-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TCL78VgmEHNPChZLRXpvCkRPIlq/wqmI4dxMhcV4LqYS40BqyToyCQrz0Uz6IC7A oQaCHNZCP1eWqYqzoSmQ6g== 0001047469-98-029468.txt : 19980806 0001047469-98-029468.hdr.sgml : 19980806 ACCESSION NUMBER: 0001047469-98-029468 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 4 FILED AS OF DATE: 19980805 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PROBUSINESS SERVICES INC CENTRAL INDEX KEY: 0001028751 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROCESSING & DATA PREPARATION [7374] IRS NUMBER: 942976066 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1 SEC ACT: SEC FILE NUMBER: 333-60745 FILM NUMBER: 98677890 BUSINESS ADDRESS: STREET 1: 4125 HOPYARD RD CITY: PLEASANTON STATE: CA ZIP: 94588 BUSINESS PHONE: 5107373500 MAIL ADDRESS: STREET 1: 4125 HOPYARD RD CITY: PLEASANTON STATE: CA ZIP: 94588 S-1 1 S-1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 5, 1998 REGISTRATION NO. 333- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------- FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ PROBUSINESS SERVICES, INC. (Exact name of Registrant as specified in its charter) -------------------------- DELAWARE 7374 94-2976066 (State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer incorporation) Classification Code Number) Identification Number)
4125 HOPYARD ROAD PLEASANTON, CA 94588 (925) 737-3500 (Address, including zip code, and telephone number, including area code, of Registrant's principal executive offices) -------------------------- THOMAS H. SINTON PRESIDENT AND CHIEF EXECUTIVE OFFICER 4125 HOPYARD ROAD PLEASANTON, CA 94588 (925) 737-3500 (Name, address, including zip code, and telephone number, including area code, of agent for service) -------------------------- COPIES TO: ALAN K. AUSTIN KENNETH L. GUERNSEY ELIZABETH R. FLINT KARYN R. SMITH BRIAN C. ERB MICHAEL W. HAUPTMAN JOHN L. WHITTLE COOLEY GODWARD LLP MARY ELIZABETH SHANNON ONE MARITIME PLAZA WILSON SONSINI GOODRICH & ROSATI 20TH FLOOR PROFESSIONAL CORPORATION SAN FRANCISCO, CA 94111 650 PAGE MILL ROAD (415) 693-2000 PALO ALTO, CA 94304 (650) 493-9300
-------------------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date of this Registration Statement. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, as amended, check the following box. / / If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If delivery of the Prospectus is expected to be made pursuant to Rule 434, please check the following box. / / ------------------------ CALCULATION OF REGISTRATION FEE
PROPOSED MAXIMUM AGGREGATE TITLE OF EACH CLASS OF SECURITIES TO BE REGISTERED OFFERING PRICE (1)(2) AMOUNT OF REGISTRATION FEE Common Stock, par value $0.001 per share.................. $110,000,000 $32,450
(1) Includes the aggregate offering price of shares which the Underwriters have the option to purchase to cover over-allotments, if any. (2) Estimated solely for the purpose of computing the amount of the registration fee pursuant to rule 457(o) promulgated under the Securities Act of 1933, as amended. ------------------------------ THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Information contained herein is subject to completion or amendment. A registration statement relating to these securities has been filed with the Securities and Exchange Commission. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. This Prospectus shall not constitute an offer to sell or the solicitation of an offer to buy nor shall there be any sale of these securities in any State in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such State. SUBJECT TO COMPLETION, DATED AUGUST 5, 1998 PROSPECTUS 2,475,000 SHARES [LOGO] COMMON STOCK All of the 2,475,000 shares of Common Stock offered hereby are being sold by ProBusiness Services, Inc. ("ProBusiness" or the "Company"). The Company has declared a 3-for-2 stock split in the form of a stock dividend, to be paid on August 7, 1998 to holders of record on July 31, 1998. All share and per share information in this Prospectus has been adjusted to reflect this stock split. The Common Stock offered hereby is quoted on the Nasdaq National Market under the symbol "PRBZ." On August 4, 1998, the last reported sale price of the Common Stock was $52.75 (equivalent to $35.167 after giving effect to the stock split). See "Price Range of Common Stock." SEE "RISK FACTORS" BEGINNING ON PAGE 5 FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE SHARES OF COMMON STOCK OFFERED HEREBY. ------------------------ THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
UNDERWRITING PROCEEDS TO PRICE TO PUBLIC DISCOUNT(1) COMPANY(2) Per Share................................ $ $ $ Total(3)................................. $ $ $
(1) The Company has agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act of 1933, as amended. See "Underwriting." (2) Before deducting expenses payable by the Company estimated at $670,000. (3) The Company has granted to the Underwriters a 30-day option to purchase up to an additional 371,250 shares of Common Stock solely to cover over-allotments, if any. See "Underwriting." If all such shares are purchased, the total Price to Public, Underwriting Discount and Proceeds to Company will be $ , $ and $ , respectively. The Common Stock is offered by the several Underwriters when, as and if delivered to and accepted by them and subject to their right to reject orders in whole or in part. It is expected that delivery of the certificates for the Common Stock will be made on or about , 1998. WILLIAM BLAIR & COMPANY BANCAMERICA ROBERTSON STEPHENS SG COWEN THE DATE OF THIS PROSPECTUS IS , 1998 The Inside Front Cover of the Prospectus includes text stating, "ProBusiness is a leading provider of outsourced payroll processing, payroll tax filing and benefits administration services to large employers." Below the text is an arrow pointing to the ProBusiness logo at the bottom right side of the page. The background photo behind the text depicts ProBusiness service personnel assisting a client. GATEFOLD: The Gatefold consists of three horizontal tiers, the top and the middle containing text and photographs and the bottom containing text related to the text and photographs in the middle tier. The top tier consists of captions accompanying the following: the ProBusiness logo, a rectangular collage of photographs and a rectangle containing client logos. In the background of the top tier is a photograph of ProBusiness service personnel assisting a client. The middle tier consists of the words "Business Partnership" at the far left in italics, then three equal-size rectangular photographs and, at the far right, a collage of four overlapping rectangular photographs. The middle tier photographs are connected by downward arrows to corresponding captions, which are in the bottom tier of the gatefold. Description #1: Description of the left section of the upper tier of the gatefold: The ProBusiness logo with text below it stating, "ProBusiness focuses on providing added value to large employers with its high quality and cost-effective employee administrative services." Description #2: Description of the center section of the upper tier of the gatefold: A collage of photographs depicting various documents and items related to the services provided by ProBusiness. Description #3: Description of the right section of the upper tier of the gatefold: A rectangular containing the logos of the following eight companies: CCH Incorporated, Advanced Micro Devices, Inc., 3Com Corporation, AST Research, Inc., Yahoo Inc., Oracle Corporation, Boise Cascade Corporation, First Allmerica Financial Life Insurance Company and First Data Corporation. Caption: "ProBusiness's clients include many large employers in diverse industries." This caption appears below the rectangle containing the clients' logos in Description #3. Description #4: Description of the left section of the middle tier of the gatefold: "Business Partnership." Caption: "ProBusiness differentiates itself from its competitors by establishing a business partnership with each client. The Company develops relationships with each client by assessing payroll processing needs, reengineering and designing payroll systems and processes and implementing a cost-effective solution. The Company maintains an ongoing relationship by providing proactive account management and technical support." This caption appears below the text described in Description #4. Description #5: Description of the left corner section of the middle tier of the gatefold: A rectangular photograph of an account manager of ProBusiness assisting a client. Caption: "Client Service--Delivering high quality, responsive and professional client service is a key competitive advantage of the Company. Each client works with a personal account manager who serves as the client's day-to-day contact and is responsible for meeting the client's needs. The Company believes that its low client-to-account manager ratio is a key factor in enabling the Company to achieve a high payroll client retention rate." This caption appears below the photograph in Description #5. Description #6: Description of the center section of the middle tier of the gatefold: A rectangular photograph of two employees of the Company using personal computers in the Company's production facility. Caption: "Technology--ProBusiness's proprietary PC-based, distributed architecture is reliable, flexible and scalable. This technology enables the Company to provide high levels of client service and customized solutions that can be easily upgraded and integrated with the client's other systems." This caption appears below the photograph in Description #6. Description #7: Description of the right center section of the middle tier of the gatefold: A rectangular photograph of a ProBusiness specialist diagramming a client's payroll system on a white board. Caption: "Expertise--ProBusiness delivers technical expertise through specialists in design, process, implementation and systems integration. The Company delivers functional and regulatory expertise in payroll, payroll tax and employee benefits." This caption appears below the photograph in Description #7. Description #8: Description of the right section of the middle tier of the gatefold: Rectangular photographs of an account manager assisting a client, documents and a computer screen, all of which relate to the service offerings provided by ProBusiness. Caption: "Comprehensive Solutions--ProBusiness provides employers with a broad range of employee administrative services: payroll processing; payroll tax filing, human resources software and employee benefits administration, including flexible benefits enrollment and processing and COBRA administration, and human resources software." This caption appears below the photograph in Description 8. ------------------------ CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK, INCLUDING STABILIZING BIDS, SYNDICATE COVERING TRANSACTIONS OR THE IMPOSITION OF PENALTY BIDS. FOR A DISCUSSION OF THESE ACTIVITIES, SEE "UNDERWRITING." IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS AND SELLING GROUP MEMBERS MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ NATIONAL MARKET IN ACCORDANCE WITH RULE 103 OF REGULATION M. SEE "UNDERWRITING." PROBUSINESS-REGISTERED TRADEMARK- AND THE PROBUSINESS LOGO ARE REGISTERED TRADEMARKS OF THE COMPANY. BENESPHERE ADMINISTRATORS-TM- AND ENROLLNET-TM- ARE TRADEMARKS OF THE COMPANY. PROSPECTUS SUMMARY THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED INFORMATION, INCLUDING "RISK FACTORS" AND THE FINANCIAL STATEMENTS AND NOTES THERETO, APPEARING ELSEWHERE IN THIS PROSPECTUS. EXCEPT AS OTHERWISE INDICATED, ALL INFORMATION IN THIS PROSPECTUS ASSUMES NO EXERCISE OF THE UNDERWRITERS' OVER-ALLOTMENT OPTION AND GIVES EFFECT TO THE THREE-FOR-TWO SPLIT OF THE COMPANY'S COMMON STOCK (THE "STOCK SPLIT") TO BE EFFECTED IN THE FORM OF A STOCK DIVIDEND PAYABLE ON AUGUST 7, 1998 TO HOLDERS OF RECORD OF THE COMMON STOCK ON JULY 31, 1998. THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET FORTH UNDER "RISK FACTORS" AND ELSEWHERE IN THIS PROSPECTUS. THE COMPANY The Company is a leading provider of employee administrative services for large employers. The Company's primary service offerings are payroll processing, payroll tax filing, benefits administration, including the enrollment and processing of flexible benefit plans and COBRA programs, and human resources software. The Company's proprietary PC-based payroll system offers the cost-effective benefits of outsourcing and high levels of client service, while providing the flexibility, control, customization and integration of an in-house system. As of June 30, 1998, the Company provided services to approximately 1,400 clients and provided payroll processing services to approximately 510 clients with an aggregate of approximately 575,000 employees and an average of approximately 1,100 employees. In addition to providing tax filing services for its payroll clients, as of June 30, 1998 the Company provided stand-alone tax filing services to 72 clients with an aggregate of more than 1.1 million employees and an average of more than 15,000 employees. For the quarter ended June 30, 1998, the Company processed 4.3 million checks for the Company's payroll clients. The Company's clients include: 3Com Corporation, Abbott Laboratories, Airtouch Communications Inc., Amoco Corporation, Inc., Ascend Communications, Inc., AST Research, Inc., Coach Leatherwear Co., Inc., Dell Computer Corporation, E*TRADE Group, Inc., First Data Corporation, The Gap, Inc., The Gillette Company, J.C. Penney Company, Inc., Kellogg USA Inc., LSI Logic Corporation, Michaels Stores, Inc., Netscape Communications Corp., Oracle Corporation, Sunglass Hut International, Inc., Toyota Motor Corporation, U.S. Bancorp, Watkins-Johnson Company and Williams-Sonoma, Inc. The demand for outsourcing employee administrative services has grown significantly and is expected to continue to grow over the next several years. According to G-2 Research, Inc., third-party payroll processing, payroll tax filing and benefits administration is expected to generate approximately $3.9 billion in revenue in 1998 and approximately $9.3 billion in revenue in 2003. Many large businesses have found that outsourcing non-core functions reduces costs, improves service, quality and efficiency, allows personnel to focus on core competencies and enhances productivity through access to advanced technologies. In recent years, payroll processing and benefits administration have increased in complexity due to continual changes in regulations and increasingly sophisticated employee benefits plans. The Company differentiates itself from its competitors through its proprietary PC-based technology, high quality, responsive and professional client service and focus on the needs of large employers. ProBusiness develops a business partnership with each client by assessing each client's payroll processing needs, reengineering and designing the client's payroll systems and processes and implementing a value-added and cost-effective solution. The Company maintains an ongoing relationship with each client using a strategic team of specialists led by a personal account manager who proactively manages each client's account and marshals the resources of the team to meet the client's specific needs. ProBusiness maintains a low client-to-account manager ratio to offer clients accessible and responsive account management. The Company believes that its low client-to-account manager ratio and focus on client service are key factors in enabling the Company to achieve a high payroll client retention rate, which was approximately 92% for fiscal year 1998. The Company's objective is to be the premier provider of employee administrative services for large employers. The Company's strategy to accomplish this objective includes expanding its client base by increasing its direct sales force, developing a comprehensive and fully integrated suite of employee administrative services, offering additional services to existing clients, pursuing strategic acquisitions, investments and alliances and extending its technology leadership. The Company is committed to maintaining the high levels of professional and personal service that it believes have allowed it to establish a competitive advantage in its industry. 3 THE OFFERING Common Stock Offered by the Company................... 2,475,000 shares Common Stock to be Outstanding after this Offering.... 19,589,855 shares(1) For general corporate purposes, including capital expenditures and working capital, as well as for potential acquisitions. See "Use of Proceeds." Use of Proceeds....................................... Nasdaq National Market Symbol......................... PRBZ
SUMMARY FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED JUNE 30, ------------------------------- 1996 1997 1998 --------- --------- --------- STATEMENTS OF OPERATIONS DATA: Revenue............................................................................. $ 13,863 $ 27,374 $ 46,317 Operating expenses: Cost of providing services........................................................ 6,435 13,659 23,859 General and administrative expenses............................................... 2,054 4,282 6,727 Research and development expenses................................................. 1,257 2,841 4,585 Client acquisition costs.......................................................... 5,388 11,706 17,858 Acquisition of in-process technology.............................................. 711 -- -- --------- --------- --------- Total operating expenses............................................................ 15,845 32,488 53,029 --------- --------- --------- Loss from operations................................................................ (1,982) (5,114) (6,712) Interest expense.................................................................... (473) (1,190) (557) Other income........................................................................ 69 59 752 --------- --------- --------- Net loss............................................................................ $ (2,386) $ (6,245) $ (6,517) --------- --------- --------- --------- --------- --------- Historical basic and diluted net loss per share(2).................................. $ (4.91) --------- --------- Shares used in computing historical basic and diluted net loss per share(2)......... 486 Pro forma basic and diluted net loss per share(2)................................... $ (0.59) $ (0.41) --------- --------- --------- --------- Shares used in computing pro forma basic and diluted net loss per share(2).......... 10,533 15,722
JUNE 30, 1998 ------------------------- ACTUAL AS ADJUSTED(3) --------- -------------- BALANCE SHEET DATA: Cash and cash equivalents.............................................................. $ 13,771 $ 95,794 Payroll tax funds invested............................................................. 332,667 332,667 Working capital........................................................................ 3,323 85,346 Total assets........................................................................... 376,009 458,032 Payroll tax funds collected but unremitted............................................. 332,667 332,667 Capital lease obligations, less current portion........................................ 1,414 1,414 Total stockholders' equity............................................................. 26,746 108,769
- ------------------------------ (1) As of June 30, 1998 (after giving effect to the Stock Split). Excludes (i) 1,800,416 shares of Common Stock subject to outstanding options; (ii) 229,500 shares of Common Stock issuable upon exercise of outstanding warrants; (iii) 1,277,510 shares of Common Stock reserved for future grant under the Company's 1996 Stock Option Plan; and (iv) 579,886 shares of Common Stock reserved for issuance under the Company's 1997 Employee Stock Purchase Plan. See "Management -- Stock Plans," "Description of Capital Stock -- Warrants" and Notes 6 and 7 of Notes to Financial Statements. (2) See Note 1 of Notes to Financial Statements for an explanation of the determination of the shares used in computing historical and pro forma basic and diluted net loss per share. (3) Adjusted to reflect the sale of the 2,475,000 shares of Common Stock offered hereby at an assumed public offering price of $35.17 per share, after deducting the estimated underwriting discount and estimated offering expenses payable by the Company, and application of the estimated net proceeds therefrom. See "Use of Proceeds" and "Capitalization." The Company was incorporated in California in October 1984 and reincorporated in Delaware in September 1997. The Company's executive offices are located at 4125 Hopyard Road, Pleasanton, California 94588, and its telephone number is (925) 737-3500. The Company maintains a World Wide Web site at www.probusiness.com. The information contained on the Company's Web site shall not be deemed to be a part of this Prospectus. 4 RISK FACTORS THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET FORTH IN THE FOLLOWING RISK FACTORS AND ELSEWHERE IN THIS PROSPECTUS. IN ADDITION TO THE OTHER INFORMATION IN THIS PROSPECTUS, THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY IN EVALUATING THE COMPANY AND ITS BUSINESS BEFORE PURCHASING THE COMMON STOCK OFFERED BY THIS PROSPECTUS. OPERATING LOSSES; NEED TO COMMIT TO EXPENSES IN ADVANCE OF REVENUE The Company has experienced significant operating losses since its inception and expects to incur significant operating losses in the future due to continued client acquisition costs, investments in research and development and costs associated with expanding its sales efforts and operations to new geographic regions. As of June 30, 1998, the Company had an accumulated deficit of approximately $25.5 million. The establishment of new client relationships involves lengthy and extensive sales and implementation processes. The sales process generally takes three to twelve months or longer, and the implementation process generally takes an additional three to nine months or longer. In connection with the acquisition of each new client, the Company incurs substantial client acquisition costs, which consist primarily of sales and implementation expenses and, to a lesser extent, marketing expenses. The Company's ability to achieve profitability will depend in part upon its ability to attract and retain new clients, offer new services and features and achieve market acceptance of new services. There can be no assurance that the Company will achieve or sustain profitability in the future. The Company has made acquisitions of businesses in the past and intends to pursue acquisitions in the future. In connection with acquisitions, the Company has in the past incurred and will likely incur in the future costs associated with adding personnel, integrating technology, increasing overhead to support the acquired businesses, acquiring in-process technology and amortization expenses related to intangible assets. Any future acquisitions could have a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." SEASONALITY; FLUCTUATIONS IN QUARTERLY RESULTS The Company's business is characterized by significant seasonality. As a result, the Company's revenue has been subject to significant seasonal fluctuations, with the largest percentage of annual revenue being realized in the third and fourth fiscal quarters, primarily due to new clients beginning services in the beginning of the tax year (the Company's third fiscal quarter) and higher interest income earned on payroll tax funds invested. Further, the Company's operating expenses are typically higher as a percentage of revenue in the first and second fiscal quarters as the Company increases personnel to acquire new clients and to implement and provide services to such new clients, a large percentage of which begin services in the third quarter. The Company's quarterly operating results have in the past and will in the future vary significantly depending on a variety of factors, including the number and size of new clients starting services, the decision of one or more clients to delay or cancel implementation or ongoing services, interest rates, seasonality, the ability of the Company to design, develop and introduce new services and features for existing services on a timely basis, costs associated with strategic acquisitions and alliances or investments in technology, the success of any such strategic acquisition, alliance or investment, costs to transition to new technologies, expenses incurred for geographic expansion, risks associated with payroll tax and benefits administration services, price competition, a reduction in the number of employees of its clients and general economic factors. Revenue from new clients typically represents a significant portion of quarterly revenue in the third and fourth fiscal quarters. A substantial majority of the Company's operating expenses, particularly personnel and related costs, depreciation and rent, is relatively fixed in advance of any particular quarter. The Company's agreements with its clients generally do not have significant penalties for cancellation. As a result, any decision by a client to delay or cancel implementation of the 5 Company's services or the Company's underutilization of personnel may cause significant variations in operating results in a particular quarter and could result in losses for such quarter. As the Company secures larger clients, the time required for implementing the Company's services increases, which could contribute to larger fluctuations in revenue. Interest income earned from investing payroll tax funds, which is a significant portion of the Company's revenue, is vulnerable to fluctuations in interest rates. In addition, the Company's business may be affected by shifts in the general condition of the economy, client staff reductions, strikes, acquisitions of its clients by other companies and other downturns. There can be no assurance that the Company's future revenue and results of operations will not vary substantially. It is possible that in some future quarter the Company's results of operations will be below the expectations of public market analysts and investors. In either case, the market price of the Company's Common Stock could be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." RISKS ASSOCIATED WITH STRATEGIC ACQUISITIONS AND INVESTMENTS While the Company has no current agreements or negotiations underway with respect to any acquisition of, or investment in, businesses that provide complementary services or technologies to those of the Company, the Company intends to make additional acquisitions of, and investments in, such businesses. There can be no assurance that any future acquisition will be completed or that, if completed, will be effectively assimilated into the Company's business. In addition, future acquisitions could result in the issuance of dilutive equity securities, the incurrence of debt or contingent liabilities, and amortization expenses related to goodwill and other intangible assets, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. Furthermore, there can be no assurance that any strategic investment will succeed. The initial cost of such an investment or the failure of such an investment to succeed could have a material adverse effect on the Company's business, financial condition and results of operations. See "-- Seasonality; Fluctuations in Quarterly Results," "Use of Proceeds," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Strategy." RISKS ASSOCIATED WITH PAYROLL TAX FILING SERVICE AND BENEFITS ADMINISTRATION SERVICES The Company's payroll tax filing service is subject to various risks resulting from errors and omissions in filing client tax returns and paying tax liabilities owed to tax authorities on behalf of clients. The Company's clients transfer to the Company contributed employer and employee tax funds. The Company processes the data received from the client and remits the funds along with a tax return to the appropriate tax authorities when due. Tracking, processing and paying such tax liabilities is complex. Errors and omissions have occurred in the past and may occur in the future in connection with such service. The Company is subject to large cash penalties imposed by tax authorities for late filings or underpayment of taxes. To date, such penalties have not been significant. However, there can be no assurance that any liabilities associated with such penalties will not have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that the Company's reserves or insurance for such penalties will be adequate. In addition, failure by the Company to make timely or accurate tax return filings or pay tax liabilities when due on behalf of clients may damage the Company's reputation and could adversely affect its relationships with existing clients and its ability to gain new clients. The Company's payroll tax filing service is also dependent upon government regulations, which are subject to continual changes. Failure by the Company to implement these changes into its services and technology in a timely manner would have a material adverse effect on the Company's business, financial condition and results of operations. In addition, since a significant portion of the Company's revenue is derived from interest earned from investing on collected but unremitted payroll tax funds, changes in policies relating to withholding federal or state income taxes or reduction in the time allowed for taxpayers 6 to remit payment for taxes owed to government authorities would have a material adverse effect on the Company's business, financial condition and results of operations. The Company's benefits administration services are subject to various risks resulting from errors and omissions in processing and filing COBRA or other benefit plan forms in accordance with governmental regulations and the respective plans. The Company processes data received from employees and employers and is subject to penalties for any late or misfiled plan forms. There can be no assurance the Company's reserves or insurance for such penalties will be adequate. In addition, failure to properly file plan forms would have a material adverse effect on the Company's reputation, which could adversely affect its relationships with existing clients and its ability to gain new clients. The Company's benefits administration services are also dependent upon government regulations which are subject to continuous changes that could reduce or eliminate the need for benefits administration services. The Company has access to confidential information and to client funds. As a result, the Company is subject to potential claims by its clients for the actions of the Company's employees arising from damages to the client's business or otherwise. There can be no assurance that the Company's fidelity bond and errors and omissions insurance will be adequate to cover any such claims. Such claims could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Service Offerings." INVESTMENT RISKS The Company invests funds, including payroll tax funds transferred to it by clients, until the Company remits the funds to tax authorities when due. The Company typically invests these funds in short-term financial instruments such as overnight U.S. government direct and agency obligations repurchase agreements, commercial paper rated A-1 and/or P-1 and money market funds with an underlying credit quality of AA or better. These investments are exposed to several risks, including credit risks from the possible inability of the borrowers to meet the terms of their obligations under the financial instruments. The Company would be liable for any losses on such investments. Interest income earned from investing these funds represents a significant portion of the Company's revenues. As a result, the Company's business, financial condition and results of operations are significantly impacted by interest rate fluctuations. The Company enters into interest rate swap agreements to minimize the impact of interest rate fluctuations. There can be no assurance, however, that the Company's swap arrangements will protect the Company from all interest rate risks. Under certain circumstances if interest rates rise, the Company would have payment obligations under its interest rate swap agreements which may not be offset by interest earned by the Company on deposited funds. A payment obligation under the Company's swap arrangements could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, there can be no assurance that the Company would have sufficient funds to meet any such swap payment obligations. A default by the Company under its swap agreements could result in acceleration and set-off by the bank of all outstanding contracts under the swap agreement, and could result in cross-defaults of other debt agreements of the Company, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." MANAGEMENT OF GROWTH The Company's business has grown significantly in size and complexity over the past four years. The Company's number of employees has increased from 325 at the end of fiscal 1997 to 500 at the end of fiscal 1998. This growth has placed, and is expected to continue to place, significant demands on the Company's management, systems, internal controls, and financial and physical resources. In order to meet such demands, the Company intends to continue to hire new employees, open new offices to attract clients in 7 new geographic regions, increase expenditures on research and development, and invest in new equipment and make other capital expenditures. In addition, the Company expects that it will need to develop further its financial and managerial controls and reporting systems and procedures to accommodate any future growth. Failure to expand any of the foregoing areas in an efficient manner could have a material adverse effect on the Company's business, financial condition and results of operations. The Company intends to open a satellite sales and implementation center in New Jersey by the end of calendar 1998 and may open additional sales offices in the future. In addition, the Company intends to move its benefits administration center from its current location in Bellevue, Washington to another location there, and the Company has leased additional office space to be built adjacent to its Pleasanton headquarters. There can be no assurance that the Company will be able to establish such facilities on a timely basis. The Company's growth may depend to some extent on its ability to successfully complete strategic acquisitions or investments to expand or complement its existing business. There can be no assurance that suitable acquisitions or investments can be identified, consummated or successfully integrated into the Company's operations. Any inability to manage growth effectively could have a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." SUBSTANTIAL COMPETITION The market for the Company's services is intensely competitive, subject to rapid change and significantly affected by new service introductions and other market activities of industry participants. The Company primarily competes with several public and private payroll service providers, such as Automatic Data Processing, Inc., Ceridian Corporation and Paychex, Inc., as well as smaller, regional competitors. Many of these companies have longer operating histories, greater financial, technical, marketing and other resources, greater name recognition and a larger number of clients than the Company. In addition, certain of these companies offer more services or features than the Company and have processing facilities located throughout the United States. The Company also competes with in-house employee services departments and, to a lesser extent, banks and local payroll companies. With respect to benefits administration services, the Company competes with insurance companies, benefits consultants and other local benefits outsourcing companies. The Company may also compete with marketers of related products and services that may offer payroll or benefits administration services in the future. The Company has experienced, and expects to continue to experience, competition from new entrants into its markets. Increased competition, the failure of the Company to compete successfully, pricing pressures, loss of market share and loss of clients could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Competition." RELIANCE ON RAPIDLY CHANGING TECHNOLOGY; RISKS OF SOFTWARE DEFECTS The technologies in which the Company has invested to date are rapidly evolving and have short life cycles, which requires the Company to anticipate and rapidly adapt to technological changes. In addition, the Company's industry is characterized by increasingly sophisticated and varied needs of clients, frequent new service and feature introductions and emerging industry standards. The introduction of services embodying new technologies and the emergence of new industry standards and practices can render existing services obsolete and unmarketable. The Company's future success will depend, in part, on its ability to develop or acquire advanced technologies, enhance its existing services with new features, add new services that address the changing needs of its clients, and respond to technological advances and emerging industry standards and practices on a timely and cost-effective basis. Several of the Company's competitors invest substantially greater amounts in research and development than the Company, which may allow them to introduce new services or features before the Company. Even if the Company is able to develop or acquire new technologies in a timely manner, it may incur substantial costs in developing or acquiring such technologies and in deploying new services and features to its clients, including costs associated with acquiring in-process technology, amortization expenses related to intangible assets and 8 costs of additional personnel. If the Company is unable to develop or acquire and successfully introduce new services and new features of existing services in a timely or cost-effective manner, the Company's business, financial condition and results of operations could be materially adversely affected. See "Business - -- Service Offerings" and "-- Research and Development." Application software used by the Company may contain defects or failures when introduced or when new versions or enhancements are released. The Company has in the past discovered software defects in certain of its applications, in some cases only after its systems have been used by clients. There can be no assurance that future defects will not be discovered in existing or new applications or releases. Any such occurrence could have a material adverse effect upon the Company's business, financial condition and results of operations. See "Business -- Technology" and "-- Research and Development." DEPENDENCE ON THIRD-PARTY PROVIDERS The Company depends on third-party courier services to deliver paychecks to clients. The Company does not have any formal written agreements with any of the courier services that it uses. Such courier services have been in the past and may be in the future unable to timely pick up or deliver the paychecks from the Company to its clients for a variety of reasons, including employee strikes, storms or other adverse weather conditions, earthquakes or other natural disasters, logistical or mechanical failures or accidents. Failure by the Company to deliver client paychecks on a timely basis could damage the Company's reputation and have a material adverse effect on the Company's business, financial condition and results of operations. DISASTER RECOVERY; RISK OF LOSS OF CLIENT DATA The Company currently conducts substantially all of its payroll and payroll tax processing at the Company's headquarters in Pleasanton, California and divides the payroll printing and finishing between its Pleasanton and Irvine, California facilities. The Irvine facility serves both as an alternative processing center and a back-up payroll center. The Company's benefits administration services are conducted solely in Bellevue, Washington, and no benefits administration back-up facility exists. The Company establishes for each payroll client a complete set of payroll data at the Pleasanton processing center, as well as at the client's site. In the event of a disaster in Pleasanton, clients would have the ability to process payroll checks based on the data they have on site if necessary. There can be no assurance that the Company's disaster recovery procedures are sufficient or that the payroll data recovered at the client site would be sufficient to allow the client to calculate and produce payroll in a timely fashion. The Company's operations are dependent on its ability to protect its computer systems against damage from a major catastrophe (such as an earthquake or other natural disaster), fire, power loss, security breach, telecommunications failure or similar event. No assurance can be given that the precautions that the Company has taken to protect itself from or minimize the impact of such events will be adequate. Any damage to the Company's data centers, failure of telecommunications links or breach of the security of the Company's computer systems could result in an interruption of the Company's operations or other loss which may not be covered by the Company's insurance. Any such event could have a material adverse effect on the Company's business, financial condition and results of operations. NEED TO ATTRACT AND RETAIN EXPERIENCED PERSONNEL The Company's success depends to a significant degree on its ability to attract and retain experienced employees. There is substantial competition for experienced personnel, which the Company expects to continue. Many of the companies with which the Company competes for experienced personnel have greater financial and other resources than the Company. The Company has in the past and may in the future experience difficulty in recruiting sufficient numbers of qualified personnel. In particular, the Company's ability to find and train implementation employees is critical to the Company's ability to 9 achieve its growth objectives. The inability to attract and retain experienced personnel as required could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Competition," "-- Employees" and "Management." RISKS ASSOCIATED WITH GEOGRAPHIC EXPANSION A substantial majority of the Company's revenue historically has been derived from clients located in the western United States. The Company's ability to achieve significant future revenue growth will in large part depend on its ability to gain new clients throughout the United States. By the end of calendar 1998, the Company intends to open a satellite sales and implementation center in New Jersey to service the eastern United States. The Company may open additional sales offices in the future. Due to the time required to sell and implement the Company's services and the fixed costs associated with opening a new center, any revenue associated with a new center will be significantly lower than the costs associated with it, potentially for a significant period of time. Growth and geographic expansion have resulted in new and increased responsibilities for management personnel and has placed and continues to place a significant strain on the Company's management and operating and financial systems. The Company will be required to continue to implement and improve its systems on a timely basis and in such a manner as is necessary to accommodate the increased number of transactions and clients and the increased size of the Company's operations. Any failure to implement and improve the Company's systems or to hire and retain the appropriate personnel to manage its operations would have a material adverse effect on the Company's business, financial condition and results of operations. In addition, an increase in the Company's operating expenses from its planned expansion will have a material adverse effect on the Company's business, financial condition and results of operations if revenue does not increase to support such expansion. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Sales and Marketing." RISKS ASSOCIATED WITH THE DEVELOPMENT AND INTRODUCTION OF NEW OR ENHANCED SERVICES The Company's future business, financial condition and results of operations will continue to depend upon the Company's ability to add new services or enhancements to existing services that address the needs of the market. Failure by the Company to successfully design, develop, integrate and introduce new services or enhancements on a timely basis could prevent the Company from maintaining existing client relationships, gaining new clients or expanding its markets and could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Research and Development." DEPENDENCE ON KEY PERSONNEL The Company's success will depend on the performance of the Company's senior management and other key employees. The loss of the services of any senior management or other key employee could have a material adverse effect on the Company's business, financial condition and results of operations. The Company generally does not enter into employment or noncompetition agreements with its employees. If one or more of the Company's key employees resigns from the Company to join a competitor or to form a competitor, the loss of such personnel and any resulting loss of existing or potential clients to any such competitor could have a material adverse effect on the Company's business, financial condition and results of operations. In the event of the loss of any key personnel, there can be no assurance that the Company would be able to prevent the unauthorized disclosure or use of its technical knowledge, practices, procedures or client lists by a former employee or that such disclosure or use would not have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Employees" and "Management." 10 IMPACT OF YEAR 2000 COMPLIANCE Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. Beginning in 2000, these date code fields will need to accept four digit entries in order to distinguish 21st century dates from 20th century dates. As a result, computer systems and/or software used by many companies will need to be upgraded to comply with "Year 2000" requirements by the end of 1999. Significant uncertainty exists in the software industry concerning the potential effects associated with such compliance issues. The Company has conducted a preliminary review of its internal computer systems to identify the systems that could be affected by the Year 2000 issue and to develop a plan to make its systems Year 2000 compliant. Based on this preliminary review, the Company has discovered certain failures to comply with Year 2000 requirements. The Company is taking action to correct the non-complying features of its systems, and the Company believes that its internal software systems will be Year 2000 compliant by 2000. There can be no assurance, however, that the Company's systems will be fully Year 2000 compliant in a timely manner, and a failure by the Company to make its internal systems Year 2000 compliant could have a material adverse effect on the Company's business, financial condition and results of operations. The Company has not determined an estimate of the costs required to correct the non-complying features, and the Company does not currently have a contingency plan in the event that it is unable to make its systems Year 2000 compliant. Additionally, the costs of making such systems Year 2000 compliant could have a material adverse effect on the Company's business, financial condition and results of operations. The Company believes that its current products are, and future products will be, fully Year 2000 compliant. The Company's past software products, many of which are currently used by clients, are not Year 2000 compliant. The Company has begun the process of transitioning existing clients to its Year 2000 compliant products; however, there can be no assurance that the Company will be successful in providing all of its clients with Year 2000 compliant products by 2000. Any failure by the Company to transition its clients to Year 2000 compliant products could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, there can be no assurance that Year 2000 errors or defects will not be discovered in the Company's current and future products. The Company is not assessing the Year 2000 compliance of its clients' systems or the possible effects on its operations of the Year 2000 compliance of its clients' systems. Due to the substantial integration between the Company's computer systems and its clients' systems, the failure by the Company's clients to have Year 2000 compliant systems could have a material adverse effect on the Company's business, financial condition and results of operations. The Company is assessing the possible effects on its operations of the Year 2000 readiness of key suppliers and subcontractors. The Company's reliance on suppliers and subcontractors, and, therefore, on the proper functioning of their information systems and software, means that failure by such suppliers and subcontractors to address Year 2000 issues could have a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Year 2000 Compliance." LIMITATIONS ON PROTECTION OF INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS The Company's success is dependent in part upon its proprietary software technology. The Company has no patents, patent applications or registered copyrights. The Company relies on a combination of contract, copyright and trade secret laws to establish and protect its proprietary technology. The Company distributes its services under software license agreements that grant clients licenses to use the Company's services and contain various provisions protecting the Company's ownership and the confidentiality of the underlying technology. The Company generally enters into confidentiality and/or license agreements with its employees and existing and potential clients, and limits access to and distribution of its software, documentation and other proprietary information. There can be no assurance that the steps taken by the 11 Company in this regard will be adequate to deter misappropriation or independent third-party development of the Company's technology. There can be no assurance that the Company's services and technology do not infringe any existing patents, copyrights or other proprietary rights of others, or that third parties will not assert infringement claims in the future. If any such claims are asserted and upheld, the costs of defense could be substantial and any resulting liability to the Company could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Proprietary Rights." UNALLOCATED NET PROCEEDS The Company has not designated any specific use for the net proceeds of the Offering. The Company currently expects to use the net proceeds for general corporate purposes, including capital expenditures and working capital. The Company also may use a portion of the net proceeds for the acquisition of companies, technology or services that complement the business of the Company or for strategic alliances with, or investments in, companies that provide complementary products and services. Accordingly, management will have significant discretion in applying the net proceeds of the Offering. See "Use of Proceeds." CONCENTRATION OF STOCK OWNERSHIP Upon completion of this Offering, the Company's directors and executive officers and their respective affiliates will beneficially own 36.7% (36.0% if the Underwriters' over-allotment option is exercised in full) of the outstanding Common Stock. As a result, these stockholders, if they act together, will be able to exercise significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, and will have power to influence any stockholder action or approval requiring a majority vote. Such concentration of ownership may also have the effect of delaying, deferring or preventing a change of control of the Company. See "Principal Stockholders" and "Description of Capital Stock." POSSIBLE VOLATILITY OF STOCK PRICE The market price of the Company's Common Stock is likely to be highly volatile following this Offering and could be subject to wide fluctuations in response to quarterly variations in operating results, announcements of technological innovations or new services by the Company or its competitors, market conditions in the information services industry, changes in financial estimates by securities analysts or other events or factors, many of which are beyond the Company's control. In addition, the stock market has experienced significant price and volume fluctuations that have particularly affected the market prices of equity securities of many technology and services companies and that often have been unrelated to the operating performance of such companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. SUBSTANTIAL DILUTION The assumed public offering price is substantially higher than the net tangible book value per share of the outstanding Common Stock. As a result, purchasers of the Common Stock offered hereby will incur immediate, substantial dilution in the amount of $30.11 per share. To the extent that outstanding options or warrants to purchase the Company's Common Stock are exercised, there will be further dilution. The Company has in the past granted a substantial number of options to purchase Common Stock to employees as part of compensation packages at exercise prices per share lower than the price per share of Common Stock offered hereby, and the Company expects that it will continue to grant a substantial number of options in the future at the fair market value of the Common Stock at such time, which possibly could be a price per share lower than the price per share of Common Stock offered hereby. In addition, the Company's employee stock purchase plan provides employees an opportunity to purchase shares below 12 prevailing market value. The Company also may issue shares of its Common Stock in connection with strategic acquisitions or alliances. Any of the foregoing could also result in dilution to stockholders. See "Dilution." SHARES ELIGIBLE FOR FUTURE SALE Sales of substantial numbers of shares of Common Stock in the public market following this Offering could adversely affect the market price of the Common Stock. Upon completion of this Offering, the Company will have outstanding an aggregate of 19,589,855 shares of Common Stock, based upon the number of shares outstanding as of June 30, 1998. Of these shares, all of the shares sold in this Offering and the 4,312,500 shares sold in the Company's initial public offering will be freely tradeable without restriction or further registration under the Securities Act. There are currently outstanding 2,539,100 shares of Common Stock issued pursuant to exercise of options granted under equity incentive plans of the Company, all of which shares are freely tradeable pursuant to Rule 701 of the Securities Act or have been registered for resale under the Securities Act. The remaining 10,263,255 shares of Common Stock were issued and sold by the Company in private transactions exempt from registration requirements of the Securities Act and will be available for immediate sale in the public market in accordance with Rule 144, in some cases subject to the volume and other resale limitations of Rule 144, other than the one-year holding period. Approximately 7,127,890 of such shares are subject to lock-up agreements under which the holders of such shares have agreed with William Blair & Company, L.L.C. not to sell or otherwise dispose of any of such shares for a period of 90 days following the date of this Prospectus, subject to certain limited exceptions. See "Shares Eligible for Future Sale." As of June 30, 1998, options to purchase 1,800,416 shares of Common Stock were outstanding, of which options to purchase 414,884 shares were then exercisable. As of June 30, 1998, 1,277,510 shares of Common Stock were available for grant pursuant to the Company's 1996 Stock Option Plan and 579,886 shares of Common Stock were available for issuance pursuant to the Company's 1997 Employee Stock Purchase Plan. In addition, as of June 30, 1998, warrants to purchase 229,500 shares of Common Stock were outstanding, all of the underlying shares of which will be eligible for sale in the public market upon exercise of the warrants. Pursuant to agreements between the Company and certain stockholders and warrantholders (or their permitted transferees), approximately 9,571,976 shares of Common Stock and 124,500 shares issuable upon exercise of warrants are entitled to certain registration rights under the Securities Act. See "Description of Capital Stock" and "Shares Eligible for Future Sale." ANTI-TAKEOVER EFFECTS OF CERTIFICATE OF INCORPORATION, BYLAWS AND DELAWARE LAW The Company's Board of Directors has the authority to issue up to 5,000,000 shares of Preferred Stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the Company's 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, while providing flexibility in connection with possible acquisitions and other corporate purposes, 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, such Preferred Stock may have other rights, including economic rights, senior to the Common Stock, and, as a result, the issuance thereof could have a material adverse effect on the market value of the Common Stock. The Company has no present plans to issue shares of Preferred Stock. In addition, the Company is subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which prohibit the Company 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. 13 The application of Section 203 also could have the effect of delaying or preventing a change of control of the Company. Further, certain other provisions of the Company's Amended and Restated Certificate of Incorporation and Bylaws and of Delaware law could delay or make more difficult a merger, tender offer or proxy contest involving the Company. These provisions include a classified board, advance notice procedures for stockholders to nominate candidates for election as directors of the Company, authorization of the Board of Directors to alter the number of directors without stockholder approval, limitations on persons who can call stockholder meetings, lack of cumulative voting and prohibition of stockholder actions by written consent. See "Description of Capital Stock -- Preferred Stock" and "-- Delaware Law and Certain Charter and Bylaw Provisions." SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS Forward-looking statements contained in this Prospectus are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995 and are highly dependent upon a variety of important factors that could cause actual results to differ materially from those reflected in such forward looking statements. When used in this document and documents referenced herein, the words "intend," "anticipate," "believe," "estimate," and "expect" and similar expressions as they relate to the Company are included to identify such forward looking statements. These forward-looking statements include statements regarding the demand for outsourcing employee administrative services; the Company's expansion of its client base; the Company's intention to increase its direct sales force; the development of a comprehensive and fully integrated suite of employee administrative services; the Company's ability to offer additional services; the initiation or completion of any strategic acquisition, investment or alliance; the Company's ability to extend its technology leadership; the Company's ability to attract and retain new clients; market acceptance of any new services offered by the Company; the Company's ability to minimize the impact of interest rate fluctuations; the Company's ability to develop its financial and managerial controls and systems; the opening of additional facilities; the sufficiency of the Company's back-up facilities and disaster recovery procedures; the Company's ability to develop or acquire new technologies; the Company's ability to attract and retain experienced employees; the ability of the Company to make its internal system Year 2000 compliant and to transition its clients to a Year 2000 compliant system; the Company's ability to maintain a high payroll client retention rate and the Company's ability to increase its national presence. These forward-looking statements are based largely on the Company's current expectations and are subject to a number of risks and uncertainties, including without limitation, those identified under "Risk Factors" and elsewhere in this Prospectus and other risks and uncertainties indicated from time to time in the Company's filings with the Securities and Exchange Commission. Actual results could differ materially from these forward-looking statements. In addition, important factors to consider in evaluating such forward-looking statements include changes in external market factors, changes in the Company's business or growth strategy or an inability to execute its strategy due to changes in its industry or the economy generally, the emergence of new or growing competitors and various other competitive factors. In light of these risks and uncertainties, there can be no assurance that the forward-looking statements contained in this Prospectus will in fact occur. 14 USE OF PROCEEDS The net proceeds from the sale of the 2,475,000 shares of Common Stock offered hereby are estimated to be approximately $82.0 million ($94.4 million if the Underwriters' over-allotment option is exercised in full) at an assumed public offering price of $35.17 per share and after deducting the estimated underwriter discount and estimated offering expenses payable by the Company. The Company intends to use the net proceeds of this Offering for general corporate purposes, including capital expenditures and working capital. The Company also may use a portion of the net proceeds for the acquisition of, or investments in, companies, technology or services that complement the business of the Company or for strategic alliances with, or investments in, companies that provide complementary products and services. No such transactions, alliances or investments are currently planned. The amounts actually expended may vary depending upon numerous factors. Pending the foregoing uses, the Company intends to invest the net proceeds from this Offering in investment-grade, short-term, interest-bearing securities, money market funds or similar short-term investments. DIVIDEND POLICY The Company has never declared or paid any cash dividends on its capital stock. The Company currently intends to retain its earnings, if any, for use in its business and does not anticipate paying any cash dividends in the foreseeable future. In addition, the Company's working capital line of credit agreement prohibits the payment of cash dividends without the lender's prior approval. PRICE RANGE OF COMMON STOCK The Company's Common Stock is quoted on the Nasdaq National Market under the symbol "PRBZ." The following table sets forth, for the fiscal periods indicated, the high and low sales prices of the Common Stock as reported by the Nasdaq National Market since the Company's initial public offering of Common Stock at $7.33 per share on September 19, 1997 (after giving effect to the Stock Split). Prior to September 19, 1997, there was no public trading market for the Common Stock.
