10-Q 1 p64038e10-q.txt 10-Q 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OSAGE SYSTEMS GROUP, INC. (Exact name of registrant as specified in its charter) DELAWARE 0-22808 95-4374983 (State of Incorporation) (Commission File No.) (IRS Employer Identification No.)

1661 EAST CAMELBACK ROAD SUITE 245 PHOENIX, ARIZONA 85016 (Address of principal executive office) (602) 274-1299 (Registrant's telephone number, including area code) Check whether the Registrant: (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. (1) Yes X No ------ ------ (2) Yes X No ------ ------ APPLICABLE ONLY TO CORPORATE ISSUERS: The number of shares outstanding of the Registrant's sole class of common stock as of November 10, 2000 was 33,151,155 shares. 2 OSAGE SYSTEMS GROUP, INC. INDEX

* The accompanying financial information is not covered by an Independent Certified Public Accountant's Report. 3 OSAGE SYSTEMS GROUP, INC. CONDENSED CONSOLIDATED BALANCE SHEETS ($ In Thousands)

See notes to unaudited condensed consolidated financial statements. 1 4 OSAGE SYSTEMS GROUP, INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in Thousands except per share amounts)

See notes to unaudited condensed consolidated financial statements. 2 5 OSAGE SYSTEMS GROUP, INC. UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS ($ in Thousands)

See notes to unaudited condensed consolidated financial statements. 3 6 OSAGE SYSTEMS GROUP, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation. In the opinion of the Company, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial position of the Company and the results of its operations and its cash flows for the periods reported. The results of operations for interim periods are not necessarily indicative of the results to be expected for the entire year. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The consolidated financial statements include the accounts of Osage Systems Group, Inc. ("Osage") and its wholly-owned subsidiaries, Osage Computer Group, Inc. ("Osage Computer"), Solsource Computers, Inc. ("Solsource"), H.V. Jones, Inc. ("HV Jones"), Open System Technologies, Inc. ("OST"), Open Business Systems, Inc. ("OBS"), Osage Systems Group Minnesota, Inc., Osage Support Center, Inc. and Osage iXi (collectively, the "Company"). All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to the prior financial statements to conform to the current classifications. The information presented within the accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company's audited Financial Statements for the fiscal years ended December 31, 1999 and 1998 and "Management's Discussion and Analysis or Plan of Operation" from the 1999 Annual Report on Form 10-KSB. 2. Earnings Per Share. The Company has adopted Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings per Share. Net loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding during the period after giving effect to stock options and the conversion of preferred shares considered to be dilutive. Because the Company incurred a loss for the three and nine months ended September 30, 2000 and 1999, the effects of the potential dilutive securities are not included in the calculations. 4 7 3. New Accounting Pronouncements. In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. Subsequent to the issuance of SFAS No. 133, the FASB received many requests to clarify certain issues causing difficulties in implementation. In June 2000, the FASB issued SFAS No. 138 responding to those requests by amending certain provisions of SFAS No. 133. The Company will adopt SFAS No. 133 and the corresponding amendments under SFAS No. 138 no later than the first quarter of the fiscal year ending December 31, 2001. SFAS No. 133, as amended by SFAS No. 138, will not have a material impact on the Company's results of operations or financial position. 4. Income Taxes. The Company accounts for income taxes using the asset and liability approach, which can result in recording tax provisions or benefits in periods different than the periods in which such taxes are paid or benefits realized. Deferred income taxes are recorded for the difference between the book and tax basis of various assets and liabilities that can provide for current recognition of expected tax benefits from temporary differences that will result in deductible amounts in future years. The Company believes an ownership change occurred in 2000, the effect of which will be to limit annual usage of net operating loss carryovers in the future, pursuant to IRC Section 382. At this time, management believes this will not result in an inability to use ultimately all of the net operating losses in the future that are not currently reserved with a valuation allowance. 5 8 The deferred income tax asset at September 30, 2000 and December 31, 1999 is comprised of the following: ($ In Thousands)

6 9 5. Convertible Preferred Stock and Capital Stock. During 1998, the Company completed a private placement offering for 1,000 shares of Series D Preferred shares (the "Series D Shares"). In connection with the private placement, warrants to purchase 100,000 shares of the Company's Common Stock at an exercise price of $5.97 per share were granted to the investor. The holder of the Series D Shares had the right at any time following the 90th day after the issuance date to convert the $1,000,000 principal amount of the shares, plus any and all accrued dividends thereon, into shares of Common Stock at the Series D conversion rate of $4.975 per share. The Series D conversion rate was subject to adjustment if the Company failed to comply with certain redemption provisions described below. As so adjusted, the conversion rate was equal to the lesser of $4.975 or 80 percent of the three lowest closing bid prices of the Common Stock during the five trading days immediately preceding the conversion date. The Series D Shares could be redeemed at the option of the holder upon 10 business days written notice after the first anniversary of the issuance date, if the closing bid price calculated as of the first anniversary of the issuance date was less than the conversion price as of the issuance date. The redemption price was 120% of the stated value ($1,000 per share) plus accrued and unpaid dividends. At the date of issuance, the carrying amount of the redeemable preferred stock was decreased by $154,000, the fair value of the common stock warrants, with a credit to additional paid-in capital. As of December 31, 1999 the preferred stock became redeemable at the option of the holder. Therefore, the preferred stock was accreted to its redemption value with an increase to the net loss in the consolidated