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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ___________
Commission file number: 000-22327
PSW TECHNOLOGIES, INC.
(Exact name of Registrant as specified in its charter)
Delaware 74-2796054
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6300 Bridgepoint Parkway, Building 3, Suite 200, Austin Texas 78730 (Address of
principal executive offices) (Zip code)
(512) 343-6666
(Registrant's telephone number including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Securities Exchanges on which Registered
None. None.
Securities registered pursuant to section 12(g) of the Act:
Common Stock, $.01 par value
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 ____
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |_|
The aggregate market value of the voting stock held by non-affiliates
of the Registrant, based upon the closing sale price of Common Stock on March 2,
1998 as reported on the Nasdaq National Market, was approximately $28 million.
As of March 2, 1998, the Registrant had outstanding 8,987,874 shares
Common Stock.
Documents Incorporated By Reference
Portions of the Proxy Statement for Registrant's 1998 Annual Meeting
of Stockholders are incorporated by reference into Part III of this Form 10-K.
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PART I
Item 1. Business
This Business section and other parts of this Form 10-K contain
forward-looking statements that involve risk and uncertainties including
statements regarding customer and industry concentration. The Company's actual
results may differ significantly from the results discussed in the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, those discussed below and in "Management's Discussion
and Analysis of Operations" in Item 7 of this Form 10-K.
PSW Technologies, Inc. ("PSW" or the "Company") provides systems
integration and software development services to information technology ("IT")
vendors and IT users. IT vendors primarily consist of software companies who
utilize the Company's services to help bring their products to market faster. IT
users generally utilize the Company's services to help define, develop and
complete high value, mission critical enterprise software systems for internal
use. Services are typically provided on a project or mission basis. In
project-based engagements, PSW is retained to complete a specifically defined
set of tasks, such as porting a specific version of client software to a new
release of an operating system. In mission-based engagements, PSW is retained to
manage, on an ongoing basis, a specific mission within the client organization,
such as responsibility for all testing functions for a client organization.
Mission engagements involve multiple projects and releases which generally come
up for renewal on an annual or other periodic basis.
The Company is flexible in structuring the terms of its client
engagements, often using a time-and-materials pricing model with set project
milestones, but employing a fixed-price model per phase in certain
circumstances. The Company works in partnership with its clients at the client
site or at PSW's facilities, as appropriate. This flexible, joint development
approach, together with the Company's utilization of proprietary methodologies,
is designed to reduce risks to PSW and its clients, maximize client satisfaction
and allow PSW to transfer expertise to its clients.
The Company was founded in 1989 as a separate division of Pencom
Systems Incorporated, ("Pencom"), a privately held corporation, to take
advantage of the large numbers of subcontractors placed by Pencom with IBM's AIX
organization in Austin, Texas. PSW was incorporated in Delaware in August 1996.
In October 1996, Pencom contributed certain assets and associated liabilities of
its software division and a portion of a software contract that had previously
been allocated to other operations of Pencom to the Company in exchange for all
of the outstanding Common Stock of the Company and certain warrants issued to
Pencom and certain of its employees to purchase shares of Common Stock of the
Company. The Company completed an initial public offering of 3,277,500 shares of
Common Stock in June and July of 1997 in which the Company received $25.7
million in net proceeds. The Company maintains its principal executive offices
at 6300 Bridgepoint Parkway, Building 3, Suite 200, Austin, Texas 78730, and its
telephone number at such location is (512) 343-6666.
Industry Background
The growing worldwide demand for IT services has been driven by the
increasing reliance on IT as a strategic tool for addressing critical business
issues. Deregulation, globalization and technological innovation are
accelerating the rate of change in business, resulting in a more complex and
intensely competitive business environment. Organizations face constant
pressures to improve the quality of products and services, reduce cost and time
to market, improve operating efficiencies and strengthen customer relationships.
These pressures are increasingly causing business managers to utilize IT to
integrate and streamline business processes with customers and suppliers thereby
decreasing response time, lowering costs and improving information flow. These
trends, together with rapid advances in technology, are primarily driving the
move from traditional host-based legacy computing systems to more flexible and
functional technologies, including the Internet, Web based user interfaces,
client/server architectures, object-oriented programming languages and tools,
distributed database management systems and the latest networking and
communications technologies.
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In order to compete in this business environment, IT departments of
Fortune 1000 companies often must deploy custom designed software applications
composed of multiple operating systems, databases, programming languages and
networking protocols throughout the enterprise. At the same time, competitive
conditions and cost pressures are increasingly forcing such companies to focus
on core competencies and reduce or limit the growth of their IT workforce.
In addition to the increasing demand for more responsive technologies
to address these business challenges, technology as a whole is becoming more
complex and individual technology life-cycles are shortening at a faster rate.
The foregoing has placed increasing pressure on IT vendors to bring new products
and new versions of proven products to market faster and simultaneously to
ensure that those products operate with an increasing number of platforms and
middleware.
The convergence of these trends is resulting in (i) an increasing
movement of Fortune 1000 companies toward joint projects with software service
firms that have a high level of expertise in critical emerging technologies,
rather than relying on their internal resources for the design and
implementation of enterprise business systems and (ii) an increasing need within
the research and development departments of key vendors of critical emerging
technologies to outsource to software service firms a portion of the
development, porting and testing of their existing and new products.
Accordingly, a growing number of IT users and IT vendors are seeking the help of
software services firms with strong technical expertise in critical emerging
technologies and the ability to implement high value solutions on a prompt and
cost-effective basis.
The PSW Strategy
PSW provides high value solutions to IT vendors and IT users by
mastering and applying critical emerging technologies, including Web based
distributed computing, object-oriented development, advanced operating systems
and systems management technologies. PSW targets companies that are developing
technologies which it believes will be important to, and likely to be widely
deployed by, its current and potential IT user clients. Through these
engagements, PSW often gains an early and comprehensive understanding of
critical emerging technologies and is therefore well positioned to service the
continued needs of these and other IT vendors, as well as the needs of the IT
user community. The Company incorporates the knowledge and expertise derived
from each of its client projects into its proprietary Genova methodologies,
enabling PSW to retain and distribute its institutional knowledge throughout the
Company and to achieve improvements in cost, quality and speed on client
projects.
Services
IT Vendor Clients
The Company provides software research and development services that
enable its IT vendor clients to improve the quality and speed to market of their
products and, PSW believes, to achieve an earlier flow of revenue and increased
revenues over the long term. PSW's services also enable these clients to focus
on their core competencies, limit their permanent headcount and relieve
temporary workload spikes.
The Company's experience with, and knowledge of, IT vendors' products
often leads to significant follow-on work in related projects with these
vendors, other IT vendors and IT users. At the same time, PSW's experience with
IT users allows it to assist its IT vendor clients as they seek to achieve
wide-spread adoption of their technologies and enables PSW to give valuable
feedback to such IT vendors regarding the most appropriate business use for
their respective technologies.
The Company offers the following suite of services to its IT vendor clients:
Development Services
The Company assists clients in the development of products, the addition of new
capabilities to existing products and the development of specialized software
for clients' customers. PSW's experience in computer architecture, system
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performance, operating systems, device drivers and middleware, as well as its
software development methodology, position the Company to enable its clients to
deliver critical software to the marketplace in a timely fashion.
Porting Services
The Company assists clients in the porting of their software products
to other computing platforms. PSW has extensive operating system experience with
Windows NT, Windows 95, Solaris, AIX, HP/UX and NEXTSTEP, as well as with the
compilers and development tools required to port software. The Company performs
the porting, testing and documentation of the client product to the specified
operating environments. The Company utilizes its Genova porting methodology to
efficiently assess the portability of software to Windows NT and other operating
environments, to determine the best approach for completing ports in a timely
manner and for improving future software portability.
Testing Services
The Company assists clients in test planning, test suite development
and test execution. System verification testing involves the design of tests to
ensure that products adhere to the specifications and standards demanded by the
client. Compatibility testing verifies that specific programs and devices work
with new operating system software. Standards compliance testing involves the
development of test suites to verify binary or source code compatibility with
published standards.
Advisory Services
The Company provides advisory services to assess development, porting,
testing or support projects from a technical, process and project management
viewpoint. The Company utilizes its Genova methodology and prior experience to
identify areas of improvement and make recommendations. In addition, assessment
services are often used to allow for the necessary research and evaluation to
develop a more extensive proposal for a client.
Support Services
The Company provides customized technical support for complex systems
to software developers or users. Support is provided on-site, on-line and by
telephone. The Company's services include help desk, defect correction and
critical situation support.
IT User Clients
The Company also develops high value, mission critical enterprise
business systems designed to enable its IT user clients to improve the quality
of the services they provide to their customers through enhanced information
capture and control, increased accuracy and efficiency and decreased costs and
response times. The Company offers services ranging from consulting, to custom
system development, to the development of systems management solutions. The
Company provides enterprise solutions in a wide variety of computing
environments utilizing leading technologies, including Web/Internet, client/
server architectures, object-oriented programming languages and tools,
distributed database management systems and the latest networking and
communications technologies.
The Company focuses on long-term, strategic enterprise solutions due to
their greater value to the client than departmental systems, and the
corresponding potential for longer-term relationships. In addition, enterprise
system projects are typically larger and more technically complex than
departmental system projects, thereby creating a barrier to entry for smaller
services firms and increasing the importance of the breadth and depth of PSW's
technical expertise when competing with other firms regardless of their size.
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The Company offers the following suite of services to its IT user
clients:
Custom Application Development Services
PSW provides services to design, construct and deploy custom enterprise
business systems utilizing Web, Internet, client/server and object oriented
technologies. The Genova Business Systems Development Methodology is used to
define business objectives, gather requirements and perform analysis, and then
design, implement, test and deploy the system. The project team for a typical
engagement consists of PSW personnel and client personnel, with PSW providing
project management and overall technical leadership. Engagement durations
may last several years and involve deployment of multiple versions of the
business system.
Systems Management Implementation Services
The Company provides planning, design and implementation services for
systems management. These services determine the availability, performance,
capacity and servicing requirements of the clients' computing infrastructure and
applications. Then using industry products primarily associated with the Tivoli
Management Environment, PSW offers serivces to design, install, configure and
test a specific system management solution for the client.
Enterprise Consulting Services
The Company offers enterprise consulting services to assist clients
with the assessment, monitoring and management of projects. PSW utilizes its
Genova Assessment Methodology, which involves a seven step process to define the
focus of the assessment, conduct the required research, analyze the findings and
provide specific actions and recommendations to the client. The Genova Business
Systems Development Methodology is also used as a benchmark to determine missing
components or deliverables in the client's project or process. The deliverable
in an enterprise consulting engagement consists of a report identifying a
project's strengths and weaknesses, assessing schedule and resource plans and
recommending specific actions. A summary report is typically presented to the
client's management.
Genova Methodologies
Software development, testing, delivery and deployment is a complex
process. Consequently, PSW employs its Genova methodologies to lower the risk of
project overruns or client dissatisfaction.
The Company believes that successful software projects require a well
designed approach, development process and underlying procedures to organize the
project team to efficiently accomplish numerous interrelated tasks. PSW's Genova
methodologies achieve this by defining the specific deliverables required at
each phase of the development process, the tasks required to develop them,
examples and templates. In addition, because the methodologies provide a common
structure between projects, PSW team members can tap the experience, ideas,
measurements and estimates of other teams who have worked on similar
engagements. Technical staff members can often get the latest information about
technologies being used on the project from PSW professionals who are working on
projects with the IT vendors who develop and support that technology.
Genova methodologies have several common elements that help align
client expectations with the project objectives. All the methodologies consist
of a thorough definition phase where client objectives and user or marketplace
requirements are defined. The definition phase of a project emphasizes
specifications which can be positively verified during the testing phase. Genova
methodologies also emphasize proper up front design prior to implementation to
minimize the risk of design flaws. The implementation phase of each methodology
includes a complete testing plan, one of the frequently underestimated parts of
a project.
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Marketing and Sales
Marketing
Strategic market planning is performed by the executive staff of the
Company, which actively seeks guidance from a number of sources to make
strategic decisions. These sources include PSW clients, senior technical staff
members, sales personnel and numerous executive contacts throughout the
industry. The executive staff meets off-site quarterly to discuss strategic
issues and actions. Action items are identified and tracked between meetings.
Senior technical staff members meet twice a year at the PSW Technology Forum to
share their views and produce a set of strategic actions for themselves and for
the executive staff to pursue business opportunities resulting from changes in
the technology landscape.
The marketing department controls and promotes key corporate messages,
consistent marketing programs and materials and ongoing public relations. This
is accomplished by working in coordination with Company initiatives and through
a program of regular communication of newsworthy items to key press and industry
analysts. Public relations is the primary vehicle used to promote corporate
image through the use of client case studies and placement of technical articles
by senior technical staff.
Service marketing supports the sales process by producing qualified
leads. The Company focuses on implementing a "value chain" that seeks to align
the communication and delivery of the highest value services possible to the
client. This includes marketing, sales, project management, methodologies,
recruiting, training and any other initiatives required to deliver consistent,
high quality service. The marketing emphasis is on communicating the value of
the service to the client and demonstrating PSW's capabilities to deliver the
service effectively.
The Company's marketing programs emphasize relationships with IT
vendors, clients and other key partners to shorten the sales cycle and increase
the productivity of PSW's sales resources. PSW works closely with these
companies during the sales process to present a unified proposal to the client.
At the same time, PSW does not resell hardware or software products of any other
IT vendor, maintaining its independence to recommend the appropriate solution to
each of its clients.
Sales
PSW's sales force consists of Business Development Managers and Senior
Account Managers. Business Development Managers identify appropriate business
opportunities and client needs. Senior members of the technical staff provide
high level technical consulting early in the client relationship to thoroughly
explore the client's needs and to propose solutions. These solutions often
result in PSW projects involving project managers and technical professionals,
in which case a Senior Account Manager will be assigned to oversee the project
and serve as the primary account manager.
Senior Account Managers are experienced professionals in both
relationship management and in understanding the business needs of either IT
vendors or IT users. They are responsible for achieving high client satisfaction
and growing additional business in their assigned accounts. Business Development
Managers are paid a commission based on the gross margin of business they
obtain. Commissions are also structured to incent finding new clients and to
incent the sale of larger engagements. Senior Account Managers are also
commissioned but have a higher base salary and lower commission leverage
than a Business Development Manager.
The sales and marketing organization utilizes a formal proposal
process to identify engagements in which the Company's technical skills and
project management capabilities are well suited to meet the needs of prospective
clients. The proposal process also involves reviews with the client, which
are designed to ensure that the engagement is based upon a jointly developed
proposal. In some cases, the client pays for an assessment to analyze the
project and make a detailed proposal. Time schedules and cost estimates are
prepared by the technical staff. A pricing model is used to determine whether
the engagement will meet or exceed Company margin targets for new business.
Pricing for fixed price projects must be approved by a Senior Vice President.
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PSW serves clients throughout the United States. The Company seeks to
establish sites in those areas that have a high concentration of IT vendors.
Current sites include Austin, Boston, and Seattle. Each site has a site manager
and sales resources to grow the Company's business and base of clients. In
addition, the Company has established a sales office in Chicago, Illinois in
order to focus on IT user opportunities. Once an engagement is started, key
personnel travel or relocate to the project site and new personnel are added by
both local and national recruiting efforts.
Employees
PSW's workforce has grown significantly over the past three years,
increasing from 167 full-time employees at December 31, 1994 to 461 full-time
employees at December 31, 1997. PSW believes that attracting and retaining
superior and innovative technical professionals, project managers and executive
management is a critical element in its ability to deliver high quality services
to its clients. Accordingly, PSW focuses on identifying and recruiting highly
qualified technical professionals at all levels within the Company. In order to
retain these professionals, the Company maintains a culture and implements
numerous programs that emphasize the importance of its employees, including
training, career development and incentive programs.
None of the Company's employees is covered by a collective bargaining
agreement. Substantially all of the Company's employees have executed an
invention assignment and confidentiality agreement. In addition, the Company
requires that all new employees execute such agreements as a condition of
employment by the Company.
Management considers its relations with its employees to be good.
Selection and Recruiting
Prior to October 1995, the Company relied significantly upon the
recruiting services of Pencom for its technical staff hires. Since that time,
the Company has decreased its reliance on Pencom by building its internal
recruiting infrastructure for technical staff hires, with Pencom accounting for
less than 15% and 4% of the Company's hires in 1996 and 1997, respectively.
Currently, the Company is a party to recruiting agency agreements with Pencom
and several other outside recruiting firms.
The Company utilizes dedicated recruiters to support management in
identifying, staffing and building pipelines for the skill types required to
meet the Company's sales efforts. PSW has a comprehensive interview and
evaluation process, which typically includes a full day of technical interviews.
The Company utilizes a sophisticated on-line recruiting system from Resumix to
quickly capture candidate resumes, allow for specific skill searches and manage
the work flow associated with a specific search.
In addition, PSW has established an employee referral program pursuant
to which existing employees receive a cash incentive for each person they refer
who becomes a PSW employee. This referral program has provided the Company with
a cost-effective means of identifying and recruiting high quality employees. In
addition to agencies and employee referals, the Company utilizes advertising,
job fairs and its Website to identify potential employees.
Career Development and Training
The Company has developed a separate Professional Development
department within Human Resources which is designed, among other things, to
ensure that project assignments and training are consistent with each employee's
career aspirations and that each employee receives meaningful quarterly and
annual performance reviews. In addition, the Company's "technical career ladder"
enables highly qualified technical professionals to reach the level of
Architect, a position which entails substantial professional authority. Finally,
the Company typically offers redeployment and/or relocation to employees upon
business changes, such as the expiration of an engagement.
The Company has developed strong internal training programs for its
technical employees, including its Windows NT certification program for
technical professionals working with the Windows NT operating environment, and
the Genova Business Systems Development Academy coursework, which trains
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employees in object-oriented business systems development using the Genova
methodology. In addition, the Company offers several management training
programs to its senior employees, including Communications & Leadership,
Overview of Management, Interviewing Effectively and Legally, Performance
Reviews, and Progressive Discipline and Termination. Finally, PSW conducts
semi-annual Technology Forums and Business Forums to increase communications and
sharing among both business units and across all locations and disciplines
within the Company.
Incentives
The Company implements a number of compensation and other incentive
programs designed to promote employee retention. Technical professionals are
compensated in accordance with the Company's merit pay program, which is based
on competitive salary ranges and is designed to reward employees based on their
individual job level and their performance in that job level. In addition, the
Company implements a "battle pay" program to compensate employees for extended
on-site work away from home. The Company also issues Common Stock options to all
PSW employees, with senior management and technical personnel receiving options
at levels intended to build a significant and long-term commitment to the
Company. Finally, the Company provides a competitive and comprehensive benefits
program which includes health care, escalating vacation time and life insurance.
Executives and other key employees participate in an annual bonus program. Other
employees receive discretionary bonuses upon recommendation and approval by
management.
Competition
The markets for the Company's services are highly competitive. The
Company believes that it currently competes principally with consulting and
software integration firms and the professional service organizations of certain
hardware and application software vendors. In addition, there are a number of
systems integrators who serve similar markets or provide similar services with
whom the Company competes or may compete in the future. Many of these companies
have significantly greater financial, technical and marketing resources than the
Company, generate greater revenues and have greater name recognition than the
Company. There are relatively low barriers to entry into the Company's markets
and the Company has faced and expects to continue to face additional competition
from new entrants into its markets.
The Company believes that the principal competitive factors in its
markets include reputation, project management expertise, industry expertise,
speed of development and implementation, technical expertise and ability to
deliver on a fixed-price as well as a time and materials basis. The Company
believes that its ability to compete also depends in part on a number of
competitive factors outside its control, including the ability of its clients or
competitors to hire, retain and motivate project managers and other senior
technical staff; the ownership by competitors of software used by potential
clients; the development by others of products and services that are competitive
with the Company's services; the price at which others offer comparable
services; the ability of its clients to perform the services themselves; and the
extent of its competitors' responsiveness to client needs. There can be no
assurance that the Company will be able to compete effectively on pricing or
other requirements with current and future competitors or that competitive
pressures faced by the Company will not cause the Company's revenue or income to
decline or otherwise materially adversely affect its business, financial
condition and results of operations. The Company has entered into employment
agreements with each of its executive officers. These agreements contain
provisions which, among others, prohibit the employee from disclosing or
otherwise using certain confidential information, assign to the Company
inventions or ideas conceived by the employee during his employment, prohibit
solicitation by the employee of clients and other employees of the Company and
prohibit the employee from accepting any opportunity (whether by contract or
full-time employment) with the Company's clients. Furthermore, the Company's
employment agreement with Dr. W. Frank King, the Company's President and Chief
Executive Officer, contains provisions, which for a period of two years,
restrict Dr. King's ability to provide services to, or solicit the business of,
the Company's clients and prospective clients. There can be no assurance that
any of the foregoing measures will prevent a former employee of the Company from
enhancing the prospects of one of the Company's competitors.
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Customers
The Company has derived a significant portion of its revenue from a
limited number of large clients. The Company's five largest clients in each of
1994, 1995, 1996 and 1997, accounted for approximately 77%, 88%, 82% and 63%,
respectively, of its revenues in each such period. The Company's largest client,
International Business Machines Corp., together with its subsidiaries
(collectively, "IBM"), accounted for approximately 52% and 39% of its revenue in
1996 and 1997, respectively. The Company expects a decline in the level of IBM
business in 1998 due to the completion of several projects for IBM nd the growth
in non-IBM business. The volume of work performed for specific clients is likely
to vary from year to year, and a major client in one year may not use the
Company's services in a subsequent year. The loss of, or reduction in PSW
services required by, any large client could have a material adverse effect
on the Company's business, financial condition and results of operations.
Most of the Company's contracts are terminable by the client following
limited notice and without penalty to the client. Further, the level of
investment by the Company's clients in IT projects can be adversely affected by
a number of factors, including changes or developments in the general technology
landscape and the internal budget cycles of such clients. The cancellation of a
large project or a significant reduction in the scope of any such project could
have a material adverse effect on the Company's business, financial condition
and results of operations, and in the past the cancellation of large projects
has adversely impacted the Company's earnings.
