UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ______________ to ______________
Commission file number 0-23173
OAO TECHNOLOGY SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware 52-1973990
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7500 Greenway Center Drive
Greenbelt, Maryland 20770
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (301) 486-0400
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes |_| No |X|
As of November 13, 2002, the registrant had outstanding 17,489,209 shares
of its Common Stock, par value $0.01 per share.
1
OAO TECHNOLOGY SOLUTIONS, INC.
Quarterly Report on Form 10-Q for the Three and
Nine Months Ended September 30, 2002
INDEX
Page Reference
--------------
COVER PAGE.....................................................................1
INDEX..........................................................................2
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets (Unaudited) as of September 30,
2002 and December 31, 2001 ...........................................3
Condensed Consolidated Statements of Operations and Comprehensive
(Loss) Income (Unaudited) for the Three and Nine Months Ended
September 30, 2002 and 2001...........................................4
Condensed Consolidated Statements of Cash Flows (Unaudited)
for the Nine Months Ended September 30, 2002 and 2001.................5
Notes to Condensed Consolidated Financial Statements (Unaudited)......6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS...........................12
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK...................................................19
Item 4. CONTROLS AND PROCEDURES.......................................20
PART II - OTHER INFORMATION...................................................20
Item 6. Exhibits and Reports on Form 8-K................................20
SIGNATURES....................................................................21
CERTIFICATIONS................................................................22
2
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
OAO TECHNOLOGY SOLUTIONS, INC.
Condensed Consolidated Balance Sheets
(Unaudited)
(in thousands, except share and per share amounts)
September 30, December 31,
----------------------------
2002 2001
----------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 10,659 $ 9,060
Accounts receivable, net 31,428 36,602
Note receivable, OAO Corporation -- 1,714
Deferred income taxes 4,141 4,040
Income tax receivable 1,975 358
Other current assets 1,980 1,305
----------------------------
Total current assets 50,183 53,079
Property and equipment, net 5,072 5,220
Purchased and developed software for sale, net 1,141 1,737
Deposits and other assets 1,668 1,355
Deferred income taxes -- 898
Intangible assets, net 11,800 12,268
----------------------------
Total assets $ 69,864 $ 74,557
============================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Term loan, current portion $ 1,800 $ 1,800
Accounts payable 8,201 6,893
Accrued expenses 4,939 5,108
Accrued compensation and benefits 8,740 10,513
Income tax payable 677 460
Unearned revenue 3,159 2,022
Current portion of capital lease obligations 583 959
----------------------------
Total current liabilities 28,099 27,755
Capital lease obligations, net of current portion and other 1,586 1,644
Term loan, net of current portion 5,457 6,753
Shareholders' equity:
Preferred stock, par $.01 per share, 10,000,000 shares authorized;
none issued and outstanding -- --
Common stock, par $.01 per share, 50,000,000 shares authorized;
17,476,709 and 18,702,710 shares issued and outstanding
as of September 30, 2002 and December 31, 2001, respectively 175 187
Additional paid-in capital 38,751 41,703
Accumulated other comprehensive net loss (912) (848)
Shareholder receivable (2,933) (2,933)
Retained (deficit) earnings (359) 296
----------------------------
Total shareholders' equity 34,722 38,405
----------------------------
Total liabilities and shareholders' equity $ 69,864 $ 74,557
============================
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
OAO TECHNOLOGY SOLUTIONS, INC.
Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income
(Unaudited)
(in thousands, except per share amounts)
Three months ended Nine months ended
September 30, September 30,
------------------------------------------------
2002 2001 2002 2001
------------------------------------------------
Revenues $ 40,490 $ 40,331 $ 123,790 $ 120,226
Direct costs 34,260 32,234 102,585 97,975
(Gain) loss on prepaid software licenses -- -- (1,418) 5,085
------------------------------------------------
6,230 8,097 22,623 17,166
Selling, general and administrative expenses 7,766 6,842 21,431 21,338
Severance and other termination costs 696 -- 2,035 --
------------------------------------------------
(Loss) income from operations (2,232) 1,255 (843) (4,172)
Interest income 34 151 65 524
Interest expense (135) (74) (359) (106)
------------------------------------------------
(Loss) income before income taxes (2,333) 1,332 (1,137) (3,754)
(Benefit) provision for income taxes (982) 566 (482) (1,595)
------------------------------------------------
Net (loss) income (1,351) 766 (655) (2,159)
Other comprehensive (loss) income:
Net change in fair value of cash flow hedge (115) -- (204) --
Foreign currency translation adjustment 114 (148) 140 33
------------------------------------------------
Comprehensive (loss) income $ (1,352) $ 618 $ (719) $ (2,126)
================================================
Net (loss) income per common share:
Basic $ (0.08) $ 0.04 $ (0.04) $ (0.12)
================================================
Diluted $ (0.08) $ 0.04 $ (0.04) $ (0.12)
================================================
Weighted average number of shares outstanding:
Basic 17,473 18,541 17,885 18,312
================================================
Diluted 17,473 18,559 17,885 18,312
================================================
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
OAO TECHNOLOGY SOLUTIONS, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(in thousands)
Nine months ended
September 30,
--------------------
2002 2001
--------------------
Cash Flows from Operating Activities:
Net loss $ (655) $ (2,159)
Adjustment to reconcile net loss to net
cash provided by operating activities:
(Gain) loss on prepaid software licenses (1,418) 5,085
Severance and other termination costs 277 --
Depreciation and amortization 3,043 3,061
Deferred income taxes 797 --
Change in assets and liabilities:
Accounts receivable 5,174 (2,217)
Other current assets and income tax receivable (2,292) (3,905)
Deposits and other assets (313) (265)
Accounts payable 1,308 2,485
Accrued expenses and accrued compensation and benefits (982) 2,374
Income tax payable 217 878
Unearned revenue 1,137 (568)
Other long-term liabilities 234 --
--------------------
Net cash provided by operating activities 6,527 4,769
--------------------
Cash Flows from Investing Activities:
Purchase of business -- (9,037)
Proceeds from repayment of note receivable, OAO Corporation 1,714 --
Expenditures for property and equipment (1,831) (1,464)
--------------------
Net cash used in investing activities (117) (10,501)
--------------------
Cash Flows from Financing Activities:
Net repayments under revolving credit agreement -- (6,000)
Repurchase of common stock (3,156) --
Proceeds from term loan -- 9,000
Payments on term loan (1,500) --
Deferred financing costs -- (136)
Proceeds from sale of common stock 373 429
Proceeds from sale-leaseback transactions -- 312
Payments on capital lease obligations (668) (517)
--------------------
Net cash used in financing activities (4,951) 3,088
--------------------
Effect of exchange rate changes on cash 140 (95)
--------------------
Net increase (decrease) in cash and cash equivalents 1,599 (2,739)
Cash and cash equivalents, beginning of period 9,060 11,779
--------------------
Cash and cash equivalents, end of period $ 10,659 $ 9,040
====================
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
OAO TECHNOLOGY SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Organization and Basis of Presentation
OAO Technology Solutions, Inc. ("the Company" or "OAOT") provides managed
IT services as a partner to global outsourcers, major corporations, and select
government agencies. The Company began its operations in 1993 as a division of
OAO Corporation, was incorporated in March 1996 and was spun off from OAO
Corporation in April 1996. The Company operates two business segments: Managed
IT Solutions and Healthcare IT Solutions.