statement of operations to arrive at the amount of loss attributable to common shareholders. On January 18, 2000, the holder of the Series D Shares converted 500 shares, at a conversion price of $1.07, into 468,736 shares of Common Stock. On February 10, 2000, the remaining 500 Series D Shares were converted, at a conversion price of $1.73, into an additional 288,468 shares of Common Stock. During 1999, the Company completed a private placement offering for 2,000 shares of Series E Preferred shares (the "Series E Shares"). In connection with the private placement, warrants to purchase 100,000 shares of the Company's Common Stock at an exercise price of $7.875 per share were granted to the investor. The holder of the Series E Shares had the right at any time following the 90th day after the issuance date to convert the $2,000,000 principal amount of the shares, plus any and all accrued dividends thereon, into shares of Common Stock at the Series E conversion rate of $6.5625 per share. The Series E conversion rate was subject to adjustment if the Company failed to comply with certain redemption provisions described below. As so adjusted, the conversion rate was equal to the lesser of $6.5625 or 80 percent of the three lowest closing bid prices of the Common Stock during the five trading days immediately preceding the conversion date. The Series E Shares could be redeemed at the option of the holder upon 10 business days written notice after the first anniversary of the issuance date if the closing bid price calculated as of the first anniversary of the issuance date was less than the conversion price as of the issuance date. The redemption price was 120% of the stated value ($1,000 per share) plus accrued and unpaid dividends. At the date of issuance, the carrying amount of the redeemable preferred stock was decreased by $180,000, the fair value of the common stock warrants, with a credit to additional paid-in capital. During the three months ended March 31, 2000, the preferred stock became redeemable at the option of the holder. 7 10 Therefore, the preferred stock was accreted to its redemption value with an increase to the net loss in the consolidated statement of operations to arrive at the amount of loss attributable to common shareholders. On February 22, 2000, the holder of the Series E Preferred Stock converted 133 shares of preferred stock into 20,267 shares of Common Stock of the Company at a conversion price of $6.5625 per common share. On March 17, 2000 the Company redeemed the remaining shares of Series E Preferred Stock at the redemption price of $1,200 per preferred share. To redeem the Series E Preferred Stock, the Company obtained $3,000,000 from the holders of the Long-Term Warrants (see Note 6) pursuant to an unsecured interest-free demand note. The note has since converted to equity pursuant to the automatic conversion that occurred concurrent with the effectiveness of the Company's Form S-3 which was filed on August 28, 2000. 6. Convertible Subordinated Debentures. On November 22, 1999, the Company completed a private placement offering for $3 million principal amount 10% Convertible Subordinated Debentures (the "Debentures"). In connection with the private placement, common stock purchase warrants were granted to the investors and to the broker of the transaction. The principal amount of the Debentures is payable on November 22, 2001 with interest payable at the rate of ten percent (10%) per annum on a quarterly basis commencing December 31, 1999. Interest may be paid in cash, or at the option of the holder, in shares of the Company's Common Stock priced at the conversion price, as defined, of the Debentures. At the option of the holder, the Debentures are convertible into shares of the Company's Common Stock at the conversion price per share at any time prior to maturity. The shares of Common Stock issuable upon the conversion of the Debentures may be resold under an effective registration statement filed with the Securities and Exchange Commission. Since the registration became effective on August 28, 2000, the Debentures have automatically converted into shares of the Company's Common Stock at the market price of the stock on the closing of the transaction. The conversion price was $.30 per share of Common Stock (reflective of a twenty percent (20%) discount to the market price of the Common Stock on October 8, 1999). The Debentures had a beneficial conversion feature which was valued at $750,000 at the date of issuance. Since the debt was convertible at any time after the Company's stockholders approved the conversion feature, this amount was charged to interest expense in May 2000 when stockholder approval was obtained. The Debentures were privately offered as a Unit, together with warrants that, subject to certain vesting provisions, entitled the holders to contingently purchase 20,000,000 shares of Common Stock of the Company at an exercise price of $.30 per share. The warrants consist of 5-year warrants to purchase 10,000,000 shares of Common Stock of the Company (the "Long-Term Warrants") and 90-day warrants to purchase 10,000,000 shares of Common Stock of the Company (the "Short-Term Warrants"). All of the Short-Term Warrants expired on February 22, 2000. The Long-Term Warrants vested in May 2000 when stockholder approval of the exercise feature of these warrants was obtained. 8 11 The carrying amount of the Debentures had been decreased by $1,325,840, the fair value of the common stock warrants issued to the holder. This amount was to be amortized as interest expense over the term of the convertible debt. However, since the debt has converted, the remaining interest accretion was recognized upon the effectiveness of the registration statement. During the fourth quarter of 1999 and the first nine months of 2000, the Company amortized $70,711 and $1,255,129 respectively as interest expense. As is discussed above, at the Company's annual meeting of stockholders, which was held on May 31, 2000, the stockholders approved the conversion and exercise feature of the Debentures and the Long-Term Warrants. A registration statement relating to the Debentures and Long-Term Warrants became effective during the third quarter of 2000. As a result, the Debentures and Warrants automatically converted resulting in approximately 20,000,000 shares of Common Stock being available to the holders of the Debentures and the Long-Term Warrants. This conversion had a dilutive effect on the existing stockholders. Furthermore, holders of the Debentures and the Long-Term Warrants now beneficially own approximately 58% of the Company's Common Stock, thereby securing