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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
Commission File No. 0-20943
Intelligroup, Inc.
------------------------------------------------------
(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 by checkmark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes: No: X
----- -----
Indicate the number of shares outstanding of each of the Issuer's classes
of common stock, as of August 11, 2003:
Class Number of Shares
----- ----------------
Common Stock, $.01 par value 16,682,875
INTELLIGROUP, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
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Page
----
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)............ 1
Consolidated Balance Sheets as of June 30, 2003 and
December 31, 2002....................................... 2
Consolidated Statements of Operations and Comprehensive
Income (Loss) for the Three and Six Months Ended
June 30, 2003 and 2002.................................. 3
Consolidated Statements of Cash Flows for the Six
Months Ended June 30, 2003 and 2002.................... 4
Notes to Consolidated Financial Statements............... 5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations........... 20
Item 3. Quantitative and Qualitative Disclosures About
Market Risk.............................................. 44
Item 4. Controls and Procedures.................................. 44
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................ 45
Item 3. Defaults Upon Senior Securities.......................... 49
Item 5. Other Information........................................ 49
Item 6. Exhibits and Reports on Form 8-K......................... 50
SIGNATURES.......................................................... 52
- i -
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)
- 1 -
INTELLIGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, 2003 and December 31, 2002
JUNE 30, DECEMBER 31,
2003 2002
------------ -------------
ASSETS
Current Assets:
Cash and cash equivalents..................................... $ 2,311,000 $ 1,163,000
Accounts receivable, less allowance for doubtful accounts
of $857,000 and $1,388,000 at June 30, 2003 and
December 31,2002, respectively........................... 16,397,000 17,745,000
Unbilled services............................................. 8,251,000 6,818,000
Prepaid income taxes.......................................... 455,000 624,000
Deferred tax asset............................................ 1,084,000 1,088,000
Other current assets.......................................... 4,066,000 2,858,000
Note receivable - SeraNova.................................... -- 4,000,000
Assets held for sale.......................................... -- 3,069,000
------------ ------------
Total current assets................................... 32,564,000 37,365,000
Property and equipment, net................................... 4,781,000 5,725,000
Deferred tax asset............................................ 156,000 118,000
Other assets.................................................. 823,000 911,000
------------ ------------
$ 38,324,000 $ 44,119,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable.............................................. $ 4,960,000 $ 5,229,000
Accrued payroll and related taxes............................. 7,173,000 5,891,000
Accrued expenses and other current liabilities................ 4,166,000 3,491,000
Deferred revenue.............................................. 1,140,000 1,280,000
Income taxes payable.......................................... 399,000 356,000
Current portion of long-term debt and obligations under
capital leases........................................... 7,421,000 6,374,000
Liabilities held for sale..................................... -- 1,681,000
------------ ------------
Total current liabilities.............................. 25,259,000 24,302,000
------------ ------------
Obligations under capital leases, less current portion.......... 69,000 63,000
Other long-term liabilities..................................... 873,000 1,028,000
------------ ------------
Total long-term liabilities............................ 942,000 1,091,000
------------ ------------
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,
16,682,000 and 16,630,000 shares issued and outstanding
at June 30, 2003 and December 31, 2002, respectively..... 167,000 166,000
Additional paid-in capital.................................... 41,425,000 41,366,000
Accumulated deficit........................................... (27,012,000) (19,168,000)
Accumulated other comprehensive loss.......................... (2,457,000) (3,638,000)
------------ ------------
Total shareholders' equity ............................. 12,123,000 18,726,000
------------ ------------
$ 38,324,000 $ 44,119,000
============ ============
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 AND SIX MONTHS ENDED JUNE 30, 2003 AND 2002
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Revenue .......................................... $28,005,000 $24,806,000 $55,240,000 $47,811,000
Cost of sales .................................... 19,509,000 16,922,000 38,818,000 32,947,000
----------- ----------- ----------- -----------
Gross profit ................................. 8,496,000 7,884,000 16,422,000 14,864,000
----------- ----------- ----------- -----------
Selling, general and administrative expenses...... 6,941,000 6,471,000 13,809,000 12,467,000
Depreciation and amortization..................... 712,000 635,000 1,411,000 1,327,000
SeraNova receivable impairment and other charges.. -- 8,362,000 5,060,000 8,362,000
Proxy contest charges ............................ 296,000 464,000 593,000 464,000
Provision for guarantee of SeraNova debt.......... 581,000 -- 581,000 --
----------- ----------- ----------- -----------
Total operating expenses ..................... 8,530,000 15,932,000 21,454,000 22,620,000
----------- ----------- ----------- -----------
Operating loss ............................... (34,000) (8,048,000) (5,032,000) (7,756,000)
Interest income .................................. 12,000 11,000 25,000 18,000
Interest expense ................................. (124,000) (95,000) (232,000) (200,000)
Other income (expense)............................ (184,000) 16,000 (233,000) 56,000
----------- ----------- ----------- -----------
Loss from continuing operations before income
tax provision ................................ (330,000) (8,116,000) (5,472,000) (7,882,000)
Income tax provision ............................. 163,000 206,000 238,000 310,000
----------- ----------- ----------- -----------
Loss from continuing operations .................. (493,000) (8,322,000) (5,710,000) (8,192,000)
Loss from discontinued operations (including
loss on sale of $1,706,000 in 2003), net
of tax provision of $0, $4,000, $15,000,
$31,000, respectively ........................ -- (239,000) (2,134,000) (358,000)
Net loss ......................................... $ (493,000) $(8,561,000) $(7,844,000) $(8,550,000)
=========== =========== =========== ===========
Earnings per share:
Basic and diluted loss per share:
Loss per share from continuing operations.... $ (0.03) $ (0.50) $ (0.34) $ (0.49)
Loss per share from discontinued operations.. -- (0.01) (0.13) (0.02)
----------- ----------- ----------- -----------
Net loss per share......................... $ (0.03) $ (0.51) $ (0.47) $ (0.51)
=========== =========== =========== ===========
Weighted average number of common shares-
basic and diluted.......................... 16,655,000 16,630,000 16,644,000 16,630,000
=========== =========== =========== ===========
Comprehensive Income (Loss)
---------------------------
Net loss ....................................... $ (493,000) $ (8,561,000) $(7,844,000) $(8,550,000)
Other comprehensive income (loss) -
Currency translation adjustments ........... (285,000) 412,000 1,181,000 (13,000)
----------- ----------- ----------- -----------
Comprehensive loss ............................. $ (778,000) $(8,149,000) $(6,663,000) $(8,563,000)
=========== =========== =========== ===========
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 SIX MONTHS ENDED JUNE 30, 2003 AND 2002
SIX MONTHS ENDED JUNE 30,
2003 2002
------------- ------------
Cash flows from operating activities:
Net loss.................................................... $ (7,844,000) $ (8,550,000)
Less: loss from discontinued operations, net of tax......... (2,134,000) (358,000)
------------ ------------
Loss from continuing operations............................. (5,710,000) (8,192,000)
Adjustments to reconcile net loss to net cash provided by
operating activities of continuing operations:
Depreciation and amortization........................... 1,783,000 1,770,000
Provision for doubtful accounts......................... 62,000 226,000
SeraNova receivable impairment and other charges........ 5,060,000 8,362,000
Provision for guarantee of SeraNova debt................ 581,000 --
Deferred income taxes................................... (34,000) 362,000
Changes in operating assets and liabilities:
Accounts receivable....................................... 1,286,000 (3,687,000)
Unbilled services......................................... (1,433,000) 2,782,000
Prepaid income taxes...................................... 169,000 (44,000)
Other current assets...................................... (1,208,000) (556,000)
Other assets.............................................. 88,000 118,000
Accounts payable.......................................... (269,000) 258,000
Accrued payroll and related taxes......................... 1,282,000 57,000
Accrued expenses and other liabilities.................... (881,000) 316,000
Accrued restructuring charges............................. (85,000) (453,000)
Deferred revenue.......................................... (140,000) (357,000)
Income taxes payable...................................... 43,000 137,000
------------ ------------
Net cash provided by operating activities of continuing
operations................................................ 594,000 1,099,000
------------ ------------
Cash flows from investing activities:
Purchase of equipment .................................... (839,000) (798,000)
------------ ------------
Net cash used in investing activities of continuing
operations................................................ (839,000) (798,000)
------------ ------------
Cash flows from financing activities:
Principal payments under capital leases................... (219,000) (334,000)
Proceeds from issuance of stock options................... 60,000 --
Other borrowings (repayments)............................. (149,000) 7,000
Net change in line of credit borrowings................... 1,266,000 (26,000)
------------ ------------
Net cash provided by (used in) financing activities of
continuing operations..................................... 958,000 (353,000)
------------ ------------
Effect of foreign currency exchange rate changes on cash.... 1,181,000 (13,000)
------------ ------------
Net increase (decrease) in cash and cash equivalents from
continuing operations ...................................... 1,894,000 (65,000)
Net decrease in cash and cash equivalents from discontinued
operations ................................................. (746,000) (595,000)
------------ ------------
Net increase (decrease) in cash and cash equivalents ......... 1,148,000 (660,000)
Cash and cash equivalents at beginning of period.............. 1,163,000 1,620,000
------------ ------------
Cash and cash equivalents at end of period.................... $ 2,311,000 $ 960,000
============ ============
Supplemental disclosures of cash flow information:
Cash paid for income taxes.................................. $ -- $ 572,000
============ ============
Cash paid for interest...................................... $ 232,000 $ 200,000
============ ============
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 June 30, 2003 and for the three and six months ended June 30,
2003 and 2002 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. Such annual financial statements did not reflect
the classification of certain subsidiaries as held for sale (see Note 5). The
consolidated balance sheet as of December 31, 2002 included herein has been
derived from the consolidated balance sheet included the Company's Annual Report
on Form 10-K, adjusted to present this classification with respect to all
subsidiaries divested subsequent to that date.
The Company's 2003 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 satisfy its operating requirements in the normal course of business.
The results of operations for interim periods are not necessarily
indicative of those that may be achieved for a full fiscal year.
- 5 -
NOTE 2 - STOCK-BASED COMPENSATION
Stock-based compensation issued to employees and directors is valued using
the intrinsic value method under Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees." Under this method, compensation
expense is recorded on the date of grant only if the current market price of the
underlying stock exceeded the exercise price. Financial Accounting Standards
Board ("FASB") Statement of Financial Accounting Standard ("SFAS") No.123,
"Accounting for Stock-Based Compensation," established accounting and disclosure
requirements using a fair-value-based method of accounting for stock-based
employee compensation plans. As allowed by SFAS No. 123, the Company has elected
to continue to apply the intrinsic-value-based method of accounting described
above, and has adopted only the disclosure requirements of SFAS No. 123.
Stock-based compensation issued to non-employees is valued using the fair value
method.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." SFAS No. 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation," to provide alternative methods of
transition for a voluntary change to the fair value-based method of accounting
for stock-based employee compensation ("Transition Provisions"). In addition,
SFAS No. 148 amends the disclosure requirements of APB Opinion No. 28, "Interim
Financial Reporting," to require pro forma disclosure in interim financial
statements by companies that elect to account for stock-based compensation using
the intrinsic value method prescribed in APB Opinion No. 25 ("Disclosure
Provisions"). The Transition Provisions of SFAS No. 148 are effective for
financial statements for fiscal years ending after December 31, 2002. The
Company continues to use the intrinsic value method of accounting for
stock-based compensation. As a result, the Transition Provisions do not have an
effect on the Company's consolidated financial statements. The Company has
adopted the Disclosure Provisions of SFAS No. 148; however, the Company will
continue to apply the intrinsic value method under APB Opinion No. 25.