The condensed consolidated financial statements included herein have been
prepared by the Company without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission ("SEC") and include, in the opinion of
management, all adjustments, consisting of normal recurring adjustments,
necessary for a fair presentation of interim period results. Certain information
and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America have been condensed or omitted pursuant to such rules and regulations.
The balance sheet at December 31, 2001 has been derived from the audited
financial statements at that date, but does not include all of the information
and footnotes required by accounting principles generally accepted in the United
States of America for complete financial statements. These condensed
consolidated financial statements should be read in conjunction with the
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K filed with the SEC for the year ended December 31, 2001 and the
Company's other filings with the SEC. The results of operations for the three
and nine month periods ended September 30, 2002 are not necessarily indicative
of the results to be expected for the full year.
2. Revenue Recognition
The Company provides services under various contracts, primarily to large
commercial customers. Revenue under fixed-price contracts is recorded under the
percentage-of-completion method based on costs incurred in relation to estimated
total costs. Revenues under time-and-materials contracts are recorded at the
contracted rates plus other direct costs as they are incurred. Service revenues
are generally recognized ratably over the period of the related contract. Losses
on contracts, if any, are recognized as soon as they become known.
The Company recognizes software revenue under the provisions of Statement
of Position (SOP) No. 97-2, "Software Revenue Recognition" (as amended by SOP
No. 98-4 and SOP No. 98-9). Except as noted below, software license fees are
recognized as revenue upon the customer's execution of a noncancelable license
agreement and the Company's delivery of the software, provided that the fee is
fixed and determinable, collectibility is probable, and no customization of the
software is required. If customization of the software is required, revenues are
recognized on the percentage-of-completion basis over the software
implementation term (generally six to twelve months).
Revenues from per member, per month (PMPM) software license arrangements
are recognized monthly over the term of the arrangement. Revenues from software
maintenance contracts are recognized ratably over the maintenance period based
upon their vendor specific objective evidence of fair value. Revenues from
consulting and training services are recognized on a time-and-materials basis as
services are performed. Amounts received in advance of the delivery of software
or the performance of services are classified as unearned revenue on the
consolidated balance sheets.
6
3. Earnings Per Share
Basic earnings per share has been calculated as net earnings divided by
basic weighted-average common shares outstanding. Diluted earnings per share has
been computed as net earnings divided by weighted-average common shares
outstanding, and, when dilutive, potential common shares from options to
purchase common stock using the treasury stock method. The dilutive effect of
shares issuable upon exercise of stock options totaling 17,665 were included in
the calculation of diluted earnings per share for the three months ended
September 30, 2001. The dilutive effect of shares issuable upon exercise of
stock options has been excluded from the diluted earnings per share calculation
for all other periods presented, as inclusion of such shares would be
anti-dilutive.
4. Segment Information
The Company operates two business segments: Managed IT Solutions and
Healthcare IT Solutions.
The Managed IT Solutions segment, consisting of our Application Solutions
and IT Infrastructure Solutions businesses, provides application management,
enterprise systems management and desktop management services encompassing
network and systems design, software solutions, integration, and management of
large-scale data-center environments, which includes on-site and remote network
systems management. In addition, we offer information technology personnel that
are utilized to augment short or indefinite term engagement requirements.
The Healthcare IT Solutions segment provides proprietary software products
and business solutions for healthcare organizations. The segment provides full
service solutions via its proprietary MC400 software on a one-time license or
PMPM basis and via its EZ-CAP software. Our integrated services include customer
service, installation, training and ongoing support.
The Company evaluates the performance of each segment based on segment
revenues and gross profit. Segment gross profit includes only direct costs.
Corporate selling, general and administrative expenses, net interest expense,
and other income and expenses are not allocated to segments.
Summary information by segment is as follows (in thousands):
Three months ended Nine months ended
September 30, September 30,
-----------------------------------------------
2002 2001 2002 2001
-----------------------------------------------
MANAGED IT SOLUTIONS
Revenues $ 35,985 $ 35,719 $ 106,409 $ 108,547
Gross profit 7,842 6,823 21,907 13,494
HEALTHCARE IT SOLUTIONS
Revenues 4,505 4,612 17,381 11,679
Gross (loss) profit (1,612) 1,274 716 3,672
TOTALS
Revenues 40,490 40,331 123,790 120,226
Gross profit 6,230 8,097 22,623 17,166
Selling, general and administrative expenses 7,766 6,842 21,431 21,338
Severance and other termination costs 696 -- 2,035 --
-----------------------------------------------
Total consolidated (loss) income from operations (2,232) 1,255 (843) (4,172)
Interest and other (expense) income, net (101) 77 (294) 418
-----------------------------------------------
Total consolidated (loss) income before income taxes $ (2,333) $ 1,332 $ (1,137) $ (3,754)
===============================================
7
5. Intangible Assets
The Company's intangible assets consisted of the following as of (in
thousands):
September 30, December 31,
2002 2001
---------------------------
Goodwill $ 8,588 $ 8,588
Software 1,800 1,800
Customer list 2,100 2,100
Less accumulated amortization (688) (220)
----------------------
Identifiable intangibles, net 3,212 3,680
----------------------
Intangible assets, net $ 11,800 $ 12,268
======================
Software and customer list are amortized on a straight-line basis over
their estimated useful lives of 5 and 7 years, respectively. The software and
customer list amortization is recognized in our Healthcare IT Solutions segment.
Amortization expense for the software and customer list was $162,000 and
$468,000 for the three and nine months ended September 30, 2002. Aggregate
amortization expense related to the software and customer list is expected to be
$660,000 per year through 2005, $540,000 in 2006, and $300,000 in 2007.