Intellectual Property Rights
The Company's future success is dependent in part upon the maintenance
and protection of its intellectual property rights and, to a lesser extent, upon
its ability to license technology from its clients. The Company relies on a
combination of copyrights, trade secrets and trademarks to protect its
intellectual property. There can be no assurance that the steps taken by the
Company to protect its intellectual property rights will be adequate, that
competitors will not be able to develop similar or functionally equivalent
methodologies or products or that the Company will be able to license technology
from its clients in the future. Furthermore, effective copyright and trade
secret protection may be unavailable or limited in certain foreign countries,
and no assurance can be given that foreign copyright and trade secret laws will
adequately protect the Company's intellectual property rights. Litigation may be
necessary to enforce the Company's intellectual property rights, to protect the
Company's trade secrets, to determine the validity and scope of the intellectual
property rights of others, including the Company's clients, or to defend against
claims of infringement. Such litigation could result in substantial costs and
diversion of resources and could have a material adverse effect on the Company's
business, financial condition and results of operations. No assurance can be
given that infringement or invalidity claims (or claims for indemnification
resulting from infringement claims against third parties, such as clients) will
not be asserted against the Company or that any such assertions would not have a
material adverse effect on the Company's business, financial condition or
results of operations. If infringement or invalidity claims are asserted against
the Company or any of its licensees, litigation may be necessary to defend the
Company or such licensees against such claims, and in certain circumstances the
Company may choose to seek to obtain a license under the third party's
intellectual property rights. There can be no assurance that such licenses will
be available on terms acceptable to the Company, if at all.
Additional Factors That Affect Future Results
In addition to the other information in this Form 10-K, the following
factors should be considered in evaluating the Company and its business.
Industry Concentration; Dependence on Large Projects. The Company has
derived and believes it will continue to derive a significant portion of its
revenue from the technology vendor industry. As a result, the Company's
business, financial condition and results of operations are influenced by
economic and other conditions affecting such industry, such as economic
downturns which could lead to a reduction in spending on IT projects, which in
turn could lead to fewer new research and development outsourcing projects being
undertaken. Further, several of the Company's client contracts limit its ability
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to provide services to competitors of such clients, thereby restricting the
field of potential future clients. In addition, as a result of the dynamic
nature of the IT vendor industry, the Company may lose clients due to the
acquisition, merger or consolidation of existing clients with entities which are
not current clients of the Company. The occurrence of any of the foregoing could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Fixed-Price Contracts and Other Project Risks. During 1996 and 1997,
approximately 12% and 20%, respectively, of the Company's revenue was generated
on a fixed price, fixed-delivery-schedule ("fixed price") basis, rather than on
a time-and-materials basis. The Company's failure to accurately estimate the
resources required for a fixed price project or its failure to complete its
contractual obligations in a timely manner consistent with the project plan upon
which its fixed price contract is based could have a material adverse effect on
the Company's business, financial condition and results of operations. In the
past, the Company has found it necessary to revise project plans after
commencement of the project and commit unanticipated additional resources to
complete certain projects, which have negatively affected the profitability of
such projects. The Company may experience similar situations in the future,
which could have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, the Company may establish
contract prices before the project design specifications are finalized, which
could result in a fixed price that proves to be too low and therefore adversely
affects the Company's business, financial condition and results of operations.
Many of the Company's engagements involve projects which are critical
to the operations of its clients' businesses and which provide benefits that may
be difficult to quantify. The Company's failure to meet a client's expectations
in the performance of its services could damage the Company's reputation and
adversely affect its ability to attract new business, and may have a material
adverse effect upon its business, financial condition and results of operations.
The Company has undertaken, and may in the future undertake, projects in which
the Company guarantees performance based upon defined operating specifications
or guaranteed delivery dates. Unsatisfactory performance or unanticipated
difficulties or delays in completing such projects may result in client
dissatisfaction and a reduction in payment to, or payment of damages by, PSW,
any of which could have a material adverse effect on the Company's business,
financial condition and results of operations. There can be no assurance that
the Company will be able to limit its liability to clients, including liability
arising from the Company's failure to meet clients' expectations in the
performance of services, through contractual provisions, insurance or otherwise.
Management of Growth. The Company's growth has placed significant
demands on its management and other resources. For example, the Company's staff
increased from 167 full-time employees at December 31, 1994 to 461 full-time
employees at December 31, 1997. The Company's ability to manage its growth
effectively will require it to continue to develop and improve its operational,
financial and other internal systems, as well as its business development
capabilities, and to continue to attract, train, retain, motivate and manage its
employees. In addition, the Company's future success will depend in large part
on its ability to continue to maintain high rates of employee utilization, set
fixed price fees accurately, maintain project quality and meet delivery dates,
all as the Company seeks to increase the number of projects in which it is
engaged. If the Company is unable to manage its growth and projects effectively,
such inability would have a material adverse effect on the quality of the
Company's services, its ability to retain key personnel and its business,
financial condition and results of operations. No assurance can be given that
the Company's growth will continue to be achieved, or if achieved, will be
maintained or that the Company will be successful in managing any such growth.
Recent Organization; Absence of Operating History as an Independent
Business; Limited Relevance of Historical Financial Information. Prior to
October 1996, the Company conducted its business and operations as the software
division of Pencom. Accordingly, the Company has only a limited independent
operating history upon which an evaluation of the Company and its prospects can
be based. Prior to October 1996, the Company also had limited accounting
capability and depended upon Pencom for most accounting functions. By October 1,
1996, the Company had assumed responsibility for most internal accounting
functions, but continued to depend upon Pencom for limited accounting support in
connection with the Company's 1996 year-end audit. There can be no assurance
that the Company will be successful in taking control of these functions from
Pencom. The Company has also relied upon, and will continue to rely upon, Pencom
10
<PAGE>
for certain legal services and recruiting functions. The Company's management
has only limited experience operating the Company as a stand-alone company,
separate and apart from Pencom. Pencom has no obligation to provide financial or
management assistance to the Company and has no plans to do so. The inability of
the Company to operate successfully as an entity independent from Pencom would
have a material adverse effect on the Company's business, financial condition
and results of operations.
The information presented for 1996 and prior periods herein reflects
the financial position, results of operations and cash flows of the Company
and its predecessor, the software division of Pencom, and such information does
not necessarily reflect what the financial position, results of operations and
cash flows of the Company would have been had the Company been operated as
a separate, stand-alone business for the periods presented prior to October 1,
1996.
Variability of Quarterly Operating Results. The Company's revenue and
operating results may fluctuate from quarter to quarter based on a number of
factors, including the number, size and scope of projects in which the Company
is engaged, the contractual terms and degree of completion of such projects, any
delays incurred in connection with a project, the Company's success in earning
bonuses or other contingent payments, employee hiring and utilization rates, the
adequacy of provisions for losses, the accuracy of estimates of resources
required to complete ongoing projects and general economic conditions. Other
factors may affect operating results includes customer budget cycles and
customer spending priorities such as the Year 2000 issue. A high percentage of
the Company's operating expenses, particularly personnel and rent, are fixed in
advance of any particular quarter. For example, while the number of professional
staff the Company employs may be adjusted to reflect active projects, such
adjustments take time and the Company must maintain a sufficient number of
senior professionals to oversee existing client engagements and to focus on
securing new client engagements. As a result, unanticipated variations in the
number or progress toward completion of the Company's projects or in employee
utilization rates may cause significant variations in operating results in any
particular quarter and could result in adverse changes to the Company's
business, financial condition and results of operations. In the first quarter
of 1998, revenues may be adversely impacted by the Company's lenghy sales cycle,
among other matters, which may cause the Company's revenues and earnings to be
below the expectations of securitites analysts. Any shortfall in revenue or
earnings from expected levels or other failures to meet expectations of
securities analysts or the market in general regarding results of operations
could have an immediate and material adverse effect on the market price of the
Company's Common Stock. Given the possibility of such quarterly fluctuations in
revenue or earnings, the Company believes that comparisons of its quarterly
results of operations are not necessarily meaningful and that such results for
one quarter should not be relied upon as an indication of future performance.
Need to Attract and Retain Professional Staff. The Company's success
will depend in large part upon its ability to attract, train, retain, motivate
and manage highly skilled employees, particularly project managers and other
senior technical personnel. Significant competition exists for employees with
the skills required to perform the services offered by the Company, and the
Company requires that a significant number of such employees travel to client
sites to perform services on its behalf, which may make a position with the
Company less attractive to potential employees. Qualified project managers,
software architects and senior technical and professional staff are in great
demand worldwide and are likely to remain a limited resource for the foreseeable
future. Furthermore, there is a high rate of attrition among such personnel.
There can be no assurance that a sufficient number of highly skilled employees
will continue to be available to the Company, that potential employees will be
willing to travel to client sites, or that the Company will be successful in
training, retaining and motivating current or future employees. The Company's
inability to attract, train and retain skilled employees or the Company's
employees' inability to achieve expected levels of performance could impair the
Company's ability to adequately manage and staff its existing projects and to
bid for or obtain new projects, which in turn would have a material adverse
effect on the Company's business, financial condition and results of operations.
Rapid Technological Advances; Risk of Targeting Emerging Technologies. The
Company has derived, and will continue to derive, a substantial portion of its
revenue from projects based on client/server systems.The client/server systems
market is continuing to develop and is subject to rapid technological change.
The Company's future success will also depend in part on its ability to develop
11
<PAGE>
IT solutions which keep pace with continuing changes in information processing
technology, evolving industry standards and changing client preferences. There
can be no assurance that the Company will be successful in addressing these
developments in a timely manner or that, if addressed, the Company will be
successful in the marketplace. The Company's delay or failure to address these
developments could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, there can be no
assurance that products or technologies developed, or services offered, by third
parties will not render the Company's services noncompetitive or obsolete. The
Company's Software Technology Unit also seeks to identify emerging technologies
which it believes will develop into critical technologies with broad application
and longevity. Once identified, the Company may commit substantial resources to
provide services to the developers of such technologies. No assurance can be
given that the technologies identified by the Company will develop into critical
technologies with broad application and longevity. The failure of the Company to
align itself with such critical emerging technologies would have a material
adverse affect on its business, financial condition and results of operations.
Dependence on Key Personnel. The Company's future success will depend
in part upon the continued services of a number of key management employees,
particularly Dr. W. Frank King, Patrick D. Motola, Brian E. Baisley, Dennis P.
Thompson and William C. Cason, and a number of key technical employees. The loss
of the services of any of the Company's key personnel could have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, the Company's credit facility prohibits material
changes in management. The Company does not maintain key-person life insurance
on any of its employees. In addition, if one or more of the Company's key
employees resigns from the Company to join a competitor or to form a competing
company, 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
such personnel, there can be no assurance that the Company would be able to
prevent the unauthorized disclosure or use of its technical knowledge, practices
or procedures by such personnel.
System Interruption and Security Risks. The Company's operations are
dependent on its ability to protect its intranet from interruption by damage
from telecommunications failure, fire, earthquake, power loss, unauthorized
entry or other events beyond the Company's control. Most of the Company's
computer equipment, including its processing equipment, is currently located at
a single site. There can be no assurance that unanticipated problems will not
cause any significant system outage or data loss. Despite the implementation of
security measures, the Company's infrastructure may also be vulnerable to
computer viruses, hackers or similar disruptive problems caused by Internet
users. Persistent problems continue to affect public and private data networks.
For example, it is common for Internet service providers to experience system
interruptions which cause the Company to lose access to the Internet, the means
by which the Company posts internal information and provides e-mail and time
sheet query and entry. Any damage or failure that causes interruptions in the
Company's operations could have a material adverse effect on the Company's
business, financial condition or results of operations.
Potential Volatility of Stock Price. The market for securities of
early-stage companies has been highly volatile in recent years as a result of
factors often unrelated to a company's operations. In addition, the Company
believes factors such as quarterly variations in operating results,
announcements of technological innovations or new products or services by the
Company or its competitors, general conditions in the IT industry or the
industries in which PSW's clients compete and changes in earnings estimates by
securities analysts, could contribute to the volatility of the price of the
Company's Common Stock. These factors, as well as general economic conditions
such as recessions or changes in interest rates, could adversely affect the
market price of the Company's Common Stock. Furthermore, in the past, following
periods of volatility in the market price of a company's securities, securities
class action claims have been brought against the issuing company. There can be
no assurance that such litigation will not occur in the future with respect to
the Company. Such litigation could result in substantial costs and a diversion
of management's attention and resources, and any adverse determination in such
litigation could also subject the Company to significant liabilities, all of
which could have a material adverse effect on the Company's business, financial
condition and results of operations.
12
<PAGE>
Effect of Certain Antitakeover Provisions. The Company's Board of
Directors has the authority to issue shares of Preferred Stock and to determine
the designations, preferences and rights and the qualifications or restrictions
of those shares without any further vote or action by the stockholders. The
rights of the holders of Common Stock will be subject to, and may be adversely
affected by, the rights of the holders of any Preferred Stock that may be issued
in the future. The issuance of Preferred Stock could have the effect of making
it more difficult for a third party to acquire a majority of the outstanding
voting stock of the Company. In addition, the Company is subject to the
antitakeover provisions of Section 203 of the Delaware General Corporation Law
(the "DGCL"). In general, this statute prohibits a publicly held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person became an interested stockholder, unless the business
combination is approved in a prescribed manner. Furthermore, certain other
provisions of the Company's Amended and Restated Certificate of Incorporation
and Amended and Restated Bylaws may have the effect of discouraging, delaying or
preventing a merger, tender offer or proxy contest, which could adversely affect
the market price of the Company's Common Stock.
13
<PAGE>
Item 2. Properties
The Company's executive offices and primary facility are located in
Austin, Texas, in a leased facility of 36,319 square feet. The lease for the
Austin facility includes an additional 11,072 square feet of space in an
adjoining building which the Company assumed in February 1998. This lease
expires on December 31, 2003 with respect to both premises and is renewable at
the option of the Company for an additional five-year term. The Company also has
a right of first refusal on additional space in such facilities exercisable
during the primary term of the lease. The Austin facility is located in the high
tech center of Austin near other leading technology firms, and includes
sophisticated laboratory, network and server facilities to support PSW's
operations and project work on a variety of computing platforms.
PSW has 8,957 square feet of additional office space in Bellevue,
Washington, strategically located near Microsoft and the IBM Kirkland
Programming Center. This facility primarily provides office and laboratory space
for the Company's Windows NT porting center, and also supports sales. PSW also
has space in Jersey City, New Jersey, Boston, Massachusetts and Chicago,
Illinois.
PSW employees are also located at client sites throughout the United
States, including Chicago, Raleigh, Atlanta, Costa Mesa, Dallas and Stamford.
Additional office expansion is anticipated in 1998. The Company believes that
its existing facilities are adequate to meet its current needs and that suitable
additional or alternative space will be available in the future on commercially
reasonable terms, if and as needed.
Item 3. Legal Proceedings
None.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted during the fourth quarter of the fiscal year
covered by this report to a vote of security holders, through the solicitation
of proxies or otherwise.
14
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's Common Stock has traded on the Nasdaq National Market
under the symbol "PSWT" since its initial public offering on June 5, 1997. Prior
to the initial public offering, there had been no public market for the Common
Stock. The following table lists the high and low sales by quarter subsequent to
the initial public offering:
High Low
Fourth quarter of 1997 $19.63 $10.31
Third quarter of 1997 $15.63 $11.38
As of March 2, 1998, there were 8,987,874 shares of the Company's
Common Stock outstanding held by 53 stockholders of record. The Company paid a
cash dividend to its stockholders of record immediately prior to the completion
of the initial public offering in an amount estimated to approximate the 1997
income tax that such stockholders are required to pay on the 1997 taxable income
allocated to them as a result of the Company's prior S Corporation status. The
Company currently intends to retain any earnings for the operations and
expansion of the Company's business and does not anticipate paying any cash
dividends in the foreseeable future. Future dividends, if any, will be
determined by the Company's Board of Directors and will depend upon the
Company's earnings, financial condition, cash requirements, future prospects,
contractual restrictions and other factors deemed relevant by the Board of
Directors.
Use of Proceeds From Registered Securities
On June 5, 1997 (the "Effective Date"), the Company's Registration
Statement on Form S-1 (Registration No. 333-21565) relating to its initial
public offering (the "IPO") was declared effective by the Securities and
Exchange Commission and the offering of up to 3,277,500 shares of the Company's
Common Stock covered by such Registration Statement commenced. The IPO, which
has been completed, was managed by Alex, Brown & Sons Incorporated and J.P.
Morgan & Co., as the representatives of the several underwriters (the
"Underwriters") of the IPO. All of the securities registered were sold for the
account of the Company at an aggregate offering price of $29.5 million. Of the
shares of Common Stock sold by the Company, 2,850,000 shares were sold on June
5, 1997, and 427,500 shares (which were subject to an overallotment option
granted by the Company to the Underwriters) were sold on July 2, 1997.
In connection with the IPO, total expenses of approximately $3.8
million were incurred by the Company, which expenses consisted of: (i) $2.1
million representing underwriting discounts and commissions paid to the
Underwriters; and (ii) other offering expenses, including without limitation,
attorney's fees, accountants' fees, printing costs and filing fees of
approximately $1.7 million. Of the other offering expenses, $101,000 were direct
or indirect payments to directors or officers of the Company or their associates
or to persons owning ten percent (10%) or more of any class of equity securities
of the Company or to affiliates of the Company. The net offering proceeds of
such shares, after deducting such total expenses, was approximately $25.7
million, of which $3.0 million was used to repay indebtedness of the Company,
$654,000 was used to satisfy certain federal income tax obligations of the
Company, $1.4 million was used to pay a dividend to the Company's stockholders
of record just prior to the IPO in respect of the estimated tax that such
stockholders are required to pay on the estimated 1997 taxable income allocated
to them, and the remaining $20.7 million was invested in short-term, interest
bearing accounts pending application of such proceeds by the Company. Other than
the amounts paid as a dividend to the stockholders of record just prior to the
IPO, no other net proceeds were paid directly or indirectly to any directors or
officers of the Company or their associates or to persons owning ten percent
(10%) or more of any class of equity securities of the Company or to affiliates
of the Company.
15
<PAGE>
Item 6. Selected Financial Data
PSW commenced operations as a corporation effective October 1, 1996.
Prior to that date, the Company conducted its business and operations as the
software division of Pencom. The selected financial data presented below have
been derived from the audited financial statements of the Company and its
predecessor and include the portion of a software contract that had previously
been allocated to Pencom. The statements of income data for the years ended
December 31, 1995, 1996 and 1997 and the balance sheet data as of December 31,
1996 and 1997 are derived from financial statements, appearing herein. The
statements of income data for the years ended December 31, 1993 and 1994 and the
balance sheet data as of December 31, 1993, 1994 and 1995 are derived from
audited financial statements not included herein. The information presented
below reflects the financial condition and results of operations of the Company
and its predecessor, and does not necessarily reflect what the financial
position and results of operations of the Company would have been had the
Company been operated as a separate, stand-alone company for the periods
presented prior to October 1, 1996, nor is it necessarily indicative of future
results. The following should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the financial statements and notes thereto appearing elsewhere in this Form
10-K.
<TABLE>
<CAPTION>
Year ended December 31,
1993 1994 1995 1996 1997
-------- -------- -------- -------- --------
(in thousands, except per share data)
<S> ...................................................................... <C> <C> <C> <C> <C>
Statements of Income Data:
Revenue .................................................................. $ 8,725 $ 12,318 $ 21,147 $ 31,274 $ 44,118
Operating expenses:
Technical staff ....................................................... 6,167 7,385 11,193 16,444 22,479
Selling and administrative staff ...................................... 1,873 2,320 3,755 5,622 8,405
Other expenses ........................................................ 1,899 2,317 3,976 5,684 7,979
Special compensation expense(1) ....................................... -- -- -- 2,193 268
-------- -------- -------- -------- -------
Total operating expenses ........................................... 9,939 12,022 18,924 29,943 39,131
-------- -------- -------- -------- -------
Income (loss) from operations ............................................ (1,214) 296 2,223 1,331 4,987
Interest income (expense), net ........................................... (329) (74) (84) (170) 431
-------- -------- -------- -------- -------
Income (loss) before provision
for income taxes ....................................................... (1,543) 222 2,139 1,161 5,418
-------- -------- -------- -------- -------
Provision for income taxes:
Nonrecurring charge for termi-
nation of Subchapter S election ...................................... -- -- -- -- 1,200
C Corporation taxes................................................... -- -- -- -- 1,000
-------- -------- -------- -------- -------
Net income (loss) ........................................................ $ (1,543) $ 222 $ 2,139 $ 1,161 $ 3,218
======== ======== ======== ======== =======
Unaudited pro forma information:
Historical income (loss) before
provision for income taxes .......................................... $ (1,543) $ 222 $ 2,139 $ 1,161 $ 5,418
Pro forma provision (benefit)
for income taxes(2) ................................................. (586) 84 813 441 1,900
======== ======== ======== ======== =======
Pro forma net income (loss) .............................................. $ (957) $ 138 $ 1,326 $ 720 $ 3,518
======== ======== ======== ======== =======
Pro forma diluted earnings
(loss) per share(3) ................................................. $ (0.14) $ 0.02 $ 0.20 $ 0.11 $ 0.41
======== ======== ======== ======== =======
Shares used in pro forma diluted
earnings (loss) per share
calculation(3) ........................................................ 6,635 6,635 6,635 6,689 8,517
======== ======== ======== ======== =======
</TABLE>
16
<PAGE>
Item 6. Selected Financial Data (continued)
<TABLE>
<CAPTION>
December 31,
1993 1994 1995 1996 1997
------- ------- ------- ------- -------
(in thousands)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Working capital ........................................................... $ 1,526 $ 1,933 $ 2,756 $ 1,648 $28,074
Total assets .............................................................. 2,533 3,538 4,982 11,943 35,420
Total stockholders' equity ................................................ 2,302 2,675 3,684 3,444 31,859
</TABLE>
(1) See Note 13 of Notes to Financial Statements for an explanation of special
compensation expense.
(2) Computed on the basis described in Notes 2 and 12 of Notes to Financial
Statements.
(3) Computed on the basis described in Note 2 of Notes to Financial Statements.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The discussion and analysis below contains forward-looking statements
that involve risks and uncertainties. These forward-looking statements and other
statements made elsewhere in this document are made in reliance upon safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. The section
below entitled "Certain Factors That May Affect Future Results, Financial
Condition and Market Price of Securities" sets forth and incorporates by
reference certain factors that could cause actual future results of the Company
to differ materially from those statements.
Overview
PSW Technologies, Inc. is a software services firm that provides high
value solutions to IT vendors and IT users by mastering and applying critical
emerging technologies. These critical technologies include Web/Internet
distributed computing, object-oriented development, advanced operating systems
and systems management technologies. IT vendors primarily consist of software
companies that utilize the Company's services to help bring their products to
market faster. IT users generally utilize the Company's services to help
define, develop and complete high value, mission critical enterprise software
systems for internal use.
The Company was founded as a separate division of Pencom in 1989 to
take advantage of the large number of subcontractors placed by Pencom with IBM's
AIX organization in Austin, Texas. As these subcontractors completed their
assignments, the most talented were recruited to become part of the permanent
technical staff of the Company. The Company's mission was to seek
project-oriented assignments to complement Pencom's existing recruiting and
staff supplementation business.
Dr. W. Frank King was hired in 1992 as the President of the Company to
continue its growth, establish profitability and develop the infrastructure that
would eventually enable it to operate as a separate company. In addition, in
1993, Dr. King focused resources to provide application development services to
address the needs of IT users. The Company established a formal sales function
in 1994, and began the Genova initiative with an emphasis on the business
development methodology. The Company first became profitable in 1994. In 1995,
the Company initiated its own recruiting function independent of Pencom.
