ITEM 1. BUSINESS
OVERVIEW Claremont provides IT solutions based on client/server software for select industries focusing on the customer care needs of its clients, including customer service, order and transaction processing, billing and logistics. Claremont typically provides its services to large organizations involved in markets that are experiencing dynamic change. Quite often these organizations are experiencing new, or more difficult, competitive pressures due to a variety of factors, including recent deregulation in their industry (e.g. communications, financial services and utilities), greater worldwide competition (e.g. manufacturing) or privatization (e.g. state and local government, employee pension and retirement and health and human services). Claremont delivers its services, including IT planning, systems integration and development and outsourcing, through a standard project management methodology. This methodology ties IT strategic planning and business process reengineering initiatives to the downstream use of object oriented software modules and transferable design frameworks in the form of standard solution components. Depending on the client's preference, Claremont delivers its services on a fixed-price, fixed-delivery-schedule basis or a time and materials basis. Claremont's clients consist of large corporations and government organizations in the United States and certain foreign markets including Canada, the United Kingdom, Australia and New Zealand.
The Company's focus on opportunities within select vertical markets is complemented by its expertise with the particular customer interface within these markets and its dedication to partner with clients to co-develop large scale business solutions. The Company's clients include AT&T, BancOne, CalPERS, Colonial Pacific, Fred Meyer, Lucent, Ohio STRS and Sprint.
INDUSTRY BACKGROUND Organizations today face constant pressure to improve the quality of products and services, reduce cost and time to market and improve operating efficiency while strengthening customer relationships. To compete effectively, organizations must improve business processes to empower the end user and must develop internal decision-making processes and methods of exchanging information that are more efficient and effective. Such changes mean that IT deployment decisions are increasingly made at the senior executive level rather than at the departmental level and are implemented across the entire organization. Information systems and their rapid development and deployment have become a source of strategic advantage and are increasingly mission-critical.
As IT systems have evolved to a value-added component of an organization's strategy, the need has grown to design, develop and deploy business applications solutions rapidly, flexibly and in a technological framework that supports today's geographically distributed business environment. Consequently, there has been a shift in the past few years in the computing platforms favored by large organizations, from single-vendor legacy mainframe-based systems to open, multi-vendor client/server computing systems, and most recently to corporate intranets. However, the benefits of client/server and other advanced technologies can be difficult to obtain, because designing, developing, deploying
and managing client/server systems is complex, time consuming and costly. In addition, organizations often lack the range and depth of skills necessary to develop these systems internally and often cannot effectively attract and retain personnel with the required technological expertise.
Organizations increasingly wish to use their information systems to address these mission-critical business processes faster and more effectively at a lower cost. Computer information systems now often serve as the primary information resource through which organizations serve their customers, and increasingly serve as the organization's primary interface to its customers. Many organizations have found that among the most compelling applications that employ client/server technology are solutions that effectively distribute information directly to the business end user who services customers, or directly to the customers themselves. Applications such as customer service, order and transaction processing, billing, distribution and logistics directly influence an organization's ability to generate customer satisfaction and revenue, and therefore tend to be priorities for allocation of any organization's capital budgets in both strong and slow economic climates.
The complexity of current technologies, the lack of sufficient in-house resources, and the competitive pressures requiring rapid implementation of new mission-critical systems in client/server and distributed technologies, have led to increasing demand for third-party solution providers. To meet that demand effectively, providers of applications and systems solutions require global reach, a full range of technical skills, ability to provide the best available technologies, in-depth knowledge of the customer interface in particular industries and the ability to manage complex technological projects to completion on time and within budget.
THE CLAREMONT SOLUTION
Claremont combines its expertise in IT consulting and large scale systems integration to provide its clients business solutions that allow them to better serve their customers. The following are key attributes of the Claremont solution:
MISSION-CRITICAL BUSINESS SOLUTIONS. The Company focuses on providing enterprise-wide IT solutions that re-engineer core business processes such as customer service, order and transaction processing, billing and logistics. Claremont's approach minimizes project risk through use of a methodology that emphasizes problem definition and solution design and can employ proven software modules and design frameworks, and through use of experienced personnel with applicable project management and industry expertise.
VERTICAL MARKET EXPERTISE AND CLIENT PARTNERSHIP. Claremont's vertical market orientation offers applications solutions that are based on in-depth knowledge of particular industries and a detailed understanding of the client's business. By targeting specific industries and developing long-term client relationships, the Company is able to provide enterprise-wide business solutions based on a detailed and thorough understanding of the industry in which the client operates as well as the client's own business processes.
REUSABLE SOFTWARE MODULES AND TRANSFERABLE DESIGN FRAMEWORKS. Claremont's standard development methodology provides a structure through which the Company's skills and
knowledge capital can be effectively leveraged in the form of reusable software modules and transferable design frameworks. The ability to employ previously constructed software modules and design frameworks in the form of standard solution components provides Claremont leverage during the design and integration phases, minimizes business risk and reduces both time to solution and project costs.
CLAREMONT SERVICES Claremont provides IT applications solutions encompassing IT planning, IT systems integration and development, and IT outsourcing of IT maintenance/enhancement services for large corporations and government organizations in the United States and certain foreign markets including Canada, the United Kingdom, Australia and New Zealand. Through its TISE methodology, the Company seeks to deliver, in a timely fashion, cost effective systems that meet the clients' needs and provide the flexibility to meet future application processing requirements. The Company's methodology for delivering its services is typically divided into the three phases illustrated below:
The following is a brief description of each phase and task of the TISE methodology:
PHASE I: IT CONSULTING. Generally, IT Consulting precedes the actual systems integration project and is completed in a timeframe of one to two months. IT Consulting typically concludes with a return-on-investment analysis and a proposal, including budgets and anticipated timeframe for implementation of the proposed solution. The purpose of this phase is to allow executives, managers and end users from the client work in partnership with Claremont consultants to develop recommendations for strategic business process changes. Claremont's preference is to also develop a high-level architectural infrastructure design in this phase, which provides Claremont, and the client, with a structural roadmap for approaching Phase II, the Systems Development/Integration phase.
PHASE II: SYSTEMS DEVELOPMENT/INTEGRATION. Systems Development/Integration generally results in delivery of a fully implemented solution in six to 24 months. Appropriate application of the TISE methodology during this phase results in the development of the IT solution, as well as the effective implementation of that solution and meaningful change in the client's business processes. Systems Development/Integration involves these stages:
PROCESS DESIGN. A key to Phase II of the TISE methodology is an assessment of the operational impact of a new system, and designing re-engineered business processes for the client to insure that the solution developed will provide the desired results. This process begins at the earliest stages of the design of the application itself, and continues throughout the Systems Development/Integration process. These processes lead to the generation of a high-level object oriented business model and the development of an architected system infrastructure, and can often draw on standard solution components already developed by Claremont as central design elements.
SYSTEM DEVELOPMENT. Once the high-level system infrastructure is in place, Claremont places an emphasis on solving detail-level system logic and design problems before coding begins, and results in sufficiently detailed specifications that enable Claremont to complete the actual coding and testing of the application's
software objects in a highly controlled, factory-like manufacturing process. In this process, where appropriate, Claremont can incorporate previously developed and reusable software modules. Because Claremont's solutions replace, rather than simply surround, the client's old and often inflexible legacy code, system development also includes the development of a significant number of interfaces to other client systems. Claremont assembles all the code from the previously completed tasks and conducts a functional test of the new system.
SYSTEM DEPLOYMENT. Complete implementation of the solution requires two final steps. The first is developing the new job descriptions and operational procedures and training people in how to take maximum advantage of the new system. The second step is to put the entire system through a complete test from the user's perspective, including testing the software, as well as the new procedures and the interfaces with existing systems.
PHASE III: OUTSOURCING. Outsourcing of the ongoing support and enhancement for the client's new system and/or total system environment is an area of services that has been growing for Claremont over the past few years. The outsourcing phase of the TISE methodology provides opportunities for the Company to enhance client partnerships and broaden the scope of its engagements.
While individual Phase I projects are small, typically $50,000 to $250,000, total client engagements regularly involve multiple projects over several years and can generate revenue in excess of $20 million. Claremont has been successful in negotiating resale rights for several of its software solutions.
Claremont provides its services on both a time and materials and fixed-price basis. Invoices for time and materials work are presented on a bi-weekly or monthly basis. Invoices for fixed-price engagements are presented in accordance with achievement of negotiated milestones or dates during the development process.