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other
Intangible Assets", which we adopted effective January 1, 2002. In accordance
with SFAS 142, the Company discontinued amortization of goodwill on January 1,
2002. The Company tests goodwill for impairment using the two-step process
prescribed in SFAS 142. The first step is a screen for potential impairment,
while the second step measures the amount of the impairment, if any. The Company
performed the required impairment tests as of January 1, 2002 and determined
that no impairment existed as of that date. The Company plans to perform the
required annual test on October 1 of each year, beginning in 2002.
The following table adjusts reported net income and earnings per share for
the three and nine months ended September 30, 2001 to exclude goodwill
amortization (in thousands, except per share amounts):
Three months ended Nine months ended
September 30, 2001 September 30, 2001
---------------------------------------
Reported net income (loss) $ 766 $ (2,159)
Add: goodwill amortization, net of tax effect 120 372
---------------------------------------
Adjusted net income (loss) $ 886 $ (1,787)
=======================================
Reported basic and diluted earnings per share $ 0.04 $ (0.12)
=======================================
Add: goodwill amortization, net of tax effect $ 0.01 $ 0.02
=======================================
Adjusted earnings per share, basic and diluted $ 0.05 $ (0.10)
=======================================
8
6. Evaluation of Long-Lived Assets
In August 2001, the FASB issued Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("FASB 144"), which addresses financial accounting and reporting for the
impairment or disposal of long-lived assets. FASB 144 supersedes both FASB
Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" and the accounting and reporting provisions
of APB Opinion No. 30, "Reporting the Results of Operation - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions," for the disposal of a Segment
of a Business (as previously defined in that opinion). FASB 144 also amends ARB
No. 51, "Consolidated Financial Statements" to eliminate the exception to
consolidation for a subsidiary for which control is likely temporary. The
Company adopted FASB 144 effective January 1, 2002. The adoption of FASB 144 had
no impact on the Company's financial position or results of operations.
7. Contingencies
The Company from time to time 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 such litigation will not have a
material adverse effect on the Company's financial position, results of
operations or cash flows.
8. Severance and Other Termination Costs
Gregory A. Pratt
On April 19, 2002, Charles A. Leader succeeded Gregory A. Pratt as
President and Chief Executive Officer. Mr. Pratt was named Vice Chairman of the
Board of Directors of the Company. In his new role, Mr. Pratt will assume the
responsibilities for merger and acquisition activity and corporate development.
Effective April 19, 2002, the Company and Mr. Pratt entered into a
Transition Agreement and General and Special Release (the Transition Agreement),
which finalized the terms of his resignation and severance in accordance with
his employment agreement. As part of the Transition Agreement, Mr. Pratt will
continue to receive certain payments through July 2003 in accordance with his
employment agreement. Severance for Mr. Pratt in the amount of $614,000 is
included in Severance and Other Termination Costs for the nine months ended
September 30, 2002, of which $379,000 is included in accrued compensation and
benefits on the balance sheet as of September 30, 2002.
In accordance with the Transition Agreement, (i) all unexercised options
granted to Mr. Pratt other than the 750,000 stock options to buy the Company's
common stock, par value $.01 (the common stock) granted to Mr. Pratt in 2001,
were forfeited and (ii) the term of the 750,000 stock options to buy the
Company's common stock granted to Mr. Pratt in 2001 was extended through January
1, 2008. As a result, the intrinsic value of the stock options was re-measured
on April 19, 2002, resulting in expense of approximately $277,000, which is
included in Severance and Other Termination Costs for the nine months ended
September 30, 2002. In addition, the Transition Agreement provides that upon
exercise of the 2001 grant and disposition of such shares, the proceeds must be
used to repay any remaining obligations under Mr. Pratt's term note to the
Company.
Other
During June 2002, a combined 19 positions were eliminated in our Managed IT
Solutions segment and corporate headquarters. All 19 employees were terminated
prior to June 30, 2002. As a result, Severance and Other Termination Costs of
approximately $448,000 was recognized for the nine months ended September 30,
2002.
During the three months ended September 30, 2002, an additional 11 positions
were eliminated in our Managed IT Solutions segment. All 11 employees were
terminated prior to September 30, 2002. As a result, Severance and Other
Termination Costs of approximately $546,000 was recognized during the three
months ended September 30, 2002. As a result of these cost cutting measures,
certain office space was vacated during the third quarter. Lease termination
fees of approximately $150,000 were incurred and are included in Severance and
Other Termination Costs during the three months ended September 30, 2002.
9
Approximately $728,000 of these Severance and Other Termination Costs are
included in accrued compensation and benefits on the balance sheet as of
September 30, 2002.
9. Prepaid Software Licenses
Write-Down of Prepaid Software Licenses
In connection with a Value Added Industry Remarketer agreement with Siebel
Systems, Inc. ("Siebel"), on August 31, 1999, the Company purchased software
licenses in the amount of $5.1 million for resale to third parties. The software
licenses were purchased with cash of $2.8 million, a future payment of $1.1
million and 228,800 shares of the Company's common stock.
During 2001, the Company wrote-off the value of its entire investment in
Siebel software licenses and filed suit against Siebel alleging breach of the
implied duty of good faith and lack of fair dealing under these agreements.
Release of Prepaid Software Licenses Obligations
On June 28, 2002, the Company and Siebel entered into a Settlement
Agreement and Mutual Release in Full (the Release), effective June 30, 2002. In
accordance with the Release, the parties provided each other with mutual
releases and both parties acknowledge that the Siebel agreements are terminated,
and that each party is released from any further performance, other than the
Company was granted an 18-month license to continue to use those Siebel products
currently installed on the Company's system. As such, 228,800 shares of the
Company's common stock provided as consideration under the Siebel agreements
were retired by the Company at the fair market value of the common stock on the
effective date of the Release, resulting in a gain of $456,000, which is
included in (Gain) Loss on Prepaid Software Licenses for the nine months ended
September 30, 2002. In addition, the Company recognized a gain of approximately
$1.1 million related to the reversal of liabilities for commitments to purchase
software licenses under the Siebel agreements, net of legal and other costs to
execute the Release of approximately $0.2 million, which is included in (Gain)
Loss on Prepaid Software Licenses for the nine months ended September 30, 2002.
