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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, 2001
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)
(201) 529-2026
Registrant's telephone number, including area code
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 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 12, 2002 was approximately $25.5 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
12, 2002: 7,353,163.
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.
TABLE OF CONTENTS
PAGE
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PART I
Item 1 Business..................................................................................... 1
Item 2 Properties................................................................................... 8
Item 3 Legal Proceedings............................................................................ 8
Item 4 Submission of Matters to a Vote of Security Holders.......................................... 9
PART II
Item 5 Market for Registrant's Common Equity and Related Stockholder Matters........................ 10
Item 6 Selected Financial Data...................................................................... 10
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................................. 12
Item 7A Quantitative and Qualitative Disclosures About Market Risk................................... 22
Item 8 Financial Statements and Supplementary Data.................................................. 22
Item 9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure...................................................................... 22
PART III
Item 10. Directors and Executive Officers of the Registrant........................................... 23
Item 11. Executive Compensation....................................................................... 23
Item 12. Security Ownership of Certain Beneficial Owners and Management............................... 23
Item 13. Certain Relationships and Related Transactions............................................... 23
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................. 25
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 SOFTWARE CONSULTING AND DEVELOPMENT--Providing consulting and
development services for computer software and systems.
o ENERGY INTELLIGENCE SOLUTIONS--Developing and marketing load control,
data communications and other energy intelligence solutions for
electric utilities and their customers.
o COMPUTER HARDWARE SALES--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., a manufacturer of semiconductors.
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.
1999 2000 2001
----------------- ----------------- -----------------
AMOUNT % AMOUNT % AMOUNT %
--------- ------- ---------- ------ ---------- ------
Software consulting and development........................... $18,784 47 $18,977 33 $12,179 27
Energy intelligence solutions................................. 5,061 13 17,105 30 13,793 30
Computer hardware sales....................................... 15,218 38 21,515 37 19,794 43
Other......................................................... 645 2 242 -- 158 --
--------- ------- ---------- ------ ---------- ------
Total Sales $39,708 100 $57,839 100 $45,924 100
========= ======= ========== ====== ========== ======
SOFTWARE CONSULTING AND DEVELOPMENT
ACQUISITION OF ENDAN
Effective December 31, 2001, our Decision Systems Israel subsidiary,
("DSIT"), completed the acquisition of Endan IT Solutions Ltd. ("Endan"), an
Israeli information technology (IT) solutions provider. Endan specializes in IT
solutions, particularly for billing applications and healthcare solutions. It
also owns two proprietary software packages, EASYBILL(TM), a comprehensive
customer service and billing system aimed at the low to middle end application
market, and ENDAN CLINIC(TM), an integrated medical information management
system with specialized applications for oncology departments.
The Endan acquisition reestablishes DSIT as a leading software and systems
solution provider in Israel, with the potential to grow sales in Israel and to
establish a presence in the US and world markets. Endan's IT expertise gives us
a broader platform of markets and competencies from which to grow our Israeli
software operations and give us reason to expect revenue improvement in 2002,
despite the continuing hi-tech slowdown. In addition, we expect to benefit from
some cost savings and efficiencies from the DSIT-Endan combination, which will
contribute to improved profitability in the coming year. We also believe that
there is significant potential for cooperation and cross marketing between
Endan's EASYBILL(TM) and ENDAN CLINIC(TM) software packages and our activities
in the energy intelligence solutions and computer hardware VAR areas which we
hope to explore and exploit over the longer term.
As a result of the Endan acquisition, our ownership of DSIT was reduced to
68%, with the remaining 32% being owned by the three former Endan shareholders.
For additional information regarding the Endan acquisition, see Note 3 to the
consolidated financial statements included in this Annual Report.
SERVICES
Through DSIT, we provide computer software and systems consulting,
development and integration services. DSIT's principal area of technological
expertise is state-of-the-art hardware with embedded real-time software systems
in a wide variety of applications, primarily telecommunications, digital signal
processing, image processing, software testing and validation, electronic
warfare, simulation and electro-optics. DSIT combines the characteristics of a
systems and software house with significant hardware development capabilities,
in a wide range of application areas, spanning from
military and aerospace applications, security and public safety systems, telecom
and datacom systems, and command and control. Through our acquisition of Endan,
DSIT now offers expertise and solutions products for billing, healthcare and
other IT applications.
We provide our services either on a time-and-materials or fixed-price
basis. When working on a time-and-materials basis, our engineers 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 1999, 2000 and 2001,
sales attributable to services provided on a time-and-materials basis were $15.2
million, $14.2 million and $7.8 million, respectively, accounting for
approximately 81%, 75% and 64% 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, accounting for these services on the
percentage-of-completion method. Since the profit margins on these projects are
primarily determined by our success in controlling project costs, margins on
these projects may vary substantially as a result of various factors, including
underestimating costs, difficulties associated with implementing new
technologies and economic and other changes that may occur during the term of
the contract. During 1999, 2000 and 2001, sales from fixed-price contracts were
$3.6 million, $4.8 million and $4.4 million respectively, accounting for
approximately 19%, 25% and 36% of segment sales for such years, respectively.
CUSTOMERS AND MARKETS
Israel has historically been the primary area of this segment's operations,
accounting for 77%, 82% and 88% of segment sales in 1999, 2000 and 2001,
respectively. This trend will continue and is expected to increase as a result
of our acquisition of Endan. We have developed a diverse customer base. In 2001,
only one customer accounted for 10% of segment revenues and no other customer
accounted for more than 6% of segment revenues.
COMPETITION
Our software consulting and development 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. 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.
As a result of the Endan acquisition, we now own two proprietary software
packages: EASYBILL(TM), a comprehensive customer service and billing system
aimed at the low to middle end application market; and ENDAN CLINIC(TM), which
manages hospital medical files and has advanced applications for oncology
departments. The intellectual property rights resulting from our consulting and
development services are generally owned by the customer for whom the services
are performed. As a result, other than EASYBILL(TM) and ENDAN CLINIC(TM), we
have no capitalized software to be sold, leased or otherwise marketed.
ENERGY INTELLIGENCE SOLUTIONS
OVERVIEW
Through our Comverge subsidiary, we design, develop and market a full
spectrum of products, services and solutions to electric utilities and energy
service companies and their residential and business customers that provide
energy intelligence-the optimal transfer and usage of energy. Comverge provides
energy intelligence solutions to energy suppliers in the U.S. and around the
world. Comverge's energy intelligence solutions is a combination of hardware
development and manufacturing capabilities with a suite of software products
which, together, help electric utilities and energy service companies and their
customers address energy usage issues through load control, data communications
and analysis, real-time pricing and integrated billing and reporting. Our load
control 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, transmit, verify and
analyze 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 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.
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In January 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 using a two-way cable TV system and as well as using an Internet-based
wireless network. Comverge employs a number of the employees who were involved
in developing this product.
In August 1999, Comverge purchased the assets and business of
Scientific-Atlanta's Control Systems business division, acquiring its load
control and gateway product lines and hiring a number of employees from this
division.
Comverge is located in Florham Park, New Jersey where its sales and
marketing and PowerCAMP(tm) software groups operate. Comverge's administrative
and engineering personnel and principal product manufacturing facility are
located in Atlanta, Georgia. Comverge also maintains a small research center
located in Israel.
PRODUCTS AND SERVICES
Comverge offers data communications and load control product solutions that
address the information and control needs of the global energy market through
our power line technology and expertise we developed, combined with our
strategic acquisitions of technology, personnel, contracts and customer base
from Lucent and Scientific-Atlanta. Our technical expertise includes load
control, broadband, wireless and powerline communications, and Internet and home
networking and automation.
Comverge currently offers products and services in four product lines:
o Real-time usage information products;
o Load control products;
o Gateway products, which combine real-time information and control; and
o PowerCAMP(tm) Software products that allow utilities to conserve,
analyze, monitor and price electric usage.
REAL-TIME USAGE INFORMATION PRODUCTS. We market the Comverge Distributed
Connection, also referred to as CDC, which is 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 cellular digital packet data (CDPD) 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 companies use load control
products to reduce 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 three major load
control products: digital control units, also known as DCUs, SuperStats(tm) and
Maingate(tm). The DCU is a switch that can be connected to any appliance, such
as an air conditioner or water heater, and that permits the utility to turn
appliances on and off from a remote location utilizing wireless communications.
Our SuperStat(tm) product combines a programmable thermostat with a wireless
communication module to provide cooling systems direct load control, 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. Maingate(tm), our gateway product, is a system 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 cellular
digital packet data, also known as CDPD. Maingate(tm) provides information and
load control to the electric service company and can significantly reduce the
customer's electricity bills. When fully integrated with our PowerCAMP(tm)
software, Maingate(tm) provides utilities with a comprehensive solution for
their diverse requirements.
Maingate(tm) 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(tm) thermostat, the water heater and up to one additional appliance
within the home, are fitted with power line communication ("PLC") based load
control devices. The load control devices and the SuperStat(tm) are networked,
and linked via the Maingate(tm) gateway to the WAN. Maingate(tm) 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
typically will increase and the pre-programmed customer response to this price
increase will automatically raise the temperature setting in order to lower
energy use. However, the
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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. Because of its ability to communicate with devices within the home,
Maingate(tm) will also support additional value-added "smart-home" products and
services as they become available. Rollout of Maingate(tm) has commenced under a
contract with Gulf Power that provides for the installation of Maingate(tm) into
40,000 homes. As of December 31, 2001, we have provided for approximately 8,500
units under this contract.
POWERCAMP(tm) SOFTWARE PRODUCTS. PowerCAMP(tm) is an extensive suite of
software developed by our engineers and deployed in several countries. The
software used in PowerCAMP(tm) has been subject to extensive field-testing and
customer interaction and has been the backbone for monitoring and analyzing
utility meter reading and load management programs using Comverge products. We
have taken this software and packaged and modularized it as a suite of
stand-alone software editions for utilities and their residential, commercial
and industrial customers. PowerCAMP(tm) can also serve those customers through a
web-based Application Service Provider, or ASP, model.
CUSTOMERS AND MARKETS
Our energy intelligence solutions business has over 500 utility customers
in eight countries and 5,000,000 end point installations worldwide. The global
market for energy intelligence solutions is still emerging, and is estimated at
$35 billion over the next four 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 Continued deregulation of the electric utility industry in the United
States and resulting increased competition among electric service
companies.
Although the effects of the current trend toward deregulation in the United
States and overseas are not certain, we anticipate that the new, more
competitive environment, combined with expected government incentives and
mandates, will result in continued growth in the demand for products designed to
gather information and manage electricity usage.
Comverge's customers are generally domestic electric utilities, electric
service companies or prime contractors that serve electric utilities. Our
largest customer is Florida's Gulf Power, which purchased over $3.6 million in
2001 and is under contract to purchase an additional $23.2 million of
Maingate(tm) systems in 2002 through 2007. 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 SuperStat(tm) 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.
COMPETITION
Within the emerging energy intelligence 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
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.
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PROPRIETARY RIGHTS
Comverge holds 12 patents and has 13 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 24% and 25% of
segment sales in 2000 and 2001, respectively) and a large law firm (which
accounted for approximately 5% and 12% in 2000 and 2001, respectively). No other
customer accounted for more than 10% 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.
BACKLOG
As of January 1, 2002, our backlog of work to be completed was $24.9
million, $23.2 million of which related to our energy intelligence solutions
segment, primarily under our contract with Gulf Power. We estimate that we will
perform $10.1 million of our backlog in 2002.
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. In January 2000 we
sold all of our interest in Tower Semiconductor Ltd. for approximately $30.9
million. Until January 2000, a subsidiary of ours managed an Israeli public
investment company. Under the management agreement, it received a management fee
equal to 4% of the amounts invested in the investment company (excluding
profits). The management agreement was not renewed in January 2000 and the
management company is no longer active. In September 2000, we completed the sale
of substantially all the assets of its CinNetic division. See Note 4 to the
Consolidated Financial Statements included in this report for additional
information regarding these transactions.
EMPLOYEES
At December 31, 2001, we employed a total of 347 people, including 257
persons in engineering and technical support, 33 in marketing and sales, and 57
in management, administration and finance. A total of 259 of our employees are
based in Israel.
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We consider our relationship with our employees to be satisfactory.
We have 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 workday, 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 current product development and enhancement and their
costs, see "2001 Compared to 2000 - Research and development expenses ("R&D")"
in "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations," and the notes to our Consolidated Financial Statements
appearing in this Annual Report.
SEGMENT INFORMATION
For additional financial information regarding our operating segments,
foreign and domestic operations and sales, see "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations" and Note 19 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.
GENERAL FACTORS
WE HAVE A HISTORY OF OPERATING LOSSES AND DO NOT EXPECT TO ACHIEVE PROFITABLE
OPERATIONS IN THE FIRST HALF OF 2002; OUR COMVERGE SUBSIDIARY MUST RAISE CAPITAL
IN ORDER TO AVOID SEVERE CUTS IN ITS OPERATING BUDGET.
We are experiencing and have in the past experienced operating losses. In
2001, 2000 and 1999, we had operating losses of approximately $10.3 million,
$3.9 million and $5.6 million, respectively. We do not expect to achieve
profitable operations during the first half of 2002, and we are uncertain
whether we will achieve profitability in the second half of 2002. Furthermore,
our Comverge subsidiary, has been the primary consumer of our cash resources and
in 2001 net cash used in their operating activities was $7.0 million. We believe
that Comverge is now in a position to seek outside financing and its management
has taken substantial steps in its effort to secure sufficient financing to fund
its activities. There are no assurances the Comverge will be able to raise
capital or raise an amount sufficient to meet the needs of its business plan.
Should Comverge not be successful in raising capital, Comverge will implement an
operating plan by the end of the second quarter of 2002 to reduce costs, so that
its operations will have breakeven cash flow by the end of the third quarter of
2002. Such an operating plan will include curtailing research and development
expenses, consolidating geographically distant operations, significantly
reducing marketing efforts on new products as well as reducing general
administrative and marketing salary expenses. The reduction in costs, however,
may leave us without essential employees and other resources necessary to
increase revenues, may not result in operations with breakeven cash flow and may
end up reducing our revenues.
THE MARKETS FOR OUR ENERGY INTELLIGENCE SOLUTIONS AND SOFTWARE CONSULTING AND
DEVELOPMENT SERVICES 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 energy intelligence solutions and software consulting
and development segments are characterized by rapid technological change. In the
energy intelligence solutions market, communications and networking technologies
are continuously changing and we will need to invest in continued product
development, both hardware and software, in order to keep pace with these
changing technologies. We may not have adequate resources to invest in
development if our Comverge subsidiary does not raise additional capital, and
our development efforts may not be successful. In the software consulting and
development market, the continuing evolution of the Internet and introduction
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of new software systems will require us to invest in additional personnel
training and/or hire new personnel. We may not have adequate resources to invest
in sufficient training or hire personnel with the necessary skills.
