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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
Commission File No. 0-20943
Intelligroup, Inc.
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(Exact Name of Registrant as Specified in Its Charter)
New Jersey 11-2880025
- ------------------------------- ------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
499 Thornall Street, Edison, New Jersey 08837
- --------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(732) 590-1600
-------------------------------
(Registrant's Telephone Number,
Including Area Code)
Indicate by checkmark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes: X No:
----- -----
Indicate the number of shares outstanding of each of the Issuer's classes
of common stock, as of November 13, 2002:
Class Number of Shares
----- ----------------
Common Stock, $.01 par value 16,630,125
INTELLIGROUP, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
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Page
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PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)............... 1
Consolidated Balance Sheets as of September 30, 2002
and December 31, 2001....................................... 2
Consolidated Statements of Operations and Comprehensive
Income(Loss) for the Three Months and Nine Months Ended
September 30, 2002 and 2001................................. 3
Consolidated Statements of Cash Flows for the Nine
Months Ended September 30, 2002 and 2001.................... 4
Notes to Consolidated Financial Statements.................. 5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............... 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk.. 37
Item 4. Controls and Procedures..................................... 37
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 38
Item 4. Submission of Matters to a Vote of Security Holders......... 41
Item 5. Other Information........................................... 41
Item 6. Exhibits and Reports on Form 8-K............................ 42
SIGNATURES............................................................... 43
CERTIFICATIONS........................................................... 44
- i -
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- 1 -
INTELLIGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2002 AND DECEMBER 31, 2001
SEPTEMBER 30, DECEMBER 31,
2002 2001
ASSETS
Current Assets:
Cash and cash equivalents....................................... $ 1,980,000 $ 2,138,000
Accounts receivable, less allowance for doubtful accounts of
$1,361,000 and $2,073,000 at September 30, 2002 and
December 31, 2001, respectively............................. 16,087,000 13,519,000
Unbilled services............................................... 7,992,000 7,536,000
Prepaid income taxes............................................ 462,000 342,000
Deferred tax assets............................................. 1,736,000 1,736,000
Other current assets............................................ 1,999,000 3,548,000
Note receivable - SeraNova...................................... 4,000,000 9,140,000
--------------- ---------------
Total current assets...................................... 34,256,000 37,959,000
Property and equipment, net..................................... 6,619,000 8,099,000
Other assets.................................................... 1,141,000 1,036,000
--------------- ---------------
$ 42,016,000 $ 47,094,000
=============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable................................................ $ 4,213,000 $ 3,548,000
Accrued payroll and related taxes............................... 6,863,000 5,465,000
Accrued expenses and other liabilities.......................... 4,106,000 4,414,000
Deferred revenue................................................ 1,228,000 1,211,000
Income taxes payable............................................ 488,000 427,000
Current portion of long term debt and obligations under
capital leases.............................................. 5,543,000 4,712,000
--------------- ---------------
Total current liabilities............................... 22,441,000 19,777,000
Deferred tax liabilities........................................... 167,000 164,000
--------------- ----------------
Obligations under capital leases, less current portion............. 67,000 371,000
--------------- ---------------
Other long-term liabilities........................................ 1,029,000 --
--------------- ---------------
Commitments and contingencies
Shareholders' Equity
Preferred stock, $.01 par value, 5,000,000 shares authorized,
none issued or outstanding.................................. -- --
Common stock, $.01 par value, 25,000,000 shares authorized,
16,630,125 shares issued and outstanding at September 30,
2002 and December 31, 2001.................................. 166,000 166,000
Additional paid-in capital...................................... 41,366,000 41,366,000
Accumulated deficit............................................. (19,222,000) (10,685,000)
Accumulated other comprehensive loss............................ (3,998,000) (4,065,000)
--------------- ---------------
Total shareholders' equity ............................... 18,312,000 26,782,000
--------------- ---------------
$ 42,016,000 $ 47,094,000
=============== ===============
The accompanying notes to consolidated financial statements are an integral part
of these balance sheets.
- 2 -
INTELLIGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
THREE MONTHS NINE MONTHS ENDED
------------ -----------------
ENDED SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------
2002 2001 2002 2001
------------- -------------- -------------- --------------
Revenue.......................................... $ 28,358,000 $ 25,538,000 $ 79,443,000 $ 85,061,000
Cost of sales.................................... 20,003,000 16,897,000 55,402,000 57,868,000
------------- -------------- -------------- --------------
Gross profit................................ 8,355,000 8,641,000 24,041,000 27,193,000
------------- -------------- -------------- --------------
Selling, general and administrative expenses..... 6,960,000 7,125,000 20,506,000 23,305,000
Depreciation and amortization.................... 643,000 992,000 2,026,000 2,854,000
SeraNova receivable impairment and other
charges........................................ -- -- 8,362,000 --
Proxy contest charges............................ 412,000 -- 876,000 --
------------- -------------- -------------- --------------
Total operating expenses.................... 8,015,000 8,117,000 31,770,000 26,159,000
------------- -------------- -------------- --------------
Operating income (loss)..................... 340,000 524,000 (7,729,000) 1,034,000
Interest income.................................. 6,000 60,000 26,000 536,000
Interest expense................................. (97,000) (151,000) (297,000) (581,000)
Other (expense) income........................... (76,000) 60,000 (36,000) 3,000
------------- -------------- -------------- --------------
Income (loss) before provision for income taxes.. 173,000 493,000 (8,036,000) 992,000
Provision for income taxes....................... 160,000 347,000 501,000 480,000
------------- -------------- -------------- --------------
Net income (loss)................................ $ 13,000 $ 146,000 $ (8,537,000) $ 512,000
============= ============== ============== ==============
Earnings per share:
Basic earnings per share:
Net income (loss) per share............... $ 0.00 $ 0.01 $ (0.51) $ 0.03
============= ============= ============= =============
Weighted average number of
common shares - Basic..................... 16,630,000 16,630,000 16,630,000 16,630,000
============= ============== ============== ==============
Diluted earnings per share:
Net income (loss) per share............... $ 0.00 $ 0.01 $ (0.51) $ 0.03
============= ============= ============= =============
Weighted average number of
common shares - Diluted................... 16,633,000 16,630,000 16,630,000 16,631,000
============= ============== ============== ==============
Comprehensive Income (Loss)
- ---------------------------
Net income (loss)................................ $ 13,000 $ 146,000 $ (8,537,000) $ 512,000
Other comprehensive income (loss) -
Currency translation adjustments.......... 80,000 73,000 67,000 (848,000)
------------- -------------- -------------- --------------
Comprehensive income (loss)...................... $ 93,000 $ 219,000 $ (8,470,000) $ (336,000)
============= ============== ============== ==============
The accompanying notes to consolidated financial statements are an integral part
of these statements.
- 3 -
INTELLIGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
NINE MONTHS ENDED SEPTEMBER 30,
2002 2001
------------- ------------
Cash flows from operating activities:
Net (loss) income.................................................... $ (8,537,000) $ 512,000
Adjustments to reconcile net (loss) income to net cash provided by
operating activities:
Depreciation and amortization.................................... 2,664,000 3,480,000
Provision for doubtful accounts.................................. 342,000 1,423,000
SeraNova receivable impairment and other charges................. 8,362,000 --
Deferred income taxes............................................ 3,000 147,000
Changes in operating assets and liabilities:
Accounts receivable................................................ (2,910,000) 3,996,000
Unbilled services.................................................. (456,000) 77,000
Other current assets............................................... 145,000 (657,000)
Other assets....................................................... (105,000) 376,000
Accounts payable................................................... 665,000 (2,455,000)
Accrued payroll and related taxes.................................. 1,398,000 (898,000)
Accrued expenses and other liabilities............................. (688,000) (794,000)
Accrued restructuring charges...................................... (529,000) (277,000)
Deferred revenue................................................... 17,000 (257,000)
Income taxes payable............................................... 61,000 8,000
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Net cash provided by operating activities............................ 432,000 4,681,000
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Cash flows from investing activities:
Purchase of equipment ............................................. (1,184,000) (2,996,000)
Purchase of software licenses...................................... -- (2,678,000)
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Net cash used in investing activities................................ (1,184,000) (5,674,000)
------------- ------------
Cash flows from financing activities:
Principal payments under capital leases.............................. (509,000) (434,000)
Other borrowings (repayments)........................................ 3,000 (90,000)
Net change in line of credit borrowings.............................. 1,033,000 892,000
Repayment of note receivable-SeraNova subsequent to spin-off date.... -- 2,060,000
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Net cash provided by financing activities.......................... 527,000 2,428,000
------------- ------------
Effect of foreign currency exchange rate changes on cash........... 67,000 (848,000)
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Net (decrease) increase in cash and cash equivalents ................... (158,000) 587,000
Cash and cash equivalents at beginning of period........................ 2,138,000 1,327,000
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Cash and cash equivalents at end of period.............................. $ 1,980,000 $ 1,914,000
============= ============
Supplemental disclosures of cash flow information:
Cash paid for income taxes........................................... $ 864,000 $ 1,081,000
============= ============
Cash paid for interest............................................... $ 297,000 $ 581,000
============= ============
The accompanying notes to consolidated financial statements are an integral part
of these statements.
- 4 -
INTELLIGROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The consolidated financial statements and accompanying financial
information as of September 30, 2002 and for the three months and nine months
ended September 30, 2002 and 2001 are unaudited and, in the opinion of
management, include all adjustments (consisting only of normal recurring
adjustments) which the Company considers necessary for a fair presentation of
the financial position of the Company at such dates and the operating results
and cash flows for those periods. The consolidated financial statements included
herein have been prepared in accordance with accounting principles generally
accepted in the United States of America and the instructions of Form 10-Q and
Rule 10-01 of Regulation S-X. Pursuant to accounting requirements of the
Securities and Exchange Commission applicable to quarterly reports on Form 10-Q,
the accompanying consolidated financial statements and these notes do not
include all disclosures required by accounting principles generally accepted in
the United States of America for audited financial statements. Accordingly,
these statements should be read in conjunction with the accounting policies and
Notes to Consolidated Financial Statements included in the Company's most recent
annual financial statements.
In November 2001, the Emerging Issues Task Force ("EITF") of the Financial
Accounting Standards Board ("FASB") concluded that reimbursable "out-of-pocket"
expenses should be classified as revenue, and correspondingly cost of services,
in the statement of operations. Most service companies, whose employees incur
incidental expenses such as airfare, mileage, hotel and out-of-town meals while
working on behalf of customers, previously reported reimbursable "out-of-pocket"
expenses on a "net" basis in the statement of operations. Accordingly, effective
January 1, 2002, the Company has reported gross reimbursable "out-of-pocket"
expenses incurred as both revenue and cost of sales in the statement of
operations. The Company has also reclassified prior period financial information
for presentation consistent with the new EITF accounting guidance. The impact of
this reclassification was an increase to both revenue and cost of sales of
$696,000 and $426,000 for the three months ended September 30, 2002 and 2001,
respectively, and $1,735,000 and $1,885,000 for the nine months ended September
30, 2002 and 2001, respectively.
The Company's 2002 operating plan contains assumptions regarding revenue
and expenses. The achievement of the operating plan depends heavily on the
timing of work performed by the Company on existing projects and the ability of
the Company to gain and perform work on new projects. Project cancellations,
delays in the timing of work performed by the Company on existing projects or
the inability of the Company to gain and perform work on new projects could have
an adverse impact on the Company's ability to execute its operating plan and
maintain adequate cash flow. In the event actual results do not meet the
operating plan, management believes it could execute contingency plans to
mitigate such effects. Such plans include additional cost reductions or seeking
additional financing. Considering the cash on hand, the credit facility and
based on the achievement of the operating plan and management's actions taken to
date, management believes it has the ability to continue to generate sufficient
cash to
- 5 -
NOTE 1 - BASIS OF PRESENTATION (CONTINUED)
satisfy its operating requirements in the normal course of business. However, no
assurance can be given that sufficient cash will be generated from operations.
The results of operations for interim periods are not necessarily
indicative of those that may be achieved for a full fiscal year.
NOTE 2 - EARNINGS PER SHARE
Basic earnings per share is computed by dividing income (loss) available to
common shareholders by the weighted average number of common stock outstanding
for the period. Diluted earnings per share reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock, unless they are antidilutive.
A reconciliation of weighted average number of common shares outstanding to
weighted average common shares outstanding assuming dilution is as follows:
Three Months Ended Nine Months Ended
------------------ -----------------
September 30, September 30,
------------- -------------
2002 2001 2002 2001
---- ---- ---- ----
Weighted average number of
common shares........................ 16,630,000 16,630,000 16,630,000 16,630,000
Common share equivalents of
outstanding stock options............ 3,000 -- -- 1,000
---------- ---------- ---------- ----------
Weighted average number of common
shares assuming dilution............. 16,633,000 16,630,000 16,630,000 16,631,000
========== ========== ========== ==========
Stock options, which would be antidilutive (2,419,000 and 3,062,000 as of
September 30, 2002 and 2001, respectively), have been excluded from the
calculations of diluted shares outstanding and diluted earnings per share.
NOTE 3 - LINES OF CREDIT
On May 31, 2000, the Company and PNC Bank, N.A. (the "Bank") entered into a
three-year revolving credit facility. Such credit facility is comprised of a
revolving line of credit pursuant to which the Company can borrow up to
$20,000,000 either at the Bank's prime rate per annum or the Euro Rate plus
1.75% to 2.5% based upon the Company's ratio of debt to earnings before
interest, taxes, depreciation and amortization ("EBITDA"). The credit facility
is collateralized by substantially all of the assets of the Company's United
States based operations. The maximum borrowing availability under the line of
credit is based upon a percentage of eligible billed and unbilled accounts
receivable, as defined. As of September 30, 2002, the Company had outstanding
borrowings under the credit facility of $5,099,000. The Company
- 6 -
NOTE 3 - LINES OF CREDIT (CONTINUED)
estimates undrawn availability under the credit facility to be $7,611,000 as of
September 30, 2002. As of December 31, 2001, the Company had outstanding
borrowings under the credit facility of $4,066,000.
