<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(MARK ONE)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
OSAGE SYSTEMS GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 0-22808 95-4374983
(State of Incorporation) (Commission File No.) (IRS Employer
Identification No.)
1661 EAST CAMELBACK ROAD
SUITE 245
PHOENIX, ARIZONA 85016
(Address of principal executive office)
(602) 274-1299
(Registrant's telephone number, including area code)
Check whether the Registrant: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 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.
(1) Yes [X] No [ ]
(2) Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares outstanding of the Registrant's sole class of common stock,
as of May 10, 1999 was 9,485,643 shares.
Transitional Small Business Disclosure Format:
Yes [ ] No [X]
<PAGE> 2
OSAGE SYSTEMS GROUP, INC.
INDEX
<TABLE>
<CAPTION>
Page
<S> <C>
PART I FINANCIAL INFORMATION*
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 1999
(unaudited) and December 31, 1998 Unaudited Condensed 1
Consolidated Statements of Operations for the Three Months
ended March 31, 1999 and 1998 2
Unaudited Condensed Consolidated Statements of Cash Flows for
the Three Months ended March 31, 1999 and 1998 3
Notes to Unaudited Condensed Consolidated Financial Statements 4 - 7
Item 2. Management's Discussion and Analysis or Plan of Operation 8 - 18
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 19
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 20
</TABLE>
* The accompanying financial information is not covered by an Independent
Certified Public Accountant's Report.
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
OSAGE SYSTEMS GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, 1999
(UNAUDITED) DECEMBER 31, 1998
-------------- -----------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,326,397 $ 3,151,572
Accounts receivable - net of allowance for doubtful
accounts of $136,000 in 1999 and $132,000 in 1998 19,716,426 14,077,862
Inventories 325,382 332,272
Prepaid expenses and other current assets 881,888 556,972
Deferred income taxes 508,000 508,000
------------ ------------
Total current assets 25,758,093 18,626,678
------------ ------------
FURNITURE AND EQUIPMENT - net 1,658,481 1,475,284
GOODWILL, less accumulated amortization of $678,342 in 1999 and $475,471
in 1998 16,278,830 15,462,427
DEFERRED INCOME TAXES 1,452,000 1,392,000
OTHER ASSETS 124,945 204,876
------------ ------------
TOTAL $ 45,272,349 $ 37,161,265
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit $ 750,000
Current portion of long-term debt $ 838,059 1,914,078
Accounts payable 21,927,792 15,857,172
Accrued expenses 3,198,799 2,141,795
Deferred revenue 1,067,757 1,185,382
Income taxes payable 70,485
------------ ------------
Total current liabilities 27,032,407 21,918,912
------------ ------------
LONG-TERM DEBT 641,510 645,104
SERIES D CONVERTIBLE PREFERRED STOCK, ISSUED AND OUTSTANDING, 1,000
SHARES IN 1999 AND 1998; TOTAL LIQUIDATION PREFERENCE, $1,000,000 765,586 765,586
SERIES E CONVERTIBLE PREFERRED STOCK, ISSUED AND OUTSTANDING, 2,000
SHARES IN 1999; TOTAL LIQUIDATION PREFERENCE, $2,000,000 1,709,174
STOCKHOLDERS' EQUITY:
Series A Preferred, $100 stated value - authorized, issued and outstanding, 10
shares in 1999 and 1998; total liquidation preference, $300,000 1,000 1,000
Series C Preferred, $50 stated value - authorized, issued and outstanding, 25
shares in 1998; total liquidation preference, $375,000 1,250
preference, $750,000
Common stock, $.01 par value - authorized, 50,000,000 shares; issued and
outstanding, 9,485,643 shares in 1999 and 9,511,058 in 1998 94,856 95,111
Additional paid-in-capital 18,994,194 17,434,279
Retained earnings (deficit) (3,966,378) (3,699,977)
------------ ------------
Total stockholders' equity 15,123,672 13,831,663
------------ ------------
TOTAL $ 45,272,349 $ 37,161,265
============ ============
</TABLE>
See notes to unaudited condensed consolidated financial statements.
1
<PAGE> 4
OSAGE SYSTEMS GROUP, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1999 MARCH 31, 1998
------------------ --------------
<S> <C> <C>
NET SALES $27,092,073 $ 5,641,932
COST OF SALES 21,412,430 4,580,010
----------- -----------
Gross profit 5,679,643 1,061,922
----------- -----------
OPERATING EXPENSES:
Selling, general and administrative expenses 5,487,412 1,193,723
Depreciation and amortization 355,097 29,265
----------- -----------
Total operating expenses 5,842,509 1,222,988
----------- -----------
OPERATING LOSS (162,866) (161,066)
INTEREST - net (163,535) 35,550
----------- -----------
LOSS BEFORE BENEFIT FOR INCOME TAXES (326,401) (125,516)
BENEFIT FOR INCOME TAXES (60,000) (39,000)
----------- -----------
NET LOSS $ (266,401) $ (86,516)
=========== ===========
LOSS PER COMMON SHARE -
BASIC AND DILUTED $ (0.03) $ (0.02)
=========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING 9,499,362 5,342,472
=========== ===========
</TABLE>
See notes to unaudited condensed consolidated financial statements.
