-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, MNkIcHjQJ/qL1FfreqsCaZab5LKvceC8mkDoTPHnES8tZkJ7gdJH6PSqaTt42nJ4 impEKQhOk1bmBk31nimVGQ== 0000927356-97-001348.txt : 19980629 0000927356-97-001348.hdr.sgml : 19980629 ACCESSION NUMBER: 0000927356-97-001348 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971113 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: ONLINE SYSTEM SERVICES INC CENTRAL INDEX KEY: 0001011901 STANDARD INDUSTRIAL CLASSIFICATION: 7373 IRS NUMBER: 841293864 STATE OF INCORPORATION: CO FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10QSB SEC ACT: SEC FILE NUMBER: 000-28462 FILM NUMBER: 97716967 BUSINESS ADDRESS: STREET 1: 1800 GLENARM PLACE STREET 2: SUITE 800 CITY: DENVER STATE: CO ZIP: 80202 BUSINESS PHONE: 3032969200 MAIL ADDRESS: STREET 1: 1800 GLENARM PL STREET 2: SUITE 800 CITY: DENVER STATE: CO ZIP: 80202 10QSB 1 FORM 10QSB FORM 10-QSB - Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB [X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of l934. For the period ended September 30, 1997. ------------------- [_] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the transition period from _____________ to _________________. Commission File Number 0-28462. ------------- ONLINE SYSTEM SERVICES, INC. - - ---------------------------- (Exact name of registrant as specified in its charter) COLORADO 84-1293864 - - ---------------------------------------------------------------- (State or other jurisdiction I.R.S. Employer of incorporation or organization Identification No.) 1800 GLENARM PLACE, SUITE 800, DENVER, CO 80202 - - --------------------------------------------------- (Address of principal executive offices) (Zipcode) (303)296-9200 - - ------------- (Registrant's telephone number, including area code) Not Applicable - - -------------- Former name, former address and former fiscal year, if changed since last report.) 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. [X] YES [_] NO APPLICABLE ONLY TO CORPORATE ISSUERS: As of November 3, 1997, Registrant had 3,221,245 shares of common stock outstanding. ONLINE SYSTEM SERVICES, INC. INDEX -----
PAGE ---- PART I. FINANCIAL INFORMATION ITEM I. FINANCIAL STATEMENTS BALANCE SHEETS AS OF SEPTEMBER 30, 1997 (UNAUDITED) AND DECEMBER 31, 1996 3 UNAUDITED STATEMENTS OF OPERATIONS, THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996, RESPECTIVELY 4 UNAUDITED STATEMENTS OF STOCKHOLDERS' EQUITY, NINE MONTHS ENDED SEPTEMBER 30, 1997 5 UNAUDITED STATEMENTS OF CASH FLOWS, NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996, RESPECTIVELY 6,7 NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 8,9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 10-15 PART II. OTHER INFORMATION ITEM 1-5. NOT APPLICABLE 16 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 16 SIGNATURES 17
2 ONLINE SYSTEM SERVICES, INC. BALANCE SHEETS
September 30, December 31, 1997 1996 (Unaudited) ------------- ------------ ASSETS Current assets: Cash and cash equivalents $2,559,773 $1,645,163 Short-term investments --- 3,855,343 Accounts receivable, net 501,100 229,350 Accrued revenue receivables 352,563 90,337 Inventory 190,209 195,941 Prepaid expenses 250,852 132,544 Short-term deposit 61,015 61,015 ---------- ---------- Total current assets 3,915,512 6,209,693 ---------- ---------- Equipment, net 852,553 486,344 Other assets 103,663 164,616 ---------- ---------- Total assets $4,871,728 $6,860,653 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 456,751 $ 331,809 Accrued expenses 33,874 17,684 Accrued salaries and taxes payable 110,501 82,806 Current portion of note and capital leases payable 24,122 30,437 Deferred revenue 15,574 48,669 ---------- ---------- Total current liabilities 640,822 511,405 ---------- ---------- Note and capital leases payable 6,196 32,647 ---------- ---------- Stockholders' equity: Preferred stock, no par value, 5,000,000 shares authorized, no shares issued or outstanding --- --- Common stock, no par value 10,000,000 shares authorized, 3,221,245 and 3,162,545 shares issued and outstanding, respectively 7,912,553 7,953,665 Stock subscriptions receivable --- (586) Accumulated deficit (3,687,843) (1,636,478) ---------- ---------- Total stockholders' equity 4,224,710 6,316,601 ---------- ---------- Total liabilities and stockholder's equity $4,871,728 $6,860,653 ========== ==========
The accompanying notes to financial statements are an integral part of these balance sheets. 3 ONLINE SYSTEM SERVICES, INC. STATEMENTS OF OPERATIONS
