SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________
Commission file number 0-23173
OAO TECHNOLOGY SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware 52-1973990
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7500 Greenway Center Drive
Greenbelt, Maryland 20770
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (301) 486-0400
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
As of November 9, 1998, the registrant had outstanding 16,449,649 shares of
its Common Stock, par value $0.01 per share.
<PAGE>
OAO TECHNOLOGY SOLUTIONS, INC.
Quarterly Report on Form 10-Q for the Quarterly Period Ended September 30, 1998
INDEX
Page
Reference
---------
COVER PAGE.................................................................. 1
INDEX....................................................................... 2
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets as of September 30, 1998
(Unaudited) and December 31, 1997................................ 3
Condensed Consolidated Statements of Operations for the Three Months
and Nine Months Ended September 30, 1998 and 1997 (Unaudited).... 4
Condensed Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1998 and 1997 (Unaudited).................... 5
Notes to Condensed Consolidated Financial Statements
(Unaudited) ..................................................... 6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS................................ 10
PART II - OTHER INFORMATION................................................. 14
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES.................................................................. 15
2
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
OAO TECHNOLOGY SOLUTIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
----------- ---------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 9,841 $ 22,221
Accounts receivable:
Billed, net of allowance for uncollectible accounts
of $1,092 and $50, respectively 14,686 12,146
Unbilled, net of allowance for uncollectible accounts
of $1,789 and $239, respectively 11,620 9,400
Note receivable- related party 2,520 --
Income tax receivable 769 --
Deferred tax asset 2,126 --
Other current assets 795 875
-------- --------
Total current assets 42,357 44,642
Property and equipment, net 4,204 4,611
Deposits and other assets 471 753
Goodwill 4,096 336
-------- --------
Total assets $ 51,128 $ 50,342
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 8,022 $ 3,773
Accrued expenses 7,175 5,720
Income tax payable 190 477
Unearned revenue 639 379
Note payable -- 378
Current maturities of capital lease obligations 223 552
Deferred income taxes -- 114
-------- --------
Total current liabilities 16,249 11,393
Capital lease obligations, net of current maturities 777 883
Commitments and contingencies -- --
Stockholders' Equity:
Common Stock, par value $0.01 per share,
authorized, 25,000,000; 16,430,315 and 16,285,050
issued and outstanding at September 30, 1998, and 164 163
December 31, 1997, respectively
Additional paid-in capital 34,807 34,454
Stockholders' receivable (4) (133)
Retained (deficit) earnings (348) 3,658
Accumulated other comprehensive income (517) (76)
-------- --------
Total stockholders' equity 34,102 38,066
-------- --------
Total liabilities and stockholders' equity $ 51,128 $ 50,342
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
statements.
3
<PAGE>
OAO TECHNOLOGY SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues $ 34,520 $ 20,618 $ 77,866 $ 59,956
Direct Costs 29,888 16,137 66,621 46,910
-------- -------- -------- --------
Gross Profit 4,632 4,481 11,245 13,046
Selling, General and Administrative 4,884 3,140 14,992 9,455
Restructuring and Other Charges 2,900 -- 2,900 --
-------- -------- -------- --------
(Loss)Income from Operations (3,152) 1,341 (6,647) 3,591
Interest and Other (Income) Expense, net (134) 106 (515) 193
-------- -------- -------- --------
(Loss) Income Before Income Taxes (3,018) 1,235 (6,132) 3,398
Income Tax (Benefit) Provision (1,046) 519 (2,126) 1,450
-------- -------- -------- --------
Net (Loss) Income $ (1,972) $ 716 $ (4,006) $ 1,948
======== ======== ======== ========
Net (Loss) Income Per Common Share:
Diluted $ (0.12) $ 0.07 $ (0.24) $ 0.19
======== ======== ======== ========
Basic $ (0.12) $ 0.07 $ (0.24) $ 0.19
======== ======== ======== ========
Weighted Average Number of Common
Shares Outstanding:
Diluted 16,430 10,489 16,375 10,414
======== ======== ======== ========
Basic 16,430 10,001 16,375 10,001
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
statements.
