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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
--------------------------
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000 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 IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
200 ROUTE 17, MAHWAH, NEW JERSEY 07430
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE
(201) 529-2026
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
COMMON STOCK PURCHASE RIGHTS
(Title of each class)
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. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the common stock held by non-affiliates of
the registrant at March 26, 2001 was approximately $31.2 million. The aggregate
market value was calculated by using the closing price of the stock on that date
on the Nasdaq National Market.
Number of shares outstanding of the registrant's common stock, as of March
26, 2001: 7,044,687.
DOCUMENTS INCORPORATED BY REFERENCE:
Certain sections of the registrant's Proxy Statement to be filed pursuant
to Regulation 14A under the Securities Exchange Act of 1934 within 120 days of
the end of the registrant's fiscal year are incorporated by reference into Part
III of this Form 10-K.
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TABLE OF CONTENTS
PAGE
PART I
Item 1 Business ....................................................... 1
Item 2 Properties ..................................................... 7
Item 3 Legal Proceedings. ............................................. 7
Item 4 Submission of Matters to a Vote of Security Holders. ........... 7
PART II
Item 5 Market for Registrant's Common Equity and
Related Stockholder Matters. ................................. 8
Item 6 Selected Financial Data. ....................................... 8
Item 7 Management's Discussion and Analysis of
Financial Condition and Results of Operations ................ 10
Item 7A Quantitative and Qualitative Disclosures About Market Risk...... 16
Item 8 Financial Statements and Supplementary Data. ................... 16
Item 9 Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure ....................... 16
PART III
Item 10 Directors and Executive Officers of the Registrant. ............ 17
Item 11 Executive Compensation. ........................................ 17
Item 12 Security Ownership of Certain Beneficial
Owners and Management ........................................ 17
Item 13 Certain Relationships and Related Party Transactions ........... 17
PART IV
Item 14 Exhibits, Financial Statement Schedules,
and Reports on Form 8-K. ..................................... 17
Certain statements contained in this report are forward-looking in nature.
These statements can be identified by the use of forward-looking terminology
such as "believes," "expects," "may," "will," "should" or "anticipates," or the
negatives thereof, or comparable terminology, or by discussions of strategy. You
are cautioned that our business and operations are subject to a variety of risks
and uncertainties and, consequently, our actual results may materially differ
from those projected by any forward-looking statements. Certain of such risks
and uncertainties are discussed below under the heading "Item 1.
Business-Factors That May Affect Future Results."
PART I
ITEM 1. BUSINESS
OVERVIEW
Data Systems & Software Inc., through its subsidiaries in the United States
and Israel, is engaged in the following businesses:
o providing consulting and development services for computer software and
systems;
o developing and marketing load control and data communications solutions for
electric utilities; and
o serving as an authorized dealer and a value-added-reseller (VAR) of
computer hardware.
In January 2000 we disposed of our equity investment in Tower Semiconductor
Ltd. ("Tower"), a manufacturer of semiconductors.
CONSULTING AND DEVELOPMENT SERVICES
SERVICES
Through our subsidiaries, Decision Systems Israel ("DSI Israel") and
International Data Operations (IDO), we provide computer software and systems
consulting, development and integration services, primarily to high technology
customers in Israel and the United States. Our principal area of technological
expertise is state-of-the-art hardware with embedded real-time software systems
in a wide variety of applications, including telecommunications, digital signal
processing, image processing and software testing and validation, electronic
warfare, simulation and electro-optics.
We provide our services either on a time-and-materials or fixed-price basis.
When working on a time-and-materials basis, our software and systems engineers,
programmers and technicians are generally sent to the customer's premises to
perform design and development activities under the customer's direction. In
these engagements, our personnel typically have no specific obligation for
product delivery. During 1998, 1999 and 2000, sales attributable to services
provided on a time-and-materials basis were $15.6 million, $15.2 million and
$14.2 million, respectively, accounting for approximately 83%, 81% and 75% of
segment sales for such years, respectively.
When working on a fixed-price basis, we undertake to deliver software or
hardware/software solutions to a customer's specifications or requirements for a
particular project. We account for these services on the
percentage-of-completion method. As the profit margins on these projects are
primarily determined by our success in controlling project costs, such margins
may vary substantially as a result of various factors, including underestimating
costs, difficulties with new technologies and economic and other changes that
may occur during the term of the contract. During 1998, 1999 and 2000 sales from
fixed-price contracts were $3.3 million, $3.6 million and $4.8 million,
respectively, accounting for approximately 17%, 19% and 25% of segment sales for
such years, respectively.
CUSTOMERS AND MARKETS
Israel has historically been the primary area of this segment's operations,
accounting for 78%, 77% and 82% of segment sales in 1998, 1999 and 2000,
respectively. We have developed a diverse customer base, such that in 2000 one
customer accounted for 15% of segment revenues and no other customer accounted
for more than 7% of segment revenues.
COMPETITION
Our consulting and development services segment faces competition from
numerous competitors, both large and small, operating in the Israeli and United
States markets, some with substantially greater financial and marketing
resources. In addition to competing for customers, we are also competing with
other consulting companies and with our customers to obtain qualified personnel,
due to a shortage of qualified engineers in Israel and the United States. We
believe that our wide range of experience and long-term relationships with large
corporations in Israel and the United States will enable us to compete
successfully and obtain future business.
PROPRIETARY RIGHTS
The intellectual property rights resulting from our consulting and
development services, generally are owned by the customer for whom the services
are performed. As a result, we have no capitalized software to be sold, leased
or otherwise marketed.
UTILITY SOLUTIONS
Through our Comverge Technologies subsidiary, we design, develop and market a
variety of load control and data communications solutions for the electric
utility market. The electric utility industry is increasingly adopting
communications and control solutions in response to the need to obtain real-time
usage information and more efficiently and cost-effectively manage peak
electricity demand. Our load con-
trol solutions allow electric companies to reduce usage or "shed load" during
peak usage periods, such as the summer air conditioning season, thereby reducing
or eliminating the need to buy costly additional power on the spot market, or
invest in new generation capacity. This solution is both cost-effective and
environmentally superior to building new generation capabilities. Our two-way
data communications solutions allow utilities to gather and transmit real-time
usage information, and can be used for automated meter reading, support
time-of-use metering, theft detection, remote connect/disconnect and other
value-added services.
HISTORY
Since 1992, we have been designing, developing and marketing two-way
interactive communications solutions that provide real-time, remote automated
meter reading ("AMR") and data management capabilities to utilities
internationally. We developed state-of-the-art, high-speed, power line carrier
technology and have deployed pilot systems in Thailand, Taiwan, Venezuela,
Argentina, Israel and Mexico.
Shortly after its formation in 1998, Comverge acquired certain assets and
licenses to intellectual property from Lucent Technologies' Utilities Solution
business division. The licensed technology relates to a product, which had been
deployed by Lucent at Public Service Electric and Gas using a two-way cable TV
system and at Duke Power using an Internet-based wireless network. A number of
the employees who were involved in developing this product are now employed by
Comverge.
In August 1999, Comverge purchased the assets and business of
Scientific-Atlanta's Control Systems business division, acquiring the division's
load control and gateway product lines and hiring a number of employees from
this division.
Comverge's headquarters and marketing and sales divisions operate out of New
Jersey, its engineering and product manufacturing facility is in Atlanta, and
its research center is in Israel.
PRODUCTS AND SERVICES
By building on the technology and expertise developed by our subsidiary in
Israel, combined with our strategic acquisitions of technology, personnel,
contracts and customer base from Lucent and Scientific-Atlanta, we have created
a global company offering data communications and control product solutions that
address the information and control needs of today's energy market. Our
technical expertise includes load control, broadband, wireless and powerline
communications, Internet and home networking and automation.
Comverge currently offers products in three product lines:
o Real-time usage information products;
o Load control products; and
o Gateway products, which combine real-time information and control.
REAL-TIME USAGE INFORMATION PRODUCTS. We are currently marketing the Comverge
Distributed Connection (CDC), a meter-reading device for gathering and
transmitting real-time usage information and providing distributed generation
monitoring and control for commercial and industrial customers. The CDC uses
Internet-based CDPD (cellular digital packet data) communications to transmit
detailed information regarding patterns of energy consumption and is targeted at
industrial and commercial customers, an important segment of the user market for
energy companies. The use of CDPD for data communication makes our product
easier to install and less expensive to run than products that require a
dedicated telephone line. Our alliances with Verizon Wireless, AT&T Wireless and
GTE give us a national platform from which to market this product.
LOAD CONTROL PRODUCTS. Power distribution utilities use load control products
to lessen peak electrical demand, avoiding the need to buy costly electricity on
the spot market or to build new generation facilities. Generators and energy
marketers can use load control products to free capacity during high cost
periods for resale to others. We offer our customers two major load control
products: digital control units (DCUs) and SuperStats. The DCU is a switch that
can be connected to any appliance, such as an air conditioner or water heater,
which permits the utility to turn appliances on and off from a remote location
utilizing wireless communications. Our SuperStat product, jointly developed with
Honeywell, combines a Honeywell programmable thermostat with a wireless
communication module to provide direct load control of heating and cooling
systems, allowing customers to choose when and how much energy to use, while
giving the utility the ability to control air conditioning systems through the
thermostat during peak usage periods.
GATEWAY PRODUCTS. Our gateway products are systems designed around a
communications "gateway," or bridge, which permits two-way real-time
communications between a local area network (LAN), such as a "network" of
appliances and other devices within a home, or a network of meters at multiple
users, and a wide area network (WAN), such as cable, telephone or CDPD. The
gateway products provide information and load control to the electric service
company and can significantly reduce the end customer's electricity bills.
Our gateway products are fully integrated and provide utilities with
comprehensive solutions for diverse requirements. Because of the different needs
and configurations of the US and foreign utility markets, we market two distinct
gateway product lines: Maingate, targeted to the domestic US utility markets,
and EPSM, which is targeted at markets outside the United States.
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Maingate provides two-way real time metering, time-of-use pricing, load
control and whole house surge suppression for residential users. In the typical
configuration, the central air conditioning system, controlled by a SuperStat
thermostat, the water heater and up to one additional appliance within the home,
are fitted with PLC-based load control devices. The load control devices and the
SuperStat are networked, and linked via the Maingate gateway to the WAN.
Maingate allows the customer to automatically respond to energy price variations
to minimize their usage during high priced periods. For example, during August
when electricity usage is high due to increased air conditioner use, the utility
generated price will rise and the pre-programmed customer response to this price
increase will automatically raise the temperature setting. However, the customer
may elect to override the direct control and set the thermostat as desired and
pay for the electricity used at peak load rates. This price responsive demand
reduces the customer's bill while reducing the utilities' peak load. The
win-win, price driven scenario is widely viewed as the best model for demand
side management, particularly in deregulated energy markets. Because of its
ability to communicate with devices within the home, Maingate will also support
additional value-added "smart-home" products and services when they become
available. Rollout of Maingate has commenced under a contract with Gulf Power
which contemplates installation of Maingate into 40,000 homes, with 1,400 units
installed through December 31, 2000.
EPSM, our international gateway product, uses existing power lines to
transmit the electricity consumption data of each meter through a hub to the
utility's main computer. A comprehensive software package controls the system's
operations and facilitates functions such as real-time load switching, peak
demand control and detection of theft of electrical power. EPSM has been
demonstrated in several pilot projects and we are actively marketing EPSM for
full-scale implementation. We believe the EPSM is a cost-effective solution for
the AMR and data management needs of utilities in international markets.
CUSTOMERS AND MARKETS
Our utility solutions business has over 450 utility customers in eight
countries and 5,000,000 end point installations worldwide. The worldwide market
for utility solutions is still emerging, with a virtually untapped potential,
estimated at $29 billion over the next five years. We anticipate growth in this
market to be driven by the following factors:
o Increasing worldwide demand for electricity and volatility of electricity
prices;
o Anticipated market and regulatory incentives to manage peak usage periods
in an economically efficient and environmentally friendly manner; and
o Widespread deregulation of the electric utility industry in the United
States and resulting increased competition among electric service
companies.
Although the final outcome of the current trend toward deregulation in the
United States and globally is unknown, we anticipate that the new, more
competitive environment, combined with anticipated government incentives and
mandates, will result in continued growth in the demand for products designed to
gather information and manage electricity usage.
DOMESTIC. Comverge's customers are generally electric utilities, electric
service companies or prime contractors that serve electric utilities. Our
largest customer is Florida's Gulf Power, which purchased over $3 million in
2000 and is under contract to purchase $22 million of Maingate systems in total.
In addition, we have significant contracts for our DCU products with other
domestic utilities and energy service companies. We have proven that our CDC and
SupersStat products work in small-scale deployments, and as our track record
grows, we expect to expand our sales to our existing customers to full-scale
deployments. In addition to expanding relationships with existing customers, our
strategy is to take advantage of the relationships with these customers to
extend our sales to their affiliates, many of whom are owned by large utility
holding companies with several owned utilities. We have also formed joint
marketing partnerships with Verizon Wireless, Schlumberger and Honeywell, and
continue to plan to expand on these relationships.
INTERNATIONAL. We continue to market pilot and full scale deployment of our
EPSM systems, building on our pilot deployments in Venezuela, Thailand and
Taiwan. Discussions continue regarding expansion of our pilot deployments. In
some instances we have formed alliances in which we function as a subcontractor,
integrating our systems into a larger utility system purchased by a utility from
a prime contractor. One such alliance is with Atlanta-based Advanced Control
Systems for a project in Taiwan. Although our primary international focus has
been on EPSM, we continue marketing efforts seeking to expand our sales of load
control products to the international market.
COMPETITION
Within the emerging utility solutions market, we face competition from a
variety of companies and products, each of which is trying to garner a share the
market. Key competitors include Itron, ABB, Schlumberger and Mainstreet Networks
for our gateway products, CEPG for commercial and industrial AMR products, and
Cannon Technologies and Itron in the load control area. In addition to these
companies, there are many other competitors and potential competitors vying for
a piece of this as yet undefined market. We believe that our products offer
significant competitive advantages because they:
o have been proven in the field;
o offer significant technological advantages over competing products; and/or
3
o cost less than many of our competitors' products.
However, some of our competitors have more resources, better market
recognition, a larger sales force or can offer features not offered by our
products. In addition, certain of our competitors manufacture and sell electric
meters or back-end billing or other software systems to utilities, possibly
providing them an advantage in marketing their utility solution products. We
cannot be certain that our products will win market acceptance or that we will
be able to capture a significant segment of the market.
PROPRIETARY RIGHTS
Comverge holds 24 patents and patents pending. We try to take all action
necessary to protect our proprietary rights. Certain products that we have
developed and are developing incorporate or are derived from intellectual
property owned by third parties under license to us.
In our product development activities, we rely on a combination of
nondisclosure agreements and technical measures to establish and protect our
proprietary rights, if any, in our products. We believe that, as a result of the
rapid pace of technological change in the software and real-time system
industries, legal protection for our products, if any, will be less significant
to our prospects than the knowledge, ability and expertise of our management and
technical personnel.
COMPUTER HARDWARE SALES
PRODUCTS AND SERVICES
Through our Databit subsidiary, we sell and service PC-based computer
hardware, software, data storage, client/server and networking solutions in the
United States. Databit is an authorized direct seller, value-added-reseller and
an authorized service provider for equipment and software from such well-known
industry leaders as Compaq, IBM, Microsoft, Oracle, 3Com, Hewlett-Packard, NEC,
Acer, Apple and Dell. We offer our customers a full range of systems integration
services, including design, implementation, hardware and software selection, and
implementation of local and wide area networks. In addition, we provide
maintenance and service to customers under extended service agreements. Our
equipment and software sales and other services are offered under separately
negotiated and priced agreements.