The credit facility provides for the following financial covenants, among
other things, (1) the Company must maintain consolidated net worth, as defined
("consolidated net worth") of (a) not less than 95% of the Company's
consolidated net worth of the immediately preceding fiscal year-end as at each
such fiscal quarter after December 31, 2000; and (b) at least 105% of the
Company's consolidated net worth as of the immediately preceding fiscal year-end
as at each such fiscal year-end subsequent to December 31, 2000; provided,
however, the foregoing covenant shall not be tested for any quarter so long as
the Company maintains, at all times during such fiscal quarter, undrawn
availability of more than $5,000,000 and (2) the Company must maintain
unconsolidated net worth, as defined ("unconsolidated net worth") of (a) not
less than 95% of the Company's unconsolidated net worth of the immediately
preceding fiscal year-end as at each such fiscal quarter after December 31,
2000; and (b) at least 105% of the Company's unconsolidated net worth as of the
immediately preceding fiscal year-end as at each such fiscal year-end subsequent
to December 31, 2000; provided, however, the foregoing covenant shall not be
tested for any quarter so long as the Company maintains, at all times during
such fiscal quarter, undrawn availability of more than $5,000,000. Additionally,
the credit facility contains material adverse change clauses with regard to the
financial condition of the assets, liabilities and operations of the Company.
As of December 31, 2001, the Company was not in compliance with the
consolidated net worth and unconsolidated net worth financial covenants. In
March 2002, the Company finalized with the Bank the terms of a waiver and
amendment to the credit agreement. The terms of the waiver and amendment
included, among other things, (1) a waiver of the covenant defaults as of
December 31, 2001, (2) a modification to the financial covenants to require that
consolidated net worth and unconsolidated net worth as of December 31, 2002 be
not less than 102% of consolidated net worth and unconsolidated net worth,
respectively, as of December 31, 2001, (3) a modification to the consolidated
net worth and unconsolidated net worth covenants to exclude any changes to
consolidated net worth and unconsolidated net worth resulting from the
write-down or write-off of up to $10,833,000 of the note due from SeraNova, and
(4) a new financial covenant requiring that the Company generate EBITDA of at
least 90% of the prior year's EBITDA.
During each of the quarters ended June 30, 2002 and September 30, 2002, the
Company incurred charges related to the Company's contested 2002 Annual Meeting
of Shareholders ("Proxy Contest"). The Proxy Contest charges included legal
fees, proxy solicitation services and printing, mailing and other costs. As a
direct result of the Proxy Contest charges, the Company was not in compliance
with the EBITDA covenant as of June 30, 2002 and September 30, 2002. The Company
is currently negotiating with the Bank and expects to receive a waiver of the
covenant defaults existing as of June 30, 2002 and September 30, 2002. There can
be no assurance, however, that the Company will be able to obtain a waiver and
appropriate amendment to the agreement on terms acceptable to the Company.
- 7 -
NOTE 3 - LINES OF CREDIT (CONTINUED)
Interest expense on debt and obligations under capital leases approximated
$297,000 and $581,000 for the nine months ended September 30, 2002 and 2001,
respectively.
NOTE 4 - NOTE RECEIVABLE - SERANOVA
On May 31, 2000, SeraNova, Inc. ("SeraNova") and the Company formalized a
$15,100,000 unsecured promissory note (the "Note") relating to net borrowings by
SeraNova from the Company through such date. The Note bears interest at the
prime rate plus 1/2%. The Company had recorded total accrued interest of
$940,000 as of December 31, 2001. The Company has not recorded any accrued
interest on the balance of the Note subsequent to the maturity date of July 31,
2001. A payment of $3,000,000 was made on September 29, 2000 with the balance
being due on July 31, 2001.
In September 2000, SeraNova consummated an $8,000,000 preferred stock
financing with two institutional investors. According to the mandatory
prepayment provisions of the Note, SeraNova was required to make a prepayment of
$3,000,000 on the Note as a result of the stock financing. Subsequently, the
Company finalized, with SeraNova, the terms of an agreement to waive, subject to
certain conditions, certain of the mandatory prepayment obligations arising as a
result of the financing. The terms of the new agreement included, among other
things, that SeraNova pay the Company (i) $500,000 upon execution of the
agreement; (ii) $500,000 on or before each of January 31, 2001, February 28,
2001, March 31, 2001, April 30, 2001 and May 31, 2001; and (iii) $400,000 on or
before December 15, 2000 to be applied either as (a) an advance payment towards
a contemplated services arrangement for hosting services to be provided to
SeraNova by Company (the "Hosting Agreement"); or (b) in the event that no such
Hosting Agreement is executed on or before December 15, 2000, an additional
advance prepayment toward the principal of the Note.
The Company received from SeraNova the $500,000 payment that was due upon
execution of the agreement and a $400,000 payment in December 2000 as an advance
payment towards the principal of the Note since no Hosting Agreement was
executed before December 15, 2000.
In 2001, the Company received principal payments totaling $2,060,000 from
SeraNova. However, SeraNova failed to make final payment of all amounts due
under the Note to the Company as of July 31, 2001. On August 16, 2001, the
Company filed a complaint against SeraNova and Silverline Technologies Limited
("Silverline"), which acquired SeraNova in March 2001. As of such date, SeraNova
was obligated to pay to the Company the remaining principal (approximately
$9,140,000) and accrued interest (approximately $940,000), or an aggregate of
$10,080,000. SeraNova then filed a counterclaim against the Company for
unspecified damages as a set-off against the Company's claims. In response to
the Company's request for a statement of damages, SeraNova stated that it was in
the process of calculating its damages, but for informational purposes claimed
compensatory damages in excess of $5,500,000 and punitive damages in the amount
of $10,000,000. The parties have completed the discovery process and a trial is
scheduled for December 16, 2002. The Company believes that there is no basis to
support the amounts claimed by SeraNova in its counterclaim for compensatory and
- 8 -
NOTE 4 - NOTE RECEIVABLE - SERANOVA (CONTINUED)
punitive damages. The inability of the Company to collect the amount due from
SeraNova and/or Silverline or an adverse decision with respect to the Company
relating to SeraNova's counterclaim could negatively affect the Company's
business, financial condition or results of operations.
In addition, during late 2001, SeraNova failed to pay certain outstanding
lease obligations to the Company's landlords. Accordingly, on March 4, 2002, the
Company filed an arbitration demand with the American Arbitration Association
against SeraNova, Silverline and Silverline Technologies, Inc. (collectively,
the "SeraNova Group"). The demand for arbitration, which sought damages, alleged
among other things that the SeraNova Group failed to pay outstanding lease
obligations to the Company's landlords and to reimburse the Company for all rent
payments made by the Company on their behalf. An arbitration hearing was held on
June 25, 2002 and June 28, 2002 seeking $525,000 in outstanding lease
obligations. On August 9, 2002, an award was issued in the amount of $616,905
(including attorney's fees) plus reimbursement of administrative fees, in favor
of the Company and against the SeraNova Group jointly and severally. The award
also includes a provision that jurisdiction is retained by the tribunal, and the
Company may seek from the tribunal any additional rents and other fees due and
owing on a quarterly basis. Accordingly, the Company filed a second demand for
$300,000 in damages for rents and other fees due and owing for the months of
June through September 2002. On August 12, 2002, an action was commenced in the
Superior Court of New Jersey to confirm the award, seek a writ of execution
against the SeraNova Group's assets, restrain the disposal of the SeraNova
Group's assets, and enjoin the distribution of proceeds from any sale of the
SeraNova Group's assets among other emergency relief. On August 13, 2002, the
Court, among other things, (i) confirmed the award and entered judgment against
SeraNova in the amount of $616,905 plus $7,100 in administrative fees, (ii)
authorized the issuance of a writ of execution against SeraNova's bank accounts
and other assets to satisfy the judgment, (iii) restrained the SeraNova Group
from disposing of any assets, including funds in their bank accounts, (iv)
authorized the attachment of all net proceeds from the sale of any assets of the
SeraNova Group up to the amount of the arbitration award to be held in an
interest bearing escrow account pending further court order and (v) scheduled a
hearing for September 3, 2002 in order for the SeraNova Group to show cause why
the relief granted by the Court to the Company against SeraNova should not be
applied to the SeraNova Group jointly and severally. A trial was held over
several days in September 2002. On October 3, 2002, the Court confirmed the
$624,000 award, jointly and severally as to all the defendants, and issued a
writ of execution against the defendant's assets. The Company does not believe
that the outcome of this claim will have a materially adverse effect on the
Company's business, financial condition or results of operations.
The Company is continuing to pursue its various legal options to obtain
payment from the SeraNova Group on the Note and outstanding lease obligations.
At the same time, the Company has also been actively engaged in discussions with
management of the SeraNova Group, with the objective of seeking an out of court
resolution to all outstanding matters involving the Note, and certain other
receivables and lease obligations. However, the Company believed that the
liquidity issues plaguing the SeraNova Group required a reassessment of the
realizability of these outstanding amounts as of June 30, 2002. Although no
final resolution had been reached, the Company believed that the substance of
these discussions provided a basis for determining the
- 9 -
NOTE 4 - NOTE RECEIVABLE - SERANOVA (CONTINUED)
approximate realizable value of the Note and other receivables, as well as an
estimate of the costs required to exit certain lease obligations. Accordingly,
the Company recorded the following charges during the quarter ended June 30,
2002:
WRITE-DOWN WRITE-OFF ASSUMPTION
OF NOTE OF OTHER OF CERTAIN
RECEIVABLE RECEIVABLES - LEASE OTHER
- SERANOVA SERANOVA OBLIGATIONS CHARGES TOTAL
----------------------------------------------------------------------------
Charges to operations during 2002... $ 5,140,000 $ 1,257,000 $ 1,501,000 $ 464,000 $ 8,362,000
Costs paid during 2002.............. -- -- (205,000) (202,000) (407,000)
Non-cash items...................... (5,140,000) (1,257,000) -- -- (6,397,000)
------------ ------------ ------------ ----------- ------------
Accrued costs as of September 30,
2002................................ $ -- $ -- $ 1,296,000 $ 262,000 $ 1,558,000
============ ============ ============ =========== ============
At June 30, 2002, the Company recorded a $5,140,000 charge to write-down
the carrying value of the Note to $4,000,000. The Company also recorded a
$1,257,000 charge to write-off the carrying value of the other SeraNova
receivables (primarily, accrued interest on the Note and a receivable for a
system implementation project). Additionally, the Company had recorded a
liability of $1,501,000 for certain lease exit costs as of June 30, 2002. Such
liability represents primarily obligated space costs for which the Company
currently believes it cannot use or sublease and the differential between
certain Company lease obligations and sublease amounts to be received. As of
September 30, 2002, $1,296,000 of the liability remains outstanding, of which
$1,029,000 is included in other long-term liabilities.
At September 30, 2002, the Company re-evaluated the realizability of the
carrying value of the Note, as well as any required change to the obligations
associated with the office space costs. Based upon the current status of the
negotiations with the SeraNova Group, the Company determined that no change to
the carrying value of the Note or the recorded liability was appropriate as of
September 30, 2002. However, if the Company were to collect less than $4,000,000
on the Note recorded as of September 30, 2002, or incur additional obligations
or costs, the SeraNova receivable write-down and/or charges would be increased
in future periods.
NOTE 5 - RESTRUCTURING AND OTHER SPECIAL CHARGES
In connection with the Company's plan to reduce costs and improve operating
efficiencies, the Company incurred a charge of $5,628,000 related to
restructuring initiatives during the year ended December 31, 1999. The
restructuring charge included settlement of the former chief executive officer's
employment agreement and additional severance payment, expenses associated with
the termination of certain employees in the United States and United Kingdom,
the closing of certain satellite offices in the United States and an additional
office in Belgium, and costs to exit certain contractual obligations.
- 10 -
NOTE 5 - RESTRUCTURING AND OTHER SPECIAL CHARGES (CONTINUED)
During the quarter ended December 31, 2001, in an effort to further refine
the Company's business strategy around its core competencies and to refocus on
more active markets, the Company recorded a $13,261,000 restructuring and other
special charges provision. The charges, which were mainly non-cash in nature,
were related primarily to the ASP business in the United States, the termination
of an agreement to build and operate a technology development and support center
in Puerto Rico, and to the restructuring and downsizing of the Company's
operations in the United Kingdom.
Activity in accrued costs for restructuring and other special charges is as
follows:
Severance and Asset
Related Costs Impairments Exit Costs Total
---------------------------------------------------------------------
Charges to operations during 1999......... $ 5,027,000 $ -- $ 601,000 $ 5,628,000
Costs paid during 1999.................... (4,162,000) -- (517,000) (4,679,000)
------------- ------------ -------------- ------------
Accrued costs as of December 31, 1999..... 865,000 -- 84,000 949,000
Costs paid during 2000.................... (608,000) -- -- (608,000)
------------- ------------ -------------- ------------
Accrued costs as of December 31, 2000..... 257,000 -- 84,000 341,000
Charges to operations during 2001......... 530,000 10,999,000 1,732,000 13,261,000
Costs paid during 2001.................... (402,000) -- (172,000) (574,000)
Non-cash utilization during 2001.......... -- (10,999,000) (1,177,000) (12,176,000)
------------- ------------ -------------- ------------
Accrued costs as of December 31, 2001..... 385,000 -- 467,000 852,000
Costs paid during 2002.................... (268,000) -- (261,000) (529,000)
------------- ------------ -------------- ------------
Accrued costs as of September 30, 2002.... $ 117,000 $ -- $ 206,000 $ 323,000
============= ============ ============== ============
The Company expects to pay out the remaining costs above within the next
9 months.
