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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 September 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 November 11, 2003:
Class Number of Shares
----- ----------------
Common Stock, $.01 par value 16,721,325
INTELLIGROUP, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
-----------------
Page
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)................. 1
Consolidated Balance Sheets as of September 30, 2003
and December 31, 2002........................................ 2
Consolidated Statements of Operations and Comprehensive
Income (Loss) for the Three and Nine Months Ended
September 30, 2003 and 2002.................................. 3
Consolidated Statements of Cash Flows for the Nine Months
Ended September 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.... 45
Item 4. Controls and Procedures....................................... 45
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................. 46
Item 3. Defaults Upon Senior Securities............................... 48
Item 4. Submission of Matters to a Vote of Security Holders........... 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
SEPTEMBER 30, 2003 AND DECEMBER 31, 2002
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents..................................... $ 2,178,000 $ 1,163,000
Accounts receivable, less allowance for doubtful accounts
of $847,000 and $1,388,000 at September 30, 2003 and
December 31, 2002, respectively............................ 16,226,000 17,745,000
Unbilled services............................................. 10,177,000 6,818,000
Prepaid income taxes.......................................... 448,000 624,000
Deferred tax assets........................................... 1,271,000 1,088,000
Other current assets.......................................... 3,900,000 2,858,000
Note receivable - SeraNova.................................... -- 4,000,000
Assets held for sale.......................................... -- 3,069,000
------------ ------------
Total current assets................................... 34,200,000 37,365,000
Property and equipment, net................................... 4,432,000 5,725,000
Deferred tax asset............................................ 152,000 118,000
Other assets.................................................. 1,066,000 911,000
------------ ------------
$ 39,850,000 $ 44,119,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable.............................................. $ 3,936,000 $ 5,229,000
Accrued payroll and related taxes............................. 8,380,000 5,891,000
Accrued expenses and other current liabilities................ 5,712,000 3,491,000
Deferred revenue.............................................. 1,697,000 1,280,000
Income taxes payable.......................................... 588,000 356,000
Current portion of long-term debt and obligations under
capital leases............................................. 6,168,000 6,374,000
Liabilities held for sale..................................... -- 1,681,000
------------ ------------
Total current liabilities............................. 26,481,000 24,302,000
------------ ------------
Obligations under capital leases, less current portion.......... 69,000 63,000
Other long-term liabilities..................................... 1,248,000 1,028,000
------------ ------------
Total long-term liabilities............................ 1,317,000 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,
16,683,000 and 16,630,000 shares issued and outstanding
at September 30, 2003 and December 31, 2002, respectively.. 167,000 166,000
Additional paid-in capital.................................... 41,425,000 41,366,000
Accumulated deficit........................................... (26,994,000) (19,168,000)
Accumulated other comprehensive loss.......................... (2,546,000) (3,638,000)
------------ ------------
Total shareholders' equity ............................. 12,052,000 18,726,000
------------ ------------
$ 39,850,000 $ 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 NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(UNAUDITED)
THREE MONTHS NINE MONTHS
------------ -----------
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- -------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenue........................................... $ 31,035,000 $ 26,668,000 $ 86,275,000 $ 74,479,000
Cost of sales..................................... 22,211,000 18,634,000 61,030,000 51,581,000
------------ ------------ ------------ ------------
Gross profit.................................. 8,824,000 8,034,000 25,245,000 22,898,000
------------ ------------ ------------ ------------
Selling, general and administrative expenses...... 7,130,000 6,324,000 20,937,000 18,791,000
Depreciation and amortization..................... 719,000 615,000 2,130,000 1,942,000
SeraNova receivable impairment and other charges.. -- -- 5,060,000 8,362,000
Proxy contest charges............................. 868,000 412,000 1,461,000 876,000
Provision for guarantee of SeraNova debt.......... (107,000) -- 474,000 --
------------ ------------ ------------ ------------
Total operating expenses...................... 8,610,000 7,351,000 30,062,000 29,971,000
------------ ------------ ------------ ------------
Operating income (loss)....................... 214,000 683,000 (4,817,000) (7,073,000)
Interest income................................... 47,000 4,000 72,000 22,000
Interest expense.................................. (91,000) (97,000) (323,000) (297,000)
Other (expense) income............................ (21,000) (9,000) (254,000) 48,000
------------ ------------ ------------ ------------
Income (loss) from continuing operations
before income tax provision .................. 149,000 581,000 (5,322,000) (7,300,000)
Income tax provision.............................. 132,000 181,000 370,000 492,000
------------ ------------ ------------ ------------
Income (loss) from continuing operations.......... 17,000 400,000 (5,692,000) (7,792,000)
Loss from discontinued operations (including
loss on sale of $1,706,000 in 2003), net
of tax provision (benefit) of $0,
$(21,000), $15,000, $9,000, respectively...... -- (387,000) (2,134,000) (745,000)
------------ ------------ ------------ ------------
Net income (loss)................................. $ 17,000 $ 13,000 $ (7,826,000) $ (8,537,000)
============ ============ ============ ============
Earnings (loss) per share:
Basic income (loss) per share:
Income (loss) per share from continuing
operations................................ $ 0.00 $ 0.02 $ (0.34) $ (0.47)
Loss per share from discontinued operations.... -- (0.02) (0.13) (0.04)
------------ ------------ ------------ ------------
Net income (loss) per share................ $ 0.00 $ 0.00 $ (0.47) $ (0.51)
============ ============ ============ ============
Weighted average number of common shares -
basic..................................... 16,683,000 16,630,000 16,656,000 16,630,000
============ ============ ============ ============
Diluted income (loss) per share:
Income (loss) per share from continuing
operations................................ $ 0.00 $ 0.02 $ (0.34) $ (0.47)
Loss per share from discontinued operations.... -- (0.02) (0.13) (0.04)
------------ ------------ ------------ ------------
Net income (loss) per share................ $ 0.00 $ 0.00 $ (0.47) $ (0.51)
============ ============ ============ ============
Weighted average number of common shares -
diluted................................... 17,132,000 16,633,000 16,656,000 16,630,000
============ ============ ============ ============
Comprehensive (Loss) Income
- ---------------------------
Net income (loss)................................. $ 17,000 $ 13,000 $ (7,826,000) $ (8,537,000)
Other comprehensive (loss) income -
Currency translation adjustments............ (89,000) 80,000 1,092,000 67,000
------------ ------------ ------------ ------------
Comprehensive (loss) income....................... $ (72,000) $ 93,000 $ (6,734,000) $ (8,470,000)
============ ============ ============ ============
The accompanying notes to consolidated financial statements are an integral part
of these statements.
