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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1997
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
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on
which registered
None. Not applicable.
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, par value $0.01 per share
(Title of class)
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of voting and non-voting common equity held by
non-affiliates of the registrant as of March 9, 1998, was approximately
$83,000,274 based on the sale price of the Common Stock on March 9, 1998, of
$9.875 as reported by the NASDAQ National Market System.
As of March 9, 1998, the registrant had outstanding 16,291,091 shares of
its Common Stock, par value $0.01 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Stockholders to
be held on May 21, 1998 are incorporated by reference in Part III, Items 10, 11,
12 and 13.
OAO TECHNOLOGY SOLUTIONS, INC.
INDEX TO FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1997
Item Page
No. No.
- ---- ----
Part I
1 Business ............................................................... 3
2 Properties ............................................................. 11
3 Legal Proceedings ...................................................... 11
4 Submission of Matters to a Vote of Security Holders .................... 12
Part II
5 Market for Registrant's Common Equity and Related Stockholder Matters .. 12
6 Selected Consolidated Financial Data ................................... 13
7 Management's Discussion and Analysis of Financial Condition
and Results of Operations .............................................. 14
8 Financial Statements and Supplementary Data ............................ 20
9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure ............................................. 38
Part III
10 Directors and Executive Officers of the Registrant ..................... 38
11 Executive Compensation ................................................. 38
12 Security Ownership of Certain Beneficial Owners and Management ......... 38
13 Certain Relationships and Related Transactions ......................... 38
Part IV
14 Exhibits, Financial Statement Schedules and Reports on Form 8-K ........ 39
2
PART I
Item I. BUSINESS.
Overview
The Company provides a wide range of outsourced information technology
("IT") solutions and professional services, including the operation of
large-scale megacenter complexes and networks (high volume system of computers
and information networks), distributed systems management ("DSM"), applications
software development and maintenance, staffing services and other IT services.
The Company provides these solutions and services, generally on a long-term,
fixed-price contractual basis, to its Strategic Clients ("Strategic Clients")
which are global providers of IT outsourcing services. The Company works with
these Strategic Clients as part of the IT outsourcing team in providing services
to a wide range of corporate clients ("Engagement Clients"), accepting delivery
responsibility for specific functional roles within the outsourcing engagements.
The Company's primary Strategic Clients have been IBM's Global Services ("IBM")
and Digital Equipment Corporation ("Digital"), which accounted for 66.2% and
24.1% of the Company's 1997 revenues, respectively. The Company is also working
towards establishing a Strategic Client relationship with Perot Systems.
Representative Engagement Clients currently include Ameritech, Campbell Soup,
McDonnell Douglas and Ryder Systems Corp. The Company's revenues have expanded
at a compound annual growth rate of 62.5% to $84.7 million in 1997 from $12.1
million in 1993. Revenues for the year ended December 31, 1997 increased by
46.3% to $84.7 million compared to $57.9 million for the year ended December 31,
1996. For the years ended December 31, 1997, 1996 and 1995, approximately 60.8%,
73.8%, and 92.0% of the Company's revenues, respectively, were derived from
fixed-price contracts. As of December 31, 1997, the Company had over 1,600
employees in 18 Company offices and 96 engagement locations in the United
States, Canada, Mexico, Brazil and the United Kingdom.
The Company believes that it is differentiated from other IT service
providers through its focus on relationships with a limited number of carefully
selected Strategic Clients, its ability to perform successfully and profitably
under multi-year, fixed-price contracts and its ability to provide services on a
national and international basis. The Company's strategy is to build long-term
relationships with Strategic Clients by understanding their business needs and
by providing specific services within large-scale outsourcing engagements more
cost-effectively than other alternatives. The Company's services range from
megacenter management operations to help desk services, business process
reengineering and software engineering support. The Company delivers its
services through customer teams, each of which has full responsibility for the
delivery of services to a specific Strategic Client. The Company's close
relationships with its Strategic Clients, its ability to rapidly transition and
integrate its management personnel into new engagements, and its ability to
effectively manage personnel in the client environment, allow the Company to
profitably price its services under fixed-price contracts. By offering
fixed-price contracts, the Company reduces the execution and pricing risk for
its Strategic Clients in their large-scale outsourcing engagements. The Company
has developed and is continuing to expand its international service delivery
capabilities in order to leverage its Strategic Clients' increasingly global IT
outsourcing efforts.
Large-scale outsourcing engagements typically involve the acquisition of IT
assets by the outsourcing provider from the Engagement Client. These assets can
range from fixed assets, such as entire data centers and computer networks, to
personnel, such as data center, help desk and programming staff. The Company's
role in outsourcing engagements usually involves the retention of IT personnel
from the Engagement Client. By retaining employees as part of its new
outsourcing engagements, to date, the Company's growth has not been impeded by
the availability of qualified technical personnel. In each new outsourcing
engagement, the Company utilizes its expertise in IT staffing and operations to
evaluate and retain outsourced staff and to reengineer the operations of the
outsourced function. Through this process, the Company historically has been
able to improve the performance of, and manage on a more cost-effective basis,
the outsourced function for its clients.
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The Company began operations in January 1993, as a separate business
division of OAO Corporation ("OAO"), and was incorporated in the State of
Delaware in March 1996. In April 1996, the Company was spun-off from OAO.
Industry
The use of outsourcing has grown rapidly as corporations have increasingly
determined that it is advantageous to focus on their core competencies and
outsource those functions that are not central to their primary mission.
According to the Yankee Group, an industry research firm, the IT outsourcing
market in 1995 was approximately $59 billion in the United States and
approximately $107 billion worldwide. In 1995, the Yankee Group estimates that
IBM was the leading provider of management/operations and business process
management services in the United States with a 28.9% market share and was one
of the top two providers of such services worldwide with a 19.7% market share.
The Company believes that a number of factors have resulted in a
significant shift in the awareness and acceptance by organizations of the
benefits of IT outsourcing. Historically, most IT outsourcing arrangements were
premised on the primary goal of cost reduction and were often limited to
discrete functions such as the management of data centers. Over the past several
years, however, a number of fundamental developments have occurred which have
caused organizations to reconsider the benefits of outsourcing their IT
functions. These developments include global competition, businesses' focus on
"core competencies," accelerating technological change and the need for
enterprise-wide system integration arising from the rapid growth in the number
of software applications and end-users throughout organizations. The principal
technology-driven change is the continuing movement by large corporations to
open, distributed computer networks using client/server architecture. The move
to open standards based computing environments continues to accelerate today as
a result of improvements in price/performance ratios for computer systems and
advances in open computing standards and enabling technologies. These
technological changes are making it increasingly difficult and expensive for
businesses to maintain in-house the necessary technical and management
capabilities to handle both their current IT needs and to effectively exploit
rapidly evolving technologies.
One of the key trends occurring in the IT outsourcing industry is an
increasing use of business partnerships and alliances among outsourcing vendors
to deliver a broader range of technical skills more cost-effectively to the
Engagement Client. Factors driving this trend include the complexity and
convergence of technology required in outsourcing engagements, lack of available
technical resources, shortened delivery times, and investment costs of
internally building technical capabilities. As a result, outsourcing providers
recognize that it is not practical to internally develop and manage all of the
technical skills and critical resources necessary to perform increasingly
complex outsourcing engagements.
Outsourcing engagements are typically characterized as being long-term in
nature and often involve the transfer by the client of certain of its
facilities, technologies and employees to the outsourcer. The outsourcer's
responsibilities under IT engagements may vary widely from engagement to
engagement, ranging from the provision of certain specific IT functions to the
management of a client's entire IT operation. Within these engagements, the
relationships often involve the provision of employees or consultants by a
subcontracting vendor to the outsourcing vendor. The subcontractor is normally
paid on a time and materials basis and the outsourcing vendor retains the
managerial responsibility for the IT services provided by such persons.
The OAOTS Advantage
The Company's approach is to be a value-added partner of choice to a
limited number of selected Strategic Clients in the provision of outsourced IT
solutions and professional services. This client focus establishes a "customer
intimate" relationship in which the Company's Strategic Clients are willing to
assign performance management responsibility to the Company for its role in the
outsourcing engagements, usually on a fixed-price basis. The Company's close
relationships with its Strategic Clients, its ability to rapidly transition and
integrate its
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management personnel into new engagements, and its ability to effectively manage
personnel in the client environment, has allowed the Company to profitably price
its services under fixed-price contracts. By generally operating under
fixed-price contracts, the Company reduces the execution and pricing risk for
its Strategic Clients in their large-scale outsourcing engagements. The Company
believes that this advantage significantly increases its ability to compete in
the provision of IT solutions and professional services.
Limited Number of Strategic Clients. The Company intends to continue
focusing on maintaining close relationships with a limited number of Strategic
Clients on a global basis. By limiting the number of these relationships, the
Company believes that it enhances its standing as a value-added partner of
choice, and limits competitive threats to its Strategic Clients. Therefore, the
Company is better positioned to obtain additional engagements which result from
the continued growth in the demand for the global IT outsourcing solutions and
services provided by the Company's Strategic Clients.
Customer-Intimate Relationships. The Company supports its Strategic Client
relationships through a dedicated customer team for each Strategic Client which
seeks to understand the business objectives of that Strategic Client and to
identify common business opportunities. The Company also supports its Strategic
Client relationships by co-locating its offices with those of its Strategic
Clients and Engagement Clients and by supporting each engagement with employees
possessing extensive background in the services required by the Strategic
Client. By delegating performance management responsibility to the Company, the
Strategic Client is afforded the opportunity to place greater focus on other
portions of the overall engagement.
Fixed-Price, Multi-year Contracts. The Company believes that it provides
added value by offering fixed-price, multi-year contracts to its Strategic
Clients. Within the industry, IT servicing vendors normally provide employees to
perform or support a specific IT function on a time and materials basis. In
contrast, the Company seeks to assume full performance management responsibility
for its specific IT functions within the total engagement. As a result, the
Company is able to offer its Strategic Clients greater cost certainty during the
course of the engagement and the Company is afforded the opportunity to realize
significant benefits by achieving efficiencies through improved management
practices and the establishment of new technical and operational methodologies.
Comprehensive IT Outsourcing Solutions and Professional Services. The
Company provides its Strategic Clients with a comprehensive offering of IT
outsourcing solutions and professional services, including: Megacenter
Operations; restructuring of server and PC networks for efficient centralized
operations and management; transition of customer IT environments to new
client/server structures; help desk implementation and operations; development
and sustaining support to applications systems; and system engineering services.
The Company has developed, and is expanding, the capability to provide such
services internationally in response to its Strategic Clients' increasingly
global needs. The Company currently maintains offices in the United States,
Canada, Mexico, Brazil and the United Kingdom.
Retention of Engagement Client Personnel. The Company intends to continue
its practice of selectively retaining the majority of the outsourced personnel.
The Company approaches its new employees on the basis that they, and the
capabilities that they represent, are the most critical assets of the Company.
With the Company, employees have the opportunity to participate in the rewards
of the Company's growth, manage their own areas of responsibility, and advance
in their profession. These practices have provided the Company with a large
number of dedicated and talented employees and have allowed the Company to
minimize recruiting and hiring expenses when entering into new engagements. As
the Company achieves efficiencies at many of its engagements it has generally
been able to reduce personnel requirements. This has enabled the Company to
leverage existing employees to expand its role in existing engagements and to
obtain and support new engagements, while providing these individuals with more
diverse career opportunities.
