##### 









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549




---

Form 10-K



---

|           |  |                                                                                                                       
|---------- |  | ----------------------------------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                                                       
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934 (no fee
    required)    
|          
|           |  | For the fiscal year ended June 30,
    2002                                                                           
|          
|or        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934 (no fee
    required)



---

ProBusiness Services, Inc.

(Exact name of Registrant as specified in its
charter)




---

|                                                   |  |                                         
|-------------------------------------------------- |  | ----------------------------------------
|Delaware                                           |  | 94-2976066                              
|(State or other jurisdiction
    of incorporation) |  | (I.R.S. Employer
    Identification No.)

4125 Hopyard Road

Pleasanton, CA 94588


(Address of principal executive
offices)


(925) 737-3500

(Registrants telephone number, including
area code)


Securities registered pursuant to
Section 12(b) of the Act:

|                    |  |                                          
|------------------- |  | -----------------------------------------
|Title of Each Class |  | Name of Each Exchange on Which Registered
|                    |  |                                          
|None                |  | None                                     

Securities registered pursuant to
Section 12(g) of the Act:

Common Stock, $.001 par value


Preferred Stock Purchase Rights, $.001 par
value


(Title of Class)




---

Indicate by check mark whether the Registrant
(1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the
past
90 days.     Yes þ          No o

Indicate by check mark if disclosure of
delinquent filers pursuant to item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this
Form 10-K or any amendment to this
Form 10-K.     þ

The aggregate market value of voting stock held
by non-affiliates of the Registrant was approximately
$155 million as of August 31, 2002 based on the
closing price of the Common Stock as reported on The Nasdaq
Stock Market for that date.

As of August 31, 2002, there were 28,400,330
shares of the Registrants Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for
Registrants 2002 Annual Meeting of Stockholders to be held
December 6, 2002 are incorporated by reference into
Part III.



---






---



##### 



PROBUSINESS SERVICES, INC.

INDEX TO ANNUAL REPORT

ON FORM 10-K


|           |           |  |    |                                                                                           |  |  |    | 
|---------- | --------- |  | -- | ----------------------------------------------------------------------------------------- |  |  | -- | 
|           |           |  |    | Page                                                                                     
|           |           |  |    |                                                                                          
|PART I    
|           | Item  1.  |  |    | Business                                                                                  |  |  | 2  | 
|           | Item  2.  |  |    | Properties                                                                                |  |  | 13 | 
|           | Item  3.  |  |    | Legal Proceedings                                                                         |  |  | 14 | 
|           | Item  4.  |  |    | Submission of Matters to a Vote of Security
    Holders                                   |  |  | 14 | 
|          
|PART II   
|           | Item  5.  |  |    | Market for Registrants Equity and Related
    Stockholder Matters                        |  |  | 14 | 
|           | Item  6.  |  |    | Selected Financial Data                                                                   |  |  | 15 | 
|           | Item  7.  |  |    | Managements Discussion and Analysis of
    Financial Condition and Results of Operations |  |  | 16 | 
|           | Item  7A. |  |    | Quantitative and Qualitative Disclosures About
    Market Risk                            |  |  | 24 | 
|           | Item  8.  |  |    | Consolidated Financial Statements and
    Supplementary Data                              |  |  | 25 | 
|           | Item  9.  |  |    | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure  |  |  | 51 | 
|          
|PART III  
|           | Item  10. |  |    | Directors and Executive Officers of the Registrant                                        |  |  | 51 | 
|           | Item  11. |  |    | Executive Compensation                                                                    |  |  | 53 | 
|           | Item  12. |  |    | Security Ownership and Related Stockholder Matters                                        |  |  | 53 | 
|           | Item  13. |  |    | Certain Relationships and Related Transactions                                            |  |  | 53 | 
|          
|PART IV   
|           | Item  14. |  |    | Exhibits, Financial Statement Schedules, and
    Reports on Form 8-K                      |  |  | 53 | 
|Signatures |           |  | 54 |                                                                                          

1



---



##### 



PROBUSINESS SERVICES, INC.



PART I


This Annual Report on Form 10-K contains
forward-looking statements that have been made pursuant to the
provisions of the Private Securities Litigation Reform Act of
1995. These forward-looking statements are based on current
expectations, estimates and projections about our industry,
managements beliefs, and certain assumptions made by
management. Words such as anticipates,
expects, intends, plans,
believes, seeks and
estimates and similar expressions are intended to
identify forward-looking statements. These statements are not
guarantees of future performance and actual actions or results
may differ materially. These statements are subject to certain
risks, uncertainties and assumptions that are difficult to
predict, including those set forth herein under Additional
Factors That May Affect Future Results. We undertake no
obligation to update publicly any forward-looking statements as
a result of new information, future events or otherwise, unless
required by law. Readers should, however, carefully review the
risk factors included in other reports or documents filed by us
from time to time with the Securities and Exchange
Commission.

Item 1.     Business

Overview

We are a leading provider of comprehensive
administrative outsourced services to large employers
nationwide, providing solutions that include corporate employee
payroll processing, payroll tax filing and other critical human
resources, or HR, and benefits functions. Our comprehensive and
integrated outsourced payroll processing and tax filing solution
has expanded to include a multitude of other similarly
integrated products including payroll administration, HR Service
and benefits administration, including the enrollment and
processing of flexible benefits plans and COBRA benefits, and
Web self-service solutions for employers which allow employees
to access personal information and perform routine
administrative tasks online such as viewing current and
historical paychecks, changing a direct deposit authorization
and verifying paid time off balances. These services are
combined into a technology platform combining sophisticated
transaction processing and Internet-enabled workstations to form
a comprehensive HR outsourcing product. We derive our revenue
from fees charged to clients for services and from interest
income earned from investing payroll tax funds.

As a leading provider of comprehensive payroll
processing and tax filing services, during FY2002, we processed
over 40.2 million paychecks for employees, filed over
4.2 million Form W-2s with the Internal Revenue
Service and managed approximately $900 million in average
daily balances from client payroll tax funds invested. Our
services and technology platform are integrated with the
clients existing in-house and third-party processing
systems, thereby performing one or more of the clients HR
administrative functions and creating what we believe to be a
highly differentiated and client-driven solution. This allows
our clients to streamline their administrative processes,
including the elimination of complex and costly functions, while
ensuring the use of industry-wide best practices. By leveraging
our significant scale, experience and depth of cross-functional
skills, our clients achieve higher levels of service and
efficiency.

Our growth strategy focuses primarily on serving
the large employer segment of the market, which we define as
organizations with more than 1,000 employees. We estimate that
approximately two-thirds of this market continues to process
their payroll internally. As companies recognize the cost and
service benefits of outsourcing these functions, the continued
penetration of this market represents a significant opportunity
for us. We believe that our business model, which requires
upfront investment in client acquisition costs to develop
long-term client relationships with large employers, allows us
to establish highly integrated, tailored and long-term client
solutions which result in substantial recurring revenue streams
which yield significant returns on this investment over time.

We were incorporated in California in October
1984 and reincorporated in Delaware in September 1997. Our
executive offices are located at 4125 Hopyard Road, Pleasanton,
California 94588, and our telephone number is
(925) 737-3500.

2



---



##### 



Industry Background

Businesses face significant and increasingly
difficult challenges in managing the multitude, complexity and
substantial costs of the administrative functions in their
internal HR operations. With administrators of internal
corporate functions facing a combination of (i) increasing
regulatory complexity, (ii) penalties for non-compliance,
(iii) rapid changes in their employee bases, (iv) a
need to maintain industry-wide best practices, and (v) a
lack of scale in their operations, companies have increasingly
turned to outsourcing to allow them to focus greater resources
on their core operations. Administrative outsourcing has
traditionally focused on HR functions such as payroll processing
and payroll tax filing. These functions lend themselves to
outsourcing because they are technologically complex and
continually evolving and the systems required are costly for
employers to design, maintain and administer with limited
internal resources and, often, without scale.

In addition to payroll processing and payroll tax
filing, other employee-related administrative functions such as
benefits administration including health and welfare
administration, Web-enabled solutions and HR management
services have similarly become increasingly complex and
difficult for employers to manage effectively. As a result, and
in large part due to the success employers experienced with
payroll based outsourcing solutions, companies have begun to
shift from outsourcing of discrete functions to comprehensive HR
solutions that are integrated into a single technology platform.
A common technology platform permits companies to leverage data
elements that are common to payroll processing, payroll tax
filing, benefits administration and other HR operations.

Third-party HR outsourcers often focus on varying
segments of the market and may not adequately serve the specific
needs of companies. Problems associated with outsourcers include
a lack of centralized data, the integration of multiple
technology platforms and an overall lack of sufficient levels of
client service. To achieve long-term success, we believe that
successful HR outsourcers must provide a strong and dynamic
technology platform, a comprehensive and integrated suite of HR
services, superior HR administrative process expertise and
premium levels of client service by focusing on a defined
segment of the market. The demand for HR and business process
outsourcing, stemming from a large and increasing number of
employers looking to outsource for the first time and those
looking to expand into more comprehensive outsourcing solutions,
is creating opportunities for outsourcers who can meet the
evolving needs of employers.

Our Solution and Competitive
Strengths

We offer our large employer target market a
comprehensive and integrated suite of HR outsourcing services
which we believe adds significant long-term value to our
clients. We have built upon our position as a leading provider
of payroll processing and tax filing services to expand the
breadth of services offered. We accomplish this with a
proprietary technology platform that integrates with
clients existing in-house and third-party processing
systems. We believe our focus on premier levels of client
service, our proprietary technology and suite of service
offerings, together with the following competitive strengths,
distinguishes us in the marketplace.

Premier Client Service
Organization.We believe that our
focus on providing high-quality, responsive and professional
client service is a major competitive advantage and one of our
clear differentiators in the marketplace. We deliver superior
client service by striving to establish a long-term business
partnership with each client. With a low client-to-account
manager ratio, we assign each client a personal account manager
who manages the account and marshals the resources of a
strategic team of specialists to meet the clients specific
needs. Additionally, we have built high-quality service features
into our technology platform such as providing redundant client
site data access, mirror-image customer service terminal
technology and automated processes enabling our professionals to
monitor client issues to ensure consistent services.
Additionally, we promote our client service culture through
incentive compensation and recognition of achievements that are
based on providing high-quality service to clients. This service
culture translates into operational excellence, as evidenced by
what we believe to be an industry-leading client retention rate
of approximately 90% for each of the last six years.

3



---



##### 



Advanced, Proprietary, Highly Scalable
Technology Platform.Our advanced
technology platform is highly scalable, configurable, and
designed to combine multiple service offerings into a single
platform that integrates with the clients other systems.
This platform reduces errors, speeds development of add-on
services, improves timeliness of issue resolution, and
significantly reduces processing and servicing costs. This
technology is applicable across all service offerings.

Proven Track Record.We are a leading provider of payroll
processing and payroll tax filing services. For FY2002, we
processed over 40.2 million paychecks for employees, filed
over 4.2 million Form W-2s with the Internal Revenue
Service and managed approximately $900 million in average
daily balances from client payroll tax funds invested. As of
June 30, 2002, we had approximately 760 payroll and tax
clients, together representing approximately 4.8 million
employees. We intend to continue to build upon both our
significant presence in the large employer market and our
existing client base in an effort to improve our competitive
position, as well as to increase our financial and operational
scale and cross-selling opportunities. Given the critical nature
of their HR services, companies in our target market are more
likely to select an outsourcing partner that is service oriented
and has demonstrated its ability to reliably deliver accurate
and high quality services.

Value-Added
Solution.We deliver value to our
clients by designing a comprehensive suite of services that
improve the efficiency of the clients HR administration. A
significant amount of the value of our services is derived from
helping our clients to streamline organizational processes and
implement best practices, which typically lead to significant
cost savings, establishing the foundation upon which we may
provide additional services in the future. To accomplish this,
we identify and build industry-wide best practices into our
systems and provide expert consultation during the sales and
implementation process to facilitate integration of our
technology with a clients legacy systems. We expect to add
functionality to our existing service offerings and to develop,
acquire or partner with other companies to increase the breadth
of services offered in the future. This may include the
acquisition of technologies that complement our existing
offerings and add new best-in-class features to our suite of
products to provide our clients with greater flexibility to
select the services that address their individual needs.

Success in Serving a Substantial and Diverse
Client Base of Large Employers.We
have over 10 years of in-depth experience delivering our
proven solutions to large employers, which we define as
organizations with over 1,000 employees, and have developed a
suite of services specifically designed to satisfy their unique
needs. As of June 30, 2002, we provided services to over
10% of the Fortune 1000companies, spanning a wide
variety of business segments and resulting in a significant
recurring revenue stream from established clients. For the year
ended June 30, 2002, no single client represented more than
3% of our revenues.

Experienced, Highly Motivated Workforce and
Management Team.We believe that our
highly skilled, diverse and well-trained workforce is one of our
greatest assets. We strive to develop leadership and client
service excellence at all levels of our organization. We seek to
hire individuals with significant industry experience, whether
these hires are account managers, research and development
personnel or integration professionals. Our officers and
directors maintain a significant ownership stake in our company
that, as of June 30, 2002, was approximately 32%, including
ownership by General Atlantic Partners, LLC (GAP).
In addition, almost all of our employees have an ownership
interest in the company via option grants and/or participation
in our employee stock purchase plan. We believe that these
equity stakes significantly contribute to our ability to provide
what we believe to be the highest level of client service in the
industry.

Service Offerings

We have over 10 years of in-depth experience
serving large employers and have developed a suite of services
specifically designed to satisfy their unique needs. We provide
a broad range of employee administrative services, including:



| |   |                                  
| | - | ---------------------------------
| |  | payroll processing;              
|
| |  | payroll tax filing;              
|
| |  | benefits administration services;

4



---



##### 





| |   |                             
| | - | ----------------------------
| |  | Comprehensive Outsourcing;  
|
| |  | human resource services; and
|
| |  | Web self-service solutions. 

We intend to develop enhancements to our existing
services internally. We also intend to expand our service
offerings through future acquisitions, alliances and investments.

Payroll Processing.We process time and attendance data to
calculate and produce employee paychecks, direct deposits and
reports for our clients. Our clients receive paychecks and
reports within approximately 24 to 48 hours of our receipt of
their electronically submitted data. Our system is highly
configurable to meet the specialized and, often times, complex
needs of large employers, yet maintains the ability to provide
high-volume processing. The system integrates easily with the
clients general ledger, HR, and time and attendance
systems. In addition, we offer many sophisticated features,
including the automatic enrollment and tracking of paid time
off, and integrated garnishment processing.

Payroll Tax Filing.We calculate and collect contributed
employer and employee payroll tax funds from clients and deposit
such funds with the appropriate tax authorities when due. We
also file all payroll tax returns and represent the client
before tax authorities in disputes or inquiries. The majority of
our existing payroll clients utilize our payroll tax service.

Benefits Administration Services.Our benefits administration services
include flexible benefits enrollment and processing, COBRA
administration, and consolidated billing and eligibility
tracking. These services include data management,
reconciliation, transaction processing, employee inquiry
management and client service.

Comprehensive Outsourcing.Our Comprehensive Outsourcing service
offering, which includes payroll administration, serves as an
extension of our clients business as we fully manage
employee inquiries and other departmental administrative
functions for payroll, HR and benefits in addition to our
traditional back-office processing services. When a client
adopts Comprehensive Outsourcing service offering, we assume the
management of such transactional administration as the recording
and verification of time, the issuance of manual checks, the
enrollment of employees in flexible spending benefit programs
and the auditing and balancing of payroll.

Human Resource Services.Our HR service offering tracks and
reports general employee information, including compensation,
benefits, skills, performance, training, job titles and medical
history. For clients who also use our payroll service, the HR
data can be transferred to the payroll services system to
eliminate the need for duplicate data entry.

Web Self-Service Solutions.Our self-service solutions provide
employers with a complete range of employee relationship
management applications. Employers have a Web tool, which not
only facilitates HR and payroll processes, but also allows
employees to utilize self-directed administration services.

Technology

We differentiate ourselves through our
proprietary technology platform. This platform integrates
substantially all technologies required to deliver high-quality
employee services to clients at low transaction costs. It is
highly scaleable, configurable and designed to combine multiple
service offerings onto a platform that integrates into the
clients other systems. This platform reduces errors speeds
development of add-on services, improves timeliness of issue
resolution and significantly reduces processing and servicing
costs. Our technology is applicable across all of our service
offerings and consists of five layers that provide services
across all administrative processes:



| |   |                                                                                        
| | - | ---------------------------------------------------------------------------------------
| |  | Applications
    payroll, tax, HR management systems and benefits;                    
|
| |  | Production
    high-speed data processing, printing and finishing systems;            
|
| |  | Internet
    employee and administrator self-service integrated into the
    platform;

5



---



##### 





| |   |                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Service
    integrated client relationship management, knowledge-base,
    imaging, interactive voice response and telephony systems; and                                           
|
| |  | Information
    Technology integrated data
    center services (such as database hosting, maintenance and
    backup), Web hosting, security and business interruption
    services.

These layers constitute an integrated data
processing system that is highly flexible, reliable and
serviceable. The platform eliminates data duplication, reduces
system latency, reduces steps and errors, improves reliability,
and provides integrated end-to-end process outsourcing.

To build the layers, we utilize industry-standard
technologies that are highly scalable and redundant. Client data
is stored on a high-availability storage area network comprised
of multiple logical servers on a high-speed Nortel and Cisco
network. Processing services are provided by an array of
inexpensive microprocessors, which are easily extensible and
highly redundant. Service technologies include third-party
technologies from Siebel, FileNet, Genesys, Periphonics, and
Nortel. We build proprietary integrated application
technologies, including payroll processing, payroll tax filing
and benefits administration, and our own Internet self-service
and portal technologies.

Our focus is on an integrated data processing
system that assures data flows easily across applications,
between clients and our company, and to and from third-party
systems. This enables us to provide high levels of service to
clients, because both clients and our service providers work
with the same data and applications. This flexible technology
platform allows us to integrate technology, process and service
into end-to-end process outsourcing solutions for clients,
allowing us to achieve higher levels of efficiency, and provide
higher levels of service to clients.

We invested $28.3 million and
$24.0 million on research and development activities during
fiscal years 2002 and 2001, respectively, which includes
capitalized software development costs.

Client Service

We believe that our focus and dedication to
providing high levels of client service is a competitive
advantage in the large employer market. Beyond developing a
business partnership with each client, we assess each
clients payroll processing needs and reengineer and design
the clients payroll systems and processes. In doing so, we
implement a value-added solution for the client. We also
maintain an ongoing relationship with each client through the
use of a strategic team that includes a sales representative, a
sales analyst, a senior project manager, an account manager and
numerous functional, regulatory and technical support
specialists. We intend to continue providing our clients with a
high level of service by hiring professionals who are
experienced in their fields. Most of our service personnel have
experience in payroll, accounting, HR or financial services
industries, and many hold Certified Public Accountant or
Certified Payroll Professional accreditation.

We continually monitor the quality of our service
via client feedback mechanisms. We obtain valuable insights into
the needs of our clients through our partnership with each
client and from client responses to surveys, which are conducted
semiannually. We use this information to help develop, identify
and optimize new service offerings and to improve the level of
service provided to clients. We also use client feedback as a
basis for incentive compensation and for recognition of
achievements.

Sales.We believe
that client service begins with the sales process. A sales
representative and a sales analyst work together to assess a
potential clients processing needs. Based on this
assessment, the sales team then identifies opportunities for
reengineering the prospective clients processes and for
designing a solution that integrates effectively with their
prospective clients other systems. The sales cycle
typically ranges from three to twelve months or longer.

Implementation.Upon
engagement by a client, we assign a team of technical support
specialists headed by a senior project manager. The senior
project manager leads the transition from the clients
former system to our system. The senior project manager also
works with the client, the sales analyst and technical support
specialists to integrate our applications with the clients
other systems and to customize the system to improve

6



---



##### 



the clients processes. We use our
systems integration expertise to facilitate the
integration of our 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 processes and systems and the
size of the client.


Account Management.We assign an account manager to each
client during the implementation process. The account manager
serves as the clients day-to-day contact with us. The
account manager coordinates the efforts of our functional,
regulatory and technical support specialists as needed. 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 us to provide clients with uninterrupted payroll
services during these periods. Account managers use a
comprehensive client relationship management system to record
and track all client calls, record client feedback and to help
ensure that the clients needs are addressed promptly and
thoroughly. We maintain a low client-to-account manager ratio in
an effort to offer clients accessible and responsive account
management.

Support Specialist.We support 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. Clients can speak directly with each of these
specialists as needed. These specialists also meet with clients
onsite or support clients indirectly through the account manager.

Clients

We target large companies with complex and
changing business needs in diverse industries. As of
June 30, 2002, we provided payroll services to over 600
clients, who had an aggregate of approximately 1.5 million
active employees and an average of approximately 2,400
employees. As of June 30, 2002, we provided payroll tax
filing services to approximately 160 clients with an aggregate
of more than 3.3 million employees and an average of more
than 20,000 employees.

We have maintained what we believe to be an
industry-leading client retention rate of approximately 90% for
each of the last six years. We believe that our low
client-to-account manager ratio and our focus on client service
are key factors in enabling us to achieve a high payroll client
retention rate. Our client retention rates have been and will
continue to be negatively impacted by clients ceasing to use our
services following a merger or sale of the client. We generally
execute multi-year contracts that contain penalties for early
termination.

Sales and Marketing

We employ a direct sales force to gain new
clients and to increase the number of services provided to
existing clients. We currently target large employers through
direct marketing, trade shows and active participation in local
chapters of the American Payroll Association. We use a
team-selling approach in which sales analysts and sales
representatives collaborate to assess a potential clients
needs and to develop a cost-effective solution. The payroll
processing and tax filing sales cycle typically ranges from
three to twelve months or longer.

As part of our strategy to provide a
comprehensive suite of employee administrative services, we have
entered into strategic alliances with such industry leaders as
Peoplesoft and SAP AG. These alliances enable us to provide
connectivity between our payroll processing and payroll tax
filing solution and our strategic partners HR application
programs. We have also formed key alliances with Intuit, Inc.,
Sheakly UniService and SmartTime, to jointly provide services to
clients.

Competition

The market for our services is intensely
competitive. It is also subject to rapid change and
significantly affected by new service introductions and other
market activities of industry participants. In payroll
processing and tax filing, we primarily compete with Automatic
Data Processing, Inc. and Ceridian Corporation. We also compete
with in-house employee services departments.

7



---



##### 



Given the critical nature of their HR services,
companies in our target market are more likely to select an
outsourcing partner that is well established and has
demonstrated its ability to reliably deliver accurate and high
quality services.

We believe that the principal competitive factors
affecting our market include the following:



| |   |                                                         
| | - | --------------------------------------------------------
| |  | client service;                                         
|
| |  | system and technology functionality and
    performance;
|
| |  | system and service flexibility;                         
|
| |  | breadth of service offering;                            
|
| |  | reputation and experience; and                          
|
| |  | service cost.                                           

If we are not able to compete favorably with
respect to these factors, our business and results of operations
will be harmed.

Proprietary Rights

We rely on a combination of contract, copyright
and trade secret laws to establish and protect our proprietary
technology. We distribute our services under service agreements
that grant clients licenses to use our services and that contain
various provisions protecting our ownership and the
confidentiality of the applicable technology. We generally enter
into confidentiality agreements with our employees and
confidentiality and/or service agreements with existing and
potential clients. We also limit access to the distribution of
our software, documentation and other proprietary information.

Employees

As of June 30, 2002, we had approximately
1,200 full-time employees. We believe that relations with our
employees are good.

Additional Factors That May Affect Future
Results

We have sustained a history of operating
losses and may not achieve profitability in the future.We have experienced significant
operating losses since our inception. Historically, we have
incurred operating losses due to continued investments in client
acquisition costs and research and development. We also incurred
costs associated with expanding our sales efforts, service
offerings and operations to new geographic regions. The general
condition of the United States economy and the current weakness
in the economy has and will continue to affect our business.
These effects have taken the forms of declines in interest
rates, client staff reductions, strikes, and acquisitions of our
clients by other companies, among others. In addition, potential
clients and existing clients are also less likely to switch
service providers and in some cases are delaying or postponing
purchasing decisions. These factors could result in the
reduction of the aggregate amount of payroll that we process and
the amount of interest that we earn on such funds. In addition,
the general condition of the United States economy is affected
by social, political and military conditions, including
terrorist threats and acts and any response by the United States
to such threats and acts.

As of June 30, 2002, we had an accumulated
deficit of $126.1 million. While our current target is to
achieve breakeven financial results for FY2003 before accounting
for preferred dividends, we may fail to achieve these financial
results by such time and it is possible that we may never
achieve or sustain profitability in the future. Failure to
generate profit would harm our financial condition and results
of operations.