10. Recent Accounting Pronouncements
In April 2002, the FASB issued Statement of Financial Standards No. 145
("SFAS 145"), "Rescission of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13, and Technical Corrections." Among other things, SFAS 145
rescinds both SFAS 4 "Reporting Gains and Losses from Extinguishment of Debt,"
and the amendment to SFAS 4, SFAS 64, "Extinguishments of Debt Made to Satisfy
Sinking-Fund Requirements." Through this rescission, SFAS 145 eliminates the
requirement that gains and losses from the extinguishment of debt be aggregated
and, if material, classified as an extraordinary item, net of the related income
tax effect. Generally, SFAS 145 is effective for transactions occurring after
May 15, 2002. The Company does not believe SFAS 145 will have a material impact
on our future earnings or financial position.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated with
Exit or Disposal Activities" which is effective January 1, 2003. SFAS 146
nullifies Emerging Issues Tasks Force Issue No. 94-3 "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." This statement requires
that an exit or disposal activity related cost be recognized when the liability
is incurred instead of when an entity commits to an exit plan. This statement is
effective for disposal activities initiated after December 31, 2002. The
Company's adoption of FAS 146 on January 1, 2003 is not expected to have a
material impact on the Company's financial condition or results of operations.
10
11. Credit Agreement
The Company has a credit agreement with a bank that provides a $15 million
revolving line of credit ("Revolver") and a $9 million term loan facility. The
Revolver provides for a commitment fee of 0.375% to 0.500% of the unused balance
and interest at the prime rate or, at the Company's option, at LIBOR plus a
risk-adjusted premium. The Revolver matures on September 30, 2003. Draws under
the Revolver in cash or letters of credit are limited to a formula driven
borrowing base determined by the levels of certain receivables, as defined in
the agreement. The agreement's term loan facility was drawn on in full to fund
the EZ-CAP acquisition. There was $7,257,000 outstanding on the term loan at
September 30, 2002, which bears interest at LIBOR plus a risk-adjusted premium,
totaling 3.8% at September 30, 2002. The term loan facility matures on September
30, 2006 and is due in sixty equal monthly principal payments, plus interest.
There were no borrowings outstanding and there was approximately $5,000,000 of
borrowing capacity available under the Revolver as of September 30, 2002. As of
September 30, 2002, the Company failed to meet the minimum fixed charge coverage
requirement of the credit agreement. The counterparty to this credit agreement
has waived this violation.
11
Item 2.
OAO TECHNOLOGY SOLUTIONS, INC.
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 Condensed
Consolidated Financial Statements and Notes thereto found in this Form 10-Q.
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 that are not historical facts contained in this Form 10-Q,
including this Management's Discussion and Analysis of Financial Condition and
Results of Operations and Notes to Consolidated Financial Statements, constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such statements are based on currently available
operating, financial and competitive information, and are subject to various
risks and uncertainties. Future events and the Company's actual results may
differ materially from the results reflected in these forward-looking
statements. Factors that might cause such a difference include, but are not
limited to: dependence on key strategic and end-user customers, the ability to
establish new strategic customer relationships, risks associated with
fixed-price contracts, future financial results, the ability to sustain and
manage growth, lower than expected revenue growth and pricing pressure from
strategic and non-strategic customers, success in achieving marketing and sales
goals and other business development initiatives, difficulties of investments in
infrastructure, uncertainties relating to the difficulties of transacting on the
Internet, potential changes in the prevailing technology away from outsourcing
IT applications, the failure of the Company to make necessary enhancements or
developments to its existing software products, possible deferral of revenue,
profit and cash flow from any increase in per-member per-month and/or
percentage-of-completion basis software sales in relation to total software
sales, inability to successfully install healthcare software sold on a timely
basis, competition in the industry, general economic conditions and level of
information technology service spending, the possibility that strategic or
end-user customers could invoke early termination clauses contained in the
Company's long-term contracts, dependence on key personnel, the ability to
attract, hire and retain personnel who possess the technical skills and
experience necessary to meet the service requirements of its clients, the
ability to successfully integrate recent acquisitions, the potential liability
with respect to actions taken by its employees, ability to control and reduce
costs of the business, risks associated with international sales including
exposure to fluctuations between the U.S. dollar and other foreign currencies,
and other risks described herein and in the Company's other Securities and
Exchange Commission filings.
Overview
We provide managed IT services as a partner to global outsourcers, major
corporations, and select government agencies. The Company operates two business
segments: Managed IT Solutions and Healthcare IT Solutions.
Critical Accounting Policies
See Management's Discussion and Analysis of Financial Condition and Results of
Operations on our Form 10-K for the year ended December 31, 2001 for a
discussion of our critical accounting policies.
Managed IT Solutions
(Application Solutions and IT Infrastructure Solutions)
Application Solutions
Application Solutions provides outsourcing for a complete set of services
that include development/integration, management, and/or support of
applications. Application outsourcing may involve the transfer of people and
application software to OAOT and possibly to a remote application solution
center. We offer both customized and pre-packaged solutions. Application
Development/Integration services are delivered on a consulting and project basis
under both time-and-materials and fixed-price arrangements, while our
application management and software solutions are made available through an
application support model or outsourced from the customer. During 2001 we exited
the software license reseller portion of this practice.
12
IT Infrastructure Solutions
Our IT Infrastructure Solutions service offerings include Network and
Desktop Management Services (NDMS), Data Center Management (DCM) and
Professional Staffing Services. NDMS and DCM provide network and systems design,
integration, and management of large-scale environments linking multiple
technologies, operating systems, protocols and geographic areas. We manage
enterprise systems and provide desktop management services, which include
on-site and remote network systems management. These services are provided,
generally under long-term fixed-price contracts, as either part of an IT
outsourcing team with its strategic customers to a wide range of end users or
directly to Fortune 1000 customers and select government agencies. Our strategic
partners and customers include IBM and Hewlett-Packard (formerly Compaq). In
2000, our data center management contract with a strategic customer was renewed
for ten years. Management believes that revenues from this contract may increase
over the term of the contract; however, there is no assurance that revenues from
this contract will increase or continue at historic revenue and profitability
levels. Professional Staffing Services offers technology personnel, primarily on
a time-and-materials basis, that are regularly utilized within engagements to
meet short or indefinite term requirements. 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. The
Professional Staffing Services business is concentrated within one strategic
customer; however, we have expanded our customer base and will continue to focus
on expanding our customer base in the future.