CUSTOMERS AND MARKETS
Computer hardware segment sales include sales to two major customers,
Montefiore Medical Center (which accounted for approximately 14% and 24% of
sales in 1999 and 2000, respectively) and Westcon (which accounted for
approximately 1% and 11% in 1999 and 2000, respectively). No other customer
accounted for more than 5% of segment sales.
COMPETITION
The market for PCs and related peripheral hardware sales in which we operate
is characterized by severe competition in price-performance, breadth of product
line, financing capabilities, technical expertise, service and overall
reputation. Manufacturers have been increasing their direct sales efforts on the
Internet and otherwise, reducing prices to end-users, which reduces profit
margins for distributors and value-added-resellers such as Databit. Our
competitors include manufacturers, other VAR's, large equipment aggregators
(some of whom sell to us) and systems integrators. Many of our competitors have
longer operating histories, greater financial resources and buying power and
larger, established customer bases. We compete by offering attractive prices and
flexible payment terms, and by helping our customers evaluate their needs and
tailoring solutions by offering other value added services such as configuration
and on site service.
SALES BY ACTIVITY
The following table shows, for the years indicated, the dollar amount and the
percentage of the sales attributable to each of the activities of our
operations.
YEAR ENDED DECEMBER 31,
---------------------------------------------------------
1998 1999 2000
AMOUNT % AMOUNT % AMOUNT %
----- ---- ----- ---- ----- ----
(DOLLARS IN THOUSANDS)
Consulting and development services ....... $18,640 50% $18,784 47% $18,977 33%
Utility solutions. ........................ 212 1% 5,061 13% 17,105 30%
Computer hardware sales. .................. 16,374 45% 15,218 38% 21,515 37%
Other ..................................... 1,484 4% 645 2% 242 0%
------ --- ------ --- ------ ---
Total sales. .............................. $36,710 100% $39,708 100% $57,839 100%
====== === ====== === ====== ===
4
BACKLOG
As of January 1, 2001, our backlog of work to be completed was $31 million,
similar to our backlog of January 1, 2000, $27 million of which related to our
utility solution segment, primarily under our contract with Gulf Power. We
estimate that we will perform $10 million of the backlog in 2001.
DISCONTINUED AND DIVESTED ACTIVITIES
In recent years we have been increasing our focus on our core businesses and
have discontinued or divested a number of activities. The multimedia
entertainment software segment suspended operating activity in the first quarter
of 1998, and in the second quarter of 1998 we sold the assets of our PHD help
desk software segment.
In January 2000 we sold all of our interest in Tower for approximately $30.9
million.
Until January 2000, Mofet Venture Capital Fund Management (1992) Ltd., of
which we were a 50% owner, managed the Mofet Israel Technology Fund ("Mofet
Fund"), an Israeli public investment company. Under the management agreement
with the Mofet Fund, the management company received a management fee equal to
4% of the amounts invested in the Fund (excluding profits). The management
agreement was not renewed in January 2000 and the management company is
therefore no longer active.
In September 2000, the Company completed the sale of substantially all the
assets of its CinNetic division.
See Note 2 to the consolidated financial statements included in this report
for additional information regarding these transactions.
EMPLOYEES
At December 31, 2000, we employed a total of 263 people, including 182
persons in engineering and technical support (approximately one-half with
advanced degrees in computer and electronic engineering), 25 in marketing and
sales, and 56 in management, administration and finance. A total of 176 of our
employees are based in Israel.
We consider our relationship with our employees to be satisfactory.
We have are no collective bargaining agreements with any of our employees.
However, with regard to our Israeli activities, certain provisions of the
collective bargaining agreements between the Israeli Histadrut (General
Federation of Labor in Israel) and the Israeli Coordination Bureau of Economic
Organizations (including the Industrialists Association) are applicable by order
of the Israeli Ministry of Labor. These provisions concern mainly the length of
the work day, contributions to a pension fund, insurance for work-related
accidents, procedures for dismissing employees, determination of severance pay
and other conditions of employment. We generally provide our Israeli employees
with benefits and working conditions beyond the required minimums. Israeli law
generally requires severance pay upon the retirement or death of an employee or
termination of employment without due cause. Furthermore, Israeli employees and
employers are required to pay specified amounts to the National Insurance
Institute, which administers Israel's social security programs. The payments to
the National Insurance Institute include health tax and are approximately 17% of
wages (up to a specified amount), of which the employee contributes
approximately 60% and the employer approximately 40%.
RESEARCH AND DEVELOPMENT (R&D)
For information on products being developed and their costs, see "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements appearing in this annual
report.
SEGMENT INFORMATION
For additional financial information regarding our operating segments,
foreign and domestic operations and export sales, see "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
Note 18 to our consolidated financial statements included in this annual report.
FACTORS WHICH MAY AFFECT FUTURE RESULTS
We may from time to time make written or oral statements that contain
forward-looking information. However, our actual results may differ materially
from our expectations, statements or projections. The following risks and
uncertainties could cause actual results to differ from our expectations,
statements or projections.
5
GENERAL FACTORS
OUR MARKETS ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGE; IF WE FAIL TO KEEP PACE,
WE WILL HAVE DIFFICULTY DEVELOPING AND MAINTAINING A MARKET FOR OUR PRODUCTS AND
SERVICES.
The markets for our utility solutions products and consulting and development
services segments are characterized by rapid technological change. We will need
to invest in continued product development and personnel training in order to
keep pace with changing technologies. We may not have adequate resources to
invest in development, and our development efforts may not be successful.
EXCHANGE RATE FLUCTUATIONS COULD INCREASE THE COST OF OUR ISRAELI OPERATIONS.
A significant portion of our sales and expenses of our Israeli operations are
in New Israeli Shekels ("NIS") linked to the dollar. Such transactions are
negotiated in dollars; however, for the convenience of the customer or vendor,
they are settled in NIS. The dollar cost of our operations in Israel will be
increased if the dollar is devalued in relation to the NIS or the NIS is
devalued in relation to the dollar at a rate lower than the rate of inflation in
Israel.
LOSS OF THE SERVICES OF A FEW KEY EMPLOYEES COULD HARM OUR OPERATIONS.
We depend on our key management and technical employees. The loss of certain
managers could diminish our ability to develop and maintain relationships with
customers and potential customers. The loss of technical personnel could harm
our ability to meet development and implementation schedules. Most of our
significant employees are bound by confidentiality and non-competition
agreements. We do not maintain a "key man" life insurance policy on any of our
executives or employees. Our future success also depends on our continuing
ability to identify, hire, train and retain other highly qualified technical and
managerial personnel. Competition for such personnel is intense. If we fail to
attract or retain highly qualified technical and managerial personnel in the
future, our business could be disrupted.
RISKS RELATED TO THE CONSULTING AND DEVELOPMENT SERVICES SEGMENT
TIGHT PROFESSIONAL LABOR MARKETS MAY MAKE IT DIFFICULT FOR US TO HIRE AND
MAINTAIN QUALIFIED PERSONNEL.
In recent years due to the surge in high-tech development we have been
experiencing a relative shortage of qualified programmers and engineers. This
has had an adverse effect on our profitability and ability to offer consulting
and project development services. Although this shortage has recently eased, it
is generally accepted that the shortage will continue. Should the shortage
become more acute, this will have an adverse effect on our profits and our
ability to offer consulting and project development services in the future.
NEW ISRAELI LABOR LAW LEGISLATION MAY RESTRICT OUR CONSULTING SERVICE BUSINESS.
Israel recently passed certain legislation limiting and restricting the
activity of manpower companies. It is uncertain whether this legislation applies
to Israeli outsourcing companies in general or to our consulting and development
activities in particular. Should the courts decide that this legislation does
apply to our Israeli consulting activity, this would have an adverse effect on
our business.
FAILURE TO ACCURATELY FORECAST COSTS OF FIXED-PRICED CONTRACTS COULD HARM OUR
BUSINESS.
When working on a fixed-price basis, we undertake to deliver software or
integrated hardware/software solutions to a customer's specifications or
requirements for a particular project. The profits from these projects are
primarily determined by our success in correctly estimating and thereafter
controlling project costs. Costs may in fact vary substantially as a result of
various factors, including underestimating costs, difficulties with new
technologies and economic and other changes that may occur during the term of
the contract. If, for any reason, our costs are substantially higher than
expected, losses on fixed-price contracts could harm our business.
RISKS RELATED TO THE UTILITY SOLUTIONS SEGMENT
We have made a significant investment in our utility solutions segment, which
develops and markets load control products and systems offering two-way
automated meter reading and related data management capability to utilities.
Although the revenue base of the segment has improved, to date this segment has
operated at a loss. The activities of this segment are subject to many risks,
including the following.
THE PACE OF UTILITY DEREGULATION HAS BEEN SLOW; THE ULTIMATE REGULATORY
STRUCTURE OF THE UTILITY INDUSTRY MAY NOT PROVIDE MANDATES OR INCENTIVES TO
PURCHASE OUR PRODUCTS.
The electric utility industry is undergoing significant deregulation. Market
observers expect deregulation to include energy choice and time-of-use pricing
requirements, which will mandate, or favor implementation by utilities of, load
control programs and the use of automated meter reading and data distribution.
However, the pace of deregulation has not been as rapid as expected and to date
only a limited number of utilities have made purchase commitments for automated
meter reading and data distribution systems. Many utilities have also
6
deferred the purchase of load control systems, pending resolution of broader
industry and regulatory developments. The results of deregulation are uncertain
and may not result in the mandates or incentives for the types of services which
require AMR systems. If the state and federal regulation does not provide these
requirements or incentives, the market for our products may not develop as we
expect.
WE MUST COMPETE WITH OTHER UTILITY SOLUTIONS COMPANIES FOR MARKET ACCEPTANCE AND
CUSTOMERS.
While we believe that the systems offered by our utility solutions segment
offer advantages over competing load control and data communications solutions,
there are alternative solutions, and we cannot predict what share of the market
we will obtain. In addition, some of our competitors have more sales and
marketing resources, better brand recognition and/or technologies that offer
alternative advantages. If our potential customers do not adopt our solutions or
do so less rapidly than we expect, our future financial results and our ability
to achieve positive cash flow or profitability will be harmed.
WE MAY ENCOUNTER DIFFICULTIES IN IMPLEMENTING OUR TECHNOLOGY, PRODUCTS AND
SERVICES.
Problems may occur in the implementation of our technology, products or
services, and we may not successfully complete the commercial implementation of
our technology on a wide scale. Future advances may render our technology
obsolete or less cost effective than competitive systems. Consequently, we may
be unable to offer competitive services or offer appropriate new technologies on
a timely basis or on satisfactory terms.
DELAYS, QUALITY CONTROL AND PRICE PROBLEMS COULD ARISE DUE TO OUR RELIANCE ON
THIRD-PARTY MANUFACTURERS OF CERTAIN COMPONENTS.
We use outside parties to manufacture components of some of our products. Our
reliance on these third-party manufacturers exposes us to risks relating to
timeliness, quality control and pricing. We have experienced certain delays and
quality control problems from third-party manufacturers and have taken steps to
alleviate them, including the decision to manufacture certain components
in-house. Delays, price increases or quality control problems at our third-party
manufacturers could harm our relationships with our customers, our operating
results and cash flow.
RISKS RELATED TO THE COMPUTER HARDWARE SEGMENT
WE FACE LOW MARGIN, MASS MARKETING COMPETITION.
The market for PCs and related peripheral hardware sales in which we operate
is characterized by severe competition in price-performance and financing
capabilities. Manufacturers and on-line Internet vendors have been increasing
their direct sales efforts on the Internet and otherwise, reducing prices to
end-users, which reduce profit margins for distributors and value added
resellers such as our Databit subsidiary. Profit margins have already
deteriorated in comparison to past years. Should this trend continue, it could
make our method of sales uneconomical.
ITEM 2. PROPERTIES
Our corporate headquarters and the principal offices for our US computer
consulting and development services and hardware sales segments are located in
Mahwah, New Jersey in approximately 5,000 square feet of office space, under a
lease which expires in September 2003. The rent for these premises currently is
$85,000 per annum. We also rent offices in New York City of approximately 3,500
square feet, under a lease which expires in October 2005, at a current rent of
$134,000 per annum. In addition, our Comverge subsidiary rents approximately
11,900 square feet in Florham Park, New Jersey, at an annual rent of $126,000
under a lease which expires January 2003, and approximately 31,668 square feet
in Gwinett, Georgia under a lease which expires in May 2006, at a current rent
of $201,000 per annum.
Our Israeli activities are conducted in approximately 18,000 square feet of
office space in the Tel Aviv metropolitan area under a lease that expires in
April 2010. The annual rent is approximately $300,000. These facilities are used
for the Israeli operations of the computer consulting and development services
segment and the utility solutions segment.
ITEM 3. LEGAL PROCEEDINGS
We are not involved in any legal proceedings that we believe, individually or
in the aggregate, will have a material adverse effect our company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
7
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our Common Stock is traded on the Nasdaq National Market System (NASDAQ/NNM)
under the symbol "DSSI." The following table sets forth, for the periods
indicated, the high and low reported sales prices per share of our Common Stock
on the Nasdaq Stock Market.
HIGH LOW
------- -------
1999
- ----
First Quarter ..................................... $3.000 $1.750
Second Quarter .................................... 4.250 1.750
Third Quarter ..................................... 4.750 2.438
Fourth Quarter .................................... 3.750 2.188
2000
- ----
First Quarter ..................................... 7.563 3.063
Second Quarter .................................... 5.688 3.000
Third Quarter ..................................... 5.250 4.125
Fourth Quarter .................................... 6.125 3.938
As of March 20, 2001, there were approximately 75 record holders of our
Common Stock. We estimate that there are approximately 2,000 beneficial owners
of our Common Stock.
We paid no dividends in 1999 or 2000 and we do not intend to pay dividends in
2001. There are currently no restrictions on our declaration and payment of
dividends.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated statement of operations data for the year ended
December 31, 2000 and consolidated balance sheet data as of December 31, 2000
has been derived from our consolidated financial statements included in this
annual report, which have been audited by KPMG LLP, independent auditors. The
selected consolidated statement of operations data for the years ended December
31, 1998 and 1999 and balance sheet data as of December 31, 1999 has been
derived from our consolidated financial statements included in this annual
report which were audited by Deloitte & Touche LLP, independent auditors. The
selected statement of operations data for the years ended December 31, 1996 and
1997 and balance sheet data as of December 31, 1996, 1997 and 1998 has been
derived from audited consolidated financial statements not included herein.
This data should be read in conjunction with our consolidated financial
statements and related notes and "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations."