- 3 -
INTELLIGROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
2003 2002
------------ ------------
Cash flows from operating activities:
Net loss.............................................................. $ (7,826,000) $ (8,537,000)
Less: loss from discontinued operations, net of tax................... (2,134,000) (745,000)
------------ ------------
Loss from continuing operations....................................... (5,692,000) (7,792,000)
Adjustments to reconcile net loss to net cash provided by
operating activities of continuing operations:
Depreciation and amortization..................................... 3,077,000 2,581,000
Provision for doubtful accounts................................... 125,000 309,000
SeraNova receivable impairment and other charges.................. 5,060,000 8,362,000
Provision for guarantee of SeraNova debt.......................... 474,000 --
Deferred income taxes............................................. (217,000) 361,000
Changes in operating assets and liabilities:
Accounts receivable................................................. 1,394,000 (3,048,000)
Unbilled services................................................... (3,359,000) (403,000)
Prepaid income taxes................................................ 176,000 (121,000)
Other current assets................................................ (1,042,000) (35,000)
Other assets........................................................ (155,000) (19,000)
Accounts payable.................................................... (1,293,000) 719,000
Accrued payroll and related taxes................................... 2,489,000 407,000
Accrued expenses and other liabilities.............................. 1,280,000 (15,000)
Accrued restructuring charges....................................... (93,000) (529,000)
Deferred revenue.................................................... 417,000 172,000
Income taxes payable................................................ 232,000 283,000
------------ ------------
Net cash provided by operating activities of continuing
operations........................................................... 2,873,000 1,232,000
------------ ------------
Cash flows from investing activities:
Purchase of equipment............................................... (1,784,000) (1,042,000)
------------ ------------
Net cash used in investing activities of continuing operations........ (1,784,000) (1,042,000)
------------ ------------
Cash flows from financing activities:
Principal payments under capital leases............................. (307,000) (509,000)
Proceeds from exercise of stock options............................. 60,000 --
Other repayments.................................................... (274,000) (48,000)
Net change in line of credit borrowings............................. 101,000 1,033,000
------------ ------------
Net cash (used in) provided by financing activities of
continuing operations............................................... (420,000) 476,000
------------ ------------
Effect of foreign currency exchange rate changes on cash.............. 1,095,000 67,000
------------ ------------
Net increase in cash and cash equivalents from continuing operations.... 1,764,000 733,000
Net decrease in cash and cash equivalents from discontinued operations.. (749,000) (767,000)
------------ ------------
Net increase (decrease) in cash and cash equivalents.................... 1,015,000 (34,000)
Cash and cash equivalents at beginning of period........................ 1,163,000 1,620,000
------------ ------------
Cash and cash equivalents at end of period.............................. $ 2,178,000 $ 1,586,000
============ ============
Supplemental disclosures of cash flow information:
Cash paid for income taxes............................................ $ 473,000 $ 864,000
============ ============
Cash paid for interest................................................ $ 323,000 $ 297,000
============ ============
The accompanying notes to consolidated financial statements are an integral part
of these statements.
- 4 -
INTELLIGROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The consolidated financial statements and accompanying financial
information as of September 30, 2003 and for the three and nine months ended
September 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 consolidated financial statements. Such annual consolidated 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 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 NINE MONTHS ENDED
-------------------------- -------------------------
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2003 2002 2003 2002
--------- ---------- ------------ ------------
Net income (loss), as reported..................... $ 17,000 $ 13,000 $ (7,826,000) $ (8,537,000)
Deduct: total stock-based employee compensation
expense determined under fair-value-based method
for all awards, net of related tax effects......... (49,000) (797,000) (1,896,000) (4,073,000)
--------- ---------- ------------ ------------
Pro forma net loss................................. $ (32,000) $ (784,000) $ (9,722,000) $(12,610,000)
========= ========== ============ ============
Basic earnings (loss) per share:
As reported.................................... $ 0.00 $ 0.00 $ (0.47) $ (0.51)
========= ========== ============ ============
Pro forma...................................... $ (0.00) $ (0.05) $ (0.58) $ (0.76)
========= ========== ============ ============
Diluted earnings (loss) per share:
As reported.................................... $ 0.00 $ 0.00 $ (0.47) $ (0.51)
========= ========== ============ ============
Pro forma...................................... $ (0.00) $ (0.05) $ (0.58) $ (0.76)
========= ========== ============ ============
- 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 110%, risk-free
interest rate of 1.61% and 1.80% and expected lives of 2.2 years and 2.2 years,
in 2003 and 2002, respectively.
NOTE 3 - EARNINGS (LOSS) PER SHARE
Basic income (loss) per share is computed by dividing net income (loss)
attributable to common shareholders by the weighted average number of common
shares outstanding for the period. Diluted income (loss) per share is computed
by dividing net income (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
income (loss) per share and diluted income (loss) per share were as follows:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
-------------- -------------- ------------- -------------
Income (loss) from continuing operations...... $ 17,000 $ 400,000 $ (5,692,000) $ (7,792,000)
Loss from discontinued operations............. -- (387,000) (2,134,000) (745,000)
-------------- -------------- ------------- -------------
Net income (loss)............................. $ 17,000 $ 13,000 $ (7,826,000) $ (8,537,000)
============== ============== ============= =============
Basic income (loss) per share:
Weighted average number of common shares -
basic ................................... 16,683,000 16,630,000 16,656,000 16,630,000
-------------- -------------- ------------- -------------
Basic income (loss) per share from
continuing operations.................... $ 0.00 $ 0.02 $ (0.34) $ (0.47)
Basic loss per share from discontinued
operations............................... -- (0.02) (0.13) (0.04)
-------------- -------------- ------------- -------------
Basic net income (loss) per share.......... $ 0.00 $ 0.00 $ (0.47) $ (0.51)
============== ============== ============= =============
Diluted income (loss) per share:
Weighted average number of common shares -
diluted.................................. 17,132,000 16,633,000 16,656,000 16,630,000
-------------- -------------- ------------- -------------
Diluted income (loss) per share from
continuing operations.................... $ 0.00 $ 0.02 $ (0.34) $ (0.47)
Diluted loss per share from discontinued
operations............................... -- (0.02) (0.13) (0.04)
-------------- -------------- ------------- -------------
Diluted net income (loss) per share........ $ 0.00 $ 0.00 $ (0.47) $ (0.51)
============== ============== ============= =============
Stock options, which would be antidilutive (1,703,000 and 2,450,000 for the
three months ended September 30, 2003 and 2002, respectively, and 1,743,000 and
2,419,000 for the nine months ended September 30, 2003 and 2002, respectively)
have been excluded from the calculations of diluted shares outstanding and
diluted income (loss) per share.
- 7 -
NOTE 4 - LINES OF CREDIT
On May 31, 2000, the Company and PNC Bank, N.A. (the "Bank") entered into a
three-year revolving credit facility. In July 2003, the credit facility was
extended until May 31, 2006. The credit facility is currently comprised of a
revolving line of credit pursuant to which the Company could borrow up to
$15,000,000 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.
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 total shareholders' equity and unconsolidated shareholders' equity
(for purposes of computing related covenant compliance) and a modification to
the computation of minimum EBITDA 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 shareholders' equity and unconsolidated shareholders'
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.
- 8 -
NOTE 4 - LINES OF CREDIT (CONTINUED)
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. In October 2003, the Company
executed with the Bank an amendment to the credit agreement. The terms of the
amendment included, among other things, (1) a waiver of the covenant default
existing as of June 30, 2003, (2) a modification to the definitions of total
shareholders' equity and unconsolidated shareholders' equity (for purposes of
computing related covenant compliance) and a modification to the computation of
minimum EBITDA to exclude the guarantee of SeraNova debt charge of $581,000 for
the quarter ended June 30, 2003 only, and a modification to the definitions of
total shareholders' equity and unconsolidated shareholders' equity (for purposes
of computing related covenant compliance) and a modification to the computation
of minimum EBITDA to exclude Proxy Contest charges of $750,000 for the quarter
ended September 30, 2003 only. As of September 30, 2003, the Company had
outstanding borrowings under the credit facility of $6,160,000. The Company
estimates undrawn availability under the credit facility to be $6,126,000 as of
September 30, 2003. As of December 31, 2002, the Company had outstanding
borrowings under the credit facility of $6,059,000. The Company was in
compliance with all covenants as of September 30, 2003.
Interest expense on debt and obligations under capital leases was $323,000
and $297,000 for the nine months ended September 30, 2003 and 2002,
respectively.
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 "Former
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 has received a total of $350,000 from Soltius
toward the note balance as of September 30, 2003.