TECHNOLOGICAL EXPERTISE Claremont provides technological resources across all of its industry practice areas and seeks to build and maintain the Company's expertise in leading edge technologies. Technology personnel are located in Montreal, Canada; Basking Ridge, New Jersey; Columbus and Cleveland, Ohio; Beaverton, Oregon; Sacramento and San Francisco, California; Seattle, Washington and North Sydney, Australia. The Company's advanced technology groups are managed on a world-wide basis so that clients, regardless of location, have access to Claremont's technical expertise.
At present, Claremont focuses its advanced technology skills in four main areas: object oriented systems development; electronic commerce (internet/intranet and groupware solutions); client/server enterprise architectures (complex network management); and on-line analytical processing (executive support systems/data warehousing). Claremont uses its relationships with hardware and software providers such as Arbor Software, Forte, Hewlett Packard, IBM, Microsoft, Netscape, Oracle, Silicon Graphics and Sun Microsystems to help ensure that it remains current with the latest technology and to serve as a source of new business opportunities for the Company's industry practice areas.
MARKETS AND CLIENTS Claremont focuses its marketing efforts on clients in information-intensive businesses, including communications, financial services, state and local government services and commercial services. Within these vertical markets, the Company targets clients for whom enterprise-wide IT solutions can provide a competitive advantage. The Company intends to continue to pursue opportunities to provide its services in other industry sectors with similar needs.
Claremont's most significant clients, in terms of revenue earned in fiscal 1997 within its industry practice areas are listed below:
COMMUNICATIONS FINANCIAL SERVICES STATE & LOCAL GOVERNMENT -------------- ------------------ ------------------------ AT&T BancOne CalPERS Lucent Colonial Pacific Leasing Mississippi PERS Telecom New Zealand Frank Russell Ohio STRS Rogers Cable Washington Department of Sprint Ecology
COMMERCIAL SERVICES ------------------- Manufacturing RETAIL HEALTH CARE UTILITIES ------------- ------ ----------- --------- Lucent Aventure The Benchmark Group Dayton Power & Merix Fred Meyer Blue Cross/Blue Shield Light Microsoft Oregon Pacificorp Oregon Steel Wacker Siltronic Weyerhauser Willamette Industries
The Company has in the past derived, and may in the future derive, a significant portion of its revenue from a relatively small number of clients. During the fiscal year ended June 30, 1997, the Company had only one client who represented at least 10% of the Company's revenue: Lucent, 14%. During the fiscal year ended June 30, 1996, the Company had three clients each of whom represented at least 10% of the Company's revenue: Lucent, 20%; Ohio STRS, 14%; and Mississippi PERS, 11%.
The Company's IT consulting services focus on four key industry sectors: communications, financial services, state and local government and commercial services which represented approximately 21%, 12%, 25% and 42%, respectively, of the Company's revenue for fiscal 1997 and 30%, 5%, 34% and 31%, respectively, of the Company's revenue for fiscal 1996.
COMMUNICATIONS. During the last 12 months, the Company has performed a number of engagements, including assisting in the development of communications products for Lucent, assisting AT&T in the redevelopment of its 900 number billing system, supporting Sprint in a joint venture with TCI and Cox Cable to deliver PCS services, providing business process reengineering services for Rogers Cable and implementing Telecom New Zealand's Internet services. The communications practice area has developed PREMOST, a billing system consisting of a reusable set of object oriented software modules constructed to support communications clients in their billing and customer care functions. Collectively, these modules represent a highly flexible tool to support these critical billing and customer care business functions. The Company believes that in suitable applications the reusable software modules will enable Claremont to offer its clients reduced development time and cost.
FINANCIAL SERVICES. Claremont's financial services practice is focused on serving clients in the credit card, leasing and investment management businesses as evidenced by its relationships with BankOne, Colonial Pacific Leasing and Frank Russell, respectively. During the past 12 months, the Company has rapidly expanded its presence in the financial services industries. Claremont intends to establish a leadership position in the credit card, leasing and investment management sub-segments of the financial services market. Claremont believes that its competitive advantage in these segments is derived from strategic relationships focused on emerging technologies including e-cash solutions endorsed by MasterCard, International; a unique knowledge of the use of data warehousing technology within the credit card industry; strong knowledge capital of the investment management business gained from pertinent experiences in the public pension business; and a strategic relationship with an innovative provider of leasing software.
STATE AND LOCAL GOVERNMENT. Claremont's state and local government practice is anchored by its longstanding strategic relationship with Ohio STRS. The relationship has produced a set of reusable software modules for the pension/retirement systems industry, which is being marketed under the name CLARETY. The CLARETY product was created using the Forte software development client/server tool set. Claremont is currently engaged in projects to implement CLARETY software for Mississippi PERS, California PERS and Nevada PERS. The Company believes that CLARETY software is the only object oriented client/server product of its kind being marketed to the pension/retirement systems market. Claremont also provides IT consulting and custom software development services to environmental and health and human services departments of state and local governments. Claremont is currently providing services to state and local governments in California, Mississippi, Missouri, Oregon, Ohio and Washington. Claremont has also developed a software product called HWIMSY for tracking hazardous waste.
COMMERCIAL SERVICES. Within the commercial services practice area, Claremont provides IT consulting, custom software development and application maintenance/enhancement services to clients in a variety of industries. As its industry expertise develops, Claremont pursues additional client engagements in new and existing geographic markets. Currently, Claremont's vertical markets include manufacturing, retail, health care and utilities. Claremont expects to expand and refine its vertical market orientation as it is able to develop new opportunities and expand existing engagements. Projects in these industries
include such applications as systems support for new food distribution systems; an inventory management system for a retail chain; an order processing system for a national wood products company and a customer service system encompassing such functions as meter management, work tracking and accounts receivable for a major utility. Claremont has begun to provide an increasing percentage of its services to commercial clients desiring assistance regarding IT strategies that involve emerging technologies such as the Internet, and Enterprise Resource Planning (ERP).
INTELLECTUAL PROPERTY RIGHTS The Company's success is dependent upon maintenance and protection of its intellectual property rights. The Company relies on a combination of copyrights, trade secrets and trademarks to protect its technology. The Company has applications pending at the United States Patent and Trademark Office with respect to the Company's VALUE SERVER, NORTHERN DIAMOND, PREMOST, CLARETY, VALUE SOFTWARE, TISE, SPIBOX AND ISTART trademarks. The Company's practice has been to enter into confidentiality agreements with its employees and signed agreements that include nondisclosure provisions with its clients.
Despite these activities, no assurance can be given that the steps taken by the Company will provide adequate protection of its intellectual property rights or that competitors will not be able to develop similar or functionally equivalent methodologies or products. Furthermore, effective copyright and trade secret protection may be unavailable or limited in certain foreign countries. In addition, litigation may be necessary to enforce the Company's intellectual property rights, to protect the Company's trade secrets, to determine the validity and scope of the intellectual property rights of others or to defend against claims of infringement. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the Company's business, financial condition and results of operations. No assurance can be given that infringement or invalidity claims (or claims for indemnification resulting from infringement claims against third parties, such as clients) will not be asserted against the Company or that any such assertions would not have a material adverse effect on the Company's business, financial condition or results of operations. If infringement or invalidity claims are asserted against the Company, litigation may be necessary to defend the Company against such claims, and in certain circumstances the Company may choose to seek to obtain a license under the third-party's intellectual property rights. There can be no assurance that such licenses will be available on terms acceptable to the Company, if at all.
BUSINESS DEVELOPMENT Claremont's business development efforts are based primarily upon personal contacts, the reputations of its senior personnel, industry marketing programs and attendance at appropriate industry forums. Claremont believes that business development is an integral part of the responsibility of practice area leaders and other senior project managers. Claremont also follows a practice of marketing its services through strategic alliances with a select list of hardware and software providers.
The Company employs an established selling methodology, the Miller-Heiman process. The Miller-Heiman process is focused on sales that involve multiple decisionmakers at different levels in large organizations. The process provides an analytical approach to identifying the key decisionmakers, determining with the client the value to be provided to
the client and managing the sales process through completion. Claremont maintains a corporate information database referred to as the Opportunity Center to manage the selling process. The sale of a new project generally involves a three to six month effort. At any given time numerous Claremont professionals are active in the development of new business. The coordination of their efforts, and the tracking of their results, is critical to Claremont's ability to forecast and adequately staff future work. Claremont's Opportunity Center is a critical management tool to assist the Company's senior executives in managing this process.
