-----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, BXjPL5q2GLuk5NdJ7P5ytnrOA4jlT7aCYiuuYWFPPXN2ppRCCDG35AWp3zz6pkhh 5JU7pWPqN5yhOHwJLG9f5g== 0001042645-99-000027.txt : 19990215 0001042645-99-000027.hdr.sgml : 19990215 ACCESSION NUMBER: 0001042645-99-000027 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19981031 FILED AS OF DATE: 19990212 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: SEC FILE NUMBER: 000-20824 FILM NUMBER: 99537578 BUSINESS ADDRESS: STREET 1: 360 WEST 31ST ST STREET 2: 11TH FLOOR CITY: NEW YORK STATE: NY ZIP: 10001 BUSINESS PHONE: 2125643730 10KSB 1 COMPUTER OUTSOURCING SERVICES, INC. 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, 1998 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) 2 Christie Heights Street Leonia, NJ 07605 ------------------------------------ ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (201) 840-4700 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 statements 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, 1998, registrant's consolidated revenues from continuing operations were $30,403,381. On January 15, 1999, the aggregate market value of the outstanding shares of voting stock held by non-affiliates of the registrant was approximately $34,571,000. On January 15, 1999, 4,616,115 shares of the registrant's Common Stock, $0.01 par value, were outstanding. A schedule of Exhibits filed herewith or incorporated by reference appears in Item 13 beginning on page 23. Transitional Small Business Disclosure Format: / / Yes /X/ No Page 1 of 52 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 services in the form of data center and business process solutions to companies, institutions, and government agencies. The Company has grown through strategic acquisitions as well as business development. The Company's core business is providing information technology, outsourcing solutions to large- and medium-size enterprises. It provides information processing services in a customized environment to a broad array of clients in a variety of industries. Due to rapid changes and increasing complexities in information technology, outsourcing is an efficient solution for many businesses. The Company expanded its information technology services to include leading edge infrastructure management consulting to Global 2000 companies through the acquisition of the business and certain assets of Enterprise Technology Group, Inc. on December 18, 1998. The Company conducts this activity through a new wholly-owned subsidiary, ETG, Inc. ("ETG"). Additionally, the Company had been in the business of providing comprehensive payroll processing and tax filing services. In December 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 bearing interest at 8.5% per annum. 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. An additional payment of $1,500,000 was received in June 1998. 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. 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. Page 2 of 52 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, software management 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. 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 technological reengineering; - Access to experienced resources to perform selected information processing functions; - Reduction of operating costs; and o Reduction of future investment in infrastructure not directly related to the core business activity. Business Strategy The Company's objective is to provide a comprehensive computer outsourcing alternative to meet all or part of its clients' information technology requirements. The Company's strategy includes the following key elements: Information Technology Services The Company's Information Technology Services allow clients to effectively process and manage core business applications such as general ledger, accounts payable, accounts 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 processing requirements Clients utilize the Company's information systems in order to focus on their core business and customer related activities while significantly reducing their operating costs. The Company has developed industry specific experience in markets which include publishing, financial services, apparel, consumer products, and health care. Its clients in these markets rely on the Company to combine its in-depth industry knowledge with information technology solutions that uniquely meet their business objectives and information processing requirements. Typically, the Company enters into contracts with clients providing for automatic renewal unless prior written notice is given. The contracts have varying terms typically ranging from one to five years. The contracts specify the rates for the Company's services. Such rates vary according to factors such as the volume and types of services used by a particular client. In some instances, a client may terminate a contract early by paying a penalty. In 1997, the Company received notice from its largest publishing client that it was exercising an option to cancel after June 30, 1999 by paying a cash penalty. Page 3 of 52 Computer Facilities Management Services The Company provides Computer Facilities Management Services at its state of the art data center to medium and large companies that outsource all or part of their Information Processing functions. These services include the Company's core Information Processing and Communications/Network Management Services which operate 24 hours per day, each day of the year. Such services are provided from a secure environment with critical back-up and safeguard systems. Electronic Commerce The Company has also developed an electronic data interchange ("EDI") subsystem. 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 automated Advance Ship Notices and interfaces with a stand-alone scanning system. The EDI subsystem allows a small apparel manufacturer or importer to conform to the EDI requirements of various large retail chains and to continue as an approved vendor of those chains without having to acquire its own data processing and interchange capability Year 2000 Testing Services The Company's Year 2000 Solution Center provides a customized production testing environment, technical production assistance, and operational support for the full range of Year 2000 testing compliance. This service allows a client to continue to run its business without impacting its internal data processing systems. Business Process Outsourcing Services The Company provides a variety of customized data processing services designed to specific client requirements. These services include the development of proprietary software utilized to solve the information processing requirements of particular clients. The Company provides the information processing services and retains ownership of the software it develops. Industry-specific outsourcing applications and services are developed, so that the Company's in-depth knowledge of a particular industry can be applied to servicing multiple clients in that field. The Company currently provides outsourcing services to approximately 480 clients in such diverse fields as financial services, publishing, home health care, apparel, and consumer products. Enterprise Infrastructure Consulting ETG's principal expertise is analyzing large data center operations to maximize operating performance and to minimize operating costs. Consulting services by this new subsidiary covers hardware; automation; disaster recovery planning; systems management; storage management; and performance reporting. ETG concentrates on aligning a client's information systems with the client's business focus to strengthen the client's technology infrastructure to enable a client to increase its competitiveness and business opportunities. Page 4 of 52 ETG's consultants perform analytical studies to identify areas of improvement. The consultants then develop a transformation plan, manage the implementation process, and monitor the results. ETG's clients include major financial and health care institutions. 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, which the Company believes generally exceeds industry standards. Because of its attention to customer service, the Company's client relationships have tended to be long-term with very low turnover, generating recurring and predictable revenues. 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. 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. The Company seeks to develop close, collaborative relationships with each client and to respond quickly to each client's needs. The client is linked to the Company's systems by leased data circuits. The Company assigns a service representative to each customer to supervise 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 software and hardware problems, and make software upgrades at any time. The Company maintains a quality assurance program which includes periodic testing of the Company's systems and services. Marketing and Sales The Company currently targets its principal marketing efforts to medium-size companies or divisions of large companies in industries such as financial services, publishing, apparel, and health care. No single client is responsible for 10% or more of the Company's revenue. The Company uses a direct-sales marketing approach in which its sales representatives solicit client appointments and make sales calls. Page 5 of 52 Initial contact is made by a variety of methods, including seminars, 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. Recently, the Company has broadened its customer base beyond the New York Metropolitan Area. In addition to internal sales efforts, the Company has formed strategic alliances to generate additional sales. ETG has entered into agreements with certain companies and individuals that would be entitled to receive compensation for their assistance in procuring consulting engagements. 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 2% and 3% of its gross revenues on software development costs. The Company is committed to maintaining 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 computer services companies and divisions of diversified enterprises, as well as the ability of existing and potential clients to install and operate their own computer 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 Affiliated Computer Services, Inc., Computer Sciences Corp., Electronic Data Systems Corporation, IBM Corporation, and Perot Systems. Aside from such major companies, the outsourcing services 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. Technological Changes Although the Company is not aware of any pending or prospective technological changes 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 changes do 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. Page 6 of 52 Intellectual Property Matters The Company's systems and processes are not protected by patents or any registered copyrights, trademarks, 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 safeguards, 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 information, and maintains numerous security procedures to help ensure that the confidentiality 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. Employees As of January 15, 1999, the Company had approximately 302 full-time and 22 part-time employees. None of the Company's employees is represented by a labor organization 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 leases a facility, containing approximately 67,000 square feet in Leonia, NJ for its headquarters and data center. The lease expires on December 31, 2008. Currently, a subtenant occupies approximately 5,750 square feet of this facility. Page 7 of 52 The Company leases office space of approximately 37,200 square feet in a New York City building where the Company has had a location since 1985. A primary lease with the landlord covers 31,500 square feet and a sublease covers the balance of 5,700 square feet. The primary lease expires on December 31, 2008, and the sublease expires on December 31, 2009. The Company has subleased the space subject to the primary lease to a subtenant under a sublease expiring on December 30, 2008, a day before the expiration of the primary lease. Currently, the Company primarily utilizes the New York space for data entry operations. The Company also maintains a data entry center of approximately 5,700 square feet in Aberdeen, NJ pursuant to a lease expiring on June 30, 2000. It also leases 11,510 square feet of office space in Charlotte, NC pursuant to a lease that expires on January 31, 2002, and maintains a 2,000 square foot sales office in Hartford, CT under a lease expiring on February 1, 2001. ETG maintains offices of approximately 3,950 square feet in Secaucus, NJ and 1,050 square feet in Glendale, CA. These leases expire on September 30, 2001 and June 30, 2003, respectively. The Company generally leases its equipment under standard commercial leases, in some cases 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 anticipated increases. Item 3. Legal Proceedings ----------------- Computer Outsourcing Services, Inc. v. Anton P. Donde, et al. In February 1998, the Company filed a lawsuit in the Federal District Court for the Southern District of New York, 98 Civ. 0956 (RLC), against Anton P. Donde and a trust controlled by Anton and Detta Donde. Anton Donde was formerly a director and vice president of the Company and was responsible for its Payroll Division. In December 1997, that division was sold to Zurich . In the lawsuit, the Company alleged that Mr. Donde intentionally attempted to interfere with such sale thereby causing damages to the Company. The Company's Board of Directors subsequently terminated Mr. Donde's employment, and Mr. Donde resigned as a director. In April 1998, Mr. Donde and the trust filed an answer denying the Company's claims, a counter claim against the Company, and third party claims alleging substantial damages against the Company and its current and former directors, including wrongful termination, breach of contract, breach of the duty of good faith, fraud, and RICO violations. In May 1998, this litigation was settled. The impact of such settlement was reflected in the Company's financial statements. Item 4. Submission of Matters to a Vote of Security Holders --------------------------------------------------- None. Page 8 of 52 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, 1997: 1st Quarter (November 1, 1996 - January 31, 1997) $4.500 $2.875 2nd Quarter (February 1, 1997 - April 30, 1997) 6.000 3.750 3rd Quarter (May 1, 1997 - July 31, 1997) 5.500 3.938 4th Quarter (August 1, 1997 - October 31, 1997) 9.500 4.875 For the year ended October 31, 1998: 1st Quarter (November 1, 1997 - January 31, 1998) 10.875 7.250 2nd Quarter (February 1, 1998 - April 30, 1998) 12.125 7.500 3rd Quarter (May 1, 1998 - July 31, 1998) 11.250 8.250 4th Quarter (August 1, 1998 - October 31, 1998) 10.938 7.250 The closing price of the Company's common stock on NASDAQ-NMS on January 15, 1999 was $12.75 per share. The Company has approximately 94 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. The Company intends to retain earnings to finance growth. Page 9 of 52 During the prior three years, the Company sold or issued its common stock, exempt from registration as private placements pursuant to Section 4(2) of the Securities Act of 1933, as shown in the following table.
AMOUNT OF CASH OR NUMBER OF DATE(S) OF THE EXPLANATION OF THE CONSIDERATION TO WHOM ISSUED COMMON SHARES TRANSACTION TRANSACTION RECEIVED NON-CASH ISSUANCES: Exercises of the option by means Five exercises of an offset against an obligation Holder of a pre-IPO between 12/95 of the Company to the option- non-qualified option 123,445 and 3/97 holder $ 487,282 Issuance of common stock as Outside counsel 22,000 9/97 payment for legal services rendered $ 89,375 Settlement of a portion of Seller of a subsidiary to contingent consideration as called the Company 23,906 4/96 for in the Agreement of Sale $ 153,000 Settlement of a portion of Seller of assets to the consideration as called for in the Company 20,000 9/98 Purchase Agreement $ 180,000 ISSUANCES FOR CASH: Holder of a pre-IPO non-qualified option 100,000 5/98 Exercise of the option for cash $ 1,000 Five exercises Exercises for cash of warrants The Underwriter(s) for the between 1/98 and given in connection with the IPO Company's IPO 66,725 2/98 $ 420,368 Exercises for cash of warrants A consultant to the Company given in connection with a 75,240 3/98 consulting agreement $ 407,500
Page 10 of 52 Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations --------------------------------------------- Results of Operations On December 19, 1997, the Company sold the four subsidiaries comprising the Payroll Division at a gain of approximately $1,700,000, net of income taxes ($0.38 per share, diluted). In the accompanying financial statements, all revenues and expenses of the Payroll Division have been classified as discontinued operations. The following discussion focuses on continuing operations. Fiscal Year 1998 as Compared to Fiscal Year 1997 For the year ended October 31, 1998, revenues increased $6,007,000 (24.6%) to $30,403,000 from $24,396,000 recorded in the year ended October 31, 1997. This increase resulted primarily from new contracts at higher levels than previously experienced. Data processing costs increased $2,757,000 to $19,829,000 (65.2% of revenues) during the current year, compared to $17,072,000 (70.0% of revenues) in the prior year. The dollar increase is associated with greater sales volume. As a percentage of revenues, however, data processing costs declined significantly, reflecting a more efficient utilization of resources due to the consolidation of operations. Selling and promotion costs increased $119,000 to $1,385,000, (4.6% of revenues) during the current year compared to $1,266,000 (5.2% of revenues) in the prior year. The dollar increase is associated with the rise in revenues. As a percentage of revenues, however, selling and promotion costs declined in the current year because of efficiencies of scale. General and administrative expenses increased $1,341,000 to $5,964,000 (19.6% of revenues) in the current year as compared to $4,623,000 (18.9% of revenues) in the prior year. At the end of fiscal 1997, the Company moved its New Jersey operations into a larger facility. During 1998, the Company has been consolidating computer and customer service operations into the new facility. The rise in expenses is principally due to increased rent and utilities for the new facility, as well as approximately $140,000 in moving costs. In continuing operations, the Company recorded a loss of $2,237,000 in 1998 from subletting substantially all of its office space in New York City. This one-time charge equals the undiscounted, out-of-pocket rent expense, net of sublease income, which will continue to be paid over the 10-year term of the sublease. In addition, the amount includes direct subleasing costs as well as the write-off of leasehold improvements associated with the subleased space. The total loss was $3,022,000, however, since the sale of the Payroll Division permitted the Company to reduce substantially its New York City space requirements, approximately 26% of the loss, or $786,000, was charged against the gain on the sale of the Payroll Division. Subletting the space permitted the Company to complete the consolidation of its operations in its Leonia, New Jersey facility. The consolidation will allow the Company to operate more efficiently and reduce future occupancy and other operating costs by approximately $720,000 in fiscal 1999. Although sublease receipts will be less than disbursements in future periods, the expense associated there- with will be charged against the accrual created by recording the sublease loss in 1998. The sublease loss, net of income tax benefit, resulted in a reduction of approximately $0.28 per share in diluted earnings from continuing opera- tions and $0.11 per share on the gain from the sale of the Payroll Division. Page 11 of 52 Net interest expense was $206,000 in 1997. For 1998, interest income exceeded interest expense by $548,000. The net change was $754,000. As a result of the sale of the Payroll Division and higher income from continuing operations, the Company had significantly higher cash and interest-earning assets in 1998 than in 1997. Since the Company repaid substantially all of its bank debt following the sale of the Payroll Division, total interest expense declined dramatically in 1998. The effective tax rate from continuing operations for fiscal 1998 was 30% primarily as a result of research and development tax credits. After the provision for income taxes, the Company recorded a 56.8% increase in income from continuing operations, from $688,000 ($0.17 per diluted share) for the year ended October 31, 1997, to $1,079,000 ($0.24 per diluted share) for the year ended October 31, 1998. With respect to discontinued operations, the loss decreased from $127,000 in 1997 to $76,000 in 1998. The loss per diluted share from discontinued operations was $0.03 in 1997 and $0.01 in 1998. Fiscal Year 1997 as Compared to Fiscal Year 1996 For the year ended October 31, 1997, revenues increased $3,174,000 (15.0%) to $24,396,000 from $21,222,000 recorded in the year ended October 31, 1996. This increase resulted primarily from new contracts with higher contractual amounts than previously experienced. Data processing costs increased $2,836,000 to $17,072,000 (70.0% of revenues) during the current year, compared to $14,236,000 (67.1% of revenues) in the prior year. Approximately half of this increase can be attributed to approximately $369,000 less software costs deferred in 1997 versus 1996. In addition, the servicing of some of the revenues mentioned above is more labor-intensive, resulting in a decrease in the overall profit margins. During fiscal 1998, the Company plans to consolidate certain of its data processing operations in an effort to improve profit margins. Selling and promotion costs decreased $247,000 to $1,266,000, (5.2% of revenues) during the current year compared to $1,513,000 (7.1 % of revenues) in the prior year. The decrease resulted from the consolidation of the sales and marketing efforts. General and administrative expenses increased $277,000 to $4,623,000 (19.0% of revenues) in the current year as compared to $4,346,000 (20.5% of revenues) in the prior year. During 1997, the Company provided additional accounts receivable reserve of $228,000 due to the default of a large processing client. In addition, during the fourth quarter of 1997, the Company moved its principal New Jersey location to a facility in Leonia, NJ, incurring approximately $140,000 in moving costs. Excluding these two unusual events, general and administrative expenses would have decreased by approximately $90,000, primarily from $136,800 in reductions in professional fees and $112,500 in corporate administrative salaries. Net interest expense decreased $91,000 to $206,000 in the current year, primarily due to $828,000 in principal payments during the year on various long-term debts, partially offset by interest paid on amounts borrowed late in the year under the Company's line of credit. Page 12 of 52 After the provision for income taxes, the Company recorded a 38.1% increase in profit from continuing operations from $498,000 ($0.12 per share) for the year ended October 31, 1996, to $688,000 ($0.17 per share) for the year ended October 31, 1997. Had the Company not needed to provide the $228,000 reserve as discussed above, income per share from continuing operations would have been approximately $0.20 per share. In discontinued operations, the pretax loss increased from $217,000 in 1996 to $291,000 in 1997. However, primarily as the result of the tax effect of increased income from non-taxable investments of client trust funds, the net loss from discontinued operations declined 23% from $165,000 ($0.04 per share) in the prior year to a loss of $127,000 ($0.03) in the current year. Liquidity and Capital Resources During the year ended October 31, 1998, the Company generated net cash of $2,522,000 from continuing operations principally by generating $2,346,000 in income from continuing operations before deductions for depreciation and amortization. The Company's investing activities provided $6,590,000, primarily from the sale of the Payroll Division, net of related costs and the investment of a portion of the proceeds in marketable debt securities. The Company also invested $1,501,000 for the purchase of equipment, new software products, and other fixed assets and $892,000 for product development and enhancement. In financing activities, the Company used $2,321,000 to repay long-term debt and capital leases and received $1,725,000 generated from exercises of stock warrants and employee stock options. As of October 31, 1998, the Company had cash and equivalents and highly liquid, short-term investments aggregating approximately of $12,621,000. In December 1998, the Company acquired the business and certain assets of Enterprise Technology Group, Incorporated. A portion of the purchase price included cash of $4,000,000 paid at the closing. In addition, in January 1999, the Company made income tax payments of approximately $2,711,000 relating to its tax year ended October 31, 1998. The Company believes that its cash, other liquid assets, operating cash flow, 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 infrastructure 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. Page 13 of 52 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: 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 business which might most significantly impact the Company if such third parties had Y2K failures. The non-application inventory process (Classification One) has been completed, and the inventories of key third party businesses and internal non-IT systems (Classification Three) are expected to be completed by March 31, 1999. The inventories for applications (Classification Two) are expected to be completed by April 30, 1999. 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. The assessment process is 80% completed. It is expected to be finalized by March 31, 1999. 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 - Classification Two is expected to be completed by February 28, 1999. For non-IT Classification Three, this phase involves the development of appropriate remedial strategies. Phase Four for Classification Three is expected to be completed by April 30, 1999. Page 14 of 52 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 55% 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 25% completed. For non-IT systems (Classification Three), Phase Five is approximately 20% 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, will be initiated by February 28, 1999. 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 computer software used for internal purposes will be expensed when incurred. Currently, the Company estimates that such costs will approximate $300,000. 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 factors such as incomplete or preliminary information or changes in government regulation and policies. 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. New Financial Accounting Standards During 1997, the Financial Accounting Standards Board issued the following pronouncements: Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"), Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"), and Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of and Enterprise and Related Information" ("SFAS 131"). The Company has adopted the provisions of SFAS 128 in fiscal year 1998, and the presentation of prior year financial information has been conformed to this pronouncement. The Company will adopt SFAS 130 and SFAS 131 in the fiscal year beginning November 1, 1998. Adoption of these pronouncements is not expected to have a significant impact on the Company. Page 15 of 52 Item 7. Financial Statements -------------------- The Financial Statements and Notes thereto are set forth beginning at page 27 of this Report. Item 8. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure -------------------------------------------------- On September 29, 1998, the Company notified Deloitte & Touche LLP ("D&T") that the Company's Board of Directors had voted not to engage D&T to perform the Company's audits. On October 29, 1998, the Company retained Ernst & Young LLP to perform the audit of the year ended October 31, 1998. D&T's Report on the financial statements for the years ended October 31, 1997 and 1996 did not contain an adverse opinion, disclaimer of opinion, nor any qualification or modification as to uncertainty, audit scope, or accounting principles. During the audits of the two previous fiscal years, and through the date of termination, there were no disagreements with D&T on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure. During the audits of the two previous fiscal years, and through the date of termination, there were no reportable events as defined in Regulation S-K, Item 304(a)1(v). PART III Item 9. Directors and Executive Officers Compliance with Section 16(a) of the Securities Exchange Act ------------------------------------------------------------ The name, principal occupation of, and certain information concerning each of the Executive Officers and Directors of the Company as of October 31, 1998 are set forth in the table below. Also set forth, following the table, is certain additional information regarding each individuals' business experience.
Director Since Name Positions with the Company Age - --------------- --------------------------------------------------- --------- --------------- Zach Lonstein Chairman of the Board of Directors and Chief Executive Officer 54 1984 Robert B. Wallach President and a Director 59 1992 Joseph Lynaugh Director 59 1998 Howard Waltman Director 66 1997 Jeffrey Millman Executive Vice President, Secretary and a Director 46 1992 John C. Platt Vice President, Treasurer, and a Director 45 1996 Thomas Laudati Senior Vice President 41 - Howard Liebman Vice President 54 - Gary Lazarawicz Vice President 49 -
Page 16 of 52 Zach Lonstein has been the Company's Chairman of the Board and Chief Executive Officer since he organized the Company in 1984, and President from 1984 to May 1996. From 1981 to 1984, Mr. Lonstein was Vice President and General Manager of the Commercial On-Line division of Informatics General Corporation ("Informatics" - subsequently renamed Sterling Federal Systems, Inc.), a computer software and services company listed on the New York Stock Exchange. In 1970, Mr. Lonstein was a founder and President of Transportation Computing Services Corp. ("TCS"). In 1981, TCS was sold to Informatics and eventually became the basis for the Commercial On-Line division, which the Company purchased in 1984. Robert B. Wallach was appointed President of the Company on May 1, 1996, and has been a Director of the Company since 1992. Prior to June 1995, he was sole proprietor of Horizons Associates, a consulting firm he founded in 1985. Mr. Wallach has more than 20 years of operating experience including senior management positions with Boeing Computer Services from 1970 to 1972 and Informatics from 1972 to 1982 and, from 1982 to 1985, as President of the Financial Information Services Group/Strategic Information division of Ziff Communications, which provided computer services to companies in the financial industry. Joseph Lynaugh was elected to the Board of Directors on September 23, 1998. Mr. Lynaugh was President and Chief Executive Officer of NYLCare Health Plans, Inc. ("NYLCare") from its formation in January 1996 until his retirement following its acquisition by Aetna US Healthcare. Prior to the formation of NYLCare, Mr. Lynaugh was President of Sanus Corporation Health Systems ("Sanus"), a national health maintenance organization of which he was a founder in 1983. Howard Waltman is Chairman of Express Scripts, Inc. ("ESI"), a Company he formed in 1986 as a subsidiary of Sanus, of which he was also a founder and former Chairman. Sanus was acquired by New York Life Insurance Company in 1987. ESI, which provides mail order pharmacy services and pharmacy claims processing services, was spun out of Sanus and taken public in June 1992. Mr. Waltman also founded Bradford National Corp., which was sold to McDonnell Douglas Corporation. Mr. Waltman also serves on the Board of Directors of qmed, Inc., and several privately-held companies. Jeffrey Millman has been Executive Vice President since 1988, Secretary and a Director since 1992, and has been with the Company since it was founded in 1984, previously holding positions of Vice President and Director of Systems and Programming with Informatics beginning in 1983. From 1979 to 1983, Mr. Millman was Director of Theatrical Computer Systems for Columbia Pictures Industries, Inc. On November 6, 1998, Mr. Millman resigned his positions with the Company and from the Company's Board to pursue other interests. John C. Platt has been an employee of the Company since it was founded 1984, and has been a Vice President of the Company since 1986, its Treasurer beginning in 1992, and a Director since 1996. Prior to 1984, Mr. Platt held various positions with Informatics and TCS. Thomas Laudati has been a Senior Vice President of the Company since 1997, and a Vice President of the Company since 1995 when the Company purchased MCC Corp. Mr. Laudati joined MCC Corp in 1988 as a senior analyst, and was promoted to Vice President of Technical Services in April 1991. Prior to joining MCC Corp., Mr. Laudati held positions in the programming departments of Horizons Bancorp and Colonial Life Insurance Company. Howard Liebman has been a Vice President since June 1996. Prior to that time, he was President of Advanced Interchange Technologies, a company he founded in 1992 which provided electronic data interchange ("EDI") and bar-code printing services to manufacturers. Before 1992, Mr. Liebman was vice president of operations for Oak Hill Corporation, an apparel manufacturer. Page 17 of 52 Gary Lazarewicz has been a Vice President of the Company since June 1995, when the Company purchased MCC Corp. Mr. Lazarewicz, who oversees all corporate research and development, joined MCC Corp. in 1979, and was promoted to Vice President in 1985. From 1971 through 1979, he was employed at Global Terminal and Computer Services, where his last position was Director of MIS Section 16(a) of the Securities Exchange Act - Beneficial Ownership Reporting Compliance ------------------------------------- Section 16(a) of the Securities Exchange Act of 1934 requires the Executive Officers and Directors of the Company, and persons who beneficially own more than ten percent of the Company's Common Stock, to file reports of ownership of Company securities and changes of ownership with the Securities and Exchange Commission. Copies of those reports must also be furnished to the Company. Based solely on a review of the copies of reports furnished to the Company or representations of the Company's Directors and Executive Officers that no additional reports were required, the Company believes that during the fiscal year ended October 31, 1998 the Executive Officers, Directors, and other persons beneficially owning more than ten percent of the Company's Common Stock complied with all applicable Section 16(a) filing requirements, except as to the Company's Controller, who had not timely filed a Form 3 and one Form 4. This individual has since filed the required forms. Item 10. Executive Compensation ---------------------- Compensation of Directors - ------------------------- During fiscal year 1998, each of the members of the Board of Directors who were not full-time employees of the Company were granted non-qualified options to purchase 1,250 shares of the Company's Common Stock for each meeting attended. Compensation of Executive Officers - ---------------------------------- The Summary Compensation Table below includes, for each of the fiscal years ended October 31, 1998, 1997, and 1996, individual compensation for services to the Company and its subsidiaries as paid to the Chief Executive Officer and all those Executive Officers of the Company whose salary exceeded $100,000 in the most recent fiscal year (together, the "Named Executives"). Page 18 of 52
SUMMARY COMPENSATION TABLE Long Term Compensation - Annual Compensation Awards --------------------------------------- ------------------ Securities All Other Fiscal Underlying Compensation ($) Name and Principal Position Year Salary ($) Bonus ($) Options (#) - ------------------------------ --------- ----------------- ------------------ ------------------ ------------------ Zach Lonstein, Chief 1998 $ 285,913 $ 75,000 25,000 $ (a) 30,000 Executive Officer and 1997 240,666 - 25,000 (a) 30,000 Chairman of the Board 1996 230,023 - 25,000 (a) 30,000 - ------------------------------ --------------------------------------------------------------------------------------------------- Robert B. Wallach, President 1998 241,667 100,000 150,000 - and Chief Operating Officer 1997 200,000 55,000 100,000 - 1996 166,667 35,000 150,000 - - ------------------------------ --------------------------------------------------------------------------------------------------- Jeffrey Millman, Executive 1998 128,555 - - - Vice President and Secretary 1997 124,628 - - - 1996 106,923 - - - - ------------------------------ --------------------------------------------------------------------------------------------------- Thomas Laudati, Senior 1998 125,833 25,000 - - Vice President 1997 104,315 8,500 12,500 - 1996 98,667 - 5,000 -
(a) Fee relating to Mr. Lonstein's guarantee of the Company's obligations relating to the purchase of MCC Corporation. (See Item 12: "Certain Relationships and Related Transactions") The following table sets forth, for the Chief Executive Officer and the Named Executives, all grants of stock options made during the fiscal year ended October 31, 1998. Executives not listed did not receive grants of stock options during the fiscal year. The Company did not award any stock appreciation rights or reprice any stock options during fiscal 1998.