Seamless Transition. The Company has consistently provided its Strategic
Clients with the capability to transition select functions from its Engagement
Clients to the outsourcing engagement without interruption of those functions.
The customer team organizes its employees, augmented by Enablement Team
personnel, into "Transition Teams," assigning them the task of selectively
retaining a high percentage of the incumbent workforce, establishing
5
a contingent redundancy in the workforce, and providing augmentation of key
positions with Company personnel during the transition period.
Growth Strategy
The Company's goal is to become one of the premier providers of outsourced
IT solutions and services by pursuing the following principal strategies:
Leverage Existing Relationships. By establishing and nurturing close
relationships with a limited number of Strategic Clients, the Company intends to
continue building a reputation for performance that supports the Company's
selection by its clients as a value-added partner of choice. In support of this
strategy, the employees that deliver services to Strategic Clients are organized
in customer teams, with each customer team responsible for a particular
Strategic Client. In addition to designated customer teams, the Company also
maintains engagement managers who are responsible for each Strategic Client
relationship and who seek to identify additional business opportunities within
the Strategic Client organization. As a result of these relationships, the
Company has been granted several engagements by Strategic Clients without the
requirement that the Company participate in a competitive selection process.
Selectively Expand Base of Strategic Clients. The Company intends to
selectively expand the number of Strategic Clients with which it maintains
relationships by carefully evaluating market opportunities with IT services and
product providers who value the Company's outsourcing approach. In expanding its
base of Strategic Clients, the Company intends to refrain from pursuing
engagement or partnership opportunities with organizations competing directly
with its existing Strategic Clients.
Increase International Presence. The Company plans to continue to expand
its international presence to capitalize on global outsourcing opportunities
with its Strategic Clients. The Company currently maintains offices in Canada,
Mexico, Brazil and the United Kingdom, and anticipates opening additional
offices within the next 24 months in Continental Europe and the Asia-Pacific
Rim. The Company uses joint venture relationships with local IT services
providers in order to broaden its international service capabilities. The
Company has established a joint venture relationship with Capita Managed
Services Limited, a local IT service provider in the United Kingdom, and has
executed Letters of Understanding regarding the establishment of joint venture
relationships with firms in Mexico, Brazil and New Zealand.
Develop Industry-Specific Expertise. The Company intends to selectively
develop expertise in industries that may offer higher-margin opportunities for
the Company's IT solutions and professional services. The Company has invested
in developing expertise in the healthcare industry, and during 1997,
strengthened its offerings in this marketplace through the acquisition of
certain assets of UniHealth Investment Company, a division of UniHealth, Inc.
(see Note 3 in the Notes to the Consolidated Financial Statements). This
division produces a software product named MC400 which assists managed care
organizations in the administration of benefits structures and provider
contracts. The Company will target other vertical markets that are undergoing
regulatory, technological or competitive changes which provide opportunities for
increased outsourcing of IT functions. The Company will likely make investments
in new technical and service capabilities to enhance its vertical market
strategy.
Pursue Acquisitions and Alliances. The Company intends to continue to
pursue expansion opportunities with other IT service providers by means of
acquisitions or alliances. The Company believes that new technical skills,
additional industry expertise, a broader client base and an expanded geographic
presence may result from these activities.
OAOTS's Services
Megacenter Operations Management. The Company's Megacenter Operations
management services cover the entire spectrum of the management and operation of
large scale computing equipment and all of its ancillary
6
equipment, systems, services and associated networks. This generally includes
the performance of any task associated with the operation or management of a
traditional mainframe data center. IBM currently engages the Company to provide
management and operations services at three of its four Megacenters in the U.S.
Each Megacenter represents the networking of IBM's data centers across a
geographic region. Megacenter Operations management provided approximately
43.0%, 60.2% and 79.8% of total revenues for the years ended December 31, 1997,
1996 and 1995, respectively.
The Company provides services which support all aspects of Megacenter
management such as policy formulation, planning, process and procedure creation,
service level development, staffing and directing the work force, budgeting and
controlling, relocation and consolidation, and upgrading of equipment, services
and systems. In performing these services, the Company is normally responsible
for the attainment of service level requirements and has the flexibility of
directing the personnel as it deems appropriate.
The Company also provides services which involve all elements of the
technical operations of a Megacenter, including management and operation of
distributed networks of systems, computer room equipment scheduling and
operations, network center operation and management, tape library management,
off-site data storage, disaster planning and recovery, tape and print equipment
operations, print distribution, help desk and call center operations,
move/add/change operations for user equipment, computer and network systems
programming, computer and network systems performance measurement and tuning,
production job scheduling and control for applications systems, maintenance and
development of software applications systems, and quality assurance for
technical operations.
A typical Megacenter engagement involves supporting a Strategic Client by
selectively accepting functions within the total outsourcing engagement. The
Company's role is to assume full responsibility for managing, staffing and
delivering service level requirements for those functions. For example, in the
Company's seven-year contractual engagement to support a very large IBM
Megacenter dispersed across the Northeast region of the U.S., the Company
performs the functions of console operations, network operations, output
processing operations, data storage operations, and user services functions such
as move/add/change operations. This Megacenter utilizes a very large network of
mainframe computer configurations that support both the Strategic Client's
internal requirements as well as those of its Engagement Clients. Within this
engagement, the Company performs defined functions on a fixed-price basis and
also supports a wide range of additional functions pursuant to certain staffing
service provisions under the contract. These additional functions may be
performed by the Company on a short or long-term basis depending on the
requirements of the Strategic Client. The Company performs these functions in
the facilities of both its Strategic Clients and its Engagement Clients,
including regional, national and international locations of its Engagement
Clients.
Distributed Systems Management ("DSM"). The Company's primary focus in DSM
services is on the evolving market for outsourced support of the desktop-network
requirements of its customers' Engagement Clients. The Company has also been
engaged to support mid-range system applications and operations. The Company
believes that the trend toward outsourcing the operation and management of
desktop-network requirements presents a major opportunity for growth. The
services being delivered by the Company vary by engagement and include: network
operating system architecture and implementation; evaluation and redesign of
server architecture; communications network evaluation and restructuring for
improved connectivity and efficiency; design and implementation of E-mail
solutions; rollout of the new desktop system into the user environment;
transition services to support a smooth migration to a new centrally managed
desktop environment; help desk services; deskside training services; asset
management support and control; design and implementation of automated
centralized asset control; and operation support, including activities
associated with changes in technology, the client's organizational structure or
physical plant changes. The Company is currently involved in DSM engagements in
three major Strategic Client programs, two with IBM and one with Digital. DSM
engagements accounted for approximately 28.3%, 17.7% and 6.9% of revenues,
respectively, for the years ended December 31, 1997, 1996 and 1995.
As an example of the Company's DSM services, the Company has teamed with
IBM to provide support for a major electric utility. This engagement involves
the outsourcing of the Engagement Client's entire desktop-server-network
configuration. The objective of the engagement was initially to rationalize the
environment to enable
7
centralized management and operations permitting the Strategic Client to improve
effectiveness and control costs. The initial scope of this engagement was for
development and implementation of the network operating system into the existing
server environment. The scope of this engagement has evolved to include
designing a new server structure, support to reengineering the communications
environment, implementation of a new standard desktop configuration, and user
support services to include deskside support. This Engagement Client's
environment includes over 6,000 workstations and approximately 100 servers.
Other IT Outsourcing and Staffing Services. The Company's relationships
with its Strategic Clients, and its posture as a value-added partner of choice
working within client engagements and facilities, provide opportunities to be
highly responsive to evolving client needs. As a result, the Company is
well-positioned to gain insight into market trends and make investments required
to pursue opportunities that result from these trends. As a result, the Company
may more selectively broaden its service offerings.
System engineering services are a natural adjunct to the Company's other
services and represent a large and growing need of its Strategic Clients. The
Company has completed a number of short to medium term engagements in this area,
including an engagement in support of a systems integration project with Perot
Systems. Within this complex project, involving the development and
implementation of a system to support the operation of the deregulated electric
utility market, the Company provided support for the system test function and
provided the networking expertise across the project. The Company believes that
there is a growing market for outsourced IT services in support of utility
deregulation.
Staffing services are a part of the Company's service offerings to its
Strategic Clients. These services, provided on a time and materials basis, are
regularly utilized within engagements to meet short or indefinite term
requirements, to deliver personnel who augment the client's staffing or to
respond to requirements that cannot be sufficiently defined to permit fixed
prices. There are also instances where an engagement has started on a time and
materials basis and evolved to a fixed-price basis as the requirements became
sufficiently defined.
Industry specific services represent a small, but growing and important
component of the Company's business. The Company has found that it can provide
significant added value to industry-specific markets by melding its proven
capabilities in IT with in-depth expertise in the targeted market. The Company
initially targeted the healthcare industry based upon the dynamics of the
industry. An evaluation of the information aspects of the industry clearly
indicated the value of shared information across the dispersed providers of
healthcare and related businesses such as employers and insurers. For example,
through the Company's acquisition in 1997 (See Note 3 in the Notes to
Consolidated Financial Statements), it is able to offer the MC400 managed care
software system, which is comprised of over 30 modules that provide a managed
care organization with all of the required processes and methodologies needed to
manage benefit structures and provider contracts. This product has further
strengthened the Company's offerings in the healthcare industry.
Relationships with Strategic Clients
IBM. The Company's relationship with its first Strategic Client, IBM, has
continued to expand in terms of revenues, the range of services provided, the
number of engagements and the number of IBM business units which have engaged
the Company's services. The Company won its first engagement with IBM in January
1993, successfully competing against several existing IBM contractors, when it
was chosen to perform a number of specific functions in a large outsourcing
contract which IBM had been awarded by McDonnell-Douglas. The initial three year
term of this engagement has subsequently been extended to a ten year term and
the scope of the engagement now encompasses the performance of functions in
support of IBM's Central Megacenter. In August 1993, the Company won a similar
engagement to perform a number of specific functions in support of IBM's
internal computer complex in the mid-Hudson Valley in New York. The Company
employed approximately 100 former IBM employees at the beginning of this
engagement. The initial two year term of this engagement has subsequently been
extended to a seven year term and the scope of the engagement now encompasses
the performance by more than 500 employees of various functions in support of
IBM's Northeast Megacenter. In early 1995, the Company won a three year
engagement to perform specific IT functions in support of IBM's South
8
Megacenter. As a result of these engagements, IBM currently engages the
Company's services at three of its four U.S. Megacenters.
IBM has also engaged the Company to perform IT services in support of other
large outsourcing contracts which it has been awarded, including engagements
with Ameritech, Amtrak, Blue Cross /Blue Shield of New Jersey and PECO Energy.
The Company was chosen to support Ameritech and PECO Energy engagements without
having to submit competitive bids. In addition, IBM has selected the Company,
without competitive bid, as a partner in two very large outsourcing engagements
for which IBM is currently in the bidding process. Revenues from IBM were 66.2%,
82.2% and 88.7%, respectively, of the Company's total revenues for the years
ended December 31, 1997, 1996 and 1995.
