Open Systems International, Inc. Consolidated Financial Report June 30, :.Li a- rey Assurance Tax Consulting

Transcription

1 Consolidated Financial Report June 30, 2012 r 1 d :.Li a- rey Assurance Tax Consulting

2 Contents Independent Auditor's Report on the Financial Statements 1 Financial Statements Consolidated balance sheets 2-3 Consolidated statements of income 4 Consolidated statements of changes in shareholders' equity, and comprehensive income 5-6 Consolidated statements of cash flows 7-8 Notes to consolidated financial statements 9-17 Independent Auditor's Report on the Supplementary Information 18 Supplementary Information Consolidating balance sheet Consolidating statement of income Consolidated schedule of operating expenses

3 M<:Giadrey llp f!l McGiadrey Independent Auditor's Report To the Shareholders Open Systems International, Inc. We have audited the accompanying consolidated balance sheet of Open Systems International, Inc. as of June 30, 2012, and the related consolidated statements of income; changes in shareholders' equity, and comprehensive income; and cash flows for the year then ended. These financial statements are the responsibility of the management of Open Systems International, Inc. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Open Systems International, Inc. as of June 30, 2012, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. The 2011 consolidated financial statements were reviewed by us, and our report thereon, dated November 3, 2011, stated that we were not aware of any material modifications that should be made to those statements for them to be in conformity with accounting principles generally accepted in the United States of America. However, a review is substantially less in scope than an audit and does not provide a basis for the expression of an opinion on the consolidated financial statements taken as a whole. Minneapolis, Minnesota December 21,

4 Consolidated Balance Sheets June 30,2012 and Assets (Note 2) 2012 (Reviewed) Current Assets Cash and cash equivalents $ 7,849,955 $ 3,987,599 Certificates of deposit 2,153,070 2,936,330 Investments held to maturity 1,092, ,075 Trade receivables, less allowance for doubtful accounts of $12,800 14,360,585 12,121,072 Inventory: Equipment inventory for resale 580, ,111 Equipment inventory assigned to projects 1,897,301 1,482,229 Prepaid expenses (Note 1) 1,011, ,448 Deferred income taxes (Note 4) 788, ,000 Total current assets 29,733,808 23,235,864 Property and Equipment (Note 3) Land 2,515,680 2,054,964 Building 10,285,618 10,285,618 Furniture and office equipment 9,864,314 9,245,398 Computer software 1,345,791 1,208,988 Leasehold improvements 2,452,410 1,864,677 26,463,813 24,659,645 Less accumulated depreciation and amortization 5,578,762 3,559,936 20,885,051 21,099,709 Other Assets Certificates of deposit 3,991,396 2,417,858 Investments held to maturity 2,841,613 4,126,917 Available-for-sale investments 1,472,869 1,577,387 Deposits and other 53,404 50,989 8,359,282 8,173,151 $ ,141 $ 52,508,724 See Notes to Consolidated Financial Statements. 2

5 2011 Liabilities and Shareholders' Equity 2012 (Reviewed) Current Liabilities Current portion of capital lease obligations (Note 3) $ 588,920 $ 223,187 Accounts payable 747,036 1,451,121 Unearned service and support revenue 10,247,988 7,077,656 Accrued expenses 4,675,323 3,900,700 Income tax payable (Note 4) 760,576 1,072,300 Total current liabilities 17,019,843 13,724,964 Capital Lease Obligations, net of current portion (Note 3) 18,233,518 17,203,503 Deferred Income Taxes (Note 4) 1,000, ,000 Unearned Service and Support Revenue 1,056,158 Common Stock and Stock Options Subject to Redemption Obligation (Note 6) 2,401,664 2,223,671 Total liabilities 39,711,183 33,981,138 Commitments (Notes 2, 3, 5 and 6) Shareholders' Equity (Note 6) Common stock, no par; authorized 1,000,000 shares; issued and outstanding 965,550 and 969,150 shares, respectively, including 115,550 and 119,150 shares, respectively, for which the redemption obligation is included with liabilities above 11,004 11,004 Retained earnings 19,053,568 17,479,004 Accumulated other comprehensive income: Foreign currency translation 134,480 87,447 Unrealized gain on available-for-sale securities 275, ,617 Total Open Systems International, Inc. shareholders' equity 19,474,787 17,802,072 Noncontrolling interest (207,829) 725,514 Total shareholders' equity 19,266,958 18,527,586 Total liabilities and shareholders' equity ~ 58,978,141 ~ 52,508,724 3