For the Three Months For the Nine Months Ended Ended September 30, September 30, 1997 1996 1997 1996 (Unaudited) (Unaudited) (Unaudited) (Unaudited) ------------ ------------ ----------- ----------- Net sales: Service sales $ 481,415 $ 273,043 $1,357,621 $ 709,223 Hardware and software sales 249,261 134,272 538,224 266,031 ---------- ---------- ----------- ----------- 730,676 407,315 1,895,845 975,254 Cost of sales: Cost of services 268,137 174,808 803,711 443,531 Cost of hardware and software 217,564 97,647 461,619 201,827 ---------- ---------- ----------- ----------- 485,701 272,455 1,265,330 645,358 ---------- ---------- ----------- ----------- Gross Margin 244,975 134,860 630,515 329,896 ---------- ---------- ----------- ----------- Operating expenses: Sales and marketing expenses 262,181 203,357 793,453 395,503 Product development expenses 277,221 129,826 716,722 299,388 General and administrative expenses 463,433 263,969 1,205,182 554,445 Depreciation and amortization 40,778 30,366 116,115 56,881 ---------- ---------- ----------- ----------- Loss from operations (798,638) (492,658) (2,200,957) (976,321) Other income: Interest income 39,969 82,462 149,592 106,824 ---------- ---------- ----------- ----------- Loss before provision for income taxes (758,669) (410,196) (2,051,365) (869,497) Provision for income taxes --- --- --- --- ---------- ----------- ----------- ----------- Net loss ($758,669) ($410,196) ($2,051,365) ($869,497) ========== =========== =========== =========== Net loss per common and common equivalent share (Note 3) ($0.24) ($0.13) ($0.65) ($0.31) ========== =========== =========== =========== Weighted average common and common equivalent shares outstanding (Note 3) 3,195,175 3,097,425 3,184,431 2,766,538 ========== =========== =========== ===========
The accompanying notes to financial statements are an integral part of these statements. 4 ONLINE SYSTEM SERVICES, INC. STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Stock Stockholders' Common Stock Subscriptions Accumulated Equity Shares Amount Receivable Deficit (Deficit) --------- --------- ------------- ----------- ------------ Balances, December 31, 1994 --- $ --- $ --- $ --- $ --- Common stock issued to founders for cash at an average price of $0.0002 per share 480,000 100 --- --- 100 Common stock issued to founders for services rendered at $0.05 per share 125,000 6,250 --- --- 6,250 Common stock issued for services rendered at $0.56 per share 370,000 207,707 --- --- 207,707 Stock subscriptions receivable --- --- (57,269) --- (57,269) Common stock issued in private placement for cash at $0.50 per share 650,000 325,000 --- --- 325,000 Net loss --- --- --- (482,239) (482,239) Subchapter S corporation losses allocated to individual shareholders --- (266,193) --- 266,193 --- --------- ----------- --------- ----------- ----------- Balances, December 31, 1995 1,625,000 272,864 (57,269) (216,046) (451) Common stock issued in conjunction with private placement 182,245 410,000 --- --- 410,000 Less offering costs --- (6,330) --- --- (6,330) Common stock issued in conjunction with initial public offering for cash at $6.75 per unit 1,265,000 8,538,750 --- --- 8,538,750 Less offering costs --- (1,306,769) --- --- (1,306,769) Exercise of stock options and warrants 90,300 45,150 --- --- 45,150 Stock subscriptions receivable --- --- 56,683 --- 56,683 Net loss --- --- --- (1,420,432) (1,420,432) --------- ----------- --------- ----------- ----------- Balances, December 31, 1996 3,162,545 7,953,665 (586) (1,636,478) 6,316,601 Exercise of stock options (unaudited) 58,700 33,888 --- --- 33,888 Purchase of option to buy common stock (unaudited) (Note 6) (75,000) (75,000) Stock subscriptions receivable (unaudited) --- --- 586 --- 586 Net loss for the nine months ended September 30, 1997 (unaudited) --- --- --- (2,051,365) (2,051,365) --------- ----------- --------- ----------- ----------- Balances, September 30, 1997 (unaudited) 3,221,245 $ 7,912,553 $ --- ($3,687,843) $ 4,224,710 ========= =========== ========= =========== ===========
The accompanying notes to financial statements are an integral part of these statements. 5 ONLINE SYSTEM SERVICES, INC. STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 1997 1996 (Unaudited) (Unaudited) ----------- ----------- Cash flows from operating activities: Net loss ($2,051,365) ($869,497) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 116,115 56,881 Stock issued for services 586 36,021 Changes in operating assets and liabilities: Accounts receivable (271,750) (173,445) Accrued revenue receivables (262,226) --- Inventory 5,732 (84,082) Prepaid expenses (118,308) (8,475) Other assets 60,953 (312,223) Accounts payable 124,942 177,890 Accrued expenses 43,885 82,298 Deferred revenue (33,095) 14,013 ----------- ----------- Net Cash Used in Operating Activities (2,384,531) (1,080,619) ----------- ----------- Cash flows from investing activities: Proceeds from short-term investments 3,855,343 --- Purchase of equipment (482,324) (314,358) ----------- ----------- Net cash provided by (used in) investing activities 3,373,019 (314,358) ----------- ----------- Cash flows from financing activities: Payments on note payable and capital leases (32,766) (29,286) Proceeds from issuance of common stock 33,888 8,948,751 Purchase of option to buy common stock (Note 6) (75,000) --- Payments on short-term notes payable --- (50,814) Payments received on stock subscriptions receivable --- 20,000 Stock offering costs --- (1,300,600) ----------- ----------- Net cash provided by (used in) financing activities (73,878) 7,588,051 ----------- ----------- Net increase in cash and cash equivalents 914,610 6,193,074 Cash and cash equivalents at beginning of period 1,645,163 25,241 ----------- ----------- Cash and cash equivalents at end of period $ 2,559,773 $ 6,218,315 =========== ===========