HIGH LOW --------- --------- FISCAL 1998: First Quarter (from September 19, 1997).................................. $ 12.92 $ 7.67 Second Quarter........................................................... 15.33 12.08 Third Quarter............................................................ 20.00 14.00 Fourth Quarter........................................................... 32.58 17.33 FISCAL 1999: First Quarter (through August 4, 1998)................................... $ 43.13 $ 29.75
On July 31, 1998, there were 372 holders of record of the Company's Common Stock. The Company believes that the number of beneficial owners of the Common Stock is substantially greater than the number of record owners because a large portion of the Common Stock is held of record in broker "street names." The last reported sale price per share of the Common Stock on August 4, 1998 on the Nasdaq National Market was $52.75 (equivalent to $35.167 after giving effect to the Stock Split). 15 CAPITALIZATION The following table sets forth the short-term indebtedness and total capitalization of the Company as of June 30, 1998 on an actual basis and on an as adjusted basis to give effect to the sale and issuance of the shares of Common Stock offered hereby at an assumed public offering price of $35.17 per share (after deducting the estimated underwriting discount and estimated offering expenses payable by the Company) and receipt and application of the estimated net proceeds therefrom. See "Use of Proceeds." This table should be reviewed in conjunction with the Financial Statements and Notes thereto appearing elsewhere in this Prospectus.
JUNE 30, 1998 ----------------------- ACTUAL AS ADJUSTED ---------- ----------- (IN THOUSANDS) Current portion of capital lease obligations............................................. $ 890 $ 890 ---------- ----------- ---------- ----------- Capital lease obligations, less current portion (1)...................................... 1,414 1,414 Stockholders' equity: Preferred Stock, $.001 par value; 5,000,000 shares authorized, no shares issued and outstanding........................................................................... -- -- Common Stock, $.001 par value; 60,000,000 shares authorized, 17,114,855 shares issued and outstanding, actual; 19,589,855 shares issued and outstanding, as adjusted (2).... 17 20 Additional paid-in capital............................................................... 53,286 135,306 Accumulated deficit...................................................................... (25,469) (25,469) Notes receivable from stockholders....................................................... (1,088) (1,088) ---------- ----------- Total stockholders' equity........................................................... 26,746 108,769 ---------- ----------- Total capitalization............................................................... $ 28,160 $ 110,183 ---------- ----------- ---------- -----------
- ------------------------ (1) See Note 4 of Notes to Financial Statements. (2) As of June 30, 1998 (after giving effect to the Stock Split). Excludes (i) 1,800,416 shares of Common Stock subject to outstanding options; (ii) 229,500 shares of Common Stock issuable upon exercise of outstanding warrants; (iii) 1,277,510 shares of Common Stock reserved for future grant under the Company's 1996 Stock Option Plan; and (iv) 579,886 shares of Common Stock reserved for issuance under the Company's 1997 Employee Stock Purchase Plan. See "Management -- Stock Plans," "Description of Capital Stock -- Warrants" and Notes 6 and 7 of Notes to Financial Statements. 16 DILUTION The net tangible book value of the Company as of June 30, 1998 was approximately $17.0 million or $0.99 per share of Common Stock. Net tangible book value per share represents the amount of the Company's total net tangible assets less total liabilities, divided by the number of shares of Common Stock issued and outstanding at that date. Dilution per share to new stockholders represents the difference between the amount paid by purchasers of shares of Common Stock in the Offering made hereby and the as adjusted net tangible book value per share of Common Stock immediately after the completion of this Offering. After giving effect to the sale of the shares of Common Stock offered hereby at an assumed public offering price of $35.17 per share and after deduction of the estimated underwriting discount and estimated offering expenses payable by the Company, the net tangible book value of the Company as of June 30, 1998, would have been approximately $99.0 million or $5.06 per share. This represents an immediate increase in net tangible book value of $4.07 per share to existing stockholders and an immediate dilution of $30.11 per share to new stockholders purchasing Common Stock in this Offering. The following table illustrates this per share dilution: Assumed public offering price per share........................... $ 35.17 --------- Net tangible book value per share at June 30, 1998.............. $ 0.99 --------- Increase in net tangible book value per share attributable to new stockholders.............................................. 4.07 --------- As adjusted net tangible book value per share after the Offering......................................................... 5.06 --------- Dilution per share to new stockholders............................ $ 30.11 --------- ---------
17 SELECTED FINANCIAL DATA The following selected statements of operations data for the years ended June 30, 1996, 1997 and 1998 and the balance sheet data at June 30, 1997 and 1998 are derived from the financial statements of the Company, which have been audited by Ernst & Young LLP, independent auditors, and are included elsewhere in this Prospectus. The statements of operations data for the years ended June 30, 1994 and 1995 and the balance sheet data at June 30, 1994, 1995 and 1996 are derived from financial statements of the Company that have been audited by Ernst & Young LLP that are not included in this Prospectus. The following selected financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Financial Statements and Notes thereto included elsewhere in this Prospectus.
YEAR ENDED JUNE 30, ------------------------------------------------------- 1994 1995 1996 1997 1998 ---------- ---------- --------- --------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENTS OF OPERATIONS DATA: Revenue.................................................. $ 4,069 $ 7,095 $ 13,863 $ 27,374 $ 46,317 Operating expenses: Cost of providing services............................. 1,629 2,703 6,435 13,659 23,859 General and administrative expenses.................... 1,202 1,304 2,054 4,282 6,727 Research and development expenses...................... 1,202 1,038 1,257 2,841 4,585 Client acquisition costs............................... 1,467 2,943 5,388 11,706 17,858 Acquisition of in-process technology................... -- -- 711 -- -- ---------- ---------- --------- --------- --------- Total operating expenses................................. 5,500 7,988 15,845 32,488 53,029 ---------- ---------- --------- --------- --------- Loss from operations..................................... (1,431) (893) (1,982) (5,114) (6,712) Interest expense......................................... (46) (86) (473) (1,190) (557) Other income............................................. -- -- 69 59 752 ---------- ---------- --------- --------- --------- Net loss................................................. $ (1,477) $ (979) $ (2,386) $ (6,245) $ (6,517) ---------- ---------- --------- --------- --------- ---------- ---------- --------- --------- --------- Historical basic and diluted net loss per share(1)....... $ (738.50) $ (139.86) $ (4.91) ---------- ---------- --------- ---------- ---------- --------- Shares used in computing historical basic and diluted net loss per share(1)....................................... 2 7 486 Pro forma basic and diluted net loss per share(1)........ $ (0.59) $ (0.41) --------- --------- --------- --------- Shares used in computing pro forma basic and diluted net loss per share(1)....................................... 10,533 15,722
JUNE 30, ------------------------------------------------------------ 1994 1995 1996 1997 1998 ----------- ----------- ---------- ---------- ---------- (IN THOUSANDS) BALANCE SHEET DATA: Cash and cash equivalents............................ $ 114 $ 852 $ 4,041 $ 5,047 $ 13,771 Payroll tax funds invested........................... -- -- 106,339 177,626 332,667 Working capital (deficiency)......................... (119) 69 3,022 41 3,323 Total assets......................................... 2,019 4,134 117,228 200,435 376,009 Payroll tax funds collected but unremitted........... -- -- 106,339 177,626 332,667 Long-term debt and note payable to stockholder, less current portion..................................... 394 1,016 8,072 8,917 -- Capital lease obligations, less current portion...... 174 168 253 1,898 1,414 Total stockholders' equity (deficit)................. 705 1,366 (136) 3,869 26,746
- ------------------------ (1) See Note 1 of Notes to Financial Statements for an explanation of the determination of the shares used in computing historical and pro forma basic and diluted net loss per share. 18 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET FORTH UNDER "RISK FACTORS" AND ELSEWHERE IN THIS PROSPECTUS. THE FOLLOWING DISCUSSION ALSO SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED ELSEWHERE IN THIS PROSPECTUS. OVERVIEW ProBusiness Services, Inc. is a leading provider of employee administrative services for large employers. The Company's primary service offerings are payroll processing, payroll tax filing, benefits administration, including the enrollment and processing of flexible benefit plans and COBRA programs, and human resources software. The Company's proprietary PC-based payroll system offers the cost-effective benefits of outsourcing and high levels of client service, while providing the flexibility, control, customization and integration of an in-house system. Since 1994, the Company has experienced significant growth of its revenue, client base and average client size. Revenue increased from $4.1 million in fiscal 1994 to $46.3 million in fiscal 1998. From June 30, 1994 to June 30, 1998, the client base for payroll processing services increased from 200 to approximately 510 clients, while the average size of the Company's payroll clients increased from approximately 400 employees to approximately 1,100 employees. The number of checks that the Company processed for its payroll clients increased from 2.9 million to 4.3 million for the quarters ended June 30, 1997 and 1998, respectively. As of June 30, 1998, the Company provided services to approximately 1,400 clients. The Company's revenue growth is primarily due to continued growth in its client base, the introduction of its payroll tax service in fiscal 1996, an increase in the average size of its clients, the introduction of new features and other services, and a high retention rate of existing payroll clients (approximately 92% for fiscal 1998). The Company does not anticipate it will sustain this rate of growth in the future. The establishment of new client relationships involves lengthy and extensive sales and implementation processes. The sales process generally takes three to twelve months or longer, and the implementation process generally takes an additional three to nine months or longer. In connection with the acquisition of each new client, the Company incurs substantial client acquisition costs, which consist primarily of sales and implementation expenses and, to a lesser extent, marketing expenses. In addition, the Company's revenue is subject to significant seasonal fluctuations, with the largest percentage of annual revenue being realized in the third and fourth fiscal quarters, primarily due to new clients beginning services in the beginning of the tax year (the Company's third fiscal quarter) and higher interest income earned on tax funds. Further, the Company's operating expenses are typically higher as a percentage of revenue in the first and second fiscal quarters as the Company increases personnel to acquire new clients and to implement and provide services to such new clients, a large percentage of which begin services in the third quarter. The Company expects this pattern to continue. The Company has experienced significant operating losses since its inception and expects to incur significant operating losses in the future due to continued client acquisition costs, investments in research and development and costs associated with expanding its sales efforts and operations to new geographic regions. As of June 30, 1998, the Company had an accumulated deficit of approximately $25.5 million. There can be no assurance that the Company will achieve or sustain profitability in the future. The Company derives its revenue from fees charged to clients for services and income earned from investing payroll tax funds. The Company generally recognizes revenue from services when such services are performed and recognizes income from investments when earned. The Company typically invests these funds in short-term financial instruments such as overnight U.S. government direct and agency obligations 19 repurchase agreements, commercial paper rated A-1 and/or P-1 and money market funds with an underlying credit quality of AA or better, which are subject to credit risks and interest rate fluctuations. See "Risk Factors -- Investment Risks." Interest income earned on collected, but unremitted payroll tax funds amounted to $1.9 million, $5.9 million and $11.5 million for fiscal 1996, 1997 and 1998, respectively. Payroll and payroll tax clients generally are subject to contracts with an initial term of 36 months. Benefits administration and human resources software clients generally are subject to contracts with an initial term of 12 months. The Company's contracts generally do not have significant penalties for cancellation. The Company's cost of providing services consists primarily of ongoing account management, tax and benefits administration operations and production costs, and, to a lesser extent, amortization of capitalized software development costs. The Company capitalizes software development costs after technological feasibility of the software relating to a service has been established and amortizes such costs using the greater of (i) the straight-line basis over the estimated useful life of the software, which is generally 36 months, or (ii) the ratio of current revenue to the total of current revenue and anticipated future revenue over the life of the related product. General and administrative expenses consist primarily of personnel costs, professional fees and other overhead costs for finance and corporate services. Research and development expenses consist primarily of personnel costs. Client acquisition costs consist of sales and implementation expenses and, to a lesser extent, marketing expenses. The Company has made acquisitions of businesses in the past and intends to pursue acquisitions in the future. In connection with acquisitions, the Company has in the past incurred and will likely incur in the future costs associated with adding personnel, integrating technology, increasing overhead to support the acquired businesses, acquiring in-process technology and amortizing expenses related to intangible assets. As a result, such acquisitions have had and any future acquisition could have an adverse effect on the Company's results of operations. In January 1997, the Company acquired all of the outstanding capital stock of BeneSphere for an initial purchase price of $3.1 million, with up to an additional $4.5 million to be paid in quarterly installments, beginning April 1998 through January 2000, if certain financial performance conditions are met. As of June 30, 1998, and in connection with the financial performance conditions, $2.2 million of the $4.5 additional purchase price had been earned. In connection with the acquisition of BeneSphere, the Company has recorded $4.5 million of goodwill, which is being amortized ratably over 20 years and could be increased by up to an additional $2.3 million if additional financial performance conditions are met. In May 1996, the Company acquired substantially all of the business and assets of Dimension Solutions for a purchase price of $1.3 million. In connection with the acquisition of Dimension Solutions, the Company recorded a one-time charge of $711,000 in fiscal 1996 relating to the purchase of in-process technology. As of June 30, 1998, the Company had federal and state net operating loss carryforwards of approximately $17.2 million and $1.2 million, respectively. The net operating loss carryforwards will expire at various dates beginning with fiscal 1999 through 2013, if not utilized. The Company's utilization of the net operating loss carryforwards may be subject to annual limitations under the Internal Revenue Code as a result of changes in the Company's ownership, which limitations could significantly restrict or partially eliminate their utilization. No income tax expense has been recorded since the Company's inception. 20 RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain items reflected in the statements of operations expressed as a percentage of revenue. There can be no assurance that the indicated trends in revenue growth or operating results will continue in the future.
YEAR ENDED JUNE 30, ------------------------------- 1996 1997 1998 --------- --------- --------- STATEMENT OF OPERATIONS DATA: Revenue.................................................................................. 100.0% 100.0% 100.0% Operating expenses: Cost of providing services............................................................. 46.4 49.9 51.5 General and administrative expenses.................................................... 14.8 15.6 14.5 Research and development expenses...................................................... 9.1 10.4 9.9 Client acquisition costs............................................................... 38.9 42.8 38.6 Acquisition of in-process technology................................................... 5.1 -- -- --------- --------- --------- Total operating expenses............................................................. 114.3 118.7 114.5 --------- --------- --------- Loss from operations..................................................................... (14.3) (18.7) (14.5) Interest expense......................................................................... (3.4) (4.3) (1.2) Other income............................................................................. 0.5 0.2 1.6 --------- --------- --------- Net loss................................................................................. (17.2)% (22.8)% (14.1)% --------- --------- --------- --------- --------- ---------
YEARS ENDED JUNE 30, 1998 AND JUNE 30, 1997 REVENUE. Revenue increased 69.2% to $46.3 million in fiscal 1998 from $27.4 million in fiscal 1997, primarily due to an increase in the number and average size of the Company's payroll and tax clients and, to a lesser extent, the inclusion of a full year's results of the Company's benefits administration services which were introduced January 1997. Interest income earned on payroll tax funds invested was $11.5 million and $5.9 million for fiscal 1998 and 1997, respectively. This increase was primarily the result of higher average daily tax balances in fiscal 1998. COST OF PROVIDING SERVICES. Cost of providing services increased 74.7% to $23.9 million in fiscal 1998 from $13.7 million in fiscal 1997 and increased as a percentage of revenue to 51.5% from 49.9%. The increase in absolute dollars was primarily due to the increase year-over-year in clients serviced. The increase as a percentage of revenue was primarily due to building management infrastructure in the Company's benefits operations and the opening of the Company's production facility in Irvine, California in fiscal 1998. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased 57.1% to $6.7 million in fiscal 1998 from $4.3 million in fiscal 1997 and decreased as a percentage of revenue to 14.5% from 15.6%. The increase in absolute dollars was primarily due to the hiring of additional management and administrative personnel to support the Company's growth and, to a lesser extent, to costs associated with the Company's benefits administration services which were introduced in January 1997 and included in general and administrative expenses for the full year of fiscal 1998. The decrease as a percentage of revenue was due primarily to the allocation of certain fixed costs over higher revenue. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses increased 61.4% to $4.6 million in fiscal 1998 from $2.8 million in fiscal 1997 and decreased as a percentage of revenue to 9.9% from 10.4%. The increase in absolute dollars was primarily a result of additional personnel and equipment to develop enhancements and new features to the Company's existing services. Research and development expenses decreased as a percentage of revenue due in part to higher revenue and an increase in the amount of expenses capitalized in fiscal 1998. Capitalized software development costs were $3.9 million and $1.4 million for fiscal 1998 and 1997, respectively. 21 CLIENT ACQUISITION COSTS. Client acquisition costs increased 52.6% to $17.9 million in fiscal 1998 from $11.7 million in fiscal 1997 and decreased as a percentage of revenue to 38.6% from 42.8%. The increase in absolute dollars was primarily due to the expanded sales and implementation force for payroll and stand-alone tax services, and inclusion of a full years' expenses related to the Company's benefits administration services introduced in January 1997. INTEREST EXPENSE. Interest expense decreased 53.2% to $557,000 in fiscal 1998 from $1.2 million in fiscal 1997. The decrease in interest expense was primarily due to the repayment of subordinated debt and repayment of borrowings under the Company's secured revolving line of credit with proceeds from the Company's initial public offering in September 1997. OTHER INCOME. Other income increased as a percentage of revenue to 1.6% in fiscal 1998 from 0.2% in fiscal 1997. The increase as a percentage of revenue was due to higher cash and investment balances resulting from the Company's initial public offering in September 1997 when compared to the same period the prior year. YEARS ENDED JUNE 30, 1997 AND JUNE 30, 1996 REVENUE. Revenue increased 97.5% to $27.4 million in fiscal 1997 from $13.9 million in fiscal 1996, primarily due to an increase in the number and average size of the Company's payroll clients, the introduction of the Company's payroll tax service in January 1996 and, to a lesser extent, the introduction of the Company's benefits administration services in January 1997. Interest income earned on payroll tax funds invested was $5.9 million and $1.9 million for fiscal 1997 and 1996, respectively. COST OF PROVIDING SERVICES. Cost of providing services increased 112.3% to $13.7 million in fiscal 1997 from $6.4 million in fiscal 1996 and increased as a percentage of revenue to 49.9% from 46.4%. The increases were primarily due to hiring additional managers for payroll account management, operations expense related to the Company's benefits administration services and, to a lesser extent, production expenses related to an increase in the number of payroll clients and increased personnel expenses related to the Company's payroll tax service, which was introduced in January 1996. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased 108.5% to $4.3 million in fiscal 1997 from $2.1 million in fiscal 1996 and increased as a percentage of revenue to 15.6% from 14.8%. The increases were primarily a result of the hiring of additional management and administrative personnel to support the Company's growth. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses increased 126.0% to $2.8 million in fiscal 1997 from $1.3 million in fiscal 1996 and increased as a percentage of revenue to 10.4% from 9.1%. The increases were primarily a result of additional personnel and equipment to develop enhancements and new features to the Company's existing services. Capitalized software development costs were $1.4 million in fiscal 1997 and $645,000 in fiscal 1996. CLIENT ACQUISITION COSTS. Client acquisition costs increased 117.3% to $11.7 million in fiscal 1997 from $5.4 million in fiscal 1996 and increased as a percentage of revenue to 42.8% from 38.9%. The increases were primarily due to expenses resulting from the establishment of a separate sales force to market the Company's payroll tax service on a stand-alone basis, increased expenses resulting from the expansion of the Company's payroll sales force and, to a lesser extent, implementation expenses related to an increased number of new clients that started services in January 1997. INTEREST EXPENSE. Interest expense increased 151.6% to $1.2 million in fiscal 1997 from $473,000 in fiscal 1996, primarily due to increased borrowing under the Company's line of credit, the issuance of promissory notes to certain investors in October and December 1995 and an increased amount of capitalized equipment leases. 22 QUARTERLY RESULTS The following table sets forth selected unaudited quarterly financial information for each of the eight quarters in the period ended June 30, 1998, as well as such data expressed as a percentage of the Company's revenue for the periods presented. This information has been derived from unaudited statements of operations data that, in the opinion of management, are stated on a basis consistent with the audited financial statements and include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of such information in accordance with generally accepted accounting principles. The Company's results of operations for any quarter are not necessarily indicative of the results to be expected in any future period.