4
<PAGE>
OAO TECHNOLOGY SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net (Loss) Income $ (4,006) $ 1,948
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization 697 163
Asset abandonment costs 2,100 --
Increase in the allowance for uncollectible accounts 2,417 --
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable 3,234 (5,493)
Other current assets 104 (340)
Income tax receivable and deferred tax asset (2,895) --
Deposits and other assets 312 (603)
Accounts payable (4,920) (813)
Accrued expenses 66 (304)
Unearned revenue 260 (25)
Income taxes payable (401) 928
-------- --------
Net cash used in operating activities (3,032) (4,539)
-------- --------
Cash flows from investing activities:
Acquisition of OAO Services (2,195) --
Payment on OAO Services debt agreement (3,465) --
Acquisition of DHR Technologies, net of cash acquired (938) --
Purchases of property and equipment (1,979) (1,925)
-------- --------
Net cash used in investing activities (8,577) (1,925)
-------- --------
Cash flows from financing activities:
Borrowings under revolving credit agreement -- 6,041
Proceeds from the exercise of stock options 235 --
Payments on stockholders' receivable 129 --
Payments on capital lease obligations (435) --
Payments on notes payable (378) --
-------- --------
Net cash (used in) provided by financing activities (449) 6,041
-------- --------
Effect of exchange rate changes on cash (322) --
Net decrease in cash and cash equivalents (12,380) (423)
Cash and cash equivalents, beginning of period 22,221 876
-------- --------
Cash and cash equivalents, end of period $ 9,841 $ 453
-------- --------
Supplemental Disclosures of Cash Flow Information
Cash payments for income taxes $769 $128
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
statements.
5
<PAGE>
OAO TECHNOLOGY SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
OAO Technology Solutions, Inc. (the "Company" or "OAOT" ) provides clients
with a wide range of IT solutions and professional services including: systems
and software engineering; the operation of large-scale service delivery centers
and networks, distributed systems management; applications development and
maintenance; staffing augmentation services; enterprise resource planning,
integration, implementation and training services; as well as state-of-the-art
software solutions for the managed care marketplace.
The condensed consolidated financial statements included herein have been
prepared by the Company without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission ("SEC") and include, in the opinion of
management, all adjustments, consisting of normal, recurring adjustments,
necessary for a fair presentation of interim period results. Certain information
and footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations. The Company believes that its
disclosures are adequate to make the information presented not misleading. These
condensed consolidated financial statements should be read in conjunction with
the financial statements and notes thereto included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1997. The results of
operations for the three and nine month periods ended September 30, 1998, are
not necessarily indicative of the results to be expected for the full year.
2. CREDIT AGREEMENTS
The Company currently has a $10.0 million revolving credit agreement (the
"Agreement") with a commercial bank. Advances under the Agreement are limited to
80% of certain eligible accounts receivable of the Company. The Company also has
a $750,000 line of credit (the "Line") with the same bank and the same terms as
the Agreement. There currently are no outstanding borrowings under either the
Agreement or the Line. The Company is required to maintain certain financial and
other covenants under these facilities. The Company was not in compliance with
certain covenants as of September 30, 1998, and is in the process of
renegotiating the terms of the existing Agreement.
3. EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share has been calculated as net earnings divided
by weighted-average common shares outstanding, while diluted earnings per share
has been computed as net earnings divided by weighted average common and diluted
shares outstanding. For the three and nine months ended September 30, 1998, all
common equivalents were anti-dilutive and therefore not included in the
calculation of diluted earnings per share. For the three and nine months ended
September 30, 1997, the Company's diluted shares outstanding were 488,000 and
413,000 respectively, for total common and dilutive shares outstanding of
10,489,000 and 10,414,000, respectively. Shares outstanding are computed using
the weighted-average number of shares of common and common equivalent shares,
which consist of stock options, for each period.
