-----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, HHk2+5y3OENH1CfHOD89rSOQA8OlxW3qRRMW/83Uv1u+EmhrzkztScA6PCS0BPzS bxbtzA2kjG1Vays1NgtdTw== 0000893816-99-000009.txt : 19990915 0000893816-99-000009.hdr.sgml : 19990915 ACCESSION NUMBER: 0000893816-99-000009 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990731 FILED AS OF DATE: 19990914 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: 10QSB SEC ACT: SEC FILE NUMBER: 000-20824 FILM NUMBER: 99711070 BUSINESS ADDRESS: STREET 1: 2 CHRISTIE HEIGHTS STREET CITY: LEONIA STATE: NJ ZIP: 07605 BUSINESS PHONE: 2018404700 10QSB 1 U. S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: July 31, 1999 Commission file number: 0-20824 COMPUTER OUTSOURCING SERVICES, INC. ----------------------------------------------------------------- (Exact name of small business issuer as specified in its charter) New York 13-3252333 ------------------------------- ------------------ (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 2 Christie Heights Street Leonia, New Jersey 07605 ---------------------------------------------------- (Address of principal executive offices) (201) 840-4700 --------------------------- (Issuer's telephone number) Check whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] There were 4,737,915 shares of the registrant's Common Stock, $0.01 par value, outstanding as of September 14, 1999. Transitional Small Business Disclosure Form (check one): Yes [ ] No [X] Page 1 of 19 PART I - FINANCIAL INFORMATION ITEM 1. Financial Statements COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS July 31, 1999 October 31, 1998 ---------------- ---------------- (Unaudited) ASSETS CURRENT ASSETS: Cash and equivalents $ 3,686,673 $ 9,403,006 Marketable debt securities, at cost which approximates market value 1,238,905 3,218,170 Trade accounts receivable, net of allowance for doubtful accounts of $296,440 and $216,659 6,249,834 4,452,117 Prepaid current income taxes 401,557 - Deferred income taxes - current 703,627 603,627 Net assets held for sale - 229,289 Prepaid expenses and other current assets 1,619,628 1,179,539 ----------- ----------- 13,900,224 19,085,748 ----------- ----------- PROPERTY and EQUIPMENT, net 2,457,822 2,508,875 ----------- ----------- OTHER ASSETS: Deferred software, net 2,055,179 1,803,013 Intangibles, net 8,641,263 2,221,842 Due from related parties, net 131,430 89,313 Deferred income taxes 367,142 718,341 Security deposits and other non-current assets 558,961 521,404 ----------- ----------- 11,753,975 5,353,913 ----------- ----------- TOTAL ASSETS $ 28,112,021 $ 26,948,536 =========== =========== See Notes to Consolidated Interim Financial Statements (Unaudited) Page 2 of 19 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS July 31, 1999 October 31, 1998 ---------------- ---------------- (Unaudited) LIABILITIES and STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 1,572,244 $ 1,029,406 Current portion of long-term debt and capitalized lease obligations 27,069 260,277 Income taxes payable - 2,468,747 Current portion of accrued loss on office sublease 251,653 365,495 Accrued expenses 981,268 2,000,355 Customer deposits and other current liabilities 118,539 202,787 ----------- ----------- 2,950,773 6,327,067 ----------- ----------- OTHER LIABILITIES: Long-term debt and capitalized lease obligations - 11,510 Accrued loss on office sublease 1,622,152 2,016,606 Deferred income from a non-competition, confidentiality, and conduct of business agreement 640,000 1,000,000 ----------- ----------- 2,262,152 3,028,116 ----------- ----------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock, $0.01 par value; 1,000,000 shares authorized, none issued - - Common stock, $0.01 par value; 10,000,000 shares authorized; shares issued and outstanding: 4,737,915 and 4,285,715 47,379 42,857 Additional paid-in capital 15,285,825 11,946,837 Treasury stock at cost; 1,000 shares (7,313) - Retained earnings 7,573,205 5,603,659 ----------- ----------- 22,899,096 17,593,353 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 28,112,021 $ 26,948,536 =========== =========== See Notes to Consolidated Interim Financial Statements (Unaudited) Page 3 of 19 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited) Nine Months ended Three Months ended July 31, July 31, ------------------------ ------------------------ 1999 1998 1999 1998 ----------- ----------- ----------- ----------- REVENUES $26,375,499 $22,751,227 $ 9,072,218 $ 7,617,026 ----------- ----------- ----------- ----------- COSTS and EXPENSES: Data processing costs 17,680,781 