In 1996, the Company formalized the Genova initiative, completed the
licensing of the Genova Object Libraries and established the Genova Academy
training. On October 1, 1996, the Company was formed as PSW Technologies, Inc.,
at which time the Company assumed responsibility for its own accounting and
finance operations but continued to depend upon Pencom for limited accounting
support in connection with the Company's year-end audit.
The Company completed an initial public offering of its Common Stock in
1997. Including the underwriters exercise of their over-allotment option, the
Company sold 3,277,500 shares of its Common Stock and raised $25.7 million in
17
<PAGE>
net proceeds from the offering. In 1997, the Company completed business systems
projects for major IT users including U.S. Bancorp, MCC Behavior Care/ Cigna
Health Care Systems and a multi-year engagement with Canon Computer Systems,
Inc. Major IT vendor projects completed during 1997 included projects for
Novell, Inc., Cadence Design Systems, Inc. and Tivoli Systems. The Company was
also named a Lotus Notes Qualified Business partner and a member of Tivoli's
10/Plus Association Business Partner in 1997.
To date, revenue has been generated principally from time-and-materials
contracts for the Company's software services. Revenue from time-and-materials
contracts is recognized during the period in which the services are provided.
The Company also enters into fixed price contracts for its software services.
Revenue from fixed price contracts is recognized using the
percentage-of-completion method over the term of the client contract, measured
by the labor incurred as a percentage of the estimated total labor used at
completion. Fixed price contract revenue represented approximately 12% and 20%
of the Company's revenue in 1996 and 1997, respectively. The cumulative impact
of revisions in percentage of completion estimates is reflected in the period in
which the revisions are made. Provisions for estimated losses on uncompleted
contracts are made on a contract-by-contract basis and are recognized in the
period in which such losses are determined. There can be no assurance of the
accuracy of the Company's future work completion estimates, and operating
results may be adversely affected by inaccurate estimates of contract related
labor.
The Company has derived a significant portion of its revenue from a
limited number of large clients. One client, IBM, accounted for 52% and 39% of
revenue in 1996 and 1997, respectively. The Company expects a decline in the
level of IBM business in 1998. The Company's relationship with IBM includes
engagements with IBM Kirkland, IBM Austin, Tivoli Systems, Inc. ("Tivoli"),
Lotus Development Corporation ("Lotus") and Transarc. The technologies involved
in these engagements include Windows 95, Windows NT, AIX, system management
software and Lotus Notes workgroup software. None of these individual
engagements accounted for more than 20% of the Company's revenue in 1996 or
1997. The Company believes that future revenue growth and profitability will
principally depend on its ability to further diversify its client base away from
IBM. During 1997, the Company's non-IBM revenue grew approximately 80% compared
to 1996.
The information presented herein reflects the financial position,
results of operations and cash flows of the Company and its predecessor, the
software division of Pencom, and such information does not necessarily reflect
what the financial position, results of operations and cash flows of the Company
would have been had the Company been operated as a separate, stand-alone
business for the periods presented prior to October 1, 1996, nor is it
necessarily indicative of future 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 the
Year 2000, these date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, computer
systems and software used by many companies may need to be updated to comply
with such "Year 2000" requirements. Significant uncertainty exists in the
consulting and software development services industry concerning the potential
effects associated with such compliance. Although all of the services currently
offered by the Company are designed to be Year 2000 compliant, there can be no
assurance that the Company's services will be compatible with third-party
software that may be integrated or used in conjunction with the Company's
services. The Company believes that its internal and financial reporting systems
will be operational through and beyond the year 2000 without significant
additional expense to the Company.
Net Charge Resulting from S Corporation Termination
From commencement through the completion of the Company's initial
public offering on June 5, 1997, the Company had elected to be treated as an S
Corporation under Subchapter S of the Internal Revenue Code of 1986, as amended.
As such, federal income taxes attributable through June 5, 1997 were the
responsibility of the individual stockholders. As a result of the initial public
18
<PAGE>
offering, the Company's Subchapter S status was terminated and the Company
recorded a deferred tax charge against income of approximately $1.2 million for
the cumulative differences between the financial reporting and income tax basis
of certain assets and liabilities existing at that date. Additionally, the
Company was required to change its method of accounting from the cash basis to
the accrual basis for income tax reporting purposes. The Company's stockholders
are obligated to pay the 1997 income taxes related to the period prior to the
completion of the offering. The Company declared and paid a dividend of $1.4
million to the S Corporation stockholders of record immediate prior to the
completion of the offering for the amount estimated to approximate the 1997
income taxes payable by the stockholders. (See Note 12 of Notes to Financial
Statements.)
Special Compensation Expense
Special compensation expense in 1996 consisted of stock-based
compensation in connection with the grants of replacement options to the
Company's employees who participated in the Pencom stock option plan and
compensation related to the cancellation of a note issued by an officer of the
Company to Pencom, which, in the aggregate, totaled $2.2 million. Special
compensation expense in 1997 consisted of stock-based compensation in connection
with grants of replacement options to the Company's employees who participated
in the Pencom stock option plan, which, in the aggregate, totaled $268,000. (See
Notes 9, 12 and 13 of Notes to Financial Statements.)
Pro Forma Income Taxes
Pro forma income taxes reflect the estimated corporate income tax
expense that the Company would have recognized had it not elected S corporation
status prior to the completion of its IPO (see Notes 2 and 12 of Notes to
Financial Statements).
Results of Operations
The following table sets forth the percentage of revenue of certain
items included in the Company's statements of income for the periods indicated:
<TABLE>
<CAPTION>
Year ended December 31,
1995 1996 1997
---- ---- ----
<S> ......................................................................................... <C> <C> <C>
Revenue ..................................................................................... 100% 100% 100%
Operating Expenses:
Technical staff ........................................................................ 53 53 51
Selling and administrative staff ....................................................... 18 18 19
Other expenses ......................................................................... 19 18 18
Special compensation expense ........................................................... -- 7 1
---- ---- ----
Total operating expenses .................................................................... 90 96 89
---- ---- ----
Income from operations ...................................................................... 10 4 11
Interest income (expense), net .............................................................. -- (1) 1
Pro forma provision for income taxes ........................................................ 4 1 4
---- ---- ----
Pro forma net income ........................................................................ 6% 2% 8%
---- ---- ----
</TABLE>
Results of Operations for 1997 Compared with 1996
Revenue
Revenue consists primarily of fees for software services provided.
Revenue was $44.1 million in 1997, an increase of 41% over 1996 revenue of $31.3
million, principally due to increases in the scope and number of client
19
<PAGE>
projects. Revenue attributable to software services rendered to IT vendors was
$27.3 million and $20.4 million in 1997 and 1996, respectively, an increase of
34% in 1997 compared to 1996. Revenue attributable to software services rendered
to IT users was $16.8 million and $10.9 million in 1997 and 1996, respectively,
an increase of 54% in 1997 compared to 1996.
One customer, including its wholly owned subsidiaries, accounted for
52% and 39% of revenue in 1997 and 1996, respectively. The Company expects a
decline in the level of business from this customer in 1998. Another customer
accounted for approximately 14% of total revenue for 1996. No other customer
accounted for more than 10% of revenue in 1997 or 1996.
Technical Staff
Technical staff expenses consist of the cost of salaries, payroll
taxes, health insurance and workers' compensation for technical staff personnel
assigned to client projects and unassigned technical staff personnel, and fees
paid to any subcontractors for work performed in connection with a client
project. Technical staff expenses were $22.5 million in 1997, an increase of 37%
over 1996 technical staff expenses of $16.4 million. The increase in technical
staff expenses was primarily due to the addition of personnel necessary to
service growth in the number and scope of customer projects. Technical staff
expenses declined to 51% of revenue in 1997 from 53% in 1996 primarily as a
result of improved pricing and productivity of the technical staff.
Selling and Administrative Staff
Selling and administrative staff expenses consist of the cost of
salaries, payroll taxes, health insurance and workers' compensation for selling
and administrative personnel, all commissions and bonuses, and the cost of
technical staff salaries for technical staff personnel assigned to methodology
development projects or performing selling or training related tasks. Selling
and administrative staff expenses were $8.4 million in 1997, an increase of 50%
from $5.6 million in 1996. The increase in selling and administrative staff
expenses was primarily due to the addition of sales and administrative
personnel, and technical staff training necessary to support the Company's
growth. Selling and administrative staff expenses increased to 19% of revenue in
1997 from 18% of revenue in 1996. The increase in selling and administrative
staff expenses as a percentage of revenue is due primarily as a result of
increases in the costs and number of sales and marketing staff.
Other Expenses
Other expenses consist of all non-staff related costs, such as
occupancy costs, travel, business insurance, business development, recruiting,
training and depreciation. Other expenses were $8.0 million in 1997, an increase
of 40% over other expenses of $5.7 million in 1996. Other expenses were 18% of
revenue in both 1997 and 1996.
Special Compensation Expense
Special compensation expense in 1997 consisted of amortization of
stock-based compensation originating in 1996, which, in the aggregate, totaled
$268,000 or less than 1% of revenue. Special compensation expense in 1996
consisted of stock-based compensation and compensation related to the
cancellation of a note payable, which, in the aggregate, totaled $2.2 million,
or 7% of revenue. See Notes 9, 12 and 13 of Notes to Financial Statements.
Income from Operations
Income from operations increased to $5.0 million in 1997 from $1.3
million in 1996. If income from operations was adjusted to exclude special
compensation expense, referred to above, income from operations would have
increased to $5.3 million in 1997, up 49% from $3.5 million in 1996. Excluding
special compensation expense, income from operations was 12% of revenue in 1997
and 11% of revenue in 1996.
20
<PAGE>
Results of Operations for 1996 Compared with 1995
Revenue
Revenue was $31.3 million in 1996, an increase of 48% over 1995 revenue
of $21.1 million, principally due to increases in the scope and number of client
projects. Revenue attributable to software services rendered to IT vendors was
$20.4 million and $14.0 million in 1996 and 1995, respectively, an increase of
45% in 1996 compared to 1995. Revenue attributable to software services rendered
to IT users was $10.9 million and $7.1 million in 1996 and 1995, respectively,
an increase of 54% in 1996 compared to 1995.
Two clients, including their subsidiaries, accounted for 66% and 76% of
revenue in 1996 and 1995, respectively. No other client accounted for more than
10% of revenue in 1996 or 1995.
Technical Staff
Technical staff expenses were $16.4 million in 1996, an increase of 47%
over 1995 technical staff expenses of $11.2 million. The increase in technical
staff expenses was primarily due to the addition of personnel necessary to
service growth in the number and scope of client projects. Technical staff
expenses were 53% of revenue in both 1996 and 1995.
Selling and Administrative Staff
Selling and administrative staff expenses were $5.6 million in 1996, up
50% from $3.8 million in 1995. The increase in selling and administrative staff
expenses was primarily due to the addition of personnel necessary to support the
Company's growth, including increases in sales and recruiting personnel, and
increases in personnel working on the Company's Genova initiative. Selling and
administrative staff expenses were 18% of revenue in both 1996 and 1995.
Other Expenses
Other expenses were $5.7 million in 1996, an increase of 43% over other
expenses of $4.0 million in 1995. Other expenses declined to 18% of revenue in
1996 from 19% in 1995, primarily as a result of the significant increase in
revenue in 1996.
Special Compensation Expense
Special compensation expense in 1996 consisted of stock-based
compensation and compensation related to the cancellation of a note payable,
which, in the aggregate, totaled $2.2 million, or 7% of revenue. See Notes 9, 12
and 13 of Notes to Financial Statements. There was no special compensation
expense in 1995.
Income from Operations
Income from operations decreased $892,000 to $1.3 million in 1996 from
$2.2 million in 1995. If income from operations was adjusted to exclude special
compensation expense, referred to above, income from operations would have grown
59% in 1996 compared with 1995. Income from operations declined to 4% of revenue
in 1996 from 10% in 1995 primarily as a result of special compensation expense
in 1996. If income from operations was adjusted to exclude special compensation
expense, income from operations would have been 11% of revenue in 1995 and 1996.
Liquidity and Capital Resources
Since commencement of its operations as a separate company on October
1, 1996, the Company has maintained its own cash accounts. Before the IPO in
June 1997, available cash balances were used to reduce bank borrowings and
amounts due to Pencom. Prior to its incorporation, the Company participated in
Pencom's centralized cash management system while it conducted its business and
21
<PAGE>
operations as the software division of Pencom. In 1995, cash was used to repay
$1.1 million of contributions by Pencom. In 1996, the Company repaid $2.9
million of contributions from Pencom.
Cash flows from operations were $3.0 million, $2.1 million and $1.6
million in 1997, 1996 and 1995, respectively. Total repayments of borrowings
were $5.1 million in 1997. The Company purchased approximately $2.7 million,
$1.2 million and $450,000 of computer and office equipment in 1997, 1996 and
1995, respectively. At December 31, 1997, the Company did not have any material
commitments for capital expenditures.
At December 31, 1997, the Company had cash and cash equivalents and
investments totaling $23.3 million, an increase from $3.2 million at December
31, 1996, primarily as a result of the completion of the IPO, pursuant to which
the Comp6any issued and sold 3,277,500 shares of its Common Stock at a price to
the public of $9.00 per share. Of the $25.7 million of net proceeds from the
IPO, approximately $3.0 million was used to repay the principal amount and
accrued interest outstanding under the Company's credit facility, as amended
(the "Credit Facility"). In connection with the completion of its IPO, the
Company also recorded liabilities for the payment of an estimated $1.8 million
income tax obligation payable over two years resultant from the conversion
from a cash basis to accrual basis method of tax accounting upon the termination
of its Subchapter S election and the payment of a $1.4 million dividend to
stockholders of the Company prior to the offering in respect of the estimated
tax that such stockholders are required to pay on the estimated 1997 taxable
income allocated to them.
The Company's revolving credit agreement with a bank which was amended
and extended until May 1, 1999, is unsecured and contains customary restrictive
covenants, including covenants requiring the Company to maintain a minimum net
worth and certain financial ratios. The revolving credit agreement is subject to
a borrowing base requirement and bears interest at the greater of (a) the bank's
prime rate or (b) the federal funds rate plus 0.25 percent. At the Company's
election, borrowings can be converted to loans which bear interest at a rate
computed based on the London Interbank Offered Rate ("LIBOR") . The weighted
average borrowing rate on the line of credit was 8.4% for 1997. At December 31,
1997, there was no amount outstanding and the available borrowing amount was
$7.5 million.
The Company anticipates that its existing capital resources described
above, including cash provided by operating activities and available bank
borrowings will be adequate to fund the Company's operations for at least the
next 12 months. There can be no assurance that changes will not occur that would
consume available capital resources before such time. The Company's capital
requirements depend on numerous factors, including potential acquisitions, the
timing of the receipt of accounts receivable, employee growth, and the
percentage of projects performed at PSW facilities. There can be no assurance
that additional funding, if necessary, will be available on favorable terms, if
at all.
Certain Factors That May Affect Future Results, Financial Condition and Market
Price of Securities
Numerous factors may affect the Company's business and its results of
operations. These factors include the client and industry concentrations;
management's ability to accurately estimate resources required for fixed-price
contracts; the Company's ability to meet client expectations and deliverable
dates, the Company's ability to manage the substantial growth of the Company;
potential for significant fluctuations in quarterly results; management's
ability to attract and retain professional staff; the Company's ability to
develop IT solutions with rapid technological advances; and general economic
and business conditions. For a discussion of these and other factors that may
affect the Company's future results, see "Business" in Item 1 of this Form 10-K.
22
<PAGE>
Item 8. Financial Statements and Supplementary Data
PSW TECHNOLOGIES, INC.
INDEX TO FINANCIAL STATEMENTS
Page
Report of Independent Auditors............................................. F-2
Balance Sheets as of December 31, 1996 and 1997............................ F-3
Statements of Income for the years ended December 31, 1995, 1996 and 1997.. F-4
Statements of Stockholders' Equity for the years ended December 31, 1995, 1996
and 1997 ...................................................................F-5
Statements of Cash Flows for the years ended December 31, 1995, 1996
and 1997................................................................... F-6
Notes to Financial Statements.............................................. F-7
<PAGE>
Report of Independent Auditors
The Stockholders and Board of Directors
of PSW Technologies, Inc.
We have audited the accompanying balance sheets of PSW Technologies, Inc. as
of December 31, 1996 and 1997 and the related statements of income,
stockholders' equity, and cash flows for each of the three years in the
period ended December 31, 1997. These statements are the responsibility of
the Company's management. Our responsiblility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generallly 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
finanacial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of PSW Technologies, Inc. at
December 31, 1996 and 1997, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Austin, Texas
January 19, 1998
F-2
<PAGE>
PSW Technologies, Inc.
Balance Sheets
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
December 31,
1996 1997
-------- --------
<S> <C> <C>
Assets
Current assets:
Cash ......................................................... $ 3,182 $ 835
Short-term investments ....................................... -- 22,470
Accounts receivable, net of allowance for doubtful
accounts of $120 and $165 in 1996 and 1997,
respectively ............................................... 6,118 7,429
Due from related party ....................................... 323 --
Unbilled revenue under customer contracts .................... 244 418
Prepaid expenses and other current assets .................... 280 483
-------- --------
Total current assets ............................................ 10,147 31,635
Property and equipment, net ..................................... 1,796 3,551
Deferred income taxes ........................................... -- 234
Total assets .................................................... $ 11,943 $ 35,420
======== ========
Liabilities and stockholders' equity
Current liabilities:
Note payable to bank ......................................... $ 5,125 $ --
Due to related party ......................................... 581 --
Accounts payable and accrued expenses ........................ 2,566 2,834
Deferred revenue ............................................. 227 --
Deferred income taxes ........................................ -- 727
-------- --------
Total current liabilities ....................................... 8,499 3,561
Commitments
Stockholders' equity:
Preferred stock, par value $.01 per share, 1,000,000 shares
authorized and none issued and outstanding ................. -- --
Common stock, par value $.01 per share, 34,000,000 shares
authorized, 5,538,463 and 8,960,935 shares issued and
oustanding at December 31, 1996 and 1997, respectively ..... 55 90
Additional paid-in capital ................................... 4,187 29,484
Deferred compensation ........................................ (641) (243)
Unrealized loss on investments ............................... -- (27)
Retained earnings (accumulated deficit) ...................... (157) 2,555
-------- --------
Total stockholders' equity ...................................... 3,444 31,859
-------- --------
Total liabilities and stockholders' equity ...................... $ 11,943 $ 35,420
======== ========
</TABLE>
See accompanying notes.
F-3
<PAGE>
PSW Technologies, Inc.
Statements of Income
(in thousands, except per share data)
<TABLE>
<CAPTION>
Year ended December 31,
1995 1996 1997
-------- ---------- ----------
<S> <C> <C> <C>
Revenue ....................................................................................... $ 21,147 $ 31,274 $ 44,118
Operating expenses:
Technical staff ............................................................................ 11,193 16,444 22,479
Selling and administrative staff ........................................................... 3,755 5,622 8,405
Other expenses ............................................................................. 3,976 5,684 7,979
Special compensation expense ............................................................... -- 2,193 268
Total operating expenses ...................................................................... 18,924 29,943 39,131
Income from operations ........................................................................ 2,223 1,331 4,987
Interest income (expense), net ................................................................ (84) (170) 431
-------- -------- --------
Income before provision for income taxes ...................................................... 2,139 1,161 5,418
-------- -------- --------
Provision for income taxes:
Nonrecurring charge for termination
of Subchapter S election ................................................................ -- -- 1,200
C Corporation taxes......................................................................... -- -- 1,000
-------- -------- --------
Total provision for income taxes .............................................................. -- -- 2,200
-------- -------- --------
Net income .................................................................................... $ 2,139 $ 1,161 $ 3,218
======== ======== ========
Unaudited pro forma information:
Historical income before provision for
income taxes ............................................................................... $ 2,139 $ 1,161 $ 5,418
Pro forma provision for income taxes .......................................................... 813 441 1,900
-------- -------- --------
Pro forma net income .......................................................................... $ 1,326 $ 720 $ 3,518
======== ======== ========
Pro forma basic earnings per share ............................................................ $ 0.24 $ 0.13 $ 0.48
======== ========= =========
Pro forma diluted earnings per share .......................................................... $ 0.20 $ 0.11 $ 0.41
======== ========= =========
Shares used in pro forma basic earnings
per share calculation ..................................................................... 5,538 5,538 7,384
======== ======== ========
Shares used in pro forma diluted earnings
per share calculation ..................................................................... 6,635 6,689 8,517
======== ======== ========
</TABLE>
See accompanying notes.
F-4
<PAGE>
<TABLE>
<CAPTION>
PSW Technologies, Inc.
Statements of Stockholders' Equity
(in thousands, except shares)
Retained
Common Stock Additional Unrealized Earnings Total
$.01 Par Value Paid-in Deferred Loss on (Accumulated Stockholders'
Shares Amounts Capital Compensation Investments Deficit) Equity
--------- --------- --------- --------- ------------- ---------- ------------
<S> ......................................<C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 ............5,538,463 $ 55 $ 6,077 $ -- $ -- $ (3,457) $ 2,675
Distributions, net ...................... -- -- (1,130) -- -- -- (1,130)
Net income .............................. -- -- -- -- -- 2,139 2,139
--------- --------- --------- --------- ------------- --------- ---------
Balance at December 31, 1995 ........... 5,538,463 55 4,947 -- -- (1,318) 3,684
Distributions, net ..................... -- -- (2,939) -- -- -- (2,939)
Deferred compensation related
to stock options .................... -- -- 2,179 (2,179) -- -- --
Amortization of deferred
compensation ........................ -- -- -- 1,538 -- -- 1,538
Net income ............................. -- -- -- -- -- 1,161 1,161
--------- --------- --------- --------- ------------- --------- ---------
Balance at December 31, 1996 ........... 5,538,463 55 4,187 (641) -- (157) 3,444
Issuance of common stock, net
of issuance costs of $3,816 ......... 3,285,500 33 25,698 -- -- -- 25,731
Employee stock purchase plan
issuance of stock ................... 53,732 1 410 -- -- -- 411
Exercise of stock options .............. 83,240 1 31 -- -- -- 32
Reclassification upon termi-
nation of S Corporation status ...... -- -- (894) -- -- 894 --
Tax benefit related to stock
option exercises .................... -- -- 182 -- -- -- 182
Forfeiture of stock options ............ -- -- (130) 130 -- -- --
Dividend ............................... -- -- -- -- -- (1,400) (1,400)
Amortization of deferred
compensation ........................ -- -- -- 268 -- -- 268
Net unrealized loss on investments ..... -- -- -- -- (27) -- (27)
investments
Net income ............................. -- -- -- -- -- 3,218 3,218
========= ========= ========= ========= ============= ========= =========
Balance at December 31, 1997 ........... 8,960,935 $ 90 $ 29,484 $ (243) $ (27) $ 2,555 $ 31,859
========= ========= ========= ========= ============= ========= =========
See accompanying notes.
