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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (NO FEE REQUIRED)
FOR THE FISCAL YEAR ENDED JUNE 30, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
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PROBUSINESS SERVICES, INC.
(Exact name of Registrant as specified in its charter)
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DELAWARE 94-2976066
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
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4125 HOPYARD ROAD
PLEASANTON, CA 94588
(Address of principal executive offices)
(925) 737-3500
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
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NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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None None
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SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.001 PAR VALUE
(Title of Class)
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES /X/ NO / /
As of September 10, 1999, there were 22,984,603 shares of the Registrant's
Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the fiscal year ended June
30, 1999 are incorporated by reference into Parts II and IV. Portions of the
Proxy Statement for Registrant's 1999 Annual Meeting of Stockholders to be held
November 18, 1999 are incorporated by reference into Part III.
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PROBUSINESS SERVICES, INC.
INDEX TO ANNUAL REPORT
ON FORM 10-K
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PART I
Item 1. Business.................................................................... 3
Item 2. Properties.................................................................. 8
Item 3. Legal Proceedings........................................................... 9
Item 4. Submission of Matters to a Vote of Security Holders......................... 9
PART II
Item 5. Market for Registrant's Equity and Related Stockholder Matters.............. 9
Item 6. Selected Financial Data..................................................... 10
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................ 10
Item 8. Financial Statements and Supplementary Data................................. 10
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure................................................................ 10
PART III
Item 10. Directors and Executive Officers of the Company............................. 11
Item 11. Executive Compensation...................................................... 13
Item 12. Security Ownership of Certain Beneficial Owners and Management.............. 13
Item 13. Certain Relationships and Related Matters................................... 13
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8K............. 15
Signatures............................................................................. 16
</TABLE>
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PROBUSINESS SERVICES, INC.
PART I.
THE FOLLOWING REPORT 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 IN THE "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" ON
PAGE 2 OF EXHIBIT 13.1 HERETO.
ITEM 1. BUSINESS
OVERVIEW
ProBusiness is a leading provider of employee outsourced administrative
services for large employers. The Company's primary service offerings are
payroll processing, payroll tax filing, benefits administrative services, human
resources software and self-service applications. The Company's proprietary
PC-based payroll system offers the cost-effective benefits of outsourcing and
high levels of client service, while providing the flexibility, control,
customization and integration of an in-house system. As of June 30, 1999, the
Company provided services to approximately 1,750 clients. As of June 30, 1999,
the Company provided payroll processing services to approximately 560 clients
with an aggregate of approximately 840,000 active employees and an average of
approximately 1,500 employees. For the quarter ended June 30, 1999, the Company
processed 5.8 million checks for the Company's payroll clients. In addition to
providing tax filing services for its payroll clients, as of June 30, 1999 the
Company provided national tax filing services to 119 clients with an aggregate
of approximately 1.7 million employees and an average of more than 14,400
employees.
The Company differentiates itself from its competitors through its
proprietary PC-based technology, high quality, responsive and professional
client service and focus on the needs of large employers. ProBusiness develops a
business partnership with each client by assessing each client's payroll
processing needs, reengineering and designing the client's payroll systems and
processes and implementing a cost-effective solution. The Company maintains an
ongoing relationship with each client using a strategic team of specialists led
by a personal account manager who proactively manages each client's account and
marshals the resources of the team to meet the client's specific needs.
ProBusiness maintains a low client-to-account manager ratio to offer clients
accessible and responsive account management. The Company believes that its low
client-to-account manager ratio and its focus on client service are key factors
in enabling the Company to achieve a high payroll client retention rate, which
was approximately 90% for fiscal 1999.
The Company provides large employers with the cost-effective benefits of
outsourcing and high levels of client service, while providing the flexibility,
system control, customization and integration of an in-house system. The Company
combines its PC-based technology and personalized client service to provide a
broad range of service offerings, including payroll processing, payroll tax
filing, benefits administrative services, human resources software and
self-service applications.
The Company's objective is to be the premier provider of employee
administrative services for large employers. The Company's strategy is to
continue providing clients with high levels of personal service and developing a
comprehensive and fully integrated suite of employee administrative services.
The Company also intends to expand its client base and provide additional
services to its existing clients.
The Company was incorporated in California in October 1984 and
reincorporated in Delaware in September 1997. The Company's executive offices
are located at 4125 Hopyard Road, Pleasanton, California 94588, and its
telephone number is (925) 737-3500.
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SERVICE OFFERINGS
The Company provides a broad range of employee administrative services,
including payroll processing, tax filing, benefits administrative services,
human resources software and self-service applications. The Company intends to
expand its service offerings through future acquisitions, alliances and
investments and to develop enhancements to its existing services internally.
PAYROLL PROCESSING
The Company processes time and attendance data to calculate and produce
employee paychecks, direct deposits and reports for its clients. Clients receive
paychecks and reports within 24 to 48 hours of the Company's receipt of the data
electronically submitted from the client. The Company's system is highly
configurable to meet the specialized needs of each client yet maintains the
ability to provide high volume processing. The system integrates easily with the
client's general ledger, human resources and time and attendance systems. In
addition, the Company offers many sophisticated features, including the
automatic enrollment and tracking of paid time off, proration of compensation
for new hires and integrated garnishment processing.
PAYROLL TAX FILING
The Company collects contributed employer and employee tax funds from
clients, deposits such funds with tax authorities when due, files all tax
returns and reconciles the client's account. The Company will also represent the
client before tax authorities in disputes or inquiries. Substantially all
existing payroll clients utilize the Company's payroll tax service. In addition,
as of June 30, 1999, the Company provided national tax services to 119 clients
with an aggregate of more than 1.7 million employees and an average of more than
14,400 employees.
ADMINISTRATIVE SERVICES
The Company's benefits administrative services include flexible benefits
enrollment and processing, COBRA administration and consolidated billing and
eligibility tracking. Employees can enroll in and choose their flexible spending
benefits through traditional paper-based forms or through Internet-accessible
enrollment sites using the Company's Enrollnet-TM- service.
HUMAN RESOURCES SOFTWARE
The Company's human resources software tracks and reports general employee
information, including compensation, benefits, skills, performance, training,
job titles and medical history. For clients that also use the Company's payroll
service, the human resources data can be transferred to the payroll services
system, thus eliminating the need for duplicate data entry.
SELF-SERVICE APPLICATIONS
The Company's self-service applications provide employers with a complete
range of employee relationship management applications. Employers have a
web-based tool to facilitate HR and payroll processes and to empower employees
with self-directed administration services.
The Company continually evaluates the addition of add-on service offerings
to expand the breadth of its solution through alliances, acquisitions or
internal development. Such additional services include administrative services
related to time and attendance, travel and entertainment, unemployment insurance
and 401(k) plans.
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CLIENT SERVICE
The Company believes that its focus and dedication to providing high levels
of client service is a competitive advantage in the large employer market.
ProBusiness develops a business partnership with each client by assessing each
client's payroll processing needs, reengineering and designing the client's
payroll system and process and implementing a value-added solution. The Company
maintains an ongoing relationship with each client using a strategic team that
includes a sales representative, a sales analyst, an implementation manager, an
account manager and numerous functional, regulatory and technical support
specialists. The Company intends to continue providing its clients with a high
level of service by hiring professionals who are experienced in their fields.
Most service personnel have experience in payroll, accounting, human resources
or financial services industries, and many hold Certified Public Accountant or
Certified Payroll Professional accreditation.
The Company continually monitors the quality of its service through client
feedback mechanisms. The Company obtains valuable insights into the needs of its
clients through its partnership with each client and from client responses to
surveys, which are conducted semi-annually. The Company uses this information to
help develop, identify and optimize new service offerings provided to existing
clients and improve the level of service provided to clients. The Company also
uses client feedback as a basis for incentive compensation and recognition of
achievements.
SALES
The Company believes that client service begins with the sales process. A
sales representative and a sales analyst work together to assess a potential
client's payroll processing needs. Based on this assessment, the sales team then
identifies opportunities to reengineer the prospective client's payroll
processes and to design a payroll solution that integrates effectively with its
other systems. The payroll sales cycle typically ranges from three to twelve
months or longer.
IMPLEMENTATION
Upon engagement by a client, the Company assigns a team of technical support
specialists, headed by an implementation manager who leads the transition from
the client's former payroll system to the Company's system. The implementation
manager works with the client, the sales analyst and technical support
specialists to integrate the Company's payroll system with the client's other
systems and to customize the system to improve the client's payroll processes.
The Company uses its systems integration expertise to facilitate the integration
of its payroll processing system with the client's existing hardware and
software. The implementation process generally takes three to nine months or
longer, depending on the complexity of the client's payroll processes and
systems and the size of the client.
ACCOUNT MANAGEMENT
An account manager is assigned to each client during the implementation
process and serves as the client's day-to-day contact at the Company. The
account manager coordinates the efforts of the Company's functional, regulatory
and technical support specialists as necessary. The account manager visits each
client regularly and establishes an annual business plan with the client that
details scheduled payroll events such as open enrollment periods for employee
benefits plans or software system changes. This annual business plan allows the
Company to provide clients with uninterrupted payroll services during these
periods. Account managers use the Company's proprietary CallLog system to record
and track all client calls, record client feedback and help ensure that the
client's needs are addressed promptly and thoroughly. The Company maintains a
low client-to-account manager ratio to offer clients accessible and responsive
account management.
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SUPPORT SPECIALIST
The Company supports each client with functional and regulatory specialists
in payroll, payroll tax and employee benefits, as well as pay data interfaces,
general ledger interfaces, paid-time-off, report writing and system integration.
Each of these specialists is available to speak directly with clients as needed,
meet with clients onsite or support clients indirectly through the account
manager.
TECHNOLOGY
The Company's proprietary PC-based technology for its payroll services
provides a platform for delivering high levels of service together with the
flexibility and control of an in-house system. The Company creates a mirrored
version of each client's system, which allows the Company's account managers to
access client information using the same data, programs and screens as the
client uses on its PC network. This enables the Company to quickly and easily
identify client problems or modify application programs in response to client
requests. The client maintains control by having direct access to all
calculation programs and all historical and transactional data, which also
provides the client with flexibility to respond quickly to employee and
third-party inquiries, to fully analyze payroll data and to generate management
reports. The Company's intuitive Windows-based interface makes navigation simple
and allows new users to be trained quickly. The Company is developing a new
suite of online self-service administrative services applications accessible
through the Internet that enable clients' employees to view paychecks and other
compensation and benefits data.
The Company's system architecture is designed to distribute payroll
processing tasks to multiple low cost, high performance PCs, which enables the
Company to scale its system continually to handle increasing transaction
volumes. The Company's PC-based application software supports the development of
customized solutions for each client that can be easily upgraded and integrated
with a client's other systems. In addition, multiple networked PCs facilitate
exception processing and rapid response that large employers require.
CLIENTS
The Company targets large companies with complex and changing business needs
in diverse industries. As of June 30, 1999, the Company provided services to
approximately 1,750 clients. Of these clients, approximately 560 were payroll
processing clients, with an aggregate of approximately 848,000 active employees
and an average of approximately 1,500 employees. For the quarter ended June 30,
1999, the Company processed 5.8 million payroll checks for the Company's payroll
clients. The Company began providing national tax filing services to clients in
1996 and, as of June 30, 1999, provided these services to 119 clients with an
aggregate of more than 1.7 million employees and an average of more than 14,400
employees. Substantially all existing payroll clients utilize the Company's
payroll tax filing service. For fiscal 1999, no client accounted for more than
3% of the Company's revenue.
The Company believes that its low client-to-account manager ratio and its
focus on client service are key factors in enabling the Company to achieve a
high payroll client retention rate, which was approximately 90% for fiscal 1999.
Historically, the Company's client retention rates have been negatively impacted
primarily due to clients ceasing to use the Company's services following a
merger or sale of the client. The Company does not have long-term contracts with
its clients, and the Company's existing contracts do not have significant
penalties for cancellation.
SALES AND MARKETING
The Company employs a direct sales force to gain new payroll and payroll tax
clients and increase the number of services provided to existing clients. The
Company currently targets large employers through direct marketing, trade shows
and active participation in local chapters of the American Payroll Association.
The Company uses a team selling approach, whereby sales analysts and sales
representatives
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collaborate to assess a potential client's needs and develop a cost-effective
solution. The payroll sales cycle typically ranges from three to twelve months
or longer. The Company primarily utilizes insurance brokers to attract new
administrative services clients.
The Company seeks to attract and retain experienced industry sales
representatives. The Company believes that its long-term competitiveness depends
on increasing further its national presence. The Company believes that
continuing to add direct sales representatives in major metropolitan areas
throughout the United States is the most effective means of increasing its
national client base. Over the past two years, the Company has added sales and
implementation representatives covering major metropolitan areas, including
Atlanta, Chicago, Dallas, New York and Seattle. To support its sales growth in
the eastern United States, the Company opened a satellite sales and
implementation center in New Jersey during the first quarter of calendar 1999.
The Company's marketing department provides support materials and marketing
communications to sales representatives, promotes public relations, conducts
direct mail campaigns, manages trade show participation, and develops and
manages its corporate Web site.
As part of its strategy to provide a comprehensive suite of employee
administrative services, the Company has recently entered into strategic
alliances with two industry leaders. The Company has formed an alliance with
Oracle to provide full connectivity between the Company's payroll and payroll
tax solution and Oracle's human resources applications programs. The Company has
also formed an alliance to provide services to clients jointly with Sheakly
UniService, a leading provider of unemployment cost control services.