For disclosure purposes, pro forma net loss and loss per share impacts are
provided as if the fair market value method under SFAS No. 123 had been applied:
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
-------------------------- ------------------------
JUNE 30, JUNE 30,
-------- --------
2003 2002 2003 2002
----------- ------------ ------------ ------------
Net loss, as reported...................... $ (493,000) $ (8,561,000) $ (7,844,000) $ (8,550,000)
Deduct: total stock-based employee
compensation expense determined under
fair-value-based method for all awards,
net of related tax effects..................... (1,674,000) (2,050,000) (1,870,000) (3,307,000)
----------- ------------ ------------ ------------
Pro forma net loss......................... $(2,167,000) $(10,611,000) $ (9,714,000) $(11,857,000)
=========== ============ ============ ============
Basic and diluted loss per share:
as reported............................ $ (0.03) $ (0.51) $ (0.47) $ (0.51)
=========== ============ ============ ============
pro forma.............................. $ (0.13) $ (0.64) $ (0.58) $ (0.71)
=========== ============ ============ ============
- 6 -
NOTE 2 - STOCK-BASED COMPENSATION (CONTINUED)
The fair value of option grants for disclosure purposes is estimated on the
date of grant using the Black-Scholes option-pricing model using the following
weighted-average assumptions: expected volatility of 108% and 109%, risk-free
interest rate of 1.49% and 3.02% and expected lives of 2.3 years and 2.3 years,
in 2003 and 2002, respectively.
NOTE 3 - EARNINGS PER SHARE
Basic earnings (loss) per share is computed by dividing net loss
attributable to common shareholders by the weighted average number of common
shares outstanding for the period. Diluted earnings (loss) per share is computed
by dividing net loss available to common shareholders by the weighted average
number of common shares outstanding, adjusted for the incremental dilution of
outstanding stock options, if applicable. The computation of basic earnings
(loss) per share and diluted earnings (loss) per share were as follows:
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
-------------------------- ------------------------
JUNE 30, JUNE 30,
-------- --------
2003 2002 2003 2002
---- ---- ---- ----
Loss from continuing operations......... $ (493,000) $ (8,322,000) $ (5,710,000) $ (8,192,000)
Loss from discontinued operations....... -- (239,000) (2,134,000) (358,000)
------------- ------------- ------------ ------------
Net loss................................ $ (493,000) $ (8,561,000) $ (7,844,000) $ (8,550,000)
============= ============ ============ ============
Basic and diluted loss per share:
Weighted average number of common
shares - basic and diluted.......... 16,655,000 16,630,000 16,644,000 16,630,000
------------- ------------- ------------ ------------
Basic and diluted loss per share
from continuing operations.......... $ (0.03) $ (0.50) $ (0.34) $ (0.49)
Basic and diluted loss per share
from discontinued operations........ -- (0.01) (0.13) (0.02)
------------- ------------- ------------ ------------
Basic and diluted net loss per share.. $ (0.03) $ (0.51) $ (0.47) $ (0.51)
============= ============ ============ ============
Stock options, which would be antidilutive (1,859,000 and 2,623,000 for the
three months ended June 30, 2003 and 2002, respectively, and 1,882,000 and
2,747,000 for the six months ended June 30, 2003 and 2002, respectively) have
been excluded from the calculations of diluted shares outstanding and diluted
earnings (loss) per share.
- 7 -
NOTE 4 - LINES OF CREDIT
On May 31, 2000, the Company and 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 could 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 June 30,
2003, the Company had outstanding borrowings under the credit facility of
$7,325,000. The Company estimates undrawn availability under the credit facility
to be $6,581,000 as of June 30, 2003. As of December 31, 2002, the Company had
outstanding borrowings under the credit facility of $6,059,000.
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.
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, as of December
31, 2002 only, 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.
- 8 -
NOTE 4 - LINES OF CREDIT (CONTINUED)
During 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. In January 2003, 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 EBITDA covenant
defaults as of June 30, 2002 and September 30, 2002, (2) a modification to the
definitions of EBITDA, total stockholders equity and unconsolidated stockholders
equity (for purposes of computing related covenant compliance) to exclude Proxy
Contest charges of $464,000 for the quarter ended June 30, 2002 and $413,000 for
the quarter ended September 30, 2002 only, (3), a reduction in the minimum
EBITDA covenant for the fourth quarter and full year 2002 only, and (4) 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 $12,600,000 of the
note due from SeraNova.
As a result of the SeraNova receivable impairment and other related charges
and the Proxy Contest charges incurred during the quarter ended March 31, 2003,
the Company was not in compliance with the consolidated net worth,
unconsolidated net worth and EBITDA covenants as of March 31, 2003. In July
2003, the Company executed with the Bank an amendment to the credit agreement.
The terms of the amendment included, among other things, (1) a 3-year extension
of the credit facility to May 31, 2006, (2) a reduction of the maximum revolving
advance amount under the credit facility to $15,000,000, (3) a waiver of the
covenant defaults existing as of March 31, 2003, (4) a modification to the
definitions of total stockholders' equity and unconsolidated stockholders'
equity (for purposes of computing related covenant compliance) and a
modification to the computation of minimum EBITDA to exclude Proxy Contest
charges of $297,000 for the quarter ended March 31, 2003 only, (5), an increase
in the minimum EBITDA covenants to $1,290,000, $1,778,000 and $1,880,000 for the
second, third and fourth quarters of 2003, respectively, and (6) 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 $13,600,000 of the note due from
SeraNova.
As a result of the charge incurred during the quarter ended June 30, 2003
related to the guarantee of SeraNova debt, the Company was not in compliance
with the EBITDA covenant as of June 30, 2003. The Company is currently
negotiating with the Bank and expects to receive a waiver of the existing
covenant default. There can be no assurance, however, that the Company will be
able to obtain a waiver to the agreement on terms acceptable to the Company, if
at all.
Interest expense on debt and obligations under capital leases was $232,000
and $200,000 for the six months ended June 30, 2003 and 2002, respectively.
- 9 -
NOTE 5 - DISCONTINUED OPERATIONS
On April 2, 2003, the Company consummated the sale (the "Sale"), effective
as of March 1, 2003, of Intelligroup Singapore Pte Ltd., a Singapore
corporation; Intelligroup Hong Kong Limited, a Hong Kong corporation;
Intelligroup Australia Pty Limited, an Australian corporation; and Intelligroup
New Zealand Limited, a New Zealand corporation, together representing the
Company's Asia-Pacific group of subsidiary companies, operating in Australia,
New Zealand, Singapore, Hong Kong and Indonesia (together, the "Subsidiaries"),
to Soltius Global Solutions PTE Ltd, a Singapore corporation ("Soltius"). As
consideration, the Company received a 5% minority shareholding in Soltius and a
$650,000 note to be paid by Soltius to the Company over a period of 12 months.
The Company received $75,000 from Soltius during the quarter ended June 30,
2003.
The Consolidated Financial Statements of the Company have been reclassified
to reflect the Sale of the Subsidiaries to Soltius as of March 31, 2003.
Accordingly, the assets, liabilities, results of operations, and cash flows of
the Subsidiaries prior to April 2, 2003 have been segregated in the Consolidated
Balance Sheets, Consolidated Statements of Operations and Comprehensive Income
(Loss) and Consolidated Statements of Cash Flows. The net operating results,
assets, liabilities and net cash flows of the Subsidiaries have been reported as
discontinued operations.
Summarized financial information for the discontinued operations of the
Subsidiaries is as follows:
FOR THE THREE MONTHS FOR THE SIX MONTHS
-------------------- ------------------
ENDED JUNE 30, ENDED JUNE 30,
-------------- --------------
2002 2003 2002
----------------- ----------- ------------
Revenue................................. $ 1,670,000 $ 1,691,000 $ 3,274,000
Pre-tax loss............................ (235,000) (413,000) (327,000)
Income tax provision.................... 4,000 15,000 31,000
Loss from discontinued operations,
excluding loss on sale............... (239,000) (428,000) (358,000)
DECEMBER 31, 2002
-----------------
Current assets.......................... $ 2,393,000
Total assets............................ 3,069,000
Current liabilities..................... 1,681,000
Net intercompany liabilities............ 3,619,000
Total liabilities....................... 5,300,000
Net deficit of discontinued operations.. (2,231,000)
Additionally, the Company reported a loss on the sale of the Subsidiaries
of $1,706,000 for the six months ended June 30, 2003.
- 10 -
NOTE 6 - 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%.
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. 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 the Company moved for summary judgment. On April 17, 2003,
the Court granted partial summary judgment and required supplemental briefing on
certain issues. On July 11, 2003, the Court heard arguments on the Company's
renewed motion for summary judgment and dismissed the defendants' counterclaims
seeking compensatory and punitive damages. Although a trial date has been
scheduled for September 16, 2003, counsel for defendants has filed a motion to
be relieved as counsel based upon defendants' failure to pay their counsel fees.
In addition, 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. In an action filed in the
Superior Court of New Jersey, the Court confirmed the $624,000 award, jointly
and severally as to the SeraNova Group, and issued a writ of execution against
the SeraNova Group's assets. The Sheriff of Middlesex County levied this writ of
execution on October 8, 2002 against a bank account held by Silverline
Technologies, Inc. On October 16, 2002, pursuant to this writ, the bank turned
over $626,247 to the Sheriff. On November 6, 2002 the Sheriff sent the funds to
the Company's attorneys and the funds were deposited into an attorney trust
account on November 8, 2002. On December 13, 2002, the Company commenced an
action in the Superior Court of New Jersey, Chancery Division, to recover
additional amounts due and owing from the SeraNova Group under the Arbitration
Award and to determine whether HSBC Bank USA ("HSBC"), a
- 11 -
NOTE 6 - NOTE RECEIVABLE - SERANOVA (CONTINUED)
creditor of the SeraNova Group, has priority to the funds levied upon by the
Sheriff. On January 31, 2003, the Court entered judgment in the Company's favor
in the amount of $218,805, representing the SeraNova Group's additional unpaid
rent arrearages under the arbitration award. On February 28, 2003, the Court
entered judgment in the Company's favor in the amount of $220,415, representing
the Company's attorney's fees in connection with the Company's efforts to
enforce the SeraNova Group's obligations under the arbitration award. On March
10, 2003, the Court ordered HSBC to produce discovery proving its priority to
the $626,247 being held in trust. Thereafter, the Company and HSBC entered into
a settlement agreement only as to the $626,247 being held in trust whereby the
Company remitted $570,228 to HSBC, and the remaining funds were released to the
Company. 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 periodically 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 $8,362,000 of SeraNova receivable
impairment and other charges during the six months ended June 30, 2002.
Specifically, the Company recorded a $5,140,000 charge to write-down the
carrying value of the Note to $4,000,000. Additionally, the Company recorded a
$1,257,000 charge to write-off the carrying value of other SeraNova receivables.
Also, the Company recorded a charge of $1,501,000 for certain lease exit costs.
Such charge represents primarily an accrued liability for certain obligated
space and equipment 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 December 31, 2002, $1,286,000 of the
liability remains outstanding, of which $1,028,000 is included in other
long-term liabilities.
As of March 31, 2003, the Company believed there had been an apparent
deterioration in the financial condition of the SeraNova Group. Accordingly, the
Company re-assessed, as of March 31, 2003, the likelihood of recovering amounts
owed by the SeraNova Group as well as the assumptions used in recording the
original lease obligation charge. Additionally, the Company was notified during
the first quarter of 2003 of its obligation to pay additional office space and
equipment rentals, which had been previously assigned to SeraNova by the
Company, because the SeraNova Group had failed to make the required payments.