Digital. Digital became a Strategic Client in January 1995, when the
Company was awarded a contract to provide services in support of an Engagement
Client in Vancouver, British Columbia. Later in 1995, the Company was awarded
additional engagements with Digital in Central and Eastern Canada. During 1996,
the Company became a delivery partner of Digital across all of Digital's
Canadian outsourcing engagements and played an important role in assisting
Digital to obtain a long-term extension of a large outsourcing contract in
Canada. In 1996, Digital was awarded an engagement to provide services in
support of one of the industry's largest desktop outsourcing engagements. This
particular Engagement Client is one of the world's largest financial
institutions and presents global opportunities for Digital and the Company. As a
result of these engagements, the Company's relationship with Digital has begun
to expand into other geographic areas, including the U.S. and the United
Kingdom. Revenues from Digital accounted for 24.1%, 11.4% and 5.4% of the
Company's total revenue for the years ended December 31, 1997, 1996 and 1995,
respectively.
Other Evolving Relationships. The foundation of the Company's business
strategy is to identify and build lasting relationships with certain major
participants in the IT outsourcing market. In 1995, the Company identified Perot
Systems as a high growth provider of IT outsourcing that was not a direct
competitor of its existing Strategic Clients. During 1995, the Company was
awarded a small engagement by Perot System's Energy Systems group. In 1996 and
1997, the Company was awarded two larger engagements with this organization. The
Company believes that the reputation being built and the client understanding
gained in these engagements provides a platform for the pursuit of a long-term
Strategic Client relationship.
In 1997, the Company held a series of meetings with executives at Oracle to
explore the potential to add more service content to their current offerings.
Similar discussions are still underway regarding partnering opportunities for
the future.
Operations
The Company's organizational structure is composed of three parts: customer
teams, an enablement team and corporate management and staff.
Customer teams are responsible for the actual delivery of the Company's
services and provide individual, specific customer focus. Each customer team has
full accountability for the success of the Company's relationship and business
execution with a particular Strategic Client and is directly responsible for the
marketing, closing, and delivery of services to that client. Within customer
teams empowered entrepreneurial business units are responsible for a single or
group of contracts or for a geographical area with its Strategic Client.
The Company's enablement team is responsible for assisting customer teams
in handling the significant upfront activities which occur during the beginning
and transition phases of engagements. The enablement team precedes customer
teams when entering new geographical locations and establishes the required
infrastructure to service clients at that location. When entering new
international locations, this often means identifying legal, accounting,
bookkeeping, and human resource support; organizing a new business entity; and
acquiring physical facilities. The enablement team also supports transition
efforts (new engagement start-ups) by providing experienced specialists to
provide facility, administrative and other support to the customer team.
9
The Company's corporate management and staff, which includes the Strategic
Programs Group, is responsible for establishing the strategic direction of the
Company, strategic marketing, investor relations, corporate finance and
accounting, human resource policy guidance, and other administrative support
services.
In structuring each outsourcing engagement, the Company works with its
Strategic Clients to identify elements within the engagement where the Company
can assume full responsibility for contract performance. The breadth of the
Company's service offerings provides meaningful flexibility to the Strategic
Client in providing a total solution to the Engagement Client's outsourcing
requirements. The Company's roles include providing services both at Strategic
Clients' and Engagement Clients' locations locally, nationally and
internationally.
In a typical engagement, the Company will retain the personnel working
within the function that is being outsourced. The Enablement Team will support
this transition, by establishing the required infrastructure to support the new
work site. In addition, this team will support the process of transitioning the
incumbent personnel, evaluating their capabilities and selectively hiring
productive outsourced personnel as Company employees. The Company strives to
cultivate strong morale and develop its culture with new employees, emphasizing
the degree to which it values these employees, who often find the opportunity to
work with the Company appealing compared to their previous positions working in
a non-core function. The customer team also focuses on "seamless transitions" by
minimizing any disruption within the outsourced function, often overstaffing new
engagements to ensure client satisfaction. Since the Company normally selects
the majority of the staff on an engagement from incumbent personnel, the
recruiting function for each new engagement is normally minimal. Therefore, the
Company's growth to date has not been impeded by the availability of qualified
technical personnel. As the Company implements efficiencies at an engagement, it
is able to selectively utilize existing employees for other engagements and
business opportunities.
As each outsourcing engagement is transitioned over to the Company,
operational management is inserted into the engagement to oversee the Company's
role on an ongoing basis. Within customer teams, the operational managers and
engagement staff are formed into empowered, entrepreneurial business units,
responsible and accountable for the outcome of this engagement. During the early
stages of each engagement, the outsourced function is evaluated and reengineered
for quality of performance and efficiency, as the Company seeks to drive down
operational costs while exceeding service delivery expectations of the client.
Each customer team has full accountability for the success of the Company's
relationships and business execution with its client, and is directly
responsible for delivering contracted solutions and services, and identifying,
marketing and closing additional new business opportunities within existing
engagements.
Sales and Marketing
To date, the Company has focused its marketing efforts on maintaining and
expanding its relationships with a limited number of Strategic Clients. The
Company's customer-intimate business model is the driving force of the sales and
marketing functions. Since the Company has co-located its offices with those of
its Strategic Clients, its customer teams are designed to focus on and serve the
Strategic Client in targeted market segments. Each customer team includes two or
more account executives who have the responsibility to expand the Company's
business with that Strategic Client. Since the customer teams are closely
aligned with and co-located with the Strategic Client, the Company is in a
better position to anticipate and respond to the Strategic Client's unique
needs, thereby creating a competitive advantage by ensuring account control and
growth with its Strategic Clients. After establishing its customer team in a
manner which the Company believes will exceed its Strategic Client's
expectations, the Company seeks to expand its marketing activities from that
location.
Once the customer teams can anticipate the Strategic Client's future needs,
the Company's Strategic Programs Group is responsible for positioning the
Company to meet these needs through new service offerings. Under the leadership
of the Strategic Programs Group, the Company has made, and will continue to
make, significant investments to position itself in key industries, technologies
and global markets.
10
Competition
The IT services market is highly competitive and is served by numerous
firms, including systems consulting and integration firms, professional services
companies, application software firms, temporary employment agencies, the
professional service groups of computer equipment companies, facilities
management and management information systems outsourcing companies, certain
"Big Six" accounting firms, and general management consulting firms. Many
participants in the commercial IT services market have significantly greater
financial, technical and marketing resources and generate greater revenues than
the Company. The Company believes that the principal competitive factors in the
commercial IT services industry include responsiveness to client needs, the
ability to cause the transition of the outsourced services to occur on a prompt
and seamless basis, quality of service, employee relations, price, management
capability and technical expertise. The Company believes that its ability to
compete also depends on a number of competitive factors outside its control,
including the ability of its competitors to hire, retain and motivate skilled
technical and management personnel, the price at which others offer comparable
services and the extent of its competitors' responsiveness to client needs.
Employees
As of December 31, 1997, the Company employed over 1,600 full time persons.
Approximately 147 of these employees have managerial responsibilities, and over
1,453 have technical responsibilities. The Company typically utilizes the
services of independent contractors only in short-term engagements and certain
international engagements. The Company believes that its relationships with its
employees are good.
Five of the Company's employees are represented by the Southern California
Professional Engineering Association under a collective bargaining agreement
which expires on January 10, 1999. Twelve of the Company's employees are
represented by the International Association of Machinists and Aerospace Workers
under a collective bargaining agreement which expires on January 15, 1999.
Twenty-four of the Company's employees are represented by the Office and
Professional Employees International Union (the "OPEIU") under a collective
bargaining agreement that expires on February 29, 2000. The Company believes
that its relationships with each union is good.
Item 2. PROPERTIES.
The Company's headquarters and principal administrative, sales and
marketing functions are located in approximately 14,100 square feet of leased
space in Greenbelt, Maryland. This lease expires in December 2003. The Company
leases office space in thirteen U.S. cities, as well as in Vancouver, British
Columbia; Toronto, Ontario; Calgary, Alberta; Sau Paulo, Brazil; and Mexico
City, Mexico. Additionally, the Company shares an office with a joint venture
partner in London, England.
The Company anticipates that additional space will be required as business
expands and believes that it will be able to obtain suitable space as needed. In
addition, the Company intends to open offices during the next 24 months in
Continental Europe and the Asia-Pacific Rim to complement its current
international offices.
Item 3. LEGAL PROCEEDINGS.
The Company believes that there are no claims or actions against the
Company the ultimate disposition of which will have a material adverse effect on
the Company's results of operations or consolidated financial position.
11
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
Stock Data: The Company's Common Stock, par value $0.01 per share,
commenced trading on the NASDAQ National Market tier of The NASDAQ Stock Market
on October 22, 1997, under the symbol "OAOT." As of December 31, 1997, there
were 1,204 record holders of the Company's Common Stock based on information
provided by the Company's transfer agent. The following table sets forth, for
the periods indicated, the high and low closing prices for the Company's Common
Stock.
1997
---------------------
Quarter High Low
---------- ---------
Fourth $ 12 1/2 $ 8 1/2
The Company has not paid cash dividends on its Common Stock to date. It is
the present policy of the Company to retain future earnings to finance the
growth and development of its business, and therefore the Company does not
anticipate paying cash dividends on its Common Stock in the foreseeable future.
Furthermore, certain financial covenants in the Company's bank credit agreement
restrict the Company's ability to pay cash dividends.
12
Item 6. SELECTED CONSOLIDATED FINANCIAL DATA.
The selected consolidated financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements of the
Company and the Notes thereto included elsewhere in this Form 10-K. The
statement of operations data for the years ended December 31, 1997, 1996, 1995
and 1994, and the balance sheet data as of December 31, 1997, 1996, 1995 and
1994 have been derived from consolidated financial statements of the Company
which have been audited by Deloitte & Touche LLP, independent auditors. The
statement of operations data for the year ended December 31, 1993 and the
balance sheet data as of December 31, 1993 have been derived from the Company's
unaudited consolidated financial statements which, in the opinion of management,
include all significant, normal and recurring adjustments necessary for a fair
presentation of the financial position and results of operations for such
unaudited period.
(In thousands, except per share amounts) For the years ended December 31,
------------------------------------------------------
1997 1996 1995 1994 1993(1)
-------- -------- -------- -------- --------
Statement of Operations Data:
Revenues $ 84,666 $ 57,891 $ 38,229 $ 22,472 $ 12,142
Direct costs 65,882 43,896 28,548 16,503 8,944
-------- -------- -------- -------- --------
Gross profit 18,784 13,995 9,681 5,969 3,198
-------- -------- -------- -------- --------
Selling, general and administrative 13,551 10,824 7,338 4,743 2,612
-------- -------- -------- -------- --------
Income from operations 5,233 3,171 2,343 1,226 586
Interest expense, net 453 46 115 61 49
-------- -------- -------- -------- --------
Income before income taxes 4,780 3,125 2,228 1,165 537
Provision for income taxes 1,912 1,315 1,139 466 215
-------- -------- -------- -------- --------
Net income $ 2,868 $ 1,810 $ 1,089 $ 699 $ 322
======== ======== ======== ======== ========
Net income per common share:
Diluted(2) $ 0.26 $ 0 17
======== ========
Basic(2) $ 0.27 $ 0.18
======== ========
(In thousands) As of December 31,
---------------------------------------------------------
1997 1996 1995 1994 1993 (1)
--------- --------- --------- --------- ---------
Balance Sheet Data:
Working capital $ 33,249 $ 4,718 $ (1,446) $ (964) $ (762)
Total assets 50,342 12,828 5,801 3,198 1,139
Capital lease obligations, including
current portion 1,435 476 251 -- --
Stockholders' equity 38,066 5,840 1,654 565 257
- -----------
(1) The Company's initial year of operations began in 1993 as a division of OAO
Corporation. The Company was incorporated in March 1996 and was spun off
from OAO Corporation in April 1996. As these were entities under common
control, the merger was accounted for similar to that of a
pooling-of-interests and as a result, the financial statements of the
Company have been presented at historical cost since its inception in 1993.