Investment risks could harm our business.We invest client deposits; including
payroll tax funds transferred to us by our clients, in
short-term, top-tier, high quality financial instruments. Among
other instruments, we invest in overnight U.S. government direct
and agency obligations, commercial paper and institutional money
market funds. Interest income earned from the investment of
client payroll tax funds

8



---



##### 



represents a significant portion of our revenue.
Our results of operations could be negatively impacted by any
adverse changes to credit quality, market valuation, interest
rates or average daily balances. The market value of an
investment could be adversely impacted by any unfavorable
changes in the credit quality of the instrument. Any other than
temporary declines in payroll tax funds invested will be funded
by corporate funds. We have historically entered into interest
rate swap agreements on a portion of our client deposits to
mitigate the impact of interest rate fluctuations on our
interest income. These swaps provide us with a known and fixed
interest rate on the estimated fixed average daily balance and
in exchange we agree to pay a floating rate typically tied to
short-term tier one commercial paper rates. However, these swap
agreements will not protect us from all interest rate risks. If
we did not accurately project the average daily balance for our
client deposits and the notional value of the swap was greater
than the actual average daily balances for the period, we may
have a payment obligation in excess of amounts earned on those
deposits invested and the hedge may be deemed ineffective. If
the company fails to earn an amount equal to the short-term
floating rate index on the investment portfolio, the company
could have a payment obligation under the agreement. If we
default under our swap agreements, the default could result in
acceleration and setoff by the bank of all outstanding contracts
under the swap agreements and could result in cross-defaults of
other debt agreements. If the party to our swap agreements fails
to meet the terms of its obligations under our executed swap
agreements, all amounts hedged under the swap agreements would
then be subject to market interest rate fluctuation and the swap
agreements could become ineffective. In the future, we may
increase or reduce the level of funds hedged with interest rate
swap agreements. If we do decrease our level of investments
covered under interest rate swap agreements, we could be subject
to greater interest rate fluctuations. Any of these consequences
could harm our business and financial condition.


Our operating results have fluctuated, and
will continue to fluctuate, from quarter to quarter, and
negative fluctuations could materially lower the price of our
common stock.Our quarterly operating
results have fluctuated in the past and will continue to
fluctuate in the future depending on a variety of factors,
including the following:



| |   |                                                                                                                                
| | - | -------------------------------------------------------------------------------------------------------------------------------
| |  | interest rates;                                                                                                                
|
| |  | a reduction in the number of employees of our
    clients;                                                                     
|
| |  | the decision of one or more clients to delay or
    cancel implementation or ongoing services;                                 
|
| |  | the number and size of new clients starting
    services;                                                                      
|
| |  | seasonality;                                                                                                                   
|
| |  | average daily balance of funds invested;                                                                                       
|
| |  | our ability to timely design, develop, introduce
    and implement services and features for new and existing
    services;    
|
| |  | services offerings provided by competitors:                                                                                    
|
| |  | costs associated with strategic acquisitions and
    alliances or investments in technology;                                   
|
| |  | the success of strategic acquisitions, alliances
    or investments;                                                           
|
| |  | costs to transition to new technologies;                                                                                       
|
| |  | risks associated with the administration of
    third-party funds for our payroll tax and benefits
    administration services;
|
| |  | price competition; and                                                                                                         
|
| |  | general economic factors.                                                                                                      

A substantial majority of our operating expenses,
particularly personnel and related costs, depreciation and rent,
are relatively fixed in advance of any particular quarter. As a
result, we may not be able to timely cut costs in response to
any decrease in revenue. For example, any decision by a client
to delay or cancel our services, or our under-utilization of
personnel, may cause significant variations in operating results
and could

9



---



##### 



result in additional losses for the applicable
quarters. Additionally, as we secure larger clients, the time
and expense required to implement our services increases, which
could contribute to larger fluctuations in results of operations.


Our future revenue and results of operations may
vary substantially. In some future quarter our results of
operations could be below the expectations of public market
analysts and investors, which could cause the market price of
our common stock to decrease dramatically.

We need to incur substantial expenses to gain
more clients and expand our offerings, but we may not realize
profits from these expenses.Our
ability to achieve profitability will depend in part upon our
ability to attract and retain new clients, offer new services
and features and achieve market acceptance of new services.
Establishing new client relationships is a time-consuming and
expensive process. It generally takes three to twelve months or
longer, and implementing our services generally takes an
additional three to nine months or longer. These sales cycles
may lengthen if the economy continues to weaken. As we acquire
each new client, we incur substantial client acquisition costs,
which consist primarily of sales and implementation expenses. We
incur these costs in advance of revenue, and we cannot guarantee
how long it will take to fully recoup these costs. If we cannot
maintain our historically high client retention rate, our return
on customer acquisition cost will be significantly lower. As we
expand our service offerings, we incur substantial operating
costs associated with hiring the management and building the
operational infrastructure. We may not realize profits from
these investments, and failure to do so would harm our financial
condition and results of operations.

We incur substantial costs investing in new
technologies but may fail to successfully introduce new
offerings.We will incur substantial
costs in developing or acquiring new technologies and in
deploying new services and features to our clients. If we cannot
develop or acquire, integrate and successfully introduce new
services and new features of existing services in a
cost-effective manner, our business will suffer. We have spent
and will continue to spend significant time and money in the
development of our next generation core processing system,
Golden GateTM, and in the development and
staffing of our outsourced employee administrative services
offering, Comprehensive Outsourcing. We may not successfully
deliver these services or the underlying system on a timely
basis. Even if successfully developed, our ability to realize
profits from these investments still depend on our ability to
acquire and retain a critical number of clients. To the extent
that any of these services or systems do not compare favorably
with the offerings of our competitors or if they are introduced
later than those of our competitors, they may not achieve market
acceptance. Our inability to successfully develop, sell,
implement or provide these and other new services on a timely
basis to existing or potential clients could harm our growth
strategy as well as our core operations. In combination with
investing in new technologies, we capitalize those software
development costs in accordance with SOP 98-1,
Accounting the Costs of Computer Software Developed or
Obtained for Internal Use. When we capitalize costs
associated with new technologies and subsequent events or
changes in circumstances indicate that the carrying amount of
these assets may not be recoverable, we would sustain
substantial write-offs. These write-offs could impact our
financial results.

In an effort to reduce our development costs we
have begun to move some of our development efforts offshore.
There are risks to working with a development company with
development resources outside the U.S., including communication
and management issues, political instability and natural
disasters. In addition, some foreign countries do not protect
proprietary rights to the same extent as the laws of the United
States. Due to these and other factors, we cannot be certain
that this strategy will be successful.

Failure to develop new services and
enhancements to existing services may render our offerings
obsolete and harm our business.Our
industry involves increasingly sophisticated and varied needs of
clients, frequent new service and feature introductions and
emerging industry standards. The introduction of services with
new technologies and the emergence of new industry standards and
practices can render existing services obsolete and
unmarketable. Our services, particularly tax filing and benefits
plan administration, depend upon government regulations that
continually change. Failure to timely implement corresponding
changes to our services and technology would harm our business
and results of operations. Our future success will depend in
part on our ability to develop or acquire advanced technologies
which keep pace with competitive offerings and to enhance our
existing services with new features. We will also need to add
new services that address the

10



---



##### 



changing needs of our clients and respond to
technological advances and emerging industry standards and
practices on a timely and cost-effective basis. If we cannot
meet these needs in a timely manner, our business will suffer.
In addition, several of our competitors invest substantially
greater amounts in research and development than we do, which
may allow them to introduce new services or features before we
do and therefore capture additional market share.


Major catastrophes and other similar problems
may cause us to lose client data and materially adversely
interrupt our operations.We currently
conduct substantially all of our payroll and payroll tax
processing at our headquarters in Pleasanton, California. We
divide the payroll printing and finishing between our Pleasanton
and Irvine, California facilities. The Irvine facility serves as
an alternative processing center and could provide backup
payroll center functions. We conduct our Comprehensive
Outsourcing operations in Bothell, Washington. We do not have a
Comprehensive Outsourcing back-up facility. For each payroll
client, we establish a complete set of payroll data at our
Pleasanton processing center, and at the clients site, as
well as a secure offsite storage site. In the event of a
disaster in Pleasanton, each client would have the ability to
process payroll checks based on the data they have at their own
site, if necessary. In addition, we have developed business
continuity plans. Our disaster recovery procedures, however, may
not be sufficient, and the payroll data recovered at the client
site may not be sufficient to allow the client to calculate and
produce payroll in a timely fashion.

Our operations depend on our ability to protect
our computer systems against damage from a major catastrophe
(such as an earthquake or other natural or man-made disaster),
fire, power loss, security breach, telecommunications failure or
similar event. The precautions we have taken to protect
ourselves from or minimize the impact of these and other events
may be inadequate. Any damage to our data centers, failure of
telecommunications links or breach of the security of our
computer systems could result in an interruption of our
operations, including a loss of data. Our insurance may not
cover these losses.

Our success depends on our ability to compete
effectively in the marketplace.The
market for our services is intensely competitive. It is also
subject to change and affected by new service and technology
introductions and other market activities of industry
participants. In payroll processing and tax filing, we primarily
compete with several public and private service providers such
as Automatic Data Processing, Inc., Ceridian Corporation and
in-house employee services departments. 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 we do. In addition, some of these
companies offer more services or features than we do and have
processing facilities located throughout the United States. We
believe the principal competitive factors affecting our market
include the following:



| |   |                                                         
| | - | --------------------------------------------------------
| |  | client service;                                         
|
| |  | system and technology functionality and
    performance;
|
| |  | system and service flexibility;                         
|
| |  | breadth of service offering;                            
|
| |  | reputation and experience; and                          
|
| |  | service cost.                                           

Our inability to compete successfully will harm
our business and results of operations. Additionally, a
significant portion of our historic revenue growth resulted from
new client acquisition. A majority of our new clients have
historically come from our competitors.

Our success depends on our ability to manage
growing and changing operations and failure to improve our
systems to accommodate growth would harm our business.As our business has grown
significantly in size and complexity over the past five years,
the growth has placed, and will continue to place, significant
demands on our management, systems, internal controls as we must
expand them to handle the substantially increased volume and
complexity of the services we provide to large employers. We
also plan to continue spending on research and development,
invest in new equipment and make other capital expenditures.
Growth

11



---



##### 



and expansion have placed and will continue to
place a strain on our operating and financial systems. To
accommodate the increased number of transactions and clients and
the increased size of our operations, we need to continue to
implement and improve our systems on a timely basis. In
addition, we expect that we will need to further develop our
financial and managerial controls, reporting systems and
procedures to accommodate future growth. Our failure to expand
successfully in any of these areas in an efficient manner would
harm our business.


We may make errors and omissions in performing
our services, which could subject us to fines and harm our
reputation.We have made errors and
omissions in the past and may make errors and omissions in
performing our services. For example, we may underpay taxes on
behalf of our clients, or we may file benefits plan forms late.
In addition to client liability, governmental authorities may
impose large cash penalties on our errors and omissions and may
preclude us from doing business in the relevant jurisdiction.
These errors and omissions are often not identified for an
extended period of time following the provision of the services,
and there may be a significant delay between the time an error
or omission occurs and when a penalty is imposed. To date,
penalties have not been significant. However, liabilities
associated with penalties for errors and omissions that occurred
in the past and those that may occur in the future could harm
our business and results of operations. Our reserves or
insurance for any penalties may not adequately protect us.
Errors and omissions may also damage our reputation and could
harm our relationships with existing clients and our ability to
gain new clients.

Our employees may violate our relationship of
trust with our clients and lead to lawsuits against us.We have access to confidential
information and to client funds. Actions taken by our employees
in breach of our relationships with our clients may damage the
clients businesses. For example, if one or more of our
employees violates confidentiality agreements or misappropriate
funds, our clients may assert claims against us. Our fidelity
bond and errors and omissions insurance may not adequately cover
claims like these. Claims of these types could damage our client
relationships and harm our business and financial condition.

Acquisitions and investments, especially
unsuccessful ones, could harm our financial results.We have in the past and intend in the
future to make additional acquisitions and investments. Future
acquisitions could result in the issuance of dilutive equity
securities, the incurrence of debt or contingent liabilities.
Furthermore, strategic acquisitions or investments may not be
successfully integrated into our existing operations, or we may
not realize the anticipated benefits. If unsuccessful, they
could harm our business and financial condition.

We rely on third party couriers, whose failure
to deliver paychecks to our clients would harm our business.We depend on third-party courier
services to deliver paychecks to clients. We do not have formal
written agreements with any of the courier services that we use.
These courier services have failed in the past and may fail in
the future to pick up or deliver the paychecks in a timely
fashion. This failure could occur as a result of many factors,
including employee strikes, storms or other adverse weather
conditions, earthquakes or other natural or man-made disasters,
logistical or mechanical failures or accidents. Failure to
deliver client paychecks in a timely manner could damage our
reputation and harm our business.

We may not have taken all necessary steps to
protect our intellectual property.Our
success depends in part upon our proprietary software
technology. We rely on a combination of contract, copyright and
trade secret laws to establish and protect our proprietary
technology. We have no patents, patent applications or
registered copyrights. We distribute our services under
agreements that grant clients the right to use our software and
services and contain various provisions protecting our ownership
and the confidentiality of the applicable technology. We
generally enter into confidentiality agreements with our
employees and confidentiality and/or license agreements with
existing and potential clients. We also limit access to and
distribution of our software, documentation and other
proprietary information. The steps taken to protect our
proprietary technology may not be adequate to deter
misappropriation. Even if they are, third parties may develop
similar or competing technologies independently.

12



---



##### 



Our stock price has fluctuated and is likely
to continue to fluctuate.The market
price of our common stock has been and is likely to continue to
be highly volatile. Our stock price could fluctuate in response
to various factors, including the following:



| |   |                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------
| |  | general economic conditions;                                                                               
|
| |  | quarterly operating results against investor
    expectations;                                             
|
| |  | changes in our competitors stock prices;                                                                  
|
| |  | trading volume of our common stock, including
    transactions by our large institutional stockholders;    
|
| |  | changes in securities analysts estimates of
    our financial performance and that of our competitors; and
|
| |  | announcements of technological innovations or new
    services by us or our competitors.                   

Many of these factors are outside our control.
These fluctuations are sometimes unrelated to our operating
performance. The market price of our common stock could decline
as a result of certain broad market fluctuations.

A handful of our stockholders have significant
control over our company, and their interests may differ from
yours.As of June 30, 2002, our
directors, executive officers, and affiliated stockholders
together controlled approximately 32% of our voting stock. If
these stockholders acted or voted together, they would have the
power to exercise a significant influence over the election of
our directors. They would also have significant control over
other matters requiring stockholder approval, including the
approval of major corporate transactions. In addition, this
concentration of ownership may delay or prevent a change in
control of our company, even when a change may be in the best
interests of the other stockholders. Furthermore, the interests
of these stockholders may not always coincide with the interests
of our company or other stockholders.

Holders of our preferred stock have rights
senior to holders of our common stock, including the right to
receive dividends that will dilute the ownership of holders of
common stock.In August 2000, we sold
1,132,075 shares of Preferred Stock to entities affiliated with
General Atlantic Partners, LLC. In the event of a merger or
acquisition, the holders of the Preferred Stock will receive
$26.50 per share before any amounts may be paid to holders of
our common stock. The holders of the Preferred Stock also will
receive cumulative dividends at an annual rate of 6.9% in the
form of additional shares of Preferred Stock. At June 30,
2002 there were 136,450 additional shares of Preferred Stock
accrued as dividends distributable. Therefore, the longer our
Preferred Stock is outstanding, the more dilution the holders of
our common stock will experience.

Our charter documents and Delaware law could
make an acquisition of our company difficult, even if an
acquisition may benefit our
stockholders.Provisions of our
certificate of incorporation, bylaws and Delaware law could make
it more difficult for a third party to acquire us, even if doing
so would benefit our stockholders. In particular, our
certificate of incorporation provides for three classes of
directors. Each director in each class is elected for a
three-year term, and a different class is elected each year.
These provisions make it difficult for a third party to gain
control of our board of directors.

We adopted a preferred stock rights plan,
which has anti-takeover effects.We
have adopted a preferred stock rights plan. The plan has the
anti-takeover effect of causing substantial dilution to a person
or group that attempts to acquire us on terms not approved by
our board of directors. The existence of the plan could limit
the price that certain investors might be willing to pay in the
future for shares of our common stock and could discourage,
delay or prevent a merger or acquisition that a stockholder may
consider favorable.

Item 2.     Properties

Our headquarters are located in Pleasanton,
California and consist of approximately 205,000 square feet of
office space leased through April 2015, and 29,000 square feet
of office space leased through May 2011. Our Comprehensive
Outsourcing and benefits administration operations center
consists of approximately 45,000 square feet and is located in
Bothell, Washington. We also maintain four additional sales and
service satellite

13



---



##### 



offices located in the United States. We believe
our existing facilities adequately serve our current needs. We
also believe we can lease additional facilities to meet future
needs.


Item 3.     Legal
Proceedings

We face routine litigation incidental to our
business. In the opinion of management, no current or pending
lawsuits, either individually or in the aggregate, are likely to
materially harm our financial condition, results of operations
or cash flows.

Item 4.     Submission
of Matters to a Vote of Security Holders

No matter was submitted to a vote of security
holders, through the solicitation of proxies or otherwise,
during the fourth quarter of the fiscal year ended June 30,
2002.

PART II

Item 5.     Market
for Registrants Common Equity and Related Stockholder
Matters

(a) Our 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 our Common Stock as reported by the Nasdaq
National Market.

|               |  |      |       |     |  |   |       | 
|-------------- |  | ---- | ----- | --- |  | - | ----- | 
|               |  | High |       | Low
|               |  |      |       |    
|FY2001:        |  |      |       |     |  |   |       | 
|First Quarter  |  | $    | 31.30 |     |  | $ | 17.25 | 
|Second Quarter |  | $    | 35.69 |     |  | $ | 25.56 | 
|Third Quarter  |  | $    | 33.78 |     |  | $ | 20.06 | 
|Fourth Quarter |  | $    | 26.55 |     |  | $ | 20.50 | 
|FY2002:        |  |      |       |     |  |   |       | 
|First Quarter  |  | $    | 29.57 |     |  | $ | 12.52 | 
|Second Quarter |  | $    | 21.96 |     |  | $ | 14.22 | 
|Third Quarter  |  | $    | 23.00 |     |  | $ | 15.88 | 
|Fourth Quarter |  | $    | 21.49 |     |  | $ | 12.50 | 

On August 8, 2002, there were 3,167
beneficial shareholders and 367 registered shareholders of
record of our Common Stock. The last reported sale price per
share of our Common Stock on September 18, 2002 on the
Nasdaq National Market was $7.05.

On August 1, 2000, we authorized, issued and
sold 1,132,075 shares of 6.9% Redeemable Convertible Preferred
Stock (Preferred Stock) to General Atlantic
Partners, LLC (GAP) and certain affiliates of GAP at
$26.50 per share and received approximately $30 million in
consideration. On December 20, 2001 we issued and sold
2,400,000 shares of our common stock to private investors at
$15.00 per share and raised net proceeds of approximately
$32.4 million. On February 6, 2002 we issued and sold
an additional 1,333,334 shares of our common stock to entities
affiliated with General Atlantic Partners, LLC at $15.00 per
share and raised net proceeds of approximately
$18.8 million.

We have never declared or paid any cash dividends
on our capital stock. We currently expect to retain future
earnings, if any, for use in our business and do not anticipate
paying any cash dividends in the foreseeable future. In
addition, our existing line of credit agreement prohibits the
payment of cash dividends without the lenders prior
approval. If we do pay cash dividends to the holders of common
stock, we are required to provide a corresponding adjustment to
the conversion rate of our outstanding Preferred Stock.

The holders of Preferred Stock are entitled to
receive cumulative dividends at an annual rate of 6.9% in the
form of additional shares of Preferred Stock. The payment of
these stock dividends commenced on

14



---



##### 



October 1, 2000. We are obligated to declare
these stock dividends quarterly on the first day of October,
January, April and July.


On August 1, 2001, our Board of Directors
adopted a stockholders rights plan. Under the plan, we
issued a dividend of one right for each share of our common
stock held by stockholders of record as of the close of business
on August 30, 2001. The plan is designed to assure our
stockholders fair value in the event of a future unsolicited
business combination or similar transaction. Each right will
initially entitle stockholders to purchase a fractional share of
our Series A Participating Preferred Stock for $170.00.
However, the rights are not immediately exercisable and will
become exercisable only upon the occurrence of certain events.
Upon the occurrence of these events, unless redeemed for $0.001
per right, the rights will become exercisable by holders, other
than rights held by an unsolicited third party acquirer, for our
shares or shares of the third party acquirer having a value of
twice the rights then-current exercise price.

Item 6.     Selected
Financial Data

|                                                                     |  |                     |         |      |  |      |         |      |  |      |           |   |  |   |           |   |  |   |           |  
|-------------------------------------------------------------------- |  | ------------------- | ------- | ---- |  | ---- | ------- | ---- |  | ---- | --------- | - |  | - | --------- | - |  | - | --------- | -
|                                                                     |  |                    
|                                                                     |  | Year Ended June 30,
|                                                                     |  |                    
|                                                                     |  | 1998                |         | 1999 |  | 2000 |         | 2001 |  | 2002
|                                                                     |  |                     |         |      |  |      |         |      |  |     
|Total revenue(1)                                                     |  | $                   | 46,534  |      |  | $    | 70,145  |      |  | $    | 104,072   |   |  | $ | 149,861   |   |  | $ | 168,640   |  
|Gross margin(2)                                                      |  | $                   | 24,915  |      |  | $    | 38,890  |      |  | $    | 61,175    |   |  | $ | 80,821    |   |  | $ | 94,083    |  
|Net loss(3)                                                          |  | $                   | (9,840  | )    |  | $    | (16,109 | )    |  | $    | (13,917   | ) |  | $ | (33,191   | ) |  | $ | (27,459   | )
|Net loss per share(4)                                                |  | $                   | (0.60   | )    |  | $    | (0.77   | )    |  | $    | (0.60     | ) |  | $ | (1.45     | ) |  | $ | (1.13     | )
|Shares used in computing basic and diluted net
    loss per share(5) |  |                     | 16,535  |      |  |      | 21,033  |      |  |      | 23,229    |   |  |   | 23,840    |   |  |   | 26,212    |  
|Total assets                                                         |  | $                   | 377,475 |      |  | $    | 710,424 |      |  | $    | 1,182,221 |   |  | $ | 1,681,126 |   |  | $ | 1,916,530 |  
|Redeemable convertible preferred stock                               |  | $                   | 2,538   |      |  | $    |        |      |  | $    |          |   |  | $ | 31,246    |   |  | $ | 33,471    |  



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                     
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | We changed our revenue recognition policy in the
    fourth quarter of FY 2001 based on guidance provided by the
    Securities and Exchange Commissions Staff Accounting
    Bulletin No. 101 (SAB 101), Revenue
    Recognition in Financial Statements. Refer to our
    discussion of Critical Accounting Policies and
    Estimates for additional information about our revenue
    recognition policy.
|   
|(2) | Gross margin, a non-GAAP measure, is defined as
    total revenue less cost of providing services, which includes
    ongoing account management, tax and benefits administration
    operations and production costs and excludes depreciation and
    amortization and client acquisition costs.                                                                                                                  
|   
|(3) | For 1999 net loss includes a $3.5 million
    charge for merger related costs.                                                                                                                                                                                                                                                                                                                                      
|   
|(4) | For 2001 net loss per share includes $0.02
    resulting from a cumulative effect of change in accounting
    principle.                                                                                                                                                                                                                                                                                            
|   
|(5) | For 1998, share data is pro forma and amounts
    have been restated to reflect an acquisition.                                                                                                                                                                                                                                                                                                                     

15



---



##### 



Item 7.     Managements
Discussion and Analysis of Financial Condition and Results of
Operations

The previous discussion and other sections of
this Form 10-K contain forward-looking statements that have
been made pursuant to the provisions of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements
are based on current expectations, estimates and projections
about our industry, managements beliefs, and certain
assumptions made by management. Words such as
anticipates, expects,
intends, plans, believes,
seeks and estimates and similar
expressions are intended to identify forward-looking statements.
These statements are not guarantees of future performance and
actual actions or results may differ materially. These
statements are subject to certain risks, uncertainties and
assumptions that are difficult to predict, including those set
forth herein under Additional Factors That May Affect
Future Results. We undertake no obligation to update
publicly any forward-looking statements as a result of new
information, future events or otherwise, unless required by law.
Readers should, however, carefully review the risk factors
included in other reports or documents filed by us from time to
time with the Securities and Exchange Commission.

Overview

We are a leading provider of comprehensive
administrative outsourced services to large employers
nationwide, providing solutions that include corporate employee
payroll processing, payroll tax filing and other critical human
resources, or HR, and benefits functions. Our comprehensive and
integrated outsourced payroll processing and tax filing solution
has expanded to include a multitude of other similarly
integrated products including payroll administration, HR Service
and benefits administration, including the enrollment and
processing of flexible benefits plans and COBRA benefits, and
Web self-service solutions for employers which allow employees
to access personal information and perform routine
administrative tasks online. These services are combined into a
technology platform combining sophisticated transaction
processing and Internet-enabled workstations to form a
comprehensive HR outsourcing product. We derive our revenue from
fees charged to clients for services and income earned from
investing client payroll tax funds held.

As a leading provider of comprehensive payroll
processing and tax filing services, during FY2002, we processed
40.2 million paychecks for employees, filed over
4.2 million Form W-2s with the Internal Revenue
Service and managed approximately $900 million in average
daily balances from payroll tax funds invested. Our services and
technology platform are integrated with the clients
existing in-house and third-party processing systems, thereby
assuming one or more of the clients HR administrative
functions and creating what we believe to be a highly
differentiated and client-driven solution. This allows our
clients to streamline their administrative processes, including
the elimination of complex and costly functions, while ensuring
the use of industry-wide best practices. By leveraging our
significant scale, experience and depth of cross-functional
skills, our clients achieve higher levels of service and
efficiency.