8
SELECTED CONSOLIDATED STATEMENT OF OPERATIONS DATA
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------------------------------
1996 1997 1998 1999 2000
----- ----- ----- ----- -----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Sales ............................................... $32,067 $ 36,154 $ 36,710 $ 39,708 $ 57,839
Cost of sales ....................................... 26,083 31,303 28,814 31,615 45,606
------- -------- -------- -------- --------
Gross profit ...................................... 5,984 4,851 7,896 8,093 12,233
Research and development expenses ................... 1,270 1,335 1,605 1,269 928
Selling, general and administrative expenses ........ 8,130 11,349 12,549 12,471 16,340
Gain on sale of division -- -- -- -- 1,144
------- -------- -------- -------- --------
Operating loss .................................... (3,416) (7,833) (6,258) (5,647) (3,891)
Interest income ..................................... 728 478 147 61 1,758
Interest expense .................................... (290) (225) (360) (910) (709)
Other income (loss), net ............................ 2,032 (244) (2,172) (306) (50)
Minority interests .................................. (141) 676 878 (275) --
Equity loss in affiliates ........................... (1,767) -- -- -- --
------- -------- -------- -------- --------
Loss from continuing operations before provision
(benefit) for income taxes ...................... (2,854) (7,148) (7,765) (7,077) (2,892)
Provision (benefit) for income taxes ................ (158) 3,507 35 62 171
------- -------- -------- -------- --------
Loss from continuing operations ................... (2,696) (10,655) (7,800) (7,139) (3,063)
Income (loss) from discontinued operations,
net of income taxes ............................... 216 211 (11,142) (8,728) (104)
Gain on sale of discontinued operations,
net of income taxes ............................... -- -- 5,998 -- 4,222
------- -------- -------- -------- --------
Income (loss) before extraordinary item ........... (2,480) (10,444) (12,944) (15,867) 1,055
Extraordinary loss on early redemption of debt ...... -- -- -- -- (943)
------- -------- -------- -------- --------
Net income (loss) ................................. $(2,480) $(10,444) $(12,944) $(15,867) $ 112
======= ======== ======== ======== ========
Basic and diluted net income (loss) per share:
Loss from continuing operations ................... $(0.37) $ (1.45) $ (1.05) $ (0.96) $ (0.41)
Discontinued operations ........................... 0.03 0.03 (0.70) (1.17) 0.56
Extraordinary item ................................ -- -- -- -- (0.13)
------- -------- -------- -------- --------
Net income (loss) per share ....... ............. $ (0.34) $ (1.42) $ (1.75) $ (2.13) $ 0.02
======= ======== ======== ======== ========
Weighted average number of shares - basic
and diluted .......................... ........... 7,369 7,369 7,391 7,433 7,422
======= ======== ======== ======== ========
SELECTED CONSOLIDATED BALANCE SHEET DATA
AS OF DECEMBER 31,
-------------------------------------------------------------------
1996 1997 1998 1999 2000
----- ----- ----- ----- -----
(IN THOUSANDS)
Working capital ...................................... $13,676 $ 7,201 $5,719 $20,030 $18,178
Total assets ......................................... 71,219 65,452 49,880 50,458 42,157
Short-term debt, including current maturities of
long-term debt ..................................... 2,124 3,709 974 7,423 591
Long-term debt, net of current maturities ............ 331 481 687 1,584 6,015
Total shareholders' equity .......................... 62,556 52,308 39,418 24,850 22,581
See Notes 2 and 3 to the consolidated financial statements included in this
annual report for a description of our various acquisitions and dispositions of
business operations and segments.
9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
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 at "Item 1. Description of Business--Factors That May
Influence Future Results."
During 2000, we operated in three reportable segments: consulting and
development services, utility solutions and computer hardware sales.
CONSULTING AND DEVELOPMENT SERVICES
Sales in our consulting and development services segment remained stable,
with an increase in Israeli sales offset by decreased domestic sales. Gross
profit margins in this segment improved due to increased fixed-price embedded
software consulting sales in Israel, more than offsetting the increased labor
costs resulting from of the relative shortage of qualified programmers and
engineers. Although this shortage has recently eased, we expect that the
competitive marketplace for qualified engineers will continue to adversely
affect margins in 2001 and future periods.
UTILITY SOLUTIONS
This segment has been evolving since we first began to develop and market
two-way interactive communications solutions for utilities in 1992. In January
1998, we acquired certain assets and licensed intellectual property from Lucent
Technologies, Inc. and began to market the Comverge Distributed Connection to
commercial and industrial customers in the U.S. In August 1999 we acquired the
Scientific-Atlanta Control Systems business division, including its line of load
control products and Maingate gateway system.
Sales increased in the first half of 2000, primarily as a result of sales of
load control products. During the second half of 2000 sales declined,
particularly sales of our load control products. We believe that this decline
reflects the seasonal nature of load control products sales, with most purchases
being made in preparation for the summer air conditioning season, as well as the
fact that sales during the first half of 1999 were particularly strong due to a
large backlog of orders during Scientific-Atlanta's phase-out from the load
control business. We do not expect significant improvement in sales before the
third quarter of 2001.
COMPUTER HARDWARE
Sales and gross profits in this segment increased dramatically in 2000.
Although gross profit margins in 2000 were slightly higher than those in 1999,
we expect the increasingly competitive market will cause downward pressure on
our gross profit margin in 2001.
10
RESULTS OF OPERATIONS
The following table sets forth selected consolidated statement of operations
data as a percentage of our total sales.
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
1996 1997 1998 1999 2000
----- ----- ----- ----- -----
Sales ............................................. 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales ..................................... 81.3 86.6 78.5 79.6 78.8
----- ----- ----- ----- -----
Gross profit .................................... 18.7 13.4 21.5 20.4 21.2
Research and development expenses ................. 4.0 3.7 4.4 3.2 1.6
Selling, general and administrative expenses ...... 25.4 31.4 34.2 31.4 28.3
Gain on sale of division .......................... -- -- -- -- 2.0
----- ----- ----- ----- -----
Operating loss .................................. (10.7) (21.7) (17.1) (14.2) (6.7)
Interest income (expense), net .................... 1.4 0.7 (0.6) (2.1) 1.8
Other income (loss), net .......................... 6.3 (0.7) (5.9) (0.8) (0.1)
Minority interests. ............................... (0.4) 1.9 2.4 (0.7) --
Equity loss in affiliates ......................... (5.5) -- -- -- --
----- ----- ----- ----- -----
Loss from continuing operations before
provision (benefit) for income taxes .......... (8.9) (19.8) (21.2) (17.8) (5.0)
Provision (benefit) for income taxes .............. (0.5) 9.7 -- 0.2 0.3
----- ----- ----- ----- -----
Loss from continuing operations ................. (8.4) (29.5) (21.2) (18.0) (5.3)
Income (loss) from discontinued operations,
net of income taxes ............................. 0.7 0.6 (30.4) (22.0) (0.2)
Gain on sale of discontinued operations,
net of income taxes ............................. -- -- 16.3 -- 7.3
----- ----- ----- ----- -----
Income (loss) before extraordinary item ........... (7.7) (28.9) (35.3) (40.0) 1.8
Extraordinary loss on early redemption of debt ... -- -- -- -- (1.6)
----- ----- ----- ----- -----
Net income (loss) ................................. (7.7)% (28.9)% (35.3)% (40.0)% 0.2%
===== ===== ===== ===== =====
The following table sets forth certain information with respect to revenues
and profits of our three reportable business segments for the years ended
December 31, 1998, 1999 and 2000, including the percentages of revenues
attributable to such segments. The column marked "Other" aggregates information
relating to miscellaneous operating segments, which may be combined for
reporting under applicable accounting principles as well as the operations from
the Company's multimedia software segment which is no longer in operation so as
to be comparable with the current year's presentation.
CONSULTING AND
DEVELOPMENT UTILITY COMPUTER
SERVICES SOLUTIONS HARDWARE OTHER TOTAL(*)
-------------- --------- -------- ----- -------
(DOLLARS IN THOUSANDS)
Year ended December 31, 2000:
Revenues from external customers .......................... $18,977 $ 17,105 $21,515 $ 204 $57,801
Percentage of total revenues from external customers 33% 30% 37% -- 100%
Segment profit (loss) ................................... $ 1,530 $ (3,216) $ 726 $ 41 $ (919)
Year ended December 31, 1999:
Revenues from external customers ........................ $18,784 $ 5,061 $15,218 $ 285 $39,348
Percentage of total revenues
from external customers 48% 13% 38% 1% 100%
Segment profit (loss) ................................... $ (832) $ (3,297) $ 328 $ 64 $(3,737)
Year ended December 31, 1998:
Revenues from external customers ........................ $18,640 $ 212 $16,374 $1,124 $36,350
Percentage of total revenues from
external customers .................................... 51% 1% 45% 3% 100%
Segment profit (loss) ..................................... $ 5,742 $ (3,428) $ 1,514 $ (957) $ 2,871
- ----------
(*) Our consolidated sales for 2000, 1999 and 1998 included $38,000, $360,000
and $360,000, respectively, in management fees received from Tower. See
Note 18 to the consolidated financial statements included in this report
for reconciliation to our consolidated financial information.
11
2000 COMPARED TO 1999
SALES. Sales increased by 46% to $57.8 million in 2000, from $39.7 million in
1999, entirely due to higher unit sales. The increase was primarily due to a
$12.0 million increase in sales in the utility solutions segment, which had its
first sales in the second quarter of 1999 and a $6.3 million, or 41%, increase
in computer hardware sales.
GROSS PROFIT. Gross profit increased by 51%, to $12.2 million in 2000, from
$8.1 million in 1999, increasing in all segments. Gross profits increased by
$2.7 million and $1.0 million in the utility solutions and computer hardware
segments, respectively, primarily due to their increased level of sales. Gross
profits increased in the consulting and development services segment to 26.2% in
2000 as compared to 23.8% in 1999. This improvement was due primarily to
increased highly profitable fixed-price embedded hardware/software system sales.
RESEARCH AND DEVELOPMENT EXPENSES ("R&D"). R&D expenses continued to decrease
in 2000 to $0.9 million from $1.3 million in 1999, as the development of our
company's utility solutions products mature.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A"). SG&A increased by 30%
to $16.3 million in 2000 from $12.5 million in 1999. This increase is primarily
due to a $3.2 million increase in marketing and administrative costs related to
the utility solutions segment, which increased its level of activity
significantly in 2000.
GAIN ON SALE OF DIVISION. In September 2000, the Company completed the sale
of substantially all the assets of its CinNetic division, included in the
consulting and development services segment, for a total of $1.8 million
resulting in a gain of $1.1 million. The CinNetic division had operating losses
of approximately $315,000 and $505,000 in 2000 and 1999, respectively.
OPERATING LOSS. Operating losses decreased by 31% to $3.9 million in 2000
from $5.6 million in 1999. The decrease is primarily due to the gain from the
sale of CinNetic in 2000, as well as the increase in gross profits and decreases
in R&D, partially offset by the increase in SG&A.
INTEREST INCOME AND INTEREST EXPENSE. The increase in interest income to $1.8
million in 2000 from $61,000 in 1999 is due to the interest income on the
investment of the proceeds from the sale of our Tower investment in January 2000
and from our long-term deposit. The decrease in interest expense in 2000 from
1999 was due primarily to the charge in 1999 of $300,000 for the beneficial
conversion feature of our Debentures.
INCOME TAXES. The provision for income taxes increased to $171,000 in 2000
from $62,000 in 1999. The tax expense is comprised primarily of foreign taxes.
We establish valuation allowances against virtually all deferred tax assets, as
we believe that it is more likely than not that they will not be realized. The
valuation allowance was the primary reason for our recording a tax expense that
resulted in the effective income tax rate in 2000 of (6%) rather than the 34% US
Federal statutory rate. For a detailed analysis of the income tax provision, see
Note 16 to the consolidated financial statements included in this annual report.
LOSSES FROM DISCONTINUED OPERATIONS. The loss in 1999 was comprised of equity
losses from our investment in Tower, which was sold in January 2000. Losses in
1999 included equity losses of $5.0 million and income taxes of $3.7 million.
These taxes represent Israeli taxes associated with the anticipated repatriation
of earnings from our Israeli subsidiary that held our investment in Tower. Prior
to the signing of a definitive sale agreement in December 1999, earnings of this
Israeli subsidiary had been considered permanently invested and, accordingly, no
income taxes were provided on such earnings.
GAIN FROM SALE OF DISCONTINUED OPERATIONS, NET OF TAXES. The gain, net of
taxes, is from the sale of our Tower investment.
EXTRAORDINARY ITEM. A portion of our convertible debentures was redeemed
prior to maturity giving rise to an extraordinary loss of $753,000. In addition,
we recognized an additional extraordinary loss of $190,000 in connection with
our refinancing of our short-term debt.
1999 COMPARED TO 1998
SALES. Sales increased by 8% to $39.7 million in 1999 from $36.7 million in
1998. The increase was primarily due to a $4.8 million increase in sales in the
utility solutions segment, which had its first sales in the second quarter of
1999. This increase was partially offset, primarily by a $1.2 million decrease
in computer hardware sales, mostly during the first half of 1999.
GROSS PROFIT. Gross profit increased by 2% to $8.1 million in 1999 from $7.9
million in 1998. The increase was primarily due to a $1.3 million increase in
utility solutions segment gross profit from the aforementioned increase in
sales. This increase was partially offset by a $1 million decrease in computer
hardware gross profits, due to the aforementioned decrease in segment sales,
coupled with a decrease in gross profit margins in this segment to 15% in 1999
from 20% in 1998 as a result of a shift in sales to lower margin customers and
products.
R&D EXPENSES. The decrease in R&D in 1999, as compared to 1998, was due to
lower R&D in the utility solutions segment, as the development of the EPSM
product approached completion.
SG&A EXPENSES. Despite the increased level of activity, SG&A remained stable
at $12.5 million in 1999 as in 1998. This was achieved as marketing and
administrative costs related to the utility solutions segment increased by
$820,000, offset primarily by a $740,000 decrease in corporate SG&A.
12
OPERATING LOSS. Operating losses decreased by 10% to $5.6 million in 1999
from $6.3 million in 1998. The decrease was primarily due to the 25% decrease in
operating losses from corporate activity and the 18% decrease in operating
losses in the utility solutions segment. These improvements were partially
offset by the 77% decrease in operating profits in the computer hardware segment
as described above.
INTEREST EXPENSE. The increase in interest expense to $910,000 in 1999 from
$360,000 in 1998 was due to the term loan taken in August 1999, to finance the
acquisition of the Scientific-Atlanta Control Systems business division,
increased utilization of our lines of credit and the finance expenses related to
the convertible debentures issued in the last quarter of 1999, including a
$300,000 non-cash charge for the beneficial conversion feature of our
Debentures.
OTHER LOSS, NET. In 1998, other loss was attributable to a net expense of
$418,000, due to the write-off of a note receivable received from the sale of
our interest in a joint venture, net of a gain on the sale of shares received
from a conversion feature in the note, the write-off of other investments and
related assets totaling $497,000 and a $1.1 million loss in connection with
guarantees given by us on behalf of an affiliate and former subsidiary of ours
that declared bankruptcy.
INCOME TAXES. The provision for income taxes increased to $62,000 in 1999
from $35,000 in 1998. We establish valuation allowances against virtually all
deferred tax assets, as we believe that it is more likely than not that they
will not be realized. For a detailed analysis of the income tax provision, see
Note 16 to the consolidated financial statements included in this annual report.
LOSSES FROM DISCONTINUED OPERATIONS. The loss in 1999 was comprised of equity
losses from our investment in Tower. Losses in 1999 included equity losses of
$5.0 and income taxes of $3.7 million. These taxes represent Israeli taxes
associated with the anticipated repatriation of earnings from our Israeli
subsidiary that held our investment in Tower. Prior to the signing of a
definitive sale agreement in December 1999, earnings of this Israeli subsidiary
were considered permanently invested and, accordingly, no income taxes were
provided on such earnings. In 1998, the loss was comprised of a write-down of
our Tower investment by $6.1 million to reflect Tower's share price as of
December 31, 1998, in addition to $3.7 million in equity losses from Tower. In
1998, the loss also included $1.3 million of losses from the PHD division
activity, which was sold during that year.
GAIN FROM SALE OF DISCONTINUED OPERATIONS. In 1998, we recognized a gain from
the sale of our PHD division, which was sold during that year.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2000, we had working capital of approximately $18.2
million, including $16.9 million cash, cash equivalents and short-term deposits.
The increase in cash and short-term deposits was due to net proceeds of $27.9
million from the sale of our Tower investment, received in January 2000 and the
net proceeds from our sale of the CinNetic division of $1.8 million in August
2000. In addition we have a long-term deposit of $6 million securing our
Comverge subsidiary's long-term bank debt in the same amount. This debt replaced
short-term debt, previously used to finance the acquisition by this subsidiary
of the Scientific-Atlanta Control Systems business division in 1999.
In February 2000 we utilized a portion of the Tower proceeds to redeem $1.7
million of our debentures for $2.0 million in cash. The $260,000 balance of the
debentures was converted into 84,794 shares of our common stock.
In addition, we used a portion of the proceeds from the sale of our Tower
investment for operations to reduce the balance of accounts payable and accrued
expenses.
