UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
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
(State or other jurisdiction of incorporation or organization)
74-2796054
(I.R.S. Employer Identification No.)
6300 Bridgepoint Parkway, Building 3, Suite 200, Austin Texas 78730
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (512) 343-6666
Indicate by check x 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 the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date: 9,070,651 shares of
the Company's Common Stock, $.01 par value, were outstanding as of April 30,
1998.
<PAGE>
PSW TECHNOLOGIES, INC.
Index to March 31, 1998, Form 10-Q
Part I -- Financial Information
Item 1. Financial Statements...............................................3
Condensed Balance Sheets -- March 31, 1998 and December 31,
1997...............................................................3
Condensed Statements of Operations -- Three Months Ended
March 31,1998 and 1997.............................................4
Condensed Statements of Cash Flows -- Three Months Ended March 31,
1998 and 1997......................................................5
Notes to Condensed Financial Statements............................6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations......................9
Part II -- Other Information
Item 1. Legal Proceedings.................................................16
Item 2. Changes in Securities.............................................16
Item 3. Defaults upon Senior Securities...................................16
Item 4. Submission of Matters to a Vote of Security Holders...............16
Item 5. Other Information.................................................16
Item 6. Exhibits and Reports on Form 8-K..................................16
Signatures........................................................18
<PAGE>
Part 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
PSW Technologies, Inc.
Condensed Balance Sheets
(in thousands, except share data)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
(Unaudited)
Assets
Current assets:
<S> ............................................................. <C> <C>
Cash ......................................................... $ 809 $ 835
Short-term investments ....................................... 21,747 22,470
Accounts receivable, net of allowance for doubtful
accounts of $165 at March 31, 1998 and December 31, 1997 ..... 7,335 7,429
Unbilled revenue under customer contracts .................... 419 418
Prepaid expenses and other current assets .................... 649 483
-------- --------
Total current assets ............................................ 30,959 31,635
Other assets .................................................... 3,828 3,785
-------- --------
Total assets .................................................... $ 34,787 $ 35,420
======== ========
Liabilities and stockholders' equity Current liabilities:
Trade payables ............................................... 525 532
Accrued expenses and other current liabilities ............... 2,438 3,029
-------- --------
Total current liabilities ....................................... 2,963 3,561
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, 9,018,125 and 8,960,935 shares
issued and outstanding at March 31, 1998 and
December 31, 1997, respectively ............................ 90 90
Additional paid-in capital .................................... 29,579 29,484
Deferred compensation ......................................... (200) (243)
Accumulated other comprehensive income ........................ 12 (27)
Retained earnings ............................................. 2,343 2,555
-------- --------
Total stockholders' equity ...................................... 31,824 31,859
-------- --------
Total liabilities and stockholders' equity ...................... $ 34,787 $ 35,420
======== ========
</TABLE>
See accompanying notes.
3
<PAGE>
PSW Technologies, Inc.
Condensed Statements of Operations
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1998 1997
-------- --------
<S> .................................................................................... <C> <C>
Revenue ................................................................................ $ 9,758 $ 10,307
Operating expenses:
Technical staff ..................................................................... 5,803 5,284
Selling and administrative staff .................................................... 2,549 1,886
Other expenses ...................................................................... 1,927 1,961
Special compensation expense ........................................................ 43 119
-------- --------
Total operating expenses ............................................................... 10,322 9,250
-------- --------
Income (loss) from operations .......................................................... (564) 1,057
Interest income (expense), net ......................................................... 252 (89)
-------- --------
Income (loss) before provision (benefit) for income taxes .............................. (312) 968
-------- --------
Provision (benefit) for income taxes ................................................... (100) --
-------- --------
Net income (loss) ...................................................................... $ (212) $ 968
======== ========
Basic earnings (loss) per share ........................................................ $ (0.02)
========
Diluted earnings (loss) per share ...................................................... $ (0.02)
========
Pro forma information:
Historical income before provision for income taxes .................................... $ 968
Pro forma provision for income taxes ................................................... 368
--------
Pro forma net income ................................................................... $ 600
========
Pro forma basic earnings per share ..................................................... $ 0.11
========
Pro forma diluted earnings per share ................................................... $ 0.09
========
Shares used in basic earnings (loss) per share calculation ............................. 8,990 5,546
======== ========
Shares used in diluted earnings (loss) per share calculation ........................... 8,990 6,740
======== ========
</TABLE>
See accompanying notes.
