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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002 COMMISSION FILE NUMBER 0-19771
DATA SYSTEMS & SOFTWARE INC.
(Exact name of registrant as specified in charter)
DELAWARE 22-2786081
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
200 ROUTE 17, MAHWAH, NEW JERSEY 07430
(Address of principal executive offices) (Zip code)
(201) 529-2026
Registrant's telephone number, including area code
Indicate by check mark 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.
|X| Yes |_| No
Number of shares outstanding of the registrant's common stock, as of November
14, 2002: 7,341,363
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DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
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TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Consolidated Financial Statements
Consolidated Balance Sheets
as of December 31, 2001 and September 30, 2002..................................... 1
Consolidated Statements of Operations
for the three and nine month periods ended September 30, 2001 and 2002............. 2
Consolidated Statement of Changes in Shareholders' Equity
for the nine month period ended September 30, 2002................................. 3
Consolidated Statements of Cash Flows
for the nine month periods ended September 30, 2001 and 2002....................... 4
Notes to Consolidated Financial Statements................................................ 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................................... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................................. 18
Item 4. Controls and Procedures..................................................................... 18
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................................... 19
SIGNATURES ................................................................................... 20
CERTIFICATIONS ................................................................................... 21
Exhibits ................................................................................... 23
Certain statements contained in this report are forward-looking in nature. These
statements are generally identified by the inclusion of phrases such as "we
expect", "we anticipate", "we believe", "we estimate" and other phrases of
similar meaning. Whether such statements ultimately prove to be accurate depends
upon a variety of factors that may affect our business and operations. Many of
these factors are described in our most recent Annual Report on Form 10-K as
filed with Securities and Exchange Commission.
PART I FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share data)
AS OF AS OF
DECEMBER 31, SEPTEMBER
ASSETS 2001 30, 2002
-------------- --------------
(unaudited)
Current assets:
Cash and cash equivalents ......................................... $ 4,025 $ 1,634
Short-term interest bearing bank deposits and debt securities ..... 1,828 473
Restricted cash ................................................... 317 7,159
Trade accounts receivable, net .................................... 10,197 8,585
Inventory ......................................................... 658 3,225
Other current assets .............................................. 1,858 1,048
-------- --------
Total current assets .......................................... 18,883 22,124
Investments ............................................................ 90 90
Property and equipment, net ............................................ 2,296 2,041
Goodwill, net of accumulated amortization of $2,677 at December 31, 2001
and $576 at September 30, 2002 ....................................... 7,737 4,929
Other intangible assets, net ........................................... 909 421
Long-term deposits ..................................................... 6,000 --
Other assets ........................................................... 676 584
Prepaid employee termination benefits .................................. 2,653 2,228
-------- --------
Total assets .................................................. $ 39,244 $ 32,417
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term debt and current maturities of long-term debt,
net of discount of $381 at September 30, 2002 ................. $ 2,499 $ 9,390
Trade accounts payable ............................................ 4,010 5,235
Accrued payroll, payroll taxes and social benefits ................ 2,193 1,765
Other current liabilities ......................................... 3,372 3,375
-------- --------
Total current liabilities ..................................... 12,074 19,765
-------- --------
Long-term liabilities:
Long-term debt .................................................... 6,182 595
Other liabilities ................................................. 285 328
Liability for employee termination benefits ....................... 3,811 3,395
-------- --------
Total long-term liabilities ................................ 10,278 4,318
-------- --------
Minority interests ..................................................... 2,530 1,630
-------- --------
Shareholders' equity:
Common stock - $.01 par value per share:
Authorized - 20,000,000 shares; Issued - 8,161,867 shares ..... 82 82
Additional paid-in capital ........................................ 36,981 37,690
Warrants .......................................................... 114 114
Deferred compensation ............................................. (14) (9)
Accumulated deficit ............................................... (18,643) (27,015)
Treasury stock, at cost - 808,704 shares .......................... (3,860) (3,860)
Shareholder's note ............................................... (298) (298)
-------- --------
Total shareholders' equity .................................... 14,362 6,704
-------- --------
Total liabilities and shareholders' equity .................... $ 39,244 $ 32,417
======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
- 1 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(in thousands, except per share data)
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ -----------------------------
2001 2002 2001 2002
------------- --------------- -------------- -------------
Sales:
Products ............................... $ 25,436 $ 24,868 $ 7,235 $ 7,207
Services ............................... 10,721 11,992 3,124 4,062
-------- -------- -------- --------
36,157 36,860 10,359 11,269
-------- -------- -------- --------
Cost of sales:
Products ............................... 20,446 19,749 5,753 5,698
Services ............................... 8,007 9,178 2,409 3,208
-------- -------- -------- --------
28,453 28,927 8,162 8,906
-------- -------- -------- --------
Gross profit ........................... 7,704 7,933 2,197 2,363
Research and development expenses ........... 2,216 1,266 863 256
Selling, general and administrative expenses 12,628 12,675 4,242 3,923
Impairment of goodwill ...................... -- 2,760 -- 2,760
-------- -------- -------- --------
Operating loss ......................... (7,140) (8,768) (2,908) (4,576)
Interest income ............................. 917 203 271 57
Interest expense ............................ (361) (743) (94) (450)
Other income, net ........................... 26 148 31 56
Minority interests .......................... -- 852 -- 649
-------- -------- -------- --------
Loss before provision for income taxes . (6,558) (8,308) (2,700) (4,264)
Provision (benefit) for income taxes ........ 18 64 (94) 7
-------- -------- -------- --------
Net loss ............................... $ (6,576) $ (8,372) $ (2,606) $ (4,271)
======== ======== ======== ========
Basic and diluted net loss per share:
Net loss per share ..................... $ (0.95) $ (1.14) $ (0.37) $ (0.58)
======== ======== ======== ========
Weighted average number of shares
outstanding - basic and diluted 6,943 7,353 6,950 7,353
======== ======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
- 2 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (unaudited)
Nine Months Ended September 30, 2002
(in thousands)
Additional
Number Common Paid-In Deferred Treasury Shareholder's Accumulated
of Shares Stock Capital Compensation Warrants Stock Note Deficit Total
-------------------------------------------------------------------------------------------------------
Balances as of
December 31, 2001 8,162 $ 82 $ 36,981 $ (14) $ 114 $ (3,860) $ (298) $(18,643) $ 14,362
Grant and
recognition of
stock option
compensation ..... -- -- 17 5 -- -- -- -- 22
Value of 10%
convertible note
allocated to
beneficial
conversion
feature and
related warrants . -- -- 692 -- -- -- -- -- 692
Net loss ........... -- -- -- -- -- -- -- (8,372) (8,372)
-------------------------------------------------------------------------------------------------
Balances as of
September 30,
2002 8,162 $ 82 $ 37,690 $ (9) $ 114 $ (3,860) $ (298) $(27,015) $ 6,704
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The accompanying notes are an integral part of these
consolidated financial statements.