EXCHANGE RATE FLUCTUATIONS COULD INCREASE THE COST OF OUR ISRAELI OPERATIONS.
A significant portion of the sales of our Israeli operations is in New
Israeli Shekels ("NIS") linked to the dollar. Such transactions are negotiated
in dollars; however, for the convenience of the customer, they are settled in
NIS. The dollar value of the revenues of our operations in Israel will decrease
if the dollar is devalued in relation to the NIS during the period from the
invoicing of a transaction to its settlement. In addition, a significant portion
of our expenses in those operations are in NIS, so that if the dollar is
devalued in relation to the NIS, the dollar value of these expenses will
increase.
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 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 SOFTWARE CONSULTING AND DEVELOPMENT SEGMENT
FAILURE TO ACCURATELY FORECAST COSTS OF FIXED-PRICED CONTRACTS COULD REDUCE OUR
MARGINS
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, we may incur losses on fixed-price contracts.
RISKS RELATED TO THE ENERGY INTELLIGENCE SOLUTIONS SEGMENT
We have made a significant investment in our energy intelligence
solutions segment, which develops and markets load control products and systems
offering two-way automated meter reading and related data management capability
to utilities. Revenues have fluctuated significantly from quarter to quarter and
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.
The pace of deregulation appears to have slowed due to the uncertainty about
deregulation in the wake of the energy crisis in California in 2000 and the
recent Enron reorganization. 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 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 SOLUTION PROVIDERS FOR MARKET ACCEPTANCE AND
CUSTOMERS.
While we believe that the systems offered by our energy intelligence
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.
-7-
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 a limited number of outside parties to manufacture components of
some of our products. Our reliance on these third party manufacturers (one of
whom is in Chapter 11 and in 2001 provided us with $6.0 million of components
representing approximately 70% of our material purchases for the year) 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. In addition, we are actively pursuing
third-party manufacturing alternatives, both to diversify and even to replace
our existing subcontractors experiencing difficulties. Implementing these
alternatives could cause some transitional delays and the diversification could
have a negative impact on price and quality control. Such 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. Should this trend continue, it
could make our method of sales uneconomical and bring into question the
long-term viability of the business model used by Databit.
A LARGE PORTION OF OUR SALES ARE CONCENTRATED IN THE GREATER NEW YORK CITY AREA.
Computer hardware sales to the greater New York City metropolitan area
represented 83%, 78% and 84% of the total segment sales for the years ended
December 31, 1999, 2000 and 2001, respectively. Furthermore, all of the sales
force for the segment is based in Manhattan and northern New Jersey. Recently,
sales in the New York City metropolitan area have been decreasing and that
downturn was significantly exacerbated by the September 11th events. If the
region does not recover from the recent economic downturn, or recover in a
manner commensurate with our expectations or our ability to control fixed costs,
our operating results could deteriorate.
ITEM 2. PROPERTIES
Our corporate headquarters and the principal offices for our U.S. software
consulting and development 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 4,700
square feet, under a lease which expires in October 2005, at a current rent of
$181,000 per annum. In addition, our Comverge subsidiary rents approximately
11,500 square feet in Florham Park, New Jersey, at an annual rent of $126,000
under a lease which expires January 2004, and approximately 31,600 square feet
of office and assembly space in Gwinett, Georgia under a lease which expires in
May 2006, at a current rent of $277,000 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
August 2009. The annual rent is approximately $290,000. These facilities are
used for the Israeli operations of the software consulting and development
segment and the energy intelligence solutions segment. In addition, as part of
our acquisition of Endan, we acquired their leased office space located in the
Tel Aviv metropolitan area under a lease that expires in July 2004. The annual
rent is approximately $81,000.
ITEM 3. LEGAL PROCEEDINGS
A recently acquired foreign subsidiary of ours is a plaintiff in an
arbitration proceeding against a customer for payment. The defendant in the
arbitration has filed a counterclaim against the subsidiary seeking $800,000 in
damages. On advice from the subsidiary's Israeli counsel, management believes
that the arbitrator will not order us to pay a substantial amount of the
counterclaim. We are not involved in any legal proceedings that we believe,
individually or in the aggregate, will have a material adverse effect our
company.
-8-
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
-9-
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
------------ ----------
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
2001:
First Quarter.........................................................................5.31 3.31
Second Quarter........................................................................8.80 3.75
Third Quarter.........................................................................7.11 5.30
Fourth Quarter........................................................................7.45 4.71
In December 2001, we issued 365,210 shares of our common stock at a
price of $6.16 per share in connection with the acquisition by DSIT of all of
the outstanding ordinary shares of Endan IT Solutions, Ltd. We relied on
Regulation S under the Securities Act of 1933 as the exemption from registration
of the offer and sale of these shares. Under the acquisition agreement, the
shares were valued based upon the average closing price of our common stock on
the Nasdaq National Market for the 60-day period ending the two days prior to
the closing date of the acquisition. Pursuant to our agreement with the former
Endan shareholders, we filed with the SEC and the SEC declared effective a
registration statement covering the resale of these shares. Under the terms of
the agreement, none of these shares may be sold in public sale before June 2002
and not more than 50% of the shares may be sold before September 2002.
As of March 15, 2002 there were 70 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 2000 or 2001 and we do not intend to pay
dividends in 2002. 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 years
ended December 31, 2000 and 2001 and consolidated balance sheet data as of
December 31, 2000 and 2001, have 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 year ended December 31, 1999 has been derived from our Consolidated
Financial Statements included in this Annual Report, which were audited by
Deloitte & Touche LLP. The selected statement of operations data for the years
ended December 31, 1997 and 1998 and balance sheet data as of December 31, 1997,
1998 and 1999 have 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."
-10-
SELECTED CONSOLIDATED STATEMENT OF OPERATIONS DATA
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
1997 1998 1999 2000 2001
---- ---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Sales..................................................... $36,154 $36,710 $39,708 $57,839 $45,924
Cost of sales............................................. 31,303 28,814 31,615 45,606 36,713
------ ------ ------ ------ ------
Gross profit........................................... 4,851 7,896 8,093 12,233 9,211
Research and development expenses......................... 1,335 1,605 1,269 928 2,284
Selling, general and administrative expenses.............. 11,349 12,549 12,471 16,340 17,643
Gain on sale of division \ subsidiary..................... -- -- -- 1,144 397
------ ------ ------ ------ ------
Operating loss......................................... (7,833) (6,258) (5,647) (3,891) (10,319)
Interest income........................................... 478 147 61 1,758 1,104
Interest expense.......................................... (225) (360) (910) (709) (459)
Other loss, net........................................... (244) (2,172) (306) (50) (132)
Minority interests........................................ 676 878 (275) -- --
------ ------ ------ ------ ------
Loss from continuing operations before provision
(benefit) for income taxes.......................... (7,148) (7,765) (7,077) (2,892) (9,806)
Provision (benefit) for income taxes...................... 3,507 35 62 171 (11)
------ ------ ------ ------ ------
Loss from continuing operations........................ (10,655) (7,800) (7,139) (3,063) (9,795)
Income (loss) from discontinued operations,
net of income taxes ..................................... 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................ (10,444) (12,944) (15,867) 1,055 (9,795)
Extraordinary loss on early redemption of debt............ -- -- -- (943) --
------ ------ ------ ------ ------
Net income (loss)...................................... $(10,444) $(12,944) $(15,867) $ 112 $(9,795)
========= ========= ========= =========== ========
Basic and diluted net income (loss) per share:
Loss from continuing operations....................... $(1.45) $(1.05) $(0.96) $(0.41) $(1.41)
Discontinued operations............................... 0.03 (0.70) (1.17) 0.56 --
Extraordinary item.................................... -- -- -- (0.13) --
-------- -------- -------- --------- --------
Net income (loss) per share - basic and diluted.... $(1.42) $(1.75) $(2.13) $0.02 $(1.41)
======= ======= ======= ===== =======
Weighted average number of shares outstanding
- basic and diluted...................................... 7,369 7,391 7,433 7,422 6,970
===== ===== ===== ===== =====
SELECTED CONSOLIDATED BALANCE SHEET DATA:
AS OF DECEMBER 31,
------------------
1997 1998 1999 2000 2001
---- ---- ---- ---- ----
(in thousands)
Working capital............................................. $7,201 $ 5,719 $20,030 $18,178 $6,867
Total assets................................................ 65,452 49,880 50,458 42,157 39,293
Short-term and long-term debt............................... 4,190 1,661 9,007 6,606 8,681
Minority interest........................................... -- 294 10 40 2,588
Total shareholders' equity.................................. 52,308 39,418 24,850 22,581 14,362
See Notes 3 and 4 to the Consolidated Financial Statements included in this
Annual Report for a description of our various acquisitions and
dispositions of business operations and segments.
-11-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW AND TREND INFORMATION
The following discussion includes statements that are forward-looking in
nature. Whether such statements ultimately prove to be accurate, depends upon a
variety of factors that may affect our business and operations. Certain of these
factors are discussed at "Item 1. Description of Business-Factors That May
Influence Future Results."
During 2001, we operated in three reportable segments: software consulting
and development, energy intelligence solutions and computer hardware sales and
we are continuing our business activity in all three segments during 2002.
SOFTWARE CONSULTING AND DEVELOPMENT
Sales in our consulting and development services segment declined due to
the general downturn in the hi-tech economy. In addition to our continuing
efforts to market in our traditional markets, in December 2001 we acquired
Endan, which expanded our service and product offerings to include IT,
particularly in the markets for billing solutions and healthcare solutions. This
acquisition of Endan maximizes economies of scale by increasing our revenue base
by over 40% based on 2001 revenues without the commensurate increase in
staffing. We therefore expect that this acquisition will serve to improve
revenue and profitability in this segment beginning in 2002.
ENERGY INTELLIGENCE SOLUTIONS
During 2001, we took some very important steps to establish Comverge as an
independent entity, including the assembly of a strong, new management team,
consisting of a new CEO, CFO, Executive Vice President and other senior
management. We believe we now have the team in place to increase revenue and to
attract the additional capital which this segment will require to execute its
plan and fulfill its potential.
We expect revenue for the segment to improve during 2002 over the levels
achieved in 2001. These revenue improvements, if they are in fact achieved, will
likely be offset in large part by the significantly higher costs associated with
the enhanced management, marketing and administrative infrastructure which has
been put into place. Based on our current plans, we do not expect the segment to
achieve profitable operations during 2002.
We intend to finance Comverge's activities during the next 12 months from
outside investment in Comverge. Should Comverge not be successful in raising
outside funding, it will implement an operating plan by the end of the second
quarter of 2002, to reduce Comverge's costs and expenses to breakeven cash flow
by the end of the third quarter of 2002. If implemented, this operating plan
would require Comverge to curtail its research and development activities,
consolidate geographically distant operations, significantly reduce its
marketing efforts and reduce general, administrative and marketing salary
expenses. Implementing this scaled back operating plan will require us to defer
certain of the product development and marketing initiatives, which are
currently underway or are planned. Implementing this scaled back operating plan
may also result in a loss of essential managerial and other employees and other
resources necessary to increase or even maintain our revenues and may not result
in breakeven operations.
COMPUTER HARDWARE
Databit's business suffered from the slowdown in the economy, especially
since September 11th, and particularly in the greater New York City metropolitan
area, the segment's primary market. In the first months of 2002, we have seen
improvement in the level of sales over that of the last few months of 2001.
Databit's customer mix continues to improve, which allowed us to improve gross
profit margin to 17.9% in 2001 as compared to 15.1% in 2000, partially
offsetting the decrease in gross profits due to reduced sales. Despite our
success in increasing gross profit margins in the past couple of years, we
expect the economic slowdown and increasingly competitive market will cause
downward pressure on our gross profit margin in 2002.
CRITICAL ACCOUNTING POLICIES
The Securities and Exchange Commission ("SEC") recently issued disclosure
guidance for "critical accounting policies." The SEC defines "critical
accounting policies" as those that require application of management's most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain and may
change in subsequent periods.
The following discussion of critical accounting policies represents our
attempt to bring to the attention of
-12-
readers of this report those accounting policies which we believe are critical
to our consolidated financial statements and other financial disclosure. It is
not intended to be a comprehensive list of all of our significant accounting
policies which are more fully described in Note 2 of the Notes to the
Consolidated Financial Statements included in this Annual Report. In many cases,
the accounting treatment of a particular transaction is specifically dictated by
generally accepted accounting principles, with no need for management's judgment
in their application. There are also areas in which the selection of an
available alternative policy would not produce a materially different result.
We have identified the following as critical accounting policies to our
Company: revenue recognition; foreign currency transactions; accounting for debt
securities; inventory; income taxes; and goodwill and other long-lived assets.
REVENUE RECOGNITION
Our revenue recognition policies are significant as our revenue is a key
component of our results of operations. Revenue from time-and-materials service
contracts, maintenance agreements and other services are recognized as services
are provided. Revenue on the sale of products and software are recognized when
persuasive evidence of an arrangement exists, the price is fixed and
determinable, delivery has occurred and there is reasonable assurance of
collection of the sales proceeds. Such revenues generally do not involve
difficult, subjective or complex judgments.
Our software and consulting development segment derived $4.4 million of its
revenues, representing approximately 10% of consolidated sales in 2001 ($4.8
million and 8% and $3.6 million and 9% in 2000 and 1999, respectively), from
fixed-price contracts, which require the accurate estimation of the cost, scope
and duration of each engagement. Revenue and the related costs for these
projects are recognized using the percentage-of-completion method as costs
(primarily direct labor) are incurred, with revisions to estimates reflected in
the period in which changes become known. If we do not accurately estimate the
resources required or the scope of work to be performed, or do not manage our
projects properly within the planned periods of time or satisfy our obligations
under the contracts, then future revenue and consulting margins may be
significantly and negatively affected or losses on existing contracts may need
to be recognized. Any such resulting changes in revenues and reductions in
margins or contract losses could be material to our results of operations.
FOREIGN CURRENCY TRANSACTIONS
We have several foreign subsidiaries which together account for
approximately 24% of our net revenues for the year ended December 31, 2001, and
42% of our assets and 37% of our total liabilities as of December 31, 2001. We
expect our percentage of foreign-based revenue to increase in 2002 as a result
of our acquisition of Endan in December 2001.
Under the relevant accounting guidance, the treatment of foreign currency
transactions is dependent upon our management's determination regarding the
functional currency of each subsidiary. The functional currency is determined
based on management judgment and involves consideration of all relevant economic
facts and circumstances affecting the subsidiary. If any subsidiary's functional
currency would be deemed to be the local currency, then any gain or loss
associated with the translation of that subsidiary's financial statements would
be included in cumulative translation adjustments on our consolidated balance
sheets and as part of comprehensive income on our consolidated statements of
operations. However, if the functional currency is deemed to be the U.S. dollar,
then any gain or loss associated with transactions in the local currency would
be included within our consolidated statement of operations. If we dispose of
any of our subsidiaries, any cumulative translation gains or losses would be
realized into our consolidated statement of operations. As of December 31, 2001,
we have determined that the functional currency of all our foreign subsidiaries
is the U.S. dollar.