See Notes 1 and 2 to the Consolidated Financial Statements.
(2) See Note 4 to Notes to Consolidated Financial Statements for information
concerning calculation of diluted and basic net income per common share.
13
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
The following discussion and analysis is provided to increase the
understanding of, and should be read in conjunction with, the Financial
Statements and Notes thereto found in Item 8 of this Form 10-K. Historical
results and percentage relationships among any amounts in these Financial
Statements are not necessarily indicative of trends in operating results for any
future period.
The statements which are not historical facts contained in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations, and Notes to Consolidated Financial Statements, are forward-looking
statements that involve certain risks and uncertainties. Actual results may
differ materially based on numerous factors, including but not limited to the
Company's dependence on key Strategic Clients, risks associated with fixed-price
contracts, competition in the industry, general economic conditions, and other
risks described herein and in the Company's other Securities and Exchange
Commission filings.
Overview
The Company provides a wide range of outsourced IT solutions and
professional services, including 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 services
generally on a long-term, fixed-price contractual basis, to Strategic Clients as
part of an IT outsourcing team providing services to a wide range of Engagement
Clients, who are the ultimate end-users of the services. The Company's primary
Strategic Clients have been IBM's Global Services and Digital Equipment
Corporation. Engagement Clients include Ameritech, McDonnell Douglas, Campbell
Soup and Ryder Systems Corporation.
The Company has experienced substantial growth since its inception, with
revenues increasing to $84.7 million in 1997, from $12.1 million in 1993. The
Company's operating results, particularly its quarterly results, can be affected
by potentially lower margins on certain incremental revenue contracts prior to
the achievement of expected operating efficiencies. Engagements which involve
new services to existing customers or services to new customers may result in
lower margins during the early term of the engagement. The Company has
historically experienced margin improvements over the course of its engagements.
In addition, operating results can be affected by the level of the Company's
investments in international and other business development. The Company
believes that its business is not seasonal. Quarterly results can be affected by
the Company's level of investment in international and other business
development, as well as the commencement of new contracts and engagements, the
loss of major Strategic Clients or Engagement Clients, the timing of personnel
cost increases and the portion of revenues derived from new client engagements.
The Company's relationship with its first Strategic Client, IBM, has
continued to expand in terms of revenues, the range of services provided, the
number of engagements and the number of IBM business units which have engaged
the Company's services. While the Company expects IBM to continue to represent
the majority of the Company's revenues for the foreseeable future, revenues from
IBM have been declining on a percentage basis, accounting for 66.2%, 82.2% and
88.7% of the Company's total revenues for the years ended December 31, 1997,
1996 and 1995, respectively. This revenue trend is primarily attributable to the
Company's expanding relationship with Digital, which became a Strategic Client
in 1995. The Company is currently a major delivery partner of Digital for
outsourcing engagements across Canada and its relationship with Digital has
expanded into other geographic areas. Revenues from Digital accounted for 24.1%,
11.4% and 5.4% of the Company's total revenues for the years ended December 31,
1997, 1996 and 1995, respectively. The loss of IBM or Digital as a Strategic
Client or a decrease in the revenue derived from the Company's relationships
with either IBM or Digital would have a material adverse effect on the Company's
business, operating results and financial condition. There can be no assurance
that either Strategic Client will continue to engage the Company's services at
historical levels, if at all. The termination or nonrenewal of a Strategic
Client's contract by an Engagement Client could also have a material adverse
effect on the Company's business, operating results and financial condition. The
Company has recently expanded its business
14
development activities to include establishing relationships with Perot Systems
and NCR. Because the Company intends to maintain relationships with a limited
number of Strategic Clients, the Company's opportunity to obtain engagements
from other entities including major competitors of these Strategic Clients will
be significantly limited. As a result, the Company's revenue will likely
continue to be derived from a limited number of clients and the Company's future
growth opportunities will likely be tied to the opportunities presented to its
Strategic Clients.
For the years ended December 31, 1997, 1996 and 1995, approximately 60.8%,
73.8% and 92.0% of the Company's revenues, respectively, were derived from
fixed-price contracts. Substantially all of the Company's Megacenter Operations
engagements, which accounted for approximately 43.0%, 60.2% and 79.8% of
revenues for the years ended December 31, 1997, 1996 and 1995, respectively, are
performed under multi-year, fixed-price contracts. These contracts range from
three to ten years in length and are accounted for under the percentage of
completion method. A portion of the Company's DSM engagements are also performed
under multi-year, fixed-price contracts. For the years ended December 31, 1997,
1996 and 1995, DSM contracts accounted for approximately 28.3%, 17.7% and 6.9%
of the Company's total revenues, respectively. The Company's fixed-price
contracts generally require the Company to meet certain pre-established levels
of service while achieving certain operating or managerial efficiencies during
the course of the engagements. Profitability is generally lower during the early
term of the these engagements as the Company invests in assuring a smooth
start-up and in attaining certain service levels prior to the implementation of
productivity improvements. Upon completion of the initial performance phase, the
Company initiates activities to increase profitability through improved
management practices and the establishment of new technical and operational
methodologies.
In 1995, the Company began an initiative to diversify its business by
increasing the scope of its service offerings and through geographic expansion.
In 1995, the Company entered into its first engagement to provide DSM services,
an area which the Company had previously performed only limited services within
other engagements. The Company believes that its DSM services represent a
significant source of future potential growth. The Company's geographic
expansion into international markets began in 1995 and has accelerated during
1996 and 1997. See Note 14 to Notes to the Consolidated Financial Statements. In
particular, primarily as a result of its relationship with Digital, the
Company's revenues derived from the Canadian market grew to $20.4 million for
the year ended December 31, 1997 from $2.1 million for the year ended December
31, 1995. The Company also has been engaged to provide services in Mexico, South
America and the United Kingdom and plans to expand its business to other
international markets. In seeking to expand its international presence, the
Company intends to enter into joint ventures, partnerships or other types of
strategic alliances with organizations located in these markets. The Company's
current and future international business activities are subject to a variety of
potential risks, including political, regulatory and trade and economic policy
risks. The Company will also be subject to the risks attendant to transacting in
foreign currencies. In addition, many foreign governments have laws which
provide employees with significantly more favorable severance and other social
welfare benefits than are generally provided in the United States.
While the IT services industry has generally experienced labor shortages
and wage inflation in excess of most other industries, the Company's engagements
have not been affected, primarily due to the Company's practice of retaining the
majority of the outsourced personnel. The Company prices its services under
these engagements on the basis of the historical cost of the outsourced
function, managerial experience and its assessment of evolving technical
factors. The Company also enters into staffing services engagements requiring
high-demand IT specialists for terms ranging up to 18 months, usually on a time
and materials basis. The Company is subject to the same general labor pressures
inherent in the IT services industry when performing these engagements, which
are primarily related to the Company's DSM and systems integration services. The
Company is dependent upon its ability to attract, hire and retain personnel who
possess the technical skills and experience necessary to meet the service
requirements of its clients. In pricing its services under shorter term
engagements, the Company evaluates the existing labor market for IT specialists
and the expected duration of the engagement.
The Company often places its employees in the workplace of Strategic
Clients and Engagement Clients. The Company is therefore exposed to potential
liability with respect to actions taken by its employees, such as damages caused
by employee errors, misuse of client-proprietary information or theft of client
property. Due to the
15
nature of the Company's potential liability with respect to any such actions,
there can be no assurance that any insurance maintained by the Company will be
adequate to cover any such liability.
The Company's primary strategy is to become one of the premier providers of
outsourced IT solutions and professional services by leveraging its existing
Strategic Client relationships, selectively expanding the base of Strategic
Clients, increasing international presence, continuing development of
industry-specific expertise and pursuing acquisitions and alliances.
Results of Operations
The following table sets forth, for the periods indicated, selected
statements of operations data as a percentage of net revenue:
Year Ended December 31,
-----------------------------
1997 1996 1995
------- ------- --------
Revenues........................................ 100.0% 100.0% 100.0%
Direct costs.................................... 77.8 75.8 74.7
----- ----- -----
Gross profit............................... 22.2 24.2 25.3
----- ----- -----
Selling, general and administrative expense..... 16.0 18.7 19.2
----- ----- -----
Income from operations.......................... 6.2 5.5 6.1
Interest expense, net........................... 0.5 0.1 0.3
----- ----- -----
Income before income taxes................. 5.7 5.4 5.8
Provision for income taxes...................... 2.3 2.3 3.0
----- ----- -----
Net income................................. 3.4% 3.1% 2.8%
===== ===== =====
Comparison of Year Ended December 31, 1997, to the Year Ended December 31, 1996
Revenues
The Company's revenues increased 46.3% to $84.7 million for the year ended
December 31, 1997, from $57.9 million for the year ended December 31, 1996. This
increase was generally attributable to increases in international revenues and
increases in revenues from newer lines of business, such as DSM services.
International revenue, primarily from the Company's relationship with Digital in
Canada, increased to $20.4 million for the year ended December 31, 1997,
compared to $6.9 million for the same prior year period. Revenues from the
Company's DSM services increased by 135.3% to $24.0 million in 1997, compared to
$10.2 million in 1996. Revenues from the Company's Megacenter Operations
increased by 4.3% to $36.4 million for the year ended December 31, 1997,
compared to $34.9 million for the year ended December 31, 1996.
Direct Costs
The Company's direct costs increased 50.1% to $65.9 million for the year
ended December 31, 1997, compared to $43.9 million for the year ended December
31, 1996. Direct costs consist primarily of direct labor costs and related
fringe benefit costs. As a percentage of revenue, direct costs increased to
77.8% for the year ended December 31, 1997, compared to 75.8% for the year ended
December 31, 1996. This percentage increase is primarily due to the higher
proportion of revenues from new engagements and new services in 1997 compared to
1996. In entering new engagements, the Company may accept short term contracts
that do not include the economies of scale, leverage or short term opportunities
for productivity improvements that are available in more
16
mature or longer term engagements. The Company believes that these initial
contracts are important in penetrating new markets and in establishing the
degree of customer confidence required to secure additional business.
Selling, General and Administrative
Selling, general and administrative ("SG&A") expenses increased 25.9% to
$13.6 million for the year ended December 31, 1997, compared to $10.8 million
for the year ended December 31, 1996. As a percentage of revenues, these
expenses decreased to 16.0% from 18.7%, which the Company generally attributes
to increased economies of scale from higher revenues. The aggregate increase was
primarily the result of the continued development of additional service
capabilities and other expenditures necessary to support the Company's growth.
The Company intends to continue building its marketing, financial and
administrative infrastructure to enable it to support its growth opportunities.
Interest Income, Expense and Tax Provision
Interest income was approximately $70,000 and $30,000 for the year ended
December 31, 1997, and 1996, respectively. Interest income increased due to
income earned on the proceeds of the Company's Initial Public Offering (the
"Offering") completed on December 4, 1997. Interest expense was approximately
$523,000 for the year ended December 31, 1997, as compared to approximately
$76,000 for the year ended December 31, 1996. Interest expense increased due to
increased borrowings in 1997 to support working capital requirements prior to
the completion of the Offering. The effective tax rate decreased to 40.0% for
the year ended December 31, 1997, compared to 42.1% for the year ended December
31, 1996, primarily due to a change in the distribution of income among various
tax jurisdictions.