2
<PAGE> 5
OSAGE SYSTEMS GROUP, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1999 MARCH 31, 1998
-------------- --------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss $ (266,401) $ (86,516)
Adjustments to reconcile net (loss) income to net cash (used in) provided by
operating activities:
Depreciation and amortization 355,097 29,265
Deferred income taxes (60,000) (23,231)
Stock-based compensation 75,000
Loss on disposal of assets 470
Changes in operating assets and liabilities:
Accounts receivable (5,638,564) (1,174,742)
Inventories 6,890 (253,039)
Prepaid expenses and other assets (290,737) (79,163)
Accounts payable 6,070,620 576,706
Accrued expenses 1,357,004 79,409
Deferred revenue (117,625) (4,673)
Income taxes payable (70,485) (71,007)
------------- ------------
Net cash provided by (used in) operating activities 1,346,269 (931,991)
------------- ------------
INVESTING ACTIVITIES:
Capital expenditures (290,142) (74,124)
Acquisition costs, net of cash received of $40,492 in 1998 (19,275) (734,064)
------------- ------------
Net cash used in investing activities (309,417) (808,188)
------------- ------------
FINANCING ACTIVITIES:
Payments under line of credit agreement (750,000)
Payments on executive officers notes payable (533,000)
Principal payments on notes payable (546,613) (311,808)
Net proceeds from sale of common stock and preferred shares 1,967,586 1,974,000
------------- ------------
Net cash provided by financing activities 137,973 1,662,192
------------- ------------
NET INCREASE (DECREASE) IN CASH 1,174,825 (77,987)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 3,151,572 2,576,323
------------- ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 4,326,397 $ 2,498,336
============= ============
</TABLE>
See notes to unaudited condensed consolidated financial statements.
3
<PAGE> 6
OSAGE SYSTEMS GROUP, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
1. Basis of Presentation.
In the opinion of the Company, the accompanying unaudited condensed
consolidated financial statements contain all adjustments (consisting
of normal recurring accruals) necessary to present fairly the financial
position of the Company and the results of its operations and its cash
flows for the periods reported. The results of operations for interim
periods are not necessarily indicative of the results to be expected
for the entire year. 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 as of the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
The consolidated financial statements include the accounts of Osage
Systems Group, Inc. ("Osage") and its wholly-owned subsidiaries, Osage
Computer Group, Inc. ("Osage Computer"), Solsource Computers, Inc.
("Solsource"), H.V. Jones, Inc. ("HV Jones"), Open System Technologies,
Inc. ("OST"), Open Business Systems, Inc. ("OBS"), Osage Systems Group
Minnesota, Inc. and Osage Support Center, Inc. (collectively, the
"Company"). All significant intercompany balances and transactions have
been eliminated in consolidation. Certain reclassifications have been
made to the prior financial statements to conform to the current
classifications.
The information presented within the accompanying unaudited condensed
consolidated financial statements should be read in conjunction with
the Company's audited Financial Statements for the fiscal years ended
December 31, 1998 and 1997 and "Management's Discussion and Analysis or
Plan of Operation" from the 1998 Annual Report on Form 10-KSB.
2. Acquisitions.
On March 17, 1998, Osage acquired Solsource pursuant to the terms of an
Agreement and Plan of Merger. Upon closing, through a wholly-owned
subsidiary, Osage acquired 100% of the outstanding capital stock of
Solsource for merger consideration of $1.1 million; consisting of
$200,000 in cash and $900,000 in newly issued common shares priced at
$6.00 per share.
4
<PAGE> 7
On March 17, 1998, Osage also completed the acquisition of HV Jones
pursuant to the terms of an Agreement and Plan of Merger dated February
27, 1998. Upon closing, through a wholly-owned subsidiary, Osage
acquired 100% of the outstanding capital stock of HV Jones for merger
consideration of $1,975,000; consisting of $395,000 in cash and $1.58
million (105.3 shares) in Series C Convertible Preferred Stock ("Series
C Shares") which converts into common stock during the four quarters
following the closing (commencing June 17, 1998) at a conversion rate
equal to the lower of $6.87 or a 33% premium over the average closing
price of the Company's common stock for the ten trading days prior to
each date of conversion. In addition, the merger consideration included
earn-out incentive shares to be issued if HV Jones achieves certain
performance targets, of which 144,535 shares valued at $1,000,000 were
earned as of March 31, 1999.
On April 24, 1998, Osage completed the acquisition of 100% of the
outstanding capital stock of OST for merger consideration of $5.26
million; consisting of $2.76 million in cash, $2.0 million in newly
issued common shares priced at $6.00 per share and $500,000 in a key
employee retention program.
On June 22, 1998, Osage completed the acquisition of 100% of the
outstanding capital stock of OBS for merger consideration of
$4,000,000; consisting of $2,000,000 in cash and $2,000,000 in newly
issued common shares priced at $5.52 per share. In addition, the merger
consideration included earn-out incentive shares to be issued if OBS
achieves certain performance targets.
On October 8, 1998, Osage acquired Electronic Commerce Network
Solutions Corporation ("E-Comm") pursuant to the terms of an Agreement
and Plan of Merger. Upon closing, through a wholly-owned subsidiary,
Osage acquired 100% of the outstanding stock of E-Comm for merger
consideration of $1,250,000; consisting of $232,500 in cash, $930,000
in newly issued common shares priced at $6.21 per share and $87,500 in
a key employee retention program. In addition, the merger consideration
included earn-out incentive shares to be issued if E-Comm achieves
certain performance targets.