The accompanying notes to financial statements are an integral part of these statements. 6 ONLINE SYSTEM SERVICES, INC. STATEMENTS OF CASH FLOWS (Continued)
For the Nine Months Ended September 30, 1997 1996 (Unaudited) (Unaudited) ----------- ----------- Supplemental Cash Flow Information: Cash paid for Interest --- $ 6,011 Income taxes --- --- Non-Cash Investing and Financing Activities: Stock Issued for services $586 $35,016 Capital lease for equipment --- 5,440 Note payable for fixed assets purchased --- 30,323
The accompanying notes to financial statements are an integral part of these statements. 7 ONLINE SYSTEM SERVICES, INC. NOTES TO FINANCIAL STATEMENTS SEPTEMBER 30, 1997 (UNAUDITED) AND DECEMBER 31, 1996 NOTE 1 - BASIS OF PRESENTATION The accompanying unaudited interim financial statements have been prepared without audit pursuant to rules and regulations of the Securities and Exchange Commission and reflect, in the opinion of management, all adjustments, which are of a normal and recurring nature, necessary for a fair presentation of the financial position and results of operations for the periods presented. The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions. Such estimates and assumptions affect the reported amounts of assets and liabilities as well as disclosure of contingent assets and liabilities at the date of the accompanying financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. The results of operations for the interim periods are not necessarily indicative of the results for the entire year. NOTE 2 - REVENUE RECOGNITION Revenue from hardware and software sales is recognized upon shipment provided that the Company has no further material obligations. Revenue from maintenance fees, training courses and Internet access are recognized as the services are performed. License fees are recognized when the Company has no further material obligations. Revenue from Web site design and consulting is recognized on the percentage of completion method on an individual contract basis. Percentage complete is determined primarily based upon the ratio that labor costs incurred bear to total estimated costs. The Company's use of the percentage of completion method of revenue recognition requires estimates of the degree of project completion. To the extent these estimates prove to be inaccurate, the revenues and gross margin, if any, reported for periods during which work on the project is ongoing may not accurately reflect the final results of the project, which can only be determined upon project completion. Provisions for any estimated losses on uncompleted contracts are made in the period in which such losses are determinable. Amounts earned but not billed are shown as accrued revenue receivables in the accompanying balance sheets. Amounts invoiced but not earned are shown as deferred revenue in the accompanying balance sheets. NOTE 3 - NET LOSS PER COMMON AND COMMON EQUIVALENT SHARE Net loss per common and common equivalent share has been computed based upon the weighted average number of common shares and common share equivalents outstanding. Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 83, common stock and common stock equivalent shares issued by the Company at prices below the initial public offering price during the twelve month period prior to the offering (using the treasury stock method for common stock and common stock equivalents at an assumed offering price of $6.75 per unit) have been included in the calculation as if they were outstanding for all periods presented regardless of whether they were antidilutive. NOTE 4 - CONCENTRATION OF CREDIT RISK The Company sells computer hardware and software and related services and in connection therewith extends credit to its customers. Credit losses, if any, have been provided for in the financial statements and are based on management's expectations. The Company's accounts receivable are subject to potential concentrations of credit risk. 8 ONLINE SYSTEM SERVICES, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 1997 (UNAUDITED) AND DECEMBER 31, 1996 NOTE 4 - CONCENTRATION OF CREDIT RISK (CONTINUED) The Company does not believe that it is subject to any unusual risks or significant risks in the normal course of it's business. The Company had three major customers for the three months ended September 30, 1997, which accounted for 40%, 15% and 10% of net sales, respectively. The Company had