- 12 -
NOTE 6 - NOTE RECEIVABLE - SERANOVA (CONTINUED)
Although the Company expects to pursue the full legal prosecution of the
SeraNova Group, the Company recorded $5,060,000 of additional charges associated
with the Note and certain other related issues during the six months ended June
30, 2003. The Company recognized an additional impairment charge of $4,000,000
related to the Note, approximately $321,000 related to other assets,
approximately $474,000 in costs required to exit certain lease obligations and
$265,000 in legal fees. The Company has determined that due to the apparent
financial condition of the SeraNova Group that recovery of the SeraNova Note is
not probable.
WRITE-DOWN WRITE-OFF LEASE
OF NOTE OF OTHER OBLIGATIONS LEGAL AND
RECEIVABLE RECEIVABLES AND OTHER
- SERANOVA - SERANOVA SETTLEMENTS 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............. -- -- (361,000) (318,000) (679,000)
Non-cash items..................... (5,140,000) (1,257,000) -- -- (6,397,000)
----------- ----------- ----------- --------- -----------
Accrued costs as of December 31,
2002............................... -- -- 1,140,000 146,000 1,286,000
Charges to operations during 2003.. 4,000,000 -- 795,000 265,000 5,060,000
Costs paid during 2003............. -- -- (644,000) (234,000) (878,000)
Non-cash items..................... (4,000,000) -- -- -- (4,000,000)
----------- ----------- ----------- --------- -----------
Accrued costs as of June 30, 2003.. $ -- $ -- $ 1,291,000 $ 177,000 $ 1,468,000
=========== =========== =========== ========= ===========
As of June 30, 2003, $1,468,000 of the liability remains outstanding, of
which $873,000 is included in other long-term liabilities. The Company expects
to pay out this liability through 2008.
NOTE 7 - RESTRUCTURING AND OTHER SPECIAL CHARGES
In December 2002, the Company recorded a $30,000 restructuring and other
special charges provision related to the downsizing of the Company's operations
in Australia. The charges resulted primarily from severance costs associated
with reducing employee headcount in the region.
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.
- 13 -
NOTE 7 - RESTRUCTURING AND OTHER SPECIAL CHARGES (CONTINUED)
Activity in accrued costs for restructuring and other special charges is as
follows:
SEVERANCE AND ASSET
RELATED COSTS IMPAIRMENTS EXIT COSTS TOTAL
------------- ----------- ---------- ---------
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
Charges to operations during 2002...... 30,000 -- -- 30,000
Costs paid during 2002................. (326,000) -- (384,000) (710,000)
------------ ----------- ----------- -----------
Accrued costs as of December 31, 2002.. 89,000 -- 83,000 172,000
Costs paid during 2003................. (85,000) -- -- (85,000)
------------ ----------- ----------- -----------
Accrued costs as of June 30, 2003...... $ 4,000 $ -- $ 83,000 $ 87,000
============ =========== =========== ===========
The Company expects to pay out the remaining costs above within the next 6
months.
NOTE 8 - SEGMENT DATA AND GEOGRAPHIC INFORMATION
The Company operates in one industry, information technology solutions and
services.
On April 2, 2003, the Company consummated the sale, effective as of March
1, 2003, of its Asia-Pacific group of subsidiary companies, operating in
Australia, New Zealand, Singapore, Hong Kong and Indonesia (See Note 5). The
operating results and financial position of the Asia-Pacific group of subsidiary
companies are reported as discontinued operations for all periods presented. The
Company now has four reportable operating segments from continuing operations,
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 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;
o Europe - includes the operations of the Company in Denmark, Sweden and
the United Kingdom. However, the Company transitioned its operations
in Sweden to Denmark as of January 1, 2003. The European headquarters
are located in Milton Keynes, United Kingdom; and
- 14 -
NOTE 8 - SEGMENT DATA AND GEOGRAPHIC INFORMATION (CONTINUED)
o Japan - includes the operations of the Company in Japan. The Japanese
headquarters are located in Tokyo, Japan.
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 for its
continuing operations are presented in the following geographic segments for the
three and six months ended June 30, 2003 and 2002.
UNITED STATES INDIA EUROPE JAPAN TOTAL
------------- ----- ------ ----- -----
THREE MONTHS ENDED JUNE 30, 2003
- --------------------------------
Revenue......................... $21,861,000 $ 3,743,000 $ 1,584,000 $ 817,000 $ 28,005,000
Depreciation & amortization..... 449,000 220,000 36,000 7,000 712,000 (1)
Operating income (loss)......... (470,000) 205,000 84,000 147,000 (34,000)(2)
Total assets.................... 28,059,000 6,722,000 2,035,000 1,508,000 38,324,000
THREE MONTHS ENDED JUNE 30, 2002
- --------------------------------
Revenue......................... $19,269,000 $3,543,000 $ 1,444,000 $ 550,000 $ 24,806,000
Depreciation & amortization..... 450,000 112,000 58,000 15,000 635,000 (3)
Operating income (loss)......... (8,150,000) 862,000 (352,000) (408,000) (8,048,000)(4)
Total assets.................... 28,463,000 5,744,000 1,738,000 1,379,000 37,324,000 (5)
SIX MONTHS ENDED JUNE 30, 2003
- ------------------------------
Revenue......................... $43,210,000 $ 7,230,000 $ 3,065,000 $1,735,000 $ 55,240,000
Depreciation & amortization..... 900,000 424,000 72,000 15,000 1,411,000 (6)
Operating income (loss)......... (6,019,000) 698,000 81,000 208,000 (5,032,000) (7)
SIX MONTHS ENDED JUNE 30, 2002
- ------------------------------
Revenue......................... $36,738,000 $ 6,597,000 $ 3,029,000 $1,447,000 $ 47,811,000
Depreciation & amortization..... 923,000 260,000 115,000 29,000 1,327,000 (8)
Operating income (loss)......... (8,035,000) 1,345,000 (541,000) (525,000) (7,756,000) (9)
- -----------
(1) Excludes $191,000 of depreciation and amortization included in cost of
sales for the three months ended June 30, 2003.
(2) Includes $296,000 of proxy contest charges and $581,000 of charges
related to the guarantee of SeraNova debt for the three months ended
June 30, 2003.
(3) Excludes $181,000 of depreciation and amortization included in cost of
sales for the three months ended June 30, 2002.
(4) Includes $8,362,000 of SeraNova receivable impairment and other
charges and $464,000 of proxy contest charges for the three months
ended June 30, 2002.
(5) Excludes $2,897,000 of assets held for sale as of June 30, 2002.
(6) Excludes $372,000 of depreciation and amortization included in cost of
sales for the six months ended June 30, 2003.
(7) Includes $5,060,000 of SeraNova receivable impairment and other
charges, $593,000 of proxy contest charges and $581,000 of charges
related to the guarantee of SeraNova debt for the six months ended
June 30, 2003.
(8) Excludes $443,000 of depreciation and amortization included in cost of
sales for the six months ended June 30, 2002.
(9) Includes $8,362,000 of SeraNova receivable impairment and other
charges and $464,000 of proxy contest charges for the six months ended
June 30, 2002.
- 15 -
NOTE 8 - SEGMENT DATA AND GEOGRAPHIC INFORMATION (CONTINUED)
Included above are application management and support revenues of
$8,341,000 and $6,110,000 for the three months ended June 30, 2003 and 2002,
respectively. In addition, application management and support revenues for the
six months ended June 30, 2003 and 2002 were $15,106,000 and $12,281,000,
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 9 - CONTINGENCIES
Guarantee of SeraNova Debt
By letter dated May 12, 2003, Zions First National Bank ("Zions") informed
the Company that Network Publishing, Inc., a former wholly-owned subsidiary of
the Company, which became a wholly-owned subsidiary of SeraNova upon the
spin-off of SeraNova by the Company in 2000, was delinquent on a loan made by
Zions and guaranteed by the Company. Zions is demanding payment of $535,608 from
the Company, plus interest accrued from April 1, 2002. The Company has requested
documentation from Zions. Zions requested that the Company execute a
confidentiality agreement before providing the documentation. The Company
intends to investigate Zion's claims upon receipt of such documentation.
However, the Company could have a liability in this matter once all
documentation is provided by Zions. Accordingly, the Company has recorded a
$581,000 provision for the guarantee of SeraNova debt in the consolidated
statement of operations during the three months ended June 30, 2003.
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 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
- 16 -
NOTE 9 - CONTINGENCIES (CONTINUED)
under the Tax Sharing Agreement. Should the spin-off be ultimately construed to
be taxable, 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.
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 each of the fiscal years ended March 31, 1997 through March 31, 2000. The
assessment is for 28 million rupees, or approximately $600,000. 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 June 30, 2003. If the Company were not successful with its
appeals, which were filed in 2001 and 2002, a future charge of approximately
$600,000 would be recorded and reflected in the Company's consolidated statement
of operations.
Proxy Contest and Related Legal Matters
During the six months ended June 30, 2003, the Company incurred $593,000 of
Proxy Contest charges. As discussed in Note 4, the Proxy Contest 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. Since the second
quarter of 2002, the Company has incurred cumulative Proxy Contest charges of
$1,666,000. The cumulative Proxy Contest charges included legal fees, proxy
solicitation services and printing, mailing and other costs. Legal costs related
to this matter continue to be incurred. However, on August 7, 2003, the Company
and Mr. Pandey executed a settlement agreement relating to, among other things,
the litigation matters including the Proxy Contest. As part of the settlement
agreement the Company has agreed to pay to Mr. Pandey an aggregate amount of
$750,000 in three equal installments over two years. Accordingly, the Company
will record a $750,000 provision for such liability in the consolidated
statement of operations during the three months ended September 30, 2003.
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 annual election. On July 12,
2002, after reviewing actual evidence of record, and hearing argument from
Pandey'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, 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
- 17 -
NOTE 9 - CONTINGENCIES (CONTINUED)
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. In
response, Pandey filed a motion seeking leave to file a Second Amended
Complaint, seeking to drop the Section 13D claims against the Company and
substitute them with claims brought under Section 14A of the Securities and
Exchange Act. On January 31, 2003, the Court denied each of the parties'
motions. On August 7, 2003, the Company and Mr. Pandey executed a settlement
agreement relating to, among other things, the litigation matters between them.
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 continued 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 is ongoing. On November 6, 2002, the
Company filed a Motion for Summary Judgment and on January 7, 2003, the Court
granted Partial Summary Judgment. On August 7, 2003, the Company and Mr. Pandey
executed a settlement agreement relating to, among other things, the litigation
matters between them.
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. On August 7, 2003, the Company and Mr. Pandey executed a
settlement agreement relating to, among other things, the litigation matters
between them.
Other Legal Matters
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 same extent as
SeraNova for false and misleading statements constituting securities laws
violations and breach of contract. After being
- 18 -
NOTE 9 - CONTINGENCIES (CONTINUED)
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. 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 parties executed a settlement agreement, which became effective upon
payment of the settlement amount. The Company paid its portion of the settlement
amount equal to an aggregate amount of $50,000 in April 2003.
The Company is engaged in other legal and administrative proceedings.
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.
- 19 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
HISTORY
-------
The Company is a strategic information technology services outsourcing
partner to the world's largest companies. Intelligroup develops, implements and
supports information technology solutions for global corporations and public
sector organizations. The Company's onsite/offshore delivery model has enabled
hundreds of customers to accelerate results and significantly reduce costs. With
extensive expertise in industry-specific enterprise solutions, Intelligroup has
earned a reputation for consistently exceeding client expectations.
