-----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, TLuKOuUTa+DwnVx7eSiKZ9c2/8vi6ZY53kDQBbTtNieXTZrVO/1x5srU1JXzSxxk 2m7gnh7iUKmWYDxlKYN4EQ== 0000893816-97-000002.txt : 19970130 0000893816-97-000002.hdr.sgml : 19970130 ACCESSION NUMBER: 0000893816-97-000002 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19961031 FILED AS OF DATE: 19970129 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: COMPUTER OUTSOURCING SERVICES INC CENTRAL INDEX KEY: 0000893816 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROCESSING & DATA PREPARATION [7374] IRS NUMBER: 133252333 STATE OF INCORPORATION: NY FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: 10KSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-20824 FILM NUMBER: 97513034 BUSINESS ADDRESS: STREET 1: 360 WEST 31ST ST STREET 2: 11TH FLOOR CITY: NEW YORK STATE: NY ZIP: 10001 BUSINESS PHONE: 2125643730 10KSB 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended: October 31, 1996 Commission file number: 0-20824 COMPUTER OUTSOURCING SERVICES, INC. (Exact name of registrant as specified in its Charter) New York 13-3252333 (State of Incorporation) (IRS Employer I.D. number) 360 West 31st Street, New York, New York 10001 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (212) 564-3730 Securities registered pursuant to Section 12(b) of the Exchange Act: None Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock, $0.01 Par Value per Share (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934, as amended, during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days: [X] Yes [ ] No. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information state- ments incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB [ ]. For the fiscal year ended October 31, 1996, registrant's consolidated revenues were $29,051,368. On January 15, 1997, the aggregate market value of the outstanding shares of voting stock held by non-affiliates of the registrant was approximately $6,094,130. On January 15, 1997, 3,744,850 shares of the registrant's Common Stock, $0.01 par value, were outstanding. DOCUMENTS INCORPORATED BY REFERENCE The registrant's Proxy Statement, to be filed in connection with its Annual Meeting of Shareholders to be held in April 1997, has been incorporated by reference herein as Items 9 through 12 of Part III. A schedule of Exhibits filed herewith or incorporated by reference appears in Item 13 beginning on page 17. Transitional Small Business Disclosure Format: [ ] Yes [X] No Page 1 of 43 PART I ITEM 1. DESCRIPTION OF BUSINESS - --------------------------------- GENERAL Computer Outsourcing Services, Inc. (together with its subsidiaries, the "Company"), organized as a New York corporation in October 1984, provides information technology solutions which include comprehensive payroll processing and tax filing services and information processing services to many industries, including publishing, transportation, financial services and apparel throughout the United States. The Company has grown through the acquisition of a number of strategically-located payroll and information processing companies. In the area of payroll processing, the Company acquired NEDS, Inc. (formerly New England Data Services, Inc.) ("NEDS"), which specializes primarily in the New England region, effective June 1, 1993. Daton Pay USA, Inc. (formerly known as Daton Data Processing, Inc.) ("Daton"), which specializes in providing payroll processing and tax filing services to clients in southern California, was acquired effective June 1, 1994. The Company acquired the payroll process- ing assets and customer list of Delta Management Services, Inc. effective August 1, 1994, and created Pay USA of New Jersey, Inc. ("Delta") to service these payroll customers. Also, the Company acquired Key-ACA Inc. ("ACA"), which provides payroll, general ledger, and other processing services to clients in New England, effective May 1, 1995. During the current fiscal year, the Company acquired the customer list of Pro Data, which will be serviced by Daton. In the area of general data and information processing, effective January 1, 1994, the Company acquired Tru-Check Computer Systems, Inc. ("TruCheck"), which provides database marketing services to consumer products companies. TruCheck is now an unincorporated division of the Company's Information Processing Division. In addition, effective June 1, 1995, the Company acquired MCC Corporation ("MCC"), which provides information processing services to companies primarily in the financial services and transportation industries. During the fiscal year ended October 31, 1996, the Company concentrated on the integration of the various acquisitions into two operating divisions. MCC, Tru- Check, and the original information processing operations of the Company were combined into the Information Processing Division. Similarly, NEDS, Daton, Delta, ACA, and the original payroll processing services provided by the Com- pany's New York location were consolidated into the Pay USA Division. THE COMPUTER OUTSOURCING INDUSTRY The outsourcing of computer services, whereby a client company obtains all or part of its information processing requirements (including systems design, soft- ware and hardware, communications, training, maintenance, and support) from an information technology provider such as the Company, continues to be a growing trend. The Company believes that it is generally 10% to 50% more cost-effective and efficient for its clients to outsource information processing services to the Company than it would be to provide equivalent services for themselves by purchasing or leasing in-house systems and hiring or contracting for service and support personnel. Page 2 of 43 Outsourcing provides clients with the following benefits: The refocus of personnel, financial and technological resources on core business and client related activities, Access to highly skilled personnel and technology resources, Access to resources that support reengineering strategies, Access to experienced resources to perform selected information processing functions, Reduction of operating costs, and, Reduction of future investment risks. BUSINESS STRATEGY The Company has consolidated its outsourcing services into two major service segments, Information Processing and Payroll Processing and Tax Filing, which allows it to more effectively service unique client requirements in several industry markets. The Company's objective is to provide a comprehensive computer outsourcing al- ternative to meet all or part of its clients' information technology require- ments. The Company's strategy includes the following key elements: OUTSOURCING SERVICES: The Company provides automated payroll processing services, which it believes to be an area with a high potential for future growth. The Company aggressively pursues marketing and sales efforts to reach potential payroll processing clients. The Company currently has ap- proximately 2,900 payroll clients. In the area of general computer out- sourcing, the Company develops and acquires industry-specific outsourcing applications and services, so that the Company's in-depth knowledge of a particular industry can then be applied to servicing multiple clients in that field. The Company currently provides outsourcing services to approx- imately 1,100 clients in such diverse fields as financial services, trans- portation, book publishing, home health care, apparel importing and manu- facturing, and consumer product manufacturing. CUSTOMER SERVICE AND SUPPORT: The Company believes that close attention to customer service and support has been, and will continue to be, crucial to its success. The Company provides a high degree of customer service and support, including customized training and rapid response to customer needs, support which the Company believes generally exceed industry stan- dards. Because of its attention to customer service, the Company's client relationships have tended to be long-term with very low turnover, generat- ing recurring and predictable revenues. The Company and its predecessors have serviced its oldest client for more than 23 years and its largest book publishing client for more than 21 years. SYSTEM FLEXIBILITY: The Company attempts to maximize utilization of its products and services by offering a wide range of services to each client. The Company's products are designed to work either on a stand-alone modular basis or as fully integrated systems. Clients can easily expand the range of services provided by the Company by adding modules as the client's needs and capacity to use them expand, thereby making an orderly transition from partial to full reliance on the Company's services. In addition, clients can increase or decrease the volume of services provided by adjusting the number of "on-line" terminals installed in their offices. Page 3 of 43 BUSINESS SEGMENTS The Company's business, conducted under various trade names, was consolidated during the year ended October 31, 1996 in the following segments: Market or Industry: Percentage of Revenues: ------------------- ----------------------- Information Processing Services ............... 63% Payroll Processing and Tax Filing Services .... 28% Other Services ................................ 9% The Company has approximately 4,000 active clients. None of the Company's clients accounted for more than 10% of total revenues for the fiscal years ended October 31, 1996 and 1995. For the year ended October 31, 1996, the Company's top ten clients aggregated approximately 33% of the Company's total revenues. Information Processing Services - ------------------------------- The Company's Information Systems Processing Service allows clients to effec- tively process and manage core business applications such as general ledger, accounts payable and receivable, order processing and inventory. The Company provides skilled personnel, secure processing environments, high service levels and state of the art and emerging technologies to meet client information pro- cessing requirements. Clients utilize the Company's information systems in order to focus on their core business and client related activities while sig- nificantly reducing their operating costs. Industry Specific Services - -------------------------- The Company has developed industry specific experience in markets which include publishing, financial services, apparel, consumer products and home health care. Its clients in these markets rely on the Company to combine its in-depth indus- try knowledge with information technology solutions which uniquely meet their business objectives and information processing requirements. Publishing Services: The Company is a leading provider of information processing services to clients in the book publishing industry through the trade name PCS Data Processing, which has specialized in servicing this industry for over 30 years. The Company currently services 30 large and small publishers, ranging from a one terminal user to large users with more than 100 terminals dedicated to the system. The Company functions as the computer department for the publishing client, offering a full range of functions, such as on-line order entry, order processing, inventory, accounts receiv- able and payable, sales history and analysis, general ledger, and royalty computation and record keeping. Services include the preparation of daily, weekly, and monthly reports pertaining to the particular applications desired by the client. Although some clients use only royalty processing, most subscribe to the full on-line publishing system offered by the Company. Currently, the Company manages virtually all the data processing require- ments of one client with annual revenues of over $250 million. During the fiscal year ended October 31, 1996, the Company was awarded a contract to consolidate the data processing subsidiaries of a large European publishing holding company. Page 4 of 43 Utilization of the Company's publishing system will allow this publishing company to close a large in-house data processing operation employing over 85 data processing personnel. Each of the Company's five largest book publishing clients, representing in the aggregate approximately 76% of the Company's total book publishing revenues and 10% of the Company's total revenues, has contracts with the Company which expire between 1997 and 2001. These contracts are automat- ically renewed for varying terms unless prior written notice is given. These contracts specify the rates for the Company's services, which rates vary according to factors such as the volume and types of services used by each customer. An agreement has been reached with the publishing divi- sion's largest client to provide expanded services. The agreement expires May 31, 2001. The client has an option to cancel after May 31, 1999 by paying a cash penalty. Financial Services: The Company's Financial Services include customized management consulting, information processing services and administrative personnel support to corporate trust, stock transfer, corporate reorganization and merger/acqui- sition clients. An example of the Company's customized Financial Services is its Corporate Reorganization Service which helps clients streamline the input and pro cessing of information from various sources in order to reduce system and programming costs. Through this service, clients receive output informa- tion in their choice of mediums and formats and real-time, on-line inquiry capabilities during transaction processing. The Company's clients include leading financial services companies. Apparel Services: The Company has designed a data processing system to serve the needs of soft goods importers and manufacturers, by providing them with accounting, billing, production data, and other information. The Company's systems give apparel companies the flexibility to outsource part or all of their data processing requirements. The Company's largest apparel industry cus- tomer, with sales of over $100 million per year, does not utilize an in- house computer system and relies on the Company for all its data processing requirements. The Company begins its relationship with each apparel client by conducting an extensive review of the client's business to determine data processing requirements, and a comprehensive data file is then established. The Com- pany thereafter works closely with the client's personnel to increase their proficiency in the use of the system. Certain features of the Company's systems have industry specific applica- tion. The accounts receivable system provides on-line cash application with a heavy emphasis on credit checking and collections. The accounts payable subsystem provides on-line check writing, vendor checking, purchase entry, tracks units of fabric purchases and cutting tickets and provides information for general ledger posting. The order subsystem tracks clients' customers' orders, billing, cut and sold information, piece goods, cutting tickets, bills of materials and other items. Page 5 of 43 The Company has also developed an electronic data interchange ("EDI") sub- system. This subsystem allows a vendor to receive orders and floor selling information from a retailer electronically and transmits invoices back to the retailer electronically. This subsystem also enables the vendor to satisfy the requirement of some chain stores to maintain an electronic product catalog accessible to the chain. The Company's EDI subsystem provides reports and on-line inquiry into orders and shipments, along with comprehensive floor selling reports. The EDI subsystem also provides auto- mated Advance Ship Notices and interfaces with a stand-alone scanning sys- tem. The EDI subsystem allows a small apparel manufacturer or importer to conform to the EDI requirements of various large retail chains and to con- tinue as an approved vendor of those chains without having to acquire its own data processing and interchange capability. Consumer Products Services: The Company provides sales data collection and other information processing services to consumer products companies. The Company develops distribution channel databases for the purpose of establishing information links between its clients and their trading partners. The Company processes sales, pro- motion and rebate information and provides custom management reports de- tailing distribution channel activity. Home Health Care Services: The Company provides scheduling, claims processing, billing and payroll services to home health care organizations. The Company provides manage- ment reports which details personnel and all service information required by clients. Specialty Outsourcing Services: The Company provides customized outsourcing solutions to companies in the transportation, banking, publishing, and other industries. In these cases the company provides all of the computer and telecommunications services required by the customer for a specific application or set of applications. Payroll Processing and Tax Services - ----------------------------------- The Pay USA Division currently provides automated payroll processing services and tax filing services to approximately 2,900 clients of all sizes, engaged in a wide variety of business with employees in all 50 states. The Company's largest payroll customers include a national leasing company and a Fortune 500 consumer products company. The Company believes that it offers a comprehensive range of payroll and related services that are equivalent to those offered by industry leaders. The Com- pany's payroll services consist primarily of the preparation of employee pay- checks and direct deposit payments, along with the necessary supporting journals and other reports. The Company supplies each client with all quarterly and an- nual Social Security and Federal, state, and local withholding and employer tax reports to be filed by clients, W-2 statements for employees, complete records for each pay period, and quarterly historical earnings records for each employee. The Company also prepares statistical and audit reports, such as pay- roll and job cost distribution reports, welfare and pension fund reports, and a payroll audit report. Page 6 of 43 The Company provides automated tax collection and filing services on behalf of clients, processing Federal, state, and local payroll withholding and employer taxes, remitting payments to the appropriate tax authorities when due. Direct deposit services are also performed where clients' employees authorize the service. As escrow agent for its full service tax collection and filing service accounts and direct deposit clients, the Company earns interest on collected but unremit- ted funds. These funds are invested in high quality, low risk interest bearing instruments. Other Services - -------------- The Company provides a variety of customized data processing services designed to specific client requirements, such as ticket analysis provided for a major international airline in connection with its marketing efforts and frequent flier program. The Company also employs over 94 key-entry operators to provide accurate and timely data entry and analysis services in connection with specific client projects. Data entry and analysis clients include the City of New York, a savings bank, a large insurance company, and a major university. CUSTOMER SUPPORT AND TRAINING The Company provides a high degree of initial and continuing customer service and support, at a level which the Company believes generally exceeds industry standards. The Company believes that its focus on customer service and support has been, and will continue to be, a key factor in its high level of customer retention and growth in revenues. As of October 31, 1996, the Company dedicated 117 full-time employees, equal to approximately 29% of its entire staff, to customer support and sales. The Company seeks to develop close, collaborative relationships with each client and to respond quickly to each client's needs. The Company generally installs its own custom-configured computer terminals, printers, and communication equipment in its clients' offices. These are "on- line" with the Company's systems, linked by leased digital or analog data cir- cuits. The Company assigns a service representative to each customer to super- vise installation and to provide on-site training and continuing support. Upon installation, the Company provides initial training at the clients' business location and comprehensive user manuals. To maintain client proficiency, the Company offers refresher training periodically, according to customer needs. Support is available at the customer site, or by telephone during business hours for system-related questions and general problem solving. Because many clients' terminals are on-line with the Company's computers, support personnel are able to communicate directly with them to diagnose errors, solve problems from soft- ware and hardware, and make software upgrades at any time. The Company main- tains a quality assurance program which entails periodic testing of the Com- pany's systems and services. MARKETING AND SALES The Company currently targets its principal marketing efforts primarily to (1) companies currently using outsourcing or payroll services in the Company's cur- rent market areas of greater New York, northern New Jersey, New England, and southern California, and (2) companies in industries such as financial services, book publishing, apparel, and transportation where the Company already has a significant presence. Page 7 of 43 The Company uses a direct-sales marketing approach in which its sales represen- tatives solicit client appointments and make sales calls. Initial contact is made by a variety of methods, including mailings, telemarketing, and attendance at industry conventions and trade shows. The Company's sales representatives and marketing support staff analyze clients' requirements and prepare product demonstrations. The Company's sales and marketing support staff includes 28 persons. Sales persons are generally paid a base salary plus a commission on sales generated. Sales and support staff are trained in the clients' technical requirements, industry operations, and customer relations such that, over the years the Com- pany's customer support staff has developed particular expertise in training and assisting its clients' personnel in utilizing the Company's systems and pro- grams. The Company places special emphasis on fulfilling its clients' require- ments in a highly responsive fashion by utilizing a flexible approach and offer- ing innovative solutions to complex situations and needs. PRODUCT DEVELOPMENT Since the computer industry is characterized by rapid change in hardware and software technology, the Company continually enhances its services to meet client requirements. In each of the past two years the Company has spent between 4% and 5% of its gross revenues on systems development costs. The Company is committed to maintain its product offerings at a very high level of technological proficiency and believes that it has developed a reputation for providing innovative solutions to client requirements. Where possible, the Company seeks to develop products characterized by a high degree of recurring usage, so that clients come to depend on the Company's services. Product development is performed by the Company's employees and, in limited instances, by outside consultants. COMPETITION Although the Company is not aware of other companies which provide as wide a range of services and customer support as the Company does, other companies do provide one or more of the Company's services. The Company's current and potential competition includes other independent computing services companies and divisions of diversified enterprises, as well as the ability of existing and potential clients to install and operate their own computing equipment. The Company knows of no reliable statistic by which it can determine the number of companies which provide computer outsourcing services. Among the best known of the Company's competitors are the outsourcing companies Computer Sciences Corp., Electronic Data Systems Corporation, IBM Corporation, and Perot Systems; as well as Automatic Data Processing, Inc., Ceridian, and Paychex, Inc., for automated payroll services. Aside from such major companies, both the out- sourcing services and payroll services industries are fragmented, with numerous companies offering services in limited geographic areas, vertical markets, or product categories. Many of the Company's competitors have substantially greater financial and other resources than the Company, and there can be no assurance that the Company will be able to compete effectively in the future. Page 8 of 43 TECHNOLOGICAL CHANGE Although the Company is not aware of any pending or prospective technological change that would adversely affect its business, new developments in technology could have a material adverse effect on the development or sale of some or all of the Company's services or could render its services noncompetitive or obsolete. There can be no assurance that the Company will be able to develop or acquire new and improved services or systems which may be required in order for it to remain competitive. The Company believes, however, that technological change does not present a material risk to the Company's business because the Company expects to be able to adapt to and acquire any new technology more easily than its existing and potential clients. In addition, technological change increases the risk of obsolescence to potential clients which might otherwise choose to maintain an in-house computer system rather than use the Company's services, thus potentially creating selling opportunities for the Company. During the year ended October 31, 1996, the Company invested $545,000 in new property and equipment. The Company expects to