6 Consolidated Statements of Income Years Ended June 30, 2012 and (Reviewed) Ratio Ratio Amount to Revenue Amount to Revenue Revenue $ 41,304, % $ 35,902, % Operating expenses 37, % 28,270, % Income from operations 4,199, % 7,632, % Other income (expense): Interest income 194, % 141, % Interest expense (1,391,821) (3.4)% (110,473) (0.3)% Foreign currency transaction loss (1 0,587) (0.0)% (13,361) 0.0% Gain on sale of available-for-sale securities 40, % 312,668 (0.9)% Loss on disposal of equipment (14,469) (0.0)% (277,086) (0.8)% (1,182,211) (2.9)% 53, % Income before income taxes 3,017, % 7,685, % Provision for income taxes (Note 4) 1,314, % 2,490, % Net Income 1,703, % 5,195, % Net (loss) income attributable to noncontrolling interest (933,343) (22.2)% 25, % Net income attributable to Open Systems International, Inc. $ 2.636, % $ 5, % See Notes to Consolidated Financial Statements. 4

7 Consolidated Statements of Changes in Shareholders' Equity, and Comprehensive Income Years Ended June 30, 2012 and 2011 Comprehensive Common Stock Income Shares Amount Balance at June 30, ,950 $ 11,004 Comprehensive income: Net income $ 5,195,067 Unrealized gain on available-for-sale securities 252,052 Foreign currency translation 94,647 Total comprehensive income ~ 5,541,766 Exercise of stock options (Note 6) 1,500 Redemption of common stock (Note 6) (300) Balance at June 30, 2011 (reviewed) 969,150 11,004 Comprehensive income: Net income $ 1,703,326 Unrealized gain on available-for-sale securities 51,118 Foreign currency translation 47,033 Total comprehensive income ~ 1,801,477 Dividends Exercise of stock options (Note 6) 2,000 Redemption of common stock (Note 6) (5,600) Balance at June 30, ,550 $ 11,004 See Notes to Consolidated Financial Statements. 5

8 Accumulated Other Retained Noncontrolling Comprehensive Earnings Interest Income (Loss) Total $ 12,309,451 $ 700,000 $ (34,635) $ 12,985,820 5,169,553 25,514 5,195, , ,052 94,647 94,647 17,479, , ,064 18,527,586 2,636,669 (933,343) 1,703,326 51,118 51' ,033 47,033 (1,062,105) (1,062,105) ~ 19,053,568 ~ (207,829) ~ 410,215 ~ 19,266,958 6

9 Consolidated Statements of Cash Flows Years Ended June 30,2012 and (Reviewed) Cash Flows From Operating Activities Net income $ 1,703,326 $ 5,195,067 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,074, ,514 Loss on disposal of property and equipment 14, ,642 Gain on sale and impairment of available-for-sale securities (40,465) (312,668) Compensation expense from stock obligation (Note 6) 277, ,602 Discount on investments held to maturity (102,625) (57,878) Deferred income taxes 58, ,000 Changes in operating assets and liabilities: Trade receivables (2,239,513) ( 4,666,603) Inventory (197,710) (935,722) Prepaid expenses and other (114,579) (545,880) Accounts payable (67,803) 314,628 Unearned revenue 4,226,490 1,539,894 Accrued expenses 972, ,901 Income taxes payable (311,724) (357,546) Net cash provided by operating activities 6,252,018 3,107,951 Cash Flows From Investing Activities Purchases of property and equipment (877,731) (1,363,569) Proceeds from sale of property and equipment 31,930 Purchases of investments held to maturity (3,585,569) Sale of investments held to maturity 631, ,741 Purchases of certificates of deposit, net (790,278) (1,559, 188) Sale of available-for-sale securities, net 196, ,356 Net cash used in investing activities (840,440) (5,936,299) Cash Flows From Financing Activities Issuance of common stock from stock option exercise (Note 6) 2,000 1,500 Repurchase of common stock (Note 6) (101,584) (1,482) Principal payments on capital lease obligations (434,566) (145,592) Dividends paid {1,062, 105) (2,371,968) Net cash used in financing activities (1,596,255) (2,517,542) Effect of Foreign Currency on Cash and Cash Equivalents 47,033 94,647 Net increase (decrease) In cash and cash equivalents 3,862,356 (5,251,243) Cash and Cash Equivalents Beginning 3, ,238,842 Ending $ 7,849,955 $ (Continued) 7