RESEARCH AND DEVELOPMENT
The Company intends to continue investing substantial resources to further
develop a comprehensive and fully integrated suite of employee administrative
services and extend the functionality of its proprietary payroll processing
systems. For example, the Company is developing a new suite of online
self-service administrative services applications accessible through the
Internet that enable clients' employees to view paychecks as well as other
compensation and benefits data. In addition, the Company expects to introduce an
integrated payroll and human resources system utilizing client/server technology
that will run on Windows 95, Windows 98 and Windows NT.
The foregoing information contains forward-looking statements that involve
risks and uncertainties. Actual events could differ materially from those
anticipated in these forward-looking statements, as a result of certain factors
including those discussed in the paragraph below.
COMPETITION
The market for the Company's services is intensely competitive, subject to
rapid change and significantly affected by new service introductions and other
market activities of industry participants. The Company primarily competes with
several public and private payroll service providers such as Automatic Data
Processing, Inc., Ceridian Corporation and Paychex, Inc., as well as smaller,
regional competitors. Many of these companies have longer operating histories,
greater financial, technical, marketing and other resources, greater name
recognition and a larger number of clients than the Company. In addition,
certain of these companies offer more services or features than the Company and
have processing facilities located throughout the United States. The Company
also competes with in-house employee services departments and, to a lesser
extent, banks and local payroll companies. With respect to benefits
administration services, the Company competes with insurance companies, benefits
consultants and other local benefits outsourcing companies. The Company may also
compete with marketers of related products and services that may offer payroll
or administrative services in the future. The Company has experienced, and
expects to continue to experience, competition from new entrants into its
markets. Increased competition could result
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in pricing pressures, loss of market share and loss of clients, any of which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company believes that the principal competitive factors affecting its
market include client service, system functionality and performance, system
scalability, reputation, system cost and geographic location. The failure of the
Company to compete successfully would have a material adverse effect on the
Company's business, financial condition and results of operations.
PROPRIETARY RIGHTS
The Company's success is dependent in part upon its proprietary software
technology. The Company relies on a combination of contract, copyright and trade
secret laws to establish and protect its proprietary technology. The Company has
no patents, patent applications or registered copyrights. 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 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.
EMPLOYEES
As of June 30, 1999, the Company had approximately 790 full-time employees.
The Company believes that its relations with its employees are good.
ITEM 2. PROPERTIES
The Company's headquarters are located in Pleasanton, California and consist
of approximately 130,000 square feet of office space leased through September
2008. The Company has signed a lease through April 2015 for a building adjacent
to its headquarters which consists of approximately 76,000 square feet of office
space. The Company also has a sales, implementation and production facility and
a back-up payroll facility in Irvine, California, where it leases approximately
14,000 square feet under a lease which terminates May 2002. In addition, the
Company has a sales office in Kettering, Ohio pursuant to a lease which
terminates in September 2000. The Company opened a satellite sales and
implementation center in Bridgewater, New Jersey, where it leases approximately
8,000 square feet of office space through April 2001.
The Company's administrative services processing operations are located in
Bothell, Washington, where the Company leases approximately 30,000 square feet
under a lease that will terminate in May 2006.
The Company's employee self service center is located in Norcross, Georgia,
where the Company leases approximately 15,000 square feet through June 2001.
The Company believes that its existing facilities are adequate for its
current needs and that additional facilities can be leased to meet future needs.
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ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders, through the
solicitation of proxies or otherwise, during the fourth quarter of the fiscal
year ended June 30, 1999.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) The Company's Common Stock is quoted on the Nasdaq National Market under
the symbol "PRBZ." The following table sets forth, for the fiscal periods
indicated, the high and low sales prices of the Common Stock as reported by the
Nasdaq National Market since the Company's initial public offering of Common
Stock at $7.33 per share on September 19, 1997 (after giving effect to the stock
split effected on August 7, 1998). Prior to September 19, 1997, there was no
public trading market for the Common Stock.
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HIGH LOW
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FISCAL 1998:
First Quarter (from September 19, 1997).................................... $ 12.92 $ 7.67
Second Quarter............................................................. $ 15.33 $ 12.08
Third Quarter.............................................................. $ 20.00 $ 14.00
Fourth Quarter............................................................. $ 32.58 $ 17.33
FISCAL 1999:
First Quarter.............................................................. $ 43.13 $ 22.38
Second Quarter............................................................. $ 47.50 $ 27.25
Third Quarter.............................................................. $ 44.75 $ 29.75
Fourth Quarter............................................................. $ 42.00 $ 24.50
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On September 13, 1999, there were 5,265 beneficial holders of record of the
Company's Common Stock. The last reported sale price per share of the Common
Stock on September 23, 1999 on the Nasdaq National Market was $27.375.
(b) On September 25, 1998, the Company commenced a secondary public offering
(the "Secondary Offering"), which consisted of 3,191,250 shares of its Common
Stock at $27.00 per share pursuant to a registration statement (No. 333-60745)
declared effective by the Securities and Exchange Commission on September 25,
1998. As of April 1, 1999, $80.7 million, all of the Company's net proceeds from
the offering were invested in short-term financial instruments. During the
period April 1, 1999 to June 30, 1999 approximately $7.1 million of the proceeds
was used for working capital. At July 1, 1999, approximately $73.6 million of
the net offering proceeds from the Secondary Offering were invested in
short-term financial instruments.
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ITEM 6. SELECTED FINANCIAL DATA
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1995 1996 1997 1998 1999
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Revenue................................................ $ 7,095 $ 14,098 $ 27,675 $ 46,534 $ 70,145
Loss from operations................................... $ (893) $ (2,820) $ (7,495) $ (9,984) $ (18,393)**
Net loss............................................... $ (979) $ (3,238) $ (8,643) $ (9,840) $ (16,109)
Gross margin........................................... $ 4,392 $ 7,509 $ 13,763 $ 22,484 $ 35,636
Operating profit before client acquisition and merger
costs................................................ $ 2,050 $ 3,453 $ 4,757 $ 8,836 $ 14,969
Net loss per share*.................................... $ (0.78) $ (0.60) $ (0.77)
Shares used in computing basic and diluted net loss per
share*............................................... 11,079 16,535 21,033
Total assets........................................... $ 4,134 $ 118,036 $ 201,499 $ 377,475 $ 710,424
Payroll tax funds...................................... -- $ 106,339 $ 177,626 $ 332,667 $ 580,452
</TABLE>
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* Amounts are pro forma for 1997 and 1998.
** Loss includes a $3.5 million charge for merger related costs. (See Note 11
of Notes to Consolidated Financial Statements.)
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required is set forth in the Company's Annual Report under
the heading "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required are identified in Item 14(a), and are set
forth in the Company's Annual Report and incorporated herein by reference.
Supplementary data required is set forth in the Company's Annual Report under
"Quarterly Financial Data (Unaudited)" and is incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There has been no change in accountants or reported disagreements on
accounting principles or practices or financial statement disclosures.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information with respect to the
executive officers and directors of the Company as of August 1, 1999.
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NAME AGE POSITION
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Thomas H. Sinton.......................... 51 Chairman of the Board, President, Chief Executive Officer,
Director
Jeffrey M. Bizzack........................ 39 Senior Vice President, Sales
Jerry W. Blalock.......................... 50 Senior Vice President, Operations and Group General Manager
Leslie A. Johnson......................... 50 Senior Vice President, Client Services and Chief Service
Officer
Steven E. Klei............................ 39 Senior Vice President, Finance, Chief Financial Officer and
Secretary
Robert E. Schneider....................... 41 Senior Vice President, Product Development and Chief Technical
Officer
William T. Clifford(1).................... 53 Director
David C. Hodgson(2)....................... 42 Director
Ronald W. Readmond(1)(2).................. 56 Director
Thomas P. Roddy(1)........................ 64 Director
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(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
MR. SINTON, founder of the Company, has served as a Director of the Company
since the Company's incorporation in October 1984, and from March 1993 to
present, Mr. Sinton has served as the President and Chief Executive Officer of
the Company. Since December 1996 and for a period between September 1989 and
February 1993, Mr. Sinton served as Chairman of the Board. Mr. Sinton holds a
B.A. degree in English Literature, Magna Cum Laude, from Harvard University, an
M.S. degree in Food Science from the University of California at Davis and an
M.B.A. degree from Stanford University. Mr. Sinton received a Fulbright
Fellowship to study at the University of Vienna in Vienna, Austria.
MR. BIZZACK has served as Senior Vice President, Sales of the Company since
July 1993. From October 1992 to July 1993, Mr. Bizzack served as Vice President,
Sales of the Company. From October 1988 to October 1992, Mr. Bizzack served as a
District Sales Manager of the Company. Mr. Bizzack attended Saint Mary's
College.
MR. BLALOCK has served as Senior Vice President, Operations and General
Group Manager of the Company since August 1999 and as Senior Vice President and
General Manager, Payroll and Tax from August 1998 to August 1999. From October
1996 to August 1998, Mr. Blalock served as Vice President and Regional General
Manager for Anacomp Corporation, a provider of document imaging services. From
January 1995 to October 1996 Mr. Blalock served as president and founder of the
Axion Group, a provider of resume scanning services. From March 1992 to December
1994 Mr. Blalock served as Divisional President of Delphi Information Systems, a
provider of automation systems to property and casualty insurers. Mr. Blalock
attended the University of La Verne.
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MS. JOHNSON has served as Senior Vice President, Client Services and Chief
Service Officer of the Company since August 1997 and served as Vice President,
Client Services of the Company from September 1993 to August 1997. From May 1992
to September 1993, Ms. Johnson was Director, National Accounts for Automatic
Data Processing. From January 1976 until her division was acquired by Automatic
Data Processing in May 1992, Ms. Johnson held several positions at BankAmerica
Corporation, most recently as Vice President, Northern California National
Accounts. Ms. Johnson holds a B.A. degree in Communications from the University
of Colorado.
MR. KLEI has served as Senior Vice President, Finance of the Company since
August 1997, as Chief Financial Officer of the Company since July 1995 and as
Secretary of the Company since August 1996. Mr. Klei served as Vice President,
Finance from July 1995 to August 1997. From April 1993 to July 1995, Mr. Klei
was Corporate Controller for Esprit de Corp, an apparel company. Mr. Klei holds
a B.S. degree in Accounting from Central Michigan University and is a Certified
Public Accountant.
MR. SCHNEIDER has served as Senior Vice President, Product Development and
Chief Technical Officer of the Company since August 1997 and served as Vice
President, Research and Development and Chief Technical Officer of the Company
from November 1996 to August 1997. From April 1995 to July 1996, Mr. Schneider
served as Senior Vice President of Product Development at Premenos Technology
Corporation, an electronic commerce software company. From February 1989 to
March 1995, Mr. Schneider held several positions at Sybase Inc., most recently
as Vice President and Business Unit Manager of the Server Products Group. Mr.
Schneider holds a B.S. degree in Computer Science from the University of San
Francisco.
MR. CLIFFORD has served as a Director of the Company since August 1997. Mr.
Clifford has served as the Chief Executive Officer of Gartner Group, Inc. since
January 1999 and as the President of Gartner Group, Inc. since October 1997.
From April 1995 to January 1999, he was the Chief Operating Officer of Gartner
Group, Inc., and from October 1993 to September 1997, he was Executive Vice
President, Operations of Gartner Group, Inc. From December 1988 to October 1993,
Mr. Clifford held various positions at Automatic Data Processing, Inc.,
including President of National Accounts and Corporate Vice President,
Information Services. Mr. Clifford holds a B.A. degree in Economics from the
University of Connecticut.
MR. HODGSON has served as a Director of the Company since March 1997. Mr.
Hodgson is a Managing Member of General Atlantic Partners LLC ("GAP LLC") and
has been with GAP LLC since 1982. Mr. Hodgson is also a director of Baan
Company, N.V., a publicly-traded software company, Atlantic Data Services, Inc.,
a publicly-traded information technology consulting company, and several other
privately-held software companies, in which GAP LLC or one of its affiliates is
an investor. Mr. Hodgson holds an A.B. degree in Mathematics from Dartmouth
College and an M.B.A. degree from Stanford University.
MR. READMOND has served as a Director of the Company since February 1997.
Since June 1998, Mr. Readmond has been President and Chief Operating Officer of
Wit Capital Group Incorporated and has been an advisor of Barbour Griffith &
Rogers, a lobbying firm, and Chairman of International Equity Partners, L.P., a
private equity and project development company since January, 1997. From August
1989 to December 1996, Mr. Readmond held various positions at Charles Schwab &
Co. Inc., most recently serving as Vice Chairman. Mr. Readmond holds a B.A.
degree in Economics from Western Maryland College.
MR. RODDY has served as a Director of the Company since 1992. Since 1988,
Mr. Roddy has served as President and Chief Executive Officer of Lafayette
Investments Inc., an investment banking and investment advisory company. Mr.
Roddy holds a B.S. degree in Biochemistry from Villanova University.
Mr. Hodgson was nominated and elected as a Director of the Company pursuant
to an agreement entered into between the Company, GAP LLC and Thomas H. Sinton
and his affiliates, in connection with
12
<PAGE>
the sale of Preferred Stock by the Company to GAP LLC. Under such agreement, GAP
LLC and Mr. Sinton and his affiliates agreed to vote their shares to elect one
director to the Board of Directors designated by GAP LLC until the third annual
meeting of stockholders after the Company's initial public offering.