Healthcare IT Solutions
The Healthcare IT Solutions segment provides managed care software
application solutions under software license agreements via its MC400 and EZ-CAP
software solutions, which are sold on a per member, per month (PMPM)
subscription basis, on a PMPM basis in an Application Service Provider model or
for a one-time perpetual license fee. Our MC400 software provides a
comprehensive solution for healthcare benefit organizations (health maintenance
organizations, indemnity insurance plans, physician hospital organizations,
independent physician organizations and self-insured employer plans, among
others). The MC400 system is web-enabled and provides over thirty modules that
include claims processing, patient care management, eligibility, enrollment,
utilization, internet connectivity, data warehousing, care management and web
portals in one integrated system. We have over fifty MC400 installed sites.
EZ-CAP is currently installed at approximately 150 clients and provides secure,
web-enabled modules for authorizations, premium billing, capitation payment,
data reconciliation, benefit administration, contract management, and health
plan and member eligibility management. The HealthCare IT solutions segment has
not met certain obligations under some of its customer agreements relating to
requirements to implement the software within certain time frames and therefore
it may be required to grant consideration to such customers for such delays.
Currently, we do not anticipate granting significant consideration to such
customers. The Healthcare IT Solutions segment is working with its customers to
allow them to meet the federal requirements of the Health Insurance Portability
and Accountability Act (HIPAA) but can offer no assurances that it will be able
to meet such requirements.
The Company recognizes software revenue under the provisions of Statement
of Position (SOP) No. 97-2, "Software Revenue Recognition" (as amended by SOP
No. 98-4 and SOP No. 98-9). Except as noted below, software license fees are
recognized as revenue upon the customer's execution of a noncancelable license
agreement and the Company's delivery of the software, provided that the fee is
fixed and determinable, collectibility is probable, and no customization of the
software is required. If customization of the software is required, revenues are
recognized on the percentage-of-completion basis over the software
implementation term (generally six to twelve months). Revenues from PMPM
software license arrangements are recognized monthly over the term of the
arrangement. As the healthcare industry and the needs of our customers become
more complex, the number of license sales requiring customization could increase
in the future. In addition, the Company is working to improve and upgrade its
customer contracting and delivery process in order to strengthen controls over
the software implementation schedule. These changes in the business process may
further lead to more license sales being accounted for under the
percentage-of-completion method.
13
We plan to continue efforts to market our software solutions on a PMPM
subscription basis. The pay-as-you-go feature of the PMPM model is attractive to
customers concerned with managing cash flow and broadens the target market for
our products. In addition, the PMPM model provides a more consistent and
predictable cash flow and revenue stream and could have a greater contract value
than a perpetual license sale. This effort to market our products on a PMPM
basis could result in the deferral of revenue, profit and cash flow in our
Healthcare IT Solutions segment in the short term.
Results of Operations
The following table sets forth, for the periods indicated, selected
statements of operations data as a percentage of revenues:
Three months ended Nine months ended
September 30, September 30,
--------------------------------------------------------------------------
(in millions) 2002 2001 2002 2001
--------------------------------------------------------------------------
Revenues $ 40.5 100.0% $ 40.3 100.0% $123.8 100.0% $120.2 100.0%
Direct costs 34.3 84.7% 32.2 79.9% 102.6 82.9% 98.0 81.5%
(Gain) loss on prepaid software licenses -- 0.0% -- 0.0% (1.4) -1.1% 5.1 4.2%
Selling, general and administrative expenses 7.8 19.3% 6.8 16.9% 21.4 17.3% 21.3 17.7%
Severance and other termination costs 0.7 1.7% -- 0.0% 2.0 1.6% -- 0.0%
--------------------------------------------------------------------------
(Loss) income from operations (2.3) -5.7% 1.3 3.2% (0.8) -0.6% (4.2) -3.5%
Interest and other income, net (0.1) -0.2% 0.1 0.2% (0.3) -0.2% 0.4 0.3%
--------------------------------------------------------------------------
(Loss) income before income taxes (2.4) -5.9% 1.4 3.5% (1.1) -0.9% (3.8) -3.2%
(Benefit) Provision for income taxes (1.0) -2.5% 0.6 1.5% (0.5) -0.4% (1.6) -1.3%
--------------------------------------------------------------------------
Net (loss) income $ (1.4) -3.5% $ 0.8 2.0% $ (0.6) -0.5% $ (2.2) -1.8%
--------------------------------------------------------------------------
Comparison of the three and nine month periods ended September 30, 2002 to the
three and nine month periods ended September 30, 2001
Revenues
Revenues increased $0.2 million to $40.5 million for the three months
ended September 30, 2002 (the "three month period"), compared to $40.3 million
for the same period in 2001. Revenues increased $3.6 million or 3.0% to $123.8
million for the nine months ended September 30, 2002 (the "nine month period"),
compared to $120.2 million for the same period in 2001. For the three month
period, revenue growth in the Managed IT Solutions segment was offset by a
decline in revenue in the Healthcare IT Solutions segment. The increase in
revenue for the nine month period was due to an increase in revenue in the
Healthcare IT Solutions segment, partially offset by a decrease in revenue in
the Managed IT Solutions segment.
Revenues from the Healthcare IT Solutions segment decreased $0.1 million
or 2.3% to $4.5 million for the three months ended September 30, 2002, compared
to $4.6 million for the same period in 2001. Revenues from the Healthcare IT
Solutions segment increased $5.7 million or 48.8% to $17.4 million for the nine
months ended September 30, 2002, compared to $11.7 million for the same period
in 2001. The slight decrease in revenues for the three month period was
attributable to a decline in MC 400 license revenue, partially offset by
increases related to EZ-CAP, implementation and PMPM revenues. The increase in
revenue during the nine month period was attributable to an increase in MC400
license revenue, stemming from both new contracts and from revenue recognized
for implementation services under contracts signed in 2001. In addition, revenue
from EZ-CAP, acquired in the third quarter of 2001, contributed to the increase.
Revenues from the Managed IT Solutions segment increased $0.3 million to
$36.0 million for the three months ended September 30, 2002, compared to $35.7
million for the same period in 2001. Revenues from the Managed IT Solutions
segment decreased $2.1 million to $106.4 million for the nine months ended
September 30, 2002, compared to $108.5 million for the same period in 2001. The
increase in revenues for the three month period was due to an increase in the
Application Solutions division, mostly offset by a decrease in the IT
Infrastructure
14
Solutions division. The decrease in revenues in the nine month period was due to
lower revenues in the IT Infrastructure Solutions division partially offset by
increases in revenues in the Application Solutions division.