majority voting control of the Company's stock. On July 21, 2000 the Company completed a private placement offering for $4 million principal amount 10% Convertible Subordinated Debentures (the "10% Debentures"). The principal amount of the Debentures is payable on July 15, 2001 with interest payable at the rate of ten percent (10%) per annum commencing July 25, 2000. Principal and interest may be paid in cash, or at the option of the Company, in shares of the Company's subsidiary Osage iXi's Common Stock priced at $1 per share. Such a conversion, assuming the full $4 million is converted, would convert into 40% of Osage iXi's stock. No interest is due if the Note is converted. Osage iXi began business on August 1, 2000. At that time, Osage iXi received certain assets and retained the services of certain individuals now utilized by other subsidiaries of the Company. For additional information refer to Part II, Item 5 "Other Information". On September 22, 2000 the Company completed a private placement of $2.25 million of 8% Convertible Subordinated Debentures (the "8% Debentures"). The principal amount of the 8% Debentures is payable on October 1, 2001 with interest payable at the rate of eight percent (8%) per annum. Subject to the holders right to convert, interest is payable quarterly in arrears commencing January 1, 2001. The conversion price is a maximum of $.80 per share subject to downward adjustment depending on the market price of the stock. For additional information refer to Part II, Item 5 "Other Information". 7. Contingencies. The Company is involved in litigation and various other legal matters that have arisen in the ordinary course of business. The Company does not believe that the ultimate resolution of existing matters will have a material adverse effect on its financial condition, results of operations, or cash 9 12 flows. On or about March 7, 2000, Halifax Fund, L.P. commenced an action against the Company, as well as Michael Lauer and three investment funds managed by him, Lancer Offshore, Inc., Lancer Partners, L.P. and Orbiter Fund, Ltd. (collectively "Lancer") in the Supreme Court of the State of New York (the "Court") captioned Halifax Fund, L.P. v. Osage Systems Group, Inc., Michael Lauer, Lancer Offshore, Inc., Lancer Partners, L.P. and Orbiter Fund, Ltd., Supreme Court of the State of New York, County of New York (Index No. 600993/00). In its complaint, Halifax alleges that the Company breached a contractual obligation to offer Halifax a right of first refusal to participate in a financing transaction the Company completed with Lancer in November 1999 (see Note 6). Halifax also alleges that the Company breached a contractual obligation to register securities issuable upon the conversion of preferred stock Halifax purchased from the Company in February 1999. Halifax seeks: (i) monetary damages in excess of $23 million for the alleged breaches of contract; (ii) specific performance of the right of first refusal; (iii) injunctive relief preventing the Company from issuing shares of its Common Stock to Lancer upon the conversion of debentures and the exercise of warrants granted in the Lancer financing; and (iv) injunctive relief preventing the Company from soliciting stockholder approval for the Lancer financing, which was a necessary condition precedent for the issuance of the Company's Common Stock under the Debentures and the Long-Term Warrants issued to Lancer. As to the remainder of the substantive claims, the Company is in the process of investigating the matter and has tentatively concluded that no breach of contract occurred. It has arrived at this conclusion in reliance on information provided by its investment bankers that they provided Halifax with the requisite written right of first refusal offer in compliance with the Company's contractual obligation to do so. Accordingly, the Company intends to vigorously defend the matter. Since the Company's investigation of the matter has not yet been completed, and since no assurances can be provided as to the ultimate outcome of litigation, particularly where fact-based disputes may arise, the Company cannot assure that it will not be subject to any liability thereunder. In the event that it is successful in asserting its claims, Halifax may be awarded relief consisting of, among others, the right to purchase securities of the Company on the same terms as the Debentures and the Long-Term Warrants offered to Lancer (in which case the Company may be caused to issue additional securities convertible into up to 13,333,333 shares of the Company's Common Stock) or monetary damages which may, if fully awarded, exceed the Company's current asset value. Due to the Company's belief that the claims are without merit, no provision has been established for any potential liability arising out of the litigation. On October 29, 1999, John E. Udelhofen and E. Michael Durbin filed an action in the United States District Court for the Northern District of Illinois against the Company. The Plaintiffs are former shareholders of Open Business Systems, Inc. ("OBS"). On June 22, 1998 The Company purchased all of the outstanding shares of OBS and the Plaintiffs entered into employment contracts with the Company. On August 17, 1999, the Company terminated the Plaintiffs' employment contracts. In the lawsuit the Plaintiffs claim their employment contracts were wrongfully terminated and seek damages in excess of $75,000 as well as declaratory relief. The Plaintiffs also claim that the Company breached the Registration Rights Agreement entered into by the parties in connection 10 13 with the sale of the stock of OBS. The Plaintiffs claim that the Company failed to timely file the necessary registration statement with the Securities and Exchange Commission with respect to the registration for resale of the Company's Common Stock distributed to plaintiffs in connection with the transaction. Plaintiffs also claim that they are owed additional sums pursuant to the "earnout" provisions of the Agreement by which the Company purchased OBS. The Company has answered Plaintiffs' claims denying that they are entitled to any relief. Additionally Osage is asserting counterclaims against certain of the Plaintiffs for violation of provisions of both the Purchase Agreement and their employment agreements. The Company accordingly believes it has valid defenses to all of the Plaintiffs' claims and intends to vigorously defend the matter. 