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.
- 20 -
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 it focus and efforts on pursuing shorter-term success
opportunities of implementing and enhancing application solutions based on SAP,
Oracle and PeopleSoft products.
At the same time, the Company redirected some of its ASP infrastructure and
personnel towards the management and support of customers' enterprise,
e-commerce and m-commerce applications ("Application Management Services").
Additionally, the Company introduced certain SAP-based proprietary tools that
are designed to reduce the time and cost of upgrading and maintaining SAP
systems ("Power Up Services(SM)"). In 2001, the Company developed pre-configured
SAP solutions for the pharmaceutical industry ("Pharma Express(SM)") and the
engineering and construction industry ("Contractor Express(SM)"). 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 companies in improving operational
efficiency and controlling manufacturing project schedules.
On April 2, 2003, the Company consummated the sale (the "Sale"), effective
as of March 1, 2003, of its Asia-Pacific group of subsidiary companies,
operating in Australia, New Zealand, Singapore, Hong Kong and Indonesia
(together, the "Subsidiaries"), to Soltius Global Solutions PTE Ltd, a Singapore
corporation ("Soltius"). As consideration, the Company received a 5% minority
shareholding in Soltius and a $650,000 note to be paid by Soltius to the Company
over a period of 12 months. The Company received $75,000 from Soltius during the
quarter ended June 30, 2003.
The Consolidated Financial Statements of the Company have been reclassified
to reflect the Sale of the Subsidiaries to Soltius as of March 31, 2003.
Accordingly, the assets, liabilities, results of operations, and cash flows of
the Subsidiaries prior to April 2, 2003 have been segregated in the Consolidated
Balance Sheets, Consolidated Statements of Operations and Comprehensive Income
(Loss) and Consolidated Statements of Cash Flows and have been reported as
discontinued operations.
Financial information regarding the Company's geographic areas and results
of operations for continuing operations appears in the footnote entitled Segment
Data and Geographic Information in the Notes to the Consolidated Financial
Statements included in Part 1. Financial Information.
REVENUES
--------
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
- 21 -
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.
EXPENSES
--------
The Company's most significant cost is project personnel expenses, which
consist of consultant salaries, benefits and payroll-related 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).
FIXED PRICE PROJECTS
--------------------
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 six
months ended June 30, 2003 and the year ended December 31, 2002, revenues
derived from projects under fixed price contracts represented 33% and 35%,
respectively, of the Company's total revenue. No single fixed price project was
material to the Company's business during the six months ended June 30, 2003 or
during 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.
CUSTOMER CONCENTRATION
----------------------
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 six months ended June 30, 2003 and the year ended December 31,
2002, the Company's ten largest customers accounted for in the aggregate,
approximately 48% and 42% of its revenue, respectively. For the six months ended
June 30, 2003, no single customer accounted for more than 10% of revenue. For
the year ended December 31, 2002, one customer accounted for more than 10% of
revenue. For the six months ended June 30, 2003 and the year ended December 31,
2002, 10% and 24%, respectively, of the Company's revenue was generated by
providing supplemental resources directly to the end-customer or as part of a
consulting team assembled by another information technology consulting firm.
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.
- 22 -
SOFTWARE PARTNERS
-----------------
For each of the six months ended June 30, 2003 and the year ended December
31, 2002, approximately 62% of the Company's total revenue was derived from
projects in which the Company implemented, extended, maintained, managed or
supported software developed by SAP. For the six months ended June 30, 2003 and
the year ended December 31, 2002, approximately 24% and 22%, 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 the six months ended June 30, 2003 and the year ended December
31, 2002, approximately 7% and 9%, respectively, of the Company's total revenue
was derived from projects in which the Company implemented, extended,
maintained, managed or supported software developed by Oracle.
COMPETITORS
-----------
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, Computer Sciences Corporation, Cap
Gemini Ernst & Young, and BearingPoint.
o Software applications vendors: including, SAP, Oracle and PeopleSoft.
o Application management consulting firms: including, Covansys, Wipro
Technologies, Infosys Technologies Limited and Satyam Computer
Services Ltd.
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.
OFFICES
-------
The Company currently serves the United States market with its headquarters
in Edison (New Jersey), and branch offices in Atlanta (Georgia), Warrenville
(Illinois) and Pleasanton (California). The Company also maintains local offices
to serve the markets in India, the United Kingdom, Denmark and Japan. The
Company leases its headquarters in Edison, New Jersey. Such lease has an initial
term of ten (10) years, which commenced in September 1998.
- 23 -
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, 2002. 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, 2002.
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 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, and (h) the
hiring of additional staff;
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;
- 24 -
o the Company's substantial reliance on key customers and large
projects;
o the Company's ability to manage fixed price projects effectively and
efficiently;
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, 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.
- 25 -
RESULTS OF OPERATIONS - CONSOLIDATED
The following table sets forth for the periods indicated certain financial
data expressed as a percentage of total revenue, for continuing operations:
Percentage of Revenue
----------------------------------------------
Three Months Six Months
Ended June 30, Ended June 30,
------------------- ------------------
2003 2002 2003 2002
---- ---- ---- ----
Revenue................................... 100.0% 100.0% 100.0% 100.0%
Cost of sales............................. 69.7 68.2 70.3 68.9
------ ----- ----- -----
Gross profit.......................... 30.3 31.8 29.7 31.1
Selling, general and administrative
expenses................................ 24.7 26.1 25.0 26.0
Depreciation and amortization expenses.... 2.5 2.6 2.5 2.8
SeraNova receivable settlement and
related charges......................... -- 33.6 9.2 17.5
Proxy contest charges..................... 1.1 1.9 1.1 1.0
Guarantee of SeraNova debt charge......... 2.1 -- 1.1 --
------ ----- ----- -----
Total operating expenses.............. 30.4 64.2 38.9 47.3
------ ----- ----- -----
Operating loss........................ (0.1) (32.4) (9.2) (16.2)
Interest income........................... -- -- -- --
Interest expense.......................... (0.4) (0.4) (0.4) (0.4)
Other income (expense).................... (0.7) 0.1 (0.4) 0.1
------ ----- ----- -----
Loss from continuing operations before
income tax provision................... (1.2) (32.7) (10.0) (16.5)
Income tax provision...................... 0.6 0.8 0.4 0.6
------ ----- ----- -----
Loss from continuing operations........... (1.8)% (33.5)% (10.4)% (17.1)%
====== ===== ===== =====
Three Months Ended June 30, 2003 Compared to Three Months Ended June 30,
2002
The following discussion compares the consolidated results from continuing
operations for the three months ended June 30, 2003 and the three months ended
June 30, 2002.
Revenue. Total revenue increased by 12.9%, or $3.2 million, from $24.8
million for the three months ended June 30, 2002, to $28.0 million for the three
months ended June 30, 2003. The increase was attributable primarily to growth in
revenue generated in the United States (an increase of $2.6 million), Japan (an
increase of $267,000), India (an increase of $200,000) and Europe (an increase
of $140,000). In 2002, the demand for the Company's services was negatively
impacted by the challenging and uncertain economic conditions, which precluded
many companies from spending resources on IT projects. Subsequently, beginning
in mid-to-late 2002, the Company began to experience an increase in demand for
services. Accordingly, the revenue growth results directly from increased demand
for the majority of the Company's services, including traditional consulting
service offerings, application management and support services and offshore
development services.
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 15.3%, or $2.6 million, from $16.9 million
for the three months ended June 30,
- 26 -
2002, to $19.5 million for the three months ended June 30, 2003. The Company's
gross profit increased by 7.8%, or $612,000, from $7.9 million for the three
months ended June 30, 2002, to $8.5 million for the three months ended June 30,
2003. The increase in cost of sales and gross profit results from the increase
in revenue. Gross margin decreased to 30.3% for the three months ended June 30,
2003, from 31.8% for the three months ended June 30, 2002. The decline in gross
margin results primarily from pricing pressures, due to the increased
competition for new projects.
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 increased by 7.3% or $470,000, to $6.9 million for the three months
ended June 30, 2003, from $6.5 million for the three months ended June 30, 2002,
but decreased as a percentage of revenue to 24.7% from 26.1%, respectively. The
increase in selling, general and administrative expenses, in absolute dollars,
was related primarily to discretionary sales and marketing expenditures, which
vary in proportion to changes in revenue. During the three months ended June 30,
2003, the Company invested in certain targeted sales and marketing initiatives,
such as participation in a number of conferences and trade shows as well as a
new branding roll-out, which are expected to grow future revenues. The decrease
in selling, general and administrative expenses, as a percentage of revenue,
reflects concerted efforts by management to control expenditures in conjunction
with growth in revenue.
Depreciation and amortization. Depreciation and amortization expenses
increased to $712,000 for the three months ended June 30, 2003, compared to
$635,000 for the three months ended June 30, 2002. The increase was primarily
due to depreciation on additional computers, equipment and software placed in
service since June 30, 2002.
SeraNova receivable impairment and other charges. During the three months
ended June 30, 2002, the Company recorded approximately $8.4 million in special
charges associated with the note receivable from SeraNova, Inc. ("SeraNova") and
certain other related issues. Although the Company had aggressively pursued its
various legal options to obtain payment from SeraNova, Silverline Technologies
Inc. and Silverline Technologies Ltd. (collectively the "SeraNova Group") on the
Note and outstanding lease obligations, the Company believed that the liquidity
issues plaguing the SeraNova Group required a reassessment of the realizability
of these outstanding amounts. During this time, the Company had also 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. 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 during the
three months ended June 30, 2002. Additionally, the Company recorded a write-off
of $1.3 million related to interest on the note and other receivables due from
the SeraNova Group. Finally, the Company recorded $1.5 million in costs required
to exit certain lease obligations related to the SeraNova Group.
- 27 -
Proxy contest charges. During the three months ended June 30, 2003 and
2002, the Company incurred $296,000 and $464,000, respectively, in legal fees
and other charges related to the Company's contested 2002 Annual Meeting of
Shareholders ("Proxy Contest"). The Proxy Contest 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. Since the second quarter of 2002,
the Company has incurred cumulative proxy charges of $1.7 million. The
cumulative Proxy Contest charges included legal fees, proxy solicitation
services and printing, mailing and other costs. On August 7, 2003, the Company
and Mr. Pandey executed a settlement agreement relating to, among other things,
the litigation matters between them including the Proxy Contest.
Provision for guarantee of SeraNova debt. By letter dated May 12, 2003,
Zions First National Bank ("Zions") informed the Company that Network
Publishing, Inc., a former wholly-owned subsidiary of the Company, which became
a wholly-owned subsidiary of SeraNova upon the spin-off of SeraNova by the
Company in 2000, was delinquent on a loan made by Zions and guaranteed by the
Company. Zions is demanding payment of $535,608 from the Company, plus interest
accrued from April 1, 2002. The Company has requested documentation from Zions.
Zions requested that the Company execute a confidentiality agreement before
providing the documentation. The Company intends to investigate Zion's claims
upon receipt of such documentation. However, the Company could have a liability
in this matter once all documentation is provided by Zions. Accordingly, the
Company has recorded a $581,000 provision for the guarantee of SeraNova debt in
the consolidated statement of operations during the three months ended June 30,
2003.
Interest income. The Company earned $12,000 in interest income during the
three months ended June 30, 2003, compared with $11,000 during the three months
ended June 30, 2002. The interest income is related primarily to certain
interest-bearing bank accounts.