The Board of Directors presently consists of five members who hold office
until the annual meeting of stockholders or until a successor is duly elected
and qualified. The Board of Directors is divided into three classes. One class
of directors is elected annually and its members hold office for a three-year
term or until their successors are duly elected and qualified, or until their
earlier removal or resignation. The number of directors may be changed by a
resolution of the Board of Directors. Executive officers are elected by the
Board of Directors. There are no family relationships among any of the directors
and executive officers of the Company.
The Board of Directors has established an Audit Committee and a Compensation
Committee. The Audit Committee recommends the engagement of auditors and reviews
the results and scope of the audit and other services provided by the Company's
independent auditors, reviews and evaluates the Company's control functions and
reviews the Company's investment policy. The Compensation Committee makes
recommendations to the Board of Directors concerning salaries and incentive
compensation for employees and consultants of the Company. The Compensation
Committee also administers the Company's 1996 Stock Option Plan and 1997
Employee Stock Purchase Plan.
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
the Company's executive officers and directors, and persons who own more than
10% of a registered class of the Company's equity securities to file reports of
ownership and changes in ownership with the Securities and Exchange Commission
("SEC"). Executive officers, directors and greater than 10% stockholders are
required by SEC rules to furnish the Company with copies of all forms they file.
Based solely on its review of the copies of such forms received by the Company
and written representations from certain reporting persons, the Company believes
that, during fiscal 1999, all Section 16(a) filing requirements applicable to
its executive officers, directors and 10% stockholders were satisfied.
ITEM 11. EXECUTIVE COMPENSATION
The information required is set forth in the Company's definitive Proxy
Statement in the sections entitled "Executive Officer Compensation" and
"Election of Class II Directors" and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP
The information required is set forth in the Company's definitive Proxy
Statement in the section entitled "Security Ownership of Certain Beneficial
Owners and Management" and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On December 5, 1996, the Company loaned $544,000 under a full recourse note
agreement at an interest rate of 6.31% per year to Robert E. Schneider, an
officer of the Company, to permit Mr. Schneider to exercise options to purchase
Common Stock of the Company. All principal and interest is due December 5, 2000.
As of June 30, 1999, Mr. Schneider had not paid any amount on the note.
On January 31, 1997, the Company loaned $250,000 under a full recourse note
agreement at an interest rate of 6.1% per year to Jeffrey M. Bizzack, an officer
of the Company, to permit Mr. Bizzack to purchase a residence. Accrued interest
must be paid on a monthly basis beginning two years from the date of the note.
All principal and accrued but unpaid interest is due January 31, 2001 unless Mr.
Bizzack's
13
<PAGE>
employment with the Company terminates, in which case, the note may become due
earlier. As of June 30, 1999, Mr. Bizzack had not paid any amount on the note.
Thomas H. Sinton and certain affiliates of GAP LLC are the principal
stockholders of InterPro Expense Systems, Inc., a Delaware corporation
("InterPro"), which in April 1998 purchased rights to certain early-stage travel
and entertainment expense processing software. Mr. Sinton is the President,
Chief Executive Officer and Chairman of the Board of the Company. David C.
Hodgson, a Director of the Company, is a managing member of GAP LLC, affiliates
of which hold more than 5% of the Company's outstanding stock. Because Mr.
Sinton and Mr. Hodgson are officers and Directors of the Company, their
investment in InterPro was required to be, and was, approved by the
disinterested directors of the Company. Any future transaction or relationship
between the Company and InterPro would be entered into on an arms-length basis
and would be approved by the Company's disinterested directors.
On September 8, 1998, the Company loaned $250,000 under a full recourse note
agreement at an interest rate of 5.42% per year to Jerry W. Blalock, an officer
of the Company, to permit Mr. Blalock to purchase a residence. All principal and
accrued but unpaid interest is due September 8, 2001 unless Mr. Blalock's
employment with the Company terminates, in which case, the note may become due
earlier. As of June 30, 1999, Mr. Blalock had not paid any amount on the note.
On November 20, 1998, the Company loaned $450,000 to William M. Hewitt, an
executive of the Company, under full recourse note agreements with an interest
rate of 5.42% per year. The notes were to permit Mr. Hewitt to purchase a
residence. Principal and interest under the notes is due in two installments of
$200,000 and $250,000 plus interest on November 20, 2000 and November 20, 2003,
respectively. As of June 30, 1999 Mr. Hewitt had not paid any amount on the
notes.
14
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this Report:
1. FINANCIAL STATEMENTS: The following Consolidated Financial Statements of
ProBusiness, Services, Inc. and Report of Ernst & Young LLP, Independent
Auditors, are incorporated by reference to the 1999 Annual Report to
Stockholders:
Consolidated Balance Sheets as of June 30, 1998 and 1999
Consolidated Statements of Operations for the years ended June 30, 1997,
1998 and 1999
Consolidated Statements of Stockholders' Equity for the years ended June 30,
1997, 1998 and 1999
Consolidated Statements of Cash Flows for the years ended June 30, 1997,
1998 and 1999
Notes to Consolidated Financial Statements
Report of Ernst & Young LLP, Independent Auditors
2. FINANCIAL STATEMENT SCHEDULE: The following financial statement schedule of
ProBusiness Services, Inc. for the fiscal years ended June 30, 1997, 1998
and 1999 is filed as part of this Report and should be read in conjunction
with the consolidated Financial Statements of ProBusiness Services, Inc.
Schedule II Valuation Allowance Schedule S-1
Schedules not listed above have been omitted because they are not applicable
or are not required or the information required to be set forth therein is
included in the Consolidated Financial Statements or Notes thereto.
3. EXHIBITS: The Exhibits listed on the accompanying Index to Exhibits
immediately following the financial statement schedule are filed as part of,
or incorporated by reference into, this Report.
(b) REPORTS OF FORM 8-K:.
On May 12, 1999, the Company filed a report on form 8-K for announcing that
on April 27, 1999, the Company completed the acquisition of Conduit Parent.
On July 12, 1999, the Company filed on Form 8-K/A an amendment to the Form
8-K previously filed on May 12, 1999, for the required financial statement
disclosure.
(c) EXHIBITS: See Item (a) above.
(d) FINANCIAL STATEMENT SCHEDULES: See Item (a) above.
15
<PAGE>
SIGNATURES
Pursuant to the requirements of section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the city of
Pleasanton, state of California, on this 28th day of September, 1999.
<TABLE>
<S> <C> <C>
PROBUSINESS SERVICES, INC.
By: /s/ THOMAS H. SINTON
-----------------------------------------
Thomas H. Sinton
PRESIDENT AND CHIEF EXECUTIVE OFFICER
</TABLE>
Pursuant to the requirements of the Securities Act of 1934, this Report has
been signed below by the following persons on behalf of the Registrant and in
the capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
President, Chief Executive
/s/ THOMAS H. SINTON Officer and Director
- ------------------------------ (Principal Executive September 28, 1999
Thomas H. Sinton Officer)
Senior Vice President,
/s/ STEVEN E. KLEI Finance, Chief Financial
- ------------------------------ Officer and Secretary September 28, 1999
Steven E. Klei (Principal Financial and
Accounting Officer)
/s/ WILLIAM T. CLIFFORD
- ------------------------------ Director September 28, 1999
William T. Clifford
/s/ DAVID C. HODGSON
- ------------------------------ Director September 28, 1999
David C. Hodgson
/s/ RONALD W. READMOND
- ------------------------------ Director September 28, 1999
Ronald W. Readmond
/s/ THOMAS P. RODDY
- ------------------------------ Director September 28, 1999
Thomas P. Roddy
</TABLE>
16
<PAGE>
SCHEDULE II
PROBUSINESS SERVICES, INC.
(IN THOUSANDS)
VALUATION ALLOWANCE
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-------------------------------
1997 1998 1999
--------- --------- ---------
<S> <C> <C> <C>
Deferred Tax Assets
Balance at beginning of year...................................................... $ 3,662 $ 6,560 $ 10,864
Additions......................................................................... 2,898 4,304 6,965
Reductions........................................................................ -- -- --
Balance at end of year............................................................ $ 6,560 $ 10,864 $ 17,829
<CAPTION>
YEAR ENDED JUNE 30,
-------------------------------
1997 1998 1999
--------- --------- ---------
<S> <C> <C> <C>
Allowance for Doubtful Accounts
Balance at beginning of year...................................................... $ 12 $ 386 $ 443
Additions......................................................................... 419 127 397
Reductions........................................................................ 45 70 24
Balance at end of year............................................................ $ 386 $ 443 $ 816
</TABLE>
S-1
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
FOOTNOTE NUMBER EXHIBIT DESCRIPTION
- --------- --------- ---------------------------------------------------------------------------------------------------
<C> <C> <S>
(1) 2.1 Agreement and Plan of Reorganization, dated May 23, 1996, between Registrant and Dimension
Solutions.
(1) 2.2 Stock Acquisition Agreement, dated January 1, 1997 between Registrant and BeneSphere
Administrators, Inc.
(4) 2.3 Agreement and Plan of Reorganization, dated as of April 27, 1999, among ProBusiness Services, Inc.
Runway Acquisition Corp., Clemco, Inc. and certain other parties.
(2) 3.1 Amended and Restated Certificate of Incorporation.
(1) 3.2 Bylaws of Registrant.
(1) 4.1 Specimen Common Stock Certificate of Registrant.
(1) 4.2 Amended and Restated Registration Rights Agreement, dated March 12, 1997, between Registrant,
General Atlantic Partners 39, L.P., GAP Coinvestment Partners, L.P. and certain stockholders of
Registrant.
(1) 4.3 Warrant to Purchase Stock, dated January 13, 1995, between Registrant and Silicon Valley Bank and
related Antidilution and Registration Rights Agreements.
(1) 4.4(a) Warrant to Purchase Stock, dated April 30, 1996, between Registrant and Coast Business Credit and
related Antidilution and Registration Rights Agreement.
(1) 4.4(b) Warrant to Purchase Stock, dated October 25, 1996, between Registrant and Coast Business Credit and
related Antidilution and Registration Rights Agreement.
(1) 4.5 Warrant to Purchase Series E Preferred Stock, dated July 31, 1996, between Registrant and LINC
Capital Management.
(1) 4.6(a) Warrant Purchase Agreement, dated November 14, 1996, between Registrant and certain purchasers.
(1) 4.6(b) Warrant to Purchase Series E Preferred Stock, dated November 14, 1996, between Registrant and T.J.
Bristow and Elizabeth S. Bristow.
(1) 4.6(c) Warrant to Purchase Series E Preferred Stock, dated November 14, 1996, between Registrant and SDK
Incorporated.
(1) 4.6(d) Warrant to Purchase Series E Preferred Stock, dated November 14, 1996, between Registrant and
Laurence Shushan and Magdalena Shushan.
(1) 4.7(a) Warrant to Purchase Common Stock, dated January 7, 1997, between Registrant and Louis R. Baransky.
(1) 4.7(b) Warrant to Purchase Common Stock, dated January 7, 1997, between Registrant and Ben W. Reppond.
(1) 4.8 Form of Note issued by Registrant on October 20, 1995 and December 12, 1995.
(4) 4.9 Waiver and Amendment dated as of April 27, 1999, among ProBusiness Services, Inc., General Atlantic
Partners 39, L.P., GAP Coinvestment Partners, L.P. and certain stockholder.
(4) 4.10 Registration Rights Agreement dated as of April 27, 1999, between ProBusiness Services, Inc. and
certain stockholders.
(3) 10.28 Sublease agreement, dated December 9, 1998, between Registrant and Maritz, Inc.
13.1 Certain sections of the Annual Report to Stockholders for the fiscal year ended June 30, 1999,
expressly incorporated herein by reference.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
27.1 Financial Data Schedule.
(4) 99.1 Press release of ProBusiness Services, Inc. dated April 27, 1999.
</TABLE>
- ------------------------
(1) Incorporated by reference to the Registrant's Registration Statement on Form
S-1, as amended (File No. 333-23189), declared effective on September 18,
1997.
(2) Incorporated by reference from the Registrant's Registration Statement on
Form S-8 (File No. 333-37129) filed with the Securities and Exchange
Commission on October 3, 1997.
(3) Incorporated by reference from the Registrant's report on Form 10-Q for the
period ended March 31, 1999.
(4) Incorporated by reference from the Registrant's report on Form 8-K filed
with the Securities and Exchange Commission on May 12, 1999.
<PAGE>
EXHIBIT 13.1
PROBUSINESS SERVICES, INC.
INDEX TO FINANCIAL INFORMATION
<TABLE>
<CAPTION>
<S> <C>
Management's Discussion and Analysis of Financial Condition and Results of Operations.................. Page 2
Consolidated Balance Sheets............................................................................ Page 13
Consolidated Statements of Operations.................................................................. Page 14
Consolidated Statements of Stockholders' Equity........................................................ Page 15
Consolidated Statements of Cash Flows.................................................................. Page 16
Notes to Consolidated Financial Statements............................................................. Page 17
Report of Independent Auditors......................................................................... Page 32
Quarterly Financial Data............................................................................... Page 33
</TABLE>
1
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS
AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM
THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN
FACTORS, INCLUDING 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
CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED ELSEWHERE IN THIS
ANNUAL REPORT.
OVERVIEW
ProBusiness Services, Inc. is a leading provider of employee outsourced
administrative services for large employers. The Company's primary service
offerings are payroll processing, payroll tax filing, benefits administration,
human resources software and self-service applications. The Company's
proprietary PC-based payroll system offers the cost-effective benefits of
outsourcing and high levels of client service, while providing the flexibility,
control, customization and integration of an in-house system.