- 3 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(dollars in thousands)
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------
2001 2002
---- ----
Cash flows used in operating activities:
Net loss .......................................................................... $ (6,576) $ (8,372)
Adjustments to reconcile net loss to net cash provided by (used in) operating
activities:
Depreciation and amortization ..................................................... 986 938
Allowance for doubtful accounts ................................................... (17) --
Stock option compensation ......................................................... -- 22
Accretion of discount on convertible note and amortization of related costs ....... -- 355
Impairment of goodwill and acquired software ...................................... -- 3,000
Minority interest ................................................................. -- (852)
Write-off of minority interest balance ............................................ -- (40)
Unrealized gain on debt securities ................................................ -- (10)
Deferred income taxes ............................................................. -- 7
Increase (decrease) in liability for employee termination benefits ................ 354 (416)
Exchange adjustment on long-term debt ............................................. -- (29)
Loss on disposition of property and equipment ..................................... 32 15
Settlement of payable to contract manufacturer...................................... -- (189)
Write-off of inventory ............................................................ 60 --
Receipt of investments for services rendered ...................................... (130) --
Change in operating assets and liabilities:
Funding of employee termination benefits ...................................... (100) 425
Restricted cash ............................................................... (7) (842)
Decrease (increase) in accounts receivable and other current assets ........... (289) 2,542
Increase in inventory ......................................................... (547) (2,567)
Decrease in other assets ...................................................... 61 105
Increase (decrease) in accounts payable and other liabilities ................. (191) 957
-------- --------
Net cash used in operating activities ......................................... (6,364) (4,951)
-------- --------
Cash flows provided by (used in) investing activities:
Short-term bank deposits, net ..................................................... 994 --
Proceeds from sale and maturity of debt securities ................................ 1,081 1,519
Investment in debt securities ..................................................... (2,810) (154)
Acquisitions of property and equipment ............................................ (774) (344)
Proceeds from sale of property and equipment ...................................... 23 --
Acquisition of intangible assets .................................................. (7) (8)
-------- --------
Net cash provided by (used in) investing activities ........................... (1,493) 1,013
-------- --------
Cash flows provided by (used in) financing activities:
Short-term debt, net .............................................................. 606 (863)
Proceeds from issuance of convertible note ........................................ -- 2,000
Borrowings of long-term debt ...................................................... -- 646
Repayments of long-term debt ...................................................... (19) (69)
Convertible note issuance costs ................................................... -- (167)
Proceeds from stock options exercises ............................................. 231 --
Purchase of treasury stock ........................................................ (907) --
-------- --------
Net cash (used in) provided by financing activities .......................... (89) 1,547
-------- --------
Net decrease in cash and cash equivalents .............................................. (7,946) (2,391)
Cash and cash equivalents at beginning of period ....................................... 10,877 4,025
-------- --------
Cash and cash equivalents at end of period ............................................. $ 2,931 $ 1,634
======== ========
Supplemental cash flow information:
Cash paid during period for interest .............................................. $ 339 $ 332
======== ========
Cash paid during period for income taxes .......................................... $ 463 $ 92
======== ========
Non-cash investing and financing activities:
Issuance of deferred compensation ................................................ $ 90
======== ========
Accounts payable incurred in acquisition of fixed assets ......................... $ 50
========
Value of beneficial conversion feature and related warrants on issuance of
convertible note ............................................................ $ 692
========
Adjustment of goodwill and intangible assets ..................................... $ 48
========
Increase in deferred tax liability associated with adjustment of intangible assets $ 17
========
The accompanying notes are an integral part of these
consolidated financial statements.
- 4 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(dollars in thousands, except per share data)
NOTE 1: BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Data
Systems & Software Inc. and subsidiaries (the "Company") have been prepared in
accordance with accounting principles generally accepted in the United States of
America for interim financial information and with the instructions to Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by accounting principles generally accepted in the United
States of America for complete consolidated financial statements. In the opinion
of management, all adjustments considered necessary for a fair presentation have
been included. Operating results for the three and nine-month periods ended
September 30, 2002 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2002. These unaudited consolidated
financial statements should be read in conjunction with the consolidated
financial statements and footnotes thereto for the year ended December 31, 2001
included in the Company's Annual Report on Form 10-K filed with the Securities
and Exchange Commission. Certain reclassifications have been made to the
Company's prior period's consolidated financial statements, to conform to the
current period's consolidated financial statement presentation.
NOTE 2: FINANCING OF OPERATIONS
As of September 30, 2002 the Company had working capital of approximately
$2,359, including $2,107 in non-restricted cash, cash equivalents and debt
security investments. Of the total working capital, $462 was in the Company's
majority-owned Israeli subsidiary dsIT and, due to Israeli tax and company law
constraints as well as the significant minority interest in dsIT, such working
capital is not available to finance US activities. Net cash used in operating
activities during the third quarter of 2002 was $2,334 in addition to $2,617 net
cash used in the first half of this year. The primary factors for the Company's
net cash usage during the third quarter of 2002, were (i) Comverge's additional
investment in inventory of $855, (bringing its total inventory to $3,074), (ii)
Comverge's loss for the period of $597 (iii) a reduction of non-restricted cash,
due to the deposit of $900 which secured a deferred payment obligation in the
financing of Comverge's additional inventory purchases and (iv) the $276
decrease in accounts payable and other liabilities. These uses of cash were
offset in part by a decrease of $1,069 in the Company's accounts receivable and
other current asset balances during the third quarter of 2002.
As of October 31, 2002 the Company's US operations had an aggregate of
approximately $1,900 in cash, cash equivalents and short-term debt securities,
reflecting a $2,000 decrease from the balance as July 31, 2002. This decrease
resulted from the following cash payments by the Company: (i) making the October
payment on account of the Laurus convertible debenture for $215 in cash, (ii) a
final payment of $193 pursuant to the settlement agreement with Bounty Investors
, (iii) a payment of $650 for Comverge's settlement with its former main
contract manufacturer for inventory and accounts payable and (v) $942 to fund
other Comverge and corporate activities. During this period the Company's
computer hardware and domestic software consulting activity was close to
breakeven, and consequently did not provide any funds to support US corporate
activity. Since October 31, 2002 the Company paid in cash to Laurus also the
second principal and interest payment of $215 , under the convertible debenture.
The Company's liquidity and ability to continue to finance as a going
concern is contingent on a number of factors:
- 5 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(dollars in thousands, except per share data)
o Need to achieve positive cash flow in computer hardware segment: In
the last four quarters the computer hardware segment operations have
been breakeven, not providing any cash to support US corporate
activities. The Company believes this segment will increase its sales
significantly as a result of a couple of large transactions already
completed and others currently being negotiated. As a result, the
level of sales in the computer hardware segment is expected to
increase from an average of $4,300 in the last four quarters to over
$7,000 in the fourth quarter and an average of more than $6,000 per
quarter in 2003. This increase in sales together with reductions in
overhead expenses in the segment are expected to generate over $700 of
cash flow in the fourth quarter of this year and an average of $320 in
each quarter of 2003.
Although these sales objectives reflect an increase of almost 50% over
average per quarter sales in the last four quarters, the Company is
reasonably confident that it will meet these projections, as a
substantial portion of the orders projected for the fourth quarter of
2002 and the first quarter of 2003 have already been received.
o Need to implement additional reduction of corporate expenses: Over the
last four quarters, the Company has been successful in reducing
corporate overhead expenses by more than 20% from an average of $846
per quarter in 2001 to $651 in the third quarter of 2002. The Company
achieved this decrease in costs primarily by reducing salary expenses
and professional fees, including a 10% cut in management salaries
since August 2002, negotiation of reduced legal billing rates and a
cap on quarterly legal expenses. In order to maintain sufficient
liquidity for the coming 12 months, the Company wishes to reduce
corporate expenses by an additional 10%, from the level in the third
quarter of 2002, to less than $600 per quarter.
o Need to minimize investment in by the Company in Comverge: Except for
the additional investment in raw material inventory noted above,
Comverge's operating cash flow continued to improve in the third
quarter of 2002. As projected in the past, the Company expects that
Comverge will be cash flow positive in the fourth quarter of 2002. The
expected improvement in operating cash flow in the fourth quarter of
this year results primarily from (i) increases in sales from contracts
in hand, resulting also from shipments delayed from the third quarter
and (ii) expected utilization of the raw material inventory purchased
by Comverge in the second and third quarters. However, if Comverge is
unable to reach an agreement to amend the contract discussed in Note 8
and shipments are as a result suspended or the contract is terminated,
sales in the fourth quarter of 2002 would be significantly lower than
currently expected having a materially adverse impact on Comverge's
cash flow, financial condition and its operations in that quarter.