In September 2000 we announced the decision to repurchase up to 500,000 of
our shares. In 2000 we repurchased a total of 500,385 shares for a total of $2.4
million.
We believe we have adequate liquidity to finance our operating activities and
corporate expenses for fiscal 2001 and the foreseeable future, including debt
service and planned capital expenditures.
DSI Israel's increased profitability in 2000 enabled it to reduce its usage
of available bank credit lines. Bank credit lines currently available to DSI
Israel total approximately $1.9 million, denominated in NIS and bearing interest
at an average interest rate of the Israeli prime rate plus 0.2% per annum. The
Israeli prime rate fluctuates and as of December 31, 2000 was 9.5%. As of
December 31, 2000, DSI Israel was utilizing $570,000 of these lines of credit.
IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS
In 2000 and 1999, the devaluation of the NIS against the dollar was at
relatively the same level as inflation in Israel. A majority of our sales are
denominated in dollars. The remaining portion is primarily denominated in NIS,
linked to the dollar. Such sales transactions are negotiated in dollars;
however, for the convenience of the customer they are settled in NIS. These
transaction amounts are linked to the dollar between the date the transactions
are entered into until the date they are effected and billed. From the time
these transactions are effected and billed, through the date of settlement,
amounts are primarily unlinked. The majority of our expenses are in dollars or
dollar-linked NIS and virtually all the remaining expenses were in NIS. The
dollar cost of our operations in Israel may be adversely affected in the future
by
13
a devaluation of the NIS in relation to the dollar, should it be significantly
different from the rate of inflation, since most transactions are linked to or
are denominated in US dollars. This adverse effect principally arises with
respect to its severance pay obligations and also with respect to the unbilled
portion of long-term projects.
As of December 31, 2000, virtually all of our monetary assets and
liabilities that were not denominated in dollars or dollar-linked NIS were
denominated in NIS, and the net amount of such monetary assets and liabilities
was not material. In the event that in the future we have material net monetary
assets or liabilities that are not denominated in dollar-linked NIS, such net
assets or liabilities would be subject to the risk of currency fluctuations.
SUMMARY QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth certain of our unaudited quarterly
consolidated financial information for the years ended December 31, 1999 and
2000. This information should be read in conjunction with our consolidated
financial statements and the notes thereto.
1999 2000
-------------------------------------- --------------------------------------
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
------- ------- ------- ------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Sales .......................................... $ 7,676 $ 8,265 $ 9,217 $14,550 $14,722 $ 15,790 $15,006 $12,321
Cost of sales .................................. 5,910 6,552 7,743 11,410 11,435 12,229 11,865 10,077
------- ------- ------- -------- ------- -------- ------- -------
Gross profit ................................... 1,766 1,713 1,474 3,140 3,287 3,561 3,141 2,244
Research and development expenses .............. 309 272 196 492 394 146 158 230
Selling, general and administrative expenses ... 2,790 2,872 2,919 3,890 4,700 3,853 3,805 3,982
Gain on sale of division ....................... -- -- -- -- -- -- 1,144 --
------- ------- ------- -------- ------- -------- ------- -------
Operating income (loss) ........................ (1,333) (1,431) (1,641) (1,242) (1,807) (438) 322 (1,968)
Interest income (expenses), net ................ (16) 190 (156) (867) 316 130 247 356
Other income (loss), net ....................... 151 (219) (267) 29 (142) -- 18 74
Minority interests ............................. 18 91 95 (479) -- -- -- --
------- ------- ------- -------- ------- -------- ------- -------
Income (loss) from continuing operations before
provision (benefit) for income taxes ......... (1,180) (1,369) (1,969) (2,559) (1,633) (308) 587 (1,538)
Provision (benefit) for income taxes ........... 37 (25) 20 30 51 25 55 40
------- ------- ------- -------- ------- -------- ------- -------
Income (loss) from continuing operations ....... (1,217) (1,344) (1,989) (2,589) (1,684) (333) 532 (1,578)
Loss from discontinued operations, net of
income taxes ................................. (1,489) (1,738) (1,115) (4,386) -- (104) -- --
Gain on sale of discontinued operations,
net of income taxes .......................... -- -- -- -- 4,222 -- -- --
------- ------- ------- -------- ------- -------- ------- -------
Income (loss) before extraordinary item ........ (2,706) (3,082) (3,104) (6,975) 2,538 (437) 532 (1,578)
Extraordinary loss on early redemption of debt -- -- -- -- (943) -- -- --
------- ------- ------- -------- ------- -------- ------- -------
Net income (loss). ............................. $(2,706) $(3,082) $(3,104) $ (6,975) $ 1,595 $ (437) $ 532 $(1,578)
======= ======= ======= ======== ======= ======== ======= =======
Basic net income (loss) per share:
Income (loss) from continuing operations ..... $ (0.16) $ (0.18) $ (0.27) $ (0.35) $ (0.23) $ (0.05) $ 0.07 $ (0.22)
Discontinued operations ...................... (0.20) (0.23) (0.15) (0.59) 0.56 (0.01) -- --
Extraordinary item ........................... -- -- -- -- (0.12) -- -- --
------- ------- ------- -------- ------- -------- ------- -------
Net income (loss) per share--basic ........... $ (0.36) $ (0.41) $ (0.42) $ (0.94) $ 0.21 $ (0.06) $ 0.07 $ (0.22)
======= ======= ======= ======== ======= ======== ======= =======
Weighted average number of shares
outstanding--basic ........................... 7,433 7,433 7,433 7,433 7,460 7,470 7,462 7,297
======= ======= ======= ======== ======= ======== ======= =======
Diluted net income (loss) per share:
Income (loss) from continuing operations ..... $ (0.16) $ (0.18) $ (0.27) $ (0.35) $ (0.23) $ (0.05) $ 0.07 $ (0.22)
Discontinued operations ...................... (0.20) (0.23) (0.15) (0.59) 0.56 (0.01) -- --
Extraordinary item ........................... -- -- -- -- (0.12) -- -- --
------- ------- ------- -------- ------- -------- ------- -------
Net income (loss) per share--diluted ........... $ (0.36) $ (0.41) $ (0.42) $ (0.94) $ 0.21 $ (0.06) $ 0.07 $ (0.22)
======= ======= ======= ======== ======= ======== ======= =======
Weighted average number of shares
outstanding--diluted ......................... 7,433 7,433 7,433 7,433 7,460 7,470 7,926 7,297
======= ======= ======= ======== ======= ======== ======= =======
14
The quarterly financial data for the first three quarters of 2000 reported
above differ from the data for these periods previously reported by us on Form
10-Q as described below:
FIRST QUARTER SECOND QUARTER THIRD QUARTER
------------------- ------------------- -------------------
PREVIOUSLY AS PREVIOUSLY AS PREVIOUSLY AS
REPORTED ADJUSTED REPORTED ADJUSTED REPORTED ADJUSTED
---------- -------- ---------- -------- ---------- --------
Income (loss) from continuing operations .............. $3,115 $(1,684) $ (807) $ (333) $ 518 $ 532
Discontinued operations ............................... -- 4,222 (104) (104) -- --
Extraordinary item .................................... (340) (943) -- -- -- --
------ ------- ------ ------ ----- -----
Net income (loss) ..................................... $2,775 $ 1,595 $ (911) $ (437) $ 518 $ 532
====== ======= ====== ====== ===== =====
Basic net income (loss) per share:
Income (loss) from continuing operations ............ $ 0.42 $ (0.23) $(0.11) $(0.05) $0.07 $0.07
Discontinued operations ............................. -- 0.56 (0.01) (0.01) -- --
Extraordinary item .................................. (0.05) (0.12) -- -- -- --
------ ------- ------ ------ ----- -----
Net income (loss) per share ........................... $ 0.37 $ 0.21 $(0.12) $(0.06) $0.07 $0.07
====== ======= ====== ====== ===== =====
Diluted net income (loss) per share:
Income (loss) from continuing operations ............ $ 0.42 $ (0.23) $(0.11) $(0.05) $0.07 $0.07
Discontinued operations ............................. -- 0.56 (0.01) (0.01) -- --
Extraordinary item .................................. (0.05) (0.12) -- -- -- --
------ ------- ------ ------ ----- -----
Net income (loss) per share ......................... $ 0.37 $ 0.20 $(0.12) $(0.06) $0.07 $0.07
====== ======= ====== ====== ===== =====
The differences between the amounts previously reported and as adjusted
principally related to: (i) The gain on sale of discontinued operations, net of
taxes of $4,222 has been reclassified from other income (loss), net, to properly
reflect the sale of our interest in Tower as a discontinued operation. Taxes
related to the sale of $460 previously provided for in the second quarter of
2000 and $307 identified in the fourth quarter of 2000 have been offset against
the gain in the first quarter of 2000 as presented above. (ii) The extraordinary
loss on early redemption of debt was restated to include an additional $413 loss
that had been previously deferred and to recognize $190 previously reported as
interest expense.
15
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
GENERAL
We are required to make certain disclosures regarding our financial
instruments, including derivatives, if any.
A financial instrument is defined as cash, evidence of an ownership interest
in an entity, or a contract that imposes on one entity a contractual obligation
either to deliver or receive cash or another financial instrument to or from a
second entity. Examples of financial instruments include cash and cash
equivalents, trade accounts receivable, loans, investments, trade accounts
payable, accrued expenses, options and forward contracts. The disclosures below
include, among other matters, the nature and terms of derivative transactions,
information about significant concentrations of credit risk, and the fair value
of financial assets and liabilities.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair values of financial instruments included in current assets and current
liabilities are estimated to approximate their book values, due to the short
maturity of such instruments. Fair value for long-term debt and long-term
deposits are estimated based on the current rates offered to the Company for
debt and deposits with the similar terms and remaining maturities. The fair
value of the Company's long-term debt and long-term deposits are not materially
different from their carrying amounts. The fair value of investments is
estimated based on market value. The estimation of fair value of the Company's
investments (book value of $153,000 at December 31, 2000) was not practicable,
although the Company believes that the estimated fair values of such investments
are not materially different from their book value.
CONCENTRATIONS OF CREDIT RISK
Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist principally of cash and cash equivalents,
short and long-term bank deposits, asset-backed securities and trade
receivables. The counterparty to a majority of the Company's cash equivalent
deposits as well as its short and long-term bank deposits is a major financial
institution of high credit standing. The counterparties to the Company's
asset-backed securities consist of various major corporations of high credit
standing. The Company does not believe there is significant risk of
non-performance by these counterparties. Approximately 16% of the trade accounts
receivable were due from a U.S. customer that pays its trade receivables over
usual credit periods. Credit risk with respect to the balance of trade
receivables is generally diversified due to the large number of entities
comprising the Company's customer base.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Furnished at the end of this report commencing on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On December 1, 2000, a representative of Deloitte & Touche LLP ("D&T")
notified us that it did not wish to stand for re-election as our independent
accountant for the 2000 fiscal year audit.
The reports of D&T on our financial statements for the past two fiscal years
did not contain an adverse opinion or disclaimer of opinion, and were not
qualified or modified as to uncertainty, audit scope or accounting principles.
During the two most recent fiscal years and through December 1, 2000, there
were no disagreements between our management and D&T as to any matter of
accounting principles or practices, financial statement disclosure, or audit
scope or procedure, which disagreement, if not resolved to the satisfaction of
D&T, would have caused it to make reference to the subject matter of the
disagreement in their reports on the financial statements for such periods
within the meaning of Item 304(a)(1)(iv) of Regulation S-K.
During the most recent fiscal years and through December 1, 2000, no
reportable events occurred (as defined in Item 304(a)(1)(v) of Regulation S-K).
D&T has furnished the Registrant with a letter addressed to the Commission
stating that it agrees with the above statements. A copy of this letter is
included as Exhibit 16.1 to this annual report.
On December 8, 2000, we engaged KPMG LLP to replace D&T as our independent
auditors. We had not consulted with KPMG prior to its engagement regarding the
application of accounting principles to a specified transaction, either
completed or proposed, the type of audit opinion that might be rendered on our
financial statements or any matter that was either the subject of a disagreement
or a reportable event within the meaning of Item 304(1)(1) of Regulation S-K.
The decision to engage KPMG as our independent accountants was approved by
the Audit Committee of our Board of Directors.
16
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information relating to each of our directors and nominees for director
and the information relating to our executive officers, appearing under the
captions "Election of Directors - Certain Information Regarding Directors and
Executive Officers," in our definitive proxy statement for the 2001 Annual
Meeting of Stockholders to be filed on or before May 1, 2001 (the "2001 Proxy
Statement"), is hereby incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information relating to compensation of directors and executive officers,
appearing under the caption "Election of Directors-Directors' Remuneration",
"Election of Directors - Employment Arrangements-Executive Compensation" in the
2001 Proxy Statement, is hereby incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information relating to security ownership, appearing under the caption
"Stock Ownership" in the 2001 Proxy Statement, is hereby incorporated by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information relating to certain relationships and transactions, appearing
under the caption "Certain Transactions" in the 2001 Proxy Statement, is hereby
incorporated by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) EXHIBITS:
3.1 Certificate of Incorporation of the Registrant, with amendments thereto
(incorporated herein by reference to Exhibit 3.1 to the Registrant's
Registration Statement on Form S-1 (File No. 33-70482) (the "1993
Registration Statement")).
3.2 By-laws of the Registrant (incorporated herein by reference to Exhibit
3.2 to the Registrant's Registration Statement on Form S-1 (File No.
33-44027) (the "1992 Registration Statement")).
3.3 Amendments to the By-laws of the Registrant adopted December 27, 1994
(incorporated herein by reference to Exhibit 3.3 of the Registrant's
Current Report on Form 8-K dated January 10, 1995).
4.1 Specimen certificate for the Common Stock (incorporated herein by
reference to Exhibit 4.2 to the 1992 Registration Statement).
4.2 Securities Purchase Agreement between the Registrant and Bounty
Investors LLC dated as of October 12, 1999, including Form of Warrant
(incorporated herein by reference to Exhibit 1 to the Registrant's
Report on Form 8-K dated October 12, 1999 (the "October 1999 8-K")).
4.3 Form of Registration Rights Agreement between the Registrant and Bounty
Investors LLC dated as of October 12, 1999 (incorporated herein by
reference to Exhibit 1 to October 1999 8-K).
4.4 Warrant to Purchase Common Stock of the Registrant dated October 12,
1999.
*10.1 Employment Agreement between the Registrant and George Morgenstern,
dated as of January 1, 1997 (incorporated herein by reference to
Exhibit 10.1 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1997 (the "1997 10-K")).
*10.2 Employment Agreement between the Registrant and Yacov Kaufman, dated as
of January 1, 1999 (incorporated by reference to Exhibit 10.22 of the
Registrants Annual Report on Form 10-K for the year ended December 31,
1999 (the "1999 10-K")).
*10.3 1991 Stock Option Plan (incorporated herein by reference to Exhibit
10.4 to the 1992 Registration Statement).
*10.4 1994 Stock Incentive Plan, as amended (incorporated herein by reference
to Exhibit 10.4 to the 1995 10-K).
*10.5 1994 Stock Option Plan for Outside Directors, as amended (incorporated
herein by reference to Exhibit 10.5 to the 1995 10-K).
10.6 1995 Stock Option Plan for Non-management Employees (incorporated
herein by reference to Exhibit 10.6 to the 1995 10-K).
17
10.7 Asset Purchase Agreement dated as of August 2, 2000 by and among the
Registrant, International Data Operations, Inc., and Eclipse Networks,
Inc. (incorporated by reference to the Registrant's Quarterly Report on
Form 10-Q for the quarter ended September 30, 2000).
10.8 Credit Agreement dated as of February 7, 2000 between Comverge
Technologies, Inc. and Bank Leumi USA (incorporated by reference to
Exhibit 10.12 of the 1999 10-K).