OPTION GRANTS IN THE LAST FISCAL YEAR - -------------------------------------------------------------------------------------------------------------------- Number of % of Total Options Securities Granted to Underlying Employees in Fiscal Exercise Options Granted Year Price Expiration Date Name ($/share) - ---------------------------- ------------------ --------------------- -------------- ------------------- Zach Lonstein 25,000 (1) 12% $10.8625 Jan 2, 2003 Robert B. Wallach 150,000 (2) 69% $8.250 Feb 18, 2008
(1) Become exercisable as to 5,000 shares in each of five years beginning January 2, 1998. (2) Become exercisable as to 30,000 shares in each of five years beginning February 18, 1998. Page 19 of 52 Aggregated Option Exercises and Fiscal Year-End Option Values - ------------------------------------------------------------- The following table contains information concerning the stock options held by the Chief Executive Officer and the Named Executives during the fiscal year ended October 31, 1998. No stock appreciation rights have been granted by the Company.
AGGREGATED OPTION EXERCISES DURING THE LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES - -------------------------------------------------------------------------------------------------------------------------------- Securities Received from Exercise Number of Securities Underlying Value of Unexercised of Options during the Year ended Unexercised Options at October 31, In-the-Money Options at October 31, 1998 1998 (#) October 31, 1998 ($) (2) --------------------------------- -------------------------------- ------------------------------------ Net Value Number of Received Un- Un-exercisable Name Shares ($)(1) Exercisable exercisable Exercisable - ------------------- -------------- -------------- --------------- ---------------- ------------- --------------- Zach Lonstein 100,000 $ 992,750 75,000 50,000 $ 260,100 $ 129,150 Robert Wallach - - 218,333 181,667 1,079,582 170,418 Jeffrey Millman 2,948 11,142 7,000 500 18,375 2,000 Thomas Laudati - - 16,500 11,000 70,906 38,625
(1) The amount shown represents the aggregate excess of the market value of the shares of common stock as of the date of the exercise over the exercise price paid. (2) The amounts shown represent the aggregate excess of the market value of shares of common stock underlying options at October 31, 1998 over the exercise price of those options. Agreements with Certain Executive Officers - ------------------------------------------ In 1992, Mr. Lonstein entered into an employment agreement with the Company. This agreement was renewed on January 1, 1995 for a term of five years, will be subject to further renewal annually beginning January 1, 2000, and provides for a base annual salary of $250,000, annual increases of 5%, and an annual bonus equal to 5% of the amount by which the Company's yearly pretax net income (as defined therein) exceeds 150% of the pretax net income for the fiscal year ended October 31, 1992. Additionally, beginning on January 1, 1995, and on each of the four succeeding anniversaries thereof, the Company agreed to grant an option to Mr. Lonstein to purchase 25,000 shares of the Company's Common Stock at an exercise price equal to 110% of the market value of the stock on that date, in accordance with the 1992 Stock Option and Stock Appreciation Rights Plan. As of October 31, 1998, four such grants have been made. In addition, the agreement requires that the Company provide Mr. Lonstein a current model automobile, pay for all repairs, maintenance, and business related expenses thereon, and to also purchase a health club membership for Mr. Lonstein and pay related expenses. The Company is the beneficiary of a $1,000,000 "key-man" life insurance policy which it maintains on Mr. Lonstein. During fiscal 1996 and 1997, Mr. Lonstein voluntarily elected to reduce his annual compensation below the amount called for in his employment agreement. Page 20 of 52 The Company and Mr. Millman entered into an employment agreement dated November 1, 1992. This agreement had a term of five years, and provided for a base annual salary of $115,000, with adjustments for increases in the cost of living index subject to a review by the Compensation Committee of the Board of Directors. This agreement was not renewed. During fiscal 1996, Mr. Millman voluntarily elected to reduce his annual compensation below the amount called for in his employment agreement. On November 6, 1998, Mr. Millman voluntarily resigned. Item 11. Security Ownership of Certain Beneficial Owners and Management -------------------------------------------------------------- The following table sets forth certain information regarding the beneficial ownership of the Company's Common Stock as of October 31, 1998 by all current Directors of the Company, the Chief Executive Officer and Named Executives, all directors and executive officers as a group, and any other person known by the Company to be the beneficial owner of more than 5% of its Common Stock. Beneficial ownership includes shares which the beneficial owner has the right to acquire within sixty days of the above date from the exercise of options, warrants, or similar obligations. If no address is shown, the address of the beneficial owner is in care of the Company.
BENEFICIAL OWNERSHIP OF THE COMPANY'S COMMON STOCK - ----------------------------------------------------------------------------------------------------- Number of Shares Percentage Name and Address of Beneficial Owner Beneficially Owned of Class - ----------------------------------------------------------------------------------- -------------- Zach Lonstein (1) 1,599,421 36.7% Robert B. Wallach (2) 221,083 4.9% Howard Waltman (3) 64,750 1.5% Joseph Lynaugh 10,000 * Jeffrey Millman (4) 7,000 * John C. Platt (5) 7,000 * Thomas Laudati (6) 16,500 * All Directors and Executive Officers as a group (7) 1,940,254 41.9% (9 persons) Cahill, Warnock Strategic Partners Fund, L.P. (8) 358,864 8.4% * Less than 1% of Class
(1) Includes 75,000 shares of Common Stock issuable upon exercise of vested options held by Mr. Lonstein. Also, includes 310,000 shares pledged as a guarantee of the Company's obligations to the seller of MCC Corporation in June 1995 (See Item 12: "Certain Relationships and Related Transactions"). (2) Includes 218,333 shares of Common Stock issuable upon exercise of vested options held by Mr. Wallach. (3) Includes 6,250 shares of Common Stock issuable upon exercise of options held by Mr. Waltman. (4) Includes 7,000 shares of Common Stock issuable upon exercise of vested options held by Mr. Millman. Page 21 of 52 (5) Includes 7,000 shares of Common Stock issuable upon exercise of vested options held by Mr. Platt. (6) Includes 16,500 shares of Common Stock issuable upon exercise of vested options held by Mr. Laudati. (7) Includes 339,583 shares of Common Stock issuable upon exercise of vested options collectively held by all directors and executive officers of the Company. (8) Based on a Form 13G filed June 24, 1998 by Cahill, Warnock Strategic Partners Fund, L.P. and five related Reporting Persons, and a Form 4 filed October 9, 1998 by Mr. Lonstein. Item 12. Certain Relationships and Related Transactions ---------------------------------------------- As of October 31, 1998, Mr. Lonstein was indebted to the Company in the amount of $63,079. This indebtedness is payable on demand and bears interest at the prime rate plus 1% per annum. As compensation for providing a personal guarantee of certain acquisition indebtedness to the selling shareholder of MCC Corporation ("MCC") acquired in 1995, Mr. Lonstein was granted a per annum fee of 3% of the $1,000,000 original value of such guarantee for the period during which the guarantee remains 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. During 1998, the Company engaged in litigation with Anton Donde, a former director and vice president of the Company. This litigation and its outcome are described above in Item 3, Legal Proceedings. In connection with his initial election to the Company's Board of Directors, Mr. Waltman purchased at least 25,000 shares of the Company's Common Stock in the open market, and has also purchased 25,000 restricted shares from Mr. Lonstein. At the time of his election to the Company's Board of Directors, Mr. Lynaugh purchased 10,000 shares of the Company's common stock from Mr. Lonstein. Page 22 of 52 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 incorporated by reference to the Company's Registration Statement on Form SB-2 (No. 33-53888NY). Exhibit No. Description 3.1A * Restated Certificate of Incorporation 3.1B Certificate of Amendment to the Certificate of Incorporation of the Company, dated June 3, 1998 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 Agreement. 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. 10.5A * Consulting Agreement dated November 1, 1992 between the Company and Berger. 10.5B 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. 10.6A * Lease dated January 14, 1991 between the Company and G-H-G Realty Company. 10.6B Agreement of Sublease between the Company as Sublessor and RSL Com USA, Inc. as Subtenant, dated as of July 31, 1998. 10.7 Agreement of Sublease between NMU Pension Plans as Sublandlord, and the Company as Subtenant, dated as of September 21, 1998. 10.8A Lease dated June 2, 1997 between the Company and Leonia Associates, LLC, incorporated by reference to the Company's Annual Report on Form 10-KSB for October 31, 1997. Page 23 of 52 Exhibit No. Description 10.8B First Amendment of Lease between Leonia Associates, LLC and the Company, dated January 16, 1998. 10.9 1992 Stock Option and Stock Appreciation Rights Plan, as amended by the stockholders of the Company at the Annual Meeting held on May 5, 1997, incorporated by reference to the Company's Registration Statement filed on Form S-8, filed on July 17, 1997. 10.10 Merger Agreement dated May 4, 1993 between the Company, New England Data Services, Inc. ("NEDS") 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. 10.11 Merger Agreement dated May 18, 1994 by and among the Company, Daton Data Processing Services, Inc. ("Daton"), Anton P. Donde, and Anton and Detta L. Donde as Trustees Incorporated by reference to the Company's Annual Report on Form 10-KSB for the year ended October 31, 1995. 10.13 Asset Purchase Agreement dated April 27, 1995 by and among the Company, Key-ACA Inc. ("ACA"), 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. 10.14 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. 10.15 Escrow Agreement dated June 8, 1995 between the Company, K-Line, Lonstein, and Chemical Bank, incorporated by reference to the Company's Annual Report on Form 10-KSB for October 31, 1995. 10.16 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. 10.17 Agreement of Sale between the Company, Zurich Payroll Solutions, Ltd, Daton, NEDS, ACA, and Pay USA of New Jersey, Inc., dated December 19, 1997, incorporated by reference to a Current Report on Form 8-K filed by the Company on January 5, 1998, and amended January 23, 1998. 10.18 Payroll Services Conversion Agreement between the Company and ADP, Inc. Page 24 of 52 Exhibit No. Description 21 List of Subsidiaries of the Company 23.A Consent of Deloitte & Touche LLP 23.B Consent of Ernst & Young LLP 27 Financial Data Schedule - included in EDGAR filing only. (b) Reports on Form 8-K ------------------- On October 6, 1998 (amended November 19, 1998), the Company reported the termination of Deloitte & Touche LLP as its auditor. On October 29, 1998, the Company reported that it had retained Ernst & Young LLP to audit the Company's financial statements. Page 25 of 52 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. February 12, 1999 /s/ Zach Lonstein --------------------------------------------- Zach Lonstein - Chief Executive Officer February 12, 1999 /s/ Nicholas J. Letizia --------------------------------------------- Nicholas J. Letizia - Chief Financial 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. February 12, 1999 /s/ Zach Lonstein -------------------------------------------- Zach Lonstein - Chairman of the Board of Directors February 12, 1999 /s/ Robert B. Wallach -------------------------------------------- Robert B. Wallach - Director February 12, 1999 /s/ John C. Platt -------------------------------------------- John C. Platt - Director February 12, 1999 /s/ Howard Waltman -------------------------------------------- Howard Waltman - Director February 12, 1999 /s/ Joseph Lynaugh -------------------------------------------- Joseph Lynaugh - Director Page 26 of 52 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page No. -------- Reports of Independent Auditors 28 Consolidated Balance Sheets - October 31, 1998 and 1997 30 Consolidated Statements of Income - Years ended October 31, 1998 and 1997 32 Consolidated Statements of Cash Flows - Years ended October 31, 1998 and 1997 33 Consolidated Statements of Stockholders' Equity - Years ended October 31, 1998 and 1997 35 Notes to Consolidated Financial Statements 36
Page 27 of 52 Report of Independent Auditors The Board of Directors and Stockholders of Computer Outsourcing Services, Inc. and Subsidiaries We have audited the accompanying consolidated balance sheet of Computer Outsourcing Services, Inc. and subsidiaries as of October 31, 1998, and the related consolidated statements of income, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Computer Outsourcing Services, Inc. and subsidiaries at October 31, 1998, and the consolidated results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. /s/ ERNST & YOUNG, LLP - ---------------------------- ERNST & YOUNG, LLP New York, New York January 11, 1999 Page 28 of 52 INDEPENDENT AUDITORS REPORT To the Board of Directors and Stockholders of Computer Outsourcing Services, Inc. and Subsidiaries New York, New York We have audited the accompanying consolidated balance sheets of Computer Outsourcing Services, Inc. and subsidiaries as of October 31, 1997, and the related consolidated statements of income, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company as of October 31, 1997, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles. /s/ DELOITTE & TOUCHE, LLP - ----------------------------- DELOITTE & TOUCHE, LLP New York, New York January 9, 1998 (January 26, 1998 as to note 6(a) in the financial statements for the year ended October 31, 1997) Page 29 of 52 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS OCTOBER 31, ------------------------- 1998 1997 ----------- ----------- ASSETS CURRENT ASSETS: Cash and equivalents (Notes 1 and 2) $ 9,403,006 $ 972,459 Marketable debt securities, at cost which approximates market value (Notes 1 and 2) 3,218,170 -- Trade accounts receivable, net of allowance for doubtful accounts of $216,659 and $111,577 4,452,117 3,990,630 Net assets of discontinued operations (Note 13) -- 6,071,333 Deferred income taxes - current (Note 9) 603,627 107,710 Net assets held for sale (Note 1) 229,289 -- Prepaid expenses and other current assets 1,179,539 1,223,759 ----------- ----------- 19,085,748 12,365,891 ----------- ----------- PROPERTY and EQUIPMENT, net (Note 3) 2,508,875 1,815,230 ----------- ----------- OTHER ASSETS: Deferred software, net (Note 4) 1,803,013 1,545,935 Intangibles, net (Note 5) 2,221,842 2,715,993 Due from related parties, net (Note 6) 89,313 176,295 Deferred income taxes (Note 9) 718,341 -- Security deposits and other non-current assets 521,404 523,797 ----------- ----------- 5,353,913 4,962,020 ----------- ----------- TOTAL ASSETS $26,948,536 $19,143,141 =========== =========== See Notes to Consolidated Financial Statements Page 30 of 52 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS OCTOBER 31, ------------------------- 1998 1997 ----------- ----------- LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 1,029,406 $ 1,246,516 Current portion of long-term debt (Note 7) 241,150 2,297,546 Current portion of capitalized lease obligations (Note 8) 19,127 23,034 Income taxes payable (Note 9) 2,468,747 243,342 Current portion of accrued loss on office sublease 365,495 -- Accrued expenses 2,000,355 1,536,330 Customer deposits and other current liabilities 202,787 231,699 ----------- ----------- 6,327,067 5,578,467 LONG-TERM LIABILITIES: Long-term debt (Note 7) 11,223 252,577 Capitalized lease obligations (Note 8) 287 19,414 Accrued loss on office sublease (Note 12) 2,016,606 -- Deferred income taxes (Note 9) -- 753,620 Deferred income from a non-competition, confidentiality, and conduct of business agreement (Note 13) 1,000,000 -- ----------- ----------- 3,028,116 1,025,611 ----------- ----------- 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; 10,000,000 shares authorized; shares issued and outstanding, 4,285,715 and 3,826,102 42,857 38,261 Additional paid-in capital 11,946,837 9,595,789 Retained earnings 5,603,659 2,905,013 ----------- ----------- 17,593,353 12,539,063 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $26,948,536 $19,143,141 =========== =========== See Notes to Consolidated Financial Statements Page 31 of 52 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED OCTOBER 31, ------------------------- 1998 1997 ----------- ----------- REVENUES $30,403,381 $24,395,644 ----------- ----------- COSTS and EXPENSES: Data processing costs 19,828,954 17,071,706 Selling and promotion costs 1,384,557 1,266,047 General and administrative costs 5,964,215 4,623,478 One-time charge for loss on office sublease 2,236,583 -- Interest (income)/expense, net (547,499) 206,330 ----------- ----------- 28,866,810 23,167,561 ----------- ----------- Income from continuing operations before provision for income taxes 1,536,571 1,228,083 Provision for income taxes (Note 8) 457,621 539,700 ----------- ----------- Income from continuing operations 1,078,950 688,383 Loss on discontinued operation, net of income tax benefits of $60,079 and $163,600 (Notes 9 and 13) (76,464) (127,054) Gain on sale of discontinued operation, net of income tax provision of $1,399,569 (Notes 9 and 13) 1,696,160 -- ----------- ----------- NET INCOME $ 2,698,646 $ 561,329 =========== =========== BASIC EARNINGS PER SHARE (Note 1): Income from continuing operations $ 0.27 $ 0.17 Loss from discontinued operation (0.02) (0.03) Gain on sale of discontinued operation 0.42 -- ----------- ----------- Net income $ 0.67 $ 0.14 =========== =========== WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING 4,058,376 3,777,089 =========== =========== DILUTED EARNINGS PER SHARE (Note 1): Income from continuing operations $ 0.24 $ 0.17 Loss from discontinued operation (0.01) (0.03) Gain on sale of discontinued operation 0.38 -- ----------- ----------- Net income $ 0.61 $ 0.14 =========== =========== WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING 4,427,921 3,995,879 =========== =========== See Notes to Consolidated Financial Statements Page 32 of 52 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW YEARS ENDED OCTOBER 31, ------------------------- 1998 1997 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Income from continuing operations $ 1,078,950 $ 688,383 Adjustments to reconcile net income/(loss) to cash provided by operating activities: Depreciation and amortization 1,267,072 1,491,527 Accrued loss on office sublease 1,789,969 -- Deferred income taxes (1,962,378) 31,462 Decrease/(increase) in: Trade accounts receivable (461,488) (852,604) Refundable taxes -- 62,989 Prepaid expenses and other current assets 44,220 (631,040) Security deposits and other noncurrent assets (51,505) (133,714) Increase/(decrease) in: Accounts payable (217,110) 196,910 Income taxes payable 1,276,429 -- Accrued expenses (213,383) 607,608 Customer deposits and other current liabilities (28,912) (34,182) ----------- ----------- Net cash provided by operating activities 2,521,864 1,427,339 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (1,500,680) (409,708) Disposal of equipment 14,960 2,074 Purchases of investments in marketable debt securities (3,218,170) -- Proceeds from sale of the Payroll Division 14,400,000 -- Payment of expenses related to sale of the Payroll Division (2,239,367) -- Deposit received from buyer for assets held for sale 25,000 -- Settlement of contingencies relating to acquisitions -- (83,322) Increase in deferred software costs (892,010) (458,517) ----------- ----------- Net cash provided by/(used in) investing activities $ 6,589,733 $ (949,473) =========== =========== Continued on next page. See Notes to Consolidated Financial Statements Page 33 of 52 COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW (CONTINUED) YEARS ENDED OCTOBER 31, ------------------------- 1998 1997 ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of long-term debt $(2,297,746) $(1,305,474) Repayments by/(advances to) related parties, net 86,982 (23,473) Exercises of stock options and warrants 1,725,055 61,106 Proceeds from borrowings of long term debt -- 1,100,000 Repayments of capital leases (23,034) (71,716) ----------- ----------- Net cash used in financing activities (508,743) (239,557) ----------- ----------- Net cash provided by continuing operations 8,602,854 238,309 ----------- ----------- CASH FLOWS FROM DISCONTINUED OPERATIONS: Loss from discontinued operations (76,464) (127,054) Adjustments to reconcile loss from discontinued operations to cash provided by discontinued operations: Depreciation and amortization 151,118 961,870 Increase in net assets of discontinued operations (246,961) (957,870) ----------- ----------- Net cash used in discontinued operations (172,307) (123,054) ----------- ----------- Net increase in cash and equivalents 8,430,547 115,255 Cash and equivalents at the beginning of the year 972,459 857,204 ----------- ----------- Cash and equivalents at the end of the year $ 9,403,006 $ 972,459 =========== =========== SUPPLEMENTAL CASH FLOW INFORMATION: Cash paid during the period for Interest expense $ 129,635 $ 323,550 =========== =========== Income taxes $ 1,092,061 $ 91,958 =========== =========== SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING ACTIVITIES: New capitalized leases for data processing equipment $ -- $ 34,222 =========== =========== Common stock issued for the purchase of software $ 180,000 $ -- =========== =========== SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES: Tax benefit associated with the exercise of non-qualified options $ 450,593 $ -- =========== =========== During 1997, $19,594 (net of tax benefits) was accreted through a charge to retained earnings in connection with a stock option (Note 12). See Notes to Consolidated Financial Statements Page 34 of 52
COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Deferred Costs in Connection with a Financing/ Common Par Paid in Retained Consulting Shares Value Capital Earnings Agreement Total -------------------------------------------------------------------------------------------- Balance, October 31, 1996 3,734,848 $37,348 $9,233,952 $2,363,278 ($35,132) $11,599,446 Stock issued for services 22,000 220 89,155 89,375 Exercises of stock options (Notes 10 and 12) 69,254 693 272,682 273,375 Amortization of deferred costs in connection with a financing and consulting agreement (Note 6) 35,132 35,132 Accretion in connection with stock option obligation, net (Note 12) (19,594) (19,594) Net income 561,329 561,329 -------------------------------------------------------------------------------------------- Balance, October 31, 1997 3,826,102 $38,261 $9,595,789 $2,905,013 -- $12,539,063 Stock issued for the purchase of assets 20,000 200 179,800 180,000 Exercises of stock options and warrants (Note 10) 439,613 4,396 1,720,659 1,725,055 Tax benefit associated with the exercise of non- qualified options 450,589 450,589 Net income 2,698,646 2,698,646 -------------------------------------------------------------------------------------------- Balance, October 31, 1998 4,285,715 $42,857 $11,946,837 $5,603,659 -- $17,593,353 ============================================================================================
See Notes to Consolidated Financial Statements Page 35 of 52 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 ("the Company") provides information technology services in the form of data center and business process solutions to companies, institutions, and government agencies. On December 19, 1997, the Company sold its payroll processing division (the "Payroll Division") (Note 13). Principles of Consolidation - The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and significant intercompany transactions have been eliminated. Cash and Equivalents and Marketable Debt Securities - Cash and equivalents include all cash, demand deposits, money market accounts, and debt instruments purchased with an original maturity of three months or less. Marketable debt securities are debt instruments purchased with maturities of between three and six months. The Company's investments in debt securities, including those included in cash equivalents, are classified as securities held-to-maturity and are carried at cost, which approximates market value. 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 improvements and assets acquired under capital leases are amortized over the shorter of the lease term or their estimated useful lives. 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 using the straight-line method over the life of the related customer contract or three to five years, whichever is shorter. Assets Held for Sale - Assets held for sale are primarily net intangibles relating to a processing activity for a small group of clients. The assets were sold after year end. Page 36 of 52 Intangible Assets - The excess of cost over net assets of acquired businesses ("goodwill") is amortized using the straight-line method over their estimated lives, typically no more than twenty 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 underlying businesses. Revenue Recognition - The Company's services are provided under a combination of fixed monthly fees and time and materials billings. Contracts with clients typically range from one to five years. Revenues are recognized monthly as billed, and costs (principally salaries) are expensed monthly as incurred. For those few contracts with other than monthly billing schedules, revenues are recognized on the percentage of completion method. 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. Deferred tax benefits are recognized to the extent that realization of such benefits are more likely than not. Earnings per Share - During the year ended October 31, 1998, the Company adopted the provisions of Statements of Accounting Standards No. 128 - "Earnings per Share" ("SFAS 128"). SFAS 128 replaces the presentation of primary and fully diluted earnings per share ("EPS") with a presentation of basic and diluted 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. Income from continuing operations per share and net income per share for the year ended October 31, 1997 has been adjusted to reflect $19,594 in accretion (net of income tax benefit) arising in connection with an option (Note 11). Stock options and warrants which are anti-dilutive are excluded from the computation of weighted average shares outstanding. All prior period EPS data has been restated to conform to SFAS 128. Certain options which are currently anti-dilutive may be dilutive in the future. 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. 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 sale. Page 37 of 52 The carrying amounts and estimated fair values of financial instruments at the end of the respective years are summarized as follows:
October 31, 1998 October 31, 1997 -------------------------------------- ---------------------------------------- Carrying Amount Estimated Fair Carrying Amount Estimated Fair Value Value -------------------------------------- ---------------------------------------- Assets: Cash and equivalents $ 9,403,006 $ 9,403,006 $ 972,459 $ 972,459 Marketable debt securities (Note 2) 3,218,170 3,217,095 - - Trade accounts receivable, net 4,452,117 4,452,117 3,990,630 3,990,630 Liabilities: Accounts payable, accrued expenses, income taxes payable, customer deposits and other current liabilities 5,701,295 5,701,295 3,257,887 3,257,887 Notes payable, bank - - 968,750 968,750 Acquisition note 210,160 209,636 630,483 625,778 Revolving line of credit - - 850,000 850,000 Other borrowings 42,213 42,325 100,890 100,158
The following methods and assumptions were used to estimate the fair value of the financial instruments presented above: Cash and equivalents - The carrying amount is a reasonable approximation of fair value. Marketable debt securities - 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, income taxes payable, 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 Note, revolving line of credit, and other borrowings - 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. Page 38 of 52 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. Reclassifications - Certain reclassifications were made to the 1997 financial statements to conform with the current year presentation. 2. Cash Equivalents and Marketable Debt Securities The following is a summary of the Company's held-to-maturity securities at October 31, 1998, which are classified as either cash equivalents or marketable debt securities based on a maturity of less than or more than three months, respectively (Note 1):