On October 15, 1998, Osage completed the acquisition of the systems
integration business of IntraNet Solutions, Inc. ("IntraNet") for
merger consideration of $1,600,000; consisting of $715,000 in cash,
$785,000 in the form of a promissory note and $100,000 in a key
employee retention program. As of March 31, 1999, the $785,000
promissory note has been paid. In addition, the merger consideration
included earn-out incentive shares to be issued based upon
predetermined financial criteria.
The Solsource, HV Jones, OST, OBS, E-Comm and the systems integration
business of IntraNet acquisitions were accounted for using the purchase
method of accounting for business combinations. The excess of assets
acquired over liabilities assumed has been allocated to goodwill and is
being amortized over 20 years. Results of operations of Solsource, HV
Jones, OST, OBS, E-Comm and the systems integration business of
5
<PAGE> 8
IntraNet have been included in the Company's statement of operations
from their respective acquisition dates.
3. Pro Forma Information.
The following pro forma summary presents the consolidated results of
operations of the Company as if the acquisitions completed during 1998
had occurred as of January 1, 1998, and do not purport to represent the
results of operations that would have actually resulted had the
purchases occurred on the indicated dates, nor should it be taken as
indicative of future results of operations. The pro forma summary data
for the three months ended March 31, 1999 and 1998 combines historical
financial information of Osage, Osage Computer, Solsource, HV Jones,
OST, OBS, E-Comm and the systems integration business of IntraNet for
the three months ended March 31, 1999 and 1998.
PRO FORMA INFORMATION FOR THE THREE MONTHS ENDED
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1999 1998
(AS REPORTED)
<S> <C> <C>
Net Sales $27,092,073 $15,558,519
Net loss $ (326,401) $ (355,514)
Net (loss) per share:
basic and diluted $ (0.03) $ (0.04)
</TABLE>
4. Earnings Per Share.
The Company has adopted Statement of Financial Accounting Standards
("SFAS") No. 128, Earnings per Share.
Net income (loss) per common share is computed by dividing net income
(loss) by the weighted average number of common shares outstanding
during the year after giving effect to stock options and the conversion
of preferred shares considered to be dilutive. Because the Company
incurred a loss for the three months ended March 31, 1999 and 1998, the
effects of the potential dilutive securities are not included in the
calculations.
6
<PAGE> 9
5. New Accounting Pronouncements.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, effective for transactions entered into in fiscal quarters
of fiscal years that begin after June 15, 1999. This statement
establishes standards for the accounting and reporting for derivative
instruments and for hedging activities. The future effect on the
Company's financial position and the results of operations has not been
determined.
6. Income Taxes.
The Company accounts for income taxes using the asset and liability
approach, which can result in recording tax provisions or benefits in
periods different than the periods in which such taxes are paid or
benefits realized. Deferred income taxes are recorded for the
difference between the book and tax basis of various assets and
liabilities which can provide for current recognition of expected tax
benefits from temporary differences that will result in deductible
amounts in future years.
The deferred income tax asset at March 31, 1999 is comprised of the
following:
<TABLE>
<S> <C>
Use of cash basis of accounting for income tax purposes $ 51,000
Allowance for doubtful accounts 51,000
Compensation 350,000
Other 56,000
-----------
Net current assets $ 508,000
===========
Net operating loss carryforwards $ 1,866,000
Goodwill (41,000)
Property (10,000)
Valuation allowance on net loss carryforwards (363,000)
-----------
Net noncurrent assets $ 1,452,000
===========
</TABLE>
7
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
CAUTIONARY STATEMENT FOR PURPOSES OF
THE "SAFE HARBOR" PROVISIONS OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
When used in this Report on Form 10-QSB, the words "may," "will," "expect,"
"anticipate," "continue," "estimate," "intend," and similar expressions are
intended to identify forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934 regarding events, conditions and financial trends which may affect the
Company's future plans of operations, business strategy, operating results and
financial position. Such statements are not guarantees of future performance and
are subject to risks and uncertainties and actual results may differ materially
from those included within the forward-looking statements as a result of various
factors. Such factors include, among others: (i) risks related to the Company's
acquisition strategy; (ii) the Company's ability to secure adequate financing to
implement its acquisition strategy; (iii) uncertainty as to whether the Company
can achieve integration of target companies in a manner intended to take
advantage of overall corporate synergies and result in an accretion to
consolidated earnings; (iv) the uncertainty of future trading prices for the
Company's Common Stock and the impact such trading prices may have upon the
Company's ability to utilize its Common Stock to facilitate its acquisition
strategy; (v) the uncertain effect of the additional dilution associated with
the future issuance of outstanding convertible securities, as well as the
dilution associated with the Company's acquisition strategy; (vi) the Company's
dependence on certain large customers and suppliers; (vii) the Company's
dependence on certain key personnel; (viii) the competitive market for technical
personnel; and (ix) the Company's ability to adapt to certain Year 2000 issues.
Additional factors are described in the Company's other public reports and
filings with the Securities and Exchange Commission. Readers are cautioned not
to place undue reliance on these forward-looking statements, which speak only as
of the date made. The Company undertakes no obligation to publicly release the
result of any revision of these forward-looking statements to reflect events or
circumstances after the date they are made or to reflect the occurrence of
unanticipated events.