The Company does not currently expect Comverge's sales in 2003 to be
as high as those projected for the fourth quarter of 2002, and,
consequently, Comverge's current cost structure would result in
negative cash flow in 2003. To address Comverge's cash flow situation,
the Company has prepared a business plan for 2003, focusing
particularly on the first quarter, which details the cost cutting
measures that must be taken before the end of 2002, to ensure Comverge
is cash flow neutral and that its cost structure reflects the exepcted
level of revenues. Should the revenue level expected be as low as that
experienced this year, the instituted business plan would include
measures that could have a severely negative effect on Comverge's
business model and the current way it does business.
-6-
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(dollars in thousands, except per share data)
Comverge is in the process of negotiating a $2,000 line of credit,
secured by its accounts receivables and inventory, guaranteed by the
Company. The line of credit, if obtained, will provide temporary
relief to Comverge's cash flow concerns but will not solve Comverge's
longer term liquidity needs. In addition, the amount available to
Comverge under this facility would be negatively impacted if its
customer suspends or terminates its agreement (see Note 8).
The Company has not been successful in attracting outside equity
funding for Comverge to date, and the current state of the capital
markets is not favorable for raising such funds. However, the
Company's long-term strategy remains to establish independent outside
funding to finance its activities. There can be no assurance that the
Company or Comverge will be able to raise additional capital or secure
alternative financing or raise amounts sufficient to meet the
long-term needs of the business; it is therefore not including the
proceeds of any such possible financing in its current liquidity
projections.
o Payments under the Laurus Convertible Note: Since September 30, 2002,
in addition to the interest payments, the Company has made the first
two principal payments on the convertible note described in Note 3, in
cash. Unless cash flow improves substantially, the remaining payments
will be made by delivering shares of its common stock, thereby
conserving cash. Payments using the Company's common stock, however,
would involve substantial dilution and could have a negative impact on
the price of the Company's common stock.
dsIT is fully utilizing its line of credit of $2,000. The Company believes
that dsIT will have sufficient liquidity to finance its activities from cash
flow from its own operations over the next 12 months. This is based on continued
utilization of its line of credit and improved operating results stemming from
continued cost reductions.
The Company believes that its plans to finance its operations over the next
12 months can be successfully implemented on a timely basis in a manner that
will not impede the Company's ability to implement its current business
strategy. However, due to the Company's liquidity, successful execution of these
plans is subject to significant risks and uncertainties, including those
associated with (i) timely manufacture and delivery of products, (ii) obtaining
additional business from current and prospective customers, and (iii) effective
and timely implementation of the Company's planned reductions in direct costs
and expenses.
Should the Company be unsuccessful in implementing its plans on a timely
basis, the Company may not have sufficient liquidity to continue with its
operations as currently conducted
NOTE 3: CONVERTIBLE NOTE
On June 11, 2002, the Company completed a transaction with Laurus Master
Fund, Ltd., pursuant to which Laurus made a $2,000 investment in the Company in
exchange for a 10% convertible note and a three-year warrant to purchase 125,000
shares of DSSI common stock at an exercise price of $4.20 per share. Under the
10% convertible note, the Company makes interest-only payments for the first
three months and thereafter the Company makes ten payments of $200 plus accrued
interest on the outstanding balance.
Laurus may convert the convertible note at any time into shares of DSSI
common stock at a fixed conversion price of $3.49, subject to certain
restrictions in the agreement. The Company may pay the principal and interest on
the convertible note, which has a one-year term, in cash, shares of DSSI common
stock, or a combination of cash and stock, at the Company's option.
- 7 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(dollars in thousands, except per share data)
Although the first two principal payments on this note, made since
September 30, 2002, have been in cash, based on its current liquidity status,
unless cash flow improves substantially, the Company currently expects to pay
most or the entire remaining principal and interest payments in shares of common
stock. Should the Company elect to make such payments in stock (in whole or in
part), the conversion price will be the lesser of (i) $3.49 and (ii) 83% of the
average of the 10 lowest closing prices during the 30 trading days prior to the
date of notice of payment. The Company's Databit subsidiary granted Laurus a
security interest in Databit's accounts receivable.
The Company estimated the fair value of the beneficial conversion feature
and related warrant at the issuance of the convertible note to be approximately
$692. Such amount was credited to additional paid-in capital and is being
charged to interest expense over the conversion period (with respect to the
note) and the exercise period (with respect to the warrants), using the
effective interest method (approximately $256 and $311 for the three and nine
months ended September 30, 2002, respectively). The face value debt of $2,000,
less $381 of unamortized debt discount, from the beneficial conversion feature
and the related warrants, is included in short-term debt and current maturities
of long-term debt, net, at September 30, 2002. In addition, the Company incurred
debt issuance costs of $167 with respect to the issuance of the convertible
note. These costs will be amortized to interest expense using the effective
interest method over the life of the note.
The interest expense with respect to the convertible note consists of the
interest payments at a rate of 10%, the amortization of debt issuance costs and
the accretion of the carrying value of the convertible note to its face value
(debt discount). Interest expense was $307 and $371, for the three and nine
months ended September 30, 2002, respectively, and is expected to be recognized
in the consolidated statement of operations as follows:
Quarter ending December 31, 2002 $246
Quarter ending March 31, 2003 $150
Quarter ending June 30, 2003 $61
NOTE 4: IMPACT OF RECENTLY ISSUED ACCOUNTING PRINCIPLES
The Company adopted the remaining provisions of Statement of Financial
Accounting Standards (SFAS) No. 141, "Business Combinations" and all of the
provisions of SFAS No. 142, "Goodwill and Other Intangible Assets", effective
January 1, 2002. Upon adoption of SFAS No. 142, the Company evaluated its
existing intangible assets and goodwill that were acquired in the purchase of
business combinations, so as to make any necessary reclassifications in order to
conform with the new classification criteria in SFAS No. 141 for recognition
separate from goodwill. Additionally, the Company has identified its reporting
units to be its operating segments and allocated the goodwill at January 1, 2002
as follows: software consulting and development - $7,190, and energy
intelligence solutions - $499.
The Company reassessed the useful lives and residual values of all
intangible assets acquired, in order to make any necessary amortization period
adjustments. If an intangible asset is identified as having an indefinite useful
life, the Company is required to test the intangible asset for impairment in
accordance with the provisions of SFAS No. 142
Impairment is measured as the excess of carrying value over the fair value
of an intangible asset with an indefinite life. Any impairment loss is measured
as of January 1, 2002 and is recognized as a cumulative effect of a change in
accounting principle. In connection with the adoption of SFAS No. 142, the
Company evaluated its intangible assets and determined that it has no indefinite
useful life intangibles. The Company has also evaluated the remaining useful
lives of its intangible assets that will continue to be amortized and determined
that no revision to the useful lives is required.