The Consolidated Financial Statements of the Company have been reclassified
to reflect the Sale of the Former Subsidiaries to Soltius as of March 31, 2003.
Accordingly, the assets, liabilities, results of operations, and cash flows of
the Former 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 Former
Subsidiaries have been reported as discontinued operations.
- 9 -
NOTE 5 - DISCONTINUED OPERATIONS (CONTINUED)
Summarized financial information for the discontinued operations of the
Former Subsidiaries is as follows:
FOR THE THREE MONTHS FOR THE NINE MONTHS
-------------------- -------------------
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- -------------------
2002 2003 2002
-------------------- ------------- -------------
Revenue.................................. $ 1,690,000 $ 1,691,000 $ 4,964,000
Pre-tax loss............................. (408,000) (413,000) (736,000)
Income tax (benefit) provision........... (21,000) 15,000 9,000
Loss from discontinued operations,
excluding loss on sale................ (387,000) (428,000) (745,000)
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 Former
Subsidiaries of $1,706,000 for the nine months ended September 30, 2003.
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 compensatory damages in excess of $5,500,000 and punitive damages in
the amount of $10,000,000. After completion of the discovery process, the
Company moved for summary judgment. On April 17, 2003, the Court granted partial
summary judgment. On July 11, 2003, the Court dismissed the defendant's
counterclaims seeking compensatory and punitive damages. On August 8, 2003,
SeraNova and Silverline Technologies, Inc. filed for Chapter 7 Bankruptcy,
thereby staying this action as to these defendants. There has been no notice
that Silverline Technologies Limited is insolvent. Shortly thereafter, counsel
for defendants asked the Court and was granted permission to be relieved as
counsel. On September 22, 2003, the Company moved for entry of default against
Silverline.
- 10 -
NOTE 6 - NOTE RECEIVABLE - SERANOVA (CONTINUED)
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 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.
- 11 -
NOTE 6 - NOTE RECEIVABLE - SERANOVA (CONTINUED)
Accordingly, the Company recorded $8,362,000 of SeraNova receivable
impairment and other charges during the nine months ended September 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 remained outstanding, of which $1,028,000 was included in other
long-term liabilities.
The Company subsequently 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 $5,060,000 of additional charges associated
with the Note and certain other related issues during the three months ended
March 31, 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................. -- -- (896,000) (265,000) (1,161,000)
Non-cash items......................... (4,000,000) -- -- -- (4,000,000)
------------- ------------ ------------- ------------ ------------
Accrued costs as of September 30, 2003. $ -- $ -- $ 1,039,000 $ 146,000 $ 1,185,000
============= ============ ============= ============ ============
As of September 30, 2003, $1,185,000 of the liability remained
outstanding, of which $748,000 was included in other long-term liabilities. The
Company expects to pay out this liability through 2008.
- 12 -
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.
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.................... (89,000) -- (4,000) (93,000)
------------- ------------ ------------- ------------
Accrued costs as of September 30, 2003.... $ -- $ -- $ 79,000 $ 79,000
============= ============ ============ ============
The Company expects to pay out the remaining costs above within the next
three months.
- 13 -
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 group 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.
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.
- 14 -
NOTE 8 - SEGMENT DATA AND GEOGRAPHIC INFORMATION (CONTINUED)
Accordingly, the Company's operating results and financial position for its
continuing operations are presented in the following geographic segments for the
three and nine months ended September 30, 2003 and 2002.
UNITED STATES INDIA EUROPE JAPAN TOTAL
------------- ----- ------ ----- -----
THREE MONTHS ENDED SEPTEMBER 30, 2003
- -------------------------------------
Revenue....................... $ 24,288,000 $ 4,117,000 $ 1,677,000 $ 953,000 $ 31,035,000
Depreciation & amortization... 440,000 182,000 90,000 7,000 719,000 (1)
Operating income (loss)....... (312,000) 423,000 (5,000) 108,000 214,000 (2)
Total assets.................. 28,892,000 6,935,000 2,830,000 1,193,000 39,850,000
THREE MONTHS ENDED SEPTEMBER 30, 2002
- -------------------------------------
Revenue....................... $ 21,121,000 $ 3,348,000 $ 1,419,000 $ 780,000 $ 26,668,000
Depreciation & amortization... 433,000 118,000 48,000 16,000 615,000 (3)
Operating income (loss)....... 772,000 381,000 (389,000) (81,000) 683,000 (4)
Total assets.................. 28,791,000 6,997,000 1,817,000 1,577,000 39,182,000 (5)
NINE MONTHS ENDED SEPTEMBER 30, 2003
- ------------------------------------
Revenue....................... $ 67,498,000 $ 11,347,000 $ 4,742,000 $2,688,000 $ 86,275,000
Depreciation & amortization... 1,340,000 606,000 162,000 22,000 2,130,000 (6)
Operating income (loss)....... (6,331,000) 1,121,000 76,000 317,000 (4,817,000)(7)
NINE MONTHS ENDED SEPTEMBER 30, 2002
- ------------------------------------
Revenue....................... $ 57,859,000 $ 9,945,000 $ 4,448,000 $2,227,000 $ 74,479,000
Depreciation & amortization... 1,356,000 378,000 163,000 45,000 1,942,000 (8)
Operating income (loss)....... (7,263,000) 1,726,000 (930,000) (606,000) (7,073,000)(9)
- -------------
(1) Excludes $212,000 of depreciation and amortization included in cost of
sales.
(2) Includes $868,000 of proxy contest charges and $(107,000) of charges
related to the guarantee of SeraNova debt.
(3) Excludes $194,000 of depreciation and amortization included in cost of
sales.
(4) Includes $412,000 of proxy contest charges.
(5) Excludes $2,833,000 of assets held for sale.
(6) Excludes $947,000 of depreciation and amortization included in cost of
sales.
(7) Includes $5,060,000 of SeraNova receivable impairment and other
charges, $1,461,000 of proxy contest charges and $474,000 of charges
related to the guarantee of SeraNova debt.
(8) Excludes $639,000 of depreciation and amortization included in cost of
sales.
(9) Includes $8,362,000 of SeraNova receivable impairment and other
charges and $876,000 of proxy contest charges.
Included in the revenue line item above are application management and
support revenues of $10,803,000 and $6,734,000 for the three months ended
September 30, 2003 and 2002, respectively. In addition, application management
and support revenues for the nine months ended September 30, 2003 and 2002 were
$25,908,000 and $19,015,000, 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.
- 15 -
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 was demanding payment of $535,608
from the Company, plus interest accrued from April 1, 2002. Accordingly, the
Company recorded $581,000 in the provision for guarantee of SeraNova debt line
item in second quarter 2003 to cover this contingency. Subsequently, in the
third quarter 2003, the Company negotiated a settlement with Zions for a total
sum of $430,000, to be paid out in installments through January 2004. The
Company has recorded the reversal of the $151,000 excess provision, less related
legal costs of $44,000, in the provision for guarantee of SeraNova debt line
item in the third quarter 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 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.
- 16 -
NOTE 9 - CONTINGENCIES (CONTINUED)
Tax Contingency in India
The Company's Indian subsidiary has received assessments 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
assessments are 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 September 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
Since the second quarter 2002, the Company has continued to incur charges
related to the Proxy Contest. The Proxy Contest resulted directly from a
shareholder of the Company ("Mr. Pandey") launching a proxy contest to take
control of the Company's Board of Directors. 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 agreed to pay to Mr. Pandey an aggregate amount
of $750,000 in three equal installments over two years, commencing October 2003.