The Company derives its revenue from fees charged to clients for services
and income earned from investing payroll tax funds. Since 1997, the Company has
experienced significant growth of its revenue, client base and average client
size. Revenue increased from $27.7 million in fiscal 1997 to $70.1 million in
fiscal 1999. From June 30, 1997 to June 30, 1999, the client base for payroll
processing services increased from 425 clients to approximately 560 clients,
while the average size of the Company's payroll clients increased from
approximately 900 employees to approximately 1,500 employees. The number of
checks that the Company processed for its payroll clients increased from 3.9
million to 5.8 million for the quarters ended June 30, 1998 and 1999,
respectively. As of June 30, 1999, the Company provided services to
approximately 1,750 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 number of employees of its clients,
the introduction of new features and other services, and a high retention rate
of existing payroll clients (approximately 90% for fiscal 1999). The Company
does not anticipate it will sustain this rate of growth in the future.
The establishment of new client relationships involves lengthy and extensive
sales and implementation processes. The sales process generally takes six to
twelve months or longer, and the implementation process generally takes an
additional three to nine months or longer. The Company has experienced
significant operating losses since its inception and expects to incur
significant operating losses in the future due to continued client acquisition
costs, investments in research and development and costs associated with
expanding sales efforts and operations in new geographic regions. As of June 30,
1999, the Company had an accumulated deficit of $47.9 million. There can be no
assurance that the Company will achieve or sustain profitability in the future.
The Company's cost of providing services consists primarily of ongoing
account management, tax and benefits administration operations and production
costs. General and administrative expenses consist primarily of personnel costs,
professional fees, and other overhead costs for finance and corporate services
and information technology. Research and development expenses consist primarily
of personnel costs. Client acquisition costs consist of sales and implementation
expenses and, to a lesser extent, marketing expenses.
In April 1999, the Company acquired Clemco, Inc. ("Conduit Parent"), the
parent and sole stockholder of Conduit Software, Inc. ("Conduit"), a leading
provider of employee relationship management applications. The acquisition was
accounted for using the pooling of interests method of accounting and as such
the Company's historical financial results have been restated to reflect the
acquisition. In connection with the acquisition, the Company issued 1,714,973
shares of its common stock to Conduit Parent's stockholders in exchange for all
of the outstanding capital stock of Conduit Parent. All outstanding options
2
<PAGE>
and warrants to purchase Conduit Parent's capital stock were converted into
options and warrants to purchase 82,987 shares of ProBusiness common stock. The
historical financial statements of ProBusiness for prior periods have been
restated to include the consolidated financial position and results of
operations of Conduit Parent. See Note 11 of Notes to Consolidated Financial
Statements.
RESULTS OF OPERATIONS
The following table sets forth certain items reflected in the consolidated
statements of operations expressed as a percentage of revenue:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-------------------------------
<S> <C> <C> <C>
1997 1998 1999
------- ------- -------
CONSOLIDATED STATEMENTS OF OPERATIONS
DATA:
Revenue................................. 100.0% 100.0% 100.0%
Operating expenses:
Cost of providing services............ 50.3% 51.7% 49.2%
General and administrative............ 17.3% 15.7% 15.3%
Research and development.............. 15.2% 13.6% 14.1%
Client acquisition costs.............. 44.3% 40.4% 42.6%
Merger costs.......................... -- -- 5.0%
------- ------- -------
Total operating expenses................ 127.1% 121.4% 126.2%
Loss from operations.................... (27.1)% (21.4)% (26.2)%
Interest expense........................ (4.3)% (1.3)% (1.0)%
Interest income and other, net.......... 0.2% 1.6% 4.2%
------- ------- -------
Net loss................................ (31.2)% (21.1)% (23.0)%
------- ------- -------
------- ------- -------
</TABLE>
REVENUE
Revenue increased 50.7% in fiscal 1999 and increased 68.1% in fiscal 1998,
primarily due to increases in the number and average size of the Company's
payroll and tax clients. Interest income earned on payroll tax funds invested
was $19.6 million, $11.5 million and $5.9 million in fiscal 1999, 1998 and 1997,
respectively. These increases were primarily due to higher average daily payroll
tax funds invested.
COST OF PROVIDING SERVICES
Cost of providing services increased 43.5% in fiscal 1999 and increased
72.9% in fiscal 1998 and decreased as a percentage of revenue to 49.2% in fiscal
1999, compared with 51.7% in fiscal 1998 and 50.3% in fiscal 1997. The increases
in absolute dollars were primarily due to increased personnel in operations such
as account management and production resulting from an increase in client base
and production expenses related to an increase in the number of payroll clients.
The decrease as a percentage of revenue in fiscal 1999 from fiscal 1998 was a
result of higher revenue. The increase as a percentage of revenue in fiscal 1998
from fiscal 1997 was primarily due to increased costs to build management
infrastructure related to benefits administrative services in fiscal 1998.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased 46.7% in fiscal 1999 and 52.6%
in fiscal 1998 and decreased as a percentage of revenue to 15.3% in fiscal 1999,
compared with 15.7% in fiscal 1998 and 17.3% in fiscal 1997. The increase in
absolute dollars in fiscal 1999 was primarily attributable to increased
investment in the Company's information technology infrastructure and the hiring
of additional management and administrative personnel to support the Company's
growth. The increase in absolute dollars in fiscal 1998 was primarily
attributable 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
3
<PAGE>
administrative services which were introduced in January 1997 and included in
general and administrative expenses for the full year in fiscal 1998. The
decreases as a percentage of revenue were primarily due to the economies
realized from relatively constant fixed costs as compared to the higher revenue.
RESEARCH AND DEVELOPMENT
Research and development expenses increased 56.9% in fiscal 1999 and 50.3%
in fiscal 1998. Research and Development expenses as a percentage of revenue
represented 14.1% in fiscal 1999, compared with 13.6% in fiscal 1998 and 15.2%
in fiscal 1997. The increases in absolute dollars were primarily a result of
additional personnel and equipment to develop new product offerings, as well as
enhancements and new features to the Company's existing services. The increase
as a percentage of revenue in fiscal 1999 from fiscal 1998 was due primarily to
a decrease in the percent of expenses capitalized. The decrease as a percentage
of revenue in fiscal 1998 from fiscal 1997 was due to higher revenues offset by
an increase in the amount of expenses capitalized. Capitalized software
development costs were $4.1 million, $3.9 million and $1.4 million in fiscal
1999, 1998 and 1997, respectively.
CLIENT ACQUISITION COSTS
Client acquisition costs increased 58.6% in fiscal 1999 and increased 53.6%
in fiscal 1998 and increased as a percentage of revenue to 42.6% in fiscal 1999
compared to 40.4% and 44.3% in fiscal 1998 and 1997, respectively. The increases
in absolute dollars in fiscal 1999 and fiscal 1998 were primarily due to the
expanded sales and implementation force for payroll and national tax services,
and to a lesser extent, expenses related to marketing. In addition, the increase
in absolute dollars in fiscal 1998 was was also due to expenses related to the
Company's benefits administrative services introduced in January 1997 and
included in client acquisition costs for the full year in fiscal 1998.
MERGER COSTS
In 1999, the Company charged to operations estimated one-time costs related
to the acquisition of Conduit Parent of $3.5 million. These costs consisted
primarily of investment banking and professional fees and other direct costs
associated with the merger.
INTEREST EXPENSE
Interest expense increased 11.7% in fiscal 1999 and decreased 49.2% in
fiscal 1998 and decreased as a percentage of revenue to 1.0% in fiscal 1999
compared to 1.3% in fiscal 1998 and 4.4% in fiscal 1997. Interest expense in
absolute dollars decreased in fiscal 1998 from 1997 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.
INTEREST INCOME AND OTHER, NET
Other income increased as a percentage of revenue to 4.2% in fiscal 1999
from 1.6% in fiscal 1998 and 0.2% in fiscal 1997. The increase as a percentage
of revenue was due to higher cash and investment balances resulting from the
Company's secondary public offering in September 1998 and initial public
offering in September 1997 when compared to the same periods in the prior years.
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. The
Company raised approximately $27.0 million from its initial public offering in
September 1997 and approximately $80.7 million from its secondary public
offering in September 1998.
4
<PAGE>
At June 30, 1999, the Company had approximately $73.6 million of cash and
cash equivalents and a $20.0 million secured revolving line of credit, which
expires in December 2000. At June 30, 1999, the Company had no outstanding
borrowings under the line of credit. See Note 3 of Notes to Consolidated
Financial Statements.
Net cash used in operating activities for fiscal 1999 was $1.1 million, net
cash provided by operating activities for fiscal 1998 was $1.7 million and net
cash used in operating activities for fiscal 1997 was $5.6 million. Net cash
used in operating activities in fiscal 1999 compared to net cash provided by
operating activities in fiscal 1998 was primarily the result of increases in net
loss, other assets and net accounts receivable, partially offset by increases in
accrued liabilities, depreciation and amortization and accounts payable. Net
cash provided by operating activities in fiscal 1998 compared to fiscal 1997 was
primarily the result of increases in accrued liabilities and depreciation and
amortization and a decrease in other assets, and, partially offset by an
increase in prepaid expenses.
Net cash used in investing activities was $28.7 million, $14.4 million and
$4.9 million for fiscal 1999, 1998 and 1997, respectively. The increase in net
cash used in investing activities in fiscal 1999 resulted primarily from the
addition of leasehold improvements related to a new research and development
facility in Pleasanton, California and a new benefits administration facility in
Bothell, Washington, the purchase and development of a customer care application
and capital expenditures for equipment, furniture and fixtures to support the
Company's increased personnel. In addition, the Company capitalized software
development costs of $4.1 million, $3.9 million and $1.4 million in fiscal 1999,
1998 and 1997, 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 $89.4 million, $21.6 million
and $11.4 million for fiscal 1999, 1998 and 1997, respectively. Net cash
provided by financing activities for fiscal 1999 related primarily to $80.7
million of net proceeds from the Company's secondary public offering of common
stock in September 1998. Net cash provided by financing activities for fiscal
1998 was primarily a result of $27.0 million of net proceeds from the Company's
initial public offering in September 1997, partially offset by net repayments
under the Company's line of credit and payments made to subordinated debt
holders.
The Company believes that existing cash and cash equivalent balances,
amounts available under its current credit facility and anticipated cash flows
from operations will be sufficient to meet its working capital and capital
expenditure requirements for at least the next 12 months. 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 also sell additional equity or debt
securities or obtain additional credit facilities.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, "Reporting Comprehensive Income. ("SFAS 130") which requires that all
items that are required to be recognized under accounting standards as
components of comprehensive income (revenues, expenses, gains and losses) be
reported in the financial statements. The Company adopted SFAS 130 effective
July 1, 1998.
In June 1997, the FASB issued SFAS No. 131,"Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131") which establishes standards for
the way public business enterprises report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports
issued to stockholders. In addition, it establishes standards for related
disclosures about products and services, geographic areas and major customers.
The Company adopted SFAS 131 effective for the year ended June 30, 1999.
5
<PAGE>
In June 1998, the FASB issued SFAS No. 133,"Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133") and in June 1999, the FASB
issued SFAS No. 137,"Accounting for Derivative and Hedging Activities-Deferral
of the Effective Date of FASB Statement No. 133" ("SFAS 133"). SFAS 133
established methods of accounting for derivative financial instruments and
hedging activities related to those instruments as well as other hedging
activities. SFAS 137 deferred for one year effective date of SFAS 133. The
Company is required to adopt SFAS 133 in fiscal 2001 and has not determined the
effect, if any, that adoption will have on its consolidated financial position
or results of operations.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
OPERATING LOSSES; NEED TO COMMIT TO EXPENSE IN ADVANCE OF REVENUES. The
Company has experienced significant operating losses since its inception and
expects to incur significant operating losses in the future due to continued
client acquisition costs, investments in research and development and costs
associated with expanding its sales efforts and operations to new geographic
regions. As of June 30, 1999, the Company had an accumulated deficit of $47.9
million. The establishment of new client relationships involves lengthy and
extensive sales and implementation processes. The sales process generally takes
six to twelve months or longer, and the implementation process generally takes
an additional three to nine months or longer. In connection with the acquisition
of each new client, the Company incurs substantial client acquisition costs,
which consist primarily of sales and implementation expenses and, to a lesser
extent, marketing expenses. The Company's ability to achieve profitability will
depend in part upon its ability to attract and retain new clients, offer new
services and features and achieve market acceptance of new services. There can
be no assurance that the Company will achieve or sustain profitability in the
future. Failure to achieve or sustain profitability in the future could have a
material adverse effect on the Company's business, financial condition and
consolidated results of operations.
SEASONALITY; FLUCTUATION IN QUARTERLY RESULTS. The Company's business is
characterized by significant seasonality. As a result, the Company's revenue has
been subject to significant seasonal fluctuations, with the largest percentage
of annual revenue being realized in the third and fourth fiscal quarters,
primarily due to new clients beginning services in the beginning of the tax year
(the Company's third fiscal quarter) and higher interest income earned on
payroll tax funds invested. Further, the Company's operating expenses are
typically higher as a percentage of revenue in the first and third fiscal
quarters as the Company increases personnel to acquire new clients and to
implement and provide services to such new clients, a large percentage of which
begin services in the third quarter.