6
<PAGE>
4. RESTRUCTURING AND OTHER CHARGES
Restructuring Charge
During the nine month periods ended September 30, 1998, in connection with
management plans to reduce costs and improve operating efficiencies, the Company
recorded pre-tax restructuring charges of approximately $800,000. The
restructuring costs related to involuntary employee termination benefits and
other costs associated with restructuring actions. Employee termination benefits
include severance, wage continuation, outplacement services and other benefits.
Asset Abandonment
During the three months ended September 30, 1998, the Company reviewed the
status of its enterprise wide financial management project and identified
previously capitalized costs of approximately $2.1 million related to components
of this project which were being abandoned during the projects implementation
and have been written off.
5. ACQUISITIONS
DHR Technologies, Inc. Acquisition
On April 2, 1998, the Company acquired certain assets and liabilities of
DHR Technologies, Inc. ("DHR") for approximately $1.1 million in cash. DHR, a
Maryland-based information technology services company and software developer,
provided technical services in a variety of disciplines, including object
oriented software engineering; World Wide Web/multimedia applications; training
and consulting; and maintenance engineering. The acquisition has been accounted
for under the purchase method of accounting, thus the results of operations of
the acquired company have been included in the consolidated financial statement
from the date of acquisition. The purchase price was allocated based on the fair
values of the assets acquired, including among other assets approximately
$162,000 of cash, and the liabilities assumed at the date of acquisition. The
purchase resulted in an excess of purchase price over net assets acquired of
approximately $1.5 million, which is being amortized on a straight-line basis
over 7 years. Pro forma information related to this acquisition is not included
herein as the acquisition was not material.
OAO Services, Inc. Acquisition
On July 24, 1998, the Company completed the acquisition of all of the
outstanding capital stock of OAO Services, Inc., pursuant to a Stock Purchase
Agreement dated July 24, 1998 among OAO Services, Inc., the Company, OAO
Corporation ("OAOC") and an individual shareholder (the individual shareholder
together with OAOC, the "Stockholders"). The acquisition was effective as of
July 1, 1998.
Pursuant to the terms of the Stock Purchase Agreement, the purchase price
payable by the Company to the Stockholders in connection with the acquisition
included (i) cash in the amount of $2,305,000, subject to certain purchase price
adjustments, (ii) the payment by OAOT to the bank of $4,561,000 for the
retirement of outstanding debt under a financing agreement (of this amount,
$3,465,611 is a paydown of the portion of the debt allocated to the Company,
with the remainder, being a payment of the balance allocated to OAOC), and (iii)
earn-out payments to the Stockholders in amounts equal to 10% of the OAOT's
Pre-Tax Profit, as defined in the Stock Purchase Agreement, in excess, if any,
of $2,000,000, subject to increases as defined in the Stock Purchase Agreement,
for the three years ending December 31, 1999, 2000 and 2001. The aggregate of
all earn-out payments under the Stock Purchase Agreement will not exceed
$5,000,000, and each earn-out payment will be payable by OAOT on the 90th
business day after the OAOT receipt of its audited financial statements for the
year for which such payment is to be made.
7
<PAGE>
Also on July 24, 1998, in connection with the acquisition of OAO Services,
OAOT entered into an Administrative Services Agreement with OAOC, under which
OAOC will provide OAO Services with administrative support services through the
earlier of the date that OAOT determines, in its sole discretion, that it no
longer requires such services, or December 31, 1998. In consideration for
providing such services, OAOT will pay to OAOC $100,000 per month. During the
three and nine month periods ended September 30, 1998, the Company incurred
$300,000 of costs under this agreement.
