleted contracts $ 1,512,782 58,544
Less cumulative billings 1,983,537 405,732
-------------- -------------
$ (470,755) (347,188)
============== =============
These amounts are shown in the accompanying consolidated balance sheets as
follows:
1998 1997
------------- -------------
Unbilled costs and accrued earnings
on uncompleted contracts $ 241,361 15,755
Billings in excess of costs and accrued
earnings on uncompleted contracts (712,116) (362,943)
------------- -------------
$ (470,755) (347,188)
============= =============
10
CLEMCO, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(4) OBLIGATION TO FINANCIAL INSTITUTION
In August 1998, the Company borrowed $149,720 from a financial institution
collateralized by the Company's right to receive $187,150 in future amounts
due to the Company under a sales contract. The obligation accrues interest
at 2% per month, has a final maturity date of March 30, 1999, and requires
the Company to make payment to the financial institution upon customer
default or if any invoiced amount to the customer is outstanding more than
90 days from the date of invoice.
(5) LONG-TERM DEBT AND OBLIGATIONS UNDER CAPITAL LEASES
The Company's long-term debt and obligations under capital leases at
December 31, 1998 and 1997 is summarized as follows:
1998 1997
----------- ------------
Notepayable to Bryan C. Toney, due in 60 equal monthly installments
of principal and interest of $6,930, interest at 7.0%, final
payment due December 31, 1999, secured by substantially all
assets of Conduit Software, Inc. and a personal guarantee of a
major shareholder $ 80,096 154,792
Capital lease obligation for furniture and fixtures, with equal
monthly payments of $1,594, effective interest at 14.52%,
due through June 2002 52,255 62,936
Capital lease obligation for computer equipment, with equal
monthly payments of $1,208, effective interest rate of 19.88%,
due through May 2001 29,639 --
Capital lease obligation for office equipment, with equal monthly
payments of $925, effective interest rate of 14%, due through
August 2000 17,121 25,440
Capital lease obligation for furniture and fixtures with equal
monthly payments of $995, effective interest at 19.28%, due
through May 2000 15,710 --
----------- ------------
Total long-term debt and obligations under capital leases 194,821 243,168
Less current installments 123,528 93,696
----------- ------------
Long-term debt and obligations under capital
leases, excluding current installments $ 71,293 149,472
=========== ============
11
CLEMCO, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
Future minimum annual payments on long-term debt and obligations under
capital leases for the next five years and in the aggregate are
summarized as follows:
LONG-TERM CAPITAL
YEAR ENDING DECEMBER 31, DEBT LEASES TOTAL
------------------------ --------- --------- ---------
1999 $ 80,096 58,870 138,966
2000 -- 47,567 47,567
2001 -- 25,512 25,512
2002 -- 9,586 9,586
2003 -- -- --
------ -------- --------
Total payments $ 80,096 141,535 221,631
======
Less amounts representing interest 26,810 26,810
-------- --------
$ 114,725 194,821
======== =======
Future minimum annual payments
under long-term debt and obligations
under capital leases for 1999 $ 138,966
Less amounts representing interest
under capital leases 15,438
--------
Current installments of long-term debt
and obligations under capital leases $ 123,528
========
(6) INCOME TAXES
The provision for income taxes includes income taxes currently payable and
those deferred because of temporary differences between the financial
statement and tax bases of assets and liabilities that will result in
taxable or deductible amounts in the future and any increase or decrease in
the valuation allowance for deferred income tax assets.