one major customer for the three months ended September 30, 1996, which accounted for 35% of net sales. The Company had one major customer for the nine months ended September 30, 1997, which accounted for 22% of net sales. The Company had one major customer for the nine months ended September 30, 1996, which accounted for 15% of net sales. NOTE 5 - NEW ACCOUNTING STANDARD In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share," which supercedes Accounting Principles Board Opinion No. 15, "Earnings per Share." SFAS No. 128 is effective for annual and interim periods ending after December 15, 1997 and simplifies the computation of earnings per share by replacing the presentation of primary earnings per share with a presentation of basic earnings per share. SFAS No. 128 requires dual presentation of basic and diluted earnings per share by entities with complex capital structures. Basic earnings per share includes no dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution of securities that could share in the earnings of an entity. The Company does not believe that its loss per share calculations will be materially affected as a result of adopting SFAS No. 128. NOTE 6 - PURCHASE OF OPTION TO BUY COMMON STOCK During the nine-month period ended September 30, 1997, the Company purchased for the price of $75,000 from a consultant to the Company, a stock option to buy 100,000 shares of the Company's common stock at $.50 per share. Upon purchase, the options were canceled. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL To date, the Company has generated revenue through the sale of design and consulting services for Web site development, resale of software licenses, mark-ups on computer hardware and software sold to customers, maintenance fees charged to customers to maintain computer hardware and Web sites, license fees based on a percentage of revenues from the Community Access Partnership ("CAP") products and services, training course fees, and monthly fees paid by customers for Internet access provided by the Company in the Denver market. The Company commenced sales in February 1995, and was in the development stage through December 31, 1995. Prior to the quarter ended September 30, 1997, the Company's focus generally was on three markets: general Web site development, maintenance and hosting; rural or small market Internet service providers ("ISP's"); and healthcare information services and continuing medical education ("CME"). These activities were divided into three separate business units early in fiscal 1997, the Business Resource Group ("BRG") for Web site-related activities; Community Access America ("CAA") for the ISP activities; and Healthcare for the CME and healthcare information activities. Each of these activities involved in varying degrees the establishment of online communities. As an outgrowth of the Company's BRG and CAA activities, and in recognition of the need to increase the availability of high-speed Internet access, the Company's focus during fiscal 1997 increasingly was on the development of online communities for broadband (high bandwidth or high data transmission capabilities) operators such as cable TV operators (wire and wireless) who the Company believes are in the best position today to provide high-speed Internet access. This focus has resulted in the introduction of the Company's CAP products and services which include a wide range of online services which enable operators and operator's customer to generate online local contact, create Web pages and conduct online commerce and banking and a turnkey product and service package which provides the equipment, training and systems necessary for the broadband operator to become a fully operational ISP. The Company intends to focus its future efforts on its CAP products and services. During November 1997, the Company announced to its customers that it was terminating Web site development, maintenance and hosting activities and began to transition this business to other companies. It is OSS's intent to discontinue Web site development activities which are not related to the development of products for its CAP program or do not involve the creation of online communities for particular businesses of information purposes. In addition, during October 1997, the Company licensed its MD Gateway Web site to Medical Education Collaborative ("MEC") and will no longer be developing products for the healthcare market. In the future, revenues from the healthcare market are expected to be limited to license fees received from MEC in connection with the use of MD Gateway. Revenues from areas that the Company no longer emphasizes represents $140,782, $772,938, and $1,063,509 of the Company's revenues during the three and nine-month periods ended September 30, 1997, and the year ended December 31, 1996, respectively, representing 19%, 41%, and 74%, respectively, of the total revenues for such periods. The Company intends to increase its capital expenditures and operating expenses in order to expand its CAP products and services to support additional subscribers in future markets and to market and provide the Company's services to a growing number of potential subscribers. As a result, OSS expects to incur additional substantial operating and net losses for the balance of fiscal 1997 and for one or more fiscal years thereafter. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) RESULTS OF OPERATIONS The following table sets forth for the periods indicated the percentage of net sales by items contained in the statements of operations. All percentages are calculated as a percentage of total net sales, with the exception of cost of services and cost of hardware and software which are calculated as a percentage of service sales and hardware/software sales, respectively.
For the Three Months For the Nine Months Ended Ended September 30, September 30, -------------------- ------------------- 1997 1996 1997 1996 ------ ------ ------ ------ Net Sales: Service sales 65.9% 67.0% 71.6% 72.7% Hardware/software sales 34.1% 33.0% 28.4% 27.3% ------ ------- ------- ------ 100.0% 100.0% 100.0% 100.0% Cost of sales: Cost of services 55.7% 64.0% 59.2% 62.5% Cost of hardware/software 87.3% 72.7% 85.8% 75.9% 66.5% 66.9% 66.7% 66.2% ------ ------- ------- ------ Gross Margin 33.5% 33.1% 33.3% 33.8% ------ ------- ------- ------ Operating expenses: Sales and marketing expenses 35.9% 49.9% 41.9% 40.5% Product development expenses 37.9% 31.9% 37.8% 30.7% General and administrative expenses 63.4% 64.8% 63.6% 56.9% Depreciation and amortization expense 5.6% 7.5% 6.1% 5.8% ------ ------- ------- ------ 142.8% 154.1% 149.4% 133.9% Loss from operations (109.3%) (121.0%) (116.1%) (100.1%) Net Loss (103.8%) (100.7%) (108.2%) (89.2%)
Three Months and Nine Months Ended September 30, 1997 and l996 (Unaudited) Net sales for the three months ended September 30, 1997 totaled $730,676, including $481,415 for service sales and $249,261 for hardware and software sales. This represents an increase of 79% above 1996 net sales of $407,315 which consisted of $273,043 for service sales and $134,272 for hardware and software sales. The Company had three major customers for the three months ended September 30, 1997, which accounted for 40%, 15% and 10% of net sales, respectively. The Company had one major customer for the three months ended September 30, 1996, which accounted for 35% of net sales. Net sales for the nine months ended September 30, 1997 totaled $1,895,845 including $1,357,621 for service sales and $538,224 for hardware and software sales. This represents an increase of 94% above 1996 net sales of $975,254 which consisted of $709,223 for service sales and $266,031 for hardware and software sales. The Company had one major customer for the nine months ended September 30, 1997, which accounted for 22% of net sales. The Company had one major customer for the nine months ended September 30, 1996, which accounted for 15% of net sales. 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The increases in sales for the 1997 three and nine-month periods, compared to 1996, were due to the expanded development of the Company's product and service offerings in the CAA, CAP, BRG, and healthcare areas, and to a substantial increase in marketing and sales activities in general. The sales increase includes website development revenue from three customers associated with electronic commerce, initial revenue from an online banking service bureau application and the sale of hardware, software and consulting services to a South American cable provider. Sales to this cable provider accounted for 40% and 22% of revenues for the three and nine-month periods ended September 30, 1997. Cost of sales as a percentage of net sales was 66.5% for the three- month 1997 period and 66.7% for the nine-month 1997 period and 66.9% and 66.2% for the comparable 1996 periods. Cost of sales on hardware and software sales are generally higher than on service sales. Therefore, the Company's overall gross profit margin is higher during periods when service sales are a greater percentage of total net sales. The mix of sales between services and hardware and software was comparable for the three-month and nine-month periods and the cost of sales percentages were lower for services and higher for equipment during the 1997 periods as compared to 1996 resulting in overall cost of sales percentages similar from year to year. The lower cost of sales for services during the 1997 periods is a result of larger web projects that utilized some reusable database code as well as consulting projects that allowed higher profit margins than custom web development projects. The higher cost of sales on hardware and software for the 1997 periods was due to equipment sales to larger customers which were at lower margins. Sales and marketing