OVERVIEW
Osage Systems Group, Inc. (the "Company") is a multi-regional provider of
network computing solutions through its twelve (12) offices located in nine (9)
states. The Company provides these solutions by deploying a life-cycle
methodology which addresses all phases of a customer's information technology
needs. This includes business needs analysis, systems architecture design,
systems implementation and ongoing systems management support. Solutions are
developed and delivered by the Company's technical consultants, who are skilled
in specialized practice areas such as enterprise infrastructure, enterprise
resource planning, electronic commerce, java application development, web
solutions, electronic publishing and network support services. The Company's
solutions integrate products that feature state of the art
8
<PAGE> 11
technology from industry-leading vendors of information technology products,
such as Sun Microsystems, Inc., Cisco Systems, Inc., Oracle Corporation,
Netscape Communications Corporation, Hewlett Packard Company, Microsoft, Fore
Systems, Inc., Lawson Software, Check Point Software Technologies, Ltd., Inktomi
Corporation and Veritas Software Corporation.
The Company's objective is to be recognized as one of the leading solution
providers of networking and internet computing needs. It intends to fulfill this
objective by, among other things, continuing its growth strategy and shifting
the focus of its product and service offerings to the development of specialized
practice areas.
The Company was originally incorporated as "Pacific Rim Entertainment, Inc."
under the laws of Delaware in 1992. From 1992 through 1996, the Company had been
engaged principally in the animated film production business. After several
years of losses following its initial public offering in 1993, the Company
suspended its business operations in 1996 and remained inactive while it sought
to identify a strategic business combination with a private operating company.
The Company acquired, and thereafter, assumed the historic business of Osage
Computer in a merger transaction (the "Merger") that became effective on
December 22, 1997. Osage Computer had been a provider of network computing
solutions since 1989.
9
<PAGE> 12
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 31, 1998
The following table sets forth for the periods indicated certain
financial data as a percentage of net sales:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------------------------------
MARCH 31, 1999 MARCH 31, 1998
----------------------------- -----------------------------
% OF % OF
AMOUNT NET SALES AMOUNT NET SALES
------------ --------- ------------ ---------
<S> <C> <C> <C> <C>
NET SALES $ 27,092,073 100.0% $ 5,641,932 100.0%
COST OF SALES 21,412,430 79.0% 4,580,010 81.2%
------------ ----- ------------ -----
Gross profit 5,679,643 21.0% 1,061,922 18.8%
------------ ----- ------------ -----
OPERATING EXPENSES:
Selling, general and administrative expenses 5,487,412 20.3% 1,193,723 21.2%
Depreciation and amortization 355,097 1.3% 29,265 0.5%
------------ ----- ------------ -----
Total operating expenses 5,842,509 21.6% 1,222,988 21.7%
------------ ----- ------------ -----
LOSS FROM OPERATIONS (162,866) -0.6% (161,066) -2.9%
INTEREST - NET (163,535) -0.6% 35,550 0.6%
------------ ----- ------------ -----
LOSS BEFORE BENEFIT FOR INCOME TAXES (326,401) -1.2% (125,516) -2.2%
BENEFIT FOR INCOME TAXES (60,000) -0.2% (39,000) -0.7%
------------ ----- ------------ -----
NET LOSS $ (266,401) -1.0% $ (86,516) -1.5%
============ ===== ============ =====
NET LOSS PER SHARE:
Basic and Diluted $ (0.03) $ (0.02)
============ ============
</TABLE>
Revenues. Net sales increased by 380%, or $21.5 million, to $27.1
million for the three months ended March 31, 1999 as compared to $5.6 million
for the same prior year period. This increase in net sales was principally
attributable to increased product, service and consulting revenues delivered to
new customers, leveraging existing customer alliances by undertaking additional
projects for existing customers, as well as cross-selling the Company's skill
set across the United States. This was due, in large part, to the Company's
aggressive acquisition and growth strategy implemented during 1998 coupled with
the strong demand for information technology products and services in the
marketplace. During 1998, the Company completed the acquisitions of Solsource,
HV Jones, OST, OBS, E-Comm and the systems integration business of IntraNet and
opened branch offices in San Antonio, Texas, Washington D.C. and New York,
10
<PAGE> 13
New York. During the first quarter of 1999, the Company opened a branch office
in Tucson, Arizona.
Consulting revenues increased 1,175% to $3.5 million for the three
months ended March 31, 1999, as compared to $272,100 for the prior year period.
This increase was primarily attributable to demand for the Company's consulting
services and technical support resulting from the Company's increased focus on
the service component of its revenue base and through its aggressive growth
strategy. In addition, the Company is in the process of productizing many of its
solutions which should have a favorable impact on its consulting revenues.
The Company's net sales are expected to increase during 1999 as the
Company further implements its acquisition and growth strategy.
The Company's acquisition strategy relies primarily upon identifying
target companies that fit within the Company's acquisition criteria and securing
financing sufficient to complete planned acquisitions. Although the Company
believes sufficient financing will become available to complete proposed
acquisitions, there can be no assurances to this effect. Presently, the
Company's available financing is being utilized primarily in operations.
Financing sufficient to maintain an aggressive acquisition program will likely
not be available until new or increased sources of financing are made available.
Furthermore, there can be no assurances as to the long-term impact of the
Company's acquisition strategy on the gross profits or net income of the
Company.