- 8 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(dollars in thousands, except per share data)
The Company was required to perform a transitional goodwill impairment
assessment within six months of adoption of SFAS No. 142. The Company completed
its transitional goodwill impairment assessment, with no adjustment to the
carrying value of its goodwill as of January 1, 2002. The goodwill impairment
assessment involves estimating the fair value of the reporting unit and
comparing it with its carrying amount. If the fair value of the reporting unit
exceeds its carrying amount, additional steps are followed to recognize a
potential impairment loss. Calculating the fair value of the reporting units
requires significant estimates and assumptions by management. The Company
estimated the fair value of the primary portion of its software consulting and
development reporting unit, subsequent to the Endan acquisition in the beginning
of 2002, by using third-party valuations.
At the end of the third quarter, management began to prepare the Company's
annual financial operating plan for 2003. As a result of this process,
management believes that, since the acquisition of Endan in December 2001, there
has been an other than temporary decline in the hi-tech market in general and
the software consulting market in Israel in particular. The Company began the
process of evaluating the carrying value of the goodwill of its software
consulting and development segment. The preliminary evaluation indicates the
software consulting and development segment's goodwill is impaired and the
Company has recognized a goodwill impairment charge of approximately $2,760 in
the three months ended September 30, 2002. The estimate of the fair value of the
segment was determined by applying a market-rate multiple to the estimated
near-term future revenue stream expected to be produced by the software
consulting and development segment (the method used at the time of the Endan
acquisition). The Company will perform its annual impairment test in the fourth
quarter of 2002 for all its reporting units (segments) and may adjust the
impairment recorded this quarter for the software consulting and development
segment.
The Company ceased amortization of goodwill acquired in purchase business
combinations, completed prior to July 1, 2001. Pro forma net loss and pro forma
basic and diluted loss per share for the nine and three months ended September
30, 2001, adjusted to exclude goodwill amounts no longer amortized, are as
follows:
Nine months ended Three months ended
SEPTEMBER 30, 2001 SEPTEMBER 30, 2001
------------------ ------------------
Net loss:
As reported ...................... $ (6,576) $ (2,606)
Add back: Goodwill amortization .. 378 125
--------- ---------
Pro forma net loss ......... $ (6,198) $ (2,481)
========= =========
Basic and diluted net loss per share:
As reported ...................... $ (0.95) $ (0.37)
Add back: Goodwill amortization .. 0.06 0.01
--------- ---------
Pro forma net loss per share $ (0.89) $ (0.36)
========= =========
Amortization of intangible assets for the nine months ended September 30,
2002 was $305. Amortization expense for each of the next five years and
thereafter is estimated as follows:
YEAR ENDING DECEMBER 31,
2002 $366
2003 117
2004 91
2005 56
2006 46
Thereafter 41
------
$717
======
- 9 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(dollars in thousands, except per share data)
Other intangible assets consist of:
As of As of
DECEMBER 31, 2001 SEPTEMBER 30, 2002
----------------- ------------------
Cost:
License ...................... $ 567 $ 567
Patents ...................... 279 288
Software and software licenses 572 260
Backlog ...................... -- 120
------ ------
$1,418 $1,235
------ ------
Less: Accumulated Amortization:
License ...................... $ 456 $ 544
Patents ...................... 53 82
Software licenses ............ -- 80
Backlog ...................... -- 108
------ ------
$ 509 $ 814
------ ------
Other intangible assets, net ... $ 909 $ 421
====== ======
Effective January 1, 2002, the Company also adopted SFAS No. 144,
"ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS". SFAS No. 144
addresses financial accounting and reporting for the impairment or disposal of
long-lived assets. SFAS No. 144 requires that long-lived assets be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used, is measured by a comparison of the carrying amount of an
asset, to the undiscounted future net cash flows expected to be generated, by
that asset. If the carrying amount of an asset exceeds its estimated future
undiscounted cash flows, an impairment charge is recognized by the amount by
which the carrying amount of the asset exceeds the fair value of the asset. SFAS
No. 144 requires the Company to separately report discontinued operations and
extends that reporting to a component of an entity that either has been disposed
of (by sale, abandonment, or in a distribution to owners) or is classified as
held for sale. Assets to be disposed of are reported at the lower of the
carrying amount or fair value less costs to sell. The adoption of SFAS No. 144
had no impact on the Company's consolidated financial statements because the
impairment assessment under SFAS No. 144 is largely unchanged from SFAS No. 121.
The provisions of this statement for assets held for sale or other disposal
generally are required to be applied prospectively to newly initiated disposal
activities and, therefore, will depend on future actions initiated by
management.
During the quarter ended September 30, 2002, the Company recorded an
impairment charge of $240 to cost of sales - services, related to acquired
software used by its software consulting and development segment.
In June 2001, the FASB issued Statement No. 143, ACCOUNTING FOR ASSET
RETIREMENT OBLIGATIONS ("SFAS 143"). SFAS 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. It applies to legal
obligations associated with the retirement of long-lived assets that result from
the acquisition, construction, development and (or) the normal operation of a
long-lived asset, except for certain obligations of lessees. This Statement
amends FASB Statement No. 19, FINANCIAL ACCOUNTING AND REPORTING BY OIL AND GAS
PRODUCING COMPANIES, and it applies to all entities. The Company is required to
adopt SFAS 143, effective for calendar year 2003. The Company does not expect
the adoption of SFAS 143 to have a material impact on its future consolidated
operations or financial position, as it is now constituted.
- 10 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(dollars in thousands, except per share data)
In July 2002, the FASB issued Statement of Financial Accounting Standards
No. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES ("SFAS
146"). SFAS 146 addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity" (including Certain
Costs Incurred in a Restructuring). The Company is required to adopt SFAS 146
effective January 1, 2003. The Company does not expect adoption of SFAS 146 to
have a material impact on its future consolidated operations or financial
position, as it is now constituted.
NOTE 5: INVENTORY
As of As of
Inventory consists of the following: DECEMBER 31, 2001 SEPTEMBER 30, 2002
----------------- ------------------
Raw materials, spare parts and supplies $ 409 $2,862
Work-in-process ....................... -- 175
Finished goods and merchandise ........ 249 188
------ ------
$ 658 $3,225
====== ======
NOTE 6: ACQUISITIONS
(a) In December 2001, the Company's dsIT subsidiary acquired all the
outstanding shares of Endan IT Solutions Ltd., for an aggregate purchase price
of $5,788. The transaction was accounted for as a purchase business combination
and partial sale of a subsidiary. The results of operations and cash flows of
Endan have been included in our consolidated financial statements beginning
January 1, 2002. For further information, refer to the notes to the consolidated
financial statements for the year ended December 31, 2001 included in our annual
report on Form 10-K.
The entire goodwill acquired was assigned to the software consulting and
development segment. In accordance with SFAS No. 142, the Company recorded in
the third quarter of 2002 an impairment of $2,760, against the software
consulting and development segment goodwill, which includes a portion of the
Endan goodwill. In connection with the acquisition, the Company continues to
evaluate the status of the litigation described in Note 15(e) to our
consolidated financial statements for the year ended December 31, 2001. While
the Company does not expect an adverse ruling, any amounts awarded or paid
during 2002 will be credited or charged to operations.
Upon receipt of third-party valuation information, it was determined that
the fair value of software acquired (five-year useful life), initially recorded
at $500 at December 31, 2001, was $428 and that the fair value of backlog
acquired (one-year useful life), not initially recorded, was $120. During the
third quarter of 2002, an impairment of software acquired was recorded, reducing
the remaining net book value by $240 (for more information see Note 4).