COMPETITION The markets for the Company's services are highly competitive. The Company believes that it currently competes principally with the internal information systems groups of its prospective clients, as well as consulting and software integration firms including Andersen Consulting, the "Big Six" accounting firms, ISSC (an affiliate of IBM), Computer Sciences Corporation and with other hardware and applications software vendors. In addition there are a number of systems integrators who serve similar markets or provide similar services, such as Cambridge Technology Partners, Renaissance Solutions, Inc., SHL Systemhouse (a subsidiary of MCI), Sapient Corporation and Technology Solutions Company, with whom the Company competes or may compete in the future. Many of these companies have significantly greater financial, technical and marketing resources than the Company, generate greater revenue and have greater name recognition than the Company. In addition, there are relatively low barriers to entry into the Company's markets and the Company has faced, and expects to continue to face, additional competition from new entrants into its markets.
The Company believes that the principal competitive factors in its markets include reputation, project management expertise, industry expertise, speed of development and implementation, technical expertise and ability to deliver on a fixed-price as well as a time and materials basis. There can be no assurance that the Company will be able to compete effectively on pricing or other requirements with current and future competitors or that competitive pressures faced by the Company will not cause the Company's revenue or gross margins to decline or otherwise materially adversely affect its business, financial condition and results of operations.
CLAREMONT PERSONNEL The success of the Company is based on attracting and retaining talented, creative and experienced people at all levels. The Company dedicates significant senior resources to its recruiting effort, primarily recruiting professionals with both IT consulting and industry experience. All of Claremont's managers and senior managers have substantial expertise in designing and implementing large-scale applications solutions, and many of them have relevant industry experience. As a result, the Company's consultants provide industry knowledge and line management expertise, in addition to technical expertise, to the Company's clients.
As of June 30, 1997, the Company had a total of 749 employees of whom there were 676 individuals in the professional staff and 73 in administrative roles.
In order to accommodate typical project development lead time, the Company has found that it must recruit and hire additional personnel on the basis of anticipated demand for their services. Although this practice has contributed to the Company's growth to date, there can be no assurance that demand for the Company's services will materialize as anticipated, and this practice could result in under-utilized employees and consequently have a material adverse effect upon the Company's business, financial condition and results of operations.
Qualified project managers and senior technical and professional staff are in great demand and are likely to remain a limited resource for the foreseeable future. Limitations in the number of available project managers and senior technical and professional staff have impaired the Company's ability to take on available new projects. There can be no assurance that the Company will be successful in attracting a sufficient number of highly-skilled employees in the future, or that it will be successful in training, retaining and motivating them. The Company's inability to attract, train and retain skilled employees or the Company's employees' inability to achieve expected levels of performance could impair the Company's ability to adequately manage and complete its existing projects and to bid for or obtain new projects. This in turn could have a material adverse effect on the Company's business, financial condition and results of operations.
ITEM 2.
ITEM 2. PROPERTIES
The Company's headquarters and principle administrative offices are located in approximately 14,597 square feet of leased space located in Beaverton, Oregon. In addition, Claremont has invested in three software development centers, which Claremont refers to as "software factories." These centers are located in Beaverton, Oregon; Montreal, Canada; and Columbus, Ohio.
The Company's west coast business development and technical development personnel operate from the Beaverton, Oregon location. The Company occupies these premises under a lease expiring in September 1999. In addition, the Company leases 14,517 square feet in Columbus, Ohio for its retirement system national practice, central region business development and technical lab. The lease relating to these premises expires in November 2000. The Company also leases office space in 12 other locations, including Basking Ridge, New Jersey; Bellevue, Washington; Cleveland, Ohio; Overland Park, Kansas; Jackson, Mississippi; Morristown, New Jersey; Sacramento, California; San Francisco, California; New York, New York; White Plains, New York; Montreal, Canada; London, United Kingdom; and North Sydney, Australia, from which regional project management and business development is conducted. Leases for these premises range from 2,503 to 10,638 square feet. The Company anticipates that additional space may be required as the Company's business operations expand and believes it will be able to obtain suitable space as needed.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
As of September 15, 1997, there were no material pending legal proceedings to which the Company or its subsidiaries are a party. From time to time, the Company becomes involved in ordinary and routine legal and regulatory proceedings incidental to the business of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders in the quarter ended June 30, 1997.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock commenced trading on the Nasdaq National Market System on July 19, 1996 with an initial offering price of $15.00 per share. On August 31, 1997 there were 138 shareholders of record of the Company's Common Stock. The Company has not paid cash dividends on its Common Stock in the past and does not anticipate paying cash dividends in the foreseeable future.
The high and low sales prices of the Company's Common Stock for each of the quarterly periods from July 19, 1996 through June 30, 1997 were as follows:
1997 High Low ---------------------------------- ------- ------- Quarter 1 (from July 19, 1996) $ 36.00 $ 15.50 Quarter 2 36.75 23.50 Quarter 3 28.25 20.50 Quarter 4 24.75 13.50
During the period from April 1, 1997 through June 2, 1997, the effective date of the Company's Registration Statement on Form S-8 relating to its stock option plans, the Company sold an aggregate of 46,964 shares of Common Stock, for an aggregate purchase price of approximately $80,000, to various persons pursuant to the exercise of options granted under the 1992 Stock Incentive Plan in reliance on Rule 701 promulgated under the Securities Act of 1933.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report on Form 10-K contains certain statements, trend analysis and other information that constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act, which involve risks and uncertainties. Actual results may differ materially from the results described in the forward-looking statements. Such forward looking statements include, but are not limited to, statements including the words "anticipate," "believe," "estimate," "expect," "intend," "plan" and other similar expressions. Such statements reflect the current views of the Company with respect to future events and are subject to certain risks, uncertainties and assumptions that include, but are not limited to, those discussed in Item 1 of this Report and in the following Management's Discussion and Analysis of Financial Condition and Results of Operations.
RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain financial data as a percentage of total revenue:
YEAR ENDED JUNE 30, ------------------------------- 1997 1996 1995 ------ ------ ------ STATEMENT OF OPERATIONS DATA: Revenue: Professional fees 99 % 95 % 100 % Resold products and services 1 5 -- ------ ------ ------ Total revenue 100 100 100 Costs and expenses: Project costs and expenses 52 51 50 Resold products and services 1 5 -- Selling, general and administrative 37 33 37 ------ ------ ------ Total costs and expenses 90 89 87 ------ ------ ------ Income from operations 10 11 13 Other income (expense), net 1 -- -- ------ ------ ------ Income before income taxes 11 11 13 Income tax expense 5 5 5 ------ ------ ------ Net income 6 % 6 % 8 % ------ ------ ------ ------ ------ ------
FISCAL 1997 COMPARED TO FISCAL 1996 REVENUE. The Company's revenue consists primarily of professional fees (including license fees for Claremont's reusable software modules), and to a lesser extent resold hardware and software products and resold contract services. The Company's professional fees increased 49 percent to $66.8 million in fiscal 1997 from $44.8 million in fiscal 1996. Professional fees increased primarily due to an increase in the number of projects performed, both for new and existing clients. In fiscal 1997 and 1996, $0.5 million, or 1 percent of revenue and $2.6 million, or 5 percent of revenue, respectively, resulted from resold products and services. Resold products and services are offered to clients on an as needed project basis and are resold with little or no mark-up. The Company does not expect resold products and services to contribute materially to its income from operations, and generally expects to make little or no profit on such products and services. The Company expects to provide such products and services only as an accommodation to the
Company's clients as requested for particular projects. Revenue from foreign operations increased 70 percent to $3.9 million in fiscal 1997 from $2.3 million in fiscal 1996.
Claremont's revenue has become decreasingly dependent upon its largest clients, though such concentration remains a characteristic of Claremont's business. The top five clients accounted for 46 percent of revenue in fiscal 1997, down from 56 percent of revenue in fiscal 1996. In fiscal 1997 and 1996 the largest client accounted for 14 percent and 20 percent of revenue, respectively. During fiscal 1997, 13 clients generated revenue in excess of $1.0 million, compared to 10 clients during fiscal 1996. The cancellation of a large project or a significant reduction in the scope of such a project could have a material adverse effect on the Company's business, financial condition and results of operations, and in the past the cancellation of a large project has had such an effect. No assurance can be given that such a reduction in concentration will continue or that client concentration will not leave the Company vulnerable to loss of projects or clients, or that such a loss would not have a material adverse impact upon the Company's business, financial condition and results of operations.