Accordingly, the Company has recorded a $750,000 provision for such liability in
the consolidated statement of operations during the three months ended September
30, 2003. Prior to the settlement, the Company incurred related additional
litigation expenses of $118,000 in the third quarter 2003. During the nine
months ended September 30, 2003, the Company incurred Proxy Contest charges of
$1,461,000.
- 17 -
NOTE 9 - CONTINGENCIES (CONTINUED)
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 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.
NOTE 10 - NEW ACCOUNTING PRONOUNCEMENTS
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS
No. 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
No. 150 requires that an issuer classify a financial instrument that is within
its scope as a liability (or an asset in some circumstances). The requirements
of this statement apply to issuers' classification and measurement of
freestanding financial instruments, including those that comprise more than one
option or forward contract. SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. The
Company's initial adoption did not have a material effect on the Company's
consolidated results of operations, consolidated financial position or
consolidated cash flows.
- 18 -
NOTE 10 - NEW ACCOUNTING PRONOUNCEMENTS (CONTINUED)
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities" ("FIN No. 46"). FIN No. 46 addresses whether
certain types of entities, referred to as variable interest entities ("VIE")
should be consolidated in a company's financial statements. A VIE is an entity
that either (1) has equity investors that lack certain essential characteristics
of a controlling financial interest (including the ability to control the
entity, the obligation to absorb the entity's expected losses and the right to
receive the entity's expected residual returns), or (2) lacks sufficient equity
to finance its own activities without financial support provided by other
entities, which in turn would be expected to absorb at least some of the
expected losses of the VIE. An entity should consolidate a VIE if it stands to
absorb a majority of the VIE's expected losses or to receive a majority of the
VIE's expected residual returns. In October 2003, the FASB issued a Final FASB
Staff Position deferring the effective date of FIN No. 46 for all public
entities until the first interim or annual period ending after December 15,
2003. As such, FIN No. 46 is effective for the Company as of March 31, 2004.
In November 2002, the Emerging Issues Task Force of the FASB reached a
consensus on EITF No. 00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables" ("EITF No. 00-21"). EITF No. 00-21 addresses how to account for
arrangements that may involve multiple revenue-generating activities. The
consensus guidance will be applicable to agreements entered into in quarters
beginning after June 15, 2003. The Company adopted EITF No. 00-21 effective July
1, 2003 and is applying it on a prospective basis. The Company's initial
adoption did not have a material effect on the Company's consolidated results of
operations, consolidated financial position or consolidated cash flows.
- 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 "Former 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 has received a total of
$350,000 from Soltius toward the note balance as of September 30, 2003.
The Consolidated Financial Statements of the Company have been reclassified
to reflect the Sale of the Former Subsidiaries to Soltius as of March 31, 2003.
Accordingly, the assets, liabilities, results of operations, and cash flows of
the Former 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
- 21 -
days. There can be no assurance that the Company's customers will continue to
enter into contracts with the Company or that existing contracts will not be
terminated. The Company provides its services either directly to end-user
organizations, or as a member of a consulting team assembled by another
information technology consulting firm. Where contractual provisions permit,
customers also are billed for reimbursement of expenses incurred by the Company
on the customers' behalf.
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/daily rate less the cost to the Company of a consultant on an
hourly/daily 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 nine
months ended September 30, 2003 and the year ended December 31, 2002, revenues
derived from projects under fixed price contracts represented 37% and 33%,
respectively, of the Company's total revenue. No single fixed price project was
material to the Company's business during the nine months ended September 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 nine months ended September 30, 2003 and the year ended
December 31, 2002, the Company's ten largest customers accounted for in the
aggregate, approximately 46% and 42% of its revenue, respectively. For the nine
months ended September 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 nine months ended September 30, 2003 and the
year ended December 31, 2002, 12% 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 the nine months ended September 30, 2003 and the year ended December
31, 2002, the Company derived the following percentages of total revenue from
projects in which the Company implemented, extended, maintained, managed or
supported software developed by SAP, PeopleSoft and Oracle:
PERCENTAGE OF REVENUE
----------------------------------------
NINE MONTHS ENDED YEAR ENDED
SEPTEMBER 30, 2003 DECEMBER 31, 2002
------------------ -----------------
SAP....................... 67% 62%
PeopleSoft................ 24% 22%
Oracle.................... 6% 9%
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, Accenture 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;
- 24 -
o the Company's reliance on continued relationships with SAP America,
Oracle and PeopleSoft, and the Company's present partnership status;
o the Company's substantial reliance on key customers and large
projects;
o the 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
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.
STRATEGIC TRANSACTIONS
The Company considers strategic transactions such as mergers and
acquisitions in the ordinary course. At the present time, the Company is not
actively considering any such transactions. The foregoing statement is made only
as of the date of this filing and should not be relied upon on any subsequent
date. While we may elect to update such information at some point in the future,
we specifically disclaim any obligation to do so, until such disclosure is
required under applicable securities laws.
- 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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------ ---------------------
2003 2002 2003 2002
------ ----- ----- -----
Revenue............................................ 100.0% 100.0% 100.0% 100.0%
Cost of sales...................................... 71.6 69.9 70.7 69.3
------ ----- ----- -----
Gross profit.................................. 28.4 30.1 29.3 30.7
Selling, general and administrative
expenses........................................ 23.0 23.7 24.3 25.2
Depreciation and amortization...................... 2.3 2.3 2.5 2.6
SeraNova receivable impairment and other charges... -- -- 5.9 11.2
Proxy contest charges.............................. 2.8 1.5 1.7 1.2
Provision for guarantee of SeraNova debt........... (0.4) -- 0.5 --
------ ----- ----- -----
Total operating expenses...................... 27.7 27.5 34.9 40.2
------ ----- ----- -----
Operating income (loss)....................... 0.7 2.6 (5.6) (9.5)
Interest income.................................... 0.2 0.0 0.1 0.0
Interest expense................................... (0.3) (0.4) (0.4) (0.4)
Other (expense) income............................. (0.1) (0.0) (0.3) 0.1
------ ----- ----- -----
Income (loss) from continuing operations before
income tax provision........................... 0.5 2.2 (6.2) (9.8)
Income tax provision............................... 0.4 0.7 0.4 0.7
------ ----- ----- -----
Income (loss) from continuing operations........... 0.1 % 1.5% (6.6)% (10.5)%
====== ===== ===== =====
Three months ended September 30, 2003 Compared to Three Months Ended
September 30, 2002
The following discussion compares the consolidated results from continuing
operations for the three months ended September 30, 2003 and the three months
ended September 30, 2002.
Revenue. Total revenue increased by 16.4%, or $4.4 million, from $26.7
million for the three months ended September 30, 2002, to $31.0 million for the
three months ended September 30, 2003. The increase was attributable primarily
to growth in revenue generated in the United States (an increase of $3.2
million), India (an increase of $770,000), Europe (an increase of $258,000) and
Japan (an increase of $173,000). 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.
- 26 -
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 19.2%, or $3.6 million, from $18.6 million
for the three months ended September 30, 2002, to $22.2 million for the three
months ended September 30, 2003. The Company's gross profit increased by 9.8%,
or $790,000, from $8.0 million for the three months ended September 30, 2002, to
$8.8 million for the three months ended September 30, 2003. The increase in cost
of sales and gross profit results from the increase in revenue. Gross margin
decreased to 28.4% for the three months ended September 30, 2003, from 30.1% for
the three months ended September 30, 2002. The decline in gross margin results
from general pricing pressures, volume discounts provided to certain of the
Company's largest customers and the impact of milestone timing on certain fixed
price engagements.