The components of income tax benefit are as follows:
1998 1997 1996
-------- -------- ----------
Current benefit:
Federal $ -- -- 16,039
State -- -- 6,111
-------- -------- ----------
-- -- 22,150
-------- -------- ----------
Deferred benefit:
Federal -- -- 62,095
State -- -- 9,132
-------- -------- ----------
-- -- 71,227
-------- -------- ----------
$ -- -- 93,377
======== ======== ==========
12
CLEMCO, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
The following is a summary of the difference between the income taxes shown
in the consolidated statements of operations and the income taxes that
would result from applying the statutory Federal income tax rate of 34% to
loss before income taxes:
1998 1997 1996
------------- ------------- -------------
Income tax benefit at statutory Federal
income tax rate $ (960,356) (851,949) (212,914)
(Increase) decrease in income tax benefit
resulting from:
State income tax benefit, net of
Federal income tax effect (117,715) (101,299) (10,060)
Nondeductible items 36,274 60,357 79,715
Research credit generated (20,000) (15,237) --
Other, net (60,461) (56,928) --
Increase in valuation allowance
for deferred income tax assets 1,122,258 965,056 49,882
------------- ------------- -------------
Actual income tax benefit $ -- -- (93,377)
============= ============= =============
The tax effects of temporary differences that give rise to deferred income
tax assets and deferred income tax liabilities at December 31, 1998 and
1997 are presented below:
1998 1997
--------------- ----------------
Deferred income tax assets:
Conversion to cash basis for income
tax reporting $ 205,607 97,641
Net operating loss carryforwards 1,895,017 909,566
Research credit carryforwards 46,777 26,777
Depreciation 5,761 --
--------------- ----------------
--------------- ----------------
Gross deferred income tax assets 2,153,162 1,033,984
Valuation allowance (2,153,162) (1,030,904)
--------------- ----------------
Net deferred income tax assets -- 3,080
Deferred income tax liability - depreciation -- (3,080)
--------------- ----------------
Net deferred income tax asset (liability) $ -- --
=============== ================
Under the asset and liability method, deferred income tax assets and
liabilities are recognized for differences between the financial statement
carrying amounts and the income tax bases of assets and liabilities which
will result in future deductible or taxable amounts and for net operating
loss and tax credit carryforwards. A valuation allowance is then
established to reduce the deferred income tax
13
CLEMCO, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
assets to the level at which it is "more likely than not" that the tax
benefits will be realized. Realization of tax benefits of deductible
temporary differences and operating loss and tax credit carryforwards
depends on having sufficient taxable income within the carryback and
carryforward periods. Sources of taxable income that may allow for the
realization of tax benefits include (1) taxable income in the current year
or prior years that is available through carryback, (2) future taxable
income that will result from the reversal of existing taxable temporary
differences, and (3) future taxable income generated by future operations.
Because of operating losses incurred by the Company in 1998 and 1997, the
Company has recorded a valuation allowance to offset all of its deferred
income tax assets. The net increase in the valuation allowance for the
years ended December 31, 1998, 1997, and 1996 was $1,122,258, $965,056, and
$49,882, respectively.
As of December 31, 1998, the Company had net operating losses and research
and experimentation credits available for carryforward of approximately
$4,700,000 and $47,000, respectively, which expire at various times
beginning in the year 2011. The utilization of these carryforwards in
future years is limited due to restrictions imposed under Section 382 of
the Internal Revenue Code regarding change in the ownership of the Company.
(7) OTHER ACCRUED EXPENSES
Other accrued expenses consist of the following at December 31, 1998 and
1997:
1998 1997
-------------- ------------
Accrued commissions $ 41,145 74,803
Accrued bonuses, vacations, and salaries 42,377 45,376
Accrued professional fees -- 140,000
Accrued sales and use tax 73,500 32,129
Accrued other 22,078 3,755
-------------- ------------
$ 179,100 296,063
============== ============
(8) PREFERRED STOCK
(a) TERMS OF CONVERTIBLE PREFERRED STOCK
The Series A, Series B, Series C, and Series D convertible preferred
stock includes dividend rights which provide for the holders to be
paid dividends at an annual rate of $.0511, $.085, $0.812, and $0.11
per share, respectively, on a quarterly basis when and if declared by
the Company's Board of Directors. Such dividends are cumulative and
accrue beginning two years from the original issue date for Series A
and Series C convertible preferred stock and accrue beginning at the
issuance date for Series B and Series D convertible preferred stock.
