U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: April 30, 1999
Commission file number: 0-20824
COMPUTER OUTSOURCING SERVICES, INC.
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(Exact name of small business issuer as specified in its charter)
New York 13-3252333
------------------------------- ------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
2 Christie Heights Street Leonia, New Jersey 07605
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(Address of principal executive offices)
(201) 840-4700
---------------------------
(Issuer's telephone number)
Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
There were 4,712,915 shares of the registrant's Common Stock, $0.01 par value,
outstanding as of June 14, 1999.
Transitional Small Business Disclosure Form (check one): Yes [ ] No [X]
Page 1 of 19
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PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
April 30, 1999 October 31, 1998
---------------- ----------------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and equivalents $ 3,347,366 $ 9,403,006
Marketable debt securities, at cost which
approximates market value 1,928,432 3,218,170
Trade accounts receivable, net of
allowance for doubtful accounts of
$261,940 and $216,659 5,865,830 4,452,117
Prepaid current income taxes 64,649 -
Deferred income taxes - current 655,327 603,627
Net assets held for sale 146,593 229,289
Prepaid expenses and other current assets 1,694,992 1,179,539
----------- -----------
13,703,189 19,085,748
----------- -----------
PROPERTY and EQUIPMENT, net 2,530,080 2,508,875
----------- -----------
OTHER ASSETS:
Deferred software, net 1,915,344 1,803,013
Intangibles, net 8,808,679 2,221,842
Due from related parties, net 106,709 89,313
Deferred income taxes 454,442 718,341
Security deposits and other
non-current assets 559,088 521,404
----------- -----------
11,844,262 5,353,913
----------- -----------
TOTAL ASSETS $ 28,077,531 $ 26,948,536
=========== ===========
See Notes to Consolidated Interim Financial Statements (Unaudited)
Page 2 of 19
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COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
April 30, 1999 October 31, 1998
---------------- ----------------
(Unaudited)
LIABILITIES and STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,455,250 $ 1,029,406
Current portion of long-term debt
and capitalized lease obligations 34,952 260,277
Income taxes payable - 2,468,747
Current portion of accrued loss on
office sublease 248,369 365,495
Accrued expenses 1,507,492 2,000,355
Customer deposits and other current
liabilities 206,879 202,787
----------- -----------
3,452,942 6,327,067
----------- -----------
OTHER LIABILITIES:
Long-term debt and capitalized
lease obligations - 11,510
Accrued loss on office sublease 1,701,690 2,016,606
Deferred income from a non-competition,
confidentiality, and conduct of
business agreement 760,000 1,000,000
----------- -----------
2,461,690 3,028,116
----------- -----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $0.01 par value; 1,000,000
shares authorized, none issued - -
Common stock, $0.01 par value; 10,000,000
shares authorized; shares issued and
outstanding: 4,708,915 and 4,285,715 47,089 42,857
Additional paid-in capital 15,186,241 11,946,837
Treasury stock at cost; 1,000 shares (7,313) -
Retained earnings 6,936,882 5,603,659
----------- -----------
22,162,899 17,593,353
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS'EQUITY $ 28,077,531 $ 26,948,536
=========== ===========
See Notes to Consolidated Interim Financial Statements (Unaudited)
Page 3 of 19
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COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Six Months ended Three Months ended
April 30, April 30,
------------------------ ------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
REVENUES $17,303,281 $15,173,675 $ 9,022,203 $ 7,957,080
----------- ----------- ----------- -----------
COSTS and EXPENSES:
Data processing costs 11,791,699 10,485,937 6,097,132 5,533,034
Selling and promotion costs 1,102,617 445,458 633,714 233,545
General and
administrative expenses 2,328,157 2,680,874 1,035,033 1,412,403