Interest expense. The Company incurred $124,000 and $95,000 in interest
expense during the three months ended June 30, 2003 and 2002, 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 increase in interest expense results from slightly
higher average outstanding borrowings under the line of credit during the three
months ended June 30, 2003.
Other income (expense). Other income (expense) results primarily from gains
(losses) associated with changes in foreign currency exchange rates. The Company
reported other expense of $184,000 during the three months ended June 30, 2003,
compared with other income of $17,000 during the three months ended June 30,
2002. The change results from foreign currency fluctuations.
Provision for income taxes. The Company's effective tax rate was 49.4% for
the three months ended June 30, 2003. The large provision for income taxes
results from taxable income in certain jurisdictions combined with a valuation
allowance offsetting other loss benefits in other jurisdictions. The Company's
net deferred tax asset as of June 30, 2003 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 $1.2 million
will be realized. The Company's effective rate was 2.5% for the three months
ended June 30, 2002.
- 28 -
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 was restricted to 90% of such
income. Further, domestic revenue from software and related services is taxable
in India. Effective April 1, 2003, the 90% tax deduction incentive restriction
was repealed and the tax incentive is again available for the entire amount of
income from the export of software and related services. For the three months
ended June 30, 2003 and 2002, the tax holiday and 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 each of the fiscal years ended March 31, 1997 through March 31, 2000. The
assessment is for 28 million rupees, or approximately $600,000. 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 June 30, 2003. If the Company were not successful with its
appeals, which were filed in 2001 and 2002, a future charge of approximately
$600,000 would be recorded and reflected in the Company's consolidated statement
of operations.
Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002
The following discussion compares the consolidated results from continuing
operations for the six months ended June 30, 2003 and the six months ended June
30, 2002.
Revenue. Total revenue increased by 15.5%, or $7.4 million, from $47.8
million for the six months ended June 30, 2002, to $55.2 million for the six
months ended June 30, 2003. The increase was attributable primarily to growth in
revenue generated in the United States (an increase of $6.5 million), India (an
increase of $633,000), Japan (an increase of $288,000) and Europe (an increase
of $37,000). In 2002, the demand for the Company's services was negatively
impacted by the challenging and uncertain economic conditions, which precluded
many companies from spending resources on IT projects. Subsequently, beginning
in mid-to-late 2002, the Company began to experience an increase in demand for
services. Accordingly, the revenue growth results directly from increased demand
for the majority of the Company's services, including traditional consulting
service offerings, application management and support services and offshore
development services.
Gross profit. The Company's cost of sales increased by 17.8%, or $5.9
million, from $32.9 million for the six months ended June 30, 2002, to $38.8
million for the six months ended June 30, 2003. The Company's gross profit
increased by 10.5%, or $1.6 million, from $14.9 million for the six months ended
June 30, 2002, to $16.4 million for the six months ended June 30, 2003. The
increase in cost of sales and gross profit results from the increase in revenue.
Gross margin decreased to 29.7% for the six months ended June 30, 2003, from
31.1% for the six months ended June 30, 2002. The decline in gross margin
results primarily from pricing pressures, due to the increased competition for
new projects.
- 29 -
Selling, general and administrative expenses. Selling, general and
administrative expenses increased by 10.8% or $1.3 million, to $13.8 million for
the six months ended June 30, 2003, from $12.5 million for the six months ended
June 30, 2002, but decreased as a percentage of revenue to 25.0% from 26.0%,
respectively. The increase in selling, general and administrative expenses, in
absolute dollars, was related primarily to discretionary sales and marketing
expenditures, which vary in proportion to changes in revenue. During the six
months ended June 30, 2003, the Company invested in certain targeted sales and
marketing initiatives, such as participation in a number of conferences and
trade shows as well as a new branding roll-out, which are expected to grow
future revenues. The decrease in selling, general and administrative expenses,
as a percentage of revenue, reflects concerted efforts by management to control
expenditures in conjunction with growth in revenue.
Depreciation and amortization. Depreciation and amortization expenses
increased to $1.4 million for the six months ended June 30, 2003, compared to
$1.3 million for the six months ended June 30, 2002. The increase was primarily
due to depreciation on additional computers, equipment and software placed in
service since June 30, 2002.
SeraNova receivable impairment and other charges. During the six months
ended June 30, 2002, the Company recorded approximately $8.4 million in special
charges associated with the note receivable from SeraNova, and certain other
related issues. Although the Company had aggressively pursued its various legal
options to obtain payment from the SeraNova Group on the Note and outstanding
lease obligations, the Company believed that the current liquidity issues
plaguing the SeraNova Group required a reassessment of the realizability of
these outstanding amounts. During this time, the Company had also 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. 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 during the
six months ended June 30, 2002. Additionally, the Company recorded a write-off
of $1.3 million related to interest on the note and other receivables due from
the SeraNova Group. Finally, the Company recorded $1.5 million in costs required
to exit certain lease obligations related to the SeraNova Group.
During the six months ended June 30, 2003, the Company recorded
approximately $5.1 million of additional charges associated with the note
receivable from SeraNova and certain other related issues. The Company
recognized an additional impairment charge of $4.0 million related to the Note,
approximately $321,000 related to other assets, approximately $474,000 in costs
required to exit certain lease obligations and $265,000 in legal fees. The
Company has determined that due to the apparent financial condition of the
SeraNova Group that recovery of the SeraNova Note is not probable.
Proxy contest charges. During the six months ended June 30, 2003 and 2002,
the Company incurred $593,000 and $464,000, respectively, in legal fees and
other charges related to the Company's contested 2002 Annual Meeting of
Shareholders. The Proxy Contest resulted directly from a shareholder of the
Company launching a hostile and costly proxy contest to take
- 30 -
control of the Company's Board of Directors. Since the second quarter of 2002,
the Company has incurred cumulative proxy charges of $1.7 million. The
cumulative Proxy Contest charges included legal fees, proxy solicitation
services and printing, mailing and other costs. On August 7, 2003, the Company
and Mr. Pandey executed a settlement agreement relating to, among other things,
the litigation matters between them including the Proxy Contest.
Provision for Guarantee of SeraNova debt. By letter dated May 12, 2003,
Zions First National Bank ("Zions") informed the Company that Network
Publishing, Inc., a former wholly-owned subsidiary of the Company, which became
a wholly-owned subsidiary of SeraNova upon the spin-off of SeraNova by the
Company in 2000, was delinquent on a loan made by Zions and guaranteed by the
Company. Zions is demanding payment of $535,608 from the Company, plus interest
accrued from April 1, 2002. The Company has requested documentation from Zions.
Zions requested that the Company execute a confidentiality agreement before
providing the documentation. The Company intends to investigate Zion's claims
upon receipt of such documentation. However, the Company could have a liability
in this matter once all documentation is provided by Zions. Accordingly, the
Company has recorded a $581,000 provision for the guarantee of SeraNova debt in
the consolidated statement of operations during the six months ended June 30,
2003.
Interest income. The Company earned $25,000 in interest income during the
six months ended June 30, 2003, compared with $18,000 during the six months
ended June 30, 2002. The interest income is related primarily to certain
interest-bearing bank accounts.
Interest expense. The Company incurred $232,000 and $200,000 in interest
expense during the six months ended June 30, 2003 and 2002, 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 increase in interest expense results from slightly
higher average outstanding borrowings under the line of credit during the six
months ended June 30, 2003.
Other income (expense). Other income (expense) results primarily from gains
(losses) associated with changes in foreign currency exchange rates. The Company
reported other expense of $233,000 during the six months ended June 30, 2003,
compared with other income of $57,000 during the six months ended June 30, 2002.
The change results from foreign currency fluctuations.
Provision for income taxes. Despite an operating loss, a provision for
income taxes of was required for the six months ended June 30, 2003 and 2002,
due to taxable income in certain jurisdictions combined with a valuation
allowance offsetting other loss benefits in other jurisdictions. The Company's
net deferred tax asset as of June 30, 2003 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 $1.2 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
- 31 -
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. Effective April 1, 2003, the 90% tax
deduction incentive restriction was repealed and the tax incentive is again
available for the entire amount of income from the export of software and
related services. For the six months ended June 30, 2003 and 2002, the tax
holiday and 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 each of the fiscal years ended March 31, 1997 through March 31, 2000. The
assessment is for 28 million rupees, or approximately $600,000. 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 June 30, 2003. If the Company were not successful with its
appeals, which were filed in 2001 and 2002, a future charge of approximately
$600,000 would be recorded and reflected in the Company's consolidated statement
of operations.
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
The Company operates in one industry, information technology solutions and
services.
On April 2, 2003, the Company consummated the sale, effective as of March
1, 2003, of its Asia-Pacific group of subsidiary companies, operating in
Australia, New Zealand, Singapore, Hong Kong and Indonesia. The operating
results and financial position of the Asia-Pacific group of subsidiary companies
are reported as discontinued operations for all periods presented. The Company
now has four reportable operating segments from continuing operations, 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 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;
o Europe - includes the operations of the Company in Denmark, Sweden and
the United Kingdom. However, the Company transitioned its operations
in Sweden to Denmark as of January 1, 2003. The European headquarters
are located in Milton Keynes, United Kingdom; and
o Japan - includes the operations of the Company in Japan. The Japanese
headquarters are located in Tokyo, Japan.
- 32 -
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 June 30, 2003 Compared to Three months Ended June 30,
2002
The following discussion compares the segment results for continuing
operations for the three months ended June 30, 2003 and the three months ended
June 30, 2002.
Revenue. The following table displays revenues by reportable segment (in
thousands).
THREE MONTHS ENDED JUNE 30,
-------------------------------------------------------
2003 2002
---- ----
PERCENTAGE PERCENTAGE
DOLLARS OF TOTAL DOLLARS OF TOTAL
------- -------- ------- --------
United States........... $ 21,861 78.1% $ 19,269 77.7%
India................... 3,743 13.4 3,543 14.3
Europe.................. 1,584 5.6 1,444 5.8
Japan................... 817 2.9 550 2.2
---------- -------- --------- --------
Total................... $ 28,005 100.0% $ 24,806 100.0%
========== ======== ========= ========
US revenue increased by 13.5%, or $2.6 million, from $19.3 million for the
three months ended June 30, 2002, to $21.9 million for the three months ended
June 30, 2003. In 2002, the demand for the US services was negatively impacted
by the challenging and uncertain economic conditions, which precluded many
companies from spending resources on IT projects. Subsequently, beginning in
mid-to-late 2002, the US began to experience an increase in demand for services.
Accordingly, the revenue growth results directly from increased demand for the
majority of US services, including traditional consulting service offerings,
application management and support services and offshore development services.
India revenue increased by 5.6%, or $200,000, from $3.5 million for the
three months ended June 30, 2002, to $3.7 million for the three months ended
June 30, 2003. 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.
Europe revenue increased by 9.7%, or $140,000, from $1.4 million for the
three months ended June 30, 2002, to $1.6 million for the three months ended
June 30, 2003. The increase was attributable primarily to the Company's
operations in Denmark (an increase of $381,000), which was slightly offset by a
decrease of revenue in the Company's operations in the United Kingdom (a
decrease of $157,000) and Sweden (a decrease of $84,000). The improvement in
Denmark was attributable primarily to a general increase in demand for local SAP
services, including a $2.0 million implementation contract with a large
agricultural-based company. The
- 33 -
decrease in the United Kingdom results primarily from efforts to maintain the
current PeopleSoft application management business while only targeting new
engagements that can be delivered using India resources. The decrease in Sweden
resulted primarily from challenging local economic conditions. Accordingly, the
Company transitioned its operations in Sweden to Denmark as of January 1, 2003.