The
14
CLEMCO, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
Company is prohibited from paying dividends on its common stock
until all accrued dividends in arrears have been paid on the
convertible preferred stock.
The holders of any series of convertible preferred stock are entitled
to require the Company to redeem for cash one half of all the then
outstanding shares and all accrued dividends thereon on or after
December 14, 2003. One year from the receipt of the redemption notice,
the holders may require the Company to redeem for cash the remaining
half of the preferred shares outstanding, including accrued dividends.
The redemption price is equal to the fair market value of the shares
as established by the Company's Board of Directors. Prior to December
14, 1998, the Series A and Series B convertible preferred stock were
entitled to receive a redemption price no less than the original
invested amount plus a 10% compounded return on the invested amount
less any preferred dividends declared and paid. However, the amended
Articles of Incorporation effective with the Series D convertible
preferred stock sale on December 14, 1998, provide that all series of
convertible preferred stock are now entitled to receive a redemption
price equal to fair market value but not less than the original
invested amount.
The Series A, Series B, and Series D convertible preferred stock also
have liquidation rights which provide, upon liquidation of the
Company, for the holders to be paid an amount equal to the original
amount invested plus a 10% compounded annual return. The Series C
convertible preferred stock liquidation right is equal to the original
amount invested. Additionally, in the event of liquidation, the Series
D convertible preferred stock is allowed to participate (on an as
converted basis) with the common shareholders in the final
distribution of funds which would occur after the Series A, Series B,
Series C, and Series D distributions have been made. The convertible
preferred stock is classified as voting. The holders of the
convertible preferred stock may convert their shares into common stock
at any time. The conversion price is equivalent to one share of common
stock for each share of convertible preferred stock subject to
adjustment for subsequent issuances of equity. The terms and
conditions of the preferred stock purchase agreement include, among
others, requirements for the Company to report financial information
to the holder and visitation rights for the holder with respect to
meetings of the Company's Board of Directors. Additionally, these
terms and conditions also restrict the Company from purchasing its
common stock, making certain investments, or entering into any
agreement, commitment, or plan of merger, reorganization, or
consolidation without the prior consent of the holder. The holders of
the convertible preferred stock also received certain other rights
including, but not limited to, certain registration rights with
respect to their investment.
(B) SALES OF CONVERTIBLE PREFERRED STOCK
On January 10, 1997, the Company sold 2,936,508 shares of the newly
designated Series A convertible preferred stock for approximately
$0.51 per share, resulting in net proceeds to the Company of
$1,247,131 and the cancellation of notes payable and accrued interest
totaling $253,425. The Company has reflected the accretion of discount
as a charge to accumulated deficit.
15
CLEMCO, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
On November 12, 1997, the Company sold 1,979,938 shares of the newly
designated Series B convertible preferred stock for approximately
$0.85 per share, resulting in net proceeds to the Company of
$1,000,000 and the cancellation of notes payable and accrued interest
totaling $682,947. The Company has reflected the accretion of discount
as a charge to accumulated deficit.
On May 14, 1998, the Company sold 416,667 shares of the newly
designated Series C convertible preferred stock for approximately
$1.20 per share, resulting in net proceeds to the Company of $500,000.
On December 14, 1998, the Company sold 3,015,848 shares of the newly
designated Series D convertible preferred stock for approximately
$1.08 per share, resulting in net proceeds to the Company of
$2,795,948 and the cancellation of notes payable and accrued interest
totaling $454,052.
(C) PREFERRED STOCK WARRANTS
In connection with notes payable issued in August 1997, the Company
issued stock purchase warrants for the purchase of 116,647 of the
Company's Series B convertible preferred stock, at an exercise price
of $.85 per share, that had a fair value of approximately $30,000 on
the date of issue. The warrants expire in November 2001. The Company
has accounted for these warrants as interest expense and an addition
to paid-in capital. The notes payable were canceled as a result of the
sale of Series B convertible preferred stock described in note 8(b)
above.