As of September 30, 1998, the Company had a receivable of approximately
$2.5 million due from OAOC. In connection with its purchase of OAO Services,
Inc. from OAOC, the Company paid excess cash purchase price of approximately
$352,000, which together with the repayment of OAOC debt of approximately $2.2
million at closing by the Company results in the total amount due from OAOC to
the Company of approximately $2.5 million. The Company entered into a promissory
note from OAOC for this amount bearing interest at Prime plus 2% due December 1,
1999. The note is guaranteed by an individual, who is the Chairman of the Board
of Directors and Chief Executive Officer of OAOC, holder of 95% of OAOC's
outstanding shares of capital stock, the Vice Chairman of the Board of Directors
of the Company, and owner of approximately 20% of the outstanding shares of
common stock of the Company, and has pledged as security approximately 1.3
million of the shares of the Company's stock, currently valued at approximately
$5.0 million.
The unaudited pro forma information for the periods set forth below give
effect to the OAO Services acquisition as if it had occurred at the beginning of
each period. The pro forma information is presented for informational purposes
only and is not necessarily indicative of the results of operations that
actually would have been achieved had the acquisition been consummated as of
that time (unaudited, dollars in thousands)
Nine months ended Year ended
September 30, 1998 December 31, 1997
------------------ -----------------
Revenue $119,948 $143,557
Net (Loss) Income $(3,602) $3,513
Diluted Earnings Per Share $(.22) $.31
Basic Earnings Per Share $(.22) $.27
8
<PAGE>
6. COMPREHENSIVE (LOSS) INCOME
In 1998, the Company adopted Statement of Financial Accounting Standard
("SFAS") No. 130, "Reporting Comprehensive Income" which was effective for
fiscal years beginning after December 15, 1997. Comprehensive income is the
change in equity of a business enterprise during a period from transactions and
other events and circumstances from non-owner sources. The Company's source of
other comprehensive income other than net income, is from foreign currency
translation adjustments and deferred compensation. There were no adjustments to
net income to arrive at comprehensive income for the three or nine months ended
September 30, 1997. The components of comprehensive income are as follows:
(dollars in thousands)
<TABLE>
<CAPTION>
Three months Three months Nine months Nine months
ended ended ended ended
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
------------------------------------------------------------
<S> <C> <C> <C> <C>
Net (Loss) Income $(1,972) $ 716 $(4,006) $ 1,948
Other Comprehensive Income:
Deferred Compensation -- -- (195) --
Foreign Currency Translation (97) -- (322) --
------------------------- -------------------------
Comprehensive (Loss) Income $(2,069) $ 716 $(4,523) $ 1,948
</TABLE>
7. NEW AUTHORITATIVE PRONOUNCEMENTS
In July 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related Information,"
and in February 1998 issued SFAS No. 132, "Employers' Disclosures about Pensions
and Other Postretirement Benefits."
SFAS No. 131 establishes standards for the way public business enterprises
report information about operating segments and the related disclosures about
products and services, geographic areas and major customers. SFAS No. 132
requires revised disclosures about pensions and post-retirement benefit plans.
Adoption of SFAS No. 132 will not have a material effect on the Company's
presentation of pension disclosures. The Company is evaluating the effect of
implementing SFAS No. 131 on its presentation of operating segments and related
disclosures. The Company will adopt SFAS Nos. 131 and 132 in the fourth quarter
of 1998.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1, "Accounting for Costs of Computer
Software Developed or Obtained for Internal Use." This Statement will be
effective in 1999 and establishes accounting standards for costs incurred in the
development or implementation of computer software. This new Statement requires
the capitalization of certain software implementation costs relating to software
developed or implemented for the Company's use. This Statement is not expected
to have a significant effect on the Company's financial position or results of
operations.
9
<PAGE>
Item 2.