The Company's quarterly operating results have in the past 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,
6
<PAGE>
the Company's business may be affected by shifts in the general condition of the
economy, client staff reductions, strikes, acquisitions of its clients by other
companies and other downturns. There can be no assurance that the Company's
future revenue and results of operations will not vary substantially. It is
possible that in some future quarter the Company's results of operations will be
below the expectations of public market analysts and investors. In either case,
the market price of the Company's Common Stock could be materially adversely
affected.
RISKS ASSOCIATED WITH STRATEGIC ACQUISITIONS AND INVESTMENTS. In April
1999, the Company acquired Conduit Parent, a leading provider of Employee
Relationship Management applications, in a transaction accounted for using the
pooling of interests method of accounting. There can be no assurance that this
acquisition will be effectively assimilated into the Company's business. The
integration of Conduit Parent will place a burden on the Company's management.
Such integration is subject to risks commonly encountered in making such
acquisitions, including, among others, loss of key personnel of the acquired
company, the difficulty associated with assimilating the personnel and
operations of the acquired company, the potential disruption of the Company's
ongoing business, the maintenance of uniform standards, controls, procedures and
policies, and the impairment of the Company's reputation and relationships with
employees and clients. There can be no assurance that the Company will be
successful in overcoming these risks or any other problems encountered in
connection with its acquisition of Conduit Parent.
The Company has no other current agreements or negotiations underway other
than those described above with respect to any acquisition of, or investment in,
businesses that provide complementary services or technologies to those of the
Company. The Company has in the past and intends in the future to make
additional acquisitions of, and investments in, such businesses. In addition,
future acquisitions could result in the issuance of dilutive equity securities,
the incurrence of debt or contingent liabilities. Furthermore, there can be no
assurance that any strategic acquisition or investment will succeed. Any future
acquisitions or investments could have a material adverse effect on the
Company's business, financial condition and results of operations.
RISKS ASSOCIATED WITH PAYROLL TAX 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.
7
<PAGE>
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 in short-term, top tier, high quality financial
instruments such as overnight U.S. government direct and agency obligation
repurchase agreements, commercial paper, and institutional money market funds
which are subject to credit risks and interest rate fluctuations. (See Note 1 of
Notes to Consolidated Financial Statements.) 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 the investment of client tax funds represents a
significant portion of the Company's revenues. As a result, the Company's
business, financial condition and results of operations are significantly
impacted by interest rate fluctuations. The Company enters into interest rate
swap agreements to minimize the impact of interest rate fluctuations. There can
be no assurance, however, that the Company's swap agreements will protect the
Company from all interest rate risks. Under certain circumstances if interest
rates rise, the Company would have payment obligations under its interest rate
swap agreements which may not be offset by interest earned by the Company on
deposited funds. A payment obligation under the Company's swap agreements could
have a material adverse effect on the Company's business, financial condition
and results of operations. A default by the Company under its swap agreements
could result in acceleration and setoff by the bank of all outstanding contracts
under the swap agreement, and could result in cross-defaults of other debt
agreements of the Company, any of which could have a material adverse effect on
the Company's business, financial condition and results of operations.
MANAGEMENT OF GROWTH. The Company's business has grown significantly in
size and complexity over the past five years. This growth has placed, and is
expected to continue to place, significant demands on the Company's management,
systems, internal controls, and financial and physical resources. In order to
meet such demands, the Company intends to continue to hire new employees, open
new offices to attract clients in new geographic regions, increase expenditures
on research and development, and invest in new equipment and make other capital
expenditures. In addition, the Company expects that it will need to develop
further its financial and managerial controls and reporting systems and
procedures to accommodate any future growth. Failure to expand any of the
foregoing areas in an efficient manner could have a material adverse effect on
the Company's business, financial condition and results of operations. The
Company opened a satellite sales and implementation center in New Jersey in
January 1999 and may open additional sales offices in the future. In May 1999,
the Company moved into an additional leased office space built adjacent to its
Pleasanton, California headquarters and moved its benefits administration center
from its location in Bellevue, Washington to Bothell, Washington. Any inability
to manage growth effectively could have a material adverse effect on the
Company's business, financial condition and results of operations.
8
<PAGE>
SUBSTANTIAL COMPETITION. The market for the Company's services is intensely
competitive, subject to rapid change and significantly affected by new service
introductions and other market activities of industry participants. The Company
primarily competes with several public and private payroll service providers,
such as Automatic Data Processing, Inc., Ceridian Corporation and Paychex, Inc.,
as well as smaller, regional competitors. Many of these companies have longer
operating histories, greater financial, technical, marketing and other
resources, greater name recognition and a larger number of clients than the
Company. In addition, certain of these companies offer more services or features
than the Company and have processing facilities located throughout the United
States. The Company also competes with in-house employee services departments
and, to a lesser extent, banks and local payroll companies. With respect to
benefits administration services, the Company competes with insurance companies,
benefits consultants and other local benefits outsourcing companies. The Company
may also compete with marketers of related products and services that may offer
payroll or benefits administration services in the future. The Company has
experienced, and expects to continue to experience, competition from new
entrants into its markets. Increased competition, the failure of the Company to
compete successfully, pricing pressures, loss of market share and loss of
clients could have a material adverse effect on the Company's business,
financial condition and 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.
DEPENDENCE ON THIRD-PARTY PROVIDERS. The Company depends on third-party
courier services to deliver paychecks to clients. The Company does not have any
formal written agreements with any of the courier services that it uses. Such
courier services have been in the past and may be in the future unable to timely
pick up or deliver the paychecks from the Company to its clients for a variety
of reasons, including employee strikes, storms or other adverse weather
conditions, earthquakes or other natural disasters, logistical or mechanical
failures or accidents. Failure by the Company to deliver client paychecks on a
timely basis could damage the Company's reputation and have a material adverse
effect on 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
9
<PAGE>
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 Bothell, Washington, and no benefits administration back-up
facility exists. The Company establishes for each payroll client a complete set
of payroll data at the Pleasanton processing center, as well as at the client's
site. In the event of a disaster in Pleasanton, clients would have the ability
to process payroll checks based on the data they have on site if necessary. In
addition, the Company has developed business continuity plans for each of the
Company's mission critical business units. There can be no assurance that the
Company's disaster recovery procedures are sufficient or that the payroll data
recovered at the client site would be sufficient to allow the client to
calculate and produce payroll in a timely fashion.
The Company's operations are dependent on its ability to protect its
computer systems against damage from a major catastrophe (such as an earthquake
or other natural disaster), fire, power loss, security breach,
telecommunications failure or similar event. No assurance can be given that the
precautions that the Company has taken to protect itself from or minimize the
impact of such events will be adequate. Any damage to the Company's data
centers, failure of telecommunications links or breach of the security of the
Company's computer systems could result in an interruption of the Company's
operations or other loss 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.
DEPENDENCE ON KEY PERSONNEL. The Company's success will depend on the
performance of the Company's senior management and other key employees. The loss
of the services of any senior management or other key employee could have a
material adverse effect on the Company's business, financial condition and
results of operations. The Company generally does not enter into employment or
noncompetition agreements with its employees. If one or more of the Company's
key employees resigns from the Company to join a competitor or to form a
competitor, the loss of such personnel and any resulting loss of existing or
potential clients to any such competitor could have a material adverse effect on
the Company's business, financial condition and results of operations. In the
event of the loss of any key personnel, there can be no assurance that the
Company would be able to prevent the unauthorized disclosure or use of its
technical knowledge, practices, procedures or client lists by a former employee
or that such disclosure or use would not have a material adverse effect on the
Company's business, financial condition and results of operations.
NEED TO ATTRACT AND RETAIN EXPERIENCED PERSONNEL. The Company's success
depends to a significant degree on its ability to attract and retain experienced
employees. There is substantial competition for experienced personnel, which the
Company expects to continue. Many of the companies with which the Company
competes for experienced personnel have greater financial and other resources
than the Company. The Company has in the past and may in the future experience
difficulty in recruiting sufficient numbers of qualified personnel. In
particular, the Company's ability to find and train implementation employees is
critical to the Company's ability to achieve its growth objectives. The
inability to attract and retain experienced personnel as required could have a
material adverse effect on the Company's business, financial condition and
results of operations.
RISK ASSOCIATED WITH GEOGRAPHIC EXPANSION. A substantial majority of the
Company's revenue historically has been derived from clients located in the
western United States. The Company's ability to achieve significant future
revenue growth will in large part depend on its ability to gain new clients
throughout the United States. Growth and geographic expansion have resulted in
new and increased responsibilities for management personnel and have placed and
continue to place a strain on the Company's management and operating and
financial systems. The Company will be required to continue to implement and
improve its systems on a timely basis and in such a manner as is necessary to
accommodate the increased number of transactions and clients and the increased
size of the Company's operations. Any failure to implement and improve the
Company's systems or to hire and retain the appropriate personnel to manage its
operations
10
<PAGE>
would have a material adverse effect on the Company's business, financial
condition and results of operations.
YEAR 2000 COMPLIANCE. Many currently installed computer systems and
software products are coded to accept only two-digit entries in the date code
field. Beginning in 2000, these date code fields will need to accept four-digit
entries in order to distinguish 21st century dates from 20th century dates. As a
result, computer systems and/or software used by many companies will need to be
upgraded to comply with Year 2000 ("Y2K") requirements by the end of 1999.
Significant uncertainty exists in the software industry concerning the potential
effects associated with such compliance issues. To address this issue we have a
Y2K project team to try to ensure that the daily operations and functionality of
the Company will not be adversely affected by the Y2K issue.
The Company believes that software applications used for providing payroll,
tax and HR services at the Company are Y2K compliant. Clients representing over
90% of the Company's revenue are currently processing on the Company's Y2K
compliant applications. All clients are expected to be processing on the
Company's Y2K compliant applications by fall of 1999. There can be no assurance
that Y2K errors or defects will not be discovered in the Company's current and
future products.
The Company has engaged a representative sample of its client base to
participate in the application testing process and validate the output; however,
the Company is not assessing the Y2K compliance of its clients' systems or the
possible effects on its operations of the Y2K compliance of its clients'
systems.
The Company is in the process of assessing Y2K compliance status with
regards to its internally developed software, third party software, hardware,
facilities, vendors and suppliers. All remediation efforts related to mission
critical software, hardware, vendors, suppliers and facilities are expected to
be completed by fall of 1999. The Company's reliance on third party suppliers
and subcontractors, and therefore, on the proper functioning of their
information systems and software, means that failure by such suppliers and
subcontractors to address Y2K issues could have a material adverse effect on the
Company's business, financial condition and results of operations.
Our Y2K compliance is dependent on key third parties also being Y2K
compliant on a timely basis; we cannot assure that the systems of certain of our
key third parties (for example, phone service providers, banks, etc.), upon
which we rely, will be converted in a timely manner, or that their failure to
convert would not have an adverse effect on our systems. In a worst-case
scenario, if one or more of our significant systems or key third parties were
not Y2K compliant by the end of 1999 this could potentially delay both clients'
payroll processing and transmission of tax payments to the local, state or
federal tax authorities. Failure by the Company to process payroll timely or
make timely or accurate tax return filings or pay tax liabilities when due on
behalf of clients may damage the Company's reputation and could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company has a business continuity plan in place in case of an event
(including disruption due to Y2K issues) that may affect our mission critical
operations. Like other businesses, many of our business processes are dependent
upon third-party providers. We have contracts in place with alternative vendors
for mission critical suppliers such as telecommunications, delivery services and
production supplies. In addition, the Company maintains a back-up generator in
case of disruption of electrical service and multiple fuel suppliers have been
contracted. There can be no assurance that the business continuity plans in
place will be adequate.
The costs for Y2K compliance have not been specifically identified within
the Company. However, the costs associated with Y2K compliance have not been,
and are not expected to be, material to our operations.
LIMITATIONS ON PROTECTION OF INTELLECTUAL PROPERTY AND PROPRIETARY
RIGHTS. The Company's success is dependent in part upon its proprietary
software technology. The Company has no patents, patent applications or
registered copyrights. The Company relies on a combination of contract,
copyright and
11
<PAGE>
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.
POSSIBLE VOLATILITY OF STOCK PRICE. The market price of the Company's
common stock is likely to be highly volatile and could be subject to wide
fluctuations in response to quarterly variations in operating results,
announcements of technological innovations or new services by the Company or its
competitors, market conditions in the information services industry, changes in
financial estimates by securities analysts or other events or factors, many of
which are beyond the Company's control. In addition, the stock market has
experienced significant price and volume fluctuations that have particularly
affected the market prices of equity securities of many technology and services
companies and that often have been unrelated to the operating performance of
such companies. These broad market fluctuations may adversely affect the market
price of the Company's common stock.
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.