Selling, general and administrative expenses. Selling, general and
administrative expenses primarily consist of salaries, and related benefits
costs, occupancy costs, sales person compensation, travel and entertainment and
professional fees. Additionally, the Company created a new strategy and
solutions group in 2003. This group, which is comprised of a number of highly
skilled consultants, is responsible for the design and development of solutions
as well as supporting the sales organization by preparing and providing
technical presentations to customers. The costs of such group of consultants are
reported within the selling, general and administrative expense category.
Selling, general and administrative expenses increased by 12.7% or $806,000, to
$7.1 million for the three months ended September 30, 2003, from $6.3 million
for the three months ended September 30, 2002, but decreased as a percentage of
revenue to 23.0% from 23.7%, respectively. The increase in selling, general and
administrative expenses, in absolute dollars, was related primarily to the
creation of the new strategy and solutions group and discretionary sales and
marketing expenditures, which vary in proportion to changes in revenue. 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 $719,000 for the three months ended September 30, 2003, compared to
$615,000 for the three months ended September 30, 2002. The increase was
primarily due to depreciation on additional computers, equipment and software
placed in service since September 30, 2002.
Proxy contest charges. Since the second quarter 2002, the Company has
continued to incur charges related to the contested 2002 Annual Meeting of
Shareholders ("Proxy Contest"). The Proxy Contest resulted directly from a
shareholder of the Company ("Mr. Pandey") launching a proxy contest to take
control of the Company's Board of Directors. 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 agreed to pay to Mr. Pandey an aggregate amount
of $750,000 in three equal installments over two years, commencing October 2003.
Accordingly, the Company has recorded a $750,000 provision for such liability in
the consolidated statement of operations during the three months ended September
30, 2003. Prior to the settlement, the Company incurred related additional
litigation expenses of $118,000 in the third quarter 2003. During the
- 27 -
three months ended September 30, 2002, the Company incurred $412,000 in legal
fees and other charges related to 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 was demanding payment of $535,608 from the Company, plus interest
accrued from April 1, 2002. Accordingly, the Company recorded a $581,000
provision in second quarter 2003 to cover this contingency. Subsequently, in the
third quarter 2003, the Company negotiated a settlement with Zions for a total
sum of $430,000, to be paid out in installments through January 2004. The
Company has recorded the reversal of the $151,000 excess provision, less related
legal costs of $44,000, in the provision for guarantee of SeraNova debt line
item in the third quarter 2003.
Interest income. The Company earned $47,000 in interest income during the
three months ended September 30, 2003, compared with $4,000 during the three
months ended September 30, 2002. The interest income is related primarily to
certain interest-bearing bank accounts. The change results from a higher average
balance of invested cash during the three months ended September 30, 2003.
Interest expense. The Company incurred $91,000 and $97,000 in interest
expense during the three months ended September 30, 2003 and 2002, respectively,
related primarily to borrowings under its line of credit. Borrowings under the
line of credit were used primarily to fund operating activities and the charges
associated with the proxy contest.
Other (expense) income. Other (expense) income results primarily from
realized (losses) gains associated with changes in foreign currency exchange
rates. The Company reported other expense of $21,000 during the three months
ended September 30, 2003, compared with other expense of $9,000 during the three
months ended September 30, 2002.
Provision for income taxes. The Company's effective tax rate was 88.6% for
the three months ended September 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 September 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 $1.4 million
will be realized. The Company's effective rate was 31.1% for the three months
ended September 30, 2002.
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
- 28 -
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 September 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 assessments 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
assessments are 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 September 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.
Nine months ended September 30, 2003 Compared to Nine Months Ended
September 30, 2002
The following discussion compares the consolidated results from continuing
operations for the nine months ended September 30, 2003 and the nine months
ended September 30, 2002.
Revenue. Total revenue increased by 15.8%, or $11.8 million, from $74.5
million for the nine months ended September 30, 2002, to $86.3 million for the
nine months ended September 30, 2003. The increase was attributable primarily to
growth in revenue generated in the United States (an increase of $9.6 million),
India (an increase of $1.4 million), Japan (an increase of $461,000) and Europe
(an increase of $294,000). 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 18.3%, or $9.4
million, from $51.6 million for the nine months ended September 30, 2002, to
$61.0 million for the nine months ended September 30, 2003. The Company's gross
profit increased by 10.2%, or $2.3 million, from $22.9 million for nine months
ended September 30, 2002, to $25.2 million for the nine months ended September
30, 2003. The increase in cost of sales and gross profit results from the
increase in revenue. Gross margin decreased to 29.3% for the nine months ended
September 30, 2003, from 30.7% for nine months ended September 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 increased by 11.4% or $2.1 million, to $20.9 million for
the nine months ended September 30, 2003, from $18.8 million for nine months
ended September 30, 2002, but
- 29 -
decreased as a percentage of revenue to 24.3% from 25.2%, respectively. The
increase in selling, general and administrative expenses, in absolute dollars,
was related primarily to the creation of the new strategy and solutions group in
2003 as well as an increase in discretionary sales and marketing expenditures.
In early 2003, the Company created a new strategy and solutions group to focus
on the design and development of solutions as well as the support of the sales
organization by preparing and providing technical presentations to customers. In
2003, the Company also 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. 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 $2.1 million for the nine months ended September 30, 2003, compared
to $1.9 million for nine months ended September 30, 2002. The increase was
primarily due to depreciation on additional computers, equipment and software
placed in service since September 30, 2002.
SeraNova receivable impairment and other charges. During the nine months
ended September 30, 2002, the Company recorded approximately $8.4 million in
special charges associated with the note receivable from SeraNova (the "Note"),
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 nine months ended September 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 nine months ended September 30, 2003, the Company recorded $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, $321,000 related to other
assets, $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. Since the second quarter 2002, the Company has
continued to incur charges related to the Proxy Contest. The Proxy Contest
resulted directly from Mr. Pandey launching a proxy contest to take control of
the Company's Board of Directors. 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
- 30 -
agreement the Company agreed to pay to Mr. Pandey an aggregate amount of
$750,000 in three equal installments over two years, commencing October 2003.
Accordingly, the Company has recorded a $750,000 provision for such liability in
the consolidated statement of operations during the nine months ended September
30, 2003. Prior to the settlement, the Company incurred related additional
litigation expenses of $711,000 during the nine months ended September 30, 2003.
During the nine months ended September 30, 2002, the Company incurred $876,000
in legal fees and other charges related to the Proxy Contest.
Provision for Guarantee of SeraNova debt. By letter dated May 12, 2003,
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 was demanding payment of
$535,608 from the Company, plus interest accrued from April 1, 2002.
Accordingly, the Company recorded $581,000 in the provision for guarantee of
SeraNova debt line item in second quarter 2003 to cover this contingency.
Subsequently, in the third quarter 2003, the Company negotiated a settlement
with Zions for a total sum of $430,000, to be paid out in installments through
January 2004. The Company has recorded the reversal of the $151,000 excess
provision, less related legal costs of $44,000, in the provision for guarantee
of SeraNova debt line item in the third quarter 2003.
Interest income. The Company earned $72,000 in interest income during the
nine months ended September 30, 2003, compared with $22,000 during the nine
months ended September 30, 2002. The interest income is related primarily to
certain interest-bearing bank accounts. The change results from a higher average
balance of invested cash during the nine months ended September 30, 2003.
Interest expense. The Company incurred $323,000 and $297,000 in interest
expense during the nine months ended September 30, 2003 and 2002, respectively,
related primarily to borrowings under its line of credit. Borrowings under the
line of credit were used primarily 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 nine months ended September 30, 2003.
Other (expense) income. Other (expense) income results primarily from
realized (losses) gains associated with changes in foreign currency exchange
rates. The Company reported other expense of $254,000 during the nine months
ended September 30, 2003, compared with other income of $48,000 during the nine
months ended September 30, 2002.