F-5
</TABLE>
<PAGE>
PSW Technologies, Inc.
Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
1995 1996 1997
-------- -------- --------
<S> ....................................................... <C> <C> <C>
Operating activities
Net income ........................................... $ 2,139 $ 1,161 $ 3,218
Adjustments to reconcile net income to net
cash provided by operating
activities:
Special compensation ............................... -- 2,193 268
Depreciation and amortization ...................... 288 424 825
Bad debt expense ................................... 52 75 45
Changes in operating assets and liabilities:
Accounts receivable .............................. (1,181) (2,344) (1,367)
Due from related party ........................... -- (323) (258)
Unbilled revenue under customer contracts ........ (100) (144) (174)
Prepaid expenses and other current assets ........ (45) (864) (203)
Due to related party ............................. -- 581 --
Accounts payable and accrued expenses ............ 648 1,154 299
Deferred revenue ................................. (214) 227 (227)
Deferred taxes ................................... -- -- 675
-------- -------- --------
Net cash provided by operating activities 1,587 2,140 3,101
-------- -------- --------
Investing activities
Purchase of short-term investments ................... -- -- (22,497)
Acquisition of property and equipment ................ (444) (1,247) (2,646)
-------- -------- --------
Net cash used in investing activities ... (444) (1,247) (25,143)
-------- -------- --------
Financing activities
Proceeds from (repayments on) line of credit, net .... -- 5,125 (5,125)
Capital distributions, net ........................... (1,130) (2,870) --
Proceeds from issuance of common stock, net of
issuance costs .................................... -- -- 26,220
Dividend paid to S corporation stockholders .......... -- -- (1,400)
-------- -------- --------
Net cash provided by (used in) financing
activities .............................. (1,130) 2,255 19,695
-------- -------- --------
Net increase (decrease) in cash ........................... 13 3,148 (2,347)
Cash, beginning of year ................................... 21 34 3,182
======== ======== ========
Cash, end of year ......................................... $ 34 $ 3,182 $ 835
======== ======== ========
Supplemental disclosure of cash flow information
Interest paid ........................................ $ 84 $ 154 $ 137
Income taxes paid .................................... $ -- $ -- $ 1,571
Supplemental schedule of non-cash activities
Unrealized loss on investments ....................... $ -- $ -- $ 27
Reduction of income taxes payable associated
with the exercise of stock options ................ $ -- $ -- $ 182
</TABLE>
See accompanying notes.
F-6
<PAGE>
PSW Technologies, Inc.
Notes to the Financial Statements
1. Nature of Business
PSW Technologies, Inc. ("PSW" or the "Company") is a software services firm,
operating in one industry segment, that provides high value solutions to IT
vendors and IT users by mastering and applying critical emerging technologies.
These critical technologies include distributed computing, object-oriented
development, advanced operating systems and systems management technologies. PSW
provides joint project-based development, porting and testing services to
selected IT vendor clients and applies the technical expertise learned to the
design and development of high value, mission critical enterprise business
systems for its Fortune 1000 end-user clients.
2. Summary of Significant Accounting Policies
Basis of Presentation
Pencom Systems Incorporated ("Pencom") provided software services via a separate
division (the "Software Division") that commenced operations in October 1989. In
addition, a portion of a software services contract was allocated between the
other operations of Pencom and the Software Division. Effective October 1, 1996,
Pencom contributed to PSW the business of the Software Division, including the
portion of the software contract that had previously been allocated to the other
operations of Pencom (see Note 3). In exchange for the net assets contributed,
Pencom received all of the then issued and outstanding shares of PSW and PSW
issued warrants to Pencom and to certain Pencom employees to purchase an
aggregate of 507,654 shares of PSW's common stock at $.04 per share. The shares
and warrants issued to Pencom were immediately thereafter distributed to Pencom
shareholders. This exchange has been accounted for in a manner similar to a
pooling of interests and accordingly, the accompanying financial statements
include the operations of the Software Division and the aforementioned portion
of the software services contract allocated to other operations of Pencom for
all periods presented.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions,
including estimates to complete contracts, that affect the reported amounts in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued Statement No. 130,
Reporting Comprehensive Income ("SFAS No. 130"). This statement establishes
standards for reporting and display of comprehensive income and its components
in a full set of general-purpose financial statements. Comprehensive income
includes all revenues, expenses, gains, and losses recognized during the period
regardless of whether they are considered to be results of operations of the
period. This statement is effective for fiscal years beginning after December
15, 1997. The Company does not expect SFAS No. 130 to have a material impact on
the financial statements.
In June 1997, the Financial Accounting Standards Board issued Statement No. 131,
("SFAS No. 131"), Disclosures about Segments of an Enterprise and Related
Information. SFAS No. 131 establishes standards to address the way in which
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
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. SFAS No. 131 is
effective for financial statements for fiscal years beginning after December 15,
1997. The Company does not expect SFAS No. 131 to have a material impact on its
financial statements.
F-7
<PAGE>
PSW Technologies, Inc.
Notes to the Financial Statements (continued)
2. Summary of Significant Accounting Policies (continued)
Share Information
All outstanding share amounts included in the accompanying financial statements
have been adjusted to reflect an 11,250-for-1 forward stock split on December
18, 1996 and the 8-for-13 reverse stock split effected described in Note 3.
Revenue Recognition
Revenue from time and materials contracts is recognized during the period for
which the services are provided.
Revenue from fixed price contracts is recognized using the
percentage-of-completion method, measured by the percentage of units of labor
incurred to the date of measurement relative to the estimated total units of
labor at completion. The cumulative impact of revisions in estimates of the
percentage to complete is reflected in the period in which the revisions are
made. Provisions for estimated losses on uncompleted contracts are made on a
contract-by-contract basis and are recognized in the period in which such losses
are determined. Revenue earned in excess of billings is classified as unbilled
revenue under customer contracts. Billings in excess of earned revenue are
classified as deferred revenue. Revenue excludes reimbursable expenses.
Costs and Expenses
Technical staff expense consists of the cost of (i) salaries, payroll taxes,
health insurance and workers' compensation for technical staff personnel
assigned to client projects, (ii) unassigned technical staff personnel and (iii)
fees paid to subcontractors for work performed in connection with client
projects.
Selling and administrative staff expense consists of (i) the cost of salaries,
payroll taxes, health insurance and workers' compensation for selling and
administrative personnel, (ii) all commissions and bonuses and (iii) technical
staff personnel assigned to development projects or performing selling,
recruiting or training related tasks.
Pencom allocated certain expenses to the Software Division, including corporate
and officers' salaries, interest and rent. Corporate and officers' salaries were
allocated based upon the percentage of time expended by certain individuals on
Software Division matters. Interest was allocated based upon interest incurred
by Pencom on its secured debt (see Note 7). Rent was allocated based on square
footage and/or employee head count. It is management's opinion that the
estimated cost of the allocated expenses on a stand alone basis would not
produce materially different results than those reflected in the 1995 and 1996
financial statements.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentration of
credit risk consist principally of cash balances, short term investments and
trade accounts receivable. The Company invests its excess cash in highly liquid
investments (short-term bank deposits) and places its investments in high
quality securities with financial institutions of high credit standing. The
Company does not require collateral from its customers. The Company maintains
allowances for potential credit losses and such losses were not material for any
of the periods presented. The Company's customers are headquartered primarily in
North America.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of
three months or less to be cash equivalents.
F-8
<PAGE>
2. Summary of Significant Accounting Policies (continued)
Depreciation and Amortization
Depreciation and amortization are computed based on the cost of the related
assets, using the straight-line method over the estimated useful lives of the
assets which range from five to seven years. Leasehold improvements are
amortized over the term of the related lease or estimated life of the leasehold
improvements, whichever is shorter.
Advertising Expense
The Company expenses advertising costs when the advertisement occurs. Total
advertising expense amounted to approximately $175,000 in 1997. Advertising
costs were not material for 1995 and 1996.
Stock Based Compensation
The Company has adopted the disclosure provisions accounts for stock-based
compensation in accordance with Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" ("SFAS 123"). SFAS 123 prescribes
accounting and reporting standards for all stock-based compensation plans,
including employee stock options, restricted stock, employee stock purchase
plans and stock appreciation rights. SFAS 123 requires compensation expense to
be recorded (i) using the new fair value method or (ii) using existing
accounting rules prescribed by Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations with pro forma disclosure of what net income and earnings per
share would have been had the Company adopted the new fair value method. The
Company intends to continue to account for its stock based compensation plans in
accordance with the provisions of APB 25 as permitted by SFAS 123.
Income Taxes
Upon formation in August 1996, the Company elected to be treated as a Subchapter
S corporation, under the Internal Revenue Code of 1986 as amended, whereby
federal income taxes are the responsibility of the individual stockholders.
Accordingly, the Company did not provide for federal income taxes. With the
closing of the Company's initial public offering, the Company's Subchapter S
status was terminated and the Company became subject to federal corporate income
taxes.
In accordance with Statement of Financial Accounting Standards, ("SFAS No.
109"), Accounting for Income Taxes, deferred income taxes were provided for all
temporary differences existing at the date of the Company's termination of its
Subchapter S status. This statement prescribes the use of the liability method
whereby deferred tax asset and liability account balances are determined based
on differences between financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse.
Pro Forma Earnings Per Share
The unaudited pro forma adjustments on the statements of income reflect an
adjustment to record a provision for income taxes as if the Company had not been
an S corporation.
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
Earnings per Share ("SFAS 128"). SFAS 128 replaced the calculation of primary
and fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. All earnings per share amounts for all periods have been
presented, and where appropriate, restated to conform to the requirements of
SFAS 128 and Securities and Exchange Commission Staff Accounting Bulletin 98.
F-9
<PAGE>
3. Stockholders' Equity
Effective October 1, 1996, in connection with the contribution of the business
of the Software Division, the Company issued 5,538,463 shares of common stock
and warrants to purchase an aggregate of 507,654 shares of common stock at $.04
per share. All warrants were exercisable upon issuance and expire in October,
2006. In exchange for the shares and warrants issued, PSW received an assignment
of a 26.67% interest in the proceeds to be received from the accounts receivable
as of September 30, 1996 and substantially all the other assets and liabilities
of the Software Division. The net assets contributed amounted to approximately
$2,100,000 (see also note 2).
On February 3, 1997, the Company's Board of Directors approved 1.) an 8-for-13
reverse stock split, which was effected on April 2, 1997, 2.) an increase in the
Company's authorized common stock from 11,250,000 to 34,000,000 shares and 3.)
an authorization of 1,000,000 shares of preferred stock of $.01 par value, which
was effected prior to the completion of the Company's initial public offering.
In June 1997, the Company completed an initial public offering of 2,850,000
shares of its authorized but unissued Common Stock at a price to the public of
$9.00 per share. In connection with the initial public offering, the Company
granted the underwriters of the offering an option to purchase up to 427,500
shares of Common Stock to cover over-allotments. On July 2, 1997, the
underwriters exercised their option, purchasing 427,500 shares of the Company's
Common Stock. The above transactions resulted in total net proceeds from the
initial public offering of $25.7 million (after deducting offering expenses and
the underwriters discount of approximately $3.8 million). The proceeds of the
offering were used to repay indebtedness, to pay certain corporate income tax
obligations of the Company and to pay dividends to existing stockholders of the
Company in amounts estimated to approximate certain of their 1997 income tax
obligations, and for working capital and other general corporate purposes. A
portion of the remaining funds may be used to fund acquisitions of complementary
businesses or technologies.
As discussed in Note 12, the Company's S corporation status was terminated
immediately upon completion of its initial public offering. Additionally, the
Company was required to change its method of tax accounting from the cash to
accrual method. The stockholders of the Company prior to the termination of the
S corporation status are obligated to pay the income taxes for the 1997 taxable
earnings of the Company allocated to them. During 1997, the Company declared and
paid a dividend of $1.4 million to these stockholders. The dividend payment was
an estimate based upon numerous assumptions, including taxable income
attributable to the conversion from the cash to the accrual method of accounting
upon the termination of the Company's S corporation status.
At December 31, 1997, the Company has reserved 507,654 shares of Common Stock
for issuance in connection with warrants outstanding and 1,978,000 shares of
Common Stock for issuance under the Company's stock purchase and stock option
plans.
4. Property and Equipment
Property and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
1996 1997
------ ------
<S> .......................................... <C> <C>
Furniture and fixtures ....................... $ 521 $1,192
Computer equipment ........................... 2,251 3,480
Computer software ............................ 266 603
Leasehold improvements ....................... 59 379
------ ------
3,097 5,654
Less accumulated depreciation and amortization 1,301 2,103
====== ======
$1,796 $3,551
====== ======
</TABLE>
F-10
<PAGE>
5. Short-Term Investments
The Company determines the appropriate classification of investments at the time
of purchase and re-evaluates such designation at each balance sheet date. The
short-term investments have been classified as available-for-sale and are
carried at fair value (quoted market prices), with unrealized holding gains and
losses reported as a separate component of stockholders' equity. The cost of
debt securities is adjusted for amortization of premiums and accretion of
discounts to maturity. Such amortization, interest income, realized gains and
losses and declines in value judged to be other than temporary are included in
net interest and other income.
Information related to the Company's investments at December 31, 1997 is as
follows (in thousands):
<TABLE>
<CAPTION>
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------------- -------------- ------------ -------
<S> ......................................... <C> <C> <C> <C>
Money market funds .......................... $ 1,801 $ -- $ -- $ 1,801
Municipal obligations ....................... 16,391 17 29 16,379
Corporate securities ........................ 4,305 20 35 4,290
=============== ============== ============ =======
$ 22,497 $ 37 $ 64 $22,470
=============== ============== ============ =======
</TABLE>
Gross gains and gross losses on the sale of investments were not significant in
1997. Short-term investments are generally comprised of variable rate securities
that provide for optional or early redemption within twelve months and the
contractual maturities are generally greater than twelve months.
6. Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consist of the following (in thousands):
<TABLE>
<CAPTION>
1996 1997
------ ------
<S> ....................................... <C> <C>
Trade payables ............................ $ 945 $ 532
Accrued vacation .......................... 307 442
Accrued bonuses ........................... 600 455
Payroll and other taxes payable ........... 216 437
Other accounts payable and accrued expenses 498 968
====== ======
$2,566 $2,834
====== ======
</TABLE>
7. Note Payable to Bank
In November 1996, the Company obtained a revolving line of credit from a bank,
providing for borrowings of up to $6.5 million. In November 1997, the line of
credit expired and was replaced with a revolving line of credit which provides
for borrowings of up to $10 million, subject to a borrowing base requirement.
Borrowings under the line of credit bear interest at the greater of (a) the
bank's prime rate or (b) the federal Funds Rate plus 0.25 percent. At the
Company's election, borrowings can be converted to loans which bear interest at
a rate computed based on the London Interbank Offered Rate ("LIBOR"). The
weighted average borrowing rate on the line of credit was 8.4% for 1997. The
line of credit contains certain restrictive convenants which, among other
things, require the Company to maintain a minimum net worth and to meet certain
financial ratios. At December 31, 1997, there was no amount outstanding and the
available borrowing amount was $7.5 million.
Interest expense includes interest allocated by Pencom through September 30,
1996. The allocation represented the Software Division's share of interest
payments paid by Pencom under its line of credit and was based on the ratio of
the monthly balance of the Software Division's accounts receivable to total
accounts receivable of the Software Division and Pencom. This line of credit was
collateralized by all accounts receivable and fixed assets for Pencom and bore
interest at a rate based on the bank's prime rate or alternative LIBOR pricing,
based on LIBOR plus 2.5%.
F-11
<PAGE>
8. Significant Customers
One customer and two of its wholly-owned subsidiaries accounted for
approximately 56%, 52% and 39% of total revenue for the years ended December 31,
1995, 1996 and 1997, respectively. This customer accounted for approximately 26%
of accounts receivable at December 31, 1997. Another customer accounted for
approximately 17% and 14% of total revenue for the years ended December 31, 1995
and 1996, respectively. No other customer accounted for more than 10% of revenue
in 1995, 1996 or 1997.
9. Employee Benefit Plans
Stock Option Plan
Effective October 1, 1996, the Company's Board of Directors and stockholders
approved and adopted the PSW Technologies, Inc. 1996 Stock Option/ Stock
Issuance Plan (the "1996 Plan"). The aggregate number of shares issuable under
the 1996 Plan has been increased to 1,715,000 shares of the Company's common
stock for issuance to employees, directors and consultants of the Company.
Incentive stock options as defined in Section 422A of the Internal Revenue Code
of 1986 and nonqualified stock options may be issued under the 1996 Plan. The
exercise price for incentive stock options may not be less than fair market
value on the date of grant, or such greater amount necessary to qualify as an
incentive stock option. The options outstanding under the 1996 Plan generally
vest in four equal annual installments commencing on the first anniversary of
the grant and expire 10 years after the date of grant. Certain of these options
are subject to acceleration clauses.
Pursuant to the organization of the Company and the contribution of net assets
of the Software Division, the Company granted replacement options for shares of
its common stock under the 1996 Plan to its employees who participated in the
Pencom Option Plan and the Pencom Option Plan was terminated. The replacement
options were granted for the same number of shares and at the same exercise
price as those options granted to the employees under the Pencom Option Plan.
The grant date determining vesting was the original grant date under the Pencom
Option Plan. Under APB 25, the difference between the estimated fair market
value of the Company's common stock and the options' exercise prices on the date
of issuance was determined to be approximately $2,179,000. This charge is being
amortized for financial reporting purposes over the vesting period of the
options and the amount recognized as expense during the years ended December 31,
1996 and 1997 amounting to approximately $1,538,000 and $268,000, respectively,
is included in special compensation expense. A deferred tax benefit is recorded
for the amortized compensation expense.
F-12
<PAGE>
PSW Technologies, Inc.
Notes to the Financial Statements (continued)
9. Employee Benefit Plans (continued)
The following table summarizes stock option activity under the 1996 Plan:
<TABLE>
<CAPTION>
Range of Exercise Prices
------------------------------------------------------------------
$0.04 - $2.60 $3.90 - $9.00 $11.50 - $15.25 Total
-------------------- --------------------- ---------------------- ----------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Number Exercise Number Exercise Number Exercise Number Exercise
of shares Price of shares Price of shares Price of shares Price
--------- -------- --------- -------- -------- ---------- ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 ..... -- $ -- -- $ -- -- $ -- -- $ --
Granted during the year .......... 632,907 0.42 452,804 4.23 -- -- 1,085,711 2.00
Exercised during the year ........ -- -- -- -- -- -- -- --
Forfeited during the year ........ (6,957) 0.72 (1,846) 4.12 -- -- (8,803) 1.44
-------- ----- -------- ----- -------- ----- ---------- ------
Balance at December 31, 1996 ..... 625,950 0.41 450,958 4.23 -- -- 1,076,908 2.00
Granted during the year .......... -- -- 306,784 8.87 177,826 12.36 484,610 10.15
Exercised during the year ........ (77,391) 0.12 (5,849) 3.92 -- -- (83,240) 0.39
Forfeited during the year ........ (41,987) 0.77 (34,136) 5.38 (2,025) 13.22 (78,148) 3.10
======== ===== ======== ===== ======= ===== ========== ======
Balance at December 31, 1997 ..... 506,572 $ 0.43 717,757 $ 6.16 175,801 $ 12.35 1,400,130 4.86
======== ===== ======== ===== ======= ===== ========== ======
Exercisable at December 31, 1996 . 360,464 $ 0.09 3,076 $ 3.90 -- $ -- 363,540 $ 0.12
======== ===== ======== ===== ======= ===== ========== ======
Exercisable at December 31, 1997 . 380,883 $ 0.20 130,693 $ 4.19 4,723 $ 13.08 516,299 $ 1.33
======== ===== ======== ===== ======= ===== ========== ======
Weighted average fair value of
options granted during 1997 .. $ -- $ 5.10 $ 7.00 $ 5.79
===== ===== ===== ======
Weighted average remaining
contractual life in years,
at December 31, 1997 ......... 5.49 7.38 8.38 6.82
===== ===== ===== =====
</TABLE>
F-13
<PAGE>
PSW Technologies, Inc.
Notes to the Financial Statements (continued)
9. Employee Benefit Plans (continued)
Employee Stock Purchase Plan
On February 3, 1997, the Board of Directors adopted the Company's Employee Stock
Purchase Plan (the "Purchase Plan") that allows eligible employees to purchase
shares of Common Stock, at semi-annual intervals, through periodic payroll
deductions under the Purchase Plan; a reserve of 400,000 shares of common stock
has been established for this purpose. The stockholders of the Company approved
the Purchase Plan on March 17, 1997.
The Purchase Plan incorporates a series of successive offering periods, each
generally with a duration of six months. The initial purchase period began on
the date of the initial public offering (see Note 3) and ended on October 31,
1997. Thereafter, purchase periods begin on the first business day in November
and May of each year and end on the last business day of April and October,
respectively. Shares of Common Stock are purchased for each participant at the
end of each purchase period. On October 31, 1997, the Company sold 53,732 shares
of Common Stock to employees through the Purchase Plan.
Payroll deductions may not exceed 15% of base salary for each purchase period
and each employee's purchases are limited to 500 shares per purchase period. The
purchase price per share is eighty-five percent of the lower of (i) the fair
market value of the Common Stock on the start date of the purchase period or
(ii) the fair market value at the end of the semi-annual purchase period. The
Purchase Plan will terminate on the last business day of April, 2007.
As specified in APB No. 25, the sale of Common Stock under the Purchase Plan
does not result in compensation expense to the Company. Under SFAS 123, however,
expense would be recognized, and accordingly, approximately $408,000 of pro
forma compensation expense relating to the sale of Common Stock under the
Purchase Plan is included in the calculation of pro forma net income and pro
forma basic earnings per share and pro forma diluted earnings per share
resulting from the grant of stock options during 1997, below. The assumptions
used to value the compensation expense resulting from the issuance of shares
under the Purchase Plan do not differ materially from the assumptions used to
value the 1997 stock options.
Employee Retirement Plan
The Company maintains a defined contribution plan (the "Plan") pursuant to
Section 401(k) of the Internal Revenue Code for employees who are at least 21
years of age. Eligible employees can elect to reduce their current compensation
up to the statutory prescribed limit and have the amount of such reduction
contributed to the Plan. The Plan also allows for the Company to make
contributions on behalf of eligible employees. A similar plan in which employees
of the Software Division were eligible to participate was maintained by Pencom.
No contributions were made to the plan in 1995, 1996 or 1997 by the Software
Division or PSW.