PROJECT COSTS AND EXPENSES. Project costs and expenses consist primarily of salaries and employee benefits for personnel dedicated to client projects and associated overhead costs including equipment depreciation and amortization. Project costs and expenses increased 47 percent to $35.3 million in fiscal 1997 from $24.0 million in fiscal 1996, representing 53 percent and 54 percent of professional fees in fiscal 1997 and 1996, respectively. The increase in project costs and expenses was due primarily to the addition of project personnel necessary to perform the larger number of client projects.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative costs and expenses consist of costs associated with the Company's executive staff, finance, facilities and human resources departments (collectively, "Administrative Personnel"), travel and business development costs. Selling, general and administrative costs and expenses increased 59 percent to $24.6 million (37 percent of professional fees) in fiscal 1997 from $15.5 million (35 percent of professional fees) in fiscal 1996. The increase is primarily due to increases in professional development and recruiting expenses associated with the increased professional personnel, increased facility expenses associated space needs resulting from the three software development centers, increased numbers of Administrative Personnel, costs related to acquisitions and increased costs associated with being a public company.
OTHER INCOME (EXPENSE), NET. Other income (expense) consists primarily of interest income on cash and cash equivalents and interest expense associated with short-term borrowings. Other income (expense), net changed to a net income of $374,000 in fiscal 1997 from a net expense of $169,000 in fiscal 1996. The increase is primarily due to the increase in interest income to $664,000 for fiscal 1997 from $49,000 for fiscal 1996, due to higher cash balances resulting from the proceeds of the Company's initial public offering, which occurred in July 1996.
INCOME TAX EXPENSE. Income tax expense represents combined federal, state and foreign taxes at an effective rate of 42 percent for fiscal 1997 compared to 43 percent for fiscal 1996. The slight decrease in the effective tax rate is due to a change in the mix of jurisdictions in which the Company does business.
FISCAL 1996 COMPARED TO FISCAL 1995 REVENUE. The Company's professional fees increased 64 percent to $44.8 million in fiscal 1996 from $27.3 million in fiscal 1995. Professional fees increased primarily due to an increase in the number of projects performed, both for new and existing clients. In fiscal 1996, $2.6 million, or 5 percent of revenue, resulted from resold products and services; there was no similar revenue of a material nature in fiscal 1995. Revenue from foreign operations increased 309 percent to $2.3 million in fiscal 1996 from $562,000 in fiscal 1995. The increase resulted primarily from operations at the Company's Montreal, Canada software factory, which commenced operations during the third quarter of fiscal 1995, largely in support of U.S. domestic clients.
Claremont's revenue has become decreasingly dependent upon its largest clients, though such concentration remains a characteristic of Claremont's business. The top five clients accounted for 56 percent of revenue in fiscal 1996, down from 76 percent of revenue in fiscal 1995. In fiscal 1996 and 1995 the largest client accounted for 20 percent and 38 percent of revenue, respectively. During fiscal 1996, ten clients generated revenue in excess of $1.0 million, compared to seven clients during fiscal 1995.
PROJECT COSTS AND EXPENSES. Project costs and expenses increased 75 percent to $24.0 million in fiscal 1996 from $13.7 million in fiscal 1995, representing 54 percent and 50 percent of professional fees in fiscal 1996 and 1995, respectively. The increase in project costs and expenses was due primarily to the addition of project personnel necessary to perform the larger number of client projects.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative costs and expenses increased 52 percent to $15.5 million in fiscal 1996 from $10.2 million in fiscal 1995. The increase is primarily due to increases in professional development and recruiting expenses associated with the increased professional personnel, increased facility expenses associated space needs resulting from new software development centers and increased numbers of Administrative Personnel and expansion into international markets during the quarter ended March 31, 1996. In addition, the Company incurred approximately $300,000 in non-recurring charges attributable to separation agreements with two terminated executives. See "Certain Transactions." Selling, general and administrative costs and expenses declined to 35 percent of professional fees in fiscal 1996 from 37 percent of professional fees in fiscal 1995, due to revenue increases outpacing selling, general and administrative costs and expenses increases on a percentage basis in the period.
OTHER INCOME (EXPENSE), NET. Other income (expense) consists primarily of interest expense associated with short-term borrowings and interest income on cash and cash equivalents. Other income (expense), net changed to a net expense of $169,000 in fiscal 1996 from a net income of $67,000 in fiscal 1995. The change is primarily attributable to
interest expense associated with bank borrowings incurred to finance the Company's acquisition of computer equipment in fiscal 1996.
INCOME TAX EXPENSE. Income tax expense represents combined federal, state and foreign taxes at an effective rate of 43 percent for fiscal 1996 compared to 39 percent for fiscal 1995. The increase in the effective tax rate is due to a change in the mix of jurisdictions in which the Company does business, as well as changes in certain federal tax laws.
VARIABILITY OF RESULTS OF OPERATIONS The Company's revenue and results of operations have fluctuated significantly in the past and will likely fluctuate in the future. Factors causing such fluctuations have included and may include, among other factors, the number, size and scope of projects in which the Company is engaged, the contractual terms and degree of completion of such projects, any delays incurred in connection with a project, employee hiring and utilization rates, the adequacy of provisions for losses, the accuracy of estimates of resources required to complete ongoing projects, general economic conditions, weather-related shut-downs in major markets, vacation days, total business days in a quarter and the business practices of clients such as deferring commitments on new projects until after the end of the calendar or the client's fiscal year. In addition, the timing of revenue is difficult to forecast because the Company's sales cycle is relatively long. A high percentage of the Company's operating expenses, particularly personnel and rent, are relatively fixed in advance of any particular quarter. For example, while the number of professional staff the Company employs may be adjusted to reflect active projects, such adjustments take time and the Company must maintain a sufficient number of senior professionals to oversee existing clients and to focus on securing new client engagements. As a result, unanticipated variations in the number or progress toward completion of the Company's projects or in employee utilization rates may cause significant variations in operating results in any particular quarter and could result in material adverse changes to the Company's business, financial condition and results of operation
Due to the foregoing factors, among others, it is possible that in some future periods the Company's results of operations will be below the expectations of the securities analysts and investors. In such event, the price of the Company's Common Stock may be materially adversely affected.
LIQUIDITY AND CAPITAL RESOURCES Since its inception, the Company has financed its operations and investments in property and equipment primarily through cash generated from operations, bank borrowings and capital lease financing. In July 1996, the Company completed its initial public offering and in August 1996, the Company sold additional shares pursuant to the exercise of the underwriters' over-allotment option. Net proceeds from the offering and over-allotment totaled $26.9 million.
At June 30, 1997, the Company had working capital of $33.2 million, including $15.2 million of cash and cash equivalents.
Cash increased $14.7 million during fiscal 1997 as a result of net cash provided from financing activities of $26.7 million, offset by $716,000 used in operations, $4.1 million for the purchase of property and equipment and $6.9 million for software development costs.
Accounts receivable increased $6.2 million to $14.0 million at June 30, 1997 from $7.8 million at June 30, 1996 primarily as a result of growth in revenues. Days sales outstanding were 66 at June 30, 1997 compared to 64 at June 30, 1996. The Company experienced a 62 percent reduction in past due accounts (defined as accounts outstanding more than 60 days) to $529,000 at June 30, 1997 compared to $1.4 million at June 30, 1996.
Revenue earned in excess of billings, which represents amounts due to the Company under contracts, primarily from government entities, that can not be billed until certain milestones are met, increased $0.9 million to $6.5 million at June 30, 1997 from $5.7 million at June 30, 1996. The Company continues to work closely with its clients to attempt to reduce the collection cycle of this asset group.
Refundable income taxes increased to $2.7 million at June 30, 1997 from a payable of $619,000 at June 30, 1996 primarily as a result of the income tax benefit associated with certain stock option exercises.
Accounts payable increased $0.5 million to $2.0 million at June 30, 1997 from $1.5 million at June 30, 1996 primarily due to growth of the business.
During fiscal 1997, the Company had capital expenditures of $4.1 million, primarily related to furniture and personal computers, and $6.9 million associated with the capitalization of software development costs. As of June 30, 1997 the Company did not have any material commitments for capital expenditures.