OAO TECHNOLOGY SOLUTIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following should be read in conjunction with the Consolidated Financial
Statements of the Company and Notes thereto included elsewhere in this quarterly
report. This report contains certain forward-looking statements that involve
risks and uncertainties. Future events and the Company's actual results could
differ materially from the results reflected in these forward-looking
statements. Factors that might cause such a difference include, but are not
limited to, dependence on key strategic customers, limited ability to establish
new strategic partner relationships, risks associated with fixed-price
contracts, ability to sustain and manage growth, variability of quarterly
operating results, dependence on key personnel, competition, and risks
associated with international sales.
Overview
The Company provides a wide range of outsourced IT solutions and
professional services, and competes in four lines of business, including Managed
Services, Staff Augmentation, Enterprise Resource Planning, and Healthcare
Solutions.
Managed Services includes the operation of large-scale data center
complexes and networks ("Megacenter Operations"), distributed systems management
("DSM"), staffing services and other IT services. The Company provides these
services to strategic clients ("Strategic Clients") as part of an IT outsourcing
team serving engagement clients ("Engagement Clients"), who are the ultimate
end-users of the services. The Company's primary Strategic Clients have been
IBM's Global Services ("IBM") and Digital Equipment Corporation ("Digital").
Engagement Clients include Ameritech, Blue Cross/Blue Shield and McDonnell
Douglas. During the nine months of 1998, the Company has invested approximately
$1.1 million the development of a new line of business, Applications Development
and Maintenance ("ADM") by opening a center in New Brunswick, Canada devoted
solely to the provision of these services (the "Northshore Solution").
The OAO Services acquisition in July of 1998 comprises the Staff
Augmentation line of business. Staff Augmentation offers a broad range of IT
skills including systems engineers, architects, and managers. OAO Services is an
IBM National Technical Subcontracting (NTS) Supplier, offering customer support
center services, year 2000 support services, and deskside support services.
Enterprise Resource Planning was developed with the acquisition of DHR
Technologies in April of 1998. DHR provides advanced computerized solutions and
related technical services to power, industrial, healthcare and financial
clients.
In addition, the Company provides consulting services and software to
managed care organizations through its Healthcare Solutions subsidiary
("Healthcare").
Results of Operations
Revenues
The Company's revenue increased approximately 67.4% and 29.9%,
respectively, to $34.5 million and $77.9 million for the three and nine months
ended September 30, 1998 compared to $20.6 million and $60.0 million for the
same prior year periods. Revenue from Managed Services decreased 13.4% and 3.6%
respectively, to $17.3 million and $55.7 million for the three and nine months
ended September 30, 1998 compared to $19.9 million and $57.8 million for the
same prior periods. This decrease is due to the expiration of certain Digital
projects, and a combination of IBM pricing pressures resulting in revenue
reductions on three continuing contracts; the elimination of approximately $2.5
million in revenue from a non-recurring project which occurred during the first
half of 1997; and the shutdown of approximately five IBM projects during the
current year. In March 1998, the Company announced a new initiative to provide
certain ADM services to IBM. This new line of business has provided
approximately $479,000 and $1.0 million in revenue for the three and nine months
ended September 30, 1998.
10
<PAGE>
While the Company is continuing to participate in proposal efforts with IBM, and
will continue to pursue the expansion of the NorthShore Solution both with IBM
and other customers, it expects the pricing pressures and certain contract
expirations to continue. Accordingly, revenue from IBM and Digital could
potentially continue to decrease.
Revenue from Staff Augmentation was $14.9 million for the three months
ended September 30, 1998. In July, 1998, the Company acquired certain assets of
OAO Services, Inc. ("Services") in a cash transaction. The acquisition has been
accounted for under the purchase method of accounting, thus the results of
operations of the acquired company have been included in the consolidated
financial statements from the date of acquisition. The purchase price was
allocated based on the fair values of the assets acquired and the liabilities
assumed at the date of acquisition. Prior to the acquisition, Services had
revenues of approximately $28.6 million, $16.5 million and $50.8 million for the
six months ended June 30, 1998, and the three and nine months ended September
30, 1997, respectively. Revenue from Staff Augmentation is expected to remain
consistent in the fourth quarter of 1998.