Comparison of Year Ended December 31, 1996, to Year Ended December 31, 1995
Revenues
The Company's revenues increased 51.6% to $57.9 million for the year ended
December 31, 1996, from $38.2 million for the year ended December 31, 1995. This
increase was primarily due to volume increases within existing contracts
resulting from growth in the Company's ongoing business, an expansion of the
scope of services provided by the Company, increases in international revenue
and increases in revenues from newer lines of business. International revenues,
primarily from the Company's relationship with Digital in Canada, increased
228.6% to $6.9 million for the year ended December 31, 1996, from $2.1 million
for the year ended December 31, 1995. Revenues from the Company's Megacenter
Operations increased 14.4% to $34.9 million for the year ended December 31,
1996, from $30.5 million for the year ended December 31, 1995. Revenues from the
Company's DSM services increased 325.0% to $10.2 million for the year ended
December 31, 1996, from $2.4 million for the year ended December 31, 1995.
Direct Costs
The Company's direct costs increased by 54.0% to $43.9 million for the year
ended December 31, 1996, from $28.5 million for the year ended December 31,
1995. As a percentage of revenues, direct costs increased to 75.8% for the year
ended December 31, 1996, from 74.7% for the year ended December 31, 1995. The
Company attributes this increase to increased revenues from DSM engagements and
the attendant costs associated with its establishment and development of this
service offering.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased 47.9% to $10.8
million for the year ended December 31, 1996, from $7.3 million for the year
ended December 31, 1995. The Company primarily attributes the aggregate increase
to the costs associated with the expansion of its international infrastructure
and to the costs associated with developing contacts and marketing in its
targeted international markets. Costs associated with these
17
initiatives were $3.1 million in 1996, compared to an insignificant amount in
1995. In addition, selling, general and administrative expenses increased as the
result of hiring of additional management and administrative personnel necessary
to support the Company's growth.
Interest Expense and Provision for Income Taxes
Interest expense was not material in either year as the Company satisfied
its working capital needs through cash generated from operations and in 1996
from a $5.0 million investment by Safeguard Scientifics, Inc. ("Safeguard"). The
effective tax rate decreased to 42.1% in 1996 from 51.1% in 1995 as a result of
losses incurred in international tax jurisdictions during 1995 for which no tax
benefit was recorded.
Liquidity and Capital Resources
Cash and cash equivalents were $22.2 million at December 31, 1997. The
$21.3 million increase in cash and cash equivalents during 1997 is due to the
receipt of $29.2 million in net proceeds from the Offering. The Company utilized
a portion of the proceeds to pay off its debt of $6.8 million, acquire certain
assets of UniHealth Investment Company (see Note 3 in the Notes to Consolidated
Financial Statements), and to fund working capital needs.
The use of cash in operations in 1997 and 1996 of $5.1 and $3.4 million,
respectively, was primarily the result of increases in both billed and unbilled
accounts receivable, partially offset by income from operations and increases in
accounts payable and accrued expenses. The overall increase in billed accounts
receivable was primarily the result of increased revenues and an increase in the
average time period in which accounts receivable have been collected. Unbilled
accounts receivable increased to $9.4 million at December 31, 1997, from $4.8
million at December 31, 1996, primarily as a result of revenue growth, as well
as performance of services under fixed price contracts in excess of billings.
This occurs when predetermined billing arrangements do not coincide with costs
incurred on the project. Furthermore, the Company often receives requests to
perform services on an as-needed basis to which it must immediately respond.
These services may sometimes be delivered prior to the receipt of written
purchase orders, resulting in a delay in billing. The majority of the unbilled
receivables at December 31, 1997, is expected to be billed within the next
twelve months. The Company has begun to take steps to improve its collection of
accounts receivable, including increased sensitivity to payment terms and
procedures for quick response orders in the contracting process, initiation of
accounts receivable collection incentive compensation, and increased ongoing
monitoring efforts. During 1997, as described below, the Company obtained a
$10.0 million accounts receivable-based credit facility to fund the increase in
receivables.
The Company's business is not capital intensive and capital expenditures in
any given year are ordinarily not significant. Capital expenditures amounted to
$2.0 million in 1997, $970,000 in 1996, and $580,000 in 1995. Capital
expenditures during 1997 included expenditures associated with the Company's new
leased corporate headquarters facility and costs associated with the development
of a new operational, administrative and financial information system. This
system, on which the Company has spent $1.5 million through December 31, 1997,
is designed to be Year 2000 compliant. Implementation is expected to be
completed by the third quarter of 1998 at an additional estimated cost of $2.5
million.
The Company currently has a $10.0 million revolving credit agreement and
$750,000 line of credit with a federally insured depository bank. Advances under
the revolving credit agreement are limited to 80.0% of certain eligible accounts
receivable of the Company, and bear interest, at the Company's option, at the
bank's overnight base rate plus 2% or at LIBOR plus 2%. As of December 31, 1997,
based on the amount of such accounts receivable, the Company was eligible to
borrow $7.2 million under the revolving credit agreement. The Company is
required to maintain certain financial and other covenants under the revolving
credit agreement and line of credit. There were no outstanding balances under
either the revolving credit agreement or the line of credit as of December 31,
1997.
The Company currently anticipates that the amounts available under its
revolving credit agreement and line of credit, cash generated from operations
and existing cash balances will be sufficient to satisfy its operating cash
18
needs through December 31, 1998. 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.
Impact of the Year 2000 Issue
The Year 2000 issue results from the fact that many computer programs were
previously written using two digits rather than four to define the applicable
year. Programs written in this way may recognize a date ending in "00" as the
year 1900 rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations. The Company is in the process
of modifying its MC 400 software to make it Year 2000 compliant. These
modifications are not significant and are expected to be completed in mid 1998.
The Company believes that any Year 2000 non-compliance in the installed base of
this software will not result in any material adverse impact on the Company's
business or financial condition. The Company is also in the process of
implementing a Year 2000 compliant internal operational, administrative and
financial information system which is expected to be implemented by the third
quarter of 1998. The Company is unable to predict the impact, if any, on the
Company's business or financial condition as a result of its Strategic Clients,
Engagement Clients, or significant vendors becoming Year 2000 compliant.
19
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Consolidated Financial Statements of OAO Technology Solutions, Inc. and
Subsidiaries are filed as part of this form 10-K.
Index to Financial Statements and Schedule Page
- ------------------------------------------ ----
Financial Statements:
Independent Auditors' Report .................................................... 21
Consolidated Statements of Operations for the years ended December 31, 1997,
1996 and 1995 ................................................................ 22
Consolidated Balance Sheets as of December 31, 1997 and 1996 .................... 23
Consolidated Statements of Cash Flows for the years ended December 31, 1997,
1996 and 1995 ................................................................ 24
Consolidated Statements of Stockholders' Equity for the years ended December 31,
1997, 1996 and 1995 .......................................................... 25
Notes to Consolidated Financial Statements ...................................... 26
Schedule:
Schedule II - Valuation and Qualifying Accounts ................................. 37
Schedules not listed above have been omitted because they are not
applicable or the information required to be set forth therein is included in
the financial statements or the notes thereto.
20
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
of OAO Technology Solutions, Inc.:
We have audited the accompanying consolidated balance sheets of OAO
Technology Solutions, Inc. and subsidiaries as of December 31, 1997 and 1996,
and the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 1997.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of OAO Technology Solutions,
Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Washington, D.C.
February 10, 1998
21
OAO TECHNOLOGY SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except Per Share Amounts)
For the years ended December 31,
-----------------------------------------
1997 1996 1995
---------- ---------- ----------
Revenues $ 84,666 $ 57,891 $ 38,229
Direct costs 65,882 43,896 28,548
---------- ---------- ----------
Gross profit 18,784 13,995 9,681
Selling, general and administrative 13,551 10,824 7,338
---------- ---------- ----------
Income from operations 5,233 3,171 2,343
Interest expense, net 453 46 115
---------- ---------- ----------
Income before income taxes 4,780 3,125 2,228
Provision for income taxes 1,912 1,315 1,139
---------- ---------- ----------
Net income $ 2,868 $ 1,810 $ 1,089
========== ========== ==========
Net income per common share:
Diluted $ 0.26 $ 0.17*
========== ==========
Basic $ 0.27 $ 0.18*
========== ==========
Weighted average number of shares outstanding:
Diluted 11,202,171 10,497,534*
========== ==========
Basic 10,598,130 10,000,000*
========== ==========
* Pro forma
The accompanying notes are an integral part of these consolidated
financial statements.
22
OAO TECHNOLOGY SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
DECEMBER 31,
-----------------------
1997 1996
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents $ 22,221 $ 876
Accounts receivable:
Billed 12,146 5,031
Unbilled 9,400 4,831
---------- ----------
21,546 9,862
Deferred income taxes -- 352
Other current assets 875 330
---------- ----------
Total current assets 44,642 11,420
Property and equipment, net 4,611 1,384
Deposits and other assets 753 24
Goodwill 336 --
---------- ----------
Total assets $ 50,342 $ 12,828
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,773 $ 1,759
Accrued expenses 5,720 3,681
Income taxes payable 477 141
Unearned revenue 379 931
Notes payable 378 --
Current portion of capital lease obligations 552 190
Deferred income taxes 114 --
---------- ----------
Total current liabilities 11,393 6,702
Capital lease obligations, net of current portion 883 286
Commitments and contingencies
Stockholders' equity:
Common stock, par value $.01 per share, 25,000,000
shares authorized; 16,285,050 and 10,000,000
shares issued and outstanding at December 31, 1997,
and 1996, respectively 163 100
Additional paid-in capital 34,454 4,950
Deferred compensation (76) --
Stockholders' receivable (133) --
Retained earnings 3,658 790
---------- ----------
Total stockholders' equity 38,066 5,840
---------- ----------
Total liabilities and stockholders' equity $ 50,342 $ 12,828
========== ==========
The accompanying notes are an integral part of these consolidated
financial statements.
23
OAO TECHNOLOGY SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars In Thousands)
For the years ended December 31,
--------------------------------
1997 1996 1995
-------- -------- --------
Cash Flows from Operating Activities:
Net income $ 2,868 $ 1,810 $ 1,089
Adjustments to reconcile net income to net cash (used in)
provided by operating activities:
Depreciation and amortization 413 245 21
Changes in assets and liabilities, net of effects of acquisition:
Accounts receivable, net (11,406) (7,831) (1,198)
Deferred income taxes 466 89 14
Other current assets (545) (293) (37)
Due from OAO Corporation -- -- (1,982)
Deposits and other assets (765) (24) --
Accounts payable 2,014 331 393
Accrued expenses 2,039 1,970 1,349
Unearned revenue (552) 174 702
Income taxes payable 336 141 --
-------- -------- --------
Net cash (used in) provided by operating activities (5,132) (3,388) 351
-------- -------- --------
Cash Flows from Investing Activities:
Expenditures for property and equipment (1,969) (970) (580)
Investment in OAO Healthcare Solutions, Inc. (398) -- --
-------- -------- --------
Net cash used in investing activities (2,367) (970) (580)
-------- -------- --------
Cash Flows from Financing Activities:
Proceeds from the sale of common stock 29,339 5,000 --
Payments on capital lease obligations (495) (57) (13)
Borrowings under credit agreements 6,800 282 250
Payments on credit agreements (6,800) -- --
-------- -------- --------
Net cash provided by financing activities 28,844 5,225 237
-------- -------- --------
Net increase in cash and cash equivalents 21,345 867 8
Cash and cash equivalents, beginning of period 876 9 1
-------- -------- --------
Cash and cash equivalents, end of period $ 22,221 $ 876 $ 9
======== ======== ========
Supplemental Disclosures of Cash Flow Information
Cash payments for interest $ 176 $ 45 $ 116
Cash payments for income taxes 844 1,085 --
Supplemental Noncash Investing and Financing Activities
Capital asset and lease obligation additions $ 1,454 $ -- $ --
The accompanying notes are an integral part of these consolidated
financial statements.