14,819,111 6,016,716 5,027,780 Selling and promotion costs 1,959,569 992,652 674,180 358,466 General and administrative expenses 3,767,337 4,664,770 1,494,318 1,517,492 Interest income, net (226,334) (396,648) (47,519) (155,786) ----------- ----------- ----------- ----------- 23,181,353 20,079,885 8,137,695 6,747,952 ----------- ----------- ----------- ----------- Income from continuing operations before provision for income taxes 3,194,146 2,671,342 934,523 869,074 Provision for income taxes 1,224,600 1,097,846 298,200 297,076 ----------- ----------- ----------- ----------- Income from continuing operations 1,969,546 1,573,496 636,323 571,998 Loss from discontinued operation, net of income tax benefit of $76,034 - (60,509) - - Gain on sale of discontinued operation, net of income tax provision - 2,092,009 - 491,088 ----------- ----------- ----------- ----------- NET INCOME $ 1,969,546 $ 3,604,996 $ 636,323 $ 1,063,086 =========== =========== =========== =========== See Notes to Consolidated Interim Financial Statements (Unaudited) Page 4 of 19 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited) Nine Months ended Three Months ended July 31, July 31, ------------------------ ------------------------ 1999 1998 1999 1998 ----------- ----------- ----------- ----------- BASIC EARNINGS PER SHARE: Income from continuing operations $ 0.43 $ 0.40 $ 0.13 $ 0.14 Loss from discontinued operation - (0.02) - - Gain on sale of discontinued operation - 0.52 - 0.11 ----------- ----------- ----------- ----------- Net income per basic share $ 0.43 $ 0.90 $ 0.13 $ 0.25 =========== =========== =========== =========== WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING 4,602,693 3,985,296 4,717,212 4,177,866 =========== =========== =========== =========== DILUTED EARNINGS PER SHARE: Income from continuing operations $ 0.40 $ 0.36 $ 0.13 $ 0.13 Loss from discontinued operation - (0.01) - - Gain on sale of discontinued operation - 0.48 - 0.10 ----------- ----------- ----------- ----------- Net income per diluted share $ 0.40 $ 0.83 $ 0.13 $ 0.23 =========== =========== =========== =========== WEIGHTED AVERAGE NUMBER OF SHARES and EQUIVALENTS OUTSTANDING 4,927,278 4,360,804 5,026,681 4,571,900 =========== =========== =========== =========== See Notes to Consolidated Interim Financial Statements (Unaudited) Page 5 of 19 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW (Unaudited) Nine Months ended July 31, ------------------------------- 1999 1998 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Income from continuing operations $ 1,969,546 $ 1,573,496 Adjustments to reconcile net income to cash (used in)/provided by operating activities: Depreciation and amortization 1,069,183 956,670 Deferred income taxes 251,199 (35,353) Decrease/(increase) in: Trade accounts receivable (1,797,717) (714,865) Prepaid expenses and other current assets (440,089) (369,889) Security deposits and other non-current assets (2,311) (48,992) Increase/(decrease) in: Accounts payable 542,838 (162,218) Income taxes payable (674,290) 120,092 Accrued expenses (1,040,010) (36,198) Customer deposits and other current liabilities (84,248) (78,295) ----------- ----------- Net cash (used in)/provided by operating activities (205,899) 1,204,448 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (474,320) (1,227,425) Disposal of equipment - 14,960 Redemption of investments in marketable debt securities 1,979,265 - Proceeds from sale of the Payroll Division - 13,650,000 Payment of expenses related to sale of the Payroll Division (337,078) (1,795,898) Payment of taxes on gain related to sale of the Payroll Division (2,196,014) - Payment for the purchase of certain assets and the business of Enterprise Technology Group, Inc. (the "Enterprise Purchase") (4,000,000) - Payment of expenses related to the Enterprise Purchase (293,701) - Payments received for assets held for sale 82,696 - Increase in deferred software costs (639,441) (603,311) ----------- ----------- Net cash (used in)/provided by investing activities $(5,878,593) $10,038,326 ----------- ----------- Continued on next page See Notes to Consolidated Interim Financial Statements (Unaudited) Page 6 of 19 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW (Unaudited - Continued) Nine Months ended July 31, ------------------------------- 1999 1998 ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of long-term debt and capital lease obligations $ (244,720) $(2,097,235) Repayments/(borrowings) by related parties, net (42,117) (47,218) Purchases of treasury stock (7,313) - Proceeds from the