8. Segment Reporting. The Company engages in business activities in two operating segments, Systems Integration and Consulting Services. However, the Consulting Services segment has not materially developed and the Company therefore has not reported separate activity at this point. The chief operating decision-makers are provided information about the revenues generated in key client industries. The resources needed to deliver the Company's services are not separately reported by industry. The Company's services are delivered to clients primarily in the United States and the Company's long-lived assets are all located in the United States. 9. Subsequent Event. During October 2000, GE Access agreed to convert an existing term loan and apply obligations due to GE Access from the Company to a new note payable. The new note is for $2.4 Million and carries an interest rate of 11%. The note is payable weekly in equal installments of $50,000 beginning January 1, 2001 until paid in full (December 2001). Until 2001, the weekly payment required is for interest only. In consideration of extending this Note and in consideration of its terms, the Company agreed to issue 140,000 three-year warrants at $1 per share. 11 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 When used in this Report on Form 10-Q, the words "may," "will," "expect," "anticipate," "continue," "estimate," "intend," and similar expressions are intended to identify forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 regarding events, conditions and financial trends which may affect the Company's future plans of operations, business strategy, operating results and financial position. Such statements are not guarantees of future performance and are subject to risks and uncertainties and actual results may differ materially from those included within the forward-looking statements as a result of various factors. Such factors include, among others: (i) risks related to the restructuring program being undertaken by the Company; (ii) risks related to the Company's acquisition strategy; (iii) the Company's ability to secure adequate financing to implement its business strategies; (iv) uncertainty as to whether the Company can achieve integration of acquired companies in a manner intended to take advantage of overall corporate synergies and result in an accretion to consolidated earnings; (v) the uncertainty of future trading prices for the Company's Common Stock and the impact such trading prices may have upon the Company's ability to utilize its Common Stock to facilitate its acquisition strategy; (vi) the uncertain effect of the additional dilution associated with the future issuance of outstanding convertible securities, as well as the dilution associated with the Company's acquisition strategy; (vii) the Company's dependence on certain large customers and suppliers; (viii) the Company's dependence on certain key personnel; and (ix) the competitive market for technical personnel. Additional factors are described in the Company's other public reports and filings with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date made. The Company undertakes no obligation to publicly release the result of any revision of these forward-looking statements to reflect events or circumstances after the date they are made or to reflect the occurrence of unanticipated events. OVERVIEW Through its operating subsidiaries, the Company markets a broad range of integrated information technology products and professional consulting services, intended to address all phases of a customer's information technology needs. The Company's ability to deliver integrated solutions is principally attributable to its technical expertise and its value-added reseller agreements with industry-leading vendors of information technology products such as Sun Microsystems, Inc., Cisco Systems, Inc., Oracle Corporation, Netscape Communications Corporation, Check Point Software Technologies, Ltd. and Veritas Software Corporation, with Sun Microsystems accounting for approximately 70% of the Company's hardware sales. The Company has also established relationships with leading aggregators of computer hardware and software products. These agreements enable the Company to provide its clients with competitive product pricing, ready product availability and services. The Company realizes revenues from the sale of products and services. Professional services are provided to customers on a time and material basis at hourly rates or on fixed contract basis that are established based upon the skill level, experience and type of service being performed. Support contract revenue is recognized over the term of the contract. Historically, most of the Company's revenues have been derived from the resale of computer and network hardware and 12 15 software products. However, in recognition that market demand is evolving toward higher margin complete information technology solutions, the Company has adopted the expansion of its service offerings to the marketplace as one of its business strategies. Management expects its consulting and service revenue to increase as a percentage of net sales as it expands its service offerings to new and existing customers. As announced on July 18, 2000, the Company is now organized into two strategic business units, Osage Consulting Services and Osage Systems Integration. System Integration customers include both our traditional base and the emerging market of Internet related companies. In 1999 Osage had in excess of 70 customers whose principal business related to the Internet such as internet service providers "ISPs", "application service providers "ASPs", business to business "B2B" commerce sites and business to consumer "B2C" commerce sites. Most of the services provided to these customers involve the basic infrastructure of their Internet installations. Osage Consulting Services, which originally focused exclusively on business intelligence and eCommerce solutions for the middle market, will now also encompass the eIntegrator Alliance Program and the newly launched Professional Services organization. A core component of the Professional Services organization has been the development of the Internet Data Center Solution Stacks, a set of packaged solutions with defined service deliverables in the areas of Storage, Security, Availability, Assurance, and Operations. These solutions can be deployed in individual client environments, or customized for use in specific eIntegrator partnerships. The expansion of the professional service offerings is in response to expanding market opportunities created by web-enabled technologies. Osage Consulting Services also provides hardware and software products to its customers and provides service capability to the system integration group. This arrangement has allowed each group to maximize sales but has blurred the clear distinction of offerings to the customer. However, the groups continue to focus on their predominant service offering to the market thus enhancing the potential for the growth in the services sector of the market. 13 16 RESULTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 1999 The following table sets forth for the periods indicated certain financial data as a percentage of net sales: ($ In Thousands)