Provision for income taxes. Despite an operating loss, a provision for
income taxes of was required for the nine months ended September 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 September 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 $1.4 million
will be realized.
- 31 -
In 1996, the Company elected a five year tax holiday in India, in
accordance with a local tax incentive program whereby no income tax will be due
in such period. Such tax holiday was extended an additional five years in 1999.
Effective April 1, 2000 pursuant to changes introduced by the Indian Finance
Act, 2000, the tax holiday previously granted is no longer available and has
been replaced in the form of a tax deduction incentive. The impact of this
change is not expected to be material to the consolidated financial statements
of the Company. Effective April 1, 2002, the tax deduction incentive for income
from the export of software and related services is restricted to 90% of such
income. Further, domestic revenue from software and related services is taxable
in India. 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 nine months
ended September 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 assessments 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
assessments are 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 September 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
- 32 -
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 manager with an
equivalent position, who reports directly to the Chief Executive Officer (CEO).
Currently, the CEO is fulfilling the requirements of this position in the US.
The CEO has been identified as the Chief Operating Decision Maker (CODM) because
he has final authority over resource allocation decisions and performance
assessment. The CODM regularly receives certain discrete financial information
about the geographical operating segments, including primarily revenue and
operating income, to evaluate segment performance.
Three months ended September 30, 2003 Compared to Three months Ended
September 30, 2002
The following discussion compares the segment results for continuing
operations for the three months ended September 30, 2003 and the three months
ended September 30, 2002.
Revenue. The following table displays revenues by reportable segment (in
thousands).
THREE MONTHS ENDED SEPTEMBER 30,
------------------------------------------------------
2003 2002
------------------------ ------------------------
PERCENTAGE PERCENTAGE
DOLLARS OF TOTAL DOLLARS OF TOTAL
------- ---------- ------- ----------
United States........ $ 24,288 78.3% $ 21,121 79.2%
India................ 4,117 13.3 3,348 12.6
Europe............... 1,677 5.4 1,419 5.3
Japan................ 953 3.0 780 2.9
--------- ------ --------- ------
Total................ $ 31,035 100.0% $ 26,668 100.0%
========= ====== ========= ======
US revenue increased by 15.0%, or $3.2 million, from $21.1 million for the
three months ended September 30, 2002, to $24.3 million for the three months
ended September 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 23.0%, or $769,000, from $3.3 million for the
three months ended September 30, 2002, to $4.1 million for the three months
ended September 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 18.2%, or $258,000, from $1.4 million for the
three months ended September 30, 2002, to $1.7 million for the three months
ended September 30, 2003. The
- 33 -
increase was attributable primarily to the Company's operations in Denmark (an
increase of $471,000), which was slightly offset by a decrease of revenue in the
Company's operations in the United Kingdom (a decrease of $200,000) and Sweden
(a decrease of $13,000). 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 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 22.2% or $173,000, from $780,000 for the three
months ended September 30, 2002, to $953,000 for the three months ended
September 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 SEPTEMBER 30,
--------------------------------
2003 2002
---------- ----------
United States...................... $ (312) $ 772
India.............................. 423 381
Europe............................. (5) (389)
Japan.............................. 108 (81)
---------- ---------
Total.............................. $ 214 $ 683
========== =========
US operating performance declined by $1.1 million, from operating income of
$772,000 for the three months ended September 30, 2002, to an operating loss of
$312,000 for the three months ended September 30, 2003. The decline in operating
performance was attributable to the increase in selling, general and
administrative expenses and Proxy Contest related charges incurred during the
three months ended September 30, 2003. The increase in selling, general and
administrative expenses related primarily to discretionary sales and marketing
expenditures, which vary in proportion to changes in revenue.
India operating income increased by $42,000, from $381,000 for the three
months ended September 30, 2002, to $423,000 for the three months ended
September 30, 2003. The increase was attributable primarily to an increase in
revenue.
Europe operating performance improved by $384,000, from an operating loss
of $389,000 for the three months ended September 30, 2002, to an operating loss
of $5,000 for the three months ended September 30, 2003. The improvement was
attributable primarily to an improvement in the operating performance of Sweden
(an improvement of $239,000), Denmark (an improvement of $112,000) and the
United Kingdom (an improvement of $33,000).
- 34 -
Japan operating performance improved by $189,000, from an operating loss of
$81,000 for the three months ended September 30, 2002, to operating income of
$108,000 for the three months ended September 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.
Nine months ended September 30, 2003 Compared to Nine months Ended
September 30, 2002
The following discussion compares the segment results for continuing
operations for the nine months ended September 30, 2003 and the nine months
ended September 30, 2002.
Revenue. The following table displays revenues by reportable segment (in
thousands).
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------------------------
2003 2002
------------------------ ------------------------
PERCENTAGE PERCENTAGE
DOLLARS OF TOTAL DOLLARS OF TOTAL
------- ---------- -------- ----------
United States..... $ 67,498 78.2% $ 57,859 77.7%
India............. 11,347 13.2 9,945 13.4
Europe............ 4,742 5.5 4,448 6.0
Japan............. 2,688 3.1 2,227 2.9
--------- ------ -------- -----
Total............. $ 86,275 100.0% $ 74,479 100.0%
========= ====== ======== ======
US revenue increased by 16.7%, or $9.6 million, from $57.9 million for the
nine months ended September 30, 2002, to $67.5 million for the nine months ended
September 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 14.1%, or $1.4 million, from $9.9 million for
the nine months ended September 30, 2002, to $11.3 million for the nine months
ended September 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 6.6%, or $294,000, from $4.4 million for the
nine months ended September 30, 2002, to $4.7 million for the nine months ended
September 30, 2003. The Company's operations in Denmark increased by $1.0
million, while the revenue in the United Kingdom and Sweden decreased by
$469,000 and $245,000, respectively. The improvement in Denmark was attributable
primarily to a general increase in demand for local SAP services,
- 35 -
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. Accordingly, the Company transitioned its operations in Sweden to
Denmark as of January 1, 2003.
Japan revenue increased by 20.7% or $461,000, from $2.2 million for the
nine months ended September 30, 2002, to $2.7 million for the nine months ended
September 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).
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2003 2002
--------- ---------
United States...................... $ (6,331) $ (7,263)
India.............................. 1,121 1,726
Europe............................ 76 (930)
Japan.............................. 317 (606)
--------- ---------
Total.............................. $ (4,817) $ (7,073)
========= =========
US operating performance improved by $932,000, from an operating loss of
$7.3 million for the nine months ended September 30, 2002, to an operating loss
of $6.3 million for the nine months ended September 30, 2003. The $7.3 million
operating loss was attributable primarily to the $8.4 million of SeraNova
receivable impairment and other charges and $876,000 of proxy contest charges
recorded during the nine months ended September 30, 2002. The $6.3 million
operating loss was attributable primarily to the $5.1 million of SeraNova
receivable impairment and other charges, the $1.5 million of proxy contest
charges and the $474,000 guarantee of SeraNova debt charge recorded during the
nine months ended September 30, 2003.
India operating income decreased by $605,000, from $1.7 million for the
nine months ended September 30, 2002, to $1.1 million for the nine months ended
September 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 $1.0 million, from an operating
loss of $930,000 for the nine months ended September 30, 2002, to operating
income of $76,000 for the nine months ended September 30, 2003. The improvement
was attributable primarily to an improvement in the operating performance of
Denmark (an improvement of $478,000), Sweden (an improvement of $463,000) and
the UK (an improvement of $65,000).