Gross Gross Estimated Unrealized Unrealized Market Cost Gains Losses Value ---------------- ---------------- ----------------- ---------------- Cash equivalents: Commercial paper $ 5,921,373 $ - $ - $ 5,921,373 ---------------- ---------------- ----------------- ---------------- Marketable debt securities: Commercial paper 1,963,817 - - 1,963,817 Corporate obligations 1,254,353 260 (1,335) 1,253,278 ---------------- ---------------- ----------------- ---------------- Subtotal 3,218,170 260 (1,335) 3,217,095 ---------------- ---------------- ----------------- ---------------- Total $ 9,139,543 $ 260 $ (1,335) $ 9,138,468 ================ ================ ================= ================
Page 39 of 52 3. Property and Equipment Property and equipment consists of the following: Depreciable Lives October 31, (Years) ---------------------------- 1998 1997 ------------- ------------- ------------ Computer equipment $ 3,699,955 $ 3,456,316 5 Computer equipment held under capital leases (Note 8) 1,278,669 1,278,669 5 Furniture and office equipment 882,199 489,434 7 Leasehold improvements 403,609 284,411 * Purchased software 991,928 450,498 5 Vehicles 32,146 17,318 3 ------------- ------------- 7,288,506 5,976,646 Less accumulated depreciation and amortization, including $1,140,161 in 1998 and $1,037,972 in 1997 attributable to capital leases (4,779,631) (4,161,416) ------------- ------------- $ 2,508,875 1,815,230 ============= ============= * Shorter of the useful life or the length of the lease. Depreciation and amortization in continuing operations was $768,753 and $798,691 for the years ended October 31, 1998 and 1997, respectively. 4. Deferred Software Costs Deferred software costs consist of the following: October 31, ----------------------------------- 1998 1997 --------------- ----------------- Costs of internally-developed software and enhancements $ 3,623,368 $ 2,731,358 Accumulated amortization (1,820,355) (1,185,423) --------------- ----------------- $ 1,803,013 $ 1,545,935 =============== ================= Amortization of deferred software costs charged to continuing operations for the years ended October 31, 1998 and 1997 were $634,932 and $411,794, respectively. Page 40 of 52 5. Intangibles Intangible assets consist of the following: October 31, ----------------------------------- 1998 1997 ---------------- ---------------- Excess of cost of investments over net assets acquired $ 1,820,925 $ 2,058,592 Customer lists 1,180,488 1,280,48 ---------------- ---------------- 3,001,413 3,339,080 Less accumulated amortization (779,571) (623,087) ---------------- ---------------- $ 2,221,842 $ 2,715,993 ================ ================ Amortization charged to continuing operations was $249,489 and $235,859 for the years ended October 31, 1998 and 1997, respectively. 6. Related Party Transactions Due from/(to) related parties consists of the following: October 31, ----------------------------------- 1998 1997 ---------------- ---------------- Due from the Chairman & Chief executive Officer and controlling shareholder, bearing interest at prime plus 1% per annum, repayable on demand $ 63,079 $ 81,443 Due from consultant (Note 12) 26,234 39,352 Due from the President, bearing interest at prime, repayable on demand - repaid in December 1997 - 55,500 ---------------- ---------------- $ 89,313 $ 176,295 ================ ================ The Company is the beneficiary of a $1,000,000 life insurance policy which it maintains on its Chief Executive Officer. As compensation for providing a personal guarantee of certain acquisition indebtedness to the selling shareholder of a company acquired in 1995, the Company's Chief Executive Officer was granted a per annum fee of 3% of the $1,000,000 original value of such guarantee for the period during which the guarantee remains 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 (Note 7). Page 41 of 52 A former director had loaned the Company $150,000. This note was repaid at its maturity on October 1, 1997. As an inducement for such former director to provide the loan, the Company's controlling stockholder and another employee sold an aggregate of 65,550 shares of common stock to the former 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 was amortized over the five year period ended October 31, 1997 on a straight-line basis. 7. Long-term Debt Long-term debt consists of the following: October 31, ----------------------------------- 1998 1997 ---------------- ---------------- Term loan (a)(d) $ - $ 968,750 Revolving line of credit (b)(d) - 850,000 Note payable issued in connection with an acquisition (c) 210,160 630,483 Notes payable, other 42,213 100,890 ---------------- ---------------- 252,373 2,550,123 Less current portion (241,150) (2,297,546) ---------------- ---------------- $ 11,223 $ 252,577 ================ ================ (a) The Company was indebted to a bank for a term loan as part of an agreement under which three loans aggregating $2,620,000 were used for acquisitions. The agreement provided for monthly principal and interest payments through May 2000. The loan interest rate in effect at October 31, 1997 was 8.5%. Substantially all of the assets of the Company were pledged as collateral for this indebtedness. (b) In March 1997, the Company and the bank entered into an additional agreement for a revolving line of credit whereby the Company was entitled to borrow up to an additional $1,500,000. Interest on the outstanding balance was 8.5% at October 31, 1997. The line of credit expired on April 30, 1998. (c) In connection with an acquisition in June 1995, the Company became obligated for a note of $840,645, payable in installments through February 1, 1999. Interest of 7.5% per annum is payable quarterly in arrears. This note is collateralized by 310,000 shares of the common stock of the Company which are personally owned by the Company's Chief Executive Officer (Note 6). (d) On December 19, 1997, utilizing the proceeds from the sale of the Payroll Division (Note 13), the Company repaid the term loan and the outstanding balance on the line of credit. Aggregate maturities of long-term debt are as follows: Page 42 of 52 Years Ending October 31, ------------------------ 1999 $ 241,150 2000 11,223 -------------- $ 252,373 ============== 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. Minimum future lease payments under capitalized leases are as follows: Years Ending October 31: ------------------------ 1999 $ 20,026 2000 294 -------------- 20,320 Less amount representing interest (906) -------------- Present value of net minimum lease payments 19,414 Less current maturities (19,127) -------------- Long-term obligations under capital leases $ 287 ============== 9. Income Taxes The provision for income taxes on continuing operations consists of: October 31, ----------------------------------- 1998 1997 ---------------- ---------------- Current: Federal $ 1,119,789 $ 381,405 State and local 576,424 126,833 Deferred (benefit)/provision (1,238,592) 31,462 ---------------- ---------------- $ 457,621 $ 539,700 ================ ================ Page 43 of 52 A reconciliation of income taxes computed at the Federal statutory rate to amounts provided is as follows: October 31, ----------------------------------- 1998 1997 ---------------- ---------------- Tax provision computed at statutory rate $ 522,434 $ 417,548 Increase/(decrease) in taxes resulting from: State and local income taxes, net of federal income taxes 38,851 83,710 Amortization of excess of cost over net assets of acquired companies 44,076 30,100 Benefit of tax credits (179,960) - Other, net 32,220 8,342 ---------------- ---------------- $ 457,621 $ 539,700 ================ ================ Temporary differences which give rise to net deferred tax assets/(liabilities) are as follows: October 31, ----------------------------------- 1998 1997 ---------------- ---------------- Deferred tax assets: Accrued loss on office sublease $ 1,189,503 $ - Deferred income from non-competition, confidentiality, and conduct of business agreement 461,800 - Accrued liabilities 110,832 23,495 Allowance for doubtful accounts 96,392 54,055 Deferred rent 63,382 - Intangibles 7,035 (5,046) Deferred compensation - 52,159 Lease transactions 7,754 55,580 Other 253,704 - ---------------- ---------------- 2,190,402 180,243 ---------------- ---------------- Deferred tax liabilities: Depreciation (76,142) (130,500) Deferred software costs (782,793) (695,653) Other (9,499) - ---------------- ---------------- (868,434) (826,153) ---------------- ---------------- Net deferred tax assets/(liabilities) $ 1,321,968 $ (645,910) ================ ================ Page 44 of 52 10. Stockholders' Equity Common Stock - The Company is authorized to issue up to 10,000,000 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 entitled to share ratably in all assets remaining after the payment of liabilities, 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. During fiscal 1998, 66,725 of these warrants were exercised. The remaining 33,275 warrants expired February 20, 1998, having been extended one month from the original expiration date by the Company' Board of Directors. In September 1994, in connection with a consulting arrangement, the Company issued warrants to purchase, after giving effect to certain anti-dilutive provisions, 50,000 shares at $5.00 per share and 25,240 shares at $6.24 per share. These warrants were exercised in March 1998. 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. This Warrant expires on June 27, 2000. The Underwriters and the consultants had the right to require the Company to register their respective shares with the Securities and Exchange Commission. On February 5, 1998, the Company registered these and other shares on Form S-3. Page 45 of 52 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 May 5, 1997, the Company's shareholders approved an amendment to the Plan increasing the maximum number of shares issuable thereunder to 1,200,000. 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 committee consisting of two non-employee directors who determine those individuals to whom options will be granted, the number of shares of common stock which may be purchased under each option, and (when necessary) the option exercise price. The committee also determines the expiration date of the options (typically 10 years, except for 10% shareholders, which expire in 5 years), and the vesting schedule of the options, which is typically 20% per year over 5 years, beginning one year from the date of the grant. Options have also been granted which vest over three years, or which were vested when granted. 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 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 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: (a) 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 (b) 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 (c) 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. Page 46 of 52 Activity during the past two years with respect to the Plan is as follows: Weighted Exercise Average Number of Price Exercise Options Range Price ----------- ------------- ---------- Options Outstanding, October 31, 1996 710,300 3.63 - 5.88 4.34 Options granted 226,300 3.25 - 7.88 4.23 Options exercised (29,254) 3.63 - 5.88 3.95 Options cancelled (57,448) 3.63 - 5.88 3.86 ----------- Options outstanding, October 31, 1997 849,898 3.25 - 7.88 4.42 Options granted 216,400 8.25 - 10.86 8.79 Options exercised (197,648) 3.63 - 7.88 4.52 Options cancelled (63,650) 3.88 - 9.56 4.83 ----------- Options outstanding, October 31, 1998 805,000 3.25 - 10.86 4.41 =========== Options available for future grant, October 31, 1998 168,098 =========== Options exercisable, October 31, 1998 466,133 =========== Options exercisable, October 31, 1997 578,764 =========== At October 31, 1998, the weighted average remaining contractual life of all options currently outstanding, whether vested or not, is approximately 6.6 years. Page 47 of 52 The Company accounts for options granted under 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 Standard No. 123 "Accounting for Stock-Based Compensation", the Company's pro forma income/(loss) and pro forma income/(loss) per common share for fiscal 1998 and 1997, respectively, would be as follows:
1998 1997 ---------------------------------------- ------------------------------------ Historical Pro Forma Historical Pro Forma ---------------- -------------------- ----------------- ---------------- Income from continuing operations $ 1,078,950 $ 815,359 $ 688,383 $ 572,803 Loss from discontinued operation (76,464) (76,464) (127,054) (127,054) Gain on sale of discontinued operation 1,696,160 1,696,160 - - ---------------- -------------------- ----------------- ---------------- Net income $ 2,698,646 $ 2,435,055 $ 561,329 $ 445,749 ================ ==================== ================= ================ Income/(loss) per diluted common share: Income from continuing operations $ 0.24 $ 0.18 $ 0.17 $ 0.14 Loss from discontinued operation (0.01) (0.01) (0.03) (0.03) Gain on sale of discontinued operation 0.38 0.38 - - ---------------- -------------------- ----------------- ---------------- Net income $ 0.61 $ 0.55 $ 0.14 $ 0.11 ================ ==================== ================= ================
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 fiscal 1998 and 1997 was $704,176 and $382,977, 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 1998: a risk-free interest rate of 6.5%; expected lives ranging from six months to five years; and expected volatility of 48.6%. 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 shares were exercised prior to October 31, 1996, 40,000 were exercised during the year ended October 31, 1997, and 100,000 were exercised during the current fiscal year. Page 48 of 52 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, 1998 and 1997, 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 to purchase up to 190,000 shares of the Company's common stock for an aggregate purchase price of $1,900. The Company was further required to 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"). The difference between the present value of the option as originally recorded in 1990 and the Put amount was accreted through periodic charges to retained earnings using the interest method. As of October 31, 1997, the holder had exercised the option for all 190,000 shares, thereby terminating the Company's obligation under the Put. For the year ended October 31, 1997, $19,594 was accreted. In connection with an acquisition in April 1993, the Company was obligated for contingent payments based on revenues of the acquired company. For the fiscal years ended October 31, 1998 and 1997, contingent payments were $26,055 and $63,472, respectively. The obligations at October 31, 1998 and 1997 are included in other current liabilities. In connection with an acquisition in June 1993, the Company was obligated for certain contingent payments based on the earnings of the acquired company for five years, payable in a combination of cash and common stock. For the fiscal years ended October 31, 1998 and 1997, no contingent payments were earned. This company was included in the sale of the Payroll Division, and the Company's obligations terminated in June 1998. The Company had also guaranteed the market value of the 150,000 shares of common stock issued in connection with this acquisition at $6.67 per share on June 30, 1998. As the market price of the stock on that date was higher, no payment was required. In January 1994, the Company guaranteed the market value of 158,812 shares of common stock issued in connection with an acquisition at $6.40 per share on January 1, 1999. Since the market price of the stock on January 1, 1999 was higher, no payment was required. In connection with an acquisition in June 1994, the Company was obligated for contingent consideration based on the defined earnings of the Payroll Division and certain other defined events. No contingent consideration had been earned on operations through December 19, 1997, when this company was included in the sale of the Payroll Division. As part of the settlement of a lawsuit, described below, the Company fulfilled its obligation for any contingent consideration. The Company had also guaranteed the market value of the 302,400 shares of common stock issued in connection with this acquisition at $5.00 on July 31, 1999. On July 31, 1998, a former officer sold the approximately 248,000 shares owned by him, and therefore, only approximately 54,400 shares are subject to the guarantee. Page 49 of 52 In connection with an acquisition in May 1995, the Company was obligated for certain contingent payments based on defined earnings of the Company's two payroll operations in New England for five years. No contingent payments were earned for fiscal 1997 nor for the period ended December 19, 1997, when this company was included in the sale of the Payroll Division. On December 24, 1997, the Company made payments aggregating $300,000 to the former stockholders of the acquired company in return for a release from any further liability under the earnings contingencies. The Company also guaranteed that market value of the 113,636 shares of common stock issued in connection with this acquisition at $5.50 per share on April 30, 2000. At October 31, 1998, no contingent liability existed for stock price guarantees relating to the foregoing acquisitions, since the market value of the Company' stock on October 31, 1998 exceeded all of the minimum price guarantees. Actual amounts that will ultimately be paid, if any, could change significantly depending upon the price of the Company' common stock on the dates such amounts are required to be settled, and upon the number of shares actually held by obligees on those dates. Employment Agreements - The Company is obligated under certain employment agreements which expire at various times through October 31, 2000. Pursuant to such agreements, the approximate annual minimum salary amounts payable are as follows: Years Ending October 31, ------------ 1999 760,200 2000 409,000 Consulting and Non-competition - 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, and provides for annual payments of $267,500 through September 30, 2001. As a partial incentive to enter into the amended agreement, the Company agreed to forgive, on each anniversary date of the agreement, 12.5% of the consultant's existing indebtedness to the Company ($26,234 at October 31, 1998 (Note 6)). The consulting agreement imposes certain non-competition restrictions on the consultant indebtedness to the Company will be amortized ratably over the term of the amended agreement. 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. In February 1998, the Company filed a lawsuit in the Federal District Court for the Southern District of New York, 98 Civ. 0956 (RLC), against a former officer-director of the Company and a trust controlled by such person and his spouse ("Defendants"). The former officer-director was responsible for the Company's Payroll Division, which was sold in December 1997 (Note 13). In the lawsuit, the Company alleged that the former officer-director intentionally attempted to interfere with that sale thereby causing damages to the Company. This person's employment was terminated by the Company's Board of Directors and subsequently, he resigned as a director. Page 50 of 52 In April 1998, Defendants filed an answer denying the Company's claims, a counter claim against the Company, and third party claims, alleging substantial damages against the Company and its current and former directors, including wrongful termination, breach of contract, breach of the duty of good faith, fraud, and RICO violations. In May 1998, this litigation was settled. The impact of such settlement is reflected in the Company's financial statements. Lease Obligations - Operating leases for facilities extend through December 31, 2009. The leases require the Company to pay certain expenses such as utilities and real estate taxes. These leases require aggregate minimum monthly rental payments of approximately $108,000 plus a proportionate share of certain of the landlord's operating expenses. The Company's obligations under the two major leases are secured by a cash deposit and a letter of credit, respectively, aggregating $281,250. Total expense for occupancy costs, net of sublease income in 1998, was approximately $1,872,000 and $1,284,000 during 1998 and 1997, respectively. During the fourth quarter of fiscal 1998, the Company completed the consolidation of its data center and most of its administrative functions into its Leonia facility. Effective as of August 1, 1998, the Company sublet approximately 31,500 square feet in its New York City location. This sublease and the related primary lease expire in 2008. Because the amount to be received under the sublease (aggregating $6,210,675) is less than the amount the Company must pay under the primary lease, a charge was taken of approximately $3,022,000. The charge represents the total amount of the shortfall over the life of the lease, and also includes the value of leasehold improvements abandoned. Since the sale of the Payroll Division also permitted the Company to reduce substantially its New York City space requirements, approximately $786,000 was charged against the gain on sale of the Payroll Division. Approximate minimum future real-estate lease payments, net of sublease income, are as follows: Years Ending October 31, ------------ 1999 $ 1,479,700 2000 1,500,100 2001 1,437,100 2002 1,281,300 2003 1,345,200 Thereafter 7,245,800 ----------------- $ 14,289,200 ================= Page 51 of 52 13. 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. Note plus accrued interest was repaid 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. 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. At October 31, 1997, and for the year then ended, the net assets and operating losses (net of related tax benefits) of Pay USA have been recorded as a discontinued operation. During the fiscal year ended October 31, 1997, revenues relating to the discontinued operations approximated $8,828,000, and pretax operating losses approximated $291,000. For the period from November 1, 1997 through the date of the Sale, revenues related to the discontinued operation approximated $1,116,700 and pretax operating losses approximated $136,500. 14. Subsequent Event - Purchase of ETG, Inc. On December 18, 1998, a subsidiary of the Company purchased certain assets and the business of Enterprise Technology Group, Incorporated ("ETG") 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 assets acquired consist predominately of intangibles associated with the business of providing information technology infrastructure management solutions to large companies and institutions. Page 52 of 52 EXHIBIT INDEX EXHIBIT NO. DESCRIPTION 3.1B Certificate of Amendment to the Certificate of Incorporation of the Company, dated June 3, 1998 10.6B Agreement of Sublease between the Company as Sublessor and RSL Com USA, Inc. as Subtenant, dated as of July 31, 1998. 10.7 Agreement of Sublease between NMU Pension Plans as Sublandlord, and the Company as Subtenant, dated as of September 21, 1998. 10.8B First Amendment of Lease between Leonia Associates, LLC and the Company, dated January 16, 1998. 10.18 Payroll Services Conversion Agreement between the Company and ADP, Inc. 21 List of Subsidiaries of the Company 23.A Consent of Deloitte & Touche LLP 23.B Consent of Ernst & Young LLP 27 Financial Data Schedule - included in EDGAR filing only. EX-3.1B 2 CERT. OF AMENDMENT OF THE CERT. OF INCORPORATION CERTIFICATE OF AMENDMENT OF THE CERTIFICATE OF INCORPORATION OF COMPUTER OUTSOURCING SERVICES, INC. UNDER SECTION 805 OF THE BUSINESS CORPORATION LAW WE THE UNDERSIGNED, Zach Lonstein and Jeffery Millman, being respectively the Chairman of the Board and Chief Executive officer and Secretary of Computer Outsourcing Services, Inc, hereby certify: 1.The original name of the corporation was Commercial On-Line Systems, Inc. and the present name is Computer Outsourcing Services, Inc. 2.The certificate of incorporation of said corporation was filed by the Department of State on October 22, 1984. 3.(a) The cerificate of incorporation is amended to increase the number of authorized shares of common stock from 7,000,000 to 10,000,000 shares. (b) To effect the foregoing, Article 4 of the cerificate of incorporation is amended to read in its entirety as follows: 4.1 AUTHORIZED CAPITAL STOCK. The total number of shares of stock which the Corporation shall have authority to issue is 11,000,000, consisting of 1,000,000,shares of preferred stock, par value $0.01 per share ("Preferred Stock"), and 10,000,000 shares of common stock, par value $0.01 per share ("Commom Stock") 4. The amendment was authorized in the following manner: On February 11, 1998 the Board Of Directors unanimously adopted a resolution approving the amendment and the shareholders of the corporation approved the amendment by the requisite vote at the 1998 Annual Meeting of Stockholders of Computer Outsourcing Services, Inc. held on June 3, 1998. IN WITNESS WHEREOF, we have signed this certifcate on June 3, 1998 and we affirm the statements contained therein as true under the penalties of perjury. /s/ -------------------------- Zach Lonstein Chairman of the Board and Cheif Executive officer /s/ -------------------------- Jeffery Millman Secretary EX-10.6B 3 AGREEMENT OF SUBLEASE - RSL COM U.S.A., INC. AGREEMENT OF SUBLEASE BETWEEN COMPUTER OUTSOURCING SERVICES, INC. AS SUBLESSOR AND RSL COM U.S.A., INC. AS SUBTENANT DATED AS OF JULY, 1998 AGREEMENT OF SUBLEASE --------------------- THIS AGREEMENT (hereinafter referred to as the "Sublease") dated as of the day of July, 1998, by and between COMPUTER OUTSOURCING SERVICES, INC., a New York corporation, having an office at 360 West 31st Street, 21 Penn Plaza, 10th Floor, New York, New York 10001 (hereinafter referred to as the "Sublessor"), and RSL COM U.S.A, INC., a Delaware corporation, having an office at 430 Park Avenue, New York, New York 10022 (hereinafter referred to as the "Subtenant"). W I T N E S S E T H : WHEREAS, Sublessor is the tenant under a certain agreement of lease dated as of January 24, 1991, as amended, between Sublessor and G-H-G Realty Company ("Landlord"), as landlord ("Overlease"), covering a portion of the basement, a portion of the Tenth (10th) Floor and the entire Eleventh (11th) Floor ("Overleased Premises") at 360 West 31st Street, New York, New York ("Building"); WHEREAS, the Overlease covers the Overleased Premises in the Building, upon and subject to the terms and conditions more particularly set forth in the Overlease; and WHEREAS, Subtenant desires to sublet from Sublessor the entire Eleventh (11th) Floor of the Overleased Premises, consisting of approximately 22,300 rentable square feet and part of the Tenth (10th) floor of the Overleased Premises, consisting of approximately 9,200 rentable square feet (hereinafter referred to as the "Demised Premises"), and Sublessor desires to sublet the same to Subtenant. NOW, THEREFORE, in consideration of the mutual obligations of the parties hereto, the parties for themselves, their successors and assigns, hereby covenant and agree, as follows: 1. SUBLEASED PREMISES. Sublessor hereby subleases to Subtenant and Subtenant hereby hires from Sublessor the Demised Premises. The premises subleased to Subtenant, together with all appurtenances, fixtures, improvements, additions and other property attached thereto or installed therein at the commencement of, or at any time during, the term of this Sublease, are hereinafter collectively referred to as the "Subleased Premises." Page 1 of 28 2. TERM. a. The Subleased Premises are subleased for a term (hereinafter referred to as the "Term") of approximately ten years, five months, to commence on 60 days from receipt by the parties hereto of Landlord's Consent (defined hereinafter) (said date is hereinafter referred to as the "Commencement Date") and to expire on December 30, 2008 (hereinafter referred to as the "Expiration Date"), or on such earlier date upon which said term may expire or be canceled or terminated pursuant to the provisions of Section 16 hereof, or such other date upon which said term may expire or be canceled or terminated pursuant to the other provisions of this Sublease or pursuant to law, upon and subject to the covenants, agreements, terms and conditions herein contained. b. In the event that the Subleased Premises are not surrendered by Subtenant upon the termination of this Sublease for any reason whatsoever other than Sublessor's default, Subtenant hereby indemnifies, holds harmless and agrees to defend Sublessor (including paying Sublessor's reasonable counsel fees and disbursements) against any and all liabilities resulting from delay by Subtenant in so surrendering the Subleased Premises, including any claims made by any succeeding tenant or prospective tenant founded upon such delay. In addition to, and not in limitation of, the provisions set forth in the immediately preceding sentence, in the event that Subtenant shall hold over after the Expiration Date, Subtenant shall pay the rental due for any such period under this Sublease, except that, in the event Subtenant shall hold over for a period in excess of fifteen (15) days, Subtenant shall pay a rental for each day Subtenant shall hold over in an amount equal to two times the total gross rent and any penalties or other charges due and payable by Sublessor pursuant to the Overlease on a pro rated daily basis as of the last day of the term of this Sublease; provided, however, that the preceding provisions set forth in this sentence shall not apply to any period during which Subtenant is holding over due solely to events of "force majeure" (as such term is hereinafter defined); during any period in which Subtenant is holding over due solely to events of force majeure, Subtenant shall pay a rental for each such day in an amount equal to the rent due and payable on a pro rated daily basis as of the last day of the term of this Sublease. As used in this Sublease, the term "force majeure" shall mean the following causes beyond Sublessor's or Subtenant's, as the case may be, reasonable control: legal or governmental restrictions, regulations or controls, labor disputes, mechanical breakdowns, inability to obtain fuel, steam, water, electricity or materials through ordinary sources, acts of God, enemy action, civil commotion, fire or other casualty. Page 2 of 28 3. FAILURE TO GIVE POSSESSION. In the event possession of the Subleased Premises is not delivered by Sublandlord to Subtenant on or prior to the Commencement Date, Sublandlord agrees to credit Subtenant's Base Rent when payable hereunder in the amount of $3,750.00 per week or $541.67 per day, as the case may be, until possession is delivered ("Delay Credit"). In the event that with the consent of the Subtenant possession of part but not all the Subleased Premises is delivered to Subtenant prior to the remainder of the Subleased Premises, the Delay Credit shall be adjusted pro rata based on the amount of square footage delivered for possession and the amount remaining. Notwithstanding anything to the contrary stated herein, in the event all of the Subleased Premises is not delivered by 120 days after receipt of the Landlord's Consent, Subtenant shall be entitled by written notice to Sublandlord to cancel this Sublease and receive the Delay Credit from Sublandlord in certified or wired funds. Subtenant shall also be entitled to cancel this Sublease by written notice to Sublandlord if Sublandlord has not delivered all of the Subleased Premises to Subtenant by 150 days after receipt of the Landlord's Consent; in such event Sublandlord shall pay the Delay Credit and an additional $55,000.00 to Subtenant by certified check or wired funds. Sublandlord shall only be entitled to remain in the Subleased Premises at such time if Sublandlord must do so for the good faith conduct of Sublandlord's business operations. 