Gross Profit. The Company's cost of sales consists primarily of the
cost to the Company of products acquired for resale. The Company's gross profit
increased by 435% or $4.6 million to $5.7 million for the three months ended
March 31, 1999 as compared to $1.1 million for the prior year period. Gross
profit margin increased to approximately 21.0% during the three months ended
March 31, 1999, as compared to approximately 18.8% experienced during the prior
year period. During early 1998, the Company experienced an overall decrease in
its gross profit margin. This decrease was primarily due to cost reductions
passed on to the Company's customers from its major vendors as a result of an
increase in demand for the Company's products, which occurred as certain
customers increased their volume of purchases. During the latter half of 1998
and continuing into 1999, the Company experienced increased gross profit margins
as a result of increased margins from certain acquisitions made during 1998, the
delivery of productized services which generally generate higher margins and the
ability of the Company to deliver complete information technology solutions to a
wider range of customers. Management believes that in the long term it will be
able to sustain its profit margin as a result of its focus on providing a broad
spectrum of products, services and support packages, and through a greater
emphasis on professional consulting and support services which typically have a
higher profit margin.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses consist primarily of salaries, sales person
compensation, employee benefits, travel, promotion and related marketing costs.
Selling, general and administrative expenses increased by 360%, or $4.3 million,
to $5.5 million for the three months ended March 31, 1999 as
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<PAGE> 14
compared to $1.2 million for the prior year. This increase in expenses is
primarily attributable to the expansion of the Company's infrastructure as it
became publicly-held by virtue of the Merger transaction during the fourth
quarter of 1997, including increased administrative personnel and increased
travel and promotion expenses associated with the growth of the business. In
addition, competition for personnel with information technology skills is
intense and the Company expects compensation to continue to increase. During
1998, the Company encountered significant recruiting costs to support the
Company's continued growth and geographic expansion and expects such costs to
continue into 1999. Corresponding increases in legal and accounting fees were
also incurred by the Company in connection with its financing and acquisition
activities. This increase is likely to be offset in the near-term as the
Company's revenues increase and the Company continues its acquisition and growth
strategy. In addition, the Company instituted a cost containment program in
December 1998 whereby synergies of a larger organization were initiated through
the removal of duplication of efforts, consolidation of systems and
administrative functions and the adoption of business processes. As a percent of
net sales, selling, general and administrative expenses during the three months
ended March 31, 1999 decreased from 21.2% experienced during the same prior year
period to 20.3%.
Depreciation and Amortization. Depreciation and amortization
of $355,100 for the three months ended March 31, 1999 reflected an increase of
1,113%, or $325,800, as compared to the same prior year period. This increase
was primarily due to the amortization of goodwill and depreciation of assets
acquired in connection with the acquisitions that occurred during 1998. At
present levels, amortization expense of approximately $850,000 is expected for
the next 20 years.
Income Taxes. The Company's effective tax rate benefit for
the three months ended March 31, 1999 was 18.4% which is primarily attributable
to the net operating loss carryforward generated during the year offset by
nondeductible goodwill.
Net Income (Loss). During the three months ended March 31,
1999, the Company incurred a net loss of $266,400 as compared to a net loss of
$86,500 for the same prior year period. The net loss for the current period,
however, includes $355,100 of non-cash charges relating to depreciation and
amortization resulting from the Company's acquisition program. Additional
factors contributing to the Company's net loss consisted of significant
increases in the Company's overhead expenses as corporate infrastructure was
established in anticipation of future growth through the Company's acquisition
program and the expansion of the Company's business through the opening of
branch offices in New York, New York and Tucson, Arizona. Management anticipates
that as greater operating efficiencies are achieved and these other
non-recurring factors are addressed, the Company's operating losses will be
reduced. Management expects that future profitability is likely to depend upon a
combination of several factors. First, the continued growth of its business
through acquisitions. Second, the management of this growth through the
integration of the businesses acquired. Third, the continued expansion of the
Company's higher margin service business.
12
<PAGE> 15
ACQUISITION STRATEGY
The Company believes there are many attractive acquisition candidates
in its industry because of the highly fragmented composition of the marketplace,
the industry participants' need for capital and their owners' desire for
liquidity. The Company is pursuing an aggressive acquisition program to
consolidate and enhance its position in its current market and to acquire
operations in new markets.
Initially, the Company intends to expand its business through
selective, strategic acquisitions of other companies with complementary
businesses in a revenue range of $5 million to $15 million per annum. Management
believes that companies in this range of revenues may be receptive to the
Company's acquisition program as often they are too small to be identified as
acquisition targets of larger public companies or to independently attempt their
own public offerings. In particular, the Company intends to focus its
acquisition strategy on candidates which have a strong relationship with key
technology vendors, a proven record of delivering high-quality network computing
solutions and a customer base of large and mid-sized companies.
The Company believes it can successfully implement its acquisition
strategy due to: (i) the highly fragmented composition of the market; (ii) its
strategy for creating a national company, which should enhance the acquired
company's ability to compete in its local and regional market through an
expansion of offered services and lower operating costs; (iii) the additional
capital that management anticipates will become available for internal growth;
(iv) the potential for increased profitability as a result of the Company's
centralization of certain administrative functions, greater purchasing power,
and economies of scale; (v) the Company's status as a public corporation; (vi) a
decentralized management strategy, which should, in most cases, enable the
acquired company's management to remain involved in the operation of the
Company; and (vii) the ability to utilize its experienced management in
identifying acquisition opportunities.