As of June 30, 1997, the Company had a total of $8.6 million of capitalized software development costs associated with the Company's reusable software modules, including CLARETY and PREMOST. To the extent capitalized software development costs are greater than the potential revenue associated with the developed software, the Company would be required to immediately expense such excess amount under SFAS 86. The amount of the excess required to be expensed in any particular period may be as much as the total amount of capitalized software development costs then carried on the Company's balance sheet, depending on the potential revenue associated with the developed software at such time. Recognition of such expenses, if any, could have a material adverse effect on the Company's results of operations.
The Company had a revolving line of credit with Bank of America Oregon, a subsidiary of BankAmerica Corporation, providing for borrowings of up to $6.0 million. As of June 30, 1997, there were no borrowings against this line. This revolving line of credit expired on August 1, 1997.
On August 21, 1997, the Company signed a business loan agreement (the "Agreement") with a commercial bank. This Agreement includes a $2.0 million line of credit and a $750 standby letter of credit. The line of credit and letter of credit bear interest at the bank's
reference rate plus .25 percent, or, at the Company's option, at rates based on the Offshore Rate or the LIBOR rate. The expiration date of this Agreement is September 1, 1999. This Agreement also covers currently outstanding term loans for an original principal amount of $5,000,000 which had previously been covered under the Business Loan Agreement dated April 24, 1995. The Agreement is secured by all machinery and equipment and receivables of the Company and contains certain financial ratio and other covenants. As of the date of this report, the Company was in compliance with all such covenants.
The Company has certain term loans with Bank of America Oregon primarily to finance equipment purchases. As of June 30, 1997 there was $1.6 million of related debt outstanding against these loans. Debt service under these lines is payable over 36 months, including principal and interest. There are three separate borrowings under this facility at interest rates ranging from 7.59 percent to 8.05 percent, and all such borrowings are secured by all of the assets of the Company.
The Company is a guarantor on a non-revolving line of credit with Bank of America Oregon, which provided for borrowings of up to $2.0 million, for purposes of facilitating the purchase of Claremont's Common Stock by Company executives in July 1995. As of June 30, 1997 there was $923,000 of related debt outstanding against the line. Advances under the line of credit were made directly to the Company executive with full recourse and bear interest at Bank of America's NT&SA Reference Rate, plus one percentage point. Claremont's guaranty is secured by a pledge of each borrower's shares of the Company's Common Stock. Advances under the line of credit are for 36 months and include monthly interest payments, made by each Company executive, with principal repayment by each Company executive due on or before July 31, 1998.
As a provider of professional services, the Company has few tangible assets against which to borrow. Therefore, the Company primarily requires equity capital to finance or leverage its working capital. The Company believes that the cash provided from operations, borrowings available under its revolving line of credit and the net proceeds of its initial public offering in July 1996 will be sufficient to meet the Company's working capital and capital expenditure requirements for at least the next fiscal year.
NEW ACCOUNTING PRONOUNCEMENTS In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 128, "Earnings per Share" ("SFAS 128"). This statement establishes a different method of computing net income per share than is currently required under the provisions of Accounting Principles Board Opinion No. 15. Under SFAS 128, the Company is required to present both basic net income per share and diluted net income per share. Basic net income per share is expected to be comparable or slightly higher than the previously presented net income per share as the effect of dilutive stock options is not considered in computing basic net income per share. Diluted net income per share is expected to be comparable or slightly lower than the previously presented net income per share. The Company will adopt SFAS 128 in the quarter ended December 31, 1997 and will restate all prior earnings per share presentations to conform to the provisions of SFAS 128.
In June 1997, the FASB issued Statement of Financial Accounting Standard No. 130, "Reporting Comprehensive Income" ("SFAS 130"). This statement establishes standards for reporting and displaying comprehensive income and its components in a full set of general purpose financial statements. The objective of SFAS 130 is to report a measure of all changes in equity of an enterprise that result from transactions and other economic events of the period other than transactions with owners. The Company expects to adopt SFAS 130 in the first quarter of 1998 and does not expect comprehensive income to be materially different from currently reported net income.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
None.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY FINANCIAL DATA
FINANCIAL STATEMENTS The financial statements required by this item begin on page of this document.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item is included under the captions ELECTION OF DIRECTORS, EXECUTIVE OFFICERS and SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE, respectively in the Company's Proxy Statement for its 1997 Annual Meeting of Shareholders and is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is included under the caption EXECUTIVE COMPENSATION in the Company's Proxy Statement for its 1997 Annual Meeting of Shareholders and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is included under the caption SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT in the Company's Proxy Statement for its 1997 Annual Meeting of Shareholders and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is included under the caption CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS in the Company's Proxy Statement for its 1997 Annual Meeting of Shareholders and is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) (1) FINANCIAL STATEMENTS The financial statements included herein are as follows:
DESCRIPTION PAGE - ----------- ---- Independent Auditors' Report Consolidated Balance Sheets, June 30, 1997 and 1996 Consolidated Statements of Operations, Years Ended June 30, 1997, 1996 and 1995 Consolidated Statements of Shareholders' Equity, Years Ended June 30, 1997, 1996 and 1995 Consolidated Statements of Cash Flows, Years Ended June 30, 1997, 1996 and 1995 Notes to Consolidated Financial Statements
(a) (2) FINANCIAL STATEMENT SCHEDULES None.
(a) (3) EXHIBITS INCLUDED HEREIN:
Number DESCRIPTION ------ ----------- 2.1 Agreement and Plan of Merger By and Among Claremont Technology Group, Inc., Claremont Acquisition Corporation, OpTex, Inc., Michael L. Johnson, Michael A. Guider, Juli A. Shivley, Richard E. Brown, Laura Henderson and Michael Lininger, dated July 10, 1997 (C) 2.2 Escrow Agreement by and among Claremont Technology Group, Inc., First Trust National Association, as an escrow agent, and Michael L. Johnson in his capacity as the Shareholder Representative for OpTex, Inc., dated July 10, 1997 (C) 3.1 Second Restated Articles of Incorporation of Claremont Technology Group, Inc. (A) 3.2 Second Amended and Restated Bylaws of Claremont Technology Group, Inc. (A) 4 Form of Shareholder Agreement under 1992 Stock Incentive Plan (A) 10.1 Form of Indemnity Agreement between Claremont Technology Group, Inc. and each of its executive officers and directors(A) 10.2 1992 Stock Incentive Plan, as amended (A) 10.3 Form of Stock Option Agreement Under 1992 Stock Incentive Plan (A) 10.4 1996 Stock Option Plan for Nonemployee Directors (A) 10.5 Letter of Agreement by and among Mr. Tony Martins, Ms. Anna Mara, Ms. Claude Gareau, Mr. Ronald Bastien, Tony Martins & Associes., Inc. and Claremont Technology Group, Inc. dated as of January 23, 1995 (A) 10.6 Employment Agreement by and between Claremont Technology Group, Inc. and Paul J. Cosgrave dated July 1, 1994 (A) 10.7 Employment Agreement by and between Claremont Consulting Group, Inc. (k/n/a Claremont Technology Group, Inc.) and Dennis M. Goett dated February 1, 1996 (A) 10.8 Employment Agreement by and between Claremont Technology Group, Inc. and Stephen Hawley dated February 5, 1993 (A)
Number DESCRIPTION ------ ----------- 10.9 Lease by and between Amberjack, Ltd. and Claremont Technology Group, Inc. dated January 13, 1995, as amended (A) 10.10 Lease by and between Birtcher Properties, Inc., Manager for Amberjack, Ltd., and Claremont Technology Group, Inc. dated November 27, 1991, as amended (A) 10.11 Lease Agreement by and between TOW Ltd. and Claremont Technology Group, Inc. dated October 1995 (A) 10.12 Claremont Technology Group, Inc. 401(k) Plan and Trust (A) 10.13 Claremont Technology Group, Inc. Employee Stock Ownership Plan (A) 10.14 Business Loan Agreement between Bank of America Oregon and Claremont Technology Group, Inc. dated August 21, 1997 (D) 10.15 Stock Purchase Agreement dated May 17, 1996 by and between Claremont Technology Group, Inc. (the Company), the shareholders of the Company, Paul J. Cosgrave and the Investors (B) 10.16 Common Stock Purchase Warrant issued by Claremont Technology Group, Inc. to DLJ Capital Corporation dated May 20, 1996 (A) 10.17 Settlement Agreement and Release dated May 20, 1996 by and between Claremont Technology Group, Inc. and DLJ Capital Corporation and associated funds (A) 11 Computation of Earnings Per Share (D) 21 Subsidiaries of the Registrant (D) 23 Consent of KPMG Peat Marwick LLP (D) 27 Financial Data Schedule (D)
(A) Incorporated by reference to Exhibits to Company's Registration Statement of Form S-1 as amended, effective July 19, 1996 (Commission Registration No. 333-04561). (B) Incorporated by reference to Exhibits to the Company's Form 10-K for the fiscal year ended June 30, 1996 as filed with the Securities and Exchange Commission on September 27, 1996. (C) Incorporated by reference to Exhibits to the Company Form 8-K, dated July 10, 1997 as filed with the Securities and Exchange Commission on July 25, 1997. (D) Filed herewith.