NOTE 6 - SEGMENT DATA AND GEOGRAPHIC INFORMATION
The Company operates in one industry, information technology solutions and
services. The Company has four reportable operating segments, which are
organized and managed on a geographical basis, as follows:
o United States ("US") - the largest segment of the Company, with
operations in the United States, Puerto Rico, South America and
Canada. Includes the operations of the Company's US subsidiary,
Empower, Inc., and all corporate functions and activities. The US and
corporate headquarters are located in Edison, New Jersey;
o Asia-Pacific ("APAC") - includes the operations of the Company in
Australia, Hong Kong, Indonesia, Japan, New Zealand and Singapore. The
APAC headquarters are located in Wellington, New Zealand;
o Europe - includes the operations of the Company in Denmark, Sweden and
the United Kingdom. The European headquarters are located in Norfolk,
United Kingdom; and
- 11 -
NOTE 6 - SEGMENT DATA AND GEOGRAPHIC INFORMATION (CONTINUED)
o India - includes the operations of the Company in India, including
services provided on behalf of other Company subsidiaries. The Indian
headquarters are located in Hyderabad, India.
Each of the operating segments has a Managing Director, or equivalent
position, which reports directly to the Chief Executive Officer (CEO).
Currently, the CEO and President is fulfilling the requirements of this position
in the US. The CEO has been identified as the Chief Operating Decision Maker
(CODM) because he has final authority over resource allocation decisions and
performance assessment. The CODM regularly receives certain discrete financial
information about the geographical operating segments, including primarily
revenue and operating income, to evaluate segment performance.
Accordingly, the Company's operating results and financial position are
presented in the following geographic segments for the three months and nine
months ended September 30, 2002 and 2001.
UNITED STATES ASIA-PACIFIC EUROPE INDIA TOTAL
------------- ------------ ------ ----- -----
Three Months Ended
- ------------------
September 30, 2002
- ------------------
Revenue....................... $ 21,121,000 $ 2,470,000 $ 1,419,000 $ 3,348,000 $ 28,358,000
Depreciation & amortization... 434,000 43,000 48,000 118,000 643,000 (1)
Operating income (loss)....... 771,000 (423,000) (389,000) 381,000 340,000 (2)
Total assets.................. 29,150,000 4,052,000 1,817,000 6,997,000 42,016,000
Three Months Ended
- ------------------
September 30, 2001
- ------------------
Revenue....................... $ 17,516,000 $ 3,117,000 $ 2,076,000 $2,829,000 $ 25,538,000
Depreciation & amortization... 556,000 67,000 199,000 170,000 992,000 (3)
Operating income (loss)....... 796,000 237,000 (972,000) 463,000 524,000
Total assets.................. 43,783,000 5,943,000 7,307,000 5,841,000 62,874,000
Nine Months Ended
- -----------------
September 30, 2002
- ------------------
Revenue....................... $ 57,859,000 $ 7,191,000 $ 4,448,000 $9,945,000 $ 79,443,000
Depreciation & amortization... 1,359,000 126,000 163,000 378,000 2,026,000 (1)
Operating income (loss)....... (7,263,000) (1,262,000) (930,000) 1,726,000 (7,729,000) (4)
Nine Months Ended
- -----------------
September 30, 2001
- ------------------
Revenue....................... $ 56,493,000 $ 10,226,000 $ 8,708,000 $9,634,000 $ 85,061,000
Depreciation & amortization... 1,630,000 236,000 564,000 424,000 2,854,000 (3)
Operating income (loss)....... 815,000 343,000 (2,878,000) 2,754,000 1,034,000
- -------------
(1) Excludes $195,000 and $638,000 of depreciation and amortization
included in cost of sales for the three months and nine months ended
September 30, 2002, respectively.
(2) Includes $412,000 of proxy contest charges for the three months ended
September 30, 2002.
(3) Excludes $217,000 and $626,000 of depreciation and amortization
included in cost of sales for the three months and nine months ended
September 30, 2001, respectively.
(4) Includes $8,362,000 of SeraNova receivable impairment and other
charges and $876,000 of proxy contest charges for the nine months
ended September 30, 2002.
- 12 -
NOTE 6 - SEGMENT DATA AND GEOGRAPHIC INFORMATION (CONTINUED)
Included above are application management and support revenues of
$7,424,000 and $6,568,000 for the three months ended September 30, 2002 and
2001, respectively. The application management and support revenues for the nine
months ended September 30, 2002 and 2001 are $20,370,000 and $17,779,000,
respectively. Other information related to the application management and
support business is not maintained and the Company determined that it would be
impractical to calculate such data.
NOTE 7 - CONTINGENCIES
Tax-Free Spin-off of SeraNova
On July 5, 2000, the Company distributed SeraNova common stock to
shareholders in a transaction that was intended to be a tax-free spin-off
pursuant to Section 355 of the Internal Revenue Code ("Section 355"). If the
distribution qualifies as a tax-free spin-off, neither the Company nor the
Company's shareholders recognize any gain or income in connection with the
transaction. However, Section 355 provides that the Company may be required to
recognize a gain on the transaction if the distribution is part of a plan
pursuant to which one or more persons acquire 50% or more of SeraNova common
stock within two years of the distribution date. The Company and SeraNova
executed a Tax Sharing Agreement, dated January 1, 2000 ("Tax Sharing
Agreement"), whereby SeraNova would indemnify the Company for any tax
liabilities in the event a future transaction of SeraNova results in the
spin-off being deemed a taxable event.
On October 27, 2000, SeraNova and Silverline Technologies Limited
("Silverline") announced that they had entered into an agreement and plan of
merger, under which Silverline would acquire SeraNova in exchange for American
depositary shares of Silverline and the assumption by Silverline of SeraNova
indebtedness. However, SeraNova management has represented that the merger with
Silverline was not contemplated at the time of the spin-off and accordingly, the
spin-off should be tax-free. Should the spin-off ultimately be construed as
taxable, the resultant tax liability could be up to $65,000,000, plus interest
and, depending on the facts that ultimately are established, penalties. SeraNova
and/or Silverline would be obligated to indemnify the Company for these amounts
under the Tax Sharing Agreement.
Tax Contingency in India
The Company's Indian subsidiary has received an assessment from the Indian
taxing authority denying tax exemptions claimed for certain revenue earned
during the fiscal years ended March 31, 1998 and March 31, 1999. The assessment
is for 25 million rupees, or approximately $520,000. Management, after
consultation with its advisors, believes the Company is entitled to the tax
exemption claimed and thus has not recorded a provision for taxes relating to
these items as of September 30, 2002. If the Company were not successful with
its appeals, which were filed in 2001 and 2002, a future charge of approximately
$520,000 would be recorded and reflected in the Company's consolidated statement
of operations.
- 13 -
NOTE 7 - CONTINGENCIES (CONTINUED)
Legal
On February 7, 2001, NSA Investments II LLC filed a complaint in the United
States District Court for the District of Massachusetts naming, among others,
SeraNova, the Company and Rajkumar Koneru, a former director of the Company, as
defendants. The plaintiff alleges that it invested $4,000,000 in SeraNova as
part of a private placement of SeraNova common stock in March 2000, prior to the
spin-off of SeraNova by the Company. The complaint, which seeks compensatory and
punitive damages, alleges that the Company, as a "controlling person" of
SeraNova, is jointly and severally liable with and to the extent as SeraNova for
false and misleading statements constituting securities laws violations. After
being served with the complaint, the Company made a request for indemnification
from SeraNova pursuant to the various inter-company agreements in connection
with the spin-off. By letter dated April 13, 2001, SeraNova's counsel, advised
the Company that SeraNova acknowledged liability for such indemnification claims
and has elected to assume the defense of the plaintiff's claims. In October
2001, the motion to dismiss, filed on behalf of the Company in May 2001, was
denied without prejudice to refile at the close of the discovery period.
Court-ordered mediation between the plaintiff and SeraNova during January and
February 2002 was unsuccessful. In January 2002, plaintiff filed a motion for
partial summary judgment as to certain claims against SeraNova. No summary
judgment motion was filed against the Company. SeraNova filed its opposition to
plaintiff's motion for partial summary judgment in February 2002. The court
heard argument on the motion for partial summary judgment on July 30, 2002. On
September 30, 2002, the Court granted plaintiff's motion in part, finding
SeraNova liable for breach of contract as a matter of law. The Company denies
the allegations made and intends to defend vigorously the claims made by the
plaintiff. It is too early in the dispute process to determine the impact, if
any, that such dispute will have upon the Company's business, financial
condition or results of operations.
The Company is engaged in other legal and administrative proceedings.
Except for the litigation related to the SeraNova Note (See Note 4), management
believes the outcome of these proceedings will not have a material adverse
effect on the Company's consolidated financial position or results of
operations.
NOTE 8 - NEW ACCOUNTING PRONOUNCEMENT
In June 2002, the Financial Accounting Standards Board (the "FASB") issued
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities." SFAS No. 146 addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." The Company is evaluating the impact of the
adoption of SFAS No. 146, which is effective for the Company as of January 1,
2003, but does not believe it will have a material impact on the Company's
financial position or results of operations.
- 14 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company provides a wide range of high-quality, cost-effective
information technology solutions and services. These services and solutions
include the development, integration, implementation, management and support of
enterprise, e-commerce and m-commerce software applications. The Company's
onsite/offshore delivery model, comprehensive suite of tools and
industry-specific solutions provide customers with a faster time-to-market and
lower total cost of ownership.
In October 1987, the Company first began to provide systems integration and
custom software development services to customers. In 1994, the Company began to
diversify its customer base by expanding the scope of its systems integration
and custom development services to include Enterprise Resource Planning ("ERP")
software. ERP software products are pre-packaged solutions for a wide-range of
business areas, including financial information, manufacturing and human
resources. For prospective customers, ERP products are an alternative to the
custom design and development of their own applications. Although ERP products
are pre-packaged solutions, there is a significant amount of technical work
involved in implementing them and tailoring their use for a particular
customer's needs.
Throughout the mid-to-late 1990s, the Company grew significantly by
capitalizing on the business opportunity to provide implementation and
customization services work to the expanding ERP market. The Company first began
to provide these technical services to customers implementing SAP software
before expanding its service offerings to include ERP products developed by
Oracle in 1995 and PeopleSoft in 1997.
In late 1999, the Company made the strategic decision to leverage its
traditional application integration and consulting experience and reposition
Intelligroup for future growth by focusing on the emerging Application Service
Provider ("ASP") market. At the same time, the Company made the strategic
decision to spin-off its Internet services business to its shareholders.
Accordingly, on January 1, 2000, the Company transferred its Internet
applications services and management consulting businesses to SeraNova, Inc.
("SeraNova"), a wholly owned subsidiary of the Company on such date. On July 5,
2000, the Company distributed all of the outstanding shares of the common stock
of SeraNova then held by the Company to holders of record of the Company's
common stock as of the close of business on May 12, 2000 (or to their subsequent
transferees) in accordance with the terms of a Distribution Agreement dated as
of January 1, 2000 between the Company and SeraNova.
During the second half of 2000, finding that the market for ASP services
had not developed and grown as projected by market analysts, the Company
significantly reduced its investment in the ASP business model. Expenditures for
marketing and direct selling initiatives were significantly decreased, as were
the infrastructure and personnel that supported the Company's ASP services. The
Company renewed its focus and efforts on pursuing shorter-term success
opportunities of implementing and enhancing application solutions based on SAP,
Oracle and PeopleSoft products (referred to as professional consulting services
or "PCS"). At the same
- 15 -
time, the Company redirected some of its ASP infrastructure and personnel
towards Application Management Services ("AMS").
A key to the renewed focus around PCS and AMS is the Company's two offshore
development facilities located in Hyderabad, India. The Company's offshore
Advanced Development Center ("ADC") allows the Company to provide
cost-effective, timely and high-quality PCS services to customers throughout the
world. The ADC delivers rapid, 24 by 7 development services, by utilizing
functional and technical consultants, in conjunction with on-site consultants at
customer locations, to provide customers with savings in development and
implementation costs and faster time to project completion.
The Company's offshore Global Support Center ("GSC") helps to provide
responsive global AMS support to customers through delivery teams that work
around-the-clock. The GSC keeps customers' critical applications, systems and
infrastructure stable, current and optimized through efficient and
cost-effective user, technical and operations support.
In late 2000, the Company introduced Power Up Services. The Company's Power
Up Services include the proprietary Uptimizer(SM) and HotPac Analyzer(SM)
services. These services assist the Company's SAP customers in cost-effectively
sizing and analyzing upgrade projects, and efficiently evaluating and testing
Support Packages.
In 2001, the Company developed Pharma Express and Contractor Express.
Pharma Express, a solution designed for small-to-medium sized life sciences
companies, improves manufacturing efficiencies and helps control the total cost
of production. Contractor Express assists engineering and construction companies
in improving operational efficiency and controlling project schedules and costs.
The majority of the Company's revenues are derived from professional
services rendered to customers. Revenue is typically recognized as services are
performed. The Company's services range from providing customers with a single
consultant to multi-personnel full-scale projects. Although the Company has
contracts with many of its customers to provide its services, in general, such
contracts are terminable upon relatively short notice, typically not more than
30 days. There can be no assurance that the Company's customers will continue to
enter into contracts with the Company or that existing contracts will not be
terminated. The Company provides its services either directly to end-user
organizations, or as a member of a consulting team assembled by another
information technology consulting firm. Where contractual provisions permit,
customers also are billed for reimbursement of expenses incurred by the Company
on the customers' behalf.
The markets for the Company's services are highly competitive. The Company
believes that its principal competitors include the internal information systems
groups of its prospective customers, as well as the following classes of
companies (some of which are also customers or referral sources of the Company):
o Consulting and software integration firms: including, IBM Global
Services, Electronic Data Systems (EDS), Computer Sciences Corporation
(CSC), Cap Gemini
- 16 -
Ernst & Young (CGE&Y), Deloitte Consulting, KPMG Consulting and PwC
Consulting.
o Software applications vendors: SAP, Oracle and PeopleSoft.
o Application management consulting firms: such as Covansys, Wipro
Technologies, Infosys Technologies Limited, and Satyam Computer
Services Ltd.
o Application service providers: USinternetworking, Inc., Corio, Inc.,
Interliant, Inc., and Agilera, Inc.