We have implemented a strategy to achieve
breakeven results for FY2003, before accounting for preferred
dividends, in a challenging economy. Economic factors continue
to negatively impact our revenue growth which include declining
interest rates, reductions in our client base workforce, slower
new client growth, and general U.S. economic conditions.
Historically, we have had significant growth in new client
revenue and correspondingly made significant investments in
client acquisition costs. Our financial strategy to reaching
breakeven in these economic conditions is to align our costs
with our expected revenues, including a significant reduction in
our investment in client acquisition costs. We anticipate our
revenue growth rate in FY2003 to be less than FY2002. While our
objective is to achieve breakeven results for FY2003, there can
be no assurance that we will achieve these results by such time
or at all.

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. We have
experienced significant operating losses since our inception. As
of June 30, 2002, we had an accumulated deficit of
$126.1 million.

Our cost of providing services consists primarily
of ongoing account management, tax and benefits administration
operations and production costs. General and administrative
expenses consist primarily of costs for finance, information
technology and corporate services. Research and development
expenses consist

16



---



##### 



primarily of personnel costs. Client acquisition
costs consist of sales and implementation expenses. Depreciation
and amortization expenses consist primarily of depreciation of
fixed assets including depreciation associated with capitalized
internal-use software development costs.


Results of Operations

The following table sets forth certain items
reflected in the consolidated statements of operations expressed
as a percentage of revenue:

|                                                                    |                                                 |                     |       |      |   |      |       |      |   |  |       |      |  
|------------------------------------------------------------------- | ----------------------------------------------- | ------------------- | ----- | ---- | - | ---- | ----- | ---- | - |  | ----- | ---- | -
|                                                                    |                                                 |                    
|                                                                    |                                                 | Year Ended June 30,
|                                                                    |                                                 |                    
|                                                                    |                                                 | 2000                |       | 2001 |   | 2002
|                                                                    |                                                 |                     |       |      |   |     
|Revenue:                                                            |                                                 |                     |       |      |   |      |       |      |   |  |       |     
|                                                                    | Service fees                                    |                     |       | 71.5 | % |      |       | 70.0 | % |  |       | 72.5 | %
|                                                                    | Interest income from payroll tax funds invested |                     |       | 28.5 | % |      |       | 30.0 | % |  |       | 27.5 | %
|                                                                    |                                                 |                     |       |      |   |      |       |      |   |  |       |     
|Total revenue                                                       |                                                 |                     | 100.0 | %    |   |      | 100.0 | %    |   |  | 100.0 | %   
|Operating expenses:                                                 |                                                 |                     |       |      |   |      |       |      |   |  |       |     
|                                                                    | Cost of providing services                      |                     |       | 41.3 | % |      |       | 46.1 | % |  |       | 44.2 | %
|                                                                    | General and administrative                      |                     |       | 13.3 | % |      |       | 15.0 | % |  |       | 15.2 | %
|                                                                    | Research and development                        |                     |       | 10.7 | % |      |       | 11.5 | % |  |       | 12.7 | %
|                                                                    | Client acquisition costs                        |                     |       | 40.6 | % |      |       | 42.7 | % |  |       | 33.8 | %
|                                                                    | Depreciation and amortization                   |                     |       | 10.3 | % |      |       | 9.1  | % |  |       | 11.5 | %
|                                                                    |                                                 |                     |       |      |   |      |       |      |   |  |       |     
|Total operating expenses                                            |                                                 |                     | 116.2 | %    |   |      | 124.4 | %    |   |  | 117.4 | %   
|                                                                    |                                                 |                     |       |      |   |      |       |      |   |  |       |     
|Loss from operations                                                |                                                 |                     | (16.2 | )%   |   |      | (24.4 | )%   |   |  | (17.4 | )%  
|Interest expense                                                    |                                                 |                     | (0.5  | )%   |   |      | (0.6  | )%   |   |  | (0.5  | )%  
|Interest income and other, net                                      |                                                 |                     | 3.3   | %    |   |      | 2.6   | %    |   |  | 1.6   | %   
|                                                                    |                                                 |                     |       |      |   |      |       |      |   |  |       |     
|Loss before cumulative effect of change in
    accounting principle |                                                 |                     | (13.4 | )%   |   |      | (22.4 | )%   |   |  | (16.3 | )%  
|Cumulative effect of change in accounting
    principle             |                                                 |                     |      |      |   |      | 0.3   | %    |   |  |      |     
|                                                                    |                                                 |                     |       |      |   |      |       |      |   |  |       |     
|Net loss                                                            |                                                 |                     | (13.4 | )%   |   |      | (22.1 | )%   |   |  | (16.3 | )%  
|                                                                    |                                                 |                     |       |      |   |      |       |      |   |  |       |     

Revenue

Service fee revenue increased 16.6% in FY2002 and
increased 40.9% in FY2001, primarily due to increases in the
number and average size of our payroll and tax clients,
partially offset by fewer employees on our clients payroll
resulting from corporate layoffs. Interest income from payroll
tax funds invested increased 3.1% in FY2002 and increased 51.6%
in FY2001. Interest income from payroll tax funds invested
decreased as a percentage of revenue in FY2002 primarily as a
result of a reduction in our average interest rate earned
primarily due to significant decreases in market interest rates
compared with the same period of FY2001. Interest income from
payroll tax funds invested increased in absolute dollars in
FY2002 primarily due to higher average daily payroll tax funds
invested, partially offset by decreases due to a reduction in
our average interest rate earned. Although average interest
rates declined 200 basis points year over year, our average
interest rate earned on invested funds in FY2002 was above the
current average market rate due to the interest rate swap
agreements we held. If current market interest rate conditions
remain unchanged our effective interest rates will decline in
the future as our swap agreements expire. In FY2001, the
year-over-year percentage increase was primarily due to higher
average daily payroll tax funds invested. See
Item 7A  Quantitative and Qualitative
Disclosures About Market Risk.

Cost of
Providing Services

Cost of providing services increased 8.0% in
FY2002 and 60.9% in FY2001 and decreased as a percentage of
total revenue to 44.2% in FY2002, compared with 46.1% in FY2001
and increased as a percentage of total revenue in FY2001 to
46.1% from 41.3% in FY2000. The decrease in FY2002 as a
percentage of revenue is

17



---



##### 



primarily due to the economies of scale and our
expanded efforts company-wide to control costs. The increases in
absolute dollars in FY2002 and FY2001 are primarily a result of
increased personnel costs in operations and account management
to service the increase in client base and the increased
investment in our Comprehensive Outsourcing service offering.
The increase in FY2001 as a percentage of revenue was due
primarily to additional expenses incurred as a result of the
investment made in our Comprehensive Outsourcing service
offering.


General and
Administrative

General and administrative expenses increased
14.3% in FY2002 and 62.2% in FY2001 and remained relatively
unchanged as a percentage of total revenue at 15.2% in FY2002,
compared with 15.0% in FY2001 and increased as a percentage of
revenue to 15.0% in FY2001 from 13.3% in FY2000. Expenses as a
percentage of revenue in FY2002 remained unchanged primarily as
a result of continued efforts to leverage our existing resources
while growing revenues, and to a lesser extent, our expanded
efforts company-wide to control costs. The increases in absolute
dollars in FY2002 and FY2001 were primarily attributable to
increased investment in our information technology
infrastructure, the hiring of additional management and
administrative personnel to support our growth and our
Comprehensive Outsourcing service offering. The increase as a
percentage of revenue in FY2001 was due primarily to additional
expenses incurred as a result of the investment made in our
Comprehensive Outsourcing service offering.

Research and
Development

Research and development expenses increased 24.2%
in FY2002 and 54.0% in FY2001 and increased as a percentage of
total revenue to 12.7% in FY2002 compared with 11.5% in FY2001
and 10.7% in FY2000. The increases in FY2002 and FY2001 were
primarily a result of additional personnel working on numerous
minor new features to our existing products and costs related to
the development of minor enhancements, including software
updates to comply with regulatory changes.

At June 30, 2002, our significant software
development projects in process were primarily related to
developing additional software for our next generation core
processing system, Golden GateTM, including an
integrated benefits administration module and an integrated
employee services portal as well as applications to support the
implementation process. To a lesser extent, we are developing
software for additional functionality associated with our
existing core processing and payroll tax servicing systems.
Capitalized internal-use software development costs were
$7.0 million, $6.8 million and $6.5 million for
FY2002, FY2001 and FY2000, respectively.

Client
Acquisition Costs

Client acquisition costs decreased 10.9% in
FY2002 and increased 51.5% in FY2001 and decreased as a
percentage of total revenue to 33.8% in FY2002, compared to
42.7% in FY2001 and 40.6% in FY2000. The decrease as a
percentage of revenue is primarily due to higher revenue,
reduced capacity, our expanded efforts company-wide to control
costs, and, to a lesser extent, an increase in direct costs
capitalized associated with the deferral of one-time
implementation revenue. The increase in absolute dollars and as
a percentage of revenue in FY2001 was primarily due to the
additional personnel costs associated with new product and
services implementation, the additional investments made to
expand the sales and services implementation capabilities for
Comprehensive Outsourcing and, to a lesser extent, expenses
related to marketing.

Depreciation
and Amortization

Depreciation and amortization expense increased
41.8% in FY2002 and 27.6% in FY2001 and increased as a
percentage of total revenue to 11.5% in FY2002, compared to 9.1%
in FY2001 and 10.3% in FY2000. The increase in absolute dollars
and as a percentage of revenue in FY2002 is primarily a result
of an increase in depreciation of computer hardware and
purchased software equipment and internal use software
depreciation related to our next generation core processing
system, Golden GateTM, and to a lesser extent,
to our integrated employee services portal. The increase in
absolute dollars FY2001 compared to FY2000 is primarily a result
of an increase in depreciation of additional computer hardware
and purchased software equipment that was placed in-service in
FY2000.

18



---



##### 



Depreciation of internal use software was
$3.1 million, $0.5 million and $0.7 million for
FY2002, FY2001 and FY2000 respectively. With respect to software
products currently capitalized and ready for their intended use,
we expect to depreciate approximately $4.3 million in
FY2003.

The following is a rollforward of the fixed asset
accumulated depreciation amounts, including capitalized
software, for the years ended June 30, 2001 and 2002 (in
thousands):

|                      |                                              |              |        |        |  
|--------------------- | -------------------------------------------- | ------------ | ------ | ------ | -
|                      |                                              | Accumulated 
|                      |                                              | Depreciation
|                      |                                              |             
|Balance June 30, 2000 |                                              | $            | 24,607 |       
|                      | Expensed during the year ended June 30, 2001 |              |        | 13,318 |  
|                      | Disposal of fixed assets                     |              |        | (1,283 | )
|                      |                                              |              |        |       
|Balance June 30, 2001 |                                              |              | 36,642 |       
|                      | Expensed during the year ended June 30, 2002 |              |        | 19,037 |  
|                      | Disposal of fixed assets                     |              |        | (1,205 | )
|                      |                                              |              |        |       
|Balance June 30, 2002 |                                              | $            | 54,474 |       
|                      |                                              |              |        |       



| |                 
| | ----------------
| | Interest Expense

Interest expense remained relatively unchanged as
a percentage of total revenue at 0.5% in FY2002 compared to 0.6%
in FY2001 and 0.5% in FY2000.



| |                                   
| | ----------------------------------
| | Interest Income and Other,
    Net

Interest income and other, net decreased as a
percentage of total revenue to 1.6% in FY2002 compared to 2.6%
in FY2001 and 3.3% in FY2000. Even though investment balances
increased from FY2002 compared to FY2001, interest income
decreased in absolute dollars and as a percentage of revenue due
to significant declines in market interest rates.

Critical Accounting Policies and
Estimates

Note 1 to the Consolidated Financial Statements
included in Item 8 of this Form 10-K discusses our
significant accounting policies. The discussion and analysis of
our financial condition and results of operations herein are
based upon our consolidated financial statements, which have
been prepared in accordance with accounting principles generally
accepted in the United States (GAAP). The preparation of these
financial statements in accordance with GAAP requires us to make
estimates and apply judgments that affect the reported amounts
of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an on-going
basis, we evaluate our estimates, including those related to
long-lived assets, investments, allowance for doubtful accounts
receivable, deferred revenue, tax penalties, contingencies and
income taxes. We base our estimates on historical experience and
on various other assumptions that are believed to be reasonable
under current facts and circumstances. Actual amounts and
results may differ from these estimates made by management under
different assumptions or conditions and our financial statements
could be affected. The significant accounting policies that we
believe are the most critical to aid in fully understanding and
evaluating our reported financial results are discussed below.

Long-Lived Assets.At June 30, 2002, the carrying
value of our fixed assets, including capitalized software
development costs, totaled $63.9 million and our intangible
assets totaled $5.4 million. This carrying value reflects
estimates, assumptions and judgments relative to capitalized
costs, useful lives, utilization, and salvage values. We review
the carrying value of our fixed assets and our intangible assets
for impairment when events or changes in circumstances indicate
that the carrying value of such assets may not be recoverable.

Fixed assets are stated at cost, net of
accumulated depreciation and amortization. Depreciation of fixed
assets 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.

19



---



##### 



We capitalize software development costs in
accordance with SOP 98-1, Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use
(SOP 98-1), under which certain internal use
software development costs incurred are capitalized and
depreciated. We capitalize costs when both the preliminary
project stage is completed and our management has authorized
further funding for the project. Capitalization of these costs
ceases no later than the point at which the project is
substantially complete and ready for its intended purpose. We
depreciate the capitalized internal use software development
costs using the straight-line method over the estimated useful
life of the software which is generally between four and seven
years. The carrying value of these assets on our balance sheet
at June 30, 2002 was $24.6 million, which represents
completed and in-process software development projects net of
depreciation. We regularly perform an assessment of our ability
to recover our investment in internal use software development
costs invested.

Intangible assets are carried at cost less
accumulated amortization. Amortization is provided on a
straight-line basis over the respective useful lives, which
range from three to twenty years.

Valuation of Financial Instruments.We enter into interest rate swap
agreements which are accounted for under Statement of Financial
Accounting Standards (SFAS) No. 133,
Accounting for Derivative Instruments and Hedging
Activities. Under SFAS No. 133, the increases and
decreases in fair value of these instruments is included in
comprehensive income/(loss) as reported on our Consolidated
Statement of Redeemable Convertible Preferred Stock and
Stockholders Equity. Any ineffective portion of an
instruments change in fair value will be immediately
recognized in operating results for the period. We have
historically entered into interest rate swap agreements to
minimize the impact of interest rate fluctuations. However,
these swap agreements will not protect us from all interest rate
risks. Circumstances that could impact the effectiveness of this
instrument are (1) the counter-party fails to meet the
terms of the instrument; (2) changes in the correlation
between the interest rate index and the interest rate earned on
our portfolio; and (3) significant reductions in our
projected balances of client funds deposited.

Valuation of Investments.All of our investments, including
payroll tax funds invested, are classified as available-for-sale
and stated at their fair market values, which are determined
based upon quoted market prices, where available. Unrealized
gains and losses on available-for-sale securities are included
in comprehensive income/(loss) as reported on our Consolidated
Statement of Redeemable Convertible Preferred Stock and
Stockholders Equity and are included as a separate
component of stockholders equity (deficit). Realized gains
and losses on available-for-sale securities are determined based
on the specific identification of the cost of securities sold.
Interest income is recognized when earned. Realized gains and
losses and interest income from payroll tax funds invested are
included in revenue. Realized gains and losses and interest
income from corporate investments are included in interest
income and other net. If the net realizable value of our
investments is determined to be less than historical cost, then
we determine whether a decline in fair value below the cost
basis is other than temporary. If the decline in
fair value is judged to be other than temporary, we write down
the cost basis of the individual security to fair value as a new
cost basis and the amount of the write-down shall be included in
earnings and accounted for as a realized loss. The new cost
basis will not be changed for subsequent recoveries in fair
value. If borrowers fail to meet the terms of their obligation
under these financial instruments, we would incur losses on
these investments.

Revenue Recognition.A majority of our revenues are
attributable to fees for providing payroll, payroll tax filing
and Comprehensive Outsourcing services, as well as, investment
income and realized gains and losses on payroll tax funds
invested.

We enter into contractual arrangements to provide
services with payroll, payroll tax filing and Comprehensive
Outsourcing clients, which typically range from three to five
years and provide for penalties in the case of early termination
by the customer. We recognize service revenue in accordance with
SAB 101 which requires that four basic criteria be met before
revenue can be recognized: (1) persuasive evidence of an
arrangement exists; (2) delivery has occurred or services
have been rendered; (3) a fee is fixed and determinable;
and (4) collectibility is reasonably assured. Determination
of collectibility is based on our judgments regarding the
collectibility of such fees. We make estimates for service
credits and allowances on services related to fees charged in
the same period as the related revenues are recorded and record
an allowance for these amounts. These estimates are based on
historical service credits, analysis of credit memo

20



---



##### 



data and other known factors. If the historical
data used to calculate these estimates do not properly reflect
future credits, then a change in the allowances would be made in
the period in which such a determination is made with an offset
to revenues. In addition, we make judgments on our ability to
collect outstanding receivables and provide an allowances for
the portion of receivables when collection becomes doubtful.
Provisions are made based upon a specific review of all
significant outstanding invoices. For those invoices not
specifically reviewed, provisions are provided at differing
rates, based upon the age of the receivable. In determining
these percentages, analysis is performed based upon historical
collection experience and current economic trends. If the
historical data used to calculate the allowance provided for
doubtful accounts does not reflect the future ability to collect
outstanding receivables, additional provisions for doubtful
accounts may be needed and the future results of operations
could be materially affected.


Interest income on collected but unremitted funds
held for clients are recognized in revenue as earned.

Effective July 1, 2000, we adopted the
Securities and Exchange Commission (SEC) Staff Accounting
Bulletin No. 101 Revenue Recognition in Financial
Statements (SAB 101). As a result, we changed
our accounting to recognize revenue from non-refundable, upfront
fees for implementation services, ratably beginning after
implementation over the expected contractual term using the
straight-line method. Additionally, we now treat the direct
costs of implementation as deferred charges that are amortized
as client acquisition costs using the straight-line method over
the term of the client contract. We defer direct implementation
costs including costs in excess of deferred revenue, which are
determined to be contractually recoverable. Recoverability of
deferred costs in excess of deferred revenue is reasonably
assured primarily as a result of penalties assessed for early
termination in the customers contract combined with the
gross margin we realize on our ongoing services rendered.

Accrual for Tax
Penalties.We have established an
estimated liability for known and potential errors and omissions
in performing our services related to our payroll tax filing
services that could result in additional payments to various
third parties for tax liabilities, penalties and interest. This
amount was estimated based upon a percent of total client funds
managed combined with specific probable settlements.

Deferred Income Taxes.As more fully described in Notes 1 and
7 to our Consolidated Financial Statements, we account for
income taxes using the liability method, under which deferred
tax assets and liabilities are determined based on differences
between the financial reporting and tax bases of our assets and
liabilities. We record a valuation allowance on our deferred tax
assets to arrive at an amount that is more likely than not to be
realized. In the future, should we determine that we are able to
realize all or part of our deferred tax assets, which presently
are fully reserved, an adjustment to our deferred tax assets
would increase income in the period in which the determination
was made.

Liquidity and Capital Resources

Since inception, we have financed our operations
primarily through sales of equity securities. On
December 20, 2001 we issued and sold 2,400,000 shares of
our common stock to private investors at $15.00 per share and
raised net proceeds of approximately $32.4 million. On
February 6, 2002 we issued and sold an additional 1,333,334
shares of our common stock to entities affiliated with General
Atlantic Partners, LLC at $15.00 per share and raised net
proceeds of approximately $18.8 million.

The following table highlights liquid assets held
for company use as of June 30, 2002 (in thousands):

|                                                 |  |           |        | 
|------------------------------------------------ |  | --------- | ------ | 
|                                                 |  | Amortized
|                                                 |  | Principal
|                                                 |  | Amount   
|                                                 |  |          
|Cash, cash equivalents                           |  | $         | 12,996 | 
|Short-term investments (91 days-1 year)          |  |           | 47,023 | 
|Long-term investments (1-2 years)                |  |           | 33,217 | 
|                                                 |  |           |        | 
|Total cash, cash equivalents and
    investments |  | $         | 93,236 | 
|                                                 |  |           |        | 

21



---



##### 



At June 30, 2002, we had $93.2 million
of cash and liquid investments, as well as a $30.0 million
secured revolving line of credit, which expires on
January 31, 2005. At June 30, 2002, we had no
outstanding borrowings under the line of credit. (See Note 4 of
Notes to Consolidated Financial Statements.)

The following table summarizes changes in cash
flow for the years ended June 30, 2001 and 2002 (in
thousands):

|                                                  |  |                     |         |        |  |      |        |        |  |      |         |   |  |   |         |   |  |   |         |  
|------------------------------------------------- |  | ------------------- | ------- | ------ |  | ---- | ------ | ------ |  | ---- | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                                  |  |                    
|                                                  |  | Year Ended June 30,
|                                                  |  |                    
|                                                  |  | 2000                |         | Change |  | 2001 |        | Change |  | 2002
|                                                  |  |                     |         |        |  |      |        |        |  |     
|Working Capital                                   |  | $                   | 40,179  |        |  | $    | 2,412  |        |  | $    | 42,591  |   |  | $ | 10,863  |   |  | $ | 53,454  |  
|Cash, cash equivalents and short-term investments |  | $                   | 40,921  |        |  | $    | 14,874 |        |  | $    | 55,795  |   |  | $ | 4,224   |   |  | $ | 60,019  |  
|Cash used in operating activities                 |  | $                   | (6,475  | )      |  | $    | 3,931  |        |  | $    | (2,544  | ) |  | $ | (4,206  | ) |  | $ | (6,750  | )
|Cash used in investing activities                 |  | $                   | (40,912 | )      |  | $    | 1,590  |        |  | $    | (39,322 | ) |  | $ | (28,758 | ) |  | $ | (68,080 | )
|Cash provided by financing activities             |  | $                   | 1,397   |        |  | $    | 41,577 |        |  | $    | 42,974  |   |  | $ | 16,159  |   |  | $ | 59,133  |  

Net cash used in operating activities increased
$4.2 million in FY2002 when compared to FY2001 and
decreased $3.9 million in FY2001 when compared to FY2000.
The increase in net cash used in operating activities in FY2002
compared to FY2001 was primarily due to a reduction of expense
accruals of $13.3 million associated with bonuses, tax
penalties, payroll taxes payable and other miscellaneous
operating expenses, partially offset by a decline in net losses
of $5.7 million and increased depreciation and amortization
expense of $5.7 due to additional fixed assets placed in service
in FY2002. The decrease in net cash used in operating activities
in FY2001 compared to FY2000 was primarily the result of
increases in accrued liabilities, depreciation and amortization
and a decrease in net accounts receivable, partially offset by
an increase in net loss and a decrease in deferred revenue.

Net cash used in operating activities for the
FY2002 was $6.8 million and the amount of cash and cash
equivalents, short-term and long-term investments on hand at
June 30, 2002 were $93.2 million. As our business is
seasonal, we typically experience a use of cash in operations in
the first two quarters of our fiscal year resulting from lower
cash balances on deposit from payroll tax funds invested. We
typically pay employee annual incentive compensation in the
first quarter of our fiscal year. We typically generate cash
from operations in the third quarter due to interest income
received from higher cash balances on deposit from payroll tax
funds invested and cash received from calendar year-end
invoicing, with our fourth quarter in general being a break-even
quarter from a cash flow perspective. We expect this trend of
cash used in operating activities to continue. (See
Additional Factors That May Affect Future Results)

Net cash used in investing activities was
$68.1 million, $39.3 million and $40.9 million
for FY2002, FY2001 and FY2000, respectively. The increase of
$28.8 million in net cash used in investing activities in
FY2002 compared to FY2001 is primarily a result of an increase
in net investment activity of $34.8 million, partially
offset by a decrease of $6.0 million in capital
expenditures for fixed assets. The increase in investments is
primarily a result of additional cash received in FY2002 from
issuance of common stock in a private placement. The decrease of
$1.6 million in net cash used in investing activities in
FY2001 compared to FY2000 is primarily a result of a decrease in
net investments of $0.5 million and a decrease of
$1.1 million in capital expenditures for fixed assets.

Net cash provided by financing activities was
$59.1 million, $43.0 million, and $1.4 million
for FY2002, FY2001 and FY2000, respectively. Net cash provided
by financing activities for FY2002 related primarily to
$57.9 million of net proceeds from the issuance of common
stock in a private placement and issuance of common stock
related to the employee stock purchase plan and the exercise of
employee stock options. Net cash provided by financing
activities for FY2001 related primarily to $29.8 million of
net proceeds from the issuance of redeemable convertible
preferred stock and issuance of common stock related to the
employee stock purchase plan and the exercise of employee stock
options and the release of the $4.6 million restricted cash
balance.