DEBT SECURITIES
Debt securities may be classified in one of three categories: trading,
available-for-sale, or held-to-maturity. Trading securities are bought and held
principally for the purpose of selling them in the near term. Held-to-maturity
securities are those securities in which we have the ability and intent to hold
the security until maturity. All securities not included in trading or
held-to-maturity, are classified as available-for-sale.
At December 31, 2001, we had $1.8 million of debt securities all of which
were classified as trading.
Trading debt securities are recorded at fair value and unrealized holding
gains are included in operations. Since we classify all of our debt securities
as trading, our results of operations are subject to possible fluctuation due to
volatility of the bond market.
-13-
INVENTORIES
Inventories are stated at the lower of cost or market and have been reduced
by an allowance for excess and obsolete inventories to establish a new cost
basis. The estimated allowance is based on management's review of inventories on
hand compared to estimated future usage and sales. We evaluate the adequacy of
these reserves quarterly.
INCOME TAXES
We have a history of unprofitable operations from losses incurred in a
number of our operations. These losses generated sizeable state, federal and
foreign tax net operating loss ("NOL") carryforwards of approximately $10.3,
$13.6 and $10.1 million as of December 31, 2001, respectively.
Generally accepted accounting principles require that we record a valuation
allowance against the deferred income tax asset associated with these NOL
carryforwards and other deferred tax assets if it is "more likely than not" that
we will not be able to utilize them to offset future income taxes. Due to the
size of the NOL carryforwards in relation to our history of unprofitable
operations, we have not recognized any of these net deferred tax assets. We
currently provide for income taxes only to the extent that we expect to pay cash
taxes for current income.
It is possible, however, that we could be profitable in the future at
levels which cause management to conclude that it is more likely than not that
we will realize all or a portion of the NOL carryforwards and other deferred tax
assets. Upon reaching such a conclusion, we would immediately record the
estimated net realizable value of the deferred tax assets at that time and would
then provide for income taxes at a rate equal to our combined federal and state
effective rates or foreign rates. Subsequent revisions to the estimated net
realizable value of the deferred tax assets could cause our provision for income
taxes to vary significantly from period to period.
GOODWILL AND OTHER LONG-LIVED ASSETS
In June 2001, the FASB issued SFAS No. 141, "Business Combinations" and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 specifies
criteria that intangible assets acquired in a business combination must meet to
be recognized and reported separately from goodwill. SFAS No. 142 requires that
goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead tested for impairment at least annually in accordance
with the provisions of SFAS No. 142. SFAS No. 142 also requires that intangible
assets with estimable useful lives be amortized over their respective estimated
useful lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS No. 121 and subsequently, SFAS No. 144 (discussed below)
after its adoption.
We adopted the provisions of SFAS No. 141 as of July 1, 2001, and SFAS No.
142 is effective January 1, 2002. Goodwill and intangible assets determined to
have an indefinite useful life acquired in a purchase business combination
completed after June 30, 2001, but before SFAS No. 142 is adopted in full, are
not amortized. Goodwill and intangible assets acquired in business combinations
completed before July 1, 2001 continue to be amortized and tested for impairment
prior to the full adoption of SFAS No. 142.
Upon adoption of SFAS No. 142, we are required to evaluate our existing
intangible assets and goodwill that were acquired in purchase business
combinations, and to make any necessary reclassifications in order to conform
with the new classification criteria in SFAS No. 141 for recognition separate
from goodwill. We will be required to reassess the useful lives and residual
values of all intangible assets acquired, and make any necessary amortization
period adjustments by March 31, 2002. If an intangible asset is identified as
having an indefinite useful life, we will be required to test the intangible
asset for impairment in accordance with the provisions of SFAS No. 142 within
the quarter ended March 31, 2002. Impairment is measured as the excess of
carrying value over the fair value of an intangible asset with an indefinite
life. Any impairment loss will be measured as of the date of adoption and
recognized as the cumulative effect of a change in accounting principle in the
quarter ended March 31, 2002.
In connection with SFAS No. 142's transitional goodwill impairment
evaluation, the Statement requires us to perform an assessment of whether there
is an indication that goodwill is impaired as of the date of adoption. To
accomplish this, we must identify our reporting units and determine the carrying
value of each reporting unit by assigning the assets and liabilities, including
the existing goodwill and intangible assets, to those reporting units as of
January 1, 2002. We will then have up to six months from January 1, 2002 to
determine the fair value of each reporting unit and compare it to the carrying
amount of the reporting unit. To the extent the carrying amount of a reporting
unit exceeds the fair value of the reporting unit, an indication exists that the
reporting unit goodwill may be impaired and we must perform the second step of
the transitional impairment test. The second step is required to be completed as
soon as possible, but no later than the end of 2002. In the second step, we must
compare the implied fair value of the reporting unit goodwill with the carrying
amount of the reporting unit goodwill, both of which would be measured as of the
date of adoption. The implied fair value of goodwill is determined by allocating
the fair value of the reporting unit to all of the assets (recognized and
unrecognized) and liabilities of the reporting unit in a manner similar to a
purchase price
-14-
allocation, in accordance with SFAS No. 141. The residual fair value after this
allocation is the implied fair value of the reporting unit goodwill. Any
transitional impairment loss will be recognized as the cumulative effect of a
change in accounting principle in our consolidated statement of operations.
In August, 2001 the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
SFAS No. 144 requires that long-lived assets be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Recoverability of assets to be held and used is measured
by a comparison of the carrying amount of an asset to undiscounted future net
cash flows expected to be generated by the asset. If the carrying amount of an
asset exceeds its estimated future undiscounted cash flows, an impairment charge
is recognized by the amount by which the carrying amount of the asset exceeds
the fair value of the asset. SFAS No. 144 requires companies to separately
report discontinued operations and extends that reporting to a component of an
entity that either has been disposed of (by sale, abandonment, or in a
distribution to owners) or is classified as held for sale. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less costs to
sell. We adopted SFAS No. 144 on January 1, 2002.
As of December 31, 2001, we had an aggregate of $7.7 million of goodwill,
net of amortization, $7.2 million of which relates to DSIT and most of which was
recognized as a result of the acquisition of Endan, and $0.5 million of which
relates to our energy intelligence solutions subsidiary, and $0.8 million of
other unamortized identifiable intangible assets. Due to the effort needed to
comply with adopting SFAS No. 141 and No. 142, it is not practicable to
reasonably estimate the impact on us of adopting these new standards, including
whether we will be required to recognize any transitional impairment losses as
the cumulative effect of a change in accounting principle.
We do not expect the adoption of SFAS No. 144 for long-lived assets to have
a material impact on our consolidated financial statements because the
impairment assessment under SFAS No. 144 is largely unchanged from SFAS No. 121.
The provisions of SFAS No. 144 for assets held for sale or other disposal
generally are required to be applied prospectively after the adoption date to
newly initiated disposal activities and, therefore, will depend on future
actions initiated by management. As a result, we cannot determine the potential
effects that adoption of SFAS No. 144 will have on our consolidated financial
statements with respect to future disposal decisions, if any.
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,
------------------------
1997 1998 1999 2000 2001
---- ---- ---- ---- ----
Sales ......................................................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales ................................................. 86.6 78.5 79.6 78.8 80.0
----- ----- ----- ----- -----
Gross profit ................................................ 13.4 21.5 20.4 21.2 20.0
Research and development expenses ............................. 3.7 4.4 3.2 1.6 5.0
Selling, general and administrative expenses .................. 31.4 34.2 31.4 28.3 38.4
Gain on sale of division ...................................... -- -- -- 2.0 0.9
----- ----- ----- ----- -----
Operating loss .............................................. (21.7) (17.1) (14.2) (6.7) (22.5)
Interest income (expense), net ................................ 0.7 (0.6) (2.1) 1.8 1.4
Other loss, net ............................................... (0.7) (5.9) (0.8) (0.1) (0.3)
Minority interests ............................................ 1.9 2.4 (0.7) -- --
----- ----- ----- ----- -----
Loss from continuing operations before
provision (benefit) for income taxes ..................... (19.8) (21.2) (17.8) (5.0) (21.4)
Provision (benefit) for income taxes .......................... 9.7 -- 0.2 0.3 (0.1)
----- ----- ----- ----- -----
Loss from continuing operations ............................. (29.5) (21.2) (18.0) (5.3) (21.3)
Income (loss) from discontinued operations, net of income taxes 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 ....................... (28.9) (35.3) (40.0) 1.8 (21.3)
Extraordinary loss on early redemption of debt ................ -- -- -- (1.6) --
----- ----- ----- ----- -----
Net income (loss)............................................ (28.9)% (35.3)% (40.0)% 0.2% (21.3)%
===== ===== ===== ===== =====
-15-
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, 1999, 2000 and 2001, 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.
SOFTWARE ENERGY
CONSULTING AND INTELLIGENCE COMPUTER
DEVELOPMENT SOLUTIONS HARDWARE OTHER TOTAL(*)
----------- --------- -------- ----- ----------
(DOLLARS IN THOUSANDS)
Year ended December 31, 2001:
Revenues from external customers ............. $ 12,179 $ 13,793 $ 19,794 $ 158 $ 45,924
Percentage of total revenues
from external customers .................... 27% 30% 43% -- 100%
Segment profit (loss) ........................ $ (2,052) $ (6,447) $ 1,006 $ (217) $ (7,710)
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)
(*) Our consolidated sales for 2000 and 1999 included $38,000 and $360,000,
respectively, in management fees received from Tower Semiconductor Ltd.
See Note 19 to the Consolidated Financial Statements included in this
report for reconciliation to our consolidated financial information.
2001 COMPARED TO 2000
SALES. Sales decreased by 21% to $45.9 in 2001 from $57.8 million in 2000,
due to a decrease in sales in all segments. Sales in the software consulting and
development segment decreased by $6.8 million, or 36%, as a result of the
continued downturn in the hi-tech economy generally and in the demand for
software consulting and development services in particular, as well as a
decrease in computer embedded software sales. Sales also decreased in the energy
intelligence solutions segment by $3.3 million, or 19%. This decrease was
primarily attributable to the inclusion in 2000 of non-recurring sales of
component inventory and order backlog purchased as part of the
Scientific-Atlanta control systems division ($1.2 million), and sales of a
specialized load control product developed for a single customer ($1.3 million).
In our computer hardware segment, sales decreased by $1.7 million, or 8%,
resulting from the slowdown in the economy, especially since September 11th, and
particularly in the greater New York City metropolitan area, which is the
primary market for the segment. Our sales in the computer hardware segment
decreased by 39% in the second half of 2001 to $7.3 million, from $12.0 million
in the second half of 2000.
GROSS PROFIT. Gross profit decreased by 25% to $9.2 million, or 20% of
sales, in 2001, from $12.2 million, or 21% of sales, in 2000. This decrease was
due to a $2.8 million, or 55%, decrease in gross profit of our software
consulting and development segment and a $513,000, or 13%, decrease in gross
profit of our energy intelligence solutions segment, partially offset by a
$309,000, or 10%, increase in gross profit in our computer hardware sales
segment. The decrease in the software consulting and development segment was due
to the decrease in sales, particularly the inclusion in 2000 of certain highly
profitable computer embedded software sales which contributed to the
deterioration in gross profit margins from 26% in 2000 to 18% in 2001. In our
energy intelligence solutions segment, the decrease in gross profit was entirely
due to the decrease in sales, while gross profit margins improved from 23% in
2000 to 25% in 2001, primarily due to the negative impact on gross margin of the
inventory component sales in 2000. In our computer hardware sales segment, the
increase in gross profit was entirely due to the improvement in gross margin
from 15% of sales in 2000 to 18% in 2001 as result of a change in our customer
mix.
RESEARCH AND DEVELOPMENT EXPENSES ("R&D"). R&D expenses more than doubled
to $2.3 million in 2001 as compared to $928,000 in 2000. This increase was due
to a concentrated effort in the energy intelligence solutions segment to
complete the development of and make available to customers a broader set of
solutions, while refocusing our existing products. Among the technologies
developed are 900 MHz communication capabilities to enhance our
-16-
DCU load control product, latest generation CDPD technology upgrade for our CDC
product and upgrade and enhancement of the control system software for our
Maingate(tm) system currently being installed at Gulf Power.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A"). SG&A increased by 8%
to $17.6 million in 2001, from $16.3 million in 2000. The increase was
attributable to a $1.6 million, or 26% increase in our energy intelligence
solutions segment. The increase in SG&A in Comverge was attributable to the
increased level of marketing and administrative costs, including costs
associated with hiring a new CEO, CFO, Executive Vice President and other senior
staff for Comverge. Salaries and related costs in Comverge increased by $1.2
million in 2001 as compared to 2000, due in large part to these hirings. This
increase was partially offset by a decrease in corporate expenses primarily due
to a non-recurring bonus of $550,000 paid to the CEO in the first quarter of
2000.
INTEREST INCOME. Interest income decreased to $1.1 million in 2001, from
$1.8 million in 2000. The decrease was primarily attributable to the decrease in
the amounts invested, as they were being utilized to finance our operations, as
well as the decrease in interest rates over the year.
INCOME TAXES. We recorded a tax benefit of $11,000 in 2001 as compared to a
tax expense of $171,000 in 2000. 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 17 to the Consolidated Financial Statements included in this
Annual Report.
2000 COMPARED TO 1999
SALES. Sales increased by 46% to $57.8 million in 2000 from $39.7 million
in 1999 due entirely to higher unit sales. The increase was primarily due to a
$12.0 million increase in sales in the energy intelligence 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 energy intelligence 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.
R&D. R&D decreased in 2000 to $0.9 million from $1.3 million in 1999, as
the development of our company's energy intelligence solutions products mature.
SG&A. SG&A increased by 30% to $16.3 million in 2000 from $12.5 million in
1999. This increase was primarily due to a $3.2 million increase in marketing
and administrative costs related to the energy intelligence solutions segment
which increased its level of activity significantly in 2000, as well as
increased corporate expenses primarily due to a $550,000 bonus to the CEO in the
first quarter of 2000.
GAIN ON SALE OF DIVISION. In September 2000, we completed the sale of
substantially all the assets of its CinNetic division (which was part of the
consulting and development services segment) for a total of $1.8 million
resulting in a gain of $1.1 million. CinNetic 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 was 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 was due to the interest income on the
investment of the proceeds from the sale of our Tower Semiconductor investment
in January 2000. The decrease in interest expense from in 2000 from 1999 was due
primarily to the charge in 1999 of $300,000 for the beneficial conversion
feature of debentures which we issued in October 1999.