QUARTER ENDED ---------------------------------------------------------------------------- 1996 1997 ------------------------ -------------------------------------------------- SEPT. 30 DEC. 31 MARCH 31 JUNE 30 SEPT. 30 DEC. 31 ----------- ----------- ----------- ----------- ----------- ----------- (IN THOUSANDS) Revenue...................................... $ 4,675 $ 5,524 $ 8,427 $ 8,748 $ 9,227 $ 10,325 Operating Expenses: Cost of providing services................. 2,288 2,950 3,907 4,514 5,019 5,772 General and administrative expenses........ 622 869 1,441 1,350 1,768 1,600 Research and development expenses.......... 625 683 732 801 1,110 1,020 Client acquisition costs................... 2,215 2,413 3,664 3,414 3,978 4,092 ----------- ----------- ----------- ----------- ----------- ----------- Total operating expenses..................... 5,750 6,915 9,744 10,079 11,875 12,484 ----------- ----------- ----------- ----------- ----------- ----------- Loss from operations......................... (1,075) (1,391) (1,317) (1,331) (2,648) (2,159) Interest expense............................. (215) (305) (380) (290) (255) (119) Other income................................. 11 1 2 45 26 234 ----------- ----------- ----------- ----------- ----------- ----------- Net loss..................................... $ (1,279) $ (1,695) $ (1,695) $ (1,576) $ (2,877) $ (2,044) ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- AS A PERCENTAGE OF TOTAL REVENUE ---------------------------------------------------------------------------- Revenue...................................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Operating Expenses: Cost of providing services................. 48.9 53.4 46.4 51.6 54.4 55.9 General and administrative expenses........ 13.3 15.7 17.1 15.4 19.2 15.5 Research and development expenses.......... 13.4 12.4 8.7 9.2 12.0 9.9 Client acquisition costs................... 47.4 43.7 43.4 39.0 43.1 39.6 ----------- ----------- ----------- ----------- ----------- ----------- Total operating expenses..................... 123.0 125.2 115.6 115.2 128.7 120.9 ----------- ----------- ----------- ----------- ----------- ----------- Loss from operations......................... (23.0) (25.2) (15.6) (15.2) (28.7) (20.9) Interest expense............................. (4.6) (5.5) (4.5) (3.3) (2.8) (1.2) Other income................................. 0.2 0.0 0.0 0.5 0.3 2.3 ----------- ----------- ----------- ----------- ----------- ----------- Net loss..................................... (27.4)% (30.7 )% (20.1 )% (18.0 )% (31.2 )% (19.8)% ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- 1998 ------------------------ MARCH 31 JUNE 30 ----------- ----------- Revenue...................................... $ 13,611 $ 13,154 Operating Expenses: Cost of providing services................. 6,424 6,644 General and administrative expenses........ 1,693 1,666 Research and development expenses.......... 1,213 1,242 Client acquisition costs................... 5,569 4,219 ----------- ----------- Total operating expenses..................... 14,899 13,771 ----------- ----------- Loss from operations......................... (1,288) (617) Interest expense............................. (87) (96) Other income................................. 242 250 ----------- ----------- Net loss..................................... $ (1,133) $ (463) ----------- ----------- ----------- ----------- Revenue...................................... 100.0% 100.0% Operating Expenses: Cost of providing services................. 47.2 50.5 General and administrative expenses........ 12.4 12.7 Research and development expenses.......... 9.0 9.4 Client acquisition costs................... 40.9 32.1 ----------- ----------- Total operating expenses..................... 109.5 104.7 ----------- ----------- Loss from operations......................... (9.5) (4.7) Interest expense............................. (0.6) (0.7) Other income................................. 1.8 1.9 ----------- ----------- Net loss..................................... (8.3 )% (3.5 )% ----------- ----------- ----------- -----------
Revenue has increased over the last eight quarters primarily as a result of the increase in the number and average size of the Company's payroll and tax clients and the introduction of the Company's benefits administration services in the third fiscal quarter in 1997. The Company's revenue is subject to significant seasonal fluctuations, with the largest percentage of annual revenue being realized in the third and fourth fiscal quarters primarily due to new clients beginning services at the beginning of the tax year in January and higher interest income earned on tax funds. The Company's operating expenses typically are higher as a percentage of revenue in the first and second fiscal quarters as the Company increases personnel to acquire new clients and to implement and provide services to such new clients, a large percentage of which begin services in January. The Company expects this pattern to continue. Cost of providing services increased in the second and fourth fiscal quarters of 1998 primarily due to increases in account management personnel and production costs related to the Company's expanded client base. 23 The Company's client acquisition costs typically fluctuate from quarter to quarter in relation to the addition of new clients. Sales, marketing and implementation costs incurred to provide services to new clients are expensed as incurred over the implementation period which typically lasts three to nine months or longer. A significant portion of these costs (including sales commissions) are expensed at the time clients begin services. In the third fiscal quarter of 1998, the increase in client acquisition costs in absolute dollars was primarily due to commission costs and costs for payroll and stand-alone tax services associated with clients beginning services in January. The Company's quarterly operating results have in the past and will in the future vary significantly depending on a variety of factors, including the number and size of new clients starting services, the decision of one or more clients to delay or cancel implementation or ongoing services, interest rates, seasonality, the ability of the Company to design, develop and introduce new services and features for existing services on a timely basis, transition costs to new technologies, expenses incurred for geographic expansion, risks associated with payroll tax and benefits administration services, price competition, a reduction in the number of employees of its clients, and general economic factors. Revenue from new clients represents a significant portion of quarterly revenue in the third and fourth fiscal quarters. A substantial majority of the Company's operating expenses, particularly personnel and related costs, depreciation and rent, is relatively fixed in advance of any particular quarter. The Company's agreements with its clients generally do not have significant penalties for cancellation. As a result, any decision by a client to delay or cancel implementation of the Company's services or the Company's underutilization of personnel may cause significant variations in operating results in a particular quarter and could result in losses for such quarter. As the Company secures larger clients, the time required for implementing the Company's services increases, which could contribute to larger fluctuations in revenue. Interest income earned from investing payroll tax funds, which is a significant portion of the Company's revenue, is vulnerable to fluctuations in interest rates. In addition, the Company's business may be affected by shifts in the general health of the economy, client staff reductions, strikes, acquisitions of its client by other companies and other downturns. There can be no assurance that the Company's future revenue and results of operations will not vary substantially. LIQUIDITY AND CAPITAL RESOURCES Since inception, the Company has financed its operations primarily through a combination of sales of equity securities, private debt and bank borrowings, and to a lesser extent, equipment leases. Prior to the initial public offering, the Company raised approximately $23.4 million in private sales of equity securities and raised approximately $27.0 million from its initial public offering in September 1997. At June 30, 1998, the Company had approximately $13.8 million of cash and cash equivalents and a $20.0 million secured revolving line of credit, which expires in December 2000. At June 30, 1998, the Company had no outstanding borrowings under the line of credit. See Note 3 of Notes to Financial Statements. Net cash provided by operating activities for fiscal 1998 was $3.6 million and net cash used in operating activities for fiscal 1997 and 1996 was $4.1 million and $202,000, respectively. Net cash provided by operating activities in fiscal 1998 compared to net cash used in operating activities in fiscal 1997 was primarily the result of increases in accrued liabilities, depreciation and deferred revenue, and decreases in other assets in fiscal 1998, partially offset by an increase in prepaid expenses and other current assets. The increase in cash used in operating activities in fiscal 1997 compared to fiscal 1996 was primarily the result of net losses and, to a lesser extent, increases in accounts receivable and other assets, partially offset by depreciation and amortization and an increase in accrued liabilities. Net cash used in investing activities was $14.3 million, $4.7 million and $3.3 million for fiscal 1998, 1997 and 1996, respectively. The increase in net cash used in investing activities in fiscal 1998 resulted primarily from (i) capital expenditures for equipment, furniture and fixtures to support the Company's 24 increased personnel, (ii) the move of the Company's corporate headquarters in early fiscal 1998 and (iii) the establishment of the Company's Irvine production facility in early fiscal 1998. In addition, the Company capitalized software development costs of $3.9 million, $1.4 million and $645,000 in fiscal 1998, 1997 and 1996 respectively. The Company expects to make additional capital expenditures for furniture, equipment and fixtures to support the continued growth of its operations. In addition, the Company anticipates that it will continue to expend funds for software development in the future. Net cash provided by financing activities was $19.5 million, $9.8 million and $6.7 million for fiscal 1998, 1997 and 1996, respectively. Net cash provided by financing activities for fiscal 1998 related primarily to $27.0 million of net proceeds from the Company's initial public offering of common stock and $959,000 from the exercise of warrants. The increase was partially offset by the payment of $3.9 million of outstanding subordinated debt and the net repayment of $4.8 million of borrowings under the Company's secured revolving line of credit. Net cash provided by financing activities for fiscal 1997 was primarily a result of $9.9 million of net proceeds from the issuance of preferred stock in March 1997. Net cash provided by financing activities for fiscal 1996 was primarily the result of $4.0 million from subordinated debt and net proceeds of $2.5 million from borrowings under line of credit agreements. The Company believes that the net proceeds from this Offering, together with existing cash balances, amounts available under its current credit facility and anticipated cash flows from operations will be sufficient to meet its working capital and capital expenditure requirements for at least the next 12 months. The Company may also utilize cash to acquire or invest in complementary businesses or to obtain the right to use complementary technologies, although the Company does not have any pending plans to do so. The Company may sell additional equity or debt securities or obtain additional credit facilities. YEAR 2000 COMPLIANCE The Company has conducted a preliminary review of its internal computer systems to identify the systems that could be affected by the Year 2000 issue and to develop a plan to make its systems Year 2000 compliant. Based on this preliminary review, the Company has discovered certain failures to comply with Year 2000 requirements. The Company is taking action to correct the noncomplying features of its systems, and the Company believes that its internal software systems will be Year 2000 compliant by 2000. There can be no assurance, however, that the Company's systems will be fully Year 2000 compliant in a timely manner, and a failure by the Company to make its internal systems Year 2000 compliant could have a material adverse effect on the Company's business, financial condition and results of operations. The Company has not determined an estimate of the costs required to correct the noncomplying features, and the Company does not currently have a contingency plan in the event that it is unable to make its systems Year 2000 compliant. Additionally, the costs of making such systems Year 2000 compliant could have a material adverse effect on the Company's business, financial condition and results of operations The Company believes that its current products are, and future products will be, fully Year 2000 compliant. The Company's past software products, many of which are currently used by clients, are not Year 2000 compliant. The Company has begun the process of transitioning existing clients to its Year 2000 compliant products; however, there can be no assurance that the Company will be successful in providing all of its clients with Year 2000 compliant products by 2000. Any failure by the Company to transition its clients to Year 2000 compliant products could have a material adverse effect on the Company's business, financial condition and results of operations. Year 2000 errors or defects, however, may be discovered in the Company's current and future products. The Company is not assessing the Year 2000 compliance of its clients' systems or the possible effects on its operations of the Year 2000 compliance of its clients' systems. Due to the substantial integration between the Company's computer systems and its clients' systems, the failure by the Company's clients to have Year 2000 compliant systems in a timely manner could have a material adverse effect on the Company's business, financial condition and results of operations. The Company is also assessing the 25 possible effects on its operations of the Year 2000 readiness of key suppliers and subcontractors. The Company's reliance on suppliers and subcontractors, and, therefore, on the proper functioning of their information systems and software, means that failure by such suppliers and subcontractors to address Year 2000 issues could have a material adverse effect on the Company's business, financial condition and results of operations. See "Risk Factors -- Impact of Year 2000 Compliance." INTEREST RATE SWAP AGREEMENTS During fiscal 1998, the Company entered into various interest rate swap agreements with a financial institution. The purpose of these agreements is to convert a portion of the interest the Company earns from collected but unremitted payroll tax funds from a floating to a fixed rate basis. The Company considers these agreements to be for "other than trading purposes" and has accounted for these agreements on an accrual basis, with each net payment or receipt due or owed under each agreement recognized in earnings during the period to which the payment or receipt relates, with no recognition on the balance sheet of the fair value of the agreements. At June 30, 1998, the aggregate fair value of these agreements was $432,000. These agreements, with fixed interest rates between 5.736% and 5.905%, each have a term of two years, one of which has a cancellation option after one year, and expire at various dates through April 2000. Interest is paid or received based upon the difference in the fixed interest rate and the contractual floating rate option times the contractual notional balance. The actual notional balance varies on a monthly basis due to fluctuations in projected holdings of collected but unremitted payroll tax funds. At June 30, 1998, the notional balance was $204.7 million and the average monthly notional balance for the remaining term of the agreements was $242.0 million. The agreements require collateral if interest rates increase and certain other conditions are met as defined in the agreements. At June 30, 1998, no collateral was required. The primary market risk to which the Company is exposed related to these agreements is interest rate risk. The Company has performed a sensitivity analysis related to these agreements assuming both positive and negative parallel shifts in interest rates of 50, 100 and 150 basis points. As a result of this analysis, the Company has determined that due to its current use of interest rate swap agreements, the Company would not experience a material adverse affect in its business, financial condition and results of operations, related to such hypothetical changes in interest rates during fiscal 1999. See "Risk Factors -- Investment Risks." 26 BUSINESS THE FOLLOWING BUSINESS SECTION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET FORTH UNDER "RISK FACTORS" AND ELSEWHERE IN THIS PROSPECTUS. OVERVIEW ProBusiness is a leading provider of employee administrative services for large employers. The Company's primary service offerings are payroll processing, payroll tax filing, benefits administration, including the enrollment and processing of flexible benefit plans and COBRA programs, and human resources software. The Company's proprietary PC-based payroll system offers the cost-effective benefits of outsourcing and high levels of client service, while providing the flexibility, control, customization and integration of an in-house system. As of June 30, 1998, the Company provided services to approximately 1,400 clients. As of June 30, 1998, the Company provided payroll processing services to approximately 510 clients with an aggregate of approximately 575,000 active employees and an average of approximately 1,100 employees. For the quarter ended June 30, 1998, the Company processed 4.3 million checks for the Company's payroll clients. In addition to providing tax filing services for its payroll clients, as of June 30, 1998 the Company provided stand-alone tax filing services to 72 clients with an aggregate of more than 1.1 million employees and an average of more than 15,000 employees. The Company differentiates itself from its competitors through its proprietary PC-based technology, high quality, responsive and professional client service, and focus on the needs of large employers. ProBusiness develops a business partnership with each client by assessing each client's payroll processing needs, reengineering and designing the client's payroll systems and processes and implementing a cost-effective solution. The Company maintains an ongoing relationship with each client using a strategic team of specialists led by a personal account manager who proactively manages each client's account and marshals the resources of the team to meet the client's specific needs. ProBusiness maintains a low client-to-account manager ratio to offer clients accessible and responsive account management. The Company believes that its low client-to-account manager ratio and its focus on client service are key factors in enabling the Company to achieve a high payroll client retention rate, which was approximately 92% for fiscal year 1998. INDUSTRY BACKGROUND Many large businesses have found that outsourcing non-core functions reduces costs, improves service, quality and efficiency, allows personnel to focus on core competencies and enhances productivity through access to advanced technologies. As a result, the demand for outsourcing employee administrative services has grown significantly and is expected to continue to grow over the next several years. According to G-2 Research, Inc., third-party payroll processing, payroll tax filing and benefits administration is expected to generate approximately $3.9 billion in revenue in 1998 and approximately $9.3 billion in revenue in 2003. Payroll processing, payroll tax filing and benefits administration lend themselves to outsourcing because both are complex and costly for employers to conduct internally. Payroll processing involves tracking employee data, calculating payroll data and producing paychecks and direct deposits, remitting and filing payroll taxes and generating management reports. Benefits administration consists of many human resources functions, such as the enrollment and processing of flexible benefits plans and the administration and management of COBRA programs. In recent years, payroll processing and benefits administration have increased in complexity due to continual changes in regulations and increasingly sophisticated employee benefit plans. For example, large employers must have the ability to calculate taxes for multiple federal, state and local government agencies, collect garnishments based on different state laws and make numerous agency filings. In addition, payroll and benefits administration systems must keep 27 pace with rapidly evolving business operations as companies increase in size, expand geographically or add new operations. Finally, these systems must be flexible and scalable to integrate with increasingly advanced computer systems as companies adopt new technologies. Despite the complexities of payroll processing and the advantages provided by outsourcing, most large employers continue to process payroll in-house because they believe their unique business needs require the control and integration of an in-house system. These in-house payroll systems generally run on expensive mainframe or minicomputer systems and require customization and significant ongoing technical support. In addition, such systems typically are operated and maintained by large payroll departments, which are supported by dedicated programmers, systems analysts and production personnel. As their payroll needs change, employers that process their payroll in-house must continue to make significant investments in personnel, hardware and software to maintain and upgrade their payroll systems. Large employers that have outsourced their payroll processing needs have looked primarily to traditional payroll service providers, which process payroll data received from clients utilizing mainframe computers located at multiple regional data centers. This approach utilizes two systems, the client's and the service provider's, which have different hardware, operating systems, software applications and data configurations. Maintaining and synchronizing two separate systems makes it difficult for these service providers to update code, add features and functionality and provide clients with customization and integration with their other systems. In addition, the complexities presented by operating two separate systems often impede the timely identification and resolution of client payroll processing problems. Many large employers that choose to outsource their employee administration functions require a payroll provider that offers a high level of flexibility and client service. In addition, these employers prefer to have a single service provider of comprehensive and integrated services for their payroll, benefits and other employee administrative needs. Given the inherent limitations of the technology used by traditional payroll processing providers, such providers are unable to deliver a highly responsive and flexible solution. As a result, the Company believes a significant opportunity exists for service providers that can furnish large employers with high quality client service and a payroll system that offers the cost-effective benefits of outsourcing, while providing the same level of control, customization and integration as an in-house system. THE PROBUSINESS SOLUTION The Company's solution provides large employers with the cost-effective benefits of outsourcing and high levels of client service, while providing the flexibility, system control, customization and integration of an in-house system. The Company combines its PC-based technology and personalized client service to provide a broad range of service offerings, including payroll processing, payroll tax filing, benefits administration and human resources software. PC-BASED TECHNOLOGY. The Company's proprietary PC-based technology for its payroll services provides a platform for delivering high levels of service together with the flexibility and control of an in-house system. The Company creates a mirrored version of each client's system, which allows the Company's account managers to access client information using the same data, programs and screens as the client uses on its PC network. This enables the Company to quickly and easily identify client problems or modify application programs in response to client requests. The client maintains control by having direct access to all calculation programs and all historical and transactional data, which also provides the client with flexibility to respond quickly to employee and third-party inquiries, to fully analyze payroll data and to generate management reports. The Company's system architecture is designed to distribute payroll processing tasks to multiple low cost, high performance PCs, which enables the Company to scale its system continually to handle increasing transaction volumes. The Company's PC-based application software supports the development of customized solutions for each client that can be easily upgraded and integrated with a client's other 28 systems. In addition, multiple networked PCs facilitate exception processing and rapid response that large employers require. CLIENT SERVICE FOCUS. The Company delivers high quality, responsive and professional service by establishing a business partnership with each client. The Company assigns each client a personal account manager, who proactively manages the account and marshals the resources of a strategic team of specialists to meet the client's specific needs. The Company maintains a low client-to-account manager ratio to offer clients accessible and responsive account management. The Company supports each client with functional and regulatory expertise in payroll, payroll tax and employee benefits, as well as specialists in pay data interfaces, general ledger interfaces, paid-time-off, report writing and systems integration. The Company uses its systems integration expertise to facilitate the integration of its payroll processing system with the client's existing hardware and software. To support and provide high quality service, the Company focuses on hiring experienced accounting and technical professionals from the payroll, accounting, human resources and financial services industries. The Company promotes its client service culture by instilling a sense of ownership in each employee through incentive compensation and recognition of achievements based on providing high quality service to clients. VALUE-ADDED SERVICES. The Company believes that it provides its clients higher value-added and more cost-effective payroll services than most other third-party providers. During the implementation process, the Company reengineers the client's payroll processes and designs a payroll system that integrates with the client's other systems. Once implementation is completed, integration between payroll and other systems is improved, eliminating manual tasks and allowing a client to redeploy specialized personnel to other functions within the organization. STRATEGY The Company's objective is to be the premier provider of employee administrative services for large employers. The Company's strategy is to continue providing clients with high levels of personal service and developing a comprehensive and fully integrated suite of employee administrative services. The Company also intends to expand its client base and provide additional services to its existing clients. The Company's ongoing strategy includes the following key factors: PROVIDE PREMIER SERVICE. The Company is committed to providing high levels of personal service and proactive account management, including maintaining a low client-to-account manager ratio. The Company believes that its ability to consistently deliver high quality service is a competitive advantage in the large employer market and is a key factor in enabling the Company to achieve a high payroll client retention rate, which was approximately 92% for fiscal year 1998. EXPAND CLIENT BASE. The Company intends to continue adding to its client base by expanding its direct sales force and locating sales representatives in major metropolitan areas throughout the United States, as well as increasing its penetration in existing markets and pursuing strategic alliances and acquisitions. PROVIDE A COMPREHENSIVE AND INTEGRATED SOLUTION. The Company's goal is to create a single data processing system that it can use as a platform to offer a full range of services to clients, thereby strengthening client relationships and improving efficiencies for both the Company and its clients. The Company intends to continue investing substantial resources to further develop a comprehensive and fully integrated suite of employee administrative services and extend the functionality of its existing proprietary technology. INCREASE SERVICES TO EXISTING CLIENTS. The Company believes that there is a significant opportunity for it to cross-sell its services to its existing client base, as few of its current clients use all of the Company's 29 services. In addition, the Company intends to leverage its relationships with existing clients to market new services and features. PURSUE STRATEGIC ACQUISITIONS AND ALLIANCES. The Company intends to pursue acquisitions and alliances to broaden its range of services and service features, enhance industry and technical expertise and acquire complementary technology. For example, during fiscal 1996, the Company introduced its human resources software and, during fiscal 1997, its benefits administration services through the acquisitions of Dimension Solutions and BeneSphere, respectively. During 1998, the Company formed alliances with SAP AG, a leading provider of enterprise business solutions, and Sheakly UniService, a leading provider of unemployment cost control services. See "-- Sales and Marketing." EXTEND TECHNOLOGY LEADERSHIP. The Company is committed to investing resources to enhance its industry-leading employee administrative services technology. The Company is developing a client/server version of its system and is broadening its administrative services offerings by developing Internet-based applications. The Company believes that the introduction of such administrative services offerings will enable it to address the growing demand for the extension of its applications throughout the enterprise. The Company's strategy involves substantial risks and uncertainties. There can be no assurance that the Company will be successful in implementing its strategy or that its strategy, even if implemented, will lead to successful achievement of the Company's objectives. If the Company is unable to implement its strategy effectively, the Company's business, financial condition and results of operations will be materially adversely affected. See "Risk Factors." SERVICE OFFERINGS The Company provides a broad range of employee administrative services, including payroll processing, tax filing, benefits administration and human resources software. The Company intends to expand its service offerings through future acquisitions, alliances and investments and to develop enhancements to its existing services internally. PAYROLL PROCESSING. The Company processes time and attendance data to calculate and produce employee paychecks, direct deposits and reports for its clients. Clients receive paychecks and reports within 24 to 48 hours of the Company's receipt of the data electronically submitted from the client. The Company's system is highly configurable to meet the specialized needs of each client yet maintains the ability to provide high volume processing. The system integrates easily with the client's general ledger, human resources and time and attendance systems. In addition, the Company offers many sophisticated features, including the automatic enrollment and tracking of paid time off, proration of compensation for new hires and integrated garnishment processing. PAYROLL TAX FILING. The Company collects contributed employer and employee tax funds from clients, deposits such funds with tax authorities when due, files all tax returns and reconciles the client's account. The Company will also represent the client before tax authorities in disputes or inquiries. Substantially all existing payroll clients utilize the Company's payroll tax service. In addition, as of June 30, 1998, the Company provided stand-alone tax services to 72 clients with an aggregate of more than 1.1 million employees and an average of more than 15,000 employees. BENEFITS ADMINISTRATION. The Company's benefits administration services include flexible benefits enrollment and processing, COBRA administration and consolidated billing and eligibility tracking. Employees can enroll in and choose their flexible spending benefits through traditional paper-based forms or through Internet-accessible enrollment sites using the Company's Enrollnet-TM- service. HUMAN RESOURCES SOFTWARE. The Company's human resources software tracks and reports general employee information, including compensation, benefits, skills, performance, training, job titles and 30 medical history. For clients that also use the Company's payroll service, the human resources data can be transferred to the payroll services system, thus eliminating the need for duplicate data entry. The Company continually evaluates the addition of add-on service offerings to expand the breadth of its solution through alliances, acquisitions or internal development. Such additional services include administrative services related to time and attendance, stock, travel and entertainment, unemployment insurance and 401(k) plans. CLIENT SERVICE The Company believes that its focus and dedication to providing high levels of client service is a competitive advantage in the large employer market. ProBusiness develops a business partnership with each client by assessing each client's payroll processing needs, reengineering and designing the client's payroll system and process and implementing a value-added solution. The Company maintains an ongoing relationship with each client using a strategic team that includes a sales representative, a sales analyst, an implementation manager, an account manager and numerous functional, regulatory and technical support specialists. The Company intends to continue providing its clients with a high level of service by hiring professionals who are experienced in their fields. Most service personnel have experience in payroll, accounting, human resources or financial services industries, and many hold Certified Public Accountant or Certified Payroll Professional accreditations. The Company continually monitors the quality of its service through client feedback mechanisms. The Company obtains valuable insights into the needs of its clients through its partnership with each client and from client responses to surveys, which are conducted semi-annually. The Company uses this information to help develop, identify and optimize new service offerings provided to existing clients and improve the level of service provided to clients. The Company also uses client feedback as a basis for incentive compensation and recognition of achievements. SALES. The Company believes that client service begins with the sales process. A sales representative and a sales analyst work together to assess a potential client's payroll processing needs. Based on this assessment, the sales team then identifies opportunities to reengineer the prospective client's payroll processes and to design a payroll solution that integrates effectively with its other systems. The payroll sales cycle typically ranges from three to twelve months or longer. IMPLEMENTATION. Upon engagement by a client, the Company assigns a team of technical support specialists, headed by an implementation manager who leads the transition from the client's former payroll system to the Company's system. The implementation manager works with the client, the sales analyst and technical support specialists to integrate the Company's payroll system with the client's other systems and to customize the system to improve the client's payroll processes. The Company uses its systems integration expertise to facilitate the integration of its payroll processing system with the client's existing hardware and software. The implementation process generally takes three to nine months or longer, depending on the complexity of the client's payroll processes and systems and the size of the client. ACCOUNT MANAGEMENT. An account manager is assigned to each client during the implementation process and serves as the client's day-to-day contact at the Company. The account manager coordinates the efforts of the Company's functional, regulatory and technical support specialists as necessary. The account manager visits each client regularly and establishes an annual business plan with the client that details scheduled payroll events such as open enrollment periods for employee benefits plans or software system changes. This annual business plan allows the Company to provide clients with uninterrupted payroll services during these periods. Account managers use the Company's proprietary CallLog system to record and track all client calls, record client feedback and help ensure that the client's needs are addressed promptly and thoroughly. The Company maintains a low client-to-account manager ratio to offer clients accessible and responsive account management. 31 SUPPORT SPECIALISTS. The Company supports each client with functional and regulatory specialists in payroll, payroll tax and employee benefits, as well as pay data interfaces, general ledger interfaces, paid-time-off, report writing and system integration. Each of these specialists is available to speak directly with clients as needed, meet with clients onsite or support clients indirectly through the account manager. TECHNOLOGY The Company's proprietary PC-based technology for its payroll services provides a platform for delivering high levels of service together with the flexibility and control of an in-house system. The Company creates a mirrored version of each client's system, which allows the Company's account managers to access client information using the same data, programs and screens as the client uses on its PC network. This enables the Company to quickly and easily identify client problems or modify application programs in response to client requests. The client maintains control by having direct access to all calculation programs and all historical and transactional data, which also provides the client with flexibility to respond quickly to employee and third-party inquiries, to fully analyze payroll data and to generate management reports. The Company's intuitive Windows-based interface makes navigation simple and allows new users to be trained quickly. The Company is developing a new suite of online self-service administrative services applications accessible through the Internet that enable clients' employees to view paychecks and other compensation and benefits data. The Company's system architecture is designed to distribute payroll processing tasks to multiple low cost, high performance PCs, which enables the Company to scale its system continually to handle increasing transaction volumes. The Company's PC-based application software supports the development of customized solutions for each client that can be easily upgraded and integrated with a client's other systems. In addition, multiple networked PCs facilitate exception processing and rapid response that large employers require. 32 CLIENTS The Company targets large companies with complex and changing business needs in diverse industries. As of June 30, 1998, the Company provided services to approximately 1,400 clients. Of these clients, approximately 510 were payroll processing clients, with an aggregate of approximately 575,000 active employees and an average of approximately 1,100 employees. For the quarter ended June 30, 1998, the Company processed 4.3 million payroll checks for the Company's payroll clients. The Company began providing stand-alone tax filing services to clients in 1996 and, as of June 30, 1998, provided these services to 72 clients with an aggregate of more than 1.1 million employees and an average of more than 15,000 employees. Substantially all existing payroll clients utilize the Company's payroll tax filing service. For fiscal 1998, no client accounted for more than 4% of the Company's revenue. Set forth below is a representative list of the Company's clients, from each of which the Company recognized revenue of at least $25,000 in fiscal 1998.
TECHNOLOGY CONSUMER AND RETAIL FINANCIAL SERVICES - -------------------------------- ----------------------------- --------------------------- 3Com Corporation Airtouch Communications, Inc. California Casualty Group Advanced Micro Devices, Inc. Amoco Corporation E*TRADE Group, Inc. Ascend Communications, Inc. Childrens Discovery Centers First Allmerica Financial AST Research, Inc. of Life Atmel Corporation America, Inc. Insurance Company Bay Networks Inc. Coach Leatherwear Co., Inc. North American Title Cadence Design Systems Inc. Dollar General Corporation Insurance Company Cisco Systems Inc. Esprit de Corp. U.S. Bancorp Dell Computer Corporation The Gap, Inc. OTHER First Data Corporation The Gillette Company Abbott Laboratories Fujitsu, Ltd. J. C. Penney Company, Inc. Allergan, Inc. Hitachi America Ltd Koll Management Services, CCH Incorporated Informix Corporation Inc. Clubcorp International Integrated Device Technology, Michaels Stores, Inc. Federal Express Corporation Inc. Natural Wonders, Inc. Pharmacia & Upjohn, Inc. Intuit Inc. St. John Knits Inc. Raychem Corporation KLA/Tencor Corporation Sunglass Hut Watkins-Johnson Company LSI Logic Corporation International, Inc. Netscape Communications Corp. Toyota Motor Corporation Newbridge Networks, Inc. U.S. Computer Services Novell, Inc. Williams-Sonoma, Inc. Oracle Corporation Ziff Davis Publishing Company Pacific Scientific Company FOOD PRODUCTS AND SERVICES Quantum Corporation BonAppetit Management Read-Rite Corporation Company Siemens Business Communication Fresh Choice, Inc. Systems, Inc. Kellogg USA Inc. Silicon Graphics, Inc. OreIda Foods Inc. Silicon Systems, Inc. Pacific Coast Producers Solectron Corporation Specialty Restaurants Corp. Storage Technology Corporation Sybase, Inc. VeriFone, Inc.
The Company believes that its low client-to-account manager ratio and its focus on client service are key factors in enabling the Company to achieve a high payroll client retention rate, which was approximately 92% for fiscal 1998. Historically, the Company's client retention rates have been negatively 33 impacted primarily due to clients ceasing to use the Company's services following a merger or sale of the client. The Company does not have long-term contracts with its clients, and the Company's existing contracts do not have significant penalties for cancellation. SALES AND MARKETING The Company employs a direct sales force to gain new payroll and payroll tax clients and increase the number of services provided to existing clients. The Company currently targets large employers through direct marketing, trade shows and active participation in local chapters of the American Payroll Association. The Company uses a team selling approach, whereby sales analysts and sales representatives collaborate to assess a potential client's needs and develop a cost-effective solution. The payroll sales cycle typically ranges from three to twelve months or longer. The Company primarily utilizes insurance brokers to attract new benefits administration clients. The Company seeks to attract and retain experienced industry sales representatives. The Company believes that its long-term competitiveness depends on increasing further its national presence. The Company believes that continuing to add direct sales representatives in major metropolitan areas throughout the United States is the most effective means of increasing its national client base. Over the past two years, the Company has added sales and implementation representatives covering major metropolitan areas, including Atlanta, Chicago, Dallas, New York and Seattle. To support its sales growth in the eastern United States, the Company intends to open a satellite sales and implementation center in New Jersey during the fourth quarter of calendar 1998. The Company's marketing department provides support materials and marketing communications to sales representatives, promotes public relations, conducts direct mail campaigns, manages trade show participation, and develops and manages corporate Web sites. As part of its strategy to provide a comprehensive suite of employee administrative services, the Company has recently entered into strategic alliances with two industry leaders. The Company has formed an alliance with SAP AG, a leading provider of enterprise business solutions, to offer customers high levels of flexibility in managing payroll and payroll tax processes by linking the Company's payroll and tax solution to SAP's HR System. The Company has also formed an alliance to provide services to clients jointly with Sheakly UniService, a leading provider of unemployment cost control services. RESEARCH AND DEVELOPMENT The Company intends to continue investing substantial resources to further develop a comprehensive and fully integrated suite of employee administrative services and extend the functionality of its proprietary payroll processing systems. For example, the Company is developing a new suite of online self-service administrative services applications accessible through the Internet that enable clients' employees to view paychecks as well as other compensation and benefits data. In addition, the Company expects to introduce an integrated payroll and human resources system utilizing client/server technology that will run on Windows 95 and Windows NT. The foregoing information contains forward-looking statements that involve risks and uncertainties. Actual events could differ materially from those anticipated in these forward-looking statements, as a result of certain factors including those discussed in the paragraph below. See "Risk Factors -- Reliance on Rapidly Changing Technology; Risks of Software Defects." COMPETITION The market for the Company's services is intensely competitive, subject to rapid change and significantly affected by new service introductions and other market activities of industry participants. The Company primarily competes with several public and private payroll service providers such as Automatic 34 Data Processing, Inc., Ceridian Corporation and Paychex, Inc., as well as smaller, regional competitors. Many of these companies have longer operating histories, greater financial, technical, marketing and other resources, greater name recognition and a larger number of clients than the Company. In addition, certain of these companies offer more services or features than the Company and have processing facilities located throughout the United States. The Company also competes with in-house employee services departments and, to a lesser extent, banks and local payroll companies. With respect to benefits administration services, the Company competes with insurance companies, benefits consultants and other local benefits outsourcing companies. The Company may also compete with marketers of related products and services that may offer payroll or benefits administration services in the future. The Company has experienced, and expects to continue to experience, competition from new entrants into its markets. Increased competition could result in pricing pressures, loss of market share and loss of clients, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company believes that the principal competitive factors affecting its market include client service, system functionality and performance, system scalability, reputation, system cost and geographic location. The failure of the Company to compete successfully would have a material adverse effect on the Company's business, financial condition and results of operations. PROPRIETARY RIGHTS The Company's success is dependent in part upon its proprietary software technology. The Company relies on a combination of contract, copyright and trade secret laws to establish and protect its proprietary technology. The Company has no patents, patent applications or registered copyrights. The Company distributes its services under software license agreements that grant clients licenses to use the Company's services and contain various provisions protecting the Company's ownership and the confidentiality of the underlying technology. The Company generally enters into confidentiality and/or license agreements with its employees and existing and potential clients, and limits access to and distribution of its software, documentation and other proprietary information. There can be no assurance that the steps taken by the Company in this regard will be adequate to deter misappropriation or independent third-party development of the Company's technology. There can be no assurance that the Company's services and technology do not infringe any existing patents, copyrights or other proprietary rights or that third parties will not assert infringement claims in the future. If any such claims are asserted and upheld, the costs of defense could be substantial and any resulting liability to the Company could have a material adverse effect on the Company's business, financial condition and results of operations. See "Risk Factors -- Reliance on Rapidly Changing Technology; Risks of Software Defects." EMPLOYEES As of June 30, 1998, the Company had 500 full-time employees. The Company believes that its relations with its employees are good. FACILITIES The Company's headquarters are located in Pleasanton, California and consist of approximately 130,000 square feet of office space leased through September 2008. The Company has signed a lease for a building to be built adjacent to its headquarters which will consist of approximately 70,000 square feet upon its planned completion in mid-1999. The Company also has a sales, implementation and production facility and a back-up payroll facility in Irvine, California, where it leases approximately 14,000 square feet under a lease which terminates May 2002. The Company is currently negotiating a lease for a satellite sales and implementation center in New Jersey. 35 The Company's benefits administration processing operations are located in Bellevue, Washington, where the Company leases approximately 6,500 square feet under a lease that will terminate in June 2003. The Company is currently negotiating a lease for a new building in Bellevue to house the Company's benefits administration processing operations. Such lease is expected to commence in early 1999. The Company believes that its existing facilities are adequate for its current needs and that additional facilities can be leased to meet future needs. 36 MANAGEMENT EXECUTIVE OFFICERS AND DIRECTORS The following table sets forth certain information with respect to the executive officers and directors of the Company as of August 1, 1998.