Many of the Company's competitors have longer operating histories, possess
greater industry and name recognition and/or have significantly greater
financial, technical and marketing resources than the Company. In addition,
there are relatively low barriers to entry into the Company's markets and the
Company has faced, and expects to continue to face, additional competition from
new entrants into its markets.
The Company has provided services on certain projects in which it, at the
request of the clients, offered a fixed price for its services. For the year
ended December 31, 2001, revenues derived from projects under fixed price
contracts represented approximately 17% of the Company's total revenue. Fixed
price contracts, in the aggregate, represented 23% of the Company's total
revenue during the nine months ended September 30, 2002. No single fixed price
project was in excess of 10% of revenue during 2001 or during the nine months
ended September 30, 2002. The Company believes that, as it pursues its strategy
of providing Application Management Services to customers, it will continue to
offer fixed price projects. The Company believes that there are certain risks
related to fixed price arrangements and thus prices such arrangements to reflect
the associated risk. There can be no assurance that the Company will be able to
complete such projects within the fixed price timeframes. The failure to perform
within such fixed price contracts, if entered into, could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company has derived and believes that it will continue to derive a
significant portion of its revenue from a limited number of customers and
projects. For the nine months ended September 30, 2002 and the year ended
December 31, 2001, the Company's ten largest customers accounted for, in the
aggregate, approximately 38% and 33% of revenue, respectively. For the nine
months ended September 30, 2002, one customer accounted for approximately 10% of
revenue. For the year ended December 31, 2001, no single customer accounted for
more than 10% of revenue. For the nine months ended September 30, 2002 and the
year ended December 31, 2001, 36% and 42%, respectively, of the Company's
revenue was generated by providing supplemental resources for consulting teams
assembled by other information technology consulting firms or directly to the
end-customer. There can be no assurance that such information technology
consulting firms will continue to engage the Company in the future at current
levels of retention, if at all.
During the nine months ended September 30, 2002 and the year ended December
31, 2001, approximately 61% and 69%, respectively, of the Company's total
revenue was derived from projects in which the Company implemented, extended,
maintained, managed or supported
- 17 -
software developed by SAP. For the nine months ended September 30, 2002 and the
year ended December 31, 2001, approximately 23% and 17%, respectively, of the
Company's total revenue was derived from projects in which the Company
implemented, extended, maintained, managed or supported software developed by
PeopleSoft. For each of the nine months ended September 30, 2002 and the year
ended December 31, 2001, approximately 9% of the Company's total revenue was
derived from projects in which the Company implemented, extended, maintained,
managed or supported software developed by Oracle.
The Company's most significant cost is project personnel expenses, which
consist of consultant salaries, benefits, payroll-related expenses, immigration
costs and consultant travel and entertainment expenses. Thus, the Company's
financial performance is based primarily upon billing margin (billable hourly
rate less the cost to the Company of a consultant on an hourly basis) and
personnel utilization rates (billable hours divided by paid hours).
The Company currently maintains its headquarters in Edison (New Jersey),
and a branch office in Atlanta (Georgia). The Company also maintains offices in
Europe (Denmark, Sweden and the United Kingdom), and Asia-Pacific (Australia,
India, Japan, New Zealand, and Singapore). The Company leases its headquarters
in Edison, New Jersey. Such lease has an initial term of ten (10) years, which
commenced in September 1998.
CRITICAL ACCOUNTING POLICIES, ESTIMATES AND RISKS
The Company's critical accounting policies are set forth in its Annual
Report on Form 10-K for the year ended December 31, 2001. There has been no
change, update or revision to the Company's critical accounting policies
subsequent to the filing of the Company's Form 10-K for the year ended December
31, 2001.
FORWARD-LOOKING STATEMENTS
This Form 10-Q contains forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended, including,
without limitation, statements regarding the Company's intention to shift more
of its focus towards the management and support of customers' enterprise,
e-commerce and m-commerce applications. Such forward-looking statements include
risks and uncertainties, including, but not limited to:
o the continued uncertainty associated with the slowdown in economies
worldwide, including its impact on IT spending habits by customers;
o the continued uncertainty of the outsourcing market and revenues
derived from anticipated application management and support business;
o the failure to maintain the minimum bid price of $1.00 per share for a
period of 30 consecutive business days or other criteria as required
for continued listing by the Nasdaq National Market;
o the substantial variability of the Company's quarterly operating
results caused by a variety of factors, many of which are not within
the Company's control, including (a) patterns of software and hardware
capital spending by customers, (b) information
- 18 -
technology outsourcing trends, (c) the timing, size and stage of
projects, (d) timing and impact of acquisitions, (e) new service
introductions by the Company or its competitors and the timing of new
product introductions by the Company's ERP partners, (f) levels of
market acceptance for the Company's services, (g) general economic
conditions, (h) the hiring of additional staff and (i) fixed price
contracts;
o changes in the Company's billing and employee utilization rates;
o the Company's ability to manage its business effectively, which will
require the Company (a) to continue developing and improving its
operational, financial and other internal systems, as well as its
business development capabilities, (b) to attract, train, retain,
motivate and manage its employees, (c) to continue to maintain high
rates of employee utilization at profitable billing rates, (d) to
successfully integrate the personnel and businesses acquired by the
Company, and (e) to maintain project quality, particularly if the size
and scope of the Company's projects increase;
o the Company's limited operating history within the outsourcing line of
business;
o the Company's reliance on continued relationships with SAP America,
Oracle and PeopleSoft, and the Company's present partnership status;
o the Company's substantial reliance on key customers and large
projects;
o the highly competitive nature of the markets for the Company's
services;
o the Company's ability to successfully address the continuing changes
in information technology, evolving industry standards and changing
customer objectives and preferences;
o the Company's reliance on the continued services of its key executive
officers and leading technical personnel;
o the Company's ability to attract and retain a sufficient number of
highly skilled employees in the future;
o the Company's ability to protect its intellectual property rights;
o uncertainties resulting from pending litigation matters and from
potential administrative and regulatory immigration and tax law
matters and from the outstanding liability of SeraNova to the Company
under the promissory note dated May 31, 2000, as amended; and
o in addition, in March 2001, SeraNova and Silverline Technologies
Limited ("Silverline") consummated the acquisition of SeraNova by
Silverline. SeraNova's management has represented that such
acquisition was not contemplated at the time of the spin-off of
SeraNova by the Company, and accordingly should not impact the
tax-free nature of the spin-off. Should the spin-off be ultimately
construed to be taxable,
- 19 -
there is a risk that if SeraNova and/or Silverline are unable or
unwilling to pay the resultant tax liability pursuant to SeraNova's
indemnification obligations under its Tax Sharing Agreement with the
Company, the Company would bear the liability to pay such resultant
tax liability.
As a result of these factors and others, the Company's actual results may
differ materially from the results disclosed in such forward-looking statements.
RESULTS OF OPERATIONS - CONSOLIDATED
The following table sets forth for the periods indicated certain financial
data expressed as a percentage of total revenue:
PERCENTAGE OF REVENUE
---------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------- -------------------------
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2002 2001 2002 2001
---- ---- ---- ----
Revenue.................................... 100.0% 100.0% 100.0% 100.0%
Cost of sales.............................. 70.5 66.2 69.7 68.0
------ ------ ------ ------
Gross profit.......................... 29.5 33.8 30.3 32.0
Selling, general and administrative
expenses................................ 24.5 27.9 25.8 27.4
Depreciation and amortization expenses..... 2.3 3.9 2.6 3.4
SeraNova settlement and related charges.... -- -- 10.5 --
Proxy contest charges...................... 1.5 -- 1.1 --
------ ------ ------ ------
Total operating expenses.............. 28.3 31.8 40.0 30.8
------ ------ ------ ------
Operating income (loss)............... 1.2 2.0 (9.7) 1.2
Other expense, net......................... (0.6) (0.1) (0.4) 0.0
------ ------ ------ ------
Income (loss) before provision for income
taxes.................................. 0.6 1.9 (10.1) 1.2
Provision for income taxes................. 0.6 1.3 0.6 0.6
------ ------ ------ ------
Net income (loss).......................... 0.0% 0.6% (10.7)% 0.6%
====== ====== ====== ======
Three Months Ended September 30, 2002 Compared to Three Months Ended
September 30, 2001
The following discussion compares the consolidated results for the three
months ended September 30, 2002 and the three months ended September 30, 2001.
Revenue. Total revenue increased by 11.0%, or $2.9 million, from $25.5
million for the three months ended September 30, 2001, to $28.4 million for the
three months ended September 30, 2002. The increase was attributable primarily
to growth in revenue generated in the United States (an increase of $3.6
million) and India (an increase of $519,000), offset by a decline in revenue
generated in Europe and Asia-Pacific (decreases of $657,000 and $647,000,
respectively). The revenue growth in the United States and India results
directly from increased demand for the majority of the Company's services,
including traditional consulting service offerings, application management and
support services, offshore development services and Power Up services. The
majority of the revenue generated in India is derived from providing
- 20 -
offshore development and support services to customers sourced through the
Company's affiliated entities in other parts of the world, but most
predominately with the United States. The decline in Europe and Asia-Pacific
reflects the continuing uncertain and weakened local economic climate, as
customers delayed, decreased or canceled IT projects.
In November 2001, the Emerging Issues Task Force ("EITF") of the Financial
Accounting Standards Board ("FASB") concluded that reimbursable "out-of-pocket"
expenses should be classified as revenue, and correspondingly cost of services,
in the statement of operations. Most service companies, whose employees incur
incidental expenses such as airfare, mileage, hotel and out-of-town meals while
working on behalf of customers, previously reported reimbursable "out-of-pocket"
expenses on a "net" basis in the statement of operations. Accordingly, effective
January 1, 2002, the Company has reported gross reimbursable "out-of-pocket"
expenses incurred as both revenue and cost of sales in the statement of
operations. The Company has also reclassified prior period financial information
for presentation consistent with the new EITF accounting guidance. The impact of
this reclassification was an increase to both revenue and cost of sales of
$696,000 and $426,000 for the three months ended September 30, 2002 and 2001,
respectively.
Gross profit. The Company's cost of sales primarily includes the cost of
salaries to consultants and related employee benefits and payroll taxes. The
Company's cost of sales increased by 18.4%, or $3.1 million, from $16.9 million
for the three months ended September 30, 2001, to $20.0 million for the three
months ended September 30, 2002. The Company's gross profit decreased by 3.3%,
or $286,000, from $8.6 million for the three months ended September 30, 2001, to
$8.4 million for the three months ended September 30, 2002. Gross margin
decreased to 29.5% for the three months ended September 30, 2002, from 33.8% for
the three months ended September 30, 2001. The decrease in gross margin results
from competitive pricing pressures experienced throughout the Company's global
operations as well as an increase in non-billable consultant time and other
related costs, primarily in Europe and Asia Pacific.
Selling, general and administrative expenses. Selling, general and
administrative expenses primarily consist of administrative salaries, and
related benefits costs, occupancy costs, sales person compensation, travel and
entertainment and professional fees. Selling, general and administrative
expenses decreased by 2.3% or $165,000, to $7.0 million for the three months
ended September 30, 2002, from $7.1 million for the three months ended September
30, 2001, and decreased as a percentage of revenue to 24.5% from 27.9%,
respectively. The decrease in selling, general and administrative expenses, in
absolute dollars and as a percentage of revenue, was related primarily to the
further containment of discretionary spending throughout the Company, as well as
the downsizing initiative completed in Europe during the fourth quarter 2001.
Depreciation and amortization. Depreciation and amortization expenses
decreased 35.2% to $643,000 for the three months ended September 30, 2002,
compared to $992,000 for the three months ended September 30, 2001. The decrease
is due primarily to the amortization and depreciation associated with the
intangible assets and long-lived assets that were written-down as part of the
Company's restructuring and other special charges provision during the quarter
ended December 31, 2001.
- 21 -
Proxy contest charges. During the three months ended September 30, 2002,
the Company incurred $412,000 in charges associated with the proxy contest. The
charges resulted directly from a shareholder of the Company launching a hostile
and costly proxy contest to take control of the Company's Board of Directors.
The charges included legal fees of $360,000, proxy solicitation services of
$17,000, and printing, mailing and other costs of $35,000.
Interest income. The Company earned $6,000 in interest income during the
three months ended September 30, 2002, compared with $60,000 during the three
months ended September 30, 2001. The Company discontinued accruing interest on
the balance of the note receivable with SeraNova subsequent to the maturity date
of the note of July 31, 2001. Such note receivable is currently in default and
the Company has commenced litigation against SeraNova (see Part II, Item 1,
Legal Proceedings).
Interest expense. The Company incurred $97,000 and $151,000 in interest
expense during the three months ended September 30, 2002 and 2001, respectively,
related primarily to borrowings under its line of credit. Borrowings under the
line of credit were used to fund operating activities and the charges associated
with the proxy contest. The decrease in interest expense results from a
combination of lower average outstanding borrowings under the line of credit and
lower interest rates charged on outstanding borrowings during the three months
ended September 30, 2002.
Other (expense) income. Other (expense) income results primarily from gains
or (losses) associated with changes in foreign currency exchange rates. The
Company reported other expense of $76,000 during the three months ended
September 30, 2002, compared with other income of $60,000 during the three
months ended September 30, 2001. The change results from foreign currency
fluctuations.
Provision for income taxes. The Company's effective rate was 92.5% and
70.4% for the three months ended September 30, 2002 and 2001, respectively. The
tax rate for the three months ended September 30, 2002 and 2001, results from
taxable income in certain countries and valuation allowances provided for the
current year losses generated in Europe and Asia-Pacific. The Company's net
deferred tax asset as of September 30, 2002 relates primarily to the US
operations. Based on anticipated profitability in the near future, management
believes it is more likely than not, that the deferred tax asset of $1.7 million
will be realized.