exercises of stock options and warrants 662,309 1,662,186 ----------- ----------- Net cash provided by/(used in) financing activities 368,159 (482,267) ----------- ----------- CASH FLOWS FROM DISCONTINUED OPERATION: Loss from discontinued operation - (60,509) Adjustments to reconcile loss from discontinued operation to cash used in discontinued operation: Depreciation and amortization - 151,118 Increase in net assets of discontinued operation - (307,813) ----------- ----------- Net cash used in discontinued operation - (217,204) ----------- ----------- Net (decrease)/increase in cash and equivalents (5,716,333) 10,543,303 Cash and equivalents at the beginning of the period 9,403,006 972,459 ----------- ----------- Cash and equivalents at the end of the period $ 3,686,673 $11,515,762 =========== =========== SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid during the period for: Interest expense $ 22,922 $ 110,622 =========== =========== Income taxes $ 3,815,968 $ 1,013,106 =========== =========== SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING ACTIVITIES: Note received for a portion of the sales price of the Payroll Division $ - $ 750,000 =========== =========== Stock issued for a portion of the Enterprise Purchase $ 2,681,201 $ - =========== =========== See Notes to Consolidated Interim Financial Statements (Unaudited) Page 7 of 19 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Common Par Paid in Treasury Retained Shares Value Capital Stock Earnings Total --------- ------- ----------- -------- ---------- ----------- Balance, October 31, 1998 4,285,715 $42,857 $11,946,837 - $5,603,659 $17,593,353 Stock issued for the Enterprise Purchase 300,000 3,000 2,678,201 2,681,201 Exercises of stock options 152,200 1,522 660,077 662,309 Purchase of treasury stock (7,313) (7,313) Net income 1,969,546 1,969,546 --------- ------- ----------- -------- ---------- ----------- Balance, July 31, 1999 4,737,915 $47,379 $15,285,825 $(7,313) $7,573,205 $22,899,096 ========= ======= =========== ======== ========== =========== See Notes to Consolidated Interim Financial Statements (Unaudited) Page 8 of 19 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The consolidated balance sheet as of July 31, 1999, and the consolidated statements of income and cash flows for the nine and three month periods ended July 31, 1999 and 1998, have been prepared by the Company without audit. In the opinion of management, all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position, results of operations, and cash flows for the periods indicated have been made. The results of operations for the periods ended July 31, 1999 and 1998 are not necessarily indicative of the operating results for the full fiscal years. Certain reclassifications have been made to the prior periods to conform to the current presentation. Certain disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These consolidated interim financial statements should be read in conjunction with the Company's Annual Report on Form 10-KSB for the fiscal year ended October 31, 1998. Effective November 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income," ("SFAS 130"). SFAS 130 establishes new rules for reporting comprehensive income and its components; however, the adoption of this statement had no impact on the Company's net income or shareholders' equity. The Company did not have any "comprehensive income" within the scope of SFAS 130 during either of the three or nine month periods ended on July 31, 1999 or July 31, 1998. The consolidated financial statements include the accounts of Computer Outsourcing Services, Inc. and its wholly-owned subsidiaries (collectively, the "Company"). All significant intercompany balances and transactions have been eliminated. 2. SALE OF THE PAYROLL DIVISION On December 19, 1997, the Company consummated the sale (the "Sale") of all the outstanding capital stock of Daton Pay USA, Inc., NEDS, Inc., Pay USA of New Jersey, Inc., and Key-ACA, Inc., each a wholly-owned subsidiary of the Company, and together comprising the Payroll Division ("Pay USA"), to Zurich Payroll Solutions, Ltd. ("Zurich" or the "Buyer"). At closing, the Company received $11,460,000, of which $10,710,000 was in cash and $750,000 was in the form of a note from the Buyer. The note plus accrued interest was paid in full in August 1998. The terms of the Sale also provided for an additional payment by the Buyer of up to $1,500,000, which amount was contingent on the revenue of Pay USA for the three months following the sale. On June 1, 1998, the Company