Japan revenue increased by 48.5% or $267,000, from $550,000 for the three
months ended June 30, 2002, to $817,000 for the three months ended June 30,
2003. The increase was due primarily to stronger demand for the Company's
consulting services within the local SAP market.
Operating Income (Loss). The following table displays operating income
(loss) by reportable segment (in thousands).
THREE MONTHS ENDED JUNE 30,
-----------------------------
2003 2002
-------- ---------
United States.......................... $ (470) $ (8,150)
India.................................. 205 862
Europe................................. 84 (352)
Japan.................................. 147 (408)
-------- ---------
Total.................................. $ (34) $ (8,048)
======== =========
US operating performance improved by $7.7 million, from an operating loss
of $8.2 million for the three months ended June 30, 2002, to an operating loss
of $470,000 for the three months ended June 30, 2003. The improvement in
operating performance was attributable primarily to the approximately $8.4
million of SeraNova receivable impairment and other charges incurred during the
three months ended June 30, 2002.
India operating income decreased by $657,000, from $862,000 for the three
months ended June 30, 2002, to $205,000 for the three months ended June 30,
2003. 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.
Europe operating performance improved by $436,000, from an operating loss
of $352,000 for the three months ended June 30, 2002, to operating income of
$84,000 for the three months ended June 30, 2003. The improvement was
attributable primarily to an improvement in the operating performance of Denmark
(an improvement of $286,000) and Sweden (an improvement of $150,000).
Japan operating performance improved by $555,000, from an operating loss of
$408,000 for the three months ended June 30, 2002, to operating income of
$147,000 for the three months ended June 30, 2003. The improvement was
attributable primarily to management efforts to re-organize and restructure the
local operations during late 2002. In December 2002, management initiated
efforts to decrease total operating expenses by reducing employee headcount and
eliminating discretionary expenditures such as sales and marketing programs,
training, etc.
- 34 -
Six months Ended June 30, 2003 Compared to Six months Ended June 30, 2002
The following discussion compares the segment results for continuing
operations for the six months ended June 30, 2003 and the six months ended June
30, 2002.
Revenue. The following table displays revenues by reportable segment (in
thousands).
SIX MONTHS ENDED JUNE 30,
-------------------------------------------------------
2003 2002
---- ----
PERCENTAGE PERCENTAGE
DOLLARS OF TOTAL DOLLARS OF TOTAL
------- -------- ------- ---------
United States........... $ 43,210 78.2% $ 36,738 76.8%
India................... 7,230 13.1 6,597 13.8
Europe.................. 3,065 5.6 3,029 6.3
Japan................... 1,735 3.1 1,447 3.1
---------- ------- ---------- --------
Total................... $ 55,240 100.0% $ 47,811 100.0%
========== ======= ========== ========
US revenue increased by 17.6%, or $6.5 million, from $36.7 million for the
six months ended June 30, 2002, to $43.2 million for the six months ended June
30, 2003. In 2002, the demand for the US services was negatively impacted by the
challenging and uncertain economic conditions, which precluded many companies
from spending resources on IT projects. Subsequently, beginning in mid-to-late
2002, the US began to experience an increase in demand for services.
Accordingly, the revenue growth results directly from increased demand for the
majority of US services, including traditional consulting service offerings,
application management and support services and offshore development services.
India revenue increased by 9.6%, or $633,000, from $6.6 million for the six
months ended June 30, 2002, to $7.2 million for the six months ended June 30,
2003. 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.
Europe revenue approximated $3.0 million for the six months ended June 30,
2003 and 2002. The Company's operations in Denmark increased by $537,000, while
the revenue in the United Kingdom and Sweden decreased by $268,000 and $232,000,
respectively. The improvement in Denmark was attributable primarily to a general
increase in demand for local SAP services, including a $2.0 million
implementation contract with a large agricultural-based company. The decrease in
the United Kingdom results primarily from efforts to maintain the current
PeopleSoft application management business while only targeting new engagements
that can be delivered using India resources. The decrease in Sweden resulted
primarily from challenging local economic conditions.
Japan revenue increased by 19.9% or $288,000, from $1.4 million for the six
months ended June 30, 2002, to $1.7 million for the six months ended June 30,
2003. The increase was due primarily to stronger demand for the Company's
consulting services within the local SAP market.
- 35 -
Operating Income (Loss). The following table displays operating income
(loss) by reportable segment (in thousands).
SIX MONTHS ENDED JUNE 30,
-----------------------------
2003 2002
-------- ---------
United States.......................... $ (6,019) $ (8,035)
India.................................. 698 1,345
Europe................................. 81 (541)
Japan.................................. 208 (525)
-------- ---------
Total.................................. $ (5,032) $ (7,756)
========= =========
US operating performance improved by $2.0 million, from an operating loss
of $8.0 million for the six months ended June 30, 2002, to an operating loss of
$6.0 million for the six months ended June 30, 2003. The $8.0 million operating
loss was attributable primarily to the $8.4 million of SeraNova receivable
impairment and other charges recorded during the six months ended June 30, 2002.
The $6.0 million operating loss was attributable primarily to the $5.1 million
of SeraNova receivable impairment and other charges recorded during the six
months ended June 30, 2003.
India operating income decreased by $647,000, from $1.3 million for the six
months ended June 30, 2002, to $698,000 for the six months ended June 30, 2003.
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.
Europe operating performance improved by $622,000, from an operating loss
of $541,000 for the six months ended June 30, 2002, to operating income of
$81,000 for the six months ended June 30, 2003. The improvement was attributable
primarily to an improvement in the operating performance of Denmark (an
improvement of $366,000), the UK (an improvement of $32,000) and Sweden (an
improvement of $224,000).
Japan operating performance improved by $733,000, from an operating loss of
$525,000 for the six months ended June 30, 2002, to operating income of $208,000
for the six months ended June 30, 2003. The improvement was attributable
primarily to management efforts to re-organize and restructure the local
operations during late 2002. In December 2002, management initiated efforts to
decrease total operating expenses by reducing employee headcount and eliminating
discretionary expenditures such as sales and marketing programs, training, etc.
LIQUIDITY AND CAPITAL RESOURCES
The Company had cash and cash equivalents of $2.3 million at June 30, 2003
and $1.2 million at December 31, 2002. The Company had working capital of $7.3
million at June 30, 2003 and $13.1 million at December 31, 2002.
Cash provided by operating activities of continuing operations was $594,000
for the six months ended June 30, 2003, resulting primarily from the SeraNova
receivable impairment and other charges of $5.1 million, depreciation and
amortization of $1.8 million, a decrease in
- 36 -
accounts receivable of $1.3 million and an increase in accrued payroll and
related taxes of $1.3 million. These amounts were partially offset by the net
loss and increases in unbilled services of $1.4 million and other current assets
of $1.2 million. The changes in operating assets and liabilities result
primarily from timing differences. Cash provided by operating activities of
continuing operations for the six months ended June 30, 2002 was $1.1 million.
The Company invested $839,000 and $798,000 in computer equipment,
internal-use computer software and office furniture and fixtures during the six
months ended June 30, 2003 and 2002, respectively. The increase results
primarily from the replacement of computer equipment and the development of
certain internal-use software.
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 could 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 June 30, 2003, the Company had outstanding
borrowings under the credit facility of $7.3 million. The Company estimates
undrawn availability under the credit facility to be $6.6 million as of June 30,
2003. As of December 31, 2002, the Company had outstanding borrowings under the
credit facility of $6.1 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.
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, as of December
31, 2002 only, to require that consolidated net worth and unconsolidated net
worth as of December 31, 2002 be not less than 102% of consolidated net
- 37 -
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 generate EBITDA of at least 90% of the prior year's EBITDA.
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.
In January 2003, 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 EBITDA covenant defaults as of
June 30, 2002 and September 30, 2002, (2) a modification to the definitions of
EBITDA, total stockholders equity and unconsolidated stockholders equity (for
purposes of computing related covenant compliance) to exclude Proxy Contest
charges of $464,000 for the quarter ended June 30, 2002 and $413,000 for the
quarter ended September 30, 2002 only, (3), a reduction in the minimum EBITDA
covenant for the fourth quarter and full year 2002 only, and (4) 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 $12.6 million of the note due from
SeraNova.
As a result of the SeraNova receivable impairment and other related charges
and the Proxy Contest charges incurred during the quarter ended March 31, 2003,
the Company was not in compliance with the consolidated net worth,
unconsolidated net worth and EBITDA covenants as of March 31, 2003. In July
2003, the Company executed with the Bank an amendment to the credit agreement.
The terms of the amendment included, among other things, (1) a 3-year extension
of the credit facility to May 31, 2006, (2) a reduction of the maximum revolving
advance amount under the credit facility to $15.0 million, (3) a waiver of the
covenant defaults existing as of March 31, 2003, (4) a modification to the
definitions of total stockholders' equity and unconsolidated stockholders'
equity (for purposes of computing related covenant compliance) and a
modification to the computation of minimum EBITDA to exclude Proxy Contest
charges of $297,000 for the quarter ended March 31, 2003 only, (5) an increase
in the minimum EBITDA covenants to $1.3 million, $1.8 million and $1.9 million
for the second, third and fourth quarters 2003, respectively, and (6) 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 $13.6 million of
the note due from SeraNova.
As a result of the charge incurred during the quarter ended June 30, 2003
related to the guarantee of SeraNova debt, the Company was not in compliance
with the EBITDA covenant as of June 30, 2003. The Company is currently
negotiating with the Bank and expects to receive a waiver of the existing
covenant default. There can be no assurance, however, that the Company will be
able to obtain a waiver to the agreement on terms acceptable to the Company, if
at all.
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%.
- 38 -
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. 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. 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 $5.5
million and punitive damages in the amount of $10.0 million. The parties have
completed the discovery process and the Company has moved for summary judgment.
On April 17, 2003, the Court granted partial summary judgment and required
supplemental briefing on certain issues. On July 11, 2003, the Court heard
arguments on the Company's renewed motion for summary judgment and dismissed the
defendant's counterclaims seeking compensatory and punitive damages. Although a
trial date has been scheduled for September 16, 2003, counsel for defendants has
filed a motion to be relieved as counsel based upon defendants' failure to pay
their counsel fees.
In addition, 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. 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. In an action filed
in the Superior Court of New Jersey, the Court confirmed the $624,000 award,
jointly and severally as to the SeraNova Group, and issued a writ of execution
against the SeraNova Group's assets. The Sheriff of Middlesex County levied this
writ of execution on October 8, 2002 against a bank account held by Silverline
Technologies, Inc. On October 16, 2002, pursuant to this writ, the bank turned
over $626,247 to the Sheriff. On November 6, 2002 the Sheriff sent the funds to
the Company's attorneys and the funds were deposited into an attorney trust
account on November 8, 2002. On December 13, 2002, the Company commenced an
action in the Superior Court of New Jersey, Chancery Division, to recover
additional amounts due and owing from the SeraNova Group under the Arbitration
Award and to determine whether HSBC Bank USA ("HSBC"), a creditor of the
SeraNova Group, has priority to the funds levied upon by the Sheriff. On January
31, 2003, the Court entered judgment in the Company's favor in the amount of
$218,805, representing the SeraNova Group's additional unpaid rent arrearages
under the arbitration award. On February 28, 2003, the Court entered judgment in
the Company's favor in the amount of $220,415, representing the Company's
attorney's fees in connection with the Company's efforts to enforce the SeraNova
Group's obligations under the arbitration award. On March 10, 2003, the Court
ordered HSBC to produce discovery proving its priority to the $626,247 being
held in trust. Thereafter, the Company and HSBC entered into a settlement
agreement only as to the $626,247 being held in trust whereby the Company
remitted $570,228 to HSBC, and the remaining funds were released
- 39 -
to the Company. 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 periodically 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 $8.4 million of SeraNova receivable
impairment and other charges as of June 30, 2002. Specifically, the Company
recorded a $5.1 million charge to write-down the carrying value of the Note to
$4.0 million. Additionally, the Company recorded a $1.3 million charge to
write-off the carrying value of other SeraNova receivables (primarily, accrued
interest on the Note and a receivable for a system implementation project).