14 17 Revenues. Net sales decreased by 4.0%, or approximately $1.2 million, to $28.8 million for the three months ended September 30, 2000 as compared to $30.0 million for the same prior year period. This decrease in net sales was attributable to an increase in the Company's focus on service sales versus hardware and software sales. The decrease is also attributable to the discontinued Solsource and E-comm operations in the fourth quarter of 1999. Management expects service revenues to increase as new opportunities associated with the Company's Consulting Services initiative are realized. The Company's net sales are expected to continue slowing somewhat during 2000 as the Company's emphasis on improved operating margins is realized. Gross Profit. The Company's cost of sales consists primarily of the cost to the Company of products acquired for resale and salaries of certain technical personnel. The Company's gross profit increased by 7.9% or $0.3 million to $4.6 million for the three months ended September 30, 2000 as compared to $4.3 million for the prior year. Gross profit margin increased to approximately 16.1% during the three months ended September 30, 2000 as compared to approximately 14.3% during the prior year. The increase in gross profit and margins was attributable to resource redeployment within Consulting Services and the Company's focus on hardware sales with improved margins. With respect to the sale of hardware, management believes that in the long run, gross profit margins on these sales will decrease. As a consequence, the Company intends to continue growing its Consulting Services business at a rate in excess of the growth of its Systems Integration business. Also, the Company believes that, as one of the larger systems integrators competing in its markets, it can obtain economies of scale, which will allow it to compete profitably in spite of any deterioration of gross profit margins. Selling, General and Administrative Expenses. Selling, general and administrative expenses consist primarily of salaries, sales person compensation, employee benefits, professional fees, travel, marketing and facility costs. Selling, general and administrative expenses decreased by 13.4% or $0.6 million to $4.3 million for the three months ended September 30, 2000 as compared to $4.9 million for the same period last year. As a percentage of sales, these costs decreased from 16.5% for the three months ended September 30, 1999 to 14.9% for the same period this year. The decrease is primarily attributable to the restructuring program initiated in the third quarter of 1999. The restructuring activity included the reduction in levels of management, the elimination of approximately forty-five positions, including several senior executive personnel, vacating certain leased facilities and canceling certain contracts. Depreciation and Amortization. Depreciation and amortization of $565,000 for the three months ended September 30, 2000 reflected an increase of 49.9%, or $188,000, as compared to the same prior year period. The increase was primarily due to the effect of amortization of goodwill, the depreciation of assets acquired in connection with acquisitions and the depreciation associated with the Company's enterprise software system. Interest Expense. Interest expense for the three months ended September 30, 2000 of $1.2 million includes interest charges associated with the Company's line of credit and term loan agreement along with interest accretion related to the common stock warrants issued to the 15 18 holder of the Debentures. Interest expense includes $753,000 of additional interest accretion related to the value of warrants issued in conjunction with the Debentures. This amount was recognized during the third quarter in conjunction with the registration of the shares of common stock. Income Taxes. The Company's effective tax rate benefit for the three months ended September 30, 2000 was 26% which is primarily attributable to the net operating loss generated during the year offset by nondeductible goodwill, interest expense and currently owed state taxes. The Company believes an ownership change occurred in 2000, the effect of which will be to limit annual usage of net operating loss carryovers in the future, pursuant to IRC Section 382. At this time, management believes this will not result in an inability to use ultimately all of the net operating losses in the future that are not currently reserved with a valuation allowance. 16 19 RESULTS OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 1999 The following table sets forth for the periods indicated certain financial data as a percentage of net sales: ($ In Thousands)

17 20 Revenues. Net sales increased by 0.7%, or approximately $0.6 million, to $84.3 million for the nine months ended September 30, 2000 as compared to $83.7 million for the same prior year period. This increase in net sales was attributable to an increase in the Company's focus on service sales as well as a comparable demand for the products the Company offers. The level of change is larger than the comparative results depict as the Company discontinued the Solsource and E-comm operations in the fourth quarter of 1999. Management expects service revenues to continue to increase as new opportunities associated with the Company's Consulting Services initiative are realized. The Company's net sales are expected to slow somewhat during 2000 as the Company emphasizes improving operating margins. Gross Profit. The Company's cost of sales consists primarily of the cost to the Company of products acquired for resale and salaries of certain technical personnel. The Company's gross profit decreased by 13.9% or approximately $2 million to $12.7 million for the nine months ended September 30, 2000 as compared to $14.7 million for the prior year period. Increased competition in the hardware and software markets was primarily responsible for the decline. Gross profit margin decreased to approximately 15.0% during the nine months ended September 30, 2000 as compared to approximately 17.6% during the prior year period. The decrease in gross profit margins was attributable to increased competition and the sale of more expensive product, with