expenses were $262,181 for the three months ended September 30, 1997 and $203,357 for the three months ended September 30, 1996. Sales and marketing expenses as a percentage of net sales decreased from 49.9% in 1996 to 35.9% in 1997. Sales and marketing expenses were $793,453 for the nine months ended September 30, 1997 and $395,503 for the nine months ended September 30, 1996. Sales and marketing expenses as a percentage of net sales increased from 40.6% in 1996 to 41.9% in 1997. The increase in dollars spent, as well as the increase as a percentage of net sales during the 1997 nine-month period, were due to the hiring of new sales and marketing personnel and associated expenditures. The Company also developed initial marketing materials, began lead generation activity and began to sell its CAA and CME products and services. In addition the Company entered into an agreement with Telemedical Systems Integration, Inc. (TMED) during the fourth quarter of 1996 to serve as the Company's primary sales group for its healthcare products, including the recently introduced CME products. The Company incurred significant expenses during the early part of the nine-month period ended September 30, 1997 related to initial training of and lead generation for this sales force. During the three-month period ended September 30, 1997, the Company incurred expenses associated with marketing and trade shows directed towards the wireless and wired cable market and continued to market its CAA and CAP products and services to markets outside of the United States. Product development expenses were $277,221 for the three months ended September 30, 1997, compared to $129,826 for the 1996 period. Product development expense as a percentage of net sales increased from 31.9% in 1996 to 37.9% in 1997. Product development expenses were $716,722 for the nine months ended September 30, 1997, compared to $299,388 for the 1996 period. Product development expense as a percentage of net sales increased from 30.7% in 1996 to 37.8% in 1997. The significant increase in these expenses, as well as the increase as a percentage of net sales during the 1997 periods, reflect the continued development of the Company's products and services. Product development expenses during the 1997 periods included the completion of the initial development of the Company's CAA and CAP products, addition of wireless cable capabilities, and initial product offerings targeted at the CME segment of the healthcare market. Product development expenses during the 1996 periods included enhancements to the initial CAA product and early development of the Company's Webquest process. Product development expenses are expected to continue to increase during the remainder of fiscal 1997 as the Company continues to develop the CAA, CAP, online banking and electronic commerce products and services. 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) General and administrative expenses were $463,433 for the three months ended September 30, 1997, compared to $263,969 for the 1996 period. General and administrative expenses as a percentage of net sales decreased from 64.8% in 1996 to 63.4% in 1997. General and administrative expenses were $1,205,182 for the nine months ended September 30, 1997, compared to $554,445 for the 1996 period. General and administrative expenses as a percentage of net sales increased from 56.9% in 1996 to 63.6% in 1997. The dollar increases and percentage increase in the nine-month period reflect the development of the Company's general and administrative infrastructure, including finance, accounting, business development and investor relations capabilities, as well as additional expenses related to being a public company. In addition, during the latter part of the nine-month period ended September 30, 1997, the Company incurred expenses and developed capabilities to enter into the international market for its CAA and CAP products and services. Depreciation and amortization expenses were $40,778 for the three months ended September 30, 1997, compared to $30,366 for the 1996 period. Depreciation and amortization expenses were $116,115 for the nine months ended September 30, 1997, compared to $56,881 for the 1996 period. These increases reflect the increase in fixed assets and equipment to support higher levels of Web site and Internet access services, CAA and CAP development and testing as well as to support the growth in the number of employees. Other income was $39,969 during the three-month period ended September 30, 1997, compared to $82,462 for the 1996 period. Other income was $149,592 during the nine-month period ended September 30, 1997, compared to $106,824 for the 1996 period. Upon completion of the Company's initial public offering in May 1996, the Company paid a portion of its outstanding debt resulting in a reduction of future interest expense and began earning interest income on the invested net