Revenues from the IT Infrastructure Solutions division decreased $2.7
million or 11.0% to $22.1 million for the three months ended September 30, 2002,
compared to $24.8 million for the same period in 2001. Revenues from IT
Infrastructure Solutions decreased $11.4 million or 14.3% to $68.2 million for
the nine months ended September 30, 2002, compared to $79.6 million for the same
period in 2001. This decline was primarily due to decreases in Network and
Desktop Management services and Professional Staffing Services revenues,
partially offset by revenues growth in our European business. The decline in
Network and Desktop Management services revenues was due to in-sourcing of
services by one customer, and lower pricing and service levels under its current
contract requirements. The decrease in Professional Staffing Services revenues
was due to continued softness in staffing requisitions from a strategic customer
and by the decline in IT staff requisitions as a result of the slow down in the
technology market. This softness is expected to continue into future periods. In
fact, one strategic customer has indicated that they do not expect a significant
increase in business until 2004. Additionally, the Managed IT Solutions segment
has experienced and expects to continue to experience pricing and volume
pressure from strategic customers due to an excess supply of IT professionals
and soft market conditions, which is expected to be partially passed through to
the Company's suppliers. The Company is attempting to diversify its customer
base in its Managed IT Solutions segment, which is expected to partially
mitigate reliance on strategic customers and diversify services.
Revenues from our Application Solutions division increased $3.0 million or 27.6%
to $13.9 million for the three months ended September 30, 2002, compared to
$10.9 million for the same period in 2001. Revenues from our Application
Solutions division increased $9.2 million or 31.8% to $38.2 million for the nine
months ended September 30, 2002, compared to $29.0 million for the same period
in 2001. This increase in revenues was due primarily to increased activity in
the Application Support and Application Management businesses and attributable
to a contract signed in 2001. Due to a lower than expected level of business
transition from the end customer, through mutual agreement with our customer,
the statement of work under the contract signed in 2001 was terminated in July
2002. This termination is expected to result in a reduction of billable
headcount by 15. In the short term this loss of revenues was offset by an early
termination settlement from the customer for the statement of work under the
service agreement. In the long term we expect further opportunities to develop
from our relationship with this customer. This division experienced an increase
in billable headcount from 447 at September 30, 2001 to 548 at September 30,
2002. Our strategic customer in this division can add or delete headcount under
our agreement based on the end customer's needs and other contract terms. We
currently anticipate a reduction in headcount during the fourth quarter of 2002,
and possible reductions in early 2003. New contracts will have to be won for
increases in billable headcount to continue. These revenue increases were
partially offset by decreases in Application Development/Integration revenue as
a result of the absence of activity from certain money-losing businesses we
exited in the last half of 2001.
Direct Costs
Direct costs increased $2.1 million to $34.3 million for the three months
ended September 30, 2002, compared to $32.2 million in the same period in 2001.
Direct costs increased $4.6 million to $102.6 million for the nine months ended
September 30, 2002, compared to $98.0 million in the same period in 2001. Direct
costs as a percentage of revenues increased to 85% for the three months ended
September 30, 2002 as compared to 80% for the same period in 2001. Direct costs
as a percentage of revenues increased to 83% for the nine months ended September
30, 2002 as compared to 81% for the same period in 2001.
For the three and nine month periods ended September 30, 2002,
improvements in profitability in the Managed IT Solutions segment were offset by
a decline in profitability in the Healthcare IT Solutions segment.
The Managed IT Solutions segment direct costs decreased $0.8 million to
$28.1 million for the three months ended September 30, 2002, compared to $28.9
million for the same period in 2001. The Managed IT Solutions segment direct
costs decreased $4.0 million to $85.9 million for the nine months ended
September 30, 2002, compared to $89.9 million for the same period in 2001. The
decrease was due to the elimination of certain unprofitable business operations
and a decrease in direct costs in the IT Infrastructure Solutions division
partially offset by increases in the Application Solutions division. This
decrease in direct costs in IT Infrastructure Solutions
15
reflects the overall decrease in activity in the division as well as
improvements in the management of direct labor expenses and savings from the
reduction of overhead personnel. The increases in Application Solutions direct
costs reflect the overall increase in business activity in the segment. The
Application Solutions division gross profit increased to $8.7 million for the
nine months ended September 30, 2002 from $4.3 million for the same period in
2001. The improvement in profitability was the result of a more favorable mix in
billable to non-billable headcount, and an overall increase in billable
headcount (from 447 in September 2001 to 548 in September 2002) in the
Application Support and Application Management practices.
Healthcare IT Solutions' direct costs for the three months ended September
30, 2002 increased $2.8 million to $6.1 million, compared to $3.3 million for
the same period in 2001. Healthcare IT Solutions' direct costs for the nine
months ended September 30, 2002 increased $8.7 million to $16.7 million,
compared to $8.0 million for the same period in 2001. The increase in direct
costs for the three and nine month periods were primarily the result of
increased expenses for consultants and customer support personnel to fulfill
software implementation commitments. We anticipate completion of several
implementations by the end of the year, which will enable us to provide ongoing
implementation services in a more timely and cost effective manner. In addition,
the purchase of EZ-CAP in the third quarter of 2001 and the expansion of the
Healthcare IT Solutions management team contributed to the increase.
(Gain) Loss on Prepaid Software Licenses
In connection with a Value Added Industry Remarketer agreement with Siebel
Systems, Inc. ("Siebel"), on August 31, 1999, the Company purchased software
licenses in the amount of $5.1 million for resale to third parties. The software
licenses were purchased with cash of $2.8 million, a future payment of $1.1
million, and 228,800 shares of the Company's common stock. During 2001, the
Company wrote-off the value of its entire investment in Siebel software licenses
and filed suit against Siebel alleging breach of the implied duty of good faith
and lack of fair dealing under these agreements.
On June 28, 2002, the Company and Siebel entered into a Settlement
Agreement and Mutual Release in Full (the Release), effective June 30, 2002. In
accordance with the Release, the parties provided each other with mutual
releases and both parties acknowledge that the Siebel agreements are terminated,
and that each party is released from any further performance other than the
Company was granted an 18-month license to continue to use those Siebel products
currently installed on the Company's system. As such, 228,800 shares of the
Company's common stock provided as consideration under the Siebel agreements
were retired by the Company at the fair market value of the common stock on the
effective date of the Release, resulting in a gain of $456,000 during the nine
months ended September 30, 2002. In addition, the Company recognized a gain of
approximately $1.1 million related to the reversal of liabilities for
commitments to purchase software licenses under the Siebel agreements, net of
legal and other costs to execute the Release of approximately $0.2 million
during the nine months ended September 30, 2002.