In 1996, the Company elected a five year tax holiday in India, in
accordance with a local tax incentive program whereby no income tax will be due
in such period. Such tax holiday was extended an additional five years in 1999.
Effective April 1, 2000 pursuant to changes introduced by the Indian Finance
Act, 2000, the tax holiday previously granted is no longer available and has
been replaced in the form of a tax deduction incentive. The impact of this
change is not expected to be material to the consolidated financial statements
of the Company. Effective April 1, 2002, the tax deduction incentive for income
from the export of software and related services is restricted to 90% of such
income. Further, domestic revenue from software and related services is taxable
in India. For the three months ended September 30, 2002 and 2001, the tax
holiday and new tax deduction favorably impacted the Company's effective tax
rate.
- 22 -
The Company's Indian subsidiary has received an assessment from the Indian
taxing authority denying tax exemptions claimed for certain revenue earned
during the fiscal years ended March 31, 1998 and March 31, 1999. The assessment
is for 25 million rupees, or approximately $520,000. Management, after
consultation with its tax advisors, believes the Company is entitled to the tax
exemption claimed and thus has not recorded a provision for taxes relating to
these items as of September 30, 2002. If the Company were not successful with
its appeals, which were filed in 2001 and 2002, a future charge of approximately
$520,000 would be recorded and reflected in the Company's consolidated statement
of operations.
Nine Months Ended September 30, 2002 Compared to Nine Months Ended
September 30, 2001
The following discussion compares the consolidated results for the nine
months ended September 30, 2002 and the nine months ended September 30, 2001.
Revenue. Total revenue decreased by 6.6%, or $5.7 million, from $85.1
million for the nine months ended September 30, 2001, to $79.4 million for the
nine months ended September 30, 2002. This decrease was attributable primarily
to the weakness in the global economy and the resulting impact on the IT
services market. The effects of the uncertain and weakened economic climate
impacted the Company, as customers delayed, decreased or canceled IT projects,
and as the Company experienced competitive pricing pressures in the provision of
consulting services.
In November 2001, the Emerging Issues Task Force ("EITF") of the Financial
Accounting Standards Board ("FASB") concluded that reimbursable "out-of-pocket"
expenses should be classified as revenue, and correspondingly cost of services,
in the statement of operations. Most service companies, whose employees incur
incidental expenses such as airfare, mileage, hotel and out-of-town meals while
working on behalf of customers, previously reported reimbursable "out-of-pocket"
expenses on a "net" basis in the statement of operations. Accordingly, effective
January 1, 2002, the Company has reported gross reimbursable "out-of-pocket"
expenses incurred as both revenue and cost of sales in the statement of
operations. The Company has also reclassified prior period financial information
for presentation consistent with the new EITF accounting guidance. The impact of
this reclassification was an increase to both revenue and cost of sales of $1.7
million and $1.9 million for the nine months ended September 30, 2002 and 2001,
respectively.
Gross profit. The Company's cost of sales decreased by 4.3%, or $2.5
million, from $57.9 million for the nine months ended September 30, 2001, to
$55.4 million for the nine months ended September 30, 2002. The Company's gross
profit decreased by 11.6%, or $3.2 million, from $27.2 million for the nine
months ended September 30, 2001, to $24.0 million for the nine months ended
September 30, 2002. This decrease was attributable primarily to lower revenues.
Gross margin decreased to 30.3% for the nine months ended September 30, 2002,
from 32.0% for the nine months ended September 30, 2001. The decrease in gross
margin results from competitive pricing pressures experienced throughout the
Company's global operations as well as an increase in non-billable consultant
time and other related costs, primarily in Europe and Asia Pacific.
- 23 -
Selling, general and administrative expenses. Selling, general and
administrative expenses decreased by 12.0%, or $2.8 million, to $20.5 million
for the nine months ended September 30, 2002, from $23.3 million for the nine
months ended September 30, 2001, and decreased as a percentage of revenue to
25.8% from 27.4%, respectively. The decrease in selling, general and
administrative expenses, in absolute dollars and as a percentage of revenue, was
related primarily to the Company's efforts to contain discretionary spending
throughout the Company's operations, as well as the downsizing initiative
completed in Europe during the fourth quarter 2001.
SeraNova receivable impairment and other charges. During the nine months
ended September 30, 2002, the Company recorded approximately $8.4 million in
special charges associated with the note receivable from SeraNova, and certain
other related issues. The Company is continuing to pursue its various legal
options to obtain payment from SeraNova, Silverline Technologies Limited and
Silverline Technologies, Inc. (collectively, the "SeraNova Group") on the Note
and outstanding lease obligations. At the same time, the Company has also been
actively engaged in discussions with management of the SeraNova Group, with the
objective of seeking an out of court resolution to all outstanding matters
involving the Note, and certain other receivables and lease obligations.
However, the Company believed that the liquidity issues plaguing the SeraNova
Group required a reassessment of the realizability of these outstanding amounts.
Although no final resolution had been reached, the Company believed that the
substance of these discussions provided a basis for determining the approximate
realizable value of the Note and other receivables, as well as an estimate of
the costs required to exit certain lease obligations. Accordingly, the Company
recognized an impairment charge in the amount of $5.1 million related to the
note. In addition, the Company recorded a write-off of $1.3 million related to
interest on the note and other receivables due from the SeraNova Group. The
Company also recorded $1.5 million in costs required to exit certain lease
obligations related to the SeraNova Group.
Proxy contest charges. During the nine months ended September 30, 2002, the
Company incurred $876,000 in charges associated with the proxy contest. The
charges resulted directly from a shareholder of the Company launching a hostile
and costly proxy contest to take control of the Company's Board of Directors.
The charges included legal fees of $684,000, proxy solicitation services of
$117,000, and printing, mailing and other costs of $75,000.
Depreciation and amortization. Depreciation and amortization expenses
decreased 29.0% to $2.0 million for the nine months ended September 30, 2002,
compared to $2.9 million for the nine months ended September 30, 2001. The
decrease is due primarily to the amortization and depreciation associated with
the intangible assets and long-lived assets that were written-down as part of
the Company's restructuring and other special charges provision during the
quarter ended December 31, 2001.
Interest income. The Company earned $26,000 in interest income during the
nine months ended September 30, 2002, compared with $536,000 during the nine
months ended September 30, 2001. The Company discontinued accruing interest on
the balance of the note receivable with SeraNova subsequent to the maturity date
of the note of July 31, 2001. Such note receivable is currently in default and
the Company has commenced litigation against SeraNova (see Part II, Item 1,
Legal Proceedings).
- 24 -
Interest expense. The Company incurred $297,000 and $581,000 in interest
expense during the nine months ended September 30, 2002 and 2001, respectively,
related primarily to borrowings under its line of credit. Borrowings under the
line of credit were used to fund operating activities and the charges associated
with the proxy contest. The decrease in interest expense results from a
combination of lower outstanding borrowings under the line of credit and lower
interest rates charged on outstanding borrowings during the nine months ended
September 30, 2002.
Other (expense) income. Other (expense) income results primarily from gains
or (losses) associated with changes in foreign currency exchange rates. The
Company reported other expense of $36,000 during the nine months ended September
30, 2002, compared with other income of $3,000 during the nine months ended
September 30, 2001. The change results from foreign currency fluctuations.
Provision for income taxes. For the nine months ended September 30, 2002
despite a loss, a provision for income taxes of $501,000 was required due to
taxable income in certain jurisdictions combined with a valuation allowance
offsetting other loss benefits in other jurisdictions. The Company's effective
tax rate was 48.4% for the nine months ended September 30, 2001 and results from
taxable income in certain countries and valuation allowances provided for the
losses generated in the United States, Europe and Asia-Pacific. The Company's
net deferred tax asset as of September 30, 2002 relates primarily to the US
operations. Based on anticipated profitability in the near future, management
believes it is more likely than not, that the deferred tax asset of $1.7 million
will be realized.
In 1996, the Company elected a five year tax holiday in India, in
accordance with a local tax incentive program whereby no income tax will be due
in such period. Such tax deduction incentive was extended an additional five
years in 1999. Effective April 1, 2000 pursuant to changes introduced by the
Indian Finance Act, 2000, the tax holiday previously granted is no longer
available and has been replaced in the form of a tax deduction incentive. The
impact of this change is not expected to be material to the consolidated
financial statements of the Company. Effective April 1, 2002, the tax deduction
incentive for income from the export of software and related services is
restricted to 90% of such income. Further, domestic revenue from software and
related services is taxable in India. For the nine months ended September 30,
2002 and 2001, the tax holiday and new tax deduction favorably impacted the
Company's effective tax rate.
The Company's Indian subsidiary has received an assessment from the Indian
taxing authority denying tax exemptions claimed for certain revenue earned
during the fiscal years ended March 31, 1998 and March 31, 1999. The assessment
is for 25 million rupees, or approximately $520,000. Management, after
consultation with its advisors, believes the Company is entitled to the tax
exemption claimed and thus has not recorded a provision for taxes relating to
these items as of September 30, 2002. If the Company were not successful with
its appeals, which were filed in 2001 and 2002, a future charge of approximately
$520,000 would be recorded and reflected in the Company's consolidated statement
of operations.
- 25 -
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
The Company has four reportable operating segments, which are organized and
managed on a geographical basis, as follows:
o United States ("US") - the largest segment of the Company, with
operations in the United States, Puerto Rico, South America and
Canada. Includes the operations of the Company's US subsidiary,
Empower, Inc., and all corporate functions and activities. The US and
corporate headquarters are located in Edison, New Jersey;
o Asia-Pacific ("APAC") - includes the operations of the Company in
Australia, Hong Kong, Indonesia, Japan, New Zealand and Singapore. The
APAC headquarters are located in Wellington, New Zealand;
o Europe - includes the operations of the Company in Denmark, Sweden and
the United Kingdom. The European headquarters are located in Norfolk,
United Kingdom; and
o India - includes the operations of the Company in India, including
services provided on behalf of other Company subsidiaries. The Indian
headquarters are located in Hyderabad, India.
Each of the operating segments has a Managing Director, or manager with an
equivalent position, who reports directly to the Chief Executive Officer (CEO).
Currently, the CEO is fulfilling the requirements of this position in the US.
The CEO has been identified as the Chief Operating Decision Maker (CODM) because
he has final authority over resource allocation decisions and performance
assessment. The CODM regularly receives certain discrete financial information
about the geographical operating segments, including primarily revenue and
operating income, to evaluate segment performance.
Three months Ended September 30, 2002 Compared to Three months Ended
September 30, 2001
The following discussion compares the segment results for the three months
ended September 30, 2002 and the three months ended September 30, 2001.
Revenue. The following table displays revenues by reportable segment (in
thousands).
THREE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------------------
2002 2001
------------------------- -------------------------
PERCENTAGE OF PERCENTAGE OF
DOLLARS TOTAL DOLLARS TOTAL
------- ------------- ------- -------------
United States................... $21,121 74.5% $17,516 68.6%
Asia-Pacific.................... 2,470 8.7 3,117 12.2
Europe.......................... 1,419 5.0 2,076 8.1
India........................... 3,348 11.8 2,829 11.1
------- ------ ------- ------
Total........................... $28,358 100.0% $25,538 100.0%
======= ====== ======= ======
- 26 -
US revenue increased by 20.6%, or $3.6 million, from $17.5 million for the
three months ended September 30, 2001, to $21.1 million for the three months
ended September 30, 2002. The increase was attributable primarily to increased
demand for the majority of the Company's service offerings, including
traditional consulting service offerings, application management and support
services, offshore development services and Power Up services.
APAC revenue decreased by 20.8% or $647,000, from $3.1 million for the
three months ended September 30, 2001, to $2.5 million for the three months
ended September 30, 2002. The decrease was due primarily to challenging economic
conditions in Japan (a decrease of $395,000) and Australia (a decrease of
$268,000), while the rest of the Asia-Pacific region increased slightly (an
increase of $16,000).
Europe revenue decreased by 31.6%, or $657,000, from $2.1 million for the
three months ended September 30, 2001, to $1.4 million for the three months
ended September 30, 2002. The decrease was attributable primarily to the United
Kingdom ("UK") operations (a decrease of $512,000), while the consolidated
Nordic operations (Denmark and Sweden) decreased slightly (a decrease of
$145,000). As a result of the decline in operating performance, the Company
executed a plan to reorganize and downsize the Company's operations in the UK in
the fourth quarter of 2001. The UK operations now consist of a much smaller core
group of billable consultants, focused primarily on providing application
management and support services in the PeopleSoft market. The decrease in Nordic
operations resulted primarily from challenging economic conditions in Sweden.
India revenue increased by 18.3%, or $519,000, from $2.8 million for the
three months ended September 30, 2001, to $3.3 million for the three months
ended September 30, 2002. The increase was attributable primarily to increased
demand for services in the United States, as a majority of the total revenue
generated in India is derived from providing offshore development and support
services to customers sourced through the Company's affiliated entities in other
parts of the world, but most predominantly with the United States.
Operating Income (Loss). The following table displays operating income
(loss) by reportable segment (in thousands).
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2002 2001
---------- ----------
United States....................... $ 771 $ 796
Asia-Pacific........................ (423) 237
Europe.............................. (389) (972)
India............................... 381 463
------- -------
Total............................... $ 340 $ 524
======= =======
US operating income decreased by $25,000, from $796,000 for the three
months ended September 30, 2001, to $771,000 for the three months ended
September 30, 2002. The decrease in operating income was attributable primarily
to the $412,000 of charges associated with the proxy contest during the three
months ended September 30, 2002. Excluding these proxy charges, the US operating
income for the three months ended September 30, 2002 was $1.2
- 27 -
million, or an increase of $387,000, compared to the same period of 2001. The
increase in operating income was attributable primarily to further containment
of discretionary selling, general and administrative expenditures, such as
employee bonuses and travel and entertainment expenses.