10.9 $6,000,000 Term Note of Comverge Technologies, Inc. dated as of February
7, 2000, payable to Bank Leumi USA (incorporated by reference to Exhibit
10.13 of the 1999 10-K).
10.10 License Agreement between the Registrant and Lucent Technologies Inc.
dated as of January 9, 1998 (incorporated herein by reference to the
Registrant's Current Report on Form 8-K dated February 17, 1998).
10.11 Warrant Repurchase Agreement dated September 25, 2000 among the
Registrant, Bank Leumi USA and Bank Leumi le-Israel.
10.12 Agreement dated January 26, 2001 between the Registrant and Bounty
Investors LLC.
10.13 Lease Agreement dated February 5, 2001 between Duke-Weeks Realty Limited
Partnership and Comverge Technologies, Inc.
*10.14 Stock Option Agreements dated as of October 1, 1999 between Powercom
Control Systems Ltd. and George Morgernstern, Yacov Kaufman and Harvey
E. Eisenberg and related promissory notes dated January 3, 2000.
16.1 Letter regarding change in certifying accountant dated December 8, 2000
(incorporated by reference to the Registrant's Current Report on Form
8-K filed December 8, 2000).
22.1 List of subsidiaries.
23.1 Consent of KPMG LLP.
23.2 Consent of Deloitte & Touche LLP.
- ----------
* This exhibit includes a management contract, compensatory plan or arrangement
in which one or more directors or executive officers of the Company
participate.
(b) FINANCIAL STATEMENT SCHEDULES.
None.
(c) REPORTS ON FORM 8-K.
Report on Form 8-K filed December 8, 2000 relating to the change in our
certifying accountant.
18
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) 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, in the Township of
Mahwah, State of New Jersey, on March 28, 2001.
DATA SYSTEMS & SOFTWARE INC.
BY /S/ GEORGE MORGENSTERN
----------------------
GEORGE MORGENSTERN
CHAIRMAN OF THE BOARD, PRESIDENT
AND CHIEF EXECUTIVE OFFICER
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT, IN
THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE
--------- ----- ----
/S/ GEORGE MORGENSTERN Chairman of the Board; President; Chief Executive March 28, 2001
- ---------------------- Officer; and Director
George Morgenstern
/S/ ROBERT L. KUHN Vice Chairman and Director March 28, 2001
------------------
Robert L. Kuhn
/S/ YACOV KAUFMAN Vice President, Chief Financial Officer (Principal March 28, 2001
----------------- Financial Officer and Principal Accounting Officer) March 28, 2001
Yacov Kaufman
/S/ HARVEY EISENBERGER Director March 28, 2001
- ----------------------
Harvey Eisenberger
/S/ ALLEN I. SCHIFF Director March 28, 2001
-------------------
Allen I. Schiff
/S/ MAXWELL M. RABB Director March 28, 2001
-------------------
Maxwell M. Rabb
/S/ SUSAN MALLEY Director March 28, 2001
----------------
Susan Malley
/S/ SHELDON KRAUSE Secretary and Director March 28, 2001
------------------
Sheldon Krause
19
DATA SYSTEMS & SOFTWARE INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED FINANCIAL STATEMENTS OF DATA SYSTEMS & SOFTWARE INC.:
Report of KPMG LLP. .................................................................... F-1
Report of Deloitte & Touche LLP. ....................................................... F-2
Consolidated Balance Sheets as of December 31, 1999 and December 31, 2000 .............. F-3
Consolidated Statements of Operations and Comprehensive Income (Loss)
for the years ended December 31, 1998, December 31, 1999 and December 31, 2000 ...... F-4
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 1998, December 31, 1999 and December 31, 2000 ....... F-5
Consolidated Statements of Cash Flows
for the years ended December 31, 1998, December 31, 1999 and December 31, 2000 ....... F-6
Notes to Consolidated Financial Statements.............................................. F-8
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders of
Data Systems & Software Inc.:
We have audited the accompanying consolidated balance sheet of Data Systems &
Software Inc. and subsidiaries as of December 31, 2000, and the related
consolidated statements of operations and comprehensive income (loss), changes
in shareholders' equity, and cash flows for the year then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Data Systems
& Software Inc. and subsidiaries as of December 31, 2000, and the results of
their operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America.
/s/ KPMG LLP
Short Hills, New Jersey
March 16, 2001
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Data Systems & Software Inc.:
We have audited the accompanying consolidated balance sheet of Data Systems &
Software Inc. (the "Company") and its subsidiaries as of December 31, 1999 and
the related consolidated statements of operations and comprehensive income
(loss), changes in shareholders' equity and cash flows for each of the two years
in the period ended December 31, 1999. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of the Company
and its subsidiaries as of December 31, 1999, and the results of their
operations and their cash flows for each of the two years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States of America.
/s/ Deloitte & Touche LLP
New York, New York
March 29, 2000
F-2
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
ASSETS
AS OF DECEMBER 31,
------------------------
1999 2000
---------- ----------
Current assets:
Cash and cash equivalents ........................... $ 1,379 $10,877
Short-term interest bearing bank deposits. .......... 1,009 5,994
Investment held for sale ............................ 25,900 --
Restricted cash ..................................... 536 302
Accounts receivable, net ............................ 10,078 9,989
Inventory ........................................... 1,249 448
Other current assets ................................ 945 1,154
------- -------
Total current assets .............................. 41,096 28,764
------- -------
Investments ......................................... -- 153
Property and equipment, net ........................... 1,853 1,535
Goodwill and other intangible assets, net .. .......... 4,285 2,826
Long-term deposits ................................... -- 6,000
Other assets ......................................... 838 543
Prepaid employee termination benefits ................. 2,386 2,336
------- -------
Total assets ..................................... $50,458 $42,157
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term bank debt and current maturities of
long-term debt .................................... $ 7,423 $ 591
Trade accounts payable .............................. 5,809 4,347
Accrued payroll, payroll taxes and social benefits .. 1,246 1,677
Other current liabilities. .......................... 6,588 3,971
------- -------
Total current liabilities ......................... 21,066 10,586
------- -------
Long-term liabilities:
Convertible debentures .............................. 1,562 --
Long-term debt ...................................... 22 6,015
Liability for employee termination benefits. ........ 2,948 2,935
------- -------
Total long-term liabilities ....................... 4,532 8,950
------- -------
Commitments and contingencies (Notes 10 and 14)
Minority interests .................................... 10 40
------- -------
Shareholders' equity:
Common stock $.01 par value per share:
Authorized 20,000,000 shares; issued and
outstanding 7,923,540 and 8,035,334 shares
at December 31, 1999 and 2000, respectively ..... 79 80
Additional paid-in capital .......................... 35,702 35,970
Warrants ............................................ 432 114
Deferred compensation expense. ...................... (73) --
Accumulated deficit ................................. (8,925) (8,813)
Treasury stock, at cost--490,262 and 990,647
shares at December 31, 1999 and 2000,
respectively. ..................................... (2,365) (4,770)
------- -------
Total shareholders' equity. ........................... 24,850 22,581
------- -------
Total liabilities and shareholders' equity. ........... $50,458 $42,157
======= =======
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1999 2000
-------- -------- --------
Sales:
Products ...................................................... $ 17,277 $ 20,300 $ 38,300
Services ...................................................... 19,433 19,408 19,539
-------- -------- --------
36,710 39,708 57,839
-------- -------- --------
Cost of sales:
Products ...................................................... 13,945 16,705 31,415
Services ...................................................... 14,869 14,910 14,191
-------- -------- --------
28,814 31,615 45,606
-------- -------- --------
Gross profit ................................................ 7,896 8,093 12,233
Research and development expenses ............................... 1,605 1,269 928
Selling, general and administrative expenses .................... 12,549 12,471 16,340
Gain on sale of division ........................................ -- -- 1,144
-------- -------- --------
Operating loss ................................................ (6,258) (5,647) (3,891)
Interest income ................................................. 147 61
1,758
Interest expense ................................................ (360) (910) (709)
Other loss, net ................................................. (2,172) (306) (50)
Minority interests .............................................. 878 (275) --
-------- -------- --------
Loss from continuing operations before
provision for income taxes .................................. (7,765) (7,077) (2,892)
Provision for income taxes ...................................... 35 62 171
-------- -------- --------
Loss from continuing operations ............................... (7,800) (7,139) (3,063)
Loss from discontinued operations, net of income taxes .......... (11,142) (8,728) (104)
Gain on sale of discontinued operations, net of income taxes .... 5,998 -- 4,222
-------- -------- --------
Income (loss) before extraordinary item ......................... (12,944) (15,867) 1,055
Extraordinary loss on early redemption of debt .................. -- -- (943)
-------- -------- --------
Net income (loss) ............................................. (12,944) (15,867) 112
Other comprehensive income (loss):
Unrealized gain on securities available for sale .............. 110 (110) --
-------- -------- --------
Comprehensive income (loss) ................................... $(12,834) $(15,977) $ 112
======== ======== ========
Basic and diluted net income (loss) per share:
Loss from continuing operations ............................... $ (1.05) $ (0.96) $ (0.41)
Discontinued operations ....................................... (0.70) (1.17) 0.56
Extraordinary item ............................................ -- -- (0.13)
-------- -------- --------
Net income (loss) per share ................................... $ (1.75) $ (2.13) $ 0.02
======== ======== ========
Weighted average number of shares outstanding--basic
and diluted .................................................. 7,391 7,433 7,422
======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS)
ACCUMULATED
OTHER
ADDITIONAL DEFERRED COMPRE-
NUMBER OF COMMON PAID-IN COMPEN- TREASURY ACCUMULATED HENSIVE
SHARES STOCK CAPITAL SATION WARRANTS STOCK DEFICIT INCOME TOTAL
--------- ------ ------- -------- -------- -------- ------- -------- -------
Balances December 31, 1997 ............. 7,709 $77 $34,193 $ -- $ -- $(1,848) $19,886 $ -- $ 52,308
Common stock issued in restricted
stock award ........................ 155 1 435 -- -- -- -- -- 436
Unamortized restricted stock award
compensation ....................... -- -- -- (436) -- -- -- -- (436)
Common stock issued as compensation .. 50 1 100 -- -- -- -- -- 101
Common stock issued upon exercise of
options ............................ 10 -- 55 -- -- -- -- -- 55
Purchase of treasury stock ........... -- -- -- -- -- (517) -- -- (517)
Amortization of restricted stock award
compensation ....................... -- -- 196 109 -- -- -- -- 305
Unrealized gain on securities
available for sale ................. -- -- -- -- -- -- -- 110 110
Net loss ............................. -- -- -- -- -- -- (12,944) -- (12,944)
----- --- ------- ----- ---- ------- ------- ---- --------
Balances, December 31, 1998 ............ 7,924 79 34,979 (327) -- (2,365) 6,942 110 39,418
Imputed interest on convertible
debenture .......................... -- -- 377 -- -- -- -- -- 377
Beneficial conversion feature
of convertible debenture ........... -- -- 300 -- -- -- -- -- 300
Amortization of restricted stock award
compensation and warrants .......... -- -- 46 254 -- -- -- -- 300
Issuance of warrants ................. -- -- -- -- 432 -- -- -- 432
Unrealized loss on securities
available for sale ................. -- -- -- -- -- -- -- (110) (110)
Net loss ............................. -- -- -- -- -- -- (15,867) -- (15,867)
----- --- ------- ----- ---- ------- ------- ---- --------
Balances, December 31, 1999 ............ 7,924 $79 $35,702 $(73) $432 $(2,365) $(8,925) $ -- $ 24,850
Conversion of convertible
debentures ......................... 85 1 259 -- -- -- -- -- 260
Exercise of options. ................. 26 -- 66 -- -- -- -- -- 66
Amortization of restricted stock
award compensation ................. -- -- -- 73 -- -- -- -- 73
Repurchase of outstanding
warrants ........................... -- -- (57) -- (318) -- -- -- (375)
Purchase of treasury shares .......... -- -- -- -- -- (2,405) -- -- (2,405)
Net income ........................... -- -- -- -- -- -- 112 -- 112
----- --- ------- ----- ---- ------- ------- ---- --------
Balances, December 31, 2000. ........... 8,035 $80 $35,970 $ -- $114 $(4,770) $(8,813) $ -- $ 22,581
===== === ======= ===== ==== ======= ======= ==== ========
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
---------------------------------
1998 1999 2000
-------- -------- --------
Cash flows used in operating activities:
Net income (loss) ............................................................... $(12,944) $(15,867) $ 112
Adjustments to reconcile net income (loss) to net cash used in operating
activities--see Schedule A .................................................. 7,129 10,833 (6,257)
-------- -------- --------
Net cash used in operating activities ............................................ (5,815) (5,034) (6,145)
-------- -------- --------
Cash flows provided by (used in) investing activities:
Short-term bank deposits, net ................................................. (1,179) 243 (4,985)
Restricted cash ............................................................... 1,034 216 234
Investment in marketable securities ........................................... (5,898) -- --
Investment in long-term deposits .............................................. -- -- (6,000)
Proceeds from sale and maturity of marketable securities ...................... 7,527 1,520 --
Proceeds from sale of Tower ................................................... -- -- 30,889
Net proceeds from sale of division ............................................ 6,595 -- 1,838
Acquisitions of property and equipment ........................................ (929) (1,276) (742)
Proceeds from sale of property and equipment .................................. 135 327 132
Funding of termination benefits ............................................... (16) (190) 50
Acquisitions of intangible assets ............................................. (504) (4,192) (17)
Purchase of minority interest share of subsidiary ............................. -- (559) --
-------- -------- --------
Net cash provided by (used in) investing activities ........................... 6,765 (3,911) 21,399
-------- -------- --------
Cash flows provided by (used in) financing activities:
Proceeds from issuance of common stock, net ................................... 156 -- --
Purchase of treasury stock .................................................... (517) -- (2,405)
Proceeds from sale of shares received in partial conversion of note receivable 1,871 -- --
Proceeds from stock options exercises ......................................... -- -- 66
Repurchase of outstanding warrants ............................................ -- -- (375)
Redemption of convertible debentures .......................................... -- -- (2,001)
Short-term debt, net .......................................................... (2,064) 7,824 (6,971)
Proceeds from long-term debt .................................................. 453 52 6,021
Issuance of convertible debentures and warrants ............................... -- 2,000 --
Repayments of long-term debt .................................................. (1,270) (555) (91)
-------- -------- --------
Net cash provided by (used in) financing activities ........................... (1,371) 9,321 (5,756)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents ............................. (421) 376 9,498
Cash and cash equivalents at beginning of year ................................... 1,424 1,003 1,379
-------- -------- --------
Cash and cash equivalents at end of year ......................................... $ 1,003 $ 1,379 $ 10,877
======== ======== ========
Supplemental cash flow information:
Cash paid during the year for:
Interest .................................................................... $ 205 $ 386 $ 764
======== ======== ========
Income taxes ................................................................ $ 195 $ 106 $ 3,596
======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
SCHEDULES TO CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1999 2000
-------- -------- --------
A. Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization .................................................... $ 1,092 $ 1,351 $ 1,628
Minority interests ............................................................... (878) 275 --
Issuance of subsidiary shares to minority interests .............................. -- -- 30
Gain on sale of Tower ............................................................ -- -- (4,989)
Allowance for write-off against note receivable .................................. 610 -- --
Allowance for bank guarantees for affiliate ...................................... 1,135 -- --
Write-off of investment in affiliates and related receivables .................... 498 -- --
Earnings on marketable debt securities ........................................... (30) -- --
Allowance for doubtful accounts .................................................. (352) 95 254
Deferred taxes ................................................................... -- -- (20)
Increase (decrease) in liability for employee termination benefits ............... 367 167 (13)
Equity loss in affiliates ........................................................ 3,908 5,102 --
Gain on sale of segment .......................................................... (5,998) -- (1,144)
Gain on sale of marketable securities ............................................ (192) (247) --
Unrealized loss from write-down of investment .................................... 6,103 237 --
Loss (gain) on sale of property, plant and equipment, net ........................ (37) 51 (4)
Amortization of restricted stock award compensation .............................. 305 300 73
Extraordinary loss on early redemption of debt ................................... -- -- 943
Discount on convertible debentures ............................................... -- 300 --
Non-cash interest expense on convertible debentures and warrants ................. -- 169 37
Other ............................................................................ 19 (15) --
Receipt of investments for services rendered ..................................... -- -- (153)
Changes in operating assets and liabilities, net of effect of
acquisitions and disposals:
Decrease (increase) in accounts receivable and other current assets ......... 1,488 (2,914) (601)
Decrease (increase) in inventory ............................................ (327) (545) 1,257
Decrease in other assets .................................................... 227 219 297
Increase (decrease) in accounts payable and other current liabilities ....... (809) 6,288 (3,852)
-------- -------- --------
$ 7,129 $ 10,833 $ (6,257)
======== ======== ========
B. Non-cash investing and financing activities:
Receipt of capital stock in partial conversion of note receivable ................ $ 1,871
========
Imputed interest on convertible debentures ....................................... $ 377
========
Unrealized gain (loss) on marketable securities available for sale ............... $ 110 $ (110)
======= ========
Adjustment of goodwill for inventory sold ........................................ $ 456
========
Adjustments to goodwill and reduction of amounts due on acquisition for funding of
operating costs and below-market sales contract ................................ $ 226
========
Issuance of shares upon conversion of convertible debt ........................... $ 260
========
Adjustment of fixed assets to other current liabilities .......................... $ 11
========
Subsidiary stock issued in exchange for certain assets ........................... $ 50
=======
The accompanying notes are an integral part of these
consolidated financial statements.