In April 1998, the Company acquired certain assets of DHR Technologies,
Inc. ("DHR") for approximately $1.1 million in cash. DHR, a Maryland-based
information technology services company and software developer, provides
technical services in a variety of disciplines, including object-oriented
software engineering; World Wide Web/multimedia applications; training and
consulting; and maintenance engineering. The acquisition has been accounted for
under the purchase method of accounting, thus the results of operations of the
acquired company have been included in the consolidated financial statements
from the date of acquisition. For the three and nine months ended September 30,
1998, DHR contributed Enterprise Resource Planning revenue of approximately
$484,000, and $1.2 million respectively. Revenue from Enterprise Resource
Planning is expected to remain constant in the fourth quarter of 1998.
Revenue from Healthcare was approximately $1.9 million and $6.0 million for
the three and nine months ended September 30, 1998. The increase in revenue was
contributed by the Company's subsidiary, OAO Healthcare Solutions, which sells
the MC400 software package and was acquired by the Company in November 1997.
This increase in Healthcare was offset by a decrease in revenue for the nine
months ended September 30, 1998 due to the decline of revenues on one legacy
project nearing completion. Revenue from Healthcare is expected to increase for
the fourth quarter of 1998, however, no assurance can be given that these
expectations will be met.
Direct Costs
The Company's direct costs increased 85.2% and 42.0%, respectively, to
$29.9 million and $66.6 million for the three and nine months ended September
30, 1998, compared to $16.1 million and $46.9 million for the same prior year
periods. Direct costs consist primarily of direct labor cost and related fringe
benefit costs. As a percentage of revenue, direct costs increased to 86.6% and
85.6% for the three and nine months ended September 30, 1998, compared to 78.3%
and 78.2% for the comparable periods in 1997.
Gross margin for Managed Services was $3.1 million and $8.9 million or
18.0% and 16.0% of the related revenues for the three and nine months ended
September 30, 1998, respectively, compared to $4.2 million and $12.1 million or
21.0% of the related revenues for the same prior year periods. Margins for
Managed Services decreased primarily as a result of IBM pricing pressures on
continuing projects which accelerated during the first quarter of 1998, and due
to the expiration of several IBM and Digital projects during the current year.
In addition, margins were adversely impacted by approximately $1.1 million of
start-up costs incurred year to date related to the Northshore Solution project.
These costs are expected to continue at a declining rate for the remainder of
1998. Staff Augmentation gross margin was $1.9 million or 12.9% of related
revenues for the three months ended September 30, 1998. Enterprise Resource
Planning gross margin was $(538,000) and $(723,000) or (111.2%) and (61.4%)
respectively for the three and nine months ended September 30, 1998. Gross
margin for Healthcare was $140,000 and $1.2 million or 7.4% and 18.9% of the
related revenues for the three and nine months ended September 30, 1998,
compared to $297,000 and $967,000 or 42.5% and 44.4% of the related revenues for
the same prior year periods. Healthcare margins decreased for the three months
ended September 30, 1998 due to a decline in revenue on one existing project
nearing completion. Healthcare margins increased for the nine months ended
September 30, 1998 due to the acquisition of OAO Healthcare Solutions in
November 1997. Healthcare margins are expected to increase
11
<PAGE>
in the fourth quarter of 1998 compared to the current quarter due to an increase
in the delivery of MC400 software licenses. Management can provide no assurance
that this expectation will be met.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 55.5% and 56.1% for
the three and nine months ended September 30, 1998 to $4.9 million and $14.8
million, respectively, compared to $3.1 million and $9.5 million for the same
prior year periods. As a percentage of revenues, these costs decreased to 14.1%
for the three months ended September 30, 1998 compared to 15.2% for the same
prior year period. The decrease is attributable to recently implemented cost
cutting initiatives. As a percentage of revenues these costs increased to 19.0%
for the nine months ended September 30, 1998, compared to 15.8% for the same
prior year periods. The increases are due to provisions for uncollectible
accounts receivable of approximately $3.2 million and $625,000 which were
recorded during the second and third quarter of 1998, respectively.