(b) REPORTS ON FORM 8-K No reports on Form 8-K were filed by the Registrant during the quarter ended June 30, 1997.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: September 15, 1997
CLAREMONT TECHNOLOGY GROUP, INC.
By /s/ PAUL J. COSGRAVE -------------------- Paul J. Cosgrave Chairman of the Board, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on September 15, 1997:
SIGNATURE TITLE - --------- -----
/s/ PAUL J. COSGRAVE Chairman of the Board, President and - -------------------- Chief Executive Officer Paul J. Cosgrave (Principal Executive Officer)
/s/ DENNIS M. GOETT Chief Financial Officer and Director - ------------------- (Principal Financial and Accounting Officer) Dennis M. Goett
/s/ NEIL E. GOLDSCHMIDT Director - ----------------------- Neil E. Goldschmidt
/s/ JERRY L. STONE Director - ------------------ Jerry L. Stone
INDEPENDENT AUDITORS' REPORT
The Board of Directors of Claremont Technology Group, Inc. and Subsidiaries:
We have audited the accompanying consolidated balance sheets of Claremont Technology Group, Inc. and subsidiaries as of June 30, 1997 and 1996 and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended June 30, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Claremont Technology Group, Inc. and subsidiaries as of June 30, 1997 and 1996 and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 1997 in conformity with generally accepted accounting principles.
/s/ KPMG PEAT MARWICK LLP
Portland, Oregon August 14, 1997
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
CLAREMONT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (IN THOUSANDS)
See accompanying notes to consolidated financial statements.
CLAREMONT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See accompanying notes to consolidated financial statements.
CLAREMONT TECHNOLOGY GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements June 30, 1997, 1996 and 1995 (In thousands, except per share amounts)
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Claremont Technology Group, Inc. (the Company) provides enterprise-wide information technology (IT) solutions that reengineer mission-critical business processes such as customer service, order and transaction processing, billing and logistics. Claremont services include IT planning, systems integration and development and outsourcing, through a project management methodology that employs reusable object oriented software modules and transferable design frameworks.
Claremont provides solutions to large organizations in select IT intensive vertical markets including commercial services, communications, financial services and state and local government. Claremont's clients consist of large corporations and government organizations in the United States and certain foreign markets.
FISCAL PERIODS
For 1997 and 1996, the Company's fiscal year ended on the Friday closest to June 30. The Company's fiscal year for 1995 ended on June 30. The fiscal year will generally be 52 weeks and periodically will consist of 53 weeks. All years presented consist of 52 weeks. For convenience the Company has indicated in these financial statements that its fiscal year ends on June 30.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the financial statements of Claremont Technology Group, Inc. and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
CASH EQUIVALENTS
For the purposes of the statement of cash flows, the Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. Cash equivalents consist of commercial paper, bankers' acceptances, and other highly liquid investments.
FINANCIAL INSTRUMENTS
The carrying amount of cash equivalents, trade receivables, accounts payable and short-term borrowings approximate fair value because of the short-term nature of these instruments. The fair value of long-term debt was estimated by discounting the future cash flows using market interest rates and does not differ significantly from that reflected in the financial statements.
Fair value estimates are made at a specific point in time, based on relevant market information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
REVENUE AND COST RECOGNITION
Revenues from fixed-price contracts are recognized on the percentage-of-completion method, measured by the percentage of cost incurred to date to the estimated total cost at completion. This method is used because management considers accumulated costs to be the best available measure of progress on these contracts. The cumulative impact of any revision in estimates of the percent complete is reflected in the year in which the changes become known. Losses on projects in progress are recognized when known. Revenue earned in excess of billings is comprised of earnings on certain contracts in excess of contractual billings on such contracts. Billings in excess of earnings are classified as deferred revenues.
Revenues from time and materials contracts are recognized during the period in which the services are provided.
ACCOUNTS RECEIVABLE
Accounts receivable are shown net of allowance for doubtful accounts of $136 and $110 at June 30, 1997 and 1996, respectively.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Equipment under capital leases is stated at the present value of future minimum lease payments at the inception of the lease.
Depreciation of property and equipment is calculated on the straight-line method over the estimated useful lives of the assets ranging from three to five years. Equipment held under capital leases and leasehold improvements are amortized straight-line over the shorter of the lease term or estimated useful lives of the assets.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
FOREIGN CURRENCY TRANSLATION
The local currency is the functional currency in the Company's foreign subsidiaries. Assets and liabilities of the foreign subsidiaries are translated to U.S. dollars at current rates of exchange, and revenues and expenses are translated using weighted average rates, in accordance with Statement of Financial Accounting Standards No. 52, "Foreign Currency Translation." Gains and losses from foreign currency translation are included as a separate component of shareholders' equity. Foreign currency transaction gains and losses are included as a component of other income and expense.
INTANGIBLE ASSETS
Software development costs incurred subsequent to establishing a product's technological feasibility are capitalized until such product is available for general release to customers in accordance with Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed". Capitalized software costs are amortized on a product-by-product basis. Amortization is recorded based on the greater of (a) the estimated economic life of the software (generally five years or less) or (b) the ratio of current gross revenues for each product to the total of current and anticipated gross revenues for each product, commencing when such product is available for general release.
Other intangibles include purchased technology and a covenant not to compete, which are amortized over periods ranging from two to five years using the straight-line method. Total amortization costs for other intangibles were $395 in fiscal 1997 and were immaterial in fiscal 1996 and 1995.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
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 at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
COMPUTATION OF NET INCOME PER SHARE
Net income per share is computed using the weighted average number of shares of common and common equivalent shares outstanding. Common equivalent shares from stock options and warrants are excluded from the computation if their effect is antidilutive, except that pursuant to the Securities and Exchange Staff Accounting Bulletins, common and common equivalents shares issued at prices below the public offering price during the twelve months immediately preceding the initial filing date have been included in the calculation as if they were outstanding for all periods presented using the treasury stock method and the initial public offering price.
In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings per Share." SFAS 128 changes the standards for computing and presenting earnings per share (EPS) and supersedes APB Opinion No. 15, "Earnings per Share." SFAS 128 simplifies the standards for computing earnings per share and makes them comparable to international EPS standards. It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. SFAS 128 is effective for financial statements issued for periods ending after December 15, 1997, including interim periods; earlier application is not permitted. This Statement requires restatement of all prior-period EPS data presented. Following is the pro forma effect of adoption on the Company's earnings per share for the years ended June 30, 1997, 1996 and 1995:
Year Ended June 30, ----------------------------------- 1997 1996 1995 ------- ------- ------- Primary EPS as reported $ 0.44 $ 0.40 $ 0.31 Effect of SFAS 128 0.12 0.26 0.21 ------- ------- ------- Basic EPS as restated $ 0.56 $ 0.66 $ 0.52 ------- ------- ------- ------- ------- -------
Fully diluted EPS as reported $ 0.44 $ 0.41 $ 0.31 Effect of SFAS 128 0.00 (0.01) 0.00 ------- ------- ------- Diluted EPS as restated $0.44 $ 0.40 $ 0.31 ------- ------- ------- ------- ------- -------
(2) ACQUISITIONS
In January 1996, the Company purchased certain assets of The Node Connection (TNC). The acquisition has been accounted for as a purchase, and the financial results of TNC have been included in the accompanying consolidated financial statements since the date of acquisition. The cost of the acquisition has been allocated on the basis of the estimated fair value of the assets acquired and the liabilities assumed.