Interest income, net (178,815) (240,862) (57,458) (149,286)
----------- ----------- ----------- -----------
15,043,658 13,371,407 7,708,421 7,029,696
----------- ----------- ----------- -----------
Income from continuing
operations before provision
for income taxes 2,259,623 1,802,268 1,313,782 927,384
Provision for income taxes 926,400 800,770 538,605 416,424
----------- ----------- ----------- -----------
Income from
continuing operations 1,333,223 1,001,498 775,177 510,960
Loss on discontinued
operation, net of income
tax benefit of $76,034 - (60,509) - -
Gain on sale of discontinued
operation, net of income
tax provision of $1,498,387 - 1,600,921 - -
----------- ----------- ----------- -----------
NET INCOME $ 1,333,223 $ 2,541,910 $ 775,177 $ 510,960
=========== =========== =========== ===========
See Notes to Consolidated Interim Financial Statements (Unaudited)
Page 4 of 19
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COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Six Months ended Three Months ended
April 30, April 30,
------------------------ ------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
BASIC EARNINGS PER SHARE:
Income from
continuing operations $ 0.29 $ 0.26 $ 0.17 $ 0.13
Loss on
discontinued operation - (0.02) - -
Gain on sale of
discontinued operation - 0.41 - -
----------- ----------- ----------- -----------
Net income per basic share $ 0.29 $ 0.65 $ 0.17 $ 0.13
=========== =========== =========== ===========
WEIGHTED AVERAGE NUMBER
OF SHARES OUTSTANDING 4,544,525 3,888,159 4,661,680 3,956,190
=========== =========== =========== ===========
DILUTED EARNINGS PER SHARE:
Income from
continuing operations $ 0.27 $ 0.23 $ 0.16 $ 0.12
Loss on
discontinued operation - (0.01) - -
Gain on sale of
discontinued operation - 0.36 - -
----------- ----------- ----------- -----------
Net income per diluted share $ 0.27 $ 0.58 $ 0.16 $ 0.12
=========== =========== =========== ===========
WEIGHTED AVERAGE NUMBER OF
SHARES and EQUIVALENTS
OUTSTANDING 4,892,069 4,379,701 4,998,159 4,222,087
=========== =========== =========== ===========
See Notes to Consolidated Interim Financial Statements (Unaudited)
Page 5 of 19
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COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)
Six Months ended April 30,
-------------------------------
1999 1998
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Income from continuing operations $ 1,333,223 $ 1,001,498
Adjustments to reconcile net income to cash
(used in)/provided by operating activities:
Depreciation and amortization 713,358 682,473
Deferred income taxes 212,199 (57,175)
Decrease/(increase) in:
Trade accounts receivable (1,413,713) (724,712)
Prepaid expenses and other current
assets (515,453) (81,048)
Security deposits and other non-current
assets - (67,054)
Increase/(decrease) in:
Accounts payable 425,844 13,568
Income taxes payable (337,382) 113,797
Accrued expenses (838,065) (297,191)
Customer deposits and other current
liabilities 4,092 (22,173)
----------- -----------
Net cash (used in)/provided by
operating activities (415,897) 561,983
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (352,735) (690,777)
Disposal of equipment - 14,960
Redemption of investments in marketable
debt securities 1,289,738 -
Proceeds from sale of the Payroll Division - 12,150,000
Payment of expenses related to sale of the
Payroll Division (201,286) (877,376)
Payment of taxes on gain related to sale
of the Payroll Division (2,196,014) -
Payment for the purchase of certain assets
and the business of Enterprise Technology
Group, Inc. (the "Enterprise Purchase") (4,000,000) -
Payment of expenses related to the
Enterprise Purchase (175,553) -
Deposits received for assets held for sale 82,696 -
Increase in deferred software costs (391,181) (386,307)
----------- -----------
Net cash (used in)/provided by
investing activities $(5,944,335) $10,210,500
----------- -----------
Continued on next page
See Notes to Consolidated Interim Financial Statements (Unaudited)
Page 6 of 19
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COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited - Continued)
Six Months ended April 30,