proceeds. The Company's investments consist of U.S. Treasury Bills, Corporate Bonds, and cash equivalents. Net losses were $758,669 in the three-month period ended September 30, 1997 compared to $410,196 for the 1996 period. Net losses were $2,051,365 in the nine-month period ended September 30, 1997 compared to $869,497 for the 1996 period. These increases in losses in the 1997 periods reflect expenses in the marketing and sales, product development, and general and administrative areas that have increased at a faster rate than net sales. This is due to the time lag associated with product development and market introduction as well as the long sales cycle for most of the Company's products and services. The Company expects to continue to experience increased operating expenses and capital investments during the remainder of fiscal 1997, as it continues to transition to its new business focus and invests in marketing and sales, product development and client services directed toward broadband providers. The Company believes that, initially, these expenses are expected to be greater than increases in net sales. As a result, OSS expects to incur additional substantial operating and net losses for the balance of fiscal 1997 and for one or more fiscal years thereafter. LIQUIDITY AND CAPITAL RESOURCES As of September 30, 1997, the Company had cash and cash equivalents of $2,559,773 and working capital of $3,274,690. The Company has financed its operations and capital equipment expenditures through a combination of public and private sales of common stock, issuing common stock for services, lease financing, short-term loans and the utilization of trade payables. During 1996, the Company completed an initial public offering of its common stock which resulted in net proceeds to the Company of $7,231,981 and the issuance of an additional 1,265,000 shares of common stock. During the nine months ended September 30, 1997, the Company purchased for the price of $75,000 from a consultant to the Company, a stock option to buy 100,000 shares of the Company's common stock at $.50 per share. Upon purchase, the options were canceled. During the nine months ended September 30, 1997, the Company purchased $482,324 of fixed assets. These purchases were primarily computer equipment, communications equipment, cable modems and software necessary to develop and demonstrate the recently introduced Cable Access America products along with hardware and software necessary to provide the online banking services on a service bureau basis. In anticipation of future 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) growth, the Company expects to invest a minimum of $150,000 during the remainder of fiscal 1997 to purchase additional computer equipment, software and office equipment. Accounts receivable balances increased from $229,350 at December 31, 1996 to $501,100 at September 30, 1997, due to the increased sales level during the nine-month period and a concentration of billing towards the end of the quarter ended September 30, 1997. Due to the Company's utilization of the percentage of completion method of revenue recognition for its Web services, an asset of $352,563, representing revenue earned and not billed, is shown as accrued revenue receivable at September 30, 1997. This amount has increased from $90,337 at December 31, 1996 due to increased revenue for the nine-month period and an increase in large web development projects that require several months to complete. A liability for amounts invoiced but not earned of $15,574 is shown as deferred revenue at September 30, 1997. The Company's hardware and software inventory of $190,209 at September 30, 1997 decreased from $195,941 at December 31, 1996, and consists of software licenses and computer hardware purchased by the Company for resale. Prepaid expenses increased to $250,852 at September 30, 1997, from $132,544 at December 31, 1996, primarily due to amounts prepaid for insurance for the Company and amounts paid to a consultant to the company for services not yet rendered. The major portion of the remaining balance consists primarily of amounts paid under a marketing and sales agreement with an independent company. These amounts consist of advanced consulting fees that are expected to be earned through commissions on sales of the Company's CME products and services. Trade account payable at September 30, 1997, increased to $456,751 from $331,809 at December 31, 1996, due to the increased level of business activity for the nine month period. The Company believes that its cash and cash equivalents and working capital are adequate to sustain operations for at least the next six months. If sufficient cashflow is not being generated at the end of this period, the Company will be required to seek additional funds through equity, debt or other external financing. There is no assurance that any additional capital resources, which the Company may need, will be available if and when required, or, if available, available on terms that will be acceptable to the Company. 