received the entire $1,500,000 contingent payment. The Company recognized a gain, net of tax, of approximately $1,700,000 in its fiscal year ended October 31, 1998, as a result of the sale of Pay USA. Page 9 of 19 Pursuant to the terms of the Sale, the Company agreed to provide the Buyer with processing services in connection with the continuing operations of Pay USA. The Company agreed to provide these services through December 31, 1999 for an initial payment of $500,000, a fixed monthly fee of $16,000 (plus a fixed amount for telephone line charges), and other monthly fees based on the level of services provided. The Buyer also paid the Company $1,440,000 at closing for the Company's agreement to refrain from (1) directly or indirectly competing with Pay USA, except as permitted in the agreement; (2) providing processing services to third parties if such processing services permitted those parties to compete with Pay USA in certain payroll processing and related activities; (3) disclosing information about Pay USA's customers; and (4) engaging in any activity that could be materially detrimental to Pay USA's business or reputation. The $1,440,000 is being amortized over the term of the agreement. The amortization of such income is included in income from continuing operations. Amortization was $360,000 and $320,000 for the nine month periods ended July 31, 1999 and 1998, respectively. For the period from November 1, 1997 through the date of the Sale, revenues related to the discontinued operation approximated $1,116,700 and the pretax operating loss approximated $136,500. 3. ACQUISITION On December 18, 1998, a subsidiary of the Company purchased certain assets and the business of Enterprise Technology Group, Incorporated ("Enterprise") for $4,000,000 in cash and 300,000 shares of the Company's common stock. Certain additional consideration in the form of cash and common stock may be payable, at various times, based upon the future performance of the acquired business over the period ending December 31, 2001. On December 28, 1998, the subsidiary changed its name to ETG, Inc. The Company used cash on hand for the payment of $4,000,000 at closing. The 300,000 shares of common stock had a value of $2,681,200 on the closing date. The Company also incurred costs of approximately $294,000 to complete the acquisition. The assets acquired consist predominately of intangibles associated with the business of providing information technology infrastructure management solutions to large companies and institutions. In connection with the acquisition, Enterprise and its principal shareholders entered into non-competition and non-solicitation agreements with the Company. A value of $50,000 was assigned to these agreements. The Company also recorded $6,856,629 in excess of cost over net assets acquired (goodwill). The goodwill is being amortized on a straight-line basis over 15 years, and the costs assigned to the agreements are being amortized over the terms of such agreements (approximately 61 months). Page 10 of 19 The following unaudited pro forma financial information shows the results of operations for the nine and three months ended July 31, 1999 and July 31, 1998 assuming the acquisition of certain assets and the business of Enterprise had occurred at the beginning of each period presented: Three Months Nine months ended July 31, ended July 31, -------------------------- -------------------------- 1999 1998 1999 1998 ----------- ----------- ----------- ----------- Revenues $26,826,000 $27,422,000 $ 9,072,000 $ 9,235,000 =========== =========== =========== =========== Income from continuing operations $ 2,004,000 $ 1,996,000 $ 636,000 $ 991,000 Loss from discontinued operation - (61,000) - - Gain on sale of discontinued operation - 2,092,000 - 491,000 ----------- ----------- ----------- ----------- Net income $ 2,004,000 $ 4,027,000 $ 636,000 $ 1,482,000 =========== =========== =========== =========== Basic earnings per share: Income from continuing operations $ 0.43 $ 0.45 $ 0.13 $ 0.22 Loss from discontinued operation - (0.02) - - Gain on sale of discontinued operation - 0.47 - 0.11 ----------- ----------- ----------- ----------- Net income $ 0.43 $ 0.90 $ 0.13 $ 0.33 =========== =========== =========== =========== Diluted earnings per share: Income from continuing operations $ 0.40 $ 0.41 $ 0.13 $ 0.22 Loss from discontinued operation - (0.01) - - Gain on sale of discontinued operation - 0.43 - 0.10 ----------- ----------- ----------- ----------- Net income $ 0.40 $ 0.83 $ 0.13 $ 0.32 =========== =========== =========== =========== 