APAC operating performance decreased by $660,000, from operating income of
$237,000 for the three months ended September 30, 2001, to an operating loss of
$423,000 for the three months ended September 30, 2002. The decrease was
attributable primarily to the operating performance in Australia (a decrease of
$190,000), Indonesia (a decrease of $173,000), Singapore (a decrease of
$158,000), Japan (a decrease of $117,000), and New Zealand (a decrease of
$22,000), as a result of local market conditions.
Europe operating performance improved by $583,000, from an operating loss
of $972,000 for the three months ended September 30, 2001, to an operating loss
of $389,000 for the three months ended September 30, 2002. The improvement was
attributable primarily to an improvement in the operating performance of the UK
of $745,000, while the Nordic operations declined by $162,000. The improvement
in the UK operating performance resulted primarily from the restructuring
program initiated in the UK during late 2001. The decline in the Nordic
operating performance resulted from competitive local conditions, primarily
within the SAP software market.
India operating income decreased by $82,000, from $463,000 for the three
months ended September 30, 2001, to $381,000 for the three months ended
September 30, 2002. The decrease was attributable primarily to an increase in
consultant salaries (as a result of both increased headcount and local market
adjustments to base consultant salaries), non-billable consultant time and other
related costs as well as a decrease in average consultant billing rates.
Nine months Ended September 30, 2002 Compared to Nine months Ended
September 30, 2001
The following discussion compares the segment results for the nine months
ended September 30, 2002 and the nine months ended September 30, 2001.
Revenue. The following table displays revenues by reportable segment (in
thousands).
NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------------------
2002 2001
------------------------- -------------------------
PERCENTAGE OF PERCENTAGE OF
DOLLARS TOTAL DOLLARS TOTAL
------- ------------- ------- -------------
United States.................... $57,859 72.8% $56,493 66.4%
Asia-Pacific..................... 7,191 9.1 10,226 12.0
Europe........................... 4,448 5.6 8,708 10.3
India............................ 9,945 12.5 9,634 11.3
------- ------ ------- ------
Total............................ $79,443 100.0% $85,061 100.0%
======= ====== ======= ======
US revenue increased by 2.4%, or $1.4 million, from $56.5 million for the
nine months ended September 30, 2001, to $57.9 million for the nine months ended
September 30, 2002. Since the latter half of 2001, the Company had experienced
challenging economic conditions that
- 28 -
precluded many companies from spending resources on IT projects, which had
adversely impacted the demand for the Company's services. Since mid-2002, the US
has begun to experience an increase in demand for services, including its
professional consulting and application management services.
APAC revenue decreased by 29.7%, or $3.0 million, from $10.2 million for
the nine months ended September 30, 2001, to $7.2 million for the nine months
ended September 30, 2002. The decrease was due primarily to challenging economic
conditions throughout the Asia-Pacific region, including Japan (a decrease of
$1.5 million), Australia (a decrease of $578,000), New Zealand (a decrease of
$488,000), Indonesia (a decrease of $307,000) and Singapore (a decrease of
$133,000).
Europe revenue decreased by 48.9% or $4.3 million, from $8.7 million for
the nine months ended September 30, 2001, to $4.4 million for the nine months
ended September 30, 2002. The decrease was attributable primarily to the United
Kingdom ("UK") operations (a decrease of $3.9 million), while the consolidated
Nordic operations (Denmark and Sweden) decreased slightly (a decrease of
$384,000). As a result of the decline in operating performance, the Company
executed a plan to reorganize and downsize the Company's operations in the UK in
the fourth quarter of 2001. The UK operations now consist of a much smaller core
group of billable consultants, focused primarily on providing application
management and support services in the PeopleSoft market. The decrease in Nordic
operations resulted primarily from challenging economic conditions in Sweden.
India revenue increased by 3.2%, or $311,000, from $9.6 million for the
nine months ended September 30, 2001, to $9.9 million for the nine months ended
September 30, 2002. The increase was attributable primarily to increased demand
for services in the US over the past couple of quarters, as a majority of the
total revenue generated in India is derived from providing offshore development
and support services to customers sourced through the Company's affiliated
entities in other parts of the world, but most predominantly with the United
States.
Operating Income (Loss). The following table displays operating income
(loss) by reportable segment (in thousands).
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2002 2001
---------- ----------
United States....................... $(7,263) $ 815
Asia-Pacific........................ (1,262) 343
Europe.............................. (930) (2,878)
India............................... 1,726 2,754
------- -------
Total............................... $(7,729) $ 1,034
======= =======
US operating performance decreased by $8.1 million, from operating income
of $815,000 for the nine months ended September 30, 2001, to an operating loss
of $7.3 million for the nine months ended September 30, 2002. The significant
decline in operating performance was a result of the charges associated with the
SeraNova receivable impairment and other charges and the proxy contest ("Special
Charges"). Excluding these Special Charges, the US operating income for the nine
months ended September 30, 2002 was $2.0 million, or an increase of $1.2
- 29 -
million, compared to the same period of the prior year. The increase in
operating income resulted primarily from the containment of discretionary
expenditures, such as employee bonuses, marketing and travel and entertainment
expenses.
APAC operating performance declined by $1.6 million, from operating income
of $343,000 for the nine months ended September 30, 2001, to an operating loss
of $1.3 million for the nine months ended September 30, 2002. The decrease was
attributable primarily to the operating performance in Japan (a decrease of
$585,000), Singapore (a decrease of $402,000) Australia (a decrease of
$390,000), Indonesia (a decrease of $129,000) and New Zealand (a decrease of
$99,000), as gross margins declined as a result of local market conditions.
Europe operating performance improved by $1.9 million, from an operating
loss of $2.9 million for the nine months ended September 30, 2001, to an
operating loss of $930,000 for the nine months ended September 30, 2002. The
improvement was attributable primarily to an improvement in the operating
performance of the UK of $2.4 million, while the Nordic operations declined by
$466,000. The improvement in the UK operating performance resulted primarily
from the restructuring program initiated in the UK during late 2001. As noted
above, the UK operations now consist of a much smaller core group of billable
consultants, focused primarily on providing application management and support
services in the PeopleSoft market. The decline in the Nordic operating
performance resulted from competitive local conditions, primarily within the SAP
software market.
India operating income decreased by $1.1 million, from $2.8 million for the
nine months ended September 30, 2001, to $1.7 million for the nine months ended
September 30, 2002. The decrease was attributable primarily to an increase in
consultant salaries (as a result of both increased headcount and local market
adjustments to base consultant salaries), non-billable consultant time and other
related costs as well as a decrease in average consultant billing rates.
LIQUIDITY AND CAPITAL RESOURCES
The Company had cash and cash equivalents of $2.0 million at September 30,
2002 and $2.1 million at December 31, 2001. The Company had working capital of
$11.8 million at September 30, 2002 and $18.2 million at December 31, 2001.
Cash provided by operating activities was $432,000 for the nine months
ended September 30, 2002, resulting primarily from depreciation and amortization
of $2.7 million, the provision for doubtful accounts of $342,000, the SeraNova
receivable impairment and other charges of $8.4 million, a decrease in other
current assets of $145,000 and increases in accounts payable of $665,000 and
accrued payroll and related taxes of $1.4 million. These amounts were partially
offset by the net loss, increases in accounts receivable of $2.9 million,
unbilled services of $456,000 and other assets of $105,000 and decreases in
accrued expenses and other liabilities of $688,000 and accrued restructuring
charges of $529,000. The increases in accounts receivable and unbilled services
result primarily from the growth in revenue during the three months ended
September 30, 2002. The changes in other current assets, other assets, accounts
payable, accrued payroll and related taxes and accrued expenses and other
liabilities result primarily from timing differences. The decrease in accrued
restructuring charges results from the payment of severance
- 30 -
and related costs and exit costs. Cash provided by operating activities during
the nine months ended September 30, 2001 was $4.7 million.
The Company invested $1.2 million and $3.0 million in computer equipment,
internal-use computer software and office furniture and fixtures during the nine
months ended September 30, 2002 and 2001, respectively. The decrease results
from concerted efforts by management to closely monitor and curtail capital
expenditures.
In conjunction with the strategic decision to focus on the emerging ASP
market, the Company invested $2.7 million in purchased computer software
licenses during the nine months ended September 30, 2001. The computer software
was to be re-sold to customers as part of the Company's ASPPlus solutions and
services. However, during the three months ended December 31, 2001, the Company
recorded a write-down of the purchased computer software, as management believed
the recoverability of the value of the assets acquired for use in the ASP
service offering was unlikely given current and future expected market
conditions.
On May 31, 2000, the Company and PNC Bank, N.A. (the "Bank") entered into a
three-year revolving credit facility. Such credit facility is comprised of a
revolving line of credit pursuant to which the Company can borrow up to $20.0
million either at the Bank's prime rate per annum or the Euro Rate plus 1.75% to
2.5% based upon the Company's ratio of debt to earnings before interest, taxes,
depreciation and amortization ("EBITDA"). The credit facility is collateralized
by substantially all of the assets of the Company's United States based
operations. The maximum borrowing availability under the line of credit is based
upon a percentage of eligible billed and unbilled accounts receivable, as
defined. As of September 30, 2002, the Company had outstanding borrowings under
the credit facility of $5.1 million. The Company estimates undrawn availability
under the credit facility to be $7.6 million as of September 30, 2002. As of
December 31, 2001, the Company had outstanding borrowings under the credit
facility of $4.1 million.
The credit facility provides for the following financial covenants, among
other things, (1) the Company must maintain consolidated net worth, as defined
("consolidated net worth") of (a) not less than 95% of the Company's
consolidated net worth of the immediately preceding fiscal year-end as at each
such fiscal quarter after December 31, 2000; and (b) at least 105% of the
Company's consolidated net worth as of the immediately preceding fiscal year-end
as at each such fiscal year-end subsequent to December 31, 2000; provided,
however, the foregoing covenant shall not be tested for any quarter so long as
the Company maintains, at all times during such fiscal quarter, undrawn
availability of more than $5.0 million and (2) the Company must maintain
unconsolidated net worth, as defined ("unconsolidated net worth") of (a) not
less than 95% of the Company's unconsolidated net worth of the immediately
preceding fiscal year-end as at each such fiscal quarter after December 31,
2000; and (b) at least 105% of the Company's unconsolidated net worth as of the
immediately preceding fiscal year-end as at each such fiscal year-end subsequent
to December 31, 2000; provided, however, the foregoing covenant shall not be
tested for any quarter so long as the Company maintains, at all times during
such fiscal quarter, undrawn availability of more than $5.0 million.
Additionally, the credit facility contains material adverse change clauses with
regard to the financial condition of the assets, liabilities and operations of
the Company.
- 31 -
As of December 31, 2001, the Company was not in compliance with the
consolidated net worth and unconsolidated net worth financial covenants. In
March 2002, the Company finalized with the Bank the terms of a waiver and
amendment to the credit agreement. The terms of the waiver and amendment
included, among other things, (1) a waiver of the covenant defaults as of
December 31, 2001, (2) a modification to the financial covenants to require that
consolidated net worth and unconsolidated net worth as of December 31, 2002 be
not less than 102% of consolidated net worth and unconsolidated net worth,
respectively, as of December 31, 2001, (3) a modification to the consolidated
net worth and unconsolidated net worth covenants to exclude any changes to
consolidated net worth and unconsolidated net worth resulting from the
write-down or write-off of up to $10.8 million of the note due from SeraNova,
and (4) a new financial covenant requiring that the Company EBITDA of at least
90% of the prior year's EBITDA.
During each of the quarters ended June 30, 2002 and September 30, 2002, the
Company incurred charges related to the Company's contested 2002 Annual Meeting
of Shareholders ("Proxy Contest"). The Proxy Contest charges included legal
fees, proxy solicitation services and printing, mailing and other costs. As a
direct result of the Proxy Contest charges, the Company was not in compliance
with the EBITDA covenant as of June 30, 2002 and September 30, 2002. The Company
is currently negotiating with the Bank and expects to receive a waiver of the
covenant defaults existing as of June 30, 2002 and September 30, 2002. There can
be no assurance, however, that the Company will be able to obtain a waiver and
appropriate amendment to the agreement on terms acceptable to the Company.
On May 31, 2000, SeraNova and the Company formalized a $15.1 million
unsecured promissory note (the "Note") relating to net borrowings by SeraNova
from the Company through such date. The Note bears interest at the prime rate
plus 1/2%. The Company had recorded total accrued interest of $1.0 million as of
December 31, 2001. The Company has not recorded any accrued interest on the
balance of the Note subsequent to the maturity date of July 31, 2001. On
September 29, 2000, the Company received a $3.0 million payment from SeraNova.
In September 2000, SeraNova consummated an $8.0 million preferred stock
financing with two institutional investors. According to the mandatory
prepayment provisions of the Note, SeraNova was required to make a prepayment of
$3.0 million on the Note as a result of the stock financing. Subsequently, the
Company finalized with SeraNova the terms of an agreement to waive, subject to
certain conditions, certain of the mandatory prepayment obligations arising as a
result of the financing. The terms of the new agreement included, among other
things, that SeraNova pay the Company (i) $500,000 upon execution of the
agreement; (ii) $500,000 on or before each of January 31, 2001, February 28,
2001, March 31, 2001, April 30, 2001 and May 31, 2001; and (iii) $400,000 on or
before December 15, 2000 to be applied either as (a) an advance payment towards
a contemplated services arrangement for hosting services to be provided to
SeraNova by the Company (the "Hosting Agreement"); or (b) in the event that no
such Hosting Agreement is executed on or before December 15, 2000, an additional
advance prepayment toward the principal of the Note.
The Company received from SeraNova the $500,000 payment that was due upon
execution of the agreement and a $400,000 payment in December 2000 as an advance
payment towards the principal of the Note since no Hosting Agreement was
executed before December 15, 2000.