be able to continue to purchase or lease state-of-the-art computer and communications equipment on acceptable terms. During the past year, the Company continued the conversion of its payroll processing units into a state-of-the-art processing platform. This platform utilizes a Hewlett Packard computer system and a 4th generation programming language. When the conversion is completed, the Company will gain efficiencies. Currently, the Company operates four different payroll platforms. The conver- sion will create additional marketing opportunities, including new services for its existing client base. INTELLECTUAL PROPERTY MATTERS The Company's systems and process are not protected by patents, or any regis- tered copyright, trademark, trade names, or service marks. To protect its proprietary products and software from illegal reproduction, the Company relies on certain mechanical techniques in addition to trade secret laws, restrictions in certain of its customer agreements with respect to use of the Company's products and disclosure to third parties, and internal non-disclosure safe- guards, including confidentiality restrictions with certain employees. In spite of the Company's efforts, it may be possible for competitors or clients to copy aspects of the Company's trade secrets. The Company believes that because of the rapid pace of technological change in the computer industry, copyright and other forms of intellectual property protection are of less significance than factors such as the knowledge and experience of the Company's management and other personnel, and the Company's ability to develop, enhance, market, and acquire new systems and services. The Company's business is not dependent upon any single license or group of licenses. The Company is experienced in handling confidential and sensitive client infor- mation, and maintains numerous security procedures to help ensure that the con- fidentiality of client data is maintained. COMPLIANCE WITH ENVIRONMENTAL LAWS The primary environmental laws applicable to the Company relate to the recycling of paper, with which laws the Company believes it is in compliance. Page 9 of 43 EMPLOYEES As of October 31, 1996, the Company had approximately 420 full-time and 50 part- time employees. None of the Company's employees is represented by a labor or- ganization and the Company is not aware of any activities seeking organization. The Company considers its relationship with its employees to be satisfactory. INSURANCE The Company maintains insurance coverage that management believes is reasonable, including errors and omissions coverage, business interruption insurance to fund its operations in the event of catastrophic damage to any of its operations centers, and insurance for the loss and reconstruction of its computer systems. The Company also maintains extensive data backup procedures to protect both client and Company data. ITEM 2. DESCRIPTION OF PROPERTY - --------------------------------- The Company maintains its executive offices, the operations of two subsidiaries, and a computer center in New York City, in a facility of approximately 30,500 square feet, under a lease which expires on December 31, 2008. The current annual rent is approximately $660,000, payable monthly plus operating expenses, and is subject to escalation. The Company's obligations under this lease are secured by a letter of credit in the face amount of $150,000. A subsidiary leases offices and a computer center in Murray Hill, New Jersey, in a facility of approximately 31,800 square feet, under a lease which expires April 30, 1998. The current annual rent is approximately $450,000, payable monthly plus operating expenses. This subsidiary also leases office and ware- house space in Aberdeen, New Jersey under leases which expire in June and August 1997, and which call for combined monthly payments of approximately $12,000. A subsidiary leases a 10,000 square foot office and payroll processing center in Cranston, Rhode Island under a lease which expires in June 1998. The current monthly rent is approximately $5,200, subject to escalation. The Company leases this property from a trust, the beneficiaries of which are the former owners of the subsidiary. A subsidiary leases approximately 9,300 square feet of office and payroll processing center in Santa Ana, California, under a lease which expires July 31, 1998. The current monthly rent is approximately $10,000, subject to esca- lations. A subsidiary leases a 10,000 square foot office and processing center in West- wood, Massachusetts under a lease which expires in the year 2000. The current annual rent is approximately $91,000 and is subject to escalation. The Company generally leases its equipment under standard commercial leases with purchase options which the Company exercises from time to time. The Company's equipment is generally covered by standard commercial maintenance agreements. The Company believes its current facilities are in good condition and will be adequate to accommodate its current volume of business plus increases anticipat- ed over the next two years. Growth beyond that will only require supplemental peripheral equipment. Page 10 of 43 ITEM 3. LEGAL PROCEEDINGS - --------------------------- There are no pending legal proceedings that, in the opinion of management, would materially affect the financial condition or results of operations of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------- None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS - ------------------------------------------------------------------------------ The Company's Common Stock is traded on the NASDAQ Stock Market under the symbol COSI. For the periods reported below, the following table sets forth the high and low bid quotations for the Common Stock as reported by NASDAQ-NMS. BID ---------------- High Low ------ ------ For the year ended October 31, 1995: 1st Quarter (November 1, 1994 - January 31, 1995) ..... $5.250 $3.750 2nd Quarter (February 1, 1995 - April 30, 1995) ....... 4.500 3.500 3rd Quarter (May 1, 1995 - July 31, 1995) ............. 4.000 3.250 4th Quarter (August 1, 1995 - October 31, 1995) ....... 5.250 3.250 For the year ended October 31, 1996: 1st Quarter (November 1, 1995 - January 31, 1996) ..... 4.750 3.250 2nd Quarter (February 1, 1996 - April 30, 1996) ....... 4.500 3.000 3rd Quarter (May 1, 1996 - July 31, 1996) ............. 6.375 3.500 4th Quarter (August 1, 1996 - October 31, 1996) ....... 4.500 3.125 The closing price of the Company's Common Stock on NASDAQ-NMS on January 15, 1997 was $3.563 per share. The Company has approximately 95 stockholders of record. In addition, the Company believes that there are approximately 1,000 beneficial owners holding their shares in "street name". The Company has not paid dividends to its stockholders since its inception and does not plan to pay dividends on its Common Stock in the foreseeable future. In addition, certain of the Company's agreements with its lenders restrict its ability to pay dividends. The Company intends to retain earnings to finance growth. Page 11 of 43 ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------- RESULTS OF OPERATIONS Certain reclassifications have been made to the fiscal 1995 and 1994 amounts discussed below to conform with the current year presentation. Fiscal Year 1996 as Compared to Fiscal Year 1995 - ------------------------------------------------ The following table sets forth, for the periods indicated, the percentage of revenues represented by selected items in the Company's Consolidated Statements of Operations. Percentage of Total Revenues Years ended October 31, ---------------------------- 1996 1995 ------ ------ Revenues ............................................ 100.0% 100.0% ------ ------ Costs and Expenses: Data Processing Costs ............................ 62.4 62.5 Selling and Promotion Costs ...................... 8.6 11.2 General and Administrative Expenses .............. 25.7 29.5 Interest Expense, net ............................ 1.2 1.0 Provision for Income Taxes ....................... 1.0 (1.4) ------ ------ Net Income/(Loss) ................................... 1.1 (2.8) ====== ====== During the fiscal year ended October 31, 1996, the Company focused on the consolidation and integration of the acquisitions made in the previous fiscal years. In fiscal 1995, the Company completed the acquisitions of ACA and MCC in May and June 1995, respectively. These were in addition to the three acquisi- tions completed in fiscal 1994: TruCheck, Daton, and Delta. ACA, Daton and Delta are payroll processing companies which, along with NEDS, comprise the Payroll Division of the Company ("Pay USA"). MCC and TruCheck, along with the original information processing operations of the Company, comprise the Infor- mation Processing Division of the Company. The Company continued the process of standardizing the Payroll Division into one processing system and consolidating the computer operations of the Information Processing Division. Until the total integration of operations is completed, including payroll system standardization, the Company will continue to ex- perience higher costs due to the cost of the conversion effort and the duplica- tion of facilities and personnel. These costs continued to have a negative im- pact on profitability in fiscal 1996. For the year ended October 31, 1996, revenues increased $6,900,000 to $29,051,000, an increase of 31.1% over the year ended October 31, 1995. The Company's Information Processing Division recorded a revenue increase of $5,391,000. A revenue increase by MCC of $5,805,000, due to the inclusion of MCC's results for the full fiscal year, more than offset a decrease in the rest of the Information Processing Division. MCC was acquired effective June 1, 1995. The Pay USA Division recorded a revenue increase of $1,509,000. Revenues of ACA, acquired as of May 1, 1995, accounted for $1,194,000 of this increase. Page 12 of 43 Data processing costs increased $4,287,000 to $18,135,000 (62.4% of revenues) during the current year, compared to $13,848,000 (62.5% of revenues) in the prior year. The Information Processing Division's data processing costs in- creased $3,956,000 to $13,510,000 (67.5% of divisional revenues). MCC's data processing costs were $4,086,000, representing 74.0% of its revenues, and ac- counting for the principal reason for the Company's increase in data processing costs as a percentage of revenues. Pay USA's data processing costs increased $331,000 to $4,625,000 (51.1% of divisional revenues). ACA's payroll processing costs increased $467,000 compared to the prior year as a result of the timing of its acquisition. Payroll processing costs aggregated $4,294,000 (57.0% of re- venues) in the prior year. Selling and promotion costs increased $10,000 to $2,501,000, but decreased 2.6% as a percentage of revenues. Increases of $320,000 and $128,000 were attrib- utable to the acquisitions of MCC and ACA, respectively. Offsetting these were decreases of $301,000 and $137,000 in the Information Processing Division and Pay USA, respectively. These decreases resulted from the consolidation of the sales and marketing efforts in each of the divisions. General and administrative expenses increased $926,000 to $7,463,000 in the current year but decreased 3.8% as a percentage of revenues. Increases of $496,000 and $526,000 were attributable to the timing of the acquisitions of MCC and ACA, respectively. During the fourth quarter of fiscal 1995, the Company recorded approximately $371,000 of charges relating principally to customer price concessions and disputed invoices and increased its allowance for bad debts in response to current market conditions. In addition, in fiscal 1995, the Company recorded charges of $43,000 relating to a terminated equipment lease and $50,000 for legal settlement costs. Excluding the above, general and ad- ministrative expenses increased by approximately $368,000, attributable to the additional costs of managing the Company's increased size and complexity. Net interest expense increased $113,000 to $339,000 in the current year, due to a higher level of borrowings partially offset by a decrease in interest income previously generated by excess proceeds from the Company's public offering. These borrowings and excess proceeds were used in part to fund the Company's acquisitions. As a result of the aforementioned, the Company recorded a profit of $333,000 ($.08 per share) for the year ended October 31, 1996 compared to a loss of $636,000 ($.19 loss per share) for the year ended October 31, 1995. Fiscal Year 1995 as Compared to Fiscal Year 1994 - ------------------------------------------------ In fiscal 1995, the Company began the process of consolidating its operations into two divisions - payroll processing and information processing. The payroll companies are being standardized onto one processing system, and the information processing companies' computer operations are in the process of being consol- idated. Until the total integration of all of the operations is completed, the Company will continue to experience higher costs due to the conversion efforts and the duplication of facilities and personnel. These activities negatively impacted profitability in fiscal 1995. Page 13 of 43 The following table sets forth, for the periods indicated, the percentage of revenues represented by selected items in the Company's Consolidated Statements of Operations. Percentage of Total Revenues Years ended October 31, ---------------------------- 1995 1994 ------ ------ Revenues ............................................ 100.0% 100.0% ------ ------ Costs and Expenses: Data Processing Costs ............................ 62.5 57.1 Selling and Promotion Costs ...................... 11.2 9.5 General and Administrative Expenses .............. 29.5 27.6 Interest Expense, net ............................ 1.0 0.2 Provision for Income Taxes ....................... (1.4) 2.6 ------ ------ Net Income/(Loss) ................................... (2.8) 3.0 ====== ====== Revenues increased 39.6% from $15,872,000 in the fiscal year ended October 31, 1994 to $22,152,000 in the fiscal year ended October 31, 1995. The following amounts were the increases in revenues arising from the timing of acquisitions in the prior and current fiscal years: $117,000 from TruCheck, acquired as of January 1, 1994; $1,800,000 from Daton, acquired as of June 1, 1994; $284,000 from certain payroll operations acquired by Pay USA of NJ, Inc. from Delta Management Systems, Inc. in August 1994; $1,214,000 from ACA, acquired as of May 1, 1995; and $3,442,000 from MCC, acquired as of June 1, 1995. These in- creases were partially offset by a decrease of $188,000 in payroll processing revenues from NEDS, and decreases of $419,000 from infomercial, apparel, and other outsourcing revenues from the Commercial Online division. Data processing costs increased from $9,066,000 in fiscal 1994 to $13,848,000 in fiscal 1995, and increased 5.4% as a percentage of revenues. Increases of $673,000, $134,000, $766,000, $11,000, and $2,759,000 were attributable to the timing of the acquisitions of Daton, Delta, ACA, TruCheck, and MCC, respective- ly. An additional $136,000 increase was experienced by NEDS and Commercial On- line from increases in shipping charges and shipping material costs. The principal components of the remaining net increase were made up of increases at Commercial Online, primarily from increased costs for forms and paper and soft- ware writeoffs related, in part, to the continuing decline in the Company's in- fomercial and apparel businesses. Selling and promotion expenses increased 1.7% as a percentage of revenues, from $1,500,000 in fiscal 1994 to $2,491,000 in fiscal 1995. Increases of $33,000, $501,000, $165,000, and $225,000 were attributable to the timing of the acquisi- tions of TruCheck, Daton, ACA, and MCC, respectively. The balance of the in- crease of approximately $67,000, was primarily attributable to expanded sales and marketing efforts at NEDS. Page 14 of 43 General and administrative expenses increased 1.9% as a percentage of sales, from $4,375,000 in fiscal 1994 to $6,536,000 in fiscal 1995. Increases of $885,000 $61,000, $350,000, and $311,000 were attributable to the timing of the acquisitions of Daton, Delta, ACA, and MCC, respectively. A loss of $43,000 was recorded in connection with a termination and return of equipment acquired under a capital lease, and the Company recorded approximately $315,000 of charges relating to customer price concessions and disputed invoices and increased its allowance for bad debts which management determined was required in response to current market conditions. In addition, the Company incurred approximately $56,000 in costs relating to an offering of debentures which was not consum- mated, and $50,000 for estimated legal settlement costs and related liabil- ities. The remaining increase, approximately $153,000, was primarily attrib- utable to increases in accounting staff and higher outside professional fees. Net interest expense increased 0.8% as a percentage of revenues, from $24,000 in fiscal 1994 to $227,000 in fiscal 1995. This was due to interest expense from the higher level of debt incurred to fund certain acquisitions, partially offset by a decrease in interest income generated in fiscal 1994 by the excess proceeds from the Company's public offering, as those funds were also used for acquisi- tions. As a result of the aforementioned, the Company recorded a loss of $636,000 ($.19 loss per share) for the year ended October 31, 1995 compared to a profit of $501,000 ($.13 per share) for the year ended October 31, 1994. LIQUIDITY AND CAPITAL RESOURCES On January 27, 1993, the Company completed its initial public offering of 1,150,000 shares of Common Stock, which yielded net proceeds of $4,927,000 to the Company. Prior to the offering, the Company had financed its operations, capital expenditures, and acquisitions through internally generated funds. The number and size of potential acquisitions had been limited. Proceeds from the offering, as well as certain borrowings discussed below, have enabled the Com- pany to achieve significant growth through the acquisition of a number of com- panies in both the payroll processing and information processing markets. During Fiscal 1996, management focused on the consolidation and integration of the acquisitions made in prior years. The Company continues to invest in its businesses through the development of new products and the enhancement of existing products. During the year ended October 31, 1996, the Company provided $2,903,000 from operations principally by generating $2,470,000 in net income before deductions for depreciation, amortization, and deferred taxes. It invested $545,000 for the purchase of equipment and spent $1,116,000 for product enhancements. In the aggregate, the Company's investing activities used $1,843,000. In its financing activities, the Company used $1,382,000 principal- ly to repay long-term debt. As a result of these factors, the Company's cash and cash equivalents decreased by $322,000. As of October 31, 1996, the Company had cash and cash equivalents of $1,084,000 and working capital of $862,000. Its current ratio (i.e., the ratio of current assets to current liabilities) was 1.18 to 1, and its debt to equity ratio was 0.66 to 1. Page 15 of 43 The Company is indebted to a bank for three term loans under a Term Loan Agree- ment ("Agreement") in original amounts aggregating $2,620,000, the proceeds of which were used to fund various acquisitions by the Company. The loans bear interest at the prime rate plus 1.5%. The Agreement provides for monthly prin- cipal and interest payments in varying amounts through May 2000. As of October 31, 1996, the outstanding balances of these loans aggregated $1,586,253. Sub- stantially all of the assets of the Company are pledged as collateral for these loans. The Agreement requires the Company to meet certain financial covenants relating to, among other things, minimum levels of income and cash flow (as defined), and limits on capital expenditures and new leases. During the year ended October 31, 1996, the Company exceeded the permitted level of capital expenditures. On January 3, 1997, the Company received a waiver with respect to this covenant. As of April 30, 1996, the Company reached an agreement with "K" Line America, Inc. to amend the terms of the original $840,645 note issued in connection with the purchase of MCC Corporation. The note is now payable in four equal install- ments at various times from March 1997 through February 1999. Interest is payable quarterly at 7.5% per annum. Management believes that its cash flow from operations will be sufficient to fund the Company's operations for at least the coming year. The Company con- tinues to seek acquisition opportunities that fit the Company's long-term strategy. Any material acquisitions may require funding in excess of the level of current and projected operating cash flows, and would require additional debt and/or equity funding. Several banks have expressed an interest in assisting the Company should such an opportunity arise, although there can be no assurance that such a transaction will be consummated. ITEM 7. FINANCIAL STATEMENTS - ------------------------------ The Financial Statements and Notes thereto are set forth beginning at page 20 of this Report. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - ------------------------------------------------------- None. PART III ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS ITEM 10. EXECUTIVE COMPENSATION ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - ------------------------------------------------------------------------ The foregoing four Items of Part III are incorporated by reference to the Company's definitive Proxy Statement in connection with its Annual Meeting of Shareholders to be filed no later than February 28, 1997. Page 16 of 43 ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K - ------------------------------------------ (a) The exhibits required to be filed as a part of this Annual Report are listed below. The exhibits marked with an asterisk (*) are incorpo- rated by reference to the Company's Registration Statement on Form SB-2 (No. 33-53888NY). Exhibit No. Description 3.1 * Restated Certificate of Incorporation 3.2 * Amended and Restated By-Laws 10.1 * Option Agreement dated May 10, 1990 between the Company, Zach Lonstein ("Lonstein"), and Stanley Berger ("Berger"). 10.2 * Option Agreement dated June 15, 1990 between the Company and Lonstein and Annex to Option Agreement, and Letter Agreement dated December 11, 1992 amending the Option Agree- ment. 10.3 * $150,000 Promissory Note dated October 2, 1992 to the order of Robert D. Goldstein. 10.4 Employment Agreement dated as of January 1, 1995 between the Company and Lonstein, incorporated by reference to the Company's Annual Report on Form 10-KSB for October 31, 1995. 10.5 * Employment Agreement dated November 1, 1992 between the Company and Jeffrey Millman. 10.6A * Consulting Agreement dated November 1, 1992 between the Company and Berger. 10.6B Consulting Agreement Amendment dated as of October 31, 1994 between the Company and Berger, incorporated by reference to the Company's Annual Report on Form 10-KSB for October 31, 1995. 10.7 * Lease dated January 14, 1991 between the Company and G-H-G Realty Company. 10.8 $200,000 Letter of Credit dated September 27, 1993 issued by Israel Discount Bank of New York on behalf of the Company in favor of G-H-G Realty Company and Amendment No. 2 dated March 8, 1995 reducing the Credit Amount to $150,000, incor- porated by reference to the Company's Annual Report on Form 10-KSB for October 31, 1995. 10.9 Lease dated June 1, 1996 between MCC corporation and "K" Line Realty, Inc. 10.10 1992 Stock Option and Stock Appreciation Rights Plan, as amended by the stockholders of the Company at the Annual Meeting held on April 27, 1995, incorporated by reference to the Company's Annual Report on Form 10-KSB for October 31, 1995. Page 17 of 43 Exhibit No. Description 10.11 Merger Agreement dated May 4, 1993 between the Company, New England Data Services, Inc. and certain of its stockholders, as amended June 22, 1993 - Incorporated by reference to the Company's Current Report on Form 8-K filed on August 26, 1993. 10.12 Merger Agreement dated December 31, 1993 between the Company, Tru-Check Computer Systems, Inc., and Roger Kaufman - Incorporated by reference to the Company's Annual Report on Form 10-KSB for the year ended October 31, 1994. 10.13 Merger Agreement dated May 18, 1994 by and among the Company, Daton Data Processing Services, Inc., Anton P. Donde, and Anton and Detta L. Donde as Trustees - Incor- porated by reference to the Company's Annual Report on Form 10-KSB for the year ended October 31, 1995. 10.14 Asset Purchase Agreement dated April 27, 1995 by and among the Company, Key-ACA Inc., Eugene B. Monosson, and Earl G. Phillips, Jr. - Incorporated by reference to a Current Report on Form 8-K filed by the Company on May 10, 1995. 10.17 Stock Purchase Agreement dated as of May 31, 1995 by and among the Company and "K" Line America, Inc. ("K-Line") - Incorporated by reference to a Current Report on Form 8-K filed by the Company on June 22, 1995. 10.18 Escrow Agreement dated June 8, 1995 between the Company, K-Line, Lonstein, and Chemical Bank, incorporated by refer- ence to the Company's Annual Report on Form 10-KSB for Oc- tober 31, 1995. 10.19 Letter agreement between the Company and K-Line, amending the terms of the Stock Purchase Agreement and associated Note, incorporated by reference to the Company's Quarterly Report on Form 10-QSB for April 30, 1996. 10.20 Agreement of Sale between Daton Pay USA, Inc. (a subsidiary of the Company) and David R. Feldman dba Pro Data, dated August 19, 1996. 