4. BASIC AND DILUTED EARNINGS PER COMMON SHARE The Company has adopted Statement of Financial Accounting Standards No. 128 "Earnings per Share" ("SFAS 128"). SFAS 128 requires the presentation of basic and diluted earnings per share ("EPS"). Basic EPS is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during each period. Diluted EPS is computed using the weighted average number of common shares plus the dilutive effect of common stock equivalents. Stock options and warrants which are anti-dilutive are excluded from the computation of weighted average shares outstanding. Certain options which currently are anti-dilutive may be dilutive in the future. Page 11 of 19 5. STOCK OPTIONS The Company accounts for options granted under the 1992 Stock Option and Stock Appreciation Rights Plan (the "Plan") in accordance with Accounting Principles Board Opinion No. 25 and related Interpretations in accounting for its stock options. Accordingly, no compensation cost has been recognized for stock option awards. Had the compensation cost been determined in accordance with Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensa- tion," the Company's pro forma income/(loss) and pro forma income/(loss) per common share for the nine months ended July 31, 1999 and 1998 would be as follows: 1999 1998 ----------------------- ----------------------- Historical Pro Forma Historical Pro Forma ---------- ---------- ---------- ---------- Income from continuing operations $1,970,000 $1,690,000 $1,573,000 $1,385,000 Loss from discontinued operation - - (61,000) (61,000) Gain on sale of discontinued operation - - 2,092,000 2,092,000 ---------- ---------- ---------- ---------- Net income $1,970,000 $1,690,000 $3,605,000 $3,416,000 ========== ========== ========== ========== Income/(loss) per diluted common share: Income from continuing operations $ 0.40 $ 0.34 $ 0.36 $ 0.32 Loss from discontinued operation - - (0.01) (0.01) Gain on sale of discontinued operation - - 0.48 0.48 ---------- ---------- ---------- ---------- Net income $ 0.40 $ 0.34 $ 0.83 $ 0.79 ========== ========== ========== ========== All incentive stock options under the Plan, other than those granted to any person holding more than 10% of the total combined voting power of all classes of outstanding stock, are granted at the fair market value of the common stock at the grant date. The weighted average fair value of the stock options granted during the nine months ended July 31, 1999 and 1998 was $519,300 and $704,000, respectively. The fair value of each stock option grant is estimated on the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 1999: a risk-free interest rate of 5.71%; expected lives of between one-half and six years; and expected volatility of 49.5%. Page 12 of 19 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS - NINE MONTH PERIODS ENDED July 31, 1999 and 1998 On December 19, 1997, the Company sold four subsidiaries comprising the Payroll Division. In the accompanying financial statements, all revenues and expenses of the Payroll Division were combined in the loss from discontinued operation. The following discussion relates only to continuing operations. On December 18, 1998, the Company acquired certain assets and the business of Enterprise Technology Group, Incorporated (the "Enterprise Purchase"). Enter- prise Technology Group provided information technology consulting services with a focus on infrastructure management solutions. During the nine month period ended July 31, 1999, revenues from continuing operations increased $3,624,000 (16%) to $26,375,000 from $22,751,000 for the comparable period ended July 31, 1998. The Company's Year-2000 revenues declined by approximately $1,233,000 from $1,531,000 to $549,000 for the period ended July 31, 1999. Increased revenues from other activities substantially exceeded the decline in Year-2000 revenues. Data processing costs increased $2,862,000 to $17,681,000 (67% of revenues) during the current period compared with $14,819,000 (65% of revenues) in the prior year's period. Data processing costs increased as a result of higher sales. Selling and promotion costs increased $967,000 to $1,960,000 (7% of revenues) during the current period compared with $993,000 (4% of revenues) in the prior year's period. The increase is principally attributable to additional sales staff. General and administrative expenses decreased $898,000 to $3,767,000 from $4,665,000, and declined to 14% of revenues for the nine months ended July 31, 1999 from 21% of revenues for the prior year's period. Certain