- 32 -
In 2001, the Company received principal payments totaling $2.1 million from
SeraNova. However, SeraNova failed to make final payment of all amounts due
under the Note to the Company as of July 31, 2001. On August 16, 2001, the
Company filed a complaint against SeraNova and Silverline Technologies Limited
("Silverline"), which acquired SeraNova in March 2001. As of such date, SeraNova
was obligated to pay to the Company the remaining principal (approximately $9.1
million) and accrued interest (approximately $1.0 million), or an aggregate of
$10.1 million. SeraNova then filed a counterclaim against the Company for
unspecified damages as a set-off against the Company's claims. In response to
the Company's request for a statement of damages, SeraNova stated that it was in
the process of calculating its damages, but for informational purposes claimed
compensatory damages in excess of $5.5 million and punitive damages in the
amount of $10.0 million. The parties have completed the discovery process and a
trial is scheduled for December 16, 2002. The Company believes that there is no
basis to support the amounts claimed by SeraNova in its counterclaim for
compensatory and punitive damages. The inability of the Company to collect the
amount due from SeraNova and/or Silverline or an adverse decision with respect
to the Company relating to SeraNova's counterclaim could negatively affect the
Company's business, financial condition or results of operations.
In addition, during late 2001, SeraNova failed to pay certain outstanding
lease obligations to the Company's landlords. Accordingly, on March 4, 2002, the
Company filed an arbitration demand with the American Arbitration Association
against the SeraNova Group (see Part II, Item 1, Legal Proceedings). The demand
for arbitration, which sought damages, alleged among other things that the
SeraNova Group failed to pay outstanding lease obligations to the Company's
landlords and to reimburse the Company for all rent payments made by the Company
on their behalf. An arbitration hearing was held on June 25, 2002 and June 28,
2002 seeking $525,000 in outstanding lease obligations. On August 9, 2002, an
award was issued in the amount of $616,905 (including attorney's fees) plus
reimbursement of administrative fees, in favor of Intelligroup and against the
SeraNova Group jointly and severally. The award also includes a provision that
jurisdiction is retained by the tribunal, and the Company may seek from the
tribunal any additional rents and other fees due and owing on a quarterly basis.
Accordingly, the Company filed a second demand for $300,000 in damages for rents
and other fees due and owing for the months of June through September 2002. On
August 12, 2002, an action was commenced in the Superior Court of New Jersey to
confirm the award, seek a writ of execution against the SeraNova Group's assets,
restrain the disposal of the SeraNova Group's assets, and enjoin the
distribution of proceeds from any sale of the SeraNova Group's assets among
other emergency relief. On August 13, 2002, the Court, among other things, (i)
confirmed the award and entered judgment against SeraNova in the amount of
$616,905 plus $7,100 in administrative fees, (ii) authorized the issuance of a
writ of execution against SeraNova's bank accounts and other assets to satisfy
the judgment, (iii) restrained the SeraNova Group from disposing of any assets,
including funds in their bank accounts, (iv) authorized the attachment of all
net proceeds from the sale of any assets of the SeraNova Group up to the amount
of the arbitration award to be held in an interest bearing escrow account
pending further court order and (v) scheduled a hearing for September 3, 2002 in
order for the SeraNova Group to show cause why the relief granted by the Court
to the Company against SeraNova should not be applied to the SeraNova Group
jointly and severally. A trial was held over several days in September 2002. On
October 3, 2002, the Court confirmed the $624,000 award, jointly and severally
as to all the defendants, and issued a writ of
- 33 -
execution against the defendant's assets. The Company does not believe that the
outcome of this claim will have a materially adverse effect on the Company's
business, financial condition or results of operations.
The Company is continuing to pursue its various legal options to obtain
payment from the SeraNova Group on the Note and outstanding lease obligations.
At the same time, the Company has also been actively engaged in discussions with
management of the SeraNova Group, with the objective of seeking an out of court
resolution to all outstanding matters involving the Note, and certain other
receivables and lease obligations. However, the Company believed that the
liquidity issues plaguing the SeraNova Group required a reassessment of the
realizability of these outstanding amounts as of June 30, 2002. Although no
final resolution had been reached, the Company believed that the substance of
these discussions provided a basis for determining the approximate realizable
value of the Note and other receivables, as well as an estimate of the costs
required to exit certain lease obligations. Accordingly, the Company recorded
the following charges during the quarter ended June 30, 2002:
WRITE-DOWN WRITE-OFF ASSUMPTION
OF NOTE OF OTHER OF CERTAIN
RECEIVABLE RECEIVABLES - LEASE OTHER
- SERANOVA SERANOVA OBLIGATIONS CHARGES TOTAL
----------------------------------------------------------------------------
Charges to operations during 2002... $ 5,140,000 $ 1,257,000 $ 1,501,000 $ 464,000 $ 8,362,000
Costs paid during 2002.............. -- -- (205,000) (202,000) (407,000)
Non-cash items...................... (5,140,000) (1,257,000) -- -- (6,397,000)
------------ ------------ ------------ ----------- ------------
Accrued costs as of September 30,
2002................................ $ -- $ -- $ 1,296,000 $ 262,000 $ 1,558,000
============ ============ ============ =========== ============
At June 30, 2002, the Company recorded a $5.1 million charge to write-down
the carrying value of the Note to $4.0 million. The Company also recorded a $1.3
million to write-off the carrying value of the other SeraNova receivables
(primarily, accrued interest on the Note and a receivable for a system
implementation project). Additionally, the Company had recorded a liability of
$1.5 million for certain lease exit costs as of June 30, 2002. Such liability
represents primarily obligated space costs for which the Company currently
believes it cannot use or sublease and the differential between certain Company
lease obligations and sublease amounts to be received. As of September 30, 2002,
$1.3 million of the liability remains outstanding, of which $1.0 million is
included in other long-term liabilities.
At September 30, 2002, the Company re-evaluated the realizability of the
carrying value of the Note, as well as any required change to the obligations
associated with the office space costs. Based upon the current status of the
negotiations with the SeraNova Group, the Company determined that no change to
the carrying value of the Note or the recorded liability was appropriate as of
September 30, 2002. However, if the Company were to collect less than $4.0
million on the Note recorded as of September 30, 2002, or incur additional
obligations or costs, the SeraNova receivable impairment and/or charges would be
increased in future periods.
The Company's 2002 operating plan contains assumptions regarding revenue
and expenses. The achievement of the operating plan depends heavily on the
timing of work performed by the Company on existing projects and the ability of
the Company to gain and perform work on new projects. Project cancellations,
delays in the timing of work performed by
- 34 -
the Company on existing projects or the inability of the Company to gain and
perform work on new projects could have an adverse impact on the Company's
ability to execute its operating plan and maintain adequate cash flow. In the
event actual results do not meet the operating plan, management believes it
could execute contingency plans to mitigate such effects. Such plans include
additional cost reductions or seeking additional financing. Considering the cash
on hand, the remaining availability under the credit facility and based on the
achievement of the operating plan and management's actions taken to date,
management believes it has the ability to continue to generate sufficient cash
to satisfy its operating requirements in the normal course of business. However,
no assurance can be given that sufficient cash will be generated from
operations.
The Company believes that its available funds, together with current credit
arrangements and the cash flow expected to be generated from operations, will be
adequate to satisfy its current and planned operations for at least the next 12
months.
NASDAQ NATIONAL MARKET
On April 4, 2002, the Company received a letter from the Nasdaq Stock
Market ("Nasdaq") advising the Company that it failed to meet Nasdaq
requirements for continued listing as the closing "bid" price of the Company's
common stock was less than $1.00 for 30 trading days. On May 13, 2002, the
Company received a letter from Nasdaq advising the Company that it had regained
compliance with the continued listing requirements.
On November 7, 2002, the Company received a letter from Nasdaq advising the
Company that it has again failed to meet Nasdaq requirements for continued
listing as the closing "bid" price of the Company's common stock was less than
$1.00 for 30 trading days. The Company now has 90 days from the notice date (or
until February 5, 2003) to regain compliance by having the bid price of the
Company's Common Stock close at $1.00 or greater for a minimum of 10 consecutive
trading days during the 90-day compliance period. A delisting from the Nasdaq
National Market could severely and adversely affect the market liquidity of the
Company's Common Stock.
COMMITMENTS
During late 2001, SeraNova failed to pay certain outstanding lease
obligations to the Company's landlords. Accordingly, on March 4, 2002, the
Company filed an arbitration demand with the American Arbitration Association
against the SeraNova Group (see Part II, Item 1, Legal Proceedings). The demand
for arbitration, which sought damages, alleged among other things that the
SeraNova Group failed to pay outstanding lease obligations to the Company's
landlords and to reimburse the Company for all rent payments made by the Company
on their behalf. An arbitration hearing was held on June 25, 2002 and June 28,
2002 seeking $525,000 in outstanding lease obligations. On August 9, 2002, an
award was issued in the amount of $616,905 (including attorney's fees) plus
reimbursement of administrative fees, in favor of Intelligroup and against the
SeraNova Group jointly and severally. The award also includes a provision that
jurisdiction is retained by the tribunal, and the Company may seek from the
tribunal any additional rents and other fees due and owing on a quarterly basis.
Accordingly, the Company filed a second demand for $300,000 in damages for rents
and other fees due and owing for the months of June through September 2002. On
August 12, 2002, an action was commenced
- 35 -
in the Superior Court of New Jersey to confirm the award, seek a writ of
execution against the SeraNova Group's assets, restrain the disposal of the
SeraNova Group's assets, and enjoin the distribution of proceeds from any sale
of the SeraNova Group's assets among other emergency relief. On August 13, 2002,
the Court, among other things, (i) confirmed the award and entered judgment
against SeraNova in the amount of $616,905 plus $7,100 in administrative fees,
(ii) authorized the issuance of a writ of execution against SeraNova's bank
accounts and other assets to satisfy the judgment, (iii) restrained the SeraNova
Group from disposing of any assets, including funds in their bank accounts, (iv)
authorized the attachment of all net proceeds from the sale of any assets of the
SeraNova Group up to the amount of the arbitration award to be held in an
interest bearing escrow account pending further court order and (v) scheduled a
hearing for September 3, 2002 in order for the SeraNova Group to show cause why
the relief granted by the Court to the Company against SeraNova should not be
applied to the SeraNova Group jointly and severally. A trial was held over
several days in September 2002. On October 3, 2002, the Court confirmed the
$624,000 award, jointly and severally as to all the defendants, and issued a
writ of execution against the defendant's assets. The Company does not believe
that the outcome of this claim will have a materially adverse effect on the
Company's business, financial condition or results of operations.
NEW ACCOUNTING PRONOUNCEMENT
In June 2002, the Financial Accounting Standards Board (the "FASB") issued
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities." SFAS No. 146 addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." The Company is evaluating the impact of the
adoption of SFAS No. 146, which is effective for the Company as of January 1,
2003, but does not believe it will have a material impact on the Company's
financial position or results of operations.
EUROPEAN MONETARY UNION (EMU)
The euro was introduced on January 1, 1999, at which time the eleven
participating EMU member countries established fixed conversion rates between
their existing currencies (legacy currencies) and the euro. The legacy
currencies will continue to be used as legal tender through January 1, 2002;
thereafter, the legacy currencies will be canceled and euro bills and coins will
be used for cash transactions in the participating countries. The Company's
European sales and operations offices have already addressed the systems issues
raised by the euro currency conversion and are cognizant of the business
implications of converting to a common currency. Since the Company currently
only operates in certain European countries that do not participate in the EMU,
the Company believes the conversion to the euro did not have a material
financial impact on its operations in Europe. Should those countries in which
the Company operates decide to join the EMU, the Company plans to re-evaluate
the financial impact of the conversion to the euro on its operations.
- 36 -
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Although the Company cannot accurately determine the precise effect thereof
on its operations, it does not believe inflation, currency fluctuations or
interest rate changes have historically had a material effect on its revenues,
sales or results of operations. Any significant effects of inflation, currency
fluctuations and changes in interest rates on the economies of the United
States, Asia and Europe could adversely impact the Company's revenues, sales and
results of operations in the future. If there were a material adverse change in
the relationship between European currencies and/or Asian currencies and the
United States Dollar, such change would adversely affect the results of the
Company's European and/or Asian operations as reflected in the Company's
financial statements. The Company has not hedged its exposure with respect to
this currency risk, and does not expect to do so in the future, since it does
not believe that it is practicable for it to do so at a reasonable cost.
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed
to ensure that information required to be disclosed by the Company in the
reports that it files or submits under the Securities Exchange Act of 1934, as
amended, is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms, and that such information is accumulated
and communicated to the Company's management, President and Chief Executive
Officer and Senior Vice President-Finance and Administration and Chief Financial
Officer, as appropriate to allow timely decisions regarding required disclosure.
Within 90 days prior to the date of this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, President and Chief Executive Officer and Senior Vice
President-Finance and Administration and Chief Financial Officer, of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures. Based upon that evaluation, the Company's President and Chief
Executive Officer and Senior Vice President-Finance and Administration and Chief
Financial Officer, have concluded that the Company's disclosure controls and
procedures are effective. There have been no significant changes in the
Company's internal controls or in other factors that could significantly affect
the internal controls subsequent to the date the Company completed its
evaluation.
- 37 -
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On February 7, 2001, NSA Investments II LLC filed a complaint in the United
States District Court for the District of Massachusetts naming, among others,
SeraNova, the Company and Rajkumar Koneru, a former director of the Company, as
defendants. The plaintiff alleges that it invested $4,000,000 in SeraNova as
part of a private placement of SeraNova common stock in March 2000, prior to the
spin-off of SeraNova by the Company. The complaint, which seeks compensatory and
punitive damages, alleges that the Company, as a "controlling person" of
SeraNova, is jointly and severally liable with and to the extent as SeraNova for
false and misleading statements constituting securities laws violations. After
being served with the complaint, the Company made a request for indemnification
from SeraNova pursuant to the various inter-company agreements in connection
with the spin-off. By letter dated April 13, 2001, SeraNova's counsel, advised
the Company that SeraNova acknowledged liability for such indemnification claims
and has elected to assume the defense of the plaintiff's claims. In October
2001, the motion to dismiss, filed on behalf of the Company in May 2001, was
denied without prejudice to refile at the close of the discovery period.