4. OVERLEASE. a. Annexed hereto as Exhibit A is a copy of the Overlease, the terms and provisions of which, except as otherwise herein provided, are hereby incorporated in and made a part hereof. b. This Sublease is subject and subordinate to the Overlease and to all amendments thereof heretofore and hereafter entered into and to any termination caused by Sublessor's default thereof in accordance with its terms and to all matters to which the Overlease is or shall be subordinate and to the consent of the Landlord in accordance with the terms of the Overlease. No amendment hereafter entered into by Sublessor and Landlord will have any adverse effect on the rights or obligations of Subtenant hereunder. Promptly after the execution of any amendment of the Overlease, Sublessor shall mail a copy thereof to Subtenant. Page 3 of 28 c. Subtenant covenants and agrees: (i) to perform and observe all of the terms, covenants, conditions and agreements of the Overlease on the part of Sublessor to be performed thereunder relating to the Subleased Premises (other than the covenant to pay Base Rent and Additional Rent and such other covenants that are to remain the obligation of Sublessor hereunder) arising after the date hereof to the extent that the same are not modified or amended by this Sublease; (ii) not to do or not to suffer any act or thing to be done on, or with respect to, the Subleased Premises which would constitute a default under the Overlease or would cause the Overlease to be canceled, terminated or forfeited by virtue of any rights of cancellation, termination or forfeiture reserved or vested in Landlord under the Overlease; and (iii) to indemnify, hold harmless and defend Sublessor (including the payment of Sublessor's reasonable counsel fees and disbursements) from and against any and all claims, liabilities, losses and damages of any kind whatsoever that Sublessor may incur by reason of, resulting from or arising out of any such cancellation, termination or forfeiture. d. Sublessor represents that as of the date hereof the Overlease is in full force and effect. Sublessor represents that Sublessor has not received as of the date hereof any notice of default from the Landlord under the Overlease and has not, to the best of its knowledge, done or suffered or caused to be done any acts which would result in any cancellation, forfeiture, or termination of the Overlease. Sublessor covenants that all rent and additional rent has been or will be paid through the Commencement Date and thereafter on a timely basis, and that Sublessor's interest in the Overlease is unencumbered. e. To the extent that any provisions of the Overlease may conflict or be inconsistent with the provisions of any Section of this Sublease, whether or not such inconsistency is expressly noted herein, the provisions of such Section of this Sublease shall prevail, provided, however, that in no event shall any greater rights as against the Landlord be conferred upon Subtenant hereunder than are conferred upon Sublessor pursuant to the Overlease. Furthermore, it is understood that, pursuant to the terms of the Overlease, certain work, services and repairs to be furnished or made thereunder may in fact be furnished or made by Landlord and not by Sublessor. Sublessor shall in no event be liable to Subtenant nor shall the obligations of Subtenant hereunder be impaired or the performance thereof excused because of any failure or delay on the part of the Landlord in furnishing any such work or services or in making any of such repairs. However, if the Landlord shall default in any of Landlord's obligations to Sublessor with respect to this Subleased Premises, Subtenant shall be entitled to participate, at its own expense, with Sublessor in the enforcement of the rights which Sublessor may have against Landlord, and Sublessor shall, at the request of Subtenant, cooperate promptly and diligently with Subtenant, including joining in any action or proceeding if necessary, to enforce the rights of Subtenant, provided that Subtenant shall Page 4 of 28 pay or reimburse Sublessor for all costs and expenses incurred by Sublessor in any such action or proceeding and shall indemnify, hold harmless and defend Sublessor (including the payment of Sublessor's reasonable counsel fees and disbursements) from any liability arising from the taking of any such action at the request of Subtenant. In the event Sublessor fails so to cooperate with Subtenant, Subtenant may act in Sublessor's name to enforce its rights as aforesaid. f. In the event of termination, re-entry or dispossess by Landlord under the Overlease, unless the Landlord shall otherwise provide, this Sublease shall automatically cease and terminate subject to the foregoing. Landlord may, at its option, take over all of the right, title and interest of Sublessor hereunder in and to the Subleased Premises, and Subtenant shall, at Landlord's option, attorn to Landlord pursuant to the then executory provisions of this Sublease, except that Landlord shall not: (i) be liable for any previous act or omission of Sublessor hereunder; (ii) be subject to any offset not expressly provided in this Sublease which theretofore accrued to Subtenant against Sublessor; or (iii) be bound by any previous modification of this Sublease or by any previous prepayment of more than one (1) month's Base Rent (as hereinafter defined), if any. If this Sublease is terminated or if Landlord takes over Sublessor's interest hereunder by reason of default under the Overlease which was not caused by a default of Subtenant under this Sublease, then such termination or taking- over shall not release Sublessor from liability to Subtenant hereunder. 5. INSURANCE; INDEMNIFICATION AND HOLD HARMLESS. a. Subtenant covenants to provide on or before the Commencement Date and to keep in force during the term of this Sublease at its own cost and expense, the insurance coverage required to be provided in paragraph 9 of the Overlease and the following insurance coverage: (i) A standard comprehensive policy of liability insurance naming Sublessor and Landlord as additional insureds, as their interest may appear, and protecting Sublessor, Landlord and Subtenant against liability occasioned by accident on or about the Subleased Premises or any appurtenances thereto. Such policy is to be written by good and solvent insurance companies authorized to do business in the State of New York and the limits of liability thereunder shall not be less than the amount of Five Million ($5,000,000.00) Dollars in respect of any one person, in the amount of Five Million ($5,000,000.00) Dollars in respect of any one accident, and in the amount of Five Million ($5,000,000.00) Dollars in respect of property damages. Such insurance may be carried under a blanket policy covering the Subleased Premises and other locations of Subtenant, if any, provided that the protection to be provided to Sublessor pursuant to this subsection shall not be diminished by virtue of such blanket policy or the joinder of other parties as insureds thereunder; and Page 5 of 28 (ii) Workers' compensation insurance providing statutory New York State benefits in connection with any work done on or about the Subleased Premises by or at the direction of Subtenant. b. All policies of insurance required hereunder shall contain an endorsement or other provision pursuant to which such insurance may not be modified or canceled, nor the amount thereof reduced, except upon at least fifteen (15) days' prior notice to Sublessor. c. Subtenant shall not carry separate or additional insurance concurrent in form or contributing in the event of any loss or damage with any insurance required to be obtained by Subtenant under this Sublease if the effect of such insurance would be to reduce the protection or the payment to be made under the insurance required hereunder, unless Sublessor is included as an insured thereunder. Subject to the foregoing, Subtenant shall be permitted to carry separate insurance on its furnishings, furniture, and equipment in the Subleased Premises. d. Prior to the time any insurance specified in this Section is first required to be carried by Subtenant and thereafter, at least fifteen (15) days prior to the expiration of any such policies, Subtenant agrees to deliver to Sublessor either copies of the aforesaid policies or certificates evidencing such insurance, provided that any such certificate shall contain an endorsement that such insurance may not be modified or canceled, nor the amount thereof reduced, except upon the prior notice required under Section (b) of this Section 5. e. (i) Sublessor and Subtenant shall each endeavor to secure an appropriate clause in, or an endorsement upon, each fire or extended coverage policy obtained by it and covering the Building, the Subleased Premises or the personal property, fixtures and equipment located therein or thereon, pursuant to which the respective insurance companies waive subrogation or permit the insured, prior to any loss, to agree with a third party to waive any claim it might have against said third party. The waiver of subrogation or permission for waiver of any claim hereinbefore referred to shall extend to the agents of each party and its employees and, in the case of Subtenant, shall also extend to all other persons and entities occupying or using the Subleased Premises in accordance with the terms of this Sublease. If and to the extent that such waiver or permission can be obtained only upon payment of an additional charge then, except as provided in clauses (ii) and (iii) of this Section 5(e), the party benefiting from the waiver or permission shall pay such charge upon demand, or shall be deemed to have agreed that the party obtaining the insurance coverage in question shall be free of any further obligations under the provisions hereof relating to such waiver or permission. Page 6 of 28 (ii) In the event that Sublessor shall be unable at any time to obtain one of the provisions referred to above in any of its insurance policies, Sublessor shall notify Subtenant thereof (and include in such notice the amount of the additional premium, if any, imposed for the inclusion of Subtenant as an insured party), and, at Subtenant's option, Sublessor shall cause Subtenant to be named in such policy or policies as one of the insureds, but if any additional premium shall be imposed for the inclusion of Subtenant as such as an insured, Subtenant shall pay such additional premium upon demand, or Sublessor shall be excused from its obligations under this Section 5(e) with respect to the insurance policy or policies for which such additional premiums would be imposed. In the event that Subtenant shall have been named as one of the insureds in any of Sublessor's policies in accordance with the foregoing, Subtenant shall endorse promptly to the order of Sublessor, without recourse, any check, draft or order for the payment of money representing the proceeds of any such policy or any other payment growing out of or connected with said policy, and Subtenant hereby irrevocably waives any and all rights in and to such proceeds and payment. (iii) In the event that Subtenant shall be unable at any time to obtain one of the provisions referred to above in any of its insurance policies, Subtenant shall notify Sublessor thereof (and include in such notice the additional premium, if any, imposed for the inclusion of Sublessor as an insured party) and, at Sublessor's option, Subtenant shall cause Sublessor to be named in such policy or policies as one of the insureds, but if any additional premium shall be imposed for the inclusion of Sublessor as an insured, Sublessor shall pay such additional premium upon demand or Subtenant shall be excused from its obligations under this Section 5(e) with respect to the insurance policy or policies for which such additional premiums would be imposed. In the event that Sublessor shall have been named as one of the insureds in any Subtenant's policies in accordance with the foregoing, Sublessor shall endorse promptly to the order of Subtenant, without recourse, any check, draft or order for the payment of money representing the proceeds of any such policy or any other payment growing out of or connected with said policy and Sublessor hereby irrevocably waives any and all rights in and to such proceeds and payment. f. If, by reason of a failure of Subtenant to comply with the provisions of Section 5(g) or Section 11 hereof, Sublessor is required pursuant to the Overlease to pay to or reimburse Landlord for all or any portion of any increased premiums for fire insurance and extended coverage, Sublessor shall notify Subtenant thereof and Subtenant shall reimburse Sublessor, on demand, for that portion of such Sublessor's payment or reimbursement occasioned because of such failure on the part of Subtenant. Page 7 of 28 g. Subtenant shall not violate, or permit the violation of, any condition imposed by the standard fire insurance policy then issued for office buildings in the Borough of Manhattan, City of New York, and shall not do, or permit anything to be done, or keep or permit anything to be kept in the Subleased Premises in violation of this Sublease or the Overlease which would subject Landlord or Sublessor to any liability or responsibility for personal injury or death or property damage, or which would increase the fire or other casualty insurance rate on the Building or the property therein over the rate which would otherwise then be in effect or which would result in insurance companies of good standing refusing to insure the Building or any of such property in amounts reasonably satisfactory to Landlord and Sublessor. h. In addition to the foregoing, upon failure of Subtenant to procure, maintain or place such insurance and pay all premiums and charges therefor, Sublessor may, upon fifteen (15) days' notice to Subtenant, do so (but shall not be obligated to do so) and in such event Subtenant agrees to pay the amount therefor, plus interest at the Interest Rate (as such term is defined in Section 8(e) hereof), from the date of such payment by Sublessor until payment in full by Subtenant, to Sublessor on demand, as Additional Rent as hereinafter defined. Notwithstanding the foregoing, if Subtenant shall fail to keep in force and effect the insurance substantially as hereinabove set forth, then Subtenant shall indemnify, save harmless and defend Landlord and Sublessor (including the payment of Landlord's and Sublessor's counsel fees and disbursements) from and against any and all liability and damages, and from and against any and all suits, claims and demands of every kind and nature, including reasonable attorneys' fees by or on behalf of any person, firm, association or corporation arising out of or based upon any accident, injury or damage, however occurring, which shall or may happen in, on, at or about the Subleased Premises, and from and against any matter or thing arising out of the condition, maintenance, repair, alteration, use, occupation, or operation of the Subleased Premises, except to the extent the same shall have been caused by the negligent acts or omissions of Sublessor, its employees or agents. Page 8 of 28 6. ASSIGNMENT AND SUBLETTING. a. Subtenant shall not assign this Sublease or Subtenant's rights in and to the Subleased Premises or sublet all or any part of the Subleased Premises without consent of the Overlandlord pursuant to the Overlease. If this Sublease is assigned or if the Subleased Premises or any part thereof is underlet or occupied by anyone other than the Subtenant, Sublessor may collect rent from the assignee, undertenant or occupant and apply the net amount collected to the rents herein reserved, but no such assignment, underletting, occupancy or collection shall be deemed a waiver of this covenant or the acceptance of the assignee, undertenant or occupant as tenant, or a release of Subtenant from the further performance or observance by Subtenant of the covenants herein contained. The consent to an assignment or underletting shall not in anyway be construed to relieve Subtenant (or any assignee or undertenant) from obtaining the express written consent of Sublessor to any further assignment or underletting. Notwithstanding any assignment or sublease which shall have been consented to by Sublessor, Subtenant shall remain primarily liable on this Sublease and shall not be released from performing and observing any of the terms, covenants and conditions of this Sublease. b. Any transfer of a 50% or greater interest in Subtenant (whether stock, partnership interest or otherwise) shall be deemed to be an assignment of this Sublease. c. Every assignment hereunder is subject to the express condition, and by accepting an assignment hereunder each assignee shall be conclusively deemed to have agreed, that if this Sublease should be terminated prior to the expiration date or if Sublessor should succeed to Subtenant's estate in the Subleased Premises, then at Sublessor's election, the assignee shall attorn to and recognize Sublessor as the assignee's landlord and the assignee shall promptly execute and deliver any instrument Sublessor may reasonably request to evidence such attornment. d. Subtenant shall furnish Sublessor with an executed counterpart of any assignment made hereunder within ten (10) days after the date of its execution. Subtenant shall remain fully liable for the performance of all of Subtenant's obligations hereunder notwithstanding any assignment provided for herein, and without limiting the generality of the foregoing, shall remain fully responsible and liable to Sublessor for all acts and omissions of any assignee or anyone claiming by, through or under any assignee which shall be in violation of any of the obligations of this Sublease and any such violation shall be deemed to be a violation by Subtenant. Page 9 of 28 e. Notwithstanding any assignment and assumption by the assignee of the obligations of Subtenant hereunder, Subtenant herein named, and each immediate or remote successor in interest of Subtenant herein named, and any guarantor of this Sublease, shall remain liable jointly and severally (as a primary obligor) with its assignee and all subsequent assignees for the performance of Subtenant's obligations hereunder, and, without limiting the generality of the foregoing, shall remain fully and directly responsible and liable to Sublessor for all acts and omissions on the part of any assignee subsequent to it in violation of any of the obligations of this Sublease. f. Notwithstanding anything to the contrary hereinabove set forth, no assignment of this Sublease shall be binding upon Sublessor unless the assignee shall execute and deliver to Sublessor an agreement, whereby such assignee agrees, unconditionally, to be personally bound by and to perform all of the obligations of Subtenant hereunder and further expressly agrees that notwithstanding such assignment the provisions of this Article shall continue to be binding upon such assignee with respect to all future assignments and transfers. A failure or refusal of such assignee to execute or deliver such an agreement shall not release the assignee from its liability for the obligations of Subtenant hereunder assumed by acceptance of the assignment of this Sublease. g. If Sublessor shall decline to give its consent to any proposed assignment, Subtenant shall indemnify, defend and hold harmless Sublessor against and from any and all loss, liability, damages, costs and expenses (including reasonable legal fees and disbursements) resulting from any claims that may be made against Sublessor by the proposed assignee or by any brokers or other persons claiming a commission or similar compensation in connection with the proposed assignment. h. In the event that (i) Sublessor fails to exercise any of its options under this Section and (ii) Subtenant fails to execute and deliver the assignment or sublease to which Sublessor consented within sixty (60) days after the giving of such consent, then, Subtenant shall again comply with all of the provisions and conditions of this Section before assigning this Sublease. i. The consent by Sublessor to an assignment or to a subletting shall not relieve Subtenant (or any successor thereto) from obtaining the express written consent of Sublessor to any further assignment or subletting. 7. USE AND OCCUPANCY. Subtenant covenants and agrees to use the Subleased Premises only for the uses permitted in the Overlease and for no other purpose. Page 10 of 28 8. ANNUAL BASE RENT AND PAYMENT DATES. a. Six months after the later of (i) Commencement Date or delivery of the Subleased Premises to Subtenant ("Free Rent Period") - 12/31/2001 $472,500 per annum In the event a portion of the Subleased Premises is delivered for Subtenant's possession prior to the delivery of the remainder of the Subleased Premises for Subtenant's possession, the Free Rent Period shall be adjusted pro rata to reflect such staggered delivery. Solely by way of example, if possession of the 10th Floor is delivered to Subtenant 60 days after receipt of Landlord's Consent while possession of the 11th Floor is delivered to Subtenant 90 days thereafter, the Free Rent period shall expire for the 10th Floor eight months from said receipt and the 11th Floor nine months from said receipt. 1/1/2002 - 12/31/2005 $535,500 per annum 1/1/2006 - 13/31/2008 $598,500 per annum b. Subtenant shall pay to Sublessor the Base Rent in equal monthly installments in advance on the first day of each and every calendar month, commencing as stated in paragraph 8(a)(i) above. If the Expiration Date occurs on a date other than the last day of a calendar month, the Base Rent for such calendar month shall be pro rated. c. (i) In addition to the Base Rent, Subtenant shall pay to Sublessor, as additional rent (hereinafter referred to as "Additional Rent"), without limitation or exception, all other sums of money as the same shall become due and payable by Subtenant under this Sublease and any specific Landlord charges imposed on Subtenant which may or may not be billed to Sublessor (e.g. - overtime service charges). (ii) In addition to the Base Rent and all other sums specified herein, and as part of the total rent to be paid, Subtenant shall pay Sublessor, as additional rent, without set-off or deduction, the following Additional Rent: (a) Taxes. If the Real Estate Taxes applicable to the Building for any lease year during the term of this lease shall exceed the Real Estate Taxes applicable to the Building for real estate tax calendar year 1998 - 99 ("Base Lease Year"), then for said lease year the Subtenant shall pay to the Sublessor as rent (in addition to all other rent payable) 9.22% of the amount of such excess. Page 11 of 28 The term "Real Estate Taxes" shall mean all the real estate taxes and assessments, special, supplemental, or otherwise, levied, assessed or imposed by federal, state or local governments against or upon the buildings of which the Overleased Premises forms a part and the land upon which the Building is located. If at any time during the term of this Sublease the methods of taxation prevailing at the commencement of the term hereof shall be altered so that in lieu of or as an addition to or as a substitute for the whole or any part of the taxes, assessments, levies, impositions or charges now levied, assessed or imposed on real estate and the improvements thereon, there shall be levied, assessed and imposed (i) a tax, assessment, levy, imposition or charge wholly or partially as capital, levy, or otherwise on the rents received thereof, or (ii) a tax, assessment, levy, imposition or charge measured by or based in whole or in part upon the Overleased Premises and imposed upon Landlord, or (iii) a license fee measured by the rents payable by Subtenant to Sublessor, or the part thereof so measured or based, shall be deemed to be included within the term "Real Estate Taxes" for the purpose hereof. Only Landlord or Sublessor may institute tax reduction or other proceedings to reduce the assessed valuation of the land and/or Building. Sublessor's failure during the sublease term to prepare and deliver any of the foregoing tax bills, statements or bills, or Sublessor's failure to make a demand, shall not in any way cause Sublessor to forfeit or surrender its rights to collect any of the foregoing items of additional rent which may have become due during the term of this sublease. Subtenant's liability for the amounts due under this Article shall survive the expiration of the term. As of the Commencement Date, Sublessor shall estimate Subtenant's annual pro rata share of Real Estate Taxes and one-twelfth (1/12) of the amount so estimated shall be paid on the first day of each calendar month in advance. Within one hundred twenty (120) days after the end of each calendar year Sublessor shall furnish Subtenant a statement in reasonable detail of the actual Real Estate Taxes prepared in accordance with sound accounting practices and thereupon there shall be an adjustment between Sublessor and Subtenant, with payment to or repayment by Sublessor, as the case may require, to the end that owner shall receive the entire amount of Tenant's annual pro rata share for such period. (b) Wage Rate. If the Wage Rate for any Operating Year shall be greater than the Base Wage Rate, then Subtenant shall in the case of such an increase pay to Sublessor as additional rent for the Subleased Premises an amount equal to the product obtained by multiplying the difference between the Wage Rate for such Operating Year and the Base Wage Rate, by the Wage Rate Multiple. All capitalized terms used in this paragraph shall have the meanings ascribed to them in the Overlease as Page 12 of 28 amended except that the Base Wage Rate shall be deemed to mean the Wage Rate for the calendar year 1998, the Operating Year shall mean the calendar year in which the term of this Sublease commences and each subsequent calendar year in which occurs any portion of the term of this Sublease, the Wage Rate Multiple shall equal 31,500 and Wage Rate as used in this Sublease shall be exclusive of the monetary value or cost of all payments or benefits of every nature and kind (including those required to be paid by the employer directly to taxing authorities or others because of the employment) including, but not limited to, social security, unemployment and other similar taxes, holiday and vacation pay, absent fund, birthdays, jury duty, medical checkup, relief time and other paid time off, incentive pay, sick pay, accident, health and welfare insurance programs, pension plans, guaranteed payment plans, and supplemental unemployment benefit programs of a similar or dissimilar nature, irrespective of whether they may be required by any Legal Requirement or otherwise. d. Subtenant shall pay all Base Rent in lawful money of the United States by check drawn on a bank or trust company branch located in the United States, delivered or mailed to the office of Sublessor, or such other place as Sublessor may designate in writing, without any setoff or deduction whatsoever, except that Subtenant shall pay the first full monthly installment of Base Rent equal to $39,375.00 upon execution hereof. e. If Subtenant shall fail to pay when due any installment or payment of Base Rent within ten (10) days after the date on which such installment or payment is due, provided Subtenant has received at least five (5) days' notice thereof (except that no such notice shall be required more than once any lease year), Subtenant shall pay interest thereon at the Interest Rate, as hereinafter defined, from the date when such installment or payment shall have become due to the date of the payment thereof, and such interest shall be deemed Additional Rent, payable simultaneously with the installment or payment for which such interest shall have accrued. For purposes of the Sublease, "Interest Rate" shall mean a rate which is four (4) points over the then prime interest rate as published in the Wall Street Journal. 