savings achieved by the Company were offset by expenses related to the Enterprise Purchase and new offices in Charlotte, North Carolina and New Haven, Con- necticut. Amortization of intangibles acquired in connection with the Enterprise Purchase was $267,000 for the nine months ended July 31, 1999. The Company recorded net interest income of $226,000 in the current nine month period compared with net interest income of $397,000 in the nine months ended July 31, 1998. The decrease of $171,000 reflects the reduction in cash and investment balances as a result of the Enterprise Purchase, the payment of taxes related to the sale of the Payroll Division, and the repayment of substantially all of the Company's long-term debt. The Company recorded a 25% increase in income from continuing operations to $1,970,000 ($0.43 and $0.40 per share for basic and diluted shares, respec- tively) for the period ended July 31, 1999 compared with $1,573,000 ($0.40 and $0.36 per share for basic and diluted shares, respectively) for the period ended July 31, 1998. Page 13 of 19 RESULTS OF OPERATIONS - THREE MONTH PERIODS ENDED JULY 31, 1999 and 1998 During the quarter ended July 31, 1999, revenues from continuing operations increased $1,455,000 (19%) to $9,072,000 from $7,617,000 for the quarter ended July 31, 1998. The Company's Year-2000 revenues declined by approximately $498,000 from $549,000 to $51,000 for the quarter ended July 31, 1999. Increased revenues from other activities substantially exceeded the decline in Year-2000 revenues. Data processing costs increased $989,000 to $6,017,000 (66% of revenues) during the current quarter compared with $5,028,000 (66% of revenues) in the prior year's quarter. Data processing costs increased as a result of higher sales. Selling and promotion costs increased $316,000 to $674,000 (7% of revenues) during the current quarter compared with $358,000 (5% of revenues) in the prior year's quarter. The increase is principally attributable to additional sales staff. General and administrative expenses decreased $23,000 to $1,494,000 from $1,517,000 and declined to 16% of revenues for the three months ended July 31, 1999 from 20% of revenues for the prior year's quarter. Certain savings achieved by the Company were offset by expenses related to the Enterprise Purchase and new offices in Charlotte, North Carolina and New Haven, Con- necticut. Amortization of intangibles acquired in connection with the Enterprise Purchase was $114,000 for the three months ended July 31, 1999. The Company recorded net interest income of $48,000 in the current quarter compared with net interest income of $156,000 in the quarter ended July 31, 1998. The decrease of $108,000 reflects the reduction in cash and investment balances as a result of the Enterprise Purchase, the payment of taxes related to the sale of the Payroll Division, and the repayment of substantially all of the Company's long-term debt. The Company recorded an 11% increase in income from continuing operations to $636,000 ($0.13 per share for both basic and diluted shares) for the quarter ended July 31, 1999 compared with $572,000 ($0.14 and $0.13 per share for basic and diluted shares, respectively) for the quarter ended July 31, 1998. Page 14 of 19 LIQUIDITY AND CAPITAL RESOURCES During the nine months ended July 31, 1999, the Company used net cash in operating activities of approximately $206,000 primarily as a result of (a) an increase in accounts receivable of $1,798,000 and prepaid expenses of $440,000 and a decrease in accrued expenses and income taxes payable of $1,714,000 offset by (b) $3,290,000 in income from operations before deductions for depreciation, amortization and deferred income taxes and, an increase in accounts payable of $543,000. In investing activities, the Company invested $4,294,000 for the Enterprise Purchase, and spent $2,533,000 for tax payments and other expenses related to the sale of the Payroll Division. In addition, the Company invested approxi- mately $474,000 in equipment, new software products, and other fixed assets and $639,000 in product development and enhancement. Finally, the Company realized $1,979,000 upon disposition of marketable securities. In financing activities, the Company received $662,000, primarily generated from exercises of employee stock options and made $245,000 in payments on long-term debt. The Company currently has only $27,000 of remaining debt, all of which will be repaid within the next twelve months. The Company is retooling a portion of its data center to provide colocation and web hosting