4
<PAGE>
PSW Technologies, Inc.
Condensed Statements of Cash Flows
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Three Months
Ended March 31,
------------------
1998 1997
------- -------
Operating activities
<S> ........................................................................................... <C> <C>
Net income (loss) ............................................................................. $ (212) $ 968
Adjustments to reconcile net income to net cash used in
operating activities:
Special compensation expense ............................................................. 43 119
Depreciation and amortization ............................................................ 236 162
Bad debt expense ......................................................................... 10 30
Changes in operating assets and liabilities:
Accounts receivable ................................................................... 84 (1,516)
Due from related party ................................................................ -- 216
Unbilled revenue under customer contracts ............................................. (1) 91
Prepaid expenses and other current assets ............................................. (166) (54)
Due to related party .................................................................. -- (581)
Trade payables ........................................................................ 25 (239)
Deferred revenue ...................................................................... -- 268
Accrued expenses and other current liabilities ........................................ (516) (415)
------- -------
Net cash used in operating activities ......................................................... (497) (951)
------- -------
Investing activities
Proceeds from the sale of short term investments .............................................. 762 --
Acquisition of property and equipment ......................................................... (311) (965)
------- -------
Net cash provided by (used in) investing activities ........................................... 451 (965)
------- -------
Financing activities
Proceeds (repayments) from line of credit, net ................................................ -- (475)
Issuance of common stock ...................................................................... 20 50
Deferred offering costs ....................................................................... -- (45)
------- -------
Net cash provided by (used in) financing activities ........................................... 20 (470)
------- -------
Net decrease in cash .......................................................................... (26) (2,386)
Cash, beginning of period ..................................................................... 835 3,182
------- -------
Cash, end of period ........................................................................... $ 809 $ 796
======= =======
Non-cash activities:
Unrealized gain on investments ................................................................ $ 39 $ --
Reduction of income taxes payable associated with the
exercise of stock options ................................................................ $ 75 $ --
</TABLE>
See accompanying notes.
5
<PAGE>
PSW Technologies, Inc.
Notes to Condensed Financial Statements
March 31, 1998
(unaudited)
1. Basis of Presentation
PSW Technologies, Inc. (the "Company") commenced operations as a separate,
stand-alone corporation effective October 1, 1996. The accompanying unaudited
financial statements have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission (the "SEC") regarding
interim financial reporting. Accordingly, they do not include all the
information and notes required by generally accepted accounting principles for
complete financial statements and should be read in conjunction with the
financial statements and notes thereto for the year ended December 31, 1997
included in the Company's annual report on Form 10-K. The accompanying financial
statements reflect adjustments, all of which are of a normal recurring nature,
which are, in the opinion of management, necessary for a fair presentation.
The results for interim periods are not necessarily indicative of full year
results.
2. Significant Accounting Policies
Adoption of Accounting Policies
As described below, the Company adopted Statement of Financial Accounting
Standards No. 130, Reporting Comprehensive Income, ("SFAS No. 130") during the
quarter ended March 31, 1998 (see Note 5).
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use, which requires certain costs relating to
the acquisition and development of internal-use software to be capitalized. In
accordance with the guidance contained therein, the Company adopted the
Statement effective January 1, 1998 and capitalized $83,000 during the three
months ended March 31, 1998.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
could affect the financial statements and accompanying notes. Actual results
could differ from those estimates.
3. Pro Forma Provision for 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. Pro forma provision
for income taxes reflect the estimated corporate income tax expense that the
Company would have recognized had it not elected to be treated as an S
corporation for the period presented.