9. ELECTRICITY, OTHER UTILITIES AND CLEANING. a. To the extent required by the Overlease, Subtenant shall pay for, at its own cost and expense, all cleaning services, and all utilities for the Overleased Premises (including gas, air conditioning, water, sewerage, hot water and heat, electricity on a direct meter with the utility for the 11th Floor and 10th Floor with the exception of 1,617 rentable square feet which Subtenant agrees to pay on a submetered basis pursuant to the terms of the Overlease as amended, light, power, telephone and other similar services), including the cost of installation and maintenance of meters and any additional items required by the Subtenant from the date Subtenant takes delivery of the Subleased Premises. Page 13 of 28 b. Subtenant agrees to maintain, repair and replace when reasonably necessary, at Subtenant's own cost and expense, the heating, air conditioning, electric lighting, electrical, and plumbing equipment serving the Subleased Premises exclusively (including light bulbs and tubes). All heating and air conditioning equipment remains the property of the Sublessor. 10. SIGNS. Subject to the consent of the Landlord, Tenant shall have the privilege of placing on the Subleased Premises such signs as it deems necessary and proper in the conduct of its business, provided Tenant pays all permit and license fees which may be required to be paid for the erection and maintenance of any and all such signs, and provided the signs are legally permitted to be installed. Tenant agrees to exonerate, save harmless, protect, and indemnify the Sublessor and the Landlord from and against any and all losses, damages, claims, suits, or actions for any damage or injury to person or property caused by the erection and maintenance of the signs or parts thereof, and insurance coverage for the signs shall be included in the public liability policy, which Tenant is required to furnish under paragraph 5 hereof. 11. PERMITS; COMPLIANCE WITH LAWS. Subtenant covenants that Subtenant will not use or suffer or permit any person to use the Subleased Premises for any unlawful purpose and that it will obtain and maintain at its sole cost and expense all licenses and permits from any and all governmental authorities having jurisdiction over the Subleased Premises which may be necessary for the conduct of Subtenant's business thereon. Subtenant further covenants to comply with all applicable laws, resolutions, codes, rules and regulations of any department, bureau, agency or any governmental authority having jurisdiction over the operation, occupancy, maintenance and use of the Subleased Premises for the purpose set forth herein to the extent required of Sublessor under the Overlease or arising from Subtenant's use. Subtenant will indemnify, hold harmless and defend Sublessor (including the payment of Sublessor's reasonable counsel fees and disbursements if Sublessor is required to appear in any action or proceeding) from and against any claims, penalties, loss, damage or expense imposed by reason of a violation of any applicable law or the rules and regulations of governmental authorities having jurisdiction thereof relating to Subtenant's use and occupancy of the Subleased Premises. Page 14 of 28 12. CONDITION OF SUBLEASED PREMISES. a. Subtenant represents that Subtenant has made a thorough examination and inspection of the Subleased Premises and is familiar with the condition thereof. Subtenant acknowledges that this Sublease has been made without any representations or warranties by Sublessor as to the present or future condition of the Subleased Premises or the appurtenances thereto or any improvements therein. It is further agreed that Subtenant does and will accept the Subleased Premises in its "as is" condition and state of repair as of the date hereof, subject to reasonable wear and tear between the date of execution hereof and the Commencement Date and Sublessor's normal moving out of the Subleased Premises. Sublessor shall have no obligation to perform any work or provide any materials therein. Notwithstanding the foregoing, Sublessor shall deliver the Subleased Premises to Subtenant broom clean and vacant. 13. ALTERATIONS OR IMPROVEMENTS. a. Subtenant shall not make any alterations or improvements to the Subleased Premises without the express prior written consent of Sublessor and Landlord in accordance with the provisions of the Overlease in each instance first obtained. Sublessor agrees not to unreasonably withhold or delay its consent to any nonstructural alterations if the consent of Landlord is first obtained or if such consent is not required. All alterations or improvements shall be made, if at all, at the sole cost and expense of Subtenant, and shall be made solely in accordance with the provisions and requirements of the Overlease, and with respect thereto: (i) all obligations of and all acts or things to be performed, done or observed on "Tenant's" part thereunder, shall be the obligations of and shall be performed, done and observed by Subtenant; and (ii) all references contained therein to "Landlord" shall be deemed to include and shall include Sublessor hereunder. b. Any personal property which may be removed without damage to the Subleased Premises shall remain the property of Subtenant, and, except as provided below, all other personal property and alterations and improvements shall become the property of Sublessor at the expiration of the term of this Sublease. At Sublessor's request, Subtenant shall be obligated, at Subtenant's sole cost and expense, to remove all or any part of Subtenant's movable personal property and all or any part of the alterations and improvements made by Subtenant or for its account, at the expiration or earlier termination of Sublease and to restore the Subleased Premises to the condition existing as of the commencement of occupancy by Subtenant of the Subleased Premises, except for ordinary wear and tear, and except for alterations made with the express prior written consent of Sublessor. Page 15 of 28 14. BROKERS. Each party warrants and represents to the other that each party has not engaged and or dealt with any broker, finder or any person acting in such capacity or similar capacity in connection with this Sublease other than Sylvan Lawrence Company, Inc. and S.L. Green Leasing, Inc. ("Broker"). This Sublease is consummated in reliance on the foregoing representation, and each party agrees to indemnify, hold harmless and defend the other from any and all losses, damages, costs, expenses, claims and liabilities arising out of any inaccuracy of said representations, including court costs and attorneys' fees and disbursements. Sublessor agrees to pay Broker a commission pursuant to separate agreement. 15. INDEMNIFICATION. a. Subtenant agrees to indemnify, hold harmless and defend Sublessor (including the payment of Sublessor's reasonable counsel fees and disbursements) against and from all liabilities, obligations, damages, penalties, claims, costs, charges, and expenses, which may be imposed or asserted against Sublessor by reason of any of the following occurring during the term hereof. (i) Any wrongful act or omission by Subtenant or any of its agents, contractors, servants, employees, licensees or invitees arising out of Subtenant's use, occupancy, control, or management of the Subleased or Demised Premises and any part thereof; (ii) Any work or thing done by Subtenant in or about the Subleased or Demised Premises or any part thereof, including, but not limited to, work done pursuant to Article 13 hereof; or (iii) Any failure on the part of Subtenant to perform or comply with any of the covenants, agreements, terms or conditions contained in this Sublease or the Overlease, on Subtenant's part to be performed, after the expiration of any applicable notice and grace periods. b. In the event any action or proceeding is brought against Sublessor by reason of any of the above, Subtenant upon written notice from and requested by Sublessor shall, at Subtenant's sole cost and expense, resist or defend any such action or proceeding, and shall pay any judgment or perform any decree resulting therefrom which shall have become final, provided that Sublessor will not settle any such action without Subtenant's express prior written consent, provided that if such consent is not forthcoming promptly after the request therefor, Subtenant shall post a bond in the amount of the offered settlement. Page 16 of 28 c. Sublessor agrees to indemnify, hold harmless and defend Subtenant (including the payment of Subtenant's reasonable counsel fees and disbursements) against and from all liabilities, obligations, damages, penalties, claims, costs, charges and expenses, which may be imposed or asserted against Subtenant by reason of (i) any event occurring prior to the term hereof or (ii) any failure of Sublessor to make timely payment of rent and additional rent under the Overlease, except to the extent that such failure results from Subtenant's failure to pay rent or additional rent under this Sublease. 16. DEFAULT PROVISIONS AND REMEDIES. a. If any one or more of the following events (hereinafter referred to as "Events of Default" ) shall occur: (i) If this Sublease or the estate of Subtenant hereunder shall be transferred or assigned by Subtenant to any person, firm corporation or other entity, whether by operation of law or otherwise, except in a manner as may be herein expressly permitted; or (ii) If default shall be made by Subtenant in the due and punctual payment of any installment of Base Rent or any Additional Rent payable under this Sublease within five (5) days after receipt of notice that such Base Rent or Additional Rent is due; or (iii) If (A) default shall be made by Subtenant in the observance or performance of any covenant, agreement, term or condition, other than those referred to in the foregoing subparagraphs (i) and (ii) of this Section 16(a), and Subtenant shall fail to remedy such default within ten (10) days after notice by Sublessor to Subtenant of such default, unless (B) such default is of such a nature that it cannot be completely remedied within such 10-day period, in which case it must be remedied within such time after the date of the giving of said notice as shall reasonably be necessary; or (iv) If Subtenant shall abandon the Subleased Premises or not perform its obligations hereunder; or (v) If at any time during the term hereof, there shall be filed by Subtenant in any court, pursuant to any statute, either of the United States or any state, a petition in bankruptcy or insolvency, or for the appointment of a receiver or Subtenant otherwise enters into an arrangement under the United States Bankruptcy Act or under any law of similar import; or Page 17 of 28 (vi) If at any time during the term hereof, there shall be filed against Subtenant or any assignee of Subtenant in any court pursuant to any statute either of the United States or of any state a petition in bankruptcy or insolvency, or for reorganization, or for the appointment of a receiver or trustee of or for Subtenant's property, and if within sixty (60) days after the commencement of any such proceeding against Subtenant the same shall not have been stayed or dismissed; or (vii) If any default declared by the Landlord under the Overlease as to which there is no grace period shall be due to any act or omission of Subtenant. In any such event, Sublessor may serve a written notice of cancellation and termination of this Sublease, and upon the expiration of five (5) days from the receipt or attempted delivery thereof, this Sublease and the term hereof shall end and expire as fully and completely as if the date of expiration of such five (5) day period were the day herein definitely fixed for the end and expiration of this Sublease and the term hereof, and Subtenant shall then quit or surrender to Sublessor the Subleased Premises and each and every part thereof, but Subtenant shall remain liable for damages and all other sums payable pursuant to the provisions of Section 16(b) below. b. If this Sublease and the term hereof shall expire and terminate as provided in Section 16(a) above: (i) Subtenant will quit and peacefully surrender the Subleased Premises to Sublessor, and Sublessor, upon or at any time after any such expiration or termination, may without further notice, enter upon and re-enter the Subleased Premises and possess and repossess itself thereof, by force, summary proceedings, ejectment or otherwise, may dispossess Subtenant and remove Subtenant and all other persons and property from the Subleased Premises and may have, hold and enjoy the Subleased Premises and the right to receive all rental income of and from the same. (ii) At any time or from time to time after any such expiration or termination, Sublessor may relet the Subleased Premises or any part thereof, in the name of Sublessor or otherwise, for such term or terms (which may be greater or less than the period which would otherwise have constituted the balance of the term of this Sublease) and on such conditions (which may include concessions or free rent) as Sublessor in its absolute discretion may determine, and Sublessor may collect and receive the rent therefor. Page 18 of 28 (iii) No such expiration or termination of this Sublease shall relieve Subtenant of Subtenant's liability and obligations which shall survive any such expiration or termination. In case of any such default, re-entry, expiration and/or dispossess by summary proceedings or otherwise, (a) the rent shall become due thereupon and be paid up to the time of such re-entry, dispossess and/or expiration, (b) Sublessor may re-let the Subleased Premises or any part or parts thereof, and agrees to use its best efforts to do so, either in the name of Sublessor or otherwise, for a term or terms, which may at Sublessor's option be less than or exceed the period which would otherwise have constituted the balance of the term of this Sublease and may grant concessions or free rent or charge a higher rental than that in this Sublease, and/or (c) Subtenant or the legal representatives of Subtenant shall also pay Sublessor as liquidated damages for the failure of Subtenant to observe and perform said Subtenant's covenants herein contained, any deficiency between the rent hereby reserved and/or covenanted to be paid and the net amount, if any, of the rents collected on account of the lease or leases of the Subleased Premises for each month of the period which would otherwise have constituted the balance of the term of this Sublease. The failure of Sublessor to re-let the premises or any part or parts thereof shall not release or affect Subtenant's liability for damages. In computing such liquidated damages there shall be added to the said deficiency such reasonable expenses as Sublessor may incur in connection with re-letting, such as legal expenses, attorneys' fees, brokerage, advertising and for keeping the Subleased Premises in good order or for preparing the same for re-letting. Any such liquidated damages shall be paid in monthly installments by Subtenant on the rent day specified in this Sublease and any suit brought to collect the amount of the deficiency for any month shall not prejudice in any way the rights of Sublessor to collect the deficiency of any subsequent month by a similar proceeding. Sublessor, in putting the Subleased Premises in good order or preparing the same for re-rental may, at Sublessor's option, make such alterations, repairs, replacements, and/or decorations in the Subleased Premises as Sublessor, in Sublessor's reasonable judgment, considers advisable and necessary for the purpose of re-letting the demised premises, and the making of such alterations, repairs, replacements, and/or decorations shall not operate or be construed to release Subtenant from liability hereunder as aforesaid. Sublessor shall in no event be liable in any way whatsoever for failure to re-let the demised premises. Sublessor shall in no event be liable in any way whatsoever for failure to re-let the Subleased Premises, or in the event that the Subleased Premises are re-let, for failure to collect the rent thereof under such re-letting, and in no event shall Subtenant be entitled to receive any excess, if any, of such net rents collected over the sums payable by Subtenant to Sublessor hereunder. In the event of a breach or threatened breach by Subtenant or Sublessor of any of the covenants or provisions hereof, Sublessor and Subtenant shall Page 19 of 28 have the right of injunction and the right to invoke any remedy allowed at law or in equity as if re-entry, summary proceedings and other remedies were not herein provided for. Mention in this Sublease of any particular remedy, shall not preclude Sublessor or Subtenant from any other remedy, in law or in equity. Subtenant hereby expressly waives any and all rights of redemption granted by or under any present or future laws in the event of Subtenant being evicted or dispossessed for any cause, or in the event of Sublessor obtaining possession of Subleased Premises, by reason of the violation by Subtenant of any of the covenants and conditions of this lease, or otherwise. (iv) If Subtenant shall abandon the Subleased Premises or not perform its obligations hereunder; or (v) If at any time during the term hereof, there shall be filed by Subtenant in any court, pursuant to any statute, either of the United States or any state, a petition in bankruptcy or insolvency, or for the appointment of a receiver or Subtenant otherwise enters into an arrangement under the United States Bankruptcy Act or under any law of similar import; or (vi) If at any time during the term hereof, there shall be filed against Subtenant or any assignee of Subtenant in any court pursuant to any statute either of the United States or of any state a petition in bankruptcy or insolvency, or for reorganization, or for the appointment of a receiver or trustee of or for Subtenant's property, and if within sixty (60) days after the commencement of any such proceeding against Subtenant the same shall not have been stayed or dismissed; or (vii) If any default declared by the Landlord under the Overlease as to which there is no grace period shall be due to any act or omission of Subtenant. In any such event, Sublessor may serve a written notice of cancellation and termination of this Sublease, and upon the expiration of five (5) days from the receipt or attempted delivery thereof, this Sublease and the term hereof shall end and expire as fully and completely as if the date of expiration of such five (5) day period were the day herein definitely fixed for the end and expiration of this Sublease and the term hereof, and Subtenant shall then quit or surrender to Sublessor the Subleased Premises and each and every part thereof, but Subtenant shall remain liable for damages and all other sums payable pursuant to the provisions of Section 16(b) below. b. If this Sublease and the term hereof shall expire and terminate as provided in Section 16(a) above: Page 20 of 28 (i) Subtenant will quit and peacefully surrender the Subleased Premises to Sublessor, and Sublessor, upon or at any time after any such expiration or termination, may without further notice, enter upon and re-enter the Subleased Premises and possess and repossess itself thereof, by force, summary proceedings, ejectment or otherwise, may dispossess Subtenant and remove Subtenant and all other persons and property from the Subleased Premises and may have, hold and enjoy the Subleased Premises and the right to receive all rental income of and from the same. (ii) At any time or from time to time after any such expiration or termination, Sublessor may relet the Subleased Premises or any part thereof, in the name of Sublessor or otherwise, for such term or terms (which may be greater or less than the period which would otherwise have constituted the balance of the term of this Sublease) and on such conditions (which may include concessions or free rent) as Sublessor in its absolute discretion may determine, and Sublessor may collect and receive the rent therefor. (iii) No such expiration or termination of this Sublease shall relieve Subtenant of Subtenant's liability and obligations which shall survive any such expiration or termination. In case of any such default, re-entry, expiration and/or dispossess by summary proceedings or otherwise, (a) the rent shall become due thereupon and be paid up to the time of such re-entry, dispossess and/or expiration, (b) Sublessor may re-let the Subleased Premises or any part or parts thereof, and agrees to use its best efforts to do so, either in the name of Sublessor or otherwise, for a term or terms, which may at Sublessor's option be less than or exceed the period which would otherwise have constituted the balance of the term of this Sublease and may grant concessions or free rent or charge a higher rental than that in this Sublease, and/or (c) Subtenant or the legal representatives of Subtenant shall also pay Sublessor as liquidated damages for the failure of Subtenant to observe and perform said Subtenant's covenants herein contained, any deficiency between the rent hereby reserved and/or covenanted to be paid and the net amount, if any, of the rents collected on account of the lease or leases of the Subleased Premises for each month of the period which would otherwise have constituted the balance of the term of this Sublease. The failure of Sublessor to re-let the premises or any part or parts thereof shall not release or affect Subtenant's liability for damages. In computing such liquidated damages there shall be added to the said deficiency such reasonable expenses as Sublessor may incur in connection with re-letting, such as legal expenses, attorneys' fees, brokerage, advertising and for keeping the Subleased Premises in good order or for preparing the same for re-letting. Any such liquidated damages shall be paid in monthly installments by Subtenant on the rent day specified in this Sublease and any Page 21 of 28 suit brought to collect the amount of the deficiency for any month shall not prejudice in any way the rights of Sublessor to collect the deficiency of any subsequent month by a similar proceeding. Sublessor, in putting the Subleased Premises in good order or preparing the same for re-rental may, at Sublessor's option, make such alterations, repairs, replacements, and/or decorations in the Subleased Premises as Sublessor, in Sublessor's reasonable judgment, considers advisable and necessary for the purpose of re-letting the demised premises, and the making of such alterations, repairs, replacements, and/or decorations shall not operate or be construed to release Subtenant from liability hereunder as aforesaid. Sublessor shall in no event be liable in any way whatsoever for failure to re-let the demised premises. Sublessor shall in no event be liable in any way whatsoever for failure to re-let the Subleased Premises, or in the event that the Subleased Premises are re-let, for failure to collect the rent thereof under such re-letting, and in no event shall Subtenant be entitled to receive any excess, if any, of such net rents collected over the sums payable by Subtenant to Sublessor hereunder. In the event of a breach or threatened breach by Subtenant or Sublessor of any of the covenants or provisions hereof, Sublessor and Subtenant shall have the right of injunction and the right to invoke any remedy allowed at law or in equity as if re-entry, summary proceedings and other remedies were not herein provided for. Mention in this Sublease of any particular remedy, shall not preclude Sublessor or Subtenant from any other remedy, in law or in equity. Subtenant hereby expressly waives any and all rights of redemption granted by or under any present or future laws in the event of Subtenant being evicted or dispossessed for any cause, or in the event of Sublessor obtaining possession of Subleased Premises, by reason of the violation by Subtenant of any of the covenants and conditions of this lease, or otherwise. (iv) To the extent permitted by applicable law, Subtenant hereby waives service of any notice of intention to re-enter provided for in any statute, law or regulation, and the service of notice of the institution of legal proceedings to that end. To the extent permitted by applicable law, Sublessor and Subtenant hereby waive trial by jury in any action, proceeding or counterclaim brought by either against the other on any matter whatsoever arising out of or in any way connected with this Sublease, the relationship of Sublessor and Subtenant, Subtenant's use or occupancy of the Subleased Premises, including any claim of injury or damage. The terms "enter", "re-enter", "entry" and "reentry" as used in this Sublease are not restricted to their technical, legal meanings. The provisions of this Section shall survive the termination of this Sublease. Page 22 of 28 (v) The failure of Sublessor or Subtenant, as the case may be, to insist in any one or more instances upon the strict performance of any one or more of the obligations of this Sublease, or to exercise any election herein contained, shall not be construed as a waiver or relinquishment for the future of the performance of such one or more obligations of this Sublease or of the right to exercise such election, but the same shall continue and remain in full force and effect with respect to any subsequent breach, act or omission. No covenant, agreement, term or condition of this Sublease to be performed or complied with by Sublessor or Subtenant, as the case may be, and no breach thereof, shall be waived, altered or modified, and no attempt shall be effective to change, modify, waive, release, discharge, terminate or effect an abandonment of this Sublease, in whole or in part, unless such waiver, alteration, modification, charge, release, discharge, termination, abandonment or executory agreement is in writing, refers expressly to this Sublease, and is signed by the party against whom enforcement thereof is sought. (vi) In the event of any breach or threatened breach by Subtenant of any of the covenants, agreements, terms or conditions contained in this Sublease, Sublessor shall be entitled to enjoin such breach or threatened breach and shall have the right to invoke any right and remedy allowed at law or in equity or by statute or otherwise as though re-entry, summary proceedings, and other remedies were not provided for in this Sublease. (vii) Each right and remedy of Sublessor provided for in this Sublease or in the Overlease shall be cumulative and shall be in addition to every other right or remedy provided for in this Sublease or Overlease as now or hereafter existing at law or in equity or by statute or otherwise, and the exercise or beginning of the exercise by Sublessor of any one or more of the rights or remedies provided for in this Sublease or in the Overlease or now or hereafter existing at law or in equity or by statute otherwise, shall not preclude the simultaneous or later exercise by Sublessor of any or all other rights or remedies provided for in this Sublease or in the Overlease now or hereafter existing at law or in equity or by statute or otherwise. (viii) Subtenant hereby agrees that, in the event Sublessor commences a summary proceeding for possession of the Subleased Premises, Subtenant will not interpose any permissive counterclaim of any nature or description whatsoever in such proceeding, except that Subtenant shall not be estopped in such action from alleging any affirmative defense Subtenant elects to claim. Page 23 of 28 17. REPARIS. Subtenant shall, throughout the term hereof, take good care of the Subleased Premises and the fixtures, appurtenances and personal property of Subtenant therein, and make all repairs thereto which would otherwise be required of Sublessor under the Overlease after the date hereof, ordinary wear and tear excepted. In addition, all damage or injury to the Subleased Premises or the Building caused by or resulting from the use of the Subleased Premises by Subtenant, Subtenant's tenants, employees, invitees or licensees, shall be repaired promptly by Subtenant at Subtenant's sole cost and expense, to the reasonable satisfaction of Sublessor. 18. WAIVER. Subtenant, on its own behalf and on behalf of all persons claiming through or under Subtenant, including all creditors, does hereby waive any and all rights and privileges, so far as is permitted by law, which Subtenant and all such persons might otherwise have under any present or future law (a) to redeem the Subleased Premises, (b) to re-enter or repossess the Subleased Premises, or (c) to restore the operation of this Sublease after Subtenant shall have been dispossessed by a judgment or by warrant of any court or judge; or after any re-entry by Sublessor, or after any expiration or termination of this Sublease and the term, whether such dispossess, re-entry, expiration or termination shall be by operation of law or pursuant to the provisions of this Sublease. The words "re-enter," "re-entry" and "re-entered" as used in this Lease shall not be deemed to be restricted to their technical legal meanings. 