Japan operating performance improved by $923,000, from an operating loss of
$606,000 for the nine months ended September 30, 2002, to operating income of
$317,000 for the nine
- 36 -
months ended September 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 $2.2 million at September 30,
2003 and $1.2 million at December 31, 2002. The Company had working capital of
$7.7 million at September 30, 2003 and $13.1 million at December 31, 2002. The
decrease in working capital resulted primarily from the sale of the Former
Subsidiaries and the write-down of the Note during the nine months ended
September 30, 2003.
Cash provided by operating activities of continuing operations was $2.9
million for the nine months ended September 30, 2003, resulting primarily from a
decrease in accounts receivable of $1.4 million and increases in accrued payroll
and related taxes of $2.5 million and accrued expenses and other liabilities of
$1.3 million. These amounts were partially offset by the net loss of $7.8
million (less the non-cash charges related to the SeraNova receivable impairment
and other charges of $5.1 million and depreciation and amortization of $3.1
million) and increases in unbilled services of $3.4 million and other current
assets of $1.0 million and a decrease in accounts payable of $1.3 million. The
changes in operating assets and liabilities result primarily from timing
differences. Cash provided by operating activities of continuing operations for
the nine months ended September 30, 2002 was $1.2 million.
The Company invested $1.8 million and $1.0 million in computer equipment,
internal-use computer software and office furniture and fixtures during the nine
months ended September 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. In July 2003, the credit facility was
extended until May 31, 2006. The credit facility is currently comprised of a
revolving line of credit pursuant to which the Company could borrow up to $15.0
million either at the Bank's prime rate per annum or the Euro Rate plus 1.75% to
2.5% based upon the Company's ratio of debt to earnings before interest, taxes,
depreciation and amortization ("EBITDA"). The credit facility is collateralized
by substantially all of the assets of the Company's United States based
operations. The maximum borrowing availability under the line of credit is based
upon a percentage of eligible billed and unbilled accounts receivable, as
defined.
As 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 shareholders' equity and unconsolidated shareholders' equity
- 37 -
(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 shareholders' equity and unconsolidated shareholders'
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. In October 2003, the Company
executed with the Bank an amendment to the credit agreement. The terms of the
amendment included, among other things, (1) a waiver of the covenant default
existing as of June 30, 2003, (2) a modification to the definitions of total
shareholders' equity and unconsolidated shareholders' equity (for purposes of
computing related covenant compliance) and a modification to the computation of
minimum EBITDA to exclude the guarantee of SeraNova debt charge of $581,000 for
the quarter ended June 30, 2003 only, and a modification to the definitions of
total shareholders' equity and unconsolidated shareholders' equity (for purposes
of computing related covenant compliance) and a modification to the computation
of minimum EBITDA to exclude Proxy Contest charges of $750,000 for the quarter
ended September 30, 2003 only. As of September 30, 2003, the Company had
outstanding borrowings under the credit facility of $6.2 million. The Company
estimates undrawn availability under the credit facility to be $6.1 million as
of September 30, 2003. As of December 31, 2002, the Company had outstanding
borrowings under the credit facility of $6.1 million. The Company was in
compliance with all covenants as of September 30, 2003.
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 compensatory damages in excess of $5.5 million and
punitive damages in the amount of $10.0 million. After completion of the
discovery process, the Company moved for summary judgment. On April 17, 2003,
the Court granted partial summary judgment. On July 11, 2003, the Court
dismissed the defendant's counterclaims seeking compensatory and punitive
damages. On August 8, 2003, SeraNova and Silverline Technologies, Inc. filed for
Chapter 7 Bankruptcy, thereby staying this action as to these defendants. There
has been no notice that Silverline Technologies Limited is insolvent. Shortly
thereafter, counsel for defendants asked the Court and was granted permission to
be relieved as counsel. On September 22, 2003, the Company moved for entry of
default against Silverline.
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.
The Company subsequently 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 three
months ended March 31, 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................. -- -- (896,000) (265,000) (1,161,000)
Non-cash items......................... (4,000,000) -- -- -- (4,000,000)
------------- ------------ ------------- ------------ ------------
Accrued costs as of September 30, 2003. $ -- $ -- $ 1,039,000 $ 146,000 $ 1,185,000
============= ============ ============= ============ ============
As of September 30, 2003, $1.2 million of the liability remained
outstanding, of which $748,000 was 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 September 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 $ 6,160,000 $6,160,000 $ -- $ -- $ --
Capital Lease Obligations 77,000 8,000 69,000 -- --
Operating Lease Obligations 7,872,000 2,078,000 4,638,000 1,156,000 --
Other Liabilities 2,215,000 967,000 939,000 309,000 --
----------- ---------- ---------- ---------- ---------
Total Contractual Obligations $16,324,000 $9,213,000 $5,646,000 $1,465,000 $ --
=========== ========== ========== ========== =========
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 September 30, 2003, the Company had outstanding borrowings under
the credit facility of $6.2 million. The Company estimates undrawn availability
under the credit facility to be $6.1 million as of September 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. In October 2003, the Company
executed with the Bank an amendment to
- 41 -
the credit agreement. The terms of the amendment included, among other things,
(1) a waiver of the covenant default existing as of June 30, 2003, (2) a
modification to the definitions of total shareholders' equity and unconsolidated
shareholders' equity (for purposes of computing related covenant compliance) and
a modification to the computation of minimum EBITDA to exclude the guarantee of
SeraNova debt charge of $581,000 for the quarter ended June 30, 2003 only, and a
modification to the definitions of total shareholders' equity and unconsolidated
shareholders' equity (for purposes of computing related covenant compliance) and
a modification to the computation of minimum EBITDA to exclude Proxy Contest
charges of $750,000 for the quarter ended September 30, 2003 only. The Company
was in compliance with all covenants as of September 30, 2003.
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
- 42 -
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
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. All defendants have answered the
complaint and discovery has commenced. On August 8, 2003, SeraNova and
Silverline Technologies, Inc. filed for Chapter 7 Bankruptcy, thereby staying
this action as to these defendants. There has been no notice that Silverline
Technologies Limited is insolvent. Court-ordered mediation is in the process of
being scheduled.
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
$125,000 during the nine months ended September 30, 2003. The Company has
accrued the remaining balance of $35,000 in the consolidated balance sheet as of
September 30, 2003.
By letter dated May 12, 2003, 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 was demanding payment of
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$535,608 from the Company, plus interest accrued from April 1, 2002.
Accordingly, the Company recorded $581,000 in the provision for guarantee of
SeraNova debt line item in second quarter 2003 to cover this contingency.
Subsequently, in the third quarter 2003, the Company negotiated a settlement
with Zions for a total sum of $430,000, to be paid out in installments through
January 2004. The Company has recorded the reversal of the $151,000 excess
provision, less related legal costs of $44,000, in the provision for guarantee
of SeraNova debt line item in the third quarter 2003.
NEW ACCOUNTING PRONOUNCEMENTS
In May 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 150, "Accounting for
Certain Financial Instruments with Characteristics of Both Liabilities and
Equity." SFAS No. 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. SFAS No. 150 requires that an issuer classify a financial instrument
that is within its scope as a liability (or an asset in some circumstances). The
requirements of this statement apply to issuers' classification and measurement
of freestanding financial instruments, including those that comprise more than
one option or forward contract. SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. The Company's initial adoption did not have a material effect on the
Company's consolidated results of operations, consolidated financial position or
consolidated cash flows.