higher dollar profitability but lower margins. With respect to the sale of hardware, management believes that in the long run, gross profit margins on these sales will decrease. As a consequence, the Company intends to continue growing its Consulting Services business at a rate in excess of the growth of its Systems Integration business. The Company believes that, as one of the larger systems integrators competing in its markets, it can obtain economies of scale, which will allow it to compete profitably in spite of any deterioration of gross profit margins. Selling, General and Administrative Expenses. Selling, general and administrative expenses consist primarily of salaries, sales person compensation, employee benefits, professional fees, travel, marketing and facility costs. Selling, general and administrative expenses decreased by 18.7% or approximately $2.8 million to $12.4 million for the nine months ended September 30, 2000 as compared to $15.2 million for the same period last year. As a percentage of sales, these costs decreased from 18.2% for the nine months ended September 30, 1999 to 14.7% for the same period this year. The decrease is primarily attributable to the restructuring program initiated in the third quarter of 1999. The restructuring activity included the reduction in levels of management, the elimination of approximately forty-five positions, including several senior executive personnel, vacating certain leased facilities and canceling certain contracts. Depreciation and Amortization. Depreciation and amortization of $1.6 million for the nine months ended September 30, 2000 reflected an increase of 43.3%, or approximately $0.5 million as compared to the same prior year period. The increase was primarily due to the effect of amortization of goodwill, depreciation of assets acquired in connection with acquisitions and the depreciation associated with the Company's enterprise software system. 18 21 Interest Expense. Interest expense for the nine months ended September 30, 2000 of $2.8 million includes interest charges associated with the Company's line of credit and term loan agreement along with interest accretion related to the common stock warrants issued to the holder of the Debentures. In addition, interest expense includes $750,000 associated with the beneficial conversion feature of the Debentures due to the conversion price reflecting a discount to the price of the Company's Common Stock on the date the Debentures were priced. This amount was recognized in May 2000 when approval by the Company's stockholders was obtained for the issuance of shares associated with the Debenture. The Company also recorded a charge of $753,000 of additional interest accretion related to the value of warrants issued in conjunction with the Debentures. This amount was recognized during the third quarter in conjunction with the registration of the shares of common stock. Income Taxes. The Company's effective tax rate benefit for the nine months ended September 30, 2000 was 24% which is primarily attributable to the net operating loss generated during the year offset by nondeductible goodwill, interest expense and currently owed state taxes. The Company believes an ownership change occurred in 2000, the effect of which will be to limit annual usage of net operating loss carryovers in the future, pursuant to IRC Section 382. At this time, management believes this will not result in an inability to use ultimately all of the net operating losses in the future that are not currently reserved with a valuation allowance. VARIABLE OPERATING RESULTS The Company's historical operating results have varied from quarter to quarter, and the Company expects that they will continue to do so. Due to the relatively fixed nature of certain of the Company's costs, including personnel and facilities costs, a decline in revenue in any fiscal quarter would result in lower profitability in that quarter. A variety of factors, many of which are not within the Company's control, influence the Company's quarterly operating results, including availability of product, the closings of acquisitions, seasonal patterns of capital spending by customers, information technology outsourcing trends, the timing, size and stage of projects, new service introductions by the Company or its competitors, levels of market acceptance for the Company's products or services or the hiring of additional staff. Operating results may also be impacted by the timing of billings and changes in the Company's billing and utilization rates. The Company believes, therefore, that past operating results and period-to-period comparisons should not be relied upon as an indication of future performance. The Company anticipates that its business will continue to be subject to such seasonal variations. Backlog The Company normally ships systems promptly after receiving an order and therefore does 19 22 not customarily have a significant backlog Liquidity And Capital Resources Historically, the Company has funded its operations primarily from cash generated by operations and, to a lesser extent, with funds from borrowings under the Company's credit facility. For the nine months ended September 30, 2000, cash flow used by operations was $2.6 million as compared to cash used by operations of $1.7 million during the same period in the prior year. The Company's cash flow from operations was negatively affected by an increase in receivables and a decrease in accrued expenses related to the purchase of vendor invoices by the Company's credit facility, partially offset by vendor purchases with credit extending beyond the Company's normal experience. The Company's working capital was $14.0 million at September 30, 2000, as compared to the working capital of $11.5 million at December 31, 1999. The increase in the Company's working capital during such period is principally attributable to the decrease in short-term debt caused by the conversion of warrants related to the Debentures, an increase to receivables and payments made under the Company's restructuring program, partially offset by an increase in obligations to vendors and additional short-term convertible subordinated debentures. Capital expenditures, which totaled $358,000 during the first nine months of 2000 were principally for computer hardware and software to support the Company's operations and for the upgrade of existing infrastructure. Cash flow from financing activities was favorably impacted by the $3.0 million interest free advance/warrant conversion (see below) and the $3.5 million of borrowings on convertible debentures, partially offset by the $2.2 million redemption of