4. Pro Forma Earnings Per Share
The pro forma basic and 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 Statement of Financial
Accounting Standards No. 128, Earnings Per Share, and the Securities and
Exchange Commission Staff Accounting Bulletin 98.
6
<PAGE>
PSW Technologies, Inc.
Notes to Condensed Financial Statements (Continued)
(unaudited)
5. Comprehensive Income
As of January 1, 1998, the Company adopted SFAS No. 130, Reporting Comprehensive
Income. SFAS No. 130 establishes new rules for the reporting and display of
comprehensive income and its components; however, the adoption of this Statement
had no impact on the Company's net income or shareholders' equity. SFAS No. 130
requires unrealized gains or losses on the Company's available-for-sale
securities, which prior to adoption were reported separately in shareholders'
equity, to be included in other comprehensive income. Prior year financial
statements have been reclassified to confirm to the requirements of SFAS No.
130.
The components of comprehensive income for the three month periods ended March
31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997(a)
----- -----
<S> ............................................................. <C> <C>
Net income (loss) ............................................... $(212) $ 600
Unrealized gain on short term investments ....................... 39 --
Income tax expense related to items of other comprehensive income (12) --
===== =====
Comprehensive income (loss) ..................................... $(185) $ 600
===== =====
</TABLE>
(a) Net income and comprehensive income amounts are presented on a
pro forma basis as if the Company had been subject to federal and
state income taxes.
The components of accumulated other comprehensive income at March 31, 1998 and
December 31, 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> ............................................ <C> <C>
Unrealized gain (loss) on short term investments $ 12 $(27)
==== ====
</TABLE>
7
<PAGE>
PSW Technologies, Inc.
Notes to Condensed Financial Statements (Continued)
(unaudited)
6. Earnings per Share
The following table sets forth the computation of basic and diluted earnings per
share (in thousands, except per share data) for the three months ended March 31:
<TABLE>
<CAPTION>
1998 1997(1)
----- ------
Numerator:
<S> ........................................ <C> <C>
Net income (loss) ......................... $(212) $ 600
===== ======
Denominator:
Shares used in basic earnings (loss) per
share calculation ...................... 8,990 5,546
Effect of dilutive securities:
Employee stock options ................. -- 689
Warrants ............................... -- 505
----- ------
Shares used in diluted earnings (loss) per
share calculation ...................... 8,990 6,740
===== ======
Basic earnings (loss) per share ............ $(0.02) $ 0.11
===== ======
Diluted earnings (loss) per share .......... $(0.02) $ 0.09
===== ======
</TABLE>
(1) Net income and earnings per share amounts are presented on a pro forma basis
as if the Company had been subject to federal and state income taxes. 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 the provisions of SFAS 128 and SAB 98 did not change earnings per
share for the three months ended March 31, 1997.
8
<PAGE>
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Except for historical information contained herein, some matters discussed in
this report constitute forward-looking statements relating to future events or
the future financial performance of the Company. Stockholders are cautioned that
such statements are only predictions and actual events or results may differ
materially. In evaluating such statements, prospective investors should
specifically consider the risks discussed below under the caption "Certain
Factors That May Affect Future Results, Financial Condition and Market Price of
Securities", as well as those discussed in the Company's filings and reports
with the Securities and Exchange Commission, including the Company's
Registration Statement on Form S-1 (File No. 333-21565).
Overview
PSW Technologies, Inc. is a software services firm, operating in one industry
segment, that provides high value solutions to information technology ("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. 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. 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 IT user
clients.
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. 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.
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.
9
<PAGE>
Results of Operations
The following table sets forth the percentage of revenue of certain items
included in the Company's condensed statement of operations for the period
indicated:
<TABLE>
<CAPTION>
Three Months ended
March 31,
1998 1997
<S> .................................................................. <C> <C>
Revenue .............................................................. 100% 100%..