21 List of Subsidiaries of the Company 23 Consent of Deloitte & Touche, LLP 27 Financial Data Schedule - included in EDGAR filing only. (b) Reports on Form 8-K None. Page 18 of 43 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. COMPUTER OUTSOURCING SERVICES, INC. January 24, 1997 /s/ Zach Lonstein - Chief Executive Officer January 24, 1997 /s/ Roger J. Kaufman - Chief Financial Officer January 24, 1997 /s/ David N. Levine - Principal Accounting Officer In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. January 24, 1997 /s/ Zach Lonstein - Chairman of the Board of Directors January 24, 1997 /s/ Jeffrey R. Millman - Director January 24, 1997 /s/ Robert B. Wallach - Director January 24, 1997 /s/ John C. Platt - Director January 24, 1997 /s/ Richard A. Krantz - Director January 24, 1997 /s/ James D. Gerson - Director January 24, 1997 /s/ Eugene Monosson - Director January 24, 1997 /s/ Anton P. Donde - Director Page 19 of 43 INDEPENDENT AUDITORS' REPORT - ---------------------------- To the Board of Directors and Stockholders of Computer Outsourcing Services, Inc. We have audited the accompanying consolidated balance sheets of Computer Outsourcing Services, Inc. and subsidiaries as of October 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion of these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. These 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, such consolidated financial statements present fairly, in all material aspects, the financial position of the companies as of October 31, 1996 and 1995, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles. /s/ Deloitte & Touche LLP New York, New York January 10, 1997 Page 20 of 43 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS October 31, ------------------------ 1996 1995 ----------- ----------- ASSETS CURRENT ASSETS: Cash and cash equivalents, including short-term, interest bearing investments of $316,346 and $662,514 ........................................... $ 1,083,545 $ 1,406,016 Trade accounts receivable, net of allowance for doubtful accounts of $305,874 and $265,415 .................. 3,716,343 3,799,940 Refundable income taxes .............................. 62,988 414,558 Prepaid expenses ..................................... 699,005 603,580 Other current assets ................................. 125,850 138,610 ----------- ----------- 5,687,731 6,362,704 ----------- ----------- PROPERTY and EQUIPMENT, net (Note 3) ................. 3,132,847 3,450,771 ----------- ----------- OTHER ASSETS: Deferred software costs, net (Note 4) ................ 1,912,505 1,083,051 Intangibles, net (Notes 2 and 5) ..................... 7,764,535 8,160,949 Due from related parties, net (Note 6) ............... 106,472 155,740 Security deposits and other non-current assets ....... 705,307 711,229 ----------- ----------- 10,488,819 10,110,969 ----------- ----------- TOTAL ASSETS ......................................... $19,309,397 $19,924,444 =========== =========== See Notes to Consolidated Financial Statements Page 21 of 43 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS October 31, ------------------------ 1996 1995 ----------- ----------- LIABILITIES and STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable ..................................... $ 1,535,816 $ 1,365,480 Current portion of long-term debt (Note 7) ........... 1,054,352 1,562,712 Current portion of capitalized lease obligations (Note 8)............................................ 195,979 158,729 Accrued expenses and taxes ........................... 1,757,355 1,843,881 Customer deposits and other current liabilities ...... 282,075 270,430 ----------- ----------- 4,825,577 5,201,232 ----------- ----------- LONG-TERM LIABILITIES: Long-term debt (Note 7) .............................. 1,629,234 2,352,175 Capitalized lease obligations (Note 8) ............... 284,775 376,293 Deferred income taxes (Note 9) ....................... 837,219 645,540 Stock option obligation (Note 12) .................... 133,146 400,939 ----------- ----------- 2,884,374 3,774,947 ----------- ----------- COMMITMENTS AND CONTINGENCIES (Note 12) STOCKHOLDERS' EQUITY (Note 10): Preferred stock, $0.01 par value; 1,000,000 shares authorized, none issued ............................ - - Common stock, $0.01 par value; 7,000,000 shares authorized; shares issued and outstanding, 3,734,850 and 3,627,499....................................... 37,348 36,275 Common stock issuable (Note 12) ...................... - 153,000 Additional paid-in capital ........................... 9,233,952 8,752,637 Retained earnings .................................... 2,363,278 2,076,615 Deferred costs arising from a financing and consulting agreement (Note 6) .................. (35,132) (70,262) ----------- ----------- 11,599,446 10,948,265 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ........... $19,309,397 $19,924,444 =========== =========== See Notes to Consolidated Financial Statements Page 22 of 43 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Years Ended October 31, ------------------------ 1996 1995 ----------- ----------- REVENUES ............................................. $29,051,368 $22,151,734 ----------- ----------- COSTS and EXPENSES: Data processing costs .............................. 18,134,577 13,847,812 Selling and promotion costs ........................ 2,501,404 2,491,438 General and administrative costs ................... 7,462,721 6,536,436 Interest expense, net of interest income .......... 339,191 226,506 ----------- ----------- 28,437,893 23,102,192 ----------- ----------- INCOME/(LOSS) BEFORE PROVISION FOR INCOME TAXES ...... 613,475 (950,458) PROVISION/(BENEFIT) FOR INCOME TAXES (Note 9) ........ 280,000 (314,493) ----------- ----------- NET INCOME/(LOSS) .................................... $ 333,475 $ (635,965) =========== =========== INCOME/(LOSS) PER COMMON SHARE (Note 1) .............. $ 0.08 $ (0.19) =========== =========== WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING (Note 1) 3,791,648 3,646,436 =========== =========== See Notes to Consolidated Financial Statements Page 23 of 43 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended October 31, ------------------------ 1996 1995 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net Income/(Loss) .................................... $ 333,475 $ (635,965) Adjustments to reconcile net income/(loss) to cash provided by operating activities: Depreciation and amortization ...................... 1,945,230 1,769,761 Amortization of excess of fair value of net assets acquired over cost ............................... - (15,749) Deferred income taxes .............................. 191,679 (207,241) Decrease/(increase) in: Cash surrender value of life insurance, net ...... (2,936) (6,693) Trade accounts receivable ........................ 83,597 613,892 Refundable taxes ................................. 351,570 (380,203) Prepaid expenses ................................. (95,425) (204,899) Other current assets ............................. 12,760 79,013 Security deposits and other noncurrent assets .... (27,632) (124,637) Increase/(decrease) in: Accounts payable ................................. 170,336 114,193 Accrued expenses and taxes ....................... (71,745) 421,595 Customer deposits and other current liabilities .. 11,645 60,271 ----------- ----------- Net cash provided by operating activities ............ 2,902,554 1,483,338 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment ................. (545,288) (548,043) Disposal of equipment .............................. 62,674 123,916 Redemption of marketable securities ................ - 1,098,269 Settlement of contingencies relating to acquisitions (104,633) (262,279) Increase in deferred software costs ................ (1,115,856) (424,847) Purchase of customer list .......................... (140,000) - Payment for purchase of MCC, net of cash acquired .. - (334,212) Payment for purchase of ACA, net of cash acquired .. - (716,091) ----------- ----------- Net cash used in investing activities ................ $(1,843,103) $(1,063,287) ----------- ----------- See Notes to Consolidated Financial Statements Page 24 of 43 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) Years Ended October 31, ------------------------ 1996 1995 ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of long-term debt ........................ $(1,381,301) $(1,035,275) Repayments of amounts due from related parties, net 49,268 54,243 Proceeds from borrowings of long term debt ......... 150,000 1,500,000 Repayments of capital leases ....................... (199,889) (151,563) Retirement of capital leases ....................... - (67,726) ----------- ----------- Net cash (used in)/provided by financing activities .. (1,381,922) 299,679 ----------- ----------- Net (decrease)/increase in cash and cash equivalents . (322,471) 719,730 Cash and cash equivalents at the beginning of the year 1,406,016 686,286 ----------- ----------- Cash and cash equivalents at the end of the year ..... $ 1,083,545 $ 1,406,016 =========== =========== SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid during the period for: Interest expense ................................... $ 404,150 $ 280,477 =========== =========== Income taxes ....................................... $ 48,391 $ 104,925 =========== =========== During 1996 and 1995, $46,812 and $68,833 (net of tax benefits), respectively, were accreted through a charge to retained earnings in connection with a stock option (Note 12). See Notes to Consolidated Financial Statements Page 25 of 43 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) Years Ended October 31, ------------------------ 1996 1995 ----------- ----------- SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Acquisition of ACA: Fair value of assets acquired....................... $ 1,729,524 Liabilities assumed ................................ (491,994) Stock issued ....................................... (462,529) ----------- Cash paid .......................................... $ 775,001 =========== Acquisition of MCC: Fair value of assets acquired ...................... $ 3,115,567 Liabilities assumed ................................ (1,713,396) Note issued ........................................ (840,645) ----------- Cash paid .......................................... $ 561,526 =========== New capitalized leases for data processing equipment . $ 145,621 $ 341,089 =========== =========== See Notes to Consolidated Financial Statements Page 26 of 43 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Deferred Costs in Connection with a Financing/ Common Par Stock Paid in Retained Consulting Shares Value Issuable Capital Earnings Agreement Total --------- ------- -------- ---------- ---------- ---------- ----------- Balances, October 31, 1994 ................. 3,427,555 $34,276 $153,000 $7,845,086 $2,781,413 $ (105,297) $10,708,478 Stock issued in connection with contingent consideration (Note 12) ....... 23,906 239 (153,000) 152,761 - Stock issued in connection with acquisitions (Note 2) ............... 113,636 1,136 480,752 481,888 Stock issued in connection with contingent consideration (Note 12) ....... 2,402 24 11,986 12,010 Exercises of stock option (Notes 10 and 12) ........................ 60,000 600 262,052 262,652 Amortization of deferred costs in connection with a financing and consulting agreement Note 6) ......... 35,035 35,035 Accretion in connection with a stock option obligation, net (Note 12) ......... (68,833) (68,833) Value of stock issuable in connection with contingent consideration (Note 12) .. 153,000 153,000 Net loss ................................... (635,965) (635,965) --------- ------- -------- ---------- ---------- ---------- ----------- Balances, October 31, 1995 ................. 3,627,499 $36,275 $153,000 $8,752,637 $2,076,615 $ (70,262) $10,948,265 Stock issued in connection with contingent consideration (Note 12) .................. 23,906 239 (153,000) 152,761 - Exercises of stock option (Notes 10 and 12) ........................ 83,445 834 328,554 329,388 Amortization of deferred costs in connection with a financing and consulting agreement Note 6) ............. 35,130 35,130 Accretion in connection with stock option obligation, net (Note 12) ................ (46,812) (46,812) Net income ................................. 333,475 333,475 --------- ------- -------- ---------- ---------- ---------- ----------- Balances, October 31, 1996 ................. 3,734,850 $37,348 - $9,233,952 $2,363,278 $ (35,132) $11,599,446 ========= ======= ======== ========== ========== ========== =========== See Notes to Consolidated Financial Statements Page 27 of 43
COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES - ------------------------------------------------------------ BUSINESS - Computer Outsourcing Services, Inc. and its wholly-owned subsidiaries (together, "the Company") provide comprehensive data process- ing services to commercial and industrial clients and payroll processing services to a diversified client base. PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All inter- company balances and significant intercompany transactions have been elim- inated. CASH AND CASH EQUIVALENTS - Cash equivalents consist of money market accounts and other highly liquid income producing securities which have original maturities of less than 90 days. These investments are stated at cost which approximates market. CONCENTRATION OF CREDIT RISK - Financial instruments that potentially subject the Company to concentration of credit risk consist primarily of temporary cash investments and trade receivables. The Company restricts investment of temporary cash investments to financial institutions with high credit standing. Credit risk on trade receivables is minimized as a result of the large and diverse nature of the Company's customer base. Ongoing credit evaluations of customers' financial condition are performed. The Company maintains reserves for potential credit losses and such losses, in the aggregate, have not exceeded management's expectations. PROPERTY AND EQUIPMENT - Property and equipment is stated at cost except for assets acquired under capital leases, which are recorded at the lesser of their fair market value at the date of the lease or the net present value of the minimum lease commitments. Depreciation is provided using the straight-line method over their estimated useful lives. Leasehold improve- ments and assets acquired under capital leases are amortized over the shorter of the lease term or their estimated useful lives. When property and equipment is disposed of, the related cost and accumu- lated depreciation or amortization are removed from the accounts, and any resulting gain or loss is reflected in income. SOFTWARE - Software that has been purchased is included in Property and Equipment and is amortized using the straight line method over five years. The cost of internally developed software and product enhancements, not reimbursed by customers, is capitalized as Deferred Software Costs. Such costs are amortized over three to five years using the straight-line method. INTANGIBLE ASSETS - The excess of cost over net assets of acquired business ("goodwill") is amortized using the straight-line method over 20 years. Other intangible assets, primarily customer lists, are amortized using the straight-line method over their estimated lives, typically no more than ten years. The carrying value of intangibles is evaluated periodically in relation to the operating performance and future undiscounted cash flows of the under- lying businesses. Page 28 of 43 INCOME TAXES - Income tax expense is based on pre-tax accounting income. Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts. Future tax benefits, such as net operating loss carryforwards, are recognized to the extent that realization of such benefits are more likely than not. INCOME PER COMMON SHARE - Income/(loss) per common share is computed using the weighted average number of common shares outstanding during each period plus the dilutive effect of common stock equivalents. Net income/(loss) per common share for the years ended October 31, 1996 and 1995 has been adjusted to reflect $68,833 and $46,812, respectively, in accretion (net of income tax benefit) arising in connection with an outstanding option (Note 12). Stock options and warrants which are anti-dilutive are excluded from the computation of weighted average shares outstanding. STOCK OPTIONS AND WARRANTS - In October 1995, the Financial Accounting Standards Board issued Statement of Financial Standards No. 123, "Account- ing for Stock-Based Compensation" ("FAS No. 123"), which requires adoption of the disclosure provisions no later than fiscal years beginning after December 15, 1995. The new standard defines a fair value method of accounting for stock options and other equity instruments. Under the fair value method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period, which is usually the vesting period. Pursuant to the new standard, companies are encouraged, but are not required, to adopt the fair value method of accounting for employee stock- based transactions. Companies are also permitted to continue to account for such transactions under Accounting Principles Board Option No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"), but would be required to disclose in a note to the financial statements pro forma net income and, if presented, earnings per share as if the company had applied the new method of accounting. The new standard also requires increased disclosures for stock-based compensation arrangements regardless of the method chosen to measure and recognize compensation for employee stock- based arrangements. The accounting requirements of the new method are effective for all trans- actions entered into during the fiscal year of adoption. The Company has elected to account for options under the provisions of APB No. 25. Disclosures required under the provisions of FAS No. 123 will be included in financial statements beginning with the year ending October 31, 1997. FAIR VALUE OF FINANCIAL INSTRUMENTS - The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments". The estimated fair values of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgement is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. Page 29 of 43 The carrying amount and estimated fair values of financial instruments at the end of the respective years are summarized as follows: October 31, 1996 October 31, 1995 ------------------------ ------------------------ Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value ----------- ----------- ----------- ----------- Assets: Cash .................. $ 767,199 $ 767,199 $ 743,502 $ 743,502 Short-term interest- bearing investments . 316,346 316,346 662,514 662,514 Trade accounts receivable .......... 4,022,217 4,022,217 4,065,355 4,065,355 Liabilities: Accounts payable, accrued expenses and taxes, and customer deposits and other current liabilities .. 3,575,246 3,575,246 3,479,791 3,479,791 Notes payable, bank ... 1,586,253 1,586,253 2,115,835 2,115,835 Acquisition Note ...... 840,645 814,780 1,405,803 1,322,015 Other Acquisition debt - - 109,973 94,956 Revolving line of credit 150,000 146,270 150,000 142,307 Other borrowings ...... 106,688 100,476 133,276 132,734 Stock option obligation 133,146 154,116 400,939 465,051 The following methods and assumptions were used to estimate the fair value of the financial instruments presented above: Cash - The carrying amount is a reasonable approximation of fair value. Short-term interest bearing instruments - Fair value is based upon quoted market prices, including accrued interest, and approximate their carrying value due to their short maturities. Trade accounts receivable, accounts payable, accrued expenses and taxes, and customer deposits and other current liabilities - The fair value of receivables and payables are assumed to equal their carrying value because of their short maturities. Notes payable, bank - Fair value is estimated by discounting the future stream of payments using the incremental borrowing rate of the Company, which represents its primary source of recourse financing. Acquisition Notes and debt, revolving line of credit, other borrowings, and stock option obligation - Interest rates that are currently available to the Company for issuance of debt with similar terms and remaining maturities are used to estimate fair value for those debt issues for which no market quotes are available. USE OF ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. Page 30 of 43 RECLASSIFICATIONS - Certain reclassifications were made to the 1995 financial statements to conform with the current year presentation. 2. ACQUISITIONS - ----------------- KEY-ACA, INC. - Effective as of May 1, 1995, the Company completed the acquisition of Key-ACA, Inc ("ACA"). The purchase price was $625,000 in cash, 113,636 shares of the Company's Common Stock, and contingent con- sideration based on future earnings levels and certain defined events (Note 12). In May 1996, the Company made a contingent payment of $13,284. The foregoing transaction was accounted for as a purchase and, accordingly, the results of ACA's operations have been included in the Company's opera- tions from the effective date of the acquisition. This transaction gave rise to approximately $356,000 of goodwill which is being amortized over a twenty-year period. MCC CORPORATION - Effective as of June 1, 1995, the Company purchased all the issued and outstanding stock of MCC Corporation ("MCC") for $1,200,922, of which $360,277 was paid in cash, and the $840,645 balance is to be paid in equal principal payments on specified dates during the period March 1, 1997 through February 1, 1999, with interest at 7.5% per annum. In addi- tion, certain amounts due from MCC to the seller on the closing date were combined into a non-interest bearing note, which was subsequently repaid. These notes are collateralized by a pledge by the Company's Chief Executive Officer of 310,000 personally owned shares of the Company's Common Stock. The seller has guaranteed the collectability of the accounts receivable purchased by the Company. The foregoing transaction was accounted for as a purchase and, accordingly, the results of MCC's operations have been included in the Company's opera- tions from the effective date of the acquisition. This transaction gave rise to approximately $99,000 of goodwill which is being amortized over a twenty-year period. The following unaudited proforma operating information assumes that the acquisitions of ACA and MCC, which were effective as of May 1, 1995 and June 1, 1995, respectively, had instead occurred at the beginning of the Company's fiscal year. Such proforma operating information does not purport to represent the actual results of operations of the consolidated companies for the period presented, nor is it indicative of future opera- ting results. Year Ended October 31, 1995 ---------------- Revenues ...................................... $ 29,394,000 ---------------- Net loss ...................................... $ (727,000) ---------------- Loss per common share ......................... $ (0.22) ---------------- Page 31 of 43 3. PROPERTY AND EQUIPMENT - --------------------------- Property and equipment consists of the following: October 31, ------------------------ 1996 1995 ----------- ----------- Computer equipment ............................. $ 3,977,492 $ 3,783,675 Computer equipment held under capital leases (Note 8) .............................. 1,844,516 1,698,895 Furniture and office equipment ................. 597,787 427,515 Leasehold improvements ......................... 329,754 302,665 Purchased software ............................. 595,756 500,597 Vehicles ....................................... 36,474 43,824 ----------- ----------- 7,381,779 6,757,171 Less accumulated depreciation and amortization . (4,248,932) (3,306,400) ----------- ----------- $ 3,132,847 $ 3,450,771 =========== =========== Depreciation and amortization was $946,159 and $ 742,251 for the years ended October 31, 1996 and 1995, respectively. 4. DEFERRED SOFTWARE COSTS - ---------------------------- Deferred software costs consist of the following: October 31, ------------------------ 1996 1995 ----------- ----------- Costs of internally-developed software and enhancements .................... $ 2,796,181 $ 1,680,325 Accumulated amortization ....................... (883,676) (597,274) ----------- ----------- $ 1,912,505 $ 1,083,051 =========== =========== Amortization and writeoffs of deferred software costs for the years ended October 31, 1996 and 1995 were $286,402 and $436,810, respectively. Page 32 of 43 5. INTANGIBLES - ----------------- Intangible assets consist of the following: October 31, ------------------------ 1996 1995 ----------- ----------- Excess of cost of investments over net assets acquired .......................... $ 5,685,891 $ 5,741,035 Customer lists ................................. 3,687,929 3,355,747 ----------- ----------- 9,373,820 9,096,782 Less accumulated amortization .................. (1,609,285) (935,833) ----------- ----------- $ 7,764,535 $ 8,160,949 =========== =========== Amortization was $641,047 and $519,845 for the years ended October 31, 1996 and 1995, respectively. 6. RELATED PARTY TRANSACTIONS - ------------------------------- Due from/(to) related parties consists of the following: October 31, ------------------------ 1996 1995 ----------- ----------- Due from the Chief Executive Officer and controlling shareholder bearing interest at prime plus 1% per annum- repayable on demand . $ 100,352 $ 118,122 Due from consultant (Note 12) .................. 52,469 65,587 Advances to former shareholder of NEDS, including interest at 7% per annum ........... 