F-7
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 1--GENERAL AND SIGNIFICANT ACCOUNTING POLICIES
(a) Description of Business
Data Systems & Software Inc., a Delaware corporation ("DSSI"), through its
subsidiaries (collectively, the "Company"), (i) provides consulting and
development services for computer software and systems, (ii) is an authorized
dealer and a value-added-reseller of computer hardware, and (iii) provides
control products and data communication solutions for utilities. DSSI's shares
are traded on the Nasdaq National Market.
(b) Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities
as of the date of the financial statements, and the reported amounts of revenues
and expenses during the reporting periods. Actual results could differ from
those estimates.
(c) Significant Accounting Policies
FOREIGN CURRENCY TRANSACTIONS
The currency of the primary economic environment in which the operations of
the Company are conducted is the United States dollar ("dollar"). Accordingly,
DSSI and all of its subsidiaries use the dollar as their functional currency.
All exchange gains and losses denominated in non-dollar currencies are reflected
in other expense, net in the consolidated statement of operations when they
arise. Such foreign currency gains and losses, net amounted to $150, $64 and $3
for the years ended December 31, 1998, 1999 and 2000, respectively.
PRINCIPLES OF CONSOLIDATION AND PRESENTATION
The consolidated financial statements of the Company include the accounts of
all majority-owned subsidiaries. The consolidated financial statements have been
prepared in conformity with accounting principles generally accepted in the
United States of America. All intercompany balances and transactions have been
eliminated. Minority interests in net income (loss) are limited to the extent of
their equity capital. Losses in excess of minority interest equity capital are
charged against the Company.
RECLASSIFICATIONS
Certain reclassifications have been made to the Company's prior years'
consolidated financial statements to conform with the current year's
consolidated financial statement presentation.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and demand deposits in banks and
short-term investments (primarily time deposits and certificates of deposit)
with original maturities of three months or less.
INVENTORY
Inventories are stated at the lower of cost or market. Cost is determined for
raw materials, spare parts and supplies on the average cost method. For work in
process and finished goods, cost is determined on the basis of standard costs,
adjusted for variances, which approximates the first-in, first-out method of
cost. For merchandise inventories, cost is determined on the first-in, first-out
method.
INVESTMENTS
Investments in which the Company owns at least 20% and not more than 50% of
the voting control or affiliates over whose operating and financial policies the
Company has the ability to exercise significant influence are accounted for by
the equity method. Pursuant to this method, the Company includes its share of
the affiliate's earnings or losses in the Company's consolidated results of
operations. Investments in less than 20% of the voting control of companies or
in other entities over whose operating and financial policies the Company does
not have the power to exercise significant influence are accounted for by the
cost method. Pursuant to this method, the Company records its investment at cost
and recognizes dividends received as income from the investee company. The
carrying values of investments are periodically reviewed to determine whether a
decline in value is other than temporary.
F-8
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 1--GENERAL AND SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Marketable equity securities which are available for sale are recorded at
fair value, and the amount of unrecognized gains or losses are recognized as a
component of accumulated other comprehensive income.
PROPERTY AND EQUIPMENT
Property and equipment are presented at cost or fair value at the date of
acquisition. Depreciation and amortization is calculated based on the
straight-line method over the estimated useful lives of the depreciable assets,
or in the case of leasehold improvements, the lease term. Improvements are
capitalized while repairs and maintenance are charged to operations as incurred.
INTANGIBLES
Goodwill represents the excess of cost over the fair value of the net assets
of subsidiaries acquired in purchase transactions. Goodwill is amortized on a
straight-line basis over its estimated useful life which ranges from five to
seven years.
The costs of licensed technology are presented at estimated fair value at
acquisition date. These costs are amortized on a straight-line basis over the
term of the license, generally five years.
The costs of registered patents and patents pending acquired from third
parties are presented at estimated fair value at acquisition date. In addition,
registration costs and fees for patents are capitalized. Registered patents
costs are amortized over the estimated remaining useful life of the patents,
from four to 14 years. Costs for patents pending are not amortized until they
are issued.
REVENUE RECOGNITION
Revenues from time-and-materials service contracts, maintenance agreements
and other services are recognized as services are provided.
Revenues from fixed-price service contracts are recognized as services are
provided using the percentage-of-completion method as costs (primarily direct
labor) are incurred, in the proportion that actual costs incurred bear to total
estimated costs. Percentage-of-completion estimates are reviewed periodically,
and any adjustments required are reflected in the period when such estimates are
revised. Losses on contracts, if any, are recognized in the period in which the
loss is determined. Fixed price projects in which the Company receives equity
shares as compensation for services rendered are recorded at the fair value of
the services provided, or equity received, whichever is more readily
determinable.
Revenues on the sale of products are recognized when the products are
shipped. Revenue from third-party hardware and software sales is recognized upon
delivery, and recorded at the gross or net amount according to the criteria
established in Emerging Issues Task Force Issue No. 99-19, "Recording Revenue
Gross as a Principal versus Net as an Agent" and Staff Accounting Bulletin No.
101, as amended, "Revenue Recognition in Financial Statements."
RESEARCH AND DEVELOPMENT EXPENSES
Research and development costs are charged to operations as incurred.
STOCK-BASED COMPENSATION
The Company accounts for employee and director stock-based compensation in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations. In accordance
therewith, the Company records compensation on fixed stock options and
restricted common stock granted to employees and directors at the date of grant
if the current market price of the Company's common stock exceeds the exercise
price of the options and restricted common stock. Compensation expense on
variable stock option grants is estimated until the measurement date. Deferred
compensation is amortized to compensation expense over the vesting period of the
underlying options. As permitted by Statement on Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), the Company
provides pro forma net income and pro forma earnings per share disclosures for
employee and director stock option grants as if the fair-value-based method
defined in SFAS No. 123 had been applied.
The Company accounts for stock-based compensation issued to consultants on a
fair value basis in accordance with SFAS No. 123 and EITF Issue No. 96-18,
"Accounting for Equity Instruments That Are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services."
F-9
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 1--GENERAL AND SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes, as well as operating
loss, capital loss and tax credit carryforwards. Deferred tax assets and
liabilities are classified as current or noncurrent based on the classification
of the related assets or liabilities for financial reporting, or according to
the expected reversal dates of the specific temporary differences, if not
related to an asset or liability for financial reporting. Valuation allowances
are established against deferred tax assets if it is more likely than not that
they will not be realized.
Income taxes associated with the undistributed earnings of a subsidiary are
not provided for in accordance with Accounting Principals Board Opinion No. 23,
when the Company has sufficient evidence that the subsidiary has invested or
will invest the undistributed earnings indefinitely. If it is determined that
the undistributed earnings of a subsidiary will be remitted in the foreseeable
future, all taxes related to the remittance of such undistributed earnings are
provided for in the current period as income tax expense.
IMPAIRMENT OF GOODWILL AND LONG-LIVED ASSETS
The carrying value of goodwill and long-lived assets is reviewed for
impairment whenever events or changes in circumstances occur indicating that the
net carrying amount may not be recoverable. The review is based on comparing the
carrying amount of the long-lived assets to the undiscounted estimated cash
flows over their remaining useful lives. If the sum of the expected undiscounted
future cash flows is less than the carrying amount of the assets, the Company
would recognize an impairment loss. The impairment loss, if determined to be
necessary, would be measured as the amount by which the carrying amount of the
asset exceeds the fair value of the asset. Assets to be disposed of are reported
at the lower of the carrying amount or fair value less costs to sell.
BASIC AND DILUTED NET INCOME (LOSS) PER SHARE
The Company presents basic net income (loss) per share and diluted net income
(loss) per share. Basic net income (loss) per share excludes dilution and is
computed by dividing net income (loss) by the weighted average number of shares
outstanding for each period presented. Diluted net income (loss) per share is
computed by dividing net income (loss) by the weighted average number of shares
outstanding plus the dilutive potential of common shares which would result from
the exercise of stock options and warrants or conversion of convertible
securities. However, the dilutive effects of stock options, warrants and
convertible securities are excluded from the computation of diluted net income
(loss) per share if doing so would be antidilutive.
NOTE 2--DISPOSITIONS
(a) In 1998 and 1999, DSSI owned 60% of the shares of Tower Semiconductor
Holdings 1993 Ltd. ("Holdings"). Holdings' only asset was its investment in
44.8% and 45.3% of Tower Semiconductor Ltd. ("Tower") for 1998 and 1999,
respectively. In December 1999, Holdings entered into an agreement to sell its
interest in Tower to the 40% minority owner of Holdings for $30,889. Closing of
the agreement was subject to third-party administrative approvals, which were
received in January 2000. As part of the agreement, Holdings declared a dividend
of $39,515 of which the Company received $23,709 (less withholding taxes of
$2,964) in January 2000. In light of the pending sale, the Company's interest in
Holdings was treated as a discontinued operation in the consolidated statements
of operations and comprehensive income (loss) for all periods presented and was
classified as an investment held for sale on the consolidated balance sheet at
December 31, 1999. In addition, the Company accrued all taxes with respect to
the anticipated repatriation of Tower's accumulated earnings. At December 31,
1999, the carrying value of the investment was stated at the agreed upon selling
price net of equity losses for the year.
Upon receipt of the administrative approvals, the Company received the
proceeds from the sale, net of the Israeli dividend withholding tax. In 2000,
the Company recorded a gain of $4,222 (net of applicable taxes of $767) with
respect to this transaction.
F-10
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 2--DISPOSITIONS -- (CONTINUED)
Set forth below is condensed financial information of Tower:
AS OF
DECEMBER 31,
------------
1999
------------
Current assets .................................................... $ 75,453
Property and equipment ............................................ 72,683
Current liabilities ............................................... 19,452
Long-term debt .................................................... 12,106
Other long-term liabilities ....................................... 1,532
Shareholders' equity .............................................. 122,121
YEAR ENDED DECEMBER 31,
-----------------------
1998 1999
---------- ---------
Sales ................................................ $ 69,637 $ 69,815
Operating loss ....................................... (23,998) (25,166)
Net loss ............................................. (15,544) (20,467)
The market value of the Company's share (net of minority interest) of
Holdings' investment in Tower as of December 31, 1998 was significantly below
the carrying value of the equity investment as of that date. Since the decline
in market price was determined to be other than temporary, the Company recorded
a write-down to market value of $6,103 at December 31, 1998 with respect to this
investment. This charge is included in loss from discontinued operations, net of
income taxes on the consolidated statement of operations and comprehensive
income (loss).
In 1998 and 1999, the Company recorded equity losses with regard to its
interest in Tower of $3,708 and $5,005, respectively. These equity losses are
included in loss from discontinued operations, net of income taxes. In addition,
in 1999, the Company recorded a provision for Israeli taxes of $3,723 with
respect to the anticipated repatriation of subsidiary income related to the
Company's sale of its interest in Tower in January 2000.
(b) In September 2000, the Company completed the sale of substantially all
the assets of its CinNetic division, included in the software development and
consulting segment, for a total of $1,838 resulting in a gain of $1,144. The
CinNetic division had an operating loss of approximately $505 and $315 for the
years ending December 31, 1999 and 2000, respectively.
(c) In April 1998 the Company sold certain assets and the technology related
to its help desk software segment for approximately $6,595. The Company
recognized a gain of approximately $5,998 before taxes in the second quarter of
1998 in connection with this transaction. This segment had an operating loss of
$1,331 in 1998. In 2000, the Company recorded an additional provision of $104
with respect to additional expenses related to the discontinued help desk
software segment. All amounts related to this segment are included in
discontinued operations.
NOTE 3--ACQUISITIONS
(a) In August 1999, the Company acquired the assets of the Control Systems
division of Scientific-Atlanta, Inc., integrating it into the Company's utility
solutions segment. The acquisition was accounted for using the purchase method.
The purchase price was $4,172 (including $172 of transaction costs), of which
$750 was not due until August 2000. The purchase price was subject to adjustment
primarily to reflect reimbursement by Scientific-Atlanta of the cost of certain
contractual obligations assumed by the Company. During 2000, the Company reduced
the deferred purchase obligation by $683 to $67 reflecting the net effect of
certain adjustments. As of December 31, 2000, the Company and Scientific-Atlanta
have not reached agreement on the final purchase price. Further adjustments, if
any, upon finalization of the purchase price will be reflected as a change to
goodwill. The adjusted purchase price of $3,954 has been allocated as follows:
$2,013 to inventory, $639 to property and equipment; $248 to patents and patents
pending; $20 to assumed liability and $1,074 to goodwill. Such allocation
includes adjustments during 2000 to the preliminary purchase price allocation at
December 31, 1999.
(b) In April 1999, the Company purchased all of the outstanding minority
interest in the Company's Decision Systems Israel subsidiary, a public company
whose shares were traded on the Tel Aviv Stock Exchange, for aggregate
consideration of $2,750. The Company recorded goodwill of approximately $2,200
in connection with the acquisition.
F-11
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 4--ACCOUNTS RECEIVABLE, NET
Accounts receivable, net consists of the following:
YEAR ENDED DECEMBER 31,
-----------------------
1998 1999
------- ------
Trade accounts receivable ........................... $ 9,251 $9,348
Unbilled work-in-process ............................ 1,008 1,076
Allowance for doubtful accounts. .................... (181) (435)
------- -------
Accounts receivable, net ............................ $10,078 $9,989
======= =======
Unbilled work-in-process principally represents direct labor and expenses
incurred on consulting contracts that have not been invoiced to the customer as
of the end of the period. Such amounts are generally billed within three months.
Bad debt expense related to trade accounts receivable was $37, $169 and $262
for the years ended December 31, 1998, 1999 and 2000, respectively. Trade
accounts receivable charged to the allowance for doubtful accounts were $74, $74
and $8 for the years ended December 31, 1998, 1999 and 2000, respectively.