-------------------------------
1999 1998
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long-term debt and
capital lease obligations $ (236,835) $(2,084,158)
Repayments/(borrowings) by
related parties, net (17,396) 71,026
Purchases of treasury stock (7,313) -
Proceeds from the exercises of stock
options and warrants 566,136 1,185,489
----------- -----------
Net cash provided by/(used in) financing
activities 304,592 (827,643)
----------- -----------
CASH FLOWS FROM DISCONTINUED OPERATION:
Loss from discontinued operation - (60,509)
Adjustments to reconcile loss from
discontinued operation to cash used
in discontinued operation:
Depreciation and amortization - 151,118
Increase in net assets of discontinued
operation - (307,813)
----------- -----------
Net cash used in discontinued
operation - (217,204)
----------- -----------
Net (decrease)/increase in cash
and equivalents (6,055,640) 9,727,636
Cash and equivalents at the
beginning of the period 9,403,006 972,459
----------- -----------
Cash and equivalents at the end
of the period $ 3,347,366 $10,700,095
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the period for:
Interest expense $ 22,405 $ 87,929
=========== ===========
Income taxes $ 3,254,330 $ 894,803
=========== ===========
SUPPLEMENTAL DISCLOSURE OF NON-CASH
INVESTING ACTIVITIES:
Note received for a portion of the sales
price of the Payroll Division $ - $ 750,000
=========== ===========
Stock issued for a portion of the
Enterprise Purchase $ 2,677,500 $ -
=========== ===========
See Notes to Consolidated Interim Financial Statements (Unaudited)
Page 7 of 19
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COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Common Par Paid in Treasury Retained
Shares Value Capital Stock Earnings Total
--------- ------- ----------- -------- ---------- -----------
Balance,
October
31, 1998 4,285,715 $42,857 $11,946,837 - $5,603,659 $17,593,353
Stock
issued
for the
Enterprise
Purchase 300,000 3,000 2,674,500 2,677,500
Exercises of
stock
options 123,200 1,232 564,904 566,136
Purchase of
treasury
stock (7,313) (7,313)
Net income 1,333,223 1,333,223
--------- ------- ----------- -------- ---------- -----------
Balance,
April
30, 1999 4,708,915 $47,089 $15,186,241 $(7,313) $6,936,882 $22,162,899
========= ======= =========== ======== ========== ===========
See Notes to Consolidated Interim Financial Statements (Unaudited)
Page 8 of 19
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COMPUTER OUTSOURCING SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The consolidated balance sheet as of April 30, 1999, and the consolidated
statements of income and cash flows for the six and three month periods ended
April 30, 1999 and 1998, have been prepared by the Company without audit. In
the opinion of management, all adjustments (consisting of only normal recurring
adjustments) necessary to present fairly the financial position, results of
operations, and cash flows for the periods indicated have been made.
The results of operations for the periods ended April 30, 1999 and 1998 are
not necessarily indicative of the operating results for the full fiscal years.
Certain reclassifications have been made to the prior periods to conform to the
current presentation.
Certain disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted. These consolidated interim financial statements should be read in
conjunction with the Company's Annual Report on Form 10-KSB for the fiscal year
ended October 31, 1998.
Effective November 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income," ("SFAS 130").
SFAS 130 establishes new rules for reporting comprehensive income and its
components; however, the adoption of this statement had no impact on the
Company's net income or shareholders' equity. The Company did not have any
"comprehensive income" within the scope of SFAS 130 during either of the three
or six month periods ended on April 30, 1999 or April 30, 1998.
The consolidated financial statements include the accounts of Computer
Outsourcing Services, Inc. and its wholly-owned subsidiaries (collectively, the
"Company"). All significant intercompany balances and transactions have been
eliminated.