1,911 1,911 Due to former shareholder of NEDS, repayable in monthly installments of principal and interest of $1,322 through September 2002 .... (52,104) (62,196) Due from former shareholder of Daton, repayable on demand, bearing interest at the prevailing money market rate ............................ 3,844 16,744 Due from former shareholder of TruCheck ........ - 15,572 ----------- ----------- $ 106,472 $ 155,740 =========== =========== The Company is the beneficiary of a $1,000,000 life insurance policy which it maintains on its Chief Executive Officer. Page 33 of 43 As compensation for providing a $1,000,000 personal guarantee of certain acquisition indebtedness to the selling shareholders of MCC (Note 2), the Company's Chief Executive Officer was granted a per annum fee of 3% of the $1,000,000 for such period as the guarantee is in effect. Such fee is being paid in the form of a monthly reduction in the Chief Executive Officer's existing indebtedness to the Company. The Company is obligated to a former director in the amount of $150,000. The loan was made pursuant to an agreement on December 7, 1992 wherein the director agreed to make a line of credit of up to $350,000 (including the initial $150,000) available to the Company for five years, and to provide certain consulting services during that period. In October 1994, the due date of the note was extended to October 1997 and the interest rate was increased to 7% from 4-1/2%. The $150,000 outstanding at October 31, 1996 and 1995 is included as a component of long-term debt (Note 7). As inducements for the director to enter into the above agreement: (a) the Company's controlling stockholder guaranteed repayment of the note, and (b) the controlling stockholder and the President of the PCS Data Processing division sold an aggregate of 65,550 shares of Common Stock to the director for $54,928, or $0.838 per share. This transaction gave rise to a deferred charge of $174,496, representing the difference between the selling price of the shares and management's estimate of the fair value at the time of the transaction. This deferred charge is being amortized over a five year period on a straight-line basis. The unamortized balance was $35,132 and $70,262 at October 31, 1996 and 1995, respectively. The director's term ended in April 1995. During the fiscal years ended October 31, 1996 and 1995, the Company paid $30,000 and $48,000 (plus expenses), respectively, to a firm controlled by the former director for various public relations services. 7. LONG-TERM DEBT - ------------------- Long-term debt consists of the following: October 31, ------------------------ 1996 1995 ----------- ----------- Notes payable, bank (a) ........................ $ 1,586,253 $ 2,115,835 Note payable issued in connection with an acquisition (Note 2) ......................... 840,645 1,405,803 Liability in connection with an acquisition (b) - 109,973 Revolving line of credit (Note 6) .............. 150,000 150,000 Notes payable, other ........................... 106,688 133,276 ----------- ----------- 2,683,586 3,914,887 Less current portion ........................... (1,054,352) (1,562,712) ----------- ----------- $ 1,629,234 $ 2,352,175 =========== =========== Page 34 of 43 (a) The Company is indebted to a bank for three term loans under a Term Loan Agreement ("Agreement") in original amounts aggregating $2,620,000, the proceeds of which were used for acquisitions. The Agreement, last amended on October 21, 1996, provides for monthly principal and interest payments in varying amounts through May 2000. Interest is computed at 1.5% over the bank's prime rate. Substan- tially all of the assets of the Company are pledged as collateral for this indebtedness. The Agreement requires the Company to meet certain financial covenants relating to, among other things, minimum levels of income and cash flow (as defined) and limits capital expenditures and new leases. During the year ended October 31, 1996, the Company exceeded the per- mitted level of capital expenditures. On January 3, 1997, the Company received a waiver with respect to this covenant. (b) In August 1994, the Company acquired certain assets for cash and con- tingent consideration based on operating performance over the follow- ing two years. The contingent consideration was estimated to be $233,000 at the time of acquisition based on the existing levels of operations. Such amount was recorded as a component of long-term debt. Aggregate maturities of long-term debt are as follows: Years Ending October 31, ------------ 1997 $ 1,054,352 1998 825,322 1999 585,162 2000 218,750 ------------ $ 2,683,586 ============ 8. CAPITALIZED LEASE OBLIGATIONS - ---------------------------------- The Company generally leases its equipment under standard commercial leases with purchase options which the Company exercises from time to time. Assets held under capitalized lease agreements are reflected in property and equipment as capital leases. Page 35 of 43 Minimum future lease payments under capitalized leases are as follows: Years Ending October 31, ------------ 1997 $ 240,168 1998 184,761 1999 118,279 2000 20,008 ----------- 563,216 Less amount representing interest ................. (82,462) ----------- Present value of net minimum lease payments ... 480,754 Less current maturities .... 195,979 ----------- Long-term obligations under capital leases ..... $ 284,775 =========== 9. INCOME TAXES - ----------------- The provision/(benefit) for income taxes consists of: October 31, ------------------------ 1996 1995 ----------- ----------- Current: Federal ...................................... $ (19,423) $ (148,566) State and local .............................. 107,744 8,075 Deferred ....................................... 191,679 (174,002) ----------- ----------- $ 280,000 $ (314,493) =========== =========== Page 36 of 43 A reconciliation of income taxes computed at the Federal statutory rate to amounts provided is as follows: October 31, ------------------------ 1996 1995 ----------- ----------- Tax provision computed at statutory rate ....... $ 208,582 $ (323,156) Increase/(decrease) in taxes resulting from: State and local income taxes, net of federal income taxes ............................... 31,584 (33,318) Amortization of excess of net assets of company acquired over cost.................. - (5,355) Benefit on non-taxable investment income...... (37,694) - Amortization of excess of cost over net assets of acquired companies................ 85,363 79,542 Other, net ................................... (7,835) (32,206) ----------- ----------- $ 280,000 $ (314,493) =========== =========== Temporary differences which give rise to net deferred tax liabilities are as follows: October 31, ------------------------ 1996 1995 ----------- ----------- Deferred tax liabilities: Depreciation ................................. $ 621,584 $ 653,451 Deferred software costs....................... 843,903 493,406 ----------- ----------- 1,465,487 1,146,857 ----------- ----------- Deferred tax assets: Lease transactions ........................... (212,447) (234,340) Intangibles .................................. (40,168) (6,974) Deferred compensation ........................ (52,158) (52,158) Allowance for doubtful accounts .............. (134,474) (117,926) Reserves ..................................... (23,495) - Net operating loss carryovers ................ (165,526) (89,919) ----------- ----------- (628,268) (501,317) ----------- ----------- Net deferred tax liabilities ................... $ 837,219 $ 645,540 =========== =========== Page 37 of 43 10. STOCKHOLDERS' EQUITY - ------------------------- COMMON STOCK - The Company is authorized to issue up to 7,000,000 shares of common stock, $0.01 par value. The holders of common stock are entitled to one vote per share. There is no cumulative voting for the election of directors. Subject to the prior rights of any series of preferred stock which may from time to time be outstanding, holders of common stock are entitled to receive ratably any dividends as may be declared by the Board of Directors of the Company out of funds legally available therefor, and upon the liquidation, dissolution , or winding up of the Company, are en- titled to share ratably in all assets remaining after the payment of lia- bilities, and payment of accrued dividends and liquidation preferences on the preferred stock outstanding, if any. Holders of common stock have no preemptive rights, and have no rights to convert their common stock into any other security. PREFERRED STOCK - The Company is authorized to issue up to 1,000,000 shares of preferred stock, $0.01 par value. The preferred stock may be issued in one or more series, the terms of which may be determined by the Board of Directors without further action by the stockholders, and may include voting rights (including the right to vote as a series on certain matters), preferences as to dividends and liquidation conversion, redemption rights, and sinking fund provisions. WARRANTS - The Underwriters of the Company's initial public offering were issued warrants to purchase an aggregate of 100,000 shares of the Company's Common Stock, at an exercise price per share of $6.30. These warrants ex- pire in January 1998. In September 1994, in connection with a consulting arrangement, the Company issued warrants to purchase an aggregate of 75,000 shares of common stock. The warrants are exercisable at $5.00 per share for the first 50,000 shares and at $6.30 per share for the remaining 25,000 shares. The consultant has the right to require the Company to register these shares with the Secu- rities and Exchange Commission. On June 27, 1995, in connection with a consulting agreement, the Company issued a warrant to purchase 75,000 shares of common stock for $5.00 per share. The warrant grants the holder certain "piggy-back registration" and other rights. STOCK OPTION PLAN - In September 1992, the Company adopted the 1992 Stock Option and Stock Appreciation Rights Plan ("the Plan") which provides for the granting of options to employees, officers, directors, and consultants for the purchase of up to 350,000 shares of common stock. On April 27, 1995, the Company's shareholders approved an amendment to the Plan in- creasing the maximum number of shares issuable thereunder to 700,000. Options granted may be either "incentive stock options" within the meaning of Section 422 of the United States Internal Revenue Code of 1986, as amended ("the Code"), or non-qualified options. Incentive stock options may be granted only to employees and officers of the Company, while non- qualified options may be issued to directors and consultants, as well as to officers and employees of the Company. The Plan is administered by a compensation committee consisting of two disinterested directors who determine those individuals to whom options will be granted, the time period during which the options or rights may be exercised, the number of shares of common stock which may be purchased under each option, and the option exercise price. Page 38 of 43 The per share exercise price of an incentive stock option may not be less than the fair market value of the common stock on the date the option is granted. The per share exercise price of a non-qualified option shall be determined by the compensation committee, except that the Company will not grant non-qualified options with an exercise price lower than 50% of the fair market value of common stock on the day the option is granted. In addition, any person who, on the date of the grant, already owns, directly or indirectly, 10% or more of the total combined voting power of all classes of stock outstanding, may only be granted an option if the exercise price of such option is at least 110% of the fair market value of the common stock on the date of the grant. The compensation committee may also grant "stock appreciation rights" ("SAR's") in connection with specific options granted under the plan. Each SAR entitles the holder to either: cash (in an amount equal to the excess of the fair value of a share of common stock over the exercise price of the related options); or common stock (the number of shares of which is to be determined by dividing the SAR's cash value by the fair market value of a share of common stock on the SAR exercise date); or a combination of cash and stock. SAR's may be granted along with options granted under the Plan, and to holders of previously granted options. No SAR's have been granted under the Plan. Activity during the past two years with respect to the Plan is as follows: Number of Exercise Options Price --------- ------------- Options outstanding, October 31, 1994 ....... 278,750 $4.50 - $5.88 Options granted ............................. 175,150 3.81 - 4.38 --------- Options outstanding , October 31, 1995 ...... 453,900 3.81 - 5.88 Options granted ............................. 277,750 3.63 - 4.68 Options canceled ............................ (21,350) 4.00 - 5.88 --------- Options outstanding, October 31, 1996 ....... 710,300 $3.63 - $5.88 ========= As of October 31, 1996, the Company had exceeded the number of options available for future grant under the Plan. The options granted during the year ended October 31, 1996 are subject to shareholder approval to increase the number of shares issuable under the Plan. The amendment is expected to be adopted at the Company's next Annual Meeting of Stockholders expected to be held in April 1997. Management and other members of the Board of Direc- tors control a sufficient number of shares to approve the above amendment. Of the options granted, 369,500 are exercisable. In addition to options granted under the Plan, two non-qualified options aggregating 290,000 shares were granted prior to the Company's initial public offering of which 150,000 were exercised prior to October 31, 1996 and 140,000 are currently exercisable. Page 39 of 43 11. RETIREMENT PLANS - --------------------- The Company maintains two 401(k) Savings Plans covering all eligible employees who have attained the age of 21 years and worked at least 1,000 hours in a one-year period. Plan participants may elect to contribute from 2% to 15% of covered compensation each year. The Company may make matching contributions at the discretion of the Board of Directors. For the years ended October 31, 1996 and 1995, the Company did not make any matching contributions. 12. COMMITMENTS AND CONTINGENCIES - ---------------------------------- CONTINGENT ACQUISITION PAYMENTS - In connection with an acquisition in 1990, the Company issued an option which allows the holder to purchase, until June 10, 1998, up to 190,000 shares of the Company's common stock for an aggregate purchase price of $1,900. The Company must purchase the option for $750,000, subject to adjustment for prior partial exercises, in the event of a proposed sale of all or substantially all of the Company's assets or in event of the holder's death (the "Put"). At the expiration of the option, the Company must purchase the unexercised portion of the option for fair value, as defined in the Option Agreement. The option provides the holder with certain "piggy-back" registration rights at the Company's expense. The difference between the present value of the option as originally recorded in 1990 and the Put amount is being accreted through periodic charges to retained earnings using the interest method. As of October 31, 1996, the holder had exercised a total of 150,000 shares, reducing the Company's obligation under the Put to $157,895. Of this amount, $133,146 has been accreted. In connection with an acquisition in April 1993, the Company is obligated for contingent payments based on revenues of the acquired company. For the fiscal years ended October 31, 1996 and 1995, contingent payments were $159,776 and $171,859, respectively. The obligations at October 31, 1996 and 1995 are included in customer deposits and other current liabilities. The purchase agreement also contains a consulting arrangement with the former owner providing for payments of $48,000 per year for marketing, new business generation and other services, and an agreement by him not to compete for five years from the date of acquisition. In connection with an acquisition, effective June 1993, the Company is obligated for certain contingent payments based on pretax earnings of the acquired company for five years. The first $1,000,000 of contingent con- sideration payable (if any) is required to be in cash with all additional payments to be made in shares of the Company's common stock. For the fiscal years ended October 31, 1996 and 1995, no contingent payments were earned. The Company also guaranteed that the market value of the 150,000 shares of Company common stock issued in connection with this acquisition will be at least $1,000,000 five years from the effective date of acqui- sition. Page 40 of 43 In connection with an acquisition effective January 1, 1994, the Company was obligated for certain contingent payments based on earnings in excess of certain base amounts of the acquired company for two years. The con- tingent payments were payable 49% in cash and 51% in shares of the Com- pany's common stock, and were capped at $600,000. In each of 1995 and 1994, contingent earnings of $300,000 were earned. At October 31, 1995, contingent amounts for the second year of $147,000 payable in cash and $153,000 payable in common stock were included in accrued expenses and common stock issuable, respectively. The Company has also guaranteed that the market value of the common stock issued in connection with this acquisition will be at least $1,016,435 five years from the effective date of acquisition. In connection with an acquisition effective June 1, 1994, the Company is obligated for contingent consideration based on future operations of the payroll division of the Company and certain other defined events. No contingent consideration has been earned through October 31, 1996. The Company also guaranteed that the market value of the 300,000 shares of Company common stock issued for the purchase will be at least $1,500,000 five years from the effective date of the acquisition. At October 31, 1996, the Company was contingently liable for approximately $1,257,000 of stock price guarantees relating to the foregoing acqui- sitions. Such amount assumes October 31, 1996 as the measurement date for these obligations and was calculated by comparing the aggregate of all ac- quisition stock price guarantees to the market value of the Company's Com- mon Stock on October 31, 1996. Actual amounts that will ultimately be paid, if any, could change significantly depending upon the price of the Company's Common Stock on the dates such amounts are required to be settled. EMPLOYMENT AGREEMENTS - The Company is obligated under certain employment agreements which expire at various times through December 2000. Pursuant to such agreements, the approximate annual minimum amounts payable are as follows: Years Ending October 31, ------------ 1997 $ 800,000 1998 654,000 1999 568,000 2000 404,000 2001 51,000 CONSULTING AND NONCOMPETITION - In connection with an acquisition, the Company entered into an agreement with the former owner of the acquired company. This agreement, as amended in October 1994, expires on September 30, 2001, provided for annual payments of $222,917 in fiscal 1994, $245,209 for fiscal 1995, and $267,500 through September 30, 2001. As a partial incentive to enter into the amended agreement, the Company has agreed to forgive, on each anniversary date of the agreement, 12.5% of the consult- ant's existing indebtedness to the Company, $52,469 at October 31, 1996 (Note 6). The consulting agreement includes certain non-competition re- strictions. The existing indebtedness to the Company will be amortized ratably over the term of the amended agreement. Page 41 of 43 In September 1994, the Company entered into a consulting agreement with a company to provide general financial consulting and to explore new oppor- tunities relating to potential financing agreements and new business acqui- sitions. The term of this agreement is two years, and provides for a mini- mum monthly retainer of $4,000. In connection with this agreement, the Company issued warrants to purchase up to an aggregate of 75,000 shares of Common Stock at prices ranging from $5.00 to $6.30 per share. On June 27, 1995, the Company entered into a consulting agreement with a former employee of MCC to provide general consulting services to the Com- pany. The term of this agreement is two years, and provides for payments of $125,000 a year. In connection with this agreement, the Company issued warrants to purchase up to an aggregate of 75,000 shares of Common Stock at a price of $5.00 per share. LITIGATION - There are no pending legal proceedings that, in the opinion of management, would materially affect the financial condition or results of operations of the Company. LEASE OBLIGATIONS - The Company maintains its executive offices, the opera- tions of two subsidiaries, and a computer center in New York City, in a facility of approximately 30,500 square feet, under a lease which expires on December 31, 2008. The current annual rent is approximately $660,000, payable monthly plus operating expenses, and is subject to escalation. The Company's obligations under this lease are secured by a letter of credit in the face amount of $150,000. A subsidiary leases offices and a computer center in Murray Hill, New Jersey, in a facility of approximately 31,800 square feet, under a lease which expires April 30, 1998. The current annual rent is approximately $450,000, payable monthly plus operating expenses. This subsidiary also leases office and warehouse space in Aberdeen, New Jersey under leases which expire in June and August 1997, and which call for combined monthly payments of approximately $12,000. A subsidiary leases a 10,000 square foot office and payroll processing center in Cranston, Rhode Island under a lease which expires in June 1998. The current monthly rent is approximately $5,200, subject to escalation. The Company leases this property from a trust, the beneficiaries of which are the former owners of the subsidiary. A subsidiary leases approximately 9,300 square feet of office and payroll processing center in Santa Ana, California, under a lease which expires July 31, 1998. The current monthly rent is approximately $10,000, subject to escalations. A subsidiary leases a 10,000 square foot office and processing center in Westwood, Massachusetts under a lease which expires in the year 2000. The current annual rent is approximately $91,000 and is subject to escalation. Page 42 of 43 Approximate minimum future building lease payments, net of sublease income, are as follows: Years Ending October 31, ------------ 1997 $ 1,393,000 1998 1,059,000 1999 743,000 2000 744,000 2001 644,000 Thereafter 4,613,000 ----------- $ 9,196,000 =========== Page 43 of 43 EX-10.9 2 THIS LEASE AGREEMENT ("Lease") is made and entered into on the 1st day of June, 1996, by and between "K" Line Realty (N.J.) Inc., (hereinafter referred to as "Landlord"); and MCC Corporation (hereinafter referred to as the "Tenant"). FOR AND IN CONSIDERATION of the rental and of the covenants and agreements hereinafter set forth to be kept and performed by Tenant, Landlord hereby leases to Tenant and Tenant hereby leases from Landlord the premises herein described for the term, at the rental and subject to and upon all of the terms, covenants and agreements hereinafter set forth. 1. DEFINED TERMS The following terms wherever initially capitalized shall have the following meanings: A. Premises: The Premises shall comprise approximately [23,763.13] square feet of the building (Level A 9,124.38 sq. ft. and Level B 14,638.75 sq. ft.) located at 535 Mountain Avenue, Murray Hill, New Jersey 07974, as said Premises are more particularly shown and identified on the office space certification which has been approved by Landlord and Tenant and is incorporated by reference herein as Exhibit "A". For all purposes of this Lease, Landlord and Tenant have agreed that the gross leasable area of the Premises is approximately [23,763.13] square feet, which for the purpose of this Lease is measured based on outside dimensions to centerline of common wall and pro-rata allocation of common and building core areas, as applicable. B. Term: The Term of this Lease shall be for a term of one (1) year commencing on June 1, 1996 and expiring on May 31, 1997 or as such period as may be extended by Tenant pursuant to Section 48. C. Commencement Date: June 1, 1996, at which time Tenant's obligation to pay Annual Basic Rent shall commence. D. Rental Year: The first Rental Year shall commence on the Commencement Date, and shall end at the close of the 12th full calendar month thereafter. E. Tenant's Proportionate Share: 18.94 % 19,010.50' (Tenant Net Usable) / 100,381.40' (Building Total Net Usable) F. Permitted Use: The Premises shall be used solely for offices in accordance with and as permitted by applicable zoning ordinances and for no other purpose. G. (i) Annual Basic Rent: The applicable Annual Basic Rent is hereinafter set forth in Article 6. (ii) Additional Rent: Any other rent and other charges to be paid by Tenant to Landlord in accordance with this Lease other than Annual Basic Rent, including but not limited to Tenant's percentage of Operating Expenses hereinafter provided in Article 8. H. Tenant Notice Address: MCC Corporation 535 Mountain Avenue Murray Hill, New Jersey 07974 Attention: Mr. Robert Wallach President I. Landlord Notice Address: "K" Line Realty (N.J.), Inc. 535 Mountain Avenue Murray Hill, New Jersey 07974 Attention: Mr. Richard B. Motta Executive Vice President J. Property: The land, as described in Exhibit B plus all buildings and all appurtenant improvements. 