Pro forma Information
Pro forma information regarding net income and earnings per share is required by
SFAS 123, and has been determined as if the Company had accounted for option
grants under the 1996 Plan and purchases of Common Stock under the Purchase Plan
using the fair value method of that Statement. The fair value of the options was
estimated at the date of grant using a Black-Scholes option pricing model with
the following weighted average assumptions:
<TABLE>
<CAPTION>
1996 Option Grants
----------------------------
Vested at Non-vested at 1997
Assumption Grant Date Grant Date Option Grants
- ---------- ------------- ------------- -------------
<S> <C> <C> <C>
Risk-free interest rate .................................... 5.93% 6.23% 6.34%
Dividend yield ............................................. 0% 0% 0%
Volatility factor of the expected
market price of the Company's
common stock ............................................. 0.374 0.374 0.521
Average life ............................................... 3 years 6 years 6 years
</TABLE>
F-14
<PAGE>
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options 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 employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
under SFAS 123 is amortized to expense over the options' vesting period. For the
years ended December 31, 1996 and 1997, pro forma net income under SFAS 123
amounted to approximately $658,000 and $2.7 million, respectively and pro forma
basic earnings per share and pro forma diluted earnings per share under SFAS 123
amounted to approximately $.012 and $0.09 in 1996 and $0.36 and $0.32 in 1997,
respectively.
10. Related Party Transactions
The Company utilizes non-exclusive recruiting services provided by Pencom.
Management believes that the terms and fees paid in connection with such
recruiting services are comparable to agreements maintained by the Company with
other unrelated recruiting firms and will continue to use these recruiting
services on a non-exclusive basis pursuant to an agreement entered into with
Pencom. In addition, certain expenses were allocated by Pencom to the Software
Division. Management believes that the allocations were reasonable. Services
provided and expenses allocated to PSW were as follows (in thousands):
<TABLE>
<CAPTION>
Year ended December 31,
1995 1996 1997
------ ------ ------
<S> ........................................... <C> <C> <C>
Services performed by related party:
Recruiting services ........................ $ 447 $ 316 $ 60
Contracted technical services .............. -- -- 9
Legal and accounting ....................... -- 21 28
Allocated expenses:
Rent ....................................... 329 448 37
Corporate and officers' salaries ........... 242 125 --
------ ------ ------
Total expenses included in other expenses 1,018 910 134
Interest ................................... 84 104 --
------ ------ ------
Total related party expenses .................. $1,102 $1,014 $ 134
====== ====== ======
</TABLE>
The Company also entered into an agreement with Pencom for certain accounting
and legal services for the period October 1, 1996 through April 30, 1997 at a
fee of $7,000 per month.
In recognition of establishing an independent profitable company, in 1996, the
Software Division cancelled a note receivable, including unpaid interest, due
from an officer and shareholder of the Company that resulted in a charge against
income of $655,000 which has been included in special compensation expense.
Assets contributed by Pencom on October 1, 1996 included an assignment of a
26.67% interest in the proceeds to be received from the accounts receivable of
the Software Division as of September 30, 1996. At December 31, 1996, "Due from
related party" includes approximately $309,000 that relates to a payment
received on behalf of Pencom which was transferred to Pencom subsequent to
December 31, 1996. Other amounts denoted "due to related party" represent
expenses that were paid on the Company's behalf by Pencom.
F-15
<PAGE>
11. Commitments
The Company leases its office space through noncancellable operating lease
arrangements including a lease for its office in Texas which was entered into on
October 31, 1996. Other than the lease related to the Texas office, the other
leases are held by Pencom and will be assigned to PSW. Future minimum rental
commitments (including amounts payable under leases held by Pencom) are as
follows:
<TABLE>
<CAPTION>
Years ending December 31 (in thousands):
<S> .................................... <C>
1998 ................................... $1,264
1999 ................................... 1,244
2000 ................................... 1,143
2001 ................................... 1,078
2002 ................................... 1,077
Thereafter ............................. 1,077
------
Total .................................. $6,883
======
</TABLE>
The premises previously occupied by the Company in Texas were leased by Pencom.
In connection with the office relocation, the Company transferred leasehold
improvements with a net book value of approximately $69,000 to Pencom. Pencom
has sub-leased these premises. However, the Company entered into an agreement
with Pencom to guarantee Pencom's sublease income. Future minimum sub-lease
rental income that the Company has guaranteed is as follows:
<TABLE>
<CAPTION>
Years ending December 31 (in thousands):
<S> .................................... <C>
1998 ................................... $ 376
1999 ................................... 380
2000 ................................... 285
------
Total .................................. $1,041
======
</TABLE>
Rent expense, including rent allocated by Pencom, for the years ended December
31, 1995, 1996 and 1997 was approximately $329,000, $601,000 and $1,258,000,
respectively.
12. Income Taxes
From commencement through June 5, 1997, the Company had elected to be treated as
an S Corporation under subchapter S of the Internal Revenue Code of 1986, as
amended. As such, federal income taxes attributable to income through June 5,
1997, were the responsibility of the individual stockholders.
As a result of the initial public offering in June of 1997, the Company's
Subchapter S status was terminated for federal and state tax purposes and the
Company recorded a deferred tax charge against income of approximately
$1,200,000 for the cumulative differences between the financial reporting and
income tax basis of certain assets and liabilities existing at that date.
Additionally, the Company was required to change its method of accounting from
the cash basis to the accrual basis for income tax reporting purposes.
The Company's stockholders are obligated to pay the 1997 income taxes related to
the period up to the completion of the offering. The Company declared and paid a
dividend of $1,400,000 to its stockholders of record immediately prior to the
completion of the public offering for the amount estimated to approximate the
1997 income taxes payable by the stockholders.
The pro forma disclosures on the statements of income reflect adjustments to
record provisions for income taxes as if the Company had not been an S
Corporation. The pro forma provisions for income taxes for the years ended
December 31, 1995 and 1996, of $813,000 and $441,000, respectively, are computed
using an effective tax rate of 38%, which differs from the federal statutory
rate of 34% primarily due to state taxes. The pro forma provision for income
taxes of $1,900,000 attributable to December 31, 1997, is computed using an
effective tax rate of 35%, which differs from the federal statutory rate of 34%
as a result of state taxes and tax-exempt income.
F-16
<PAGE>
12. Income Taxes (continued)
Significant components of the provision for income taxes are as follows:
<TABLE>
<CAPTION>
1997
------
Current:
<S> ........................................... <C>
Federal ....................................... $1,526
State ......................................... 180
------
Total Current ................................. 1,706
Deferred:
Federal ....................................... 442
State ......................................... 52
------
Total Deferred ................................ 494
======
$2,200
======
</TABLE>
The Company's effective tax rate from continuing operations differs from the
U.S. statutory income tax rate as set forth below:
<TABLE>
<CAPTION>
Pro forma Pro forma Pro forma Historical
1995 1996 1997 1997
--------- ---------- --------- ----------
<S> .................................................. <C> <C> <C> <C>
U.S. statutory income tax rate ....................... 34.0% 34.0% 34.0% 34.0%
State taxes, net of federal income tax
benefit ........................................... 4.0% 4.0% 4.0% 3.8%
Permanent differences, primarily
tax-exempt income ................................. -- -- (3.0%) (0.7%)
Nonrecurring charge due to
Subchapter S termination .......................... -- -- -- 22.1%
S Corporation income not subject to
tax ............................................... -- -- -- (20.7%)
Other ................................................ -- -- -- 2.1%
========= ========= ====== =========
Effective tax rate ................................... 38.0% 38.0% 35.0% 40.6%
========= ========= ========= =========
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred taxes as of December 31 are as follows:
<TABLE>
<CAPTION>
1997
-------
<S> <C>
Deferred tax assets:
Allowances and reserves ......... $ 183
Accrued expenses ................ 246
Stock option compensation expense 575
-------
Total deferred tax assets .......... 1,004
Deferred tax liabilities:
Fixed assets .................... (84)
Cash to accrual adjustment ...... (1,151)
Other ........................... (262)
-------
Total deferred tax liabilities ..... (1,497)
=======
Net deferred tax liabilities ....... $ (493)
=======
</TABLE>
The exercise of certain stock options which have been granted under the
Company's stock option plan give rise to compensation which is includable in the
taxable income of the applicable option holder and deductible by the Company for
federal and state income tax purposes. Any realized tax benefit arising from
exercised options in excess of the benefit previously recorded, as discussed in
Notes 9 and 13, is credited to additional paid-in capital.
F-17
<PAGE>
13. Special Compensation Expense
As described in Notes 9 and 12, charges to income were made related to the
replacement options issued to employees and the cancellation of a note from an
officer and stockholder of the Company which totaled $2,193,000 for the year
ended December 31, 1996. Amortization of deferred compensation of $268,000 was
recognized for the year ended December 31, 1997. These transactions reduced
income from operations, pro forma net income and pro forma diluted earnings per
share for the years ended December 31, 1996 and 1997 as follows (in thousands,
except per share data):
<TABLE>
<CAPTION>
1996 1997
------ ------
<S> ................................ <C> <C>
Operating income ................... $2,193 $ 268
Pro forma net income ............... 1,360 169
Pro forma diluted earnings per share 0.19 0.02
</TABLE>
Deferred compensation as of December 31, 1997 of approximately $243,000 will be
amortized over the remaining vesting periods in 1998, 1999 and 2000.
14. Earnings per Share
The following table sets forth the computation of basic and diluted earnings per
share (in thousands, except per share data):
<TABLE>
<CAPTION>
1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
Numerator:
Pro forma net income ................ $1,326 $ 720 $3,518
====== ====== ======
Denominator:
Shares used in pro forma basic
earnings per share calculation(1) . 5,538 5,538 7,384
Effect of dilutive securities:
Employee stock options ............ 592 646 627
Warrants .......................... 505 505 506
------ ------ ------
Shares used in pro forma diluted
earnings per share calculation(1) . 6,635 6,689 8,517
====== ====== ======
Pro forma basic earnings per share(1) . $ 0.24 $ 0.13 $ 0.48
====== ====== ======
Pro forma diluted earnings per share(1) $ 0.20 $ 0.11 $ 0.41
====== ====== ======
</TABLE>
(1) The pro forma basic and pro forma diluted earnings per share amounts
prior to the Company's initial public offering, which occurred during
the second quarter of 1997, have been restated as required to comply
with SFAS No. 128 and the Securities and Exchange Commission Staff
Accounting Bulletin 98 ("SAB 98"). The adoption of SFAS 128 and SAB 98
resulted in an increase to pro forma diluted earnings per share for
1995 and 1996 of $.01 per share.
F-18
<PAGE>
15. Quarterly Information (Unaudited)
Summarized quarterly financial information for 1996 and 1997 is as follows (in
thousands, except per share amounts):
<TABLE>
<CAPTION>
Quarter ended
---------------------------------------------------------------------
March 31 June 30 September 30 December 31
------------- -------------- --------------- --------------
<S> <C> <C> <C> <C>
1996
Total revenues $ 6,537 $ 6,950 $ 7,737 $ 10,050
Operating income 633 712 79 (93)
Pro forma net income 376 431 12 (99)
Pro forma diluted earnings
per share(1) $ .06 $ .06 $ - $ (.02)
Shares used in diluted earnings
per share calculation(1) 6,635 6,635 6,635 5,538
1997
Total revenues $ 10,307 $ 10,702 $ 11,258 $ 11,851
Operating income 1,057 1,177 1,417 1,336
Pro forma net income 600 721 1,111 1,086
Pro forma diluted earnings
per share(1) $ .09 $ .10 $ .11 $ .11
Shares used in diluted earnings
per share calculation(1) 6,740 7,290 9,973 10,063
</TABLE>
(1) The pro forma diluted earnings per share amounts prior to the Company's
initial public offering, which occurred during the second quarter of
1997, have been restated as required to comply with SFAS No. 128 and
the Securities and Exchange Commission Staff Accounting Bulletin 98
("SAB 98"). The adoption of SFAS 128 and SAB 98 resulted in an
increase to pro forma diluted earnings per share for 1995 and 1996
of $.01 per share.
F-19
<PAGE>
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
None.
PART III
Certain information required by Part III is omitted from this Form 10-K because
the Company will file a definitive Proxy Statement pursuant to Regulation 14A
(the "Proxy Statement") not later than 120 days after the end of the fiscal year
covered by this Form 10-K, and certain information to be included therein is
incorporated herein by reference.
Item 10. Directors and Executive Officers of the Registrant
The information required by this Item is incorporated by reference to the Proxy
Statement under the headings "Proposal 1 - Election of Directors," and Executive
Compensation - Executive Officers" and "Compliance with Section 16(a) of the
Exchange Act".
Item 11. Executive Compensation
The information required by this Item is incorporated by reference to the Proxy
Statement under the heading "Executive Compensation".
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this Item is incorporated by reference to the Proxy
Statement under the heading "Principal Stockholders".
Item 13. Certain Relationships and Related Transactions
The information required by this Item is incorporated by reference to the Proxy
Statement under the heading "Executive Compensation - Certain Transactions with
Management".
<PAGE>
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) 1. Financial Statements:
The financial statements listed in ITEM 8: Financial Statements and
Supplementary Data, above are filed as part of this Annual Report on Form 10-K.
2. Financial Statement Schedules:
All schedules are omitted because they are not applicable or the required
information is shown in the financial statements or notes thereto.
<TABLE>
<CAPTION>
3. Exhibits
<C> <S>
Number Description
**3.1 Amended and Restated Certificate of Incorporation of the Registrant.
**3.2 Amended and Restated Bylaws of the Registrant.
**4.1 Specimen Common Stock Certificate.
**4.2 See Exhibits 3.1 and 3.2 for provisions of the Certificate of
Incorporation and Bylaws of the Registrant defining rights of holders
of Common Stock of the Registrant.
**10.1 Bridgepoint Lease Agreement dated October 31, 1996 between the
Registrant and Investors Life Insurance Company of North America.
**10.2 Lease Guarantee effective January 31, 1997 between the Registrant and
Pencom Systems Incorporated.
**10.3 Office Lease dated April 25, 1996 between G&W Investment Partners and
Pencom Systems Incorporated, as amended.
**10.4 Agreement of Lease dated May 13, 1996 between Newport L.G.-I, Inc. and
Pencom Systems Incorporated.
#**10.5 Software Development Agreement having an effective date of March 9,
1994 between the Registrant and Canon Computer Systems, Inc., as
amended.
#**10.6 Software Licensing Agreement having an effective date of June 13, 1996
between the Registrant and Canon Computer systems Incorporated.
**10.7 Service Agreement No. 200.504 dated November 26, 1990 between the
Registrant and International Business Machines Corporation, as amended
to date.
10.8 Software Task Order Agreement dated November 20, 1995 between the
Registrant and Tivoli Systems, Inc., as amended.
10.9 Credit Agreement dated November 8, 1997 between the Registrant and
Texas Commerce Bank National Association.
10.10 Promissory Note dated November 8, 1997 from the Registrant to Texas
Commerce Bank National Association.
**10.11 Accounts Receivable Agreement dated October 1, 1996 between the
Registrant and Pencom Systems Incorporated.
**10.12 Letter Agreement dated October 2, 1996 between the Registrant and
Pencom Systems Incorporated.
**10.13 Recruiting Services Agreement dated January 20, 1997 between the
Registrant and Pencom Systems Incorporated.
**10.14 Stockholders Agreement dated October 1, 1996 between the Registrant and
certain stockholders of the Registrant.
**10.15 Registration Rights Agreement dated October 1, 1996 between the
Registrant and certain stockholders and warrantholders of the
Registrant.
**10.16 Employment Agreement dated October 19, 1992 between Dr. William Frank
King and Pencom Systems Incorporated.
**10.17 Employment Agreement dated October 1, 1996 between Dr. W. Frank King
and the Registrant.
**10.18 Employment Agreement dated July 1, 1993 between the Registrant and
Patrick Motola.
**10.19 Employment Agreement dated September 27, 1993 between the Registrant
and William Cason. **10.20 Employment Agreement dated October 19,
1993 between the Registrant and Brian Baisley.
10.21 Employment Agreement dated September 15, 1994 between the Registrant
and Dennis Thompson.
**10.22 1996 Stock Option/Stock Issuance Plan.
**10.23 Employee Stock Purchase Plan.
**10.24 PSW Profit Sharing Plan.
**10.25 Description of Executive Bonus Plan.
**10.26 Stock Purchase Agreement dated as of January 1, 1997 between Michael J.
Maples and the Registrant.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<C> <S>
**10.27 Stock Subscription dated October 1, 1996 between Pencom Systems
Incorporated and the Registrant.
**10.28 Asset Contribution Agreement dated October 1, 1996 between Pencom
Systems Incorporated and the Registrant.
**10.29 Assignment and Assumption Agreement dated October 1, 1996 between the
Registrant and Pencom Systems Incorporated.
**10.30 Warrant dated October 1, 1996 issued by the Registrant to Pencom
Systems Incorporated.
**10.31 Warrant dated October 1, 1996 issued by the Registrant to Stephen
Markman.
**10.32 Warrant dated October 1, 1996 issued by the Registrant to
Thomas Pallister.
**10.33 Warrant dated October 1, 1996 issued by the Registrant
to Joy Venegas.
23.1 Consent of Ernst & Young L.L.P.
27.1 Financial Data Schedule
- ---------
</TABLE>
** Incorporated herein by reference to the Company's Registration
Statement on Form S-1 (File No. 333-21565).
# The Company has been granted confidential treatment with respect to
certain portions of these documents. The portions of these documents
which have been omitted are denoted by an asterisk[*]. The omitted
portions of these documents have been filed with the Securities and
Exchange Commission pursuant to Rule 406 under the Securities Act of
1933.
Reports on Form 8-K:
During the quarter ended December 31, 1997, no current reports on Form 8-K
were filed.
<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.
PSW TECHNOLOGIES, INC.
March 27, 1998 By: /s/ W. Frank King
- -------------- -------------------------------------------
Date Dr. W. Frank King, President, Chief
Executive Officer and Director
(Principal Executive Officer)
March 27, 1998 By: /s/ Patrick D. Motola
- -------------- -------------------------------------------
Date Patrick D. Motola, Senior Vice President of
Operations, Chief Financial Officer and
Secretary (Principal Financial Officer)
March 27, 1998 By: /s/ Keith D. Thatcher
- -------------- -------------------------------------------
Date Keith D. Thatcher, Vice President of
Finance and Treasurer
(Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange 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.
March 27, 1998 By: /s/ Wade E. Saadi
- -------------- -------------------------------------------
Date Wade E. Saadi,
Chairman of the Board of Directors
March 27, 1998 By: /s/ Edward C. Ateyeh, Jr.
- -------------- -------------------------------------------
Date Edward C. Ateyeh, Jr., Director
March 27, 1998 By: /s/ Thomas A. Herring
- -------------- -------------------------------------------
Date Thomas A. Herring, Director
March 27, 1998 By: /s/ Kevin B. Kurtzman
- -------------- -------------------------------------------
Date Kevin B. Kurtzman, Director
March 27, 1998 By: /s/ Michael J. Maples
- -------------- -------------------------------------------
Date Michael J. Maples, Director
March 27, 1998 By: /s/ Jonathan D. Wallace, Esq.
- -------------- -------------------------------------------
Date Jonathan D. Wallace, Esq., Director
EXHIBIT 10.8
AMENDMENT NO. 2
TO
Tivoli Systems, Inc. and PSW Technologies, Inc.
Software Task Order Agreement
Dated November 20, 1995
This Amendment No. 2 is made between the parties effective this 1st day of
December 1997, to the Software Task Order Agreement (hereinafter the
"Agreement") dated November 20, 1995 and as amended by Amendment No. 1 to assign
the Agreement from Pencom Software to PSW Technologies, Inc. on November 8,
1996. The parties agree to amend the Agreement as follows:
1. Paragraph 12.1 Term of Agreement.
This paragraph currently reads:
This Agreement shall be effective upon the parties execution of this Agreement,
and shall remain in force for a period of two (2) years, unless otherwise
terminated as provided herein; provided, however, that the Work Statement shall
remain in effect after such termination, until the Work Statement is terminated
as provided herein or performance thereunder is completed.
This paragraph is replaced by:
This Agreement shall be effective upon the parties' execution of this Agreement,
and shall remain in force through December 31, 1998, provided, however, the
Agreement shall be extended automatically for additional one (1) year periods
unless otherwise terminated as provided herein. Additionally, Work Statements in
progress shall remain in effect after such termination, until the Work Statement
is terminated as provided herein or performance thereunder is completed.
2. All other terms and conditions of the Agreement remain in full force and
effect.
The parties hare read this Amendment and agree to its terms by their execution
below.
Tivoli Systems, Inc. PSW Technologies, Inc.
BY: /s/ Howard J. Nicholas BY: /s/ Patrick Motola
Title: Manager, Contract Services Title: CFO & VP Operations
Date: January 22, 1998 Date: January 22, 1998
EXHIBIT 10.12
Amended and Restated Credit Agreement November 8,1997
PSW TECHNOLOGIES, INC.
AMENDED AND RESTATED CREDIT AGREEMENT
THIS AMENDED AND RESTATED CREDIT AGREEMENT (as amended, restated and
supplemented from time to time, this Agreement) between PSW TECHNOLOGIES, INC.
(Borrower) and TEXAS COMMERCE BANK NATIONAL ASSOCIATION (Bank) is dated as of
November 8, 1997 (the Effective Date).
PRELIMINARY STATEMENT, Borrower and Bank entered into a Credit Agreement dated
as of November 8, 1996, and have agreed to modify and replace such agreement in
its entirety, as provided hereinafter.
1. THE LOANS.
REVOLVING CREDIT NOTE 1.1.A Subject to the terms and conditions hereof, Bank
agrees to make loans (Loans) to Borrower from time to time before the
Termination Date, not to exceed at any one time outstanding the lesser of
(i) $10,000,000.00 or (ii) the greater of $7,500,000.00 or the Borrowing Base
(such amount referred to herein as the Commitment). Borrower has the right to
borrow, repay and reborrow the Loans. Each Loan and each repayment must be at
least the minimum amount required in the Note. Loans may only be used for
financing Borrower's working capital needs and for making acquisitions. Chapter
15 of the Texas Credit Code (and any successor enactment) will not apply to this
Agreement, the Note or any Loan. Loans will be evidenced by, and will bear
interest and be payable as provided in, the promissory note of Borrower dated
the Effective Date (together with any and all renewals, extensions,
modifications and replacements thereof and substitutions therefor, the Note).
Termination Date means the earlier of. (a) May 1, 1999; or (b) the date
specified by Bank pursuant to Section 6.1 hereof.
LETTERS OF CREDIT 1.1.B Upon Borrower's application on the Bank's standard form
(Application), Bank in its discretion may from time to time until the
Termination Date issue commercial and standby tenets of credit (Letters of
Credit) subject terms and conditions of this Agreement. Each Application made by
Borrower after the effective date of this Section 1.1B shall be deemed to be for
a Letter of Credit subject to this Agreement, unless such Application expressly
and prominently states otherwise. The Commitment shall be reduced by the sum of.