2. SALE OF THE PAYROLL DIVISION
On December 19, 1997, the Company consummated the sale (the "Sale") of all the
outstanding capital stock of Daton Pay USA, Inc., NEDS, Inc., Pay USA of New
Jersey, Inc., and Key-ACA, Inc., each a wholly-owned subsidiary of the Company,
and together comprising the Payroll Division ("Pay USA"), to Zurich Payroll
Solutions, Ltd. ("Zurich" or the "Buyer"). At closing, the Company received
$11,460,000, of which $10,710,000 was in cash and $750,000 was in the form of
a note from the Buyer. The note plus accrued interest was paid in full in
August 1998. The terms of the Sale also provided for an additional payment by
the Buyer of up to $1,500,000, which amount was contingent on the revenue of Pay
USA for the three months following the sale. On June 1, 1998, the Company
received the entire $1,500,000 contingent payment. The Company recognized a
gain, net of tax, of approximately $1,700,000 in its fiscal year ended October
31, 1998, as a result of the sale of Pay USA.
Page 9 of 19
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Pursuant to the terms of the Sale, the Company agreed to provide the Buyer with
processing services in connection with the continuing operations of Pay USA.
The Company agreed to provide these services through December 31, 1999 for an
initial payment of $500,000, a fixed monthly fee of $16,000 (plus a fixed amount
for telephone line charges), and other monthly fees based on the level of
services provided. The Buyer also paid the Company $1,440,000 at closing for
the Company's agreement to refrain from (1) directly or indirectly competing
with Pay USA, except as permitted in the agreement; (2) providing processing
services to third parties if such processing services permitted those parties
to compete with Pay USA in certain payroll processing and related activities;
(3) disclosing information about Pay USA's customers; and (4) engaging in any
activity that could be materially detrimental to Pay USA's business or
reputation. The $1,440,000 is being amortized over the term of the agreement.
The amortization of such income is included in income from continuing
operations. Amortization was $240,000 and $200,000 for the six month periods
ended April 30, 1999 and 1998, respectively.
For the period from November 1, 1997 through the date of the Sale, revenues
related to the discontinued operation approximated $1,116,700 and the pretax
operating loss approximated $136,500.
3. ACQUISITION
On December 18, 1998, a subsidiary of the Company purchased certain assets and
the business of Enterprise Technology Group, Incorporated ("Enterprise") for
$4,000,000 in cash and 300,000 shares of the Company's common stock. Certain
additional consideration in the form of cash and common stock may be payable, at
various times, based upon the future performance of the acquired business over
the period ending December 31, 2001. On December 28, 1998, the subsidiary
changed its name to ETG, Inc.
The Company used cash on hand for the payment of $4,000,000 at closing. The
300,000 shares of common stock had a value of $2,677,500. The Company also
incurred costs of approximately $290,000 to complete the acquisition. The
assets acquired consist predominately of intangibles associated with the
business of providing information technology infrastructure management solutions
to large companies and institutions.
In connection with the acquisition, Enterprise and its principal shareholders
entered into non-competition and non-solicitation agreements with the Company.
A value of $50,000 was assigned to these agreements. The Company also recorded
$6,852,928 in excess of cost over net assets acquired (goodwill). The goodwill
is being amortized on a straight-line basis over 15 years, and the agreements
are being amortized over the terms of such agreements (approximately 61 months).