Selling, General and Administrative Expenses
For the three months ended September 30, 2002 and 2001, selling, general
and administrative expenses (SGA) were $7.8 million and $6.8 million, or 19% and
17% of revenues, respectively. For the nine months ended September 30, 2002 and
2001, SGA was $21.4 million and $21.3 million, or 17% and 18% of revenues,
respectively. For the three month period SGA increased as savings from a
Company-wide effort to reduce costs, including the elimination of certain
non-essential positions, were offset by increases in SGA in the Healthcare IT
Solutions segment as a result of an increase in management and staff to
facilitate growth and the EZ-CAP acquisition. During the nine month period ended
September 30, 2001, the write down of certain receivables and advances were
included in SGA, totaling $1.7 million, which did not recur in 2002. Absent
these write downs, SGA for the nine month period increased $1.8 million. This
increase in SGA is primarily due to increases in SGA in the Healthcare IT
Solutions segment as a result of an increase in management and staff to
facilitate growth and the EZ-CAP acquisition. In addition, we have added sales
and contract support staff in our Public Sector business as we continue to
pursue new contracts in the Federal IT market.
16
Severance and Other Termination Costs
Gregory A. Pratt
On April 19, 2002, Charles A. Leader succeeded Gregory A. Pratt as
President and Chief Executive Officer. Mr. Pratt was named Vice Chairman of the
Board of Directors of the Company. In his new role, Mr. Pratt will assume the
responsibilities for merger and acquisition activity and corporate development.
Effective April 19, 2002, the Company and Mr. Pratt entered into a
Transition Agreement and General and Special Release (the Transition Agreement),
which finalized the terms of his resignation and severance in accordance with
his employment agreement. As part of the Transition Agreement, Mr. Pratt will
continue to receive certain payments through July 2003 in accordance with his
employment agreement. Accordingly, severance for Mr. Pratt in the amount of
$614,000 was recorded during the nine months ended September 30, 2002.
In accordance with the Transition Agreement, (i) all unexercised options
granted to Mr. Pratt other than the 750,000 stock options to buy the Company's
common stock, par value $.01 (the common stock) granted to Mr. Pratt in 2001,
were forfeited and (ii) the term of 750,000 stock options to buy the Company's
common stock granted to Mr. Pratt in 2001 was extended through January 1, 2008.
As a result, the intrinsic value of the 2001 stock options was re-measured on
April 19, 2002, resulting in expense of approximately $277,000 during the nine
months ended September 30, 2002.
Other
During June 2002, a combined 19 positions were eliminated in our Managed
IT Solutions segment and corporate headquarters. All 19 employees were
terminated prior to June 30, 2002. As a result, Severance and Other Termination
Costs of approximately $448,000 was recognized in the nine months ended
September 30, 2002.
During the three months ended September 30, 2002, an additional 11
positions were eliminated in our Managed IT Solutions segment. All 11 employees
were terminated prior to September 30, 2002. As a result, Severance and Other
Termination Costs of approximately $546,000 was recognized in the three month
period. As a result of these cost cutting measures, certain office space was
vacated during the third quarter. Lease termination fees of approximately
$150,000 were incurred and recorded in Severance and Other Termination Costs
during the three month period.
The Company expects to incur additional Severance and Other Termination
Costs during the fourth quarter of 2002 related to measures to streamline our
Healthcare IT Solutions business.
Interest and Other Income and Provision for Income Taxes
For the three and nine months ended September 30, 2002, net interest and
other income (expense) decreased to $(0.1) million and $(0.3) million,
respectively, from $0.1 million and $0.4 million for the respective periods in
2001. The decrease was primarily due to lower interest rates on invested cash
and an increase in interest expense related to the term loan used to finance the
EZ-CAP acquisition. The Company's effective tax rate was approximately 42.5% for
the benefit for income taxes for the three and nine months ended September 30,
2002, essentially consistent with the same periods in 2001.
Liquidity and Capital Resources
Cash and cash equivalents were $10.7 million as of September 30, 2002,
versus $9.1 million as of December 31, 2001. Cash provided by operations was
$6.5 million for the nine months ended September 30, 2002, compared with cash
provided by operations of $4.8 for the same period in 2001. The increase in cash
provided by operations was primarily due to a decrease in accounts receivable,
an increase in accounts payable, and non cash charges for depreciation and
amortization, partially offset by a non cash gain related to prepaid software
licenses and increases in other assets and income tax receivable.
17
Cash used in investing activities was $0.1 million in the nine months
ended September 30, 2002, which was a result of our receipt of payment in full
of the note receivable from OAO Corporation, offset by cash used to purchase
computers and office equipment.
Financing activities used cash of $5.0 million in the nine months ended
September 30, 2002. This use of cash was primarily to fund the repurchase and
retirement of our common stock under our stock repurchase program and payments
on our term loan and capital lease obligations.
The Company has a credit agreement with a bank that provides a $15 million
revolving line of credit ("Revolver") and a $9 million term loan facility. The
Revolver provides for a commitment fee of 0.375% to 0.500% of the unused balance
and interest at the prime rate or, at the Company's option, at LIBOR plus a
risk-adjusted premium. The Revolver matures on September 30, 2003. Draws under
the Revolver in cash or letters of credit are limited to a formula driven
borrowing base determined by the levels of certain receivables, as defined in
the agreement. The agreement's term loan facility was drawn on in full to fund
the EZ-CAP acquisition. There was $7,257,000 outstanding on the term loan at
September 30, 2002, which bears interest at LIBOR plus a risk-adjusted premium,
totaling 3.8% at September 30, 2002. The term loan facility matures on September
30, 2006 and is due in sixty equal monthly principal payments, plus interest.
There were no borrowings outstanding and there was approximately $5,000,000 of
borrowing capacity available under the Revolver as of September 30, 2002.
As of September 30, 2002, the Company failed to meet the minimum fixed
charge coverage requirement of the credit agreement. The counterparty to this
credit agreement has waived this violation.
We are currently in the process of renegotiating our credit agreement. We
believe we are in good standing with the counterparty to our credit agreement,
however, there is no assurance that we will be able to obtain incremental
borrowing capacity under a renegotiated credit agreement.
We currently anticipate that our existing cash balances and any cash
generated from operations will be sufficient to satisfy our operating cash needs
for the foreseeable future. We may use bank credit to leverage our financial
position. We have suspended our previously announced acquisition program while
we renegotiate our credit agreement. We may use available cash generated from
operations to purchase and retire up to 2 million shares of our Common Stock on
the open market under a Board of Director approved plan. In addition, we may
consider seeking additional public or private debt or equity financing to fund
future growth opportunities. No assurance can be given, however, that such
additional debt or equity financing will be available or on terms and conditions
acceptable to us.