(a)'the face amount of all outstanding Letters of Credit; and (b) the amount of
any unreimbursed drawings or other amounts owing to the Bank under or in respect
of any Letter of Credit or Application (such sum being the "L/C Obligations"),
so that, on any date, the sum of (x)'all Loans outstanding and (y) all UC
Obligations does not exceed the Commitment. The aggregate amount of L/C
Obligations shall never exceed $5,000,000.00 at any one time. Each Application
shall be deemed to include Borrower's representation that no default under this
Agreement exists and is continuing as of the date of such application, and that
all of Borrower's representations and warranties are true as of such date. Each
Application and UC Obligation is an Obligation within the meaning of this
Agreement. Bank is entitled to all rights, powers, benefits, privileges and
remedies granted under any provision of the Loan Documents and by law or in
equity in respect of all UC Obligations. Bank's rights and interests under this
Agreement and the other Loan Documents shall be cumulative with the rights and
interests granted in each Application (which shall be included in the definition
of "Loan Documents"). Any Event of Default under this Agreement shall be a
default under each Application, and each default against the terms of any
Application is an Event of Default under this Agreement. Borrower shall pay all
fees and charges quoted by Bank to Borrower at the time of the Application is
made, or if not quoted, all of Bank's standard fees and charges as of such time.
Bank may (but is not required to) make advances under the Note without notice to
Borrower to pay any UC Obligation.
BORROWING BASE 1.2 The Borrowing Base will be the amount shown as the BORROWING
BASE on the most recent Borrowing Base Report, subject to verification by Bank
and calculated using the eligibility criteria, borrowing base factors and dollar
ceilings for various components specified in the attached Exhibit'A,
incorporated herein by reference; provided, however that REQUIRED PAYMENT 1.3 If
the unpaid amount of the Loans at any time exceeds the Borrowing Base then in
effect, Borrower must make a payment on the Note in an amount sufficient to
reduce the unpaid principal balance of the Note to an amount no more than the
greater of $7,500,000.00 or the amount of the Borrowing Base. Such payment shall
be accompanied by any prepayment charge required by the Note and shall be due
concurrently with the Borrowing Base Report.
COMMITMENT FEE; TERMINATION 1.4 Borrower will pay a commitment fee (computed on
the basis of a year comprised of 360 days of 3/16% per annum on the daily
average difference between the Commitment and the principal balance of the Note,
from the date hereof to the Termination Date. The Commitment fee shall be
computed, and be due and payable, quarterly in arrears. Borrower shall be
entitled, upon delivery of 30 days advance written notice to Bank, to terminate
its use of the unused portion of the Commitment as of the effective date of such
notice. Upon the effective date of such notice of termination, accrual of the
commitment fee shall cease; Borrower shall thereupon not have the right to
borrow or reborrow new Loans under the Commitment (notwithstanding anything in
this Agreement or the other Loan Documents to the contrary); and the amount of
such fee seemed through the effective date of such termination shall be
immediately due and payable.
CAPITAL ADEQUACY 1.5 With respect to any Loan bearing interest at the LIBOR
Rate, if Bank determines after the date of this Agreement that any change in
applicable laws, rules or regulations regarding capital adequacy, or any change
in the interpretation or administration thereof by any appropriate governmental
agency, or compliance with any request or directive to Bank regarding capital
adequacy (whether or not having the force of law) of any such agency, increases
the capital required to be maintained with respect to any Loan bearing interest
at the LIBOR Rate and therefore reduces the rate of return on Bank's capital
below the level Bank could have achieved but for such change or compliance
(taking into consideration Bank's policies with respect to capital adequacy),
then Borrower will pay to Bank from time to time, within 15 days of Bank's
request, any additional amount required to compensate Bank for such reduction.
Bank will request any additional amount by delivering to Borrower a certificate
of Bank setting forth the amount necessary to compensate Bank. The certificate
will be conclusive and binding, absent manifest error. Bank may make any
assumptions, and may use any allocations of costs Ad expenses and any averaging
and attribution methods, which Bank in good faith finds reasonable.
2. CONDITIONS PRECEDENT.
ALL LOANS 2.1 Bank is not obligated to make any Loan unless: (a) Bank has
received the following, duly executed and in Proper Form: (1)'a Request for
Loan, substantially in the form of Exhibit B, within the time required in the
Note; provided however, Bank may accept and act upon verbal advance requests
received from Borrower's representative reasonably believed by Bank to be
authorized to make such requests; (2) if the aggregate outstanding amount of
Loans after making the requested Loan will exceed $7,500,000-00, a Borrowing
Base Report within the time required by this Agreement; and (3)'such other
documents as Bank reasonably may require; (b) no Event of Default exists; and
(e)'the making of the Loan is not prohibited by, or subjects Bank to any penalty
or onerous condition under any Legal Requirement. If Bank fails to make Loans
solely on the basis of clause (c) of the preceding sentence, then during the
period that such clause (c) applies, the commitment fee provided for in section
1.4 shall not accrue.
FIRST LOAN 2.2 In addition to the matters described in the preceding section,
Bank will not be obligated to make the first Loan unless Bank has received all
of the Loan Documents specified on Annex I in Proper Form.
3. REPRESENTATIONS AND WARRANTIES. To induce Bank to enter into this Agreement
and to make the Loans, Borrower represents and warrants as of the Effective Date
that each of the following statements is true and correct:
ORGANIZATION AND STATUS 3.1 Borrower and each Subsidiary of Borrower is duly
organized, validly existing and in good standing under the laws of the
jurisdiction of its organization; has all power and authority to conduct its
business as presently conducted, and is duly qualified to do business and in
good standing in each jurisdiction in which the nature of the business conducted
by it makes such qualification desirable. Borrower has no Subsidiary other than
those listed on Annex if and each Subsidiary is owned by Borrower in the
percentage set forth on Annex II.
FINANCIAL STATEMENTS 3.2 All financial statements delivered to Bank are complete
and correct and fairly present, in accordance with generally accepted accounting
principles, consistently applied ("GAAP"), the financial condition and the
results of operations of Borrower and each Subsidiary of Borrower as at the
dates and for the periods indicated. No material adverse change has occurred in
the assets, liabilities, financial condition, business or affairs of Borrower or
any Subsidiary of Borrower since the dates of such financial statements. Neither
Borrower nor any Subsidiary of Borrower is subject to any instrument or
agreement materially and adversely affecting its financial condition, business
or affairs.
ENFORCEABILITY 3.3 The Loan Documents are legal, valid and binding obligations
of the Borrower enforceable in accordance with their respective terms, except as
may be limited by bankruptcy, insolvency and other similar laws affecting
creditors' rights generally. The execution, delivery and performance of the Loan
Documents have all been duly authorized by all necessary action; are within the
power and authority of the Borrower; do not and will not violate any Legal
Requirement, the Organizational Documents of the Borrower or any agreement or
instrument binding or affecting the Borrower or any of its Property.
COMPLIANCE 3.4 Borrower and each Subsidiary of Borrower has filed all applicable
tax returns and paid all taxes shown thereon to be due, except those for which
extensions have been obtained and those which are being contested in good faith
and for which adequate reserves have been established. Borrower and each
Subsidiary of Borrower is in compliance with all applicable Legal Requirements
and manages and operates (and will continue to manage and operate) its business
in accordance with good industry practices. Neither Borrower nor any Subsidiary
of Borrower is in default in the payment of any other indebtedness or under any
agreement to which it is a party. The Parties have obtained all consents of and
registered with all Governmental Authorities or other Persons required to
execute, deliver and perform the Loan Documents.
LITIGATION 3.5 Except as previously disclosed to Bank in writing, there is no
litigation or administrative proceeding pending or, to the knowledge of
Borrower, threatened against, nor any outstanding judgment, order or decree
affecting Borrower or any Subsidiary of Borrower before or by any Governmental
Authority which, if determined adversely to Borrower, would have a material
adverse effect on Borrower's business or financial condition.
TITLE AND RIGHTS 3.6 Borrower and each Subsidiary of Borrower has good and
marketable title to its Property, free and clear of any Lien except for Liens
permitted by this Agreement and the other Loan Documents. Except as otherwise
expressly stated in the Loan Documents or permitted by this Agreement, the Liens
of the Loan Documents will constitute valid and perfected first and prior Liens
on the Property described therein, subject to no other Liens whatsoever.
Borrower and each Subsidiary of Borrower possesses all permits, licenses,
patents, trademarks and copyrights requited to conduct its business. All
casements, rights-of-way and other rights necessary to maintain and operate
Borrower's Property have been obtained and are in full force and effect.
REGULATION U; BUSINESS PURPOSE 3.7 None of the proceeds of any Loan will be used
to purchase or carry, directly or indirectly, any margin stock or for any other
purpose which would make this credit a "purpose credit" within the meaning of
Regulation U of the Board of Governors of the Federal Reserve System. All Loans
will be used for business, commercial, investment or other similar purpose and
not primarily for personal, family, or household use or primarily for
agricultural purposes as such terms are used in Chapter One of the Texas Credit
Code.
ENVIRONMENT 3.8 Borrower and each Subsidiary of Borrower have complied with
applicable Legal Requirements in each instance in which any of them have
generated, handled, used, stored or disposed of any hazardous or toxic waste or
substance, on or off its premises (whether or not owned by any of them). Neither
Borrower nor any Subsidiary of Borrower has any material contingent liability
for noncompliance with environmental or hazardous waste laws. Neither Borrower
nor any Subsidiary of Borrower has received any notice that it or any of its
Property or operations does not comply with, or that any Governmental Authority
is investigating its compliance with, any environmental or hazardous waste laws.
INVESTMENT COMPANY ACT/PUBLIC UTILITY HOLDING COMPANY ACT 3.9 Neither Borrower
nor any Subsidiary of Borrower is an investment company within the meaning of
the Investment Company Act of 1940 or a holding company or an affiliate of a
holding company or a public utility within the meaning of the Public Utility
Holding Company Act of 1935, as amended.
STATEMENTS BY OTHERS 3.10 All material written statements and information
provided by or on behalf of Borrower, any Subsidiary of Borrower or any other of
the Parties in connection with any Loan Document constitute the representations
and warranties of Borrower hereunder.
4. AFFIRMATIVE COVENANTS. Borrower agrees to do, and if necessary cause to be
done, and cause its Subsidiaries to do, each of the following:
CORPORATE FUNDAMENTALS 4.1 (a) Pay when due all taxes and governmental charges
of every kind upon it or against its income, profits or Property, unless and
only to the extent that the same shall be contested in good faith and adequate
reserves have been established therefor; (b)'and keep in full force and effect
all of its licenses, permits and franchises as may be reasonably necessary to
conduct its business properly and efficiently; (c) Do all things necessary to
preserve its corporate existence and its qualifications and rights in all
jurisdictions where such qualification is necessary or desirable; (d)'Comply
with all applicable Legal Requirements; and (a) Protect, maintain and keep in
good repair its Property and make all replacements and additions to its Property
as may be reasonably necessary to conduct its business properly and efficiently.
INSURANCE 4.2 Maintain insurance with such reputable financially sound insurers,
on such of its Property and personnel, in such amounts and against such risks as
is customary with similar Persons or as may be reasonably required by Bank, and
furnish Bank satisfactory evidence thereof promptly upon request. These
insurance provisions are cumulative of the insurance provisions of the other
Loan Documents. Bank must be named as a beneficiary, loss payee or additional
insured of such insurance as its interest may appear and Borrower must provide
Bank with copies of the policies of insurance and a certificate of the insurer
that the insurance required by this section may not be canceled, reduced or
affected in any manner without 30 days' prior written notice to Bank.
FINANCIAL INFORMATION/BORROWING BASE REPORT 4.3 Furnish to Bank in Proper Form
(i)'the financial statements prepared in conformity with GAAP on consolidated
and consolidating bases and the other information described in, and within the
times required by, Exhibit C. Reporting Requirements, Financial Covenants and
Compliance Certificate attached hereto and incorporated herein by reference;
(ii) the Borrowing Base Report substantially in the form of, and within the time
required by, Exhibit A along with the other information required by Exhibit A to
be submitted; (iii)'within the time required by Exhibit C, Exhibit C signed and
certified by the chief financial officer or president of Borrower; (iv) promptly
after such request is submitted to the appropriate Governmental Authority, any
request for waiver of funding standards or extension of amortization periods
with respect to any employee benefit plan; (v)'copies of special audits,
studies, reports and analyses prepared for the management of Borrower by outside
parties and (vi) such other information relating to the financial condition and
affairs of the Borrower and guarantors and their Subsidiaries as Bank may
request from time to time in its discretion.
MATTERS REQUIRING NOTICE 4.4 Notify Bank immediately, upon acquiring knowledge
of (a)'the institution or threatened institution of any lawsuit or
administrative proceeding which, if adversely determined, might materially
adversely affect Borrower; (b) any material adverse change in the assets,
liabilities, financial condition, business or affairs of Borrower; (c) any Event
of Default; or (d) any reportable event or any prohibited transaction in
connection with any employee benefit plan.
INSPECTION 4.5 Permit Bank and its affiliates to inspect and photograph its
Property, to examine and copy its files, books and records, and to discuss its
affairs with its officers and accountants, at such times and intervals and to
such extent as Bank reasonably desires.
ASSURANCES 4.6 Promptly execute and deliver any and all further agreements,
documents, instruments, and other writings that Bank may request to cure any
defect in the execution and delivery of any Loan Document or more fully to
describe particular aspects of the agreements set forth or intended to be set
forth in the Loan Documents.
CERTAIN CHANGES 4.7 Notify Bank at least 30 days prior to the date that any of
the Parties changes its name or the location of its chief executive office or
principal place of business or the place where it keeps its books and records,
EXHIBIT C 4.8 Comply with each of the other affirmative covenants set forth in
Exhibit C.
5. NEGATIVE COVENANTS. The Borrower will not, and no Subsidiary of Borrower
will, without the prior written consent of the Bank, which Bank shall be
entitled to withhold in its sole and absolute discretion (Bank agreeing that it
will respond in writing to each written request for such consent with reasonable
promptness):
INDEBTEDNESS 5.1 Create, incur, or permit to exist, or assume or guarantee,
directly or indirectly, or become or remain liable with respect to, any
Indebtedness, contingent or otherwise, unless there is a permitted amount in
Exhibit C, except: (a)'Indebtedness to Bank, or secured by Liens permitted by
this Agreement, or otherwise approved in writing by Bank, and renewals and
extensions (but not increases) thereof-, and (b)'current accounts payable and
unsecured current liabilities, not the result of borrowing, to vendors,
suppliers and Persons providing services, for expenditures for goods and
services normally required by it in the ordinary course of business and on
ordinary trade terms.
LIENS 5.2 Create or permit to exist any Lien upon any of its Property now owned
or hereafter acquired, or acquire any Property upon any conditional sale or
other title retention device or arrangement or any purchase money security
agreement; or in any manner directly or indirectly sell, assign, pledge or
otherwise transfer any of its accounts or other Property, unless as permitted in
Exhibit C, except: (a)'Liens, not for borrowed money, arising in the ordinary
course of business; (b)'Liens for taxes not delinquent or being contested in
good faith by appropriate proceedings; (e)'Liens in effect on the date hereof
and disclosed to Bank in writing, so long as neither the principal Indebtedness
secured thereby nor the Property covered thereby increases; and (d) Liens in
favor of Bank, or otherwise approved in writing by Bank. Notwithstanding
anything to the contrary herein, Borrower will not, and no Subsidiary of
Borrower will permit any Lien on any inventory that secures the Loans unless
Bank shall provide Borrower with Bank's prior written consent.
FINANCIAL AND OTHER COVENANTS 5.3 Fail to comply with the required financial
covenants and other covenants described, and calculated as set forth, in Exhibit
C. Unless otherwise provided on Exhibit'C, all such amounts and ratios will be
calculated: (a)'on the basis of GAAP; and (b)'on a consolidated basis.
Compliance with the requirements of Exhibit C will be determined as of the dates
of the financial statements to be provided to Bank.
CORPORATE CHANGES 5.4 In any single transaction or series of transactions,
directly or indirectly: (a)'liquidate or dissolve; (b)'sell or dispose of any
interest in any of its Subsidiaries, or permit any of its Subsidiaries to issue
any additional equity other than to Borrower; (c)'sell, convey or lease all or
any substantial part of its assets, except for sale of inventory in the ordinary
course of business; or (d)'permit any change in ownership of Borrower affecting
more than 49% of the stock ownership of Borrower (as of the Effective Date).
RESTRICTED PAYMENTS 5.5 Unless otherwise provided on Exhibit C, at any time
redeem, retire or otherwise acquire, directly or indirectly, any shares of its
capital stock or other equity interest.
NATURE OF BUSINESS; MANAGEMENT 5.6 Substantially change the nature of its
business or enter into any business which is substantially different from the
business in which it is presently engaged, or permit any material change in its
management (which shall be understood to have occurred if more than one of the
persons who are President, Chief Financial Officer and the Vice President of
Finance of the Borrower are changed).
AFFILIATE TRANSACTIONS 5.7 Enter into any transaction or agreement with any
Affiliate except upon terms substantially similar to those obtainable from
wholly unrelated sources.
SUBSIDIARIES 5.8 Form, create or acquire any Subsidiary; except that Borrower
shall be permitted to do any of the foregoing in compliance with the covenants
in Exhibit C, if in advance of or substantially simultaneously with such action
such Subsidiary shall execute a continuing guaranty of the Obligations in Proper
Form.
6. EVENTS OF DEFAULT AND REMEDIES.
EVENTS OF DEFAULT 6.1 Each of the following is an "Event of Default":
(a) Any Obligor fails to pay any principal of or interest on the Note or any
other obligation under any Loan Document as and when due; or
(b) Any Obligor or any Subsidiary of Borrower fails to pay at maturity, or
within any applicable period of grace, any principal of or interest on any other
borrowed money obligation (which shall not include any capital lease) in excess
of $100,000.00, or fails to observe or perform any term, covenant or agreement
contained in any agreement with respect to any such obligation; or
(c) Any representation or warranty made in connection with any Loan Document was
incorrect, false or misleading when made; or
(d) Any Obligor violates any covenant contained in any Loan Document; or
(e) An event of default occurs under any other Loan Document and any cure or
grace period with respect to such default has elapsed with such default
continuing; or
(f) Final judgment for the payment of money over $1,000,000.00 is rendered
against Obligor or any Subsidiary of Borrower and remains undischarged for a
period of 30 days during which execution is not effectively stayed; or
(g) The making of any levy, seizure, garnishment, sequestration or attachment
thereof or thereon; or the uninsured loss, theft, substantial damage, or
destruction of any material portion of Borrower's Property; or
(h) Any order is entered in any proceeding against Borrower or any Subsidiary of
Borrower decreeing the dissolution, liquidation or split-up thereof, and such
order shall remain in effect for 30 days; or
(i) Any Obligor or any subsidiary of Borrower makes a general assignment for the
benefit of creditors or shall petition or apply to any tribunal for the
appointment of a trustee, custodian, receiver or liquidator of all or any
substantial part of its business, estate or assets or shall commence any
proceeding under any bankruptcy, insolvency, dissolution or liquidation law of
any jurisdiction, whether now or hereafter in effect; or any such petition or
application shall be filed or any such proceeding shall be commenced against any
Obligor or any subsidiary of Borrower and the Obligor or such subsidiary by any
act or omission shall indicate approval thereof, consent thereto or acquiescence
therein, or an order shall be entered appointing a trustee, custodian, receiver
or liquidator of all or any substantial part of the assets of any Obligor or any
subsidiary of Borrower or granting relief to any Obligor or any subsidiary of
Borrower or approving the petition in any such proceeding, and such order shall
remain in effect for more than 30 days; or any Obligor or any subsidiary of
Borrower shall fail generally to pay its debts as they become due or suffer any
writ of attachment or execution or any similar process to be issued or levied
against it or any substantial part of its property which is not released,
stayed, handed or vacated within 30 days after its issue or levy; or
(j) Any Obligor or any Subsidiary of Borrower conceals or removes any part of
its Propeny, with intent to hinder, delay or defraud any of its creditors:
(A)'makes or permits a transfer of any of its Property which may be fraudulent
under any bankruptcy, fraudulent conveyance or similar law; or (B)'makes any
unscheduled transfer of its Property to or for the benefit of a creditor at a
time when other creditors similarly situated have not been paid; or
(k) A material adverse change occurs in the assets, liabilities or financial
condition of any Obligor, or any Subsidiary of Borrower, which is reasonably
related to such Obligor's ability to perform its obligations under the Loan
Documents and/or usability to avoid any Event of Default; or
(1) Any change occurs in the ownership of Borrower other than as expressly
permitted by this Agreement; or (in) Any Obligor that is not an individual
dissolves.
RIGHTS AND REMEDIES 6.2 If any Event of Default defined in Section 6.1 occurs,
then Bank may do any or all of the following: (1) declare the Obligations to be
immediately due and payable without notice of acceleration or of intention to
accelerate, presentment and demand or protest, all of which are hereby expressly
waived; (2) without notice to any Obligor, terminate the Commitment and
accelerate the Termination Date; (3) set off, in any order, against the
indebtedness of Borrower under the Loan Documents any debt owing by Bank to
Borrower (whether such debt is owed individually or jointly), including, but not
limited to, any deposit account, which right is hereby granted by Borrower to
Bank; and (4) exercise any and all other rights pursuant to the Loan Documents,
at law, in equity or otherwise.
CURE PERIOD FOR CERTAIN EVENTS OF DEFAULT 6.3 Notwithstanding any other
provision of this Agreement or any other Loan Document to the contrary, the Bank
shall not take the actions described in Section'6.2 during the Cure Period (as
defined hereinafter), with respect to: (i)'any Event of Default described in
section 6.1 (a) or (b) which consists of delay in making a payment of money; or
(it) an Event of Default described in section 6.1 (b) or (d) which consists of
delay in delivering reports or documents; or (iii)'an Event of Default described
in section 6.1(d) which consists of a curable failure to maintain a financial
covenant set out in Exhibit C Part C. With respect to an Event of Default
described in clause (i)'of the preceding sentence, the "Cure Period" shall be 5
business days beginning on the first day of the Event of Default. With respect
to an Event of Default described in clause (it) or (in) of the first sentence of
this section, the "Cure Period" shall be 15 calendar days beginning on the first
day of the Event of Default. This section 6.3 shall be void and of no effect
unless Borrower shall, to the extent Borrower has actual knowledge thereof,
provide prompt notices to Bank (in writing if requested by the Bank) of (x)'the
occurrence or expected occurrence of such Event of Default, with a certification
to Bank of Borrower's good faith expectation that such Event of Default shall be
cured by Borrower before the end of the Cure Period; and (y)'the occurrence of
Borrower's cure of the Event of Default before the end of the Cure Period,
During the Cure Period, an Event of Default shall be deemed to have occurred and
be continuing until actually cured by Borrower, for all purposes including
without limitation Section 2. 1(b) hereof If the Event of Default is not cured
before the end of the Cure Period, Bank shall have all of the rights described
in Section'6.2 and each of the other Loan Documents without any restriction
imposed by this section whatsoever. This section shall not restrict the Bank
from taking any remedy with respect to any Event of Default not specified in the
first sentence of this section.