Page 10 of 19
<PAGE>
The following unaudited pro forma financial information shows the results of
operations for the six and three months ended April 30, 1999 and April 30, 1998
assuming the acquisition of certain assets and the business of Enterprise had
occurred at the beginning of each period presented:
Three Months
Six Months ended April 30, ended April 30,
-------------------------- --------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
Revenues $17,754,000 $18,187,000 $ 9,022,000 $ 8,544,000
=========== =========== =========== ===========
Income from continuing
operations $ 1,368,000 $ 1,005,000 $ 775,000 $ 357,000
Loss from discontinued
operation - (61,000) - -
Gain on sale of
discontinued operation - 1,601,000 - -
----------- ----------- ----------- -----------
Net income $ 1,368,000 $ 2,545,000 $ 775,000 $ 357,000
=========== =========== =========== ===========
Basic earnings per share:
Income from continuing
operations $ 0.30 $ 0.22 $ 0.17 $ 0.08
Loss from discontinued
operation - (0.02) - -
Gain on sale of
discontinued operation - 0.41 - -
----------- ----------- ----------- -----------
Net income $ 0.30 $ 0.61 $ 0.17 $ 0.08
=========== =========== =========== ===========
Diluted earnings per share:
Income from continuing
operations $ 0.28 $ 0.21 $ 0.16 $ 0.08
Loss from discontinued
operation - (0.01) - -
Gain on sale of
discontinued operation - 0.36 - -
----------- ----------- ----------- -----------
Net income $ 0.28 $ 0.56 $ 0.16 $ 0.08
=========== =========== =========== ===========
4. BASIC AND DILUTED EARNINGS PER COMMON SHARE
The Company has adopted Statement of Financial Accounting Standards No. 128
"Earnings per Share" ("SFAS 128"). SFAS 128 requires the presentation of basic
and diluted earnings per share ("EPS"). Basic EPS is computed by dividing
income available to common stockholders by the weighted average number of
common shares outstanding during each period. Diluted EPS is computed using
the weighted average number of common shares plus the dilutive effect of common
stock equivalents. Stock options and warrants which are anti-dilutive are
excluded from the computation of weighted average shares outstanding. Certain
options which currently are anti-dilutive may be dilutive in the future.
Page 11 of 19
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5. STOCK OPTIONS
The Company accounts for options granted under the 1992 Stock Option and Stock
Appreciation Rights Plan (the "Plan") in accordance with Accounting Principles
Board Opinion No. 25 and related Interpretations in accounting for its stock
options. Accordingly, no compensation cost has been recognized for stock option
awards. Had the compensation cost been determined in accordance with Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," the Company's pro forma income/(loss) and pro forma income/(loss)
per common share for the six months ended April 30, 1999 and 1998 would be as
follows:
1999 1998
----------------------- -----------------------
Historical Pro Forma Historical Pro Forma
---------- ---------- ---------- ----------
Income from continuing
operations $1,333,000 $1,155,000 $1,002,000 $ 889,000
Loss from discontinued
operation - - (61,000) (61,000)
Gain on sale of
discontinued operation - - 1,601,000 1,601,000
---------- ---------- ---------- ----------
Net income $1,333,000 $1,155,000 $2,542,000 $2,429,000
========== ========== ========== ==========
Income/(loss) per diluted
common share:
Income from continuing
operations $ 0.27 $ 0.24 $ 0.23 $ 0.20
Loss from discontinued
operation - - (0.01) (0.01)
Gain on sale of
discontinued operation - - 0.36 0.36
---------- ---------- ---------- ----------
Net income $ 0.27 $ 0.24 $ 0.58 $ 0.55
========== ========== ========== ==========
All incentive stock options under the Plan, other than those granted to any
person holding more than 10% of the total combined voting power of all classes
of outstanding stock, are granted at the fair market value of the common stock
at the grant date. The weighted average fair value of the stock options granted
during the six months ended April 30, 1999 and 1998 was $507,569 and $704,176,
respectively. The fair value of each stock option grant is estimated on the
date of the grant using the Black-Scholes option pricing model with the
following weighted average assumptions used for grants in 1999: a risk-free
interest rate of between 4.65% and 5.44%; expected lives of between one-half and
six years; and expected volatility of 48.5%.
Page 12 of 19
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ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS - SIX MONTH PERIODS ENDED April 30, 1999 and 1998
On December 19, 1997, the Company sold four subsidiaries comprising the Payroll
Division. In the accompanying financial statements, all revenues and expenses
of the Payroll Division were combined in the loss from discontinued operation.
The following discussion relates only to continuing operations.
On December 18, 1998, the Company acquired certain assets and the business of
Enterprise Technology Group, Incorporated (the "Enterprise Purchase"). Enter-
prise Technology Group provided information technology consulting services with
a focus on infrastructure management solutions.
During the six month period ended April 30, 1999, revenues from continuing
operations increased $2,129,000 (14%) to $17,303,000 from $15,174,000 for the
comparable period ended April 30, 1998. The Company's Year-2000 revenues
declined by approximately $735,000 from $982,000 to $247,000 for the period
ended April 30, 1999. Increased revenues from other activities substantially
exceeded the decline in Year-2000 revenues.