10 Consolidated Statements of Cash Flows (Continued) Years Ended June 30,2012 and 2011 Supplemental Disclosures of Cash Flow Information Cash paid for interest Cash paid for income taxes, net Supplemental Schedule of Noncash Investing and Financing Activities Equipment acquired under capital leases Property and equipment additions included in accounts payable and accrued expenses $ $ (Reviewed) 1,286,937 $ 110, ,830,314 $ 15,496, See Notes to Consolidated Financial Statements. 8

11 Notes to Consolidated Financial Statements Note 1. Summary of Significant Accounting Policies Description of business: Open Systems International, Inc. (OSI) is in the business of providing advanced electric power automation systems, which include specialized computer software, software development, training and support, as well as supplying computer hardware, to customers in the electric utility industry. OSI's customers are located throughout the world, with the majority in North America. Principles of consolidation: The accompanying consolidated financial statements include the accounts of Open Systems International, Inc. (OSI) and its wholly owned subsidiary, OSI Automation Software Systems Co., Ltd. (OS I Beijing), which are collectively reflected as OS I. During fiscal 2011, OSI completed construction on a new corporate headquarters in Medina, a suburb of Minneapolis, Minnesota. Arrowhead Holdings, LLC was established to construct and lease the building to OS I. Arrowhead Holdings, LLC is owned by major shareholders of OSI and is not a wholly owned subsidiary of OSI. Arrowhead Holdings, LLC is consolidated in this financial report under accounting guidance that establishes standards for when a variable-interest entity should be consolidated with its primary beneficiary. A variable-interest entity should be consolidated by the company if it has either the power to direct the entity's most significant activities or the ability to participate in the entity's economics. Arrowhead Holdings, LLC is required to be consolidated with OSI due to corporate guarantees provided by OSI to the lending organization. Collectively, these entities are considered the Company. All material intercompany accounts and transactions have been eliminated in consolidation. Revenue recognition: The Company's revenue includes fees for standard software design, custom software design, implementation, training, software maintenance and computer hardware sales. Revenues from fixed-fee contracts are recognized as services are rendered using the percentage-ofcompletion method of accounting (based on the achievement of milestones included with the contracts or based upon costs incurred with the contracts). If it is determined that a loss will result from performance under a contract, the entire amount of the loss is charged against income in the period in which the determination is made. The Company invoices its customers on projects as agreed-upon project milestones are achieved and accepted by the customer. Costs in excess of billings on uncompleted milestones included in prepaid expenses were $594,000 and $548,000 as of June 30, 2012 and 2011, respectively. Service and maintenance revenue includes fees for help desk support, product upgrade privileges, and user group membership and is deferred upon the original sale and recognized over the term of the agreement. In subsequent years, the Company bills each customer for maintenance prior to the beginning of the contract period and recognizes such revenue ratably over the life of that contract, generally one year. Vendor-specific objective evidence of fair value for service and maintenance revenue is established based on standard pricing and renewal rates. Use of estimates: 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 at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and cash equivalents: For purposes of reporting cash flows, the Company considers all highly liquid debt instruments to be cash equivalents. In addition, the Company has one- to five-year certificates of deposit, which have been classified as noncurrent assets on the consolidated balance sheet. The Company maintains its cash in bank deposit accounts that, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts. 9