services. The capital costs associated with this activity will be approximately $3,000,000. As of July 31, 1999, the Company had cash and equivalents and highly liquid, short-term investments aggregating approximately $4,926,000. The Company believes that its cash, other liquid assets, funds generated from operations, and potential borrowing capacity will provide adequate resources to fund its ongoing operating requirements. OTHER MATTERS Certain of the Company's computer systems may need to be reprogrammed to correct what is known as the Year 2000 Problem ("Y2K"). This is a condition whereby a program does not properly interpret a two-digit year, reading "00" as 1900 rather than 2000. As a result, nearly all computer systems, except for the most recent software and hardware versions, may produce computing errors or fail to function after December 31, 1999. The Company is also at risk from Y2K failures on the part of its major business counterparts, including suppliers, distributors, licensees, and manufacturers, as well as potential failures in public and private infrastructures services, including electricity, water, gas, transportation, and communications. Failures resulting from the Y2K problem could adversely affect the Company's ability to service its clients. The Company has appointed a senior officer, reporting directly to the President, as the Y2K Compliance Coordinator. He works closely with the operations managers, senior management, and the Company's vendors. The Company has developed a multi-phased approach to resolve the Y2K issues that are reasonably within its control. The Company's approach to and the anticipated timing of each phase are described below: Page 15 of 19 Phase One - Identification. The first phase entailed identifying the technical areas, business units, and infrastructure that might be affected by the Y2K problem. The identification resulted in three primary classifications. The first is the computer and communications hardware and non-application software the Company obtains from vendors. This category consists of processing for all client and internal Company applications. The second classification is the Company's applications used to service clients and internal users. The third classification relates to all non-direct computer ("Non-IT") associated issues such as elevators, phone systems, security access systems, as well as services provided by non-computer related vendors such as utility companies. Phase One has been completed. Phase Two - Inventory. The second phase entails an inventory of all hardware and software (including business and operational applications, operating systems, and third party products) that may be at risk, and identification of key third party businesses which might most significantly impact the Company if such third parties had Y2K failures. Phase Two has been completed. Phase Three - Assessment. Once each at-risk application has been identified, it will be determined how critical the application is to client and business operations and the potential impact of failure. Applications are classified as "critical", "important", or "non-critical". A "critical" system is one that, if not operational, would cause the shutdown of all or a portion of a business unit within two weeks, while an "important" system is one that would cause such a shutdown within two months. Phase Three has been completed. Phase Four - Strategy. For applications, this phase entails the assessment of each application system (Classification Two). The application's ability to perform in Y2K, estimated cost to make Y2K compliant, availability of replacement alternatives, and for applications used for clients, the total annual revenue and expenses, are evaluated. The assessment will result in a plan to upgrade the current application, migrate to a replacement Y2K- compliant application, or cease processing of an application that produces a marginal profit. Phase Four is 99% complete. Phase Five - Remediation. The remediation phase involves creating project plans; acquiring necessary resources; implementing new hardware, software, and applications; and executing the strategies developed in Phase Four. Testing and certification is also included within this phase. For non-application systems (Classification One), Phase Five is approximately 85% completed. The delivery of Y2K-compliant products by third party vendors will have an effect on the final completion date. For application systems, (Classification Two), Phase Five is approximately 75% completed. For non-IT systems (Classification