2. PREMISES 2.1 Landlord hereby leases to Tenant, and Tenant hereby rents from Landlord, the Premises and all related improvements attributable thereto for Tenant's use. Tenant's lease of the Premises shall include the right to use Tenant's Proportionate Share of the parking spaces in the parking areas of the Property as designated by Landlord and as particularly described on Exhibit C hereto, and the right of access and use of the dining and other common areas (excluding mechanical rooms) on the Property and in the building. 2.2 Tenant agrees that at any time and from time to time, at reasonable intervals, within twenty (20) days after written request by Landlord and/or its assignee, mortgagee or other secured parties as may be designated by Landlord to deliver to Landlord, a certificate (based on Tenant's best knowledge and belief stating; (i) that this Lease is unmodified and in full force and effect (or if there have been modifications, that this Lease is in full force and effect as modified, and identifying the modification agreements, or if this Lease is not in full force and effect the certificate shall so state); (ii) the date to which rental has been paid under this Lease; (iii) whether or not there is any existing default by either party under this Lease with respect to which a notice of default has been served, and if there is any such default, specifying the nature and extent thereof; (iv) whether or not there are any set-offs, defenses or counterclaims against enforcement of the obligations to be performed by Tenant under this Lease; and (v) such other matters relating to this Lease as may be reasonably requested by Landlord or any of its designees. Landlord agrees to furnish to Tenant at reasonable intervals, within twenty (20) days after written request by Tenant a reciprocal certificate setting forth the applicable facts as herein above referred to in this Article 2.2. 3. TERM 3.1 The Term of this Lease is the Term. In the event the Commencement Date is any date other than the first day of the month, the one (1) year lease term shall commence on the first day of the month next succeeding delivery of the Premises, and in such event Tenant shall be obligated to pay to Landlord pro-rata Annual Basic Rent and Additional Rent from the Commencement Date to the last day of the month in which the Commencement Date occurs. 3.2 This Lease shall expire at the end of the Term, without the necessity of any notice from either Landlord or Tenant to terminate the same. 4. USE OF THE PREMISES The Tenant may use the Premises for Permitted Use. Under no circumstance shall Tenant use for itself, sublet or allow an other party (including itself to use, possess or occupy the Premises as an industrial establishment in whole or in part as that term is defined under N.J.S.A. 13:1 K-8(fl the Industrial Site Recovery Act ("ISRA"). Tenant shall not cause or suffer to be committed any act which creates a violation of ISRA or otherwise causes any filing to be made pursuant to ISRA, Spill Compensation Act or any other environmental law; all such costs and expenses resulting from Tenant's use of the Premises shall be Tenant's sole responsibility. 5. RENT PAYABLE During the Term, Tenant covenants and agrees to pay to Landlord, as rental for the Premises, the Annual Basic Rent and any and all Additional Rent in accordance with this Lease. 6. ANNUAL BASIC RENT 6.1 Effective as of the Commencement Date, and during the one (1) year Term hereof and the one (1) year renewal period should said option be exercised, Tenant shall pay to Landlord Annual Basic Rent in the amount of [$329,073.81]. The stated sum represents the base rates of: Level A: 9,124.38' sq. ft. @ $12.00 per GRSF = $109,492.56 Level B: 14,638.75' sq. ft. @ $15.00 per GRSF = $219.581.25 $329,073.81 and Tenant Electric at [$1.65] per GRSF of the Premises per annum less the Level A Computer Room. It should be noted that the Level A Computer Room shall be submetered and separately billed at rates currently in force by Jersey Central Power and Light Company (JCP&L). 6.2 Tenant covenants to pay all Annual Basic Rent and Additional Rent when due and payable, without any set-off, deduction, counterclaim, demand or previous notice whatsoever, except as may herein be specifically provided. Any monies paid or expenses incurred by Landlord to correct defaults in any of the Tenants obligations hereunder, after such notice to Tenant as required in this Lease, shall be payable to Landlord as Additional Rent. Any Additional Rent provided for in this Lease shall be paid together with the Annual Basic Rent, unless the same shall be required to be paid upon demand or as otherwise expressly stated in this Lease. Annual Basic Rent shall be paid or delivered to Landlord at the Landlord's Notice Address. 6.3 Receipt and acceptance by Landlord of any Annual Basic Rent, Additional Rent, and any other charge with knowledge of Tenant's default in any covenant or condition of this Lease shall not be deemed a waiver of such default. 6.4 The Tenant agrees that it will pay one-twelfth (1/12th) the Annual Basic Rent and Additional Rent as herein provided, promptly on the first day of each and every month in equal monthly installments, or as otherwise in this Lease required. Without waiving any of Landlord's other remedies for failure to pay Annual Basic Rent or Additional Rent as in this Lease contained, the Tenant agrees that any Annual Basic Rent or Additional Rent not paid within ten (10) days after such payment is due shall require payment by Tenant of (i) the delinquent Annual Basic Rent and/or Additional Rent; and (ii) payment of a late charge of 5 cents for each dollar of delinquent Annual Basic Rent or Additional Rent, if payment is not made within 5 days after notice is given of such non-payment by Tenant. 7. UTILITIES 7.1 Tenant shall be responsible at its sole cost and expense to pay for its use of utilities which may be separately metered to the Leased Premises (i.e., electricity for the Level A Computer Room raised floor area only). Utilities not separately metered shall be paid for by Tenant as part of Operating Expenses as hereinafter provided, including general purpose electricity, natural gas, domestic water and standby sprinkler charges, if any. Tenant shall pay for electricity consumed in the Premises at the rate stated in Section 6.1 hereof. 8. OPERATING EXPENSES 8.1 For all purposes hereof: (a) "Taxes" shall include all real estate taxes, assessments, sewer taxes and charges, and other governmental charges imposed upon the Property, or any governmental charges levied in substitution thereof. (b) If Landlord received a refund of Taxes for any calendar year during the Term, Landlord shall apply the refund against Operating Expenses after first deducting the reasonable cost and expenses incurred by Landlord in effecting the refund. If this Lease terminates before the end of the period for which the Operating Expenses so reduced apply, Tenant shall be paid a pro-rated portion of its share of such refund. (c) If at any time during the Term, the method or scope of taxation other than a tax based on Landlord's net income prevailing at the date of execution of this Lease shall be altered, modified or enlarged so as to cause the method of taxation to be changed, in whole or in part, so that in substitution for the Taxes, there may be a capital levy or other imposition based on the value of the Premises, or the rents received therefrom, or some other form of assessment based in whole or in part on some other valuation of the Landlord's real property including the Premises, then and in such event, such substituted tax or imposition shall be payable and discharged pro-rata, in accordance with the obligations set forth in this Article 8. Such substitute tax shall be computed as if the building where the only property owned by the Landlord. (d) No provision hereof shall be deemed to require Tenant to pay municipal, state or federal income, capital levy, estate, succession, inheritance, use, sales or corporate franchise taxes imposed upon Landlord. 8.2 For all purposes hereof: (A) "Operating Expenses" shall mean all expenses, including Taxes, incurred by Landlord in connection with the operation, maintenance, repair and replacement of and to the Property, during the lease year including, without limitation, (i) wages and fringe benefit payments to persons engaged in such operation, maintenance and repair; (ii) the cost of building and cleaning supplies and service and maintenance contracts with independent contractors; (iii) all charges for insurance coverage on the Property, including fire and casualty insurance in broad form, public liability insurance, casualty rent insurance and such other insurance reasonably required by Landlord or other parties having an insurable interest. Landlord reserves the right to adjust the amount of coverage from time to time as may be required to provide adequate coverage consistent with then existing economic conditions; and (iv) management fee costs not to exceed three (3%) percent of the gross Annual Basic Rent attributable to the Building. (B) Operating Expenses shall not include the following: (a) salaries or benefits for Landlord's executives and employees above the grade of building manager, and of any employee who does not devote substantially all of his time to the Building; b) to the extent such costs constitute capital costs under generally accepted accounting principles, the cost of replacement of HVAC, mechanical, security, electrical, plumbing systems, or of any substantial component or part of such systems beyond the scope of routine maintenance and repair; resurfacing of the parking area or of the driveways on the Project or any other cost which is capital in nature, provided if Landlord shall purchase any item of capital equipment or make any capital expenditure which has the effect of reducing the expenses which would be included in Operating Expenses, then the costs of such capital equipment or capital expenditure may be included in Operating Expenses if amortized over the useful life of the item on a straight line basis, but only to the extent of the reduction in each calendar year of cost which would otherwise be included in Operating Expenses, until the savings or reductions in Operating Expenses equal Landlord's costs for such capital expenditure. If Landlord shall lease any items of capital equipment which results in savings or reductions in expenses which would otherwise be included in Operating Expenses, then the rentals and other costs paid pursuant to such leasing shall be included in Operating Expenses for the calendar year in which they were incurred, but only to the extent of the reduction which would otherwise be included in Operating Expenses; (c) expenditures for which Landlord is reimbursed from any insurance carrier, or any other source; (d) cost of repairs or replacements incurred by reason of fire or other casualty or condemnation; (e) advertising and promotional expenditures; (f) cost incurred in performing work or furnishing services for any tenant (including Tenant), whether at such tenant's or Landlord's expense, to the extent that such work or service is in excess of any work or service that Landlord is obligated to furnish to Tenant at Landlord's expense; (g) depreciation, except as provided above; (h) bad debt loss, rent loss, or reserves for either of them; (i) Snow Removal (which shall be assessed as incurred based on Tenant's Proportionate Share); j) the cost of electricity furnished to any particular tenant and paid for by such tenant; (k) financing costs, including points, commitment fees, broker's fees, legal fees, and mortgage interest and amortization payments; (l) costs incurred in connection with the construction of the Building or the initial development of the Project; (m) costs, expenses or expenditures relating to the duties, liabilities or obligations of other tenants in the Project; (n) any costs incurred by Landlord arising out of its failure to perform or breach of any of its covenants, agreements, representations, warranties, guarantees or indemnities made for the benefit of Tenant under this lease; (o) legal fees, space planner's fees, broker's commissions and other costs incurred by Landlord in connection with leasing space and negotiating leases with tenants of the Project, or legal fees in connection with disputes between Landlord and any tenant of the Project, or between Landlord and any mortgagee; (p) lease payments for rented equipment, the cost of which equipment constitutes a capital expenditure if the equipment were purchased; and any late fees, penalties, interest charges or similar fees incurred by Landlord; (q) costs of improving, altering, constructing or redecorating any space leased to tenants of the Building; (r) any cost representing an amount paid to a person, firm, corporation, or other entity related to Landlord which is in excess of the amount which would have been paid in the absence of such relationship; (s) costs incurred by Landlord to remedy any defects in the design of or materials used in, or the defective installation of the structural steel framing, roof, foundation and underground utility lines forming a part of or servicing the Building or the Project; (t) costs associated with the operation of the business of the entity which constitutes Landlord as the same are distinguished from the costs of operation of the Project, including, without limitation, accounting and legal expenses, costs of selling, syndicating, financing, mortgaging or hypothecating Landlord's interest in the Building, costs of any disputes between Landlord and its employees, building managers, or other tenants; (u) amounts paid as ground rental; (v) any changes or improvements the Landlord is required o make due to changes in applicable law, or on account of any environmental cleanup not caused by Tenant; (w) expenses for vacant space, including utilities and security, should the building be less than eighty-five (85%) percent tenanted; and (x) any expenses incurred by Landlord in connection with providing cafeteria service to Tenant. Tenant pays for this service on the basis of the number of employees in its employ. (C) "Operational Year" shall mean each calendar year during the Term. 8.3 (i) The Landlord shall make a reasonable estimate of the Operating Expenses for each Operational Year, and Tenant shall pay as Additional Rent Tenant's Proportionate Share of Operating Expenses in twelve (12) equal monthly installments beginning in January of the Operational Year in question, except for the first Operational Year when Tenant shall pay its pro-rata share of such expenses beginning on the Commencement Date. Tenant shall have the right, upon reasonable notice, during business hours to review the business records applicable to the Operating Expenses and to copy any invoices or other billings or documents applicable thereto which copies shall be made at Tenant's cost and expense. (ii) At the end of each calendar year, Landlord will furnish to Tenant a statement of actual Operating Expenses for the Operational Year just elapsed and the parties shall adjust in a single payment from the Tenant or the Landlord, as the case may be, any difference between the estimated and actual Operating Expenses. (iii) Any required payment to Landlord or Tenant as applicable shall be made within thirty (30) days after Landlord furnishes the required statement of actual Operating Expenses. 8.4 Every statement forwarded by Landlord to Tenant pursuant to this Article 8 shall be binding upon Tenant unless, within thirty (30) days after the receipt of such statement, Tenant notifies Landlord, in writing in detail, of Tenant's objections thereto. Any unresolved dispute as to such statement shall be determined as per clause 55. 8.5 If the last year of the Term ends on any day other than the last day of a calendar year, any payment due to Landlord or to Tenant by reason of any increase or decrease in Operating Expenses shall be pro-rated on the basis of a 365 day year by computing Operating Costs for the entire year and then prorating such amount for the number of days this Lease was in effect during such year. Notwithstanding the termination of this Lease, and within ten (10) days after receipt of Landlord's statement regarding the determination of the Operating Costs for the calendar year in which this Lease terminates, Tenant shall pay to Landlord or Landlord shall pay to Tenant, as the case may be, an amount equal to the difference between Tenant's Proportionate Share of the increases in Operating Costs for such year (as prorated) and the amount previously paid by Tenant toward such increases. This covenant shall survive the expiration or termination of this lease. 9. LEASEHOLD IMPROVEMENTS 9.1 Tenant to take space "as is" and shall at its cost, construct its leasehold improvements. The above notwithstanding, Landlord has in accordance with specific agreement with Tenant, made certain modifications to the demised space at no cost to Tenant. Landlord further warrants that modifications which were made for the previous Tenant and which continue to exist were made in accordance with Federal and Local code provisions and that a Certificate of Occupancy was duly tendered by the Borough of New Providence. Tenant, has been in possession of the demised space under a sub-lease since May 1, 1995 and hereby affirms that the space as defined under Clause 1 of this Lease was tendered in satisfactory condition. 9.2 Tenant acknowledges that except as herein otherwise expressly provided, neither Landlord nor any agent of Landlord has made any representation or warranty with respect to the Premises or the Building or with respect to the suitability of either for the conduct of Tenant's business, nor has Landlord agreed to undertake any modification, alteration or improvement to the Premises except as indicated above. The taking of possession of the Premises by Tenant shall conclusively establish that the Premises and the Building were at such time in satisfactory condition. 9.3 (a) Tenant shall not do nor permit anything to be done in or about the Premises nor bring or keep anything therein which will in any way increase the existing rate or affect any fire or other insurance upon the Building or any of its contents, or cause a cancellation of any insurance policy covering said Building or any part thereof or any of its contents, nor shall Tenant sell or permit to be kept, used or sold in or about said Premises any articles which may be prohibited by standard form policy of fire insurance. (b) Tenant shall not do or permit anything to be done in or about the Premises which will in any way obstruct or interfere with the rights of other tenants or occupants of the Building, or injure or annoy them, or use or allow the Premises to be used for an unlawful purpose, nor shall Tenant cause, maintain or permit any nuisance in or about the Premises. Tenant shall not commit or suffer to be committed any waste in or upon the Premises. Tenant shall not bring onto the Premises any apparatus, equipment or supplies that may overload the Premises or the Building or any utility or elevator systems or jeopardize the structural integrity of the Building or any part thereof. (c) Tenant shall not use the Premises or permit anything to be done in or about the Premises which will in any way conflict with, and at its sole cost and expense shall promptly comply with, any Legal Requirement now in force or which may hereafter be enacted or promulgated relating to the condition, use or occupancy of the Premises, excluding structural changes. The judgment of any court of competent jurisdiction or the admission of Tenant in any action against Tenant, whether Landlord be a party thereto or not, that Tenant has violated any Legal Requirement, shall be inclusive of the fact as between Landlord and Tenant. 9.4 In the event Tenant shall require any work in addition to Landlord's work, it shall advise Landlord of such requirement and Landlord shall submit in writing to Tenant the extra cost of such additional work, together with the details of the scope of such work to be performed ("Extra Tenant Work"). In the event Tenant requests Extra Tenant Work, it shall pay the cost thereof to Landlord within fifteen (15) days after written requisition thereof and certification by Landlord's architect that the Extra Tenant Work has been completed as required. 9.5 Landlord covenants and agrees that all Landlord's Work shall be performed in a good and workmanlike manner and in accordance with all applicable laws and regulations. 9.6 The Premises shall be deemed Ready for Occupancy upon the Commencement Date. 10. REPAIRS AND MAINTENANCE 10.1 During the Term, the Landlord, as part of Operating Expenses (except as may be otherwise herein provided), shall keep in good order, safe condition and repair, the structural parts of the Building, including the walls, roof, concrete floor, foundation and structural steel, together with plumbing, utility lines and facilities serving the Premises, except for repairs or maintenance occasioned by the negligence or deliberate act of Tenant or its agents, servants, employees and invitees, which shall be then repaired by Landlord at the cost and expense of the Tenant. (Capital expenditures as previously covered in Clause 8 above remain as Landlord's sole expense and obligation). Repairs caused, occasioned by other tenant's in the Building shall be charged to said tenant's account and not made part of these operating expenses. 10.2 The Landlord shall as part of Operating Expenses take good care of and maintain and repair the lawns, shrubbery, driveway, sidewalks, entranceways, foyers, curbs and parking area on the Property. The Landlord shall provide snow removal, the payment being covered as per clause 8.2 (B) (i). 10.3 Tenant agrees to keep the Premises in as good repair as they are at the beginning of the Term, reasonable use and wear thereof and damage by fire or other casualty excepted. Tenant further agrees not to damage, overload, deface or commit waste of the Premises. Subject to the provisions of Section 12.4 hereof, Tenant shall be responsible for all damage of any kind or character to the Premises caused by Tenant or Tenant's employees, agents or invitees in excess of ordinary wear and tear, including the windows, glass, floors, walls and ceilings, caused by Tenant or by anyone using or occupying the Premises by, through or under Tenant. Landlord shall repair the same, and Tenant agrees to pay the costs incurred therefor to Landlord upon demand to the extent that those costs are not covered by warranty. Anything hereinabove contained to the contrary notwithstanding, it is expressly understood and agreed that the Tenant shall, at its sole cost and expense, be responsible for the repair, maintenance and replacement of any items installed by Landlord for Tenant's use as leasehold improvements that do not constitute part of the realty. 10.4 Anything hereinabove contained to the contrary notwithstanding, Landlord shall upon due notification and at Tenants cost and expense, replace all light bulbs, fluorescent fixtures and ballasts after their initial installation by Landlord. 11. JANITORIAL SERVICES Landlord shall furnish janitorial services and garbage disposal, for the Building and Premises the cost of which shall be included as part of Operating Expenses (See Exhibit "F"). Landlord shall comply with all laws in the disposal of recyclable materials. 12. INSURANCE 12.1 Tenant shall, at all times during the term of this Lease, and at its own cost and expense, procure and continue in force the following insurance coverage: (a) Commercial General Liability Insurance with a combined single limit for personal or bodily injury and property damage of not less than $2,000,000 or such other level of coverage that Landlord may require in its commercially reasonable judgment, with at least a $1,000,000 umbrella. (b) Fire and Extended Coverage Insurance, including vandalism and malicious mischief coverage, covering and in an amount equal to the full replacement value of all fixtures, furniture and improvements installed in the Premises by or at the expense of Tenant. 12.2 The aforementioned minimum limits of policies shall in no event limit the liability of Tenant hereunder. The aforesaid insurance shall name Landlord as an additional insured. Said insurance shall be with companies having a rating of not less than A+, XI in "Best Insurance Guide". Tenant shall furnish from the insurance companies or cause the insurance companies to furnish certificates of coverage. No such policy shall be cancelable or subject reduction of coverage or other modification or cancellation except after thirty (30) days prior written notice to Landlord by the insurer except only ten (10) days notice shall be required in the event of non-payment of premium. All such policies shall be written as primary policies, not contributing with and not in excess of the coverage which Landlord may carry. Tenant shall, at least twenty (20) days prior to the expiration of such policies, furnish Landlord with evidence of renewals or binders. Tenant agrees that if Tenant does not take out and maintain such insurance, Landlord may (but shall not be required to) procure said insurance on Tenant's behalf and charge Tenant the premiums together with a reasonable handling charge and Interest from the date paid by Landlord, payable upon demand. Tenant shall have the right to provide such insurance coverage pursuant to blanket policies obtained by Tenant, provided such blanket policies expressly afford coverage to the Premises and to Tenant as required by this Lease. 12.3 During the term of this Lease Landlord shall maintain in effect: (A) Insurance on the Building against fire, extended coverage perils and vandalism and malicious mischief (to the extent such Overages are available), with responsible insurers licensed to do business in New Jersey insuring the Building in an equal amount to at least ninety-five percent (95%) of the replacement cost thereof, excluding foundations, footings and underground installations; (B) Commercial general liability insurance in limits of not less than $3,000,000. Landlord may, but shall not be obligated to, carry insurance against additional perils and/or in greater amounts. 