Also, the Company recorded a charge of $1.5 million for certain lease exit
costs. Such charge represents primarily an accrued liability for obligated space
and equipment 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 December 31, 2002, $1.3 million of the
liability remains outstanding, of which $1.0 million is included in other
long-term liabilities.
As of March 31, 2003, the Company believed there had been an apparent
deterioration in the financial condition of the SeraNova Group. Accordingly, the
Company re-assessed, as of March 31, 2003, the likelihood of recovering amounts
owed by the SeraNova Group as well as the assumptions used in recording the
original lease obligation charge. Additionally, the Company was notified during
the first quarter of 2003 of its obligation to pay additional office space and
equipment rentals, which had been previously assigned to SeraNova by the
Company, because the SeraNova Group had failed to make the required payments.
Although the Company expects to pursue the full legal prosecution of the
SeraNova Group, the Company recorded $5.1 million of additional charges
associated with the Note and certain other related issues during the six months
ended June 30, 2003. The Company recognized an additional impairment charge of
$4.0 million related to the Note, approximately $321,000 related to other
assets, approximately $474,000 in costs required to exit certain lease
obligations and $265,000 in legal fees. The Company has determined that due to
the apparent financial condition of the SeraNova Group that recovery of the
SeraNova Note is not probable.
- 40 -
WRITE-DOWN WRITE-OFF LEASE
OF NOTE OF OTHER OBLIGATIONS LEGAL AND
RECEIVABLE RECEIVABLES AND OTHER
- SERANOVA - SERANOVA SETTLEMENTS 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............. -- -- (361,000) (318,000) (679,000)
Non-cash items..................... (5,140,000) (1,257,000) -- -- (6,397,000)
----------- ----------- ----------- --------- -----------
Accrued costs as of December 31,
2002............................... -- -- 1,140,000 146,000 1,286,000
Charges to operations during 2003.. 4,000,000 -- 795,000 265,000 5,060,000
Costs paid during 2003............. -- -- (644,000) (234,000) (878,000)
Non-cash items..................... (4,000,000) -- -- -- (4,000,000)
----------- ----------- ----------- --------- -----------
Accrued costs as of June 30, 2003.. $ -- $ -- $ 1,291,000 $ 177,000 $ 1,468,000
=========== =========== =========== ========= ===========
As of June 30, 2003, $1.5 million of the liability remains outstanding, of
which $873,000 is included in other long-term liabilities. The Company expects
to pay out this liability through 2008.
CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS
The following tables summarize the Company's contractual obligations and
other commercial commitments as of June 30, 2003:
PAYMENTS DUE BY PERIOD
------------------------------------------------------------------
DESCRIPTION OF LESS THAN 1 - 3 3 - 5 MORE THAN
- -------------- --------- ----- ----- ---------
CONTRACTUAL OBLIGATION TOTAL 1 YEAR YEARS YEARS 5 YEARS
- ---------------------- ----- ------ ----- ----- -------
Revolving Credit Facility $ 7,325,000 $7,325,000 $ -- $ -- $ --
Capital Lease Obligations 165,000 96,000 69,000 -- --
Operating Lease Obligations 8,203,000 1,149,000 4,956,000 2,098,000 --
Other Liabilities 1,468,000 595,000 535,000 338,000 --
----------- ---------- ---------- ---------- --------
Total Contractual Obligations $17,161,000 $9,165,000 $5,560,000 $2,436,000 $ --
=========== ========== ========== ========= ========
The Company uses its $15.0 million revolving credit facility with PNC Bank
to fund the working capital needs of the business; therefore, the outstanding
borrowings under the credit facility fluctuate accordingly. The credit facility
is collateralized by substantially all of the assets of the 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 June 30, 2003, the Company had outstanding borrowings under the
credit facility of $7.3 million. The Company estimates undrawn availability
under the credit facility to be $6.6 million as of June 30, 2003. As of December
31, 2002, the Company had outstanding borrowings under the credit facility of
$6.1 million.
As a result of the charge incurred during the quarter ended June 30, 2003
related to the guarantee of SeraNova debt, the Company was not in compliance
with the EBITDA covenant as of June 30, 2003. The Company is currently
negotiating with the Bank and expects to receive a waiver of the existing
covenant default. There can be no assurance, however, that the Company will be
able to obtain a waiver to the agreement on terms acceptable to the Company, if
at all.
- 41 -
The Company has also entered into various contractual arrangements to
obtain certain office space, office equipment and vehicles under capital and
operating leases.
The Company's 2003 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 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.
COMMITMENTS
Beginning in 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. 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. In
an action filed in the Superior Court of New Jersey, the Court confirmed the
$624,000 award, jointly and severally as to the SeraNova Group, and issued a
writ of execution against the SeraNova Group's assets. The Sheriff of Middlesex
County levied this writ of execution on October 8, 2002 against a bank account
held by Silverline Technologies, Inc. On October 16, 2002, pursuant to this
writ, the bank turned over $626,247 to the Sheriff. On November 6, 2002 the
Sheriff sent the funds to the Company's attorneys and the funds were deposited
into an attorney trust account on November 8, 2002. On December 13, 2002, the
Company commenced an action in the Superior Court of New Jersey, Chancery
Division, to recover additional amounts due and owing from the SeraNova Group
under the Arbitration Award and to determine whether HSBC, a creditor of the
SeraNova Group, has priority to the funds levied upon by the Sheriff. On January
31, 2003, the Court entered judgment in the Company's favor in the amount of
$218,805, representing the SeraNova Group's additional unpaid rent arrearages
under the arbitration award. On February 28, 2003, the Court entered judgment in
the Company's favor in the amount of $220,415, representing the Company's
attorney's fees in connection with the Company's efforts to enforce the SeraNova
Group's
- 42 -
obligations under the arbitration award. On March 10, 2003, the Court ordered
HSBC to produce discovery proving its priority to the $626,247 being held in
trust. Thereafter, the Company and HSBC entered into a settlement agreement only
as to the $626,247 being held in trust whereby the Company remitted $570,228 to
HSBC, and the remaining funds were released to the Company. 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 October 4, 2002, the Company filed a complaint in the Superior Court of
New Jersey, Middlesex County against the SeraNova Group and 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. All
defendants have answered the complaint and discovery has commenced.
On January 30, 2003, CA Metro Center Limited Partnership filed a complaint
in the Superior Court of California, County of San Mateo, against the Company
and SeraNova as defendants. The Complaint seeks damages against the defendants
in the amount of $186,312 for breach of a lease agreement relating to the lease
of premises occupied by SeraNova. The plaintiff granted the Company an extension
of time in which to answer the complaint while the parties engaged in settlement
discussions. The parties have executed a settlement agreement whereby the
Company will pay an aggregate of $160,000 over time, with the last payment being
due on or before November 30, 2003. The Company has paid an aggregate of $85,000
during the six months ended June 30, 2003. The Company has accrued the remaining
balance of $75,000 in the consolidated balance sheet as of June 30, 2003.
During 2002, SeraNova failed to pay certain obligations under a telephone
equipment lease agreement, which the Company assigned to SeraNova in February of
2001. On March 12, 2003, CIT Communications Finance Corporation ("CIT") filed a
complaint in the Superior Court of New Jersey, Law Division, Morris County,
against Intelligroup and SeraNova, jointly and severally, as defendants. The
complaint, which seeks damages, alleges among other things that the defendants
failed to pay outstanding lease obligations in the amount of $217,899. In March
2003, the parties executed a settlement agreement whereby the Company was
obligated to pay to CIT an aggregate of $127,000. The Company paid such amount
to CIT in May 2003.
By letter dated May 12, 2003, Zions First National Bank ("Zions") informed
the Company that Network Publishing, Inc., a former wholly-owned subsidiary of
the Company, which became a wholly-owned subsidiary of SeraNova upon the
spin-off of SeraNova by the Company in 2000, was delinquent on a loan made by
Zions and guaranteed by the Company. Zions is demanding payment of $535,608 from
the Company, plus interest accrued from April 1, 2002. The Company has requested
documentation from Zions. Zions requested that the Company execute a
confidentiality agreement before providing the documentation. The Company
intends to investigate Zion's claims upon receipt of such documentation.
However, the Company could have a liability in this matter once all
documentation is provided by Zions. Accordingly, the Company has recorded a
$581,000 provision for the guarantee of SeraNova debt in the consolidated
statement of operations during the three months ended June 30, 2003.
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EUROPEAN MONETARY UNION (EMU)
The Company currently only operates in certain European countries that do
not participate in the EMU. Therefore, the Company believes that the recent
conversion to the euro did not have a material financial impact on its
operations in Europe. However, the Company would re-evaluate the financial
impact of the conversion to the euro on its operations should those countries in
which the Company operates decide to join the EMU.
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's management, with the participation of the Company's President
and Chief Executive Officer and Senior Vice President-Finance and Administration
and Chief Financial Officer, evaluated the effectiveness of the Company's
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Exchange Act) as of June 30, 2003. In designing and evaluating the
Company's disclosure controls and procedures, management recognized that any
controls and procedures, no matter how well designed and operated, can provide
only reasonable assurance of achieving their objectives and management
necessarily applied its judgment in evaluating the cost-benefit relationship of
possible controls and procedures. Based on this evaluation, the Company's
President and Chief Executive Officer and Senior Vice President-Finance and
Administration and Chief Financial Officer concluded that, as of June 30, 2003,
the Company's disclosure controls and procedures were (1) designed to ensure
that material information relating to the Company, including its consolidated
subsidiaries, is made known to the Company's President and Chief Executive
Officer and Senior Vice President-Finance and Administration and Chief Financial
Officer by others within those entities, particularly during the period in which
this report was being prepared and (2) effective, in that they provide
reasonable assurance that information required to be disclosed by the Company in
the reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms.
No change in the Company's internal control over financial reporting (as
defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during
the fiscal quarter ended June 30, 2003 that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
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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 same extent as
SeraNova for false and misleading statements constituting securities laws
violations and breach of contract. 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. 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 parties executed
a settlement agreement, which became effective upon payment of the settlement
amount. The Company paid its portion of the settlement amount equal to an
aggregate amount of $50,000 in April 2003.
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 the Company
moved for summary judgment. On April 17, 2003, the Court granted partial summary
judgment and required supplemental briefing on certain issues. On July 11, 2003,
the Court heard arguments on the Company's renewed motion for summary judgment
and dismissed the defendant's counterclaims seeking compensatory and punitive
damages. Although a trial date has been scheduled for September 16, 2003,
counsel for defendants has filed a motion to be relieved as counsel based upon
defendants' failure to pay their counsel fees.