NOTE 5--INVENTORY
Inventory consists of the following:
AS OF DECEMBER 31,
----------------------
1999 2000
------ ------
Raw materials, spare parts and supplies ............... $1,047 $ 35
Work in process ....................................... 72 --
Finished goods and merchandise ........................ 130 413
------ -----
$1,249 $448
====== =====
NOTE 6--OTHER CURRENT ASSETS
Other current assets consist of the following:
AS OF DECEMBER 31,
--------------------
1999 2000
----- ------
Prepaid expenses. ..................................... $397 $ 240
Interest receivable ................................... -- 514
Other ................................................. 548 400
----- ------
...................................................... $945 $1,154
===== ======
NOTE 7--INVESTMENT
In 2000, the Company received equity shares of $153 as partial compensation
for services rendered to two start-up companies. The investment is accounted for
using the cost method.
F-12
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 8--PROPERTY AND EQUIPMENT, NET
Property and equipment consist of the following:
ESTIMATED USEFUL LIFE AS OF DECEMBER 31,
--------------------- ------------------
(IN YEARS) 1999 2000
------ ------
Cost:
Computer hardware and software ... 3 $3,201 $3,463
Office furniture and equipment ... 4-10 1,606 1,802
Motor vehicles ................... 7 365 85
Leasehold improvements ........... Term of Lease 240 246
------ ------
5,412 5,596
------ ------
Accumulated depreciation and amortization:
Computer hardware and software ....................... 2,355 2,864
Office furniture and equipment ....................... 815 930
Motor vehicles ....................................... 193 60
Leasehold improvements ............................... 196 207
------ ------
3,559 4,061
------ ------
Property and equipment, net ............................ $1,853 $1,535
====== ======
Depreciation and amortization in respect of property and equipment amounted
to $867, $792 and $834 for 1998, 1999 and 2000, respectively.
NOTE 9--GOODWILL AND OTHER INTANGIBLE ASSETS, NET
Goodwill and other intangible assets consists of the following:
AS OF DECEMBER 31,
---------------------
1999 2000
------ ------
Goodwill, net of accumulated amortization of
$1,519 and $2,174, respectively ..................... $3,668 $2,350
License, net of accumulated amortization of
$225 and $341, respectively. ........................ 343 227
Patents, net of accumulated amortization of
$1 and $23, respectively. ........................... 274 249
------ ------
$4,285 $2,826
====== ======
Amortization in respect of goodwill, license and patents amounted to $232,
$559 and $794 for 1998, 1999 and 2000, respectively.
NOTE 10--DEBT
Debt consists of the following:
AS OF DECEMBER 31,
---------------------
1999 2000
------ ------
Convertible debentures (see Note 12) ................. $1,562 $ --
Bank debt. ........................................... 5,947 6,000
Lines of credit ...................................... 1,395 573
Capital lease obligations ............................ 103 33
------ ------
9,007 6,606
Less current portion ................................. 7,423 591
------ ------
$1,584 $6,015
====== ======
Bank debt at December 31, 1999 included $5,947 borrowed to finance the
acquisition described in Note 3a. The debt bears interest at prime plus 1% (9.5%
at December 31, 1999) and the principal was due in August 2000. In February
2000, the Company refinanced the bank debt with a $6,000 loan. In connection
with the refinancing, the Company recognized an extraordinary loss of $190 for
the write-off of the unamortized premium associated with a warrant issued to the
lender (see Note 15). No income tax benefit on this extraordinary item was
recog-
F-13
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 10--DEBT -- (CONTINUED)
nized as the Company is in a tax loss carryforward position. The $6,000 loan
principal is payable in a single installment upon maturity in February 2002 and
bears interest at LIBOR plus 0.75% (7.15% at December 31, 2000) payable
quarterly. The Company was required to deposit $6,000 with the lender as
collateral for the loan. This deposit bears interest at a rate of 6.9% and
matures in February 2002.
At December 31, 2000, the Company had approximately $1.9 million in Israeli
credit lines available. These credit lines are denominated in NIS and bear
interest at an average rate of the Israeli prime rate plus 0.2% per annum. The
Israeli prime rate fluctuates and as of December 31, 2000 was 9.5%.
The Company's capital lease obligations are payable through 2004.
NOTE 11--OTHER CURRENT LIABILITIES
Other current liabilities consists of the following:
AS OF DECEMBER 31,
---------------------
1999 2000
------ ------
Taxes payable ......................................... $3,723 $1,185
Lien allowance ........................................ 558 558
Deferred income ....................................... 324 385
Deferred acquisition costs ............................ 750 47
Other ................................................. 1,233 1,796
------ ------
$6,588 $3,971
====== ======
NOTE 12--CONVERTIBLE DEBENTURES
In October 1999, the Company completed a $2,000 private placement of 0%
Convertible Subordinated Debentures (the "Debentures"), payable in October 2001,
and 100,000 warrants with an exercise price of $3.06625 to purchase common stock
of the Company. In addition, the Company issued 20,000 warrants with an exercise
price of $3.06625, as partial compensation to a finder in connection with the
private placement. The warrants expire in October 2002. The Debentures were
immediately convertible into common stock of the Company at a conversion price
equal to the lower of $3.06625 and 85% of the average closing bid prices for the
common stock for the five trading days preceding delivery notice of the
conversion. The estimated fair value of the beneficial conversion feature of the
Debentures of $300 was immediately charged to interest expense in 1999.
The Company used the Black-Scholes valuation method to estimate the fair
value of the 120,000 warrants to purchase common stock of the Company, using a
risk free interest rate of 6%, an expected life of three years (which is equal
to its contractual life), expected annual volatility of 63% and no expected
dividends. The warrants' value of $114 reduced the carrying value of the debt
and is amortized as additional interest expense over the term of the Debentures
($12 and $9 in 1999 and 2000, respectively).
Imputed interest on the Debentures, totaling $377, based on a rate of 10%,
was to be amortized over the life of the Debentures. For the years ending
December 31, 1999 and 2000, $41 and $19, respectively, was amortized to interest
expense with the remaining balance offset against the Debentures. The effective
interest rate on the Debentures after consideration of the imputed interest and
warrants issued is approximately 12%.
In February 2000, the Company extinguished a portion of the Debentures for an
aggregate redemption price of $2,001. The Company recorded an extraordinary loss
of $753 due to the early redemption. No income tax benefit on this extraordinary
item was recognized as the Company is in a tax loss carryforward position. The
$260 unredeemed balance of the convertible debentures was converted into 84,794
shares of common stock of the Company in accordance with the terms of the
Debentures.
NOTE 13--LIABILITY FOR EMPLOYEE TERMINATION BENEFITS
Under Israeli law and labor agreements, the Company's subsidiaries in Israel
are required to make severance and pension payments to dismissed employees and
to employees leaving employment in certain other circumstances. The obligation
for severance pay benefits, as determined by the Israeli Severance Pay Law, is
based upon length of service and last salary. These obligations are
substantially covered by
F-14
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 13--LIABILITY FOR EMPLOYEE TERMINATION BENEFITS-- (CONTINUED)
regular deposits with recognized severance pay and pension funds and by the
purchase of insurance policies. The pension plans are multi-employer and
independent of the Company. Pension and severance pay costs for 1998, 1999 and
2000 of approximately $1,486, $1,355 and $1,276, respectively, were included in
selling, general and administrative expenses.
NOTE 14--COMMITMENTS AND CONTINGENCIES
(a) Leases of Property and Equipment
Rental and leasing expenses for 1998, 1999 and 2000 amounted to $1,258,
$1,463 and $1,326, respectively. Future minimum lease payments on non-cancelable
operating leases as of December 31, 2000 are as follows:
YEAR ENDING
DECEMBER 31,
------------
2001. ..................................... $ 1,270
2002. ..................................... 1,157
2003. ..................................... 816
2004. ..................................... 462
2005. ..................................... 397
Thereafter ................................ 957
------
$5,059
======
(b) Employee Retirement Savings Plan
The Company sponsors a tax deferred retirement savings plan that permits
eligible U.S. employees to contribute varying percentages of their compensation
up to the limit allowed by the Internal Revenue Service. This plan also provides
for discretionary Company contributions. No discretionary contributions were
made for the years ended December 31, 1998, 1999 and 2000.
(c) Guarantees
In 1998, the Company accrued a loss for contingent performance of bank
guarantees of approximately $1,135 (included in other loss, net). The Company's
remaining commitment under these guarantees (included in other current
liabilities) is $558 at December 31, 1999 and 2000. The Company has
collateralized a portion of these guarantees by means of a deposit (classified
as restricted cash) of $536 and $223 as of December 31, 1999 and 2000,
respectively.
(d) Royalties
The Company is committed to pay royalties to the Government of Israel on
proceeds from the sale of certain products in which the Government of Israel
participated in the research and development by way of grants. Royalties are
currently payable at a rate of 4% of the annual sales of the product. The amount
payable as royalties is limited to the amount of the original grant of $595. The
net amount due in respect of these grants amounted to approximately $547 at
December 31, 2000.
(e) Litigation
The Company is involved in various legal actions and claims arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's consolidated financial position, results of operations or liquidity.
NOTE 15--SHAREHOLDERS' EQUITY
(a) Stock Option Plans
The Company's stock option plans provide for the granting to officers,
directors and other key employees of options to purchase shares of common stock
at not less than 85% of the market value of the Company's common stock on the
date of grant. The purchase price must be paid in cash. To date, the Company has
issued options under the plans at exercise prices equal to the market value of
the Company's com-
F-15
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 15--SHAREHOLDERS' EQUITY -- (CONTINUED)
mon stock of the date of the grant. All options expire within five to ten years
from the date of the grant. The options generally vest over a two to three year
period from the date of the grant. At December 31, 2000, the total authorized
number of options or other equity instruments granted or available for grant
under the various plans was 2,620,225.
A summary status of the Company's option plans as of December 31, 1998, 1999
and 2000, as well as changes during each of the years then ended, is presented
below:
1998 1999 2000
---------------------- ---------------------- ----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
--------- ----- --------- ----- --------- -----
(IN SHARES) (IN SHARES) (IN SHARES)
Outstanding at beginning of year .............. 1,456,067 $6.57 1,498,717 $6.39 1,723,850 $5.32
Granted ....................................... 95,000 $3.49 408,450 $2.10 412,275 $5.36
Exercised ..................................... (10,000) $5.50 -- -- (27,000) $2.46
Forfeited ..................................... (42,350) $6.02 (183,317) $7.00 (554,350) $6.38
--------- --------- ---------
Outstanding at end of year .................... 1,498,717 $6.39 1,723,850 $5.32 1,554,775 $5.01
========= ========= =========
Exercisable at end of year .................... 1,309,050 $6.64 1,276,683 $5.70 1,121,406 $4.95
========= ========= =========
EXERCISABLE AS OF
OUTSTANDING AS OF DECEMBER 31, 2000 DECEMBER 31, 2000
-------------------------------------------------- ----------------------------
WEIGHTED AVERAGE WEIGHTED WEIGHTED
NUMBER REMAINING AVERAGE NUMBER AVERAGE
RANGE OF EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- ------------------------ ---------------- ---------------- -------------- ----------- --------------
(IN SHARES) (IN YEARS) (IN SHARES)
$1.80-2.00 .................................... 294,000 5.34 $ 1.82 251,667 $ 1.81
$2.44-3.69 .................................... 247,000 5.94 3.14 131,666 3.08
$4.50-6.00 .................................... 297,500 2.45 5.53 270,833 5.57
$6.06-7.88 .................................... 693,775 3.99 6.62 444,740 6.58
$11.13 ........................................ 22,500 4.73 11.13 22,500 11.13
--------- -----------
1,554,775 1,121,406
========= ===========
The weighted average grant-date fair value of the 95,000, 408,450 and 412,275
options granted during 1998, 1999 and 2000, respectively, amounted to $1.65,
$1.60 and $2.85 per option, respectively. The Company utilized the Black-Scholes
option pricing model to estimate fair value, utilizing the following assumptions
for the respective years (all in weighted averages):
1998 1999 2000
------ ------ ------
Risk-free interest rate ....................... 5.0% 6.0% 5.0%
Expected life of options, in years ............ 6.6 6.8 5.9
Expected annual volatility .................... 39% 78% 82%
Expected dividend yield ....................... None None None
F-16
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 15--SHAREHOLDERS' EQUITY -- (CONTINUED)
Had compensation cost for the Company's option plans been determined based on
fair value at the grant dates for awards made in 1998, 1999 and 2000 under such
plans in accordance with SFAS No. 123, the Company's pro forma net income (loss)
and net income (loss) per share would have been as follows:
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1999 2000
--------- --------- --------
Net income (loss) as reported ............. $ (12,944) $ (15,867) $ 112
Pro forma net loss ........................ (13,010) (16,658) (927)
Basic net loss per share--as reported ..... (1.75) (2.13) 0.02
Pro forma basic net loss per share ........ (1.77) (2.24) (0.12)
Diluted net income (loss)
per share as reported ................... (1.75) (2.13) 0.01
Pro forma diluted net loss per share ...... (1.77) (2.24) (0.12)
The pro forma information in the above table also gives effect to the
application of SFAS No. 123 on the share option plans of the Company's
subsidiary.
(b) Warrants
The Company has issued warrants at exercise prices equal to or greater than
market value of the Company's common stock at the date of issuance. A summary of
warrant activity follows:
1998 1999 2000
---------------------- ---------------------- ----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
--------- ----- --------- ----- --------- -----
(IN SHARES) (IN SHARES) (IN SHARES)
Outstanding at beginning of year ............... 197,500 $10.18 197,500 $10.18 370,000 $ 3.23
Granted ........................................ -- -- 370,000 3.23 -- --
Repurchased by Company ......................... -- -- -- -- (250,000) 3.31
Forfeited ...................................... -- -- (197,500) 10.18 -- --
------- -------- --------
Outstanding at end of year ..................... 197,500 $10.18 370,000 $ 3.23 120,000 $ 3.07
======= ======== ========
In August 1999, the Company granted a lender 250,000 warrants to purchase
common stock with an exercise price of $3.31 per share, the fair market value of
the Company's common stock at the date of the grant. The warrants were to expire
on August 31, 2002. In September 2000, the Company repurchased the 250,000
warrants outstanding from the lender for $1.50 per warrant.
(c) Stock Awards
In March 1996, the Company granted 100,000 shares of common stock to its
Chief Executive Officer. The shares vested over a three-year period. Deferred
compensation in the aggregate amount of $587, equal to the shares' fair value on
the date of the grant, was recorded against additional paid-in capital at the
date of grant, of which $196 and $46 was amortized to compensation expense
during 1998 and 1999, respectively.
In August 1998, the Company granted 155,000 shares of common stock to its
Chief Executive Officer. The shares generally vest over a two-year period,
except that the vesting of 20,000 of the shares may be delayed until certain
performance goals have been met. These performance goals have not been met since
the date of grant. Deferred compensation in the aggregate amount of $436, equal
to the shares' fair value on the date of the grant, was recorded against
additional paid-in capital at the date of grant, of which $109, $254 and $73 was
amortized to compensation expense during 1998, 1999 and 2000, respectively.
(d) Stock Repurchase Program
In August 1998, the Company's Board of Directors authorized the purchase of
up to 500,000 shares of the Company's common stock. In September 2000, the
Company's Board of Directors authorized the purchase of up to an additional
500,000 shares of the Company's common stock. During 1998 and 2000, the Company
purchased 150,900 and 500,385 of its common stock, respectively, and at December
31, 2000 owned in the aggregate 990,647 of its own shares.
F-17
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 15--SHAREHOLDERS' EQUITY -- (CONTINUED)
(e) Other
In March 1996, the Company's Board of Directors adopted a stockholder rights
plan providing for the distribution of common stock purchase rights at the rate
of one right for each share of the Company's common stock held by shareholders
of record as of the close of business on April 1, 1996. The rights plan is
designed to deter coercive takeover tactics, including the accumulation of
shares in the open market or through private transactions, and to prevent an
acquirer from gaining control of the Company without offering a fair price to
all of the Company's shareholders. Each right initially entitles shareholders to
buy one-half of a share of common stock of the Company for $15. Generally, the
right will be exercisable only if a person or group acquires beneficial
ownership of 15% or more of the Company's common stock or commences a tender or
exchange offer upon consummation of which such person or group would
beneficially own 15% or more of the Company's common stock.