REMEDIES CUMULATIVE 6.4 No remedy, right or power of Bank is exclusive of any
other remedy, right or power now or hereafter existing by contract, at law, in
equity, or otherwise, and all remedies, rights and powers are cumulative.
7. MISCELLANEOUS.
NO WAIVER 7.1 No waiver of any default or Event of Default will be a waiver of
any other default or Event of Default. No failure to exercise or delay in
exercising any right or power under any Loan Document will be a waiver thereof,
nor shall any single or partial exercise of any such right or power preclude any
further or other exercise thereof or the exercise of any other right or power.
The making of any Loan during either the existence of any default or Event of
Default, or subsequent to the occurrence of an Event of Default will not be a
waiver of any such default or Event of Default. No amendment, modification or
waiver of any Loan Document will be effective unless the same is in writing and
signed by the Person against whom such amendment, modification or waiver is
sought to be enforced. No notice to or demand on any Person shall entitle any
Person to any other or further notice or demand in similar or other
circumstances.
NOTICES 7.2 All notices required under the Loan Documents shall be in writing
and either delivered against receipt therefor, or mailed by registered or
certified mail, return receipt requested, in each case addressed to the address
shown on the signature page hereof or to such other address as a party may
designate. Except for the notices required by Section'2.1, which shall be given
only upon actual receipt by Bank, notices shall be deemed to have been given
(whether actually received or not) when delivered (or, if mailed, on the next
Business Day).
GOVERNING LAW/ARBITRATION 7.3 (a)'UNLESS OTHERWISE SPECIFIED THEREIN, EACH LOAN
DOCUMENT IS GOVERNED BY TEXAS LAWS AND THE APPLICABLE LAWS OF THE UNITED STATES
OF AMERICA. To the maximum extent permitted by law, any controversy or claim
arising out of or relating to the Loans or any Loan Document, including but not
limited to any claim based on or arising from an alleged tort or an alleged
breach of any agreement contained in any of the Loan Documents, shall, at the
request of any party to the Loan or Loan Documents (either before or after the
commencement of judicial proceedings), be settled by mandatory and binding
arbitration in accordance with the Commercial Arbitration Rules of the American
Arbitration Association (the "AAA Rules") and pursuant to Title 9 of the United
States Code, or if Title 9 does not apply, the Texas General Arbitration Act. In
any arbitration proceeding: (i) all statutes of limitations which would
otherwise be applicable shall apply; and (it) the proceeding shall be conducted
in the city in which the office of Bank originating the Loans is located by a
panel of three arbitrators. Arbitrators are empowered to resolve any controversy
by summary rulings substantially similar to summary judgments and motions to
dismiss. Arbitrators may order discovery conducted in accordance with the
Federal Rules of Civil Procedures. All arbitrators will be selected by the
process of appointment from a panel, pursuant to the AAA Rules. Any award
rendered in the arbitration proceeding will be final and binding, and judgment
upon any such award may be entered in any court having jurisdiction. (b)'If any
party to the Loan or Loan Documents files a proceeding in any court to resolve
any controversy or claim, such action will not constitute a waiver of the right
of such party or a bar to the right of any other party to seek arbitration under
the provisions of this Section or that of any other claim or controversy, and
the court shall, upon motion of any party to the proceeding, direct that the
controversy or claim be arbitrated in accordance with this Section. (c) No
provision of, or the exercise of any rights under, this Section shall limit or
impair the right of any party to the Loan Documents before, during or after any
arbitration proceeding to: (i)'exercise self-help remedies including but not
limited to setoff or repossession; (ii)'foreclose any Lien on or security
interest in any Collateral; or (iii)'obtain relief from a court of competent
jurisdiction to prevent the dissipation, damage, destruction, transfer,
hypothecation, pledging or concealment of assets or Collateral including, but
not limited to attachments, garnishments, sequestrations, appointments of
receivers, injunctions or other relief to preserve the status quo, (d)'To the
maximum extent permitted by applicable law and the AAA Rules, neither Bank nor
any Obligor or any Affiliate, officer, director, employee, attorney, or agent of
either shall have any liability with respect to, and Bank and each Obligor
waives, releases, and agrees not to sue any of them upon, any claim for any
special, indirect, incidental and consequential damages suffered or incurred by
such Person in connection with, arising out of, or in any way related to, this
Agreement or any of the other Loan Documents. Each of Bank and each Obligor
waives, releases, and agrees not to sue each other or any of their Affiliates,
officers, directors, employees, attorneys, or agents for consequential or
punitive damages in respect of any claim in connection with, arising out of, or
in my way related to, this Agreement or any of the other Loan Documents, or any
of the transactions contemplated by this Agreement or any of the other Loan
Documents. Nothing contained herein, however, shall be construed as a waiver of
any Obligor's or the Bank's tight to compel arbitration of disputes pursuant to
subparagraphs (a) and (b), above.
(e) Nothing herein shall be considered a waiver of the right or protections
afforded Bank by 12 U.S.C. 9 1, Texas Banking Code Art. 342-609 or anysimilar
statute.
(f) Each party agrees that any other party may proceed against any other liable
Person, jointly or severally, or against one or more of them, less than all,
without impairing rights against any other liable Persons. A party shall not be
required to join the principal Obligor or any other liable Persons (e.g.,
sureties or guarantors) in any proceeding against any Person. A party may
release or settle with one or more liable Persons as the party deems fit without
releasing or impairing right to proceed against any Persons not so released.
SURVIVAL; PARTIES BOUND; TERM OF AGREEMENT 7.4 All representations, warranties,
covenants and agreements made by or on behalf of Borrower in connection with the
Loan Documents will survive the execution and delivery of the Loan Documents;
will not be affected by any investigation made by any Person, and will bind
Borrower and the successors, trustees, receivers and assigns of Borrower and
will benefit the successors and assigns of the Bank; provided that Bank's
agreement to make Loans to Borrower will not inure to the benefit of any
successor or assign of Borrower. Except as otherwise provided herein, the term
of this Agreement will be until the later of the final maturity of the Note and
the full and final payment of all Obligations and all amounts due under the Loan
Documents.
DOCUMENTARY MATTERS 7.5 This Agreement may be executed in several identical
counterparts, on separate counterparts; each counterpart will constitute an
original instrument, and all separate counterparts will constitute but one and
the same instrument. The headings and captions in the Loan Documents have been
included solely for convenience and should not be considered in construing the
Loan Documents. If any provision of any Loan Document is invalid, illegal or
unenforceable in any respect under any applicable law, the remaining provisions
will remain effective. The Loans and all other obligations and indebtedness of
Borrower to Bank are entitled to the benefit of the Loan Documents.
EXPENSES 7.6 Upon the execution of this Agreement, Borrower agrees to pay Bank a
$500.00 fee for Bank's preparation, negotiation and handling of this Agreement.
Following the execution of this Agreement, Borrower agrees to pay on demand all
out-of-pocket expenses (including, without limitation, the fees and expenses of
counsel for Bank) in connection with the negotiation, preparation, execution,
filing, recording, modification, supplementing and waiver of the Loan Documents
and the making, servicing and collection of the Loans. The obligations of the
Borrower under this and the following section will survive the termination of
this Agreement.
USURY NOT INTENDED 7.8 Borrower and Bank intend to conform strictly to
applicable usury laws. Therefore, the total amount of interest (as defined under
applicable law) contracted for, charged or collected under this Agreement or any
other Loan Document will never exceed the Highest Lawful Rate. If Bank contracts
for, charges or receives any excess interest, it will be deemed a mistake. Bank
will automatically reform the Loan Document or charge to conform to applicable
law, and if excess interest has been received, Bank will either refund the
excess to Borrower or credit the excess on any unpaid principal amount of the
Note or any other Loan Document. All amounts constituting interest will be
spread throughout the full term of the Loan Document or applicable Note in
determining whether interest exceeds lawful amounts.
NO COURSE OF DEALING 7.9 NO COURSE OF DEALING BY BORROWER WITH BANK, NO COURSE
OF PERFORMANCE AND NO TRADE PRACTICES OR OTHER EXTRINSIC EVIDENCE OF ANY NATURE
MAY BE USED TO CONTRADICT, VARY, SUPPLEMENT OR MODIFY ANY TERM OF THIS
AGREEMENT.
8. DEFINITIONS.
Unless the context otherwise requires, capitalized terms used in Loan Documents
and not defined elsewhere shall have the meanings provided by GAAP, except as
follows:
Account Debtor means any person in any way obligated on or in connection with
any Account. Affiliate means, as to any Person, any other Person (a) that
directly or indirectly, through one or more intermediaries, controls or is
controlled by, or is under common control with, such Person; (b)'that directly
or indirectly beneficially owns or holds five percent (5%) or more of any class
of voting stock of such Person; or (c)'five percent (5%) or more of the voting
stock of which is directly or indirectly beneficially owned or held by the
Person in question. The term "control" means to possess, directly or indirectly,
the power to direct the management and policies of a Person, whether through the
ownership of voting securities, by contract, or otherwise. Bank is not under any
circumstances to be deemed an Affiliate of Borrower or any of its Subsidiaries.
Authority Documents means certificates of authority to transact business,
certificates of good standing, borrowing resolutions (with secretary's
certificate), secretary's certificates of incumbency, and other documents which
empower and enable Borrower or its representatives to enter into agreements
evidenced by Loan Documents or evidence such authority. Business Day means a day
when the main office of Bank is open for the conduct of commercial lending
business. Corporation means corporations, partnerships, limited liability
companies, joint ventures, joint stock associations, associations, banks,
business trusts and other business entities.
Debt means all revolving, term and other interest and non-interest bearing debt
from banks and other financial institutions excluding accounts payable and other
accruals.
EBITDA means Borrower's earnings before interest, taxes, depreciation,
amortization and other Specified Non-Cash Charges. Government Accounts means
receivables owed by the U.S. government or by the government of any state,
county, municipality, or other political subdivision as to which Bank's security
interest or ability to obtain direct payment of the proceeds is governed by any
federal or state statutory requirements other than those of the Uniform
Commercial Code, including, without limitation, the Federal Assignment of Claims
Act of 1940, as amended. Governmental Authority means any foreign governments]
authority, the United States of America, any state of the United States and any
political subdivision of any of the foregoing, and any agency, department,
commission, board, bureau, court or other tribunal having jurisdiction over Bank
or any Obligor, or any Subsidiary of Borrower or their respective Property.
Highest Lawful Rate means the maximum nonusurious rate of interest permitted to
be charged by applicable Federal or Texas law (whichever permits the bigger
lawful rate) from time to time in effect. if Chapter One of the Texas Credit
Code establishes the Highest Lawful Rate, the Highest Lawful Rate is the
"indicated rate ceiling" as defined in that Chapter. Indebtedness means and
includes (a) all items which in accordance with GAAP, would be included on the
liability side of a balance sheet on the date as of which Indebtedness is to be
determined (excluding capital stock, surplus, surplus reserves and deferred
credits); it being understood that operating lease obligations and other such
obligations which under GAAP do not appear as liabilities on Borrower's balance
sheet are not Indebtedness; (b)'all guaranties, endorsements and other
contingent obligations in respect of, or any obligations to purchase or
otherwise acquire, Indebtedness of others, and (e)'all Indebtedness secured by
any Lien existing on any interest of the Person with respect to which
indebtedness is being determined, in Property owned subject to such Lien,
whether or not the Indebtedness secured thereby has been assumed. Legal
Requirement means any law, ordinance, decree, requirement, order, judgment,
rule, regulation (or interpretation of any of the foregoing) of, and the terms
of any license or permit issued by, any Governmental Authority. Lien shall mean
any mortgage, pledge, charge, encumbrance, security interest, collateral
assignment or other lien or restriction of any kind, whether based on common
law, constitutional provision, statute or contract. Loan Documents means this
Agreement, the agreements, documents, instruments and other writings
contemplated by this Agreement or listed on Annex 1, all other assignments,
deeds, guaranties, pledges, instruments, certificates and agreements now or
hereafter executed or delivered to the Bank pursuant to any of the foregoing,
and all amendments, modifications, renewals, extensions, increases and
rearrangements of, and substitutions for, any of the foregoing. Obligations
means all principal, interest and other amounts which are or become owing under
this Agreement, the Note or any other Loan Document.
Obligor means each Borrower and any guarantor, surety, co-signer, general
partner or other person who may now or hereafter be obligated to pay all or any
part of the Obligations.
Organizational Documents means, with respect to a corporation, the certificate
of incorporation, articles of incorporation and bylaws of such corporation; with
respect to a limited liability company, the articles of organization,
regulations and other documents establishing such entity, with respect to a
partnership, joint venture, or trust, the agreement, certificate or instrument
establishing such entity; in each case including all modifications and
supplements thereof as of the date of the Loan Document referring to such
Organizational Document and any and all future modifications thereof which are
consented to by Bank. Parties means all Persons other than Bank executing any
Loan Document, Person means any individual, Corporation, trust, unincorporated
organization, Governmental Authority or any other form of entity. Proper Form
means in form and substance satisfactory to the Bank. Property means any
interest in any kind of property or asset, whether real, personal or mixed,
tangible or intangible. Specified Non-Cash Charges means all non-cash charges to
the Borrower's income statement (not reflected as depreciation or amortization)
(a)'resulting from stock option transactions; or (b)'as agreed in writing by
Bank in its sole discretion, upon Borrower's request.
Subordinated Debt means any Indebtedness subordinated to Indebtedness due Bank
pursuant to a written subordination agreement in Proper Form by and among Bank,
subordinated creditor and Borrower which at a minimum must prohibit: (a)'any
action by subordinated creditor which will result in an occurrence of an Event
of Default or default under this Agreement, tire subordination agreement or the
subordinated Indebtedness; and (b)'upon the happening of any Event of Default or
default under any Loan Document, the subordination agreement, or any instrument
evidencing the subordinated Indebtedness (i)'any payment of principal and
interest on the subordinated Indebtedness; (ii)'any act to compel payment of
principal or interest on subordinated Indebtedness; and (iii)'any action to
realize upon any Property securing the subordinated Indebtedness.
Subsidiary means, as to a particular parent Corporation, any Corporation of
which 50% or more of the indicia of equity rights is at the time directly or
indirectly owned by such parent Corporation or by one or more Persons controlled
by, controlling or under common control with such parent Corporation.
THIS WRITTEN LOAN AGREEMENT REPRESENTS THE FINAL AGREEMENT BETWEEN BANK AND THE
PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR
SUBSEQUENT ORAL AGREEMENTS OF BANK AND THE PARTIES. THERE ARE NO UNWRITTEN ORAL
AGREEMENTS BETWEEN BANK AND THE PARTIES.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the Effective
Date.
BORROWER: PSW TECHNOLOGIES, INC.
By: /s/ Patrick Motola
Name: Patrick Motola
Title: CFO, Sr. VP
BANK: TEXAS COMMERCE BANK NATIONAL ASSOCIATION
By: /s/ Ralph T. Beasley
Name: Ralph T. Beasley
Title: Vice President
EXHIBIT'S ANNEXES
A Borrowing Base Report I Loan Documents
B Request for Loan II Subsidiaries
C Reporting Requirements, Financial Covenants,
and Compliance Certificate
EXHIBIT 10.13
Promissory Note, PSW Technologies, Inc.,
November 8,1997
PROMISSORY NOTE
(this "Note")
U.S. $10,000,000.00 November 8, 1997 ("Date")
FOR VALUE RECEIVED, PSW TECHNOLOGIES, INC. ("Borrower"), a Delaware corporation,
promises to pay to the order of TEXAS COMMERCE BANK NATIONAL ASSOCIATION
("Bank") on or before May 1, 1999 (the "Termination Date"), at its banking house
at 700 Lavaca, P.O. Box 550, Austin, Travis County, Texas 78701-0001, or at such
other location as Bank may designate, in lawful money of the United States of
America, the lesser of-. (i)'the principal sum of TEN MILLION AND NO/100THS
UNITED STATES DOLLARS (U.S. $10,000,000.00) (the "Maximum Loan Total"); or
(ii)'the aggregate unpaid principal amount of all loans made by Bank to Borrower
pursuant to the terms of the Credit Agreement (as hereinafter defined) (each
such loan being a "Loan"), which may be outstanding on the Termination Date.
Each Loan shall be due and payable on the maturity date agreed to by Bank and
Borrower with respect to such Loan (the "Maturity Date"). In no event shall any
Maturity Date fall on a date after the Termination Date. Subject to the terms
and conditions of this Note and the Loan Documents, Borrower may borrow, repay
and reborrow all or any part of the credit provided for herein at any time
before the Termination Date, there being no limitation on the number of Loans
made so long as the total unpaid principal amount at any time outstanding does
not exceed the Maximum Loan Total.
"Alternate Base Rate" shall mean for any day, a rate per annum (rounded upwards,
if necessary, to the next higher 1/16 of 1 %) equal to the greatest of. (a)'the
Prime Rate or (b)'the Federal Funds Effective Rate in effect on such day plus
1/4 of 1%. For purposes hereof, "Prime Rate" shall mean the rate of interest per
annum determined from time to time by the Bank as its prime rate in effect at
its principal office in Houston, Texas and thereafter entered in the minutes of
its Loan and Discount Committee; each change in the Prime Rate shall be
effective on the date such change is determined; without special notice to the
Maker or any other person or entity. THE PRIME RATE IS A REFERENCE RATE AND DOES
NOT NECESSARILY REPRESENT THE LOWEST OR BEST RATE ACTUALLY CHARGED TO ANY
CUSTOMER AND ANY STATEMENT, REPRESENTATION OR WARRANTY IN THAT REGARD OR TO THAT
EFFECT IS EXPRESSLY DISCLAIMED BY BANK. PAYEE MAY MAKE LOANS AT RATES OF
INTEREST AT, ABOVE OR BELOW THE PRIME RATE. "Federal Funds Effective Rate" shall
mean, for any day, the weighted average of the rates on overnight Federal funds
transactions with members of the Federal Reserve System arranged by Federal
funds brokers, as published on the next succeeding Business Day by the Federal
Reserve Bank of New York, or, if such rate is not so published for any day which
is a Business Day, the average of the quotations for the day of such
transactions received by the Bank from three Federal funds brokers of recognized
standing selected by Bank. If for any reason the Bank shall have determined
(which determination shall be conclusive absent manifest error) that it is
unable to ascertain the Federal Funds Effective Rate for any reason, including
the inability or failure of the Bank to obtain sufficient quotations in
accordance with the terms thereof, the Alternate Base Rate shall be determined
without regard to clause (b)'of the first sentence of this definition, as
appropriate, until the circumstances giving rise to such inability no longer
exist. Any change in the Alternate Base Rate due to a change in the Prime Rate
or the Federal Funds Effective Rate shall be effective on the effective date of
such change in the Prime Rate or the Federal Funds Effective Rate, respectively.
"Alternate Base Rate Loan" means a Loan which bears interest at a rate
determined by reference to the Alternate Base Rate.
"Assessment Rate" means, for any date, the annual rate (rounded upwards, if not
already a whole multiple of 1/16 of 1%, to the next higher 1/16 of 1%) most
recently estimated by the Bank as the then current net annual assessment rate
that will be employed in determining amounts payable by the Bank to the Federal
Deposit Insurance Corporation for insurance by the Corporation of time deposits
made in dollars at its domestic offices.
"Board" means the Board of Governors of the Federal Reserve System of the United
States.
"Borrowing Date" means any Business Day on which Bank shall make a Loan
hereunder.
"Business Day" means a day: (i)'on which Bank and commercial banks in New York
City are generally open for business; and (ii)'with respect to LIBOR Loans, on
which dealings in United States Dollar deposits are carried out in the interbank
markets.
"Highest Lawful Rate", means the maximum nonusurious rate of interest from time
to time permitted by applicable law. if Texas law determines the Highest Lawful
Rate, Bank has elected the "indicated" (weekly) ceiling as defined in the Texas
Credit Code or any successor statute. Bank may from time to time, as to current
and future balances, elect and implement any other ceiling under such Code
and/or revise the index, formula or provisions of law used to compute the rate
on this open-end account by notice to Borrower, if and to the extent permitted
by, and in the manner provided in such Code. "Interest Period" means the period
commencing on the Borrowing Date and ending on the Maturity Date, consistent
with the following provisions. The duration of each Interest Period shall be:
(a)'in the case of an Alternate Base Rate Loan, a period of 90 days unless any
portion thereof is converted to a LIBOR Loan hereunder; and (b)'in the case of a
LIBOR Loan, a period of up to one, two or three months; in each case as selected
by Borrower in accordance with the terms of this Note. Borrower's choice of
Interest Period is subject to the following limitations: (i)'No Interest Period
shall end on a date after the Termination Date; and (ii)'if the last day of an
Interest Period would be a day other than a Business Day, the Interest Period
shall end on the next succeeding Business Day (unless the Interest Period
relates to a LIBOR Loan and the next succeeding Business Day is in a different
calendar month than the day on which the Interest Period would otherwise end, in
which case the Interest Period shall end on the next preceding Business Day).
"LIBOR Loan" means a Loan which bears interest at a rate determined by reference
to the LIBOR Rate. "LIBOR Rate" means a per annum interest rate determined by
Bank by dividing: (i)'the average rate per annum (rounded upwards, if necessary,
to the next 1/16 of 1%) of the rates per annum at which United States dollar
deposits in an amount comparable to the principal amount of the LIBOR Loan to
which such LIBOR Rate is applicable for a term equal to or substantially equal
to the Interest Period are offered by Bank to prominent banks in the London
interbank market at approximately 11:00 a.m., London time, two Business Days
prior to the commencement of the applicable Interest Period; by (ii)'Statutory
Reserves.
"LIBOR Spread" means a spread of the following basis points (100 basis points
equaling 1.00%), based upon the Borrower's ratio of Total Funded Liabilities to
EBITDA as of the most recent fiscal quarter End Date (March 31, June 30,
September 30 and December 31) as defined and calculated in accordance with
Financial Covenant'#2 in Exhibit C of the Credit Agreement (as hereinafter
defined):
- -------------------------------- --------------------------------------
Total Funded Liabilities LIBOR Spread
/EBITDA (basis points)
- -------------------------------- --------------------------------------
if .74 or less then 125
- -------------------------------- --------------------------------------
- -------------------------------- --------------------------------------
if .75 to 1.49 then 150
- -------------------------------- --------------------------------------
- -------------------------------- --------------------------------------
if 1.56 or more then 175
- -------------------------------- --------------------------------------
"Loan Documents" means this Note and any document or instrument evidencing,
securing, guaranteeing or given in connection with this Note, including, but not
limited to, that certain Credit Agreement of even date herewith entered into by
and between Borrower and Bank (as may be amended from time to time, the "Credit
Agreement").