Three), Phase Five is approximately 80% completed. Testing for non-IT systems has been initiated; however, due to the Company's reliance on third party vendors for these systems, the Company cannot estimate precisely when this phase will be completed. The Company has initiated written and telephonic communications with key third party businesses. Communications with public and private providers of infrastructure services, to ascertain and evaluate their efforts in addressing Y2K compliance, has been initiated. Page 16 of 19 Phase Six - Contingency Planning. This phase entails developing an emergency plan in the event non-IT (Classification Three) or non-application systems (Classification One) malfunction or are not functional at the start of the Year 2000. The use of a "backup" computer maintained by an independent third party, alternative communications carriers, and backup generators are some of the contingencies being explored. The Company estimates that all of these plans will be completed by December 1999. Based upon its efforts to date, the Company believes that the vast majority of both its computer and its non-IT systems, including all critical and important systems, will remain up and running after January 1, 2000. Internal and external costs specifically associated with Y2K modifications for internal purposes are being expensed when incurred. Currently, the Company estimates that such costs will approximate $300,000, of which approximately $200,000 has been incurred through August 1999. FORWARD-LOOKING STATEMENTS This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. As such, final results could differ from estimates or expectations due to risks and uncertainties including but not limited to: incomplete or preliminary information; changes in government regulation and policies; continued acceptance of the Company's products and services in the marketplace; competitive factors; new products; technological changes; the Company's dependence on third party suppliers; intellectual property rights; and other risks. For any of these factors, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, as amended. Page 17 of 19 PART II - OTHER INFORMATION ITEM 4 - Submission of Matters to a Vote of Security Holders The Annual Meeting of Stockholders of the Company was held on June 23, 1999, at which the following actions were taken: (1) The Stockholders of the Company approved a plan, previously adopted by the Board of Directors, to reincorporate the Company under the laws of Delaware. This action required the affirmative vote of at least 2/3 of all outstanding shares. The plan was approved by a vote of 3,251,054 (69%) in favor with 69,616 (1.5%) opposed and 11,175 abstained. (2) The six persons named in the table below were elected as Directors of the Company for the terms as shown, or until their respective successors are duly elected and qualified. Shares Voted Shares Nominee Term For Election Withheld --------------------- ------ ------------ ------------ Zach Lonstein 3 yrs 4,361,620 21,375 Robert B. Wallach 3 yrs 4,361,620 21,375 John C. Platt 2 yrs 4,361,620 21,375 Joseph Lynaugh 2 yrs 4,361,620 21,375 Howard Waltman 1 yr 4,361,620 21,375 Warren Ousley 1 yr 4,361,620 21,375 (3) The Company's 1992 Stock Option and Stock Appreciation Rights Plan was amended to increase the number of shares for which options may be granted from 1,200,000 to 1,700,000, and to permit cashless exercises of options. The Stockholders approved this amendment by a vote of 3,073,293 in favor and 242,207 opposed with 16,350 shares abstaining ITEM 6 - Exhibits and Reports on Form 8-K (a) Exhibits: 27 Financial Data Schedule, filed electronically only. (b) Reports on Form 8-K: None. Page 18 of 19 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. COMPUTER OUTSOURCING SERVICES, INC. /s/ September 14, 1999 ------------------------------------ Zach Lonstein Chief Executive Officer /s/ September 14, 1999 ------------------------------------- Nicholas J. Letizia Chief Financial Officer Page 19 of 19 EX-27 2
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE COMPANY'S QUARTERLY REPORT ON FORM 10-QSB FOR THE PERIOD ENDED JULY 31, 1999, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENT. 9-MOS OCT-31-1999 NOV-01-1999 JUL-31-1999 3,686,673 1,238,905 6,546,274 296,440 0 13,900,224 7,827,400 5,369,578 28,112,021 2,950,773 27,069 0 0 47,379 22,851,717 28,112,021 0 26,375,499 0 17,680,781 5,726,906 103,500 18,949 3,194,146 1,224,600 1,969,546 0 0 0 1,969,546 0.43 0.40 ALL CURRENT
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