Series E preferred stock as well as $1.8 million of net repayments of debt. In March 2000, the Company received $3.0 million as an interest-free advance. The advance was used to redeem the Company's outstanding shares of Series E Convertible Preferred Stock. Upon the effectiveness in August of the Registration Statement filed with the Securities and Exchange Commission, the $3 million was converted from an interest free advance to payment for the aforementioned warrants. At the Company's annual meeting of stockholders held on May 31, 2000, the stockholders voted on the conversion and exercise feature of the convertible debentures and Common stock purchase warrants (collectively, the "Debenture") sold by the Company to Michael Lauer and three investment funds managed by him (collectively, "Lancer") in November 1999 (the "Lancer Financing"). The stockholders approved the conversion and exercise features of the Derivative Securities and as a result, the Company issued approximately 20,000,000 shares of its Common Stock to Lancer or its designees, which had an extremely dilutive effect on the existing stockholders. Furthermore, Lancer and its designees beneficially own approximately 58% of the Company's Common Stock, thereby securing majority voting control of the Company's stock. 20 23 RECENTLY ISSUED ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. Subsequent to the issuance of SFAS No. 133, the FASB received many requests to clarify certain issues causing difficulties in implementation. In June 2000, the FASB issued SFAS No. 138 responding to those requests by amending certain provisions of SFAS No. 133. The Company will adopt SFAS No. 133 and the corresponding amendments under SFAS No. 138 no later than the first quarter of the fiscal year ending December 31, 2001. SFAS No. 133, as amended by SFAS No. 138, will not have a material impact on the Company's results of operations or financial position. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. As of September 30, 2000, the Company had approximately $16.2 million floating-rate debt outstanding. The Company's management believes the interest rate risk represented by this debt is not material. The Company has not, and does not plan to, enter into any derivative financial instruments for hedging or speculative purposes. As of September 30, 2000, the Company had no other significant material exposure to market risk. PART II. OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. On January 6, 2000, the Company issued 500,000 shares of Common Stock in connection with the acquisition of the e-publishing and systems integration practice groups of Sharon O'Reilly and Michael Lowther. Of these shares, each of Sharon O'Reilly and Michael Lowther received 250,000 shares. In addition, the Company may, at its option, issue additional shares of Common Stock in lieu of cash payments of $220,000 for deferred acquisition consideration. In October, the Company satisfied this obligation by issuing 176,000 shares of the Company's common stock. The Company had previously paid $44,000 in cash related to this obligation. The issuance of the original 500,000 shares was exempt from registration pursuant to Section 4(2) of the Act and Rule 506 of Regulation D as an issuer transaction not involving a public offering. On March 10, 2000, the Company issued 15,000 shares of Common Stock to Harbour International, Inc. in consideration of a general release given pursuant to the terms of a settlement agreement between Harbour International and the Company. The issuance of the original 240,000 shares was exempt from registration pursuant to Section 4(2) of the Act and Rule 506 of Regulation D as an issuer transaction not involving a public offering. The Company's stockholders approved an amendment to the Company's Certificate of 21 24 Incorporation to increase the number of shares of Common Stock the Company is authorized to issue from 50,000,000 to 100,000,000. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. On May 31, the Company held its Annual Meeting whereby the holders of the Company's Common Stock voted to approve each of the following proposals: (1) The issuance of more than 20% of the Company's outstanding Common Stock upon the conversion of outstanding debentures and the exercise of outstanding warrants at below-market prices (the debentures and warrants are collectively referred to as the "Debentures") related to the November 22, 1999 private placement offering for $3 million; (2) Re-elected the current directors and elected Edward Stead, a new director to serve until the 2003 Annual Meeting of Stockholders or until their successors are elected and qualified; (3) An amendment to the Company's Certificate of Incorporation (the "Certificate") to increase the number of shares of Common Stock the Company is authorized to issue from 50,000,000 to 100,000,000; (4) Ratify the appointment of Deloitte & Touche LLP as the Company's independent auditors for the year ending December 31, 2000; and At the Annual Meeting, the holders of the Company's Common Stock did not approve the following proposals: (1) An amendment to the Certificate to eliminate the classification of the Board of Directors into three different classes. (2) An amendment to the Certificate eliminating a super majority voting requirement for the stockholders to amend the Certificate. 22 25 ITEM 5. OTHER INFORMATION. Osage Systems Group, Inc. ("Osage") has obtained $2,000,000 related to a $4,000,000 convertible debenture as a result of the following transaction. The proceeds will be used for the operational and capital needs of Osage and its subsidiaries. As a requirement for the funding, Osage formed a new wholly-owned subsidiary called Osage iXi, Inc. ("Osage iXi"), a Delaware corporation. Effective as of August 1, 2000, pursuant to an Assignment and Assumption Agreement dated July 21, 2000 among Osage, Osage iXi and the other Osage subsidiaries (the "Other Osage Subsidiaries"), Osage caused the Other Osage Subsidiaries to transfer to Osage iXi the assets held by them which were primarily associated with their information technology consulting business (the "Consulting Business"). In addition, the Other Osage Subsidiaries transferred to Osage iXi their employees which will be primarily associated with the Consulting Business. In consideration for such transfers, Osage iXi agreed to assume the liabilities and obligations of the Other Osage Subsidiaries primarily relating to the Consulting Business and to employ such employees (with such employees being leased by the Other Osage Subsidiaries to Osage iXi until December 31, 2000, at which time they will become employees