24
OAO TECHNOLOGY SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollars and Shares in Thousands)
For the years ended December 31, 1997, 1996 and 1995
--------------------------------------------------------------------------------------
Common Stock
--------------------
Additional Total
Paid-In Deferred Stockholders' Retained Stockholders'
Shares Amount Capital Compensation Receivable Earnings Equity
-------- ---------- ---------- ------------ ----------- ---------- ------------
Balance, December 31, 1994 5,000 $ 50 $ -- $ -- $ -- $ 515 $ 565
Net income -- -- -- -- -- 1,089 1,089
------ -------- -------- -------- -------- -------- --------
Balance, December 31, 1995 5,000 50 -- -- -- 1,604 1,654
Net income -- -- -- -- -- 1,810 1,810
Sale of common stock 5,000 50 4,950 -- -- -- 5,000
Distribution to OAO Corporation -- -- -- -- -- (2,624) (2,624)
------ -------- -------- -------- -------- -------- --------
Balance, December 31, 1996 10,000 100 4,950 -- -- 790 5,840
Exercise of stock options 50 1 99 -- -- -- 100
Sale of common stock 6,235 62 29,310 -- (133) -- 29,239
Option grants to Advisory Council
members -- -- 95 (95) -- -- --
Amortization of deferred
compensation
-- -- -- 19 -- -- 19
Net income -- -- -- -- -- 2,868 2,868
------ -------- -------- -------- -------- -------- --------
Balance, December 31, 1997 16,285 $ 163 $ 34,454 $ (76) $ (133) $ 3,658 $ 38,066
====== ======== ======== ======== ======== ======== ========
The accompanying notes are an integral part
of these consolidated financial statements.
25
OAO TECHNOLOGY SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF COMPANY AND CORPORATE ORGANIZATION
OAO Technology Solutions, Inc. (the "Company") along with its wholly owned
subsidiaries, provides a wide range of outsourced information technology
solutions and professional services, including the operation of large-scale data
center complexes and networks, distributed systems management, staffing services
and other information technology services.
The Company's business began in January 1993, as a separate business
division of OAO Corporation ("OAO"), an organization that provides IT services
to governmental entities. OAO formed the Company as a separate business division
in order to provide IT solutions and services to corporate clients. The Company
became a wholly-owned subsidiary of OAO when it was incorporated in September
1995. The Company was re-incorporated in the State of Delaware in March 1996. In
April 1996, the Company was spun-off from OAO.
Subsequently, on April 8, 1996, Safeguard Scientifics, Inc. ("Safeguard")
invested $5.0 million in the Company in exchange for 5.0 million shares of
common stock, which represented 50% of the common stock outstanding as of that
date.
The accompanying financial statements reflect the Company's operations
since its formation as a division of OAO. Prior to the spin-off and
recapitalization as a new company in April, 1996, the Company's financial
statements include allocations of indirect costs of OAO, primarily rent and
administrative costs, of approximately $484,000 and $2.2 million for the years
ended December 31, 1996 and 1995, respectively. These allocations have been
based on the relative sales and labor costs of the Company as compared to the
total sales and labor costs of OAO and its subsidiaries. Such allocations were
consistent with that required by the Defense Contract Audit Agency in connection
with the administration of OAO's U.S. government contracts and are considered
reasonable by management. In connection with the spin-off and subsequent
investment by Safeguard, certain obligations to the Company from OAO as of the
date of the spin-off, in the amount of $2.6 million were forgiven by the Company
and treated as a distribution to OAO. This transaction has been reflected in the
accompanying financial statements as a reduction of stockholders' equity at the
date of the spin-off.
Subsequent to the spin-off in 1996, the Company was charged administrative
fees by OAO of approximately $600,000 through September 30, 1996, for
administration of the accounting and human resource functions. No additional
fees have been charged by OAO subsequent to September 30, 1996. Such charges
were negotiated with OAO based on the charges for such services under the
allocation methodology prior to the spin-off and are considered reasonable by
management.
On October 22, 1997, the Company filed a registration statement for the
Initial Public Offering (the "Offering") of approximately 6.7 million shares of
the Company's common stock. Of these shares, the Company sold 6.2 million shares
and three existing shareholders sold 485,000 shares.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation. The accompanying consolidated financial
statements include the accounts of OAO Technology Solutions, Inc. and its wholly
owned subsidiaries: OAO Systems; Inc.; OAO Healthcare Solutions, Inc.; OAO
Canada, Ltd.; Canadian Network Resources, Ltd.;
26
Canadian Resources Management, Ltd.; OAO of Mexico, S.A. de C.V.; OAO Brazil,
LTDA; and OAO UK Limited. All accounts of non-U.S. subsidiaries have been
translated into U.S. dollars and included in the consolidated financial
statements. All intercompany accounts and transactions have been eliminated.
Revenue Recognition. The Company provides services under contracts,
primarily to large commercial customers. Revenue is recognized on the majority
of fixed price contracts for services over the term of the contract. Revenue
under other fixed price contracts is recognized on the basis of the estimated
percentage of completion of services rendered. Revenues under time-and-materials
contracts are recorded at the contracted rates times the labor hours plus other
direct costs as incurred. Anticipated losses on all contracts are recognized as
soon as they become known.
The Company accounts for software revenues in accordance with the American
Institute of Certified Public Accountants' ("AICPA") Statement of Position
("SOP") 91-1, "Software Revenue Recognition." Revenues earned under software
license agreements with end users are generally recognized when the software has
been shipped, payment is due within one year, collectibility is probable, and
there are no significant obligations remaining.
Unearned Revenue. Unearned revenue at December 31, 1997 and 1996,
represents prepayment for purchases of services that had not been rendered as of
the respective dates.
Cash and Cash Equivalents. The Company considers all securities with a
remaining maturity of three months or less at the date of purchase to be cash
equivalents. At December 31, 1997, the Company's cash equivalents consisted of
overnight reverse repurchase agreements and demand deposits.
Property and Equipment. Property and equipment is recorded at cost. The
cost of office furniture, computer and office equipment, and purchased software
is depreciated from the date of installation using the straight-line method over
the estimated useful lives of the assets, which range from three to five years.
Included in property and equipment are leasehold improvements and leased
equipment, which are depreciated using the straight-line method over the shorter
of their estimated useful lives or the term of the related leases. Software
development costs incurred for products to be used internally are capitalized
and are amortized on a straight line basis over five years. Capitalized software
costs are included in property and equipment in the accompanying consolidated
balance sheet. Amortization of these costs commences upon completion of the
implementation of the software.
Income Taxes. The provision for income taxes includes Federal and state
income taxes currently payable plus the net change during the year in the
deferred tax liability or asset. The current or deferred tax consequences of all
events that have been recognized in the financial statements are measured based
on provisions of enacted tax law to determine the amount of taxes payable or
refundable in future periods.
Currency Translation. The assets and liabilities of the Company's foreign
subsidiaries whose functional currency is other than the U.S. Dollar are
translated at the exchange rates in effect on the reporting date, and income and
expenses are translated at the weighted average exchange rate during the period.
The net effect of such translation gains and losses, as well as transaction
gains and losses, were not material.
Use of Estimates. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
27
Concentration of Risk. The Company's largest customer accounted for
approximately 66%, 82%, and 89% of total revenues for the years ended December
31, 1997, 1996, and 1995, respectively. In addition, one other customer
accounted for approximately 24%, 11% and 5% of total revenues for the years
ended December 31, 1997, 1996 and 1995 respectively.
Financial instruments that potentially subject the Company to concentration
of credit risk principally consist of accounts receivable and cash equivalents.
The Company's largest customer accounted for approximately 30% and 76% of
accounts receivable as of December 31, 1997 and 1996, respectively. In addition,
other customers with balances in excess of 10% accounted for approximately 46%
and 19% of accounts receivable as of December 31, 1997 and 1996, respectively.
The Company performs ongoing credit evaluations of its customers, but generally
does not require collateral to support customer receivables. Losses on
uncollectible accounts have consistently been within management's expectations.
The Company has investments in overnight reverse repurchase agreements with
a commercial bank. As of December 31, 1997 and 1996, the Company had invested
approximately $20.9 million and $0 in overnight reverse repurchase agreements
with this bank. The bank provides underlying collateral consisting of U.S
government securities which fully secures the carrying value of the reverse
repurchase agreements. Because the transactions are entered into and settled
daily, management believes that the risk of market value impairment on a given
day is nominal.
Stock-Based Compensation. In 1996, the Company adopted Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation." As permitted under this Statement, the Company continues to
follow the accounting provisions of Accounting Principles Board ("APB") Opinion
No. 25 for the recognition and measurement of employee stock-based compensation
and therefore provides only the disclosures required under SFAS No. 123.
3. ACQUISITION
In November 1997, the Company acquired certain assets of UniHealth
Investment Company, a division of UniHealth, Inc., for approximately $398,000 in
cash. This division produces a software product named MC400 which assists
managed care organizations in the administration of benefits structures and
provider contracts. This acquisition has been accounted for under the purchase
method of accounting, and accordingly, the results of operations of the acquired
division 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 acquired assets and assumed liabilities at the date of acquisition. The
purchase resulted in an excess of purchase price over net assets acquired of
approximately $340,000, 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.
4. NET INCOME PER COMMON SHARE
In February 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 128, "Earnings Per Share." This statement requires dual presentation of
basic and diluted earnings per share on the face of the income statement. Basic
earnings per share excludes dilution and is computed by dividing income
available to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock. SFAS No. 128 is effective for
fiscal years ending after December 15, 1997, and accordingly, has been adopted
by the Company as of December 31, 1997.
28
Calculation of basic and diluted net income per common share for the year
ended December 31, 1996, is on a pro forma basis based upon operations for the
period, assuming the incorporation, spin-off and the issuance of the common
stock all took place on January 1, 1996. For the period ended December 31, 1997,
and 1996, the weighted average number of shares outstanding for the calculation
of diluted net income per common share includes 604,000 and 498,000 potentially
dilutive shares from employee stock options outstanding, respectively. The
Company uses the treasury stock method to calculate the potential dilution of
employee stock options. For the years ended December 31, 1997 and 1996, net
income available to common stockholders was not affected by the Company's
potentially dilutive securities.
Comparative net income per common share data have been restated for prior
periods. In connection therewith, common stock and options issued within one
year prior to the original filing of the Company's Offering at prices below the
Offering price, which had previously been considered outstanding for all periods
presented, have been reflected in the computations of basic and diluted net
income per common share in accordance with SFAS No. 128 and Securities and
Exchange Commission Staff Accounting Bulletin No. 98, issued February 3, 1998.
Such common stock and options have been treated as outstanding only since
issuance.