12.4 To the extent permitted by their respective policies of insurance, Landlord and Tenant each hereby waive any right of recovery against the other and the authorized representatives of the other for any loss or damage that is covered by any policy of insurance maintained by either party with respect to the Premises or the Complex or any operation therein. Each party shall obtain from its insurer under each policy a waiver of all right of recovery by way of subrogation against the other party in connection with any claim, loss or damage covered by such policy. 13. SIGNS Subject to Landlord's prior written consent, which shall not be unreasonably withheld, Tenant shall have the right to be listed on the interior sign tablet of the building lobby, expressly subject to the following terms and conditions: (1) The location of the Landlord's sign tablet shall be established by Landlord. (2) Tenant shall have the right to install signage on its entrance door(s) comparable to other signage in the building. (3) The cost of installation of Tenant's sign and the cost of maintenance of the sign tablet shall be at Tenants sole cost and expense. (4) Tenant shall not erect roof signs. (5) Any such signage shall be used only to identify the name of Tenant. 14. FIXTURES 14.1 The Tenant is given the right and privilege of installing and removing its property, equipment and fixtures in the Premises during the Term. However, if prior to the expiration, of this Lease, Tenant is in default and moves out, or is dispossessed, and fails to remove any property, equipment and fixtures or other property within thirty (30) days after such, dispossess or removal, then and in that event, the said property, equipment and fixtures or other property shall be deemed at the option of the Landlord to be abandoned; or in lieu thereof, at Landlord's option, Landlord may remove such property and charge the reasonable cost and expense of removal and storage to Tenant. The terms and conditions hereof are expressly subject to the terms and conditions of Article 27 hereof with respect to the subsequent Alterations to the Premises. 14.2 Except as otherwise expressly provided for in this Lease, it is expressly understood and agreed that Tenant may install, connect and operate equipment as may be deemed necessary by Tenant for its business, subject to compliance with applicable rules and regulations of government boards and bureaus having jurisdiction thereof. Subject to the terms and conditions of this Lease, the movable machinery, trade fixtures and equipment belonging to the Tenant shall at all times be considered and intended to be personal property of the Tenant, and not part of the Property, and subject to removal by the Tenant, provided that the Tenant, at its own cost and expense, pays for any damage to the Premises caused by such removal. 15. GLASS The Landlord expressly covenants and agrees to replace any broken glass (with same type and quality) in the windows or other apertures of the Premises which may become damaged or destroyed at its cost and expense except if such damage is occasioned by the Tenant, its agents, servants or employees. 16. ASSIGNMENT AND SUBLETTING 16.1 Subject to Section 16.4 the Tenant may not assign this lease or sublet the leased premises or a portion thereof, unless it shall first advise the Landlord in writing, by hand, reputable overnight courier or by certified mail, return receipt requested, of its intention to assign or sublease. In such event, the Landlord shall have ten (10) days from receipt of such notice to elect to re-capture the premises or the portion thereof that Tenant wishes to sublet, and terminate the within lease or to consent to the assignment of the lease or the sublease of the premises, which consent shall not be unreasonably withheld, provided the proposed assignee or sub-tenant is financially responsible, and in the case of an assignment, shall assume in writing the terms and conditions of the within lease on the part of the Tenant to be performed, failure of which shall be cause for Landlord to reject the assignment. 16.2 If Landlord elects to recapture the leased premises, Tenant shall surrender the leased premises ninety (90) days after Landlord's written notice of its election to recapture, and this Lease shall terminate as if the last day of the Term had occurred. 16.3 In connection with any permitted assignment or subletting (subject to compliance with this Article 16.3 and Article 16.5), the Tenant covenants and agrees that: (i) the Tenant shall pay monthly to the Landlord 50% of any increment in rent received by Tenant per square foot per annum over the annual rent then in effect during the year of assignment or subletting, which payment shall be made monthly together with the required rental payment to be paid pursuant to Article 6 and (ii) if Tenant receives any consideration or value for such assignment or subletting, Landlord shall be paid 50% of any such consideration or value within ten (10) days after receipt of same by Tenant. As a condition hereunder, Tenant warrants and represents to Landlord that it will furnish to Landlord a copy of all pertinent documents with respect to any such assignment or subletting so as to establish Tenant's obligation to Landlord hereunder. 16.4 The Landlord's consent shall not be required and the terms and conditions of Article 16.1 and 16.3 shall not apply as to Landlord's right to recapture if the Tenant assigns this lease or subleases the premises to a parent, subsidiary, affiliate or a company into which Tenant is merged or with which Tenant is consolidated, or to the purchaser of all of the assets of or a majority of shares of stock in Tenant, provided however that there shall be no change in use of the premises. 16.5 In the event of any permitted assignment or subletting the Tenant shall remain and be directly and primarily responsible for payment and performance of the within lease obligations, and the Landlord reserves the right, at all times, to require and demand that the Tenant pay and perform the terms and conditions of this lease. No such assignment or subletting shall be made to any assignee or subtenant who shall occupy the premises for any use other than that which is permitted to the Tenant, or for any use which may be deemed extra hazardous, or which would in any way materially violate applicable laws, ordinance or rules and regulations of governmental boards and bodies having jurisdiction. 17. FIRE AND CASUALTY 17.1 Within fifteen (15) days from the date of any fire or casualty including, without limitation, a force majeure type of event that renders the Premises untenantable, the Tenant to give Landlord notice of any fire or other casualty, Landlord shall obtain from its Architect, or if its Architect shall not be in existence from any AIA architect of reputation in the office-industrial building field, a certification certifying in his opinion the time within which the building can be restored and constructed under standard construction conditions (hereinafter called the "Restoration Time"). Landlord shall promptly deliver such certification to the Tenant (hereinafter referred to as "Landlord's Notice"), and in the event the damage be so substantial that the Building cannot be restored within one hundred twenty(120) days from the date of such fire or casualty based on the certified Restoration Time hereinabove referred to, then in that event the Tenant shall have the right within thirty (30) days after receipt of such notice to advise Landlord that it elects to terminate the Lease. Except as provided in Section 17.2 hereof, nothing herein contained, however, shall obligate the Landlord in any event to restore the Premises and Landlord shall have the right to terminate the Lease at its sole election in the event the Premises cannot be restored within the one hundred twenty (120) day period. In the event Landlord or Tenant so elects then tenant shall surrender the Premises forthwith, provided that Tenant shall continue to pay pro-rata Annual Basic Rent and Additional Rent for any portion of the Premises which it continues to occupy and conduct business pending such surrender of the Premises. Rent shall abate from the date of casualty or damage with respect to that portion of the Premises the Tenant cannot occupy for its business purposes until the Premises is restored. 17.2 In the event such damage or casualty can be restored within 120 days then, Landlord shall diligently repair and restore the Premises, Building and improvements within the Restoration Time and during such Restoration Time Annual Basic Rent and Additional Rent shall abate proportionately from the date of such damage or casualty during the period of reconstruction for any portion of the Premises which Tenant cannot occupy. 17.3. In the event of such fire or casualty as above provided, the tenant agrees, at its cost and expense, to forthwith remove any and all of its equipment, fixtures, stock and personal property as the same may be required to permit Landlord to expedite rebuilding and/or repair. In any event, the Tenant shall assume at its sole risk the responsibility for damage or security with respect to such fixtures and equipment in the event the area where the same may be located has been damaged, until the Building shall be restored and made secure. 18. COMPLIANCE WITH LAWS, RULES AND REGULATIONS 18.1 The Landlord represents that as of the Commencement Date and throughout the Term, the Property shall be in good repair and condition and that there will be substantial and material compliance with all statutes, rules, ordinances, orders, regulations and requirements of the Federal, State, County and City Government including without limitation, all environmental laws, including those referenced in Section 4 hereof, and any and all of their departments and bureaus applicable to Tenant's use of the Premises and Building, and also to all rules, orders and regulations of the Board of Fire Underwriters, or its local equivalent. Landlord shall keep, defend, save and hold harmless the Tenant for any and all damages and liability arising from the violation of the above representation by Landlord, any previous owners of the Property, and any tenant (past or present) (other than Tenant) on the Property. 18.2 (i) Provided there is no abrogation of that which is stipulated in 18.1 above, in which case Landlord shall remain responsible, the Tenant covenants and agrees that it will, during the Lease Term, promptly, at Tenant's cost and expense, execute and comply with all statutes, ordinances, rules, orders, regulations and requirements of the Federal, State, County and City Government and of any and all their departments and bureaus, applicable to the Premises. (ii) Provided there is no abrogation of that which is stipulated in 18.1 above, in which case Landlord shall remain responsible, the Tenant covenants and agrees, at its own cost and expense, to comply with such regulations or requests as may be reasonably required by all fire or liability insurance carriers providing insurance for the Premises, and will further comply with such other requirements that may be promulgated by the Board of Fire Underwriters, in connection with Tenant's use and occupancy of the Premises in the conduct of its business. Tenant reserves the right, at its cost and expense, to contest any of the foregoing, provided that it will indemnify, defend and save Landlord harmless from any fine, penalty, imposition of lien as may be occasioned by such contest. 18.3 In case the Tenant shall fail or neglect to comply with the aforesaid statutes, ordinances, rules, orders, regulations and requirements or any of them, or in case the Tenant shall neglect or fail to make any necessary repairs, then the Landlord or the Landlord's agents (without any obligation upon the Landlord so to do) may after thirty (30) days' written notice from Landlord to Tenant, except for emergency repairs which may be made immediately after notice, enter said Premises (subject to Tenant's reasonable security and safety requirements) and make said repairs and comply with any and all of the said statutes, ordinances, rules, orders, regulations or requirements, at the cost and expense of the Tenant and in case of the Tenant's failure to pay therefor, the said cost and expense shall be added to the next month's Annual Basic Rent and be due and payable by Tenant. This provision is in addition to the right of the Landlord to terminate this Lease by reason of any default on the part of the Tenant, subject to the rights of the Tenant as hereinabove mentioned in the manner as in this Lease otherwise provided. 19. COVENANT AGAINST LIENS Tenant agrees that it shall not encumber the Premises or the Lease by any lien, charge or encumbrance. The violations of this Article shall be considered a default by Tenant unless the Tenant removes the lien or bonds it within thirty (30) days after Tenant receives notice of the lien. After notice to Tenant, Landlord shall have, in addition to all other remedies provided herein and by law, the right, but no obligation, to cause the same to be released by such means as it shall deem proper, including payment of the claim giving rise to such lien. All such sums paid by Landlord and all expenses incurred by it in connection therewith, including attorneys' fees and costs, shall be payable to Landlord by Tenant on demand with interest until paid. Landlord shall have the right at all times to post and keep posted on the Premises any notices permitted or required by law, or which Landlord shall deem proper, for the protection of Landlord and the Premises, and any other party having an interest therein, from mechanics' and materialmen's liens. 20. QUIET ENJOYMENT The Landlord further covenants that the Tenant, on paying the Annual Basic Rent and Additional Rent and performing the covenants and conditions contained in this Lease, shall and may peaceably and quietly have, hold and enjoy the Premises for the Term aforesaid. 21. INDEMNITY 21.1 (a) Tenant agrees to indemnify Landlord against and save Landlord harmless from any and all loss, cost, penalties, fines and reasonable attorneys' fees and disbursements not covered by Landlords insurance, arising from (i) any default or breach by Tenant in the observance or performance of any of the material terms, covenants or conditions of this Lease by Tenant or (ii) any negligence or willful misconduct of Tenant, its agents, servants, employees invitees or licensees of Tenant in, on, or about the Premises, or any part of the Complex during the Term of this Lease. The obligation of Tenant hereunder shall not be deemed a waiver of subrogation to be obtained as hereinbefore provided in Article 12.2. (b) Landlord agrees to indemnify Tenant against and save Tenant harmless from any and all loss, cost liability, damage, and expense, including without limitation penalties, fines and reasonable attorneys' fees and disbursements, incurred in connection with or arising from (i) any default or breach by Landlord in the observance of the material terms, covenants, or conditions of this Lease by the Landlord, or (ii) any negligence or willful misconduct of Landlord, or its contractors, agents, servants, employees, invitees, or licensees in, on, or about the Premises, or any part of the Complex during the Term of this Lease. (c) Notwithstanding the foregoing, and in no event (except for Landlord's or Tenant's negligence or willful misconduct, unless expressly defined in this Lease) shall Landlord or Tenant be liable for indirect or consequential damages of the other (including lost profits) however occurring. 21.2 Except for Landlord's negligence or willful misconduct, Landlord shall not be liable for injury or damage which may be sustained by the person or property of Tenant, its employees, invitees or customers, or any other person in or about the Premises caused by or resulting from fire, steam, electricity, gas, water or rain, which may leak or flow from or into any part of the Premises, or from the breakage, leakage, obstruction or other defects of the pipes, sprinklers, wires, appliances, plumbing, air conditioning, telephone cabling or wiring, or lighting fixtures of the same, whether the damage or injury results from conditions arising upon the Premises or upon other portions of the Building of which the Premises are a part, or from other sources. Neither Landlord or Tenant shall be liable for any damages arising from any act or neglect of any other tenant of the Building. 22. DEFAULT BY TENANT 22.1 Each of the following shall be deemed a default by Tenant and breach of this Lease: (1) (i) filing of a petition by the Tenant for adjudication as a bankrupt, or for reorganization, or for any arrangement under any federal or state insolvency, bankruptcy or similar statute, provided that filing of a petition against Tenant by other parties with respect to bankruptcy, insolvency, or otherwise, will be a breach only if the proceedings are not stayed or dismissed within six (6) months, provided that Annual Basic Rent and Additional Rent are being paid during said six (6) month period; (ii) voluntary dissolution of liquidation of the Tenant, except pursuant to corporate reorganization; (iii) appointment of a permanent receiver or a permanent trustee of all or substantially all the property of the Tenant providing the receiver or trustee is not dismissed within six (6) months. (iv) taking possession of the property of the Tenant by a government officer or agency pursuant to statutory authority for dissolution, rehabilitation, reorganization or liquidation of the Tenant. (v) making by the Tenant of an assignment for the benefit of creditors. If any event mentioned in this subdivision (1) shall occur, Landlord may thereupon or at any time thereafter elect to cancel this Lease by ten (10) days' notice to the Tenant, and this Lease shall terminate on the day in such notice specified with the same force and effect as if that date were the date herein fixed for the expiration of the Term of the Lease. (2) (i) Default in the payment of the Annual Basic Rent or Additional Rent herein reserved or any part thereof for a period for ten (10) days after written notice to Tenant that same is due and payable. (ii) A default in the performance of any other covenant or condition of this Lease on the part of the Tenant to be performed for a period of twenty (20) days after written notice. For purposes of this subdivision (2) (ii) hereof, no default on the part of Tenant in performance of any covenants or obligations on the part of Tenant to be performed in accordance with the terms and conditions of this Lease shall be deemed to exist if steps shall have been commenced by Tenant within the twenty (20) day notice period after notice to rectify the same and shall be prosecuted to completion with reasonable diligence, subject, however, to unavoidable delays. 22.2 In case of any such default under Article 22.1 (2) and at any time thereafter following the expiration of the respective grace periods above mentioned, Landlord may serve a notice upon the Tenant electing to terminate this Lease upon a specified date not less than three (3) days after the date of serving such notice, provided such notice advises Tenant that the default may be cured within the said three (3) day period. This Lease shall then expire on the date so specified as if that date has originally fixed as the expiration date of the Term herein granted, provided a default under Article 22.1 (2) hereof shall be deemed waived if such default is made good or cured before the date specified for termination in the notice of termination served on Tenant. 22.3 In case this Lease shall be lawfully terminated as hereinbefore provided, or by summary proceedings or otherwise, Landlord or its agents may, immediately or any time thereafter, re-enter and resume possession of the Premises or such part thereof, and remove all persons and property therefrom, either by summary proceedings or by a suitable action or proceeding at law, without being liable for any damages therefor. No re-entry by Landlord shall be deemed an acceptance of a surrender of this Lease. 22.4 In case this Lease shall be terminated as hereinafter provided, or by summary proceedings or otherwise, Landlord shall use its best efforts, in its own name and in its own behalf, to relet the whole or any portion of the Premises, for any period equal to or greater or less than the remainder of the then current Term, for any sum which is commercially reasonable, to any tenant which it may deem suitable and satisfactory, and for any use and purpose which it may deem appropriate, and in connection with any such Lease Landlord may make such changes in the character of the improvements on the Premises as Landlord may determine to be appropriate or helpful in effecting such lease and may grant commercially reasonable concessions or free rent. Landlord agrees that it shall undertake reasonable steps to mitigate Tenant's damages hereunder. Landlord shall not in any event be required to pay Tenant any surplus of any sums received by Landlord on a reletting of the Premises in excess of the Annual Basic Rent reserved in this lease, but all said sums shall be credited toward Tenant's obligations occasioned pursuant to this Article 22. 22.5 (1) In case this Lease be terminated by summary proceedings or otherwise as provided in this Article 22, and whether or not the Premises be relet, Landlord shall be entitled to recover from the Tenant, the following: (i) a sum equal to all reasonable expenses, if any, including reasonable counsel fees, incurred by Landlord in recovering possession of the Premises, and all reasonable costs and charges for the care of said Premises while vacant, which damages shall be due and payable by Tenant to Landlord at such time or times as such shall have been incurred by Landlord; (ii) a sum equal to all damages set forth in this Article 22 and in Article 23 hereinafter referred to; and (iii) such other relief as the law may allow. (2) Separate actions may be maintained by Landlord against Tenant from time to time to recover any damages which, at the commencement of any such action, have then or theretofore become due and payable to the Landlord under this Article 22 and subsections hereof without waiting until the end of the then current Term, including such action for anticipatory breach or such other remedies available to Landlord in law or in equity. Any action taken by Landlord hereunder shall not be deemed a waiver of any other right or remedy which Landlord may have in law or in equity. (3) All sums which Tenant has agreed to pay by way of taxes, sewer charges, water rents or water meter charges, insurance premiums and other similar items becoming due from time to time under the terms of this Lease shall be deemed Additional Rent reserved in this Lease within the meaning of this Article 22 and subsections hereof. 23. LIABILITY OF TENANT FOR DEFICIENCY In addition to Landlord's rights heretofore provided in Article 22, in the event that the relation of the Landlord and Tenant may cease or terminate by reason of the default by the Tenant and the reentry of the Landlord as permitted by the terms and conditions contained in this Lease or by the ejectment of the Tenant by summary proceedings or other judicial proceedings, it is hereby agreed that the Tenant shall remain liable to pay in monthly payments the Annual Basic Rent and Additional Rent which shall accrue subsequent to the reentry by the Landlord, and the Tenant expressly agrees to pay as damages for the breach of the covenants herein contained the difference between the Annual Basic Rent and Additional Rent reserved and the then Fair Market Rental Value of the Premises or actual rent collected and received, if any, by the Landlord, during the remainder of the unexpired Term, as the amount of such difference or deficiency shall from time to time be ascertained. 24. LANDLORD'S REMEDIES 24.1. The rights and remedies given to the Landlord in this Lease are distinct, separate and cumulative remedies, and no one of them, whether or not exercised by the Landlord, shall be deemed to be in exclusion of any of the others. 24.2 In addition to any other legal remedies for violation or breach by or on the part of the Tenant or by any undertenant or by anyone holding or claiming under the Tenant or any one of them, of the restrictions, agreements or covenants of this Lease on the part of the Tenant to be performed or fulfilled, such violation or breach shall be restrainable by injunction at the suit of the Landlord. 24.3. No receipt of money by the Landlord from any receiver, trustee or custodian or debtors in possession shall reinstate, continue or extend the Term of this Lease or affect any notice theretofore given to the Tenant, or to any such receiver, trustee, custodian or debtor in possession, or operate as waiver or estoppel of the right of the Landlord to recover possession of the Premises for any of the causes therein enumerated by any lawful remedy; and the failure of the Landlord to enforce any covenant or condition by reason of its breach by the Tenant shall not be deemed to void or affect the right of the Landlord to enforce the same covenant or condition on the occasion of any subsequent default or breach. 