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
increase in 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 17 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 Semiconductor, 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 Semiconductor. Prior to the signing of a definitive sale
agreement in
-17-
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 Semiconductor 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
its refinancing of its short-term debt.
LIQUIDITY AND CAPITAL RESOURCES
We have had a history of operating losses in 2001, 2000 and 1999 of
approximately $10.3 million, $3.9 million and $5.6 million, respectively. We do
not expect to be profitable in the first half of 2002. Additionally, we are
uncertain whether we will achieve profitability in the second half of 2002. As
of December 31, 2001 we had working capital of approximately $6.9 million,
including $5.9 million in cash, cash equivalents and debt security investments.
In addition we had a long-term deposit of $6 million securing Comverge's
long-term bank debt of the same amount which remains pledged to the bank. Net
cash used in operating activities in 2001 was $8.7 million. The cash used was
primarily for the operations of our Comverge subsidiary ($7.3 million) and US
operations, primarily corporate activities ($1.4 million). DSIT, however,
had breakeven cash flow for 2001.
The cash used in financing and investment activities in 2000 included $1.5
million in connection with the Endan acquisition by DSIT as well as $907,000 for
the purchase of shares of our common stock. We have no current plans to invest
cash for these purposes during 2002 and 2003.
During 2001, we reached agreement with our bank to extend the maturity of
our $6.0 million term loan to February 2003. The loan is secured by a DSSI
guarantee and the pledge of a $6.0 million bank deposit.
As of December 31, 2001, DSIT was utilizing $2.4 million of its then $3
million line of credit. DSIT is in the process of restructuring its bank
financing and in March 2002 replaced a portion of its line of credit with a
long-term loan. The long-term loan for approximately $640,000 is denominated in
NIS, payable over five years and bears interest at 7.9% per annum. As part of
the restructuring, DSIT's line of credit was reduced to approximately $2.3
million, denominated in NIS and bearing an average interest rate of the Israeli
prime rate plus 0.2% per annum. The Israeli prime rate fluctuates and as of
December 31, 2001 was 5.3%.
We intend to finance the activities of DSIT during the next 12 months from
cash flow from operations. We believe that the recent acquisition by DSIT will
assist in not only increasing profitability but also cash generated from these
activities. We do not expect to utilize cash flow from DSIT to finance our
US-based activities due to Israeli withholding taxes, as well as the fact that
our ownership was reduced to 68% as a result of the Endan acquisition.
We intend to finance our US-based operating activities and our corporate
activities from cash on hand and from operating cash flow from the computer
hardware segment. Based on its current business plan, we do not have sufficient
liquidity to finance the operations of our energy intelligence solutions segment
for the 12 months following the date of this report. We intend to finance these
activities during 2002 from outside investment. We believe that Comverge is in a
position now where it can seek outside capital and its management has taken
substantial steps in its effort to secure sufficient financing to fund its
activities. However, there is no assurance that Comverge will be able to raise
capital or raise an amount sufficient to meet the needs of its business plan.
Should Comverge not be successful in raising outside funding, it will implement
an operating plan by the end of the second quarter of 2002, to reduce costs, so
that it will have breakeven cash flow by the end of the third quarter of 2002.
Such an operating plan will include curtailing research and development
expenses, consolidating geographically distant operations, significantly
reducing marketing efforts and reducing general administrative and marketing
salary expenses. The reduction in costs, however, may leave us without essential
employees and other resources necessary to increase revenues, may not result in
operations with breakeven cash flow and may end up reducing our revenues. We
believe that should we be successful in implementing the foregoing measures we
will have adequate liquidity to finance our operating activities and corporate
expenses for the 24 months following the date of this report.
-18-
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Our contractual obligations and commitments at December 31, 2001
principally include obligations associated with our outstanding indebtedness,
future minimum operating lease obligations and contractual obligations to our
CEO for payments for his post-retirement consulting services to us are as set
forth in the table below.
Cash Payments Due During Year Ending December 31,
---------------------------------------------------------
(In Thousands)
CONTRACTUAL OBLIGATIONS TOTAL 2002 2003 2004 AFTER 2004
- ---------------------- ----- ---- ---- ---- ----------
Long-term debt related to US operations $ 6,011 $ 4 $6,004 $ 3 --
Long-term debt related to Israeli operations 258 79 67 48 $ 64
Operating leases 5,840 1,687 1,365 850 1,938
Consulting agreement with CEO 1,624 -- -- 295 1,329
------- ------ ------ ------ ------
Total contractual cash obligations $13,733 $1,770 $7,436 $1,196 $3,331
======= ====== ====== ====== ======
We expect to finance these contractual commitments from cash on hand and
cash generated from operations.
We also have obligations under various agreements and other arrangements
with officers and other employees with respect to severance arrangements and
multiyear employment agreements.
Under Israeli law and labor agreements, DSIT is required to make severance
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 regular deposits with recognized
severance pay and pension funds and by the purchase of insurance policies. As of
December 31, 2001, DSIT had total of $3.8 million in potential severance
obligations, of which approximately $2.6 million was funded and approximately
$1.2 was unfunded.
Under the terms of his employment agreement with us, we have an obligation
to pay our Chief Executive Officer consulting fees over a seven year period upon
his retirement on December 31, 2003. Although we contemplate that those payments
will begin on January 1, 2004, our CEO has the option to terminate his
employment agreement and begin his consulting period on or prior to December 31,
2003. During the first four years of the consulting period, we would have to pay
our CEO 50% of his salary in effect at the time of termination and 25% of that
salary during the last three years of the consulting period, plus contributions
to a non-qualified defined contribution retirement plan equal to 25% of the
consulting fee. At the start of the consulting period, we are also required to
fund amounts payable for the term of the consulting period, by the purchase of
an annuity or similar investment product. The CEO's salary for 2002 is $472,500
per annum.
We also have severance arrangements under an employment agreement with our
Chief Financial Officer to pay severance under certain circumstances. If our CFO
employment agreement is terminated by us or by him for reasons other than for
cause, we must pay him (i) an amount equal to 150% of his last month's salary
multiplied by the number of years (including partial years) that the CFO worked
for us, plus (ii) an amount equal to five times his last month's salary or two
times such salary if the CFO terminates the employment agreement other than
after a change in control or a breach by us of his employment agreement. Our
severance obligation would be reduced by the amount contributed by us to certain
Israeli pension and severance funds pursuant to the CFO's employment agreement.
As of December 31, 2001, the unfunded portion of such severance obligation was
$64,000.
Our energy intelligence solutions subsidiary may in certain circumstances
be liable to make severance payments to its CEO and its Executive Vice
President. Under the employment agreement with the CEO of the subsidiary if his
employment is terminated without cause, the subsidiary would have to pay the
subsidiary CEO one year of base salary, or if there has been an IPO for the
subsidiary, three years of base salary plus up to 15% of any excess parachute
payment, plus, if such termination is before December 31, 2002, his base salary
through December 31. The subsidiary CEO's salary for 2002 is $250,000 per annum.
Under our employment agreement with the Executive Vice President of our
utility solutions segment, if such officer's employment agreement were
terminated without cause, the subsidiary would have to pay to such officer three
months of base salary ($200,000 during 2002) for each year (or partial year) of
service to the subsidiary up to a maximum of one year of salary. The Executive
Vice President's employment commenced in March 2001.
Our energy intelligence solutions subsidiary is not obligated to make any
severance payments under these agreements if the CEO or the Executive Vice
President voluntary terminates his employment agreement.
-19-
IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS
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
in Israel are in NIS, while a portion is in dollars or dollar-linked NIS.
The dollar cost of our operations in Israel may be adversely affected in
the future by a revaluation of the NIS in relation to the dollar, should it be
significantly different from the rate of inflation. In 2001 the devaluation of
the NIS against the dollar was 9.3%, whereas in 2000 the NIS appreciated against
the dollar by 2.7%. Inflation in Israel was 1.4% and 0% during these same
periods, respectively. During the first two months of 2002, the NIS was further
devalued against the dollar by 6.5% and inflation during this period was 1.3%.
As of December 31, 2001, 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.
PAYMENTS TO RELATED PARTIES
We paid an individual as a director and vice president, who is the son of
our Chief Executive Officer, approximately $132,000 $280,000 and $197,000 for
the years ending December 31, 1999, 2000 and 2001, respectively. We also have
engaged certain of our directors to render professional services to us. One or
our directors is principal of a law firm that we engage to perform legal
services for us. We paid to this firm legal fees and out-of-pocket disbursements
(which includes fees and expenses of special counsel hired on our behalf) of
approximately $494,000, $474,000 and $575,000 for the years ended December 31,
1999, 2000 and 2001, respectively. We also engaged an asset management firm that
is controlled by one of our directors. This firm provides discretionary asset
management services to us. In the year ended December 31, 2001, we paid fees of
$13,000 to this asset management firm. At December 31, 2001, this asset
management firm administered approximately $2.1 million of our assets, including
$1.8 million of our debt securities.
Management believes that the terms of each of the above transactions were
on substantially the same terms as would be reached in a transaction with an
unrelated third party.
SUMMARY QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth certain of our unaudited quarterly
consolidated financial information for the years ended December 31, 2000 and
2001. This information should be read in conjunction with our Consolidated
Financial Statements and the notes thereto.
2000 2001
---- ----
FIRST SECOND THIRD FOURTH FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER QUARTER
------- ------- ------- ------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Sales. ................................ $14,722 $15,790 $15,006 $12,321 $13,229 $12,569 $10,359 $9,767
Cost of sales.......................... 11,435 12,229 11,865 10,077 10,418 9,565 7,878 8,852
------ ------ ------ ------ ------ ----- ----- -----
Gross profit .......................... 3,287 3,561 3,141 2,244 2,811 3,004 2,481 915
Research and development............... 394 146 158 230 482 871 863 68
Selling, general and administrative ... 4,700 3,853 3,805 3,982 4,303 4,391 4,526 4,423
Gain on sale of division/subsidiary.... -- -- 1,144 -- -- -- -- 397
-------- -------- ----- -------- -------- -------- -------- ------
Operating income (loss)................ (1,807) (438) 322 (1,968) (1,974) (2,258) (2,908) (3,179)
Interest income, net................... 141 332 183 359 195 184 177 89
Other income (loss), net............... (75) (114) 82 91 (61) 56 31 (158)
------- ----- ------- ------- ------- ------- ------- -------
Income (loss) from continuing
operations before provision
(benefit) for income taxes. .......... (1,741) (220) 587 (1,518) (1,840) (2,018) (2,700) (3,248)
Provision (benefit) for income taxes... 51 (25) 55 40 27 85 (94) (29)
-------- ------- ------- -------- -------- -------- ------- ------
Income (loss) from continuing
operations ........................... (1,792) (245) 532 (1,558) (1,867) (2,103) (2,606) (3,219)
-20-
Loss from discontinued
operations, net of income taxes....... -- (104) -- -- -- -- -- --
Gain on sale of discontinued
operations, net of income taxes....... 4,222 -- -- -- -- -- -- --
----- ------- -------- -------- -------- --------- ------- ------
Income (loss) before
extraordinary item ................. 2,430 (349) 532 (1,558) (1,867) (2,103) (2,606) (3,219)
Extraordinary loss on early redemption
of debt............................. 943 -- -- -- -- -- -- --
------ ------ ------- -------- ------- --------- ------- ------
Net income (loss)...................... $1,487 $ (349) $532 $(1,558) $(1,867) $(2,103) $(2,606) $(3,219)
====== ====== ======= ======== ======= ======= ======= ========
Basic net income (loss) per share:
Income (loss) from continuing
operations ......................... $(0.24) $ (0.04) $0.07 $(0.22) $(0.27) $(0.30) $(0.37) $(0.46)
Discontinued operations............. 0.56 (0.01) -- -- -- -- -- --
Extraordinary item.................. (0.12) -- -- -- -- -- -- --
------ ------- ------- -------- ------- ------ ------ ------
Net income (loss) per share......... $0.20 $(0.05) $0.07 $(0.22) $(0.27) $(0.30) $(0.37) $(0.46)
====== ======= ======= ======== ===== ====== ===== =====
Weighted average number of shares
outstanding - basic................. 7,460 7,470 7,462 7,297 6,964 6,910 6,950 7,009
===== ====== ======= ======== ===== ===== ===== =====
Diluted net income (loss) per share:
Income (loss) from continuing
operations ......................... $(0.24) $(0.04) $0.07 $(0.22) $(0.27) $(0.30) $(0.37) (0.46)
Discontinued operations............. 0.56 (0.01) -- -- -- -- -- --
Extraordinary item.................. (0.12) -- -- -- -- -- -- --
------ -- -- -- -- -- -- --
Net income (loss) per share......... $(0.20) $(0.05) $0.07 $(0.22) $(0.27) $(0.30) $(0.37) $(0.46)
====== ====== ====== ======= ====== ====== ====== ======
Weighted average number of shares
outstanding - diluted............... 7,460 7,470 7,926 7,297 6,964 6,910 6,950 7,009
===== ===== ====== ======= ===== ===== ===== =====
-21-
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.
In March 2001, we retained Malley Associates Capital Management, an asset
management firm that is controlled by one of our directors, to provide
discretionary asset management services to us, currently with respect to $2.1
million of our funds. Malley Associates may invest our funds in fixed income
government and corporate securities, money market mutual funds, short-term money
market instruments and equity securities. Malley Associates has complete
discretion and authority to invest our funds in these accounts without prior
consultation with us.
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 their short
holding periods and stable market interest rates. Fair value for long-term debt
and long-term deposits are estimated based on the current rates offered to us
for debt and deposits with similar terms and remaining maturities. The fair
value of our 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 our investments (book value of
$90,000 at December 31, 2001) was not practicable, although we believe 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 us 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 our cash equivalent deposits as well as our short
and long-term bank deposits is a major financial institution of high credit
standing. The counterparties to our asset-backed securities consist of various
major corporations of high credit standing. We do not believe there is
significant risk of non-performance by these counterparties. Approximately 11%
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 our 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
Not applicable.
-22-
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 2002 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 2002 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 2002 Proxy Statement,
is hereby incorporated by reference.
-23-
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
Current 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 (incorporated herein by reference to Exhibit 4.4 to the
Registrant's Annual Report on Form 10-K for the year ended December
31, 2000 (the "2000 10-K")).
*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 Registrant'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 herein 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 Registrant's Form 10-K for the year
ended December 31, 1995 (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).
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 herein 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 herein by
reference to Exhibit 10.12 of the 1999 10-K).
10.9 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).
10.10 Warrant Repurchase Agreement, dated September 25, 2000, among the
Registrant, Bank Leumi USA and Bank Leumi le-Israel (incorporated
herein by reference to Exhibit 10.11 to the 2000 10-K).