NAME AGE POSITION - ------------------------------------------------------ --- ------------------------------------------------ Thomas H. Sinton...................................... 50 Chairman of the Board, President, Chief Executive Officer, Director Jeffrey M. Bizzack.................................... 38 Senior Vice President, Sales Leslie A. Johnson..................................... 49 Senior Vice President, Client Services and Chief Service Officer Steven E. Klei........................................ 38 Senior Vice President, Finance, Chief Financial Officer and Secretary Robert E. Schneider................................... 40 Senior Vice President, Product Development and Chief Technical Officer William T. Clifford(1)................................ 52 Director David C. Hodgson(2)................................... 41 Director Ronald W. Readmond(1)(2).............................. 55 Director Thomas P. Roddy(1).................................... 63 Director
- ------------------------ (1) Member of the Audit Committee. (2) Member of the Compensation Committee. MR. SINTON, founder of the Company, has served as a Director of the Company since the Company's incorporation in October 1984, and from March 1993 to present, Mr. Sinton has served as the President and Chief Executive Officer of the Company. Since December 1996 and for a period between September 1989 and February 1993, Mr. Sinton served as Chairman of the Board. Mr. Sinton holds a B.A. degree in English Literature, MAGNA CUM LAUDE, from Harvard University, an M.S. degree in Food Science from the University of California at Davis and an M.B.A. degree from Stanford University. Mr. Sinton received a Fulbright Fellowship to study at the University of Vienna in Vienna, Austria. MR. BIZZACK has served as Senior Vice President, Sales of the Company since July 1993. From October 1992 to July 1993, Mr. Bizzack served as Vice President, Sales of the Company. From October 1988 to October 1992, Mr. Bizzack served as a District Sales Manager of the Company. Mr. Bizzack attended Saint Mary's College. MS. JOHNSON has served as Senior Vice President, Client Services and Chief Service Officer of the Company since August 1997 and served as Vice President, Client Services of the Company from September 1993 to August 1997. From May 1992 to September 1993, Ms. Johnson was Director, National Accounts for Automatic Data Processing. From January 1976 until her division was acquired by Automatic Data Processing in May 1992, Ms. Johnson held several positions at BankAmerica Corporation, most recently as Vice President, Northern California National Accounts. Ms. Johnson holds a B.A. degree in Communications from the University of Colorado. MR. KLEI has served as Senior Vice President, Finance of the Company since August 1997, as Chief Financial Officer of the Company since July 1995 and as Secretary of the Company since August 1996. Mr. Klei served as Vice President, Finance from July 1995 to August 1997. From April 1993 to July 1995, Mr. Klei was Corporate Controller for Esprit de Corp, an apparel company. From December 1990 to April 1993, Mr. Klei provided consulting services to financially troubled companies based on his experience at New Home Interiors, a regional operator of showrooms for home products and services. In such capacity, Mr. Klei joined Rainbow Records ("Rainbow"), a retailer of records and videos, as a consultant 37 in December 1990 at which time Rainbow was contemplating a liquidation. Mr. Klei presided over the orderly liquidation of Rainbow as Chief Financial Officer from April 1991 to February 1992. Subsequently, Rainbow entered into involuntary bankruptcy and received final approval from the bankruptcy court in the Northern District of California in Oakland. Mr. Klei holds a B.S. degree in Accounting from Central Michigan University and is a Certified Public Accountant. MR. SCHNEIDER has served as Senior Vice President, Product Development and Chief Technical Officer of the Company since August 1997 and served as Vice President, Research and Development and Chief Technical Officer of the Company from November 1996 to August 1997. From April 1995 to July 1996, Mr. Schneider served as Senior Vice President of Product Development at Premenos Technology Corporation, an electronic commerce software company. From February 1989 to March 1995, Mr. Schneider held several positions at Sybase Inc., most recently as Vice President and Business Unit Manager of the Server Products Group. Mr. Schneider holds a B.S. degree in Computer Science from the University of San Francisco. MR. CLIFFORD has served as a Director of the Company since August 1997. Mr. Clifford has been the President of Gartner Group Research and the Chief Operating Officer of Gartner Group, Inc. since April 1995 and Executive Vice President, Operations of Gartner Group, Inc. since October 1993. From December 1988 to October 1993 Mr. Clifford held various positions at Automatic Data Processing, Inc., including President of National Accounts and Corporate Vice President, Information Services. Mr. Clifford holds a B.A. degree in Economics from the University of Connecticut. MR. HODGSON has served as a Director of the Company since March 1997. Mr. Hodgson is a Managing Member of General Atlantic Partners LLC ("GAP LLC") and has been with GAP LLC since 1982. Mr. Hodgson is also a director of Baan Company, N.V., a publicly-traded software company, Walker Interactive, a publicly-traded software company, and several other privately-held software companies, in which GAP LLC or one of its affiliates is an investor. Mr. Hodgson holds an A.B. degree in Mathematics from Dartmouth College and an M.B.A. degree from Stanford University. MR. READMOND has served as a Director of the Company since February 1997. Since June 1998, Mr. Readmond has been President and Chief Operating Officer of Wit Capital Group Incorporated and has been an advisor of Barbour Griffith & Rogers, a lobbying firm, and Chairman of International Equity Partners, L.P., a private equity and project development company since January, 1997. From August 1989 to December 1996, Mr. Readmond held various positions at Charles Schwab & Co. Inc., most recently serving as Vice Chairman. Mr. Readmond holds a B.A. degree in Economics from Western Maryland College. MR. RODDY has served as a Director of the Company since 1992. Since 1988, Mr. Roddy has served as President and Chief Executive Officer of Lafayette Investments Inc., an investment banking and investment advisory company. Mr. Roddy holds a B.S. degree in Biochemistry from Villanova University. Mr. Hodgson was nominated and elected as a Director of the Company pursuant to an agreement entered into between the Company, GAP LLC and Thomas H. Sinton and his affiliates, in connection with the sale of Preferred Stock by the Company to GAP LLC. Under such agreement, GAP LLC and Mr. Sinton and his affiliates agreed to vote their shares to elect one director to the Board of Directors designated by GAP LLC until the third annual meeting of stockholders after the Company's initial public offering. The Board of Directors presently consists of five members who hold office until the annual meeting of stockholders or until a successor is duly elected and qualified. The Board of Directors is divided into three classes. One class of directors is elected annually and its members hold office for a three-year term or until their successors are duly elected and qualified, or until their earlier removal or resignation. The number of directors may be changed by a resolution of the Board of Directors. Executive officers are elected by the 38 Board of Directors. There are no family relationships among any of the directors and executive officers of the Company. The Board of Directors has established an Audit Committee and a Compensation Committee. The Audit Committee recommends the engagement of auditors and reviews the results and scope of the audit and other services provided by the Company's independent auditors, reviews and evaluates the Company's control functions and reviews the Company's investment policy. The Compensation Committee makes recommendations to the Board of Directors concerning salaries and incentive compensation for employees and consultants of the Company. The Compensation Committee also administers the Company's 1996 Stock Option Plan and 1997 Employee Stock Purchase Plan. See "-- Stock Plans." DIRECTOR COMPENSATION Members of the Company's Board of Directors do not receive compensation for their services as directors. Certain directors have been granted options to purchase Common Stock in the past, and options may be granted to Directors of the Company in the future. Mr. Clifford, Mr. Hodgson, Mr. Roddy and Mr. Readmond have received options to purchase 22,500, 22,500, 93,750, and 22,500 shares, respectively, of the Company's Common Stock, at exercise prices ranging from $0.16 to $6.00 per share. EXECUTIVE COMPENSATION The following table sets forth the compensation paid to (i) the Chief Executive Officer and (ii) the Company's four other most highly compensated executive officers (collectively with the Chief Executive Officer, the "Named Executive Officers") for services rendered in all capacities to the Company during the fiscal years ended June 30, 1997 and June 30, 1998. SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION AWARDS(1) ------------- ANNUAL COMPENSATION SECURITIES ---------------------- UNDERLYING NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS(#) - ------------------------------------------------------------------ --------- ---------- ---------- ------------- Thomas H. Sinton ................................................. 1998 $ 181,250 $ 120,000 52,500 President and Chief Executive Officer 1997 150,000 -- -- Jeffrey M. Bizzack ............................................... 1998 150,000 115,000 30,000 Senior Vice President, Sales 1997 131,250 82,000 -- Leslie A. Johnson ................................................ 1998 150,000 90,000 30,000 Senior Vice President, Client Services and Chief Service Officer 1997 131,250 30,000 19,500 Robert E. Schneider .............................................. 1998 150,000 75,000 15,000 Senior Vice President, Product Development and Chief Technical 1997 82,980 25,000 -- Officer Steven E. Klei ................................................... 1998 150,000 50,000 30,000 Senior Vice President, Finance and Chief Financial Officer 1997 127,100 30,000 --
39 The following table sets forth information regarding stock options granted during the fiscal year ended June 30, 1998 to each of the Named Executive Officers. OPTION GRANTS IN FISCAL 1998
INDIVIDUAL GRANTS(1) POTENTIAL REALIZABLE ---------------------------------------------------------------- VALUE AT ASSUMED NUMBER OF ANNUAL RATES OF STOCK SECURITIES PERCENT OF TOTAL EXERCISE PRICE APPRECIATION FOR UNDERLYING OPTIONS GRANTED TO PRICE PER OPTION TERM ($)(4) OPTIONS EMPLOYEES IN FISCAL SHARE ---------------------- NAME GRANTED(#)(1) 1998 (%)(2) ($)(3) EXPIRATION DATE 5% 10% - -------------------------- ------------- ------------------- ----------- --------------- ---------- ---------- Thomas H. Sinton.......... 52,500 5.78 13.08 11/17/2007 1,902,075 3,321,675 Jeffrey M. Bizzack........ 30,000 3.30 5.83 8/12/2007 1,282,800 2,051,100 Leslie A. Johnson......... 30,000 3.30 5.83 8/12/2007 1,282,800 2,051,100 Robert E. Schneider....... 15,000 1.65 5.83 8/12/2007 641,400 1,025,550 Steven E. Klei............ 30,000 3.30 5.83 8/12/2007 1,282,800 2,051,100
- ------------------------ (1) The options granted are immediately exercisable, but are subject to repurchase in the event the optionee's employment with the Company ceases for any reason. The options generally vest over four years as follows: 25% of the shares one year from the grant date and as to 1/48th of the shares in each successive month thereafter, with full vesting occurring on the fourth anniversary date. The options have a term of ten years, subject to earlier termination in certain situations related to termination of employment. See "Stock Plans." (2) Based on a total of 907,875 options granted to all employees, consultants and directors during fiscal 1998. (3) Represents the fair market value of the underlying Common Stock as determined by the Board of Directors on the date of grant. (4) The potential realizable value at 5% and 10% appreciation is calculated by assuming that the last reported sales price of $31.17 per share on June 30, 1998 appreciates at the indicated rate for the remaining portion of the term of the option and that the option is exercised at the exercise price and sold on the last day of its term at the appreciated price. Stock price appreciation of 5% and 10% is assumed pursuant to rules promulgated by the Securities and Exchange Commission and does not represent the Company's prediction of its stock price performance. 40 The following table sets forth for each of the Named Executive Officers the shares acquired and the value realized on each exercise of stock options during the year ended June 30, 1998 and the number and value of securities underlying unexercised options held by the Named Executive Officers at June 30, 1998. FISCAL YEAR AGGREGATED OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES
NUMBER OF SECURITIES UNDERLYING UNEXERCISED VALUE OF UNEXERCISED OPTIONS AT FISCAL YEAR- IN-THE- MONEY OPTIONS AT END(#) FISCAL YEAR-END($)(1) SHARES ACQUIRED VALUE -------------------------- -------------------------- NAME ON EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - -------------------------------- --------------- --------------- ----------- ------------- ----------- ------------- Thomas H. Sinton................ -- -- -- 52,500 -- 949,377 Jeffrey M. Bizzack.............. -- -- -- 30,000 -- 760,001 Leslie A. Johnson............... -- -- 8,531 40,969 238,868 1,067,133 Robert E. Schneider............. -- -- -- 15,000 -- 380,001 Steven E. Klei.................. -- -- 18,250 46,250 563,986 1,262,181
- ------------------------ (1) The amount set forth represents the difference between the closing Common Stock share price of $31.17 on June 30, 1998, as reported by the Nasdaq National Market, and the applicable exercise price, multiplied by the applicable number of options. STOCK PLANS 1989 STOCK OPTION PLAN. The Company's 1989 Stock Option Plan (the "1989 Plan") provided for the granting to employees (including officers and employee directors) of "incentive stock options" within the meaning of the Internal Revenue Code of 1986, as amended (the "Code") and for the granting to employees, directors and consultants of nonstatutory stock options. In February 1997, the Board of Directors of the Company increased the shares available for future grants under the 1989 Plan by 2,063,649 for a total of 4,480,872. Options granted under the 1989 Plan before the effective date of the amendment and restatement to the 1996 Plan in September, 1997, described below, remain outstanding in accordance with their terms, but no further options were granted under the 1989 Plan after the effective date of the amendment and restatement to the 1996 Plan. 1996 STOCK OPTION PLAN. The Company's 1996 Stock Option Plan (the "1996 Plan") was adopted by the Board of Directors in February 1996 under the name "Executive Stock Option Plan." The 1996 Plan provides for the granting to employees (including officers and employee directors) of incentive stock options and for the granting to employees, directors and consultants of nonstatutory stock options. In November 1996 and February 1997, the Board of Directors of the Company approved, effective September 19, 1997, an amendment and restatement of the 1996 Plan to (i) rename the Executive Stock Option Plan as the "1996 Stock Option Plan" and (ii) authorize an increase in the number of shares reserved for issuance under the plan of any unused or canceled shares under the 1989 Plan plus annual increases equal to the lesser of (a) 375,000 shares, (b) two percent (2%) of the number of outstanding shares of Common Stock on such date or (c) a lesser amount determined by the Board. The 1996 Plan is administered by the Board of Directors or a committee appointed by the Board (the "Administrator") and has a term of ten years. As of June 30, 1998, the Company had granted an aggregate of 4,894,788 shares of Common Stock under the 1996 Plan and the 1989 Plan. As of June 30, 1998, options to purchase an aggregate of 1,800,416 shares of Common Stock were outstanding under the 1996 Plan and the 1989 Plan and 1,277,510 shares remained available for future grants under the 1996 Plan. Subject to the provisions of the 1996 Plan, the Administrator has the authority to determine the individuals to whom stock options are to be granted, the number of shares to be covered by each option, the exercise price, the fair market value of the Common Stock, the type of option, the term of the option, 41 the restrictions, if any, on the exercise of the option, the terms for the payment of the option price and other terms and conditions. Incentive stock options granted under the 1996 Plan must have an exercise price of (i) at least 110% of fair market value of the Common Stock on the date of grant if granted to an employee who owns stock representing more than 10% of the voting power of all classes of stock of the Company, any parent or any subsidiary or (ii) at least 100% of fair market value of the Common Stock on the date of grant if granted to any other employee. In the case of a nonstatutory stock option, the per share exercise price is determined by the Administrator. No participant may be granted in any fiscal year of the Company an option to purchase more than 187,500 shares, and over the remaining term of the 1996 Plan such participant may not be granted options to purchase more than 375,000 additional shares. Payments by option holders upon exercise of an option may be made (as determined by the Administrator) in cash or such other form of payment as permitted under the 1996 Plan, including without limitation, by promissory note or by surrender of certain shares of Common Stock. In addition, an optionee may pay the exercise price by means of a so-called "cashless exercise." In the event of a proposed merger of the Company with or into another corporation, outstanding options may be assumed or equivalent options may be substituted by such successor corporation or a parent or subsidiary of such successor corporation. In the event that such successor corporation does not agree to assume options or substitute equivalent options, optionees will have the right to exercise their options as to all shares subject to such options, including shares as to which options would not otherwise be exercisable. 1997 EMPLOYEE STOCK PURCHASE PLAN. The Company's 1997 Employee Stock Purchase Plan (the "Purchase Plan") was adopted by the Board of Directors in November 1996 and amended in August 1997 and September 1997. The Company has reserved a total of 750,000 shares of Common Stock for issuance under the Purchase Plan, of which 170,114 have been issued, with the number of shares to be increased annually on each anniversary date of the adoption of the Purchase Plan by a number of shares equal to the lesser of (i) 225,000 shares, (ii) one and one-half percent (1.5%) of the outstanding number of shares on such date or (iii) a lesser number determined by the Board. The Purchase Plan, which is intended to qualify under Section 423 of the Code, permits eligible employees of the Company to purchase Common Stock through payroll deductions of up to 10% of their base straight time gross earnings and commissions, including payments for overtime, shift premiums, incentive compensation, incentive payments, bonuses or other payments. An eligible employee's right to purchase stock under the Purchase Plan may not accrue at a rate that exceeds $25,000 worth of stock in any calendar year. The price of Common Stock purchased under the Purchase Plan will be 85% of the lower of the fair market value of the Common Stock on the first day of an offering period or last day of the applicable purchase period. Employees may end their participation in the Purchase Plan at any time during an offering period, and they will be paid their payroll deductions to date. Participation ends automatically upon termination of employment with the Company. Rights granted under the Purchase Plan are not transferable by a participant other than by will, the laws of descent and distribution, or as otherwise provided under the plan. The initial offering period under the Purchase Plan is approximately 26 months and commenced on September 19, 1997 and will end on the last trading day on or before November 15, 1999. A second offering period commenced on May 18, 1998 and will end on the last trading day on or before May 15, 2000. Subsequent offering periods will last 24 months and will commence on the first trading day on or after November 16 and May 16 of each year during which the Purchase Plan is in effect, and will terminate on the last trading day in the periods ending 24 months later. Each 24-month offering period will consist of four purchase periods of approximately six months duration. The Purchase Plan will be administered by the Board of Directors or by a committee appointed by the Board. Employees are eligible to participate if they are customarily employed by the Company or any designated subsidiary for at least 20 hours per week and for more than five months in any calendar year. 401(K) PLAN The Company maintains a 401(k) retirement savings plan (the "401(k) Plan"). The 401(k) Plan provides that each participant may contribute up to 18% of his or her pre-tax gross compensation (up to a 42 statutorily prescribed annual limit of $10,000 in 1998). The percentage elected by certain highly compensated participants may be required to be lower. All amounts contributed by employee participants and earnings on these contributions are fully vested at all times. Employee participants may elect to invest their contributions in various established funds. LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS The Company's Amended and Restated Certificate of Incorporation limits the liability of directors to the maximum extent permitted by Delaware law. Delaware law provides that a corporation's certificate of incorporation may contain a provision eliminating or limiting the personal liability of directors for monetary damages for breach of their fiduciary duties as directors, except for liability (i) for any breach of their duty of loyalty to the corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) for unlawful payments of dividends or unlawful stock repurchases or redemptions as provided in Section 174 of the Delaware General Corporation Law or (iv) for any transaction from which a director derives an improper personal benefit. The Company's Bylaws provide that the Company shall indemnify its directors and officers and may indemnify its employees and agents to the fullest extent permitted by law. The Company has entered into agreements to indemnify its directors and officers, in addition to the indemnification provided for in the Company's Amended and Restated Certificate of Incorporation and Bylaws. These agreements, among other things, indemnify the Company's directors and officers for certain expenses (including attorneys' fees), judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by or in the right of the Company, arising out of such person's services as a director or officer of the Company, any subsidiary of the Company or any other company or enterprise to which the person provides services at the request of the Company. The Company believes that these provisions and agreements are necessary to attract and retain qualified directors and officers. At present, there is no pending litigation or proceeding involving any director, officer, employee or agent of the Company where indemnification will be required or permitted. The Company is not aware of any threatened litigation or proceeding that might result in a claim for such indemnification. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Compensation Committee is composed of Messrs. Hodgson and Readmond. No interlocking relationship exists between any member of the Company's Board of Directors and the board of directors or compensation committee of any other company, nor has any such interlocking relationship existed in the past. 43 CERTAIN TRANSACTIONS Between May 1994 and September 1995, Thomas H. Sinton, a Director and officer of the Company, and his immediate family loaned an aggregate of $1,040,000 to the Company at interest rates of 10.0% per year. The Company has paid all such loans in full. On December 5, 1996, the Company loaned $544,000 under a full recourse note agreement at an interest rate of 6.31% per year to Robert E. Schneider, an officer of the Company, to permit Mr. Schneider to exercise options to purchase Common Stock of the Company. All principal and interest is due December 5, 2000. As of June 30, 1998, Mr. Schneider had not paid any amount on the note. On January 31, 1997, the Company loaned $250,000 under a full recourse note agreement at an interest rate of 6.1% per year to Jeffrey M. Bizzack, an officer of the Company, to permit Mr. Bizzack to purchase a residence. Accrued interest must be paid on a monthly basis beginning two years from the date of the note. All principal and accrued but unpaid interest is due January 31, 2001 unless Mr. Bizzack's employment with the Company terminates, in which case, the note may become due earlier. As of June 30, 1998, Mr. Bizzack had not paid any amount on the note. It is anticipated that Lafayette Investments, Inc., an affiliate of the Company, will be an Underwriter in the Offering and will receive a portion of the underwriting discount. Thomas P. Roddy, a Director of the Company, is President and Chief Executive Officer of Lafayette Investments, Inc. See "Underwriting." Thomas H. Sinton and certain affiliates of GAP LLC are the sole stockholders of InterPro Expense Systems, Inc., a Delaware corporation ("InterPro"), which in April 1998 purchased rights to certain early-stage travel and entertainment expense processing software. Mr. Sinton is the President, Chief Executive Officer and Chairman of the Board of the Company. David C. Hodgson, a Director of the Company, is a managing member of GAP LLC, affiliates of which hold more than 5% of the Company's outstanding stock. Because Mr. Sinton and Mr. Hodgson are officers and Directors of the Company, their investment in InterPro was required to be, and was, approved by the disinterested directors of the Company. Any future transaction or relationship between the Company and InterPro would be entered into on an arms-length basis and would be approved by the Company's disinterested directors. Information with respect to compensation to directors and executive officers is set forth under "Management -- Director Compensation" and "-- Executive Compensation." 44 PRINCIPAL STOCKHOLDERS The following table sets forth certain information regarding the beneficial ownership of Common Stock, as of June 30, 1998, concerning (a) each person or entity known by the Company to own beneficially more than 5% of the outstanding shares of Common Stock, (b) each director of the Company, (c) each of the Named Executive Officers, and (d) all directors and executive officers of the Company as a group. Unless otherwise noted in the footnotes to the table, (i) the Company believes that the persons named in the table have sole voting and investment power with respect to all shares of Common Stock indicated as being beneficially owned by them and (ii) officers and directors can be contacted at the principal offices of the Company.
PERCENTAGE OF SHARES BENEFICIALLY OWNED(1) SHARES ------------------------ BENEFICIALLY PRIOR TO AFTER NAME OF BENEFICIAL OWNERS OWNED OFFERING OFFERING - --------------------------------------------------------------------------------- ----------- ----------- ----------- Thomas H. Sinton(2).............................................................. 4,190,246 24.5% 21.4% General Atlantic Partners, LLC(3)................................................ 2,174,199 12.7 11.1 Jeffrey M. Bizzack(4)............................................................ 180,061 * * Leslie A. Johnson(5)............................................................. 134,361 * * Steven E. Klei(6)................................................................ 84,173 * * William T. Clifford(7)........................................................... 5,625 * * David C. Hodgson(3).............................................................. 2,179,824 12.7 11.1 Ronald W. Readmond(8)............................................................ 17,881 * * Thomas P. Roddy(9)............................................................... 314,731 1.8 1.6 Robert E. Schneider(10).......................................................... 118,081 * * All executive officers and directors as a group (9 persons)(11).................. 7,224,983 42.0 36.7
- ------------------------ * Represents beneficial ownership of less than one percent. (1) Based on 17,114,855 shares of Common Stock outstanding prior to the Offering and 19,589,855 outstanding upon completion of the Offering. A person is deemed to be the beneficial owner of securities that can be acquired by such person within 60 days of June 30, 1998 upon the exercise of warrants or vested options. Calculations of percentage of beneficial ownership assume the exercise by only the respective named stockholder of all options and warrants for the purchase of Common Stock held by such stockholder which are exercisable within 60 days of June 30, 1998. (2) Includes 14,219 shares issuable upon exercise of vested options and 46,875 shares subject to the Company's repurchase rights. Also includes shares held by the Silas D. Trust Estate, the Silas Jack Sinton Family Trust, the Thomas H. Sinton and Jane Nibley Sinton 1989 Irrevocable Trust and Jane N. Sinton as a custodian for minor children. (3) Includes 1,851,009 shares held by General Atlantic Partners 39, L.P. ("GAP 39") and 323,190 shares held by GAP Coinvestment Partners, L.P. ("GAP Coinvestment"). The general partner of GAP 39 is GAP LLC. The managing members of GAP LLC are Steven A. Denning, Stephen P. Reynolds, David C. Hodgson, J. Michael Cline, William O. Grabe and William E. Ford. The same managing members of GAP LLC are the general partners of GAP Coinvestment. Mr. Hodgson is a director of the Company. Mr. Hodgson disclaims beneficial ownership of shares owned by GAP 39 and GAP Coinvestment, except to the extent of his pecuniary interests therein. Also includes with respect to Mr. Hodgson 5,625 shares issuable upon exercise of vested options held personally by Mr. Hodgson. The address for GAP 39, GAP Coinvestment, GAP LLC and Mr. Hodgson is c/o General Atlantic Service Corporation, Three Pickwick Plaza, Greenwich, CT 06830. 45 (4) Includes 7,500 shares issuable upon exercise of vested options and 17,031 shares subject to the Company's repurchase rights. (5) Includes 16,844 shares issuable upon exercise of vested options and 6,249 shares subject to the Company's repurchase rights. Also includes 15,894 shares held by Weir L. Johnson, of which 6,843 shares are issuable upon exercise of vested options and 3,281 shares are subject to the Company's repurchase rights. (6) Includes 28,250 shares issuable upon exercise of vested options and 16,406 shares subject to the Company's repurchase rights. (7) Represents 5,625 shares issuable upon exercise of vested options held by Mr. Clifford. (8) Includes 8,437 shares issuable upon exercise of vested options held by Mr. Readmond. (9) Includes (i) 39,345 shares held by the Lafayette Investments Inc. of which Mr. Roddy is President and Chief Executive Officer, (ii) 27,600 shares held by the Lafayette Investments Inc. 401(k) Plan and Trust, (iii) 51,207 shares held by Delaware Charter Guarantee FBO Thomas P. Roddy R-IRA, (iv) 24,000 shares held by Guarantee and Trust Co. TTEE FBO Thomas P. Roddy IRA and (v) 13,302 by Mary W. Roddy. (10) Includes 3,750 shares issuable upon exercise of vested options and 65,625 shares subject to the Company's repurchase rights. (11) Includes 97,093 shares issuable upon exercise of vested options and 155,737 shares subject to the Company's repurchase rights. 46 DESCRIPTION OF CAPITAL STOCK The authorized capital stock of the Company consists of 60,000,000 shares of Common Stock, par value $0.001 per share ("Common Stock"), and 5,000,000 shares of Preferred Stock, par value $0.001 per share ("Preferred Stock"). The following summary is qualified in its entirety by reference of the Company's Certificate of Incorporation, which is filed as an exhibit to the Registration of which this Prospectus is a part. COMMON STOCK As of June 30, 1998, there were 17,114,855 shares of Common Stock outstanding held of record by 376 stockholders. The holders of Common Stock are entitled to one vote for each share held of record on all matters submitted to a vote of the stockholders. The holders of Common Stock are not entitled to cumulative voting rights with respect to the election of directors, and as a consequence, minority stockholders will not be able to elect directors on the basis of their votes alone. Subject to preferences that may be applicable to any then outstanding shares of Preferred Stock, holders of Common Stock are entitled to receive ratably such dividends as may be declared by the Board of Directors out of funds legally available therefore. See "Dividend Policy." In the event of a liquidation, dissolution or winding up of the Company, holders of Common Stock are entitled to share ratably in all assets remaining after payment of liabilities and the liquidation preference of any then outstanding Preferred Stock. Holders of Common Stock have no preemptive rights and no right to convert their Common Stock into any other securities. There are no redemption or sinking fund provisions applicable to the Common Stock. All outstanding shares of Common Stock are, and all shares of Common Stock to be outstanding upon completion of this Offering will be, fully paid and nonassessable. PREFERRED STOCK The Board of Directors have the authority, without further action by the stockholders, to issue up to 5,000,000 shares of Preferred Stock in one or more series and to fix the rights, preferences, privileges and restrictions thereof, including dividend rights, conversion rights, voting rights, terms of redemption, liquidation preferences, sinking fund terms and the number of shares constituting any series or the designation of such series, without any further vote or action by stockholders. The issuance of Preferred Stock could adversely affect the voting power of holders of Common Stock and the likelihood that such holders will receive dividend payments and payments upon liquidation and could have the effect of delaying, deferring or preventing a change in control of the Company. The Company has no present plan to issue any shares of Preferred Stock. WARRANTS In connection with a loan agreement, the Company issued Coast Business Credit ("Coast") a warrant to purchase 28,500 shares of the Company's Common Stock at an exercise price of $2.65 per share, exercisable at any time through April 30, 2001. In connection with an amendment to the loan agreement between Coast and the Company to extend the line of credit, the Company issued a warrant to Coast to purchase an additional 28,500 shares of the Company's Common Stock at an exercise price of $2.65 per share, exercisable through October 25, 2001. In connection with a built-to-suit lease, the Company issued Britannia Hacienda V Limited Partnership ("Britannia Hacienda") and its partners warrants to purchase an aggregate of 67,500 shares of Common Stock at an exercise price of $2.65 per share, exercisable through September 24, 2002. In connection with its acquisition of BeneSphere, the Company issued warrants to purchase an aggregate of 75,000 shares of Common Stock to two former shareholders of BeneSphere at an exercise price of $6.00 per share, exercisable at any time through January 7, 2002. On July 1, 1997, the Company issued a warrant to purchase an aggregate of 30,000 shares of Common Stock at a purchase price of $6.00 per share exercisable through July 1, 2002. 47 REGISTRATION RIGHTS OF CERTAIN HOLDERS The holders (or their permitted transferees) of approximately 9,571,976 shares of Common Stock and 124,500 shares issuable upon exercise of warrants (collectively the "Holders") are entitled to certain rights with respect to the registration of such shares under the Securities Act of 1933, as amended (the "Securities Act"). If the Company proposes to register its Common Stock, subject to certain exceptions, under the Securities Act, the Holders are entitled to notice of the registration and are entitled to include, at the Company's expense, such shares therein, provided that the managing underwriter has the right to limit a certain number of such shares included in the registration. The Holders have waived their registration right with respect to this Offering. In addition, certain of the Holders may require the Company at its expense on no more than two occasions to file a registration statement under the Securities Act with respect to their shares of Common Stock. Such rights may not be exercised until 180 days after the completion of this Offering. In addition, GAP LLC may request the Company to file a registration statement under the Securities Act with respect to 1,724,199 shares of Common Stock on one occasion as long as certain conditions are met. If the Holders, by exercising their demand registration rights, cause a large number of securities to be registered and sold in the public market, such sales could have an adverse effect on the market price for the Company's Common Stock. Moreover, if the Company were to include in a Company initiated registration shares held by the Holders pursuant to exercise of their "piggyback" registration rights, such sales may have an adverse effect on the Company's ability to raise additional capital. DELAWARE LAW AND CERTAIN CHARTER AND BYLAW PROVISIONS The Company is subject to the provisions of Section 203 of the General Corporation Law of Delaware. Section 203 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. A "business combination" includes mergers, asset sales and other transactions resulting in a financial benefit to the interested stockholder. Subject to certain exceptions, an "interested stockholder" is a person who, together with affiliates and associates, owns, or within three years did own, 15% or more of the corporation's voting stock. The Company's Amended and Restated Certificate of Incorporation (the "Charter") provides for the division of the Board of Directors into three classes with staggered three-year terms. See "Management -- Executive Officers and Directors." Under the Charter, any vacancy on the Board of Directors, however occurring, including a vacancy resulting from an enlargement of the Board, may only be filled by vote of a majority of the directors then in office. The classification of the Board of Directors and the limitations on the removal of directors and filling of vacancies could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from acquiring, control of the Company. The Charter also provides that any action required or permitted to be taken by the stockholders of the Company at an annual meeting or special meeting of stockholders may only be taken if it is properly brought before such meeting and may not be taken by written action in lieu of a meeting. The Charter further provides that special meetings of the stockholders may only be called by the Chairman of the Board of Directors, the Chief Executive Officer, the President of the Company, the Board of Directors or the holders of shares entitled to cast not less than 40% of the votes at that meeting. Under the Bylaws, in order for any matter to be considered "properly brought" before a meeting, a stockholder must comply with certain requirements regarding advance notice to the Company. The foregoing provisions could have the effect of delaying until the next stockholders meeting stockholder actions which are favored by the holders of a majority of the outstanding voting securities of the Company. These provisions may also discourage another person or entity from making a tender offer for the Company's Common Stock, because such person or entity, even if it acquired a majority of the outstanding voting securities of the Company, would 48 be able to take action as a stockholder (such as electing new directors or approving a merger) only at a duly called stockholders meeting, and not by written consent. The General Corporation Law of Delaware provides generally that the affirmative vote of a majority of the shares entitled to vote on any matter is required to amend a corporation's certificate of incorporation or bylaws, unless a corporation's certificate of incorporation or bylaws, as the case may be, requires a greater percentage. The Charter requires the affirmative vote of the holders of at least 66 2/3% of the shares of capital stock of the Company issued and outstanding and entitled to vote to amend or repeal any of the foregoing Charter provisions. The 66 2/3% stockholder vote would be in addition to any separate class vote that might in the future be required pursuant to the terms of any series Preferred Stock that might be outstanding at the time any such amendments are submitted to stockholders. The Bylaws also may be amended or repealed by a majority vote of the Board of Directors subject to any limitations set forth in the Bylaws. TRANSFER AGENT AND REGISTRAR Norwest Bank Minnesota, National Association is the transfer agent and registrar for the Company's Common Stock. 49 SHARES ELIGIBLE FOR FUTURE SALE Sales of substantial numbers of shares of Common Stock in the public market following this Offering, or the perception that such sales could occur, could adversely affect the market price for the Common Stock. Furthermore, sales of substantial amounts of Common Stock in the public market after various resale restrictions lapse could adversely affect the prevailing market price and the ability of the Company to raise equity capital in the future. Upon completion of this Offering, the Company will have outstanding an aggregate of 19,589,855 shares of Common Stock, based upon the number of shares outstanding as of June 30, 1998. Of these shares, all of the shares sold in this Offering and the 4,312,500 shares sold in the Company's initial public offering will be freely tradeable without restriction or further registration under the Securities Act. There are currently outstanding 2,539,100 shares of Common Stock issued pursuant to exercise of options granted under equity incentive plans of the Company, all of which shares are freely tradeable pursuant to Rule 701 of the Securities Act or registration on a previously filed Form S-8. The remaining 10,263,255 shares of Common Stock were issued and sold by the Company in private transactions exempt from registration requirements of the Securities Act and will be available for immediate sale in the public market in accordance with Rule 144, in some cases subject to transfer restrictions in lock-up agreements with William Blair & Company, L.L.C. described below and the volume and other resale limitations of Rule 144, other than the one year holding period. In addition, as of June 30, 1998, there were outstanding options to purchase 1,800,416 shares of Common Stock and warrants to purchase 229,500 shares of Common Stock. The Company and its directors, executive officers and certain stockholders (together, holding an aggregate of 7,127,890 shares of the Company's Common Stock) have agreed not to offer, sell, contract to sell or otherwise dispose of any shares of Common Stock or any securities convertible into shares of Common Stock or register for sale under the Securities Act any shares of Common Stock for a period of 90 days after the date of this Prospectus without the prior written consent of William Blair & Company, L.L.C., other than the Company's sale of shares in this Offering, the issuance of Common Stock upon the exercise of outstanding options, and the Company's issuance of options and shares under existing stock option and stock purchase plans. The holders of approximately 9,571,976 shares of Common Stock and 124,500 shares of Common Stock issuable upon exercise of warrants are parties to registration rights agreements with the Company that provide "piggyback" registration rights that allow such holders, under certain circumstances, to include shares of Common Stock in registration statements initiated by the Company or other stockholders. Such registration rights agreements also permit demand registrations on Form S-3 registration statements, provided the Company is eligible to register securities on such form. The number of shares sold in the public market could increase if any holders exercise such rights. See "Description of Capital Stock -- Registration Rights." In general, under Rule 144 as currently in effect, an affiliate of the Company, or person (or persons whose shares are aggregated) who has beneficially owned, for at least one year but less than two years, securities subject to Rule 144, is entitled to sell in any three month period a number of shares that does not exceed the greater of (i) 1% of the then-outstanding shares of the Common Stock (approximately 195,898 shares immediately after the Offering) or (ii) the average weekly trading volume during the four calendar weeks immediately preceding the date on which notice of the sale is filed with the Securities and Exchange Commission. Sales pursuant to Rule 144 are subject to certain requirements relating to manner of sale, notice and availability of current public information about the Company. A person (or persons whose shares are aggregated) who is not deemed to have been an affiliate of the Company at any time during the 90 days immediately preceding the sale and who has beneficially owned the shares proposed to be sold for at least two years (including the holding period of any prior owner except an affiliate) is entitled to sell such shares pursuant to Rule 144(k) without complying with the requirements relating to manner of sale, 50 notice and information availability described above. In general, under Rule 701 of the Securities Act as currently in effect, any employee, consultant or advisor of the Company who purchases shares from the Company in connection with a compensatory stock or option plan or other written agreement related to compensation is eligible to resell such shares 90 days after the effective date of the Company's initial public offering (which was completed September 19, 1997) in reliance on Rule 144, but without compliance with certain restrictions, including the holding period, contained in Rule 144. No predictions can be made as to the effect, if any, that market sales of shares of Common Stock prevailing from time to time may have on the market price of the Common Stock. Nevertheless, sales of significant numbers of shares of the Common Stock in the public market may adversely affect the market price of the Common Stock offered hereby and could impair the Company's future ability to raise capital through an offering of its equity securities. 51 UNDERWRITING The several Underwriters named below (the "Underwriters"), for which William Blair & Company, L.L.C., BancAmerica Robertson Stephens and SG Cowen Securities Corporation are acting as representatives (the "Representatives"), have severally agreed, subject to the terms and conditions set forth in the Underwriting Agreement by and among the Company and the Underwriters (the "Underwriting Agreement"), to purchase from the Company, and the Company has agreed to sell to each of the Underwriters, the respective number of shares of Common Stock set forth opposite each Underwriter's name in the table below:
NUMBER OF UNDERWRITER SHARES - --------------------------------------------------------------------------------- ---------- William Blair & Company, L.L.C................................................... BancAmerica Robertson Stephens................................................... SG Cowen Securities Corporation.................................................. ---------- Total...................................................................... 2,475,000 ---------- ----------
The nature of the Underwriters' obligations under the Underwriting Agreement is such that all shares of Common Stock offered hereby, excluding shares covered by the over-allotment option granted to the Underwriters, must be purchased if any are purchased. The Representatives have advised the Company that the Underwriters propose to offer the shares of Common Stock to the public at the public offering price set forth on the cover page of this Prospectus and to select dealers at such price less a concession of not more than $ per share. The Underwriters may allow, and such dealers may reallow, a concession not in excess of $ per share to certain other dealers. After the public offering contemplated hereby, the public offering price and other selling terms may be changed by the Representatives. The Company has granted to the Underwriters an option exercisable within 30 days after the date of this Prospectus, to purchase up to an additional 371,250 shares of Common Stock to cover over-allotments, at the same price per share to be paid by the Underwriters for the other shares offered hereby. If the Underwriters purchase any such additional shares pursuant to this option, each of the Underwriters will be committed to purchase such additional shares in approximately the same proportion as set forth in the table above. The Underwriters may exercise the option only for the purpose of covering over-allotments, if any, made in connection with the distribution of the shares of Common Stock offered hereby. The Company, its directors and executive officers and certain stockholders of the Company have agreed not to offer, sell, contract to sell or otherwise dispose of any shares of Common Stock or any securities convertible into shares of Common Stock or register for sale under the Securities Act any shares of Common Stock for a period of 90 days after the date of this Prospectus without the prior written consent of William Blair & Company, L.L.C., other than the Company's sale of shares in this Offering, the issuance of Common Stock upon the exercise of outstanding options, and the Company's issuance of options and shares under existing stock option and stock purchase plans. See "Shares Eligible for Future Sale." The Representatives have advised the Company that, pursuant to Regulation M under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), certain persons participating in the Offering may engage in transactions that may stabilize, maintain or otherwise affect the market price of the 52 Common Stock, including stabilizing bids, syndicate covering transactions or the imposition of penalty bids. A "stabilizing bid" is a bid for, or the purchase of, the Common Stock on behalf of the Underwriters for the purpose of fixing or maintaining the price of the Common Stock. A "syndicate covering transaction" is the bid for, or the purchase of, the Common Stock on behalf of the Underwriters to reduce a short position incurred by the Underwriters in connection with the Offering. A "penalty bid" is an arrangement permitting the managing underwriter to reclaim the selling concession otherwise accruing to an Underwriter or syndicate member in connection with the Offering if the Common Stock originally sold by such Underwriter or syndicate member is purchased by the Underwriters in a syndicate covering transaction and has therefore not been effectively placed by such Underwriter or syndicate member. The Representatives have advised the Company that such transactions may be effected on the Nasdaq National Market or otherwise and, if commenced, may be discontinued at any time. One or more of the Underwriters currently act as market makers for the Common Stock and may engage in "passive market making" in such securities on the Nasdaq National Market in accordance with Rule 103 of Regulation M under the Exchange Act. Rule 103 permits, upon the satisfaction of certain conditions, underwriters participating in a distribution that are also Nasdaq market makers in the security being distributed to engage in limited market making transactions during the period when Rule 103 would otherwise prohibit such activity. Rule 103 prohibits underwriters engaged in passive market making generally from entering a bid or effecting a purchase price that exceeds the highest bid for those securities displayed on the Nasdaq National Market by a market maker that is not participating in the distribution. Under Rule 103, each underwriter engaged in passive market making is subject to a daily net purchase limitation equal to the greater of (i) 30% of such entity's average daily trading volume during the two full calendar months immediately preceding, or any 60 consecutive calendar days ending within the ten calendar days preceding, the date of the filing of the registration statement under the Securities Act pertaining to the security to be distributed or (ii) 200 shares of common stock. The Company has agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act, or to contribute to payments the Underwriters may be required to make in respect thereof. LEGAL MATTERS The legality of the issuance of the shares of Common Stock offered hereby will be passed upon for the Company by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California. As of June 30, 1998, certain members of Wilson Sonsini Goodrich & Rosati, P.C. beneficially owned an aggregate of 12,268 shares of the Company's Common Stock. Certain legal matters in connection with this Offering will be passed upon for the Underwriters by Cooley Godward LLP, San Francisco, California. EXPERTS The financial statements of ProBusiness Services, Inc. as of June 30, 1997 and 1998 and for each of the three years in the period ended June 30, 1998 appearing in this Prospectus and elsewhere in the Registration Statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein and in the Registration Statement, and are included in reliance upon such report given upon the authority of such firm as experts in accounting and auditing. ADDITIONAL INFORMATION The Company has filed with the Securities and Exchange Commission (the "Commission"), a Registration Statement on Form S-1 and exhibits and schedules thereto under the Securities Act, with respect to the Common Stock offered hereby. This Prospectus does not contain all of the information set forth in the Registration Statement and the exhibits and schedules thereto. Certain items are omitted in accordance with the rules and regulations of the Commission. For further information with respect to the 53 Company and the Common Stock offered hereby, reference is made to the Registration Statement and the exhibits and schedules filed therewith. Statements contained in this Prospectus as to the contents of any contract or any other document referred to are not necessarily complete, and, in each instance, reference is made to the copy of such contract or document filed as an exhibit to the Registration Statement, each such statement being qualified in all respects by such reference to such exhibit. A copy of the Registration Statement, and the exhibits and schedules thereto, may be inspected without charge at the public reference facilities maintained by the Commission in Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the Commission's regional offices located at the Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and Seven World Trade Center, 13th Floor, New York, New York 10048, and copies of all or any part of the Registration Statement may be obtained from the Commission upon the payment of the fees prescribed by the Commission. The Company is subject to the information requirements of the Exchange Act and in accordance therewith files reports and other information with the Commission. Reports, proxy statements and other information filed by the Company can be inspected and copied (at prescribed rates) at the locations listed above. Quotations relating to the Company's Common Stock appear on the Nasdaq National Market and such reports, proxy statements and other information concerning the Company also can be inspected at the offices of the Nasdaq Stock Market, 1753 K Street, N.W., Washington, D.C. 20006. The Commission maintains a World Wide Web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission. The address of the site is http://www.sec.gov. 54 PROBUSINESS SERVICES, INC. INDEX TO FINANCIAL STATEMENTS
PAGE Report of Independent Auditors............................................................................. F-2 Balance Sheets............................................................................................. F-3 Statements of Operations................................................................................... F-4 Statements of Stockholders' Equity (Deficit)............................................................... F-5 Statements of Cash Flows................................................................................... F-6 Notes to Financial Statements.............................................................................. F-8
F-1 REPORT OF INDEPENDENT AUDITORS The Board of Directors and Stockholders ProBusiness Services, Inc. We have audited the accompanying balance sheets of ProBusiness Services, Inc. as of June 30, 1997 and 1998 and the related statements of operations, stockholders' equity (deficit), and cash flows for each of the three years in the period ended June 30, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ProBusiness Services, Inc. at June 30, 1997 and 1998 and the results of its operations and its cash flows for each of the three years in the period ended June 30, 1998 in conformity with generally accepted accounting principles. /s/ ERNST & YOUNG LLP Walnut Creek, California July 23, 1998 F-2 PROBUSINESS SERVICES, INC. BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
JUNE 30, ---------------------- 1997 1998 ---------- ---------- ASSETS Current assets: Cash and cash equivalents............................................................... $ 5,047 $ 13,771 Accounts receivable, net of allowance of $365,000 at June 30, 1997 and $420,000 at June 30, 1998.............................................................................. 2,476 2,612 Prepaid expenses and other current assets............................................... 643 2,122 ---------- ---------- 8,166 18,505 Payroll tax funds invested................................................................ 177,626 332,667 ---------- ---------- Total current assets...................................................................... 185,792 351,172 Equipment, furniture and fixtures, net.................................................... 7,623 13,958 Other assets.............................................................................. 7,020 10,879 ---------- ---------- Total assets.............................................................................. $ 200,435 $ 376,009 ---------- ---------- ---------- ---------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable........................................................................ $ 1,089 $ 1,750 Accrued liabilities..................................................................... 4,984 10,403 Deferred revenue........................................................................ 1,279 2,139 Current portion of capital lease obligations............................................ 773 890 ---------- ---------- 8,125 15,182 Payroll tax funds collected but unremitted................................................ 177,626 332,667 ---------- ---------- Total current liabilities................................................................. 185,751 347,849 Note payable to stockholder............................................................... 250 -- Long-term debt............................................................................ 8,667 -- Capital lease obligations, less current portion........................................... 1,898 1,414 Commitments Stockholders' equity: Preferred stock, $.001 par value; authorized: 5,000,000 shares; issued and outstanding: 3,228,034 shares at June 30, 1997..................................................... 3 -- Common stock, $.001 par value; authorized: 60,000,000 shares; issued and outstanding: 2,295,416 shares at June 30, 1997 and 17,114,855 shares at June 30, 1998.............. 2 17 Additional paid-in capital.............................................................. 23,904 53,286 Accumulated deficit..................................................................... (18,952) (25,469) Notes receivable from stockholders...................................................... (1,088) (1,088) ---------- ---------- Total stockholders' equity................................................................ 3,869 26,746 ---------- ---------- Total liabilities and stockholders' equity................................................ $ 200,435 $ 376,009 ---------- ---------- ---------- ----------
See accompanying notes. F-3 PROBUSINESS SERVICES, INC. STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
YEAR ENDED JUNE 30, ------------------------------- 1996 1997 1998 --------- --------- --------- Revenue.......................................................................... $ 13,863 $ 27,374 $ 46,317 Operating expenses: Cost of providing services..................................................... 6,435 13,659 23,859 General and administrative expenses............................................ 2,054 4,282 6,727 Research and development expenses.............................................. 1,257 2,841 4,585 Client acquisition costs....................................................... 5,388 11,706 17,858 Acquisition of in-process technology........................................... 711 -- -- --------- --------- --------- Total operating expenses......................................................... 15,845 32,488 53,029 --------- --------- --------- Loss from operations............................................................. (1,982) (5,114) (6,712) Interest expense................................................................. (473) (1,190) (557) Other income..................................................................... 69 59 752 --------- --------- --------- Net loss......................................................................... $ (2,386) $ (6,245) $ (6,517) --------- --------- --------- --------- --------- --------- Historical basic and diluted net loss per share (NOTE 1)......................... $ (4.91) --------- --------- Shares used in computing historical basic and diluted net loss per share (NOTE 1).............................................................................. 486 Pro forma basic and diluted net loss per share (NOTE 1).......................... $ (0.59) $ (0.41) --------- --------- --------- --------- Shares used in computing pro forma basic and diluted net loss per share (NOTE 1).............................................................................. 10,533 15,722
See accompanying notes. F-4 PROBUSINESS SERVICES, INC. STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
PREFERRED STOCK COMMON STOCK ------------------------------------- ------------------------------------- ADDITIONAL ADDITIONAL PAID-IN PAID-IN ACCUMULATED SHARES AMOUNT CAPITAL SHARES AMOUNT CAPITAL DEFICIT ----------- ----------- ----------- ----------- ----------- ----------- ------------- Balance at June 30, 1995........ 2,613,301 $ 2 $ 11,682 20,142 $ -- $ 3 $ (10,321) Issuance of Series E preferred stock at $7.94 per share, net of issuance costs.............. 40,000 -- 317 -- -- -- -- Exercise of stock options....... -- -- -- 1,802,334 2 365 -- Issuance of preferred stock warrants....................... -- -- 200 -- -- -- -- Net loss........................ -- -- -- -- -- -- (2,386) ----------- --- ----------- ----------- ----- ----------- ------------- Balance at June 30, 1996........ 2,653,301 2 12,199 1,822,476 2 368 (12,707) Issuance of Series F preferred stock at $17.40 per share, net of issuance costs.............. 574,733 1 9,850 -- -- -- -- Exercise of stock options....... -- -- -- 472,940 - 1,166 -- Issuance of preferred stock warrants....................... -- -- 321 -- -- -- -- Net loss........................ -- -- -- -- -- -- (6,245) ----------- --- ----------- ----------- ----- ----------- ------------- Balance at June 30, 1997........ 3,228,034 3 22,370 2,295,416 2 1,534 (18,952) Issuance of common stock in connection with initial public offering, net of offering costs.......................... -- -- -- 4,312,500 4 27,005 -- Conversion of preferred stock into common stock.............. (3,288,034) (3) (22,370) 9,684,102 10 22,363 -- Exercise of warrants............ -- -- -- 415,725 1 958 -- Exercise of stock options....... -- -- -- 236,998 -- 317 -- Issuance of stock under employee stock purchase plan............ -- -- -- 170,114 -- 1,060 -- Issuance of warrants............ -- -- -- -- -- 49 -- Net loss........................ -- -- -- -- -- -- (6,517) ----------- --- ----------- ----------- ----- ----------- ------------- Balance at June 30, 1998........ -- $ -- $ -- 17,114,855 $ 17 $ 53,286 $ (25,469) ----------- --- ----------- ----------- ----- ----------- ------------- ----------- --- ----------- ----------- ----- ----------- ------------- NOTES TOTAL RECEIVABLE STOCKHOLDERS' FROM EQUITY STOCKHOLDERS (DEFICIT) ------------- ------------- Balance at June 30, 1995........ $ -- $ 1,366 Issuance of Series E preferred stock at $7.94 per share, net of issuance costs.............. -- 317 Exercise of stock options....... -- 367 Issuance of preferred stock warrants....................... -- 200 Net loss........................ -- (2,386) ------------- ------------- Balance at June 30, 1996........ -- (136) Issuance of Series F preferred stock at $17.40 per share, net of issuance costs.............. -- 9,851 Exercise of stock options....... (1,088) 78 Issuance of preferred stock warrants....................... -- 321 Net loss........................ -- (6,245) ------------- ------------- Balance at June 30, 1997........ (1,088) 3,869 Issuance of common stock in connection with initial public offering, net of offering costs.......................... -- 27,009 Conversion of preferred stock into common stock.............. -- -- Exercise of warrants............ -- 959 Exercise of stock options....... -- 317 Issuance of stock under employee stock purchase plan............ -- 1,060 Issuance of warrants............ -- 49 Net loss........................ -- (6,517) ------------- ------------- Balance at June 30, 1998........ $ (1,088) $ 26,746 ------------- ------------- ------------- -------------
See accompanying notes. F-5 PROBUSINESS SERVICES, INC. STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED JUNE 30, ------------------------------- 1996 1997 1998 --------- --------- --------- OPERATING ACTIVITIES Net loss $ (2,386) $ (6,245) $ (6,517) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization................................................... 1,146 2,574 4,285 Acquisition of in-process technology............................................ 711 -- -- Change in operating assets and liabilities: Accounts receivable, net........................................................ (521) (1,002) (136) Prepaid expenses and other current assets....................................... (214) (254) (1,479) Other assets.................................................................... 201 (1,782) 1,577 Accounts payable.............................................................. 360 438 661 Accrued liabilities........................................................... 650 1,990 4,338 Deferred revenue.............................................................. (149) 174 860 --------- --------- --------- Net cash provided by (used in) operating activities......................... (202) (4,107) 3,589 INVESTING ACTIVITIES Acquisition of BeneSphere Administrators, Inc., net of cash acquired.............. -- (245) -- Additional consideration paid in connection with the acquisition of BeneSphere Administrators, Inc.............................................................. -- -- (1,127) Purchase of equipment, furniture and fixtures..................................... (2,682) (2,775) (9,353) Capitalization of software development costs...................................... (645) (1,409) (3,858) Notes receivable from stockholders................................................ -- (295) -- --------- --------- --------- Net cash used in investing activities....................................... (3,327) (4,724) (14,338) FINANCING ACTIVITIES Borrowings under bank line of credit agreements................................... 5,934 24,727 6,874 Repayments of borrowings under line of credit agreements.......................... (3,478) (23,831) (11,632) Repayments under long term debt............................................... -- -- (3,909) Proceeds from note payable.................................................... 4,000 -- -- Repayments under note payable................................................. -- (534) -- Proceeds from notes payable to stockholders................................... 250 275 -- Repayments under notes payable to stockholders................................ (227) (275) (250) Principal payments on capital lease obligations............................... (128) (454) (955) Proceeds from issuance of preferred stock..................................... -- 9,851 -- Proceeds from issuance of common stock........................................ 367 78 29,345 --------- --------- --------- Net cash provided by financing activities......................................... 6,718 9,837 19,473 --------- --------- --------- Net increase in cash and cash equivalents......................................... 3,189 1,006 8,724 Cash and cash equivalents, at beginning of year................................... 852 4,041 5,047 --------- --------- --------- Cash and cash equivalents, at end of year......................................... $ 4,041 $ 5,047 $ 13,771 --------- --------- --------- --------- --------- --------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the period for interest.......................................... $ 377 $ 1,507 $ 552 --------- --------- --------- --------- --------- --------- SUPPLEMENTAL SCHEDULE OF NON CASH INVESTING AND FINANCING ACTIVITIES Purchase of equipment, furniture and fixtures under capital leases................ $ 210 $ 2,644 $ 588 --------- --------- --------- --------- --------- --------- Issuance of warrants.............................................................. $ 200 $ 161 $ 49 --------- --------- --------- --------- --------- ---------
F-6 PROBUSINESS SERVICES, INC. STATEMENTS OF CASH FLOWS (CONTINUED) (IN THOUSANDS)
YEAR ENDED JUNE 30, ------------------------------- 1996 1997 1998 --------- --------- --------- Notes receivable from stockholders issued in connection with stock option exercises........................................................................ $ -- $ 1,088 $ -- --------- --------- --------- --------- --------- --------- ACQUISITION OF DIMENSION SOLUTIONS, INC. Issuance of Series E preferred stock............................................ $ 317 $ -- $ -- Liabilities assumed............................................................. 947 -- -- --------- --------- --------- $ 1,264 $ -- $ -- --------- --------- --------- --------- --------- --------- ACQUISITION OF BENESPHERE ADMINISTRATORS, INC. Issuance of warrants............................................................ $ -- $ 160 $ -- Liabilities assumed............................................................. -- 2,445 -- Note payable to BeneSphere Administrators, Inc.................................. -- 250 -- --------- --------- --------- $ -- $ 2,855 $ -- --------- --------- --------- --------- --------- --------- BeneSphere contingent consideration............................................... $ -- $ -- $ 2,208 --------- --------- --------- --------- --------- ---------
See accompanying notes. F-7 PROBUSINESS SERVICES, INC. NOTES TO FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES OPERATIONS ProBusiness Services, Inc. (the "Company") provides employee administrative services for large employers. The Company's primary service offerings are payroll processing, payroll tax filing, human resources software and benefits administration, including the enrollment and processing of flexible benefit plans and COBRA programs. On May 23, 1996, the Company acquired substantially all of the business and assets of Dimension Solutions, Inc. ("Dimension Solutions") for approximately $1,300,000. The transaction was recorded under the purchase method of accounting, and the results of operations of Dimension Solutions have been included in the financial statements of the Company beginning May 24, 1996. On January 1, 1997, the Company acquired all of the outstanding stock of BeneSphere Administrators, Inc. ("BeneSphere"), a Washington corporation. The transaction was recorded under the purchase method of accounting, and the results of operations of BeneSphere have been included in the financial statements of the Company beginning January 2, 1997 (Note 10). PAYROLL PROCESSING AND PAYROLL TAX FILING SERVICES In connection with its payroll tax filing services, the Company collects funds from clients for payment of payroll taxes, holds such funds in financial institution until payment is due (such funds being segregated from the Company's other accounts), remits such funds to the appropriate taxing authorities, and files related federal, state and local tax returns, coupons, or other required payroll tax data ("payroll tax filings"). For such services, the Company derives its payroll tax filing service revenue from fees charged and from interest income it receives on payroll tax funds temporarily held pending remittance on behalf of its clients to taxing authorities ("collected but unremitted payroll tax funds"). These collected but unremitted payroll tax funds and the related liability to clients for such funds are included in the accompanying balance sheets as current assets and current liabilities. The amount of funds held under these arrangements with customers may vary significantly during the year. The Company invests collected but unremitted payroll tax funds in various financial instruments which consisted of overnight U.S. government, agency and mortgage backed repurchase agreements ($40,965,000), money market funds ($134,520,000) and cash and cash equivalents ($2,141,000) at June 30, 1997, and of overnight U.S. government, agency and mortgage backed repurchase agreements ($279,801,000), money market funds ($50,076,000) and cash and cash equivalents ($2,790,000) at June 30, 1998. As a result of the types of financial instruments in which the Company invests, the carrying amount of such investments approximates fair value. The Company's collected but unremitted payroll tax fund investments are held primarily with one custodial financial institution. Interest income earned on collected but unremitted payroll tax funds, which is classified as revenue, amounted to approximately $1,896,000, $5,925,000, and $11,521,000 for fiscal 1996, 1997 and 1998, respectively. The Company's payroll tax filing service is subject to various risks resulting from errors and omissions in the payment of payroll taxes and related payroll tax filings. The Company processes data received from client's and remits funds along with any required payroll tax filings to the appropriate tax authorities when due. Tracking, processing and paying such tax liabilities is complex. Errors and omissions have occurred in the past and may occur in the future in connection with such service. The Company is subject to cash penalties imposed by tax authorities for late filings or underpayment of taxes. To date, such penalties have not been significant. However, there can be no assurance that any liabilities associated with such penalties F-8 PROBUSINESS SERVICES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) will not have a material adverse effect on the Company's business, financial condition or results of operations. At June 30, 1997 and 1998, the Company had accrued approximately $586,000 and $971,000, respectively, for potential tax penalties. There can be no assurance that the Company's accruals or insurance for such penalties will be adequate. In addition, failure by the Company to make timely or accurate payroll tax payments or filings when due may damage the Company's reputation and adversely affect its relationships with existing clients and its ability to gain new clients. The Company's payroll tax service is also dependent upon government regulations, which are subject to continuous changes. Failure by the Company to implement these changes into its services and technology in a timely manner could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, since a significant portion of the Company's revenue is derived from interest earned from the investment of collected but unremitted payroll tax funds, changes in policies relating to withholding federal or state income taxes or reduction in the time allowed for taxpayers to remit payment of taxes owed to government authorities could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's benefits administration services are subject to various risks resulting from errors and omissions in processing and filing COBRA or other benefit plan forms in accordance with governmental regulations and the respective plans. The Company processes data received from employees and employers and is subject to penalties for any late or misfiled plan forms. There can be no assurance the Company's accruals or insurance for such penalties will be adequate. In addition, failure to properly file plan forms would have a material adverse effect on the Company's reputation, which could adversely affect its relationships with existing clients and its ability to gain new clients. The Company's benefits administration services are also dependent upon government regulations which are subject to continuous changes that could reduce or eliminate the need for benefits administration services. The Company has access to confidential information and to client funds. As a result, the Company is subject to potential claims by its clients for the actions of the Company's employees arising from damages to the client's business or otherwise. There can be no assurance that the Company's fidelity bond and errors and omissions insurance will be adequate to cover any such claims. Such claims could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's operations are dependent on its ability to protect its computer systems against damage from a major catastrophe (such as an earthquake or other natural disaster), fire, power loss, security breach, telecommunications failure or similar event. The Company currently conducts substantially all of its payroll and payroll tax processing and production at the Company's headquarters in Pleasanton, California. No assurance can be given that the precautions that the Company has taken to protect itself from or minimize the impact of such events will be adequate. Any damage to the Company's data centers, failure of telecommunications links or breach of the security of the Company's computer systems could result in an interruption of the Company's operations or other loss which may not be covered by the Company's insurance. Any such event could have a material adverse effect on the Company's business, financial condition and results of operations. INTEREST RATE SWAP AGREEMENTS During fiscal 1998, the Company entered into various interest rate swap agreements with a financial institution. The purpose of these agreements is to convert a portion of the interest the Company earns F-9 PROBUSINESS SERVICES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) from collected but unremitted payroll tax funds from a floating to a fixed rate basis. The Company considers these agreements to be for "other than trading purposes" and has accounted for these agreements on an accrual basis, with each net payment or receipt due or owed under each agreement recognized in earnings during the period to which the payment or receipt relates, with no recognition on the balance sheet of the fair value of the agreements. At June 30, 1998, the aggregate fair value of these agreements was $432,000. These agreements, with fixed interest rates between 5.736% and 5.905%, each have a term of two years, one of which has a cancellation option after one year, and expire at various dates through April 2000. Interest is paid or received based upon the difference in the fixed interest rate and the contractual floating rate option times the contractual notional balance. The actual notional balance varies on a monthly basis due to fluctuations in projected holdings of collected but unremitted payroll tax funds. At June 30, 1998, the notional balance was $204,700,000 and the average monthly notional balance for the remaining term of the agreements was $242,000,000. The agreements require collateral if interest rates increase and certain other conditions are met as defined in the agreements. At June 30, 1998, no collateral was required. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses during the period. Such estimates include, but are not limited to, provisions for doubtful accounts and penalties and interest relating to payroll tax processing and estimates regarding the recoverability of capitalized software. Actual results could differ from these estimates. CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents. Cash and cash equivalents have a carrying amount which approximates fair value. The Company's cash, cash equivalents and payroll tax funds invested are held primarily with two financial institutions. EQUIPMENT, FURNITURE AND FIXTURES Equipment, furniture and fixtures are stated at cost, net of accumulated depreciation and amortization. Depreciation of equipment, furniture and fixtures is computed using the straight-line method over the estimated useful lives of the assets which range from three to seven years. Leasehold improvements and assets under capital leases are amortized over the shorter of the life of the asset or the term of the lease. REVENUE RECOGNITION Revenue from payroll processing and payroll tax filing services under client contracts is recognized as the services are performed. Interest income earned on unremitted payroll tax funds invested is recognized as earned. The Company's sales are primarily to customers in the United States. Credit evaluations are performed as necessary and the Company does not require collateral from customers. F-10 PROBUSINESS SERVICES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) SOFTWARE DEVELOPMENT COSTS The Company accounts for software development costs in accordance with Statement of Financial Accounting Standards No. 86 "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed." The Company capitalizes software development costs incurred after establishing technological feasibility of the product prior to the general release of the service using the product. Costs incurred in connection with the enhancement of the Company's existing products or after the general release of the service using the product are expensed in the current period and included in the research and development costs within the statement of operations. The Company amortizes the capitalized software development costs using the greater of the straight-line basis over the estimated product life, which is generally a 36 month period, or the ratio of current revenue to the total of current revenue and anticipated future revenue over the life of the related product. Such amortization is included in cost of providing services within the statement of operations. ACCOUNTING FOR STOCK-BASED COMPENSATION The Company accounts for employee stock options in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and has adopted the "disclosure only" alternative as described in FAS No. 123, "Accounting for Stock-Based Compensation" ("FAS 123") (Note 7). IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In June 1997, the Financial Accounting Standards Board ("FASB") issued FAS No. 130, "Reporting Comprehensive Income" ("FAS 130"), and FAS No. 131, "Disclosure about Segments of an Enterprise and Related Information" ("FAS 131"). The Company is required to adopt these statements in fiscal 1999. FAS 130 establishes new standards for reporting and displaying comprehensive income and its components. FAS 131 requires disclosure of certain information regarding operating segments, products and services, geographic areas of operation and major customers. The Company has not reached a conclusion as to the appropriate segments, if any, it will be required to report to comply with the provisions of FAS 131. Adoption of these statements is not expected to have a significant impact on the Company's financial position, results of operations or cash flows. In June 1998, the FASB issued FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"). The Company is required to adopt FAS 133 in fiscal 2000. FAS 133 established methods of accounting for derivative financial instruments and hedging activities related to those instruments as well as other hedging activities. The Company has not yet determined what the effect of FAS 133 will be on the operations and financial position of the Company. RECLASSIFICATIONS Certain prior year balances have been reclassified to conform to the current year presentation. BASIC AND DILUTED NET LOSS PER SHARE (HISTORICAL AND PRO FORMA) Historical net loss per share is presented under the requirements of FAS No. 128, "Earnings Per Share" ("FAS 128"). FAS 128 replaced the previously reported primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primarily earnings per share, basic earnings per share F-11 PROBUSINESS SERVICES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) excludes any dilutive effects of options, warrants, convertible securities and shares subject to repurchase. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. Common stock equivalent shares from convertible preferred stock and from stock options and warrants are not included in the calculation of diluted net loss per share as the effect is anti-dilutive. All net loss per share amounts for all periods have been presented to conform to the FAS 128 requirements. In February 1998, Staff Accounting Bulletin No. 98 ("SAB 98") was issued and amends the existing Securities and Exchange Commission ("SEC") staff guidance primarily to give effect to FAS 128. Under SAB 98, certain shares of convertible preferred stock, options and warrants to purchase shares of common stock, issued at prices below the per share price of shares sold in the company's initial public offering in September 1997 and previously included in the computations of shares used in computing net loss per share pursuant to previous staff accounting bulletins have now been excluded from the computation. Pro forma net loss per share has been computed as described above and also gives effect, under SEC guidance, to the conversion of preferred stock to common stock not included above that automatically converted upon completion of the Company's initial public offering, using the if-converted method. A reconciliation of shares used in the calculation of historical and pro forma basic and diluted net loss per share follows (in thousands except share and per share information):
YEAR ENDED JUNE 30, ------------------------------- 1996 1997 1998 --------- --------- --------- Historical: Net loss........................................................................ $ (2,386) $ (6,245) $ (6,517) --------- --------- --------- --------- --------- --------- Weighted average shares of common stock outstanding used in computing basic and diluted net loss per share.................................................... 486 1,999 13,596 --------- --------- --------- --------- --------- --------- Basic and diluted net loss per share............................................ $ (4.91) $ (3.12) $ (0.48) --------- --------- --------- --------- --------- --------- Pro forma: Net loss........................................................................ $ (6,245) $ (6,517) --------- --------- --------- --------- Shares used in computing basic and diluted net loss per share (from above)...... 1,999 13,596 Pro forma adjustment to reflect the effect of the conversion of preferred stock from the date of issuance..................................................... 8,534 2,126 --------- --------- Weighted average shares used in computing pro forma basic and diluted net loss per share..................................................................... 10,533 15,722 --------- --------- --------- --------- Pro forma basic and diluted net loss per share.................................. $ (0.59) $ (0.41) --------- --------- --------- ---------
If the Company had reported net income, the calculation of diluted earnings per share (historical and pro forma) would have included the shares used in the computation of historical and pro forma net loss per share as well as an additional 356,000, 466,000 and 797,000 common equivalent shares related to the outstanding options and warrants not included above (determined using the treasury stock method) for fiscal 1996, 1997 and 1998, respectively. F-12 PROBUSINESS SERVICES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. EQUIPMENT, FURNITURE AND FIXTURES Equipment, furniture and fixtures consist of the following (in thousands):
JUNE 30, ---------------------- 1997 1998 ---------- ---------- Equipment and leasehold improvements.................................. $ 9,981 $ 18,172 Furniture and fixtures................................................ 1,973 3,239 ---------- ---------- 11,954 21,411 Less accumulated depreciation and amortization........................ (4,331) (7,453) ---------- ---------- $ 7,623 $ 13,958 ---------- ---------- ---------- ----------
Equipment, furniture and fixtures include amounts for assets acquired under capital leases, principally production, office and computer equipment, of $3,515,000 and $3,863,000 at June 30, 1997 and 1998, respectively. Accumulated amortization of these assets was $854,000 and $1,712,000 at June 30, 1997 and 1998, respectively. 3. LONG-TERM DEBT LINE OF CREDIT AGREEMENTS On June 30, 1998, the Company executed an Amended and Restated Loan and Security Agreement with a financial institution. The agreement provides for borrowings that are limited to the lesser of $20,000,000, or the sum of five times the Company's average monthly net collections, as defined in the agreement, plus the lesser of five times the Company's average monthly collections of the interest on tax investment funds as defined in the agreement or $5,000,000, plus $1,500,000. The agreement superseded all previous line of credit agreements and amendments thereto with the financial institution that existed as of June 30, 1997. At June 30, 1998, no borrowings were outstanding under the agreement and the amount available for borrowing under the agreement was approximately $20,000,000. Borrowings outstanding under the agreement bear interest at the bank's prime rate plus 1% (9.5% at June 30, 1998) and are collateralized by substantially all of the Company's assets not otherwise encumbered. The financial covenants of the agreement require the Company to maintain minimum net worth and earnings to debt service ratios. The agreement expires on December 31, 2000, and is subject to automatic and continuous renewal unless termination notice is given by either party in accordance with the agreement. All borrowings outstanding at June 30, 1997 totaling $4,758,000, under the previous agreements, were paid in September 1997 with the proceeds from the Company's initial public offering. SUBORDINATED NOTES PAYABLE In October 1995 and December 1995, the Company issued $1,100,000 and $2,900,000, respectively of subordinated notes payable to investors. The subordinated notes and interest accrued thereon were repaid in their entirety in September 1997 with proceeds from the Company's initial public offering. F-13 PROBUSINESS SERVICES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. LONG-TERM DEBT (CONTINUED) NOTE PAYABLE TO STOCKHOLDER A $250,000 subordinated note payable to a stockholder was assumed in the acquisition of Dimension Solutions. The note was repaid in fiscal 1998. 4. LEASE OBLIGATIONS The Company leases its facilities and various equipment under non-cancelable operating leases which expire at various dates through 2010. The Company is also obligated under a number of capital equipment leases expiring at various dates through 2003. The future minimum lease payments under capital and operating leases subsequent to June 30, 1998 are summarized as follows (in thousands):