The Company intends, where possible, to make a platform acquisition in
a targeted market by acquiring an established, high quality local company.
Management defines a "platform acquisition" as one that creates a significant
presence for the Company in a new geographic market. The Company will likely
retain the management as well as the operating, sales and technical personnel of
a platform acquisition to maintain continuity of operations and customer
service. The Company will seek to increase an acquired company's revenues and
improve its profitability by implementing the Company's operating strategies for
internal growth.
A "tuck-in" acquisition on the other hand will more likely occur in an
existing market, will be smaller than a platform acquisition and will enable the
Company to offer additional services or expand into secondary markets within the
region already served. When justified by the size and business line of an
existing market acquisition, the Company expects to retain the management, along
with the operating, sales and technical personnel of the acquired company while
seeking to improve that company's profitability by implementing the Company's
operating
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<PAGE> 16
strategies. The Company also contemplates effecting tuck-in acquisitions of
small companies or individual systems integration operations in existing
markets. In most instances, operations acquired by tuck-in acquisition can be
integrated into the Company's existing operations in that market, resulting in
the elimination of duplicate overhead and operating costs.
Since the beginning of 1998, the Company has executed its acquisition
strategy through the acquisition of Solsource (March 17, 1998), HV Jones (March
17, 1998), OST (April 24, 1998), OBS (June 22, 1998), E-Comm (October 8, 1998)
and the systems integration business of IntraNet (October 15, 1998). These
acquisitions were accounted for under the purchase method of accounting for
business combinations. Accordingly, the Company's results of operations include
only the operations of each of these companies from the date of acquisition
through the end of the period reported.
Through its internal and acquisition growth, the Company expanded its
operations from Phoenix, Arizona to San Diego, California, Houston, Texas,
Austin, Texas, San Antonio, Texas, Ft. Lauderdale, Florida, Chicago, Illinois,
Minneapolis, Minnesota, Madison, Wisconsin, Washington, D.C., New York, New York
and Tucson, Arizona.
VARIABLE OPERATING RESULTS
The Company's historical operating results have varied from quarter to
quarter, and the Company expects that they will continue to do so. Due to the
relatively fixed nature of certain of the Company's costs, including personnel
and facilities costs, a decline in revenue in any fiscal quarter would result in
lower profitability or increase the loss in that quarter. A variety of factors,
many of which are not within the Company's control, influence the Company's
quarterly revenues, including seasonal patterns of hardware and software capital
spending by customers, information technology outsourcing trends, the timing,
size and stage of projects, new service introductions by the Company or its
competitors, levels of market acceptance for the Company's products or services
or the hiring of additional staff. Operating results also may be impacted by the
timing of revenues and changes in the Company's utilization rates. The Company
believes, therefore, that past operating results and period-to-period
comparisons should not be relied upon as an indication of future performance.
The Company anticipates that its business will continue to be subject to such
seasonal variations.
BACKLOG
The Company normally ships systems promptly after receiving an order
and therefore does not customarily have a significant backlog.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has funded its operations primarily from cash
generated by operations and, to a lesser extent, with funds from borrowings
under the Company's credit facility. For the three months ended March 31, 1999,
cash flow from operations was $1.3 million as compared to cash used in operating
activities of ($932,000) during the same prior year period. The Company's cash
flow from operations has been positively affected by the extended terms
14
<PAGE> 17
granted by the Company's major distributor offset by increases in accounts
receivable and other assets.
The Company's working capital deficit was $1.3 million at March 31,
1999, as compared to a deficit of $3.3 million at December 31, 1998. The
favorable impact on the Company's working capital deficit is principally
attributable to improved operating results from the fourth quarter of 1998,
coupled with the receipt of proceeds from the sale of preferred shares during
the first quarter of 1999.
Capital expenditures, which totaled $290,100 during the three month
period ended March 31, 1999, were principally for computer hardware and software
to support the Company's expanding operations and for an internal financial
application system for the purpose of improving operating efficiencies and
integrating the companies acquired during 1998.
Cash flow from financing activities during the three-month period ended
March 31, 1999 was favorably impacted by the $2.0 million of net proceeds
received from the sale of preferred shares offset by $1.8 million of debt
repayments.
The Company has a $13 million credit facility with Finova Capital
Corporation that consists of both a revolving line of credit and an inventory
line. Borrowings under the revolving line of credit cannot exceed $10.5 million
at any one time and bear interest at prime (7.75% at March 31, 1999) plus three
percent. Amounts outstanding under the inventory line which are paid within
sixty days of invoice date do not bear interest. Interest is payable monthly on
amounts outstanding over sixty days under the inventory line at prime (7.75% at
March 31, 1999) plus six percent. There were no outstanding borrowings under the
revolving line of credit at March 31, 1999. Amounts outstanding under the
inventory line were $11,188,424 at March 31, 1999.
As its operations continue to expand, additional financing will be
required to support the continued growth of the Company. The inability to secure
such financing may have an adverse effect on the operations of the Company.
Principally all of the Company's currently available cash from operations and
financing is being utilized to help support the Company's operations. The
Company will need to secure additional financing in the near term in order to
continue the acquisition and growth strategy implemented during 1998. Since its
future profitability is likely dependent upon the continuation of the Company's
acquisition and growth strategy, failure to secure new or increased sources of
financing would not only delay the Company's growth program, but could also have
an adverse effect on the Company's ability to achieve profitable operations.