12 Notes to Consolidated Financial Statements Note 1. Summary of Significant Accounting Policies (Continued) Trade receivables: Trade receivables are carried at original invoice amount less an estimate for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful accounts by regularly evaluating individual customer receivables and considering a customer's financial condition and credit history, and current economic conditions. Trade receivables are written off when deemed uncollectible. Recoveries of trade receivables previously written off are recorded when received. A trade receivable is considered to be past due if any portion of the receivable balance is outstanding for more than 90 days. Inventories: Equipment inventory for resale includes computer hardware components to be used in future projects. This inventory is stated at the lower of cost (first in, first out) or market. Equipment inventory assigned to projects includes computer hardware components purchased for specific projects. This inventory is accounted for using the specific-identification method. Property and equipment: Depreciation of property and equipment is computed on the straight-line and accelerated methods over the following estimated useful lives: Years Building Furniture and office equipment Computer software Leasehold improvements Over the estimated useful life of the asset Investments held to maturity: The Company invests in debt securities, consisting of governmental bonds, which are classified as held-to-maturity. Held-to-maturity securities consist solely of debt securities that the Company has the positive intent and ability to hold to maturity and are stated at the amortized cost. Interest on the debt securities is recognized in income as earned. The amortized cost and fair value of debt securities classified as held-to-maturity, by contractual maturity, as of June 30, 2012 and 2011, are as follows: Amortized Cost 2012 Market Value Due within one year $ 1,092,536 $ 1,101,144 Due after one year through four years 2,313,947 2,361,229 Due after four years 527, ,285 $ 3.934,149 $

13 Notes to Consolidated Financial Statements Note 1. Summary of Significant Accounting Policies (Continued) 2011 (Reviewed) Amortized Market Cost Value Due within one year Due after one year through four years Due after four years $ 336,075 2,943,483 1,183,434 $ 4, $ 338,425 2,942,634 1,162,352 $ 4,443,411 Available-for-sale investments: The Company's available-for-sale investments consist of marketable equity securities. Management determines the appropriate classification of the securities at the time they are acquired and evaluates the appropriateness of such classifications at each balance sheet date. Available-for-sale securities are stated at fair value, and unrealized gains or losses are reported as a separate component of shareholders' equity. When a determination has been made that a decline in fair value is other than temporary, the cost of the impaired security is adjusted down to fair value by a charge to the consolidated statement of income. The fair value of equity securities classified as available-for-sale is as follows: June 30, 2012 Other-Than- Unrealized Unrealized Temporary Fair Cost Gain Loss Impairment Value Equity securities $ 1,283,609 $ 275,735 $ $ (86,475) $ 1, June 30, 2011 (Reviewed) Other-Than- Unrealized Unrealized Temporary Fair Cost Gain Loss Impairment Value Equity securities ~ 1,402,360 ~ 227,777 ~ (3, 160) ~ (49,590) ~ 1,577,387 Management evaluates available-for-sale securities for other-than-temporary impairment at least on an annual basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The Company recorded a loss for other-than-temporary impairment of securities of $86,475 and $49,590 in 2012 and 2011, respectively. 11

14 Notes to Consolidated Financial Statements Note 1. Summary of Significant Accounting Policies (Continued) Changes in the unrealized gain on available-for-sale securities are as follows: Years Ended June (Reviewed) Balance, beginning Loss recorded on unrealized other-than-temporary impairment Changes in unrealized holding loss during the year Balance, ending $ ~ 224,617 $ (27,435) 86,475 49,590 (35,357) 202, ,735 ~ 224,617 Advertising costs: Advertising costs are charged to operations when incurred. Advertising expense for the years ended June 30, 2012 and 2011, was approximately $310,000 and $295,000, respectively. Fair value measurements: The Company follows guidance for fair value measurements that provides a framework for measuring fair value under generally accepted accounting principles. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Leve/1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below: Leve/1: Inputs are unadjusted quoted prices in active markets for identical assets or liabilities. Level 2: Inputs are unadjusted quoted prices in active markets for similar assets or liabilities, or unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability. Level 3: Inputs are unobservable for the asset or liability. The Company attempts to use the best available information in measuring fair value. The asset and liability fair value measurement level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. There have been no changes in the methodologies used at June 30, 2012 and The Company's available-for-sale securities are based on quoted market prices and are categorized as Leve/1. The fair value of investments in certificates of deposit and held-to-maturity securities are valued at amortized cost, which approximates fair value, and are categorized as Level 2. Income taxes: Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss or tax credit carryforwards, and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the amounts of assets and liabilities recorded for income tax and financial reporting purposes. Deferred tax assets are reduced by a valuation allowance when management determines that it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. 12