12
<PAGE>
PROBUSINESS SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
JUNE 30,
--------------------
1998 1999
--------- ---------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents............................................. $ 13,946 $ 73,575
Accounts receivable, net of allowances of $443 at June 30, 1998 and
$816 at June 30, 1999............................................... 3,266 4,599
Prepaid expenses and other current assets............................. 2,243 3,777
--------- ---------
19,455 81,951
Payroll tax funds invested.............................................. 332,667 580,452
--------- ---------
Total current assets.................................................... 352,122 662,403
Equipment, furniture and fixtures, net.................................. 14,318 31,024
Other assets............................................................ 11,035 16,997
--------- ---------
Total assets............................................................ $ 377,475 $ 710,424
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable...................................................... $ 1,932 $ 3,657
Accrued liabilities................................................... 13,406 23,183
Deferred revenue...................................................... 2,139 1,944
Current portion of capital lease obligations.......................... 1,060 1,110
--------- ---------
18,537 29,894
Payroll tax funds collected but unremitted............................ 332,667 580,452
--------- ---------
Total current liabilities............................................. 351,204 610,346
Long-term debt.......................................................... 327 --
Capital lease obligations, less current portion......................... 1,496 548
Commitments
Redeemable convertible preferred stock, no par value, issuable in
series; authorized: 831,871 shares; issued and outstanding: 262,780 at
June 30, 1998 and none at June 30, 1999 (liquidation
preference--$2,291 at June 30, 1998 and none at June 30, 1999)........ 2,538 --
Stockholders' equity:
Common stock, $.001 par value; authorized: 60,000,000 shares; issued
and outstanding: 18,008,729 shares at June 30, 1998 and 22,942,362
at June 30, 1999.................................................... 18 23
Additional paid-in capital............................................ 54,854 148,284
Accumulated deficit................................................... (31,787) (47,896)
Notes receivable from stockholders.................................... (1,175) (881)
--------- ---------
Total stockholders' equity.............................................. 21,910 99,530
--------- ---------
Total liabilities and stockholders' equity.............................. $ 377,475 $ 710,424
--------- ---------
--------- ---------
</TABLE>
13
<PAGE>
PROBUSINESS SERVICES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-----------------------------------------
1997 1998 1999
--------- ------------------ ----------
<S> <C> <C> <C>
Revenue................................................................ $ 27,675 $ 46,534 $ 70,145
Operating expenses:
Cost of providing services........................................... 13,912 24,050 34,509
General and administrative........................................... 4,800 7,326 10,750
Research and development............................................. 4,206 6,322 9,917
Client acquisition costs............................................. 12,252 18,820 29,862
Merger costs......................................................... -- -- 3,500
--------- ------- ----------
Total operating expenses............................................... 35,170 56,518 88,538
Loss from operations................................................... (7,495) (9,984) (18,393)
Interest expense....................................................... (1,207) (613) (685)
Interest income and other, net......................................... 59 757 2,969
--------- ------- ----------
Net loss............................................................... $ (8,643) $ (9,840) $ (16,109)
--------- ------- ----------
--------- ------- ----------
Basic and diluted net loss per share................................... $ (0.77)
----------
----------
Shares used in computing basic and Diluted net loss per share.......... 21,033
----------
----------
Pro forma net loss per share........................................... $ (0.78) $ (0.60)
--------- -------
--------- -------
Shares used in computing pro forma net loss per share.................. 11,079 16,535
--------- -------
--------- -------
</TABLE>
14
<PAGE>
PROBUSINESS SERVICES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT SHARE AND AMOUNTS)
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK
------------------------------------- -------------------------------------
ADDITIONAL ADDITIONAL
PAID-IN PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL SHARES AMOUNT CAPITAL DEFICIT
----------- ----------- ----------- ----------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances at June 30, 1996......... 2,653,301 $ 2 $ 12,199 2,312,976 $ 2 $ 213 $ (13,304)
Issuance of Series F preferred
stock at $17.40 per share, net
of issuance costs............... 574,733 1 9,850 -- -- -- --
Issuance of common stock.......... -- -- -- 83,314 -- 153 --
Exercise of stock options......... -- -- -- 472,940 1 1,165 --
Issuance of preferred stock
warrants........................ -- -- 321 -- -- -- --
Net loss and comprehensive loss... -- -- -- -- -- -- (8,643)
----------- ----- ----------- ----------- ----- ----------- ------------
Balances at June 30, 1997......... 3,228,034 3 22,370 2,869,230 3 1,531 (21,947)
----------- ----- ----------- ----------- ----- ----------- ------------
Issuance of common stock in
connection with public offering,
net of offering costs........... -- -- -- 4,312,500 4 27,005 --
Conversion of preferred stock into
common stock.................... (3,228,034) (3) (22,370) 9,684,102 10 22,363 --
Conversion of redeemable
convertible preferred stock into
common stock.................... -- -- -- 320,060 -- 1,571 --
Exercise of warrants.............. -- -- -- 415,725 1 958 --
Exercise of common stock
options......................... -- -- -- 236,998 -- 317 --
Issuance of common stock under the
employee stock purchase plan.... -- -- -- 170,114 -- 1,060 --
Repayment of notes receivable from
stockholders.................... -- -- -- -- -- -- --
Issuance of common stock
warrants........................ -- -- -- -- -- 49 --
Net loss and comprehensive loss... -- -- -- -- -- -- (9,840)
----------- ----- ----------- ----------- ----- ----------- ------------
Balances at June 30, 1998......... -- -- -- 18,008,729 18 54,854 (31,787)
----------- ----- ----------- ----------- ----- ----------- ------------
Issuance of common stock in
connection with public offering,
net of offering costs........... -- -- -- 3,191,250 3 80,708 --
Exercise of common stock
warrants........................ -- -- -- 178,790 -- 450 --
Exercise of common stock
options......................... -- -- -- 342,562 -- 1,062 --
Conversion of redeemable
convertible preferred stock into
common stock.................... -- -- -- 819,055 1 8,130 --
Issuance of common stock under the
employee stock purchase plan.... -- -- -- 401,976 1 2,984 --
Repayment of notes receivable from
stockholders.................... -- -- -- -- -- -- --
Issuance of common stock
warrants........................ -- -- -- -- -- 96 --
Net loss and comprehensive loss... -- -- -- -- -- -- (16,109)
----------- ----- ----------- ----------- ----- ----------- ------------
----------- ----- ----------- ----------- ----- ----------- ------------
Balances at June 30, 1999......... -- $ -- $ -- 22,942,362 $ 23 $ 148,284 $ (47,896)
----------- ----- ----------- ----------- ----- ----------- ------------
----------- ----- ----------- ----------- ----- ----------- ------------
<CAPTION>
NOTES TOTAL
RECEIVABLE STOCKHOLDERS'
FROM EQUITY
STOCKHOLDERS (DEFICIT)
------------- ------------
<S> <C> <C>
Balances at June 30, 1996......... $ -- $ (888)
Issuance of Series F preferred
stock at $17.40 per share, net
of issuance costs............... -- 9,851
Issuance of common stock.......... (100) 53
Exercise of stock options......... (1,088) 78
Issuance of preferred stock
warrants........................ -- 321
Net loss and comprehensive loss... -- (8,643)
------------- ------------
Balances at June 30, 1997......... (1,188) 772
------------- ------------
Issuance of common stock in
connection with public offering,
net of offering costs........... -- 27,009
Conversion of preferred stock into
common stock.................... -- --
Conversion of redeemable
convertible preferred stock into
common stock.................... -- 1,571
Exercise of warrants.............. -- 959
Exercise of common stock
options......................... -- 317
Issuance of common stock under the
employee stock purchase plan.... -- 1,060
Repayment of notes receivable from
stockholders.................... 13 13
Issuance of common stock
warrants........................ -- 49
Net loss and comprehensive loss... -- (9,840)
------------- ------------
Balances at June 30, 1998......... (1,175) 21,910
------------- ------------
Issuance of common stock in
connection with public offering,
net of offering costs........... -- 80,711
Exercise of common stock
warrants........................ -- 450
Exercise of common stock
options......................... -- 1,062
Conversion of redeemable
convertible preferred stock into
common stock.................... -- 8,131
Issuance of common stock under the
employee stock purchase plan.... -- 2,985
Repayment of notes receivable from
stockholders.................... 294 294
Issuance of common stock
warrants........................ -- 96
Net loss and comprehensive loss... -- (16,109)
------------- ------------
------------- ------------
Balances at June 30, 1999......... $ (881) $ 99,530
------------- ------------
------------- ------------
</TABLE>
15
<PAGE>
PROBUSINESS SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-------------------------------
<S> <C> <C> <C>
1997 1998 1999
--------- --------- ---------
OPERATING ACTIVITIES
Net loss............................................................................. $ (8,643) $ (9,840) $ (16,109)
Adjustments to reconcile net loss to net cash provided by (used in) operating
activities:
Depreciation and amortization.................................................... 2,789 4,380 7,316
Other............................................................................ 71 325 93
Issuance of warrants............................................................. -- 30 96
Issuance of common stock for services............................................ 53 -- --
Changes in operating assets and liabilities:
Accounts receivable, net....................................................... (1,194) (317) (1,333)
Prepaid expenses and other current assets...................................... (170) (1,544) (1,534)
Other assets................................................................... (1,776) 1,729 (777)
Accounts payable............................................................... 659 589 1,725
Accrued liabilities............................................................ 2,544 5,529 9,625
Deferred revenue............................................................... 83 860 (195)
--------- --------- ---------
Net cash provided by (used in) operating activities.................................. (5,584) 1,741 (1,093)
--------- --------- ---------
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) (2,367)
Purchases of equipment, furniture and fixtures....................................... (2,902) (9,433) (22,223)
Capitalization of software development costs......................................... (1,409) (3,858) (4,100)
Notes receivable from stockholder.................................................... (295) -- --
--------- --------- ---------
Net cash used in investing activities................................................ (4,851) (14,418) (28,690)
--------- --------- ---------
FINANCING ACTIVITIES
Borrowings under line of credit agreements........................................... 24,727 6,874 --
Repayments of borrowings under line of credit agreements............................. (23,831) (11,632) --
Proceeds from long-term debt and notes payable....................................... 185 820 451
Repayments under long-term debt and notes payable.................................... (534) (4,059) (323)
Proceeds from notes payable to stockholder........................................... 425 -- --
Repayments under note payable to stockholder......................................... (275) (250) --
Principal payments on capital lease obligations...................................... (454) (1,036) (1,263)
Proceeds from issuance of redeemable and convertible preferred stock................. 11,098 1,500 5,045
Proceeds from issuance of common stock............................................... 78 29,345 85,208
Repayment of notes receivable from stockholder....................................... -- 13 294
--------- --------- ---------
Net cash provided by financing activities............................................ 11,419 21,575 89,412
--------- --------- ---------
Net increase in cash and cash equivalents............................................ 984 8,898 59,629
Cash and cash equivalents, beginning of period....................................... 4,064 5,048 13,946
--------- --------- ---------
Cash and cash equivalents, end of period............................................. $ 5,048 $ 13,946 $ 73,575
--------- --------- ---------
--------- --------- ---------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest............................................. $ 1,529 $ 590 $ 652
--------- --------- ---------
--------- --------- ---------
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Purchases of equipment under capital lease obligations............................... $ 2,827 $ 738 $ 365
--------- --------- ---------
--------- --------- ---------
Issuances of warrants................................................................ $ 161 $ 49 $ --
--------- --------- ---------
--------- --------- ---------
Notes receivable from stockholders issued in connecction with stock option
exercises.......................................................................... $ 1,188 $ -- $ --
--------- --------- ---------
--------- --------- ---------
Issuance of preferred stock in satisfaction of notes payable......................... $ 252 $ 683 $ 455
--------- --------- ---------
--------- --------- ---------
Conversion of redeemable and convertible preferred stock to common stock............. $ -- $ 22,373 $ 8,131
--------- --------- ---------
--------- --------- ---------
ACQUISITION OF BENESPHERE ADMINISTRATORS, INC.
Issuance of warrants................................................................. $ 160 $ -- $ --
Liabilities assumed.................................................................. 2,445 -- --
Notes payable to BeneSphere Administrators, Inc. .................................... 250 -- --
--------- --------- ---------
$ 2,855 $ -- $ --
--------- --------- ---------
--------- --------- ---------
BeneSphere contingent consideration.................................................. $ -- $ 2,208 $ 2,519
--------- --------- ---------
--------- --------- ---------
</TABLE>
16
<PAGE>
PROBUSINESS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY AND 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, benefits administrative services, human
resources software and self-service applications.
In 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 11).
In April 27, 1999, the Company acquired all of the outstanding stock of
Clemco, Inc. ("Conduit Parent"), a Georgia corporation. Conduit Parent is the
parent and sole stockholder of Conduit Software, Inc., a provider of employee
relationship management applications. The transaction was recorded using the
pooling-of interests method of accounting, and as such, all financial
information have been restated to reflect the acquisition. (Note 11)
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company.
All significant intercompany transactions and balances have been eliminated in
consolidation.
PAYROLL PROCESSING, PAYROLL TAX FILING SERVICES AND BENEFITS ADMINISTRATION
SERVICES
In connection with its payroll tax filing services, the Company collects
funds from clients for payment of payroll taxes, holds such funds in a financial
institution 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
consolidated 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 ($279.8
million), money market funds ($50.1 million) and cash and cash equivalents ($2.8
million) at June 30, 1998 and of overnight U.S. government, agency and mortgage
backed repurchase agreements ($44.6 million), money market funds ($422.1
million), commercial paper ($69.5 million), variable rate instruments ($40.0
million) and cash and cash equivalents ($4.3 million) at June 30, 1999. 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 $5.9 million, $11.5 million and $19.6 million for fiscal 1997,
1998 and 1999, 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
17
<PAGE>
PROBUSINESS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
client's 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, 1998 and 1999, the Company had accrued
approximately $971,000 and $2.3 million, 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.
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.
18
<PAGE>
PROBUSINESS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INTEREST RATE MANAGEMENT
During fiscal 1998 and 1999, 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 variable 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 revenue during the period
to which the payment or receipt relates, with no recognition on the balance
sheet of the fair value of the agreements. The aggregate fair value of these
agreements was $432,000 and $(3.2) million at June 30, 1998 and 1999,
respectively.