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) LENGTH OF SALES CYCLE; POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS The decision to purchase the Company's products and services is often an enterprise-wide decision by prospective customers and may require the Company to engage in a lengthy sales cycle. The pursuit of sales leads typically involves an analysis of the prospective customer's needs, preparation of a written proposal, one or more presentations and contract negotiations. The Company often provides significant education to prospective customers regarding the use and benefits of Internet or Intranet technologies and products such as Edify's Electronic Workforce. Extensive Web site development or licensing of Electronic Workforce may also involve a substantial commitment of capital and the attendant delays frequently associated with approving large capital expenditures and reviewing new technologies that affect key operations. While the sales cycle varies from customer to customer, it typically has ranged from one to six months for Web site design and support, and from one to three months for Cable Access America projects. The sales cycle may also be subject to a prospective customer's budgetary constraints and internal acceptance reviews, over which the Company has little or no control. Consequently, if sales forecasted from a specific customer for a particular quarter are not realized in that quarter, the Company is unlikely to be able to generate revenue from alternate sources in time to compensate for the shortfall. If a larger order is delayed or lost to a competitor, the Company's revenues for that quarter could be materially diminished. Moreover, to the extent that significant sales occur earlier than expected, operating results for subsequent quarters may be adversely affected. Further, as a result of the Company's limited operating history, the Company does not have historical financial data for a sufficient number of periods on which to base planned operating expenses. Accordingly, the Company's expense levels are based in part on its expectations as to future revenues and to a large extent are fixed. The Company typically operates with little or no backlog and the sales cycles for its products and services may vary significantly. As a result, quarterly sales and operating results generally depend on the volume and timing of and ability to close customer contracts within the quarter, which are difficult to forecast. The Company may be unable to adjust spending on a timely manner to compensate for any unexpected revenue shortfalls. Accordingly, any significant shortfall of demand for the Company's products and services in relation to the Company's expectations would have an immediate adverse impact on the Company's business, operating results and financial condition. In addition, the Company plans to increase its operating expenses to fund product development and increase sales and marketing. To the extent that such expenses precede or are not subsequently followed by increased revenues, the Company's business, operating results and financial condition will be materially adversely affected. FORWARD LOOKING INFORMATION Information contained in this report, other than historical information, should be considered forward looking and reflects management's current view of future events and financial performance that involve a number of risks and uncertainties. The factors that could cause actual results to differ materially include, but are not limited to, the following: general economic product development and technology changes; competition and pricing pressures; length of sales cycle; variability of sales order flow; and management growth. 15 Part II.-- Other Information - - ---------------------------- Items 1-5. Not Applicable Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit 27 - Financial Data Schedule (b) Reports on Form 8-K during the quarter ended September 30, 1997 None 16 Signatures In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ONLINE SYSTEM SERVICES, INC. Date: November 12, 1997 By /S/Thomas S. Plunkett ----------------------- Vice President and Chief Financial Officer 17 EX-27 2 FINANCIAL DATA SCHEDULE
5 3-MOS 9-MOS DEC-31-1997 DEC-31-1997 JUL-01-1997 JAN-01-1997 SEP-30-1997 SEP-30-1997 2,559,773 2,559,773 0 0 893,489 893,489 39,826 39,826 190,209 190,209 3,915,512 3,915,512 1,141,266 1,141,266 288,713 288,713 4,871,728 4,871,728 640,822 640,822 6,196 6,196 0 0 0 0 7,912,535 7,912,535 (3,687,843) (3,687,843) 4,871,728 4,871,728 249,261 538,224 730,677 1,895,846 217,564 461,619 485,701 1,265,330 0 0 0 0 (39,969) (149,562) (758,669) (2,051,365) 0 0 (758,669) (2,051,365) 0 0 0 0 0 0 (758,669) (2,051,365) (0.24) (0.64) (0.24) (0.64)
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