YEAR 2000 READINESS
The Company has developed a Year 2000 readiness plan to help it identify and
resolve Year 2000 issues associated with the Company's internal systems and the
products and services provided by the Company. The plan includes development of
corporate awareness, assessment,
15
<PAGE> 18
implementation (including remediation and upgrading of certain systems),
validation testing and contingency planning.
The Company has completed the assessment phase of its plan, reviewing internal
non-IT systems (such as building security, voice mail, telephone and other
systems containing embedded microprocessors). As it relates to these systems,
the Company is currently in the process of installing upgrades and patches
recommended by the third party vendors to make such systems and equipment Year
2000 ready.
The Company's material internal IT systems consist principally of financial,
accounting, project management and human resources application software created
by third parties. The Company has also completed the assessment phase of its
plan with respect to these systems. The Company believes that, based on oral
statements made by manufacturers and/or statements published on manufacturers'
web sites, that most of these systems are Year 2000 ready. With respect to the
systems that are not currently Year 2000 ready, at the manufacturers'
recommendations, the Company is installing patches and upgrades. For example,
the Company recently installed patches in its versions of the Windows 95 and
Windows NT operating systems in order for those operating systems to become Year
2000 ready. The manufacturers of the Company's computer hardware platforms,
principally servers, have indicated that the versions currently used by the
Company are Year 2000 ready.
The Company believes that a majority of the costs associated with becoming Year
2000 compliant are not incremental to the Company, but rather represent a
reallocation of existing resources and regularly scheduled system upgrades and
maintenance. In addition, regardless of the Year 2000 problem, the Company is
currently undergoing an internal financial application system upgrade and
implementation for the purpose of improving operating efficiencies and
integrating companies acquired during 1998. The Company estimates that the costs
of its Year 2000 efforts will be approximately $1.5 million. This estimate does
not include potential expenditures related to customers or other claims. The
Company currently anticipates the aforementioned evaluation and remediation of
its systems to be completed by mid 1999. The Company anticipates that it will
complete the stage of its Year 2000 program involving installation of patches
and upgrades to its third party software and hardware by mid 1999. However, if
compliance efforts are not completed on time, or additional compliance efforts
are required of which the Company is not currently aware, or the cost of any
required updating or modification of our IT systems exceeds the Company's
estimates, the Year 2000 issue could have a material adverse effect on the
Company's business, results of operations and financial condition.
The Company has not yet developed a comprehensive contingency plan to address
the situations that may result if it is unable to achieve Year 2000 readiness of
the Company's major IT and non-IT systems. The Company intends to devise
contingency plans by mid 1999 designed to mitigate the effects on the conduct of
the Company's business in the event the Year 2000 issue results in the
unavailability of any material IT or non-IT systems. There can be no assurance
that any contingency plans developed by the Company will prevent any such
service interruption or a material adverse effect on the Company.
16
<PAGE> 19
In addition to the Company's internal systems, the Company relies on third party
relationships in the conduct of its business. For example, the Company relies on
the services of the landlords of its facilities, telecommunication companies,
banks, utilities, and commercial airlines. The Company is currently attempting
to receive assurances from its landlords and material vendors regarding their
Year 2000 readiness, and to the extent such assurances are not given, the
Company intends to devise contingency plans designed to ameliorate the negative
effects on the Company in the event the Year 2000 issue results in the
unavailability of these services or systems. There can be no assurance that any
contingency plans developed by the Company will prevent any such service
interruption on the part of one or more of the Company's third party vendors or
suppliers from having a material adverse effect on the Company's business,
results of operations or financial condition. In addition, the failure on the
part of the accounting systems of the Company's clients due to the Year 2000
issue could result in a delay in the payment of invoices issued by the Company
for services and expenses. A failure of the accounting systems of a significant
number of the Company's clients would have a material adverse effect on the
Company's business, results of operations and financial condition.
The Company's business involves designing, developing and implementing mission
critical software applications for its clients. In addition, the Company has
recommended, implemented and customized various third-party hardware and
software packages for its clients, certain of which may not be Year 2000 ready.
Former, present and future clients may assert that certain services performed or
products sold or recommended by the Company are not Year 2000 ready. Because the
Company has designed, developed and implemented hardware, software and systems
for a large number of clients since 1991, there can be no way of assuring that
all such software programs and systems will be Year 2000 ready. This uncertainty
is magnified by the fact that in many cases the Company's clients retain the
right to maintain, alter and modify the systems developed and implemented by the
Company after the completion of an engagement. Due to the potential significant
impact of the Year 2000 issue on the operations of the Company's clients, the
Company may be faced with claims regardless of whether the failure relates to
services provided by the Company. If asserted, such claims (and the associated
defense costs) could have a material adverse effect on the Company's business,
results of operations and financial condition.
The Company's policy has been to attempt to include provisions in its client
contracts that, among other things, disclaim implied warranties, limit the
duration of express warranties, limit the Company's total dollar liability to an
amount specified in the contract, disclaim consequential or other such damages
and disclaim any liability arising from third-party software that is
implemented, customized or installed by the Company. There can be no assurance
that the Company will be able to obtain these contractual protections in
agreements concerning future projects, or that any contractual provisions
governing current and completed projects will prevent clients from asserting
claims against the Company with respect to the Year 2000 issue. There also can
be no assurance that the contractual protections, if any, obtained by the
Company will effectively operate to protect the Company from, or limit the
amount of, any liability arising from claims asserted against the Company.