Beginning in 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. The demand
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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. In an action filed in the Superior Court
of New Jersey, the Court confirmed the $624,000 award, jointly and severally as
to the SeraNova Group, and issued a writ of execution against the SeraNova
Group's assets. The Sheriff of Middlesex County levied this writ of execution on
October 8, 2002 against a bank account held by Silverline Technologies, Inc. On
October 16, 2002, pursuant to this writ, the bank turned over $626,247 to the
Sheriff. On November 6, 2002 the Sheriff sent the funds to the Company's
attorneys and the funds were deposited into an attorney trust account on
November 8, 2002. On December 13, 2002, the Company commenced an action in the
Superior Court of New Jersey, Chancery Division, to recover additional amounts
due and owing from the SeraNova Group under the Arbitration Award and to
determine whether HSBC Bank USA ("HSBC"), a creditor of the SeraNova Group, has
priority to the funds levied upon by the Sheriff. On January 31, 2003, the Court
entered judgment in the Company's favor in the amount of $218,805, representing
the SeraNova Group's additional unpaid rent arrearages under the arbitration
award. On February 28, 2003, the Court entered judgment in the Company's favor
in the amount of $220,415, representing the Company's attorney's fees in
connection with the Company's efforts to enforce the SeraNova Group's
obligations under the arbitration award. On March 10, 2003, the Court ordered
HSBC to produce discovery proving its priority to the $626,247 being held in
trust. Thereafter, the Company and HSBC entered into a settlement agreement only
as to the $626,247 being held in trust whereby the Company remitted $570,228 to
HSBC, and the remaining funds were released to the Company. 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. On June 6, 2003, the Court granted summary judgment in favor
of the Company on all counts of the complaint and Mr. Pandey did not oppose the
Company's motion for attorney's fees. On August 7, 2003, the Company and Mr.
Pandey executed a settlement agreement relating to, among other things, the
litigation matters between them.
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 annual election. On July 12,
2002, after reviewing actual evidence of record, and hearing argument from
Pandey's counsel, the Court held that there was no basis to
- 46 -
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, 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.
In response, Pandey filed a motion seeking leave to file a Second Amended
Complaint, seeking to drop the Section 13D claims against the Company and
substitute them with claims brought under Section 14A of the Securities and
Exchange Act. On January 31, 2003, the Court denied each of the parties'
motions. On August 7, 2003, the Company and Mr. Pandey executed a settlement
agreement relating to, among other things, the litigation matters between them.
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 continued 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 is ongoing. On November 6, 2002, the
Company filed a Motion for Summary Judgment and on January 7, 2003, the Court
granted Partial Summary Judgment. On August 7, 2003, the Company and Mr. Pandey
executed a settlement agreement relating to, among other things, the litigation
matters between them.
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. On August 7, 2003, the Company and Mr. Pandey executed a
settlement agreement relating to, among other things, the litigation matters
between them.
On October 4, 2002, the Company filed a complaint in the Superior Court of
New Jersey, Middlesex County against the SeraNova Group and 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. All
defendants have answered the complaint and discovery has commenced.
- 47 -
On January 30, 2003, CA Metro Center Limited Partnership filed a complaint
in the Superior Court of California, County of San Mateo, against the Company
and SeraNova as defendants. The Complaint seeks damages against the defendants
in the amount of $186,312 for breach of a lease agreement relating to the lease
of premises occupied by SeraNova. The plaintiff granted the Company an extension
of time in which to answer the complaint while the parties engaged in settlement
discussions. The parties have executed a settlement agreement whereby the
Company will pay an aggregate of $160,000 over time, with the last payment being
due on or before November 30, 2003. The Company has paid an aggregate of $85,000
during the six months ended June 30, 2003. The Company has accrued the remaining
balance of $75,000 in the consolidated balance sheet as of June 30, 2003.
During 2002, SeraNova failed to pay certain obligations under a telephone
equipment lease agreement, which the Company assigned to SeraNova in February of
2001. On March 12, 2003, CIT Communications Finance Corporation ("CIT") filed a
complaint in the Superior Court of New Jersey, Law Division, Morris County,
against Intelligroup and SeraNova, jointly and severally, as defendants. The
complaint, which seeks damages, alleges among other things that the defendants
failed to pay outstanding lease obligations in the amount of $217,899. In March
2003, the parties executed a settlement agreement whereby the Company was
obligated to pay to CIT an aggregate of $127,000. The Company paid such amount
to CIT in May 2003.
By letter dated May 12, 2003, Zions First National Bank ("Zions") informed
the Company that Network Publishing, Inc., a former wholly-owned subsidiary of
the Company, which became a wholly-owned subsidiary of SeraNova upon the
spin-off of SeraNova by the Company in 2000, was delinquent on a loan made by
Zions and guaranteed by the Company. Zions is demanding payment of $535,608 from
the Company, plus interest accrued from April 1, 2002. The Company has requested
documentation from Zions. Zions requested that the Company execute a
confidentiality agreement before providing the documentation. The Company
intends to investigate Zion's claims upon receipt of such documentation.
However, the Company could have a liability in this matter once all
documentation is provided by Zions. Accordingly, the Company has recorded a
$581,000 provision for the guarantee of SeraNova debt in the consolidated
statement of operations during the three months ended June 30, 2003.
There is no other material litigation pending to which the Company is a
party or to which any of its property is subject.
- 48 -
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
On May 31, 2000, the Company and PNC Bank, N.A. (the "Bank") entered into a
three-year revolving credit facility. As a result of the SeraNova receivable
impairment and other related charges and the Proxy Contest charges incurred
during the quarter ended March 31, 2003, the Company was not in compliance with
the consolidated net worth, unconsolidated net worth and EBITDA covenants as of
March 31, 2003. In July 2003, the Company executed with the Bank an amendment to
the credit agreement. The terms of the amendment included, among other things,
(1) a 3-year extension of the credit facility to May 31, 2006, (2) a reduction
of the maximum revolving advance amount under the credit facility to $15.0
million, (3) a waiver of the covenant defaults existing as of March 31, 2003,
(4) a modification to the definitions of total stockholders equity and
unconsolidated stockholders equity (for purposes of computing related covenant
compliance) and a modification to the computation of minimum EBITDA to exclude
Proxy Contest charges of $297,000 for the quarter ended March 31, 2003 only, (5)
an increase in the minimum EBITDA covenants to $1.3 million, $1.8 million and
$1.9 million for the second, third and fourth quarters 2003, respectively, and
(6) 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 $13.6 million of
the note due from SeraNova.
As a result of the charge incurred during the quarter ended June 30, 2003
related to the guarantee of SeraNova debt, the Company was not in compliance
with the EBITDA covenant as of June 30, 2003. The Company is currently
negotiating with the Bank and expects to receive a waiver of the existing
covenant default. There can be no assurance, however, that the Company will be
able to obtain a waiver to the agreement on terms acceptable to the Company, if
at all.
ITEM 5. OTHER INFORMATION
On April 2, 2003, the Company consummated the sale, effective as of March
1, 2003, of its Asia-Pacific group of subsidiary companies, operating in
Australia, New Zealand, Singapore, Hong Kong and Indonesia to Soltius Global
Solutions PTE Ltd, a Singapore corporation ("Soltius"). As consideration, the
Company received a 5% minority shareholding in Soltius and a $650,000 note to be
paid by Soltius to the Company over a period of 12 months. The Company received
$75,000 from Soltius during the quarter ended June 30, 2003. The consideration
was determined as a result of arms-length negotiations between the parties.
On May 30, 2003, the Company executed a letter agreement with PNC Bank
extending the term of the credit facility from May 31, 2003 to July 31, 2003. On
July 31, 2003, the Company executed a third amendment to the loan documents,
among other things, extending the term of the credit facility to May 31, 2006.
On August 4, 2003, Prabhas Panigrahi, a member of the Board of Directors
(the "Board") of the Company since June 2002, resigned from the Board. Mr.
Panigrahi's resignation as a Director did not involve any disagreement with the
Company on any matter relating to the Company's operations, policies or
practices, and Mr. Panigrahi has not requested that any matter be disclosed.
- 49 -
On August 7, 2003, the Company and Ashok Pandey executed a settlement
agreement pursuant to which, among other things: (1) the parties agreed to
release each other from any and all claims and settle all current litigation
matters between them; (2) the Company agreed to pay Pandey an aggregate amount
of $750,000 to Pandey in three equal installments over two years; (3) the
Company waived all amounts due by Pandey to the Company pursuant to the award
granted by the Court in one of the actions filed by the Company against Pandey;
(4) the Company agreed to include Pandey or his designee who is reasonably
acceptable to the Company's Board of Directors (the "Board") in its slate of
nominees for election to the Board at its Annual Meeting of Shareholders to be
held in 2003, 2004 and 2005; (5) Pandey agreed to certain standstill provisions
relating to acquiring shares of the Company's voting securities, solicitation of
proxies, waging of a proxy contest or tender offer or initiating or supporting a
shareholder proposal for a three-year period; (6) Pandey agreed to vote for the
slate of directors proposed by the Board for a three-year period; and (7) the
parties agreed not to disparage each other.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
32 Certification pursuant to 18 U.S.C Section 1350.
(b) Reports on Form 8-K.
On April 4, 2003, the Company filed a Form 8-K to report that on
April 2, 2003, the Company consummated the sale of Intelligroup
Singapore Pte Ltd., a Singapore corporation, Intelligroup Hong
Kong Limited, a Hong Kong corporation, Intelligroup Australia Pty
Limited, an Australian corporation and Intelligroup New Zealand
Limited, a New Zealand corporation, together representing the
Company's Asia-Pacific group of subsidiary companies, operating
in Australia, New Zealand, Singapore, Hong Kong and Indonesia, to
Soltius Global Solutions PTE Ltd., a Singapore corporation.
On April 17, 2003, the Company filed a Form 8-K/A with the
Securities and Exchange Commission to provide the financial
statements and pro forma financial required under Item 7 related
to the sale of the Company's Asia-Pacific Group of subsidiary
companies to Soltius Global Solutions PTE Ltd.
On May 13, 2003, the Company furnished a Form 8-K under Item 9,
containing a copy of its earnings release for the period ending
March 31, 2003 (including financial statements) pursuant to Item
12 (Results of Operations and Financial Condition).
On June 3, 2003, the Company filed a Form 8-K with the Securities
and Exchange Commission to report that on May 30, 2003, the
Company executed a letter
- 50 -
agreement with PNC Bank and Empower, Inc., a wholly-owned
subsidiary of the Company, extending the term of the PNC Bank
credit facility from May 31, 2003 to July 31, 2003.
On August 5, 2003, the Company filed a Form 8-K with the
Securities and Exchange Commission to report the following: (1)
On July 31, 2003, the Company executed a third amendment to the
loan documents with PNC Bank and Empower, Inc., a wholly-owned
subsidiary of the Company, among other things, extending the term
of the credit facility to May 31, 2006 and (2) On August 4, 2003,
Prabhas Panigrahi, a member of the Board of Directors (the
"Board") of Intelligroup, Inc. (the "Company") since June 2002,
resigned from the Board. Mr. Panigrahi's resignation as a Director
did not involve any disagreement with the Company on any matter
relating to the Company's operations, policies or practices, and
Mr. Panigrahi has not requested that any matter be disclosed.
On August 12, 2003, the Company filed a Form 8-K with the
Securities and Exchange Commission to report that on August 7,
2003, the Company and Ashok Pandey ("Pandey") executed a
settlement agreement providing for, among other things, the
settlement of all current litigation between the parties, payments
to be made by the Company to Mr. Pandey and that Pandey abide by
certain standstill provisions relating to, among other matters,
participating in any proxy contests, and vote for the Company
slate of directors for a three-year period.
- 51 -
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: August 14, 2003 By: /s/ Nagarjun Valluripalli
------------------------------------
Nagarjun Valluripalli,
Chairman of the Board, President and
Chief Executive Officer
(Principal Executive Officer)
DATE: August 14, 2003 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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