25. NOTICES All notices required or permitted to be given to the Landlord or Tenant shall be given by certified mail, return receipt requested, or by reputable overnight courier or via facsimile if confirmed within ten (10) days by receipt f hardcopy at the Notice Address, and/or such other place as the Landlord or Tenant may designate in writing, and shall be deemed given upon the date of delivery as evidenced by the postal receipt or facsimile confirmation slip. 26. NON-WAIVER The failure of a party to insist upon strict performance of any of the covenants or conditions of this Lease, or to exercise any option of such party herein conferred in any one or more instances, shall not be construed as a waiver by such party of any of its rights or remedies in this Lease, and shall not be construed as a waiver, relinquishment or failure of any such covenants, conditions, or options, but the same shall be and remain in full force and effect. Any waiver, relinquishment or failure by a party to insist upon strict performance of any of the covenants or conditions of this Lease shall also not operate as a waiver of any past breaches. 27. RIGHT OF TENANT TO MAKE ALTERATIONS AND IMPROVEMENTS 27.1 The Landlord and Tenant agree that Tenant shall not have the right to make any alterations, additions or improvements (all hereinafter referred to as "Alterations") to the Premises during the term of the Lease, except with the express prior written consent of the Landlord, which consent Landlord shall not unreasonably withhold or delay. 27.2 If Landlord consents to Tenant's request to make alterations, additions or improvements to the Premises, Landlord shall inform Tenant at the time of its approval whether Landlord will require the requested improvements to be removed at the end of the Term, and, it is understood and agreed that the same shall be construed in accordance with the following express terms and conditions: (i) Tenant shall submit to Landlord for prior approval copies of its proposed plans in connection with the work to be performed, the approval of which plans shall not be unreasonably withheld or delayed by Landlord, provided that the structural integrity of the Premises shall not be materially lessened by reason thereof, nor the Building systems be impaired; (ii) such work shall be installed and completed in a good and workmanlike manner in compliance with all applicable laws, rules, regulations and ordinances, and the specifications for such work shall equal or exceed the specifications for the original construction of the improvements under this Lease, taking into consideration any changes in construction practices and technology which may exist at the time of the Alterations; (iii) Tenant shall have procured and paid for all permits and licenses required in connection therewith; and (iv) during the period when the Alterations are being made, Tenant shall maintain or require its contractors to maintain public liability insurance with respect to any Alterations in the minimum amount ONE MILLION ($1,000,000.00) DOLLARS per occurrence. 27.3 Notwithstanding the provisions of Section 27.1 hereof, Tenant may make Non-Structural Tenant Alterations (hereinafter defined) to the Premises without the prior written consent of Landlord, provided Tenant complies with Articles 27.2 (ii) through (iv). For the purposes of this Article 27.2, Non-Structural Tenant Alterations shall be deemed to be any work which (i) does not affect or alter the outside appearance, or the strength of the Building including the foundation, the roof, and the columns and beams (ii) would not require Tenant interference with primary Building systems and core areas of the Building, and (iii) would not impair or diminish existing Building systems or equipment, including but not limited to HVAC, electrical, structural, plumbing or other systems. 27.4 Landlord conditions its consent to the Tenant Alterations on Tenant, at the end of the Term or earlier termination of this Lease, either (i) restoring the Premises to its condition immediately prior to the work, or (ii) paying for the cost of restoration as reasonably estimated by Landlord. Landlord shall not require restoration for any Tenant Alterations unless such work materially diminishes the value of the Premises. It shall be Tenant's option whether it shall perform the work pursuant to clause (i) hereof or pay the Landlord the estimated cost of same pursuant to clause (ii) hereof. 27.5 Tenant shall have no obligation for any restoration or removal under any of the following circumstances: (i) any Non-Structural Tenant Alteration or; (ii) any work performed by Landlord or Tenant prior to the Commencement Date; or (iii) if Landlord does not require removal at the time it approves Tenant's plans. 27.6 Tenant may, at its own cost and expense, without Landlord's consent, install, replace or remove any fixtures, trade fixtures, machinery, and equipment (all hereinafter referred to as "Trade Fixtures"). Any such Trade Fixtures shall not become the property of Landlord other than replacement of Trade Fixtures which were the property of, and were originally installed by Landlord. Tenant shall, at the Lease Expiration Date, remove all, or any part of such Trade Fixtures and repair any damage occasioned by such removal. 27.7 Nothing herein contained shall be construed as a consent on the part of the Landlord to subject the estate of the Landlord to liability under the Mechanic's Lien Law of the State of New Jersey, it being expressly understood that the Landlord's estate shall not be subject to such liability. 28. WARRANTY OF TITLE Landlord represents that it has good and marketable fee simple title to the Premises which are the subject of this Lease, and that it has the full right, capacity and authority to enter into the within Lease agreement. 29. EASEMENTS Without any obligation on the part of the Landlord so to do, Landlord reserves the right, easement and privilege to enter on the Premises in order to install, at its own cost and expense, any storm drains and sewers and/or utility lines or service in connection therewith as may be required by the Landlord in connection with service of the Premises. It is understood and agreed that if such work as may be required by Landlord requires an installation which may displace any paving, lawn, seeded area or shrubs, the Landlord, shall, at its own cost and expense, as condition of Landlord's rights hereunder, restore said paving, lawn seeded area or shrubs. The Landlord covenants that the foregoing work shall not interfere with the normal operation of Tenant's business. 30. AIR, WATER, TOXIC WASTE AND GROUND POLLUTION 30.1 The Tenant expressly covenants and agrees to indemnify, defend, and save the Landlord harmless against any claim, damage, liability, costs, penalties, or fines which the Landlord may suffer as a result of air, water, topic waste or ground pollution caused by the Tenant in its use of the Premises during the term. The Tenant covenants and agrees to notify the Landlord immediately of any claim or notice served upon it with respect to any such claim that the Tenant is causing air, water, topic waste or ground pollution; and the Tenant, in any event, will take immediate steps to halt, remedy or cure any pollution of air, water, topic waste or ground caused by the Tenant by its use of the Premises. Tenant's use of the Premises is not subject to ISRA, and Tenant's use of the Premises will not cause the Premises to be subject to ISRA. If, in the future, Tenant's use of the Premises becomes, or causes the Premises to become subject to ISRA, Tenant agrees that it will, at the expiration of the Lease Term, comply at its own cost and expense with the requirements of ISRA or equivalent act, as the same may be applicable to the use and occupancy by Tenant of the Premises. Tenant, however, shall not be responsible for any hazardous or toxic material or condition not occasioned by Tenant in connection with its use and occupancy of the Premises. The foregoing covenant shall survive the expiration or termination of the within Lease. Tenant shall be responsible for and shall indemnify Landlord for any damages excluding indirect, or consequential damages occasioned by Landlord as a result of Tenant's failure to effectuate ISRA, if applicable, or other environmental law compliance hereunder. 30.2 Landlord represents and warrants that any handling, transportation, storage, treatment or use of hazardous or toxic material that have occurred on the Premises or the property prior to the Commencement Date have been in compliance with all applicable federal, state, and local laws, regulations and ordinances; that to best of Landlord's knowledge, no leak, spill, release, discharge, emission or disposal of hazardous or toxic material has occurred on the Premises or the property prior to the Commencement Date; that the soil, groundwater, and soil vapor on or under the Premises or the property are free of hazardous or toxic materials as of the Commencement Date and that to the best of Landlord's knowledge as of the Commencement Date the Premises or the Project do not contain any asbestos, PCBs or underground storage tanks. 30.3 Landlord agrees to indemnify, defend and hold Tenant and its officers, employees and agents harmless from any claims, judgments, damages, penalties, fines, costs, liabilities (including sums paid in settlements of claims) or loss including, without limitation, reasonable attorneys' fees, consultant fees, and expert fees which arise during or after the term of this Lease from or in connection with the presence or suspected presence of hazardous or toxic material in the soil, groundwater or soil vapor on or under the Premises or the property, or Landlord's breach of Article 30.2, unless the hazardous or toxic materials is the responsibility of Tenant under this Lease. This indemnity shall survive the expiration or earlier termination of this Lease. 31. STATEMENT OF ACCEPTANCE Upon the delivery of the Premises to the Tenant pursuant to the terms and conditions of this Lease, the Tenant covenants and agrees that at Landlord's request, it will acknowledge in writing that it accepts the Premises and agrees to pay Annual Basic Rent from the Commencement Date, subject to the terms and conditions of the Lease as herein contained. 32. FORCE MAJEURE Except for the obligation of the Tenant to pay Annual Basic Rent and Additional Rent as in this Lease provided, the period of time during which the Landlord or Tenant is prevented from performing any act required to be performed under this Lease by reason of fire, catastrophe, strikes, lockouts, civil commotion, acts of God or the public enemy, government prohibitions or preemptions, embargoes, inability to obtain material or labor by reason of governmental regulations or prohibitions, or the act or default of the other party, shall be added to the time for performance of such act. In order to invoke the benefits of this Article 32, notice shall be given in writing to the other party invoking the benefits hereunder within 10 days after the occurrence of any event claimed to have caused delay hereunder. 33. CONDEMNATION 33.1 If due to condemnation or taking or seizure by any authority having the right of eminent domain (i) a portion of the Building or Property is taken which taking shall unreasonably or unduly interfere with the use of the Demised Premises (as certified by Tenants Board of Directors), Property, or Building by Tenant; or (ii) access to the Demised Premises be denied; then and in either of such events as hereinabove provided, the Lease Term created shall, at the option of the Tenant, terminate, cease and become null and void from the date when the authority exercising the power of eminent domain takes or interferes with the use of the Building. Landlord also agrees that it will, to the extent practicable and available, restore the Premises taken, subject to compliance with existing zoning regulations and engineering feasibility. Landlord also agrees that if Tenant does not cancel the Lease as herein permitted, Landlord will use its good faith efforts to replace the parking spaces to reasonable contiguity to the Premises. The Tenant shall only be responsible for the payment of Annual Basic Rent until the time of surrender. In any event, no part of the Landlord's condemnation award shall belong to or be claimed by the Tenant. Without diminishing Landlord's award, the Tenant shall have the right to make a claim against the condemning authority for such independent claim which it may have and as may be allowed by law, for costs and damages due to relocating, personal property losses, moving and other similar costs and charges directly incurred by the Tenant and resulting from such condemnation. 33.2 In the event of any partial taking which would not be cause for termination of the within Lease and a taking which would be cause for termination, but in which event the Tenant shall elect to retain the balance of the Premises remaining after such taking, then and in either event, the Annual Basic Rent shall abate in an amount to be mutually agreed upon between the Landlord and Tenant based on the relationship that the character of the property taken bears to the property which shall remain after such condemnation. In any event, no part of the Landlord's condemnation award shall belong to or be claimed by the Tenant. However, the Landlord shall, to the extent permitted by applicable law and as the same may be practicable on the site of the Premises, at the Landlord's sole cost and expense, promptly make such repairs and alterations in order to restore the Building and/or improvements to the extent of the condemnation award, which restoration shall be made in the same manner and in accordance with the same time periods hereinbefore provided in Article 17. In the event there is any dispute as to the amount of rent abatement, the same shall be submitted to the American Arbitration Association for binding determination at the equal administrative cost of Landlord and Tenant. 34. SURRENDER OF PREMISES On the last day, or earlier permitted termination of the Lease Term, Tenant shall quit and surrender the Premises in good and orderly condition and repair (reasonable wear and tear, and damage by fire or other casualty excepted), and shall deliver and surrender the Premises to the Landlord peaceably, together with all alterations, additions and improvement in, to or on the Premises made by Tenant as permitted under the Lease. Prior to the expiration of the Lease Term the Tenant shall remove all of its property, fixtures, equipment and trade fixtures from the Premises. All property not removed by Tenant shall be deemed abandoned by Tenant, and Landlord reserves the right to charge the reasonable cost of such removal to the Tenant, which obligation shall survive the Lease termination and surrender hereinabove provided. Tenant shall be responsible to repair and/or replace any portion of the Premises damaged, or which may require restoration occasioned by such removal. If the Premises be not surrendered within sixty (60) days after the end of the Lease term, Tenant shall indemnify Landlord against loss or liability resulting from such delay by Tenant in surrendering the Premises, including, without limitation any claims made by any succeeding tenant founded on the delay, provided Tenant is given at least 15 days notice of such Tenant's planned occupancy. Without limiting Tenant's liability as hereinabove referred to, in the event surrender is delayed by Tenant. Tenant shall pay to Landlord a sum equal to one hundred twenty five (125%) percent of the Annual Basic Rent and 100% of the Additional Rent payable monthly prior to the expiration of the Lease Term, prorated per diem for the holdover term. All Annual Basic Rent and Additional Rent adjustments and executory covenants as in the Lease provided shall survive the Lease termination and surrender of the Premises in accordance with their terms. 35. SHORT FORM LEASE It is understood between the parties hereto that this Lease will not be recorded, but that if requested by either party a short form of lease, describing the property leased hereby, giving the Term of this Lease, and making particular mention of any special clauses as herein contained, will be recorded in accordance with the laws governing and regulating the recording of such documents in the State of New Jersey. 36. LEASE CONSTRUCTION This Lease shall be construed pursuant to the laws of the State of New Jersey. This Lease shall be construed according to its plain meaning as if prepared by both of the parties hereto. 37. BIND AND INURE CLAUSE The terms, covenants and conditions of the within Lease shall be binding upon and inure to the benefit of each of the parties hereto, their respective executors, administrators, heirs, successors and assigns, as the case may be. 38. DEFINITIONS The neuter gender, when used herein and in the acknowledgment hereafter set forth, shall include all persons and corporations, and words used in the singular shall include words in the plural where the text of the instrument so requires. 39. DEFINITION OF TERM OF "LANDLORD" When the term "Landlord" is used in this Lease it shall be construed to mean and include only the owner of the fee title of the Premises. Upon the transfer by the Landlord of the fee title hereunder, the Landlord shall advise the Tenant in writing by certified mail, return receipt requested, of the name of the Landlord's transferee. In such event, the then Landlord shall be automatically freed and relieved from and after the date of such transfer of title of all personal liability with respect to the performance of any of the covenants and obligations on the part of the Landlord herein contained to be performed, after the date of such transfer, provided any such transfer and conveyance by the Landlord is expressly subject to the assumption in writing by the grantee or transferee of the obligations of the Landlord to be performed pursuant to the terms and conditions of the within Lease after the date of transfer of title. 40. SUBORDINATION AND NON-DISTURBANCE 40.1 This Lease shall be subject and subordinate at all times to the lien of any mortgages or ground rents or other encumbrances now or hereafter placed on the Premises without the necessity of any further instrument or act on the part of Tenant to effectuate such subordination. Tenant covenants and agrees to execute and deliver upon demand such instrument or instruments evidencing such subordination of the Lease to the lien of any such mortgage or ground rent or other encumbrances as shall be desired by a mortgagee or proposed mortgagee. 40.2 Within thirty (30) days after the execution of this Lease, Landlord shall use reasonable efforts to obtain and deliver to Tenant from any present mortgagee, trustee, fee owner, prime lessor or any person having an interest in the building superior to this Lease ("Superior Interest") a written nondisturbance agreement in recordable form providing that so long as Tenant performs all of the terms, covenants and conditions of this Lease and agrees to attorn to the holder of the Superior Interest, Tenant's rights under this Lease shall not be disturbed and shall remain in full force and effect for the Term, and Tenant shall not be named or joined by the holder of the Superior Interest in any action or proceeding to foreclose thereunder. Tenant's agreement to subordinate its Lease to any future Superior Interest is conditioned upon Landlord furnishing a nondisturbance agreement in accordance with Article 40. Landlord represents that as of the date of this Lease Landlord owns 100% of the fee simple title to the Property. 41. AUTHORITY Landlord and Tenant, by their respective signatories, do hereby warrant one to the other that the parties executing the within Lease have the full authority to execute the within Lease and the bind Landlord and Tenant respectively. 42. BROKERAGE Landlord and Tenant mutually represent one to the other that neither party dealt with any brokers in connection with the initiation, negotiation and consummation of the within Lease transaction. 43. SECURITY Upon execution of this Lease, the Tenant shall deposit an amount equal to one (1) months Basic Rent and Tenant Electric with the Landlord being the sum of Thirty Thousand Six Hundred Ninety and 25/100 Dollars ($30,690.25) as security for the full and faithful performance of this Lease upon the part of the Tenant to be performed. Upon termination of this Lease, and providing the Tenant is not in default hereunder and has performed all of the conditions of this Lease, the Landlord shall return the said security to the Tenant plus all interest that accrues thereon. Anything herein contained to the contrary notwithstanding, it is expressly understood and agreed that the said security deposit shall bear interest. Landlord and Tenant covenant and agree that each will not assign, pledge, hypothecate, mortgage or otherwise encumber the aforementioned security during the term of this lease. Whenever under this Lease the Basic Rent shall be increased, Tenant shall deposit with Landlord such additional sums as shall increase the amount of security held by Landlord so as to make it equal to one (1) months of then prevailing Basic Rent. Landlord shall deposit the security funds in a separate interest bearing account to the benefit of Tenant less one percent (1%) for Landlords administrative costs. 44. FINANCIAL STATEMENTS Tenant agrees that it will furnish to Landlord upon Landlord's request its latest financial statements which Landlord may require and if such financial statements are not available, furnish to Landlord its latest financial statement certified by an executive officer of the Tenant. Such request, however, shall not be made more than once in any calendar year, except if specifically required for any financing or refinancing of the Land and Building of which the Premises are a part. Any statements furnished hereunder shall be subject to a letter of confidentiality to be issued by the person requesting such statement. 45. EXCULPATION OF LANDLORD Neither Landlord nor its principals shall have any personal obligation for payment of any indebtedness or for the performance of any obligation under this lease but the payment of the indebtedness and the performance of obligations expressed herein may be enforced only against the Premises, and the rents, issues and profits thereof, and the Tenant agrees that no deficiency judgment or other judgment for money damages shall in any event be entered by it against the Landlord or its principals personally in any action; provided, however, that the provisions of this Article shall in no way affect Tenant's other remedies for the payment of any indebtedness or for the enforcement of Landlord's covenants under this Lease. 46. MORTGAGEE NOTICE CLAUSE Tenant agrees to give any mortgagee of which Tenant has notice (in accordance with Article 25 hereof), a copy of any Notice of Default served upon the Landlord by Tenant provided that prior to such notice Tenant has been notified, in writing, (by way of Notice of Assignment of Rents and Leases, or otherwise) of the name and address of such mortgagees. Tenant further agrees that if Landlord shall have failed to cure such default within the time provided for in this lease, then the Mortgagees shall have an additional thirty (30) days within which to cure such default or if such default cannot be cured within that time, then such additional time as may be necessary if within such thirty (30) days, any Mortgagee has commenced and is diligently pursuing the remedies necessary to cure such default (including but not limited to commencement of foreclosure proceedings, if necessary to effect such cure), in which event this lease shall not be terminated while such remedies are being so diligently pursued, but Tenant shall otherwise be entitled to all other remedies specified herein. 47. RULES Tenant shall comply with the rules and regulations annexed hereto and made a part hereof as Exhibit D. The Landlord reserves the right to adopt, amend or repeal, from time to time, reasonable rules and regulations (the "Rules") concerning the use and occupancy of the Demised Premises, which shall be applicable to all tenants of the Building. Notice of the Rules, if any, shall be given to the Tenant, in writing. 48. OPTION TO RENEW Tenant shall have two options to renew the Term of this Lease as follows: 48.1 First Renewal Option. Provided the Tenant is not in default pursuant to the terms and conditions of this Lease at the time of renewal notice and as of date of commencement of renewal term, the Tenant is hereby given the right and privilege to renew the within Lease for an additional one (1) year period, to commence at the end of the initial Term (the First Renewal Period"), which renewal shall be on all the same terms and conditions as during the original Term, including, without limitation, there shall be no change in the rent. In order to exercise its option for the First Renewal Period, Tenant must give Landlord notice of its intent to renew, in writing, in accordance with the provisions of Article 25 hereof, no later than three (3) months prior to the expiration of the original Term of this Lease. 48.2 Second Renewal Option Provided the Tenant is not in default pursuant to the terms and conditions of this Lease at the time of renewal notice and as of the date of commencement of the second renewal term, the Tenant is hereby given the right and privilege to renew the within Lease for an additional one (1) year period, to commence at the end of the First Renewal Period, which renewal shall be at the then current Fair Market Value for Murray Hill, NJ and the Interstate 78/287 Interchange Market, but not less than the rate Tenant is currently paying. 