22



---



##### 



We believe that existing cash and cash equivalent
balances, short-term and long-term investments and amounts
available under our credit facility and anticipated cash flows
from operations will be sufficient to meet our operating and
capital expenditure requirements for at least the next
12 months. We may also utilize cash to acquire or invest in
complementary businesses or to obtain the right to use
complementary technologies. We may also sell additional equity
or debt securities or obtain additional credit facilities.



| |                        
| | -----------------------
| | Contractual Obligations

Our contractual obligations at June 30,
2002, are summarized as follows (in thousands):

|                          |                               |                        |        |             |  |             |       |             |  |        |        |        |  |   |        |        |  |   |        |        | 
|------------------------- | ----------------------------- | ---------------------- | ------ | ----------- |  | ----------- | ----- | ----------- |  | ------ | ------ | ------ |  | - | ------ | ------ |  | - | ------ | ------ | 
|                          |                               |                       
|                          |                               | Payments Due by Period
|                          |                               |                       
|                          |                               |                        |        | FY2004-     |  | FY2007-     |       |            
|                          |                               |                        |        | FY2003      |  | FY2006      |       | FY2008      |  | After 
|                          |                               | Total                  |        | Commitments |  | Commitments |       | Commitments |  | FY2008
|                          |                               |                        |        |             |  |             |       |             |  |       
|Note Payable              |                               | $                      | 1,288  |             |  | $           | 466   |             |  | $      | 822    |        |  | $ |       |        |  | $ |       |       
|Capital lease obligations |                               |                        | 132    |             |  |             | 132   |             |  |        |       |        |  |   |       |        |  |   |       |       
|Operating leases          |                               |                        | 72,364 |             |  |             | 6,718 |             |  |        | 19,782 |        |  |   | 12,779 |        |  |   | 33,085 |       
|                          |                               |                        |        |             |  |             |       |             |  |        |        |        |  |   |        |        |  |   |        |       
|                          | Total Contractual Obligations |                        | $      | 73,784      |  |             | $     | 7,316       |  |        | $      | 20,604 |  |   | $      | 12,779 |  |   | $      | 33,085 | 
|                          |                               |                        |        |             |  |             |       |             |  |        |        |        |  |   |        |        |  |   |        |       

We lease our facilities and various equipment
under non-cancelable operating leases, which expire at various
dates through 2011. The facility leases generally require us to
pay operating costs, including property taxes, insurance and
maintenance, and contain renewal options and provisions
adjusting the lease payments based upon changes in operating
costs or in fixed increments. Rent expense is reflected on a
straight-line basis over the terms of the related leases. We are
also obligated under capital equipment leases, which expire at
various dates through 2003.

We have committed to utilize $3.5 million of
software development services with a company providing onshore
and offshore development services. These services commenced on
July 1, 2002. We have no other significant commitments or
obligations other than those described in the analysis above. We
do not have any relationships with unconsolidated entities or
financial partnerships, such as entities often referred to as
structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance
sheet arrangements or other contractually narrow or limited
purposes. Further, we have not guaranteed any obligations of
unconsolidated entities nor have we any commitment or intent to
provide additional funding to any such entity.



| |                          
| | -------------------------
| | Other Balance Sheet Items

Prepaid expenses and other current assets were
$22.7 million at June 30, 2002 compared to
$12.6 million at June 30, 2001. The primary reason for
this increase was an increase in the fair market value of our
short-term derivatives and, to a lesser extent, an increase in
interest receivable.



| |                             
| | ----------------------------
| | New Accounting Pronouncement

In July 2001, the Financial Accounting Standards
Board (FASB) issued SFAS No. 141,
Business Combinations, and SFAS No. 142,
Goodwill and Other Intangible Assets. SFAS
No. 141 eliminates the pooling-of-interests method of
accounting for business combinations, except for qualifying
business combinations that were initiated prior to July 1,
2001. Under SFAS No. 142, goodwill and indefinite lived
intangible assets are no longer amortized but are reviewed
annually, or more frequently if impairment indicators arise, for
impairment. We adopted SFAS No. 142 on July 1, 2002,
and we believe SFAS Nos. 141 and 142 will not have a
material impact on our consolidated financial statements.

In October 2001, the FASB issued SFAS
No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, which supersedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of, and provides a single
accounting model for long-lived assets to be disposed of. We
adopted SFAS No. 144 on July 1, 2002, and we believe
that SFAS No. 144 will not have a material impact on our
consolidated financial statements.

23



---



##### 



In July 2002, the FASB issued SFAS No. 146
Accounting for Costs Associated with Exit or Disposal
Activities (FAS 146). FAS 146
addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies EITF
Issue No. 94-3. Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a
Restructuring) (EITF 94-3). The principal
difference between FAS 146 and EITF 94-3 relates to
FAS 146s requirements for the timing of recognizing a
liability for a cost associated with an exit or disposal
activity. FAS 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when
the liability is incurred. Under EITF 94-3 liability for an exit
cost was recognized at the date of an entitys commitment
to an exit plan. FAS 146 is effective for exit or disposal
activities that are initiated after December 31, 2002, with
early adoption encouraged. FAS 146 is applied prospectively
upon adoption and is not anticipated to have a material impact
on our current financial position or results of operations.

Item 7A.     Quantitative
and Qualitative Disclosures About Market Risk

We invest funds from collected but unremitted
payroll tax funds. In FY2002, we held certain derivative-based
products to mitigate interest rate fluctuation risk. In FY2000,
2001 and 2002, we entered into various interest rate swap
agreements with a financial institution. The purpose of these
agreements is to convert a portion of the interest we earn from
collected but unremitted payroll tax funds from a variable to a
fixed rate basis. We typically enter into hedge instruments with
notional amounts that cover the majority of our average daily
balance of the funds invested. As a result of the current
interest rate environment, we may not continue to enter into
swap agreements for a majority of these funds and will be
subject to interest rate fluctuations. Based on our derivative
positions at June 30, 2002, we reported a net asset of
$19.2 million for the fair value of our derivative
portfolio and a corresponding amount in other comprehensive
income. In FY2002, the fair value of our derivative based
products increased as a result of the downward trend in interest
rates throughout the year. Assuming a hypothetical decrease in
interest rates of 100 basis points given the June 30, 2002
derivative positions, the resulting potential increases in fair
value of the derivatives would be approximately
$10 million. Conversely, a corresponding increase in
interest rates would result in a comparable decrease in fair
value. This hypothetical decrease or increase in the fair value
of the portfolio would be recorded as an adjustment to the
portfolios recorded value, with an offsetting amount
recorded as other comprehensive income (loss) in the
statement of stockholders equity, with no related or
immediate impact to the results of operations.

The following is a table of interest rate swaps
agreements outstanding as of June 30, 2002 (dollars in
millions):

|                      |  |          |       |            |  |  |      |  
|--------------------- |  | -------- | ----- | ---------- |  |  | ---- | -
|                      |  | Average  |       | Fixed Rate
|                      |  | Notional |       | Received  
|                      |  | Amount   |       | on Swap   
|                      |  |          |       |           
|Expiring January 2003 |  | $        | 250.0 |            |  |  | 5.81 | %
|Expiring May 2003     |  | $        | 312.7 |            |  |  | 4.84 | %
|Expiring January 2005 |  | $        | 227.2 |            |  |  | 5.23 | %

The collateral exposure associated with our
various interest rate swap agreements are limited by interest
rate caps we hold. As of June 30, 2002, we held one
interest rate cap agreement with an expiration date of January
2003, with a cap rate of 8.0%. The aggregate fair value of this
cap agreement at June 30, 2002 was not material.

We place our investments with high quality credit
issuers and, by policy, limit the amount of credit exposure to
any one issuer. As stated in our investment policy, our first
priority is to reduce the risk on principal loss. Consequently,
we seek to preserve our invested funds by limiting default risk,
market risk, and reinvestment risk. Additionally, our investment
policy guidelines limit the size and duration of our individual
investments.

24



---



##### 





|        |                                                             
|------- | ------------------------------------------------------------
|Item 8. | Consolidated Financial Statements and
    Supplementary Data

PROBUSINESS SERVICES, INC.

FINANCIAL REPORTING INDEX

|                                                       |                                                                                                                                         |      |    |    | 
|------------------------------------------------------ | --------------------------------------------------------------------------------------------------------------------------------------- | ---- | -- | -- | 
|                                                       |                                                                                                                                         | Page
|                                                       |                                                                                                                                         |     
|Report of Ernst & Young, LLP, Independent
    Auditors |                                                                                                                                         |      | 26 |   
|                                                      
|Consolidated Financial Statements:                     |                                                                                                                                         |      |    |   
|                                                      
|                                                       | Consolidated Balance Sheets as of June 30,
    2001 and 2002                                                                            |      |    | 27 | 
|                                                      
|                                                       | Consolidated Statements of Operations for the
    years ended June 30, 2000, 2001 and 2002                                              |      |    | 28 | 
|                                                      
|                                                       | Consolidated Statements of Redeemable Preferred
    Stock and Stockholders Equity for the years ended
    June 30, 2000, 2001 and 2002 |      |    | 29 | 
|                                                      
|                                                       | Consolidated Statements of Cash Flows for the
    years ended June 30, 2000, 2001 and 2002                                              |      |    | 30 | 
|                                                      
|                                                       | Notes to Consolidated Financial Statements                                                                                              |      |    | 31 | 
|                                                      
|Quarterly Financial Data                               |                                                                                                                                         |      | 49 |   

25



---



##### 



REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Stockholders

ProBusiness Services, Inc.


We have audited the accompanying consolidated
balance sheets of ProBusiness Services, Inc. as of June 30,
2001 and 2002, and the related consolidated statements of
operations, redeemable convertible preferred stock and
stockholders equity, and cash flows for each of the three
years in the period ended June 30, 2002. 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
auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the consolidated financial
statements referred to above present fairly, in all material
respects, the consolidated financial position of ProBusiness
Services, Inc. at June 30, 2001 and 2002, and the
consolidated results of its operations and its cash flows for
each of the three years in the period ended June 30, 2002,
in conformity with accounting principles generally accepted in
the United States.



| |                       
| | ----------------------
| | /s/ ERNST & YOUNG, LLP

Walnut Creek, California

July 26, 2002, except for note 15,


as to which the date is August 29, 2002


26



---



##### 



PROBUSINESS SERVICES, INC.

CONSOLIDATED BALANCE SHEETS

|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          |                             |           |         |   |   |           |          |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | --------------------------- | --------- | ------- | - | - | --------- | -------- | -
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          |                            
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          | June 30,                   
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          |                            
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          | 2001                        |           | 2002   
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          |                             |           |        
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          |                            
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          | (In thousands, except share
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          | and per share amounts)     
|ASSETS                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                   
|Current assets:                                                                                                                                                                                                                                                     |                                                                                                                                                                          |                             |           |         |   |   |           |         
|                                                                                                                                                                                                                                                                    | Cash and cash equivalents                                                                                                                                                |                             | $         | 28,693  |   |   | $         | 12,996   |  
|                                                                                                                                                                                                                                                                    | Short-term investments                                                                                                                                                   |                             |           | 27,102  |   |   |           | 47,023   |  
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          |                             |           |         |   |   |           |         
|Total cash, cash equivalents and short-term
    investments                                                                                                                                                                                                         |                                                                                                                                                                          |                             | 55,795    |         |   |   | 60,019    |         
|                                                                                                                                                                                                                                                                    | Accounts receivable, net of allowances of $1,968
    at June 30, 2001, and $1,494 at June 30, 2002                                                                       |                             |           | 12,774  |   |   |           | 11,692   |  
|                                                                                                                                                                                                                                                                    | Prepaid expenses and other current assets                                                                                                                                |                             |           | 12,597  |   |   |           | 22,686   |  
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          |                             |           |         |   |   |           |         
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          |                             | 81,166    |         |   |   | 94,397    |         
|Payroll tax funds invested                                                                                                                                                                                                                                          |                                                                                                                                                                          |                             | 1,511,124 |         |   |   | 1,705,209 |         
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          |                             |           |         |   |   |           |         
|Total current assets                                                                                                                                                                                                                                                |                                                                                                                                                                          |                             | 1,592,290 |         |   |   | 1,799,606 |         
|Long-term investments                                                                                                                                                                                                                                               |                                                                                                                                                                          |                             | 3,200     |         |   |   | 33,217    |         
|Fixed assets, net                                                                                                                                                                                                                                                   |                                                                                                                                                                          |                             | 64,806    |         |   |   | 63,921    |         
|Other assets                                                                                                                                                                                                                                                        |                                                                                                                                                                          |                             | 20,830    |         |   |   | 19,786    |         
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          |                             |           |         |   |   |           |         
|Total assets                                                                                                                                                                                                                                                        |                                                                                                                                                                          | $                           | 1,681,126 |         |   | $ | 1,916,530 |         
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          |                             |           |         |   |   |           |         
|                                                                                                                                                                                                                                                                   
|LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED
    STOCK AND STOCKHOLDERS EQUITY                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                   
|Current Liabilities:                                                                                                                                                                                                                                                |                                                                                                                                                                          |                             |           |         |   |   |           |         
|                                                                                                                                                                                                                                                                    | Accounts payable                                                                                                                                                         |                             | $         | 5,845   |   |   | $         | 5,693    |  
|                                                                                                                                                                                                                                                                    | Accrued liabilities                                                                                                                                                      |                             |           | 28,011  |   |   |           | 26,203   |  
|                                                                                                                                                                                                                                                                    | Deferred revenue                                                                                                                                                         |                             |           | 4,596   |   |   |           | 8,456    |  
|                                                                                                                                                                                                                                                                    | Current portion of capital lease obligations                                                                                                                             |                             |           | 123     |   |   |           | 125      |  
|                                                                                                                                                                                                                                                                    | Current portion of note payable                                                                                                                                          |                             |           |        |   |   |           | 466      |  
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          |                             |           |         |   |   |           |         
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          |                             | 38,575    |         |   |   | 40,943    |         
|Payroll tax funds collected but unremitted                                                                                                                                                                                                                          |                                                                                                                                                                          |                             | 1,511,124 |         |   |   | 1,705,209 |         
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          |                             |           |         |   |   |           |         
|Total current liabilities                                                                                                                                                                                                                                           |                                                                                                                                                                          |                             | 1,549,699 |         |   |   | 1,746,152 |         
|Deferred liabilities, less current portion                                                                                                                                                                                                                          |                                                                                                                                                                          |                             | 18,790    |         |   |   | 23,209    |         
|Capital lease obligations, less current portion                                                                                                                                                                                                                     |                                                                                                                                                                          |                             | 137       |         |   |   |          |         
|Note payable, less current portion                                                                                                                                                                                                                                  |                                                                                                                                                                          |                             |          |         |   |   | 822       |         
|Commitments and contingencies                                                                                                                                                                                                                                       |                                                                                                                                                                          |                             |          |         |   |   |          |         
|Redeemable convertible preferred stock, $.001 par
    value; authorized: 1,800,000 shares; issued and outstanding:
    1,132,075 at June 30, 2001 and June 30, 2002
    (Liquidation preference of $31,400 and $33,625 at June 30,
    2001 and 2002, respectively) |                                                                                                                                                                          |                             | 31,246    |         |   |   | 33,471    |         
|Stockholders equity:                                                                                                                                                                                                                                               |                                                                                                                                                                          |                             |           |         |   |   |           |         
|                                                                                                                                                                                                                                                                    | Preferred stock, $.001 par value; authorized:
    3,200,000 shares; issued and outstanding: none at June 30,
    2001 and June 30, 2002                                  |                             |           |        |   |   |           |         |  
|                                                                                                                                                                                                                                                                    | Common stock, $.001 par value; authorized:
    60,000,000 shares; issued and outstanding: 24,138,617 shares at
    June 30, 2001, and 28,389,454 shares at June 30, 2002 |                             |           | 24      |   |   |           | 28       |  
|                                                                                                                                                                                                                                                                    | Additional paid-in capital                                                                                                                                               |                             |           | 163,411 |   |   |           | 221,341  |  
|                                                                                                                                                                                                                                                                    | Notes receivable from stockholders                                                                                                                                       |                             |           | (87     | ) |   |           |         |  
|                                                                                                                                                                                                                                                                    | Accumulated deficit                                                                                                                                                      |                             |           | (96,403 | ) |   |           | (126,087 | )
|                                                                                                                                                                                                                                                                    | Accumulated other comprehensive income                                                                                                                                   |                             |           | 14,309  |   |   |           | 17,594   |  
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          |                             |           |         |   |   |           |         
|Total stockholders equity                                                                                                                                                                                                                                          |                                                                                                                                                                          |                             | 81,254    |         |   |   | 112,876   |         
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          |                             |           |         |   |   |           |         
|Total liabilities, redeemable convertible
    preferred stock and stockholders equity                                                                                                                                                                              |                                                                                                                                                                          | $                           | 1,681,126 |         |   | $ | 1,916,530 |         
|                                                                                                                                                                                                                                                                    |                                                                                                                                                                          |                             |           |         |   |   |           |         

See accompanying notes.

27



---



##### 



PROBUSINESS SERVICES, INC.



CONSOLIDATED STATEMENTS OF
OPERATIONS


|                                                                        |                                                                |                       |         |         |   |      |         |         |   |   |         |         |  
|----------------------------------------------------------------------- | -------------------------------------------------------------- | --------------------- | ------- | ------- | - | ---- | ------- | ------- | - | - | ------- | ------- | -
|                                                                        |                                                                |                      
|                                                                        |                                                                | Year Ended June 30,  
|                                                                        |                                                                |                      
|                                                                        |                                                                | 2000                  |         | 2001    |   | 2002
|                                                                        |                                                                |                       |         |         |   |     
|                                                                        |                                                                |                      
|                                                                        |                                                                | (In thousands, except
|                                                                        |                                                                | per share amounts)   
|Revenue:                                                                |                                                                |                       |         |         |   |      |         |         |   |   |         |        
|                                                                        | Service fees                                                   |                       | $       | 74,378  |   |      | $       | 104,835 |   |   | $       | 122,223 |  
|                                                                        | Interest income from payroll tax funds invested                |                       |         | 29,694  |   |      |         | 45,026  |   |   |         | 46,417  |  
|                                                                        |                                                                |                       |         |         |   |      |         |         |   |   |         |        
|Total revenue                                                           |                                                                |                       | 104,072 |         |   |      | 149,861 |         |   |   | 168,640 |        
|Operating expenses:                                                     |                                                                |                       |         |         |   |      |         |         |   |   |         |        
|                                                                        | Cost of providing services                                     |                       |         | 42,897  |   |      |         | 69,040  |   |   |         | 74,557  |  
|                                                                        | General and administrative                                     |                       |         | 13,858  |   |      |         | 22,478  |   |   |         | 25,683  |  
|                                                                        | Research and development                                       |                       |         | 11,159  |   |      |         | 17,183  |   |   |         | 21,345  |  
|                                                                        | Client acquisition costs                                       |                       |         | 42,261  |   |      |         | 64,018  |   |   |         | 57,018  |  
|                                                                        | Depreciation and amortization                                  |                       |         | 10,729  |   |      |         | 13,689  |   |   |         | 19,407  |  
|                                                                        |                                                                |                       |         |         |   |      |         |         |   |   |         |        
|Total operating expenses                                                |                                                                |                       | 120,904 |         |   |      | 186,408 |         |   |   | 198,010 |        
|                                                                        |                                                                |                       |         |         |   |      |         |         |   |   |         |        
|Loss from operations                                                    |                                                                |                       | (16,832 | )       |   |      | (36,547 | )       |   |   | (29,370 | )      
|Interest expense                                                        |                                                                |                       | (512    | )       |   |      | (952    | )       |   |   | (824    | )      
|Interest income and other, net                                          |                                                                |                       | 3,427   |         |   |      | 3,898   |         |   |   | 2,735   |        
|                                                                        |                                                                |                       |         |         |   |      |         |         |   |   |         |        
|Net loss before cumulative effect of change in
    accounting principle |                                                                |                       | (13,917 | )       |   |      | (33,601 | )       |   |   | (27,459 | )      
|Cumulative effect of change in accounting
    principle                 |                                                                |                       |        |         |   |      | 410     |         |   |   |        |        
|                                                                        |                                                                |                       |         |         |   |      |         |         |   |   |         |        
|Net loss                                                                |                                                                | $                     | (13,917 | )       |   | $    | (33,191 | )       |   | $ | (27,459 | )      
|                                                                        |                                                                |                       |         |         |   |      |         |         |   |   |         |        
|Net loss applicable to common shareholders:                             |                                                                |                       |         |         |   |      |         |         |   |   |         |        
|                                                                        | Net loss                                                       |                       | $       | (13,917 | ) |      | $       | (33,191 | ) |   | $       | (27,459 | )
|                                                                        | Preferred dividends                                            |                       |         |        |   |      |         | 1,399   |   |   |         | 2,225   |  
|                                                                        |                                                                |                       |         |         |   |      |         |         |   |   |         |        
|Net loss applicable to common shareholders                              |                                                                | $                     | (13,917 | )       |   | $    | (34,590 | )       |   | $ | (29,684 | )      
|                                                                        |                                                                |                       |         |         |   |      |         |         |   |   |         |        
|Basic and diluted net loss per share:                                   |                                                                |                       |         |         |   |      |         |         |   |   |         |        
|                                                                        | Before cumulative effect of change in accounting
    principle |                       | $       | (0.60   | ) |      | $       | (1.47   | ) |   | $       | (1.13   | )
|                                                                        | Cumulative effect of change in accounting
    principle        |                       |         |        |   |      |         | 0.02    |   |   |         |        |  
|                                                                        |                                                                |                       |         |         |   |      |         |         |   |   |         |        
|Basic and diluted net loss per share                                    |                                                                | $                     | (0.60   | )       |   | $    | (1.45   | )       |   | $ | (1.13   | )      
|                                                                        |                                                                |                       |         |         |   |      |         |         |   |   |         |        
|Shares used in computing basic and diluted net
    loss per share       |                                                                |                       | 23,229  |         |   |      | 23,840  |         |   |   | 26,212  |        
|                                                                        |                                                                |                       |         |         |   |      |         |         |   |   |         |        

See accompanying notes.

28



---



##### 



PROBUSINESS SERVICES, INC.