These agreements, with fixed interest rates between 5.905% and 4.75%, each
have a term of two years, and expire at various dates through May 2001. Interest
is paid or received based upon the product of the contractual notional balance
multiplied by the difference in the fixed interest rate and the contractual
floating rate option. The contractual notional balance varies on a monthly basis
due to fluctuations in projected holdings of collected but unremitted payroll
tax funds. At June 30, 1999, the notional balance was $318 million and the
average monthly notional balance for the remaining term of the agreements was
$298 million. The agreements require collateral at the option of the financial
institution if interest rates increase and certain other conditions are met as
defined in the agreements.
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.
REVENUE RECOGNITION
Revenue from payroll processing and payroll tax filing services under client
contracts is recognized as the services are performed provided that no other
obligations are required to be performed. Interest income earned on unremitted
payroll tax funds invested is recognized as earned.
19
<PAGE>
PROBUSINESS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets are included in other assets and are
carried at cost less accumulated amortization. Amortization is provided on a
straight-line basis over the respective useful lives, which range from three to
twenty years. Management periodically reviews the carrying amounts of the
Company's intangible assets for indications of impairment.
SOFTWARE DEVELOPMENT COSTS
The Company accounts for software development costs in accordance with
Statement of Financial Accounting Standards ("SFAS") 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. In accordance with SFAS No. 2,
"Accounting for Research and Development Costs," which establishes accounting
and reporting standards for research and development, 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 consolidated statements of operations.
In connection with the Company's merger with Conduit Parent, the Company
accounted for various contracts as end-user funding arrangements. The Company
recorded the costs incurred under these arrangements as research and development
expense and the revenues earned as a reduction of research and development
expense. Research and development expense was reduced by $1,705,000, $1,232,000
and 1,072,000 for fiscal 1997, 1998 and 1999, respectively, for the revenues
earned under these arrangements.
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 SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123") (Note 7).
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
Comprehensive Income (Loss)
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, & Reporting Comprehensive Income. ("SFAS 130") which requires that all
items that are required to be recognized under accounting standards as
components of comprehensive income (revenues, expenses, gains and losses) be
reported in the financial statements. The Company adopted SFAS 130 effective
July 1, 1998.
20
<PAGE>
PROBUSINESS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Disclosures about Segments of an Enterprise
In June 1997, the FASB issued SFAS No. 131,"Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131") which establishes standards for
the way public business enterprises report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports
issued to stockholders. In addition, it establishes standards for related
disclosures about products and services, geographic areas and major customers.
The Company adapted SFAS 130 effective July 1, 1998.
Derivative Instruments and Hedging Activities
In June 1998, the FASB issued SFAS No. 133,"Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133") and in June 1999, the FASB
issued SFAS No. 137,"Accounting for Derivative and Hedging Activities-Deferral
of the Effective Date of FASB Statement No. 133" ("SFAS 133"). SFAS 133
established methods of accounting for derivative financial instruments and
hedging activities related to those instruments as well as other hedging
activities. SFAS 137 deferred for one year effective date of SFAS 133. The
Company is required to adopt this statement in fiscal 2001 and has not
determined the effect, if any, that adoption will have on its consolidated
financial position or results of operations.
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)
Shares used in computing basic and diluted net income (loss) per share are
based on the weighted average shares outstanding in each period. Basic net
income (loss) per share excludes any dilutive effects of stock options. Diluted
net income (loss) per share includes the dilutive effect of the assumed exercise
of stock options using the treasury stock method. However, the effect of
outstanding stock options has been excluded from the calculation of diluted net
loss per share as their inclusion would be antidilutive.
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.
21
<PAGE>
PROBUSINESS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
A reconciliation of shares used in the calculation of historical and pro
forma basic and diluted net loss per share follows (in thousands except per
share information):
<TABLE>
<CAPTION>
1997 1998 1999
--------- --------- ----------
<S> <C> <C> <C>
HISTORICAL:
Net loss.................................................. $ (8,643) $ (9,840) $ (16,109)
--------- --------- ----------
Weighted average shares of common stock outstanding used
in computing basic and diluted net loss per share....... 2,545 14,410 21,033
--------- --------- ----------
Basic and diluted net loss per share...................... $ (3.40) $ (0.68) $ (0.77)
--------- --------- ----------
PRO FORMA:
Net loss.................................................. $ (8,643) $ (9,840)
--------- ---------
Shares used in computing basic and diluted net loss per
share (from above)...................................... 2,545 14,410
Pro forma adjustment to reflect the effect of the
conversion of preferred stock from the date of
issuance................................................ 8,534 2,125
--------- ---------
Weighted average shares of used in computing pro forma
basic and diluted net loss per share.................... 11,079 16,535
--------- ---------
Pro forma basic and diluted net loss per share............ $ (0.78) $ (0.60)
--------- ---------
</TABLE>
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 688,000, 1,193,000 and 1,271,000 common equivalent shares related to
outstanding stock options and warrants not included above (determined using the
treasury stock method) for fiscal 1997, 1998 and 1999, respectively.
2. EQUIPMENT, FURNITURE AND FIXTURES
Equipment, furniture and fixtures consist of the following (in thousands):
<TABLE>
<CAPTION>
JUNE 30,
--------------------
1998 1999
--------- ---------
<S> <C> <C>
Equipment and leasehold improvements..................... $ 18,891 $ 39,563
Furniture and fixtures................................... 3,383 4,614
--------- ---------
22,274 44,177
Less accumulated depreciation and amortization........... (7,956) (13,153)
--------- ---------
$ 14,318 $ 31,024
--------- ---------
</TABLE>
Equipment, furniture and fixtures include amounts for assets acquired under
capital leases, principally production, office and computer equipment, of
$4,015,000 and $4,167,000 at June 30, 1998 and 1999, respectively. Accumulated
amortization of these assets was $1,735,000 and $2,751,000 at June 30, 1998 and
1999, respectively.
22
<PAGE>
PROBUSINESS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. LONG-TERM DEBT
LINE-OF-CREDIT AGREEMENTS
On 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, 1999, 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% (7.75% at June 30, 1999) 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.
4. LEASE OBLIGATIONS
The Company leases its facilities and various equipment under non-cancelable
operating leases which expire at various dates through 2015. The facility leases
generally require the Company to pay operating costs, including property taxes,
insurance and maintenance, and contain renewal options and provisions adjusting
the lease payments based upon changes in operating costs or in fixed increments.
Rent expense is reflected on a straight-line basis over the terms of the related
leases. The Company is also obligated under a number of capital equipment leases
expiring at various dates through 2004. The future minimum lease payments under
capital and operating leases subsequent to June 30, 1999 are summarized as
follows (in thousands):
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
--------- -----------
<S> <C> <C>
Year ending June 30,
2000................................................................... $ 1,264 $ 4,870
2001................................................................... 228 4,883
2002................................................................... 212 4,935
2003................................................................... 180 4,794
2004................................................................... 26 4,495
Thereafter............................................................. -- 30,523
--------- -----------
Total minimum lease payments............................................. $ 1,910 $ 54,500
--------- -----------
Less amounts representing interest....................................... 252
---------
Present value of net minimum capital lease obligations................... 1,658
Less current portion..................................................... 1,110
---------
$ 548
---------
</TABLE>
Rent expense was approximately $1,666,000, $3,247,000 and $4,543,000 for
fiscal 1997, 1998 and 1999, respectively.
23
<PAGE>
PROBUSINESS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. INCOME TAXES
As of June 30, 1999, the Company had federal net operating loss
carryforwards of approximately $30.1 million which expire in the fiscal years
2000 through 2019. Of this amount, approximately $8.3 million can be utilized
only against the taxable income of one of the Company's subsidiaries. The
Company also had federal research and development tax credit carryforwards of
approximately $1.6 million which expire in the fiscal years 2009 through 2019.
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 and similar state provisions. The annual
limitation may result in the expiration of net operating losses and credits
before utilization.
<TABLE>
<CAPTION>
JUNE 30,
--------------------
1998 1999
--------- ---------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards...................... $ 7,591 $ 10,768
Research and development credit carryforwards......... 1,499 2,283
Equipment, furniture and fixtures..................... 1,010 2,225
Accrued liabilities................................... 2,147 4,731
--------- ---------
Gross deferred tax assets............................... 12,247 20,007
Less valuation allowance................................ (10,864) (17,829)
--------- ---------
Deferred tax assets..................................... 1,383 2,178
Deferred tax liabilities:
Capitalized software development costs................ (1,338) (2,035)
Other................................................. (45) (143)
--------- ---------
Gross deferred tax liabilities.......................... (1,383) (2,178)
Net deferred taxes...................................... $ -- $ --
--------- ---------
</TABLE>
Significant components of the Company's deferred tax assets and liabilities
are as follows (in thousands):
A valuation allowance has been established and, accordingly, no benefit has
been recognized for the Company's net operating losses and deferred tax assets.
The net valuation allowance increased by approximately $7.0 million during the
year ended June 30, 1999. 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.
Deferred tax assets relating to net operating loss carryforwards as of June
30, 1999 include approximately $2.5 million associated with stock option
activity for which any subsequently recognized tax benefits will be credited
directly to stockholder's equity.
24
<PAGE>
PROBUSINESS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. REDEEMABLE CONVERTIBLE PREFERRED STOCK
As indicated in Note 11, in connection with the Company's acquisition of
Conduit Parent, the Company restated its consolidated financial statements to
include the consolidated financial position and results of operations of Conduit
Parent.
In November 1997, Conduit Parent sold 215,800 shares of Series B redeemable
convertible preferred stock for approximately $7.80 per share, resulting in net
proceeds to the Company of $1,000,000 and the cancellation of notes payable and
accrued interest totaling $683,000. The Company has reflected the accretion of
discount as a charge to accumulated deficit. In May 1998, Conduit Parent sold
46,980 shares of Series C redeemable convertible preferred stock for
approximately $11.01 per share, resulting in net proceeds to the Company of
$500,000. In December 1998, Conduit Parent sold 328,715 shares of Series D
redeemable convertible preferred stock for approximately $9.91 per share,
resulting in net proceeds to the Company of $2,795,000 and the cancellation of
notes payable and accrued interest totaling $455,000. In February 1999, Conduit
Parent sold 227,560 shares of Series D redeemable convertible preferred stock
for approximately $9.91 per share, resulting in net proceeds to the Company of
$2,250,000.
Effective with the merger of Conduit Parent with ProBusiness, all shares of
redeemable convertible preferred stock were converted to Conduit Parent common
stock and were exchanged for 819,055 shares of ProBusiness common stock.
7. 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 September 1998, the Company completed a secondary public offering of the
Company's common stock. The offering consisted of 2,775,000 shares of common
stock issued to the public at $27.00 per share. In September 1998, the
underwriters exercised an option to purchase an additional 416,250 shares of
common stock at the price of $27.00 per share to cover over-allotments.
WARRANTS
The following table represents a summary of warrants outstanding as of June
30, 1999:
<TABLE>
<CAPTION>
EXERCISE PRICE
DATE ISSUED EXPIRATION PER SHARE NUMBER OF SHARES
- ---------------------------------------- ------------------ --------------- -----------------
<S> <C> <C> <C>
November 1996........................... September 2002 $ 2.65 67,500
July 1997............................... July 2002 $ 6.00 30,000
------
97,500
------
------
</TABLE>
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. During fiscal 1999,
the Company issued 178,790 shares of common stock
25
<PAGE>
PROBUSINESS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. STOCKHOLDERS' EQUITY (CONTINUED)
upon exercise of warrants, a portion of which were exercised pursuant to net
exercise provisions, for a total of $450,000.
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% distribution to
stockholders of record as of July 31, 1998. As a result of the stock split,
authorized and outstanding common shares increased 50% 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.
8. 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 shares. 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, however, 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 reserved 1,125,000 shares of common stock
for exercise of stock options under the Executive Plan. The grant of incentive
stock options 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
26
<PAGE>
PROBUSINESS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. STOCK OPTION AND STOCK PURCHASE PLANS (CONTINUED)
common stock are included in stockholders' equity (deficit). In November 1998,
the Company's stockholders approved an amendment to the 1996 Plan to increase
the number of shares reserved for issuance by an additional 950,000 shares.
In connection with the acquisition of Conduit Parent, as discussed in Note
1, the Company converted options to purchase shares of Conduit Parent common
stock into options to purchase shares of the Company's common stock. The number
of shares of the Company's common stock issuable under each option and the
exercise price for each grant were adjusted by an exchange ratio. The Company
did not assume the Stock Incentive Plan ("Conduit Parent Plan") under which the
options had been originally granted. The Conduit Parent Plan was terminated and
no further options will be granted under the Conduit Parent Plan. The converted
options continue to be subject to the terms of the Conduit Parent Plan. The
Conduit Parent Plan provided for the granting of incentive stock options as well
as nonstatutory stock options. The exercise prices of all options granted prior
to the acquisition were determined by the Conduit Parent Board of Directors and
were not less than the fair market value per share on the date of grant. The
options generally expire ten years from the date of grant and are exercisable as
determined by the Conduit Parent Board of Directors at the date of the grant.