48.3 The aforesaid calculation shall be submitted by Landlord to Tenant within ten (10) days after Landlord's receipt of Tenant's second renewal notice. If Tenant agrees with Landlord's calculation of the Fair Market Rent for the Premises, the calculation shall be submitted as an addendum to this Lease. If Tenant does not agree with Landlord's calculation, Tenant may rescind its second renewal notice no later than two months prior to the end of the First Renewal Period, and this Lease shall then terminate as of the end of the First Renewal Period. It is agreed that if the rental increase calculation shall not have been made at the time of commencement of the second renewal term, Tenant shall continue to pay the rent applicable at the end of the First Renewal Period, provided however, that upon the giving of notice by Landlord to Tenant of the adjustment of rental calculated as aforesaid, the amount of any increase of rent shall be due upon demand by Landlord retroactively for any months of the second renewal term as to which such increased rental shall not have been paid and the adjusted rent shall thereafter be paid at the regular times for payment of the basic rent. 48.4 Tenant shall also pay Additional Rent in the same manner as required in Article 1 G (ii), which payment of Annual Basic Rent and Additional Rent in the same manner as required and in accordance with Article 6. 48.5 The right, option, and privilege of the Tenant to renew this Lease for a second renewal period as hereinabove set forth is expressly conditioned upon the Tenant delivering to the Landlord, in writing, in accordance with the provisions of Article 25 hereof, notice of its intention to renew, which notice shall be given to the Landlord by the Tenant no later than three (3) months prior to the date fixed for termination of the First Renewal Period. 49. THIRD PARTY LITIGATION Should Landlord, without fault on Landlord's part, be made a party to any litigation instituted by Tenant or by any third party against Tenant, or by or against any person holding under or using the Premises by license of Tenant, or for the foreclosure of any lien for labor or material furnished to or for Tenant or any such other person or otherwise arising out of or resulting from any act or transaction of Tenant or of any such other person, Tenant covenants to save and hold Landlord harmless from any judgment rendered against Landlord or the Premises or any part thereof, and all costs and expenses, including reasonable attorney's fees, incurred by Landlord in or in connection with such litigation. 50. INVALIDITY OF PARTICULAR PROVISIONS Wherever in this Lease any portion or part thereof has been stricken out, whether or not any relative provision has been added, this Lease shall be read and construed as if the material so stricken were never included herein and no implication shall be drawn from the text of the material so stricken which would be inconsistent in any way with the construction or interpretation which would be appropriate if such material were never contained herein. 51. COST OF PERFORMING OBLIGATIONS Unless otherwise specified, the respective obligations of the parties to keep, perform and observe the terms, covenants or conditions of this Lease shall be at the sole cost and expense of the party so obligated. 52. MODIFICATION This Lease may not be modified except by an instrument in writing signed by the parties hereto. 53. INTEGRATION The agreements contained in this Lease constitute the full and final agreement between the parties hereto as to the subject matter hereof, and all prior agreements or writings of any nature between the parties hereto are hereby superseded and are integrated herein. 54. WAIVER OF JURY TRIAL The parties waive the right to a jury trial with respect to any action, including any action for damage or injury arising out of this Lease or Tenant's use or occupancy of the Premises. 55. ARBITRATION Any arbitration for which provision is made herein shall be conducted in accordance with the then prevailing rules of the American Arbitration Association. The parties shall each appoint an arbiter within fifteen (15) business days after receiving the list of available arbiters. The two (2) arbitrators shall select a third arbiter within fifteen (15) days after the selection of the first two and a simple majority of two arbitrators will prevail. The arbitrators' determination shall be binding upon Landlord and Tenant. Any arbiter provided for herein shall have had at least ten (10) years experience with commercial real estate leases. The fees and expenses of the arbitrator(s) shall be divided equally between Landlord and Tenant. Landlord and Tenant shall each bear their own expenses (including, but not limited to, attorney's fees and expenses of witnesses) in any arbitration proceeding. The arbitration proceeding shall be held in Murray Hill, New Jersey. IN WITNESS WHEREOF, the parties have hereunto set their hands and seals or caused these presents to be signed by its proper corporate officers and caused its proper corporate seal to be hereunto affixed, the day and year first above written. WITNESS: "K" LINE REALTY (N.J.) INC. /s/ Lesley C. Tischio /s/ By: Richard B. Motta Executive Vice President Landlord WITNESS: MCC CORPORATION /s/ Barbara Lopez /s/ By: Robert Wallach President Tenant STATE OF NEW JERSEY ) ) SS: COUNTY OF Middlesex) BE IT REMEMBERED, that on this 31st day of May, 1996, before me, the subscriber, personally appeared. Richard B. Motta, who, I am satisfied, is the person who signed the within Instrument, as the Executive Vice President of the Landlord named therein, and he thereupon acknowledged that he signed, sealed and delivered the same as his act and deed for the uses and purposes therein expressed. /s/ Joseph Leanza NOTARY PUBLIC OF NEW JERSEY My Commission expires Aug. 15, 1998 STATE OF NEW JERSEY ) ) SS: COUNTY OF Union ) BE IT REMEMBERED, that on this 31st day of May, 1996 before me, the subscriber, personally appeared Robert Wallach, who I am satisfied, is the person who signed the within Instrument as President of the Tenant named therein, and he thereupon acknowledged that the said instrument made by the corporation and sealed with its corporate seal, was signed, sealed with the corporate seal and delivered by him as such officer and is the voluntary act and deed of the corporation, made by virtue of authority from its Board of Directors. /s/ Kirsten M. Beck NOTARY PUBLIC OF NEW JERSEY Commission expires Feb. 28, 2001 EX-10.20 3 AGREEMENT OF SALE BETWEEN DAVID R FELDMAN D.B.A. PRO DATA A SOLE PROPRIETORSHIP SITUATED AT 408 WESTMINSTER SUITE 7, NEWPORT BEACH, CA 92663 WHO IS THE SELLER AND HEREAFTER IS NAMED PRO DATA. AND DATON PAY USA INC. A CALIFORNIA CORPORATION SITUATED AT 1560 BROOKHOLLOW DRIVE, SANTA ANA, CA 92705 WHO IS THE BUYER AND HEREAFTER IS NAMED PAY USA. CONTENTS: A GENERAL TERMS AND DEFINITIONS B PAYMENT TERMS C CONVERSION D CLIENT OWNERSHIP E MISCELLANEOUS F WARRANTIES OF THE SELLER & BUYER G RESTRAINT OF TRADE H DISPUTE RESOLUTION A: GENERAL TERMS AND DEFINITIONS: 1. PRO DATA IS A PAYROLL PROCESSING SERVICE SOLELY OWNED BY DAVID R FELDMAN. 2. PAY USA IS A PAYROLL PROCESSING SERVICE OWNED BY COMPUTER OUTSOURCING SERVICES, INC. 3. PRO DATA WISHES TO SELL AND PAY USA WISHES TO PURCHASE THE PAYROLL PROCESSING CLIENT BASE OF PRO DATA. 4. THE PAYROLL PROCESSING CLIENT BASE THAT IS FOR SALE IS LISTED IN DETAIL IN ATTACHMENT 1. ATTACHMENT 1 REPPRESENTS THE COMPLETE PAYROLL PROCESSING CLIENT BASE OF PRO DATA. 5. EACH CLIENT LISTED ON THE CLIENT BASE IS TO BE CONSIDERED AN INDIVIDUAL COMPONENT FOR THE PURPOSE OF COMPUTING THE PURCHASE PRICE, ESTABLISHING THE CONVERSION DATE, THE PRICE CALCULATION PERIOD AND THE PAYOFF DATE. 6. THE EFFECTIVE DATE OF THIS AGREEMENT IS AUGUST 19, 1996. 7. GROSS REVENUE SHALL MEAN THE TOTAL AMOUNT BILLED FOR PAYROLL PROCESSING SERVICES EXCLUDING THE FOLLOWING FEES; SET-UP FEES, FEES FOR SALE OF SUPPLIES, QUARTERLY RETURN PREPARATION FEES, CUSTOM PROGRAMMING FEES, SALES TAX AND ANY COLLECTION FEES. DELIVERY FEES ARE SPECIFICALLY INCLUDED IN GROSS REVENUE. 8. CONVERSION DATE SHALL MEAN THE DATE AN INDIVIDUAL CLIENT BEGINS PAYROLL PROCESSING SERVICES WITH PAY USA. 9. PRICE CALCULATION PERIOD SHALL MEAN THE PERIOD AN INDIVIDUAL CLIENT PROCESSES ITS PAYROLL WITH PAY USA. FOR EACH CONVERTED CLIENT THE PRICE CALCULATION PERIOD STARTS ON THE CONVERSION DATE. THE PRICE CALCULATION PERIOD ENDS SIX MONTHS FOLLOWING THE CONVERSION DATE. 10. THE FINAL PURCHASE PRICE IS SET AT 200% OF THE ACTUAL GROSS REVENUE OF PAY USA DURING THE PRICE CALCULATION PERIOD FOR EACH CLIENT LISTED IN ATTACHMENT 1. 11. THE FINAL CONVERSION DATE IS THE CONVERSION DATE OF THE LAST CLIENT LISTED IN ATTACHMENT 1 THAT BEGINS PROCESSING ITS PAYROLL WITH PAY USA. BOTH PRO DATA AND PAY USA WILL PUT FORTH THEIR BEST EFFORT TO ENSURE THE FINAL CONVERSION DATE OCCURS NO LATER THAN OCTOBER 31, 1996. 12. DURING THE PRICE CALCULATION PERIOD OF EACH CLIENT, PAY USA GUARANTEES TO BILL THE CLIENTS LISTED IN ATTACHMENT 1 THAT CONVERT, AT A RATE EQUAL TO OR GREATER THAN THE AMOUNT PRO DATA WOULD HAVE CHARGED FOR THE EQUIVALENT PROCESSING SERVICES. PAY USA WILL CHARGE ITS CUSTOMARY CHARGES FOR ANY ADDITIONAL SERVICES PROVIDED BY PAY USA THAT PRO DATA DID NOT PROVIDE ITS CLIENTS. THE MAJOR EXAMPLES OF SUCH ADDITIONAL SERVICES ARE FULL TAX FILING AND DIRECT DEPOSIT. B: PAYMENT TERMS: 13. THE PAYMENT TERMS IN BRIEF ARE AS FOLLOWS; a) A DOWN PAYMENT ON THE DATE OF SIGNING THE AGREEMENT - 8/19/96 b) A SECOND PAYMENT PAYABLE 3 MONTHS AFTER THE FINAL CONVERSION DATE. c) A FINAL PAYMENT PAYABLE 6 MONTHS AFTER THE FINAL CONVERSION DATE. 14. THE DOWN PAYMENT THE DOWN PAYMENT IS CALCULATED AT 50% (FIFTY PERCENT) OF PRO DATA'S ACTUAL BILLING FOR THE QUARTER ENDED JUNE 30, 1996 ANNUALIZED FOR THE CLIENTS LISTED IN ATTACHMENT 1. 15. THE DOWN PAYMENT IS DUE AND PAYABLE BY PAY USA TO PRO DATA ON THE DATE OF SIGNING THIS AGREEMENT; AUGUST 19, 1996. 16. PRO DATA'S ACTUAL BILLING FOR THE QUARTER ENDED 6/30/96 IS LISTED IN DETAIL IN ATTACHMENT 1 AND TOTALS $36411.58. ANNUALIZED THIS AMOUNTS TO $139310.72. 50% OF $139310.72 AMOUNTS TO $69655.36. $69655.36 IS ROUNDED UP TO $70000.00 WHICH IS AGREED TO BE THE AMOUNT OF THE DOWN PAYMENT. 17. THE AMOUNT PRO DATA RECEIVES FOR THE DOWN PAYMENT ($70000.00) MAY BE INVESTED BY PRO DATA IN ANY LOW RISK LIQUID INVESTMENT OF PRO DATA'S CHOICE. SUCH INVESTMENT SHALL BE A CERTIFICATE OF DEPOSIT IN OUR JOINT NAMES. ALL INCOME EARNED OR ACCRUED ON THE INVESTMENT(S) SHALL BE FOR PRO DATA'S SOLE BENEFIT. 18. UPON THE OCCURRENCE OF THE CONVERSION DATE OF THE 40TH CLIENT LISTED IN ATTACHMENT 1, THE DEPOSIT IN 17 ABOVE WILL BECOME SOLELY PRO DATA'S PROPERTY. 19. THE SECOND PAYMENT THE SECOND PAYMENT IS BASED ON 90% OF PAY USA'S ACTUAL GROSS REVENUE FOR THE CLIENTS LISTED IN ATTACHMENT 1. THE AMOUNT IS CALCULATED FOR EACH CLIENT LISTED IN ATTACHMENT 1 INDIVIDUALLY USING EACH INDIVIDUAL CONVERTED CLIENT'S FIRST 3 MONTH PRICE CALCULATION PERIOD. THE TOTAL GROSS REVENUE FOR EACH CONVERTED CLIENT IS ANNUALIZED (MULTIPLIED BY 4) AND THE GRAND TOTAL IS MULTIPLIED BY 90 (NINETY) PERCENT. 20. THE AMOUNT CALCULATED IN 19 ABOVE IS REDUCED BY THE $70000.00 DOWN PAYMENT. THE NET AMOUNT IS DUE AND PAYABLE TO PRO DATA WITHIN 5 BUSINESS DAYS FOLLOWING THE 3 MONTH PERIOD AFTER THE FINAL CONVERSION DATE. 21. PAY USA WILL PROVIDE PRO DATA A DETAILED SCHEDULE TO SUPPORT THE CALCULATION OF THE SECOND PAYMENT. THIS SCHEDULE WILL AS A MINIMUM CONTAIN THE FOLLOWING DETAIL. CLIENT NAME AND FREQUENCY. CLIENT CONVERSION DATE. INDIVIDUAL CLIENT BILLING DETAIL FOR THE 3 MONTH PERIOD. THE BILLING DETAIL WILL SHOW EACH PROCESSING DATE AND CHARGE. DETAILS OF EXCLUDED CHARGES BY INDIVIDUAL CLIENT BY DATE. ANNUALIZED CALCULATION. 22. THE FINAL PAYMENT THE FINAL PAYMENT IS BASED ON 100% OF PAY USA'S ACTUAL GROSS REVENUE. THE FINAL PURCHASE PRICE IS CALCULATED FOR EACH CLIENT LISTED IN ATTACHMENT 1 INDIVIDUALLY USING EACH INDIVIDUAL CONVERTED CLIENT'S FIRST 6 MONTH PRICE CALCULATION PERIOD. THE TOTAL GROSS REVENUE FOR EACH CONVERTED CLIENT IS ANNUALIZED (MULTIPLIED BY 2). 23. THE AMOUNT CALCULATED IN 22 ABOVE IS REDUCED BY THE $70000.00 DOWN PAYMENT AND THE AMOUNT OF THE SECOND PAYMENT. THE NET FINAL PAYMENT AMOUNT IS DUE AND PAYABLE TO (OR FROM) PRO DATA WITHIN 5 BUSINESS DAYS FOLLOWING THE 6 MONTH PERIOD AFTER THE FINAL CONVERSION DATE. 24. PAY USA WILL PROVIDE PRO DATA A DETAILED SCHEDULE TO SUPPORT THE CALCULATION OF THE FINAL PAYMENT. THIS SCHEDULE WILL AS A MINIMUM CONTAIN THE FOLLOWING DETAIL. CLIENT NAME AND FREQUENCY. CLIENT CONVERSION DATE. INDIVIDUAL CLIENT BILLING DETAIL FOR THE 6 MONTH PERIOD. THE BILLING DETAIL WILL SHOW EACH PROCESSING DATE AND CHARGE. DETAILS OF EXCLUDED CHARGES BY EACH CLIENT BY DATE. ANNUALIZED CALCULATION. 25. NO PAYMENT WILL BE MADE FOR ANY CLIENT LISTED IN ATTACHMENT 1 THAT CONVERTS TO PAY USA AND PRIOR TO THE EXPIRATION OF THAT INDIVIDUAL CLIENT'S SIX MONTH PRICE CALCULATION PERIOD PERMANENTLY CANCELS PAY USA'S SERVICES. 26. CLIENTS WHO CONVERT TO PAY USA AND TEMPORARILY SUSPEND PROCESSING SERVICES OF PAY USA PRIOR TO THE EXPIRATION OF THAT CLIENT'S SIX MONTH PRICE CALCULATION PERIOD (BUT DO NOT CANCEL SUCH SERVICES) WILL BE PAID FOR BASED ON THE ACTUAL (REDUCED) AMOUNT OF BILLING DURING THAT CLIENT'S SIX MONTH CALCULATION PERIOD, ANNUALIZED. 27. THE SCHEDULES REFERRED TO IN 21 AND 24 MAY BE AUDITED BY PRO DATA AND THE COST OF ANY SUCH AUDIT SHALL BE FOR PRO DATA'S ACCOUNT. PAY USA SHALL PROVIDE SUPPORTING DOCUMENTATION REQUESTED BY PRO DATA. IF NO SUCH REQUEST IS RECEIVED FROM PRO DATA BY PAY USA WITHIN 10 BUSINESS DAYS FOLLOWING PRO DATA'S RECEIPT OF PAYMENT FROM PAY USA, IT WILL BE ASSUMED PRO DATA HAS WAIVED ITS RIGHT TO AUDIT THE PAYMENT SCHEDULES AND THE PAYMENT MADE WILL BE DEEMED FINAL AND ACCEPTED BY PRO DATA. 28. IF ANY OF THE PAYMENTS ABOVE ARE PAID LATE, A PENALTY OF 10% OF THE LATE PAYMENT WILL BECOME DUE AND PAYABLE TO PRO DATA. 29a) IF, DUE TO THE FAULT OF PAY USA, THE FINAL CONVERSION DATE WOULD OCCUR LATER THAN OCTOBER 31, 1996, THEN OCTOBER 31, 1996 WILL BE DEEMED THE FINAL CONVERSION DATE. ANY CLIENTS CONVERTED AFTER OCTOBER 31, 1996 WILL HAVE THEIR PRICE CALCULATION PERIOD PRORATED (REDUCED) ACCORDINGLY. FOR THE PURPOSE OF COMPUTING THE SECOND PAYMENT AND FINAL PAYMENT SUCH CLIENTS WILL BE ANNUALIZED BASED ON THEIR PRORATED PRICE CALCULATION PERIOD. THIS PRORATED PRICE CALCULATION WILL PRODUCE AN ANNUALIZED AMOUNT NO LESS THAN WOULD HAVE BEEN DERIVED HAD A FULL PRICE CALCULATION PERIOD BEEN USED. 29b) IN ORDER TO FURTHER CLARIFY 29a THE FOLLOWING EXAMPLE IS GIVEN: IF A CLIENT CONVERTED ON NOVEMBER 30, 1996, THE PRICE CALCULATION PERIOD WOULD BE PRO-RATED TO TWO (2) MONTHS FOR THE PURPOSE OF COMPUTING THE SECOND PAYMENT AND FIVE (5) MONTHS FOR THE PURPOSE OF COMPUTING THE FINAL PAYMENT. FOR THE SECOND PAYMENT, THE ANNUALIZED CALCULATION WOULD BE CALCULATED AS FOLLOWS. GROSS REVENUE FOR THE TWO (2) MONTH PERIOD MULTIPLIED BY 6. FOR THE FINAL PAYMENT, THE ANNUALIZED CALCULATION WOULD BE CALCULATED AS FOLLOWS: GROSS REVENUE FOR THE FIVE (5) MONTH PERIOD DIVIDED BY FIVE (5) AND MULTIPLIED BY 12. 30. THE PURPOSE OF 29 ABOVE IS TO ENSURE THAT THE SECOND PAYMENT IS DUE AND PAYABLE NO LATER THAN 5 BUSINESS DAYS AFTER JANUARY 31, 1997 AND THAT THE FINAL PAYMENT IS DUE AND PAYABLE NO LATER THAN 5 BUSINESS DAYS AFTER APRIL 30, 1997. C: CONVERSION 31. THE CONVERSION OF THE INDIVIDUAL CLIENTS WILL START NO LATER THAN AUGUST 26, 1996 AND IS PLANNED TO END NO LATER THAN OCTOBER 31, 1996. 32. PRO DATA AND PAY USA WILL WORK TOGETHER TO PROVIDE A SMOOTH AND ACCURATE CONVERSION FROM PRO DATA'S PROCESSING TO PAY USA'S. THE COSTS INCURRED BY BOTH PRO DATA AND PAY USA IN CONNECTION WITH THEIR OBLIGATIONS REGARDING THE CONVERSION SHALL BE INCURRED AT THEIR OWN EXPENSE. BOTH PRO DATA AND PAY USA WILL PERFORM THEIR NORMAL CONTROLS AND CHECKING PROCEDURES TO VERIFY THE ACCURACY OF THE CONVERSION. 33. PAY USA AND PRO DATA WILL WORK TOGETHER TO TRANSFER THE INDIVIDUAL EMPLOYEE DATA ELECTRONICALLY. PRO DATA WILL PROVIDE PAY USA WITH THE EMPLOYEE DATA IN ASCII FORMAT AND PAY USA WILL CONVERT SUCH DATA INTO A FORMAT REQUIRED BY ITS SYSTEMS. 34. PRO DATA WILL PROVIDE PAY USA WITH A SCHEDULE OF THE PLANNED CLIENT CONVERSION DATES. THE SCHEDULE WILL SHOW THE CLIENT NAME; PROCESSING FREQUENCY; CONTACT NAME; TARGET CONVERSION DATE AND OTHER PERTINENT CLIENT DETAIL TO HELP INFORM PAY USA OF THE NATURE AND SPECIFIC REQUIREMENTS OF EACH INDIVIDUAL CLIENT. 35. PRO DATA AND PAY USA AGREE ON THE FOLLOWING APPROACH TO ENSURE THE MAXIMUM CLIENT CONVERSION RATE: 35a ) PRO DATA WILL SEND TO EACH OF ITS CLIENTS A LETTER EXPLAINING THAT PAY USA HAS PURCHASED PRO DATA'S CLIENT BASE AND THAT PAY USA WILL BEGIN CONVERTING THE CLIENT TO PAY USA. THE LETTER WILL LIST THE ADVANTAGES OF THE CONVERSION, THE REASON FOR THE SALE AND WILL URGE THE CLIENTS TO CONVERT AND TAKE ADVANTAGE OF PAY USA'S ADDITIONAL SERVICES. THIS CLIENT NOTIFICATION LETTER AS WELL AS A PAY USA NEW CLIENT PACKAGE WILL BE INCLUDED WITH THE DELIVERY OF THE PROJECTED FINAL PAYROLL OF THAT CLIENT. A SAMPLE LETTER IS INCLUDED WITH THIS AGREEMENT AND IS LABELED ATTACHMENT 2 AND NO CHANGE WILL BE MADE TO THE CLIENT NOTIFICATION LETTER WITHOUT PAY USA'S PRIOR CONSENT. 35b) PRO DATA WILL NOTIFY PAY USA EACH DAY AS TO WHICH CLIENTS IT HAS SENT THE LETTER AND PACKAGE TO. PAY USA WILL CONTACT THE CLIENT THE DAY FOLLOWING RECEIPT OF THE FINAL PAYROLL FROM PRO DATA AND INTRODUCE PAY USA. 35c) PRO DATA WILL PROMPTLY SUPPLY TO PAY USA IN ELECTRONIC AND PAPER FORMAT THE NECESSARY DATA TO ENABLE PAY USA TO ACCURATELY CONVERT THE CLIENT AND TO BEGIN PROCESSING SERVICES FOR THE CLIENT. SUCH DATA WILL AS A MINIMUM ENABLE PAY USA TO CAPTURE THE CLIENT'S YEAR TO DATE EARNING AND DEDUCTION DATA IN DETAIL BY EMPLOYEE; THE CLIENT'S EMPLOYEE MASTER FILE DATA; THE CLIENT COMPANY DATA AND ANY OTHER PERTINENT DATA THAT PRO DATA AND PAY USA DEEM IMPORTANT. 35d) PRO DATA WILL ASSIST PAY USA IN SELLING AND PROMOTING ADDITIONAL SERVICES OF PAY USA'S TO THE CLIENTS LISTED IN ATTACHMENT 1 THAT CONVERT TO PAY USA. 36. PRO DATA WILL CONTINUE TO PROVIDE PAYROLL PROCESSING SERVICES TO THE CLIENTS WHO HAVE NOT YET CONVERTED TO PAY USA. ALL COSTS AND INCOME IN RELATION TO THE PERFORMANCE OF SUCH SERVICES ARE FOR THE SOLE ACCOUNT OF PRO DATA. 37. CLIENTS WHO DO NOT CONVERT TO PAY USA MAY CONTINUE TO RECEIVE PAYROLL PROCESSING SERVICES FROM PRO DATA. PRO DATA WILL ALSO HAVE THE RIGHT TO SELL SUCH NON-CONVERTING CLIENTS ELSEWHERE SUBJECT TO THE PROVISO THAT THE SALE OF SUCH NON-CONVERTING CLIENTS MUST BE COMPLETED PRIOR TO DECEMBER 31, 1996 AND SUBJECT FURTHER TO THE PENALTY CLAUSE IN 38 BELOW. 38. PRO DATA WILL BE ASSESSED A SURCHARGE PAYABLE TO PAY USA OF 10% OF THE ANNUALIZED REVENUE ON ATTACHMENT 1 OF NON-CONVERTING CLIENTS REFERRED TO IN 37 ABOVE. HOWEVER THIS SURCHARGE SHALL NOT BE ASSESSED IF 80% (BASED ON ANNUALIZED REVENUE) OF THE CLIENTS LISTED ON ATTACHMENT 1 ACTUALLY CONVERT. NO PENALTY WILL BE PAYABLE IF THE NON-CONVERTING CLIENTS ARE NOT SOLD ELSEWHERE BY PRO DATA. 39. CLIENTS WHO PAY USA CANNOT CONVERT OR WHO PAY USA DOES NOT WANT TO CONVERT, FOR WHATEVER REASON, MAY CONTINUE TO RECEIVE PAYROLL PROCESSING SERVICES FROM PRO DATA AND PRO DATA SHALL HAVE THE RIGHT TO SELL SUCH CLIENTS ELSEWHERE. SUCH SALES MUST BE COMPLETED PRIOR TO DECEMBER 31, 1996. NO PENALTY WILL BE PAYABLE ON SUCH SALES. D: CLIENT OWNERSHIP 40. OWNERSHIP OF THE INDIVIDUAL CLIENTS WILL PASS FROM PRO DATA TO PAY USA ON THE DATE PAY USA FIRST PROCESSES THAT CLIENT'S PAYROLL. E: MISCELLANEOUS 41. PAY USA WILL PREPARE, FOR CONVERTED CLIENTS, AT NO CHARGE QUARTERLY RETURNS AND 1996 ANNUAL TRANSMITTALS AND W2'S FOR EACH CLIENT LISTED IN ATTACHMENT 1 THAT CONVERTS TO PAY USA. PAY USA MAY AT IT'S OPTION CHARGE FOR QUARTERLY RETURNS FOR STATES OTHER THAN CALIFORNIA IN CONFORMITY WITH PRO DATA'S PRIOR BILLING PRACTICES FOR OUT OF STATE RETURNS. 42. NO CONVERSION CHARGES WILL BE BILLED BY PAY USA FOR CONVERTING THE CLIENTS LISTED IN ATTACHMENT 1 FROM PRO DATA TO PAY USA. 43. NO OTHER ASSETS OF PRO DATA ARE INCLUDED IN THIS AGREEMENT OF SALE. SPECIFICALLY EXCLUDED ARE THE ACCOUNTS RECEIVABLE OF PRO DATA; THE BOOKKEEPING SERVICES PROVIDED BY PRO DATA; ANY SUPPLIES OR DEPRECIABLE ASSETS OF PRO DATA AND THE TAXABLE SALES SERVICES OF PRO DATA. PRO DATA AGREES TO INDEMNIFY AND HOLD HARMLESS PAY USA FROM ANY CLAIMS ARISING OUT OF OR RELATED TO PRO DATA'S BUSINESS PRIOR TO THE DATE OF THIS AGREEMENT. 44. PAY USA ASSUMES NO LIABILITIES OR OBLIGATIONS OF PRO DATA. 45. THIS AGREEMENT CONTAINS ALL OF THE ITEMS ON WHICH PRO DATA AND PAY USA HAVE AGREED. NO OTHER ORAL OR WRITTEN REPRESENTATIONS, UNDERSTANDINGS OR WARRANTIES EXIST EXCEPT AS SPECIFICALLY WRITTEN IN THIS AGREEMENT. ANY MODIFICATION TO THIS AGREEMENT SHALL BE IN WRITING. 46. EXCEPT AS SPECIFICALLY MENTIONED IN THIS AGREEMENT, PRO DATA AND PAY USA WILL BEAR THEIR OWN RESPECTIVE COSTS IN CONNECTION WITH THIS AGREEMENT AND IN RESPECT TO FULFILLING THEIR OBLIGATIONS OF THIS AGREEMENT. F: WARRANTIES OF THE SELLER AND BUYER WARRANTIES OF PRO DATA: ALL INFORMATION CONTAINED IN ATTACHMENT 1 IS TRUE, ACCURATE AND COMPLETE AS OF AUGUST 19, 1996. ALL OF THE CLIENTS THAT HAVE CANCELED OR TERMINATED FROM PRO DATA'S SERVICE ARE NOTED AS SUCH IN ATTACHMENT 1 AND NO AMOUNT IS INCLUDED FOR SUCH CLIENTS IN THE ANNUALIZED TOTAL OF $139310.72 PRO DATA IS A PROPERLY FORMED SOLE PROPRIETORSHIP, VALIDLY OPERATING UNDER THE LAWS OF THE STATE OF CALIFORNIA. DAVID R FELDMAN AS THE SOLE OWNER OF PRO DATA HAS THE POWER AND AUTHORITY TO EXECUTE AND PERFORM ALL OF PRO DATA'S OBLIGATIONS SET OUT IN THIS AGREEMENT. WARRANTIES OF PAY USA: PAY USA IS A PROPERLY FORMED AND ORGANIZED CORPORATION, VALIDLY OPERATING UNDER THE LAWS OF THE STATE OF CALIFORNIA AND THAT ANTON DONDE IS THE DULY ELECTED PRESIDENT OF PAY USA. ANTON DONDE AS THE PRESIDENT OF PAY USA HAS THE POWER AND AUTHORITY TO EXECUTE AND PERFORM ALL OF PAY USA'S OBLIGATIONS SET OUT IN THIS AGREEMENT. G: RESTRAINT OF TRADE FOR THE PERIOD JANUARY 1, 1997 THROUGH DECEMBER 31, 1999, NEITHER PRO DATA NOR DAVID FELDMAN MAY: DIRECTLY OR INDIRECTLY PROVIDE PAYROLL SERVICES TO ANY COMPANY, ANYWHERE THAT PAYUSA CURRENTLY DOES BUSINESS SOLICIT OR REFER ANY CLIENT INCLUDED IN ATTACHMENT 1 TO ANY OTHER PAYROLL PROCESSING SERVICE H: DISPUTE RESOLUTION ALL CLAIMS, DISPUTES AND OTHER MATTERS IN CONTROVERSY ("DISPUTE") ARISING DIRECTLY OR INDIRECTLY OUT OF OR RELATED TO THIS AGREEMENT, OR THE BREACH THEREOF, WHETHER CONTRACTUAL OR NONCONTRACTUAL, AND WHETHER DURING THE TERM OR AFTER THE TERMINATION OF THIS AGREEMENT, SHALL BE RESOLVED EXCLUSIVELY ACCORDING TO THE PROCEDURES SET FORTH BELOW. MEDIATION. NEITHER PARTY SHALL COMMENCE AN ARBITRATION PROCEEDING UNLESS SUCH PARTY SHALL FIRST GIVE A WRITTEN NOTICE (A "DISPUTE NOTICE") TO THE OTHER PARTY SETTING FORTH THE NATURE OF THE DISPUTE. THE PARTIES SHALL ATTEMPT IN GOOD FAITH TO RESOLVE THE DISPUTE BY MEDIATION UNDER THE AMERICAN ARBITRATION ASSOCIATION COMMERCIAL MEDIATION RULES IN EFFECT ON THE DATE OF THE DISPUTE NOTICE. IF THE PARTIES CANNOT AGREE ON THE SELECTION OF A MEDIATOR WITHIN 20 DAYS AFTER DELIVERY OF THE DISPUTE NOTICE, THE MEDIATOR WILL BE SELECTED BY THE AMERICAN ARBITRATION ASSOCIATION. IF THE DISPUTE HAS NOT BEEN RESOLVED BY MEDIATION WITHIN 60 DAYS AFTER DELIVERY OF THE DISPUTE NOTICE, THEN THE DISPUTE SHALL BE DETERMINED BY ARBITRATION IN ACCORDANCE WITH THE PROVISIONS SET FORTH BELOW. ARBITRATION. ANY DISPUTE THAT IS NOT SETTLED BY MEDIATION AS PROVIDED ABOVE SHALL BE RESOLVED BY ARBITRATION BEFORE A SINGLE ARBITRATOR APPOINTED BY THE AMERICAN ARBITRATION ASSOCIATION OR ITS SUCCESSOR IN ORANGE COUNTY, CALIFORNIA. THE DETERMINATION OF THE ARBITRATOR SHALL BE FINAL AND ABSOLUTE. THE ARBITRATOR SHALL BE GOVERNED BY THE DULY PROMULGATED RULES AND REGULATIONS OF THE AMERICAN ARBITRATION ASSOCIATION OR ITS SUCCESSOR THEN IN EFFECT, AND THE PERTINENT PROVISIONS OF THE LAWS OF THE STATE OF CALIFORNIA RELATING TO ARBITRATION. THE DECISION OF THE ARBITRATOR MAY BE ENTERED AS A FINAL JUDGMENT IN ANY COURT OF THE STATE OF CALIFORNIA OR ELSEWHERE. THE ARBITRATOR SHALL HAVE NO POWER OR AUTHORITY TO AWARD PUNITIVE DAMAGES. PRE-ARBITRATION DISCOVERY SHALL BE LIMITED TO ONE DEPOSITION PER PARTY NOT EXCEEDING EIGHT HOURS EACH. THE ARBITRATOR SHALL BE FREE TO AWARD ATTORNEYS' FEES TO THE PREVAILING PARTY. PRO DATA PAY USA BY: /s/ David R. Feldman BY: /s/ Anton Donde DATE: August 19, 1996 DATE: August 19, 1996 EX-21 4 EXHIBIT 21 List of Subsidiaries of Computer Outsourcing Services, Inc. As of October 31, 1996 NEDS, Inc. (formerly New England Data Services, Inc.), a New York corporation. Daton Pay USA, Inc. (formerly Daton Data Processing Services, Inc.), a California corporation. Pay USA of New Jersey, Inc.(formerly Delta Acquisition, Inc.), a New York corporation. Key-ACA, Inc., a Delaware corporation. MCC Corporation, a New Jersey corporation. Wholly-owned subsidiaries of MCC Corporation: MCC Key Services, Inc., a New Jersey corporation MICR Corporate Services, a New York corporation. EX-23 5 INDEPENDENT AUDITORS' REPORT We consent to the incorporation by reference in a Registration Statement on Form S-8 covering a Stock Option and Stock Appreciation Rights Plan relating to 700,000 common shares and a Registration Statement No. 33-94040 on Form S-3 of Computer Outsourcing Services, Inc. of our report dated January 10, 1997 appearing in this Annual Report on Form 10-KSB for the year ended October 31, 1996 /s/ Deloitte & Touche LLP New York, New York January 27, 1997 EX-27 6
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS INCLUDED IN THE COMPANY'S ANNUAL REPORT ON FORM 10-KSB AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR OCT-31-1996 OCT-31-1996 1,083,545 0 3,716,343 (305,874) 0 5,687,731 3,132,847 (4,248,932) 19,309,397 4,825,577 1,914,009 0 0 37,348 11,562,098 19,309,397 0 29,051,368 0 20,635,981 7,462,721 116,064 339,191 613,475 280,000 333,475 0 0 0 333,475 0.08 0.08 NET INCLUDES LONG-TERM PORTION OF CAPITAL LEASES AND OTHER LONG-TERM DEBT, LESS CURRENT PORTION INCLUDED IN CURRENT LIABILITIES. INCLUDES PAID-IN-CAPITAL, RETAINED EARNINGS, AND UNAMORTIZED DEFERRED COSTS ARISING FROM A FINANCING AND CONSULTING AGREEMENT. INCLUDES DATA PROCESSING AND SELLING COSTS. GENERAL AND ADMINISTRATIVE EXPENSES, INCLUDING THE "LOSS PROVISION" SHOWN BELOW.
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