Data processing costs increased $1,306,000 to $11,792,000 (68% of revenues)
during the current period compared with $10,486,000 (69% of revenues) in the
prior year's period. Data processing costs increased as a result of higher
sales.
Selling and promotion costs increased $657,000 to $1,103,000 (6% of revenues)
during the current period compared with $445,000 (3% of revenues) in the prior
year's period. The increase is principally attributable to additional sales
staff.
General and administrative expenses decreased $353,000 to $2,328,000 from
$2,681,000, and declined to 14% of revenues for the six months ended April
30, 1999 from 18% of revenues for the prior year's period. Certain savings
achieved by the Company were offset by expenses related to the Enterprise
Purchase and new offices in Charlotte, North Carolina and New Haven, Con-
necticut. Amortization of intangibles acquired in connection with the
Enterprise Purchase was $156,000 for the six months ended April 30, 1999.
The Company recorded net interest income of $179,000 in the current six month
period compared with net interest income of $241,000 in the six months ended
April 30, 1998. The decrease of $62,000 reflects the reduction in cash and
investment balances as a result of the Enterprise Purchase, the payment of taxes
related to the sale of the Payroll Division, and the repayment of substantially
all of the Company's long-term debt.
The Company recorded a 33% increase in income from continuing operations to
$1,333,000 ($0.29 and $0.27 per share for basic and diluted shares, respec-
tively) for the period ended April 30, 1999 compared with $1,001,000 ($0.26 and
$0.23 per share for basic and diluted shares, respectively) for the period ended
April 30, 1998.
Page 13 of 19
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RESULTS OF OPERATIONS - THREE MONTH PERIODS ENDED April 30, 1999 and 1998
During the quarter ended April 30, 1999, revenues from continuing operations
increased $1,065,000 (13%) to $9,022,000 from $7,957,000 for the quarter ended
April 30, 1998. The Company's Year-2000 revenues declined by approximately
$413,000 from $493,000 to $80,000 for the quarter ended April 30, 1999.
Increased revenues from other activities substantially exceeded the decline in
Year-2000 revenues.
Data processing costs increased $564,000 to $6,097,000 (68% of revenues) during
the current quarter compared with $5,533,000 (70% of revenues) in the prior
year's quarter. Data processing costs increased as a result of higher sales.
Selling and promotion costs increased $400,000 to $634,000 (7% of revenues)
during the current quarter compared with $234,000 (3% of revenues) in the prior
year's quarter. The increase is principally attributable to additional sales
staff.
General and administrative expenses decreased $377,000 to $1,035,000 from
$1,412,000 and declined to 11% of revenues for the three months ended April
30, 1999 from 18% of revenues for the prior year's quarter. Certain savings
achieved by the Company were offset by expenses related to the Enterprise
Purchase and new offices in Charlotte, North Carolina and New Haven, Con-
necticut. Amortization of intangibles acquired in connection with the
Enterprise Purchase was $117,000 for the three months ended April 30, 1999.
The Company recorded net interest income of $57,000 in the current quarter
compared with net interest income of $149,000 in the quarter ended April 30,
1999. The decrease of $92,000 reflects the reduction in cash and investment
balances as a result of the Enterprise Purchase, the payment of taxes related to
the sale of the Payroll Division, and the repayment of substantially all of the
Company's long-term debt.
The Company recorded a 52% increase in income from continuing operations to
$775,000 ($0.17 and $0.16 per share for basic and diluted shares, respectively)
for the quarter ended April 30, 1999 compared with the $511,000 ($0.13 and
$0.12 per share for basic and diluted shares, respectively) for the quarter
ended April 30, 1998.
Page 14 of 19
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LIQUIDITY AND CAPITAL RESOURCES
During the six months ended April 30, 1999, the Company used net cash in
operating activities of approximately $416,000 primarily as a result of (a) an
increase in accounts receivable of $1,414,000 and prepaid expenses of $515,000
and a decrease in accrued expenses of $838,000 offset by (b) $2,047,000 in
income from operations before deductions for depreciation and amortization and
an increase in accounts payable of $426,000.