In February 1997, the Company acquired certain assets and liabilities of Pacific Star Technologies Pty. Limited from Queensland Systems Integration Pty. Limited ("QSI"), a software and systems integration company, for $291. The acquisition has been accounted for as a purchase, and financial results have been included in the accompanying consolidated financial statements since the date of acquisition. The cost of the acquisition has been allocated on the basis of the estimated fair value of the assets acquired and the liabilities assumed.
The separate operational results of QSI are not material and accordingly pro-forma financial results have been omitted.
In April 1997, the Company issued 60 shares of common stock in exchange for all of the outstanding common stock of the TDS Group, Inc. ("TDS"). TDS specializes in developing comprehensive information systems for government and non-profit organizations. The acquisition has been accounted for as a pooling of interests and accordingly, the Company's consolidated financial statements have been restated to include the results of TDS for fiscal 1997. Results of TDS prior to fiscal 1997 were immaterial, thus prior periods presented have not been restated.
Merger costs of $140 were incurred and charged to expense in the fourth quarter of 1997 for services rendered to facilitate completion of the transaction.
(3) BALANCE SHEET COMPONENTS
PROPERTY AND EQUIPMENT, NET
Property and equipment, net consists of the following: June 30, -------------------- 1997 1996 ------- ------- Furniture and equipment $ 1,538 $ 1,147 Computer equipment and software 8,428 4,759 Leased equipment 216 216 Leasehold improvements 149 108 ------- ------- 10,331 6,230 Less accumulated depreciation and amortization (4,487) (2,161) ------- ------- Property and equipment, net $ 5,844 $ 4,069 ------- ------- ------- -------
Depreciation expense for the years ended June 30, 1997, 1996 and 1995 was $2,326, $1,178 and $469, respectively.
ACCRUED EXPENSES
The Company's accrued expenses consist of the following: June 30, ------------------- 1997 1996 ------- ------- Accrued payroll $ 885 $ 787 Accrued vacation 1,854 1,105 Accrued payroll taxes 418 710 Accrued profit sharing 366 682 Accrued other 41 70 ------- ------- $ 3,564 $ 3,354 ------- ------- ------- -------
(4) INVESTMENT IN PARTNERSHIP
Claremont Retirement Solutions, Ltd. (the Partnership) was formed with one of the Company's major customers to receive royalties from Claremont Retirement Technologies, Inc. ("CRTI") for future sales of a pension/retirement system template to other public and private pension funds. CRTI has obtained licensing rights from the Partnership to remarket the template. CRTI's initial equity contribution to the Partnership represents approximately 1 percent of the Partnership's total capital.
(5) LEASES
The Company leases certain of its office space through noncancelable operating lease arrangements. The leases expire May 31, 1998 through September 30, 2002, and are net leases with the Company paying all executory costs, including insurance, utilities, and maintenance. Rental expense for operating leases during the years ended June 30, 1997, 1996 and 1995 was approximately $793, $820 and $404, respectively.
Future minimum lease payments under noncancelable operating leases (with initial or remaining lease terms in excess of one year) are as follows:
Year Ending June 30, 1998 $ 856 1999 743 2000 524 2001 373 2002 203 Thereafter 31 ------- Total minimum lease payments $ 2,730 ------- -------
(6) LONG-TERM DEBT
Long-term debt consists of the following: June 30, ----------------------- 1997 1996 -------- -------- 7.6% installment loan payable in monthly installments of $61, including interest, with final payment due April 1999, secured by certain furniture and equipment $ 1,189 $ 1,799
7.59% installment loan payable in monthly installments of $14 with final payment due November 1998, secured by certain furniture and equipment 222 334
8.05% installment loan payable in monthly installments of $16, including interest, with final payment due May 1998, secured by certain furniture and equipment 167 389 -------- -------- 1,578 2,522 Less current installment of long- term debt (993) (944) -------- -------- Long-term debt, excluding current installments $ 585 $ 1,578 -------- -------- -------- --------
The aggregate maturities of long-term debt for years subsequent to June 30, 1997 are as follows:
Year Ending June 30, 1998 $ 993 1999 585 ------- Total payments on long-term debt $ 1,578 ------- -------
During 1995, the Company entered into a $2 million line of credit with a bank, which was subsequently increased to $6 million in June 1996, with an interest rate of .25 percentage points above the bank's reference rate (8.75 percent at June 30, 1997). This line of credit is secured by furniture, equipment, and accounts receivable. At June 30, 1997, there were no amounts outstanding on this line of credit. This line of
credit expired on August 1, 1997 and the Company entered into a new line of credit agreement dated August 21, 1997 (see note 16 Subsequent Events).
The Company is a guarantor on a nonrevolving line of credit with a bank, which provides for borrowings of up to $2 million for purposes of facilitating the purchase of Company common stock by Company executives. As of June 30, 1997, there was $923 of related debt outstanding against the line. Advances under the line of credit were made directly to the Company executive with full recourse and bear interest. Advances under the line of credit were for 36 months and include monthly interest payments, made by each Company executive, with principal repayment by each Company executive on or before July 31, 1998.
The various lines of credit with Bank of America Oregon are contained in a master Business Loan Agreement, which includes covenants relating to the maintenance of certain financial ratios and minimum net worth. The Company was in compliance with these covenants at June 30, 1997.
The Company has available a standby letter of credit for up to $125. As of June 30, 1997, there were no amounts outstanding under the line of credit (see note 16 Subsequent Events).
In August 1997, the Company signed a business loan agreement (the "Agreement") with a commercial bank. This Agreement includes a $2.0 million line of credit and a $750 standby letter of credit. The line of credit and letter of credit bear interest at the bank's reference rate plus .25 percent, or, at the Company's option, at rates based on the Offshore Rate or the LIBOR rate. The expiration date of this Agreement is September 1, 1999. This Agreement also covers currently outstanding term loans for an original principal amount of $5,000 which had previously been covered under the Business Loan Agreement dated April 24, 1995. The Agreement is secured by all machinery and equipment and receivables of the Company and contains certain financial ratio and other covenants.
(7) INCOME TAXES
The components of income tax expense are as follows: Year Ended June 30, ------------------------------- 1997 1996 1995 ------- ------- ------- Current: Federal $ 967 $ 1,232 $ 1,351 State and local 300 319 398 Foreign -- -- 26 ------- ------- ------- 1,267 1,551 1,775 Deferred: Federal 1,930 552 (314) State and local 494 147 (109) Foreign (647) -- -- ------- ------- ------- 1,777 699 (423) ------- ------- ------- $ 3,044 $ 2,250 $ 1,352 ------- ------- ------- ------- ------- -------
The actual income tax expense differs from the expected tax expense (computed by applying the U.S. federal and corporate income tax rate of 34 percent to net income before income taxes) as follows:
Year Ended June 30, ------------------------------- 1997 1996 1995 ------- ------- ------- Computed expected income tax expense $ 2,479 $ 1,793 $ 1,190 Increase (reduction) in income tax expense resulting from: State income tax expense 518 292 214 Other 47 165 (52) ------- ------- -------
Income tax expense $ 3,044 $ 2,250 $ 1,352 ------- ------- ------- ------- ------- -------
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below:
June 30, ------------------- 1997 1996 ------- ------- Deferred tax assets: Accrued expenses $ 342 $ 215 Expenses deductible in future periods -- 42 State net operating loss carryforward 358 -- Alternative minimum tax credit carryforward 120 -- Foreign net operating losses 647 -- Other 90 61 ------- ------- Total gross deferred tax assets 1,557 318
Deferred tax liability: Capitalized software development costs (3,360) (812) Property and equipment, due to differences in depreciation (5) (15) ------- ------- Total gross deferred tax liabilities (3,365) (827) ------- -------
Net deferred tax assets (liabilities) $ (1,808) $ (509) ------- ------- ------- -------
(8) STOCK INCENTIVE PLANS
During fiscal 1992, the Company adopted, and the Board of Directors approved, a stock incentive plan for eligible employees, directors and outside consultants of the Company (the 1992 Plan). Either non-qualified or incentive stock options may be issued under this plan and are exercisable for a period of up to ten years from the date of grant. Certain of these options are subject to acceleration clauses. As of June 30, 1996, the Company had authorized issuance of such options to purchase up to an aggregate of 5,000 shares of its common stock. The options vest and are exercisable over various periods from the initial grant date.