19. ANTICIPATORY BREACH. In the event of any breach or threatened breach by Subtenant or any persons claiming through or under Subtenant of any of the agreements, terms, covenants or conditions contained in this Sublease, Sublessor shall be entitled to enjoin such breach or threatened breach and shall have the right to invoke any right and remedy allowed at law or in equity or by statute or otherwise as if re-entry, summary proceedings or other specific remedies were not provided for in this Sublease. 20. NOTICES. a. Any notice, statement, demand or other communication required or permitted to be given, rendered or made by either party to the other, pursuant to this Sublease or pursuant to any applicable law or requirement of public authority, shall be in writing (whether or not so stated Page 24 of 28 elsewhere in this Sublease) and shall be given, rendered or made by overnight courier services such as Federal Express, providing for a receipt on delivery, or by certified or registered mail, return receipt requested, addressed to the other party at the address hereinabove set forth, and shall be deemed to have been given, rendered or made on the second (2nd) business day following the day so mailed or sent by overnight courier services, unless mailed outside of the State of New York, in which case it shall be deemed to have been given, rendered or made on the earlier of actual receipt, or the expiration of the normal period of time for delivery of mail from the post office of origin to the post office of destination. Either party may, by notice as aforesaid, designate a different address or addresses for notice, statements, demands or other communications intended for it. b. If there occurs any interruption of registered mail service lasting more than five (5) consecutive business days, notices may be given by telegram, overnight courier service, or personal delivery, but shall not be effective until personally received by an executive officer of a party which is a corporation, or a managing partner of a party which is a partnership or a principal of any other entity. 21. END OF TERM. Subtenant shall surrender the Subleased Premises to Sublessor at the expiration or sooner termination of this Sublease in the same order and condition as delivered to Subtenant, except for reasonable wear and tear, damage by the elements and damages caused by perils and condemnation excepted, and Subtenant shall remove all of its property from the Subleased Premises. Sublessor may require Subtenant to remove all or a portion of any structural alterations, improvements or additions in and to the Subleased Premises made by Subtenant without Sublessor's express prior written approval, to repair any damage caused by such removal to Sublessor's satisfaction and to restore the Subleased Premises to the condition existing as of the commencement of occupancy by Subtenant of the Subleased Premises, excepting therefrom reasonable wear and tear. 22. SECURITY. Subtenant has deposited with Sublessor the sum of $178,400.00 as security ("Security Deposit") for the faithful performance and observance by Subtenant of the terms, provisions and conditions of this Sublease; it is agreed that in the event Subtenant defaults in respect of any of the terms; provisions and conditions of this Sublease, including, but not limited to, the payment of rent and additional rent, Sublessor may use, apply or retain the whole or any part of the security so deposited to the extent required for the payment of any rent and additional rent or any other sum as to which Subtenant is in default or for any Page 25 of 28 sum which Sublessor may expend or may be required to expend by reason of Subtenant's default in respect of any of the terms, covenants and conditions of this Sublease, including but not limited to, any damages or deficiency in the re-letting of the Subleased Premises, whether such damages or deficiency accrued before or after summary proceedings or other re-entry by Sublessor. In the event that Subtenant shall fully and faithfully comply with all of the terms, provisions, covenants and conditions of this Sublease, Sublessor shall: (i) return a portion of the Security Deposit to Sublessee equal to the sum of $89,250.00 not later than July 1, 2003 and (ii) the security shall be returned to Subtenant after the date fixed as the end of the Sublease and after delivery of entire possession of the Subleased Premises to Sublessor. In the event of a sale of the land and building or leasing of the building, of which the Subleased Premises form a part, Sublessor shall have the right to transfer the security to the vendee or lessee and Sublessor shall thereupon be released by Subtenant from all liability for the return of such security; and Subtenant agrees to look to the new Sublessor solely for the return of said security, and it is agreed that the provisions hereof shall apply to every transfer or assignment made of the security to a new Sublessor. Subtenant further covenants that it will not assign or encumber or attempt to assign or encumber the monies deposited herein as security and that neither Sublessor nor its successors or assigns shall be bound by any such assignment, encumbrance, attempted assignment or attempted encumbrance. In lieu of a cash security deposit, Subtenant may deliver the Security Deposit to Sublandlord in the form of a clean, irrevocable, non-documentary and unconditional letter of credit in the amount of the Security Deposit (the "Letter of Credit") issued by and drawable upon any commercial bank which is a member of the New York Clearing House Association or other bank satisfactory to Sublandlord, trust company, national banking association or savings and loan association with offices for banking purposes in the City of New York (the "Issuing Bank"), which has outstanding unsecured, uninsured and unguaranteed), indebtedness, or shall have issued a letter of credit or other credit facility that constitutes the primary security for any outstanding indebtedness (which is otherwise uninsured and unguaranteed, that is then rated, without regard to qualification of such rating by symbols such as "+" or "-" or numerical notation, "Aa" or better by Moody's Investors Service and "AA: or better by Standard & Poor's Rating Service, and has combined capital, surplus and undivided profits of not less than $500,000,000. The Letter of Credit shall (a) name Sublandlord as beneficiary, (b) be in the amount of the Security Deposit, (c) have a term of not less than one year, (d) permit multiple drawings, (e) be fully transferable by Sublandlord without the payment of any fees or charges by Sublandlord, and (f) otherwise be in form and content satisfactory to Sublandlord. If upon any transfer of the Letter of Credit, any fees or charges shall be so imposed, then such fees or charges shall be payable solely by Subtenant and the Letter of Credit shall so specify. The Letter Page 26 of 28 of Credit shall provide that it shall be deemed automatically renewed, without amendment, for consecutive periods of one year each thereafter during the term of this sublease unless the Issuing Bank sends a notice (the "Non-Renewal Notice") to Sublandlord by certified mail, return receipt requested, not less than 45 days next preceding the then expiration date of the Letter of Credit stating that the Issuing Bank has elected not to renew the Letter of Credit. Sublandlord shall have the right, upon receipt of the Non-Renewal Notice, to draw the full amount of the Letter of Credit, by sight draft on the Issuing Bank, and shall thereafter hold or apply the cash proceeds of the Letter of Credit pursuant to the terms of this Article. The Letter of Credit shall state that drafts drawn under and in compliance with the terms of the Letter of Credit will be duly honored upon presentation to the Issuing Bank at an office location in Manhattan. The Letter of Credit shall be subject in all respects to the Uniform Customs and Practice for Documentary Credits (1993 revision), International Chamber of Commerce Publication No. 500. 23. MISCELLANEOUS. a. Section headings contained in this Agreement are for reference purposes only and shall not in any way affect the meaning or interpretation of this Agreement. b. This Agreement shall be interpreted and given effect in accordance with the laws of the State of New York. c. This Agreement expresses the whole agreement between the parties, there being no representation, warranty or other agreement not herein expressly set forth or provided for. No change, modification of or addition to this Agreement shall be valid unless in writing and signed by each of the parties hereto. d. Each party hereto agrees that it will execute and deliver such further instruments and will take such further action as may be necessary to discharge or perform or carry out any of their respective obligations and agreements hereunder. Each party hereto represents to the other that each has full authority to enter into this Sublease. e. This Sublease shall not be recorded in the land records of the County of New York. f. Nothing contained in this Sublease shall be deemed or construed to create any relationship between the parties hereto other than sublandlord and subtenant, and the parties hereby acknowledge that they are not, and shall not be deemed by this Sublease to be partners or joint venturers. Page 27 of 28 g. The incorporation of the Overlease in this Sublease is intended to clarify the rights of Landlord to which this Sublease is subject and the limitations imposed on Subtenant's use and occupancy of the Demised Premises and not to establish rights or obligations or Sublessor or Subtenant which are not provided for in this Sublease. h. This Sublease is subject to the consent of the Landlord pursuant to the terms of the Overlease of the terms of this Sublease and Sublessee's plans for the initial alterations of the Subleased Premises as set forth in the plans annexed hereto as Exhibit B and made part hereof ("Landlord Consent"). In the event the conditions contemplated in this paragraph are not met, Sublessor shall promptly return to Subtenant any monies paid hereunder and this Sublease and the rights and obligations of the parties hereunder shall be terminated. If Landlord Consent is not received within 30 days from the date of this Sublease, Subtenant may cancel this Sublease by notice given after the expiration of such 30-day period and prior to the granting of such consent, in which case Sublessor shall promptly return to Subtenant any monies paid hereunder and this Sublease and the rights and obligations of the parties hereunder shall be terminated. IN WITNESS WHEREOF, the undersigned have hereunto set their hands this day of July, 1998. RSL COM U.S.A, INC. By: /S/ ---------------------------------- Name: Edmond J. Thomas Title: President COMPUTER OUTSOURCING SERVICES, INC. By: /S/ ---------------------------------- Name: Zach Lonstein Title: Chairman EXHIBIT A ----------- Overlease (see annexed Overlease) EXHIBIT B ----------- Sublessee's Plans (See Annexed) EX-10.7 4 AGREEMENT OF SUBLEASE - NMU PENSION PLAN AGREEMENT OF SUBLEASE between NMU PENSION PLAN, Sublandlord and COMPUTER OUTSOURCING SERVICES, INC., Subtenant Premises: --------- Portion of the Tenth (10th) Floor 360 West 31st Street New York, New York PROSKAUER ROSE LLP 1585 Broadway New York, New York 10036 (212) 969-3000 TABLE OF CONTENTS 1. Subleasing of Premises ................................... 1 2. Term ..................................................... 1 3. Fixed Rent and Additional Rent ........................... 2 4. Subordination to and Incorporation of the Lease .......... 6 5. Alterations .............................................. 7 6. Covenants with Respect to the Lease ...................... 7 7. Services and Repairs ..................................... 8 8. Consents ................................................. 9 9. Termination of Lease ..................................... 10 10. Sublease, Not Assignment ................................. 10 11. Damage, Destruction, Fire and other Casualty; Condemnation 11 12. No Waivers ............................................... 11 13. Notices .................................................. 11 14. Indemnity ................................................ 12 15. Broker ................................................... 13 16. Condition of the Premises ................................ 13 17. Consent of the Prime Landlord to this Sublease ........... 13 18. Assignment, Subletting and Mortgaging .................... 14 19. Partnership Subtenant .................................... 15 20. Miscellaneous ............................................ 16 Exhibit "A"- Floor Plan of Subleased Premises - i - AGREEMENT OF SUBLEASE (this "Sublease"), made as of the 21st day of September, 1998, between NMU PENSION PLAN, an unincorporated asociation, having an office at 360 West 31st Street, New York, New York 10019 ("Sublandlord"), and COMPUTER OUTSOURCING SERVICES, INC., a New York corporation, having an office at 360 West 31st Street, New York, New York 10019 ("Subtenant"). W I T N E S S E T H : - - - - - - - - - - WHEREAS, by Agreement of Lease (the "Initial Lease"), dated March, 1994, between G-H-G Realty Company (the "Prime Landlord"), as landlord, and Sublandlord, as tenant, the Prime Landlord leased to Sublandlord certain premises situated on the entire third (3rd) floor, a portion of the tenth (10th) floor, and a portion of the basement level (collectively, the "Initial Premises") as more particularly described in the Lease and located at the building (the "Building") located at 360 West 31st Street, New York, New York; and WHEREAS, by Amendment of Lease (the "First Amendment"), dated November 15, 1994, between Prime Landlord, as landlord, and Sublandlord, as tenant, the Prime Landlord leased to Sublandlord certain premises situated on an additional portion of the tenth (10th) floor (the "Additional Tenth Floor Premises") of the Building (collectively, the Initial Lease and the First Amendment are referred to herein as the Lease); and WHEREAS, Sublandlord desires to sublease to Subtenant (i) that portion of the Initial Premises consisting of a portion of the tenth (10th) floor of the Building, and (ii) the Additional Tenth Floor Premises (collectively, the "Subleased Premises"), as more particularly described on Exhibit A attached hereto and made a part hereof, and Subtenant desires to hire the Subleased Premises from Sublandlord on the terms and conditions contained herein. NOW, THEREFORE, in consideration of the mutual covenants herein contained, it is mutually agreed as follows: 1. SUBLEASING OF PREMISES. Sublandlord hereby subleases to Subtenant, and Subtenant hereby hires from Sublandlord, the Subleased Premises, upon and subject to the terms and conditions hereinafter set forth. 2. TERM. The term (the "Term") of this Sublease shall commence on October 9, 1998 (the "Commencement Date") and shall terminate on December 31, 2009 (the "Expiration Date"), or on such earlier date upon which the Term shall expire or be canceled or terminated pursuant to any of the conditions or covenants of this Sublease or pursuant to law. 3. FIXED RENT AND ADDITIONAL RENT 3.1. Subtenant shall pay to Sublandlord, commencing on April 9, 1999 (the "Rent Commencement Date"), in currency which at the time of payment is legal tender for public and private debts in the United States of America, as fixed rent ("Fixed Rent") during the Term, three (3) business days prior to the first (1st) day of each month during the Term (it being agreed that since the Rent Commencement Date occurs on a date other than the first (1st) day of a calendar month, the Fixed Rent with respect to the month of April, 1999 shall be pro-rated on a per diem basis) (i) for the period commencing on the Rent Commencement Date and ending on September 30, 1999, the sum of Ninety-Three Thousand Five Hundred Eighty-Eight Dollars ($93,588.00) per annum, payable in equal monthly installments of Seven Thousand Seven Hundred Ninety-Nine Dollars ($7,799.00), (ii) for the period commencing on October 1, 1999 and ending on September 30, 2000, the sum of Ninety-Six Thousand Four Hundred Twenty-Four Dollars ($96,424.00) per annum, payable in equal monthly installments of Eight Thousand Thirty-Five and 33/100 Dollars ($8,035.33), (iii) for the period commencing on October 1, 2000 and ending on September 30, 2001, the sum of Ninety-Nine Thousand Three Hundred Sixteen and 72/100 Dollars ($99,316.72) per annum, payable in equal monthly installments of Eight Thousand Two Hundred Seventy-Six and 39/100 Dollars ($8,276.39), (iv) for the period commencing on October 1, 2001 and ending on September 30, 2002, the sum of One Hundred Two Thousand Three Hundred Twenty-Two and 88/100 Dollars ($102,322.88) per annum, payable in equal monthly installments of Eight Thousand Five Hundred Twenty-Six and 91/100 Dollars ($8,526.91), (v) for the period commencing on October 1, 2002 and ending on September 30, 2003, the sum of One Hundred Five Thousand Four Hundred Forty-Two and 48/100 Dollars ($105,442.48) per annum, payable in equal monthly installments of Eight Thousand Seven Hundred Eighty-Six and 87/100 Dollars ($8,786.87), (vi) for the period commencing on October 1, 2003 and ending on September 30, 2004, the sum of One Hundred Eight Thousand Six Hundred Eighteen and 80/100 ($108,618.80) per annum, payable in equal monthly installments of Nine Thousand Fifty-One and 57/100 Dollars ($9,051.57), Page 2 of 17 (vii) for the period commencing on October 1, 2004 and ending on September 30, 2005, the sum of One Hundred Eleven Thousand Nine Hundred Eight and 56/100 Dollars ($111,908.56) per annum, payable in equal monthly installments of Nine Thousand Three Hundred Twenty-Five and 71/100 Dollars ($9,325.71), (viii) for the period commencing on October 1, 2005 and ending on September 30, 2006, the sum of One Hundred Fifteen Thousand Three Hundred Eleven and 76/100 Dollars ($115,311.76) per annum, payable in equal monthly installments of Nine Thousand Six Hundred Nine and 31/100 Dollars ($9,609.31), (ix) for the period commencing on October 1, 2006 and ending on September 30, 2007, the sum of One Hundred Eighteen Thousand Seven Hundred Seventy-One and 68/100 Dollars ($118,771.68) per annum, payable in equal monthly installments of Nine Thousand Eight Hundred Ninety-Seven and 64/100 Dollars ($9,897.64), (x) for the period commencing on October 1, 2007 and ending on September 30, 2008, the sum of One Hundred Twenty- Two Thousand Three Hundred Forty-Five and 04/100 Dollars ($122,345.04) per annum, payable in equal monthly installments of Ten Thousand One Hundred Ninety-Five and 42/100 Dollars ($10,195.42), (xi) for the period commencing on October 1, 2008 and ending on September 30, 2009, the sum of One Hundred Twenty- Six Thousand Thirty-One and 84/100 Dollars ($126,031.84) per annum, payable in equal monthly installments of Ten Thousand Five Hundred Two and 65/100 Dollars ($10,502.65), and (xii) for the period commencing on October 1, 2009 and ending the Expiration Date, the sum of One Hundred Twenty- Nine Thousand Eight Hundred Thirty-Two and 08/100 Dollars ($129,832.08) per annum, payable in equal monthly installments of Ten Thousand Eight Hundred Nineteen and 34/100 Dollars ($10,819.34). 3.2. (i) For each Tax Year during the Term, Subtenant shall pay to Sublandlord as and for additional rent an amount (the "Sublease Tax Payment") equal to nineteen and one-half percent (19.5%) ("Subtenant's Percentage") of the amount by which the additional basic rental with respect to Taxes payable by Sublandlord for such Tax Year, as computed by the Prime Landlord pursuant to an Escalation Statement delivered to Sublandlord in accordance with the Lease, exceeds the additional basic rental with respect to Taxes payable by Sublandlord for the Tax Year commencing July 1, 1998 and ending June 30, 1999 (the "Sublease Base Tax Year"). Page 3 of 17 (ii) At any time during or after the Term, Sublandlord shall render to Subtenant a written statement or statements (a "Sublease Tax Statement"), together with a reproduced copy of the Escalation Statement received from the Prime Landlord for the current or next succeeding Tax Year (if theretofore issued by the Prime Landlord), showing (i) a comparison of the additional basic rental with respect to Taxes payable by Sublandlord for the Tax Year with the additional basic rental with respect to Taxes for the Sublease Base Tax Year and (ii) the amount of the Sublease Tax Payment resulting from such comparison. Subtenant shall pay to Sublandlord, in twelve (12) equal monthly installments, in advance, five (5) business days prior to the date upon which the corresponding payment is due and payable to the Prime Landlord by Sublandlord, one-twelfth (1/12th) of the Sublease Tax Payment shown on the Sublease Tax Statement, except that if at the time Sublandlord delivers a Sublease Tax Statement to Subtenant, the Sublease Tax Payment shall have accrued for a period prior to the delivery of the Sublease Tax Statement, Subtenant shall pay such accrued portion of the Sublease Tax Payment in full within fifteen (15) days after receipt of such Sublease Tax Statement. If Sublandlord shall be required to pay any additional basic rental with respect to Taxes on any other date or dates than as presently required by the Lease, then the due date of the installments of the Tax Payment shall be correspondingly accelerated or revised so that the Sublease Tax Payment (or the applicable installment thereof) is due five (5) days prior to the date the corresponding payment is due to the Prime Landlord. Sublandlord's failure to render a Sublease Tax Statement during or with respect to any Tax Year shall not prejudice Sublandlord's right to render a Sublease Tax Statement during or with respect to any subsequent Tax Year, and shall not eliminate or reduce Subtenant's obligation to make Sublease Tax Payments pursuant to this Section 3.2 for such Tax Year. (iii) The Sublease Tax Payment shall be prorated for any partial Tax Year in which the Term shall commence or end. If a Sublease Tax Statement is furnished to Subtenant after the commencement of the Tax Year in respect of which such Sublease Tax Statement is rendered, Subtenant shall, within fifteen (15) days thereafter, pay to Sublandlord an amount equal to the amount of any underpayment of the Sublease Tax Payment with respect to such Tax Year and, in the event of an overpayment, Sublandlord shall either pay to Subtenant or, at Sublandlord's election, credit against the next installments of Fixed Rent and payments of additional rent, the amount of Subtenant's overpayment. (iv) Only the Prime Landlord shall be eligible to institute tax reduction or other proceedings to reduce the assessed valuation of the Building. Should the Prime Landlord be successful in any such reduction proceedings and obtain a rebate for any Tax Year for which Subtenant has paid installments of the Tax Payment, Sublandlord shall either pay to Subtenant, or at Sublandlord's election, credit against the next installments of the Fixed Rent and payments of additional rent payable under this Page 4 of 17 Sublease, an amount equal to Subtenant's Percentage of any such rebate for which Sublandlord shall receive a credit from the Prime Landlord. In the event that the assessed valuation which had been utilized in computing the Taxes payable for the Sublease Base Tax Year is reduced (as a result of settlement, final determination or legal proceedings or otherwise) then (x) the Taxes for the Sublease Base Tax Year shall be retroactively adjusted to reflect such reduction, (y) the installments of Sublease Tax Payments shall be increased accordingly, and (z) all retroactive additional rent resulting from such adjustment shall be payable by Subtenant within seven (7) days after the rendition of a bill therefor. 3.3. If Subtenant shall fail to pay when due any installment of Fixed Rent or additional rent, Subtenant shall pay to Sublandlord, in addition to such installment of Fixed Rent or additional rent, as the case may be, as a late charge and as additional rent, a sum equal to interest at the Applicable Rate (hereinafter defined) per annum on the amount unpaid, commencing from the date such payment was due to and including the date of payment. The "Applicable Rate" shall be the rate equal to the lesser of (a) two (2) percentage points above the then current rate publicly announced by The Chase Manhattan Bank, N.A. or its successor as its "base rate" (or such other term as may be used by The Chase Manhattan Bank, N.A. from time to time for the rate presently referred to as its "base rate") or (b) the maximum rate permitted by applicable law, 3.4. All Fixed Rent, additional rent, and all other costs, charges and sums payable by Subtenant hereunder (collectively, "Rental"), shall constitute rent under this Sublease, and shall be payable to Sublandlord at its address as set forth in Article 13 hereof, unless Sublandlord shall otherwise so direct in writing. 3.5. Subtenant shall promptly pay the Rental as and when the same shall become due and payable without set-off, offset or deduction of any kind whatsoever, except as expressly set forth herein, and, in the event of Subtenant's failure to pay the same when due (subject to grace periods provided herein), Sublandlord shall have all of the rights and remedies provided for herein or at law or in equity, in the case of non-payment of rent. 3.6. Sublandlord's failure during the Term to prepare and deliver any statements or bills required to be delivered to Subtenant hereunder, or Sublandlord's failure to make a demand under this Article 3 or under any other provisions of this Sublease shall not in any way be deemed to be a waiver of, or cause Sublandlord to forfeit or surrender its rights to collect any additional rent which may have become due pursuant to this Article 3 during the Term. Subtenant's liability for Fixed Rent and additional rent due under this Article 3 accruing during the Term, and Sublandlord's obligation to refund overpayments of or adjustments to Fixed Rent or additional rent paid to it by Subtenant, shall survive the expiration or sooner termination of this Sublease. Page 5 of 17 3.7. Except as otherwise provided herein, in no event shall any adjustment of any payments payable by Subtenant result in a decrease in Fixed Rent, nor shall any adjustment of any item of additional rent payable by Subtenant result in a decrease in any other item of additional rent payable by Subtenant, it being understood and agreed that the payment of any item of additional rent under this Article 3 is an obligation supplemental to Subtenant's obligations to pay Fixed Rent and any other item of additional rent. 3.8. If a Tax Year shall end after the expiration of this Sublease, the additional rent payable by Subtenant in respect thereof shall be prorated to correspond to that portion of such Tax Year occurring within the Term. 4. SUBORDINATION TO AND INCORPORATION OF THE LEASE. 4.1. This Sublease is in all respects subject and subordinate to the terms and conditions of the Lease (a true and complete copy of which has been furnished by Sublandlord to Subtenant), and to all matters to which the Lease is subject and subordinate. Subtenant shall indemnify Sublandlord for, and shall hold it harmless from and against, any and all losses, damages, penalties, liabilities, costs and expenses, including, without limitation, reasonable attorneys' fees and disbursements, which may be sustained or incurred by Sublandlord by reason of Subtenant's failure to keep, observe or perform any of the terms, provisions, covenants, conditions and obligations on Sublandlord's part to be kept, observed or performed under the Lease to the extent same shall have been incorporated herein, or otherwise arising out of or with respect to Subtenant's use and occupancy of the Subleased Premises from and after the Commencement Date. 4.2. Except as otherwise expressly provided in, or otherwise inconsistent with, this Sublease, or to the extent not applicable to the Subleased Premises, the terms, provisions, covenants, stipulations, conditions, rights, obligations, remedies and agreements contained in the Lease are incorporated in this Sublease by reference, and are made a part hereof as if herein set forth at length, (i) except for the references to "Landlord" in the specific sections of the Lease referred to in Section 4.3 hereof, Sublandlord shall be substituted for all references to the "Landlord" under the Lease to the extent that the reference to Landlord is in its capacity as landlord under the Lease and not in any other capacity, (ii) Subtenant shall be substituted for the "Tenant" under the Lease, and (iii) Subleased Premises shall be substituted for "demised premises" under the Lease, except that the following provisions of the Lease and any references to such provisions shall be deemed deleted therefrom and shall have no force and effect as between Sublandlord and Subtenant: Page 6 of 17 (i) with respect to the Initial Lease: Article 1, Article 2, Section 3.01(b), Article 21, Article 24, Section 43.09, Article 44, Schedule A, Schedule A-1, Schedule C, and Schedule D; and (ii) with respect to the First Amendment: Section 2, Section 3, Section 4, Section 5, Section 6, Section 7, Section 8, Exhibit A, Exhibit B, and Exhibit C. 4.3. The references to "Landlord" in the Initial Lease in Article 3, Article 4, Article 5, Article 6, Article 7, Article 8, Article 10, Article 13, Article 14, Article 16, Section 22.01, Article 25, Article 31, Article 36, Article 39, Article 40, Article 42, Article 45, shall continue to refer to the Prime Landlord. The references to "Landlord" in Article 9, Article 11, Article 15, Article 17, Article 18, Article 19, Article 20, Article 26, Article 27, Article 28, Article 29, Article 30, Article 32, Article 34, and Article 35 of the Initial Lease shall be deemed to refer collectively to the Prime Landlord and Sublandlord. 