10.11 Agreement dated January 26, 2001, between the Registrant and Bounty
Investors LLC (incorporated herein by reference to Exhibit 10.12 to
the 2000 10-K).
10.12 Lease Agreement, dated February 5, 2001, between Duke-Weeks Realty
Limited Partnership and Comverge Technologies, Inc. (incorporated
herein by reference to Exhibit 10.13 to the 2000 10-K).
*10.13 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) (incorporated
herein by reference to Exhibit 10.14 to the 2000 10-K).
10.14 Share Purchase Agreement, dated as of November 29, 2001, by and among
the Registrant, Decision Systems Israel Ltd., Endan IT Solutions Ltd.,
Kardan Communications Ltd., Neuwirth Investments Ltd., Jacob Neuwirth
(Noy) and Adv. Yossi Avraham, as Trustee for Meir Givon (incorporated
herein by reference to Exhibit 10.1 to the Registrant's Current Report
on Form 8-K dated December 13, 2001).
-24-
10.15 Registration Rights Agreement, dated as of December 13, 2001, by and
among the Registrant, Kardan Communications Ltd. and Adv. Yossi
Avraham, as Trustee for Meir Givon (incorporated herein by reference
to Exhibit 10.2 to the Registrant's Current Report on Form 8-K dated
December 13, 2001).
10.16 Employment Agreement, dated as of September 1, 2001, by and between
Comverge Technologies, Inc. and Robert M. Chiste (incorporated
herein by reference to Exhibit 10.1 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 30, 2001).
10.17 Restricted Stock Purchase Agreement, dated as of September 1, 2001,
by and between Data Systems & Software Inc. and Robert M. Chiste
(incorporated herein by reference to Exhibit 10.2 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2001).
10.18 Option Agreement, dated as of September 1, 2001, by and between
Comverge Technologies, Inc. and Robert M. Chiste (incorporated
herein by reference to Exhibit 10.3 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 30, 2001).
10.19 Contract for Asset Management Services between the Registrant and
Malley Associates Capital Management, Inc. (incorporated herein by
reference to Exhibit 10.1 to the Registrant's Quarterly Report on
Form 10-Q for the quarter ended March 31, 2001).
10.20 Employment Agreement dated as of March 30, 2001 between Comverge
Technologies, Inc. and Joseph D. Esteves (incorporated herein by
reference to Exhibit 10.1 to the Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 2001).
#10.21 Agreement, dated as of January 31, 2002, between Comverge
Technologies, Inc. and Bank Leumi USA.
#10.22 $6,000,000 Term Note of Comverge Technologies, Inc. dated as of
January 31, 2002, payable to Bank Leumi USA.
#*10.23 First Amendment to Employment Agreement, dated as of May 17, 2001,
by and between the Registrant and George Morgenstern.
16.1 Letter regarding change in certifying accountant dated December 8,
2000 (incorporated herein by reference to our Current Report on Form
8-K filed December 8, 2000).
#21.1 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
Registrant participate.
# This Exhibit is filed herewith.
(b) FINANCIAL STATEMENT SCHEDULES.
None.
(c) REPORTS ON FORM 8-K.
(i) Report on Form 8-K, dated October 31, 2001, filed on November
2, 2001, relating to a press release issued by us regarding
the execution by Decision Systems Israel Ltd. of a memorandum
of understanding for the acquisition of Endan IT Solutions
Ltd.
(ii) Report on Form 8-K, dated December 13, 2001, filed on December
28, 2001, relating to the acquisition by Decision Systems
Israel Ltd. of all of the outstanding ordinary shares of Endan
IT Solutions Ltd.
-25-
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 25, 2002.
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 25, 2002
- -------------------------------------------- Officer; and Director
George Morgenstern
/s/ ROBERT L. KUHN Vice Chairman and Director March 25, 2002
- --------------------------------------------
Robert L. Kuhn
/s/ YACOV KAUFMAN Vice President, Chief Financial Officer March 25, 2002
- -------------------------------------------- (Principal Financial Officer and Principal
Yacov Kaufman Accounting Officer)
/s/ SHLOMIE MORGENSTERN Vice President and Director March 25, 2002
- --------------------------------------------
Shlomie Morgenstern
/s/ ALLEN I. SCHIFF Director March 25, 2002
- --------------------------------------------
Allen I. Schiff
/s/ MAXWELL M. RABB Director March 25, 2002
- --------------------------------------------
Maxwell M. Rabb
/s/ SUSAN MALLEY Director March 25, 2002
- --------------------------------------------
Susan Malley
/s/ HOWARD A. GUTZMER
- -------------------------------------------- Director March 25, 2002
Howard A. Gutzmer
/s/ SHELDON KRAUSE Secretary and Director March 25, 2002
- --------------------------------------------
Sheldon Krause
-26-
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, 2000 and December 31, 2001................................................................... F-3
Consolidated Statements of Operations and Comprehensive Income (Loss)
for the years ended December 31, 1999, December 31, 2000 and December 31, 2001.................................. F-4
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 1999, December 31, 2000 and December 31, 2001................................... F-5
Consolidated Statements of Cash Flows
for the years ended December 31, 1999, December 31, 2000 and December 31, 2001................................... 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 sheets of Data Systems &
Software Inc. and subsidiaries as of December 31, 2000 and 2001, and the related
consolidated statements of operations and comprehensive income (loss), changes
in shareholders' equity, and cash flows for each of the years in the two-year
period ended December 31, 2001. 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. The
consolidated financial statements of Data Systems & Software Inc. and
subsidiaries as of December 31, 1999 and for the year ended December 31, 1999
were audited by other auditors whose report dated March 29, 2000, expressed an
unqualified opinion on those statements.
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 2000 and 2001 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 2001, and
the results of their operations and their cash flows for each of the years in
the two-year period ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America.
As discussed in Note 2 to the consolidated financial statements, the Company
adopted Statements of Financial Accounting Standards No. 141, Business
Combinations, and No. 142, Goodwill and Other Intangibles, for purchase method
business combinations completed after June 30, 2001.
/s/ KPMG LLP
Short Hills, New Jersey
March 8, 2002
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Data Systems & Software Inc.:
We have audited the accompanying consolidated statements of operations and
comprehensive income (loss), changes in shareholders' equity and cash flows of
Data Systems & Software Inc. (the "Company") and its subsidiaries for the year
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 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 results of operations and the cash flows
of the Company and its subsidiaries for the year 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)
AS OF
DECEMBER 31,
-------------
2000 2001
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents ................................................ $ 10,877 $ 4,025
Short-term interest bearing bank deposits and debt securities ............ 5,994 1,828
Restricted cash .......................................................... 302 317
Accounts receivable, net ................................................. 9,989 10,197
Inventory ................................................................ 448 658
Other current assets ..................................................... 1,154 1,907
-------- --------
Total current assets .................................................. 28,764 18,932
Investments ................................................................. 153 90
Property and equipment, net ................................................. 1,535 2,296
Goodwill, net ............................................................... 2,350 7,737
Other intangible assets, net ................................................ 476 837
Long-term deposits .......................................................... 6,000 6,000
Other assets ................................................................ 543 748
Prepaid employee termination benefits ....................................... 2,336 2,653
-------- --------
Total assets .......................................................... $ 42,157 $ 39,293
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term bank debt and current maturities of long-term debt ............ $ 591 $ 2,499
Trade accounts payable ................................................... 4,347 4,010
Accrued payroll, payroll taxes and social benefits ....................... 1,677 2,193
Other current liabilities ................................................ 3,971 3,363
-------- --------
Total current liabilities ............................................. 10,586 12,065
-------- --------
Long-term liabilities:
Long-term debt ........................................................... 6,015 6,182
Other liabilities ........................................................ -- 285
Liability for employee termination benefits .............................. 2,935 3,811
-------- --------
Total long-term liabilities ........................................... 8,950 10,278
-------- --------
Commitments and contingencies (Note 15)
Minority interests .......................................................... 40 2,588
-------- --------
Shareholders' equity:
Common stock $.01 par value per share:
Authorized 20,000,000 shares; issued 8,035,334 and 8,161,867 shares
at December 31, 2000 and 2001, respectively ......................... 80 82
Additional paid-in capital ............................................... 35,970 36,981
Warrants ................................................................. 114 114
Deferred compensation .................................................... -- (14)
Accumulated deficit ...................................................... (8,813) (18,643)
Treasury stock, at cost - 990,647 and 808,704 shares at December 31, 2000
and 2001, respectively ............................................. (4,770) (3,860)
Stockholder's note ...................................................... -- (298)
-------- --------
Total shareholders' equity .................................................. 22,581 14,362
-------- --------
Total liabilities and shareholders' equity ............................ $ 42,157 $ 39,293
======== ========
The accompanying notes are an integral part of these 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,
------------------------
1999 2000 2001
---- ---- ----
Sales:
Products .................................................................. $ 20,300 $ 38,300 $ 32,717
Services .................................................................. 19,408 19,539 13,207
-------- -------- --------
39,708 57,839 45,924
-------- -------- --------
Cost of sales:
Products .................................................................. 16,705 31,415 26,277
Services .................................................................. 14,910 14,191 10,436
-------- -------- --------
31,615 45,606 36,713
-------- -------- --------
Gross profit ........................................................... 8,093 12,233 9,211
Research and development expenses ............................................ 1,269 928 2,284
Selling, general and administrative expenses ................................. 12,471 16,340 17,643
Gain on sale of division/subsidiary .......................................... -- 1,144 397
-------- -------- --------
Operating loss ............................................................ (5,647) (3,891) (10,319)
Interest income .............................................................. 61 1,758 1,104
Interest expense ............................................................. (910) (709) (459)
Other loss, net .............................................................. (306) (50) (132)
Minority interests ........................................................... (275) -- --
-------- -------- --------
Loss from continuing operations before provision (benefit) for income taxes (7,077) (2,892) (9,806)
Provision (benefit) for income taxes ......................................... 62 171 (11)
-------- -------- --------
Loss from continuing operations ........................................... (7,139) (3,063) (9,795)
Loss from discontinued operations, net of income taxes ....................... (8,728) (104) --
Gain on sale of discontinued operations, net of income taxes ................. -- 4,222 --
-------- -------- --------
Income (loss) before extraordinary item ...................................... (15,867) 1,055 (9,795)
Extraordinary loss on early redemption of debt ............................... -- (943) --
-------- -------- --------
Net income (loss) ......................................................... (15,867) 112 (9,795)
Other comprehensive income (loss):
Unrealized gain on securities available for sale .......................... (110) -- --
-------- -------- --------
Comprehensive income (loss) ............................................... $(15,977) $ 112 $ (9,795)
======== ======== ========
Basic and diluted net income (loss) per share:
Loss from continuing operations ......................................... $ (0.96) $ (0.41) $ (1.41)
Discontinued operations ................................................. (1.17) 0.56 --
Extraordinary item ...................................................... -- (0.13) --
-------- -------- --------
Net income (loss) per share ......................................... $ (2.13) $ 0.02 $ (1.41)
======== ======== ========
Weighted average number of shares outstanding - basic and diluted ............ 7,433 7,422 6,970
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS)
ACCUMULATED
OTHER
ADDITIONAL STOCK- COMPRE-
NUMBER OF COMMON PAID-IN DEFERRED TREASURY ACCUMULATED HOLDER'S HENSIVE
SHARES STOCK CAPITAL COMPENSATION WARRANTS STOCK DEFICIT NOTE INCOME TOTAL
------ ----- ------- ------------ -------- ----- ------- ---- ------ -----
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
Exercise of options................... 77 1 192 -- -- 73 (35) -- -- 231
Issuance of shares.................... 50 1 297 -- -- -- -- (298) -- --
Issuance of deferred compensation..... -- -- 16 (16) -- -- -- -- -- --
Amortization of deferred compensation. -- -- -- 2 -- -- -- -- -- 2
Treasury shares issued in respect
of acquisition at average cost.... -- -- 506 -- -- 1,744 -- -- -- 2,250
Purchase of treasury shares........... -- -- -- -- -- (907) -- -- -- (907)
Net loss.............................. -- -- -- -- -- -- (9,795) -- -- (9,795)
-- -- -- -- -- -- ------- -- -- -------
Balances, December 31, 2001............ 8,162 $ 82 $36,981 $ (14) $ 114 $ (3,860) $(18,643) $(298) $ -- $14,362
===== ===== ======= ===== ===== ======== ========== ====== ==== ========
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,
1999 2000 2001
---- ---- ----
Cash flows used in operating activities:
Net income (loss)................................................................. $(15,867) $112 $(9,795)
Adjustments to reconcile net income (loss) to net cash used in operating
activities--see Schedule A..................................................... 11,624 (6,257) 1,075
------ ------- -------
Net cash used in operating activities............................................. (4,243) (6,145) (8,720)
------ ------- -------
Cash flows provided by (used in) investing activities:
Short-term bank deposits, net........................................................ 243 (4,985) 5,994
Restricted cash...................................................................... 216 234 (15)
Investment in long-term deposits..................................................... -- (6,000) --
Investment in debt securities........................................................ -- -- (3,215)
Proceeds from sale and maturity of marketable and debt securities.................... 1,520 -- 1,383
Proceeds from sale of investment held for sale....................................... -- 30,889 --
Net proceeds from sale of division................................................... -- 1,838 --
Acquisitions of property and equipment............................................... (637) (742) (897)
Proceeds from sale of property and equipment......................................... 327 132 23
Funding of termination benefits...................................................... (190) 50 (36)
Acquisitions of intangible assets.................................................... -- (17) (7)
Business acquisitions -see Schedule C................................................ (6,181) -- (500)
------- ------- -----
Net cash provided by (used in) investing activities............................... (4,702) 21,399 2,730
------- ------- -----
Cash flows provided by (used in) financing activities:
Purchase of treasury stock........................................................... -- (2,405) (907)
Proceeds from stock options exercises................................................ -- 66 231
Repurchase of outstanding warrants................................................... -- (375) --
Redemption of convertible debentures................................................. -- (2,001) --
Short-term debt borrowings (repayments), net......................................... 7,824 (6,971) 836
Proceeds from long-term debt......................................................... 52 6,021 --
Issuance of convertible debentures and warrants...................................... 2,000 -- --
Repayment of debt acquired in acquisition............................................ -- -- (1,000)
Repayments of long-term debt......................................................... (555) (91) (22)
------ ------- -------
Net cash provided by (used in) financing activities............................... 9,321 (5,756) (862)
------ ------- -------
Net increase (decrease) in cash and cash equivalents................................. 376 9,498 (6,852)
Cash and cash equivalents at beginning of year....................................... 1,003 1,379 10,877
------ ------- -------
Cash and cash equivalents at end of year............................................. $1,379 $10,877 $4,025
======= ======= =======
Supplemental cash flow information:
Cash paid during the year for:
Interest....................................................................... $386 $764 $372
Income taxes................................................................... $106 $3,596 $459
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,
------------------------
1999 2000 2001
---- ---- ----
A. Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization......................................................... $1,351 $1,628 $1,338
Minority interests.................................................................... 275 -- --
Issuance of subsidiary shares to minority interests................................... -- 30 --
Gain on sale of investment held for sale.............................................. -- (4,989) --
Allowance for doubtful accounts....................................................... 95 254 (279)
Deferred taxes........................................................................ -- (20) 14
Increase (decrease) in liability for employee termination benefits.................... 167 (13) 332
Equity loss in affiliates............................................................. 5,102 -- --
Gain on sale of segment/subsidiary stock.............................................. -- (1,144) (397)
Loss (gain) on sale of marketable securities and debt securities, net................. (247) -- 4
Loss from write-down of investment.................................................... 237 -- 227
Write-down of inventory............................................................... -- -- 391
Loss (gain) on sale of property, plant and equipment, net............................. 51 (4) 33
Amortization of restricted stock award and deferred compensation...................... 300 73 2
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 -- 7
Receipt of investments for services rendered.......................................... -- (153) (164)
Changes in operating assets and liabilities, net of effect of
acquisitions and disposals:
Decrease (increase) in accounts receivable and other current assets............... (2,914) (601) 1,427
Decrease (increase) in inventory.................................................. 962 1,257 (601)
Decrease in other assets.......................................................... 219 297 81
Increase (decrease) in accounts payable and other current liabilities............. 5,538 (3,852) (1,445)
Increase in other liabilities..................................................... -- -- 105
-------- ---------- ---------
$11,624 $(6,257) $1,075
======== ======== =========
B. Non-cash investing and financing activities:
Imputed interest on convertible debentures.......................................... $ 377
======
Unrealized gain (loss) on marketable securities available for sale ................... $(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 from conversion of convertible debt................................ $260
====
Adjustment of fixed assets to other current liabilities............................... $11
===
Issuance of deferred compensation..................................................... $16
===
Shares of subsidiary issued in respect of acquisition................................. $2,938
======
Issuance of treasury shares in respect of acquisition................................. $2,250
======
Issuance of shares for subordinated note.............................................. $ 298
=======
Reduction of goodwill from realization of deferred tax asset in acquisition........... $ 180
=======
Write-off of retired and fully depreciated property and equipment..................... $1,842
======
C. Assets/liabilities acquired in acquisitions:
Current assets........................................................................ (1,507) (2,124)
Property and equipment................................................................ (639) (609)
Goodwill and intangibles.............................................................. (4,226) (6,570)
Other assets.......................................................................... -- (386)
Current liabilities................................................................... 750 1,958
Long-term debt........................................................................ -- 1,319
Other liabilities and minority interests.............................................. (559) 3,482
Deferred taxes........................................................................ -- 180
Shareholders' Equity.................................................................. -- 2,250
----- -----
$(6,181) $(500)
======== =====
F-7
The accompanying notes are an integral part of these consolidated financial
statements.