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities" ("FIN No. 46"). FIN No. 46 addresses whether
certain types of entities, referred to as variable interest entities ("VIE")
should be consolidated in a company's financial statements. A VIE is an entity
that either (1) has equity investors that lack certain essential characteristics
of a controlling financial interest (including the ability to control the
entity, the obligation to absorb the entity's expected losses and the right to
receive the entity's expected residual returns), or (2) lacks sufficient equity
to finance its own activities without financial support provided by other
entities, which in turn would be expected to absorb at least some of the
expected losses of the VIE. An entity should consolidate a VIE if it stands to
absorb a majority of the VIE's expected losses or to receive a majority of the
VIE's expected residual returns. In October 2003, the FASB issued a Final FASB
Staff Position deferring the effective date of FIN No. 46 for all public
entities until the first interim or annual period ending after December 15,
2003. As such, FIN No. 46 is effective for the Company as of March 31, 2004.
In November 2002, the Emerging Issues Task Force of the FASB reached a
consensus on EITF No. 00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables" ("EITF No. 00-21"). EITF No. 00-21 addresses how to account for
arrangements that may involve multiple revenue-generating activities. The
consensus guidance will be applicable to agreements entered into in quarters
beginning after June 15, 2003. The Company adopted EITF No. 00-21 effective July
1, 2003 and is applying it on a prospective basis. The Company's initial
adoption did not have a material effect on the Company's consolidated results of
operations, consolidated financial position or consolidated cash flows.
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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 September 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 September 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 September 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 August 16, 2001, the Company filed a complaint in the Superior Court of
New Jersey, Middlesex County, against SeraNova, Inc., and Silverline
Technologies Limited and Silverline Technologies, Inc. (collectively,
"Silverline"), 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 compensatory damages in
excess of $5,500,000 and punitive damages in the amount of $10,000,000. After
completion of the discovery process, the Company moved for summary judgment. On
April 17, 2003, the Court granted partial summary judgment. On July 11, 2003,
the Court dismissed the defendant's counterclaims seeking compensatory and
punitive damages. On August 8, 2003, SeraNova and Silverline Technologies, Inc.
filed for Chapter 7 Bankruptcy, thereby staying this action as to these
defendants. There has been no notice that Silverline Technologies Limited is
insolvent. Shortly thereafter, counsel for defendants asked the Court and was
granted permission to be relieved as counsel. On September 22, 2003, the Company
moved for entry of default against Silverline Technologies Limited.
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, sought damages in excess of
$400,000, based on allegations that Mr. Pandey breached certain terms and
conditions of a separation agreement he entered into with the Company. Mr.
Pandey 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 the Company's motion for attorney's fees was
unopposed. 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 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
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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 2002 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. 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 alleged, among other things, that the defendants
violated federal securities laws in connection with the Company's 2002 proxy
contest. The defendants 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. All defendants have answered the
complaint and discovery has commenced. On August 8, 2003, SeraNova and
Silverline Technologies, Inc. filed for Chapter 7 Bankruptcy, thereby staying
this action as to these defendants. There has been no notice that Silverline
Technologies Limited is insolvent. Court-ordered mediation is in the process of
being scheduled.
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
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Company in 2000, was delinquent on a loan made by Zions and guaranteed by the
Company. Zions was demanding payment of $535,608 from the Company, plus interest
accrued from April 1, 2002. Accordingly, the Company recorded a $581,000
provision in second quarter 2003 to cover this contingency. Subsequently, in the
third quarter 2003, the Company negotiated a settlement with Zions for a total
sum of $430,000, to be paid out in installments through January 2004. The
Company has recorded the reversal of the $151,000 excess provision, less related
legal costs of $44,000, in the provision for guarantee of SeraNova debt line
item in the third quarter 2003.
There is no other material litigation pending to which the Company is a
party or to which any of its property is subject.
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 shareholders' equity and
unconsolidated shareholders' 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. In October 2003, the Company
executed with the Bank an amendment to the credit agreement. The terms of the
amendment included, among other things, (1) a waiver of the covenant default
existing as of June 30, 2003, (2) a modification to the definitions of total
shareholders' equity and unconsolidated shareholders' equity (for purposes of
computing related covenant compliance) and a modification to the computation of
minimum EBITDA to exclude the guarantee of SeraNova debt charge of $581,000 for
the quarter ended June 30, 2003 only, and a modification to the definitions of
total shareholders' equity and unconsolidated shareholders' equity (for purposes
of computing related covenant compliance) and a modification to the computation
of minimum EBITDA to exclude Proxy Contest charges of $750,000 for the quarter
ended September 30, 2003 only.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Shareholders of the Company was held on October 14,
2003.
There were present at the meeting in person or by proxy shareholders
holding an aggregate of 13,522,706 shares of Common Stock. The results of the
vote taken at such meeting with respect to each nominee for Director were as
follows:
Common Stock Nominees For Withheld
--------------------- --- --------
Nagarjun Valluripalli 13,419,239 103,467
Klaus P. Besier 13,346,618 176,088
Dennis McIntosh 13,473,505 49,201
Alexander Graham Wilson 13,486,006 36,700
Nick Di Iorio 13,425,005 97,701
Ashok Pandey 13,043,397 479,309
In addition, a vote was taken on the proposal to ratify the appointment of
Deloitte & Touche LLP as the independent auditors of the Company for the fiscal
year ending December 31, 2003. Of the shares present at the meeting in person or
by proxy, 13,514,366 shares of Common Stock were voted in favor of such
proposal, 6,690 shares of Common Stock were voted against such proposal and
1,650 shares of Common Stock abstained from voting.
ITEM 5. OTHER INFORMATION
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.
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 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,
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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.
Nagarjun Valluripalli, the Chairman of the Board, President, Chief
Executive Officer and a Director of the Company is an owner (the "Owner") of
real estate located at 5-9-22, Secretariat Road in Hyderabad, India. On October
2, 2003, Intelligroup Asia Private, Ltd., a 99.8% owned and wholly-controlled
subsidiary of the Company and the Owner executed a memorandum of understanding
(the "MOA") relating to a proposed lease whereby the Owner would lease the 5th
and 6th floors of the property to the Company for certain of the Company's India
operations. The MOA provides for, among other things, a minimum lease period of
three years with a renewal option for an additional three years and monthly
payments of approximately $45,500 per month. A deposit in the amount of
approximately $326,087 was paid to the Owner in October 2003, with an additional
deposit of approximately $356,522 to be paid to the Owner in December 2003.
Prior to the execution of the MOA, the Company's Board of Directors determined
that the terms and conditions set forth in the MOA were no less favorable to the
Company than could be obtained from unrelated third parties.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
10.1 Fourth Amendment to Loan Documents and Waiver Agreement dated
October 22, 2003, between the Company, Empower, Inc. and PNC
Bank, National Association.
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.
32.1 Certification pursuant to 18 U.S.C Section 1350.
32.2 Certification pursuant to 18 U.S.C Section 1350.
(b) Reports on Form 8-K.
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.
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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 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.
On August 13, 2003, the Company furnished a Form 8-K under Item 9,
containing a copy of its earnings release for the period ending June
30, 2003 (including financial statements) pursuant to Item 12 (Results
of Operations and Financial Condition).
On August 20, 2003, the Company filed a Form 8-K, with the Securities
and Exchange Commission to report that the Company had scheduled its
Annual Meeting of Shareholders for Tuesday, October 14, 2003.
On October 28, 2003, the Company furnished a Form 8-K under Item 12,
containing a copy of its earnings release for the period ending
September 30, 2003 (including financial statements).
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Intelligroup, Inc.
DATE: November 14, 2003 By: /s/ Nagarjun Valluripalli
-----------------------------------------
Nagarjun Valluripalli,
Chairman of the Board, President and
Chief Executive Officer
(Principal Executive Officer)
DATE: November 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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