CONSOLIDATED STATEMENTS OF REDEEMABLE
CONVERTIBLE PREFERRED STOCK


AND STOCKHOLDERS EQUITY


|                                                                                                                   |                                                                |                 |           |                 |  |                      |        |            |  |                                      |   |             |  |               |   |              |  |         |            |               |  |        |    |   |  |   |         |   |  |   |      |   |  |   |          |   |  |   |        |        |   |   |         |        |  
|------------------------------------------------------------------------------------------------------------------ | -------------------------------------------------------------- | --------------- | --------- | --------------- |  | -------------------- | ------ | ---------- |  | ------------------------------------ | - | ----------- |  | ------------- | - | ------------ |  | ------- | ---------- | ------------- |  | ------ | -- | - |  | - | ------- | - |  | - | ---- | - |  | - | -------- | - |  | - | ------ | ------ | - | - | ------- | ------ | -
|                                                                                                                   |                                                                |                 |           |                 |  |                     
|                                                                                                                   |                                                                |                 |           |                 |  | Stockholders Equity
|                                                                                                                   |                                                                |                 |           |                 |  |                     
|                                                                                                                   |                                                                |                 |           |                 |  |                      |        |            |  |                                     
|                                                                                                                   |                                                                |                 |           |                 |  | Common Stock         |        |           
|                                                                                                                   |                                                                | Redeemable      |           |                 |  |                      |        |           
|                                                                                                                   |                                                                | Convertible     |           |                 |  |                      |        | Notes      |  |                                      |   | Accumulated |  |              
|                                                                                                                   |                                                                | Preferred Stock |           | Preferred Stock |  |                      |        | Additional |  | Receivable                           |   |             |  | Other         |   | Total       
|                                                                                                                   |                                                                |                 |           |                 |  |                      |        | Paid in    |  | From                                 |   | Accumulated |  | Comprehensive |   | Stockholders
|                                                                                                                   |                                                                | Shares          |           | Amount          |  | Shares               |        | Amount     |  | Shares                               |   | Amount      |  | Capital       |   | Stockholders |  | Deficit |            | Income/(Loss) |  | Equity
|                                                                                                                   |                                                                |                 |           |                 |  |                      |        |            |  |                                      |   |             |  |               |   |              |  |         |            |               |  |       
|                                                                                                                   |                                                                |                 |           |                 |  |                      |        |            |  |                                      |   |             |  |               |   |             
|                                                                                                                   |                                                                |                 |           |                 |  |                      |        |            |  | (In thousands, except share amounts) |   |             |  |               |   |             
|Balances at June 30, 1999                                                                                          |                                                                |                 |          |                 |  | $                    |       |            |  |                                      |  |             |  | $             |  |              |  |         | 22,942,362 |               |  | $      | 23 |   |  | $ | 148,284 |   |  | $ | (881 | ) |  | $ | (47,896  | ) |  | $ |       |        |   | $ | 99,530  |       
|Exercise of common stock warrants                                                                                  |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         |           |               |  |        |   |   |  |   | 259     |   |  |   |     |   |  |   |         |   |  |   |       |        |   |   | 259     |       
|Exercise of common stock options, net of
    repurchased shares                                                    |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         | 336,884    |               |  |        |   |   |  |   | 2,460   |   |  |   |     |   |  |   |         |   |  |   |       |        |   |   | 2,460   |       
|Issuance of common stock under the employee stock
    purchase plan                                                |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         | 304,781    |               |  |        |   |   |  |   | 3,525   |   |  |   |     |   |  |   |         |   |  |   |       |        |   |   | 3,525   |       
|Repayment of notes receivable from stockholders                                                                    |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         |           |               |  |        |   |   |  |   |        |   |  |   | 593  |   |  |   |         |   |  |   |       |        |   |   | 593     |       
|Net loss and comprehensive loss                                                                                    |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         |           |               |  |        |   |   |  |   |        |   |  |   |     |   |  |   | (13,917  | ) |  |   |       |        |   |   | (13,917 | )     
|                                                                                                                   |                                                                |                 |           |                 |  |                      |        |            |  |                                      |   |             |  |               |   |              |  |         |            |               |  |        |    |   |  |   |         |   |  |   |      |   |  |   |          |   |  |   |        |        |   |   |         |       
|Balances at June 30, 2000                                                                                          |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         | 23,584,027 |               |  |        | 23 |   |  |   | 154,528 |   |  |   | (288 | ) |  |   | (61,813  | ) |  |   |       |        |   |   | 92,450  |       
|Issuance of redeemable convertible preferred
    stock in connection with additional funding, net of funding costs |                                                                |                 | 1,132,075 |                 |  |                      | 29,847 |            |  |                                      |  |             |  |               |  |              |  |         |           |               |  |        |   |   |  |   |        |   |  |   |     |   |  |   |         |   |  |   |       |        |   |   |        |       
|Redeemable convertible preferred stock dividend                                                                    |                                                                |                 |          |                 |  |                      | 1,399  |            |  |                                      |  |             |  |               |  |              |  |         |           |               |  |        |   |   |  |   |        |   |  |   |     |   |  |   | (1,399   | ) |  |   |       |        |   |   | (1,399  | )     
|Exercise of common stock warrants                                                                                  |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         | 23,039     |               |  |        |   |   |  |   |        |   |  |   |     |   |  |   |         |   |  |   |       |        |   |   |        |       
|Exercise of common stock options                                                                                   |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         | 315,360    |               |  |        | 1  |   |  |   | 4,346   |   |  |   |     |   |  |   |         |   |  |   |       |        |   |   | 4,347   |       
|Issuance of common stock under the employee stock
    purchase plan                                                |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         | 216,191    |               |  |        |   |   |  |   | 4,537   |   |  |   |     |   |  |   |         |   |  |   |       |        |   |   | 4,537   |       
|Repayment of notes receivable from stockholders                                                                    |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         |           |               |  |        |   |   |  |   |        |   |  |   | 201  |   |  |   |         |   |  |   |       |        |   |   | 201     |       
|Net loss                                                                                                           |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         |           |               |  |        |   |   |  |   |        |   |  |   |     |   |  |   | (33,191  | ) |  |   |       |        |   |   | (33,191 | )     
|Other comprehensive income/(loss):                                                                                 |                                                                |                 |           |                 |  |                      |        |            |  |                                      |   |             |  |               |   |              |  |         |            |               |  |        |    |   |  |   |         |   |  |   |      |   |  |   |          |   |  |   |        |        |   |   |         |       
|                                                                                                                   | Cumulative effect of adoption of SFAS No 133                   |                 |           |                |  |                      |        |           |  |                                      |   |            |  |               |   |             |  |         |            |              |  |        |    |  |  |   |         |  |  |   |      |  |  |   |          |  |  |   |        | (5,016 | ) |   |         | (5,016 | )
|                                                                                                                   | Increase in fair value of derivative instruments
    and other |                 |           |                |  |                      |        |           |  |                                      |   |            |  |               |   |             |  |         |            |              |  |        |    |  |  |   |         |  |  |   |      |  |  |   |          |  |  |   |        | 19,325 |   |   |         | 19,325 |  
|                                                                                                                   |                                                                |                 |           |                 |  |                      |        |            |  |                                      |   |             |  |               |   |              |  |         |            |               |  |        |    |   |  |   |         |   |  |   |      |   |  |   |          |   |  |   |        |        |   |   |         |       
|Total comprehensive loss                                                                                           |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         |           |               |  |        |   |   |  |   |        |   |  |   |     |   |  |   |         |   |  |   |       |        |   |   | (18,882 | )     
|                                                                                                                   |                                                                |                 |           |                 |  |                      |        |            |  |                                      |   |             |  |               |   |              |  |         |            |               |  |        |    |   |  |   |         |   |  |   |      |   |  |   |          |   |  |   |        |        |   |   |         |       
|Balances at June 30, 2001                                                                                          |                                                                |                 | 1,132,075 |                 |  |                      | 31,246 |            |  |                                      |  |             |  |               |  |              |  |         | 24,138,617 |               |  |        | 24 |   |  |   | 163,411 |   |  |   | (87  | ) |  |   | (96,403  | ) |  |   | 14,309 |        |   |   | 81,254  |       
|Redeemable convertible preferred stock dividend                                                                    |                                                                |                 |          |                 |  |                      | 2,225  |            |  |                                      |  |             |  |               |  |              |  |         |           |               |  |        |   |   |  |   |        |   |  |   |     |   |  |   | (2,225   | ) |  |   |       |        |   |   | (2,225  | )     
|Issuance of common stock under private placement,
    net of funding costs of $4,841                               |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         | 3,733,334  |               |  |        | 4  |   |  |   | 51,159  |   |  |   |     |   |  |   |         |   |  |   |       |        |   |   | 51,163  |       
|Exercise of common stock warrants                                                                                  |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         | 4,335      |               |  |        |   |   |  |   | 41      |   |  |   |     |   |  |   |         |   |  |   |       |        |   |   | 41      |       
|Exercise of common stock options                                                                                   |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         | 218,186    |               |  |        |   |   |  |   | 2,351   |   |  |   |     |   |  |   |         |   |  |   |       |        |   |   | 2,351   |       
|Issuance of common stock under the employee stock
    purchase plan                                                |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         | 294,982    |               |  |        |   |   |  |   | 4,379   |   |  |   |     |   |  |   |         |   |  |   |       |        |   |   | 4,379   |       
|Repayment of notes receivable from stockholders                                                                    |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         |           |               |  |        |   |   |  |   |        |   |  |   | 87   |   |  |   |         |   |  |   |       |        |   |   | 87      |       
|Net loss                                                                                                           |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         |           |               |  |        |   |   |  |   |        |   |  |   |     |   |  |   | (27,459  | ) |  |   |       |        |   |   | (27,459 | )     
|Other comprehensive loss:                                                                                          |                                                                |                 |           |                 |  |                      |        |            |  |                                      |   |             |  |               |   |              |  |         |            |               |  |        |    |   |  |   |         |   |  |   |      |   |  |   |          |   |  |   |        |        |   |   |         |       
|                                                                                                                   | Increase in fair value of derivative instruments               |                 |           |                |  |                      |        |           |  |                                      |   |            |  |               |   |             |  |         |            |              |  |        |    |  |  |   |         |  |  |   |      |  |  |   |          |  |  |   |        | 5,039  |   |   |         | 5,039  |  
|                                                                                                                   | Unrealized losses on available for sale securities             |                 |           |                 |  |                      |        |            |  |                                      |   |             |  |               |   |              |  |         |            |               |  |        |    |   |  |   |         |   |  |   |      |   |  |   |          |   |  |   |        | (1,754 | ) |   |         | (1,754 | )
|                                                                                                                   |                                                                |                 |           |                 |  |                      |        |            |  |                                      |   |             |  |               |   |              |  |         |            |               |  |        |    |   |  |   |         |   |  |   |      |   |  |   |          |   |  |   |        |        |   |   |         |       
|Total comprehensive loss                                                                                           |                                                                |                 |          |                 |  |                      |       |            |  |                                      |  |             |  |               |  |              |  |         |           |               |  |        |   |   |  |   |        |   |  |   |     |   |  |   |         |   |  |   |       |        |   |   | (24,174 | )     
|                                                                                                                   |                                                                |                 |           |                 |  |                      |        |            |  |                                      |   |             |  |               |   |              |  |         |            |               |  |        |    |   |  |   |         |   |  |   |      |   |  |   |          |   |  |   |        |        |   |   |         |       
|Balances at June 30, 2002                                                                                          |                                                                |                 | 1,132,075 |                 |  | $                    | 33,471 |            |  |                                      |  |             |  | $             |  |              |  |         | 28,389,454 |               |  | $      | 28 |   |  | $ | 221,341 |   |  | $ |     |   |  | $ | (126,087 | ) |  | $ | 17,594 |        |   | $ | 112,876 |       
|                                                                                                                   |                                                                |                 |           |                 |  |                      |        |            |  |                                      |   |             |  |               |   |              |  |         |            |               |  |        |    |   |  |   |         |   |  |   |      |   |  |   |          |   |  |   |        |        |   |   |         |       

See accompanying notes.

29



---



##### 



PROBUSINESS SERVICES, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                                     |                                                                                 |                                              |                                           |      |        |        |         |   |        |        |         |   |        |        |  
|-------------------------------------------------------------------- | ------------------------------------------------------------------------------- | -------------------------------------------- | ----------------------------------------- | ---- | ------ | ------ | ------- | - | ------ | ------ | ------- | - | ------ | ------ | -
|                                                                     |                                                                                 |                                             
|                                                                     |                                                                                 | Year Ended June 30,                         
|                                                                     |                                                                                 |                                             
|                                                                     |                                                                                 | 2000                                         |                                           | 2001 |        | 2002  
|                                                                     |                                                                                 |                                              |                                           |      |        |       
|                                                                     |                                                                                 |                                             
|                                                                     |                                                                                 | (In thousands)                              
|Operating activities                                                 |                                                                                 |                                              |                                           |      |        |        |         |   |        |        |         |  
|Net loss                                                             |                                                                                 | $                                            | (13,917                                   | )    |        | $      | (33,191 | ) |        | $      | (27,459 | )
|                                                                     | Adjustments to reconcile net loss to net cash
    used in operating activities: |                                              |                                           |      |        |        |         |   |        |        |         |   |       
|                                                                     |                                                                                 | Depreciation and amortization                |                                           |      | 10,729 |        |         |   | 13,689 |        |         |   | 19,407 |       
|                                                                     |                                                                                 | Loss on disposal of fixed assets             |                                           |      |       |        |         |   | 1,401  |        |         |   | 314    |       
|                                                                     |                                                                                 | Cumulative effect of accounting change       |                                           |      |       |        |         |   | (410   | )      |         |   |       |       
|                                                                     |                                                                                 | Changes in operating assets and liabilities: |                                           |      |        |        |         |   |        |        |         |   |        |       
|                                                                     |                                                                                 |                                              | Accounts receivable, net                  |      |        | (6,170 | )       |   |        | (2,005 | )       |   |        | 1,082  |  
|                                                                     |                                                                                 |                                              | Prepaid expenses and other current assets |      |        | (1,527 | )       |   |        | (2,867 | )       |   |        | (3,039 | )
|                                                                     |                                                                                 |                                              | Other assets                              |      |        | (840   | )       |   |        | (2,129 | )       |   |        | (3,415 | )
|                                                                     |                                                                                 |                                              | Accounts payable                          |      |        | 412    |         |   |        | 1,776  |         |   |        | (152   | )
|                                                                     |                                                                                 |                                              | Accrued liabilities                       |      |        | (6,103 | )       |   |        | 15,514 |         |   |        | 2,225  |  
|                                                                     |                                                                                 |                                              | Deferred revenue                          |      |        | 10,941 |         |   |        | 5,678  |         |   |        | 4,287  |  
|                                                                     |                                                                                 |                                              |                                           |      |        |        |         |   |        |        |         |  
|Net cash used in operating activities                                |                                                                                 |                                              | (6,475                                    | )    |        |        | (2,544  | ) |        |        | (6,750  | )
|Investing activities                                                 |                                                                                 |                                              |                                           |      |        |        |         |   |        |        |         |  
|Purchases of available for sale investments                          |                                                                                 |                                              | (15,335                                   | )    |        |        | (43,941 | ) |        |        | (94,988 | )
|Maturities of available for sale investments                         |                                                                                 |                                              |                                          |      |        |        | 29,107  |   |        |        | 45,374  |  
|Purchases of fixed assets                                            |                                                                                 |                                              | (25,577                                   | )    |        |        | (24,488 | ) |        |        | (18,466 | )
|                                                                     |                                                                                 |                                              |                                           |      |        |        |         |   |        |        |         |  
|Net cash used in investing activities                                |                                                                                 |                                              | (40,912                                   | )    |        |        | (39,322 | ) |        |        | (68,080 | )
|Financing activities                                                 |                                                                                 |                                              |                                           |      |        |        |         |   |        |        |         |  
|(Increase) decrease in restricted cash                               |                                                                                 |                                              | (4,616                                    | )    |        |        | 4,616   |   |        |        |        |  
|Proceeds from long-term debt and notes payable                       |                                                                                 |                                              |                                          |      |        |        |        |   |        |        | 1,500   |  
|Repayments under long-term debt and notes payable                    |                                                                                 |                                              |                                          |      |        |        |        |   |        |        | (212    | )
|Principal payments on capital lease obligations                      |                                                                                 |                                              | (824                                      | )    |        |        | (574    | ) |        |        | (135    | )
|Proceeds from issuance of redeemable convertible
    preferred stock |                                                                                 |                                              |                                          |      |        |        | 29,847  |   |        |        |        |  
|Proceeds from issuance of common stock, net of
    funding costs     |                                                                                 |                                              | 6,244                                     |      |        |        | 8,884   |   |        |        | 57,893  |  
|Repayment of notes receivable from stockholder                       |                                                                                 |                                              | 593                                       |      |        |        | 201     |   |        |        | 87      |  
|                                                                     |                                                                                 |                                              |                                           |      |        |        |         |   |        |        |         |  
|Net cash provided by financing activities                            |                                                                                 |                                              | 1,397                                     |      |        |        | 42,974  |   |        |        | 59,133  |  
|                                                                     |                                                                                 |                                              |                                           |      |        |        |         |   |        |        |         |  
|Net increase (decrease) in cash and cash
    equivalents             |                                                                                 |                                              | (45,990                                   | )    |        |        | 1,108   |   |        |        | (15,697 | )
|Cash and cash equivalents, beginning of period                       |                                                                                 |                                              | 73,575                                    |      |        |        | 27,585  |   |        |        | 28,693  |  
|                                                                     |                                                                                 |                                              |                                           |      |        |        |         |   |        |        |         |  
|Cash and cash equivalents, end of period                             |                                                                                 | $                                            | 27,585                                    |      |        | $      | 28,693  |   |        | $      | 12,996  |  
|                                                                     |                                                                                 |                                              |                                           |      |        |        |         |   |        |        |         |  
|Supplemental disclosure of cash flow
    information                 |                                                                                 |                                              |                                           |      |        |        |         |   |        |        |         |  
|Interest paid                                                        |                                                                                 | $                                            | 475                                       |      |        | $      | 613     |   |        | $      | 924     |  
|                                                                     |                                                                                 |                                              |                                           |      |        |        |         |   |        |        |         |  

See accompanying notes.

30



---



##### 



PROBUSINESS SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

1.     The Company
and Summary of Significant Accounting Policies

Operations

ProBusiness Services, Inc. (the
Company) provides comprehensive administrative
outsourced employee services for large employers nationwide. The
Companys primary service offerings are payroll processing,
payroll tax filing, benefits administration services,
Comprehensive Outsourcing services, human resources services and
Web self-service solutions.

On September 30, 1999, the Company formed a
wholly-owned subsidiary, ProBusiness Holding Company, Inc.
(ProBusiness Holdings), in order to meet the
requirements of certain clients associated with the transfer,
investment and distribution of payroll tax funds invested. All
client payroll tax funds transferred to the Company are directed
to, and maintained by, ProBusiness Holdings. ProBusiness
Holdings responsibilities are limited to the payment of
all payroll tax funds collected but unremitted and the transfer
to the Company of all interest income and realized gains and
losses on investments derived from such balances.

Basis of
Presentation

The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiary. All
significant intercompany transactions and balances have been
eliminated in consolidation.

Business
Activities

Payroll Processing.The Company processes time and
attendance data to calculate and produce employee paychecks,
direct deposits and reports for its clients. The Companys
clients receive paychecks and reports of their electronically
submitted data. The system integrates easily with the
clients general ledger, human resource, and time and
attendance systems. In addition, the Company offers features,
including the automatic enrollment and tracking of paid time off
and integrated garnishment processing.

Payroll Tax Filing.The Company calculates and collects
contributed employer and employee payroll tax funds from clients
and deposits such funds with the appropriate tax authorities
when due. The Company also files all payroll tax returns and
represents clients before tax authorities in disputes or
inquiries. The majority of the Companys existing payroll
clients also utilize the Companys payroll tax service.

Benefits Administration Services.The Companys benefits
administration services include flexible benefits enrollment and
processing, COBRA administration and consolidated billing and
eligibility tracking. These services include data management,
transaction processing and employee inquiry management.

Comprehensive Outsourcing Services.The Companys Comprehensive
Outsourcing service offering, which includes payroll
administration, serves as an extension of the clients
business as the Company fully manages employee inquiries and
other departmental administrative functions for payroll, human
resource and benefits in addition to the traditional back-office
processing services. When a client adopts the Comprehensive
Outsourcing service offering, the Company assumes the management
of such transactional administration as the recording and
verification of time, the issuance of manual checks, the
enrollment of employees in flexible spending benefit programs
and the auditing and balancing of payroll.

Human Resources Services.The Companys human resources
service offering (HR) tracks and reports general
employee information, including compensation, benefits, skills,
performance, training, job titles and medical history. For
clients who also use the Companys payroll service, the HR
data can be integrated with the payroll service system to
eliminate the need for duplicate data entry.

Web Self-Service Solutions.The Companys Web self-service
solutions provide employers with a complete range of employee
relationship management services. Employers have a Web tool,
which not only

31



---



##### 



PROBUSINESS SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

facilitates human resource and payroll processes,
but also allows employees to utilize self-directed
administration services.

Use of
Estimates

The preparation of financial statements and the
related disclosures in conformity with accounting principles
generally accepted in the United States 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 amounts reported in the consolidated
financial statements and accompanying notes. For the Company,
such estimates include, but are not limited to, service credit
revenue reserve, provisions for doubtful accounts and penalty
interest relating to payroll tax processing, impairment charges
related to long lived assets, useful lives assigned for
depreciation and amortization of assets, valuation of
investments and financial instruments, income taxes and
contingencies. Actual results could differ from these estimates,
and such differences could be material to the Companys
consolidated financial position and results of operations.

Cash and Cash
Equivalents

The Company considers all highly liquid
investments with an original maturity of three months or less to
be cash equivalents. At June 30, 2002, cash and cash
equivalents ($13.0 million) consisted primarily of taxable
investments in money market funds held with one credit worthy
domestic financial institution.

Corporate
Investments and Payroll Tax Funds Invested

Corporate investments represent the
Companys short-term and long-term investments and consist
primarily of debt securities. The Companys short-term
investments have original maturities greater than three months,
but less than one year from the balance sheet dates. The
Companys long-term investments have original maturities of
one year or greater from the balance sheet dates. Payroll tax
funds invested include cash, money market securities and debt
securities. All of the Companys investments, including
payroll tax funds invested, are classified as available-for-sale
and stated at their fair market values, which are determined
based on quoted market prices, where available. Management
determines the appropriate classification of investments at the
time of purchase and reevaluates such designation at the end of
each period. Unrealized gains and losses on available-for-sale
securities are reported as other comprehensive income/(loss) and
are included as a separate component of stockholders
equity (deficit). Realized gains and losses on
available-for-sale securities are determined based on the
specific identification on the cost of securities sold. Interest
income is recognized when earned. Realized gains and losses and
interest income from payroll tax funds invested are included in
revenue. Realized gains and losses and interest income from
corporate investments are included in interest income and other
net (Note 3). If the net realizable value of the
investments is less than historical cost, then the Company
determines whether a decline in fair value below the cost basis
is other than temporary. If the decline in fair
value is judged to be other than temporary, a write down of the
cost basis of the individual security to fair value as a new
cost basis and the amount of the write-down is accounted for as
a realized loss. The new cost basis will not be changed for
subsequent recoveries in fair value.

The Company places its investments with high
quality credit issuers and, by policy, limits the amount of
credit exposure to any one issuer. As stated in the
Companys investment policy, the Companys first
priority is to reduce the risk on principal loss. Consequently,
the investment policy guidelines limit the size and duration of
the individual investments.

As a result of the types of financial instruments
in which the Company invests, the carrying amount of such
investments approximates fair value. If borrowers fail to meet
the terms of their obligations under these financial
instruments, the Company would incur losses on these
investments. The Companys collected but unremitted payroll
tax funds investments are held primarily with one custodial
financial institution.

32



---



##### 



PROBUSINESS SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Derivative
Financial Instruments

The Company adopted Statement of Financial
Accounting Standards (SFAS) No. 133,
Accounting for Derivative Instruments and Hedging
Activities, effective July 1, 2000. SFAS No. 133
requires the Company to recognize all derivatives, such as
interest rate swap agreements, on the consolidated balance sheet
at fair value regardless of the purpose for holding the
instrument. If the derivative is a hedge, depending on the
nature of the hedge, changes in the fair value of the derivative
will either be offset against the change in fair value of the
hedged assets, liabilities or firm commitments through operating
results or recognized in other comprehensive income/(loss) until
the hedged item is recognized in operating results. Any
ineffective portion of a derivatives change in fair value
will be immediately recognized in operating results.
Circumstances that could impact the effectiveness of this
instrument are (1) the counter-party fails to meet the
terms of the instrument; (2) changes in the correlation
between the interest rate index and the interest rate earned on
our portfolio; and (3) significant reductions in our
projected balances of client funds deposited.

For derivative instruments that are designated
and qualify as a cash flow hedge (i.e., hedging the exposure to
variability in expected future cash flows that is attributable
to a particular risk), the effective portion of the gain or loss
on the derivative instrument is reported as a component of other
comprehensive income/(loss) and reclassified into operating
results in the same period or periods during which the hedged
transaction affects operating results. The remaining gain or
loss on the derivative instrument in excess of the cumulative
change in the present value of future cash flows of the hedged
item, if any, is recognized in current operating results during
the period of change. For derivative instruments not designated
as hedging instruments, the gain or loss is recognized in
current operating results during the period of change.

The Company enters into interest rate swap
agreements, which are designated as cash flow hedges, for
interest rate risk exposure management purposes. The interest
rate swap agreements utilized by the Company effectively modify
the Companys exposure to interest rate risk by converting
a portion of the Companys floating rate interest income to
a fixed rate. These agreements, with fixed interest rates
between 4.835% and 7.355%, at inception each had an original
term of approximately two years and expire at various dates
through December 2004. Interest is paid or received based upon
the product of the contractual notional balance multiplied by
the difference in the fixed interest rate and the contractual
floating rate option. The contractual notional balance varies on
a monthly basis due to fluctuations in projected holdings of
collected but unremitted payroll tax funds. At June 30,
2002, the notional balance was $494.2 million and the
average monthly notional balance for the remaining term of the
agreements was $391.8 million. The agreements require
collateral at the option of the financial institution if
interest rates increase and certain other conditions are met as
defined in the agreements.

During the years ended June 30, 2001 and
2002, the Company did not recognize a net gain or loss related
to the ineffective portion of its hedging instruments, and no
net gain or loss related to the portion of the hedging
instrument excluded from the assessment of hedge effectiveness.
The Company recognized no gains or losses during fiscal years
2001 or 2002, for cash flow hedges that have been discontinued.

The cumulative effect as of July 1, 2000 of
adopting FAS 133 was to record a net liability of
$5.0 million and a corresponding offset to other
comprehensive loss. During fiscal years 2001 and 2002 the
Company recorded an increase in the fair value of derivative
instruments of $19.3 and $5.0 million, respectively and
reported a net asset of $14.2 and $19.2 million for the
fair value of the Companys derivative portfolio at
June 30, 2001 and 2002. At June 30, 2002, the Company
expects to recognize approximately $13.6 million of net
gains on derivative instruments from accumulated other
comprehensive income/(loss) to earnings during the next twelve
months as a result of the interest rate swap agreements. Actual
amounts ultimately reclassified to earnings are dependent on the
actual floating interest rates in effect when the contractual
notional amounts mature.

33



---



##### 



PROBUSINESS SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

During fiscal year 2002, the Company held
interest rate cap agreements. The purposes of these financial
products are to limit the collateral exposure associated with
the various interest rate swap agreements held by the Company.
As of June 30, 2002, the Company held one interest rate cap
agreement with an expiration date of January 2003 with a cap
rate of 8.0%. The aggregate fair value of this agreement was
immaterial.

Long-Lived
Assets

Long-lived assets include the carrying value of
our fixed assets, including capitalized software development
costs and our intangible assets. The carrying values reflect
estimates, assumptions and judgments relative to capitalized
costs, useful lives, utilization, and salvage values.

Fixed assets are stated at cost, net of
accumulated depreciation and amortization. Depreciation of fixed
assets 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.

Effective July 1, 1999, the Company has
capitalized software development costs in accordance with
SOP 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use
(SOP 98-1), under which certain internal use
software development costs incurred may be capitalized and
depreciated over the estimated useful lives of the software. The
Company capitalizes costs when both the preliminary project
stage is completed and the Companys management has
authorized further funding for the project. Capitalization of
these costs ceases no later than the point at which the project
is substantially complete and ready for its intended purpose.
The Company depreciates the capitalized internal-use software
development costs using the straight-line method over the
estimated useful life which is generally between four and seven
years.

Intangible assets, which have generally resulted
from business combinations accounted for as purchases, are
included in other assets and are carried at cost less
accumulated amortization. Amortization is provided on a
straight-line basis over the respective useful lives, which
range from three to twenty years.

The Company reviews long-lived assets and
identifiable intangible assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of
these assets may not be recoverable. The Company records a loss
for the excess of the assets carrying value over the fair
value. The Company did not recognize any impairment loss in
fiscal years 2000, 2001, 2002.