(b) During the second quarter of 2002, the Company's Comverge subsidiary
purchased certain assets to be used in a 70MW energy conservation program in the
greater Houston, Texas area for $100.
NOTE 7: OTHER MATERIAL TRANSACTIONS.
In September 2002, Comverge reached a settlement with a contract
manufacturer to resolve a dispute regarding outstanding accounts payables owed
by Comverge and breach of contract by the contract manufacturer. Pursuant to the
settlement, Comverge agreed to pay $1,350 to the contract manufacturer for the
purchase of $536 of raw materials in full settlement of the $1,538 of payables
originally owed by Comverge, allowing Comverge to record a $724 decrease in the
cost of sales in the third quarter. The terms of the settlement provides for an
initial payment at closing of $450 and three installment payments of $300 each
payable on October 4, November 4, and December 4. The deferred payments are
backed by a letter of credit, which is secured by the Company with cash
collateral. Comverge plans to resell approximately $388 of the acquired
inventory to unrelated contract manufacturers and consume the remainder in its
internal manufacturing operations.
- 11 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(dollars in thousands, except per share data)
NOTE 8: SUBSEQUENT EVENTS.
In October 2002, Comverge was notified by a customer to temporarily suspend
the work Comverge was then performing under a major contract and due for
completion in the fourth quarter of 2002 due to the customer's concerns
regarding one of Comverge's technology vendors. Subsequently, the customer
agreed to allow Comverge to resume work pending an amendment to the contract
that has been agreed to in principle and will satisfactorily address the
customer's concerns that led to the suspension. If Comverge is unsuccessful in
receiving a signed amendment to the contract and the customer attempts to
exercise its rights to suspend or terminate the contract, such action could have
a materially adverse impact on Comverge's financial condition and its operations
in the fourth quarter.
NOTE 9: SEGMENT INFORMATION
SOFTWARE
CONSULTING ENERGY
AND INTELLIGENCE COMPUTER
DEVELOPMENT SOLUTIONS HARDWARE OTHER TOTAL
----------- ------------ -------- ----- -----
Nine months ended September 30, 2002:
Revenues from external customers .. $ 10,636 $ 12,683 $ 13,415 $ 126 $ 36,860
Intersegment revenues ............. 72 870 73 -- 1,015
Segment gross profit .............. 1,704 3,918 2,260 51 7,933
Segment income (loss)* ............ (3,553) (2,465) 36 (2) (5,984)
Nine months ended September 30, 2001:
Revenues from external customers .. $ 9,647 $ 10,391 $ 16,005 $ 114 $ 36,157
Intersegment revenues ............. 275 836 75 -- 1,186
Segment gross profit .............. 1,743 2,971 2,964 26 7,704
Segment income (loss) ............. (1,469) (4,481) 980 (8) (4,978)
Three months ended September 30, 2002:
Revenues from external customers .. $ 3,339 $ 3,259 $ 4,638 $ 33 $ 11,269
Intersegment revenues ............. 53 391 27 -- 471
Segment gross profit .............. 412 1,144 801 6 2,363
Segment income (loss)* ............ (2,862) (597) 61 (7) (3,405)
Three months ended September 30, 2001:
Revenues from external customers .. $ 2,527 $ 4,283 $ 3,519 $ 30 $ 10,359
Intersegment revenues ............. 185 233 18 -- 436
Segment gross profit .............. 179 1,267 778 (27) 2,197
Segment income (loss) ............. (807) (1,458) 174 -- (2,091)
* Segment loss for the nine and three month periods ended September 30,
2002 in the software consulting and development segment include a
charge of $3,000 for impairment of goodwill and acquired
software reduced by $528 for minority interests.
RECONCILIATION OF SEGMENT INCOME (LOSS) TO NET LOSS:
Nine months ended Three months ended
September 30, September 30,
-------------------------- -----------------------
2001 2002 2001 2002
------------ ----------- ----------- -----------
Total loss for reportable segments ......... $(4,970) $(5,982) $(2,091) $(3,398)
Other operational segment loss ............. (8) (2) -- (7)
------- ------- ------- -------
Total operating loss .................. (4,978) (5,984) (2,091) (3,405)
Net income (loss) of corporate headquarters* (1,598) (2,388) (515) (866)
------- ------- ------- -------
Total net loss ............................. $(6,576) $(2,606) $(4,271) $(8,372)
======= ======= ======= =======
* Net loss of corporate headquarters for the nine and three months ended
September 30, 2002 includes $311 and $256 of interest expense related
to the amortization of the fair value of the beneficial conversion
feature and related warrants at the issuance of the convertible note
in June of 2002.
- 12 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW AND TREND INFORMATION
The following discussion includes statements that are forward-looking in
nature. Whether such statements ultimately prove to be accurate, depends upon a
variety of factors that may affect our business and operations. Certain of these
factors are discussed in our Annual Report on Form 10-K for the year ended
December 31, 2001 (the "2001 10-K") under "Factors That May Influence Future
Results" and in "Item 1. Description of Business - Factors That May Influence
Future Results".
During the periods included in this report, we operated in three reportable
segments: software consulting and development, energy intelligence solutions,
and computer hardware. The following analysis should be read together with the
segment information provided in Note 9 to the interim unaudited consolidated
financial statements included in this quarterly report, which information is
hereby incorporated by reference into this Item 2.
SOFTWARE CONSULTING AND DEVELOPMENT
With the expanded product offerings and revenue base resulting from the
acquisition of Endan in December 2001, our software consulting and development
segment has been able to partially offset the drop in revenues, compared to the
immediately preceding quarter, due to the continued weakness in the hi-tech
sector in general and the software consulting and development market in
particular. Revenues for this segment in the third quarter of 2002 continued to
decline, albeit at slower rate than it would have been without the Endan
acquisition. We expect that these market conditions will cause revenues to
continue to decline in the fourth quarter of 2002, and will stay at depressed
levels for the foreseeable future. In light of this other than temporary decline
in the high tech markets and in preparing its financial projections for 2003,
the Company recorded a non-cash charge of $3 million from impairment of the
segment's goodwill and software. However, we expect to reduce losses and the
results from operations to continue to improve, as they did this quarter, due to
the continued efforts to improve the cost structure at dsIT both in terms of
personnel and efficiency of operations.
It is difficult to discern the effect of the general downward trend in the
hi-tech markets from the effect of the turmoil in Israel over the last year and
the negative effect on the Israeli economy. Should the unrest continue, it is
unclear how our business there will be effected in the future.
ENERGY INTELLIGENCE SOLUTIONS
Comverge sales decreased in the third quarter of 2002, compared to the
immediately preceding quarter and the third quarter of 2001, primarily due to
fewer product shipments caused by production delays that were due to the
replacement of its main contract manufacturer, start-up problems with new
product lines and delayed shipments under a major contract due to customer
concerns regarding one of Comverge's technology vendors. In October 2002,
Comverge was notified by a customer to temporarily suspend the work Comverge was
then performing under a major contract and due for completion in the fourth
quarter of 2002 due to the customer's concerns regarding one of Comverge's
technology vendors. Subsequently, the customer agreed to allow Comverge to
resume work pending an amendment to the contract that has been agreed to in
principle and will satisfactorily address the customer's concerns that led to
the suspension. As a result of our expectation to fulfill this major contract,
the shift of product shipments to the fourth quarter of 2002 and general
improvement in business, we expect Comverge sales to increase significantly in
the fourth quarter, compared to the third quarter. Comverge recorded a $724
non-recurring credit to cost of sales in the third quarter of 2002 as a result
of a settlement with its former main contract manufacturer. Gross profit from
its ongoing operations, not including the non-recurring credit decreased
primarily as a result of a decrease in sales with relatively higher profit
margins, partially being deferred to the next quarter. In addition, Comverge is
continuously working on improving its cost structure and employee related
expenses and these are expected to decline in the coming quarters as the result
of cost saving initiatives implemented in, and prior to, the third quarter of
2002. As a result of the expected increases in sales, improved cost structure
and expected decreases in inventory levels, cash flows from operating activities
are expected to continue to improve in the fourth quarter of 2002.