17
<PAGE> 20
The foregoing discussion of the Company's Year 2000 readiness contains forward
looking statements, including estimates of the timeframes and costs for
addressing the known Year 2000 issues confronting the Company, and is based on
management's current estimates, which were derived using numerous assumptions.
There can be no assurance that these estimates will prove accurate and actual
events and results could differ materially from those anticipated. Specific
factors that might cause such material differences include, but are not limited
to, the ability of the Company to identify and correct all Year 2000 problems
and the success of third parties with whom the Company does business in
addressing their Year 2000 issues.
IMPACT OF INFLATION
The effects of inflation on the Company's operations were not significant during
the periods presented.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, effective for transactions entered into in
fiscal quarters of fiscal years that begin after June 15, 1999. This statement
establishes standards for the accounting and reporting for derivative
instruments and for hedging activities. The future effect on the Company's
financial position and the results of operations has not been determined.
18
<PAGE> 21
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
RECENT SALES OF UNREGISTERED SECURITIES.
1. On February 9, 1999, the Company sold 2,000 shares of Series E
Convertible Preferred Stock (the "Series E Shares") at a purchase price of
$1,000 per share for aggregate sales consideration of $2,000,000. The Series E
Shares are convertible into common stock at a conversion price of $6.5625 per
share, subject to adjustment. As part of the transaction, the Company issued
warrants to purchase 100,000 shares of common stock at an exercise price of
$7.875. The warrants expire on February 9, 2002. The Series E Shares and
warrants were sold to Halifax Fund, L.P., an institutional investor, in a
private placement transaction exempt from registration pursuant to Section 4(2)
and Rule 506 of Regulation D of the Securities Act of 1933, as amended (the
"Act").
2. On February 12, 1999, the Company issued 20,000 shares of Common
Stock at a purchase price of $4.75 per share to IP Services Corp., an accredited
investor, in a private placement transaction exempt from registration pursuant
to Section 4(2) of the Act and Rule 506 of Regulation D as an issuer transaction
not involving a public offering. As part of the transaction, the Company also
issued IP Services Corp. three-year warrants to purchase 10,000 shares of common
stock at an exercise price of $5.25 per share. In connection with this
transaction, the Company realized gross proceeds of $95,000 and paid a brokerage
fee consisting of a cash commission of $9,500 and warrants to purchase 10,000
shares of the Company's Common Stock at an exercise price of $5.25 per share for
a term of three years.
ITEM 5. OTHER INFORMATION.
On April 28, 1999, the Company filed a registration statement
("Registration Statement") on Form S-3 with the Securities and Exchange
Commission ("SEC") relating to the resale to the public by certain selling
security holders of 3,706,776 shares of common stock, subject to adjustment. The
Registration Statement has not yet become effective.
On May 12, 1999, the Company filed a registration statement on Form S-8
with the SEC relating to the resale to the public 8,358,900 shares of common
stock issuable upon the exercise of options granted or to be granted under the
Company's 1993 Amended and Restated Stock Option Plan, its 1999 Employee Stock
Purchase Plan or options granted as part of compensatory arrangements not
pursuant to a plan.
19
<PAGE> 22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
EXHIBIT NUMBER
(REFERENCED TO ITEM
601 OF REG. S-B)
DESCRIPTION METHOD OF FILING
27 Financial Data Schedule Filed herewith
20
<PAGE> 23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this Form 10-QSB to be signed on its behalf by
the undersigned, thereunto duly authorized.
OSAGE SYSTEMS GROUP, INC.
By:/s/ Jack R. Leadbeater Dated: May 14, 1999
----------------------------------------
Jack R. Leadbeater
Chairman of the Board and
Chief Executive Officer
By:/s/ John Iorillo Dated: May 14, 1999
----------------------------------------
John Iorillo
Chief Financial Officer (Principal
Financial and Accounting Officer)
21
<PAGE> 24
EXHIBIT INDEX
EXHIBIT NUMBER
(REFERENCED TO ITEM
601 OF REG. S-B)
DESCRIPTION
27 Financial Data Schedule
22
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 4,326,397
<SECURITIES> 0
<RECEIVABLES> 19,852,426
<ALLOWANCES> 136,000
<INVENTORY> 325,382
<CURRENT-ASSETS> 25,758,093
<PP&E> 2,702,910
<DEPRECIATION> 1,044,429
<TOTAL-ASSETS> 45,272,349
<CURRENT-LIABILITIES> 27,032,407
<BONDS> 0
2,474,760
1,000
<COMMON> 94,856
<OTHER-SE> 15,027,816
<TOTAL-LIABILITY-AND-EQUITY> 45,272,349
<SALES> 27,092,073
<TOTAL-REVENUES> 27,092,073
<CGS> 21,412,430
<TOTAL-COSTS> 21,412,430
<OTHER-EXPENSES> 5,842,509
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (163,535)
<INCOME-PRETAX> (266,401)
<INCOME-TAX> (60,000)
<INCOME-CONTINUING> (266,401)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (266,401)
<EPS-PRIMARY> (0.03)
<EPS-DILUTED> (0.03)
</TABLE>