In July 2001, the FASB issued SFAS No. 141,
Business Combinations, and SFAS No. 142,
Goodwill and Other Intangible Assets. SFAS
No. 141 eliminates the pooling-of-interests method of
accounting for business combinations, except for qualifying
business combinations that were initiated prior to July 1,
2001. Under SFAS No. 142, goodwill and indefinite lived
intangible assets are no longer amortized but are reviewed
annually, or more frequently if impairment indicators arise, for
impairment. The Company will adopt SFAS Nos. 141 and 142 on
July 1, 2002 and believes that SFAS Nos. 141 and 142 will
not have a material impact on its consolidated financial
statements.

In October 2001, the FASB issued SFAS
No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, that supersedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of, and provides a single
accounting model for long-lived assets to be disposed of. The
Company will adopt SFAS No. 144 on July 1, 2002, and
believes that SFAS No. 144 will not have a material impact
on its consolidated financial statements.



| |                    
| | -------------------
| | Revenue Recognition

A majority of the Companys revenues are
attributable to fees for providing payroll, payroll tax filing
and Comprehensive Outsourcing services, as well as, investment
income on payroll tax funds invested. Service fees

34



---



##### 



PROBUSINESS SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

are recognized as the services are performed, and
earned under service arrangements with clients where service
fees are fixed or determinable and collectibility is reasonably
assured. Revenue from processing and other services under client
contracts is recognized as the services are performed provided
that no other obligations are required to be performed. Interest
income on collected but not yet remitted funds held for clients
is recognized in revenue as earned.

The Companys sales are primarily to clients
in the United States. Credit evaluations are performed as
necessary, and the Company does not require collateral from
clients. The Company has not experienced any significant credit
losses.

The Company generally requires its payroll tax
outsourcing customers to remit payroll tax liability funds to
the Company in advance of the applicable payroll due date, via
electronic funds transfer. These funds are classified as payroll
tax funds invested in the accompanying consolidated balance
sheets. Interest earned on invested balances resulting from
timing differences between the collection of these funds from
customers and the remittance of such funds to outside parties is
included in total revenue in the accompanying consolidated
statements of operations, as this interest income represents an
integral part of the revenue generated from the Companys
services. Interest income generated from the Companys
corporate cash, cash equivalents and short and long-term
investment balances is included in interest income in the
accompanying consolidated statements of operations, as this
interest income does not result from the Companys direct
operating activities.

The Company enters into contractual arrangements
to provide services with payroll, payroll tax filing and
Comprehensive Outsourcing clients, which typically range from
three to five years and provide for penalties in the case of
early termination by the customer. Effective July 1, 2000,
the Company adopted the Securities and Exchange Commission (SEC)
Staff Accounting Bulletin No. 101 Revenue Recognition
in Financial Statements (SAB 101). As a
result, the Company changed its accounting to recognize revenue
from non-refundable, upfront fees for implementation services,
ratably beginning after implementation over the expected
contractual term using the straight-line method. As a result of
the adoption of SAB 101, the Company now treats the direct costs
of implementation as deferred charges that are amortized as
client acquisition costs using the straight-line method over the
same term as the related revenue. In addition, the Company
defers direct costs in excess of deferred revenue when
recoverability of deferred costs in excess of deferred revenue
is contractually and reasonably assured primarily as a result of
penalties assessed for early termination in the customers
contract combined with the gross margin earned for the period in
which services are rendered.

The Company defers the recognition of revenue for
which it has an ongoing obligation to the customer. The Company
defers revenue from non-refundable, upfront fees for
implementation services, that are then recognized ratably over
the contractual term or the expected term of the client
relationship in accordance with SAB 101. The Company also
defers the portion of revenue on certain client arrangements
entered into prior to June 2000 that relate to the
Companys commitment to convert clients data and
interfaces to the Companys Golden GateTM
platform. Deferred revenue attributable to the Golden
GateTM conversions will decrease in future
periods as the deferred revenue for clients whose data is
converted to the Companys Golden GateTM
platform is recognized after the conversion is performed over
the remaining term of the original arrangement. Furthermore, the
deferred revenue attributable to clients who choose not to
convert their data or terminate services with us is recognized
at that time. In addition, the Company defers revenue for annual
HR and benefits administration services and recognizes the
revenue over the applicable service period, which is typically
one year.



| |                                                         
| | --------------------------------------------------------
| | Allowances for Doubtful Accounts and
    Service Credits

The Company makes judgments as to its ability to
collect outstanding receivables and provides allowances for the
portion of receivables when collection becomes doubtful.
Provisions are made based upon a

35



---



##### 



PROBUSINESS SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

specific review of all significant outstanding
invoices. For those invoices not specifically reviewed,
provisions are provided at differing rates, based upon the age
of the receivable. In determining these percentages, analysis is
performed based upon historical collection experience and
current economic trends. If the historical data used to
calculate the allowance provided for doubtful accounts does not
reflect the future ability to collect outstanding receivables,
additional provisions for doubtful accounts may be needed and
the future results of operations could be materially affected.

The Company also records a provision for
estimated service credits and allowances on services related to
fees charged in the same period as the related revenues are
recorded. These estimates are based on historical service
credits, analysis of credit memo data and other known factors.
If the historical data used to calculate these estimates do not
properly reflect future credits, then a change in the allowances
would be made in the period in which such a determination is
made with an offset to revenues.



| |                          
| | -------------------------
| | Accrual for Tax Penalties

The Company has established an estimated
liability for known and potential errors and omissions in
performing services related to its payroll tax filing services
that could result in additional payments to various third
parties for tax liabilities, penalties and interest. This amount
was estimated based upon a percent of total client funds managed
combined with specific probable settlements (Note 12).



| |             
| | ------------
| | Income Taxes

The Company uses the liability method to account
for income taxes. Under this method, deferred tax assets and
liabilities are measured based on differences between the
financial reporting and tax basis of assets and liabilities
using enacted tax rates and laws that are expected to be in
effect when the differences are expected to reverse. Valuation
allowances are established when necessary to reduce deferred tax
assets to the net amounts expected to be realized (Note 7).

While the Company has considered future taxable
income and ongoing prudent and feasible tax planning strategies
in assessing the need for the valuation allowance, there is no
assurance that the valuation allowance would not need to be
increased to cover additional deferred tax assets that may not
be realizable. Any increase in valuation allowance could have a
material adverse impact on the Companys income tax
provision and net income in the period in which such
determination is made.



| |                    
| | -------------------
| | Deferred Bonus Plan

The Company has entered into a deferred bonus
plan with certain employees of the Company to defer portions of
their incentive bonus earned during fiscal year 2001 and 2002.
Subject to certain conditions of the plan, these employees will
receive their bonus payments in fiscal year 2004 and 2005. A
deferred compensation liability has been recorded for the future
payments related to service rendered to date. The deferred
compensation liability for these future payments at
June 30, 2001 and 2002, was $1,030,000 and $5,022,000,
respectively (Note 12).



| |                                            
| | -------------------------------------------
| | Accounting for Stock-Based
    Compensation

The Company accounts for stock option and equity
awards in accordance with the provisions of Accounting
Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB 25), and has
elected to follow the disclosure only alternative
prescribed by FASB Statement No. 123, Accounting for
Stock-Based Compensation (SFAS 123)
(Note 10).



| |                         
| | ------------------------
| | Research and Development

Research and development costs that are not
capitalizable are expensed as incurred.

36



---



##### 



PROBUSINESS SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                             
| | ----------------------------
| | New Accounting Pronouncement

In July 2002, the FASB issued SFAS No. 146
Accounting for Costs Associated with Exit or Disposal
Activities (FAS 146). FAS 146
addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies EITF
Issue No. 94-3. Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a
Restructuring) (EITF 94-3). The principal
difference between FAS 146 and EITF 94-3 relates to
FAS 146s requirements for the timing of recognizing a
liability for a cost associated with an exit or disposal
activity. FAS 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when
the liability is incurred. Under EITF 94-3 a liability for
an exit cost was recognized at the date of an entitys
commitment to an exit plan. FAS 146 is effective for exit
or disposal activities that are initiated after
December 31, 2002, with early adoption encouraged.
FAS 146 is applied prospectively upon adoption and is not
anticipated to have a material impact on the Companys
current financial position or results of operations.



| |                                         
| | ----------------------------------------
| | Basic and Diluted Net Loss per
    Share

Shares used in computing basic and diluted net
loss per share are based on the weighted average shares
outstanding in each period. Net loss applicable to common
stockholders includes the Redeemable Convertible Preferred Stock
(Preferred Stock) dividend of $1.4 million and
$2.2 million for the years ended June 30, 2001 and
2002. Basic net loss per share excludes any dilutive effects of
stock options. Diluted net loss per share includes the dilutive
effect of the assumed exercise of stock options using the
treasury stock method. However, the effect of outstanding stock
options has been excluded from the calculation of diluted net
loss per share, as their inclusion would be antidilutive.

If the Company had reported net income, the
calculation of diluted earnings per share would have included
the shares used in the computation of historical net loss per
share as well as an additional 907,000, 1,744,000 and 1,670,000
common equivalent shares related to outstanding stock options,
preferred stock and warrants not included above (determined
using the treasury stock method) for the year ended
June 30, 2000, 2001 and 2002, respectively.



| |                  
| | -----------------
| | Reclassifications

Certain prior year balances have been
reclassified to conform to the current year presentation
including depreciation and amortization, capitalized
internal-use software, long-term deferred bonus plan and loss on
disposal of fixed assets.

2.     Fixed
Assets

Fixed assets consist of the following (in
thousands):

|                                               |  |          |         |      |  |   |         | 
|---------------------------------------------- |  | -------- | ------- | ---- |  | - | ------- | 
|                                               |  |         
|                                               |  | June 30,
|                                               |  |         
|                                               |  | 2001     |         | 2002
|                                               |  |          |         |     
|Equipment and leasehold improvements           |  | $        | 72,088  |      |  | $ | 81,136  | 
|Furniture and fixtures                         |  |          | 6,196   |      |  |   | 7,117   | 
|Capitalized software                           |  |          | 23,164  |      |  |   | 30,142  | 
|                                               |  |          |         |      |  |   |         | 
|                                               |  |          | 101,448 |      |  |   | 118,395 | 
|Less accumulated depreciation and amortization |  |          | 36,642  |      |  |   | 54,474  | 
|                                               |  |          |         |      |  |   |         | 
|                                               |  | $        | 64,806  |      |  | $ | 63,921  | 
|                                               |  |          |         |      |  |   |         | 

37



---



##### 



PROBUSINESS SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Fixed assets include amounts for assets acquired
under capital leases, principally production, office and
computer equipment, of $3,953,000 and $3,885,000 at
June 30, 2001 and 2002, respectively. Accumulated
amortization of these assets were $3,647,000 and $3,749,000 at
June 30, 2001 and 2002, respectively.

Depreciation and amortization expense in the
accompanying consolidated statement of operations consist of the
following (in thousands):

|                         |  |          |        |      |  |      |        |  |  |   |        | 
|------------------------ |  | -------- | ------ | ---- |  | ---- | ------ |  |  | - | ------ | 
|                         |  |         
|                         |  | June 30,
|                         |  |         
|                         |  | 2000     |        | 2001 |  | 2002
|                         |  |          |        |      |  |     
|Fixed asset depreciation |  | $        | 10,306 |      |  | $    | 13,318 |  |  | $ | 19,037 | 
|Goodwill amortization    |  |          | 423    |      |  |      | 371    |  |  |   | 370    | 
|                         |  |          |        |      |  |      |        |  |  |   |        | 
|                         |  | $        | 10,729 |      |  | $    | 13,689 |  |  | $ | 19,407 | 
|                         |  |          |        |      |  |      |        |  |  |   |        | 

3.     Payroll Tax
Funds Invested and Corporate Investments

Payroll tax funds invested and corporate
investments at June 30, 2001 and 2002 consist of the
following (in thousands):

|                                                                           |  |      |           |        |  |      |           |        |  |   |           |   |  |   |           | 
|-------------------------------------------------------------------------- |  | ---- | --------- | ------ |  | ---- | --------- | ------ |  | - | --------- | - |  | - | --------- | 
|                                                                           |  |      |           |       
|                                                                           |  | 2001 |           | 2002  
|                                                                           |  |      |           |       
|                                                                           |  | Cost |           | Market |  | Cost |           | Market
|                                                                           |  |      |           |        |  |      |           |       
|Money market funds and other cash equivalents                              |  | $    | 660,724   |        |  | $    | 660,724   |        |  | $ | 1,306,685 |   |  | $ | 1,306,685 | 
|Available for sale securities:                                             |  |      |           |        |  |      |           |        |  |   |           |   |  |   |           | 
|Corporate obligations                                                      |  |      | 771,921   |        |  |      | 772,043   |        |  |   | 233,868   |   |  |   | 233,324   | 
|Variable rate instruments                                                  |  |      | 41,300    |        |  |      | 41,300    |        |  |   | 85,202    |   |  |   | 79,603    | 
|Government & agency securities                                             |  |      |          |        |  |      |          |        |  |   | 117,684   |   |  |   | 118,503   | 
|Certificates of deposit                                                    |  |      | 67,348    |        |  |      | 67,359    |        |  |   | 37,321    |   |  |   | 37,331    | 
|Sovereign government instruments                                           |  |      |          |        |  |      |          |        |  |   | 4,350     |   |  |   | 4,369     | 
|                                                                           |  |      |           |        |  |      |           |        |  |   |           |   |  |   |           | 
|Total available-for-sale securities                                        |  |      | 880,569   |        |  |      | 880,702   |        |  |   | 478,425   |   |  |   | 473,130   | 
|                                                                           |  |      |           |        |  |      |           |        |  |   |           |   |  |   |           | 
|Total payroll tax funds invested and corporate
    investments             |  | $    | 1,541,293 |        |  | $    | 1,541,426 |        |  | $ | 1,785,110 |   |  | $ | 1,779,815 | 
|                                                                           |  |      |           |        |  |      |           |        |  |   |           |   |  |   |           | 
|Amortization of premiums and discounts                                     |  |      |          |        |  |      |           |        |  |   | (1,674    | ) |  |   |           | 
|Recognized other than temporary losses on payroll
    tax funds invested   |  |      |          |        |  |      |           |        |  |   | (2,000    | ) |  |   |           | 
|                                                                           |  |      |           |        |  |      |           |        |  |   |           |   |  |   |           | 
|Amortized cost of payroll tax funds invested
    and corporate investments |  | $    | 1,541,293 |        |  |      |           |        |  | $ | 1,781,436 |   |  |   |           | 
|                                                                           |  |      |           |        |  |      |           |        |  |   |           |   |  |   |           | 
|Classification of investments on Consolidated
    Balance Sheet            |  |      |           |        |  |      |           |        |  |   |           |   |  |   |           | 
|Payroll tax funds invested                                                 |  | $    | 1,511,124 |        |  | $    | 1,511,124 |        |  | $ | 1,705,209 |   |  | $ | 1,699,575 | 
|Short and long-term investments                                            |  |      | 30,169    |        |  |      | 30,302    |        |  |   | 79,901    |   |  |   | 80,240    | 
|                                                                           |  |      |           |        |  |      |           |        |  |   |           |   |  |   |           | 
|Total payroll tax funds invested and corporate
    investments             |  | $    | 1,541,293 |        |  | $    | 1,541,426 |        |  | $ | 1,785,110 |   |  | $ | 1,779,815 | 
|                                                                           |  |      |           |        |  |      |           |        |  |   |           |   |  |   |           | 

The Company has not experienced any significant
losses on its corporate investments. However, during the year
ended June 30, 2002, the Company recognized other than
temporary losses on certain payroll tax funds invested
aggregating $2.0 million. No such losses were recognized in
fiscal 2000 or 2001. When market values of payroll tax funds
invested are below cost, the difference is accounted for as an
offset to other

38



---



##### 



PROBUSINESS SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

corporate assets. As of June 30, 2002, the
amortized cost of the payroll tax funds invested was
$1,701.5 million: comprised of $1,705.2 million
original cost, less $2.0 million realized loss and
$1.7 million amortization of premiums and discounts as
outlined in the table above. The difference between the
amortized cost of $1,701.5 million and the market value of
$1,699.6 million of payroll tax funds invested at
June 30, 2002 is $1.9 million of unrealized losses
which is accounted for as an offset to interest income
receivable, a component of prepaid expenses and other current
assets on the consolidated balance sheet. Associated with the
investment portfolio of payroll tax funds invested the Company
has recorded a net asset of $19.2 million at June 30,
2002, representing gains in the fair value of the Companys
derivative financial instruments which is included in prepaid
expenses and other current assets and other assets on the
consolidated balance sheet (Note 1 and Note 12).

Gross unrealized gains and losses for
available-for-sale securities for the years ended June 30,
2001 and 2002 are as follows (in thousands):

|                                |  |      |     |      |  |   |        |  
|------------------------------- |  | ---- | --- | ---- |  | - | ------ | -
|                                |  | 2001 |     | 2002
|                                |  |      |     |     
|Gross unrealized gains          |  | $    | 136 |      |  | $ | 2,213  |  
|Gross unrealized losses         |  |      | (3  | )    |  |   | (3,834 | )
|                                |  |      |     |      |  |   |        |  
|Net unrealized gains and losses |  | $    | 133 |      |  | $ | (1,621 | )
|                                |  |      |     |      |  |   |        |  

Gross realized gains and losses for
available-for-sale securities for the years ended June 30,
2001 and 2002 are as follows (in thousands):

|                              |  |      |   |      |  |   |        |  
|----------------------------- |  | ---- | - | ---- |  | - | ------ | -
|                              |  | 2001 |   | 2002
|                              |  |      |   |     
|Gross realized gains          |  | $    | 1 |      |  | $ | 153    |  
|Gross realized losses         |  |      |  |      |  |   | (2,327 | )
|                              |  |      |   |      |  |   |        |  
|Net realized gains and losses |  | $    | 1 |      |  | $ | (2,174 | )
|                              |  |      |   |      |  |   |        |  

There were no realized gains or losses for the
year ended June 30, 2000.

The cost and fair value of by contractual
maturity are shown below (in thousands):

|                                         |  |      |         |            |  |   |         | 
|---------------------------------------- |  | ---- | ------- | ---------- |  | - | ------- | 
|Maturity Date:                           |  | Cost |         | Fair Value
|                                         |  |      |         |           
|Due in one year or less                  |  | $    | 201,792 |            |  | $ | 201,012 | 
|Due after one year through three years   |  |      | 166,908 |            |  |   | 167,543 | 
|Due after three years through five years |  |      | 83,304  |            |  |   | 77,890  | 
|Due after five years through ten years   |  |      | 22,071  |            |  |   | 22,302  | 
|Due after ten years                      |  |      | 4,350   |            |  |   | 4,383   | 
|                                         |  |      |         |            |  |   |         | 
|Total available-for-sale securities      |  | $    | 478,425 |            |  | $ | 473,130 | 
|                                         |  |      |         |            |  |   |         | 

4.     Line-of-Credit
Agreement

On December 21, 2001, the Company executed a
Loan and Security Agreement with a financial institution.
Borrowings outstanding under the agreement bear interest at that
banks prime rate minus 0.75% (prime rate was 4.75% at
June 30, 2002) and are collateralized by substantially all
of the Companys assets, excluding fixed assets. The amount
available for borrowing under the agreement is $30,000,000. At
June 30, 2002, no borrowings were outstanding under the
agreement. On June 28, 2002 the agreement was amended and
now expires on January 31, 2005.

39



---



##### 



PROBUSINESS SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

5.     Deferred
Revenue

At June 30, 2002 the components of deferred
revenue in the accompanying consolidated balance sheet were as
follows (in thousands):

|                                                |                                                          |          |        |        |  |   |        |        | 
|----------------------------------------------- | -------------------------------------------------------- | -------- | ------ | ------ |  | - | ------ | ------ | 
|                                                |                                                          |         
|                                                |                                                          | June 30,
|                                                |                                                          |         
|                                                |                                                          | 2001     |        | 2002  
|                                                |                                                          |          |        |       
|Short-term:                                     |                                                          |          |        |        |  |   |        |       
|                                                | Upfront fees for implementation services                 |          | $      | 2,752  |  |   | $      | 6,974  | 
|                                                | Annual HR and benefits administrative services           |          |        | 1,844  |  |   |        | 1,482  | 
|                                                |                                                          |          |        |        |  |   |        |       
|                                                |                                                          |          | 4,596  |        |  |   | 8,456  |       
|                                                |                                                          |          |        |        |  |   |        |       
|Long-term:                                      |                                                          |          |        |        |  |   |        |       
|                                                | Upfront fees for conversion to Golden
    GateTMplatform |          |        | 13,061 |  |   |        | 11,804 | 
|                                                | Upfront fees for implementation services                 |          |        | 4,699  |  |   |        | 6,383  | 
|                                                |                                                          |          |        |        |  |   |        |       
|                                                |                                                          |          | 17,760 |        |  |   | 18,187 |       
|                                                |                                                          |          |        |        |  |   |        |       
|Total short-term and long-term deferred revenue |                                                          | $        | 22,356 |        |  | $ | 26,643 |       
|                                                |                                                          |          |        |        |  |   |        |       

6.     Commitments
and Contingencies

On December 21, 2001, the Company entered
into an equipment lease financing arrangement (note
payable) with a bank for the amount of $1.5 million.
This note payable finances certain computer and office equipment
that the Company uses for its day-to-day business activities.
The note payable is repayable ratably on a monthly basis over a
three-year period and bears an interest rate of 12.85%. The note
payable is secured by specific fixed assets. The amount due
under this note at June 30, 2002 is $1.3 million.

The Company leases its facilities and various
equipment under non-cancelable operating leases, which expire at
various dates through 2015. The facility leases generally
require the Company to pay operating costs, including property
taxes, insurance and maintenance, and contain renewal options
and provisions adjusting the lease payments based upon changes
in operating costs or in fixed increments. Rent expense is
reflected on a straight-line basis over the terms of the related
leases. The Company is also obligated under capital equipment
leases expiring in 2003.

The future minimum lease payments under capital
and operating leases subsequent to June 30, 2002, are
summarized as follows (in thousands):

|                                                           |            |         |     |           |  |   |        |        | 
|---------------------------------------------------------- | ---------- | ------- | --- | --------- |  | - | ------ | ------ | 
|                                                           |            | Capital |     | Operating
|                                                           |            | Leases  |     | Leases   
|                                                           |            |         |     |          
|Year ending June 30,                                       |            |         |     |           |  |   |        |       
|                                                           | 2003       |         | $   | 132       |  |   | $      | 6,718  | 
|                                                           | 2004       |         |     |          |  |   |        | 6,741  | 
|                                                           | 2005       |         |     |          |  |   |        | 6,623  | 
|                                                           | 2006       |         |     |          |  |   |        | 6,418  | 
|                                                           | 2007       |         |     |          |  |   |        | 6,360  | 
|                                                           | Thereafter |         |     |          |  |   |        | 39,504 | 
|                                                           |            |         |     |           |  |   |        |       
|Total minimum lease payments                               |            | $       | 132 |           |  | $ | 72,364 |       
|                                                           |            |         |     |           |  |   |        |       
|Less amounts representing interest                         |            |         | 7   |           |  |   |        |       
|                                                           |            |         |     |           |  |   |        |       
|Present value of net minimum capital lease
    obligations |            | $       | 125 |           |  |   |        |       
|                                                           |            |         |     |           |  |   |        |       

40



---



##### 



PROBUSINESS SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Rent expense was approximately $5,013,000,
$5,569,000 and $7,646,000 for fiscal years 2000, 2001 and 2002,
respectively.

The Company is a party to routine litigation
incidental to its business. In the opinion of management such
current or pending lawsuits, either individually or in the
aggregate, are not likely to have a material adverse effect on
the Companys financial condition, results of operations or
cash flows.

In June 2002, the Company committed to utilize
$3,500,000 of software development services with a company
providing onshore and offshore development services. These
services commenced on July 1, 2002.

7.     Income
Taxes

As of June 30, 2002, the Company had federal
net operating loss carryforwards of approximately $92,000,000.
The Company also had federal research and development tax credit
carryforwards of approximately $2,100,000. The federal net
operating loss and credit carryforwards will expire at various
dates beginning with the fiscal year ending 2004 through 2022,
if not utilized. The Company also has state research and
development tax credit carryforwards of approximately $1,400,000
that will carryforward indefinitely.

Utilization of the net operating losses and
credits may be subject to a substantial annual limitation due to
the ownership change limitations provided by the Internal
Revenue Code of 1986 and similar state provisions. The annual
limitation may result in the expiration of net operating losses
and credits before their utilization.

Significant components of the Companys
deferred tax assets and liabilities are as follows (in
thousands):

|                               |                                               |          |         |        |   |   |         |        |  
|------------------------------ | --------------------------------------------- | -------- | ------- | ------ | - | - | ------- | ------ | -
|                               |                                               |         
|                               |                                               | June 30,
|                               |                                               |         
|                               |                                               | 2001     |         | 2002  
|                               |                                               |          |         |       
|Deferred tax assets:           |                                               |          |         |        |   |   |         |       
|                               | Net operating loss carryforwards              |          | $       | 23,785 |   |   | $       | 32,347 |  
|                               | Research and development credit carryforwards |          |         | 3,614  |   |   |         | 3,556  |  
|                               | Fixed assets                                  |          |         | 1,463  |   |   |         | 2,023  |  
|                               | Deferred revenue                              |          |         | 7,576  |   |   |         | 7,264  |  
|                               | Accruals                                      |          |         | 6,239  |   |   |         | 8,571  |  
|                               |                                               |          |         |        |   |   |         |       
|Gross deferred tax assets      |                                               |          | 42,677  |        |   |   | 53,761  |       
|Less valuation allowance       |                                               |          | (30,997 | )      |   |   | (39,437 | )     
|                               |                                               |          |         |        |   |   |         |       
|Deferred tax assets            |                                               |          | 11,680  |        |   |   | 14,324  |       
|                               |                                               |          |         |        |   |   |         |       
|Deferred tax liabilities:      |                                               |          |         |        |   |   |         |       
|                               | Capitalized software development costs        |          |         | (5,946 | ) |   |         | (6,608 | )
|                               | Unrealized gain                               |          |         | (5,734 | ) |   |         | (7,716 | )
|                               |                                               |          |         |        |   |   |         |       
|Gross deferred tax liabilities |                                               |          | (11,680 | )      |   |   | (14,324 | )     
|                               |                                               |          |         |        |   |   |         |       
|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 net valuation allowance increased by $8,440,000
during the year ended June 30, 2002. 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 inception. The
Company will continue to assess the realizability of the
deferred tax assets based on actual and forecasted operating
results.