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
-----------------------------
WEIGHTED AVERAGE
NUMBER OF EXERCISE PRICE
SHARES PER
---------- -----------------
<S> <C> <C>
Outstanding at June 30, 1996................................... 964,617 $ 0.27
Granted...................................................... 998,691 4.83
Exercised.................................................... (472,940) 2.39
Canceled..................................................... (173,672) 2.51
---------- ------
Outstanding at June 30, 1997................................... 1,316,696 2.62
Granted...................................................... 924,105 11.82
Exercised.................................................... (236,998) 1.34
Canceled..................................................... (187,157) 7.12
---------- ------
Outstanding at June 30, 1998................................... 1,816,646 7.21
Granted...................................................... 1,141,295 30.86
Exercised.................................................... (342,562) 2.88
Canceled..................................................... (111,519) 23.74
---------- ------
Outstanding at June 30, 1999................................... 2,503,860 17.81
---------- ------
---------- ------
</TABLE>
A summary of the activity under all plans is set forth below:
As of June 30, 1999, options to purchase 659,235 shares of common stock were
vested and exercisable at an average exercise price of $6.39 per share and
options to purchase 1,939,947 shares were available for future grant. As of June
30, 1999, options to purchase approximately 127,000 shares of common stock had
been exercised which are subject to repurchase.
The weighted-average fair value of options granted during fiscal 1997, 1998
and 1999 was $1.01, $6.98 and $20.99 per share, respectively.
27
<PAGE>
PROBUSINESS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. STOCK OPTION AND STOCK PURCHASE PLANS (CONTINUED)
The following table summarizes information concerning currently outstanding
and exercisable options at June 30, 1999:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
--------------------------------------------------
WEIGHTED AVERAGE EXERCISABLE
REMAINING ----------------------------
CONTRACTUAL LIFE WEIGHTED AVERAGE WEIGHTED AVERAGE
EXERCISE PRICE SHARES (YEARS) EXERCISE PRICE SHARES EXERCISE PRICE
- ----------------------------------- ---------- ------------------- ----------------- --------- -----------------
<S> <C> <C> <C> <C> <C>
$ 0.13--$ 4.83..................... 496,657 6.87 $ 2.35 319,170 $ 1.89
$ 5.83--$18.92..................... 823,812 8.20 $ 9.25 304,191 $ 8.99
$19.17--$27.00..................... 692,941 9.05 $ 26.36 28,935 $ 22.77
$30.00--$45.34..................... 490,450 9.63 $ 35.78 6,939 $ 31.30
---------- ---------
2,503,860 659,235
---------- ---------
</TABLE>
STOCK-BASED COMPENSATION
As permitted under SFAS 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 SFAS 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 SFAS 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 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 within the note above. The fair value
of the Company's stock-based awards to employees was estimated using the
following weighted-average assumptions:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-------------------------------
1997 1998 1999
--------- --------- ---------
<S> <C> <C> <C>
Expected life (in years)............................................. 2 2 4
Expected volatility.................................................. 0.001 0.746 0.907
Risk-free interest rate.............................................. 6.20% 5.50% 5.50%
Expected dividend yield.............................................. 0.00% 0.00% 0.00%
</TABLE>
28
<PAGE>
PROBUSINESS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. STOCK OPTION AND STOCK PURCHASE PLANS (CONTINUED)
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 (in thousands, except for
per share information):
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
---------------------------------
1997 1998 1999
--------- ---------- ----------
<S> <C> <C> <C>
Net Loss, as reported....................................... ($ 8,643) ($ 9,840) ($ 16,109)
Net Loss, as adjusted....................................... ($ 8,754) ($ 10,792) ($ 21,058)
Historical net loss per share, as reported.................. ($ 3.40) ($ 0.68) ($ 0.77)
Historical net loss per share, as adjusted.................. ($ 3.44) ($ 0.75) ($ 1.00)
Pro forma net loss per share, as reported................... ($ 0.78) ($ 0.60)
Pro forma net loss per share, as adjusted................... ($ 0.79) ($ 0.65)
</TABLE>
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 at least 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, 1999, a
total of 572,090 shares had been issued under the Plan for the first three
six-month purchase periods. Under the Purchase Plan, the Company's employees,
subject to certain restrictions, may purchase shares of common stock at the
lesser of 85% 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.
9. 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 1997, 1998 or 1999.
29
<PAGE>
PROBUSINESS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. CONSOLIDATED BALANCE SHEET DETAIL
<TABLE>
<CAPTION>
JUNE 30,
--------------------
<S> <C> <C>
1998 1999
--------- ---------
Capitalized software development costs.................................. $ 5,247 $ 8,744
Prepaid lease expense................................................... 133 93
Notes receivable from employees......................................... 422 1,113
Goodwill and other intangible assets.................................... 4,636 6,048
Deposits and other...................................................... 597 999
--------- ---------
$ 11,035 $ 16,997
--------- ---------
--------- ---------
</TABLE>
Other assets consist of the following (in thousands):
Accumulated amortization for capitalized software development costs was
approximately $802,000 and $1,148,000 at June 30, 1998 and 1999, respectively.
Accumulated amortization for goodwill and other intangible assets was
approximately $855,000 and $1,881,000 at June 30, 1998 and 1999, 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 and bears interest at 6.10% per year. In September 1998, 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 September 2001, bears
interest at 5.42%. In November 1998, the Company advanced $450,000 in the form
of a note receivable from a stockholder who is also an executive of the Company.
The note bears interest at 5.42% per year and $200,000 of the note is due in
November 2000, with the remainder payable in November 2003. All of the notes are
full recourse.
Accrued liabilities consist of the following (in thousands):
<TABLE>
<CAPTION>
JUNE 30,
--------------------
<S> <C> <C>
1998 1999
--------- ---------
Accrued expenses........................................................ $ 7,042 $ 13,161
Accrued tax penalties and related reserves.............................. 971 3,265
Accrued payroll and related expenses.................................... 3,322 4,424
Accrued BeneSphere contingent consideration (Note 11)................... 1,081 1,233
Other................................................................... 990 1,100
--------- ---------
$ 13,406 $ 23,183
--------- ---------
</TABLE>
11. BUSINESS COMBINATIONS
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. The contingent consideration was
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 accrued at a rate of 9% per annum on all earned but unpaid balances.
In January 1998 and 1999, the Company accrued an additional $2,208,000 and
$2,519,000, respectively, of contingent consideration and recorded goodwill in
the same amount related to the BeneSphere
30
<PAGE>
PROBUSINESS SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. BUSINESS COMBINATIONS (CONTINUED)
acquisition as described above. As of June 30, 1999 the Company had a remaining
outstanding balance of $1,233,000 for accrued contingent consideration, which is
classified as accrued liabilities in the accompanying consolidated balance
sheet. Goodwill arising from the acquisition is being amortized on a
straight-line basis over 20 years.
In April 1999, the Company acquired Clemco, Inc. ("Conduit Parent"); the
parent and sole stockholder of Conduit Software, Inc., a provider of employee
relationship management applications. The merger was accounted for using the
pooling-of-interests method of accounting and as such the Company's historical
financial results for all dates and periods prior to the merger have been
restated to reflect the merger. In connection with the acquisition, the Company
issued 1,714,973 shares of its common stock to Conduit Parent's stockholders in
exchange for all of the outstanding common and preferred stock of Conduit
Parent. All outstanding options and warrants to purchase Conduit Parent's
capital stock were converted into options and warrants to purchase 82,987 shares
of ProBusiness common stock. In connection with the business combination, the
Company incurred direct transaction costs of approximately $3,500,000, which
consisted primarily of fees for investment banking, legal and accounting
services incurred in conjunction with the merger. Of this, $598,000 was paid
before June 30, 1999. The balance of $2,902,000 is included in current
liabilities on the consolidated balance sheet and is anticipated to be paid
within 12 months. The Company's consolidated results of operations include
adjustments to conform the presentation and accounting policies of Conduit
Parent to ProBusiness' accounting policies.
The following information shows revenues and net loss of the separate
companies for the periods preceding the combination (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED
----------------------------
Revenues: JUNE 30, 1997 JUNE 30, 1998
------------- ------------- NINE
MONTHS
ENDED
MARCH 31, 1999
--------------
(UNAUDITED)
<S> <C> <C> <C>
ProBusiness................................... $ 27,374 $ 46,317 $ 50,126
Conduit Parent................................ 301 217 190
------------- ------------- --------------
Combined.................................... $ 27,675 $ 46,534 $ 50,316
------------- ------------- --------------
------------- ------------- --------------
Net Loss:
ProBusiness................................... $ (6,245) $ (6,517) $ (5,728)
Conduit Parent................................ (2,398) (3,323) (4,430)
------------- ------------- --------------
Combined.................................... $ (8,643) $ (9,840) $ (10,158)
------------- ------------- --------------
------------- ------------- --------------
</TABLE>
12. SEGMENT INFORMATION
The Company has adopted SFAS 131 effective July 1, 1998. The new rules
established revised standards for public companies relating to the reporting of
financial information about operating segments. The Company has identified one
reportable operating segment based upon the provisions of SFAS 131. The Company
is a provider of employee administrative services for large employers.
The Company's Chief Operating Decision Maker ("CODM"), who is the President
and Chief Executive Officer, evaluates performance based on a measure of
consolidated gross margin, operating profit before client acquisition costs and
profit or loss from operations. The accounting policies of the reportable
segment is the same as those described in the summary of significant accounting
policies. Based on the above, the Company's consolidated statements of
operations disclose the available financial information of its reportable
segment in accordance with SFAS 131 for fiscal 1997, 1998 and 1999.
31
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
ProBusiness Services, Inc.
We have audited the accompanying consolidated balance sheets of ProBusiness
Services, Inc. as of June 30, 1998 and 1999, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended June 30, 1999. 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 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
ProBusiness Services, Inc. at June 30, 1998 and 1999, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended June 30, 1999, in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
Walnut Creek, California
July 29, 1999
32
<PAGE>
PROBUSINESS SERVICES, INC.
QUARTERLY FINANCIAL DATA*
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------
1998 1999
-------------------- ----------------------
SEPT. 30 DEC. 31 MARCH 31 JUNE 30
--------- --------- ----------- ---------
<S> <C> <C> <C> <C>
Revenue............................................................... $ 14,255 $ 16,102 $ 19,959 $ 19,829
Operating expenses:
Cost of providing services.......................................... 7,711 8,325 9,150 9,323
General and administrative.......................................... 2,565 2,658 2,745 2,782
Research and development............................................ 1,916 2,353 2,981 2,667
Client acquisition costs............................................ 6,456 6,659 8,487 8,260
Merger costs........................................................ -- -- -- 3,500
--------- --------- ----------- ---------
Total operating expenses.............................................. 18,648 19,995 23,363 26,532
--------- --------- ----------- ---------
Loss from operations.................................................. (4,393) (3,893) (3,404) (6,703)
Interest expense...................................................... (230) (16) (288) (151)
Other income.......................................................... 186 804 1,076 903
Net loss.............................................................. $ (4,437) $ (3,105) $ (2,616) $ (5,951)
--------- --------- ----------- ---------
--------- --------- ----------- ---------
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------
1997 1998
-------------------- ----------------------
SEPT. 30 DEC. 31 MARCH 31 JUNE 30
--------- --------- ----------- ---------
<S> <C> <C> <C> <C>
Revenue............................................................... $ 9,274 $ 10,327 $ 13,735 $ 13,198
Operating expenses:
Cost of providing services.......................................... 5,068 5,817 6,472 6,693
General and administrative.......................................... 1,887 1,782 1,822 1,835
Research and development............................................ 1,445 1,604 1,439 1,834
Client acquisition costs............................................ 4,115 4,343 5,820 4,542
--------- --------- ----------- ---------
Total operating expenses.............................................. 12,515 13,546 15,553 14,904
--------- --------- ----------- ---------
Loss from operations.................................................. (3,241) (3,219) (1,818) (1,706)
Interest expense...................................................... (261) (169) (87) (96)
Other income.......................................................... 26 234 244 253
--------- --------- ----------- ---------
Net loss.............................................................. $ (3,476) $ (3,154) $ (1,661) $ (1,549)
--------- --------- ----------- ---------
--------- --------- ----------- ---------
</TABLE>
- ------------------------
* All amounts for all periods have been restated to include the consolidated
results of operations of Conduit Parent.
33
<PAGE>
EXHIBIT 23.1
CONSENT AND REPORT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in this Annual Report (Form
10-K) of ProBusiness Services, Inc. of our report dated July 29, 1999 included
in the 1999 Annual Report to Stockholders of ProBusiness Services, Inc.
Our audits also included the consolidated financial statement schedule of
ProBusiness Services, Inc. listed in Item 14(a). This schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion based on our audits. In our opinion, the consolidated financial
statement schedule referred to above, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
/s/ Ernst & Young LLP
Walnut Creek, California
September 24, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
PROBUSINESS SERVICES, INC. FORM 10-K FOR THE YEAR ENDED JUNE 30, 1999 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> JUN-30-1999
<CASH> 73,575
<SECURITIES> 0
<RECEIVABLES> 5,415
<ALLOWANCES> 816
<INVENTORY> 0
<CURRENT-ASSETS> 662,403
<PP&E> 44,177
<DEPRECIATION> 13,153
<TOTAL-ASSETS> 710,424
<CURRENT-LIABILITIES> 610,346
<BONDS> 0
0
0
<COMMON> 23
<OTHER-SE> 99,507
<TOTAL-LIABILITY-AND-EQUITY> 710,424
<SALES> 0
<TOTAL-REVENUES> 70,145
<CGS> 0
<TOTAL-COSTS> 34,509
<OTHER-EXPENSES> 54,029
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 685
<INCOME-PRETAX> (16,109)
<INCOME-TAX> 0
<INCOME-CONTINUING> (16,109)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (16,109)
<EPS-BASIC> (.77)
<EPS-DILUTED> (.77)
</TABLE>