Court-ordered mediation between the plaintiff and SeraNova during January and
February 2002 was unsuccessful. In January 2002, plaintiff filed a motion for
partial summary judgment as to certain claims against SeraNova. No summary
judgment motion was filed against the Company. SeraNova filed its opposition to
plaintiff's motion for partial summary judgment in February 2002. The court
heard argument on the motion for partial summary judgment on July 30, 2002. On
September 30, 2002, the Court granted plaintiff's motion in part, finding
SeraNova liable for breach of contract as a matter of law. The Company denies
the allegations made and intends to defend vigorously the claims made by the
plaintiff. It is too early in the dispute process to determine the impact, if
any, that such dispute will have upon the Company's business, financial
condition or results of operations.
On August 16, 2001, the Company filed a complaint in the Superior Court of
New Jersey, Middlesex County, against SeraNova, Inc. and Silverline Technologies
Limited, which acquired SeraNova in March 2001. The complaint, which seeks
damages, alleges among other things that SeraNova failed to pay amounts owing
under (i) an unsecured promissory note totaling $10,079,717, and (ii) a system
implementation project totaling $511,573. On September 25, 2001, SeraNova and
Silverline filed a joint Answer to the Company's complaint. In addition,
SeraNova filed a counterclaim against the Company for unspecified damages as a
set-off against the Company's claims. Thereafter, in response to the Company's
request for a statement of damages, SeraNova stated that it was in the process
of calculating its damages, but for informational purposes claimed compensatory
damages in excess of $5,500,000 and punitive damages in the amount of
$10,000,000. The parties have completed the discovery process and a trial is
scheduled for December 16, 2002. The Company believes that there is no basis to
support the amounts claimed by SeraNova in its counterclaim for compensatory and
punitive damages. The inability of the Company to collect the amount due from
SeraNova and/or Silverline or an adverse decision with respect to the Company
relating to SeraNova's counterclaim could negatively affect the Company's
business, financial condition or results of operations.
On March 4, 2002, the Company filed an arbitration demand with the American
Arbitration Association against the SeraNova Group. The demand for arbitration,
which sought damages, alleged among other things that the SeraNova Group failed
to pay outstanding lease
- 38 -
obligations to the Company's landlords and to reimburse the Company for all rent
payments made by the Company on their behalf. An arbitration hearing was held on
June 25, 2002 and June 28, 2002 seeking $525,000 in outstanding lease
obligations. On August 9, 2002, an award was issued in the amount of $616,905
(including attorney's fees) plus reimbursement of administrative fees, in favor
of Intelligroup and against the SeraNova Group jointly and severally. The award
also includes a provision that jurisdiction is retained by the tribunal, and the
Company may seek from the tribunal any additional rents and other fees due and
owing on a quarterly basis. Accordingly, the Company filed a second demand for
$300,000 in damages for rents and other fees due and owing for the months of
June through September 2002. On August 12, 2002, an action was commenced in the
Superior Court of New Jersey to confirm the award, seek a writ of execution
against the SeraNova Group's assets, restrain the disposal of the SeraNova
Group's assets, and enjoin the distribution of proceeds from any sale of the
SeraNova Group's assets among other emergency relief. On August 13, 2002, the
Court, among other things, (i) confirmed the award and entered judgment against
SeraNova in the amount of $616,905 plus $7,100 in administrative fees, (ii)
authorized the issuance of a writ of execution against SeraNova's bank accounts
and other assets to satisfy the judgment, (iii) restrained the SeraNova Group
from disposing of any assets, including funds in their bank accounts, (iv)
authorized the attachment of all net proceeds from the sale of any assets of the
SeraNova Group up to the amount of the arbitration award to be held in an
interest bearing escrow account pending further court order and (v) scheduled a
hearing for September 3, 2002 in order for the SeraNova Group to show cause why
the relief granted by the Court to the Company against SeraNova should not be
applied to the SeraNova Group jointly and severally. A trial was held over
several days in September 2002. On October 3, 2002, the Court confirmed the
$624,000 award, jointly and severally as to all the defendants, and issued a
writ of execution against the defendant's assets. The Company does not believe
that the outcome of this claim will have a materially adverse effect on the
Company's business, financial condition or results of operations.
On June 14, 2002, the Company filed a complaint in the Superior Court of
New Jersey, Mercer County, against Ashok Pandey, a shareholder and former
officer and director of the Company. The complaint, which seeks damages in
excess of $400,000, alleges among other things that Mr. Pandey breached certain
terms and conditions of a separation agreement he entered into with the Company
and that Mr. Pandey has been unjustly enriched in an amount of $350,000 from the
Company. Mr. Pandey has filed an Answer to the Company's complaint denying the
Company's claims. The parties are currently proceeding with the discovery
process. The Company does not believe that the outcome of this claim will have a
material adverse effect on the Company's business, financial condition or
results of operations.
On June 26, 2002, Ashok Pandey filed a Complaint in the United States
District Court for the District of New Jersey, alleging that certain
shareholders of the Company constituted a group that held more than 5% of the
outstanding shares of the Company's common stock and had not filed a Schedule
13D disclosure statement with the Securities and Exchange Commission. On June
28, 2002, plaintiff obtained an ex parte injunctive order from the Court barring
Srini Raju, an alleged member of the "group" and a shareholder holding 4.61% of
the Company's common stock, from voting in the Company's Annual Meeting of
Shareholders (the "Annual Meeting"). On July 12, 2002, after reviewing actual
evidence of record, and hearing argument from plaintiff's counsel, the Court
held that there was no basis to enjoin Mr. Raju from voting his shares at the
Annual Meeting. After the election, Pandey sought to file an amended complaint
dropping certain defendants, and adding others, including the Company. On
September 27,
- 39 -
2002, the Court granted plaintiff's motion, and allowed certain limited
discovery to proceed. On October 11, 2002, the Company filed a motion for
Judgment on the Pleadings in its favor, arguing that the relief sought by
plaintiff, the retroactive sterilization of Mr. Raju's shares and the
invalidation of his votes at the Annual Meeting, is not sanctioned by law, and
is unavailable as a remedy. On November 11, 2002, Pandey notified the Court of
and served on the Company's counsel his cross motion seeking to file a second
amended complaint seeking, among other things, a resolicitation of proxies to
elect new directors to the Company's Board of Directors. The Company's motion
and Pandey's cross motion are awaiting further briefing and a decision by the
Court
On July 2, 2002, Ashok Pandey filed a complaint in the Superior Court of
New Jersey, Middlesex County, in connection with the Company's recent Proxy
contest with respect to the Annual Meeting. In his Complaint, plaintiff claimed
that Intelligroup's Board of Directors violated their fiduciary duties by
adjourning the Annual Meeting from July 2, 2002 to July 16, 2002. On July 3,
2002, the Court denied Plaintiff's application for emergent relief, and ruled
that Intelligroup could adjourn its Annual Meeting, finding that plaintiff's
conduct in obtaining ex parte injunctive relief in federal court enjoining the
voting of 4.61% of the Company's outstanding common stock without notice to the
Company, "estopped [Pandey] from complaining about the adjournment." Despite the
court's denial of his emergent application, plaintiff indicated to the Court on
August 16, 2002, that he would continue the litigation in an effort to have the
court sanction his unilateral attempt to hold an annual meeting and election on
July 2, 2002, despite the Company's adjournment of the meeting and the absence
of its Board of Directors and a quorum of its shareholders on July 2, 2002. The
Company filed its Answer and Affirmative Defenses on August 30, 2002 and
discovery has commenced.
On July 3, 2002, the Company filed a complaint in the United States
District Court for the District of New Jersey, naming Ashok Pandey, TAIB
Securities, Inc., Beechrock Holdings Limited and Braydon Holdings Limited as
defendants. The complaint alleges, among other things, that the defendants
violated federal securities laws in connection with the Company's recent proxy
contest. The defendants have filed an Answer to the Company's complaint denying
the Company's claims. A case management conference has been scheduled by the
Court for November 18, 2002. The Company does not believe that the outcome of
this claim will have a material adverse effect on the Company's business,
financial condition or results of operations.
On October 4, 2002, the Company filed a complaint in the Superior Court of
New Jersey, Middlesex County against the SeraNova Group and HSBC Bank USA
(`HSBC") seeking compensatory, consequential and punitive damages arising out of
SeraNova's and Silverline's failure to pay certain amounts due and owing the
Company, SeraNova's fraudulent conveyance of assets and customer accounts to
Silverline, and HSBC's allegedly knowing acceptance of a fraudulent guarantee of
Silverline's debt to HSBC from SeraNova. Defendants have been served, but have
not yet answered the Complaint. The inability of the Company to collect the full
amount due from SeraNova and/or Silverline could negatively affect the Company's
business, financial condition or results of operation.
There is no other material litigation pending to which the Company is a
party or to which any of its property is subject.
- 40 -
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Shareholders of the Company was held on July 16,
2002.
There were present at the meeting in person or by proxy shareholders
holding an aggregate of 13,837,314 shares of Common Stock. The results of the
vote taken at such meeting with respect to each nominee for Director were as
follows:
Common Stock Nominees For Withheld
--------------------- --- --------
Nagarjun Valluripalli 7,178,024 6,655
Klaus P. Besier 7,174,024 10,655
Dennis McIntosh 7,176,774 7,905
Alexander Graham Wilson 7,178,774 5,905
Prabhas Panigrahi 7,177,024 7,655
Nick Di Iorio 7,177,024 7,655
Ashok Pandey 6,641,469 11,166
Wendy Rayner 6,641,469 11,166
Stephen Savitt 6,641,469 11,166
John Supplee 6,641,469 11,166
Tarun Chandra 6,641,469 11,166
Yoshikazu "Jin" Nakamura 6,641,469 11,166
Accordingly, Nagarjun Valluripalli, Klaus P. Besier, Dennis McIntosh,
Alexander Graham Wilson, Prabhas Panigrahi and Nic Di Iorio were duly elected as
Directors of the Company.
ITEM 5. OTHER INFORMATION
In June 2002, after a review of the recent events concerning Arthur
Andersen LLP ("Andersen"), the Company's Board of Directors delegated to its
Audit Committee the responsibility to work with the Company's management to
review the qualification of the major national accounting firms to serve as the
Company's independent public accountants for the fiscal year ending December 31,
2002. On July 25, 2002, the Company dismissed Andersen, as the Company's
auditors. Andersen's reports on the Company's consolidated financial statements
for each of the years ended December 31, 2001, 2000 and 1999 did not contain an
adverse opinion or disclaimer of opinion, nor were they qualified or modified as
to uncertainty, audit scope or accounting principals. During the years ended
December 31, 2001 and 2000 and the subsequent interim period through July 25,
2002, there were no disagreements with Andersen on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedure which, if not resolved to Andersen's satisfaction, would have caused
Andersen to make reference to the subject matter in connection with its report
on the Company's consolidated financial statements for such years. Further,
there were no reportable events as defined in Item 304(a)(1)(v) of Regulation
S-K.
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On July 25, 2002, the Company's Board of Directors, upon the recommendation
of its Audit Committee, engaged Deloitte & Touche LLP as the Company's new
independent auditors.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
10.1 Employment Agreement between the Company and Nagarjun
Valluripalli dated September 20, 2002.
99.1 Certification pursuant to 18 U.S.C Section 1350.
(b) Reports on Form 8-K.
On July 2, 2002, the Company filed a Form 8-K with the Securities and
Exchange Commission relating to the Company's adjournment of its
Annual Meeting from Tuesday, July 2, 2002 to Tuesday, July 16, 2002.
On August 1, 2002, the Company filed a Form 8-K with the Securities
and Exchange Commission relating to the Company's dismissal of Arthur
Andersen LLP as the Company's auditor and its engagement of Deloitte &
Touche LLP as the Company's new independent auditor.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Intelligroup, Inc.
DATE: November 14, 2002 By: /s/ Nagarjun Valluripalli
--------------------------------------------
Nagarjun Valluripalli,
Chairman of the Board, President and
Chief Executive Officer
(Principal Executive Officer)
DATE: November 14, 2002 By: /s/ Nicholas Visco
--------------------------------------------
Nicholas Visco,
Senior Vice President-Finance and
Administration and Chief Financial Officer
(Principal Financial and Accounting Officer)
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CERTIFICATIONS
I, Nagarjun Valluripalli certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Intelligroup,
Inc.;
2. Based on my knowledge, this Quarterly Report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this Quarterly Report;
3. Based on my knowledge, the financial statements, and other financial
information included in this Quarterly Report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this Quarterly Report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this Quarterly Report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this Quarterly Report (the "Evaluation
Date"); and
c. presented in this Quarterly Report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
- 44 -
6. The registrant's other certifying officers and I have indicated in
this Quarterly Report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
DATE: November 14, 2002 By: /s/ Nagarjun Valluripalli
---------------------------------
Nagarjun Valluripalli
Chairman of the Board, President
and Chief Executive Officer
I, Nicholas Visco certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of Intelligroup,
Inc.;
2. Based on my knowledge, this Quarterly Report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this Quarterly Report;
3. Based on my knowledge, the financial statements, and other financial
information included in this Quarterly Report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this Quarterly Report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this Quarterly Report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this Quarterly Report (the "Evaluation
Date"); and
c. presented in this Quarterly Report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
- 45 -
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this Quarterly Report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
DATE: November 14, 2002 By: /s/ Nicholas Visco
---------------------------------------
Nicholas Visco
Senior Vice President-Finance and
Administration and Chief Financial Officer
- 46 -