(9) SHAREHOLDERS' DEFICIT
(A) AMENDMENTS TO THE ARTICLES OF INCORPORATION
During 1998, the Company's Articles of Incorporation were amended to
increase the number of authorized shares of capital stock that the
Company can issue to 60,617,995 shares which includes authority to
issue up to 50,000,000 shares of common stock, 3,000,000 shares of no
par value Series A convertible preferred stock, 2,097,585 shares of no
par value Series B convertible preferred stock, 416,667 shares of no
par value Series C convertible preferred stock, and 5,103,743 shares
of no par value Series D convertible preferred stock. The significant
terms of the Series A, Series B, Series C, and Series D convertible
preferred stock are described in note 8(a).
16
CLEMCO, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(B) SHAREHOLDERS' AGREEMENT
The Company is a party to a Shareholders' Agreement (the "Agreement")
among certain common and preferred shareholders of the Company. The
Agreement includes restrictions and requirements, including but not
limited to providing the Company and other shareholders who are
parties to the Agreement with a right of first refusal to purchase
shares from common and preferred shareholders of the Company upon
certain events as described in the Agreement. The Agreement also
includes, among other terms, certain demand and piggyback registration
rights.
(C) COMMON STOCK AWARD
In January 1997, the Company's president was awarded 264,550 shares of
common stock with a fair value of approximately $52,910. The Company
recorded the fair value of the award as compensation expense.
(D) COMMON STOCK WARRANTS
In connection with the settlement of a dispute with an unrelated third
party, in July 1998, the Company issued stock purchase warrants for
the purchase of 100,000 shares of the Company's common stock, at an
exercise price of $1.20 per share, that had a fair value of
approximately $32,000 on the date of issue. The warrants expire five
years from the date of issuance. The Company has accounted for these
warrants as professional services expense and an addition to paid-in
capital.
In connection with notes payable issued in November 1998, the Company
issued stock purchase warrants for the purchase of 112,495 shares of
the Company's common stock that had a fair value of approximately
$64,100 on the date of issue. The Company has accounted for these
warrants as interest expense and an addition to paid-in capital. The
notes payable were canceled as a result of the sale of Series D
convertible preferred stock described in note 8(b) above. 50,000 of
the warrants have an exercise price of $.85 per share and expire five
years from the date of issuance, and 62,495 of the warrants have an
exercise price of $.01 per share and expire ten years from the date of
issuance.
(E) STOCK OPTION PLAN
The Company adopted a stock option plan (the "Plan") effective
December 31, 1996 in which key employees or key persons such as
advisors or consultants who have provided valuable services to the
Company, as determined by the Board of Directors, are rewarded with
either nonqualified or incentive stock options to acquire the
Company's common stock. During 1998, the Company increased the number
of shares available under the Plan from 670,000 to 1,184,714.
17
CLEMCO, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
At December 31, 1998, there were 777,264 shares available for grant
under the Plan. The following table summarizes option plan activity
for the years ended December 31, 1998, 1997, and 1996:
1998 1997 1996
------------------------- ----------------------- ------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------- ----------- ------- ----------- --------- -----------
Outstanding at beginning of year 225,500 $ .52 131,500 $ .35 56,500 $ .13
Granted 327,700 .99 178,500 .61 75,000 .51
Exercised (18,750) .10 -- -- -- --
Forfeited/canceled (145,750) .71 (84,500) .43 -- --
---------- ------- --------
Outstanding at end of year 388,700 .86 225,500 .52 131,500 .35
========== ======= ========
========== ======= ========
Weighted-average fair value of
stock options granted .30 .18 .14
The following table summarizes information about stock options
outstanding and exercisable as of December 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------------------- --------------------------------
WEIGHTED-
NUMBER AVERAGE WEIGHTED- NUMBER WEIGHTED-
RANGES OF OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT AVERAGE
EXERCISE DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
PRICES 1998 LIFE PRICE 1998 PRICE
------------ --------------- ------------- ------------ --------------- ------------
$ .10 -.20 12,500 6.6 $ .16 10,625 $ .15
.21 -.51 50,500 8.3 .51 6,250 .51
.52 -.75 183,900 9.0 .75 -- --
.76 - 1.20 141,800 9.6 1.20 -- --
------------- ---------------
.10 - 1.20 388,700 9.1 .86 16,875 .29
============= ===============
The per share weighted-average fair value of stock options granted was
calculated using the Black Scholes option-pricing model with the
following weighted-average assumptions: dividend yield of 0%, expected
volatility of 0%, risk-free interest rate of 6.3% and an expected life
of five years.