In investing activities, the Company invested $4,176,000 for the Enterprise
Purchase, and spent $2,397,000 for tax payments and other expenses related to
the sale of the Payroll Division. In addition, the Company invested approxi-
mately $353,000 in equipment, new software products, and other fixed assets and
$391,000 in product development and enhancement. Finally, the Company realized
$1,290,000 upon disposition of marketable securities.
In financing activities, the Company received $566,000, primarily generated from
exercises of employee stock options and made $237,000 in payments on long-term
debt. The Company currently has only $35,000 of remaining debt, all of which
will be repaid within the next twelve months.
As of April 30, 1999, the Company had cash and equivalents and highly liquid,
short-term investments aggregating approximately $5,276,000. The Company
believes that its cash, other liquid assets, funds generated from operations,
and potential borrowing capacity will provide adequate resources to fund its
ongoing operating requirements.
OTHER MATTERS
Certain of the Company's computer systems may need to be reprogrammed to correct
what is known as the Year 2000 Problem ("Y2K"). This is a condition whereby a
program does not properly interpret a two-digit year, reading "00" as 1900
rather than 2000. As a result, nearly all computer systems, except for the
most recent software and hardware versions, may produce computing errors or
fail to function after December 31, 1999.
The Company is also at risk from Y2K failures on the part of its major business
counterparts, including suppliers, distributors, licensees, and manufacturers,
as well as potential failures in public and private infrastructures services,
including electricity, water, gas, transportation, and communications.
Failures resulting from the Y2K problem could adversely affect the Company's
ability to service its clients.
The Company has appointed a senior officer, reporting directly to the President,
as the Y2K Compliance Coordinator. He works closely with the operations
managers, senior management, and the Company's vendors. The Company has
developed a multi-phased approach to resolve the Y2K issues that are reasonably
within its control. The Company's approach to and the anticipated timing of
each phase are described below:
Page 15 of 19
<PAGE>
Phase One - Identification. The first phase entailed identifying the technical
areas, business units, and infrastructure that might be affected by the Y2K
problem. The identification resulted in three primary classifications. The
first is the computer and communications hardware and non-application software
the Company obtains from vendors. This category consists of processing for
all client and internal Company applications. The second classification is the
Company's applications used to service clients and internal users. The third
classification relates to all non-direct computer ("Non-IT") associated issues
such as elevators, phone systems, security access systems, as well as services
provided by non-computer related vendors such as utility companies. Phase One
has been completed.
Phase Two - Inventory. The second phase entails an inventory of all hardware
and software (including business and operational applications, operating
systems, and third party products) that may be at risk, and identification of
key third party businesses which might most significantly impact the Company if
such third parties had Y2K failures. Phase Two has been completed.
Phase Three - Assessment. Once each at-risk application has been identified, it
will be determined how critical the application is to client and business oper-
ations and the potential impact of failure. Applications are classified as
"critical", "important", or "non-critical". A "critical" system is one that, if
not operational, would cause the shutdown of all or a portion of a business unit
within two weeks, while an "important" system is one that would cause such a
shutdown within two months. Phase Three has been completed.
Phase Four - Strategy. For applications, this phase entails the assessment of
each application system (Classification Two). The application's ability to
perform in Y2K, estimated cost to make Y2K compliant, availability of
replacement alternatives, and for applications used for clients, the total
annual revenue and expenses, are evaluated. The assessment will result in a
plan to upgrade the current application, migrate to a replacement Y2K-
compliant application, or cease processing of an application that produces a
marginal profit. Phase Four is 99% complete.