Options to purchase 364,247 and 76,667 shares of common stock at $5.10 and
$5.00, respectively, were outstanding during the second half of 1997 but were
not included in the computation of diluted net income per common share because
the options' exercise prices were greater than the average market price of the
common shares. The options were still outstanding at December 31, 1997.
5. RECENT AUTHORITATIVE PRONOUNCEMENTS
In February 1997, the FASB issued SFAS No. 129, "Disclosure of Information
about Capital Structure." The Company is required to adopt the provisions of
this Statement for the year ending December 31, 1998. This Statement extends the
previous requirements to disclose certain information about an entity's capital
structure found in APB Opinions No.10, "Omnibus Opinion-1996," No. 15, "Earnings
per Share," and FASB Statement No. 47, "Disclosure of Long-Term Obligations,"
for entities that were subject to the requirements of those standards. As the
Company has been subject to the requirements of each of those standards,
adoption of SFAS No. 129 will have no impact on the Company's financial
statements.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which establishes standards for the reporting and display of
comprehensive income and its components in the financial statements. The Company
is required to adopt the provisions of the statement for fiscal periods
beginning after December 15, 1997. The Statement may require the Company to make
additional disclosures.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which requires the Company to present
certain information about operating segments and related information, including
geographic and major customer data, in its financial statements and in condensed
financial statements for interim periods. The Company is required to adopt the
provisions of the Statement for the year ending December 31, 1998. The Statement
may require the Company to make additional disclosures.
In October 1997, the AICPA issued SOP 97-2, "Software Revenue Recognition."
This SOP provides guidance on recognizing revenue on software transactions, and
is effective for transactions entered into in fiscal years beginning after
December 15, 1997. The Company believes the adoption of this SOP will not have a
material impact its financial statements.
29
6. UNBILLED ACCOUNTS RECEIVABLE
Unbilled receivables at December 31, 1997 and 1996 consisted of the
following (in thousands):
1997 1996
--------- ---------
Unbilled receivables pending receipt of contractual
authorization of billing $ 500 $ 1,900
Services performed in excess of billings 8,900 2,931
--------- ---------
Total unbilled accounts receivable $ 9,400 $ 4,831
========= =========
Unbilled receivables include certain costs and a portion of the fee and
expected profit, which is billable upon completion of the contracts or the
completion of certain tasks under terms of the contracts. Revenues have
therefore been recognized under the percentage of completion method for services
performed which are not billable under the terms of certain contracts.
Additionally, since the Company receives requests to perform services on an
as-needed basis and must immediately respond to these requests, the
administrative processing to create the applicable purchase orders may occur
after services have actually been provided. The majority of the unbilled
receivables at December 31, 1997 is expected to be billed within the next twelve
months. At December 31, 1997 and 1996, unbilled receivables are net of a reserve
for uncollectible accounts of $239,000 and $400,000, respectively.
7. PROPERTY AND EQUIPMENT
Property and equipment at December 31, 1997 and 1996, consisted of (in
thousands):
1997 1996
--------- ---------
Furniture and equipment $ 1,461 $ 820
Leasehold improvements 308 47
Leased equipment 1,846 578
Capitalized software 1,844 430
--------- ---------
5,459 1,875
Less accumulated depreciation and amoritization (848) (491
--------- ---------
Net property and equipment $ 4,611 $ 1,384
========= =========
The Company leases furniture, equipment and automobiles, and financed
certain leasehold improvements under capital leases. The capitalized costs and
related accumulated amortization, included in the amounts above, at December 31,
1997 and 1996, are (in thousands):
1997 1996
--------- ---------
Leased equipment $ 1,846 $ 578
Leasehold improvements 205 19
Less accumulated depreciation and amoritization (319) (191)
--------- ---------
$ 1,732 $ 406
========= =========
30
8. ACCRUED EXPENSES
Accrued expenses at December 31, 1997 and 1996, consisted of (in
thousands):
1997 1996
--------- ---------
Accrued salaries, bonuses, and other employee benefits $ 3,321 $ 2,222
Payroll taxes and amounts withheld from employees 858 746
Other accrued foreign taxes 295 --
Accrued equipment purchases 577 --
Other 669 713
--------- ---------
Total accrued expenses $ 5,720 $ 3,681
========= =========
9. CREDIT AGREEMENTS
The Company has a $10.0 million Revolving Credit Agreement (the
"Agreement") with a bank. The Agreement, which matures on May 31, 1999, provides
for a commitment fee of 0.375% on the unused portion and interest at the prime
rate or, at the Company's option, at the bank's overnight base rate plus 2%, or
LIBOR plus 2%. Borrowings under the Agreement are limited to a percentage of
eligible billed receivables. The Agreement also requires the maintenance of
certain financial covenants and prohibits the payment of dividends.
Additionally, the Company has a $750,000 line of credit (the "Line") with the
same bank and the same terms as the Agreement. Total borrowings under the
Agreement and the Line were $6.8 million during the year, with no outstanding
amounts at December 31, 1997.
10. CAPITAL LEASE OBLIGATIONS
Capital lease obligations consists of the following at December 31, 1997
and 1996:
1997 1996
--------- ---------
(in thousands)
Capital lease obligations bearing interest at
5.00% to 11.72%, aggregate monthly
payments of approximately $53,000 $ 1,435 $ 476
Less current portion of capital lease obligations (552) (190)
--------- ---------
Long term portion of capital lease obligations $ 883 $ 286
========= =========
Future payments under the capital lease obligations are summarized below (in
thousands):
Capital
Year ended December 31, Leases
- ----------------------- --------
1998 $ 609
1999 517
2000 344
2001 105
2002 50
Thereafter 45
--------
1,670
Less amounts representing interest (235)
--------
Total $ 1,435
========
31
11. STOCKHOLDERS' EQUITY
During 1997, the Board of Directors approved an increase in the number of
authorized shares of common stock to 25.0 million shares, a par value of $0.01
per share, and a split of all shares of common stock at a ratio of 1.6667 to
one. All share amounts have been restated to give effect to the stock split. In
addition, the Board authorized the issuance of 5.0 million shares of preferred
stock, of which none have been issued.
In 1996, the Company adopted the 1996 Equity Compensation Plan (the "Plan")
under which the Company is authorized to grant stock options to employees,
officers, directors, and consultants. The Plan provides for the issuance of up
to 3.2 million shares of common stock pursuant to the grant of incentive stock
options, nonqualified stock options, stock appreciation rights, and restricted
stock awards. Generally, these options vest ratably over a four or five year
period and expire six to ten years after the date of grant. The exercise price
of options granted under the Plan is equal to the estimated fair market value on
the date of grant. The Company accounts for employee options under APB Opinion
No. 25, under which no compensation cost has been recognized. Pursuant to SFAS
No. 123, the Company recognized approximately $19,000 of compensation expense on
options granted to Advisory Council members for the year ended December 31,
1997.
A summary of the status of the Company's stock option plan at December 31,
1997 and 1996 and changes during the years then ended is presented below.
Number Weighted
of Exercise Average
Option Price Exercise
Shares Per Share Price
--------- ---------- ---------
Outstanding, January 1, 1996 -- -- --
Granted 1,133,333 $2.00-$2.40 $ 2.02
Canceled (16,667) 2.00 2.00
Exercised -- -- --
---------
Outstanding, December 31, 1996 1,116,666 2.00-2.40 2.02
Granted 505,083 2.40-5.10 4.74
Canceled (66,223) 2.00-2.40 2.01
Exercised (50,050) 2.00 2.00
---------
Outstanding, December 31, 1997 1,505,476 2.00-5.10 2.93
=========
Options Outstanding Options Exercisable
- ------------------------------------------------------------------------ ---------------------------
Number Weighted Numbers
Range Outstanding Average Weighted Exercisable Weighted
of at Remaining Average at Average
Exercise December 31, Contractual Exercise December 31, Exercise
Prices 1997 Life (in years) Price 1997 Price
----------- ------------ -------------- ---------- ------------ --------
$2.00-$2.40 1,064,559 4.44 $ 2.04 306,689 $ 2.02
5.00 - 5.10 440,917 6.09 5.08 243,415 5.09
----------- --------- -------------- ---------- ----------- --------
$2.00-$5.10 1,505,476 4.92 $ 2.93 550,104 $ 3.58
=========== ========= ============== ========== =========== ========
As of December 31, 1997 and 1996, 550,104 and 102,020 options,
respectively, were exercisable with a weighted average exercise price of $3.58
and $2.00, respectively. As of December 31, 1997 and 1996, 1.2 million and
383,334 options were available for grant, respectively.
32
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 1997 and 1996, respectively: risk-free interest
rates of 6.15 and 5.94 percent; no expected dividend yields; and expected lives
of 3.83 and 6.00 years. As no grants were made subsequent to the Company's
Offering, no volatility was considered in the calculation for 1997 or 1996.
Using these assumptions, the fair value of the stock options granted in 1997 and
1996 on a per share, weighted average basis was $0.96 and $1.02, respectively,
which would be amortized as compensation expense over the vesting period of the
options.
Had compensation cost for these plans been recognized under SFAS No. 123,
the Company's net income and earnings per share would have been reduced to the
following pro forma amounts (in thousands, except per share data).
1997 1996
---------- ---------
Net income:
As reported $ 2,868 $ 1,810
Pro forma $ 2,663 $ 1,647
Diluted net income per common share:
As reported $ 0.26 $ 0.17
Pro forma $ 0.24 $ 0.16
Basic net income per common share:
As reported $ 0.27 $ 0.18
Pro forma $ 0.25 $ 0.16
12. INCOME TAXES
The Company's provision for income taxes for the years ended December 31,
1997, 1996 and 1995, consisted of the following (in thousands):
1997 1996 1995
--------- ---------- --------
Current - Federal $ 829 $ 1,006 $ 921
- Foreign 481 -- --
- State 136 220 204
--------- ---------- --------
Total current provision 1,446 1,226 1,125
--------- ---------- --------
Deferred - Federal 411 68 11
- State 55 21 3
--------- ---------- --------
Total deferred provision 466 89 14
--------- ---------- --------
Total provision $ 1,912 $ 1,315 $ 1,139
========= ========== ========
The provision for income taxes differs from the amount computed by applying
the statutory federal income tax rate as follows:
1997 1996 1995
--------- ---------- --------
Expected statutory amount 34.0% 34.0% 34.0%
Nondeductible expenses 1.4 2.0 2.0
Losses of foreign subsidiaries -- -- 10.5
State income taxes, net of federal benefit 4.6 4.6 4.6
Other -- 1.5 --
--------- ---------- --------
Effective Rate 40.0% 42.1% 51.1%
========= ========== ========
33
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and amounts used for income tax purposes.
The tax effect of significant temporary differences that comprise the
deferred tax assets and liabilities at December 31, 1997 and 1996, are as
follows (in thousands):
1997 1996
------- --------
Deferred tax assets:
Accrued employee benefits $ 25 $ 102
Losses of foreign subsidiaries -- 250
------- --------
Total deferred tax assets 25 352
Deferred tax liabilities: (139) --
------- --------
Net deferred tax (liabilities) assets $ (114) $ 352
======= ========
13. EMPLOYEE BENEFIT PLANS
In 1996, the Company approved the temporary adoption of the OAO Corporation
Employee Savings Plan as the employee savings plan. Effective September 30,
1996, the Company established a separate 401(k) Plan, the OAO International
Corporation Employee Savings Plan (the "401(k) Plan"), and completed the
rollover of assets held under the OAO Corporation Employee Savings Plan to the
new plan. The 401(k) Plan covers substantially all of the Company's U.S.
employees. Participants may contribute to the Plan an amount between 1% and 15%
of their total annual compensation. The Company makes matching contributions of
20% of each participant's contributions up to 10%. Company matching
contributions amounted to approximately $353,000 and $201,000 in 1997 and 1996,
respectively.