4.4. Sublandlord represents that as of the date hereof, the Lease is in full force and effect. Sublandlord represents that Sublandlord has not received as of the date hereof any notice of default from the Landlord under the Lease, and has not, to the best of its knowledge, done or suffered or caused to be done any acts which would result in any cancellation, forfeiture, or termination of the Lease. Sublandlord covenants that Sublandlord's interest in the Lease is unencumbered. 5. ALTERATIONS. Subtenant shall not make any alterations, installations, improvements, additions or other physical changes (other than decorative modifications) in or about the Subleased Premises ("Subtenant Alterations") without first obtaining the consent of the Prime Landlord with respect thereto. Sublandlord agrees to cooperate with Subtenant, at no cost to Sublandlord, in order to obtain such consent. Any Subtenant Alterations shall be performed by Subtenant, at Subtenant's sole cost and expense, in accordance with the applicable provisions of the Lease. 6. COVENANTS WITH RESPECT TO THE LEASE. 6.1. Subtenant shall not do anything that would constitute a default under the Lease or omit to do anything that Subtenant is obligated to do under the terms of this Sublease so as to cause there to be a default under the Lease. 6.2. The time limits set forth in the Lease for the giving of notices, making demands, performance of any act, condition or covenant, or the exercise of any right, remedy or option, are changed for the purpose of this Sublease, by lengthening or shortening the same in each instance, as appropriate, so that notices may be given, demands made, or any act, condition or covenant performed, or any right, remedy or Page 7 of 17 option hereunder exercised, by Sublandlord or Subtenant, as the case may be (and each party covenants that it will do so), within three (3) days prior to the expiration of the time limit, taking into account the maximum grace period, if any, relating thereto contained in the Lease. Each party shall promptly deliver to the other party copies of all notices, requests or demands which relate to the Premises or the use or occupancy thereof after receipt of same from the Prime Landlord. 7. SERVICES AND REPAIRS. 7.1. Notwithstanding anything to the contrary contained in this Sublease or in the Lease, Sublandlord shall not be required to provide any of the services that the Prime Landlord has agreed to provide, whether or not specified in Article 21 of the Lease (or required by law), or to furnish the electricity to the Subleased Premises that the Prime Landlord has agreed to furnish pursuant to the Lease (or required by law), or make any of the repairs or restorations that the Prime Landlord has agreed to make pursuant to the Lease (or required by law), or to comply with any laws or requirements of any governmental authorities, or take any other action that the Prime Landlord has agreed to provide, furnish, make, comply with, or take, or cause to be provided, furnished, made, complied with or taken under the Lease, but Sublandlord agrees to use all diligent efforts, at Subtenant's sole cost and expense, to obtain the same from the Prime Landlord (provided, however, that Sublandlord shall not be obligated to use such efforts or take any action which might give rise to a default under the Lease), and Subtenant shall rely upon, and look solely to, the Prime Landlord for the provision, furnishing or making thereof or compliance therewith. If the Prime Landlord shall default in the performance of any of its obligations under the Lease, Sublandlord shall, upon request and at the expense of Subtenant, timely institute and diligently prosecute any action or proceeding which Subtenant, in its reasonable judgment, deems meritorious, in order to have the Prime Landlord make such repairs, furnish such electricity, provide such services or comply with any other obligation of the Prime Landlord under the Lease or as required by law. Subtenant shall indemnify and hold harmless Sublandlord from and against any and all such claims arising from or in connection with such request, action or proceeding. This indemnity and hold harmless agreement shall include indemnity from and against any and all liability, fines, suits, demands, costs and expenses of any kind or nature, including, without limitation, reasonable attorneys' fees and disbursements, incurred in connection with any such claim, action or proceeding brought thereon. Subtenant shall not make any claim against Sublandlord for any damage which may arise, nor shall Subtenant's obligations hereunder be diminished, by reason of (i) the failure of the Prime Landlord to keep, observe or perform any of its obligations pursuant to the Lease, unless such failure is due to Sublandlord's negligence or misconduct, or (ii) the acts or omissions of the Prime Landlord, its agents, contractors, servants, employees, invitees or licensees. The provisions of this Article 7 shall survive the expiration or earlier termination of the Term hereof. Page 8 of 17 7.2. It is expressly understood and agreed that (i) Subtenant shall obtain electricity (in accordance with the specifications set forth in Article 4 of the Lease, except to the extent that such electricity may be used by Sublandlord in other portions of the premises demised to Sublandlord under the Lease) from the Prime Landlord, and (ii) the consumption of electricity by Subtenant in the Subleased Premises shall be submetered. Sublandlord shall furnish to Subtenant a written statement (an "Electricity Statement") setting forth Sublandlord's cost of the electricity consumed by Subtenant in the Subleased Premises. Sublandlord's failure during the Term to deliver any Electricity Statement or Sublandlord's failure to make a demand for payment shall not in any way be deemed to be a waiver of, or cause Sublandlord to forfeit or surrender, its rights to collect any portion of the amount listed on the Electricity Statement which may have become due during the Term. Subtenant's liability for the amount due pursuant to this Section 7.2 shall survive the expiration or sooner termination of this Sublease. 8. CONSENTS. 8.1. Sublandlord agrees that whenever its consent or approval is required hereunder, or where something must be done to Sublandlord's satisfaction, it shall not unreasonably withhold or delay such consent or approval; provided, however, that whenever the consent or approval of the Prime Landlord, the lessor under a superior lease, or the mortgagee under a mortgage, as the case may be, is also required pursuant to the terms of the Lease, if the Prime Landlord, the lessor under a superior lease, or the mortgagee under a mortgage shall withhold its consent or approval for any reason whatsoever, Sublandlord shall not be deemed to be acting unreasonably if it shall also withhold its consent or approval. If the Prime Landlord shall withhold its consent or approval in connection with this Sublease or the Subleased Premises in any instance where, under the Lease, the consent or approval of the Prime Landlord may not be unreasonably withheld, Sublandlord, upon the request and at the expense of Subtenant, shall either (i) timely institute and diligently prosecute any action or proceeding which Subtenant, in its reasonable judgment, deems meritorious, in order to dispute such action by the Prime Landlord, or (ii) permit Subtenant, to the extent allowable under the Lease, to institute and prosecute such action or proceeding in the name of the Prime Landlord, provided that Subtenant shall keep Sublandlord informed of its actions and shall not take any action which might give rise to a default under the Lease. Page 9 of 17 8.2. If Subtenant shall request Sublandlord's consent and Sublandlord has agreed, under the terms of this Sublease, that neither its consent nor its approval shall be unreasonably withheld, and Sublandlord shall fail or refuse to give such consent or approval, and Subtenant shall dispute the reasonableness of Sublandlord's refusal to give its consent or approval, Tenant may, at its option, as its sole and exclusive remedy, submit such dispute to arbitration in the City of New York under the Expedited Procedures provisions of the Commercial Arbitration Rules of the American Arbitration Association ("AAA") (presently Rules 53 through 57 and, to the extent applicable, Section 19); provided, however, that with respect to any such arbitration, (i) the list of arbitrators referred to in Rule 54 shall be returned within five (5) days from the date of mailing; (ii) the parties shall notify the AAA by telephone, within four (4) days of any objections to the arbitrator appointed and will have no right to object if the arbitrator so appointed was on the list submitted by the AAA and was not objected to in accordance with the second paragraph of Rule 54; (iii) the Notice of Hearing referred to in Rule 55 shall be shall be four (4) days in advance of the hearing; (iv) the hearing shall be held within seven (7) days after the appointment of the arbitrator; (v) the arbitrator shall have no right to award damages; (vi) the decision and award of the arbitrator shall be final and conclusive on the parties; and (vii) the losing party shall pay the reasonable fees and expenses, if any, of both parties in connection with such arbitration, including the expenses and fees of the arbitrator selected. 9. TERMINATION OF LEASE. If the lease is terminated by the Prime Landlord pursuant to the terms thereof with respect to all or any portion of the Subleased Premises prior to the Expiration Date for any reason whatsoever, including, without limitation, by reason of casualty or condemnation, this Sublease shall thereupon terminate with respect to any corresponding portion of the Subleased Premises, and (unless such termination of the Lease shall be as a result of Sublandlord's default thereunder or a voluntary surrender of the Subleased Premises, other than a surrender of the Subleased Premises permitted under the Lease with respect to a termination of the Lease by reason of casualty to or condemnation of the Subleased Premises or the Building) Sublandlord shall not be liable to Subtenant by reason thereof. In the event of such termination, Sublandlord shall return to Subtenant that portion of the Rental paid in advance by Subtenant with respect to such portion of the Subleased Premises, if any, prorated as of the date of such termination. 10. SUBLEASE, NOT ASSIGNMENT. Notwithstanding anything contained herein, this Sublease shall be deemed to be a sublease of the Subleased Premises and not an assignment, in whole or in part, of Sublandlord's interest in the Lease. Page 10 of 17 11. DAMAGE, DESTRUCTION, FIRE AND OTHER CASUALTY: CONDEMNATION. Notwithstanding any contrary provision of this Sublease or the provisions of the Lease herein incorporated by reference, Subtenant shall not have the right to terminate this Sublease as to all or any part of the Subleased Premises, or be entitled to an abatement of Rent, additional rent or any other item of Rental, by reason of a casualty or condemnation affecting the Subleased Premises unless Sublandlord is entitled to terminate the Lease or is entitled to a corresponding abatement with respect to its corresponding obligation under the Lease. If Sublandlord is entitled to terminate the Lease for all or any portion of the Subleased Premises by reason of casualty or condemnation, Subtenant may terminate this Sublease as to any corresponding part of the Subleased Premises by written notice to Sublandlord given at least five (5) business days prior to the date(s) Sublandlord is required to give notice to the Prime Landlord of such termination under the terms of the Lease. 12. NO WAIVERS. Failure by Sublandlord in any instance to insist upon the strict performance of any one or more of the obligations of Subtenant under this Sublease, or to exercise any election herein contained, shall in no manner be or be deemed to be a waiver by Sublandlord of any of Subtenant's defaults or breaches hereunder or of any of Sublandlord's rights and remedies by reason of such defaults or breaches, or a waiver or relinquishment for the future of the requirement of strict performance of any and all of Subtenant's obligations hereunder. Further, no payment by Subtenant or receipt by Sublandlord of a lesser amount than the correct amount or manner of payment of Rental due hereunder shall be deemed to be other than a payment on account, nor shall any endorsement or statement on any check or any letter accompanying any check or payment be deemed to effect or evidence an accord and satisfaction, and Sublandlord may accept any checks or payments as made without prejudice to Sublandlord's right to recover the balance or pursue any other remedy in this Sublease or otherwise provided at law or equity. 13. NOTICES. Any notice, statement, demand, consent, approval, advice or other communication required or permitted to be given, rendered or made by either party to the other, pursuant to this Sublease or pursuant to any applicable law or requirement of public authority (collectively, "Communications") shall be in writing and shall be deemed to have been properly given, rendered or made only if sent by personal delivery, receipted by the party to whom addressed, or registered or certified mail, return receipt requested, posted in a United States post office station in the continental United States, addressed (i) to Subtenant at its address first above written, Attention: Chief Operating Officer, with a copy to Swidler Berlin Shereff Friedman, LLP, 919 Third Avenue, New York, New York 10022, Attention: Michael J. Shapiro, Esq., and (ii) to Sublandlord at its address first above written, Attention: Chief Operating Officer, with a copy to Proskauer Rose LLP, 1585 Broadway, New York, New York 10036, Attention: Martin J. Oppenheimer, Esq. All such communications shall be deemed to Page 11 of 17 have been given, rendered or made when delivered and receipted by the party to whom addressed, in the case of personal delivery, or three (3) days after the day so mailed. Either party may, by notice as aforesaid actually received, designate a different address or addresses for communications intended for it. 14. INDEMNITY. 14.1. Subtenant shall not do or permit any act or thing to be done upon the Subleased Premises which may subject Sublandlord to any liability or responsibility for injury, dam ages to persons or property or to any liability by reason of any violation of any requirement of law, and shall exercise such control over the Subleased Premises as to fully protect Subl andlord against any such liability. Subtenant shall indemnify and save harmless Sublandlord, the Parties (hereinafter defined) and the employees, agents and contractors of any of the foregoing (collectively, the "Indemnitees") from and against (except if due to the negligence, wilful act or omission of Sublandlord or the Parties), (a) all claims of whatever nature against the Indemnitees arising from any act, omission or negligence of Sub tenant, its contractors, licensees, agents, servants, employees, invitees or visitors, (b) all claims against the Indemnitees arising from any accident, injury or damage whatsoever caused to any person or to the property of any person and occurring during the Term in or about the Subleased Premises, and (c) all claims against the Indemnitees arising from any accident, injury or damage occurring outside of the Subleased Premises but anywhere within or about the Real Property, where such accident, injury or damage results or is claimed to have resulted from an act, omission or negligence of Subtenant or Subtenant's contractors, licensees, agents, servants, employees, invitees or visitors. This indemnity and hold harmless agreement shall include indemnity from and against any and all liability, fines, suits, demands, costs and expenses of any kind or nature (including, without limitation, attorneys' fees and disbursements) incurred in or in connection with any such claim or proceeding brought thereon, and the defense thereof. 14.2. If any claim, action or proceeding is made or brought against Sublandlord, which claim, action or proceeding Subtenant shall be obligated to indemnify Sublandlord against pursuant to the terms of this Lease, then, upon demand by the Sublandlord, Subtenant, at its sole cost and expense, shall resist or defend such claim, action or proceeding in the Sublandlord's name, if necessary, by such attorneys as Sublandlord shall approve, which approval shall not be unreasonably withheld or unduly delayed. Attorneys for Subtenant's insurer are hereby deemed approved for purposes of this Section 14.2. Notwithstanding the foregoing, Sublandlord may retain its own attorneys to defend or assist in defending any claim, action or proceeding involving potential liability of Five Million Dollars ($5,000,000) or more, and Subtenant shall pay the reasonable fees and disbursements of such attorneys. The provisions of this Section 14 shall survive the expiration or earlier termination of the Term hereof. Page 12 of 17 15. BROKER. Each party hereto covenants, warrants and represents to the other party that it has had no dealings, conversations or negotiations with any broker other than S.L. Green Leasing, Inc. ("Broker") concerning the execution and delivery of this Sublease. Each party hereto agrees to indemnify and hold harmless the other party against and from any claims for any brokerage commissions and all costs, expenses and liabilities in connection therewith, including, without limitation, reasonable attorneys' fees and disbursements, arising out of its respective representations and warranties contained in this Article 15 being untrue. Sublandlord shall pay any brokerage commissions due to Broker pursuant to a separate agreement between Sublandlord and Broker. The provisions of this Article 15 shall survive the expiration or earlier termination of the Term hereof. 16. CONDITION OF THE PREMISES. Subtenant agrees to accept the Subleased Premises in its "as is" condition on the date hereof, reasonable wear and tear between the date hereof and the Commencement Date excepted. Sublandlord has not made and does not make any representations or warranties as to the physical condition of the Subleased Premises, the use to which the Subleased Premises may be put, or any other matter or thing affecting or relating to the Subleased Premises, except as specifically set forth in this Sublease. Sublandlord shall have no obligations whatsoever to alter, improve, decorate or otherwise prepare the Subleased Premises for Subtenant's occupancy. 17. CONSENT OF THE PRIME LANDLORD TO THIS SUBLEASE. Consent of the Prime Landlord to this Sublease Consent of the Prime Landlord to this Sublease. Subtenant hereby acknowledges and agrees that this Sublease is subject to and conditioned upon Sublandlord obtaining the written consent (the "Consent") of the Prime Landlord as provided in the Lease. Promptly following the execution and delivery hereof, Sublandlord shall submit this Sublease to the Prime Landlord. Subtenant hereby agrees that it shall cooperate in good faith with Sublandlord and shall comply with any reasonable requests made of Subtenant by Sublandlord or the Prime Landlord in the procurement of the Consent. In no event shall Sublandlord or Subtenant be obligated to make any payment to the Prime Landlord in order to obtain the Consent or the consent to any provision hereof, other than as expressly set forth in the Lease. In the event that the Prime Landlord shall not have executed and delivered the Consent within forty-five (45) days after the date of this Sublease, either party shall have the right to cancel this Sublease by written notice given to the other at any time thereafter prior to the execution and delivery of the Consent, and with the giving of such notice this Sublease shall be deemed canceled and of no further force or effect and neither party shall have any liability or obligation to the other in respect thereof. Page 13 of 17 18. ASSIGNMENT, SUBLETTING AND MORTGAGING. 18.1. Subtenant shall not assign, sell, transfer (whether by operation or law or otherwise), pledge, mortgage or otherwise encumber this Sublease or any portion of its interest in the Subleased Premises, nor sublet all or any portion of the Subleased Premises or permit any other person or entity to use or occupy all or any portion of the Subleased Premises, without the prior written consent of the Prime Landlord. Provided that Subtenant shall comply with the provisions of the Lease (including, without limitation, Section 11 thereof) and this Sublease with respect to subletting, Sublandlord agrees that its consent shall not be required to a subletting of all or any portion of the Subleased Premises provided that the Prime Landlord shall consent to such subletting. Upon the request of Subtenant, Sublandlord, at Subtenant's sole cost and expense, shall request the consent of the Prime Landlord and cooperate with Subtenant in obtaining any consent. 18.2. If this Sublease be assigned, or if the Subleased Premises or any part thereof be sublet (whether or not Sublandlord and the Prime Landlord shall have consented thereto), Sublandlord, after default by Subtenant in its obligations hereunder, may collect rent from the assignee or subtenant and apply the net amount collected to the Rental herein reserved, but no such assignment or subletting shall be deemed a waiver of the covenant set forth in this Article 18, or the acceptance of the assignee or subtenant as a tenant, or a release of Subtenant from the further performance and observance by Subtenant of the covenants, obligations and agreements on the part of Subtenant to be performed or observed herein. The consent by Sublandlord or the Prime Landlord to an assignment, sale, pledge, transfer, mortgage or subletting shall not in any way be construed to relieve Subtenant from obtaining the express consent in writing, to the extent required by this Sublease or the Lease, of Sublandlord and the Prime Landlord to any further assignment, sale, pledge, transfer, mortgage or subletting. 18.3. Either a transfer (including the issuance of treasury stock or the creation and issuance of new stock) of a controlling interest in the shares of Subtenant (if Subtenant is a corporation, other than a professional corporation, or trust) or a transfer of a majority of the total interest in Subtenant (if Subtenant is a partnership, including a limited liability partnership, or a limited liability company) at any one time or over a period of time through a series of transfers, shall be deemed an assignment of this Sublease and shall be subject to all of the provisions of this Sublease, including, without limitation, the requirements that Subtenant obtain Sublandlord's prior consent thereto. The transfer of shares of Subtenant (if Subtenant is a corporation or trust) for purposes of this Section 18.3 shall not include the sale of shares by persons other than those deemed "insiders" within the meaning of the Securities Exchange Act of 1934, as amended, which sale is effected through the "over-the-counter market" or through any recognized stock exchange. Page 14 of 17 19. PARTNERSHIP SUBTENANT. If Subtenant is a partnership (including, without limitation, a limited liability partnership) or a limited liability company or a professional corporation (or is comprised of two (2) or more Persons, individually or as co-partners of a partnership (including, without limitation a limited liability partnership), as members of a limited liability company or as shareholders of a professional corporation) or if Subtenant's interest in this Lease shall be assigned to a partnership (including, without limitation, a limited liability partnership) a limited liability company or a professional corporation (or to two (2) or more Persons, individually or as co-partners of a partnership, as members of a limited liability company or shareholders of a professional corporation) pursuant to this Sublease (any such partnership, professional corporation and such Persons are referred to in this Article 19 as "Partnership Subtenant"), the following provisions shall apply to such Partnership Subtenant: (a) the liability of each of the parties comprising Partnership Subtenant shall be joint and several; (b) each of the parties comprising Partnership Subtenant hereby consents in advance to, and agrees to be bound by (x) any written instrument which may hereafter be executed by Partnership Subtenant or any successor entity, changing, modifying, extending or discharging this Lease, in whole or in part, or surrendering all or any part of the Subleased Premises to Sublandlord, and (y) any notices, demands, requests or other communications which may hereafter be given by Partnership Subtenant or by any of the parties comprising Partnership Subtenant; (c) any bills, state ments, notices, demands, requests or other communications given or rendered to Partnership Subtenant or to any of such parties shall be binding upon Partnership Subtenant and all such parties; (d) if Partnership Subtenant shall admit new partners, shareholders or members, as the case may be, Partnership Subtenant shall give Sublandlord notice of such event not later than ten (10) Business Days prior to the admission of such partner(s), shareholder(s) or member(s) together with an assumption agreement in form and substance satisfactory to Sublandlord pursuant to which each of such new partners, shareholders or members, as the case may be, shall, by their admission to Partnership Subtenant, agree to assume joint and several liability for the performance of all of the terms, covenants and conditions of this Lease (as the same may have been or thereafter be amended) on Subtenant's part to be observed and performed; it being expressly understood and agreed that each such new partner, shareholder or member (as the case may be) shall be deemed to have assumed joint and several liability for the performance of all of the terms, covenants and conditions of this Lease (as the same may have been or thereafter be amended), whether or not such new partner, shareholder or member shall have executed such assumption agreement, and that neither Subtenant's failure to deliver such assumption agreement nor the failure of any such new partner or shareholder, as the case may be, to execute or deliver any such agreement to Sublandlord shall vitiate the provisions of this clause (d) of this Article 19). Page 15 of 17 20. MISCELLANEOUS. 20.1. This Sublease contains the entire agreement between the parties and all prior negotiations and agreements are merged in this Sublease. Any agreement hereafter made shall be ineffective to change, modify or discharge this Sublease in whole or in part unless such agreement is in writing and signed by the parties hereto. No provision of this Sublease shall be deemed to have been waived by Sublandlord or Subtenant unless such waiver be in writing and signed by Sublandlord or Subtenant, as the case may be. The covenants and agreements contained in this Sublease shall bind and inure to the benefit of Sublandlord and Subtenant and their respective permitted successors and assigns. 20.2. In the event that any provision of this Sublease shall be held to be invalid or unenforceable in any respect, the validity, legality or enforceability of the remaining provisions of this Sublease shall be unaffected thereby. 20.3. The paragraph headings appearing herein are for purposes of convenience only and are not deemed to be a part of this Sublease. 20.4. Capitalized terms used herein shall have the same meanings as are ascribed to them in the Lease, unless otherwise expressly defined herein. 20.5. This Sublease is offered to Subtenant for signa ture with the express understanding and agreement that this Sublease shall not be binding upon Sublandlord unless and until Sublandlord shall have executed and delivered a fully executed copy of this Sublease to Subtenant. 20.6. Neither the partners comprising Sublandlord (if Sublandlord is a partnership), nor the shareholders, partners, directors or officers of Sublandlord or any of the foregoing (collectively, the "Parties") shall be liable for the performance of Sublandlord's obligations under this Sublease. Subtenant shall look solely to Sublandlord to enforce Sublandlord's obligations hereunder and shall not seek damages against any of the Parties. Subtenant shall look only to the assets of Sublandlord for the satisfaction of Subtenant's remedies for the collection of a judgment (or other judicial process) requiring the payment of money by Sublandlord in the event of any default by Sublandlord hereunder, and no property or assets of the Parties shall be subject to levy, execution or other enforcement procedure for the satisfaction of Subtenant's remedies under or with respect to this Sublease, the relationship of Sublandlord and Subtenant hereunder or Subtenant's use or occupancy of the Subleased Premises. 