"Obligations" means all principal, interest and other amounts which are or
become owing under this Note or any other Loan Document.
"Obligor" means Borrower and any guarantor, surety, co-signer, general partner
or other person who may now or hereafter be obligated to pay all or any part of
the Obligations.
Specified Non-Cash Charges means all non-cash charges to the Borrower's income
statement (not reflected as depreciation or amortization) (a)'resulting from
stock option transactions; or (b)'as agreed in writing by Bank in its sole
discretion, upon Borrower's request.
"Statutory Reserves" means the difference (expressed as a decimal) of the number
one minus the aggregate of the maximum reserve percentages (including, without
limitation, any marginal, special, emergency, or supplemental reserves)
expressed as a decimal established by the Board and any other banking authority
to which Bank is subject to, with respect to the LIBOR Rate, for Eurocurrency
Liabilities (as defined in Regulation D of the Board). Such reserve percentages
shall include, without limitation, those imposed under such Regulation D. LIBOR
Loans shall be deemed to constitute Eurocurrency Liabilities and as such shall
be deemed to be subject to such reserve requirements without benefit of or
credit for proration, exceptions or offsets which may be available from time to
time to any bank under such Regulation D. Statutory Reserves shall be adjusted
automatically on and as of the effective date of any change in any reserve
percentage. Loans may be either Alternate Base Rate Loans or LIBOR Loans, as
selected by Borrower in accordance with the terms of this Note. Borrower shall
pay interest on the unpaid principal amount of each Alternate Base Rate Loan at
a rate per annum equal to the lesser of., (i)'the Alternate Base Rate in effect
from time to time (the "Effective Alternate Base Rate"); or (ii)'the Highest
Lawful Rate. Accrued interest on each Alternate Base Rate Loan is due and
payable on the first day of each month and at the Maturity Date. Borrower shall
pay interest on the unpaid principal amount of each LIBOR Loan for the Interest
Period with respect thereto at a rate per annum equal to the lesser of. (i)'the
LIBOR Rate plus the LIBOR Spread (the "Ratio Effective LIBOR Rate") (the Initial
Effective LIBOR Rate or the Ratio Effective LIBOR Rate, whichever applies, is
hereinafter sometimes the "Effective LIBOR Rate"); or (ii)'the Highest Lawful
Rate. Accrued interest on each LIBOR Loan is due on the last day of each
Interest Period applicable thereto and on any prepayment (on the amount
prepaid).
If at any time the effective rate of interest which would otherwise be payable
on any Loan evidenced by this Note exceeds the Highest Lawful Rate, the rate of
interest to accrue on the unpaid principal balance of such Loan during all such
times shall be limited to the Highest Lawful Rate, but any subsequent reductions
in such interest rate shall not become effective to reduce such interest rate
below the Highest Lawful Rate until the total amount of interest accrued on the
unpaid principal balance of such Loan equals the total amount of interest which
would have accrued if the Effective Alternate Base Rate, or Effective LIBOR
Rate, whichever is applicable, had at all times been in effect.
Each LIBOR Loan shall be in an amount not less than $500,000.00 and an integral
multiple of $100,000.00. Interest shall be computed on the basis of the actual
number of days elapsed and a year comprised of 360 days.
The unpaid principal balance of this Note at any time will be the total amounts
advanced by Bank, less the amount of all payments or prepayments of principal.
Absent manifest error, the records of Bank will be conclusive as to amounts
owed. Loans shall be made on Borrower's irrevocable notice to Bank, given not
later than 10:00 A.M. (Houston time) on, in the case of LIBOR Loans, the third
Business Day prior to the proposed Borrowing Date or, in the case of Alternate
Base Rate Loans, the Business Day of the proposed Borrowing Date. Each notice of
a requested borrowing (a "Notice of Requested Borrowing") under this paragraph
may be oral or written, and shall specify: (i)'the requested amount;
(ii)'proposed Borrowing Date; (iii)'whether the requested Loan is to be an
Alternate Base Rate Loan or LIBOR Loan; and (iv)'Interest Period for the LIBOR
Loan. If any Notice of Requested Borrowing shall be oral, Borrower shall deliver
to Bank prior to the Borrowing Date a confirmatory written Notice of Requested
Borrowing. Borrower may on any Business Day prepay the outstanding principal
amount of any Alternate Base Rate Loan, in whole or in part, without penalty or
premium. Borrower shall have the right to prepay any LIBOR Loan, subject to
Borrower's indemnity and reimbursement set out hereinafter.
Provided that no Event of Default has occurred and is continuing, Borrower may
elect to continue all or any part of any LIBOR Loan beyond the expiration of the
then current Interest Period relating thereto by providing Bank at least three
Business Day's written or telecopy notice of such election, specifying the Loan
or portion thereof to be continued and the Interest Period therefor and whether
it is to be an Alternate Base Rate Loan or LIBOR Loan provided that any
continuation as a LIBOR Loan shall not be less than $500,000.00 and shall be in
an integral multiple of $100,000.00. If an Event of Default shall have occurred
and be continuing, the Borrower shall not have the option to elect to continue
any such LIBOR Loan or to convert Alternate Base Rate Loans into LIBOR Loans.
Provided that no Event of Default has occurred and is continuing, Borrower may
elect to convert any Alternate Base Rate Loan at any time or from time to time
to a LIBOR Loan by providing Bank at least three Business Day's written or
telecopy notice of such election, specifying each Interest Period therefor. Any
conversion of Alternate Base Rate Loans shall not result in a borrowing of LIBOR
Loans in an amount less than $500,000.00 and in integral multiples of
$100,000.00. If at any time Bank determines in good faith (which determination
shall be conclusive) that any change in any applicable law, rule or regulation
or in the interpretation, application or administration thereof makes it
unlawful, or any central bank or other governmental authority asserts that it is
unlawful, for Bank or its foreign branch or branches to maintain any LIBOR Loan
by means of dollar deposits obtained in the London interbank market (any of the
above being described as a "LIBOR Event"), then, at the option of Bank, the
aggregate principal amount of all LIBOR Loans outstanding shall be prepaid;
however the prepayment may be made with an Alternate Base Rate Loan. Upon the
occurrence of any LIBOR Event, and at any time thereafter so long as such LIBOR
Event shall continue, the Bank may exercise its aforesaid option by giving
written notice thereof to Borrower within 30 days after Bank's determination
that a LIBOR Event has occurred).
If any domestic or foreign law, treaty, rule or regulation (whether now in
effect or hereinafter enacted or promulgated, including Regulation D of the
Board) or any interpretation or administration thereof by any governmental
authority charged with the interpretation or administration thereof (whether or
not having the force of law): (a)'changes, imposes, modifies, applies or deems
applicable any reserve, special deposit or similar requirements in respect of
any LIBOR Loan; or (b)'imposes on Bank or the interbank eurocurrency deposit and
transfer market or the market for domestic bank certificates or deposit any
other condition affecting any such LIBOR Loan; and the result of any of the
foregoing is to impose a cost to Bank of agreeing to make, funding or
maintaining any such LIBOR Loan or to reduce the amount of any sum receivable by
Bank in respect of any such Loan, then Bank may notify Borrower in writing of
the happening of such event and Borrower shall upon demand pay to Bank such
additional amounts as will compensate Bank for such costs as determined by Bank.
Without prejudice to the survival of any other agreement of Borrower under this
Note, the obligations of Borrower under this paragraph shall survive the
termination of this Note. Borrower will indemnify Bank against, and reimburse
Bank on demand for, any loss, cost or expense incurred or sustained by Bank
(including without limitation any loss, cost or expense incurred by reason of
the liquidation or reemployment of deposits or other funds acquired by Bank to
fund or maintain LIBOR Loans) as a result of. (a)'any payment or prepayment
(whether permitted by Bank or required hereunder or otherwise) of all or a
portion of any LIBOR Loan on a day other than the Maturity Date of such Loan;
(b)'any payment or prepayment, whether required hereunder or otherwise, of any
LIBOR Loan made after the delivery of a Notice of Requested Borrowing but before
the applicable Borrowing Date if such payment or prepayment prevents the
proposed Loan from becoming fully effective; or (c)'the failure of any LIBOR
Loan to be made by Bank due to any action or inaction of Borrower. Such funding
losses and other costs and expenses shall be calculated and billed by Bank and
such bill shall, as to the costs incurred, be conclusive absent manifest error.
All past-due principal and interest on this Note, will, at Bank's option, bear
interest at the lesser of Highest Lawful Rate, or a rate per annum equal to the
Alternate Base Rate plus three percent (3%).
In addition to all principal and accrued interest on this Note, Borrower agrees
to pay: (a)'all reasonable costs and expenses incurred by Bank and all owners
and holders of this Note in collecting this Note through probate,
reorganization, bankruptcy or any other proceeding; and (b)'reasonable
attorney's fees if and when this Note is placed in the hands of an attorney for
collection. Borrower and Bank intend to conform strictly to applicable usury
laws. Therefore, the total amount of interest (as defined under applicable law)
contracted for, charged or collected under this Note will never exceed the
Highest Lawful Rate. If Bank contracts for, charges or receives any excess
interest, it will be deemed a mistake. Bank will automatically reform the
contract or charge to conform to applicable law, and if excess interest has been
received, Bank will either refund the excess to Borrower or credit the excess on
the unpaid principal amount of this Note. All amounts constituting interest will
be spread throughout the full term of this Note in determining whether interest
exceeds lawful amounts.
If any Event of Default (as defined in the Credit Agreement) occurs, then Bank
may do any or all of the following: (i)'cease making Loans hereunder;
(ii)'declare the Obligations to be immediately due and payable, without notice
of acceleration or of intention to accelerate, presentment and demand or protest
or notice of any kind, all of which are hereby expressly waived; (iii)'set off,
in any order, against the Obligations any debt owing by Bank to any Obligor,
including, but not limited to, any deposit account, which right is hereby
granted by each Obligor to Bank; and (iv)'exercise any and all other rights
under the Loan Documents, at law, in equity or otherwise.
No waiver of any default is a waiver of any other default. Bank's delay in
exercising any right or power under any Loan Document is not a waiver of such
right or power.
Each Obligor severally waives notice, demand, presentment for payment, notice of
nonpayment, notice of intent to accelerate, notice of acceleration, protest,
notice of protest, and the filing of suit and diligence in collecting this Note
and all other demands and notices, and consents and agrees that its liabilities
and obligations will not be released or discharged by any or all of the
following, whether with or without notice to it or any other Obligor, and
whether before or after the stated maturity hereof-. (i)'extensions of the time
of payment; (ii)'renewals; (iii)'acceptances of partial payments; (iv) releases
or substitutions of any collateral or any Obligor; and (v)'failure, if any, to
perfect or maintain perfection of any security interest in any collateral. Each
Obligor agrees that acceptance of any partial payment will not constitute a
waiver and that waiver of any default will not constitute waiver of any prior or
subsequent default.
Where appropriate the neuter gender includes the feminine and the masculine and
the singular number includes the plural number. Borrower represents and agrees
that: all Loans evidenced by this Note are and will be for business, commercial,
investment or other similar purpose and not primarily for personal, family, or
household use as such terms are used in Chapter One of the Texas Credit Code.
Borrower represents and agrees that each of the following statements is true
unless the box preceding that statement is checked and initialed by Borrower and
Bank: (i)'No advances will be used primarily for agricultural purposes as such
term is used in the Texas Credit Code. (ii)'No advances will be used for the
purpose of purchasing or carrying any margin stock as that term is defined in
Regulation U of the Board. Notwithstanding anything contained herein or in any
other Loan Document, if this is a consumer credit obligation (as defined or
described in 12 C.F.R. 227, Regulation AA, promulgated by the Board), the
security for this credit obligation will not extend to any non-possessory
security interest in household goods (as defined in Regulation AA) other than a
purchase money security interest, and no waiver of any notice contained herein
or therein will extend to any waiver of notice prohibited by Regulation AA.
Chapter 15 of the Texas Credit Code (and any successor enactment) shall not
apply to this Note or to any Loan evidenced by this Note. This Note is governed
by Texas law. If any provision of this Note is illegal or unenforceable, that
illegality or unenforceability will not affect the remaining provisions of this
Note. BORROWER AND BANK AGREE THAT THE COUNTY IN WHICH BANK'S PRINCIPAL OFFICE
IS LOCATED IN TEXAS IS PROPER VENUE FOR ANY ACTION OR PROCEEDING BROUGHT BY
BORROWER OR BANK, WHETHER IN CONTRACT, TORT, OR OTHERWISE. ANY ACTION OR
PROCEEDING AGAINST BORROWER MAY BE BROUGHT IN ANY STATE OR FEDERAL COURT IN SUCH
COUNTY TO THE EXTENT NOT PROHIBITED BY APPLICABLE LAW. TO THE EXTENT PERMITTED
BY APPLICABLE LAW BORROWER HEREBY IRREVOCABLY (A) SUBMITS TO THE NONEXCLUSIVE
JURISDICTION OF SUCH COURTS, AND (B) WAIVES ANY OBJECTION IT MAY NOW OR
HEREAFTER HAVE AS TO THE VENUE OF ANY SUCH ACTION OR PROCEEDING BROUGHT IN ANY
SUCH COURT OR THAT ANY SUCH COURT IS AN INCONVENIENT FORUM. BORROWER AGREES THAT
SERVICE OF PROCESS UPON IT MAY BE MADE BY CERTIFIED OR REGISTERED MAIL, RETURN
RECEIPT REQUESTED, AT ITS ADDRESS SPECIFIED BELOW. BANK MAY SERVE PROCESS IN ANY
OTHER MANNER PERMITTED BY LAW AND MAY BRING ANY ACTION OR PROCEEDING AGAINST
BORROWER OR WITH RESPECT TO ANY OF ITS PROPERTY IN COURTS IN OTHER PROPER
JURISDICTIONS OR VENUES.
For purposes of this Note, any assignee or subsequent holder of this Note will
be considered the "Bank," and each successor to Borrower will be considered the
"Borrower."
Each Borrower and cosigner represents that if it is not a natural person, it is
duly organized and validly existing and in good standing under the laws of the
state of its incorporation or organization; has full power to own its properties
and to carry on its business as now conducted; is duly qualified to do business
and is in good standing in each jurisdiction in which the nature of the business
conducted by it makes such qualification desirable; and has not commenced any
dissolution proceedings. Each Borrower and cosigner that is subject to the Texas
Revised Partnership Act ("TRPA") agrees that Bank is not required to comply with
Section 3.05(d) of the TRPA and agrees that Bank may proceed directly against
one or more partners or their property without first seeking satisfaction from
partnership property. Each Borrower and cosigner represents that if it conducts
business under an assumed business or professional name it has properly filed
Assumed Name Certificate(s) in the office(s) required by Chapter 36 of the Texas
Business and Commerce Code. Each of the persons signing below as Borrower or
cosigner represents that he/she has full requisite power and authority to
execute and deliver this Note to Bank on behalf of the party for whom he/she
signs and to bind such party to the terms and conditions of this Note and that
this Note is enforceable against such party. NO COURSE OF DEALING BETWEEN
BORROWER AND BANK, NO COURSE OF PERFORMANCE, NO TRADE PRACTICES, AND NO
EXTRINSIC EVIDENCE OF ANY NATURE MAY BE USED TO CONTRADICT OR MODIFY ANY TERM OF
THIS NOTE OR ANY OTHER LOAN DOCUMENT. THIS NOTE AND THE OTHER WRITTEN LOAN
DOCUMENTS REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE
CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL
AGREEMENTS OF THE PARTIES.
THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES.
IN WITNESS WHEREOF, Borrower has executed this Note effective the day, month and
year first aforesaid.
BORROWER: PSW TECHNOLOGIES, INC.
By: /s/ Patrick Motola
Name: Patrick Motola
Title: CFO, SR. VP
(Bank's signature is provided as its acknowledgment of the above as the final
written agreement between the parties and as its agreement with each Borrower
subject to TRPA that Bank is not required to comply with Section 3.05(d) of
TR.PA.)
TEXAS COMMERCE BANK NATIONAL ASSOCIATION
By: /s/ Ralph T. Beasley
Name: Ralph T. Beasley
Title: Vice President
EXHIBIT 10.24
CONSENT AND ASSIGNMENT AGREEMENT
This CONSENT AND ASSIGNMENT AGREEMENT (the "Agreement") is entered into as of
October 1, 1996, by and among PSW TECHNOLOGIES, INC., PENCOM SYSTEMS
INCORPORATED ("PSI") and Dennis Thompson ("Employee").
WHEREAS, PSI and Employee entered into that certain Employment Agreement dated
September 15, 1994 (the "Employment Agreement") attached hereto as Exhibit A,
pursuant to which PSI agreed to employ Employee on the terms and conditions
contained therein.
WHEREAS, PSI desires to assign the benefits and the burdens of the Employment
Agreement to PSW, and PSW desires to accept such as an assignment.
NOW, THEREFORE, for good and valuation consideration, the receipt and
sufficiency of which is hereby acknowledged, the parties hereto hereby agree as
follows:
1. PSI hereby assigns to PSW, and PSW hereby accepts, all of PSI's right,
title and interest under the Employment Agreement, including but not
limited to all the benefits and burdens of the Employment Agreement.
2. Employee hereby consents to the assignment of the Employment Agreement from
PSI to PSW.
3. This Agreement shall be governed by and construed under the laws of the
State of Texas.
4. This Agreement, together with the Employment Agreement, constitute the full
and entire understanding and agreement among the parties with regard to the
subjects hereof and thereof.
5. This Agreement shall be binding upon and inure to the benefit of the
parties hereto and their respective legal representatives, successors and
assigns.
6. This Agreement may be executed in any number of counterparts, each of which
shall be deemed an original, but all of which together shall constitute one
instrument.
IN WITNESS WHEREOF, the parties hereto have caused this CONSENT AND ASSIGNMENT
AGREEMENT to be executed as of the day and year first above written.
PENCOM SYSTEMS INCORPORATED
/s/ Jonathan Wallace, Esq.
--------------------------
Jonathan Wallace, Esq.
General Counsel
PSW TECHNOLOGIES, INC.
/s/ W. Frank King
------------------------
W. Frank King
President and CEO
/s/ Dennis Thompson
------------------------
Employee
EXHIBIT A
EMPLOYMENT AGREEMENT
This agreement, entered into this 15th day of September, 1994, between PENCOM
SOFTWARE (PSW), a division of PENCOM SYSTEMS INCORPORATED, a New York
corporation and Dennis Thompson (herein after referred to as "EMPLOYEE").
1. PSW hereby employs EMPLOYEE in the position of Regional Sales
Representative.
2. EMPLOYEE shall receive a salary of $20,000.00 per annum, paid in
twenty-four (24) equal semi-monthly installments of $833.33. EMPLOYEE shall
receive the benefits set forth in the "Benefits Package" as amended from
time to time.
3. EMPLOYEE will devote his or her full business time and best efforts to PSW,
will provide technical services on such projects or to such clients as PSW
designates, and will perform such administrative duties related to his or
her other duties as PSW may reasonably assign.
4. EMPLOYEE agrees not to disclose to third parties, or to use for his or her
own benefit, information, materials or other property (including without
limitation, source code, object code, design documents, test suites,
protocols, other computer related information, the customer list, billing
rates, methods of doing business or other materials marked confidential)
belonging to PSW, or its clients. All information gained as a result of
this Agreement is confidential and such information shall not be disclosed
to third parties. EMPLOYEE further agrees that upon termination he or she
will return to PSW all such information and material in his or her
possession. This paragraph shall survive the expiration or termination of
this Agreement.
5. EMPLOYEE shall not during the term of this Agreement, and for a period of
one year thereafter, directly or indirectly:
a. Solicit or induce any employee or consultant of PSW to terminate his or her
employment.
b. Solicit or induce any customer of PSW to terminate its business
relationship with PSW, including firms that have been customers of PSW
within the twelve (12) months preceding EMPLOYEE'S termination.
c. Accept any opportunity (whether of a contract or full-time employment) with
a PSW client if Employee learned about the opportunity in the course of
Employee's employment by PSW.
6. EMPLOYEE agrees to disclose to PSW in writing any and all documentation,
inventions, improvements or discoveries which arise out of his or her
employment with PSW.
7. All copyrightable work is "work for hire" and EMPLOYEE hereby assigns to
PSW all rights and interest in any copyrightable work, invention or idea
made or conceived while in the performance of any job-related duties during
the term of this Agreement. EMPLOYEE will execute any documents, and at
PSW's expense provide any cooperation reasonably necessary to create or
record any such transfer of ownership.
8. EMPLOYEE represents that EMPLOYEE has the right to enter into this
Agreement without infringing any prior agreement to which EMPLOYEE is a
party; that all deliverable work provided hereunder will be original and
will not infringe any copyright, patent or other intellectual property
right; that the EMPLOYEE is an American citizen or legal permanent resident
of the United States and, at the same time this Agreement is signed, will
sign an I-9 form and will provide to PSW the documentation required.
EMPLOYEE will obey all PSW rules and regulations as they may be issued from
time to time.
9. It is understood that either party may terminate this Agreement without
cause by giving two weeks prior written notice to the other. In its sole
discretion, PSW may terminate employee, without cause, effective
immediately, upon payment of two weeks salary to employee. PSW may
terminate immediately upon written notice to EMPLOYEE for cause (including
without limitation PSW's client requesting termination of EMPLOYEE's
services).
10. This Agreement will be governed by Texas law.
11. This Agreement may not be assigned by either party without the prior
written consent of the other.
12. This Agreement, and any written amendments thereto, contain all terms and
conditions agreed upon by the parties hereto, and no other agreements, oral
or otherwise, shall be deemed to exist or to bind any of the parties
hereto. All previous communications, representations, warranties, promises,
conditions or agreements of any kind shall not be binding upon the parties
unless incorporated into this Agreement. This Agreement may not be amended
or modified, except by a writing signed by both parties.
READ AND ACCEPTED BY EMPLOYEE
/s/ Dennis Thompson
_____________________________________
Dennis Thompson
Address of Employee is as follows:
314 Nautilus
Austin, TX 78738
PENCOM SOFTWARE
(a division of Pencom Systems Incorporated)
/s/ Wade E. Saadi
_____________________________________
Wade E. Saadi
President
Pencom Systems Incorporated
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (Form
S-8) pertaining to the 1996 Stock Option / Stock Issuance Plan and the Employee
Stock Purchase Plan of PSW Technologies, Inc., of our report dated January 19,
1998, with respect to the financial statements of PSW Technologies, Inc.
included in the Annual Report (Form 10-K) for the year ended December 31, 1997.
/s/ ERNST & YOUNG LLP
Austin, Texas
March 23, 1998
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
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<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1996
<PERIOD-START> JAN-01-1997 JAN-01-1996
<PERIOD-END> DEC-31-1997 DEC-31-1996
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