CAPITAL OPERATING LEASES LEASES --------- ----------- Year ending June 30, 1999................................................................... $ 1,180 $ 3,476 2000................................................................... 1,029 4,067 2001................................................................... 297 4,434 2002................................................................... 158 4,402 2003................................................................... 158 4,186 Thereafter............................................................. -- 25,710 --------- ----------- Total minimum lease payments......................................... 2,822 $ 46,275 ----------- ----------- Less amounts representing interest....................................... 518 --------- Present value of net minimum capital lease obligations................... 2,304 Less current portion..................................................... 890 --------- $ 1,414 --------- ---------
Rent expense was approximately $707,000, $1,487,000 and $3,028,000 for fiscal 1996, 1997 and 1998, respectively. 5. INCOME TAXES As of June 30, 1998, the Company had federal and state net operating loss carryforwards of approximately $17,200,000 and $1,200,000, respectively. The Company also had federal and state research and development tax credit carryforwards of approximately $1,057,000 and $442,000, respectively. The federal net operating loss and credit carryforwards will expire at various dates beginning with the fiscal year ending 1999 through 2013, if not utilized. The state net operating loss carryforwards will expire at various dates beginning with the fiscal 1999 through 2003, if not utilized. The state credit carryforwards do not expire. Utilization of the net operating losses and credits may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986, as amended (the "Code"), and similar state provisions. The annual limitation may result in the expiration of net operating losses and credits before utilization. F-14 PROBUSINESS SERVICES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. INCOME TAXES (CONTINUED) Significant components of the Company's deferred tax assets and liabilities are as follows (in thousands):
JUNE 30, -------------------- 1997 1998 --------- --------- Deferred tax assets: Net operating loss carryforwards....................................... $ 4,965 $ 5,951 Research and development credit carryforwards.......................... 650 1,499 Depreciation........................................................... 428 1,010 Accrued liabilities and allowances..................................... 330 2,147 --------- --------- Gross deferred tax assets................................................ 6,373 10,607 Less valuation allowance................................................. (5,988) (9,224) --------- --------- Deferred tax assets...................................................... 385 1,383 Deferred tax liabilities: Capitalized software development costs................................. (313) (1,338) Other.................................................................. (72) (45) --------- --------- Gross deferred tax liabilities........................................... (385) (1,383) --------- --------- Net deferred taxes....................................................... $ -- $ -- --------- --------- --------- ---------
A valuation allowance has been established and, accordingly, no benefit has been recognized for the Company's net operating losses and other deferred tax assets. The Company believes that, based on a number of factors, the available objective evidence creates sufficient uncertainty regarding the realizability of the deferred tax assets such that a full valuation allowance has been recorded. These factors include the Company's history of net losses since its inception and expected near-term future losses. The Company will continue to assess the realizability of the deferred tax assets based on actual and forecasted operating results. The net valuation allowance increased by $2,391,000 and $3,236,000, respectively during fiscal 1997 and 1998. 6. STOCKHOLDERS' EQUITY In September 1997, the Company completed its initial public offering of common stock. The offering consisted of 3,750,000 shares of common stock issued to the public at $7.33 per share. Upon the closing of the initial public offering, all outstanding shares of preferred stock were converted into common stock. In October 1997, the underwriters exercised an option to purchase an additional 562,500 shares of common stock at the initial public offering price of $7.33 per share to cover over-allotments in connection with the initial public offering. F-15 PROBUSINESS SERVICES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 6. STOCKHOLDERS' EQUITY (CONTINUED) WARRANTS The following tables represents a summary of warrants outstanding as of June 30, 1998:
NUMBER OF EXERCISE PRICE SHARES JUNE DATE ISSUED EXPIRATION PER SHARE 30, 1998 - ------------------ ------------------ --------------- ------------- April 1996 April 2001 $ 2.65 28,500 October 1996 October 2001 2.65 28,500 November 1996 September 2002 2.65 67,500 January 1997 January 2002 6.00 75,000 July 1997 July 2002 6.00 30,000 ------------- 229,500 ------------- -------------
In connection with the Company's initial public offering, the Company issued 367,288 shares of common stock upon the exercise of warrants, a portion of which were exercised pursuant to a net exercise provisions, for total proceeds of $923,000. In addition, during fiscal 1998, the Company issued 48,437 shares of common stock upon exercise of warrants, a portion of which were exercised pursuant to net exercise provisions, for a total of $36,000. All other warrants noted as exercised above were exercised pursuant to net exercise provisions. STOCK SPLIT On July 23, 1998, the Board of Directors approved a three-for-two split of its $.001 par value common stock in the form of a 50 percent distribution to stockholders of record as of July 31, 1998. As a result of the stock split, authorized and outstanding common shares increased 50 percent and capital in excess of par was reduced by the par value of the additional common shares issued. The rights of the holders of these securities were not otherwise modified. All references in the financial statements to number of shares, per share amounts, stock option data and market prices of the Company's common stock have been restated for the effect of the stock split. 7. STOCK OPTION AND STOCK PURCHASE PLANS STOCK OPTION PLANS The Company's 1989 Stock Option Plan (the "1989 Plan") provided for the granting to employees (including officers and employee directors) of "incentive stock options" within the meaning of the Code and for the granting to employees, directors and consultants of nonstatutory stock options. In February 1997, the Board of Directors of the Company increased the shares available for future grants under the 1989 Plan by 2,063,649 for a total of 4,480,872. Options granted under the 1989 Plan before the effective date of the amendment and restatement to the 1996 Plan in September, 1997, described below, remain outstanding in accordance with their terms, but no further options were granted under the 1989 Plan after the effective date of the amendment and restatement to the 1996 Plan. In 1996, the Company established the 1996 Executive Stock Option Plan ("Executive Plan") which provides for stock options to employees and consultants. Under the Executive Plan, the Board of Directors may grant nonstatutory stock options to employees and consultants and incentive stock options to F-16 PROBUSINESS SERVICES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. STOCK OPTION AND STOCK PURCHASE PLANS (CONTINUED) employees only. The Company has reserved 1,125,000 shares of common stock for exercise of stock options under the Executive Plan. The grant of incentive stock option to an employee who owns stock representing more than 10% of the voting power of all classes of stock of the Company must be no less than 110% of the fair market value per share on the date of grant. Fair market value is determined by the Board of Directors. For all other employees the options must be no less than 100% of the fair market value per share on the date of grant. All nonstatutory stock options granted are at a price that is determined by the Board of Directors. The options generally expire ten years from the date of grant and are exercisable as determined by the Board of Directors. In November 1996, the Board of Directors and stockholders approved, effective upon the initial public offering, an amendment and restatement of the Executive Plan to rename the 1996 Executive Stock Option Plan to the 1996 Stock Option Plan (the "1996 Plan") and authorized an increase in the number of shares reserved for issuance under the 1996 Plan of any unused or canceled shares under the 1989 Plan, and an annual increase equal to the lesser of (a) 375,000 shares, (b) 2% of the outstanding shares of common stock on such date or (c) a lesser amount determined by the Board. The 1996 Plan provides for grants to employees (including officers and employee directors) of incentive stock options and for the granting to employees, directors and consultants of nonqualified stock options. Notes receivable for the purchase of common stock are included in stockholders' equity (deficit). A summary of the activity under the 1989 and 1996 Plans is set forth below:
OUTSTANDING OPTIONS ---------------------------- WEIGHTED AVERAGE NUMBER OF EXERCISE PRICE SHARES PER SHARE ----------- --------------- Outstanding at June 30, 1995.................................... 1,528,344 $ 0.17 Granted....................................................... 1,583,895 0.29 Exercised..................................................... (1,802,334) 0.22 Canceled...................................................... (345,703) 0.22 ----------- ------ Outstanding at June 30, 1996.................................... 964,202 0.27 Granted....................................................... 994,005 4.83 Exercised..................................................... (472,940) 2.39 Canceled...................................................... (171,603) 2.51 ----------- ------ Outstanding at June 30, 1997.................................... 1,313,664 2.67 Granted....................................................... 907,875 11.82 Exercised..................................................... (236,998) 1.34 Canceled...................................................... (184,125) 7.12 ----------- ------ Outstanding at June 30, 1998.................................... 1,800,416 $ 6.97 ----------- ------ ----------- ------
F-17 PROBUSINESS SERVICES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. STOCK OPTION AND STOCK PURCHASE PLANS (CONTINUED) As of June 30, 1998, options to purchase 414,884 shares of common stock were vested and exercisable at an average exercise price of $2.03 per share and options to purchase 1,277,510 shares were available for future grant. As of June 30, 1998, options to purchase approximately 317,000 shares of common stock had been exercised which are subject to repurchase. The weighted-average fair value of options granted during fiscal 1996, 1997 and 1998 was $0.06, $1.01 and $6.98 per share, respectively. The following table summarizes information concerning currently outstanding and exercisable options at June 30, 1998:
OUTSTANDING ---------------------------------------- EXERCISABLE WEIGHTED ---------------------- AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE CONTRACTUAL EXERCISE EXERCISE EXERCISE PRICE SHARES LIFE PRICE SHARES PRICE - ----------------------------------- ---------- --------------- ----------- --------- ----------- $0.13 - $0.26...................... 399,084 7.10 $ 0.26 231,235 $ 0.25 $0.83 - $4.83...................... 399,707 8.41 $ 4.02 141,932 $ 3.75 $5.83 - $6.00...................... 620,250 9.03 $ 5.91 40,967 $ 5.86 $12.08 - $31.17.................... 381,375 9.57 $ 18.84 750 $ 19.33 ---------- --------- ----------- 1,800,416 414,884 ---------- --------- ---------- ---------
STOCK-BASED COMPENSATION As permitted under FAS 123, the Company has elected to continue to follow APB 25 in accounting for stock-based awards to employees. Under APB 25, the Company has not recognized any compensation expense with respect to such awards, since the exercise price of the stock options awarded are equal to the fair market value of the underlying security on the grant date. Disclosure of information regarding net loss and net loss per share is required by FAS 123, which also requires that the information be determined on an "as adjusted" basis as if the Company had accounted for its stock-based awards to employees granted subsequent to June 30, 1995, under the fair value method of FAS 123. The fair value of the Company's stock-based awards to employees was estimated as of the date of the grant using a Black-Scholes option pricing model. Limitations on the effectiveness of the Black-Scholes option valuation model are that it was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable and that the model requires the use of highly subjective assumptions including expected stock price volatility. Because the Company's stock-based awards to employees have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock-based awards to employees. The Company has plans which award employees stock options. These F-18 PROBUSINESS SERVICES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. STOCK OPTION AND STOCK PURCHASE PLANS (CONTINUED) plans are discussed in the note above. The fair value of the Company's stock-based awards to employees was estimated using the following weighted-average assumptions:
YEAR ENDED JUNE 30, ------------------------------- 1996 1997 1998 --------- --------- --------- Expected life (in years)......................................... 3 2 2 Expected volatility.............................................. 0.001 0.001 0.746 Risk free interest rate.......................................... 6.2% 6.2% 5.5% Expected dividend yield.......................................... 0.0% 0.0% 0.0%
For disclosure purposes, the adjusted estimated fair value of the Company's stock-based awards to employees is amortized over the vesting period for options. The Company's adjusted information follows (in thousands, except for per share information):
YEAR ENDED JUNE 30, ------------------------------- 1996 1997 1998 --------- --------- --------- Net loss, as reported......................................... $ (2,386) $ (6,245) $ (6,517) --------- --------- --------- --------- --------- --------- Net loss, as adjusted......................................... $ (2,403) $ (6,355) $ (7,427) --------- --------- --------- --------- --------- --------- Historical net loss per share, as reported.................... $ (4.91) $ (3.12) $ (0.48) --------- --------- --------- --------- --------- --------- Historical net loss per share, as adjusted.................... $ (4.94) $ (3.18) $ (0.55) --------- --------- --------- --------- --------- --------- Pro forma net loss per share, as reported..................... $ (0.59) $ (0.41) --------- --------- --------- --------- Pro forma net loss per share, as adjusted..................... $ (0.60) $ (0.47) --------- --------- --------- ---------
Because FAS 123 is applicable only to the Company's stock-based awards granted subsequent to June 30, 1995, its effect will not be fully reflected until approximately fiscal 1999. 1997 EMPLOYEE STOCK PURCHASE PLAN The Company's 1997 Employee Stock Purchase Plan (the "Purchase Plan") was adopted by the Board of Directors in November 1996 and amended in August 1997, for which employees who work a minimum of 20 hours per week and for five months in any calendar year are eligible. There were 750,000 shares of common stock authorized for issuance under the Purchase Plan with an annual increase to be added on each anniversary date of the adoption of the Purchase Plan equal to the lesser of (a) 225,000 shares, (b) 1.5% of the outstanding shares on such date or (c) a lesser amount determined by the Board of Directors. As of June 30, 1998, 170,114 shares had been issued for the first purchase. Under the Purchase Plan, the Company's employees, subject to certain restrictions, may purchase shares of common stock at the lesser of 85 percent of the fair market value at either the beginning of each two-year offering period or the end of each six-month purchase period within the two-year offering period. Plan purchases are limited to 10% of each employee's compensation. F-19 PROBUSINESS SERVICES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. EMPLOYEE BENEFIT PLAN The Company maintains a tax deferred savings plan under section 401(k) of the Code (the "Plan"), for the benefit of certain qualified employees. Employees may elect to contribute to the Plan, through payroll deductions of up to 18% of their compensation, subject to certain limitations. The Company, at its discretion, may make additional contributions. The Company did not make any contributions to the Plan in fiscal 1996, 1997 or 1998. 9. BALANCE SHEET DETAIL Other assets consist of the following (in thousands):
JUNE 30, -------------------- 1997 1998 --------- --------- Capitalized software development costs................................... $ 1,716 $ 5,247 Deferred financing costs................................................. 1,043 -- Prepaid lease expense.................................................... 161 133 Notes receivable from employees.......................................... 376 422 Goodwill and other intangible assets..................................... 2,627 4,625 Deposits and other....................................................... 1,097 452 --------- --------- $ 7,020 $ 10,879 --------- --------- --------- ---------
Accumulated amortization for capitalized software development costs was approximately $475,000 and $802,000 at June 30, 1997 and 1998, respectively. Accumulated amortization for goodwill and other intangible assets was approximately $80,000 and $384,000 at June 30, 1997 and 1998, respectively. In January 1997, the Company advanced $250,000 in the form of a note receivable from a stockholder who is also an executive officer. The note is due in January 2001, bears interest at 6.10% and is full recourse. Accrued liabilities consist of the following (in thousands):
JUNE 30, -------------------- 1997 1998 --------- --------- Accrued expenses......................................................... $ 2,773 $ 4,408 Accrued tax penalties.................................................... 586 971 Accrued payroll and related expenses..................................... 1,361 3,322 Accrued acquisition costs................................................ 144 -- Accrued BeneSphere contingent consideration (Note 10).................... -- 1,081 Other.................................................................... 120 621 --------- --------- $ 4,984 $ 10,403 --------- --------- --------- ---------
10. BUSINESS ACQUISITIONS In January 1997, the Company acquired all of the outstanding stock of BeneSphere. The purchase price consisted of $500,000 in cash, of which $250,000 was paid upon closing and $250,000 was paid in April 1997, warrants to purchase 75,000 shares of the Company's common stock at a price of $6.00 per F-20 PROBUSINESS SERVICES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) 10. BUSINESS ACQUISITIONS (CONTINUED) share and with an estimated fair value of $160,000, the assumption of $2,445,000 of BeneSphere's liabilities (including acquisition costs) plus additional contingent consideration based on BeneSphere's revenues in excess of certain base amounts, as defined in the agreement, over the next two calendar years following the acquisition which cannot exceed $4,500,000. The contingent consideration is payable in cash in four quarterly payments beginning April 1, 1998 for the calendar year 1997 payment and April 1, 1999 for the calendar year 1998 payment. Interest shall accrue at a rate of 9% per annum on all earned but unpaid balances. A summary of the purchase price allocation is as follows (in thousands):
Current and other assets............................................................. $ 517 Goodwill............................................................................. 2,278 Customer list........................................................................ 310 --------- Total purchase price allocation...................................................... $ 3,105 --------- ---------
Goodwill arising from the acquisition is being amortized on a straight-line basis over 20 years. In January 1998, the Company accrued an additional $2,208,000 of contingent consideration and recorded goodwill in the same amount related to the BeneSphere acquisition as described above. As of June 30, 1998, the Company had made two quarterly payments relating to the contingent consideration and had a remaining outstanding balance of $1,081,000 which is classified as accrued liabilities. 11. SUBSEQUENT EVENTS PUBLIC OFFERING On July 23, 1998, the Board of Directors authorized the Company to proceed with a public offering of the Company's common stock. F-21 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY OF THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT ANY INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE OF THIS PROSPECTUS. ------------------------ TABLE OF CONTENTS
PAGE ---- Prospectus Summary........................................................ 3 Risk Factors.............................................................. 5 Safe Harbor for Forward-Looking Statements................................ 14 Use of Proceeds........................................................... 15 Dividend Policy........................................................... 15 Price Range of Common Stock............................................... 15 Capitalization............................................................ 16 Dilution.................................................................. 17 Selected Financial Data................................................... 18 Management's Discussion and Analysis of Financial Condition and Results of Operations............................................................... 19 Business.................................................................. 27 Management................................................................ 37 Certain Transactions...................................................... 44 Principal Stockholders.................................................... 45 Description of Capital Stock.............................................. 47 Shares Eligible for Future Sale........................................... 50 Underwriting.............................................................. 52 Legal Matters............................................................. 53 Experts................................................................... 53 Additional Information.................................................... 53 Index to Financial Statements............................................. F-1
2,475,000 SHARES [LOGO] COMMON STOCK --------------- PROSPECTUS , 1998 -------------- WILLIAM BLAIR & COMPANY BANCAMERICA ROBERTSON STEPHENS SG COWEN - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth the costs and expenses, other than underwriting discounts and commissions, payable by the Company in connection with the sale and distribution of Common Stock being registered. All amounts are estimates except the registration fee and the NASD filing fee.
AMOUNT TO BE PAID ---------- Registration fee.................................................................. $ 32,450 NASD filing fee................................................................... 11,500 Printing expenses................................................................. 120,000 Legal fees and expenses........................................................... 200,000 Accounting fees and expenses...................................................... 200,000 Blue sky fees and expenses........................................................ 5,000 Transfer agent and registrar fees and expenses.................................... 5,000 Nasdaq National Market application and listing fees............................... 17,500 Miscellaneous..................................................................... 78,550 ---------- Total......................................................................... $ 670,000
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS Reference is made to Article Ninth of the Amended and Restated Certificate of Incorporation of the Company filed herewith as Exhibit 3.1; Article VI of the Bylaws of the Company, filed herewith as Exhibit 3.2; Section 145 of the Delaware General Corporation Law; and the form of indemnification agreement filed herewith as Exhibit 10.14 which, among other things, and subject to certain conditions, authorize the Company to indemnify, or indemnify by their terms, as the case may be, the directors and officers of the Company against certain liabilities and expenses incurred by such persons in connection with claims made by reason of their being such a director or officer. Section 10 of the form of the Underwriting Agreement filed as Exhibit 1.1 to this Registration Statement provides for indemnification by the Underwriters and their controlling persons, on the one hand, and of the Company and its controlling persons on the other hand, for certain liabilities arising under the Securities Act of 1933, as amended (the "Act"), the Exchange Act of 1934, as amended, or otherwise. The Company has obtained directors and officers insurance providing indemnification for certain of the Company's directors, officers, affiliates, partners or employees for certain liabilities. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES The following information does not give effect to (i) the one-for-two automatic conversion of the Company's Preferred Stock into the Company's Common Stock in connection with the Company's initial public offering or (ii) the three-for-two split of the Company's Common Stock effected in the form of a stock dividend payable to holders of record as of July 31, 1998. (a) In February 1998, the Company issued 8,106 shares of its Series E Preferred Stock pursuant to the net exercise of a warrant by Silicon Valley Bank at an exercise price of $7.94 per share. (b) In October 1995, the Company issued warrants to purchase 34,630 shares of Series E Preferred Stock of the Company at an exercise price of $7.94 per share to 9 stockholders under a loan agreement whereby the Company issued promissory notes to such stockholders with an aggregate principal amount of II-1 $1,100,000. In December 1995, the Company issued warrants to purchase 91,296 shares of Series E Preferred Stock of the Company at an exercise price of $7.94 per share to an additional 37 stockholders under a separate loan agreement whereby the Company issued promissory notes to such stockholders with an aggregate principal amount of $2,900,000. In September and October 1997, the stockholders exercised the warrants, a portion of which were exercised pursuant to net exercise provisions, to purchase 122,430 shares of Series E Preferred Stock for aggregate cash proceeds of $923,000. (c) In April 1996, the Company issued a warrant to purchase 9,500 shares of its Series E Preferred Stock at an exercise price of $7.94 per share to Coast Business Credit ("Coast") in connection with a line of credit. (d) In May 1996, in connection with its acquisition of Dimension Solutions, Inc. ("Dimension Solutions") the Company issued 40,000 shares of Series E Preferred Stock to Dimension Solutions. (e) In July 1996, the Company issued a warrant to purchase 10,000 shares of its Series E Preferred Stock at an exercise price of $7.94 per share to LINC Capital Management in connection with an equipment lease. In November 1997, LINC Capital Management purchased 8,040 shares of Series E Preferred Stock, a portion of which was exercised under a net exercise provision, for aggregate cash proceeds of $36,000. (f) In October 1996, the Company issued a warrant to purchase 9,500 shares of its Common Stock at an exercise price of 7.94 per share to Coast in connection with an amendment to the line of credit. (g) In November 1996, the Company issued a warrant to purchase 22,500 shares of its Common Stock at an exercise price of $7.94 per share to Britannia Hacienda V Limited Partnership and its partners in connection with a facilities lease. (h) In January 1997, the Company issued warrants to purchase an aggregate of 50,000 shares of its Common Stock at an exercise price of $9.00 per share to two of the former shareholders of BeneSphere in connection with the Company's acquisition of BeneSphere. (i) In March 1997, the Company issued 574,733 shares of Series F Preferred Stock to two affiliates of GAP LLC at $17.40 per share for an aggregate purchase price of $10,000,354. (j) In July 1997, the Company issued a warrant to purchase 20,000 shares of its Common Stock to a client of the Company at an exercise price of $9.00 per share. (k) Since 1989 and through June 30, 1998, the Company has granted stock options to purchase 4,894,788 shares of the Company's Common Stock at a weighted average exercise price of $3.30 per share to employees, consultants and directors pursuant to its 1996 Stock Option Plan, or predecessor plans. Of these options, 555,272 have been canceled without being exercised, 2,539,100 have been exercised and 1,800,416 remain outstanding. The sales and issuances of securities described in paragraphs (a) through (j) were deemed to be exempt from registration under the Securities Act by virtue of Section 4(2) of the Securities Act as transactions by an issuer not involving a public offering. The sales and issuances of securities described in paragraph (k) were deemed to be exempt from registration from the Securities Act by virtue of either Rule 701 of the Securities Act as they were offered and sold pursuant to written compensatory benefit plans as provided by Rule 701 or Section 4(2) of the Securities Act as transaction by an issuer not involving a public offering. II-2 ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (A) EXHIBITS
EXHIBIT EXHIBIT FOOTNOTE NUMBER DESCRIPTION - ----------- ----------- ------------------------------------------------------------------------------------------- 1.1 Form of Underwriting Agreement. (1) 2.1 Agreement and Plan of Reorganization, dated May 23, 1996, between Registrant and Dimension Solutions. (1) 2.2 Stock Acquisition Agreement, dated January 1, 1997, between Registrant and BeneSphere Administrators, Inc. (2) 3.1 Amended and Restated Certificate of Incorporation. (1) 3.2 Bylaws of the Registrant. (1) 4.1 Specimen Common Stock Certificate of Registrant. (1) 4.2 Amended and Restated Registration Rights Agreement, dated March 12, 1997 between Registrant, General Atlantic Partners 39, L.P., GAP Coinvestment Partners, L.P. and certain stockholders of Registrant. (1) 4.3 Warrant to Purchase Stock, dated January 13, 1995, between Registrant and Silicon Valley Bank and related Antidilution and Registration Rights Agreements. (1) 4.4(a) Warrant to Purchase Stock, dated April 30, 1996, between Registrant and Coast Business Credit and related Antidilution and Registration Rights Agreement. (1) 4.4(b) Warrant to Purchase Stock, dated October 25, 1996, between Registrant and Coast Business Credit and related Antidilution and Registration Rights Agreement. (1) 4.5 Warrant to Purchase Series E Preferred Stock, dated July 31, 1996, between Registrant and LINC Capital Management. (1) 4.6(a) Warrant Purchase Agreement, dated November 14, 1996, between Registrant and certain purchasers. (1) 4.6(b) Warrant to Purchase Series E Preferred Stock, dated November 14, 1996, between Registrant and T.J. Bristow and Elizabeth S. Bristow. (1) 4.6(c) Warrant to Purchase Series E Preferred Stock, dated November 14, 1996, between Registrant and SDK Incorporated. (1) 4.6(d) Warrant to Purchase Series E Preferred Stock, dated November 14, 1996, between Registrant and Laurence Shushan and Magdalena Shushan. (1) 4.7(a) Warrant to Purchase Common Stock, dated January 7, 1997, between Registrant and Louis R. Baransky. (1) 4.7(b) Warrant to Purchase Common Stock, dated January 7, 1997, between Registrant and Ben W. Reppond. (1) 4.8 Form of Note issued by Registrant on October 20, 1995 and December 12, 1995 (see also Exhibit 10.12). 5.1* Opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation. (1) 10.1 Lease Agreement, dated August 12, 1992, First Amendment to Lease, dated March 23, 1994, Second Amendment to Lease dated December 9, 1994, and Third Amendment to Lease, dated March 16, 1995 between Registrant and Hacienda Park Associates. 10.2* Sublease, dated April 14, 1998, between the Registrant and Documentum, Inc. (1) 10.3 Lease Agreement and Addendum Number One, dated August 26, 1993, and First Amendment to Lease, dated March 23, 1994, between Registrant and Hacienda Park Associates.
II-3
EXHIBIT EXHIBIT FOOTNOTE NUMBER DESCRIPTION - ----------- ----------- ------------------------------------------------------------------------------------------- (1) 10.4 Lease Agreement, dated March 23, 1994, First Amendment, dated May 25, 1994 and Second Amendment, dated October 5, 1994 between Registrant and Hacienda Park Associates. (1) 10.5 Lease Agreement, dated November 13, 1995, and First Amendment to Lease, dated February 23, 1996, between Registrant and Hacienda Park Associates. (1) 10.6* Built-to-Suit Lease, dated September 27, 1996, and First Amendment, dated January 27, 1998, between Registrant and Britannia Hacienda V Limited Partnership. (1) 10.7 Office Lease, dated March 22, 1996, between Benefits-Plus Administrators, Inc. and the Trustees under the Will and of the Estate of James Campbell, Deceased and related Guaranty of Lease. 10.8* Sublease, dated October 10, 1997, between Registrant and Drake Mortgage Corporation. 10.9* Build-to-Suit lease, dated January 27, 1998, between Registrant and Britannia Hacienda V Limited Partnership. (1) 10.10 1996 Stock Option Plan and related Form of Stock Option Agreement. (1) 10.11 1996 Employee Stock Purchase Plan. (1) 10.12 Employment and Non-competition Agreement, dated May 23, 1996 between Registrant and Dwight L. Jackson. (1) 10.13 Equipment Lease and Addendum No. 1, dated July 31, 1996, between Registrant and LINC Capital Management and related Equipment Schedule. (1) 10.14 Form of Indemnification Agreement between Registrant and executive officers and directors. (1) 10.15 Loan Agreement, dated October 20, 1995 between Registrant and certain investors, and First Amendment to Loan Agreement, dated December 12, 1995, between Registrant and certain investors. (1) 10.16* Amended and Restated Loan and Security Agreement, dated April 30, 1998, between Registrant and Coast Business Credit. (1) 10.17 Promissory Note, dated December 5, 1996, between Registrant and Robert Schneider. (1) 10.18 Promissory Note, dated January 7, 1997, between Registrant and Alison Elder. (1) 10.19 Promissory Note, dated January 31, 1997, between Registrant and Jeffrey Bizzack. (1) 10.20 Office Building Lease between Koll Center Irvine Number Two and Registrant dated November 7, 1994, and Amendments Nos. 1 and 2, thereto. (1) 10.21 Lease (Full Service Office Lease), as amended by and between Callahan Pentz Properties and Registrant, assigned to Registrant on February 29, 1996. (1) 10.22 Promissory Note, dated December 31, 1996 between BeneSphere Administrators, Inc. and Alison Elder. (1) 10.23 Series F Stock Purchase Agreement dated March 12, 1997, between Registrant, General Atlantic Partners 39, L.P. and GAP Coinvestment Partners, L.P. (1) 10.24 Stockholders Agreement dated March 12, 1997 between Registrant, General Atlantic Partners 39, L.P., GAP Coinvestment Partners, L.P. and Sinton (as defined therein). (1) 10.25 Standard Office Lease -- Gross, dated March 27, 1997 between Registrant and Westwood Holdings, Inc. (1) 10.26 ISDA Master Agreement dated June 10, 1997 between Registrant and First Union National Bank. 23.1 Consent of Ernst & Young LLP, Independent Auditors. 23.2* Consent of Wilson Sonsini Goodrich & Rosati, P.C. (included in Exhibit 5.1).
II-4
EXHIBIT EXHIBIT FOOTNOTE NUMBER DESCRIPTION - ----------- ----------- ------------------------------------------------------------------------------------------- 24.1 Powers of attorney (See page II-6) 27.1 Financial Data Schedule.
- ------------------------ * To be filed by amendment. (1) Incorporated by reference to the Registrant's Registration Statement on Form S-1, as amended (File No. 333-23189), declared effective on September 18, 1997. (2) Incorporated by reference from the Registrant's Registration Statement on Form S-8 (File No. 333-37129) filed with the Securities and Exchange Commission on October 3, 1998. (b) Financial Statement Schedules Schedule II Valuation Allowance Schedule ITEM 17. UNDERTAKINGS The undersigned Registrant hereby undertakes to provide to the Underwriters at the closing specified in the Underwriting Agreement certificates in such denominations and registered in such names as required by the Underwriters to permit prompt delivery to each purchaser. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. The undersigned Registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this Registration Statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-5 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Pleasanton, State of California, on this 5th day of August, 1998. PROBUSINESS SERVICES, INC. By: /s/ THOMAS H. SINTON ----------------------------------------- Thomas H. Sinton PRESIDENT AND CHIEF EXECUTIVE OFFICER
POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Thomas H. Sinton and Steven E. Klei, and each of them singly, as true and lawful attorneys-in-fact and agents with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities to sign the Registration Statement filed herewith and any or all amendments to said Registration Statement (including post-effective amendments and registration statements filed pursuant to Rule 462 and otherwise), and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission or any regulatory authority granting unto said attorneys-in-fact and agents the full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the foregoing, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated:
SIGNATURE TITLE DATE - ------------------------------------------------------ -------------------------------------- ----------------- /s/ THOMAS H. SINTON President, Chief Executive Officer and ------------------------------------------- Director (Principal Executive August 5, 1998 Thomas H. Sinton Officer) Senior Vice President, Finance, Chief /s/ STEVEN E. KLEI Financial Officer and Secretary ------------------------------------------- (Principal Financial and Accounting August 5, 1998 Steven E. Klei Officer) /s/ WILLIAM T. CLIFFORD ------------------------------------------- Director August 5, 1998 William T. Clifford /s/ DAVID C. HODGSON ------------------------------------------- Director August 5, 1998 David C. Hodgson /s/ RONALD W. READMOND ------------------------------------------- Director August 5, 1998 Ronald W. Readmond /s/ THOMAS P. RODDY ------------------------------------------- Director August 5, 1998 Thomas P. Roddy
II-6 SCHEDULE II PROBUSINESS, INC. (DOLLARS IN THOUSANDS) VALUATION ALLOWANCE
YEAR ENDED JUNE 30, ------------------------------- 1996 1997 1998 --------- --------- --------- DEFERRED TAX ASSETS Balance at beginning of year......................................................... $ 2,988 $ 3,597 $ 5,988 Additions............................................................................ 609 2,391 3,236 Reductions........................................................................... -- -- -- Balance at end of year............................................................... $ 3,597 $ 5,988 $ 9,224
YEAR ENDED JUNE 30, ------------------------------- 1996 1997 1998 --------- --------- --------- ALLOWANCE FOR DOUBTFUL ACCOUNTS Balance at beginning of year......................................................... $ -- $ -- $ 365 Additions............................................................................ -- 365 84 Reductions........................................................................... -- -- 29 Balance at end of year............................................................... $ -- $ 365 $ 420
S-1 EXHIBIT INDEX
EXHIBIT EXHIBIT FOOTNOTE NUMBER DESCRIPTION - ----------- ----------- ------------------------------------------------------------------------------------------- 1.1 Form of Underwriting Agreement. (1) 2.1 Agreement and Plan of Reorganization, dated May 23, 1996, between Registrant and Dimension Solutions. (1) 2.2 Stock Acquisition Agreement, dated January 1, 1997, between Registrant and BeneSphere Administrators, Inc. (2) 3.1 Amended and Restated Certificate of Incorporation. (1) 3.2 Bylaws of the Registrant. (1) 4.1 Specimen Common Stock Certificate of Registrant. (1) 4.2 Amended and Restated Registration Rights Agreement, dated March 12, 1997 between Registrant, General Atlantic Partners 39, L.P., GAP Coinvestment Partners, L.P. and certain stockholders of Registrant. (1) 4.3 Warrant to Purchase Stock, dated January 13, 1995, between Registrant and Silicon Valley Bank and related Antidilution and Registration Rights Agreements. (1) 4.4(a) Warrant to Purchase Stock, dated April 30, 1996, between Registrant and Coast Business Credit and related Antidilution and Registration Rights Agreement. (1) 4.4(b) Warrant to Purchase Stock, dated October 25, 1996, between Registrant and Coast Business Credit and related Antidilution and Registration Rights Agreement. (1) 4.5 Warrant to Purchase Series E Preferred Stock, dated July 31, 1996, between Registrant and LINC Capital Management. (1) 4.6(a) Warrant Purchase Agreement, dated November 14, 1996, between Registrant and certain purchasers. (1) 4.6(b) Warrant to Purchase Series E Preferred Stock, dated November 14, 1996, between Registrant and T.J. Bristow and Elizabeth S. Bristow. (1) 4.6(c) Warrant to Purchase Series E Preferred Stock, dated November 14, 1996, between Registrant and SDK Incorporated. (1) 4.6(d) Warrant to Purchase Series E Preferred Stock, dated November 14, 1996, between Registrant and Laurence Shushan and Magdalena Shushan. (1) 4.7(a) Warrant to Purchase Common Stock, dated January 7, 1997, between Registrant and Louis R. Baransky. (1) 4.7(b) Warrant to Purchase Common Stock, dated January 7, 1997, between Registrant and Ben W. Reppond. (1) 4.8 Form of Note issued by Registrant on October 20, 1995 and December 12, 1995 (see also Exhibit 10.12). 5.1* Opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation. (1) 10.1 Lease Agreement, dated August 12, 1992, First Amendment to Lease, dated March 23, 1994, Second Amendment to Lease dated December 9, 1994, and Third Amendment to Lease, dated March 16, 1995 between Registrant and Hacienda Park Associates. 10.2* Sublease, dated April 14, 1998, between the Registrant and Documentum, Inc. (1) 10.3 Lease Agreement and Addendum Number One, dated August 26, 1993, and First Amendment to Lease, dated March 23, 1994, between Registrant and Hacienda Park Associates. (1) 10.4 Lease Agreement, dated March 23, 1994, First Amendment, dated May 25, 1994 and Second Amendment, dated October 5, 1994 between Registrant and Hacienda Park Associates. (1) 10.5 Lease Agreement, dated November 13, 1995, and First Amendment to Lease, dated February 23, 1996, between Registrant and Hacienda Park Associates.
EXHIBIT EXHIBIT FOOTNOTE NUMBER DESCRIPTION - ----------- ----------- ------------------------------------------------------------------------------------------- (1) 10.6* Built-to-Suit Lease, dated September 27, 1996, and First Amendment, dated January 27, 1998, between Registrant and Britannia Hacienda V Limited Partnership. (1) 10.7 Office Lease, dated March 22, 1996, between Benefits-Plus Administrators, Inc. and the Trustees under the Will and of the Estate of James Campbell, Deceased and related Guaranty of Lease. 10.8* Sublease, dated October 10, 1997, between Registrant and Drake Mortgage Corporation. 10.9* Build-to-Suit lease, dated January 27, 1998, between Registrant and Britannia Hacienda V Limited Partnership. (1) 10.10 1996 Stock Option Plan and related Form of Stock Option Agreement. (1) 10.11 1996 Employee Stock Purchase Plan. (1) 10.12 Employment and Non-competition Agreement, dated May 23, 1996 between Registrant and Dwight L. Jackson. (1) 10.13 Equipment Lease and Addendum No. 1, dated July 31, 1996, between Registrant and LINC Capital Management and related Equipment Schedule. (1) 10.14 Form of Indemnification Agreement between Registrant and executive officers and directors. (1) 10.15 Loan Agreement, dated October 20, 1995 between Registrant and certain investors, and First Amendment to Loan Agreement, dated December 12, 1995, between Registrant and certain investors. (1) 10.16* Amended and Restated Loan and Security Agreement, dated April 30, 1998, between Registrant and Coast Business Credit. (1) 10.17 Promissory Note, dated December 5, 1996, between Registrant and Robert Schneider. (1) 10.18 Promissory Note, dated January 7, 1997, between Registrant and Alison Elder. (1) 10.19 Promissory Note, dated January 31, 1997, between Registrant and Jeffrey Bizzack. (1) 10.20 Office Building Lease between Koll Center Irvine Number Two and Registrant dated November 7, 1994, and Amendments Nos. 1 and 2, thereto. (1) 10.21 Lease (Full Service Office Lease), as amended by and between Callahan Pentz Properties and Registrant, assigned to Registrant on February 29, 1996. (1) 10.22 Promissory Note, dated December 31, 1996 between BeneSphere Administrators, Inc. and Alison Elder. (1) 10.23 Series F Stock Purchase Agreement dated March 12, 1997, between Registrant, General Atlantic Partners 39, L.P. and GAP Coinvestment Partners, L.P. (1) 10.24 Stockholders Agreement dated March 12, 1997 between Registrant, General Atlantic Partners 39, L.P., GAP Coinvestment Partners, L.P. and Sinton (as defined therein). (1) 10.25 Standard Office Lease -- Gross, dated March 27, 1997 between Registrant and Westwood Holdings, Inc. (1) 10.26 ISDA Master Agreement dated June 10, 1997 between Registrant and First Union National Bank. 23.1 Consent of Ernst & Young LLP, Independent Auditors. 23.2* Consent of Wilson Sonsini Goodrich & Rosati, P.C. (included in Exhibit 5.1). 24.1 Powers of attorney (See page II-6) 27.1 Financial Data Schedule.