Recent Accounting Pronouncements
In April 2002, the FASB issued Statement of Financial Standards No. 145
("SFAS 145"), "Rescission of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13, and Technical Corrections." Among other things, SFAS 145
rescinds both SFAS 4 "Reporting Gains and Losses from Extinguishment of Debt,"
and the amendment to SFAS 4, SFAS 64, "Extinguishments of Debt Made to Satisfy
Sinking-Fund Requirements." Through this rescission, SFAS 145 eliminates the
requirement that gains and losses from the extinguishment of debt be aggregated
and, if material, classified as an extraordinary item, net of the related income
tax effect. Generally, SFAS 145 is effective for transactions occurring after
May 15, 2002. The Company does not believe SFAS 145 will have a material impact
on our future earnings or financial position.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated
with Exit or Disposal Activities" which is effective January 1, 2003. SFAS 146
nullifies Emerging Issues Tasks Force Issue No. 94-3 "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." This statement requires
that an exit or disposal activity related cost be recognized when the liability
is incurred instead of when an entity commits to an exit plan. This statement is
effective for disposal activities initiated after December 31, 2002. The
Company's adoption of FAS 146 on January 1, 2003 is not expected to have a
material impact on the Company's financial condition or results of operations.
18
Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary market risk is foreign currency exposure and
changing interest rates. We conduct business in foreign countries, primarily
Canada and the United Kingdom. Foreign currency transaction gains and losses
were not material to our results of operations during the three and nine months
ended September 30, 2002 or 2001. We believe our foreign currency risk is
related primarily to the difference between amounts the Company receives and
disburses in Canada in U.S. dollars from U.S. dollar denominated contracts. Our
foreign currency risk will increase with the growth of our business. Our
interest rate risk is related to the variable rate on amounts outstanding on our
credit agreement. Amounts outstanding on the term loan bear interest at LIBOR
plus a risk-adjusted premium, totaling 3.8% at September 30, 2002.
On October 31, 2001, to comply with the terms of our credit agreement, we
entered into an interest rate swap agreement effectively converting the interest
rate from variable to fixed on 63.33% of the principal amount outstanding on the
term loan. The swap agreement is for a period of 4 years and fixes the variable
portion of the interest rate on the term loan to 2.67% through October 2002,
4.09% through October 2003, 5.22% through 2004 and 5.72% through 2005. As of
September 30, 2002, the notional amount of the term loan covered by the swap
agreement was $4,700,000 and the market value of the swap was a liability of
$207,000. The interest rate under this swap agreement, including the
risk-adjusted premium, was 4.67% at September 30, 2002.
Through September 30, 2002, we have not entered into any significant
foreign currency forward exchange contracts or other derivative financial
instruments to hedge the effects of potential adverse fluctuations in foreign
currency exchange rates or interest rates, other than described herein; however,
the Company periodically reviews its exposure to foreign currency and interest
rate risk and may take action to limit its exposure if deemed appropriate.
19
Item 4. Controls and Procedures
a) Evaluation of disclosure controls and procedures.
As required by Rule 13a-14 under the Exchange Act, (the "Act") within 90 days
prior to the filing date of this quarterly report (the "Evaluation Date"), the
Company carried out an evaluation of the effectiveness of the design and
operation of the Company's disclosure controls and procedures. This evaluation
was carried out under the supervision and with the participation of the
Company's management, including the Company's chief executive officer and chief
financial officer. Based upon that evaluation, the Company's chief executive
officer and chief financial officer concluded that the Company's disclosure
controls and procedures as currently in effect are effective in ensuring that
the information required to be disclosed by the Company in the reports it files
or submits under the Act is (i) accumulated and communicated to the Company's
management (including the Chief Executive Officer and Chief Financial Officer)
in a timely manner, and (ii) recorded, processed, summarized and reported within
the time periods specified in the SEC's rules and forms.
b) Changes in internal controls.
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect the Company's internal controls
subsequent to the Evaluation Date, including any corrective actions with regard
to significant deficiencies and material weaknesses.
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Designation Description
- ----------- -----------
99.1 Certification of Charles A. Leader pursuant to 18 U.S.C. Section 1350.
99.2 Certification of J. Jeffrey Fox pursuant to 18 U.S.C. Section 1350.
(b) Reports on Form 8-K
1) The Company filed a Form 8-K with the Commission on August 14, 2002 to
report that Charles A. Leader, President and Chief Executive Officer of
the Company and J. Jeffrey Fox, Senior Vice President of Finance and Chief
Financial Officer of the Company, each furnished to the Securities and
Exchange Commission personal certifications pursuant to 18 U.S.C. Section
1350. This report on Form 8-K was dated August 14, 2002.
2) The Company filed a Form 8-K with the Commission on August 20, 2002 to
report that the Company announced the appointments of Charles A. Leader,
OAOT's President and Chief Executive Officer, Donald Glickman, General
Paul X. Kelley and George A. Sawyer as members of its Board of Directors,
expanding OAOT's Board of Directors to 11 members. This report on Form 8-K
was dated August 16, 2002.
3) The Company filed a Form 8-K with the Commission on August 22, 2002 to
report that the Company announced that its board of directors authorized a
share repurchase program for up to two million shares of common stock,
using cash on hand and cash flow generated from operations. This report on
Form 8-K was dated August 21, 2002.
20
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OAO Technology Solutions, Inc.
(Registrant)
Date: November 14, 2002 By: /s/ Charles A. Leader
--------------------------
Charles A. Leader
President and Chief Executive Officer
Date: November 14, 2002 By: /s/ J. Jeffrey Fox
--------------------------
J. Jeffrey Fox
Senior Vice President of Finance and
Chief Financial Officer
21
CERTIFICATIONS
I, Charles A. Leader, President and Chief Executive Officer of OAO Technology
Solutions, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of OAO Technology
Solutions, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data and
have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 14, 2002 By: /s/ Charles A. Leader
--------------------------
Charles A. Leader
President and Chief Executive Officer
22
CERTIFICATIONS
I, J. Jeffrey Fox, Senior Vice President of Finance and Chief Financial Officer
of OAO Technology Solutions, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of OAO Technology
Solutions, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data and
have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 14, 2002 By: /s/ J. Jeffrey Fox
---------------------
J. Jeffrey Fox
Senior Vice President of Finance and
Chief Financial Officer
23