Restructuring and Other Charges
During the three months ended September 30, 1998, in connection with
management plans to reduce costs and improve operating efficiencies, the Company
recorded pre-tax restructuring charges of approximately $800,000. The
restructuring costs relate primarily to involuntary employee termination
benefits. Employee termination benefits include severance, wage continuation,
outplacement services and other benefits.
During 1997, the Company began implementation of an enterprise wide
financial management project. The program included modules for general ledger,
accounts receivable, accounts payable, project accounting and human resources.
During the three months ended September 30, 1998, due to significant cost
overruns and project definition changes, the Company hired an outside consultant
to review the status of this project. Based on this review, the Company
abandoned certain of the original software modules and the related
implementation costs. As a result, the Company recorded a write off of
approximately $2.1 million related to this abandonment. Other
Liquidity and Capital Resources
Cash and cash equivalents were $9.8 million as of September 30, 1998, and
$453,000 as of September 30, 1997. Cash flows used in operations were $3.0
million for the nine months ended September 30, 1998 and $4.5 million for the
nine months ended September 30, 1997. The Company primarily funded its uses of
cash in 1998 from operations and the proceeds received from the rights offering,
and in 1997 from borrowings under the Company's credit facility prior to the
completion of the rights offering. The use of cash in operations for the nine
months ended September 30, 1998, was primarily the result of the increase in
income tax receivable as well as decreases in accounts payable and accounts
receivable.
The use of cash in investing activities for the nine months ended September
30, 1998 was primarily the result of the acquisitions of OAO Services, Inc. and
DHR Technologies, Inc. The Company's business is not capital intensive, and
expenditures in any given year are ordinarily not significant. Capital
expenditures in the first nine months of 1998 included expenditures associated
with the development of a operational, administrative and financial information
system. The Company has recorded an asset abandonment cost on the operational,
administrative and financial information system of approximately $2.1 million.
The Company expects to incur additional capitalized costs of approximately $1.0
million associated with the development and implementation of a new management
information systems through the first quarter of 1999.
The Company currently has a $10.0 million revolving credit agreement (the
"Agreement") with a commercial bank. Advances under the Agreement are limited to
80% of certain eligible accounts receivable of the Company. The Company also has
a $750,000 line of credit (the "Line") with the same bank which has the same
terms as the Agreement. The Company is required to maintain certain financial
and other covenants under these facilities with which they were not in
compliance as of September 30, 1998. Since there currently are no outstanding
borrowings under either the Agreement or the Line, there is no liability
resulting from the violation of the covenants. However, under the existing
Agreement, funds would not be available for the Company's use. The Company
believes it would be able to obtain funds if needed by renegotiating the terms
of the existing Agreement or entering into a new financing arrangement with a
different bank.
The Company currently anticipates that its existing cash balances as well
as cash generated from operations will be sufficient to satisfy its operating
cash needs for the foreseeable future. The Company believes that additional bank
credit would be available to fund such operating and capital requirements if the
Company's cash needs expand more rapidly than expected. In addition, the Company
could consider seeking additional public or private debt or equity financing to
fund future growth opportunities. No assurance can be given, however, that such
bank credit or debt or equity financing will be available to the Company on
terms and conditions acceptable to the Company, if at all.
12
<PAGE>
Year 2000 (Y2K) Issue
The Company recognizes the need to ensure that its operations will not be
adversely impacted by Y2K failures. Accordingly, in January of 1998, the Company
initiated a program to determine it's state of readiness for its information
technology and non-information technology systems and to identify and properly
address issues associated with the Y2K issue. The Company has made substantial
progress in assessing how it will be impacted by the issue. In June of 1998, a
company wide initiative began to assess third party vendor state of readiness.