15 Notes to Consolidated Financial Statements Note 1. Summary of Significant Accounting Policies (Continued) The Company follows the accounting standard on accounting for uncertainty in income taxes, which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under this guidance, the Company may recognize a tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by taxing authorities, based on the technical merits of the position and the assumption that that taxing authorities have all of the same information as the Company. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement. The guidance on accounting for uncertainty in income taxes also addresses derecognition, classification, interest and penalties on income taxes, and accounting in interim periods. The Company evaluates its tax positions in accordance with the accounting standard on accounting for uncertainty in income taxes, which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under this guidance, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement. The guidance on accounting for uncertainty in income taxes also addresses derecognition, classification, interest and penalties on income taxes, and accounting in interim periods. Foreign currency translation and transaction adjustments: The Company translates assets and liabilities of its foreign subsidiaries at current exchange rates and related revenues and expenses at average rates of exchange in effect during the year. The resulting translation adjustment is recorded as a separate component of stockholders' equity, since the functional currency of the foreign subsidiaries is not the U.S. dollar. Net foreign currency exchange gains and losses resulting from foreign currency transactions are included in the determination of net income. Reclassifications: Certain reclassifications have been made to the 2011 consolidated balance sheet, with no effect on net income, to conform to the 2012 presentation. Subsequent events: The Company considered subsequent events through December 21,2012, the date the consolidated financial statements were available to be issued, in preparing the consolidated financial statements and notes thereto. Note 2. Financing Lines of credit: At June 30, 2012, OSI had no advances outstanding under its operating lines of credit, under which it is allowed to borrow up to $12,000,000. OSI has two lines of credit, which bear interest between the LIBOR rate plus 1.25 percent and 2.00 percent. Facility A is for $6,000,000 and is secured by a security interest in certain assets of OSI as well as a guarantee by two shareholders of OSI. Facility B is for $6,000,000 and is secured by a security interest in certain assets of OS I. Both agreements expire on January 31,2013, if not renewed. Outstanding letters of credit totaled $2,520,000 as of June 30,2012, which reduce the total available borrowings. The terms of the operating lines of credit agreement described above contain various requirements to maintain certain financial ratios and minimum levels of net income. 13