41



---



##### 



PROBUSINESS SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Deferred tax assets relating to net operating
loss carryforwards as of June 30, 2002 include
approximately $5,600,000 associated with stock option activity
for which any subsequently recognized tax benefits will be
credited directly to stockholders equity.

8.     Redeemable
Convertible Preferred Stock

On August 1, 2000, the Company authorized,
issued and sold 1,132,075 shares of Preferred Stock to General
Atlantic Partners, LLC (GAP) and certain affiliates
of GAP at $26.50 per share. The Preferred Stock ranks senior to
the Companys common stock (Common Stock). The
holders of the Preferred Stock are entitled to receive
cumulative dividends at an annual rate of 6.9% in the form of
additional shares of Preferred Stock. The payment of these
dividends commenced on October 1, 2000, and these dividends
are payable quarterly on the first day of October, January,
April and July. Upon liquidation of the Company, the holders of
the Preferred Stock are entitled to be paid an amount equal to
$26.50 per share plus all accrued and unpaid dividends. Any
holder of Preferred Stock has the right to convert such
holders shares of Preferred Stock into shares of the
Companys Common Stock at a rate of one share of Preferred
Stock to one share of the Companys Common Stock, subject
to adjustments, as defined. The Company has the option to
convert all of the Preferred Stock to Common Stock for a period
of five days after August 1, 2005 if the then current
market price of the Companys Common Stock price is equal
to or greater than $26.50 per share on such date at a rate of
one share of Preferred Stock to one share of the Companys
Common Stock, subject to adjustments, as defined. If, as of any
date after August 1, 2003, the then current market price of
the Companys Common Stock is equal to or greater than
$39.00 per share, the Company may redeem any or all of the then
current outstanding Preferred Stock at $26.50 per share. The
conversion rate for the Preferred Stock is subject to adjustment
for stock splits, stock dividends and recapitalizations, among
other things, after the date of issue of such stock. In the
event of a change in control of the Company, holders of at least
two-thirds of the Preferred Stock can elect to treat the
transaction as a liquidation and for this reason the Preferred
Stock is considered to be redeemable by the holders
of the Preferred Stock.

The holders of the Preferred Stock vote, as a
single class, with the Companys common shareholders,
except that as long as GAP owns a majority of the Companys
Preferred Stock, the then holders of such Preferred Stock are
entitled to elect one director to the Companys Board of
Directors. As of June 30, 2002, a Partner of GAP is a
member of the Companys current Board of Directors.

9.     Stockholders
Equity

Warrants

At June 30, 2002 there were warrants to
purchase 45,561 shares of common stock outstanding. These
warrants were issued in November 1996 with an exercise price of
$2.65 and expire in September 2002.

During the year ended June 30, 2002, the
Company issued 4,335 shares of common stock upon the exercise of
a warrant, all of which were exercised pursuant to a net
exercise provision. During the year ended June 30, 2001,
the Company issued 23,039 shares of common stock upon exercise
of warrants, all of which were exercised pursuant to net
exercise provisions. During the year ended June 30, 2000,
no warrants were exercised.

42



---



##### 



PROBUSINESS SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                        
| | ---------------------------------------
| | Shares Reserved for Future
    Issuance

At June 30, 2002, the Company has reserved
shares of common stock for future issuance as follows:

|                                                                 |  |  |           | 
|---------------------------------------------------------------- |  |  | --------- | 
|Stock options outstanding                                        |  |  | 5,986,084 | 
|Redeemable convertible preferred stock outstanding               |  |  | 1,132,075 | 
|Redeemable convertible preferred stock dividends                 |  |  | 136,450   | 
|Stock options available for grant                                |  |  | 2,181,971 | 
|Stock available for grant under employee stock
    purchase plan |  |  | 261,972   | 
|Warrants outstanding                                             |  |  | 45,561    | 
|                                                                 |  |  |           | 
|                                                                 |  |  | 9,744,113 | 
|                                                                 |  |  |           | 

On August 1, 2001 the Companys Board
of Directors adopted a stockholders rights plan. Under the
plan, the Company issued a dividend of one right for each share
of common stock of the Company held by stockholders of record as
of the close of business on August 30, 2001. The plan is
designed to attempt to assure stockholders fair value in the
event of a future unsolicited business combination or similar
transaction involving the Company.

Each right will initially entitle stockholders to
purchase a fractional share of the Companys Series A
Participating Preferred Stock for $170.00. However, the rights
are not immediately exercisable and will become exercisable only
upon the occurrence of certain events. Upon the occurrence of
these events, unless redeemed for $0.001 per right, the rights
will become exercisable by holders, other than rights held by an
unsolicited third party acquirer, for shares of the Company or
of the third party acquirer having a value of twice the
rights then-current exercise price.

10.     Stock Option
and Stock Purchase Plans

Stock Option
Plans

The Companys 1989 Stock Option Plan
(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 1999, 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 shares.
Options granted under the 1989 Plan before the effective date of
the amendment and restatement to the 1996 Plan in September
1997, described below, remain outstanding in accordance with
their terms; however, no further options were granted under the
1989 Plan after the effective date of the amendment and
restatement to the 1996 Plan.

In 1996, the Company established the 1996
Executive Stock Option Plan (Executive Plan), which
provides for stock options to employees and consultants. Under
the Executive Plan, the Board of Directors may grant
nonstatutory stock options to employees and consultants and
incentive stock options to employees only. The Company reserved
1,125,000 shares of common stock for exercise of stock options
under the Executive Plan. The grant of incentive stock options
to an employee who owns stock representing more than 10% of the
voting power of all classes of stock of the Company must be no
less than 110% of the fair market value per share on the date of
grant. Fair market value is determined by the Board of
Directors. For all other employees the options must be no less
than 100% of the fair market value per share on the date of
grant. All nonstatutory stock options granted are at a price
that is determined by the Board of Directors. The options
generally expire ten years from the date of grant and are
exercisable as determined by the Board of Directors.

43



---



##### 



PROBUSINESS SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 (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). In November 1998, the Companys stockholders
approved an amendment to the 1996 Plan to increase the number of
shares reserved for issuance by an additional 950,000 shares. In
November 1999 and November 2001, the Companys stockholders
approved 1,500,000 and 2,000,000 additional shares, respectively.

A summary of the activity under all plans is set
forth below:

|                             |           |                     |           |                |   |   |       |       | 
|---------------------------- | --------- | ------------------- | --------- | -------------- | - | - | ----- | ----- | 
|                             |           |                    
|                             |           | Outstanding Options
|                             |           |                    
|                             |           |                     |           | Weighted      
|                             |           | Number              |           | Average       
|                             |           | of                  |           | Exercise Price
|                             |           | Shares              |           | Per Share     
|                             |           |                     |           |               
|Outstanding at June 30, 1999 |           |                     | 2,503,860 |                |   | $ | 17.81 |      
|                             | Granted   |                     |           | 2,807,175      |   |   |       | 21.72 | 
|                             | Exercised |                     |           | (357,978       | ) |   |       | 7.16  | 
|                             | Canceled  |                     |           | (608,451       | ) |   |       | 24.87 | 
|                             |           |                     |           |                |   |   |       |      
|Outstanding at June 30, 2000 |           |                     | 4,344,606 |                |   |   | 20.24 |      
|                             | Granted   |                     |           | 1,765,974      |   |   |       | 23.31 | 
|                             | Exercised |                     |           | (315,360       | ) |   |       | 13.77 | 
|                             | Canceled  |                     |           | (686,378       | ) |   |       | 24.48 | 
|                             |           |                     |           |                |   |   |       |      
|Outstanding at June 30, 2001 |           |                     | 5,108,842 |                |   |   | 21.14 |      
|                             | Granted   |                     |           | 1,972,265      |   |   |       | 14.84 | 
|                             | Exercised |                     |           | (218,186       | ) |   |       | 10.56 | 
|                             | Canceled  |                     |           | (876,837       | ) |   |       | 23.23 | 
|                             |           |                     |           |                |   |   |       |      
|Outstanding at June 30, 2002 |           |                     | 5,986,084 |                |   | $ | 19.14 |      
|                             |           |                     |           |                |   |   |       |      

As of June 30, 2002, options to purchase
2,518,795 shares of common stock were vested and exercisable at
an average exercise price of $20.60 per share and options to
purchase 2,181,971 shares were available for future grant. As of
June 30, 2002, there were no outstanding shares of common
stock subject to repurchase.

44



---



##### 



PROBUSINESS SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following table summarizes information
concerning currently outstanding and exercisable options at
June 30, 2002:

|               |  |                     |           |             |  |                |      |             |  |                |       |  |  |  |           |  |  |   |       | 
|-------------- |  | ------------------- | --------- | ----------- |  | -------------- | ---- | ----------- |  | -------------- | ----- |  |  |  | --------- |  |  | - | ----- | 
|               |  |                     |           |             |  |               
|               |  | Outstanding Options |           |             |  |               
|               |  |                     |           |             |  |               
|               |  |                     |           | Weighted    |  |                |      |            
|               |  |                     |           | Average     |  |                |      | Exercisable
|               |  |                     |           | Remaining   |  |                |      |            
|               |  |                     |           | Contractual |  | Weighted       |      |             |  | Weighted      
|               |  |                     |           | Life        |  | Average        |      |             |  | Average       
|Exercise Price |  | Shares              |           | (Years)     |  | Exercise Price |      | Shares      |  | Exercise Price
|               |  |                     |           |             |  |                |      |             |  |               
|$0.20-$13.23   |  |                     | 1,567,764 |             |  |                | 8.34 |             |  | $              | 11.02 |  |  |  | 447,419   |  |  | $ | 5.92  | 
|$13.33-$18.38  |  |                     | 2,190,954 |             |  |                | 7.89 |             |  | $              | 17.41 |  |  |  | 778,049   |  |  | $ | 18.09 | 
|$18.75-$28.00  |  |                     | 1,597,779 |             |  |                | 7.72 |             |  | $              | 24.51 |  |  |  | 926,400   |  |  | $ | 25.12 | 
|$28.13-$44.63  |  |                     | 629,587   |             |  |                | 7.68 |             |  | $              | 31.79 |  |  |  | 366,927   |  |  | $ | 32.42 | 
|               |  |                     |           |             |  |                |      |             |  |                |       |  |  |  |           |  |  |   |       | 
|               |  |                     | 5,986,084 |             |  |                | 7.94 |             |  | $              | 19.14 |  |  |  | 2,518,795 |  |  | $ | 20.60 | 
|               |  |                     |           |             |  |                |      |             |  |                |       |  |  |  |           |  |  |   |       | 

Stock-Based
Compensation

Pro forma information regarding the results of
operations and net loss per share is determined as if the
Company had accounted for its employee stock options using the
fair value method. Under this method, the fair value of each
option granted is estimated on the date of grant using the
Black-Scholes valuation model.

The Company uses the intrinsic value method in
accounting for its employee stock options because, as discussed
below, the alternative fair value accounting requires the use of
option valuation models that were not developed for use in
valuing employee stock options. Under the intrinsic value
method, when the exercise price of the Companys employee
stock options equals the market price of the underlying stock on
the date of grant, no compensation expense is recognized.

Option valuation models were developed for use in
estimating fair value of traded options that have no vesting
restrictions and are fully transferable. In addition, option
valuation models require the input of highly subjective
assumptions, including the expected life of the option. Because
the Companys employee stock options have characteristics
significantly different from those of traded options and because
changes in the subjective input assumptions can materially
affect the fair value estimates, in managements opinion,
the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.

The fair value of the Companys stock-based
awards to employees was estimated using the following
weighted-average assumptions:

|                         |  |                     |       |      |  |      |       |   |  |  |       |  
|------------------------ |  | ------------------- | ----- | ---- |  | ---- | ----- | - |  |  | ----- | -
|                         |  |                    
|                         |  | Year Ended June 30,
|                         |  |                    
|                         |  | 2000                |       | 2001 |  | 2002
|                         |  |                     |       |      |  |     
|Expected life (in years) |  |                     | 4     |      |  |      | 4     |   |  |  | 4     |  
|Expected volatility      |  |                     | 0.628 |      |  |      | 0.637 |   |  |  | 0.604 |  
|Risk-free interest rate  |  |                     | 6.30  | %    |  |      | 4.81  | % |  |  | 4.19  | %
|Expected dividend yield  |  |                     | 0.00  | %    |  |      | 0.00  | % |  |  | 0.00  | %

The weighted average fair value of stock options
granted during the years ended June 30, 2000, 2001 and 2002
was $11.79, $12.23, and $8.03 per share, respectively. For pro
forma disclosure purposes, the estimated

45



---



##### 



PROBUSINESS SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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,
|                                           |  |                    
|                                           |  | 2000                |         | 2001 |  | 2002
|                                           |  |                     |         |      |  |     
|Net loss, as reported                      |  | $                   | (13,917 | )    |  | $    | (33,191 | ) |  | $ | (27,459 | )
|Net loss, as adjusted                      |  | $                   | (21,913 | )    |  | $    | (45,169 | ) |  | $ | (40,209 | )
|Historical net loss per share, as reported |  | $                   | (0.60   | )    |  | $    | (1.45   | ) |  | $ | (1.13   | )
|Historical net loss per share, as adjusted |  | $                   | (0.94   | )    |  | $    | (1.95   | ) |  | $ | (1.53   | )

1997 Employee
Stock Purchase Plan

The Companys 1997 Employee Stock Purchase
Plan (Purchase Plan) was adopted by the Board of
Directors in November 1996 and amended in August 1997. Employees
who work a minimum of 20 hours per week at least five months in
any calendar year are eligible to participate in the Purchase
Plan. As of June 30, 2002, there were 1,650,000 shares of
common stock authorized for issuance under the Purchase Plan.
Under the Purchase Plan there is 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, 2002,
a total of 1,388,028 shares had been issued under the Purchase
Plan. Under the Purchase Plan, the Companys employees,
subject to certain restrictions, may purchase shares of common
stock at the lesser of 85% of the fair market value at either
the beginning of each two-year offering period or the end of
each six-month purchase period within the two-year offering
period. Purchase Plan purchases are limited to 10% of each
employees compensation for offering periods beginning on
or prior to November 1, 1999 and limited to 15% for
offering periods beginning on or after May 1, 2000.

11.     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 made a contribution of $455,000 in the year ended
June 30, 2002. The Company did not make any contributions
to the Plan in the years ended June 30, 2000 or 2001.

12.     Consolidated
Balance Sheet Detail

Increases to allowances for doubtful accounts and
service credits for fiscal years 2000, 2001 and 2002 were
$990,000, $704,000 and none respectively, and decreases to
allowances for doubtful accounts and service credits for fiscal
years 2000, 2001 and 2002 were $121,000, $421,000 and 474,000,
respectively.

Prepaid expenses and other current assets consist
of the following (in thousands):

|                           |  |          |        |      |  |   |        | 
|-------------------------- |  | -------- | ------ | ---- |  | - | ------ | 
|                           |  |         
|                           |  | June 30,
|                           |  |         
|                           |  | 2001     |        | 2002
|                           |  |          |        |     
|Short-term derivatives     |  | $        | 4,771  |      |  | $ | 13,581 | 
|Interest income receivable |  |          | 3,625  |      |  |   | 3,602  | 
|Other                      |  |          | 4,201  |      |  |   | 5,503  | 
|                           |  |          |        |      |  |   |        | 
|                           |  | $        | 12,597 |      |  | $ | 22,686 | 
|                           |  |          |        |      |  |   |        | 

46



---



##### 



PROBUSINESS SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Other assets, long-term, consist of the following
(in thousands):

|                       |  |          |        |      |  |   |        | 
|---------------------- |  | -------- | ------ | ---- |  | - | ------ | 
|                       |  |         
|                       |  | June 30,
|                       |  |         
|                       |  | 2001     |        | 2002
|                       |  |          |        |     
|Long-term derivatives  |  | $        | 9,811  |      |  | $ | 5,662  | 
|Intangible assets, net |  |          | 5,735  |      |  |   | 5,365  | 
|Other                  |  |          | 5,284  |      |  |   | 8,759  | 
|                       |  |          |        |      |  |   |        | 
|                       |  | $        | 20,830 |      |  | $ | 19,786 | 
|                       |  |          |        |      |  |   |        | 

Accumulated amortization for intangible assets
was approximately $2,193,000 and $2,563,000 at June 30,
2001 and 2002, respectively.

At June 30, 2001 and 2002, outstanding notes
receivable from officers and employees of the Company, that are
included in other assets, totaled $2,031,000 and $2,222,000,
respectively. These notes are full recourse and bear interest at
various rates between 4.74% and 6.50%. Principal and accrued
interest is due at various times to June 2006.

Accrued liabilities consist of the following (in
thousands):

|                                     |  |          |        |      |  |   |        | 
|------------------------------------ |  | -------- | ------ | ---- |  | - | ------ | 
|                                     |  |         
|                                     |  | June 30,
|                                     |  |         
|                                     |  | 2001     |        | 2002
|                                     |  |          |        |     
|Accrued expenses                     |  | $        | 8,821  |      |  | $ | 8,882  | 
|Accrued tax penalties                |  |          | 7,289  |      |  |   | 6,296  | 
|Accrued payroll and related expenses |  |          | 11,109 |      |  |   | 10,985 | 
|Other                                |  |          | 792    |      |  |   | 40     | 
|                                     |  |          |        |      |  |   |        | 
|                                     |  | $        | 28,011 |      |  | $ | 26,203 | 
|                                     |  |          |        |      |  |   |        | 

Deferred liabilities consist of the following (in
thousands):

|                    |  |          |        |      |  |   |        | 
|------------------- |  | -------- | ------ | ---- |  | - | ------ | 
|                    |  |         
|                    |  | June 30,
|                    |  |         
|                    |  | 2001     |        | 2002
|                    |  |          |        |     
|Deferred revenue    |  | $        | 17,760 |      |  | $ | 18,187 | 
|Deferred bonus plan |  |          | 1,030  |      |  |   | 5,022  | 
|                    |  |          |        |      |  |   |        | 
|                    |  | $        | 18,790 |      |  | $ | 23,209 | 
|                    |  |          |        |      |  |   |        | 

Accumulated other comprehensive income consist of
the following (in thousands):

|                                                                                 |  |          |        |      |  |   |        |  
|-------------------------------------------------------------------------------- |  | -------- | ------ | ---- |  | - | ------ | -
|                                                                                 |  |         
|                                                                                 |  | June 30,
|                                                                                 |  |         
|                                                                                 |  | 2001     |        | 2002
|                                                                                 |  |          |        |     
|Cumulative fair value of derivative instruments                                  |  | $        | 14,176 |      |  | $ | 19,215 |  
|Cumulative net unrealized gains and losses on
    available-for-sale investments |  |          | 133    |      |  |   | (1,621 | )
|                                                                                 |  |          |        |      |  |   |        |  
|                                                                                 |  | $        | 14,309 |      |  | $ | 17,594 |  
|                                                                                 |  |          |        |      |  |   |        |  

13.     Segment
Information

The Company has two reportable operating
segments: payroll, tax services and other, and Comprehensive
Outsourcing and benefits services. See Note 1 for a description
of these business activities. The Company reports segment
revenue information consistent with the presentation made to the
Companys management for decision-making purposes. At this
time the Company does not evaluate segment performance based on

47



---



##### 



PROBUSINESS SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

operating income, as it is currently impractical
for the Company to allocate expenses amongst its two operating
segments. There are no intersegment sales. Revenue for each
segment is as follows (in thousands):

|                                                |  |      |         |      |  |   |         | 
|----------------------------------------------- |  | ---- | ------- | ---- |  | - | ------- | 
|                                                |  | 2001 |         | 2002
|                                                |  |      |         |     
|Payroll, Tax Service and Other                  |  | $    | 134,305 |      |  | $ | 149,056 | 
|Comprehensive Outsourcing and Benefits Services |  |      | 15,556  |      |  |   | 19,584  | 
|                                                |  |      |         |      |  |   |         | 
|Total                                           |  | $    | 149,861 |      |  | $ | 168,640 | 
|                                                |  |      |         |      |  |   |         | 

All revenues are derived from customers in the
United States. All long-lived assets are located in the United
States. No customers represent more than ten percent of the
Companys revenues.

14.     Related Party
Transactions

The Company has entered into transactions with a
company in which our Chief Executive Officer has a material
investment. In addition, the Companys President and Chief
Executive Officer is on the Board of Directors of this company.
The amount of purchased professional services, software licenses
and maintenance fees were none, $470,000, and $613,000 for
fiscal year 2000, 2001 and 2002, respectively. The services and
licenses purchased from this company primarily related to
implementation and integration of a time and attendance product
on behalf of our clients.

15.     Subsequent
Events (Unaudited)

On August 22, 2002 the Company entered into
a Source Code License Agreement (License Agreement)
and a Development Agreement with a vendor in which our Chief
Executive Officer has a material investment (Note 14). The
License Agreement allows the Company to use and license a time
and attendance product in exchange for consideration of
$1,250,000. The Development Agreement provides that the vendor
will assist the Company in further development of this product
through the provision of technical services which will be
incurred as work is completed on a time and materials basis. In
addition, the Companys President and Chief Executive
Officer is on the Board of Directors of this company.

On August 29, 2002 the Company entered into
an equipment lease financing arrangement with a financing
company in the amount of $2.0 million. This leasing
arrangement finances certain computer and office equipment that
the Company uses for its day-to-day business activities. The
lease financing is repayable ratably on a monthly basis over a
three-year period. The equipment financing will be secured by
specific fixed assets. No amounts have been drawn against this
lease to date.

48



---



##### 



PROBUSINESS SERVICES, INC.