20.7. This Sublease shall be governed by and construed in accordance with the laws of the State of New York. Page 16 of 17 IN WITNESS WHEREOF, the parties hereto have duly executed this Sublease as of the day and year first above written. NMU PENSION PLAN, Sublandlord By: /S/ -------------------------------- Name: WJ DENNIS Title: ADMINISTRATOR COMPUTER OUTSOURCING SERVICES, INC., Subtenant By: /S/ -------------------------------- Name: ZACH LONSTEIN Title: CHAIRMAN/CEO EXHIBIT "A" ----------- FLOOR PLAN OF SUBLEASED PREMISES This floor plan is annexed to and made a part of this Agreement of Sublease solely to indicate the Subleased Premises by outlining and diagonal marking. All areas, conditions, dimensions and locations are approximate. EX-10.8B 5 FIRST AMENDMENT OF LEASE - LEONIA ASSOCIATES, LLC FIRST AMENDMENT OF LEASE ------------------------ DATE: January 16th, 1998 LANDLORD: LEONIA ASSOCIATES, L.L.C. a New Jersey Limited Liability Company ADDRESS OF LANDLORD: c/o Sterling Management Corp. 72 Essex Street Lodi, NJ 07644 TENANT: COMPUTER OUTSOURCING SERVICES, INC., a New York Corporation, ADDRESS OF TENANT: 2 Christie Heights Leonia, New Jersey 07605 LEASE DATE: June 2, 1997 BUILDING: 2 Christie Heights Leonia, NJ 07605 Landlord and Tenant, being bound unto a lease, dated the Lease Date, for a portion of the Building (the "Lease"), hereby agree to modify and amend the Lease in the following manner: 1. DEMISED PREMISES OR PREMISES. As of January 1, 1998 (the "Effective Date"), Paragraph (7) of the Preamble to the Lease shall be deleted in its entirety and the following is substituted therefor: "(7) Demised Premises or Premises: Approximately SIXTY SEVEN THOUSAND (67,000) gross rentable square feet on the First (1st) and Second (2nd) Floors (the entire Building) delineated on Exhibit A annexed hereto, which includes an allocable share of the Common Facilities as defined in Paragraph 42(c), which size is stipulated and agreed to by the parties hereto." 2. EXHIBIT A. As of the Effective Date, Exhibit A annexed to the Lease is hereby deleted in its entirety and revised Exhibit A annexed hereto shall be substituted therefor for all purposes under the Lease. 3. FIXED BASIC RENT. Paragraph (9) of the Preamble to the Lease is hereby modified to provide that Fixed Basic Rent for the remainder of the Term shall be payable as follows: I. Fixed Basic Rent for January 1, 1998 through March 31, 1998 shall mean: (A) Yearly Rate: SEVEN HUNDRED TWENTY FIVE THOUSAND AND 00/100 ($725,000.00) DOLLARS plus an amount equal to twenty-five point four (25.4%) percent of the Real Estate Taxes for the Building. (B) Monthly Installment: SIXTY THOUSAND FOUR HUNDRED SIXTEEN AND 66/100 ($60,416.00) DOLLARS plus an amount equal to twenty-five point four (25.4%) percent of the Real Estate Taxes for the Building, which shall be payable monthly on the first day of each month, in advance, in the amount of $2,750.00. In the event the actual amount of the Real Estate Taxes for the building for the first quarter of 1998 is greater or less than that paid by Tenant pro rata for the Additional Space, the appropriate adjustment shall be made by and between Landlord and Tenant as soon as practicable after the final 1998 bill is issued. II. Fixed Basic Rent for April 1, 1998 through June 30, 1998 shall mean: (A) Yearly Rate: SEVEN SIXTY SEVEN THOUSAND FIVE HUNDRED AND 00/00 ($767,500.00) DOLLARS plus an amount equal to twenty-five point four (25.4%) percent of the Real Estate Taxes for the Building. (B) Monthly Installment: SIXTY THREE THOUSAND NINE HUNDRED FIFTY-EIGHT AND 33/100 ($63,958.33) DOLLARS plus an amount equal to twenty-five point four (25.4%) percent of the Real Estate Taxes for the Building, which shall be payable monthly on the first day of each month, in advance, in the amount of $2,750.00. In the event the actual amount of the Real Estate Taxes for the building for the second quarter of 1998 is greater or less than that paid by Tenant pro rata for the Additional Space, the appropriate adjustment shall be made by and between Landlord and Tenant as soon as practicable after the final 1998 bill is issued. III. Fixed Basic Rent for July 1, 1998 through September 30, 1998 shall mean: (A) Yearly Rate: EIGHT HUNDRED TWENTY SEVEN THOUSAND AND 00/100 ($827,000.00) DOLLARS plus an amount equal to twenty-five point four (25.4%) percent of the Real Estate Taxes for the Building. (B) Monthly Installment: SIXTY EIGHT THOUSAND NINE HUNDRED SIXTEEN AND 66/100 ($68,916.66) DOLLARS plus an amount equal to twenty-five point four (25.4%) percent of the Real Estate Taxes for the Building, which shall be payable monthly on the first day of each month, in advance, in the amount of $2,750.00. In the event the actual amount of the Real Estate Taxes for the building for the third quarter of 1998 is greater or less than that paid by Tenant pro rata for the Additional Space, the appropriate adjustment shall be made by and between Landlord and Tenant as soon as practicable after the final 1998 bill is issued. IV. Fixed Basic Rent for Four Years and Three Months, commencing October 1, 1998 through December 31, 2002, shall mean THREE MILLION EIGHT HUNDRED THREE THOUSAND SEVEN HUNDRED FIFTY AND 001/00 ($3,803,750.00) DOLLARS. (A) Yearly Rate: EIGHT HUNDRED NINETY FIVE THOUSAND AND 00/100 ($895,000.OO) DOLLARS. (B) Monthly Installment: SEVENTY FOUR THOUSAND FIVE HUNDRED EIGHTY THREE AND 33/100 ($74,583.33) DOLLARS. V. Fixed Basic Rent for Six Years, commencing January 1, 2003 through December 31, 2008 shall mean SIX MILLION ONE HUNDRED SEVENTY FOUR THOUSAND AND 00/100 ($6,174,000.00) DOLLARS. (A) Yearly Rate: ONE MILLION TWENTY NINE THOUSAND AND 00/100 ($1,029,000.00) DOLLARS. (B) Monthly Installment: EIGHTY FIVE THOUSAND SEVEN HUNDRED FIFTY 00/100 ($85,750.00) DOLLARS. 4. TENANT'S PERCENTAGE. Commencing January 1, 1998, Paragraph (10) of the Preamble to the Lease shall be deleted in its entirety and the following is substituted therefor: "(10) Tenant's Percentage: One hundred (100%) percent, which percentage is stipulated and agreed to by the parties hereto, subject to adjustment as provided for in Paragraph 42(e)." 5. PARKING SPACES. As of the Effective Date, Paragraph 12 of the Preamble of the Lease shall be deleted in its entirety and the following substituted therefor: "(12) Parking Spaces shall mean all of the parking spaces reserved for the Building." 6. MONTHLY OPERATING COSTS ESTIMATES. Commencing January 1, 1998, the amount of estimated monthly payments for Operating Costs paid by Tenant pursuant to Paragraph 23(B)(b) of the Lease shall be changed from TEN THOUSAND and 00/100 ($10,000.00) DOLLARS to THIRTEEN THOUSAND SEVEN HUNDRED FIFTY and 00/100 ($13,750.00) DOLLARS. 7. LANDLORD'S WORK - Landlord agrees, that at Landlord's expense, it will do substantially all of the work in the additional Seventeen Thousand (17,000) gross rental square feet (the "Additional Space") to be occupied by Tenant hereunder in accordance with Exhibit B, annexed hereto and made a part hereof ("Landlord's Work"). Except as set forth in Exhibit B, Landlord shall have no obligation to perform any other Landlord's Work in the Additional Space, and Tenant specifically agrees that it will accept the Additional Space in its current "as is" condition. In the event the cost of Landlord's Work, inclusive of all hard and soft costs, is less than ONE HUNDRED EIGHTY FIVE THOUSAND ($185,000.00) DOLLARS, the amount of differential between Landlord's actual cost and said amount will be paid to Tenant by Landlord in the form of a rent credit to be applied to the Fixed Basic Rent for October 1998 or sixty (60) days after the substantial completion of Landlord's Work, whichever is later. 8. RENT CREDIT FOR CHECK METER. In lieu of the check meters to have been provided by Landlord pursuant to Paragraph 22 of the Lease, prior to this agreement, the Landlord grants Tenant a rent credit of TEN THOUSAND ($10,000.00) DOLLARS to be applied to the monthly rent installment for Fixed Basic Rent for the month of October 1998. 9. ACKNOWLEDGMENT OF PRIOR BUILDOUT CONTRIBUTION. Tenant acknowledges receipt and payment of Landlord's obligation to contribute EIGHT HUNDRED THOUSAND ($800,000.00) DOLLARS towards Tenant's buildout as provided in Paragraph 27(b) of the Lease. 10. SCOPE OF CLEANING SERVICES. Anything contained in Paragraphs 20 and 22 to the contrary notwithstanding, the Tenant shall have the right, upon written notice to the Landlord, to increase or decrease the scope of cleaning services to be provided by Landlord, in which event the cost of same to be paid by Tenant shall be adjusted accordingly. 11. BUILDING STANDARD ELECTRIC SERVICE. I. Paragraph 22(a)(i) of the Lease is hereby deleted in its entirety and the following substituted therefor: "(a) Landlord agrees to redistribute Building Standard Office Electrical Service (as hereinafter defined) to the Premises consistent with the requirements as set forth in this Lease (not exceeding the present electrical capacity at the Premises) upon the following terms and conditions: (i) Tenant shall pay to Landlord all of the electrical power consumed in the Demised Premises and Building as determined by the rate structure then existing for the utility company supplying the electrical energy to the Demised Premises and the Building, inclusive of common areas. Said payments shall be due as Additional Rent with the next installment of Fixed Basic Rent therefor becoming due." II. Paragraph 22(b) of the Lease is hereby deleted in its entirety and the following substituted therefor: "(b) The "Building Standard Electric Service" shall, unless otherwise provided by agreement in writing between the parties, be defined as the provision by Landlord of electrical current for usual office requirements, equipment and heating, ventilating and air-conditioning systems, twenty-four (24) hours a day, seven (7) days a week. In no event shall Building Standard Electric Service include electrical current for any computer room installation, data processing center, or for any requirements needing greater than a 15-amp line. All installments of electrical fixtures, appliances and equipment within the Demised Premises shall be subject to Landlord's prior written approval which approval shall not be unreasonably withheld or unduly delayed. Nothing herein shall be construed as conferring on Landlord the right or option to cut off electric service to the Building, except in instances requiring emergency or necessary repairs, it being intended that electrical service to the elevators and Demised Premises shall be available on a twenty-four (24) hours basis. III. The following provision is hereby added to Paragraph 22 of the Lease: (d) At Tenant's sole and exclusive cost and option, to be exercised upon reasonable written notice to the Landlord and the utility company furnishing electrical service and energy to the Building (the "Utility Company"), the Tenant shall arrange to obtain all electric, energy and utility service directly from the Utility Company, and may utilize the then existing electric feeders, risers and wiring used for such purpose and only to the extent of Tenant's then authorized connected load. In this event, (i) Landlord shall not be obligated to supply or pay any part of any cost required for Tenant's electric, energy and utility service; (ii) the Tenant shall provide Landlord with proof of payment to the Utility Company of its monthly utility bill; (iii) the failure by the Tenant to make payment in full of its monthly utility bill from the Utility Company within thirty (30) days of the rendering of such bill shall constitute a default under this Lease. 12. OPTION. Paragraph 56(a) of the Lease is hereby amended so that "$1,183,350.00" is substituted for "$948,750.00" in the last line thereof. 13. DELETIONS. The following provisions of the Lease are hereby deleted and deemed null and void and of no further force and effect: (a) Paragraph 27 (a) (b) Paragraph 47 (c) The last sentence of Paragraph 36. (d) Paragraph 57 (b) (e) Paragraph 59 14. INTERPRETATION. In the event of any inconsistencies between this Amendment of Lease and the Lease, this Amendment of Lease shall govern and be binding. All words and terms used in this Amendment of Lease shall be construed without regard to any presumption or other rule requiring construction against the party causing this instrument to be drafted, since the Tenant has been afforded an opportunity to submit revisions to the text hereof. 15. COMPLETE AGREEMENT. This Agreement, together with instrument modified hereby, constitute the complete agreement and understanding between the parties hereto with respect to the matters set forth herein and therein, and supersede and terminate any and all prior negotiations or understandings between the parties hereto. No alteration, amendment or modification of any of the terms and provisions of this Agreement and the instruments modified hereby shall be valid unless made pursuant to an instrument in writing signed by each of the parties hereto. The parties do not intend to confer any benefit hereunder on any person, firm, corporation or other entity, other than the parties hereto. 16. RATIFICATION OF LEASE. Except as expressly modified and amended by the Amendment of Lease, all of the terms, provisions and conditions of the Lease are hereby ratified and confirmed by Landlord and Tenant. 17. BINDING EFFECT. This Amendment of Lease shall inure to the benefit of and be binding upon the parties hereto and their respective legal representatives, successors and permitted assigns. 18. CORPORATE AGREEMENT. Each party represents and warrants to the other that this Amendment of Lease has been duly authorized and approved by its Board of Directors or Members, as the case may be. The undersigned officer and representative of the corporation and Manager of the Limited Liability Company executing this Agreement represent and warrant that they have authority to execute this Amendment of Lease on behalf of their respective entities. IN WITNESS WHEREOF, Landlord and Tenant have hereunto set their hands and seals as of the day and year above first written; the parties affixing their signatures hereto warrant the one to the other that they possess the requisite authority to enter into this transaction and to sign this instrument. ATTEST: LEONIA ASSOCIATES, L.L.C By: Jeffco Holding Ltd. a NJ corporation, Manager By: /s/ - ------------------------ ----------------------------------- Jeffrey E. Cole, President COMPUTER OUTSOURCING SERVICES, INC. a New York Corporation By: /s/ - ------------------------ ----------------------------------- Robert Wallach, President EXHIBIT A Page 1 of 2 (D R A W I N G) EXHIBIT A Page 2 of 2 (D R A W I N G) EXHIBIT B Landlord's Work Page 1 of 3 Landlord shall, at Landlord's sole cost and expense: 1. Build space as per attached plan. 2. Landlord shall replace the components of the existing VAV boxes located in the Additional Space with new components similar to those currently existing in the Building. 3. Carpet and paint space to match existing installation. 4. Replace damaged ceiling tiles. 5. Re-arrange lighting as per mutually agreeable construction drawings. 6. Add necessary electrical outlets as per a mutually agreeable construction drawings. 7. Art work in lobby subject to Tenant's approval. EXHIBIT B Page 2 of 3 (D R A W I N G) EXHIBIT B Page 3 of 3 (D R A W I N G) EX-10.18 6 PAYROLL SERVICE CONVERSION AGREEMENT PAYROLL SERVICE CONVERSION AGREEMENT PAYROLL SERVICE CONVERSION AGREEMENT dated as of 11/5/98 between COMPUTER OUTSOURCING SERVICES, INC., whose principal place of business is located at 360 W 31ST, New York, New York 10001 (the "Seller"), and ADP, INC., whose principal offices are located at One ADP Boulevard, Roseland, New Jersy 07068, with a branch office at 99 Jefferson Road. Parsippany, New Jersy 07054 ("ADP"). In consideration of the Seller's desire to sell, and ADP's desire to purchase, the exclusive right to convert the entire payroll services client base of the Seller (the "Client Base"), as described on Exhibit A which is a part of this Agreement, to ADP's payroll service, the Seller and ADP agree as follows: 1. SALE AND PURCHASE OF THE SELLER'S CLIENT BASE. (a) The seller hereby sells, assigns and transfers to ADP the exclusive right to convert the Client base to ADP's payroll services. Each client who agrees to convert tp ADP's payroll services by signing ADP's standard form of Price Quotation prior to December 31, 1998 (the "Final Conversion Date") is referred to in this Agreement as a "Converted Client". (b) The purchase price for this exclusive right shall be paid by ADP to the Seller as follows: (i) upon the execution and delivery of this Agreement by each party, an amount equal to $25,000 (the "Down Payment"); (ii) Within fifteen business days February 1 1999, an amount equal to (x) 100% of the annualized aggregate amount of recurring payroll or payroll-related processing fees and charges invoiced by ADP to the Converted Clients for the month of January 1999, for those payroll services that are the same as those provided by the Seller to such Converted Clients, minus (y) the Down Payment (provided that if Down Payment exceeds the actual amount calculated under clause (x) of this Paragraph 1(b)(ii), the Seller shall reimburse ADP the amount of such excess within 10 days); and (iii) In the event any converted Client shall begin processing after the month of January, 1999 but within 6 months of the final Conversion Date, ADP shall within 15 days after the completion of the first full month of processing for such Client pay the Seller in respect of Client an amount calculated in accordance with Paragraph 1(b)(ii) above. For purposes of clarity, the annualized aggregate amount will not include (i) fees derived from set-up, training, shipping, delivery and installation, custom programming sale or rental of equipment, maintenance, or the provision of checks, forms, or other supplies, (ii) fees for official bank checks, W-2 forms, or tax reports, (iii) state and local taxes, special one-time report fees and refundable deposits, or (iv) thrid party pass-through charges. For purposes of Paragraph 1(b)(ii), the Seller understands that the processing fees and charges invoiced by ADP to the Clients will be equal to the lesser of ADP's standard rates for such services (as previoulsy disclosed to the Seller) and the processing fees and charges reflected on Exhibit A. 2. CONVERSION OF THE CLIENT BASE. (a) ADP shall commence, at its own expense, converting the Client Base from the Seller's payroll services to ADP's payroll services. Only those clients included in the Client Base that elect to convert to ADP will be so converted. (b) From the date of this Agreement through the Final Conversion Date the Seller shall take all actions reasonably requested by ADP to maximize the number of clients that elect to convert to ADP. The Seller shall, at its own expense, cooperate with and assist ADP in converting the Client Base to ADP, which shall include (i) accompanying ADP personnel on visits to each client in order to facilitate the contemplated conversion of such client to ADP's payroll services, and (ii) transferring to ADP all files (including billing and pricing information) for each client that elects to convert to ADP. (c) From the date of this Agreement through the final Conversion Date (or such earlier date on which a given client is coverted), the Seller shall continue to perform all of its payroll services (and payroll-related tax services, if any ) for each client in a reliable and dependable manner in the same fashion as such payroll services (and payroll related tax services, if any) are being performed by the Seller on the date hereof. Thereafter, neither the Seller nor any entity which is affiliated with the Seller may provide such clients with such payroll services. 3. REPRESENTATIONS AND WARRANTIES OF THE SELLER. The Seller and each of the individuals executing this Agreement on his or her behalf with respect to this Paragraph 3 hereby represents and warrants to ADP that: (i) Schedule A sets forth a complete list of all clients in the Client Base; (ii) for each client in the Client Base, the Seller is the payroll services provider to the client; (iii) the company name and identifying number, special reports and delivery locations, frequency of payroll (and related tax services,if any) processings and the actual price per cycle (or if the actual price is not available, the Seller's reasonable estimate of the price per cycle) for each client included in the Client Base, are set forth on Exhibit A; and that all information set forth on Exhibit A is true, accurate and complete as of the date of this Agreement; (iv) none of the clients has canceled or terminated, or made any threat to the Seller to cancel or terminate, its payroll services (and/or related payroll tax services, if any) relationship with the Seller; (v) this Agreement is a binding agreement of the Seller; (vi) to the knowledge of the Seller, Seller is not prohibited by any law or regulation from entering into this Agreement; and (vii) the Seller has not used a boker or any other representative who would be entitled to a broker's commission, finder's fee or similar compensation in connection with this Agreement. 4. NO ASSUMPTION OF OBLIGATIONS AND LIABILITIES. The Seller agrees that ADP is only purchasing the right to convert the Client Base from the Seller's payroll service (and payroll related tax services, if any) to ADP's payroll services pursuant to the terms and conditions of this Agreement. ADP is not assuming any obligations or liabilies whatsover of the Seller (including, without limitation, (i) the hiring of any of the of the Seller's employees, (ii) any liabilities for tax filings, if any, with respect to periods prior to the date a client converts to ADP or (iii) any other obligation under any agreement or commitment of the Seller with any of its past, present or future clients), and the Seller agrees to indemnify ADP against al such obligations and liabilities. 5. CONFIDENTIALITY; NON-COMPETITION (a) The Seller agrees that Exhibit A and all information contained therein, and all client lists and other client information relative to the Client Base, if any , are confidential and that it will use all reasonable precautions to keep such information confidential and secret, including without limitation, restricting access to such information to those employees of the Seller who have a need to know such information (the "Permitted Persons"). The Seller agrees that it will use all reasonable efforts (which reasonable efforts shall include, but not be limited to, taking the same precautions the Seller takes to protect its own confidential and/or proprietary information) to prohibit any of the Permitted persons from divulging, using or publishing any of such information to any person or entity whatsover, except in strict accordance with the terms of this Agreement. If the Seller, any of the Permitted Persons, or any of the Seller's other present or former employees, agents or representatives shall attempt to divulge, use or publish any of such information in any manner, ADP shall have the right in addition to such other remedies which may be available to it, to injunctive relief enjoining such acts or attempts, it being hereby agreed and acknowledged that legal remedies are inadequate. (b) (i) Except to the limited extent provided for in Paragraph 2(c) above or as otherwise agreed in writing between the Seller and ADP, between the date hereof and the date which is 2 1/2 years after the Final Conversion Date (the "Non-Competition Period"), the Seller agrees that it shall not,directly or indirectly, (A) provide payroll services (and /or related payroll tax service) to any thrid person or entity whatsoever (whether or not affiliated with the Seller), or (B) provide, sell, license, or otherwise transfer any software, systems or documentation on, through, or by which any payroll services (and /or related payroll tax services) can be performed, to any third person or entity whatsover (whether or not affiliated with the Seller). (ii) During the Non-Competition period, the Seller not solicit or refer any of the Client Base or any clients of the Seller whatsoever to any other vender of payroll sevices (and/or related payroll tax services), and/or of any software, systems or documentation on, through, or by which such payroll services (and/or related payroll tax services) could be performed, or otherwise intentionally interfere with or interrupt ADP's payroll services relationships with the Converted Clients or any other of its clients. (c) Each of the individuals executing yhis Agreement on his or her own behalf hereby agrees to be bound individually to the same extent as the Seller by the provisions of this paragraph 5. 6. MISCELLANEOUS. (a) This Agreement together with Exhibit A attached hereto, contains the full understanding of the Seller and ADP with respect to its subject matter and supersedes all existing agreements and all other oral, written or other communications between them concerning its subject matter. This Agreement may not be modified in any way except by a writing signed by duly authorized representatives of ADP and the Seller. This Agreement may not be assigned in whole or in part by the Seller without the prior witten consent of ADP. (b) All notices shall be in writing and shall be mailed by frist class mail or personally delivered to the parties at the addresses set forth on the first page of this Agreement or to any other address designated by either party in writing to the other after the date hereof, and such notices shall be effective three days after mailed or when personally delivered. Any notice to ADP shall include a copy to ADP, Inc., One ADP Boulevard, Roseland, New Jersey 07068, Attention: General Counsel. (c) If any provision of this Agreement (including, without limitation any provisions of Paragraph 5) shall be deemed unenforceable, the enforceability of the remaining provisions shall not in any way be affected or impaired thereby and the provision in question shall be enforced to the fullest extent permitted by law. (d) The termination or expiration of this Agreement for any reason shall in no way impair the right or obligations of the parties under Paragraphs 4 and 5. IN WITNESS WHEREOF, the Seller and ADP have caused this Agreement to be executed as of the date first written above. ADP,INC. By: /s/ ---------------------- Tim Maloney Regional Controller COMPUTER OUTSOURCING SERVICES INC. By: /s/ Name: John C. Platt Title: Vice President Accepted and Agreed as to Paragraphs 3 and 5 only: /s/ ------------------------- John C. Platt ------------------------- Accecpted and Agreed as to Paragraph 5 only: /s/ ------------------------- John C. Platt ------------------------- EX-21 7 LIST OF SUBSIDIARIES EXHIBIT 21 List of Subsidiaries of Computer Outsourcing Services, Inc. As of October 31, 1998 MICR Corporate Services, a New York corporation. MCC Key Services, Inc., a New Jersey corporation The following four companies, comprising the Payroll Division, were sold on December 19, 1997. Daton Pay USA, Inc. (formerly Daton Data Processing Services, Inc.), a California corporation. NEDS, Inc. (formerly New England Data Services, Inc.), a New York corporation. Pay USA of New Jersey, Inc.(formerly Delta Acquisition, Inc.), a New York corporation. Key-ACA, Inc., a Delaware corporation. EX-23.A 8 CONSENT OF DELOITTE & TOUCHE LLP INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in the Registration Statement of Computer Outsourcing Services, Inc., on Form S-8 of our report dated January 9, 1998 (January 26, 1998 as to note 6a in the financial statements for the year ended October 31, 1997) appearing in the Annual Report on Form 10-K of the Registrant for the year ended October 31, 1998. /s/ DELOITTE & TOUCHE, LLP - ----------------------------- DELOITTE & TOUCHE, LLP New York, New York January 25, 1999 EX-23.B 9 CONSENT OF ERNST & YOUNG LLP INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in the Registration Statement on Form S-8 of our report dated January 11, 1998 with respect to the consolidated financial statements of Computer Outsourcing Services, Inc., included in the Annual Report on Form 10-KSB for the year ended October 31, 1998. /s/ ERNST & YOUNG, LLP - ------------------------- ERNST & YOUNG, LLP New York, New York January 25, 1999 EX-27 10 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS INCLUDED IN THE COMPANY'S ANNUAL REPORT ON FORM 10KSB FOR THE PERIOD ENDED OCTOBER 31, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH REPORT. 12-MOS 12-MOS OCT-31-1998 OCT-31-1997 OCT-31-1998 OCT-31-1997 9,403,006 972,459 3,218,170 0 4,668,776 4,102,207 216,659 111,577 0 0 19,085,748 12,365,891 7,288,506 5,976,646 4,779,631 4,161,416 26,948,536 19,143,141 6,327,067 5,578,467 271,787 2,592,571 0 0 0 0 42,857 38,261 17,550,496 12,500,802 26,948,536 19,143,141 0 0 30,403,381 24,395,644 0 0 19,828,954 17,071,706 9,585,355 5,889,525 115,429 368,235 108,402 318,560 1,536,571 1,228,083 457,621 539,700 1,078,950 688,383 (76,464) (127,054) 0 0 0 0 2,698,646 561,329 0.67 0.14 0.61 0.14 1997 Amounts include reclasses to conform to the 1998 presentation. New FDS information is accordingly provided herein. Current portion equals $260,277 in 1998 and 2,320,580 in 1997. Inlcudes a one-time sublease loss in 1998 of $2,236,583. Includes after-tax gain in 1998 on sale of discontinued operation of $1,696,160.
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