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
NOTE 1--NATURE OF OPERATIONS
(a) Description of Business
Data Systems & Software Inc., a Delaware corporation ("DSSI"), through
its subsidiaries (collectively, the "Company"), (i) provides software consulting
and development services, (ii) is an authorized dealer and a
value-added-reseller of computer hardware, and (iii) provides energy
intelligence solutions for utilities and energy companies. The Company's
operations are based in the United States and in Israel. DSSI's shares are
traded on the Nasdaq National Market.
(b) Financing of Operations
The Company has had a history of operating losses in 2001, 2000 and
1999 of approximately $10.3 million, $3.9 million and $5.6 million,
respectively. The Company does not expect to be profitable in the first half of
2002. Additionally, the Company is uncertain whether it will achieve
profitability in the second half of 2002. As of December 31, 2001 the Company
had working capital of approximately $6.9 million, including $5.9 million in
cash, cash equivalents and debt security investments. In addition the Company
had a long-term deposit of $6 million securing its energy intelligence solutions
subsidiary's long-term bank debt of the same amount which remains pledged to the
bank. Net cash used in operating activities in 2001 was $8.7 million. The cash
used was primarily for the operations of the Company's energy intelligence
solutions subsidiary ($7.3 million) and US operations and corporate activities
($1.4 million). The Company's subsidiary, Decision Systems Israel Ltd. (DSIT),
however, had breakeven cash flow for 2001.
The Company intends to finance its US-based operating activities and
its corporate activities, other than those of its energy intelligence solutions
subsidiary, from cash on hand and from operating cash flow. The Company's energy
intelligence solutions subsidiary is seeking to finance its activities through
outside investment. Should the energy intelligence solutions subsidiary not be
successful in raising outside funding, it intends implement an operating plan to
reduce costs and expenses to breakeven cash flow by the end of the third quarter
of 2002. This operating plan would require this subsidiary to curtail its
research and development activities, consolidate geographically distant
operations, significantly reduce its marketing efforts and reduce general,
administrative and marketing salary expenses. Based on these plans, the Company
believes that it will have adequate liquidity to finance its operating
activities and corporate expenses through March 31, 2004.
(c) 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. Some of the more significant
estimates being made involve percentage of completion for fixed-price contracts
and the evaluation of the recoverability of inventory, goodwill and deferred tax
assets. Actual results could differ from those estimates.
NOTE 2--SUMMARY OF 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, the Company 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 (losses), net amounted
to $64, $3 and $(3) for the years ended December 31, 1999, 2000 and 2001,
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
F-8
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.
DEBT SECURITIES
The Company classifies its debt securities in one of three categories:
trading, available-for-sale, or held-to-maturity. Trading securities are bought
and held principally for the purpose of selling them in the near term.
Held-to-maturity securities, are those securities in which the Company has the
ability and intent to hold the security until maturity. All securities not
included in trading or held-to-maturity, are classified as available-for-sale.
Trading and available-for-sale securities are recorded at fair value.
Held-to-maturity securities are recorded at amortized cost, adjusted for the
amortization or accretion of premiums or discounts. Unrealized holding gains and
losses on trading securities, are included in operations. Unrealized holding
gains and losses, net of the related tax effect on available-for-sale securities
are excluded from operations and are reported as a separate component of
accumulated other comprehensive income until realized. Realized gains and losses
from the sale of available-for-sale securities are determined on a specific
identification basis.
A decline in the market value of any available-for-sale or
held-to-maturity security, below cost that is deemed to be other than temporary,
results in a reduction in carrying amount to fair value. The impairment is
charged to operations and a new cost basis for the security is established.
Premiums and discounts are amortized or accreted over the life of the related
held-to-maturity or available-for-sale security as an adjustment to yield using
the effective interest method. Dividend and interest income are recognized when
earned. All investments in debt securities are classified as trading or
held-to-maturity and are recorded in short-term interest bearing bank deposits
and debt securities in the consolidated balance sheet.
DERIVATIVE INSTRUMENTS
In June 1998 and June 2000, the Financial Accounting Standards Board
("FASB") issued Statement on Financial Accounting Standard ("SFAS") No. 133,
"Accounting for Derivative Instruments and Hedging Activities", and SFAS No.
138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities", an amendment of SFAS No. 133, respectively, which establish
accounting and reporting standards for all derivative instruments and hedging
activities. These statements require an entity to recognize all derivatives as
either assets or liabilities in the balance sheet and measure those investments
at fair value. The Company's adoption of these pronouncements on January 1, 2001
had no effect on the Company's consolidated results of operations, financial
position and financial disclosures, as the Company has no derivatives or
embedded derivatives requiring separate accounting and disclosure. In addition,
the Company does not engage in hedging activities of foreign currency.
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 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.
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.
GOODWILL
Goodwill represents the excess of cost over the fair value of the net
assets of subsidiaries acquired in purchase business combinations. Goodwill
resulting from business combinations completed before July 1, 2001 is amortized
on a straight-line basis over its estimated useful life which ranges from five
to seven years. Goodwill from the Company's acquisition of Endan IT Solutions
Ltd. ("Endan") in December 2001 (see Note 3) is not amortized, but instead
tested for impairment at least annually beginning in 2002 (see "Newly Adopted
Accounting Principles" below) in accordance with
F-9
the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets".
OTHER INTANGIBLES
The costs of licensed technology and software are presented at
estimated fair value at acquisition date. These costs are amortized on a
straight-line basis over the term of the license or estimated useful life of the
software, 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 fourteen years. Costs for patents pending are not amortized until
they are issued.
REVENUE RECOGNITION
Revenue 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 from the sale of software licenses are recognized under the
percentage-of-completion method as the Company's software requires significant
modification and customization. Revenues from postcontract support ("PCS") are
recognized on a straight-line basis over the term of the PCS contract.
Revenues on the sale of products which are shipped from the Company's
stock of inventory are recognized when the products are shipped. In accordance
with Emerging Issues Task Force ("EITF") Issue No. 99-19 "Recording Revenue
Gross as a Principal Versus Net as an Agent", revenue from drop shipments of
third-party hardware and software sales are recognized upon delivery, and
recorded at the gross amount when the Company is responsible for fulfillment of
the customer order, has latitude in pricing, customizes the product to the
customer's specifications and has discretion in the selection of the supplier.
Revenue from drop shipment third-party software sales is recognized upon
delivery, and recorded net of costs when the Company acts principally as an
agent or broker in the transaction.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development costs are charged to operations as incurred.
Research and development expenses consist primarily of labor and related costs.
SALE OF STOCK OF SUBSIDIARY
The Company recognizes gains and losses from the sale of subsidiary
stock through the consolidated statement of operations.
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 SFAS No. 123, "Accounting for Stock-Based
Compensation", 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".
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
F-10
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.
F-11
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.
NEWLY ADOPTED ACCOUNTING PRINCIPLES
In June 2001, the FASB issued SFAS No. 141, "Business Combinations" and
SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 requires that
the purchase method of accounting be used for all business combinations. SFAS
No. 141 specifies criteria that intangible assets acquired in a business
combination must meet to be recognized and reported separately from goodwill.
SFAS No. 142 will require that goodwill and intangible assets with indefinite
useful lives no longer be amortized, but instead tested for impairment at least
annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also
requires that intangible assets with estimable useful lives be amortized over
their respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS No. 121 and subsequently, SFAS
No. 144 after its adoption.
The Company adopted the provisions of SFAS No. 141 as of July 1, 2001,
and SFAS No. 142 is effective January 1, 2002. Goodwill and intangible assets
determined to have an indefinite useful life acquired in a purchase business
combination completed after June 30, 2001, but before SFAS No. 142 is adopted in
full, are not amortized. Goodwill and intangible assets acquired in business
combinations completed before July 1, 2001 continue to be amortized and tested
for impairment prior to the full adoption of SFAS No. 142.
Upon adoption of SFAS No. 142, the Company is required to evaluate its
existing intangible assets and goodwill that were acquired in purchase business
combinations, and to make any necessary reclassifications in order to conform
with the new classification criteria in SFAS No. 141 for recognition separate
from goodwill. The Company will be required to reassess the useful lives and
residual values of all intangible assets acquired, and make any necessary
amortization period adjustments by March 31, 2002. If an intangible asset is
identified as having an indefinite useful life, the Company will be required to
test the intangible asset for impairment in accordance with the provisions of
SFAS No. 142 within the quarter ended March 31, 2002. Impairment is measured as
the excess of carrying value over the fair value of an intangible asset with an
indefinite life. Any impairment loss will be measured as of the date of adoption
and recognized as the cumulative effect of a change in accounting principle in
the quarter ended March 31, 2002.
In connection with SFAS No. 142's transitional goodwill impairment
evaluation, the Statement requires the Company to perform an assessment of
whether there is an indication that goodwill is impaired as of the date of
adoption. To accomplish this, the Company must identify its reporting units and
determine the carrying value of each reporting unit by assigning the assets and
liabilities, including the existing goodwill and intangible assets, to those
reporting units as of January 1, 2002. The Company will then have up to six
months from January 1, 2002 to determine the fair value of each reporting unit
and compare it to the carrying amount of the reporting unit. To the extent the
carrying amount of a reporting unit exceeds the fair value of the reporting
unit, an indication exists that the reporting unit goodwill may be impaired and
the Company must perform the second step of the transitional impairment test.
The second step is required to be completed as soon as possible, but no later
than the end of 2002. In the second step, the Company must compare the implied
fair value of the reporting unit goodwill with the carrying amount of the
reporting unit goodwill, both of which would be measured as of the date of
adoption. The implied fair value of goodwill is determined by allocating the
fair value of the reporting unit to all of the assets (recognized and
unrecognized) and liabilities of the reporting unit in a manner similar to a
purchase price allocation, in accordance with SFAS No. 141. The residual fair
value after this allocation is the implied fair value of the reporting unit
goodwill. Any transitional impairment loss will be recognized as the cumulative
effect of a change in accounting principle in the Company's consolidated
statement of operations.
As of December 31, 2001, the Company has unamortized goodwill in the
amount of $7,737 and unamortized identifiable intangible assets in the amount of
$837, all of which will be subject to the transition provisions of SFAS No. 142.
Amortization expense related to goodwill was $442, $515, and $503 for the for
the years ended December 31, 1999,
F-12
2000 and 2001, respectively. In connection with the adoption of SFAS No. 142,
the Company has evaluated its intangible assets and determined that it has no
indefinite useful life intangibles. The Company has also evaluated the remaining
useful lives of its intangible assets that will continue to be amortized and has
determined that no revision to the useful lives will be required. The Company
expects to complete its initial impairment review of goodwill by the end of the
second quarter of 2002. Because of the extensive effort needed to comply with
adopting SFAS No. 142 it is not practicable to reasonably estimate whether any
transitional impairment losses associated with the Company's goodwill will be
required to be recognized.
In August, 2001 the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
SFAS No. 144 requires that long-lived assets be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Recoverability of assets to be held and used is measured
by a comparison of the carrying amount of an asset to undiscounted future net
cash flows expected to be generated by the asset. If the carrying amount of an
asset exceeds its estimated future undiscounted cash flows, an impairment charge
is recognized by the amount by which the carrying amount of the asset exceeds
the fair value of the asset. SFAS No. 144 requires companies to separately
report discontinued operations and extends that reporting to a component of an
entity that either has been disposed of (by sale, abandonment, or in a
distribution to owners) or is classified as held for sale. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less costs to
sell. The Company is required to adopt SFAS No. 144 on January 1, 2002. The
Company does not expect the adoption of SFAS No. 144 for long-lived assets to
have a material impact on its consolidated financial statements because the
impairment assessment under SFAS No. 144 is largely unchanged from SFAS No.
121. The provisions of this statement for assets held for sale or other disposal
generally are required to be applied prospectively after the adoption date to
newly initiated disposal activities and, therefore, will depend on future
actions initiated by management. As a result, the Company cannot determine the
potential effects that adoption of SFAS No. 144 will have on its consolidated
financial statements with respect to future disposal decisions, if any.