The Company is in the process of obtaining compliance certificates from its
third party vendors, however, the Company is unable to definitively determine
that all third party vendors will reach Y2K-ready status. As of September 30,
1998, the Company has surveyed all of its business and critical systems, and
plans for replacement of non-compliant equipment and software have been put in
place. The cost of the replacement systems is estimated at approximately $1.0
million, scheduled to be incurred in the fourth quarter of 1998 and the first
quarter of 1999 under the normal course of business. The Comapny does not have a
written contingency plan in place addressing the effect, if any, should any of
its third party vendors fail to deliver Y2K compliance. Any additional need for
contingency plans or back-up systems will be addressed and determined during th
first half of 1999.
The activities involved in the Company's Y2K program necessarily involve
estimates and projections, as described above, of activities and resources that
will be required in the future. These estimates and projections may be revised
as work progresses on this program. If any of the significant third party
vendors are not Y2K compliant and/or the Company fails to identify or replace
non-compliant equipment or software and noncompliance causes a material
disruption to the business of the Company, the Company's revenues and financial
position could be materially adversely affected. There can be no assurance that
the Year 2000 will not have a material adverse effect on the Company's financial
position of results of operations.
13
<PAGE>
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit Page
No. Description No.
- - --------------------------------------------------------------------------------
27.1 Financial Data Schedule. (1) 16
- - ----------
(1) Filed herewith.
(b) Reports on Form 8-K
1. The Company filed a Form 8-K with the Commission on June 29, 1998, to
report its announcement of the appointment of a new Chief Executive
Officer, the signing of letters of intent to acquire two companies,
and the expected loss for the second quarter of 1998. No financial
statements were filed with this report.
2. The Company filed a form 8-K with the Commission on August 7, 1998, in
connection with the July 24, 1998 acquistion of all of the outstanding
capital stock of OAO Services, Inc. No financial statements were filed
with this report
3. The Company filed a Form 8-K/A with the Commission on October 6, 1998,
to provide the financial statements required to be included in the
current report on Form 8-K dated July 24, 1998 in connection with the
acquisition of all of the outstanding capital stock of OAO Services,
Inc.
14
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OAO Technology Solutions, Inc.
(Registrant)
Date: 11/16/98 By: /s/ GREGORY A. PRATT
-----------------------------------
Gregory A. Pratt
Chief Executive Officer and President
Date: 11/16/98 By: /s/ SAMUEL D. HORGAN
----------------------------------
Samuel D. Horgan
Chief Financial Officer
15
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 9,841
<SECURITIES> 0
<RECEIVABLES> 29,187<F1>
<ALLOWANCES> (2,881)
<INVENTORY> 0
<CURRENT-ASSETS> 42,357
<PP&E> 4,204<F2>
<DEPRECIATION> 0
<TOTAL-ASSETS> 51,128
<CURRENT-LIABILITIES> 16,249
<BONDS> 777<F3>
0
0
<COMMON> 164
<OTHER-SE> 33,938
<TOTAL-LIABILITY-AND-EQUITY> 51,128
<SALES> 0
<TOTAL-REVENUES> 77,866
<CGS> 0
<TOTAL-COSTS> 66,621
<OTHER-EXPENSES> 17,892
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (515)<F4>
<INCOME-PRETAX> (6,132)
<INCOME-TAX> (2,126)
<INCOME-CONTINUING> (4,006)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,006)
<EPS-PRIMARY> (0.24)
<EPS-DILUTED> (0.24)
<FN>
<F1> Shown net of allowance for uncollectible accounts on face of Consolidated
Balance Sheet.
<F2> Shown in this Financial Data Schedule net of related accumulated
depreciation for consistency with Consolidated Balance Sheet.
<F3> Represents the long-term portion of capital lease obligations.
<F4> Represents interest income of the Company.
</FN>
</TABLE>