During fiscal 1996, the Company also adopted and the Board of Directors approved the 1996 Stock Option Plan for Nonemployee Directors (the 1996 Nonemployee Director Plan). Under the terms of the 1996 Nonemployee Director Plan, directors of the Company who are not employees of the Company or any subsidiary of the Company are eligible to receive nonqualified options to purchase shares of common stock. A total of 200 shares of common stock have been reserved for issuance upon exercise of stock options granted under the 1996 Nonemployee Director Plan. Upon election to the Board of Directors, each director is granted an option to purchase 20 shares, which option will vest over a three-year period (each a "Recruitment Grant"). Following the first annual meeting of shareholders after a Recruitment Grant is fully vested, the nonemployee director holding such fully-vested Recruitment Grant will receive an option to purchase an additional 15 shares of common stock, which option will vest over a three-year period (a "First Renewal Grant"). Furthermore, following the first annual meeting of shareholders after a nonemployee director's First Renewal Grant is fully vested, and following every third annual meeting of shareholders thereafter, such nonemployee director will be granted an option to purchase an additional 15 shares of common stock, which option will vest over a three-year period. The exercise price of options granted under the 1996 Nonemployee Director Plan may not be less than the fair market value of a share of common stock on the date of the grant of the option.
The following table summarizes stock option activity through June 30, 1997:
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123
During 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 ("SFAS 123") which defines a fair value based method of accounting for an employee stock option and similar equity instrument and encourages all entities to adopt that method of accounting for all of their employee stock compensation plans. However, it also allows an entity to continue to measure compensation cost for those plans using the method of accounting prescribed by Accounting Principles Board Opinion 25 ("APB 25"). Entities electing to remain with the accounting in APB 25 must make pro forma disclosures of net income and, if presented, earnings per share, as if the fair value based method of accounting defined in SFAS 123 had been adopted.
The Company has elected to account for its stock-based compensation plans under APB 25; however, the Company has computed, for pro forma disclosure purposes, the value of all options granted during 1997 and 1996 using the following weighted average assumptions for grants:
For the Year Ended June 30, 1997 1996 ------------ ------------
Risk-free interest rate 6.0% 6.0% Expected dividend yield 0% 0% Expected lives 5 years 5 years Expected volatility 70% n/a
Using the Black-Scholes methodology for 1997 and the minimum value method for 1996, the total value of options granted during fiscal 1997 and 1996 was $4,460 and $259, respectively, which would be amortized on a pro forma basis over the vesting period of the options (typically five years). The weighted average fair value of options granted during fiscal 1997 and 1996 was $5.50 per share and $0.48 per share, respectively. If the Company had accounted for its stock-based compensation plans in accordance with SFAS 123, the Company's net income and net income per share would approximate the pro forma disclosures below:
For the Year Ended June 30, 1997 1996 ------------------ ----------------- As Pro As Pro Reported Forma Reported Forma -------- ------- -------- ------- Net income $ 4,246 $ 4,003 $ 3,023 $ 2,997 Net income per share $ 0.44 $ 0.42 $ 0.40 $ 0.39
The effects of applying SFAS 123 in this pro forma disclosure may not be indicative of future amounts. SFAS 123 does not apply to awards prior to July 1, 1995.
The following table summarizes information about stock options outstanding and exercisable at June 30, 1997:
(9) EMPLOYEE STOCK OWNERSHIP PLAN
In June 1995, the Company established an Employee Stock Ownership Plan (ESOP) for all non-union U.S. employees. The ESOP is designed to invest primarily in common stock of the Company. Each nonunion employee of the Company or any affiliated company automatically participates in the ESOP on the January 1 or July 1 following such employee's date of hire.
A participant's account becomes fully vested and nonforfeitable after seven years of service with the Company, or earlier if the participant attains age 65, becomes totally disabled or dies. The participant's account vests at the rate of 10 percent per year for the first four years of employment, and at the rate of 20 percent per year for each year thereafter, until fully vested. The Company pays all administrative costs of the ESOP.
The Company makes all contributions to the ESOP, which may be made in either cash or shares of common stock. The contributions to the ESOP for the years ended June 30, 1997, 1996 and 1995 consisted of cash of $150, $448 and $300, respectively. Future contributions to the ESOP will be made at the Company's discretion.
(10) PROFIT SHARING PLAN
In January 1990, the Company adopted a qualified profit sharing plan pursuant to Section 401(k) of the Internal Revenue Code. The plan requires participants to be at least 21 years of age and have completed at least one hour of service. Employees can make voluntary contributions up to limitations prescribed by the Internal Revenue Code. Company matching contributions are discretionary. For the years ended June 30, 1997, 1996 and 1995, the Company recognized discretionary matching contributions of $117, $129 and $75, respectively.
(11) STOCK WARRANT
On May 20, 1996, the Company issued a five-year warrant to purchase 400 shares of common stock at an exercise price of $10.33 per share. The warrant was exercised on October 23, 1996 using a net exercise provision, for a total of 283,029 shares of the Company's Common Stock. As of June 30, 1997, the warrant was fully exercised and no shares of the Company's Common Stock remain issuable under this warrant.
(12) BUSINESS AND CREDIT CONCENTRATION
Revenues from certain of the Company's largest customers individually exceeded 10 percent of revenues as follows: Year Ended June 30, -------------------- 1997 1996 1995 ------ ----- ----- Ohio State Teachers Retirement System 8% 14% 38% Lucent Technologies 14% 20% 19% Mississippi Public Employee Retirement System 3% 11% --
At June 30, 1997 and 1996, the trade accounts receivable and revenue in excess of billings balances from these customers were $5,425 and $5,882, respectively.
(13) RELATED PARTY TRANSACTIONS
The Company issued promissory notes totaling $514 and $385 to certain employees during the fiscal years ended June 30, 1996 and 1995, respectively. The notes are due at varying dates through July 31, 1997 and bear interest at rates ranging from 4% to 7.1%.
The Company entered into a retirement and severance agreement with its founder, Steven L. Darrow, and (as of the date of the agreement, March 15, 1996) largest shareholder. Under that agreement, in exchange for his commitment not to compete with the Company for five years, the Company agreed to pay an amount equal to one year's salary, provide a continuation of medical benefits during his lifetime, forgive certain loans from the Company and pay resulting withholding taxes, and grant him and certain trusts and individuals to whom he had transferred stock certain "piggyback" registration rights. With respect to this agreement, the Company recorded $966 as a covenant not to compete and classified such amount under "other noncurrent assets". Additionally, the agreement provided for the acceleration of the exercisability of otherwise not yet exercisable stock options for the 35.8 shares of the Company's common stock with an exercise price of $1.03 each, resulting in noncash compensation expense of $107.
The Company retained a board member as a consultant through his consulting firm, and also directly as a part-time employee, for payments aggregating $73 in fiscal year 1996 and $113 in fiscal 1995. The consulting and employment arrangement with the board member ended effective April 26, 1996.
(14) COMMITMENTS AND CONTINGENCIES
The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial position, results of operations or liquidity.
The Company has approximately $500 of performance bonds outstanding as of June 30, 1997.
The Company has entered into three-year employment agreements with its president and chief financial officer. These agreements became effective upon retaining these individuals and provide for an initial base salary of $400 and $295, respectively. Each agreement states that if the executive's employment is terminated by the Company for reasons other than cause, the executive's base salary will continue for the longer of three years from the start date or six months from the termination date. Regardless of the reason for termination, each agreement contains commitments of noncompetition and nonsolicitation of the Company's personnel. These commitments last the longer of 18 months after departure from the Company, or for as long as base salary continues to be paid.
(15) BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates primarily in one business segment, providing systems integration services.
Revenue by geographical area is provided below: Year Ended June 30, -------------------------------------- 1997 1996 1995 ---------- --------- --------- United States $ 63,388 45,004 $ 26,730 Canada 3,363 2,321 562 Australia 581 -- -- ---------- --------- ---------
Total $ 67,332 47,325 $ 27,292 ---------- --------- --------- ---------- --------- ---------
(16) SUBSEQUENT EVENTS
ACQUISITIONS In July 1997, the Company completed two business combinations that were accounted for as purchases. The Company purchased Communications Informatiques Trilan Canada, Inc. ("Trilan") and OpTex, Inc. ("OpTex"). The results of operations of each acquisition will be included in the Company's results of operations from the date of acquisition. Trilan offers technology consulting services specializing in network management, call and help center management and outsourcing. OpTex develops billing and customer management software for the communications industry and provides customer service and complete billing services through its fully functional service bureau for communications industry clients.