Phase Five - Remediation. The remediation phase involves creating project
plans; acquiring necessary resources; implementing new hardware, software, and
applications; and executing the strategies developed in Phase Four. Testing
and certification is also included within this phase. For non-application
systems (Classification One), Phase Five is approximately 85% completed. The
delivery of Y2K-compliant products by third party vendors will have an effect
on the final completion date. For application systems, (Classification Two),
Phase Five is approximately 70% completed. For non-IT systems (Classification
Three), Phase Five is approximately 80% completed. Testing for non-IT systems
has been initiated; however, due to the Company's reliance on third party
vendors for these systems, the Company cannot estimate precisely when this phase
will be completed. The Company has initiated written and telephonic
communications with key third party businesses. Communications with public and
private providers of infrastructure services, to ascertain and evaluate their
efforts in addressing Y2K compliance, has been initiated.
Page 16 of 19
<PAGE>
Phase Six - Contingency Planning. This phase entails developing an emergency
plan in the event non-IT (Classification Three) or non-application systems
(Classification One) malfunction or are not functional at the start of the Year
2000. The use of a "backup" computer maintained by an independent third party,
alternative communications carriers, and backup generators are some of the
contingencies being explored. The Company estimates that all of these plans
will be completed by December 1999. Based upon its efforts to date, the
Company believes that the vast majority of both its computer and its non-IT
systems, including all critical and important systems, will remain up and
running after January 1, 2000.
Internal and external costs specifically associated with Y2K modifications for
internal purposes are being expensed when incurred. Currently, the Company
estimates that such costs will approximate $300,000, of which approximately
$150,000 has been incurred through May 1999.
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of Section
21E of the Securities Exchange Act of 1934, as amended. As such, final results
could differ from estimates or expectations due to risks and uncertainties
including but not limited to: incomplete or preliminary information; changes in
government regulation and policies; continued acceptance of the Company's
products and services in the marketplace; competitive factors; new products;
technological changes; the Company's dependence on third party suppliers;
intellectual property rights; and other risks. For any of these factors, the
Company claims the protection of the safe harbor for forward-looking statements
contained in the Private Securities Litigation Reform Act of 1995, as amended.
Page 17 of 19
<PAGE>
PART II - OTHER INFORMATION
ITEM 6 - Exhibits and Reports on Form 8-K
(a) Exhibits:
27 Financial Data Schedule, filed electronically only.
(b) Reports on Form 8-K:
Form 8-K/A was filed on March 5, 1999 to provide financial statements
and pro forma financial information relating to the acquisition of
certain assets and the business of Enterprise Technology Group, Inc.
on December 18, 1998.
Page 18 of 19
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
COMPUTER OUTSOURCING SERVICES, INC.
/s/
June 14, 1999 ------------------------------------
Zach Lonstein
Chief Executive Officer
/s/
June 14, 1999 -------------------------------------
Nicholas J. Letizia
Chief Financial Officer
Page 19 of 19
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S QUARTERLY REPORT ON FORM 10-QSB FOR THE PERIOD ENDED APRIL 30, 1999,
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENT.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> OCT-31-1999
<PERIOD-END> APR-30-1999
<CASH> 3,347,366
<SECURITIES> 1,928,432
<RECEIVABLES> 6,127,770
<ALLOWANCES> 261,940
<INVENTORY> 0
<CURRENT-ASSETS> 13,703,189
<PP&E> 7,818,000
<DEPRECIATION> 5,287,920
<TOTAL-ASSETS> 28,077,531
<CURRENT-LIABILITIES> 3,452,942
<BONDS> 34,952
0
0
<COMMON> 47,089
<OTHER-SE> 22,115,810
<TOTAL-LIABILITY-AND-EQUITY> 28,077,531
<SALES> 0
<TOTAL-REVENUES> 17,303,281
<CGS> 0
<TOTAL-COSTS> 11,756,535
<OTHER-EXPENSES> 3,465,938
<LOSS-PROVISION> 69,000
<INTEREST-EXPENSE> 18,432
<INCOME-PRETAX> 2,259,623
<INCOME-TAX> 926,400
<INCOME-CONTINUING> 1,333,223
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,333,223
<EPS-BASIC> 0.29
<EPS-DILUTED> 0.27
</TABLE>