- 13 -
COMPUTER HARDWARE
Databit sales in the third quarter of 2002 continued to improve for the
fourth consecutive quarter and were 3% above the preceding quarter and 32% above
sales in the third quarter of 2001. We expect a more marked increase in sales in
the fourth quarter and to generally maintain the current level of sales for
2003.
RESULTS OF OPERATIONS
The following table sets forth certain information with respect to the
results of our operations for the three and nine months ended September 30, 2001
and 2002, including the percentage of total revenues during each period
attributable to selected components of operations statement data and for the
period-to-period percentage changes in such components.
Nine months ended September 30, Three months ended September 30,
---------------------------------------------------- --------------------------------------------------
2001 2002 Change 2001 2002 Change
----------------- --------------------- ------ ------------------ ------------------- ------
% of % of % of % of % of % of
($,000) sales ($,000) sales 2001 ($,000) sales ($,000) sales 2001
------ ----- ------- ----- ---- ------- ----- ------- ----- ----
Sales .................... $ 36,157 100% $ 36,860 100% 2% $ 10,359 100% $ 11,269 100% 9%
Cost of sales ............ 28,453 79 28,927 78 1 8,162 79 8,906 79 6
-------- ----- -------- ------- -------- ----- ------- -----
Gross profit .......... 7,704 21 7,933 22 3 2,197 21 2,363 21 8
R&D expenses ............. 2,216 6 1,266 3 (43) 863 8 256 2 (70)
SG&A expenses ............ 12,628 35 12,675 34 0 4,242 41 3,923 35 (8)
Impairment of goodwill ... -- -- 2,760 7 -- -- 2,760 24
-------- ----- -------- ------- -------- ----- ------- -----
Operating loss ........ (7,140) (20) (8,768) (24) 23 (2,908) (28) (4,576) (41) 57
Interest income
(expense), net ........... 556 2 (540) (1) (197) 177 2 (393) (3) (322)
Other income, net ........ 26 0 148 0 469 31 0 56 0 81
Minority interests ....... -- -- 852 2 -- -- 649 6
-------- ----- -------- ------- -------- ----- ------- -----
Loss before provision . (6,558) (18) (8,308) (23) 27 (2,700) (26) (4,264) (38) 58
for income taxes
Provision for income taxes 18 0 64 0 256 (94) (1) 7 0 (107)
-------- ----- -------- ------- -------- ----- ------- -----
Net loss .............. $ (6,576) (18)% $ (8,372) (23)% 27% $ (2,606) (25)% $ (4,271) (38)% 64%
======== ===== ======== ======= ======== ===== ======= =====
SALES. Sales in the third quarter and first nine months of 2002 were $11.3
million and $36.9 million, respectively, increasing over the same periods in
2001 by 9% and 2%, respectively. Sales in the third quarter of 2002 were 12%
below those of the immediately preceding quarter. The increase compared to the
third quarter of 2001 was primarily due to increased sales in both software
consulting and development and computer hardware segments, partially offset by a
decrease in energy intelligence solution sales. That decrease was the primary
reason for the decrease in sales in the third quarter as compared to the
immediately preceding quarter, while sales in the other segments remained
relatively stable during the period.
Energy intelligence solution sales in the third quarter of 2002 were $3.3
million, 24% below sales in the third quarter of 2001 and 32% below sales in the
immediately preceding quarter. Segment sales in the first nine months of this
year were $12.7 million, 22% above sales in the first nine months in 2001. The
decrease in this segment's sales in the third quarter was primarily attributable
to fewer product shipments caused by production delays, due to the replacement
of Comverge's main contract manufacturer and start-up problems with the
introduction of new products.
Sales in the computer hardware segment continued to improve and were $4.6
million and $13.4 million in the third quarter and first nine months of 2002,
respectively. This reflects a 32% increase over sales in the third quarter of
2001, though still 16% below sales of the first nine months of 2001. This
segment's third quarter sales were 3% over sales in the immediately preceding
quarter.
Software consulting and development sales were $3.3 million and $10.6
million in the third quarter and first nine months of 2002, respectively,
increasing by 32% and 10%, compared to the same periods of 2001, respectively.
This improvement in sales, was entirely attributable to the expanded revenue
base achieved as a result of the Endan acquisition by dsIT in December 2001,
which more than offset the general weakness in the global hi-tech markets and in
the software consulting and development market in particular. This continued
weakness in the hi-tech markets is the primary reason for the 3% decrease in
sales in the third quarter of 2002 compare to the immediately preceding quarter.
- 14 -
GROSS PROFIT. Gross profit in the third quarter of 2002 was $2.4 million
increasing 8% compared to the third quarter of 2001, although 9% below the
immediately preceding quarter. Gross profit in the first nine months of 2002 was
$7.9 million increasing by 3% compared to the first nine months of 2001.
The increase in gross profit in the third quarter and first nine months of
2002, compared to the same periods in 2001, was primarily due to a non-recurring
$724 credit to cost of sales resulting from Comverge's settlement with its
former contract manufacturer. This credit was partially offset by other
non-recurring charges of $240 for the impairment of acquired software and $125
one time warranty accrual. In addition, gross profit margins from operations,
excluding non-recurring expenses, improved in our software consulting and
development segment from 11% in the third quarter of 2001 to 19% in third
quarter of 2002, while remaining stable in comparing the nine-month periods.
This improvement in gross profit margins in the software consulting and
development segment, was partially offset by a decrease in gross profit margins
in the computer hardware segment from 22% in the third quarter of 2001 to 17% in
the third quarter of 2002. In addition, the gross profit margin in the energy
intelligence solutions segment in the third quarter of 2002, excluding the
non-recurring credit and debit, decreased as a result of a decrease higher
profit margin sales, which were partially being deferred to the next quarter.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A"). In the third quarter
of 2002 SG&A was $3.9 million, decreasing by 12% and 8%, compared to the
immediately preceding quarter and third quarter of 2001, respectively. This
decrease primarily reflects decreases in overhead expenses in the utility
solutions segment as well as a continued decrease in corporate expenses. SG&A in
the first nine months of 2002 was at a level similar to that of the same period
of 2001.
IMPAIRMENT OF GOODWILL. With the acquisition of Endan by our dsIT
subsidiary in December 2001, we recognized goodwill and acquired software valued
at a total of $6.4 million. This value was supported by third party valuations
prepared at the time of the acquisition, based on sales and business projections
made at that time. Since then, the hi-tech market in general and that of
software consulting in particular have continued to deteriorate. We have made
concerted efforts to offset this negative trend with cost cutting measures
already implemented. As we look forward to the coming year, the expense recorded
reflects our reassessment of the values then recorded with respect to the entire
software consulting and development segment to reflect our current sales
projections, based on the same valuation models then employed. We are confident
that the cost cutting measures already implemented, will provide for breakeven
and even positive performance in the coming quarters, justifying the remaining
goodwill and value attached to this segment.