QUARTERLY FINANCIAL DATA

The Companys fiscal year 2001 and 2002
unaudited consolidated quarterly financial information is as
follows (in thousands):

|                                                                  |                                                 |               |         |                |   |          |        |         |   |   |        |        |   |   |        |        |  
|----------------------------------------------------------------- | ----------------------------------------------- | ------------- | ------- | -------------- | - | -------- | ------ | ------- | - | - | ------ | ------ | - | - | ------ | ------ | -
|                                                                  |                                                 |              
|                                                                  |                                                 | Quarter Ended
|                                                                  |                                                 |              
|                                                                  |                                                 |               |         |               
|                                                                  |                                                 | 2001          |         | 2002          
|                                                                  |                                                 |               |         |               
|                                                                  |                                                 | Sept. 30      |         | Dec. 31        |   | March 31 |        | June 30
|                                                                  |                                                 |               |         |                |   |          |        |        
|                                                                  |                                                 |               |         |                |   |         
|                                                                  |                                                 |               |         | (Unaudited)    |   |         
|                                                                  |                                                 |               |         | (In thousands) |   |         
|Revenue:                                                          |                                                 |               |         |                |   |          |        |         |   |   |        |        |   |   |        |       
|                                                                  | Service fees                                    |               | $       | 30,372         |   |          | $      | 31,398  |   |   | $      | 30,536 |   |   | $      | 29,917 |  
|                                                                  | Interest income from payroll tax funds invested |               |         | 10,523         |   |          |        | 10,837  |   |   |        | 14,675 |   |   |        | 10,382 |  
|                                                                  |                                                 |               |         |                |   |          |        |         |   |   |        |        |   |   |        |       
|Total revenue                                                     |                                                 |               | 40,895  |                |   |          | 42,235 |         |   |   | 45,211 |        |   |   | 40,299 |       
|Operating expenses:                                               |                                                 |               |         |                |   |          |        |         |   |   |        |        |   |   |        |       
|                                                                  | Cost of providing services                      |               |         | 19,027         |   |          |        | 19,155  |   |   |        | 19,515 |   |   |        | 16,860 |  
|                                                                  | General and administrative                      |               |         | 6,640          |   |          |        | 6,528   |   |   |        | 6,366  |   |   |        | 6,149  |  
|                                                                  | Research and development                        |               |         | 5,418          |   |          |        | 5,172   |   |   |        | 5,254  |   |   |        | 5,501  |  
|                                                                  | Client acquisition costs                        |               |         | 15,883         |   |          |        | 13,417  |   |   |        | 14,934 |   |   |        | 12,784 |  
|                                                                  | Depreciation and amortization                   |               |         | 4,367          |   |          |        | 4,719   |   |   |        | 5,206  |   |   |        | 5,115  |  
|                                                                  |                                                 |               |         |                |   |          |        |         |   |   |        |        |   |   |        |       
|Total operating expenses                                          |                                                 |               | 51,335  |                |   |          | 48,991 |         |   |   | 51,275 |        |   |   | 46,409 |       
|Loss from operations                                              |                                                 |               | (10,440 | )              |   |          | (6,756 | )       |   |   | (6,064 | )      |   |   | (6,110 | )     
|Interest expense                                                  |                                                 |               | (197    | )              |   |          | (167   | )       |   |   | (245   | )      |   |   | (215   | )     
|Interest income and other, net                                    |                                                 |               | 748     |                |   |          | 464    |         |   |   | 709    |        |   |   | 814    |       
|                                                                  |                                                 |               |         |                |   |          |        |         |   |   |        |        |   |   |        |       
|Net loss                                                          |                                                 | $             | (9,889  | )              |   | $        | (6,459 | )       |   | $ | (5,600 | )      |   | $ | (5,511 | )     
|                                                                  |                                                 |               |         |                |   |          |        |         |   |   |        |        |   |   |        |       
|Net loss applicable to common shareholders:                       |                                                 |               |         |                |   |          |        |         |   |   |        |        |   |   |        |       
|                                                                  | Net loss                                        |               | $       | (9,889         | ) |          | $      | (6,459  | ) |   | $      | (5,600 | ) |   | $      | (5,511 | )
|                                                                  | Preferred dividends                             |               |         | (542           | ) |          |        | (555    | ) |   |        | (565   | ) |   |        | (563   | )
|                                                                  |                                                 |               |         |                |   |          |        |         |   |   |        |        |   |   |        |       
|Net loss applicable to common shareholders                        |                                                 | $             | (10,431 | )              |   | $        | (7,014 | )       |   | $ | (6,165 | )      |   | $ | (6,074 | )     
|                                                                  |                                                 |               |         |                |   |          |        |         |   |   |        |        |   |   |        |       
|Basic and diluted net loss per share                              |                                                 | $             | (0.43   | )              |   | $        | (0.28  | )       |   | $ | (0.22  | )      |   | $ | (0.21  | )     
|                                                                  |                                                 |               |         |                |   |          |        |         |   |   |        |        |   |   |        |       
|Shares used in computing basic and diluted net
    loss per share |                                                 |               | 24,204  |                |   |          | 24,682 |         |   |   | 27,641 |        |   |   | 28,322 |       
|                                                                  |                                                 |               |         |                |   |          |        |         |   |   |        |        |   |   |        |       

49



---



##### 



|                                                                        |                                                 |               |         |         |   |          |         |         |   |   |        |        |   |   |        |        |  
|----------------------------------------------------------------------- | ----------------------------------------------- | ------------- | ------- | ------- | - | -------- | ------- | ------- | - | - | ------ | ------ | - | - | ------ | ------ | -
|                                                                        |                                                 |              
|                                                                        |                                                 | Quarter Ended
|                                                                        |                                                 |              
|                                                                        |                                                 |               |         |        
|                                                                        |                                                 | 2000          |         | 2001   
|                                                                        |                                                 |               |         |        
|                                                                        |                                                 | Sept. 30      |         | Dec. 31 |   | March 31 |         | June 30
|                                                                        |                                                 |               |         |         |   |          |         |        
|Revenue                                                                 |                                                 |               |         |         |   |          |         |         |   |   |        |        |   |   |        |       
|                                                                        | Service fees                                    |               | $       | 22,363  |   |          | $       | 26,143  |   |   | $      | 27,073 |   |   | $      | 29,256 |  
|                                                                        | Interest income from payroll tax funds invested |               |         | 7,940   |   |          |         | 8,473   |   |   |        | 14,927 |   |   |        | 13,686 |  
|                                                                        |                                                 |               |         |         |   |          |         |         |   |   |        |        |   |   |        |       
|Total revenue                                                           |                                                 | $             | 30,303  |         |   | $        | 34,616  |         |   | $ | 42,000 |        |   | $ | 42,942 |       
|Operating expenses:                                                     |                                                 |               |         |         |   |          |         |         |   |   |        |        |   |   |        |       
|                                                                        | Cost of providing services                      |               |         | 14,557  |   |          |         | 16,719  |   |   |        | 18,606 |   |   |        | 19,158 |  
|                                                                        | General and administrative                      |               |         | 4,872   |   |          |         | 5,536   |   |   |        | 6,001  |   |   |        | 6,069  |  
|                                                                        | Research and development                        |               |         | 4,655   |   |          |         | 3,949   |   |   |        | 4,422  |   |   |        | 4,157  |  
|                                                                        | Client acquisition costs                        |               |         | 13,612  |   |          |         | 15,431  |   |   |        | 18,144 |   |   |        | 16,831 |  
|                                                                        | Depreciation and amortization                   |               |         | 3,191   |   |          |         | 3,225   |   |   |        | 3,524  |   |   |        | 3,749  |  
|                                                                        |                                                 |               |         |         |   |          |         |         |   |   |        |        |   |   |        |       
|Total operating expenses                                                |                                                 |               | 40,887  |         |   |          | 44,860  |         |   |   | 50,697 |        |   |   | 49,964 |       
|Loss from operations                                                    |                                                 |               | (10,584 | )       |   |          | (10,244 | )       |   |   | (8,697 | )      |   |   | (7,022 | )     
|Interest expense                                                        |                                                 |               | (184    | )       |   |          | (194    | )       |   |   | (289   | )      |   |   | (285   | )     
|Interest income and other, net                                          |                                                 |               | 1,009   |         |   |          | 1,046   |         |   |   | 1,081  |        |   |   | 762    |       
|                                                                        |                                                 |               |         |         |   |          |         |         |   |   |        |        |   |   |        |       
|Net loss before cumulative effect of change in
    accounting principle |                                                 |               | (9,759  | )       |   |          | (9,392  | )       |   |   | (7,905 | )      |   |   | (6,545 | )     
|Cumulative effect of change in accounting
    principle                 |                                                 |               | 410     |         |   |          |        |         |   |   |       |        |   |   |       |       
|                                                                        |                                                 |               |         |         |   |          |         |         |   |   |        |        |   |   |        |       
|Net loss                                                                |                                                 | $             | (9,349  | )       |   | $        | (9,392  | )       |   | $ | (7,905 | )      |   | $ | (6,545 | )     
|                                                                        |                                                 |               |         |         |   |          |         |         |   |   |        |        |   |   |        |       
|Net loss applicable to common shareholders:                             |                                                 |               |         |         |   |          |         |         |   |   |        |        |   |   |        |       
|                                                                        | Net loss                                        |               | $       | (9,349  | ) |          | $       | (9,392  | ) |   | $      | (7,905 | ) |   | $      | (6,545 | )
|                                                                        | Preferred dividends                             |               |         |        |   |          |         | 344     |   |   |        | 518    |   |   |        | 537    |  
|                                                                        |                                                 |               |         |         |   |          |         |         |   |   |        |        |   |   |        |       
|Net loss applicable to common shareholders                              |                                                 | $             | (9,349  | )       |   | $        | (9,736  | )       |   | $ | (8,423 | )      |   | $ | (7,082 | )     
|                                                                        |                                                 |               |         |         |   |          |         |         |   |   |        |        |   |   |        |       
|Basic and diluted net loss per share:                                   |                                                 |               |         |         |   |          |         |         |   |   |        |        |   |   |        |       
|Before cumulative effect of change in accounting
    principle          |                                                 | $             | (0.42   | )       |   | $        | (0.41   | )       |   | $ | (0.35  | )      |   | $ | (0.29  | )     
|Cumulative effect of change in accounting
    principle                 |                                                 |               | 0.02    |         |   |          |        |         |   |   |       |        |   |   |       |       
|                                                                        |                                                 |               |         |         |   |          |         |         |   |   |        |        |   |   |        |       
|Basic and diluted net loss per share                                    |                                                 | $             | (0.40   | )       |   | $        | (0.41   | )       |   | $ | (0.35  | )      |   | $ | (0.29  | )     
|                                                                        |                                                 |               |         |         |   |          |         |         |   |   |        |        |   |   |        |       
|Shares used in computing basic and diluted net
    loss per share       |                                                 |               | 23,588  |         |   |          | 23,739  |         |   |   | 23,952 |        |   |   | 24,081 |       
|                                                                        |                                                 |               |         |         |   |          |         |         |   |   |        |        |   |   |        |       

50



---



##### 



Item 9.     Changes
in and Disagreements with Accountants on Accounting and
Financial Disclosure

There has been no change in accountants or
reported disagreements on accounting principles or practices or
financial statement disclosures.

PART III

Item 10.     Directors
and Executive Officers of the Registrant

The following table sets forth certain
information with respect to our executive officers and directors
as of September 24, 2002.

|                         |  |     |    |          |  |                                                                             
|------------------------ |  | --- | -- | -------- |  | ----------------------------------------------------------------------------
|Name                     |  | Age |    | Position
|                         |  |     |    |         
|Thomas H. Sinton         |  |     | 54 |          |  | Chairman of the Board, President, Chief Executive
    Officer, Director     
|Jeffrey M. Bizzack       |  |     | 42 |          |  | Executive Vice President, Sales and Services                                
|Jerry W. Blalock         |  |     | 53 |          |  | Executive Vice President and Group General Manager                          
|Steven E. Klei           |  |     | 42 |          |  | Executive Vice President, Finance, Chief
    Financial Officer and Secretary
|William T. Clifford      |  |     | 56 |          |  | Director                                                                    
|David C. Hodgson         |  |     | 45 |          |  | Director                                                                    
|Ronald W. Readmond(1)(2) |  |     | 59 |          |  | Director                                                                    
|Dennis Raney(1)(2)       |  |     | 60 |          |  | Director                                                                    
|Samuel Spadafora(1)(2)   |  |     | 59 |          |  | Director                                                                    



---



|    |                                      
|--- | -------------------------------------
|(1) | Member of the Audit Committee.       
|   
|(2) | Member of the Compensation Committee.

Mr. Sinton, our founder, has served as one of our
directors since we incorporated in October 1984. Since March
1993, and for a period between September 1989 and February 1993
Mr. Sinton has served as our President and Chief Executive
Officer. 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 our Executive Vice
President, Sales and Marketing since May 2002. From November
1999 to April 2002 Mr. Bizzack served as our Executive Vice
President, Sales and Services. From July 1993 to February 2000,
Mr. Bizzack served as our Senior Vice President, Sales and
from October 1992 to July 1993, Mr. Bizzack served as our
Vice President, Sales. From October 1988 to October 1992,
Mr. Bizzack served as our District Sales Manager.
Mr. Bizzack attended Saint Marys College.

Mr. Blalock has served as our Executive Vice
President, Group General Manager since October 1999. From August
1998 to October 1999, Mr. Blalock served as our Senior Vice
President and General Manager. From October 1996 to August 1998,
Mr. Blalock served as Vice President and Regional General
Manager for Anacomp Corporation, a provider of document imaging
services. Mr. Blalock attended the University of
La Verne.

Mr. Klei has served as our Executive Vice
President, Finance since February 2000. Mr. Klei served as
our Senior Vice President, Finance from August 1997 to February
2000. Mr. Klei has served as our Chief Financial Officer
since July 1995 and as our Secretary since August 1996.
Mr. Klei served as our Vice President, Finance from July
1995 to August 1997. Mr. Klei holds a B.S. degree in
Accounting from Central Michigan University and is a Certified
Public Accountant.

51



---



##### 



Mr. Clifford has served as one of our directors
since August 1997. Mr. Clifford has served as a Managing
Member of New Vista Capital, a venture capital firm, from April
2000 to present. Mr. Clifford also serves as Chairman of
Authentor Systems, Inc., a security management and
authentication software company. Mr. Clifford served as
President and Chief Executive Officer of Warrantycheck.com, an
internet provider, from November 1999 to April 2000. From
January 1999 to October 1999, Mr. Clifford served as the
Chief Executive Officer of Gartner Group, Inc., a provider of
information and analysis on the technology industries, and as
the President there since October 1997. From April 1995 to
January 1999, he was the Chief Operating Officer of Gartner
Group, Inc., and he was Executive Vice President, Operations
there from October 1993 to September 1997. 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 one of our
directors since March 1997. Mr. Hodgson is a Managing
Member of GAP, a private equity investment firm that invests in
Internet and information technology on a global basis, and has
been with GAP or its predecessor since 1982. Mr. Hodgson is
also a director of Atlantic Data Services, Inc., a provider of
professional computer services for the banking industry,
ScreamingMedia, Inc., a developer of proprietary technologies
for the aggregation and distribution of digital content over the
Internet, and several other privately-held information
technology companies, in which GAP 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 one of our directors
since February 1997. From January 2001 to June 2001,
Mr. Readmond served as a director and Chief Executive
Officer of TruMarkets Inc., an automated bond trading company.
Mr. Readmond previously served as a director and Vice
Chairman of Wit Soundview Group, an investment bank, from June
2000 to October 2000 and as director, President and Chief
Operating Officer there from June 1998 to June 2000. 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. Raney joined our board of directors
effective July 1, 2002, filling a vacancy created by a
retired Board member. Mr. Raney has served as Chief
Financial Officer of eONE Global, a company that identifies,
develops and operates emerging electronic payment systems and
related technologies that address e-commerce challenges, since
July 2001. From March 1998 to July 2001, Mr. Raney served
as Chief Financial Officer and Executive Vice President of
Novell, Inc., a producer of network software. From March 1997 to
December 1997, Mr. Raney served as Chief Financial Officer
and Executive Vice President of QAD, Inc., a provider of
enterprise resource planning software. Mr. Raney has also
served as a director and audit committee member of Redleaf,
Inc., a technology operating company that provides services and
capital for pre-seed state technology companies, since 2001.
Mr. Raney previously served as a director and audit
committee member of W.R. Hambrecht & Company, an
enterprise-neutral investment firm, from November 1998 to July
2001 and served as a director and audit committee member of ADAC
Laboratories, a company that designs, develops, manufactures,
sells and services electronic medical imaging and information
systems, from March 1999 to March 2001. Mr. Raney holds a
B.S. degree in chemical engineering from the South Dakota
School of Mines & Technology and an MBA from the
University of Chicago.

Mr. Spadafora joined our board of directors
effective July 1, 2002, filling a newly created board seat.
Since November 1999, Mr. Spadafora has served as Chairman
of Chordiant Software, Inc., an enterprise software company, and
from June 1998 to January 2002, has also served as Chief
Executive Officer there. From April 1994 to June 1998,
Mr. Spadafora served as vice president of worldwide field
operations for the microelectronic business of Sun Microsystems.
Mr. Spadafora had served as a director of Chordiant
Software since 1998. Mr. Spadafora holds a B.A. in
marketing from Eastern Michigan University.

Under the terms of the August 2000 investment by
affiliates of GAP in our Preferred Stock, as long as GAP or its
affiliates own a majority of the Preferred Stock, the holders of
the Preferred Stock are entitled to elect one director to our
Board of Directors. As of June 30, 2002, Mr. Hodgson,
a Partner of GAP, is a member of our current Board of Directors.

52



---



##### 



Section 16(a) of the Securities Exchange Act
of 1934, as amended, requires our executive officers and
directors, and persons who own more than 10% of a registered
class of our equity securities to file reports of ownership and
changes in ownership with the Securities and Exchange
Commission. Executive officers, directors and greater than 10%
stockholders are required by the Securities and Exchange
Commission rules to furnish us with copies of all forms they
file. Based solely on our review of the copies of such forms
received by us and written representations from certain
reporting persons, we believe that, during fiscal year 2002, all
Section 16(a) filing requirements applicable to our
executive officers, directors and 10% stockholders were
satisfied.

Item 11.     Executive
Compensation

The information required is set forth in our
definitive Proxy Statement in the sections entitled
Executive Officer Compensation and Election of
Class II Directors and is incorporated herein by
reference.

Item 12.     Security
Ownership and Related Stockholder Matters

The information required is set forth in our
definitive Proxy Statement in the section entitled
Security Ownership of Certain Beneficial Owners and
Management and is incorporated herein by reference.

Item 13.     Certain
Relationships and Related Transactions

The information required is set forth in our
definitive Proxy Statement in the section entitled Certain
Transactions and is incorporated herein by reference.

PART IV

Item 14.     Exhibits,
Financial Statement Schedules and Reports on
Form 8-K.

(a) The following documents are filed as a
part of this Report:



| |                                                                                                                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1. Financial Statements:                                                                                                                                                                                                                                    
|
| | See Item 8. of this annual report on form
    10-K.                                                                                                                                                                                                         
|
| | 2. Financial Statement Schedules:
    Schedules have been omitted because they are not applicable or
    are not required or the information required to be set forth
    therein is included in the Consolidated Financial Statements or
    Notes thereto.
|
| | 3. Exhibits: The Exhibits listed on
    the accompanying Index to Exhibits immediately following the
    financial statement schedule are filed as part of, or
    incorporated by reference into, this Report.                                             

(b) Reports of Form 8-K.

No reports on Form 8-K were filed during the
quarter ended June 30, 2002.

(c) Exhibits: See
Item (a) above.

(d) Financial Statement Schedules:
See Item (a) above.

53



---



##### 



SIGNATURES

Pursuant to the requirements of section 13
or 15(d) of the Securities Exchange Act of 1934, the Registrant
has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the city of
Pleasanton, state of California, on this 30th day of September
2002.



| |                           
| | --------------------------
| | PROBUSINESS SERVICES, INC.



| |     |                     
| | --- | --------------------
| | By: | /s/ THOMAS H. SINTON

| |                                          
| | -----------------------------------------
| |                                          
| | President and Chief Executive
    Officer

Pursuant to the requirements of the Securities
Act of 1934, this Report has been signed below by the following
persons on behalf of the Registrant and in the capacities and on
the dates indicated:

|                                           |  |                                                                                                                    |  |                    |  | 
|------------------------------------------ |  | ------------------------------------------------------------------------------------------------------------------ |  | ------------------ |  | 
|                                           |  |                                                                                                                    |  |                   
|Signature                                  |  | Title                                                                                                              |  | Date              
|                                           |  |                                                                                                                    |  |                   
|/s/ THOMAS H. SINTONThomas H. Sinton       |  | President, Chief Executive
    Officer and Director
    (Principal Executive Officer)                              |  | September 30, 2002
|                                          
|                                          
|/s/ STEVEN E. KLEISteven E. Klei           |  | Executive Vice President,
    Finance, Chief Financial Officer
    and Secretary (Principal Financial
    Officer) |  | September 30, 2002
|                                          
|/s/ GLENDA M. CITRAGNOGlenda M. Citragno   |  | Vice President, Finance and
    Principal Accounting Officer                                                       |  | September 30, 2002
|                                          
|/s/ WILLIAM T. CLIFFORDWilliam T. Clifford |  | Director                                                                                                           |  | September 30, 2002
|                                          
|/s/ DAVID C. HODGSONDavid C. Hodgson       |  | Director                                                                                                           |  | September 30, 2002
|                                          
|/s/ DENNIS R. RANEYDennis R. Raney         |  | Director                                                                                                           |  | September 30, 2002
|                                          
|/s/ RONALD W. READMONDRonald W. Readmond   |  | Director                                                                                                           |  | September 30, 2002
|                                          
|/s/ SAMUEL T. SPADAFORASamuel T. Spadafora |  | Director                                                                                                           |  | September 30, 2002

54



---



##### 



INDEX TO EXHIBITS

|         |     |        |  |                     |    |       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|-------- | --- | ------ |  | ------------------- | -- | ----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Footnote |     | Number |  | Exhibit Description
|         |     |        |  |                    
|         | (2) |        |  |                     | 3  | .1    |  | Amended and Restated Certificate of Incorporation.                                                                                                                                                                                                                                                                                                                                                                                                                           
|         | (1) |        |  |                     | 3  | .2    |  | Bylaws of Registrant.                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|         | (1) |        |  |                     | 4  | .1    |  | Specimen Common Stock Certificate of Registrant.                                                                                                                                                                                                                                                                                                                                                                                                                             
|         | (1) |        |  |                     | 4  | .2    |  | Amended and Restated Registration Rights
    Agreement, dated March 12, 1997, between Registrant,
    General Atlantic Partners 39, L.P., GAP Coinvestment Partners,
    L.P. and certain stockholders of Registrant.                                                                                                                                                                                                                                                        
|         | (6) |        |  |                     | 4  | .2(a) |  | Amendment to Amended and Restated Registration
    Rights Agreement, dated August 1, 2000, between Registrant,
    General Atlantic Partners 39, L.P., GAP Coinvestment
    Partners, L.P., General Atlantic Partners 70, L.P., GAP
    Coinvestment Partners II, L.P. and GapStar, LLC.                                                                                                                                                                                     
|         | (8) |        |  |                     | 4  | .2(b) |  | Waiver and Amendment to the Amended and Restated
    Registration Rights Agreement dated as of December 20, 2001
    by and among the Registrant, General Atlantic Partners 39,
    L.P., GAP Coinvestment Partners L.P., General Atlantic
    Partners 70, L.P., GAP Coinvestment Partners II, L.P.,
    GapStar, LLC, Thomas H. Sinton and the holders of a
    majority the Registrants registrable securities pursuant
    to the Amended Registration Rights Agreement.
|         | (4) |        |  |                     | 4  | .9    |  | Waiver and Amendment, dated as of April 27,
    1999, among Registrant, General Atlantic Partners 39, L.P.,
    GAP Coinvestment Partners, L.P. and certain stockholders of
    Registrant.                                                                                                                                                                                                                                                                                  
|         | (5) |        |  |                     | 4  | .11   |  | Certificate of Designation of 6.9% Senior
    Redeemable Convertible Preferred Stock dated August 1, 2000.                                                                                                                                                                                                                                                                                                                                                                   
|         | (7) |        |  |                     | 4  | .12   |  | Preferred Stock Rights Agreement, dated as of
    August 8, 2001, between Registrant and Wells Fargo Bank, MN
    N.A., including the Certificate of Designation, the form of
    Rights Certificate and the Summary of Rights attached thereto as
    Exhibits A, B and C, respectively.                                                                                                                                                                                    
|         | (9) |        |  |                     | 4  | .13   |  | Common Stock Purchase Agreement, made as of
    December 20, 2001, by and among the Registrant and the
    purchasers.                                                                                                                                                                                                                                                                                                                                                       
|         | (5) |        |  |                     | 10 | .1    |  | 6.9% Senior Redeemable Convertible Preferred
    Stock Purchase Agreement, dated as of August 1, 2000,
    between Registrant and General Atlantic Partners 70, L.P., GAP
    Coinvestment Partners II, L.P. and GapStar, LLC.                                                                                                                                                                                                                                               
|         | (3) |        |  |                     | 10 | .2*   |  | 1996 Stock Option Plan (as amended).                                                                                                                                                                                                                                                                                                                                                                                                                                         
|         | (2) |        |  |                     | 10 | .3*   |  | 1996 Employee Stock Purchase Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                           
|         | (1) |        |  |                     | 10 | .4*   |  | Form of Indemnification Agreement between
    Registrant and executive officers and directors.                                                                                                                                                                                                                                                                                                                                                                               
|         |     |        |  |                     | 10 | .5    |  | Loan and Security Agreement between Registrant
    and Comerica Bank-California.                                                                                                                                                                                                                                                                                                                                                                                             
|         |     |        |  |                     | 10 | .6    |  | First amendment to Loan and Security Agreement
    between Registrant and Comerica Bank-California.                                                                                                                                                                                                                                                                                                                                                                          
|         | (9) |        |  |                     | 10 | .7    |  | Common Stock Purchase Agreement, made as of
    December 20, 2001, by and among the Registrant and the
    purchasers.                                                                                                                                                                                                                                                                                                                                                       
|         |     |        |  |                     | 21 | .1    |  | Subsidiaries of the Registrant.                                                                                                                                                                                                                                                                                                                                                                                                                                              
|         |     |        |  |                     | 23 | .1    |  | Consent and Report of Independent Auditors.                                                                                                                                                                                                                                                                                                                                                                                                                                  
|         |     |        |  |                     | 99 | .1    |  | Certification pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                              



---



| |   |                                                                     
| | - | --------------------------------------------------------------------
| | * | Indicates management compensatory plan, contract
    or arrangement.



|    |                                                                                                                                                                                          
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to the
    Registrants Registration Statement on Form S-1, as
    amended (File No. 333-23189), declared effective on
    September 18, 1997.                 
|   
|(2) | Incorporated by reference from the
    Registrants Registration Statement on Form S-8 (File
    No. 333-37129) filed with the Securities and Exchange
    Commission on October 3, 1997.

55



---



##### 





|    |                                                                                                                                                                                        
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(3) | Incorporated by reference from the
    Registrants Registration Statement on Form S-8 (File
    No. 333-85916) filed with the Securities and Exchange
    Commission on April 9, 2002.
|   
|(4) | Incorporated by reference from the
    Registrants report on Form 8-K filed with the
    Securities and Exchange Commission on May 12, 1999.                                          
|   
|(5) | Incorporated by reference from the
    Registrants report on Form 8-K filed with the
    Securities and Exchange Commission on August 16, 2000.                                       
|   
|(6) | Incorporated by reference from the
    Registrants report on Form 10-K filed with the
    Securities and Exchange Commission on September 28, 2000.                                   
|   
|(7) | Incorporated by reference from the
    Registrants report on Form 8-K filed with the
    Securities and Exchange Commission on August 17, 2001.                                       
|   
|(8) | Incorporated by reference from the
    Registrants report on Form 8-K filed with the
    Securities and Exchange Commission on January 7, 2002.                                       
|   
|(9) | Incorporated by reference from the
    Registrants report of Form 8-K/ A filed with the
    Securities and Exchange Commission on February 19, 2002.                                  

56