NOTE 3--ACQUISITIONS
(a) In December 2001, a subsidiary of the Company acquired 100% of the
shares of Endan in a transactions accounted for as a purchase business
combination and partial sale of a subsidiary. Endan is a privately-held Israeli
information technology software and consulting firm and as a result of the
acquisition became an integral part of the Company's software consulting and
development segment. The acquisition was consummated in order to broaden the
Company's markets into information technology and in order to take advantage of
economies of scale and synergistic cost savings. Endan's results from operations
for the period from acquisition to December 31, 2001 have not been included in
the Company's consolidated statement of operations due to immateriality.
The aggregate purchase price for Endan was $5,788, comprised of (i)
$2,250 representing the issuance of 365,210 shares of DSSI common stock valued
at $6.16 per share, which represents the average closing price of the Company's
common stock for a 60 day trading period prior to the closing of the acquisition
as agreed upon by the parties (an amount not materially different from a
valuation of the Company's common stock based on three days before and after the
date the acquisition was announced), (ii) $2,912 representing the estimated
value of 32% of the outstanding ordinary shares of DSIT, (iii) $500 of cash,
(iv) $100 of estimated closing costs and (v) $26 representing the fair value of
options to purchase DSIT ordinary shares in exchange for the cancellation of
outstanding Endan stock options. The Company recognized a gain of $397 on the
issuance of ordinary shares representing a 32% interest in DSIT in connection
with this transaction.
In addition to the purchase consideration mentioned above, the Company
was also required to provide $1,100 to DSIT to enable repayment by Endan of a
$1,000 loan previously made by Kardan Communications Ltd. ("Kardan"), Endan's
majority shareholder prior to the acquisition.
The following table summarizes the estimated fair value of the assets
acquired and liabilities assumed at December 31, 2001, the effective date of
acquisition before the repayment of the Kardan debt. The Company is in the
process of obtaining third-party valuations of certain intangible assets; thus,
the allocation of the purchase price is preliminary and subject to refinement
upon receipt of the third party valuation information and evaluation of the
outcome of the litigation discussed in Note 15 (e).
F-13
Current assets $2,124
Property and equipment 609
Intangible assets 500
Goodwill 6,070
Other assets 386
-------
Total assets acquired 9,689
-----
Current liabilities 1,858
Long-term debt 1,319
Other liabilities 544
Deferred tax liability created in acquisition 180
------
Total liabilities assumed 3,901
------
Net assets acquired $5,788
======
The intangible assets represent the fair value of software licenses
acquired (five-year useful life). The goodwill resulting from the acquisition is
not deductible for income tax purposes and will not be amortized for financial
statement purposes in accordance with SFAS No. 142. The entire goodwill acquired
was assigned to the software consulting and development segment.
The following unaudited pro forma information presents a summary of
consolidated results of operations of the Company as if this acquisition had
occurred at the beginning of each of the periods presented, with pro forma
adjustments to give effect to the amortization of acquired intangibles and a
reduction of interest expense resulting from Endan's repayment of a $1,000 loan.
The unaudited pro forma information does not include the amortization of
goodwill acquired as it is not required to be amortized pursuant to SFAS No.
142. The gain on the partial sale of 32% of DSIT is excluded from the unaudited
pro forma consolidated results of operations as it is non-recurring. The
unaudited pro forma consolidated results of operations are provided for
illustrative purposes only and do not purport to represent what the Company's
results of operations would actually have been, nor do they purport to project
the Company's results of operations for any future period.
YEAR ENDED DECEMBER 31,
2000 2001
---- ----
Net sales....................................................... $63,408 $52,355
Net loss from continuing operations............................. $(3,894) $(9,884)
Loss per share from continuing operations - basic and diluted... $(0.50) $(1.35)
(b) In August, 1999, the Company acquired the assets of the Control
Systems division of Scientific-Atlanta, Inc., integrating it in into the
Company's energy intelligence solutions segment. The acquisition was accounted
for using the purchase method. As of December 31, 2000, the Company and
Scientific-Atlanta had not reached agreement on the final purchase price. The
Company finalized the purchase price in August 2001 without further adjustment
to the purchase price or goodwill. The final purchase price of $3,954 was
allocated as follows: $2,013 to inventory; $639 to property and equipment; $248
to patents and patents pending; $20 to assumed liabilities and $1,074 to
goodwill.
NOTE 4--DISPOSITIONS
(a) In 1999, DSSI owned 60% of the shares of Tower Semiconductor
Holdings 1993 Ltd. ("Holdings"). Holdings' only asset was its investment in
45.3% of Tower Semiconductor Ltd. ("Tower"). 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. In addition, the Company accrued all taxes
with respect to the anticipated repatriation of Tower's accumulated earnings.
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-14
Set forth below is condensed financial information of Tower:
YEAR ENDED DECEMBER 31,
-----------------------
1999
-----
Sales.................................... $69,815
Operating loss........................... (25,166)
Net loss................................. (20,467)
In 1999, the Company recorded equity losses with regard to its interest
in Tower of $5,005. The equity loss is 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 2000, the Company recorded a provision of $104 in loss from
discontinued operations with respect to additional expenses related to its
discontinued help desk software segment that was sold in 1998.
NOTE 5--ACCOUNTS RECEIVABLE, NET
Accounts receivable, net consists, of the following:
AS OF DECEMBER 31,
------------------
2000 2001
---- ----
Trade accounts receivable.................................................... $9,348 $9,095
Unbilled work-in-process..................................................... 1,076 1,362
Allowance for doubtful accounts.............................................. (435) (260)
----- -----
Accounts receivable, net $9,989 $10,197
====== =======
Unbilled work-in-process represents direct labor and expenses incurred
on consulting contracts that has 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 $169, $262
and $71 for the years ended December 31, 1999, 2000 and 2001, respectively.
NOTE 6--INVENTORY
Inventory consists of the following:
AS OF DECEMBER 31,
------------------
2000 2001
---- ----
Raw materials, spare parts and supplies...................................... $35 $409
Finished goods and merchandise............................................... 413 249
--- ---
$448 $658
==== ====
NOTE 7--OTHER CURRENT ASSETS
Other current assets consist of the following:
AS OF DECEMBER 31,
------------------
2000 2001
---- ----
Prepaid expenses............................................................. $240 $391
Interest receivable.......................................................... 514 817
Income tax receivable........................................................ 159 385
Other........................................................................ 241 314
------ ------
$1,154 $1,907
====== ======
NOTE 8--INVESTMENTS
In 2000 and 2001, the Company received equity shares of $153 and $164,
respectively, as partial compensation for services rendered to two start-up
companies. The investments are recorded at the fair value of the services
provided and are accounted for using the cost method. In 2001, the Company wrote
off the investment in one of the start-up companies based
F-15
upon management's estimate of expected future cash flows from the investment and
that the impairment in the investment is other than temporary. The writedown of
$227 in the fourth quarter of 2001 with respect to this investment is included
in selling, general and administrative expenses.
NOTE 9--PROPERTY AND EQUIPMENT, NET
Property and equipment consist of the following:
ESTIMATED USEFUL LIFE AS OF DECEMBER 31,
-------------------
(IN YEARS) 2000 2001
---------- ---- ----
Cost:
Computer hardware and software........................... 3 $3,463 $2,568
Office furniture and equipment........................... 4-10 1,802 2,276
Motor vehicles........................................... 7 85 561
Leasehold improvements................................... Term of Lease 246 279
--- ---
5,596 5,684
----- -----
Accumulated depreciation and amortization:
Computer hardware and software.................................................... 2,864 2,052
Office furniture and equipment.................................................... 930 1,099
Motor vehicles.................................................................... 60 146
Leasehold improvements............................................................ 207 91
--- -----
4,061 3,388
----- -----
Property and equipment, net.......................................................... $1,535 $2,296
====== ======
Depreciation and amortization in respect of property and equipment
amounted to $792, $834 and $689 for 1999, 2000 and 2001, respectively. In 2001,
approximately $1,842 of fully depreciated assets were written off the Company's
books.
NOTE 10--GOODWILL AND OTHER INTANGIBLE ASSETS, NET
Goodwill and other intangible assets consists of the following:
AS OF DECEMBER 31,
2000 2001
---- ----
Goodwill, net of accumulated amortization of $2,174 and $2,677 respectively...... $2,350 $7,737
License, net of accumulated amortization of $341 and $457 respectively........... 227 111
Patents, net of accumulated amortization of $23 and $53 respectively............. 249 226
Software licenses................................................................ -- 500
------ ------
$2,826 $8,574
====== ======
Amortization in respect of goodwill, license and patents amounted to
$559, $794 and $649 for 1999, 2000 and 2001, respectively. In accordance with
SFAS No. 142, no amortization is recorded on goodwill arising from the Company's
acquisition of Endan in December 2001.
NOTE 11--DEBT
Debt consists of the following:
AS OF DECEMBER 31,
2000 2001
---- ----
Bank debt........................................................................ $6,000 $6,254
Lines of credit.................................................................. 573 2,416
Capital lease obligations........................................................ 33 11
------ ------
6,606 8,681
Less current portion............................................................. 591 2,499
------ ------
$6,015 $6,182
====== ======
Bank debt includes a $6,000 loan which is payable in a single
installment upon maturity in February 2003 and various loans from Israeli banks.
The $6,000 loan bears interest at LIBOR plus 0.75% (adjusted quarterly), payable
quarterly (LIBOR at December 31, 2001: 1.88%). In February 2000, the Company
refinanced this loan and recognized an extraordinary loss of $190 for the
write-off of the unamortized premium associated with a warrant issued to the
lender (see Note 16). No income tax benefit on this extraordinary item was
recognized as the Company establishes valuation allowances against its deferred
tax assets as it is more likely than not that they will not be realized. In
connection with this loan, the Company is required to deposit $6,000 with the
lender as collateral for the loan. The deposit is currently held in a
F-16
one month time deposit bearing interest at 1.7%. The deposit will continue to be
renewed at market rates so long as the loan is outstanding. As the compensating
balance is required for the term of the loan, the deposit is shown as a
non-current asset.
The loans from Israeli banks are in New Israeli Shekels (NIS) linked
either to the U.S. dollar ($158) or the Israeli Consumer Price Index (the Index)
($96) due through 2006. The loans bear a weighted average interest rate of 6.3%.
During the year ended December 31, 2001, the Index increased by 1.4%. In
connection with these loans a lien in favor of the Israeli banks was placed on
some of DSIT's assets and contract plus rights.
At December 31, 2001, the Company had approximately $3,000 in Israeli
credit lines available to DSIT, of which approximately $2,416 was then being
used and $584 was available for future draws. These credit lines are generally
for a term of one year, denominated in NIS and bear interest at a weighted
average rate of the Israeli prime rate per annum (at December 31, 2000 Israeli
prime plus 0.2% per annum). The Israeli prime rate fluctuates and as of December
31, 2001 was 5.3% (9.5% at December 31, 2000).
The Company's capital lease obligations are payable through 2004.
The aggregate maturities of debt for each of the five years subsequent
to December 31, 2001 are as follows:
YEAR ENDING
DECEMBER 31,
-------------
2002..................................................................................... $2,499
2003..................................................................................... 6,071
2004..................................................................................... 51
2005..................................................................................... 41
2006..................................................................................... 19
--------
$8,681
========
NOTE 12--OTHER CURRENT LIABILITIES
Other current liabilities consists of the following:
AS OF DECEMBER 31,
2000 2001
---- ----
Taxes payable.................................................................... $1,185 $805
Lien allowance................................................................... 558 558
Deferred income.................................................................. 385 169
Deferred acquisition costs....................................................... 47 --
Other............................................................................ 1,796 1,831
----- ------
$3,971 $3,363
====== ======
NOTE 13--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 was 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 in 2000 of $753 due to the early redemption. No income tax
benefit on this extraordinary item was recognized as the Company establishes
valuation allowances against its deferred tax assets as it is more likely than
not that they will not be realized. In 2000, the $260 unredeemed balance of the
convertible
F-17
debentures was converted into 84,794 shares of common stock of the Company in
accordance with the terms of the Debentures.
NOTE 14--LIABILITY FOR EMPLOYEE TERMINATION BENEFITS
Under Israeli law and labor agreements, the Company's subsidiaries in
Israel are required to make severance 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 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 1999, 2000 and
2001 of approximately $1,355, $1,276 and $1,394, respectively, are included in
cost of sales (services) and selling, general and administrative expenses.
NOTE 15--COMMITMENTS AND CONTINGENCIES
(a) Leases of Property and Equipment
Rental and leasing expenses, for 1999, 2000 and 2001, were to $1,463,
$1,326 and $1,521, respectively. Future minimum lease payments on non-cancelable
operating leases as of December 31, 2001 are as follows:
YEAR ENDING
DECEMBER 31,
--------------
2002..................................................................................... $1,687
2003..................................................................................... 1,365
2004..................................................................................... 850
2005..................................................................................... 752
2006..................................................................................... 417
Thereafter............................................................................... 769
-------
$5,840
=======
(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, 1999, 2000 and 2001.
(c) Guarantees
Previously, the Company accrued a loss for contingent performance of
bank guarantees. The Company's remaining commitment under these guarantees
(included in other current liabilities) is $558 at December 31, 2000 and 2001.
The Company has collateralized a portion of these guarantees by means of a
deposit (classified as restricted cash) of $223 and $238 as of December 31, 2000
and 2001, 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, though
limited to $630, the amount of the original grant. The Company's future net
royalty obligation in respect of these grants is not to exceed $522 at December
31, 2001.
(e) Litigation
One of the Company's recently acquired subsidiaries is a plaintiff in
an arbitration proceeding against a customer for payment. The defendant in the
arbitration has filed a counterclaim of approximately $800. Based on advice from
the Company's counsel, management believes that the arbitrator will not order
the Company to pay a substantial amount of the counterclaim. The Company is
involved in various other 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 16--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 common 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
F-18
grant. At December 31, 2001, the total authorized number of options or other
equity instruments available for grant under the various plans was 2,920,225, of
which 1,568,442 were granted options outstanding, 255,000 were issued as
restricted shares, 91,866 were exercised or forfeited and the remaining
1,034,917 were available for issuance.