16 Notes to Consolidated Financial Statements Note 2. Financing (Continued) Common Bond Fund: Arrowhead Holdings, LLC obtained financing through a lease agreement with the City of Minneapolis, Minnesota, for Taxable Limited Tax Supported Development Revenue Bond Common Bond Fund Series (CBF). This is a government-administered organization, which issued revenue bonds during June 2010 for the construction of the new OSI headquarters. CBF issued both serial and term bonds with maturity dates from 2012 through 2040 and an average interest rate of 7.36 percent. The total par amount of the bonds was $18,000,000, with net proceeds after issuance costs equal to $17,302,859. The building construction was complete in June 2011, and the bond proceeds are recorded as a capital lease to CBF on the consolidated financial statements. The final construction draw payable by CBF to Arrowhead Holdings, LLC at June 30, 2011, equaled $441,758 and was recorded as a receivable from CBF on the consolidated financial statements. Arrowhead Holdings, LLC has begun leasing the facility and will assume ownership at the conclusion of the 30-year term of the lease. Arrowhead Holdings, LLC will provide lease payments to CBF from lease payments to be received from OSI through Open Systems International, Inc. has executed a 30-year lease with Arrowhead Holdings, LLC to lease the corporate headquarters building and has executed agreements with CBF to be the guarantor of this financial arrangement. Performance bonds: OSI, at the request of certain customers, is required to post a performance bond to secure completion of its project obligations. At June 30, 2012 and 2011, respectively, three bonds and six bonds totaling approximately $13,633,000 and $8,064,000 were outstanding. The bonds are currently issued and underwritten by The Hartford, and ACE Insurance Company. The obligations under these bonds are anticipated to be released by the bonding company once the customers grant final approval and a warranty period of one year is completed. Note 3. Lease Obligations Operating leases: The Company leases certain office space under operating leases expiring at various dates through April The leases require the Company to pay base rent, plus certain operating costs. The Company also leases vehicles under operating lease agreements. Rent expense for the years ended June 30, 2012 and 2011, was approximately $161,000 and $756,000, respectively. The following is a schedule of approximate future minimum lease payments under the operating leases as of June 30, 2012: Years Ending June 30, $ $ 186, ,000 4, ,000 Capital leases: The Company leases land, building, and land improvements through a capital lease agreement with CBF as noted previously for a total cost of approximately $17,597,000 with accumulated depreciation of approximately $1,199,000 at June 30, 2012, and no accumulated depreciation at June 30, In addition, the Company leases furniture, computers and office equipment under capital leases. The cost of the equipment was approximately $3,330,000 and $3,124,000 at June 30, 2012 and 2011, respectively. Accumulated amortization at June 30, 2012 and 2011, was approximately $1,722,000 and $1,474,000, respectively. 14

17 Notes to Consolidated Financial Statements Note 3. Lease Obligations (Continued) The following is a schedule by year. of approximate remaining minimum payments required under capital leases, together with the present value at June 30, 2012: Years Ending June Thereafter Total minimum lease payments Less amount representing interest Total capital lease obligation Less current portion Long-term portion $ 1,899,000 1,896,000 1,860,000 1,834,000 1,594,000 33,111,000 42,194,000 (23,371,000) 18,823, ,000 $ 18,234,000 Note 4. I nco me Taxes The Company's deferred tax assets and liabilities are as follows: Deferred tax assets: Accrued compensation Common stock and stock options subject to repurchase obligation (Note 6) Capital loss carryforwards Deferred revenue Other Less valuation allowance Deferred tax liabilities: Depreciation Unrealized loss on available-for-sale securities Other Net deferred income tax assets (liabilities) $ ~ June (Reviewed) 614,000 $ 611,000 14,000 25,000 78, , ,000 67,000 69, , ,000 15,000 52, , ,000 (988,000) (841,000) (63,000) (63,000) (31,000) (18,000) (212,000) ~ (154,000) 15

18 Notes to Consolidated Financial Statements Note 4. Income Taxes (Continued) The Company has capital loss carryforwards, which will expire at various dates from June 30, 2014, through June 30, The components giving rise to the net deferred tax assets (liabilities) described above have been included in the accompanying consolidated balance sheets as of June 30, 2012 and 2011, as follows: (Reviewed) Current assets $ 788,000 $ 675,000 Noncurrent liabilities (1,000,000) (829,000) $ (212,000) $ (154,000) The components of income tax expense for the years ended June 30, 2012 and 2011, are as follows: (Reviewed) Current $ 1,255,000 $ 2,053,000 Deferred 59, ,000 Provision for income taxes $ 1.314,000 $ Note 5. Profit Sharing Plan OSI has a 401 (k) profit sharing plan that covers all qualified employees. OSI contributes a match of 50 percent of employee contributions up to 6 percent. For the years ended June 30, 2012 and 2011, OSI had matching contributions of $329,000 and $293,000, respectively. OSI may make a profit sharing contribution at the discretion of the Board of Directors. For the years ended June 30, 2012 and 2011, discretionary profit sharing contributions to the plan totaled $550,000 and $500,000, respectively. Note 6. Common Stock and Stock Option Redemption Obligation OSI has granted common stock and stock options to certain employees as compensation for services. The stock options have an exercise price of $1 per share and vest over a period of three to five years. Upon termination of employment with OSI, the holders of common stock acquired through compensation or exercise of an option can require OSI to repurchase the shares at book value. Due to this repurchase option, the outstanding stock options and common stock resulting from compensation or exercised options are accounted for as a liability on the consolidated balance sheet based upon the redemption value for outstanding shares and vested options. Accordingly, compensation expense is recognized for the vesting of options and changes in book value. 16