INTEREST EXPENSE. The net interest expense in the 2002 periods, as opposed
to net interest income in the 2001 periods, as well as the increase over
interest expense in the immediately preceding quarter, resulted primarily from
the $307 finance expense incurred in the third quarter of 2002, for the
amortization of costs associated with the convertible debenture issued towards
the end of the second quarter of 2002. In addition, interest income decreased as
a result of decreasing funds invested, as they are utilized to finance our
domestic operations, as well as a decrease in interest rates. The financial
expenses associated with the convertible debenture will continue in the next
three quarters, at a decreasing rate.
MINORITY INTERESTS. Minority interests, reflects primarily the minority
interests in our dsIT subsidiary, since the Endan acquisition in December 2001.
The increase in minority interests reflects their participation in losses
generated by dsIT in the third quarter of 2002 including a portion of the
impairment of goodwill and acquired software in this segment as described above.
NET LOSS. The net loss in the third quarter and first nine months of 2002
increased to $4.3 million and $8.4 million, respectively, compared to $2.6
million and $6.6 million, in the same periods of 2001. These increases were
principally due to the aforementioned impairment of goodwill and acquired
software.
- 15 -
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2002 we had working capital of approximately $2,359,000
including $2,107,000 in non-restricted cash, cash equivalents and debt security
investments. Of the total working capital, $462,000 was in our majority-owned
Israeli subsidiary dsIT and, due to Israeli tax and company law constraints as
well as the significant minority interest in dsIT, such working capital is not
available to finance US activities. Net cash used in operating activities during
the third quarter of 2002 was $2,334,000 in addition to $2,617,000 net cash used
in the first half of this year. The primary factors for our net cash usage
during the third quarter of 2002, were (i) Comverge's additional investment in
inventory of $855,000 (bringing its total inventory to $3,074,000), (ii)
Comverge's loss for the period of $597,000 (iii) a reduction of non-restricted
cash, due to the deposit of $900,000 which secured a deferred payment obligation
in the financing of Comverge's additional inventory purchases and (iv) the
$276,000 decrease in accounts payable and other liabilities. These uses of cash
were offset in part by a decrease of $1,069,000 in our accounts receivable and
other current asset balances during the third quarter of 2002.
As of October 31, 2002 our US operations had an aggregate of approximately
$1,900,000 in cash, cash equivalents and short-term debt securities, reflecting
a $2,000,000 decrease from the balance as July 31, 2002. This decrease resulted
from the following cash payments by us: (i) making the October payment on
account of the Laurus convertible debenture for $215,000 in cash, (ii) a final
payment of $193,000 pursuant to the settlement agreement with Bounty Investors,
(iii) a payment of $650,000 for Comverge's settlement with its former main
contract manufacturer for inventory and accounts payable and (v) $942,000 to
fund other Comverge and corporate activities. During this period our computer
hardware and domestic software consulting activity was close to breakeven, and
consequently did not provide any funds to support US corporate activity. Since
October 31, 2002 we paid in cash to Laurus also the second principal and
interest payment of $215,000 under the convertible debenture.
Our liquidity and ability to continue as a going concern is contingent on a
number of factors:
o Need to achieve positive cash flow in computer hardware segment: In
the last four quarters the computer hardware segment operations have
been breakeven, not providing any cash to support US corporate
activities. We believe this segment will increase its sales
significantly as a result of a couple of large transactions already
completed and others currently being negotiated. As a result, the
level of sales in the computer hardware segment is expected to
increase from an average of $4,300,000 in the last four quarters to
over $7,000,000 in the fourth quarter and an average of more than
$6,000,000 per quarter in 2003. This increase in sales together with
reductions in overhead expenses in the segment are expected to
generate over $700,000 in cash flow in the fourth quarter of this year
and an average of $320,000 in each quarter of 2003.
Although these sales objectives reflect an increase of almost 50% over
average per quarter sales in the last four quarters, we are reasonably
confident that it will meet these projections, as a substantial
portion of the orders projected for the fourth quarter of 2002 and the
first quarter of 2003 have already been received.
o Need to implement additional reduction of corporate expenses: Over the
last four quarters, we have been successful in reducing corporate
overhead expenses by more than 20% from an average of $846,000 per
quarter in 2001 to $651,000 in the third quarter of 2002. We achieved
this decrease in costs primarily by reducing salary expenses and
professional fees, including a 10% cut in management salaries since
August 2002, negotiation of reduced legal billing rates and a cap on
quarterly legal expenses. In order to maintain sufficient liquidity
for the coming 12 months, we wish to reduce corporate expenses by an
additional 10%, from the level in the third quarter of 2002, to less
than $600,000 per quarter.
o Need to minimize our investment in Comverge: Except for the additional
investment in raw material inventory noted above, Comverge's operating
cash flow continued to improve in the third quarter of 2002.
-16 -
As projected in the past, we expect that Comverge will be cash flow
positive in the fourth quarter of 2002. The expected improvement in
operating cash flow in the fourth quarter of this year results
primarily from (i) increases in sales from contracts in hand,
resulting also from shipments delayed from the third quarter and (ii)
expected utilization of the raw material inventory purchased by
Comverge in the second and third quarters. However, if Comverge is
unable to reach an agreement to amend the contract discussed in Note 8
and shipments are as a result suspended or the contract is terminated,
sales in the fourth quarter of 2002 would be significantly lower than
currently expected having a materially adverse impact on Comverge's
cash flow, financial condition and its operations in that quarter.
We do not currently expect Comverge's sales in 2003 to be as high as
those projected for the fourth quarter of 2002, and, consequently,
Comverge's current cost structure would result in negative cash flow
in 2003. To address Comverge's cash flow situation, we have prepared a
business plan for 2003, focusing particularly on the first quarter,
which details the cost cutting measures that must be taken before the
end of 2002, to ensure Comverge is cash flow neutral and that its cost
structure reflects the expected level of revenue. Should the revenue
level expected be as low as that experienced this year, the instituted
business plan would include measures that could have a severely
negative effect on Comverge's business model and the current way it
does business.
Comverge is in the process of negotiating a $2,000,000 line of credit,
secured by its accounts receivables and inventory, guaranteed by us.
The line of credit, if obtained, will provide temporary relief to
Comverge's cash flow concerns but will not solve comverge's longer
term liquidity needs. In addition, the amount available to Comverge
under this facility would be negatively impacted if its customer
suspends or terminates its agreement (see Note 8).
We have has not been successful in attracting outside equity funding
for Comverge to date, and the current state of the capital markets is
not favorable for raising such funds. However, our long-term strategy
remains to establish independent outside funding to finance its
activities. There can be no assurance that we or Comverge will be able
to raise additional capital or secure alternative financing or raise
amounts sufficient to meet the long-term needs of the business; we are
therefore not including proceeds of any such possible financing in our
current liquidity projections.
o Payments under the Laurus Convertible Note: Since September 30, 2002,
we have made the first two principal payments on the convertible note
described in Note 3, in cash. Unless cash flow improves substantially,
the remaining payments will be made by delivering shares of its common
stock, thereby conserving cash. Payments using the Company's common
stock, however, would involve substantial dilution and could have a
negative impact on the price of our common stock.
dsIT is fully utilizing its line of credit of $2,000,000. We believe that
dsIT will have sufficient liquidity to finance its activities from cash flow
from its own operations over the next 12 months. This is based on continued
utilization of its line of credit and improved operating results stemming from
continued cost reductions.