- ------------------------ * To be filed by amendment. (1) Incorporated by reference to the Registrant's Registration Statement on Form S-1, as amended (File No. 333-23189), declared effective on September 18, 1997. (2) Incorporated by reference from the Registrant's Registration Statement on Form S-8 (File No. 333-37129) filed with the Securities and Exchange Commission on October 3, 1998. EX-1.1 2 UA AGRMT Exhibit 1.1 ProBusiness Services, Inc. _____ Shares Common Stock (1) UNDERWRITING AGREEMENT ______________, 1998 William Blair & Company, L.L.C. BancAmerica Robertson Stephens SG Cowen Securities Corporation As Representatives of the Several Underwriters Named in Schedule A c/o William Blair & Company, L.L.C. 222 West Adams Street Chicago, Illinois 60606 Ladies and Gentlemen: SECTION 1. INTRODUCTORY. ProBusiness Services, Inc. ("COMPANY") a Delaware corporation, has an authorized capital stock consisting of 5,000,000 shares of Preferred Stock, $0.001 par value, none of which were outstanding as of June 30, 1998 and 60,000,000 shares, $0.001 par value, of Common Stock ("COMMON STOCK"), of which ________ shares were outstanding as of such date. The Company proposes to issue and sell ________ shares of its authorized but unissued Common Stock ("FIRM SHARES") to the several underwriters named in Schedule A as it may be amended by the Pricing Agreement hereinafter defined ("UNDERWRITERS"), who are acting severally and not jointly. In addition, the Company proposes to grant to the Underwriters an option to purchase up to __________ additional shares of Common Stock ("OPTION SHARES") as provided in Section 4 hereof. The Firm Shares and, to the extent such option is exercised, the Option Shares, are hereinafter collectively referred to as the "SHARES." You have advised the Company that the Underwriters propose to make a public offering of their respective portions of the Shares as soon as you deem advisable after the registration statement hereinafter referred to becomes effective, if it has not yet become effective, and the Pricing Agreement hereinafter defined has been executed and delivered. - ---------------------- (1) Plus an option to acquire up to _____ additional shares to cover overallotments. Prior to the purchase and public offering of the Shares by the several Underwriters, the Company and the Representatives, acting on behalf of the several Underwriters, shall enter into an agreement substantially in the form of Exhibit A hereto (the "PRICING AGREEMENT"). The Pricing Agreement may take the form of an exchange of any standard form of written telecommunication between the Company and the Representatives and shall specify such applicable information as is indicated in Exhibit A hereto. The offering of the Shares will be governed by this Agreement, as supplemented by the Pricing Agreement. From and after the date of the execution and delivery of the Pricing Agreement, this Agreement shall be deemed to incorporate the Pricing Agreement. The Company hereby confirms its agreement with the Underwriters as follows: SECTION 2. REPRESENTATIONS AND WARRANTIES OF THE COMPANY. The Company represents and warrants to the several Underwriters that: (a) A registration statement on Form S-1 (File No. 333-_____) and a related preliminary prospectus with respect to the Shares have been prepared and filed with the Securities and Exchange Commission ("COMMISSION") by the Company in conformity with the requirements of the Securities Act of 1933, as amended, and the rules and regulations of the Commission thereunder (collectively, the "1933 ACT;" all references herein to specific rules are rules promulgated under the 1933 Act); and the Company has so prepared and has filed such amendments thereto, if any, and such amended preliminary prospectuses as may have been required to the date hereof. If the Company has elected not to rely upon Rule 430A, the Company has prepared and will promptly file an amendment to the registration statement and an amended prospectus. If the Company has elected to rely upon Rule 430A, it will prepare and file a prospectus pursuant to Rule 424(b) that discloses the information previously omitted from the prospectus in reliance upon Rule 430A. There have been or will promptly be delivered to you three signed copies of such registration statement and amendments, three copies of each exhibit filed therewith, and conformed copies of such registration statement and amendments (but without exhibits) and of the related preliminary prospectus or prospectuses and final forms of prospectus for each of the Underwriters. Such registration statement (as amended, if applicable) at the time it becomes effective and the prospectus constituting a part thereof (including the information, if any, deemed to be part thereof pursuant to Rule 430A(b) and/or Rule 434), as from time to time amended or supplemented, are hereinafter referred to as the "REGISTRATION STATEMENT," and the "PROSPECTUS," respectively, except that if any revised prospectus shall be provided to the Underwriters by the Company for use in connection with the offering of the Shares which differs from the Prospectus on file at the Commission at the time the Registration Statement became or becomes effective (whether or not such revised prospectus is required to be filed by the Company pursuant to Rule 424(b)), the term Prospectus shall refer to such revised prospectus from and after the time it was provided to the Underwriters for such use. If the Company elects to rely on Rule 434 of the 1933 Act, all references -2- to "Prospectus" shall be deemed to include, without limitation, the form of prospectus and the term sheet, taken together, provided to the Underwriters by the Company in accordance with Rule 434 of the 1933 Act ("RULE 434 PROSPECTUS"). Any registration statement (including any amendment or supplement thereto or information which is deemed part thereof) filed by the Company under Rule 462(b) ("RULE 462(b) REGISTRATION STATEMENT") shall be deemed to be part of the "Registration Statement" as defined herein, and any prospectus (including any amendment or supplement thereto or information which is deemed part thereof) included in such registration statement shall be deemed to be part of the "Prospectus", as defined herein, as appropriate. The Securities Exchange Act of 1934, as amended, and the rules and regulations of the Commission thereunder are hereinafter collectively referred to as the "EXCHANGE ACT". (b) The Commission has not issued any order preventing or suspending the use of any preliminary prospectus or instituted proceedings for that purpose, and each preliminary prospectus has conformed in all material respects with the requirements of the 1933 Act and, as of its date, has not included any untrue statement of a material fact or omitted to state a material fact necessary to make the statements therein, in light of the circumstances under which they were made, not misleading; and when the Registration Statement became or becomes effective, and at all times subsequent thereto, up to the First Closing Date and the Second Closing Date hereinafter defined, as the case may be, the Registration Statement, including the information deemed to be part of the Registration Statement at the time of effectiveness pursuant to Rule 430A(b), if applicable, and the Prospectus and any amendments or supplements thereto, contained and will contain all material information that is required to be stated therein in accordance with the 1933 Act and in all material respects conformed or will in all material respects conform to the requirements of the 1933 Act, and neither the Registration Statement nor the Prospectus, nor any amendment or supplement thereto, included or will include any untrue statement of a material fact or omitted or will omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading; PROVIDED, HOWEVER, that the Company makes no representation or warranty as to information contained in or omitted from any preliminary prospectus, the Registration Statement, the Prospectus or any such amendment or supplement in reliance upon and in conformity with written information furnished to the Company by or on behalf of any Underwriter through the Representatives specifically for use in the preparation thereof. (c) The Company and its subsidiaries have been duly incorporated and are validly existing as corporations in good standing under the laws of their respective places of incorporation, with corporate and other power and authority to own, lease and operate their properties and conduct their business as described in the Prospectus; the Company and each of its subsidiaries are duly qualified to do business as foreign corporations under the corporation law of, and are in good standing as such in, each jurisdiction in which they own or lease substantial properties, have an office, or in which substantial business is conducted and such qualification is required except in any such case where the failure to so qualify or be in good standing would not have a material adverse effect upon -3- the Company and its subsidiaries taken as a whole; no proceeding of which the Company has knowledge has been instituted in any such jurisdiction, revoking, limiting or curtailing, or seeking to revoke, limit or curtail, such power and authority or qualification; and each of the Company and its subsidiaries is in possession of and operating in compliance with all authorizations, licenses, certificates, consents, orders and permits from state, federal and other regulatory authorities which are material to the conduct of its business, all of which are valid and in full force and effect. (d) Except as disclosed in the Registration Statement, the Company owns directly or indirectly 100 percent of the issued and outstanding capital stock of each of its subsidiaries, free and clear of any claims, liens, pledges, encumbrances or security interests and all of such capital stock has been duly authorized and validly issued and is fully paid and nonassessable. (e) The issued and outstanding shares of capital stock of the Company as set forth in the Prospectus have been duly authorized and validly issued, are fully paid and nonassessable, and conform to the description thereof contained in the Prospectus. (f) The Shares have been duly authorized and when issued, delivered and paid for pursuant to this Agreement, will be validly issued, fully paid and nonassessable, and will conform to the description thereof contained in the Prospectus. (g) The making and performance by the Company of this Agreement and the Pricing Agreement have been duly authorized by all necessary corporate action and will not violate any provision of the Company's charter or bylaws and will not result in a breach of, or be in contravention of, or constitute a default under (i) any provision of any material agreement, franchise, license, indenture, mortgage, deed of trust, or other instrument to which the Company or any subsidiary is a party or by which the Company, any subsidiary or the property of any of them may be bound or affected, or (ii) any material order, rule or regulation applicable to the Company or any subsidiary of any court or regulatory body, administrative agency or other governmental body having jurisdiction over the Company or any subsidiary or any of their respective properties, or any order of any court or governmental agency or authority entered in any proceeding to which the Company or any subsidiary was or is now a party or by which it is bound. No consent, approval, authorization or other order of any court, regulatory body, administrative agency or other governmental body, domestic or foreign, is required for the execution and delivery of this Agreement or the Pricing Agreement or the consummation of the transactions contemplated herein or therein, except for compliance with the 1933 Act or the Exchange Act, or blue sky laws applicable to the public offering of the Shares by the several Underwriters, which requirements will have been satisfied prior to the Closing Date (as defined herein) in all material respects, and clearance of such offering with the National Association of Securities Dealers, Inc. ("NASD"). This Agreement has been duly executed and delivered by the Company. -4- (h) The accountants who have expressed their opinions with respect to certain of the financial statements and schedules included in the Registration Statement are independent accountants as required by the 1933 Act. (i) The consolidated financial statements and schedules of the Company included in the Registration Statement as filed with the Commission present fairly the consolidated financial position of the Company and its subsidiaries as of the respective dates of such financial statements, and the consolidated results of operations and cash flows of the Company for the respective periods covered thereby, all in conformity with generally accepted accounting principles consistently applied throughout the periods involved, except as disclosed in the Prospectus; and the supporting schedules included in the Registration Statement present fairly the information required to be stated therein. The financial information set forth in the Prospectus under "Selected Consolidated Financial Data" presents fairly on a basis consistent with the audited financial statements presented in the Prospectus, the information set forth therein. No other statements or schedules are required to be included in the Registration Statement. The pro forma financial statements and other pro forma information included in the Prospectus present fairly the information shown therein, have been prepared in accordance with generally accepted accounting principles and the Commission's rules and guidelines with respect to pro forma financial statements and other pro forma information, have been properly compiled on the pro forma basis described therein, and, in the opinion of the Company, the assumptions used in the preparation thereof are reasonable and the adjustments used therein are appropriate under the circumstances. (j) Neither the Company nor any subsidiary is in violation of its charter or bylaws or in default under any consent decree, or in default with respect to any material provision of any material lease, loan agreement, franchise, license, permit or other contract obligation to which it is a party; and there does not exist any state of facts which constitutes an event of default as defined in such documents or which, with notice or lapse of time or both, would constitute such an event of default, in each case, except for defaults which neither singly nor in the aggregate are material to the Company and its subsidiaries taken as a whole. (k) There are no material legal or governmental proceedings pending, or to the best of the Company's knowledge, threatened to which the Company, any subsidiary or any of their respective officers is or may be a party or of which material property owned or leased, or rights held, by the Company or any subsidiary is or may be the subject, or related to environmental or discrimination matters which are not disclosed in the Prospectus, or which question the validity of this Agreement or the Pricing Agreement or any action taken or to be taken pursuant hereto or thereto, or which might prevent consummation of the transactions contemplated therein, or which is required to be disclosed in the Registration Statement or the prospectus and is not so disclosed. -5- (l) There are no holders of securities of the Company having rights to registration thereof or preemptive rights to purchase Common Stock except as disclosed in the Prospectus. Holders of registration rights have waived such rights with respect to the offering being made by the Prospectus. (m) Except as set forth in the Registration Statement and the Prospectus, the Company and each of its subsidiaries have good and marketable title to all the properties and assets reflected as owned in the financial statements hereinabove described (or elsewhere in the Prospectus), subject to no lien, mortgage, pledge, charge or encumbrance of any kind except those, if any, reflected in such financial statements (or elsewhere in the Prospectus) or which are not material to the Company and its subsidiaries taken as a whole. The Company and each of its subsidiaries hold their respective leased properties which are material to the Company and its subsidiaries taken as a whole under valid and enforceable leases, except as may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws relating to or affecting creditors' rights generally or by general equitable principles. The Company and its subsidiaries own or lease all such properties necessary to its operations as described in the Prospectus. (n) The Company has not taken and will not take, directly or indirectly, any action designed to or which has constituted or which might reasonably be expected to cause or result, under the Exchange Act or otherwise, in stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Shares. (o) Subsequent to the respective dates as of which information is given in the Registration Statement and Prospectus, and except as contemplated by the Prospectus, the Company and its subsidiaries, taken as a whole, have not incurred any material liabilities or obligations, direct or contingent, nor entered into any material transactions not in the ordinary course of business and there has not been any material adverse change in their condition (financial or otherwise) or results of operations nor any material change in their capital stock, short-term debt or long-term debt, nor any dividend or distribution of any kind declared, paid or made on the capital stock of the Company or a subsidiary. There has not been any loss or damage (whether or not insured) to the property of the Company or any subsidiary which has had a material adverse effect on the Company. (p) The Company agrees not to sell, contract to sell or otherwise dispose of any Common Stock or securities convertible into Common Stock (except Common Stock issued pursuant to currently outstanding options, warrants or convertible securities) for a period of 90 days after this Agreement becomes effective without the prior written consent of William Blair & Company, L.L.C. Each officer and director of the Company has agreed in writing that each such person will not, for a period beginning the date of the writing and ending 90 days from the date of the final Prospectus (the "LOCK-UP PERIOD"), offer to sell, contract to sell, or otherwise sell, dispose of, loan, pledge or grant any rights with respect to (collectively, a "DISPOSITION") any shares of Common Stock, any options or -6- warrants to purchase any shares of Common Stock or any securities convertible into or exchangeable for shares of Common Stock (collectively, "SECURITIES") now owned or hereafter acquired directly by such person or with respect to which such person has or hereafter acquires the power of disposition, otherwise than (i) if the undersigned is an individual, he or she may transfer any Securities either during his or her lifetime or on death by will or intestacy to his or her immediate family or to a trust, the beneficiaries of which are exclusively the undersigned and/or a member or members of his or her immediate family; and (ii) if the undersigned is an entity, it may transfer Securities as a distribution to limited partners or shareholders of the undersigned, provided, however, that prior to any such transfer each transferee shall execute an agreement, satisfactory to William Blair & Company, L.L.C., pursuant to which each transferee shall agree to receive and hold such Securities subject to the provisions hereof. The foregoing restriction has been expressly agreed to preclude the holder of the Securities from engaging in any hedging or other transaction which is designed to or reasonably expected to lead to or result in a Disposition of Securities during the Lock-up Period, even if such Securities would be disposed of by someone other than such holder. Such prohibited hedging or other transactions would include, without limitation, any short sale (whether or not against the box) or any purchase, sale or grant of any right (including, without limitation, any put or call option) with respect to any Securities or with respect to any security (other than a broad-based market basket or index) that includes, relates to or derives any significant part of its value from Securities. Furthermore, such person has also agreed and consented to the entry of stop transfer instructions with the Company's transfer agent against the transfer of the Securities held by such person except in compliance with this restriction. The Company has provided to counsel for the Underwriters a complete and accurate list of all securityholders of the Company and the number and type of securities held by each securityholder. The Company has provided to counsel for the Underwriters true, accurate and complete copies of all of the agreements pursuant to which its officers, directors and stockholders have agreed to such or similar restrictions (the "LOCK-UP AGREEMENTS") presently in effect or effected hereby. The Company hereby represents and warrants that it will not release any of its officers, directors or other stockholders from any Lock-up Agreements currently existing or hereafter effected without the prior written consent of William Blair & Company, L.L.C. (q) There is no material document of the Company or its subsidiaries of a character required to be described or referred to in the Registration Statement or the Prospectus or to be filed as an exhibit to the Registration Statement which is not accurately described in all material respects or filed as required. (r) The Company together with its subsidiaries owns and possesses all right, title and interest in and to, or has duly licensed from third parties, all patents, patent rights, trade secrets, inventions, know-how, trademarks, trade names, copyrights, service marks and other proprietary rights ("TRADE RIGHTS") material to the business of the Company and each of its subsidiaries taken as a whole. Neither the Company nor any of its subsidiaries has received any notice of, and neither has knowledge of, any infringement, misappropriation or conflict from any third party as to such material -7- Trade Rights which has not been resolved or disposed of and neither the Company nor any of its subsidiaries has infringed, misappropriated or otherwise conflicted with material Trade Rights of any third parties, which infringement, misappropriation or conflict would have a material adverse effect upon the condition (financial or otherwise), of the Company and its subsidiaries taken as a whole. (s) The conduct of the business of the Company and each of its subsidiaries is in compliance in all respects with applicable federal, state, local and foreign laws and regulations, except where the failure to be in compliance would not have a material adverse effect upon the condition (financial or otherwise) or results of operations of the Company and its subsidiaries taken as a whole. (t) All offers and sales of the Company's capital stock have been issued in compliance with all federal and state securities laws, were not issued in violation of or subject to any preemptive rights or other rights to subscribe for or purchase securities, and the authorized and outstanding capital stock of the Company is as set forth in the Prospectus under the caption "Capitalization" as of the date stated therein and conforms in all material respects to the statements relating thereto contained in the Registration Statement and the Prospectus (and such statements correctly state the substance of the instruments defining the capitalization of the Company in all material respects); the Firm Shares and the Option Shares have been duly authorized for issuance and sale to the Underwriters pursuant to this Agreement and, when issued and delivered by the Company against payment therefor in accordance with the terms of this Agreement, will be duly and validly issued and fully paid and nonassessable, and will be sold free and clear of any pledge, lien, security interest, encumbrance, claim or equitable interest; and no preemptive right, co-sale right, registration right, right of first refusal or other similar right of stockholders exists with respect to any of the Firm Shares or Option Shares or the issuance and sale thereof other than those that have been expressly waived prior to the date hereof and those that will automatically expire upon and will not apply to the consummation of the transactions contemplated on the Closing Date. No further approval or authorization of any stockholder, the Board of Directors of the Company or others is required for the issuance and sale or transfer of the Shares except as may be required under the 1933 Act or the Exchange Act or under state or other securities or blue sky laws. All issued and outstanding shares of capital stock of each subsidiary of the Company have been duly authorized and validly issued and are fully paid and nonassessable, and were not issued in violation of or subject to any preemptive right or other rights to subscribe for or purchase shares and are owned by the Company free and clear of any pledge, lien, security interest, encumbrance, claim or equitable interest. Except as disclosed in the Prospectus and the financial statements of the Company, and the related notes thereto, included in the Prospectus, the Company does not have outstanding any options to purchase, or any preemptive rights or other rights to subscribe for or to purchase, any securities or obligations convertible into, or any contracts or commitments to issue or sell, shares of its capital stock or any such options, rights, convertible securities or obligations. The description of the Company's stock option, stock bonus and other stock plans or arrangements, and the options or other rights granted and exercised thereunder, set forth in the Prospectus accurately and fairly -8- presents the information required to be shown with respect to such plans, arrangements, options and rights. (u) The Company has timely filed all necessary federal and state income and franchise tax returns and has paid all taxes shown as due thereon, and there is no tax deficiency that has been, or to the best knowledge of the Company might be, asserted against the Company or its subsidiaries or any of its properties or assets that would or could have a material adverse affect upon the condition (financial or otherwise) of the Company and its subsidiaries taken as a whole, and all tax liabilities are adequately provided for on the books of the Company and its subsidiaries. (v) A registration statement relating to the Common Stock has been declared effective by the Commission pursuant to the Exchange Act and the Common Stock is duly registered thereunder. The Shares have been listed on the Nasdaq National Market, subject to notice of issuance or sale of the Shares, as the case may be. (w) The Company has been advised concerning the Investment Company Act of 1940, as amended, and the rules and regulations thereunder (the "INVESTMENT COMPANY ACT"), and the Company does not, and does not intend to conduct its business in a manner in which it would become, an "investment company" of "controlled" by an "investment company" as defined in Section 3(a) of the Investment Company Act. (x) The Company confirms as of the date hereof that it is in compliance with all provisions of Section 1 of Laws of Florida, Chapter 92-198, AN ACT RELATING TO DISCLOSURE OF DOING BUSINESS WITH CUBA. (y) Neither the Company nor any subsidiary has at any time during the past five (5) years (i) made any unlawful contribution to any candidate for foreign office or failed to disclose fully any contribution in violation of law, or (ii) made any payment to any federal or state governmental officer or official, or other person charged with similar public or quasi-public duties, other than payments required or permitted by the laws of the United States or any jurisdiction thereof. (z) The Company and each subsidiary maintain insurance with insurers of recognized financial responsibility of the types and in the amounts generally deemed adequate for their respective business and consistent with insurance coverage maintained by similar companies in similar businesses, including, but not limited to, insurance covering real and personal property owned or leased by the Company or any subsidiary against theft, damage, destruction, acts of vandalism and all other risks customarily insured against, all of which insurance is in full force and effect; neither the Company nor any subsidiary has been refused any insurance coverage sought or applied for; and neither the Company nor any subsidiary has any reason to believe that it will not be able to renew its existing insurance coverage as and when such coverage expires or to obtain similar coverage from similar insurers as may -9- be necessary to continue its business at a cost that would not materially and adversely affect the condition (financial or otherwise), earnings, operations, business or business prospects of the Company and the subsidiaries considered as one enterprise. (aa) To the best of Company's knowledge, no labor disturbance by the employees of the Company or any subsidiary exists or is imminent; and the Company is not aware of any existing or imminent labor disturbance by the employees of any of its principal third-party service providers that might be expected to result in a material adverse change in the condition (financial or otherwise), earnings, operations, business or business prospects of the Company and the subsidiaries considered as one enterprise. No collective bargaining agreement exists with any of employees of the Company or any subsidiary and, to the best of the Company's knowledge, no such agreement is imminent. (bb) Each of the Company and its subsidiaries maintains a system of internal accounting controls sufficient to provide reasonable assurances that (i) transactions are executed in accordance with management's general or specific authorizations, (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and to maintain accountability for assets, (iii) access to assets is permitted only in accordance with management's general or specific authorization, and (iv) the recorded accountability for assets is compared with existing assets at reasonable intervals and appropriate action is taken with respect to any differences. (cc) There are no outstanding loans, advances (except normal advances for business expenses in the ordinary course of business) or guarantees of indebtedness by the Company to or for the benefit of any of the officers or directors of the Company or any subsidiary or any of the members of the families of any of them that are required to be disclosed in the Registration Statement and Prospectus that are not so disclosed. (dd) Except as set forth in the Registration Statement and Prospectus, (i) each of the Company and the Subsidiary is in compliance with all rules, laws and regulations relating to the use, treatment, storage and disposal of toxic substances and protection of health or the environment ("Environmental Laws") which are applicable to its business, (ii) neither the Company nor the Subsidiary has received notice from any governmental authority or third party of an asserted claim under Environmental Laws, which claim is required to be disclosed in the Registration Statement and the Prospectus, (iii) to its knowledge, neither the Company nor the Subsidiary has conducted any activities that would require it to make future material capital expenditures to comply with Environmental Laws and (iv) no property which is owned, leased or occupied by the Company or the Subsidiary has been designated as a Superfund site pursuant to the Comprehensive Response, Compensation, and Liability Act of 1980, as amended (42 U.S.C. Section 9601, ET SEQ.), or otherwise designated as a contaminated site under applicable state or local law. -10- (ee) The agreements to which the Company or the Subsidiary is a party described in the Registration Statement and Prospectus are valid agreements, enforceable by the Company and the Subsidiary (as applicable) except as the enforcement thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally or by general equitable principles and, to the best of the Company's knowledge, the other contracting party or parties thereto are not in material breach or material default under any of such agreements. (ff) The Company has not distributed and will not distribute prior to the later of (i) the Closing Date, or any date on which Option Shares are to be purchased, as the case may be, and (ii) completion of the distribution of the Shares, any offering material in connection with the offering and sale of the Shares other than any Preliminary Prospectuses, the Prospectus, the Registration Statement and other materials, if any, permitted by the Act. (gg) All outstanding shares of capital stock of the Company have been issued in compliance with all federal and state securities laws, were not issued in violation of or subject to any preemptive rights or other rights to subscribe for or purchase securities, and the authorized and outstanding capital stock of the Company is as set forth in the Prospectus under the caption "Capitalization" as of the date stated therein and conforms in all material respects to the statements relating thereto contained in the Registration Statement and the Prospectus (and such statements correctly state the substance of the instruments defining the capitalization of the Company in all material respects); the Firm Shares and the Option Shares have been duly authorized for issuance and sale to the Underwriters pursuant to this Agreement and, when issued and delivered by the Company against payment therefor in accordance with the terms of this Agreement, will be duly and validly issued and fully paid and nonassessable, and will be sold free and clear of any pledge, lien, security interest, encumbrance, claim or equitable interest; and no preemptive right, co-sale right, registration right, right of first refusal or other similar right of stockholders exists with respect to any of the Firm Shares or Option Shares or the issuance and sale thereof other than those that have been expressly waived prior to the date hereof and those that will automatically expire upon and will not apply to the consummation of the transactions contemplated on the Closing Date. No further approval or authorization of any stockholder, the Board of Directors of the Company or others is required for the issuance and sale or transfer of the Shares except as may be required under the Act or the Exchange Act or under state or other securities or blue sky laws. All issued and outstanding shares of capital stock of each subsidiary of the Company have been duly authorized and validly issued and are fully paid and nonassessable, and were not issued in violation of or subject to any preemptive right or other rights to subscribe for or purchase shares and are owned by the Company free and clear of any pledge, lien, security interest, encumbrance, claim or equitable interest. Except as disclosed in the Prospectus and the financial statements of the Company, and the related notes thereto, included in the Prospectus, the Company does not have has outstandng any options to purchase, or any preemptive rights or other rights to subscribe for or to purchase, any securities or obligations convertible into, or any contracts or commitments to issue or sell, shares of its capital stock or any such options, -11- rights, convertible securities or obligations. The description of the Company's stock option, stock bonus and other stock plans or arrangements, and the options or other rights granted and exercised thereunder, set forth in the Prospectus accurately and fairly presents the information required to be shown with respect to such plans, arrangements, options and rights. SECTION 3. REPRESENTATIONS AND WARRANTIES OF THE UNDERWRITERS. The Representatives, on behalf of the several Underwriters, represent and warrant to the Company that the information set forth (a) on the cover page of the Prospectus with respect to price, underwriting discount and terms of the offering and (b) under "Underwriting" in the Prospectus was furnished to the Company by and on behalf of the Underwriters for use in connection with the preparation of the Registration Statement and is correct and complete in all material respects. SECTION 4. PURCHASE, SALE AND DELIVERY OF SHARES. On the basis of the representations, warranties and agreements herein contained, but subject to the terms and conditions herein set forth, the Company agrees to sell to the Underwriters named in Schedule A hereto, and the Underwriters agree, severally and not jointly, to purchase the Firm Shares from the Company at the price per share set forth in the Pricing Agreement. The obligation of each Underwriter to the Company shall be to purchase from the Company that number of full shares which (as nearly as practicable, as determined by you) bears to ________________, the same proportion as the number of Shares set forth opposite the name of such Underwriter in Schedule A hereto bears to the total number of Firm Shares to be purchased by all Underwriters under this Agreement. The initial public offering price and the purchase price shall be set forth in the Pricing Agreement. At 9:00 A.M., Chicago Time, on the fourth business day, if permitted under Rule 15c6-1 under the Exchange Act, (or the third business day if required under Rule 15c6-1 under the Exchange Act or unless postponed in accordance with the provisions of Section 12) following the date the Registration Statement becomes effective (or, if the Company has elected to rely upon Rule 430A, the fourth business day, if permitted under Rule 15c6-1 under the Exchange Act, (or the third business day if required under Rule 15c6-1 under the Exchange Act) after execution of the Pricing Agreement), or such other time not later than ten business days after such date as shall be agreed upon by the Representatives and the Company, the Company will deliver to you at the offices of counsel for the Underwriters or through the facilities of The Depository Trust Company for the accounts of the several Underwriters, certificates representing the Firm Shares to be sold by it against payment of the purchase price therefor by delivery of federal or other immediately available funds, by wire transfer or otherwise, to the Company. Such time of delivery and payment is herein referred to as the "First Closing Date." The certificates for the Firm Shares so to be delivered will be in such denominations and registered in such names as you request by notice to the Company prior to 10:00 A.M., Chicago Time, on the second full business day preceding the First Closing Date, and will be made available at the Company's expense for checking and packaging by the Representatives at 10:00 A.M., Chicago Time, on the business day preceding the First Closing Date. Payment for the Firm Shares so to be delivered shall be made at the time and in the manner described above at the offices of counsel for the Underwriters. -12- In addition, on the basis of the representations, warranties and agreements herein contained, but subject to the terms and conditions herein set forth, the Company hereby grants an option to the several Underwriters to purchase, severally and not jointly, up to an aggregate of ________ Option Shares, at the same purchase price per share to be paid for the Firm Shares, for use solely in covering any overallotments made by the Underwriters in the sale and distribution of the Firm Shares. The option granted hereunder may be exercised at any time (but not more than once) within 30 days after the date of the initial public offering upon notice by you to the Company setting forth the aggregate number of Option Shares as to which the Underwriters are exercising the option, the names and denominations in which the certificates for such shares are to be registered and the time and place at which such certificates will be delivered. Such time of delivery (which may not be earlier than the First Closing Date), being herein referred to as the "Second Closing Date," shall be determined by you, but if at any time other than the First Closing Date, shall not be earlier than three nor later than 10 full business days after delivery of such notice of exercise. The number of Option Shares to be purchased by each Underwriter shall be determined by multiplying the number of Option Shares to be sold by a fraction, the numerator of which is the number of Firm Shares to be purchased by such Underwriter as set forth opposite its name in Schedule A and the denominator of which is the total number of Firm Shares (subject to such adjustments to eliminate any fractional share purchases as you in your absolute discretion may make). Certificates for the Option Shares will be made available at the Company's expense for checking and packaging at 10:00 A.M., Chicago Time, on the first full business day preceding the Second Closing Date. The manner of payment for and delivery of the Option Shares shall be the same as for the Firm Shares as specified in the preceding paragraph. You have advised the Company that each Underwriter has authorized you to accept delivery of its Shares, to make payment and to receipt therefor. You, individually and not as the Representatives of the Underwriters, may make payment for any Shares to be purchased by any Underwriter whose funds shall not have been received by you by the First Closing Date or the Second Closing Date, as the case may be, for the account of such Underwriter, but any such payment shall not relieve such Underwriter from any obligation hereunder. SECTION 5. COVENANTS OF THE COMPANY. The Company covenants and agrees that: (a) The Company will advise you promptly of the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement or of the institution of any proceedings for that purpose, or of any notification of the suspension of qualification of the Shares for sale in any jurisdiction or the initiation or threatening of any proceedings for that purpose, and will also advise you promptly of any request of the Commission for amendment or supplement of the Registration Statement, of any preliminary prospectus or of the Prospectus, or for additional information. (b) The Company will give you notice of its intention to file or prepare any amendment to the Registration Statement (including any post- effective amendment) or any Rule 462(b) -13- Registration Statement or any amendment or supplement to the Prospectus (including any revised prospectus which the Company proposes for use by the Underwriters in connection with the offering of the Shares which differs from the prospectus on file at the Commission at the time the Registration Statement became or becomes effective, whether or not such revised prospectus is required to be filed pursuant to Rule 424(b) and any term sheet as contemplated by Rule 434) and will furnish you with copies of any such amendment or supplement a reasonable amount of time prior to such proposed filing or use, as the case may be, and will not file any such amendment or supplement or use any such prospectus to which you or counsel for the Underwriters shall reasonably object. (c) If the Company elects to rely on Rule 434 of the 1933 Act, the Company will prepare a term sheet that complies with the requirements of Rule 434. If the Company elects not to rely on Rule 434, the Company will provide the Underwriters with copies of the form of prospectus, in such numbers as the Underwriters may reasonably request, and file with the Commission such prospectus in accordance with Rule 424(b) of the 1933 Act by the close of business in New York City on the second business day immediately succeeding the date of the Pricing Agreement. If the Company elects to rely on Rule 434, the Company will provide the Underwriters with copies of the form of Rule 434 Prospectus, in such numbers as the Underwriters may reasonably request, by the close of business in New York on the business day immediately succeeding the date of the Pricing Agreement. (d) If at any time when a prospectus relating to the Shares is required to be delivered under the 1933 Act any event occurs as a result of which the Prospectus, including any amendments or supplements, would include an untrue statement of a material fact, or omit to state any material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, or if it is necessary at any time to amend the Prospectus, including any amendments or supplements thereto and including any revised prospectus which the Company proposes for use by the Underwriters in connection with the offering of the Shares which differs from the prospectus on file with the Commission at the time of effectiveness of the Registration Statement, whether or not such revised prospectus is required to be filed pursuant to Rule 424(b) to comply with the 1933 Act, the Company promptly will advise you thereof and will promptly prepare and file with the Commission an amendment or supplement which will correct such statement or omission or an amendment which will effect such compliance; and, in case any Underwriter is required to deliver a prospectus nine months or more after the effective date of the Registration Statement, the Company upon request, but at the expense of such Underwriter, will prepare promptly such prospectus or prospectuses as may be necessary to permit compliance with the requirements of Section 10(a)(3) of the 1933 Act. (e) Neither the Company nor any of its subsidiaries will, prior to the earlier of the Second Closing Date or termination or expiration of the related option, incur any liability or obligation, direct or contingent, or enter into any material transaction, other than in the ordinary course of business, except as contemplated by the Prospectus. -14- (f) Neither the Company nor any of its subsidiaries will acquire any capital stock of the Company prior to the earlier of the Second Closing Date or termination or expiration of the related option nor will the Company declare or pay any dividend or make any other distribution upon the Common Stock payable to stockholders of record on a date prior to the earlier of the Second Closing Date or termination or expiration of the related option, except in either case as contemplated by the Prospectus. (g) Not later than November 30, 1999 the Company will make generally available to its securityholders an earnings statement (which need not be audited) covering a period of at least 12 months beginning after the effective date of the Registration Statement, which will satisfy the provisions of the last paragraph of Section 11(a) of the 1933 Act. (h) During such period as a prospectus is required by law to be delivered in connection with offers and sales of the Shares by an Underwriter or dealer, the Company will furnish to you at its expense, subject to the provisions of subsection (d) hereof, copies of the Registration Statement, the Prospectus, each preliminary prospectus and all amendments and supplements to any such documents in each case as soon as available and in such quantities as you may reasonably request, for the purposes contemplated by the 1933 Act. (i) The Company will cooperate with the Underwriters in qualifying or registering the Shares for sale under the blue sky laws of such jurisdictions as you designate, and will continue such qualifications in effect so long as reasonably required for the distribution of the Shares. The Company shall not be required to qualify as a foreign corporation or to file a general consent to service of process in any such jurisdiction where it is not currently qualified or where it would be subject to taxation as a foreign corporation. (j) During the period of five years hereafter, the Company will furnish you and each of the other Underwriters with a copy (i) as soon as practicable after the filing thereof, of each report filed by the Company with the Commission, any securities exchange or the NASD; (ii) as soon as practicable after the release thereof, of each material press release in respect of the Company; and (iii) as soon as available, of each report of the Company mailed to stockholders. (k) The Company will use the net proceeds received by it from the sale of the Shares being sold by it in the manner specified in the Prospectus. (l) If, at the time of effectiveness of the Registration Statement, any information shall have been omitted therefrom in reliance upon Rule 430A and/or Rule 434, then immediately following the execution of the Pricing Agreement, the Company will prepare, and file or transmit for filing with the Commission in accordance with such Rule 430A, Rule 424(b) and/or Rule 434, copies of an amended Prospectus, or, if required by such Rule 430A and/or Rule 434, a post-effective -15- amendment to the