A summary status of the Company's option plans as of December 31, 1999,
2000 and 2001, as well as changes during each of the years then ended, is
presented below:
1999 2000 2001
---- ---- ----
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......... 1,498,717 $6.39 1,723,850 $5.32 1,554,775 $5.01
Granted............................... 408,450 2.10 412,275 5.36 273,500 5.38
Exercised............................. -- -- (27,000) 2.46 (91,866) 2.51
Forfeited............................. (183,317) 7.00 (554,350) 6.38 (167,967) 6.04
--------- --------- ---------
Outstanding at end of year............... 1,723,850 5.32 1,554,775 5.01 1,568,442 5.11
========= ========= =========
Exercisable at end of year............... 1,276,683 5.70 1,121,406 4.95 1,102,404 4.85
========= ========= =========
OUTSTANDING AS OF DECEMBER 31, 2001 EXERCISABLE AS OF DECEMBER 31, 2001
----------------------------------- -----------------------------------
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............... 231,000 4.36 $1.82 231,000 $1.82
$2.44 - 3.69............... 230,500 5.09 3.15 170,800 3.07
$4.50 - 6.00............... 378,967 4.40 5.11 202,629 5.07
$6.06 - 7.88............... 705,475 3.26 6.64 475,475 6.57
$11.13.................. 22,500 3.73 11.13 22,500 11.13
--------- ---------
1,568,442 1,102,404
========= =========
The weighted average grant-date fair value of the 408,450, 412,275 and
273,500 options granted during 1999, 2000 and 2001, respectively, amounted to
$1.60, $2.85 and $3.27 per option, respectively. The Company utilized the
Black-Scholes option pricing model to estimate fair value, utilizing the
following assumptions for the respective years (all in weighted averages):
1999 2000 2001
---- ---- ----
Risk-free interest rate.................................................... 6.0% 5.0% 4.9%
Expected life of options, in years......................................... 6.8 5.9 6.1
Expected annual volatility................................................. 78% 82% 60%
Expected dividend yield.................................................... None None None
F-19
Had compensation cost for the Company's option plans been determined based
on fair value at the grant dates for awards made in 1999, 2000 and 2001 under
such plans in accordance with SFAS No. 123, the Company's pro forma net income
(loss) and net income (loss) per share would have been as follows:
YEAR ENDED DECEMBER 31,
--------------------------
1999 2000 2001
---- ---- ----
Net income (loss) as reported...............................................$(15,867) $112 $(9,795)
Pro forma net loss........................................................... (16,658) (927) (10,511)
Basic net loss per share-as reported......................................... (2.13) 0.02 (1.41)
Pro forma basic net loss per share........................................... (2.24) (0.12) (1.51)
Diluted net income (loss) per share as reported.............................. (2.13) 0.01 (1.41)
Pro forma diluted net loss per share......................................... (2.24) (0.12) (1.51)
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
subsidiaries.
(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:
1999 2000 2001
---- ---- ----
WEIGHTED WEIGHTED WEIGHTED
NUMBER OF AVERAGE NUMBER OF AVERAGE NUMBER OF AVERAGE
WARRANTS EXERCISE PRICE WARRANTS EXERCISE PRICE WARRANTS EXERCISE PRICE
-------- -------------- --------- -------------- -------- --------------
(IN SHARES) (IN SHARES) (IN SHARES)
Outstanding at beginning of year 197,500 $10.18 370,000 $3.23 120,000 $ 3.07
Granted......................... 370,000 3.23 -- -- -- --
Repurchased by Company.......... -- -- (250,000) 3.31 -- --
Forfeited....................... (197,500) 10.18 -- -- -- --
--------- ------- -------
Outstanding at end of year...... 370,000 $3.23 120,000 $3.07 120,000 $ 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 and was amortized to compensation expense over the vesting
period. In 1999, the remaining $46 was amortized.
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 $254 and $73 was
amortized to compensation expense during 1999 and 2000, respectively.
In September 2001, the Company entered into a restricted stock purchase
agreement with the newly hired Chief Executive Officer (CEO) of the Company's
energy intelligence solutions segment subsidiary. Pursuant to this agreement,
the Company issued to the segment CEO 50,000 shares of its common stock at a
purchase price of $5.95 per share. The common stock was paid for by assigning
and endorsing to the Company a 6% subordinated note, due April 15, 2010, in the
principal amount of $297,500. The subordinated note was issued by Philip
Services Corp. (NasdaqNM: PSCD) in favor of the segment CEO under a trust
indenture with Wilmington Trust Company. The subordinated note is assignable,
pays interest semi-annually, is subject to a sinking fund for the mandatory
redemption of the subordinated note by no more than four annual payments,
beginning in April 15, 2006 and is reflected as a reduction in shareholders'
equity until paid.
(d) Stock Repurchase Program
In September 2000, the Company's Board of Directors authorized the
purchase of up to 500,000 shares of the Company's common stock. During 2000 and
2001, the Company purchased 500,385 and 198,600 of its common stock,
respectively, and at December 31, 2001 owned in the aggregate 808,704 of its own
shares.
(e) Other
In March 1996, the Company's Board of Directors adopted a stockholder
rights plan providing for the distribution
F-20
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.
In September 2001, the Company granted the newly hired CEO of its
energy intelligence solutions segment subsidiary an option to purchase 357,200
shares of stock in the energy intelligence solutions segment subsidiary which is
equal to 6% of the outstanding capital stock of the subsidiary on a fully
diluted basis. The options vest in three equal tranches on January 1, 2002, 2003
and 2004 and terminate on December 31, 2006. The exercise price of these options
as was determined by an independent appraiser was $1.20 per share.
NOTE 17--INCOME TAXES
(a) Composition of loss before income taxes is as follows:
YEAR ENDED DECEMBER 31,
---------------------------
1999 2000 2001
---- ---- ----
Domestic................................................................... $(5,809) $(3,238) $(6,767)
Foreign.................................................................... (1,268) 346 (3,039)
------- ------- -------
$(7,077) $(2,892) $(9,806)
======= ======= =======
(b) Income tax expense (benefit) consists of the following:
YEAR ENDED DECEMBER 31,
-----------------------
1999 2000 2001
---- ---- ----
Current:
Federal.............................................................. $ -- $ -- $ (29)
State and local...................................................... 35 46 (56)
Foreign.............................................................. 22 145 60
------ ------ ------
57 191 (25)
------ ------ ------
Deferred:
Federal.............................................................. 5 -- --
State and local...................................................... -- (20) 14
Foreign.............................................................. -- -- --
------ ------ ------
5 (20) (14)
------ ------ ------
Income tax expense (benefit) from continuing operations ........... 62 171 (11)
Income tax expense from :
Discontinued operations *............................................ 3,723 -- --
Gain on sale of discontinued operations.............................. -- 767 --
------ ------ ------
Total income tax expense (benefit) $3,785 $ 938 $ (11)
====== ====== ======
* 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 4).
F-21
(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,
-----------------------
1999 2000 2001
---- ---- ----
Statutory Federal rates................................ 34% 34% 34%
Increase (decrease) in income tax rate resulting from:
Non-deductible expenses............................... -- (7) (4)
State and local income taxes, net..................... 9 7 5
Net operating loss carryforward....................... 4 16 --
Other................................................. (3) (8) (1)
Valuation allowance................................... (45) (48) (34)
---- ---- ----
Effective income tax rates............................... (1)% (6)% 0%
==== === ====
(d) Analysis of Deferred Tax Assets (Liabilities)
Deferred tax assets consist of the following: AS OF DECEMBER 31,
--------------------
2000 2001
---- ----
Accelerated depreciation for tax purposes........... $ 15 $ 35
Intangible asset basis differences.................. 47 23
Other temporary differences......................... 901 1,504
Net operating and capital loss carryforwards........ 5,882 8,518
Alternative minimum tax credit carryforwards........ 371 --
---- -----
7,216 10,080
Valuation allowance................................. (7,196) (9,894)
------- ------
Net deferred tax assets............................. $ 20 $ 186
======= =======
Deferred tax liabilities consist of the following: AS OF DECEMBER 31,
--------------------
2000 2001
---- ----
Intangible asset basis differences.................. $ -- $ 180
------- -------
Total deferred tax liabilities...................... $ -- $ 180
======= =======
Net deferred tax assets consist of the following: AS OF DECEMBER 31,
---------------------
2000 2001
---- ----
Deferred tax assets - current....................... $ 18 $ 3
Deferred tax assets - non-current................... 2 183
Deferred tax liabilities - non-current.............. -- (180)
------- -------
Net deferred tax assets............................. $ 20 $ 6
======= =======
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 2000
and 2001 was a decrease of $8,113 and an increase of $2,698, respectively.
(e) Summary of Tax Loss Carryforwards
As of December 31, 2001, the Company had various net operating loss
carryforwards, which expire as follows:
EXPIRATION FEDERAL STATE FOREIGN
---------- ------- ----- --------
2002-2004.............................. $-- $49 $--
2005-2006.............................. -- 4,076 --
2007-2008.............................. -- 9,455 --
2019-2021.............................. 10,257 -- --
Unlimited.............................. -- -- 10,126
-------- ------- -------
Total.................................. $10,257 $13,580 $10,126
======== ======= =======
NOTE 18--RELATED PARTY BALANCES AND TRANSACTIONS
The Company paid consulting and other fees to directors of $97, $5 and
$109 for the years ended December 31, 1999, 2000 and 2001, respectively, which
is included in 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
F-22
approximately $494, $474 and $575 for the years ended December 31, 1999, 2000
and 2001, respectively. Approximately $55 and $36, owed to this firm as of
December 31, 2000 and 2001, respectively, is included in other current
liabilities. The Company paid a director and vice president of the Company, who
is the son of the Company's Chief Executive Officer, approximately $132, $280
and $197 for the years ending December 31, 1999, 2000 and 2001, respectively. In
2000, a loan and accumulated interest of $526 to the Company's Chief Executive
officer was repaid in full. An asset management firm that is controlled by a
director of the Company provides discretionary asset management services to the
Company. In the year ended December 31, 2001, the Company has paid fees of $13
to the asset management firm. At December 31, 2001, the asset management firm
administered approximately $2,053 of the Company's assets, including $1,828 of
its debt securities.
NOTE 19--SEGMENT REPORTING AND GEOGRAPHIC INFORMATION
(a) General Information
The Company has three reportable segments: software consulting and
development, computer hardware sales and energy intelligence solutions.
(i) The software consulting and development segment provides computer
software and systems consulting and development services.
(ii) The computer hardware segment is an authorized dealer and
value-added reseller of computer hardware.
(iii) The energy intelligence solutions segment (formerly known as the
utilities 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 No. 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 No. 131, related depreciable assets, along
with other identifiable assets, are allocated to such division.
F-23
The following tables represent segmented data for the years ended December 31,
2001, 2000 and 1999:
SOFTWARE ENERGY
CONSULTING AND INTELLIGENCE COMPUTER
DEVELOPMENT SOLUTIONS HARDWARE OTHER(*) TOTAL
----------- --------- -------- -------- -----
Year ended December 31, 2001:
Revenues from external customers .............. $ 12,179 $ 13,793 $ 19,794 $ 158 $ 45,924
Intersegment revenues ......................... 283 1,164 107 -- 1,554
Interest revenue .............................. 18 3 -- -- 21
Interest expense .............................. 154 311 -- -- 465
Depreciation and amortization ................. 281 706 22 -- 1,009
Segment income (loss) ......................... (2,052) (6,447) 1,006 (217) (7,710)
Income tax expense ............................ 57 10 21 -- 88
Segment assets ................................ 16,346 5,537 2,886 -- 24,769
Expenditures for segment assets ............... 361 512 20 -- 893
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 income (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 income (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
* Represents segments below the quantitative thresholds of SFAS No. 131, as
follows: in 2001, a VAR software operation in Israel and a holding company;
in 2000, a VAR software operation in Israel, a holding company and residual
operations from the Company's multimedia software segment; and in 1999, a VAR
software operation in Israel and residual operations from the multimedia
software segment.
F-24
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, 1999, 2000 and 2001:
FOR THE YEARS ENDING DECEMBER 31,
----------------------------------
1999 2000 2001
---- ---- ----
Revenues:
Total revenues for reportable segments $39,063 $57,597 $45,766
Other operational segment revenues 285 204 158
-------- -------- --------
Total operating revenues 39,348 51,801 45,924
Revenue from management fee derived by
non-operating segment (corporate headquarters) 360 38 --
-------- -------- -----------
Total consolidated revenues $39,708 $57,839 $45,924
======= ======= =======
Income (loss):
Total loss for reportable segments $(3,801) $(960) $(7,243)
Other operational segment operating income (loss) 64 41 (217)
--------- --------- --------
Total operating loss (3,737) (919) (7,460)
Net loss of corporate headquarters (3,411) (2,180) (2,242)
Loss from discontinued operations included in reportable segments -- 104 --
Income tax expense (benefit) included in reportable segments 71 103 (92)
-- --- ----
Consolidated loss from continuing operations
before provision for income taxes $(7,077) $(2,892) $(9,794)
======== ======== ========
AS OF DECEMBER 31,
--------------------
2000 2001
Assets:
Total assets for reportable segments $16,795 $24,769
Other operational segment assets 64 --
---------------------
16,859 24,769
Unallocated amounts: Net assets of corporate headquarters * 25,298 14,524
------ ------
Total consolidated assets $42,157 $39,293
======= =======
* Unallocated assets in 2001 include cash and cash equivalents of $3,745 as
well as investments in debt securities and long-term bank deposits of
$7,828. Unallocated assets in 2000 include cash and cash equivalents of
$10,385 as well as investments in short and long-term bank deposits of
$11,994.
SEGMENT CONSOLIDATED
TOTALS ADJUSTMENTS TOTALS
------ ------------- ------------
Other Significant Items
Year ended December 31, 2001
Depreciation and amortization................................................... $1,009 $329 $1,338
Expenditures for assets......................................................... 893 4 897
Income tax expense (benefit).................................................... 88 (99) (11)
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
The reconciling items are all corporate headquarters data, which are not
included in the segment information. None of the other adjustments are
significant.
F-25
YEAR ENDED DECEMBER 31,
------------------------
1999 2000 2001
---- ---- ----
Revenues based on location of customer:
United States................................................................ $23,579 $41,659 $33,800
Israel....................................................................... 15,401 15,431 10,382
Far East..................................................................... 708 226 540
Other........................................................................ 20 523 1,202
----------- ---------- ---------
$39,708 $57,839 $45,924
======= ======= =======
AS OF DECEMBER 31,
2000 2001
---- ----
Long-lived assets located in the following countries:
Israel................................................................................... $775 $1,373
United States............................................................................ 760 923
(e) Major Customers
Revenues from Major Customers: CONSOLIDATED SALES
YEAR ENDED DECEMBER 31,
------------------------
CUSTOMER SEGMENT 1999 2000 2001
- -------- ------- ---- ---- ----
% OF TOTAL % OF TOTAL % OF TOTAL
REVENUES REVENUES REVENUES REVENUES REVENUES REVENUES
-------- -------- -------- -------- -------- --------
A....... Computer hardware 5,561 14.2 5,084 8.8 4,894 10.7
----- ---- ----- --- ----- --------
NOTE 20--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
investment (book value of $90 at December 31, 2001) 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, debt 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 debt 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 11% of the trade accounts receivable at December 31, 2001 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-26