Operating expenses:
Technical staff ................................................... 59 52
Selling and administrative staff .................................. 26 18
Other expenses .................................................... 20 19
Special compensation expense ...................................... 1 1
---- ----
Total operating expense .............................................. 106 90
---- ----
Income (loss) from operations ........................................ (6) 10
Interest income (expense), net ....................................... 3 --
Provision (benefit) from income taxes ................................ (1) 4(a)
---- ----
Net income (loss) .................................................... (2)% 6%(a)
==== ====
</TABLE>
(a) Net income is presented on a pro forma basis as if the Company had been
fully subject to federal and state income taxes.
First Three Months of 1998 Compared with First Three Months of 1997
Revenue
The Company's revenue consists primarily of fees for software services provided.
Revenue was $9.8 million in the first three months of 1998, down 5% from $10.3
million for the first three months of 1997, principally due to the decline in
IBM business partially offset by 49 new projects and 15 new clients in the first
quarter of 1998. Revenue attributable to software services rendered to IT
vendors was $6.3 million and $6.2 million in first three months of 1998 and the
first three months of 1997, respectively, an increase of 1% in the first three
months of 1998 over the first three months of 1997. Revenue attributable to
software services rendered to IT users was $3.5 million and $4.1 million for the
first three months of 1998 and the first three months of 1997, respectively, a
decrease of 15% in the first three months of 1998 over the first three months of
1997.
One client, including its wholly owned subsidiaries, accounted for 34% and 48%
of revenue in each of the first three months of 1998 and 1997, respectively. No
other client accounted for more than 10% of revenue for either period.
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
subcontractors for work performed in connection with a client project. Technical
staff expenses were $5.8 million in the first three months of 1998, an increase
of 10% over $5.3 million for the first three months of 1997. The increase in
technical staff expenses was primarily due to the addition of personnel to
service the increase in scope and number of client projects during 1997.
Technical staff expenses increased to 59% of revenue in the first three months
of 1998 from 52% in the first three months of 1997, primarily as a result of
lower utilization of technical staff and lower revenues.
10
<PAGE>
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 $2.5 million in the first three months of
1998, an increase of 35% from $1.9 million in the first three months of 1997.
The increase in selling and administrative staff expenses was primarily due to
the addition of sales and administrative personnel, and increased technical
staff training. Selling and administrative staff expenses were 26% of revenue in
the first three months of 1998 compared to 18% of revenue in the first three
months of 1997, primarily as a result of increases in the sales staff, greater
technical staff involvement in sales and lower revenues.
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 $1.9 million in the first three months of
1998, an decrease of 2% over other expenses of $2.0 million in the first three
months of 1997, principally due to expense controls and lower recruiting costs.
Other expenses were 20% of revenue in the first three months of 1998 compared to
19% in the first three months of 1997 due to lower revenues.
Special Compensation Expense
Special compensation expense consists of stock-based compensation in connection
with the grants of replacement options to the Company's employees who
participated in the Pencom Systems Incorporated stock option plan. Special
compensation expense was $43,000 in the first three months of 1998 and $119,000
in the first three months of 1997, or 1% of revenue in each of the respective
periods.
Income (Loss) from Operations
The Company recorded a loss from operations of $564,000 in the first three
months of 1998, down from $1.1 million of income from operations in the first
three months of 1997. Due primarily from the decrease in revenue, loss from
operations was 6% of revenue in the first three months of 1998, down from income
from operations of 10% of revenue in the first three months of 1997.
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. The pro forma
disclosures on the statements of operations reflect adjustments to record
provisions for income taxes as if the Company had not been an S Corporation.
The pro forma provision for income taxes of $368,000 for the quarter ended March
31, 1997 is computed using an estimated annual effective tax rate of 38%, which
differs form the federal statutory rate of 34% primarily due to state taxes.
The historical benefit for income taxes of $100,000 for the quarter ended March
31, 1998, is computed using an estimated annual effective tax rate of 32%, which
differs from the federal statutory rate of 34% as a result of state taxes and
tax-exempt income.
11
<PAGE>
Net Loss and Pro Forma Net Income
Net loss was $212,000 in the first three months of 1998 and pro forma net income
was $600,000 in the first three months of 1997. Net loss was 2% of revenue in
the first three months of 1998 and pro forma net income was 6% of revenue in the
first three months of 1997.