The Company applies the provisions of APB Opinion No. 25 in accounting
for its stock option plan and, accordingly, no compensation cost has
been recognized for stock options in the accompanying consolidated
financial statements. Had the Company determined compensation cost
based on the fair value of the options at the grant date, the
Company's pro forma net loss would not have been significantly
different from the actual net loss reflected in the accompanying
statements of operations.
18
CLEMCO, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(F) NOTE RECEIVABLE FROM EMPLOYEE FOR COMMON STOCK
In November 1996, the Company issued 500,000 shares of common stock to
an employee in exchange for a $100,000 nonrecourse note receivable
secured by the underlying common stock. The note receivable bears no
interest and is due in full in November 2000. The balance of the note
was $86,667 and $100,000 at December 31, 1998 and 1997, respectively.
(10) COMMITMENTS
(A) OPERATING LEASE COMMITMENTS
The Company leases office facilities and furniture and office
equipment under operating leases expiring in 1999. Rental expense
under all operating lease agreements for the years ended December 31,
1998, 1997, and 1996 was $236,366, $148,624, and $126,383,
respectively. Minimum future annual rental payments under all
noncancelable operating leases with remaining terms greater than one
year is $76,985 for the year ending December 31, 1999 and none
thereafter.
(B) OBLIGATION UNDER CONSULTING AGREEMENT
In connection with the acquisition of Information Management, Inc.
("IMI"), the Company entered into a consulting agreement with the
prior owner whereby the prior owner is entitled to payments equal to
1.5% of net revenues of the Company for the period January 1, 1995
through December 31, 1999. The minimum amount of such contingent
payments over the term of the agreement is to be $250,000 and the
maximum amount is to be $650,000. The Company recorded the minimum
obligation under the consulting agreement of $250,000 as part of the
purchase price related to the acquisition of IMI and has reduced such
obligation for all payments made to the prior owner since the
effective date of the acquisition which have been based upon 1.5% of
net revenues. The outstanding amount due under the obligation was
$144,633 and $177,928 at December 31, 1998 and 1997, respectively.
(11) EMPLOYEE BENEFIT PLAN
The Company maintains a 401(k) plan (the "Plan") which covers all eligible
full-time employees. The Company provided discretionary matching
contributions to the Plan during the years ended December 31, 1998, 1997,
and 1996 totaling $12,853, $8,823, and $9,228, respectively.
19
CLEMCO, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1998 and 1997
(12) MAJOR CUSTOMERS
For the year ended December 31, 1998, four customers accounted for 25%,
21%, 17%, and 11% of total revenues, respectively.
For the year ended December 31, 1997, three customers accounted for 35%,
24%, and 13% of total revenues, respectively.
For the year ended December 31, 1996, three customers accounted for 30%,
12%, and 10% of total revenues, respectively.
(13) SUBSEQUENT EVENT
On April 27, 1999, the Company entered into an Agreement and Plan of
Reorganization with ProBusiness Services, Inc., whereby the Company would
be acquired by ProBusiness Services, Inc. under a transaction to be
accounted for by the pooling-of-interests method. ProBusiness Services,
Inc. would be the surviving company in the merger.
20