We believe that our plans to finance our operations over the next 12 months
can be successfully implemented on a timely basis in a manner that will not
impede our ability to implement its current business strategy. However, due to
our liquidity, execution of these plans is subject to significant risks and
uncertainties, including those associated with (i) timely manufacture and
delivery of products, (ii) obtaining additional business from current and
prospective customers, and (iii) effective and timely implementation of our
planned reductions in direct costs and expenses.
Should we be unsuccessful in implementing our plans on a timely basis, we
may not have sufficient liquidity to continue with our operations as currently
conducted.
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NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued Statement No. 143, ACCOUNTING FOR ASSET
RETIREMENT OBLIGATIONS ("SFAS 143"). SFAS 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. It applies to legal
obligations associated with the retirement of long-lived assets that result from
the acquisition, construction, development and (or) the normal operation of a
long-lived asset, except for certain obligations of lessees. This Statement
amends FASB Statement No. 19, FINANCIAL ACCOUNTING AND REPORTING BY OIL AND GAS
PRODUCING COMPANIES, and it applies to all entities. We are required to adopt
SFAS 143, effective for calendar year 2003. We do not expect the adoption of
SFAS 143 to have a material impact on our future consolidated operations or
financial position, as we are now constituted.
In July 2002, the FASB issued Statement of Financial Accounting Standards
No. 146, ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES ("SFAS
146"). SFAS 146 addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity" (including Certain
Costs Incurred in a Restructuring). We are required to adopt SFAS 146, effective
January 1, 2003. We do not expect the adoption of SFAS 146 to have a material
impact on our future consolidated operations or financial position, as we are
now constituted.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of business, we are exposed to fluctuations in
interest rates on the $6.0 million of debt incurred to finance our capital
expenditures as well as short-term and long-term debt, currently $1.8 million
and $590,000, respectively, to finance our operations in Israel. Our convertible
note, with a face value of $2 million, has a fixed rate of interest of 10%;
however, the conversion feature of our convertible note is exposed to
fluctuations in the price of our common stock. Additionally, our monetary assets
and liabilities (net liability of approximately $855,000) in Israel are exposed
to fluctuations in exchange rates. We do not employ specific strategies, such as
the use of derivative instruments or hedging, to manage our interest rate or
exchange rate exposures. In addition, we currently have $411,000 invested in
debt securities with maturities in excess of one year. These debt securities are
classified as trading securities and expose us to interest rate risk with
respect to the effect fluctuations of market interest rates have on the
valuation of these securities.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF CONTROLS AND PROCEDURES
Within 90 days prior to the date of filing of this report, we carried out
an evaluation, under the supervision and with the participation of our
management, including the Chief Executive Officer and the Chief Financial
Officer, of the design and operation of our disclosure controls and procedures.
Based on this evaluation, our Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures are effective for
gathering, analyzing and disclosing the information we are required to disclose
in the reports we file under the Securities Exchange Act of 1934, within the
time periods specified in the SEC's rules and forms.
CHANGES IN CONTROLS AND PROCEDURES
There have been no significant changes in our internal controls or in other
factors that could significantly affect internal controls subsequent to the date
of our most recent evaluation.
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PART II - OTHER INFORMATION
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Amendment to Employment Agreement, dated as of June 1, 2002, between
the registrant and Yacov Kaufman.
99.1 Certification of Chief Executive Officer pursuant to Section 906 of
Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer pursuant to Section 906 of
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
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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 its
Principal Financial Officer thereunto duly authorized.
DATA SYSTEMS & SOFTWARE INC.
Dated: November 14, 2002
By: /S/ YACOV KAUFMAN
--------------------------------------
Yacov Kaufman
Vice President and Chief Financial Officer
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I, George Morgenstern, the Chief Executive Officer of Data Systems &
Software Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Data Systems &
Software Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and to the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Dated: November 14, 2002 By: \S\ GEORGE MORGENSTERN
------------------------------
George Morgenstern
Chief Executive Officer
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I, Yacov Kaufman, the Chief Financial Officer of Data Systems & Software
Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Data Systems &
Software Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and to the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Dated: November 14, 2002 By: \S\ YACOV KAUFMAN
----------------------
Yacov Kaufman
Chief Financial Officer
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EXHIBIT 10.1
AMENDMENT TO EMPLOYMENT AGREEMENT
AMENDMENT TO EMPLOYMENT AGREEMENT dated as of June 1, 2002 between DATA SYSTEMS
& SOFTWARE INC., a Delaware corporation (the "Company"), and YACOV KAUFMAN (the
"Executive"),
W I T N E S S E T H:
WHEREAS, the Executive and the Company signed an employment agreement on January
1, 1999 and wish to extend it and amend certain terms; and
WHEREAS, the Executive has successfully fulfilled the responsibilities of his
positions in the Company and its subsidiaries; and
WHEREAS, the Company desires to assure itself of the Executive's continued
services, and the Executive is willing to continue to provide such services to
the company, all upon the terms and conditions hereinafter set forth.
NOW, THEREFORE, in consideration of the promises hereinafter set forth, the
parties hereto, intending to be legally bound, hereby agree as follows:
EMPLOYMENT.
To extend the Employment Period as defined in the Employment Agreement.
COMPENSATION.
To amend Paragraph 2(a) in the Employment Agreement so as to reflect the salary
previously approved and pay the Executive a salary at the rate of $13,333 per
month, retroactive to January1, 2001. In addition, commencing on January 1, 2002
an additional sum of $3,334 per month.
TERMINATION.
Replace Paragraph 4(c) of the Employment Agreement with;
(c) In addition to the severance payment pursuant to Paragraph 4(b), upon the
termination of the Executive's employment, the Company shall pay the Executive a
termination payment equal to six times his last month's total compensation.
This payment is in addition to any other rights and payments owing to the
Executive under this Agreement."
COUNTERPARTS.
This Agreement may be executed in counterparts, each of which shall constitute
an original and which together shall constitute one and the same agreement.
IN WITNESS WHEREOF the parties hereto have executed this Agreement, as of
the day and year first above written.
DATA SYSTEMS & SOFTWARE INC.
\S\ YACOV KAUFMAN By:\S\ GEORGE MORGENSTERN
------------------------ ------------------------
Yacov Kaufman George Morgenstern
CEO and President
By:\S\ SHELDON KRAUSE
--------------------
Sheldon Krause
Secretary
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EXHIBIT 99.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Data Systems & Software Inc. (the
"Company") on Form 10-Q for the three and nine month periods ended September 30,
2002 as filed with the Securities and Exchange Commission on the date hereof
(the "Report"), I, George Morgenstern, Chief Executive Officer of the Company,
certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the
Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of
the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and result of operations of the Company.
/S/ GEORGE MORGENSTERN
- ------------------------
George Morgenstern
Chief Executive Officer
November 14, 2002
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EXHIBIT 99.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Data Systems & Software Inc. (the
"Company") on Form 10-Q for the three and nine month periods ended September 30,
2002 as filed with the Securities and Exchange Commission on the date hereof
(the "Report"), I, Yacov Kaufman, Chief Financial Officer of the Company,
certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the
Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of
the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and result of operations of the Company.
/S/ YACOV KAUFMAN
- -------------------
Yacov Kaufman
Chief Financial Officer
November 14, 2002
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