Registration Statement (including an amended Prospectus), containing all information so omitted. If required, the Company will prepare and file, or transmit for filing, a Rule 462(b) Registration Statement not later than the date of the execution of the Pricing Agreement. If a Rule 462(b) Registration Statement is filed, the Company shall make payment of, or arrange for payment of, the additional registration fee owing to the Commission required by Rule 111. (m) The Company will comply with all registration, filing and reporting requirements of the Exchange Act and the Nasdaq National Market. SECTION 6. PAYMENT OF EXPENSES. Whether or not the transactions contemplated hereunder are consummated or this Agreement becomes effective as to all of its provisions or is terminated, the Company agrees to pay (i) all costs, fees and expenses (other than legal fees and disbursements of counsel for the Underwriters and the expenses incurred by the Underwriters) incurred in connection with the performance of the Company's obligations hereunder, including without limiting the generality of the foregoing, all fees and expenses of legal counsel for the Company and of the Company's independent accountants, all costs and expenses incurred in connection with the preparation, printing, filing and distribution of the Registration Statement, each preliminary prospectus and the Prospectus (including exhibits and financial statements) and all amendments and supplements provided for herein, this Agreement, the Pricing Agreement and the blue sky Memorandum, (ii) all costs, fees and expenses (including legal fees not to exceed $__________ and disbursements of counsel for the Underwriters) incurred by the Underwriters in connection with qualifying or registering all or any part of the Shares for offer and sale under blue sky laws, including the preparation of a blue sky memorandum relating to the Shares and clearance of such offering with the NASD; and (iii) all fees and expenses of the Company's transfer agent, printing of the certificates for the Shares and all transfer taxes, if any, with respect to the sale and delivery of the Shares to the several Underwriters. SECTION 7. CONDITIONS OF THE OBLIGATIONS OF THE UNDERWRITERS. The obligations of the several Underwriters to purchase and pay for the Firm Shares on the First Closing Date and the Option Shares on the Second Closing Date shall be subject to the accuracy of the representations and warranties on the part of the Company herein set forth as of the date hereof and as of the First Closing Date or the Second Closing Date, as the case may be, to the accuracy of the statements of officers of the Company made pursuant to the provisions hereof, to the performance by the Company of its obligations hereunder, and to the following additional conditions: (a) The Registration Statement shall have become effective either prior to the execution of this Agreement or not later than 1:00 P.M., Chicago Time, on the first full business day after the date of this Agreement, or such later time as shall have been consented to by you but in no event later than 1:00 P.M., Chicago Time, on the third full business day following the date hereof; and prior to the First Closing Date or the Second Closing Date, as the case may be, no stop order suspending the effectiveness of the Registration Statement shall have been issued and no proceedings for that purpose shall have been instituted or shall be pending or, to the knowledge of the Company or you, shall be -16- contemplated by the Commission. If the Company has elected to rely upon Rule 430A and/or Rule 434, the information concerning the initial public offering price of the Shares and price-related information shall have been transmitted to the Commission for filing pursuant to Rule 424(b) within the prescribed period and the Company will provide evidence satisfactory to the Representatives of such timely filing (or a post-effective amendment providing such information shall have been filed and declared effective in accordance with the requirements of Rules 430A and 424(b)). If a Rule 462(b) Registration Statement is required, such Registration Statement shall have been transmitted to the Commission for filing and become effective within the prescribed time period and, prior to the First Closing Date, the Company shall have provided evidence of such filing and effectiveness in accordance with Rule 462(b). (b) The Shares shall have been qualified for sale under the blue sky laws of such states as shall have been specified by the Representatives. (c) The legality and sufficiency of the authorization, issuance and sale or transfer and sale of the Shares hereunder, the validity and form of the certificates representing the Shares, the execution and delivery of this Agreement and the Pricing Agreement, and all corporate proceedings and other legal matters incident thereto, and the form of the Registration Statement and the Prospectus (except financial statements) shall have been approved by counsel for the Underwriters exercising reasonable judgment. (d) You shall not have advised the Company that the Registration Statement or the Prospectus or any amendment or supplement thereto, contains an untrue statement of fact, which, in the opinion of counsel for the Underwriters, is material or omits to state a fact which, in the opinion of such counsel, is material and is required to be stated therein or necessary to make the statements therein not misleading. (e) Subsequent to the execution and delivery of this Agreement, there shall not have occurred any change, or any development involving a prospective change, in or affecting particularly the business or properties of the Company or its subsidiaries, whether or not arising in the ordinary course of business, which, in the judgment of the Representatives, makes it impractical or inadvisable to proceed with the public offering or purchase of the Shares as contemplated hereby. (f) There shall have been furnished to you, as Representatives of the Underwriters, on the First Closing Date or the Second Closing Date, as the case may be, except as otherwise expressly provided below: (i) An opinion of Wilson Sonsini Goodrich & Rosati, P.C., counsel for the Company, addressed to the Underwriters and dated the First Closing Date or the Second Closing Date, as the case may be, to the effect that: -17- (1) The Company has been duly incorporated and is validly existing as a corporation in good standing under the laws of the jurisdiction of its incorporation; (2) The Company has the corporate power and authority to own, lease and operate its properties and to conduct its business as described in the Prospectus; (3) The Company is duly qualified to do business as a foreign corporation and is in good standing in each jurisdiction, if any, in which the ownership or leasing of its properties or the conduct of its business requires such qualification, except where the failure to be so qualified or be in good standing would not have a material adverse effect on the condition (financial or otherwise), earnings, operations or business of the Company and the Subsidiary considered as one enterprise. To such counsel's knowledge, the Company does not own or control, directly or indirectly, any corporation, association or other entity other than BeneSphere Administrators, Inc.; (4) The authorized, issued and outstanding capital stock of the Company is as set forth in the Prospectus under the caption "Capitalization" as of the date stated therein, the issued and outstanding shares of capital stock of the Company have been duly and validly issued and are fully paid and nonassessable, and, to such counsel's knowledge, will not have been issued in violation of or subject to any preemptive right, co-sale right, registration right, right of first refusal or other similar right; (5) The Firm Shares or the Option Shares, as the case may be, to be issued by the Company pursuant to the terms of this Agreement have been duly authorized and, upon issuance and delivery against payment therefor in accordance with the terms hereof, will be duly and validly issued and fully paid and nonassessable, and will not have been issued in violation of or subject to any preemptive right, co-sale right, registration right, right of first refusal or other similar right; (6) The Company has the corporate power and authority to enter into this Agreement and to issue, sell and deliver to the Underwriters the Shares to be issued and sold by it hereunder; (7) This Agreement has been duly authorized by all necessary corporate action on the part of the Company and has been duly executed and delivered by the Company and, assuming due authorization, execution and delivery by you, is a valid and binding agreement of the Company, enforceable in accordance with its terms, except insofar as indemnification provisions may be limited by applicable law and except as enforceability may be limited by bankruptcy, insolvency, reorganization, moratorium or similar laws relating to or affecting creditors' rights generally or by general equitable principles; -18- (8) The Registration Statement has become effective under the Act and, to such counsel's knowledge, no stop order suspending the effectiveness of the Registration Statement has been issued and no proceedings for that purpose have been instituted or are pending or threatened under the Act; (9) The Registration Statement and the Prospectus, and each amendment or supplement thereto (other than the financial statements, including supporting schedules, and financial data derived therefrom, as to which such counsel need express no opinion), as of the effective date of the Registration Statement, complied as to form in all material respects with the requirements of the Act and the applicable Rules and Regulations; (10) The information in the Prospectus under the caption "Description of Capital Stock," to the extent that it constitutes matters of law or legal conclusions, has been reviewed by such counsel and is a fair summary of such matters and conclusions; and the forms of certificates evidencing the Common Stock and filed as exhibits to the Registration Statement comply with Delaware law; (11) The description in the Registration Statement and the Prospectus of the charter and bylaws of the Company and of federal statutes and the General Corporation Law of the State of Delaware are accurate summaries thereof and fairly present the information required to be presented by the Act and the applicable Rules and Regulations; (12) To such counsel's knowledge, there are no agreements, contracts, leases or documents to which the Company is a party of a character required to be described or referred to in the Registration Statement or Prospectus or to be filed as an exhibit to the Registration Statement which are not described or referred to therein or filed as required; (13) The performance of this Agreement and the consummation of the transactions herein contemplated (other than performance of the Company's indemnification obligations hereunder, concerning which no opinion need be expressed) will not (a) result in any violation of the Company's charter or bylaws or (b) to such counsel's knowledge, result in a material breach or violation of any of the terms and provisions of, or constitute a material default under, any material bond, debenture, note or other evidence of indebtedness, or any material lease, contract, indenture, mortgage, deed of trust, loan agreement, joint venture or other agreement or instrument known to such counsel to which the Company is a party or by which its properties are bound, or any applicable statute, rule or regulation known to such counsel or, to such counsel's knowledge, any material order, writ or decree of any court, government or governmental agency or body having jurisdiction over the Company or over any of its properties or operations; -19- (14) No consent, approval, authorization or order of or qualification with any court, government or governmental agency or body having jurisdiction over the Company or over any of its properties or operations is necessary in connection with the consummation by the Company of the transactions herein contemplated, except such as have been obtained under the Act or such as may be required under state or other securities or Blue Sky laws in connection with the purchase and the distribution of the Shares by the Underwriters; (15) To such counsel's knowledge, there are no legal or governmental proceedings pending or threatened against the Company or the Subsidiary of a character required to be disclosed in the Registration Statement or the Prospectus by the Act or the Rules and Regulations, other than those described therein; (16) To such counsel's knowledge, the Company is not presently (a) in material violation of its charter or bylaws or (b) in material breach of any order, writ or decree of any court or governmental agency or body having jurisdiction over the Company or over any of its properties or operations; and (17) To such counsel's knowledge, except as set forth in the Registration Statement and Prospectus, no holders of Common Stock or other securities of the Company have registration rights with respect to securities of the Company and, except as set forth in the Registration Statement and Prospectus, all holders of securities of the Company having rights known to such counsel to registration of such shares of Common Stock or other securities, because of the filing of the Registration Statement by the Company have, with respect to the offering contemplated by this Agreement, waived such rights or such rights have expired by reason of lapse of time following notification of the Company's intent to file the Registration Statement. In addition, such counsel shall state that such counsel has participated in conferences with certain officers and other representatives of the Company, including its independent certified public accountants and with you and your counsel, at which such conferences the contents of the Registration Statement and the Prospectus and related matters were discussed, and although they have not independently verified the accuracy, completeness or fairness of such information, nothing has come to the attention of such counsel which leads them to believe that, at the time the Registration Statement became effective and at all times subsequent thereto up to and on the Closing Date and on any later date on which Option Shares are to be purchased, the Registration Statement (other than the financial statements, including supporting schedules, and other financial and statistical information derived therefrom, as to which such counsel need express no comment) contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the -20- statements therein not misleading, or at the Closing Date or any later date on which the Option Shares are to be purchased, as the case may be, the Prospectus (except as aforesaid) contained any untrue statement of a material fact or omitted to state a material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading. Counsel rendering the foregoing opinion may rely as to questions of law not involving the laws of the United States or the State of California and Delaware upon opinions of local counsel, and as to questions of fact upon representations or certificates of officers of the Company, and of government officials, in which case their opinion is to state that they are so relying and that they have no knowledge of any material misstatement or inaccuracy in any such opinion, representation or certificate. Copies of any opinion, representation or certificate so relied upon shall be delivered to you, as Representatives of the Underwriters, and to Underwriters' Counsel. In rendering such opinion, such counsel may state that they are relying upon the certificate of Norwest Bank Minnesota, National Association, the transfer agent for the Common Stock, as to the number of shares of Common Stock at any time or times outstanding, and that insofar as their opinion under clause (7) above relates to the accuracy and completeness of the Prospectus and Registration Statement, it is based upon a general review with the Company's representatives and independent accountants of the information contained therein, without independent verification by such counsel of the accuracy or completeness of such information. Such counsel may also rely upon the opinions of other competent counsel and, as to factual matters, on certificates of officers of the Company and of state officials, in which case their opinion is to state that they are so doing and copies of said opinions or certificates are to be attached to the opinion unless said opinions or certificates (or, in the case of certificates, the information therein) have been furnished to the Representatives in other form. (ii) Such opinion or opinions of Wilson Sonsini Goodrich & Rosati, P.C., counsel for the Underwriters, dated the First Closing Date or the Second Closing Date, as the case may be, with respect to the incorporation of the Company, the validity of the Shares, the Registration Statement and the Prospectus and other related matters as you may reasonably require, and the Company shall have furnished to such counsel such documents and shall have exhibited to them such papers and records as they request for the purpose of enabling them to pass upon such matters. (iii) A certificate of the chief executive officer and the chief financial officer of the Company, dated the First Closing Date or the Second Closing Date, as the case may be, to the effect that: -21- (1) the representations and warranties of the Company set forth in Section 2 of this Agreement are true and correct as of the date of this Agreement and as of the First Closing Date or the Second Closing Date, as the case may be, and the Company has complied with all the agreements and satisfied all the conditions on its part to be performed or satisfied at or prior to such Closing Date; and (2) the Commission has not issued an order preventing or suspending the use of the Prospectus or any preliminary prospectus filed as a part of the Registration Statement or any amendment thereto; no stop order suspending the effectiveness of the Registration Statement has been issued; and to the best knowledge of the respective signers, no proceedings for that purpose have been instituted or are pending or contemplated under the 1933 Act. The delivery of the certificate provided for in this subparagraph shall be and constitute a representation and warranty of the Company as to the facts required in the immediately foregoing clauses (1) and (2) of this subparagraph to be set forth in said certificate. (iv) At the time the Pricing Agreement is executed and also on the First Closing Date or the Second Closing Date, as the case may be, there shall be delivered to you a letter addressed to you, as Representatives of the Underwriters, from Ernst & Young, LLP independent auditors, the first one to be dated the date of the Pricing Agreement, the second one to be dated the First Closing Date and the third one (in the event of a second closing) to be dated the Second Closing Date, to the effect set forth in Schedule B. There shall not have been any change or decrease specified in the letters referred to in this subparagraph which makes it impractical or inadvisable in the judgment of the Representatives to proceed with the public offering or purchase of the Shares as contemplated hereby. (v) Such further certificates and documents as you may reasonably request. All such opinions, certificates, letters and documents shall be in compliance with the provisions hereof only if they are satisfactory to you and to Cooley Godward LLP, counsel for the Underwriters, which approval shall not be unreasonably withheld. The Company shall furnish you with such manually signed or conformed copies of such opinions, certificates, letters and documents as you request. If any condition to the Underwriters' obligations hereunder to be satisfied prior to or at the First Closing Date is not so satisfied, this Agreement at your election will terminate upon notification to the Company without liability on the part of any Underwriter or the Company, except for the expenses to be paid or reimbursed by the Company pursuant to Sections 6 and 10 hereof and except to the extent provided in Section 11 hereof. -22- SECTION 8. REIMBURSEMENT OF UNDERWRITERS' EXPENSES. If the sale to the Underwriters of the Shares on the First Closing Date is not consummated because any condition of the Underwriters' obligations hereunder is not satisfied or because of any refusal, inability or failure on the part of the Company to perform any agreement herein or to comply with any provision hereof, unless such failure to satisfy such condition or to comply with any provision hereof is due to the default or omission of any Underwriter, the Company agrees to reimburse you and the other Underwriters upon demand for all out-of-pocket expenses (including reasonable fees and disbursements of counsel) that shall have been reasonably incurred by you and them in connection with the proposed purchase and the sale of the Shares. Any such termination shall be without liability of any party to any other party except that the provisions of this Section, Section 6 and Section 10 shall at all times be effective and shall apply. SECTION 9. EFFECTIVENESS OF REGISTRATION STATEMENT. You and the Company will use your and its best efforts to cause the Registration Statement to become effective, if it has not yet become effective, and to prevent the issuance of any stop order suspending the effectiveness of the Registration Statement and, if such stop order be issued, to obtain as soon as possible the lifting thereof. SECTION 10. INDEMNIFICATION. (a) The Company agrees to indemnify and hold harmless each Underwriter and each person, if any, who controls any Underwriter within the meaning of the 1933 Act or the Exchange Act against any losses, claims, damages or liabilities, joint or several, to which such Underwriter or such controlling person may become subject under the 1933 Act, the Exchange Act or other federal or state statutory law or regulation, at common law or otherwise (including in settlement of any litigation if such settlement is effected with the written consent of the Company, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in the Registration Statement, including the information deemed to be part of the Registration Statement at the time of effectiveness pursuant to Rule 430A and/or Rule 434, if applicable, any preliminary prospectus, the Prospectus, or any amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading; and will reimburse each Underwriter and each such controlling person for any legal or other expenses reasonably incurred by such Underwriter or such controlling person in connection with investigating or defending any such loss, claim, damage, liability or action; PROVIDED, HOWEVER, that the Company will not be liable in any such case to the extent that (i) any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in the Registration Statement, any preliminary prospectus, the Prospectus or any amendment or supplement thereto in reliance upon and in conformity with written information furnished to the Company by or on behalf of any Underwriter through the Representatives, specifically for use therein; or (ii) if such statement or omission was contained or made in any preliminary prospectus and corrected in the Prospectus and (1) any such loss, claim, damage or liability suffered or incurred by any Underwriter (or any person who controls any Underwriter) resulted from an action, claim or suit by any person who purchased Shares which are the subject thereof from such Underwriter in the offering and (2) such Underwriter failed to deliver or provide a copy of the Prospectus to such person at or prior to the confirmation -23- of the sale of such Shares in any case where such delivery is required by the 1933 Act. In addition to its other obligations under this Section 10(a), the Company agrees that, as an interim measure during the pendency of any claim, action, investigation, inquiry or other proceeding arising out of or based upon any statement or omission, or any alleged statement or omission, described in this Section 10(a), it will reimburse the Underwriters on a monthly basis for all reasonable legal and other expenses incurred in connection with investigating or defending any such claim, action, investigation, inquiry or other proceeding, notwithstanding the absence of a judicial determination as to the propriety and enforceability of the Company's obligation to reimburse the Underwriters for such expenses and the possibility that such payments might later be held to have been improper by a court of competent jurisdiction. This indemnity agreement will be in addition to any liability which the Company may otherwise have. (b) Each Underwriter will severally indemnify and hold harmless the Company, each of its directors, each of its officers who signed the Registration Statement and each person, if any, who controls the Company within the meaning of the 1933 Act or the Exchange Act, against any losses, claims, damages or liabilities to which the Company, or any such director, officer or controlling person may become subject under the 1933 Act, the Exchange Act or other federal or state statutory law or regulation, at common law or otherwise (including in settlement of any litigation, if such settlement is effected with the written consent of such Underwriter), insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue or alleged untrue statement of any material fact contained in the Registration Statement, any preliminary prospectus, the Prospectus, or any amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in the Registration Statement, any preliminary prospectus, the Prospectus, or any amendment or supplement thereto in reliance upon and in conformity with Section 3 of this Agreement or any other written information furnished to the Company by such Underwriter through the Representatives specifically for use in the preparation thereof; and will reimburse any legal or other expenses reasonably incurred by the Company, or any such director, officer or controlling person in connection with investigating or defending any such loss, claim, damage, liability or action. In addition to their other obligations under this Section 10(b), the Underwriters agree that, as an interim measure during the pendency of any claim, action, investigation, inquiry or other proceeding arising out of or based upon any statement or omission, or any alleged statement or omission, described in this Section 10(b), they will reimburse the Company on a monthly basis for all reasonable legal and other expenses incurred in connection with investigating or defending any such claim, action, investigation, inquiry or other proceeding, notwithstanding the absence of a judicial determination as to the propriety and enforceability of the Underwriters' obligation to reimburse the Company for such expenses and the possibility that such payments might later be held to have been improper by a court of competent jurisdiction. This indemnity agreement will be in addition to any liability which such Underwriter may otherwise have. -24- (c) Promptly after receipt by an indemnified party under this Section of notice of the commencement of any action, such indemnified party will, if a claim in respect thereof is to be made against an indemnifying party under this Section, notify the indemnifying party of the commencement thereof; but the omission so to notify the indemnifying party will not relieve it from any liability which it may have to any indemnified party except to the extent that the indemnifying party was prejudiced by such failure to notify. In case any such action is brought against any indemnified party, and it notifies an indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate in, and, to the extent that it may wish, jointly with all other indemnifying parties similarly notified, to assume the defense thereof, with counsel satisfactory to such indemnified party; PROVIDED, HOWEVER, if the defendants in any such action include both the indemnified party and the indemnifying party and the indemnified party shall have reasonably concluded that there may be legal defenses available to it and/or other indemnified parties which are different from or additional to those available to the indemnifying party, or the indemnified and indemnifying parties may have conflicting interests which would make it inappropriate for the same counsel to represent both of them, the indemnified party or parties shall have the right to select separate counsel to assume such legal defense and otherwise to participate in the defense of such action on behalf of such indemnified party or parties. Upon receipt of notice from the indemnifying party to such indemnified party of its election so to assume the defense of such action and approval by the indemnified party of counsel, the indemnifying party will not be liable to such indemnified party under this Section for any legal or other expenses subsequently incurred by such indemnified party in connection with the defense thereof unless (i) the indemnified party shall have employed such counsel in connection with the assumption of legal defense in accordance with the proviso to the next preceding sentence (it being understood, however, that the indemnifying party shall not be liable for the expenses of more than one separate counsel, approved by the Representatives in the case of paragraph (a) representing all indemnified parties not having different or additional defenses or potential conflicting interest among themselves who are parties to such action), (ii) the indemnifying party shall not have employed counsel satisfactory to the indemnified party to represent the indemnified party within a reasonable time after notice of commencement of the action or (iii) the indemnifying party has authorized the employment of counsel for the indemnified party at the expense of the indemnifying party. No indemnifying party shall, without the prior written consent of the indemnifid party, effect any settlement of any pending or threatened proceeding in respect of which any indemnified party is or could have been a party and indemnity could have been sought hereunder by such indemnified party, unless such settlement includes an unconditional release of such indemnified party from all liability arising out of such proceeding. (d) If the indemnification provided for in this Section is unavailable to an indemnified party under paragraphs (a) or (b) hereof in respect of any losses, claims, damages or liabilities referred to therein, then each applicable indemnifying party, in lieu of indemnifying such indemnified party, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities (i) in such proportion as is appropriate to reflect the relative benefits received by the Company and the Underwriters from the offering of the Shares or (ii) if the allocation provided by clause (i) above is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in clause (i) above but also the relative fault of the Company and the Underwriters in connection -25- with the statements or omissions which resulted in such losses, claims, damages or liabilities, as well as any other relevant equitable considerations. The respective relative benefits received by the Company and the Underwriters shall be deemed to be in the same proportion in the case of the Company as the total price paid to the Company for the Shares by the Underwriters (net of underwriting discount but before deducting expenses), and in the case of the Underwriters as the underwriting discount received by them bears to the total of such amounts paid to the Company and received by the Underwriters as underwriting discount in each case as contemplated by the Prospectus. The relative fault of the Company and the Underwriters shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission to state a material fact relates to information supplied by the Company or by the Underwriters and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The amount paid or payable by a party as a result of the losses, claims, damages and liabilities referred to above shall be deemed to include any legal or other fees or expenses reasonably incurred by such party in connection with investigating or defending any action or claim. The Company and the Underwriters agree that it would not be just and equitable if contribution pursuant to this Section were determined by pro rata allocation or by any other method of allocation which does not take account of the equitable considerations referred to in the immediately preceding paragraph. Notwithstanding the provisions of this Section, no Underwriter shall be required to contribute any amount in excess of the amount by which the total price at which the Shares underwritten by it and distributed to the public were offered to the public exceeds the amount of any damages which such Underwriter has otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the 1933 Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. The Underwriters' obligations to contribute pursuant to this Section are several in proportion to their respective underwriting commitments and not joint. (e) The provisions of this Section shall survive any termination of this Agreement. SECTION 11. DEFAULT OF UNDERWRITERS. It shall be a condition to the agreement and obligation of the Company to sell and deliver the Shares hereunder, and of each Underwriter to purchase the Shares hereunder, that, except as hereinafter in this paragraph provided, each of the Underwriters shall purchase and pay for all Shares agreed to be purchased by such Underwriter hereunder upon tender to the Representatives of all such Shares in accordance with the terms hereof. If any Underwriter or Underwriters default in their obligations to purchase Shares hereunder on the First Closing Date and the aggregate number of Shares which such defaulting Underwriter or Underwriters agreed but failed to purchase does not exceed 10 percent of the total number of Shares which the Underwriters are obligated to purchase on the First Closing Date, the Representatives may make arrangements satisfactory to the Company for the purchase of such Shares by other persons, including any of the Underwriters, but if no such arrangements are made by such date the nondefaulting Underwriters shall be obligated severally, in proportion to their respective commitments hereunder, to purchase the Shares which such defaulting Underwriters agreed but failed to purchase on such -26- date. If any Underwriter or Underwriters so default and the aggregate number of Shares with respect to which such default or defaults occur is more than the above percentage and arrangements satisfactory to the Representatives and the Company for the purchase of such Shares by other persons are not made within 36 hours after such default, this Agreement will terminate without liability on the part of any nondefaulting Underwriter or the Company, except for the expenses to be paid by the Company pursuant to Section 6 hereof and except to the extent provided in Section 10 hereof. In the event that Shares to which a default relates are to be purchased by the nondefaulting Underwriters or by another party or parties, the Representatives or the Company shall have the right to postpone the First Closing Date for not more than seven business days in order that the necessary changes in the Registration Statement, Prospectus and any other documents, as well as any other arrangements, may be effected. As used in this Agreement, the term "Underwriter" includes any person substituted for an Underwriter under this Section. Nothing herein will relieve a defaulting Underwriter from liability for its default. SECTION 12. EFFECTIVE DATE. This Agreement shall become effective immediately as to Sections 6, 8, 10 and 13 and as to all other provisions at 10:00 A.M., Chicago Time, on the day following the date upon which the Pricing Agreement is executed and delivered, unless such a day is a Saturday, Sunday or holiday (and in that event this Agreement shall become effective at such hour on the business day next succeeding such Saturday, Sunday or holiday); but this Agreement shall nevertheless become effective at such earlier time after the Pricing Agreement is executed and delivered as you may determine on and by notice to the Company or by release of any Shares for sale to the public. For the purposes of this Section, the Shares shall be deemed to have been so released upon the release for publication of any newspaper advertisement relating to the Shares or upon the release by you of telegrams (i) advising Underwriters that the Shares are released for public offering, or (ii) offering the Shares for sale to securities dealers, whichever may occur first. SECTION 13. TERMINATION. Without limiting the right to terminate this Agreement pursuant to any other provision hereof: (a) This Agreement may be terminated by the Company by notice to you or by you by notice to the Company at any time prior to the time this Agreement shall become effective as to all its provisions, and any such termination shall be without liability on the part of the Company to any Underwriter (except for the expenses to be paid or reimbursed pursuant to Section 6 hereof and except to the extent provided in Section 10 hereof) or of any Underwriter to the Company. (b) This Agreement may also be terminated by you prior to the First Closing Date, and the option referred to in Section 4, if exercised, may be cancelled at any time prior to the Second Closing Date, if (i) trading in securities on the New York Stock Exchange shall have been suspended or minimum prices shall have been established on such exchange, or (ii) a banking moratorium shall have been declared by Illinois, New York, or United States authorities, or (iii) there shall have been -27- any change in financial markets or in political, economic or financial conditions which, in the opinion of the Representatives, either renders it impracticable or inadvisable to proceed with the offering and sale of the Shares on the terms set forth in the Prospectus or materially and adversely affects the market for the Shares, or (iv) there shall have been an outbreak of major armed hostilities between the United States and any foreign power which in the opinion of the Representatives makes it impractical or inadvisable to offer or sell the Shares. Any termination pursuant to this paragraph (b) shall be without liability on the part of any Underwriter to the Company or on the part of the Company to any Underwriter (except for expenses to be paid or reimbursed pursuant to Section 6 hereof and except to the extent provided in Section 10 hereof). SECTION 14. REPRESENTATIONS AND INDEMNITIES TO SURVIVE DELIVERY. The respective indemnities, agreements, representations, warranties and other statements of the Company, of its officers and of the several Underwriters set forth in or made pursuant to this Agreement will remain in full force and effect, regardless of any investigation made by or on behalf of any Underwriter or the Company or any of its or their partners, principals, members, officers or directors or any controlling person, as the case may be, and will survive delivery of and payment for the Shares sold hereunder. SECTION 15. NOTICES. All communications hereunder will be in writing and, if sent to the Underwriters will be mailed, delivered or telegraphed and confirmed to you c/o William Blair & Company, L.L.C., 222 West Adams Street, Chicago, Illinois 60606, with a copy to Kenneth L. Guernsey, Cooley Godward LLP, One Maritime Plaza, 20th Floor, San Francisco, California 94111; and if sent to the Company will be mailed, delivered or telegraphed and confirmed to the Company at its corporate headquarters with a copy to Alan K. Austin, Wilson Sonsini Goodrich & Rosati, 650 Page Mill Road, Palo Alto, California, 94304. SECTION 16. SUCCESSORS. This Agreement and the Pricing Agreement will inure to the benefit of and be binding upon the parties hereto and their respective successors, personal representatives and assigns, and to the benefit of the officers and directors and controlling persons referred to in Section 10, and no other person will have any right or obligation hereunder. The term "successors" shall not include any purchaser of the Shares as such from any of the Underwriters merely by reason of such purchase. SECTION 17. REPRESENTATION OF UNDERWRITERS. You will act as Representatives for the several Underwriters in connection with this financing, and any action under or in respect of this Agreement taken by you will be binding upon all the Underwriters. SECTION 18. PARTIAL UNENFORCEABILITY. If any section, paragraph or provision of this Agreement is for any reason determined to be invalid or unenforceable, such determination shall not affect the validity or enforceability of any other section, paragraph or provision hereof. SECTION 19. APPLICABLE LAW. This Agreement and the Pricing Agreement shall be governed by and construed in accordance with the laws of the State of Illinois. -28- If the foregoing is in accordance with your understanding of our agreement, kindly sign and return to us the enclosed duplicates hereof, whereupon it will become a binding agreement among the Company and the several Underwriters including you, all in accordance with its terms. Very truly yours, PROBUSINESS SERVICES, INC. By Thomas H. Sinton Chief Executive Officer The foregoing Agreement is hereby confirmed and accepted as of the date first above written. WILLIAM BLAIR & COMPANY, L.L.C. BANCAMERICA ROBERTSON STEPHENS SG COWEN SECURITIES CORPORATION Acting as Representatives of the several Underwriters named in Schedule A. By William Blair & Company, L.L.C. By ------------------------------------------- -29- SCHEDULE A Number of Firm Shares to be Underwriter Purchased - ----------- ---------------------------- William Blair & Company, L.L.C . . . . . . . . BancAmerica Robertson Stephen. . . . . . . . . SG Cowen Securities Corporatio . . . . . . . . ----------------------------- TOTAL. . . . . . . . . . . . . . . ----------------------------- ----------------------------- SCHEDULE B Comfort Letter of Ernst & Young, LLP (1) They are independent public accountants with respect to the Company and its subsidiaries within the meaning of the 1933 Act. (2) In their opinion the consolidated financial statements and schedules of the Company and its subsidiaries included in the Registration Statement and the consolidated financial statements of the Company from which the information presented under the caption "Selected Consolidated Financial Data" has been derived which are stated therein to have been examined by them comply as to form in all material respects with the applicable accounting requirements of the 1933 Act. (3) On the basis of specified procedures (but not an examination in accordance with generally accepted auditing standards), including inquiries of certain officers of the Company and its subsidiaries responsible for financial and accounting matters as to transactions and events subsequent to ____________, 1998, a reading of minutes of meetings of the stockholders and directors of the Company and its subsidiaries since ____________, 1998, a reading of the latest available interim unaudited consolidated financial statements of the Company and its subsidiaries (with an indication of the date thereof) and other procedures as specified in such letter, nothing came to their attention which caused them to believe that (i) the unaudited consolidated financial statements of the Company and its subsidiaries included in the Registration Statement do not comply as to form in all material respects with the applicable accounting requirements of the 1933 Act or that such unaudited financial statements are not fairly presented in accordance with generally accepted accounting principles applied on a basis substantially consistent with that of the audited financial statements included in the Registration Statement, and (ii) at a specified date not more than five days prior to the date thereof in the case of the first letter and not more than two business days prior to the date thereof in the case of the second and third letters, there was any change in the capital stock or long-term debt or short-term debt (other than normal payments) of the Company and its subsidiaries on a consolidated basis or any decrease in consolidated net current assets or consolidated stockholders' equity as compared with amounts shown on the latest unaudited balance sheet of the Company included in the Registration Statement or for the period from the date of such balance sheet to a date not more than five days prior to the date thereof in the case of the first letter and not more than two business days prior to the date thereof in the case of the second and third letters, there were any decreases, as compared with the corresponding period of the prior year, in consolidated net sales, consolidated income before income taxes or in the total or per share amounts of consolidated net income except, in all instances, for changes or decreases which the Prospectus discloses have occurred or may occur or which are set forth in such letter. (4) They have carried out specified procedures, which have been agreed to by the Representatives, with respect to certain information in the Prospectus specified by the Representatives, and on the basis of such procedures, they have found such information to be in agreement with the general accounting records of the Company and its subsidiaries. -32- EXHIBIT A PROBUSINESS SERVICES, INC. ____________ Shares Common Stock (2) - --------------------- (2)Plus an option to acquire up to _______ additional shares to cover overallotments. PRICING AGREEMENT ____________, 1998 William Blair & Company, L.L.C. BancAmerica Robertson Stephens SG Cowen Securities Corporation As Representatives of the Several Underwriters c/o William Blair & Company, L.L.C. 222 West Adams Street Chicago, Illinois 60606 Ladies and Gentlemen: Reference is made to the Underwriting Agreement dated ____________, 1998 (the "UNDERWRITING AGREEMENT") relating to the sale by the Company and the purchase by the several Underwriters for whom William Blair & Company, L.L.C., BancAmerica Robertson Stephens and SG Cowen Securities Corporation are acting as representatives (the "REPRESENTATIVES"), of the above Shares. All terms herein shall have the definitions contained in the Underwriting Agreement except as otherwise defined herein. Pursuant to Section 4 of the Underwriting Agreement, the Company agrees with the Representatives as follows: 1. The initial public offering price per share for the Shares shall be $__________. 2. The purchase price per share for the Shares to be paid by the several Underwriters shall be $__________, being an amount equal to the initial public offering price set forth above less $__________ per share. Schedule A is amended as follows: If the foregoing is in accordance with your understanding of our agreement, kindly sign and return to us the enclosed duplicates hereof, whereupon it will become a binding agreement among the Company and the several Underwriters, including you, all in accordance with its terms. -34- Very truly yours, PROBUSINESS SERVICES, INC. By Chief Executive Officer The foregoing Agreement is hereby confirmed and accepted as of the date first above written. WILLIAM BLAIR & COMPANY, L.L.C. BANCAMERICA ROBERTSON STEPHENS SG COWEN SECURITIES CORPORATION Acting as Representatives of the several Underwriters. By William Blair & Company, L.L.C. By -------------------------------------- Principal -35- EX-23.1 3 EXHIBIT 23.1 EXHIBIT 23.1 CONSENT AND REPORT OF INDEPENDENT AUDITORS We consent to the reference to our firm under the caption "Experts" and to the use of our report dated July 23, 1998, in the Registration Statement (Form S-1 No. 333- ) and related Prospectus of ProBusiness Services, Inc. for the registration of shares of its common stock. Our audits also included the financial statement schedule of ProBusiness Services, Inc. listed in Item 16(b). This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ ERNST & YOUNG LLP Walnut Creek, California August 5, 1998 EX-27.1 4 EXHIBIT 27.1
5 1,000 12-MOS 12-MOS 12-MOS JUN-30-1996 JUN-30-1997 JUN-30-1998 JUL-01-1995 JUL-01-1996 JUL-01-1997 JUN-30-1996 JUN-30-1997 JUN-30-1998 0 5,047 13,771 0 0 0 0 2,476 2,612 0 365 420 0 0 0 0 185,792 351,172 0 11,954 21,411 0 4,331 7,453 0 200,435 376,009 0 185,751 347,849 0 0 0 0 0 0 0 3 0 0 2 17 0 3,864 26,729 0 200,435 376,009 0 0 0 13,863 27,374 46,317 0 0 0 6,435 13,659 23,859 9,410 18,829 29,170 0 0 0 473 1,190 557 (2,386) (6,245) (6,517) 0 0 0 (2,386) (6,245) (6,517) 0 0 0 0 0 0 0 0 0 (2,386) (6,245) (6,517) (4.91) (0.59) (.41) (4.91) (0.59) (.41)
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