Liquidity and Capital Resources
At March 31, 1998, the Company had cash and short term investments totaling
$22.6 million, a decrease from $23.3 million at December 31, 1997, primarily as
a result of funding working capital requirements.
The Company maintains a Credit Facility with a bank providing for borrowings of
up to $10 million, subject to a borrowing base requirement. The Credit Facility
expires on May 1, 1999. Available borrowings under the Credit Facility are based
upon a percentage of the Company's eligible accounts receivable. At March 31,
1998, no amount was outstanding under the Credit Facility and the available
borrowing amount was $7.5 million.
The Company anticipates that its existing capital resources described above,
together with cash provided by operating activities 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 the
Company's 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
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
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 1997 and the
first three months of 1998, approximately 20% and 11%, 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.
12
<PAGE>
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. The Company has also undertaken projects in which
a material portion of total revenue is earned based upon meeting specified
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 447 full-time
employees at March 31, 1998. 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 Systems Incorporated, ("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 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.
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 which may effect operating results include customer budget cycles and
customer spending priorities such as the Year 2000 compliance 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
13
<PAGE>
business, financial condition and results of operations. In the second quarter
of 1998, revenues may be adversely impacted by the Company's lengthy sales
cycle, among other matters, which may cause the Company's revenues and earnings
to be below the expectations of securities 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 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, Keith D. Thatcher, 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.
14
<PAGE>
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 and 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.
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.
15
<PAGE>
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings
The Company is not a party to any material legal proceedings.
Item 2. Changes in Securities
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a)Exhibits
<TABLE>
<CAPTION>
Number Description
<C> <S>
**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.
X10.8 Software Task Order Agreement dated November 20, 1995 between the
Registrant and Tivoli Systems, Inc., as amended.
X10.9 Credit Agreement dated November 8, 1997 between the Registrant and Texas
Commerce Bank National Association. X10.10 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.
16
<PAGE>
**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.
X10.21 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.
**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.
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.
X Incorporated herein by reference to the Company's Form 10-K for the
year ended December 31, 1997.
(b) Reports on Form 8-K
None.
17
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PSW TECHNOLOGIES, INC.
(Registrant)
Date: May 15, 1998 __________/s/____________
Dr. W. Frank King
President and Chief Executive Officer
(Principal Executive Officer)
Date: May 15, 1998 __________/s/____________
Keith D. Thatcher
Vice President of Finance, Treasurer and
Chief Financial Officer
(Principal Financial Officer)
Date: May 15, 1998 __________/s/____________
Kasaundra L. Simpson
Financial Reporting and Budgeting Manager
(Principal Accounting Officer)
18
<PAGE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C> <C>
RESTATED
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> MAR-31-1998 MAR-31-1997
<PERIOD-START> JAN-1-1998 JAN-1-1997
<PERIOD-END> MAR-31-1998 MAR-31-1997
<CASH> 809 796
<SECURITIES> 21,747 0
<RECEIVABLES> 7,500 7,754
<ALLOWANCES> 165 150
<INVENTORY> 0 0
<CURRENT-ASSETS> 30,959 8,994
<PP&E> 5,926 4,287
<DEPRECIATION> 2,331 1,463
<TOTAL-ASSETS> 34,787 11,938
<CURRENT-LIABILITIES> 2,963 7,357
<BONDS> 0 0
0 0
0 0
<COMMON> 90 55
<OTHER-SE> 31,734 4,526
<TOTAL-LIABILITY-AND-EQUITY> 34,787 11,938
<SALES> 0 0
<TOTAL-REVENUES> 9,758 10,307
<CGS> 0 0
<TOTAL-COSTS> 5,803 5,284
<OTHER-EXPENSES> 4,519 3,966
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> (252) 89
<INCOME-PRETAX> (312) 968
<INCOME-TAX> (100) 368
<INCOME-CONTINUING> (212) 600
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (212) 600
<EPS-PRIMARY> (0.02) 0.11
<EPS-DILUTED> (0.02) 0.09
</TABLE>