19 Notes to Consolidated Financial Statements Note 6. Common Stock and Stock Option Redemption Obligation (Continued) The following table summarizes the redemption obligation activity: Years Ended June (Reviewed) Redemption obligation, beginning Issuance of common stock from stock option exercise Repurchase of common stock Compensation expense (income) from stock obligation Redemption obligation, ending The following table summarizes the stock option activity: $ ~ 2,223,671 $ 1,546,051 2,000 1,500 (1 01,584) (1,482) 277, ,602 2,401,664 ~ 2,223,671 Years Ended June (Reviewed) Options outstanding, beginning Options exercised Options outstanding, ending 4,000 (2,000) ,500 (1,500) The options expire at various times through 2012, or if the employee terminates employment with the Company. At June 30, 2012 and 2011, respectively, there were 117,550 and 123,150 shares and stock options subject to this potential repurchase obligation. Note 7. Major Customers During the year ended June 30,2012, net sales to one customer represented approximately 10 percent of the Company's consolidated revenues, and the trade receivables from this customer were approximately $1,784,000 as of June 30, There were no sales to this customer during the year ended June 30,

20 McGii\drey LlP II McGiadrey Independent Auditor's Report on the Supplementary Information To the Shareholders Open Systems International, Inc. Our audit was conducted for the purpose of forming an opinion on the consolidated financial statements as a whole. The consolidating and other supplementary information is presented for purposes of additional analysis rather than to present the financial position, results of operations, and cash flows of the individual companies and is not a required part of the consolidated financial statements. Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the consolidated financial statements. The consolidating and other supplementary information has been subjected to the auditing procedures applied in the audit of the consolidated financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the consolidated financial statements, or to the consolidated financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the information is fairly stated in all material respects in relation to the consolidated financial statements as a whole. While the consolidated financial statements are prepared based upon accounting principles generally accepted in the United States of America (GAAP), the individual entity financial information differs from such principles relative to the accounting for the facility lease between the two entities. GAAP would require Open Systems International, Inc. to capitalize the lease and Arrowhead Holdings, LLC to treat the lease as a direct financing lease. The Company has chosen not to record the lease in this manner, as the impact is eliminated in consolidation. Therefore, the accompanying supplementary consolidating financial statements are not intended to reflect each entity's financial position, results of operations, and cash flows in accordance with accounting principles generally accepted in the United States of America. Minneapolis, Minnesota December 21,

21 Consolidating Balance Sheet June 30, 2012 Assets Current Assets Cash and cash equivalents Certificates of deposit Investments held to maturity Trade receivables Inventory: Equipment inventory for resale Equipment inventory assigned to projects Prepaid expenses Deferred income taxes Total current assets OSI $ 7,482,081 $ 2,153,070 1,092,536 14,360, ,749 1,897,301 1,011, ,000 29,365,934 Arrowhead Holdings, LLC 367,874 $ 367,874 Eliminalions Consolidated $ 7,849,955 2,153,070 1,092,536 14,360, ,749 1,897,301 1,011, ,000 29,733,808 Property and Equipment Land Building Furniture and office equipment Computer software Leasehold improvements 6,077,472 1,345, ,817 8,413,080 2,515,680 10,285,618 3,786,842 1,462,593 18,050,733 2,515,680 10,285,618 9,864,314 1,345,791 2,452,410 26,463,813 Less accumulated depreciation and amortization 4,379,823 4,033,257 1,198,939 16,851,794 5,578,762 20,885,051 Other Assets Certificates of deposit Investments held to maturity Available-for-sale investments Due from affiliates Deposits and other $ 3,991,396 2,841,613 1,472, ,244 53,404 8,710,526 42,109,717 $ 136, ,219 17,355,887 $ (487,463) (487,463) ( ) $ 3,991,396 2,841,613 1,472,869 53,404 8,359,282 58,978,141 19