If any person ("Acquiring Person") becomes the beneficial owner of 15% or
more of the Company's common stock, other than pursuant to a tender or exchange
offer for all outstanding shares of the Company approved by a majority of the
Company's independent directors, then, subject to certain exceptions set forth
in the rights plan, each right not owned by the Acquiring Person or related
parties will entitle its holder to purchase, at the right's then current
exercise price, shares of the Company's common stock (or in certain
circumstances, as determined by the Board of Directors, cash, other property or
other securities) having a value of twice the right's then current exercise
price. The Company will generally be entitled to redeem the rights at one half
of one cent per right at any time until 10 days (subject to extension) following
a public announcement that a 15% position has been acquired. The rights plan
will expire in March 2006.
F-18
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 16--INCOME TAXES
(a) Composition of loss from continuing operations before income taxes is as
follows:
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1999 2000
------- ------- -------
Domestic ................................... $(5,137) $(5,809) $(3,238)
Foreign .................................... (2,628) (1,268) 346
------- ------- -------
$(7,765) $(7,077) $(2,892)
======= ======= =======
(b)Income taxes consist of the following:
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1999 2000
------- ------- -------
Current:
Federal .................................. $ -- $ -- $ --
State and local .......................... (8) 35 46
Foreign .................................. 52 22 145
------- ------- -------
44 57 191
------- ------- -------
Deferred:
Federal .................................. -- 5 --
State and local .......................... (9) -- (20)
Foreign .................................. -- -- --
------- ------- -------
(9) 5 (20)
------- ------- -------
Income tax from continuing operations ...... 35 62 171
Income tax expense from :
Discontinued operations * ................ -- 3,723 --
Gain on sale of discontinued operations .. -- -- 767
------- ------- -------
Total income tax expense ................. $ 35 $ 3,785 $ 938
======= ======= =======
- ----------
* Represents a provision for Israeli taxes with respect to the anticipated
repatriation of subsidiary income related to the Company's sale of its
interest in Tower in January 2000 (see Note 2).
(c) Effective Income Tax Rates
Set forth below is a reconciliation between the federal tax rate and the
Company's effective income tax rates:
YEAR ENDED DECEMBER 31,
--------------------------------
1998 1999 2000
------- ------- -------
Statutory federal rates .................... 34% 34% 34%
Increase (decrease) in income tax rate
resulting from:
Non-deductible expenses .................... 5 -- (7)
State and local income taxes, net .......... 2 9 7
Net operating loss carryforward ............ (5) 4 16
Other ...................................... 1 (3) (8)
Valuation allowance ........................ (37) (45) (48)
------- ------- -------
Effective income tax rates ................. 0% (1)% (6)%
======= ======= =======
F-19
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 16--INCOME TAXES -- (CONTINUED)
(d) Analysis of Deferred Tax Assets (Liabilities)
Deferred tax assets (liabilities) consist of the following:
AS OF DECEMBER 31,
--------------------
1999 2000
-------- -------
Accelerated depreciation for tax purposes ............. $ 11 $ 15
Intangible asset basis differences .................... 59 47
Other temporary differences ........................... 1,231 901
Net operating and capital loss carryforwards .......... 10,315 5,882
Alternative minimum tax credit carryforwards .......... 3,693 371
-------- -------
15,309 7,216
Valuation allowance ................................... (15,309) (7,196)
-------- -------
Net deferred tax asset ................................ $ -- $ 20
======== =======
Net deferred tax assets consist of the following:
AS OF DECEMBER 31,
---------------------
1999 2000
-------- -------
Deferred tax assets--current .......................... $ -- $ 18
Deferred tax assets--non-current ...................... -- 2
Deferred tax liabilities .............................. -- --
Net deferred tax asset ................................ $ -- $ 20
======== =======
Until 1999, due to the history of losses in the Company's operations, a
valuation allowance was established against all deferred tax assets. Currently,
no valuation allowance is established for the Company's operations which are
reasonably expected to utilize their deferred tax assets. Valuation allowances
relate principally to net operating loss and capital loss carryforwards and
foreign tax credit carryforwards. The change in the valuation allowance in 1999
and 2000 was an increase of $5,121 and a decrease of $8,113, respectively.
(e) Summary of Tax Loss Carryforwards
As of December 31, 2000, the Company had various net operating loss
carryforwards, which expire as follows:
EXPIRATION FEDERAL STATE FOREIGN
------ ------- ------
2001-2002 .................................... $ -- $ 720 $ --
2003-2004 .................................... -- 6,973 --
2005-2007 .................................... -- 7,207 --
2020 ......................................... 1,178 -- --
Unlimited .................................... -- -- 8,555
------ ------- ------
Total ........................................ $1,178 $14,900 $8,555
====== ======= ======
NOTE 17--RELATED PARTY BALANCES AND TRANSACTIONS
Other assets include a loan, bearing interest at an annual rate of 7%, to its
Chief Executive Officer. The balance of this loan, including interest, was
approximately $511 at December 31, 1999. The loan was repaid in full in 2000.
The Company paid consulting and other fees to directors of $108, $97 and $5 for
the years ended December 31, 1998, 1999 and 2000, respectively, which is
included in selling, general and administrative expenses. Approximately $92, $32
and $(22) was recorded as an expense reimbursement from an affiliate during the
years ended December 31, 1998, 1999 and 2000, respectively, and was reflected as
a reduction (increase) of selling, general and administrative expenses. The
Company paid legal fees for services rendered and out-of-pocket disbursements to
a firm in which a director is a principal, of approximately $410, $494 and $474
for the years ended December 31, 1998, 1999 and 2000, respectively.
Approximately $176 and $55, owed to this firm as of December 31, 1999 and 2000,
respectively, was included in other current liabilities. The Company paid the
director of operations of one of its subsidiaries, who is the son of the
Company's Chief Executive Officer, approximately $122, $132 and $280 for the
years ending December 31, 1998, 1999 and 2000, respectively.
F-20
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 18--SEGMENT REPORTING AND GEOGRAPHIC INFORMATION
(a) General Information
The Company has three reportable segments: consulting and development
services; computer hardware sales; and utility solutions.
(i) The consulting and development services segment provides computer
software and systems consulting and development services, primarily to
high-technology customers.
(ii) The computer hardware segment is an authorized dealer and value added
reseller of computer hardware.
(iii) The utility solutions segment develops load control and data
communication solutions for utilities.
The Company's reportable segments are strategic business units that offer
different products and services. They are managed separately because each
business requires different technology and marketing strategies. Similar
operating segments that operate in different countries are aggregated into one
reportable segment in accordance with the provisions of SFAS 131.
(b) Information about Profit or Loss and Assets
The accounting policies of all the segments are those described in the
summary of significant accounting policies. The Company evaluates performance
based on the profit or loss from operations before income taxes not including
nonrecurring gains and losses.
The Company accounts for intersegment sales and transfers as if the sales or
transfers were to third parties, that is, at current market prices. The Company
does not systematically allocate assets to the divisions of the subsidiaries
constituting its consolidated group, unless the division constitutes a
significant operation. Accordingly, where a division of a subsidiary constitutes
a segment that does not meet the quantitative thresholds of SFAS 131,
depreciation expense is recorded against the operations of such segment, without
allocating the related depreciable assets to that segment. However, where a
division of a subsidiary constitutes a segment that does meet the quantitative
thresholds of SFAS 131, related depreciable assets, along with other
identifiable assets, are allocated to such division.
F-21
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 18--SEGMENT REPORTING AND GEOGRAPHIC INFORMATION -- (CONTINUED)
The following tables represent segmented data for the years ended December
31, 2000, 1999 and 1998:
CONSULTING AND
DEVELOPMENT UTILITY COMPUTER
SERVICES SOLUTIONS HARDWARE OTHER(*) TOTAL
------- ------- ------- ------ -------
Year ended December 31, 2000:
Revenues from external customers .... $18,977 $17,105 $21,515 $ 204 $57,801
Intersegment revenues ............... 58 1,507 215 -- 1,780
Interest revenue .................... 59 3 -- -- 62
Interest expense .................... 136 412 -- -- 548
Depreciation and amortization ....... 362 833 38 6 1,239
Segment profit (loss) ............... 1,530 (3,216) 726 41 (919)
Income tax expense (benefit) ....... 107 9 (13) -- 103
Segment assets ...................... 7,324 4,534 4,937 64 16,859
Expenditures for segment assets ..... 358 361 17 -- 736
Year ended December 31, 1999:
Revenues from external customers .... $18,784 $ 5,061 $15,218 $ 285 $39,348
Intersegment revenues ............... 597 167 40 -- 804
Interest revenue .................... 43 -- -- -- 43
Interest expense .................... 233 1 5 -- 239
Depreciation and amortization ....... 416 516 48 15 995
Segment profit (loss) ............... (832) (3,297) 328 64 (3,737)
Equity in net income of investees ... (98) -- -- -- (98)
Income tax expense .................. 60 1 10 -- 71
Segment assets ...................... 7,748 6,829 5,352 6 19,935
Expenditures for segment assets ..... 286 954 28 -- 1,268
Year ended December 31, 1998:
Revenues from external customers .... $18,640 $ 212 $16,374 $1,124 $36,350
Intersegment revenues ............... 124 -- 22 159 305
Interest revenue .................... 57 -- -- -- 57
Interest expense .................... 235 2 9 -- 246
Depreciation and amortization ....... 458 359 45 72 934
Segment profit (loss) ............... 5,742 (3,428) 1,514 (957) 2,871
Loss on note ........................ 418 -- -- -- 418
Equity in net income of investees ... (198) -- -- -- (198)
Income tax expense (benefit) ........ 20 -- (43) -- (23)
Segment assets ...................... 9,992 1,544 3,659 26 15,221
Expenditures for segment assets ..... 301 591 30 -- 922
- ----------
* Represents three segments below the quantitative thresholds of SFAS 131, as
follows: in 2000, a VAR software operation in Israel, a holding company, and
residual operations from the Company's multimedia software segment; in 1999,
a VAR software operation in Israel and residual operations from the
multimedia software segment; and in 1998, a VAR software operation in Israel
and an Internet database venture. The 1998 operations from the multimedia
software segment also have been included in "other" so as to be comparable
with the current year's presentation.
F-22
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 18--SEGMENT REPORTING AND GEOGRAPHIC INFORMATION -- (CONTINUED)
(c) Reconciliations
The following tables represent a reconciliation of the segment data to
consolidated statement of operations and balance sheet data for the years ended
December 31, 1998, 1999 and 2000:
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------
1998 1999 2000
-------- -------- --------
Revenues:
Total revenues for reportable segments ..... $ 35,226 $ 39,063 $ 57,597
Other operational segment revenues ......... 1,124 285 204
Revenue from management fee derived
by non-operating segment (corporate
headquarters) ............................ 360 360 38
-------- -------- --------
Total consolidated revenues ................ $ 36,710 $ 39,708 $ 57,839
======== ======== ========
Operating income (loss):
Total operating loss for reportable
segments ................................. $ (2,601) $ (3,417) $ (369)
Other operational segment operating
income (loss) ............................ (603) 64 41
Unallocated amounts: Net loss of
corporate headquarters ................... (3,054) (2,294) (3,563)
-------- -------- --------
Total consolidated operating loss .......... $ (6,258) $ (5,647) $ (3,891)
======== ======== ========
AS OF DECEMBER 31,
-------------------
1999 2000
------- -------
Assets:
Total assets for reportable segments ................... $19,929 $16,795
Unallocated amounts: Net assets of
corporate headquarters * ............................. 30,529 25,362
------- -------
Total consolidated assets .............................. $50,458 $42,157
======= =======
- ----------
* Unallocated assets in 2000 include cash and cash equivalents of $10,395 as
well as investments in short and long-term bank deposits of $11,994.
Unallocated assets in 1999 include the Tower investment (net of minority
interest) of $25,900 at December 31, 1999 (see Note 2).
SEGMENT CONSOLIDATED
TOTALS ADJUSTMENTS TOTALS
------- ----------- ------------
Other Significant Items:
Year ended December 31, 2000
Depreciation and amortization .............. $ 1,239 $ 389 $ 1,628
Expenditures for assets .................... 736 6 742
Income tax expense ......................... 103 68 171
Income tax expense for
discontinued operations .................. -- 767 767
Year ended December 31, 1999
Depreciation and amortization .............. $ 995 $ 356 $ 1,351
Expenditures for assets .................... 1,268 8 1,276
Equity in net income of investees .......... (97) (5,004) (5,101)
Income tax expense (benefit) ............... 71 (9) 62
Income tax expense for
discontinued operations .................. -- 3,723 3,723
The reconciling items are all corporate headquarters data, which are not
included in the segment information. The reconciling item to adjust equity in
net income of investees in 1999 is the Company's share of Tower's loss. The
reconciling item to adjust income tax expense in 1999 is the tax expense related
to the anticipated repatriation of subsidiary income related to the Company's
sale of its interest in Tower. None of the other adjustments are significant.
F-23
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 18--SEGMENT REPORTING AND GEOGRAPHIC INFORMATION -- (CONTINUED)
(d) Geographic Information
YEAR ENDED DECEMBER 31,
---------------------------
1998 1999 2000
------- ------- -------
Revenues based on location of customer:
Israel ........................................... $14,637 $15,401 $15,431
United States .................................... 22,073 23,579 41,659
Far East ......................................... -- 708 226
Other ............................................ -- 20 523
------- ------- -------
$36,710 $39,708 $57,839
======= ======= =======
AS OF
DECEMBER 31,
----------------
1999 2000
------ ----
Long-lived assets located in the following countries:
Israel ..................................................... $ 852 $775
United States .............................................. 1,001 760
(e) Major Customers
REVENUES FROM MAJOR CUSTOMERS CONSOLIDATED SALES
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
CUSTOMER SEGMENT 1998 1999 2000
- ---------------- ------------------- ---------------- ------------------
% OF % OF % OF
TOTAL TOTAL TOTAL
REVENUES REVENUES REVENUES REVENUES REVENUES REVENUES
-------- -------- -------- -------- -------- --------
A Computer hardware ... $ 5,930 15.8% $ 90 0.2% $ 331 0.6%
B Computer hardware ... 4,470 11.9 5,651 14.2 5,084 8.8
------- ---- ------ ---- ------ ----
$10,400 27.7% $5,741 14.4% $5,415 9.4%
======= ==== ====== ==== ====== ====
NOTE 19--FINANCIAL INSTRUMENTS
(a) Fair Value of Financial Instruments
Fair values of financial instruments included in current assets and current
liabilities are estimated to approximate their book values, due to the short
maturity of such instruments. Fair values for long-term debt and long-term
deposits are estimated based on the current rates offered to the Company for
debt and deposits with the similar terms and remaining maturities. The fair
value of the Company's long-term debt and long-term deposits are not materially
different from their carrying amounts. The fair value of investments is
estimated based on market value. The estimation of fair value of the Company's
investments (book value of $153 at December 31, 2000) was not practicable,
although the Company believes that the estimated fair values of such investments
are not materially different from their book values.
(b) Concentrations of Credit Risk
Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist principally of cash and cash equivalents,
short and long-term bank deposits, asset-backed securities and trade
receivables. The counterparty to a majority of the Company's cash equivalent
deposits as well as its short and long-term bank deposits is a major financial
institution of high credit standing. The counterparties to the Company's
asset-backed securities consist of various major corporations of high credit
standing. The Company does not believe there is significant risk of
non-performance by these counterparties. Approximately 16% of the trade accounts
receivable at December 31, 2000 were due from a U.S. customer that pays its
trade receivables over usual credit periods. Credit risk with respect to the
balance of trade receivables is generally diversified due to the large number of
entities comprising the Company's customer base.
F-24