of Osage iXi). SPH Investments, Inc. ("SPH") and HMA Associates, Inc. (HMA") (collectively, the "Lenders") entered into a certain Convertible Promissory Note Purchase Agreement (the "Note Purchase Agreement") with Osage and Osage iXi dated July 21, 2000 pursuant to which the Lenders committed to purchase a total of $4,000,000 of Convertible Senior Subordinated Notes (the "Notes") (each Lender is committed to purchase $2,000,000 of the Notes). On July 25, 2000 the Lenders purchased a total of $2,000,000 of such Notes. Pursuant to the Note Purchase Agreement, the Lenders are required to purchase an additional $2,000,000 of such Notes, with $1,000,000 of such Notes to be purchased on or before September 30, 2000 and $1,000,000 of such Notes to be purchased on or before November 30, 2000. To date, the Company has not received additional funds beyond the original $2 million funding. The Notes bear interest at the rate of ten percent (10%) per annum and have a maturity date of July 15, 2001. In addition to the interest, if the Notes are neither prepaid prior to July 15, 2001 nor converted into shares of stock (as described below), Osage is required to pay a redemption fee equal to ten percent (10%) of the principal amount of the Notes. Pursuant to two letter Agreements dated July 24, 2000 and July 26, 2000 between Osage and SPH, in consideration of services rendered by SPH to Osage in connection with this financing, Osage agreed to pay SPH an amount equal to five percent (5%) of the amount of the original Notes which is repaid (the "Service Fee"). Osage also agreed that it would advance to SPH the amount of the Service Fee which will be payable in the event that Osage repays $2,000,000 of the Notes. Repayment of the Notes is subordinated to Osage's obligations for repayment of its obligations to Coast Business Credit and GE Access. The Notes are secured by a security interest on all of the assets of Osage and its subsidiaries (which are subordinated to the security interests granted by Osage and its subsidiaries in favor of Coast Business Credit and GE Access). In the event that the Notes have not been repaid in full on or before January 15, 2001, Osage agreed under the Note Purchase Agreement to declare a dividend of 600,000 shares of the Common Stock of Osage iXi to its shareholders and to pursue a separate listing of Osage iXi on either the American Stock Exchange or the NASDAQ market. 23 26 In the event that the Notes are not repaid prior to July 15, 2001, unless there is then an outstanding Event of Default (as defined under the Notes), on such date the Notes shall automatically be converted into shares of common stock of Osage iXi at the rate of one (1) share for each one ($1.00) dollar of the outstanding principal amount of the Notes. Assuming that all $4,000,000 of the Notes are converted into shares of common stock of Osage iXi, based on the current number of such shares outstanding, the Lenders will own forty (40%) percent of the then issued and outstanding stock of Osage iXi. On September 22, 2000, we completed a private placement transaction intended to raise gross proceeds of $2,250,000 for general working capital purposes. The following securities were sold in the private placement: - $2,250,000 of our 8% convertible notes, convertible into shares of common stock at a price of $0.80 per share, subject to downward adjustment based on the trading price of our common stock. The closing market price of our stock on September 22, 2000 was $0.75, and - Warrants to purchase 675,000 shares of our common stock. The securities were sold to six (6) accredited investors. The private placement requires two separate closings. At the initial closing on September 22, 2000, we realized net proceeds of $1,355,000 after payment of a finder's fee in the amount of $120,000 and escrow and counsel fees in the amount of $25,000, and we issued the following: - $1,500,000 of 8% convertible notes, and - Warrants to purchase 337,500 shares of common stock immediately exercisable at $1.25 per share. The final closing will occur three (3) days after the effective date of this registration statement. At the final closing, we will receive net proceeds of $690,000 after payment of a finder's fee in the amount of $60,000, and we will issue the following: - $750,000 of 8% convertible notes, and - Warrants to purchase an additional 337,500 shares of common stock immediately exercisable at $1.50 per share. Pursuant to the private placement, we were required to file a registration statement on Form S-3 with the SEC no later than on or about November 5, 2000 (the filing occurred on October 26, 2000) registering the public resale of (i) 200% of the shares of common stock issuable upon conversion of the notes; and (ii) 100% of the shares of common stock issuable upon exercise of the warrants. We are required to cause the registration statement to be declared effective by the SEC by no later than December 21, 2001. Our failure to comply with these deadlines will result in a fine 24 27 payable to the investors equal to 1% of the principal amount of the notes for the first thirty (30) days period or part thereof of noncompliance and 2% for each thirty (30) day period or part thereof thereafter. Failure to cause the registration statement to be declared effective within sixty (60) days after required effective date, will be deemed an event of default under the notes resulting in the acceleration of the our obligation to repay the principal amount of the notes. In September the Company retained Global Capital Markets, LLC (Global) as a consultant to advise the Company on corporate finance and business development matters. The term of the Agreement is one year and the compensation to Global consists of 520,000 three-year warrants at a price of $1.0625 per share. In addition, the Company agreed to reimburse Global for reasonable expenses and to indemnify Global for its actions while acting on behalf of the Company. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits:

(b) Reports on Form 8-K The company did not issue any reports on Form 8-K during the quarter ended September 30, 2000 25 28 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on by the undersigned, thereunto duly authorized OSAGE SYSTEMS GROUP, INC. Date: November 14, 2000 By: /s/ Phil Carter --------------------------- -------------------------------- Phil Carter Chairman of the Board and Chief Executive Officer Date: November 14, 2000 By: /s/ Robert T. Peterson --------------------------- -------------------------------- Robert T. Peterson Chief Financial Officer/ Principal Accounting Officer 26 29 EXHIBIT INDEX

OSAGE SYSTEMS GROUP INC 10-Q