22 Liabilities and Shareholders' Arrowhead Eguit~ OSI Holdin~s. LLC Eliminations Consolidated Current Liabilities Current portion of capital lease obligations $ 393,099 $ 195,821 $ $ 588,920 Accounts payable 747, ,036 Unearned service and support revenue 10,247,988 10,247,988 Accrued expenses 4,572, ,884 4,675,323 Income tax payable 760, ,576 Total current liabilities 16,721, ,705 17,019,843 Capital Lease Obligations, net of current portion 1,319,751 16,913,767 18,233,518 Deferred Income Taxes 1,000,000 1,000,000 Unearned Service and Support Revenue 1,056,158 1,056,158 Due to Affiliates 136, ,244 (487,463) Common Stock and Stock Options Subject to Redemption Obligation 2,401,664 2,401,664 Total liabilities 22,634,930 17,563,716 (487,463) 39,711,183 Shareholders' Equity Common stock, no par; authorized 1,000,000 shares; issued and outstanding 965,550 shares, including 118,954 shares for which the redemption obligation is included with liabilities above 11,004 11,004 Retained earnings 19,053,568 19,053,568 Accumulated other comprehensive income: Foreign currency translation 134, ,480 Unrealized gain on available-forsale securities 275, ,735 Total Open Systems International, Inc. shareholders' equity 19,474,787 19,474,787 Noncontrolling interest (207,829) (207,829) Total shareholders' equity 19,474,787 (207,829) 19,266,958 Total liabilities and shareholders' equity ~ 42,109,717 ~ 17,355,887 ~ (487,463) ~ 58,978,141 20

23 Consolidating Statement of Income Year Ended June 30, 2012 Arrowhead OSI Holdings, LLC Eliminations Consolidated Revenue $ 41,304,810 $ 1,634,615 $ (1,634,615) $ 41,304,810 Operating expenses 37,540,862 1,199,026 (1,634,615) 37,105,273 Income from operations 3,763, ,589 4,199,537 Other income (expense): Interest income 192,730 1, ,201 Interest expense (21,418) (1,370,403) (1,391,821) Foreign currency transaction loss (10,587) (10,587) Gain on sale and impairment of available-for-sale securities 40,465 40,465 Loss on disposal of equipment (14,469) (14,469) 186,721 (1,368,932) (1,182,211) Income (loss) before income taxes 3,950,669 (933,343) 3,017,326 Provision for income taxes (Note 4) 1,314,000 1,314,000 Net Income (loss) 2,636,669 (933,343) 1,703,326 Less: Net income attribulable to noncontrolling interest (933,343) (933,343) Net Income attributable to Open Systems, International, Inc. ~ 2,636,669 ~ ~ ~ 2,636,669 21

24 Consolidated Schedule of Operating Expenses Years Ended June 30,2012 and (Reviewed) Ratio Ratio Amount to Revenue Amount to Revenue Accounting, legal and professional services $ 354, % $ 258, % Advertising 309, % 295, % Automobile and mileage 43, % 37, % Consulting services 1,248, % 705, % Cost of equipment sales 6,028, % 2,720, % Depreciation and amortization 2,074, % 648, % Dues and subscriptions 51, % 48, % Education and training 32, % 18, % Insurance: General 170, % 125, % Group 1,150, % 957, % Other 129, % 137, % Meals and entertainment 549, % 331, % Miscellaneous 473, % 254, % Office rent 108, % 755, % Office supplies and expense 560, % 412, % Payroll processing fees 21, % 18, % Payroll taxes 1,535, % 1,307, % Performance bond expense 200, % 15, % Postage/shipping 110, % 92, % Profit sharing and 401 (k) 879, % 792, % Salaries: Officers 364, % 361, % Other 16,978, % 14,234, % Bonus 1,720, % 1,761, % Support service 135, % 85, % Telephone 135, % 139, % Trade shows 363, % 214, % Travel 1,308, % 1,390, % Utilities % 147, % ~ 37,105, % ~ 28,270, % 22