14. GEOGRAPHIC AREA INFORMATION
The Company generated substantially all of its revenues in the United
States and Canada during the three years ended December 31, 1997. The following
represents a summary of information by geographic area (in thousands):
For the years ended December 31,
1997 1996 1995
-------- -------- --------
Revenues:
United States $ 64,080 $ 51,000 $ 36,147
Canada 20,421 6,891 2,082
Other consolidated entities 165 -- --
-------- -------- --------
$ 84,666 $ 57,891 $ 38,229
-------- -------- --------
Income before income taxes:
United States $ 5,011 $ 5,682 $ 2,848
Canada 1,501 228 (620)
Other consolidated entities (1,732) (2,785) --
-------- -------- --------
$ 4,780 $ 3,125 $ 2,228
-------- -------- --------
Identifiable assets:
United States $ 47,413 $ 12,733 $ 5,948
Canada 3,798 2,473 603
Eliminations and other consolidated entities (869) (2,378) (750)
-------- -------- --------
$ 50,342 $ 12,828 $ 5,801
-------- -------- --------
34
Sales between geographic areas are not material. Costs related to business
development in international locations other than Canada of approximately $1.8
million and $3.1 million, respectively, have been included in "Other
Consolidated Entities" for the years ended December 31, 1997 and 1996. Prior to
1996, costs incurred in this area were not significant. Identifiable assets are
those assets used in the operations in each geographic area.
15. RELATED PARTY TRANSACTIONS
The Company and OAO Services, Inc. ("Services"), a subsidiary of OAO, are
related parties as a common group of shareholders hold a substantial ownership
interest in both companies. During 1997 and 1996, the Company served as a
subcontractor on several contracts with Services. Total revenues recorded under
these contracts amounted to $4.2 million and $1.6 million, respectively, for the
years ended December 31, 1997 and 1996. At December 31, 1997 and 1996, the
Company has $1.9 million and $764,000 of billed receivables and $502,000 and
$297,000 of unbilled receivables, respectively, which are due from Services.
At the date of its investment in the Company, April 8, 1996 (Note 1),
Safeguard paid $5.0 million to Services, in return for a grant by Services to
the Company of an option to purchase at anytime through April 8, 2000, all of
the shares of common stock of Services at an exercise price based on revenues
and earnings levels of Services for the 12 months prior to the date of exercise.
Pursuant to the terms of an agreement dated July 11, 1997, the Services'
option was canceled in consideration of the right granted to the Company and
Safeguard to receive certain future payments in the event of any sale of OAO and
Services or any public offering by OAO which occurs prior to April 8, 2000. In
each instance, the minimum amount to be received by the Company would be
$500,000, with the potential for a higher amount based on the value of the
transaction.
The Company has entered into an administrative services agreement with
Safeguard, which provides for payment of a maximum fee of 1% of gross revenues
per year, not to exceed $125,000 for the six months ended September 30, 1996,
and $500,000 per year thereafter. The Company charged $500,000 and $250,000 to
operations for the years ended December 31, 1997 and 1996, respectively, in
connection with this agreement.
16. COMMITMENTS AND CONTINGENCIES
The Company has entered into long-term lease agreements for office space
and equipment. The minimum fixed rental commitments related to all noncancelable
operating leases are approximately as follows (in thousands):
Operating
Year ended December 31, Leases
----------------------- ----------
1998 $ 821
1999 603
2000 554
2001 415
2002 367
Thereafter 367
----------
Total minimum lease payments $ 3,127
==========
35
A number of these leases have escalation clauses for increases in real
estate taxes, operating costs, and inflation and provide various renewal options
up to five years. Rent expense for the years ended December 31, 1997, 1996, and
1995, approximated $821,000, $355,000, and $118,000, respectively.
The Company is involved in various litigation arising in the normal course
of business. In management's opinion, the Company's ultimate liability or loss,
if any, resulting from this litigation will not have a material adverse effect
on the accompanying financial statements.
17. QUARTERLY FINANCIAL DATA (UNAUDITED)
Set forth below are selected unaudited financial statements of operations
data for the last eight fiscal quarters of the Company. In Management's opinion,
the results below have been prepared on the same basis as the audited financial
statements contained herein and include all material adjustments, consisting of
only normal recurring adjustments, necessary for a fair presentation of the
information for the periods. Results of any one or more quarters are not
necessarily indicative of annual results or continuing trends.
1997 Quarters Ended
---------------------------------------------------------
(In thousands, except per share data) March 31, June 30, Sept. 30, Dec. 31,
----------- ----------- ---------- ----------
Revenues $ 19,161 $ 20,177 $ 20,618 $ 24,710
Gross profit 4,341 4,224 4,481 5,738
Income from operations 1,022 1,228 1,341 1,642
Income before income taxes 1,017 1,146 1,235 1,382
Net income $ 584 648 $ 716 $ 920
Net income per common share:
Diluted $0.05 $0.06 $0.07 $0.07
Basic $0.06 $0.06 $0.07 $0.08
Weighted average number of shares outstanding:
Diluted 10,740,388 10,736,756 10,489,132 12,463,572
Basic 10,000,000 10,000,282 10,001,098 11,718,916
1996 Quarters Ended
---------------------------------------------------------
(In thousands, except per share data) March 31, June 30, Sept. 30, Dec. 31,
----------- ----------- ---------- ----------
Revenues $ 11,498 $ 12,823 $ 15,996 $ 17,574
Gross profit 2,925 3,226 3,636 4,208
Income from operations 624 653 767 1,127
Income before income taxes 601 646 760 1,118
Net income $ 351 $ 374 $ 440 $ 645
Net income per common share:
Diluted $0.04 $0.04 $0.04 $0.06
Basic $0.04 $0.04 $0.04 $0.06
Weighted average number of shares outstanding:
Diluted 10,000,000 10,659,500 10,659,500 10,662,279
Basic 10,000,000 10,000,000 10,000,000 10,000,000
36
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Additions
------------------------
Balance at Charges to Charges to
beginning costs and other Balance at
(In thousands) of period expenses accounts(B) Deductions(C) end of period
---------- --------- ---------- ------------ -------------
Allowance for uncollectible
accounts (A)
Year ended December 31, 1995 -- -- -- -- --
Year ended December 31, 1996 -- -- 400 -- 400
Year ended December 31, 1997 400 50 161 289
- -----------
(A) Reflected on the Balance Sheet as a reduction of Accounts Receivable
(B) Provided as a reduction of revenue for the year ended December 31, 1996.
Provided as a reduction of accounts receivable purchased in the acquisition
of certain assets of UniHealth Investment Company (see Note 3 in the Notes
to Consolidated Financial Statements) for the year ended December 31, 1997.
(C) Provided as a recovery of revenue.
37
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item is incorporated by reference to the
sections of the Registrant's definitive Proxy Statement for the Annual Meeting
of Stockholders to be held on May 21, 1998 (the "Proxy Statement"), entitled
"Election of Directors - Nominees," "Executive Officers" and "Common Stock
Ownership of Principal Stockholders and Management - Compliance with Section
16(a) Beneficial Ownership Reporting Compliance," to be filed with the
Commission.
Item 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the
sections of the Proxy Statement entitled "Election of Directors Compensation of
Directors" and "Executive Compensation and Other Information," to be filed with
the Commission.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANGEMENT.
The information required by this Item is incorporated by reference to the
section of the Proxy Statement entitled "Common Stock Ownership of Principal
Stockholders and Management," to be filed with the Commission.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated by reference to the
sections of the Proxy Statement entitled "Election of Directors Nominees" and
"Executive Compensation and Other Information - Compensation Committee
Interlocks and Insider Participation," to be filed with the Commission.
38
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K.
Exhibit Page
No. Description No.
- --------- ---------------------------------------------------------------------------------- ----
3.1 Amended and Restated Certificate of Incorporation of the Company, as amended.(2)
3.2 Amended and Restated By Laws of the Company.(2)
10.1 Conformed form of Vendor Agreement between the Company and Integrated Systems
Solutions Corporation, as amended.(2)
10.2 Basic Order Agreement between Digital Equipment Corporation and OAO Canada
Limited/OAO Technology Solutions, Inc.(2)(3)
10.3 Amended and Restated OAO Technology Solutions, Inc. 1996 Equity Compensation
Plan.(2)
10.4 Employment Agreement between William R. Hill and the Company, dated
April 1, 1996.(2)
11.1 Statement Regarding Computation of Earnings Per Share.(1) 42
21.1 Subsidiaries of the Registrant.(2)
27.1 Financial Data Schedule.(1) 43
- ----------
(1) Filed herewith.
(2) Incorporated by reference to the Company's Registration Statement on Form
S-1(Registration No. 333-00796) declared effective on October 22, 1997.
(3) Confidential Treatment Requested. The entire agreement has been filed
separately with the Securities and Exchange Commission.
39
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
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.
By: /s/ William R. Hill
----------------------------
William R. Hill
Chief Executive Officer
and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ William R. Hill Chief Executive Officer, March 24, 1998
- ----------------------------------- President and Director
William R. Hill (Principal Executive Officer)
/s/ Samuel D. Horgan Chief Financial Officer and March 24, 1998
- ----------------------------------- Treasurer (Principal Financial
Samuel D. Horgan and Accounting Officer)
/s/ Jerry L. Johnson Chairman of the Board of Directors March 24, 1998
- -----------------------------------
Jerry L. Johnson
Director March 24, 1998
/s/ Cecile D. Barker
- -----------------------------------
Cecile D. Barker
Director March 24, 1998
/s/ Thomas C. Lynch
- -----------------------------------
Thomas C. Lynch
Director March 24, 1998
/s/ Frank B. Foster, III
- -----------------------------------
Frank B. Foster, III
Director March 24, 1998
/s/ Yvonne Brathwaite Burke
- -----------------------------------
Yvonne Brathwaite Burke
Director March 24, 1998
/s/ John Lehman
- -----------------------------------
John Lehman
40
EXHIBITS
Exhibit Page
No. Description No.
- --------- ---------------------------------------------------------------------------------- ----
3.1 Amended and Restated Certificate of Incorporation of the Company, as amended.(2)
3.2 Amended and Restated By-Laws of the Company.(2)
10.1 Conformed form of Vendor Agreement between the Company and Integrated Systems
Solutions Corporation, as amended.(2)
10.2 Basic Order Agreement between Digital Equipment Corporation and OAO Canada
Limited/OAO Technology Solutions, Inc.(2)(3)
10.3 Amended and Restated OAO Technology Solutions, Inc. 1996 Equity Compensation
Plan.(2)
10.4 Employment Agreement between William R. Hill and the Company, dated
April 1, 1996.(2)
11.1 Statement Regarding Computation of Earnings Per Share.(1) 42
21.1 Subsidiaries of the Registrant.(2)
27.1 Financial Data Schedule.(1) 43
- ----------
(1) Filed herewith.
(2) Incorporated by reference to the Company's Registration Statement on Form
S-1(Registration No. 333-00796) declared effective on October 22, 1997.
(3) Confidential Treatment Requested. The entire agreement has been filed
separately with the Securities and Exchange Commission.
41