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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003 COMMISSION FILE NUMBER 0-19771
DATA SYSTEMS & SOFTWARE INC.
(Exact name of registrant as specified in charter)
Delaware 22-2786081
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
200 Route 17, Mahwah, New Jersey 07430
(Address of principal executive offices) (Zip code)
(201) 529-2026
Registrant's telephone number, including area code
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
|X| Yes |_| No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
| | Yes |X| No
Number of shares outstanding of the registrant's common stock, as of August
8, 2003: 8,359,959
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DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I. Financial Information
Item 1. Unaudited Consolidated Financial Statements
Consolidated Balance Sheets
as of December 31, 2002 and June 30, 2003......................... 1
Consolidated Statements of Operations
for the six and three month periods ended June 30, 2002 and 2003.. 2
Consolidated Statement of Changes in Shareholders' Equity
for the six month period ended June 30, 2003..................... 3
Consolidated Statements of Cash Flows
for the six month periods ended June 30, 2002 and 2003............ 4
Notes to Consolidated Financial Statements........................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.........................................14
Item 3. Quantitative and Qualitative Disclosures about Market Risk...........20
Item 4. Controls and Procedures..............................................20
PART II. Other Information
Item 2. Changes in Securities and Use of Proceeds ...........................21
Item 6. Exhibits and Reports on Form 8-K.....................................21
Signatures ...................................................................22
Certain statements contained in this report are forward-looking in nature. These
statements are generally identified by the inclusion of phrases such as "we
expect", "we anticipate", "we believe", "we estimate" and other phrases of
similar meaning. Whether such statements ultimately prove to be accurate depends
upon a variety of factors that may affect our business and operations. Many of
these factors are described in our most recent Annual Report on Form 10-K as
filed with Securities and Exchange Commission.
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(dollars in thousands, except share data)
As of
December 31, June 30,
ASSETS 2002 2003
-------- --------
Current assets: (unaudited)
Cash and cash equivalents ...................................... $1,150 $1,868
Restricted cash ................................................ 241 1,241
Trade accounts receivable, net ................................. 12,267 5,943
Inventory ...................................................... 2,217 67
Other current assets ........................................... 1,401 837
-------- --------
Total current assets ....................................... 17,276 9,956
Investment in affiliated company .................................... - 3,270
Property and equipment, net ......................................... 1,972 801
Goodwill ............................................................ 4,929 4,430
Other intangible assets, net ........................................ 404 148
Long-term deposits - restricted ..................................... 5,700 500
Other assets ........................................................ 669 746
Prepaid employee termination benefits ............................... 2,355 2,319
-------- --------
Total assets ............................................... $33,305 $22,170
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term debt and current maturities of long-term debt, net .. $3,755 $1,825
Trade accounts payable ......................................... 5,185 2,214
Accrued payroll, payroll taxes and social benefits ............. 2,098 1,444
Other current liabilities ...................................... 3,411 2,992
-------- --------
Total current liabilities .................................. 14,449 8,475
-------- --------
Long-term liabilities:
Long-term debt ................................................. 6,278 644
Other liabilities .............................................. 477 289
Liability for employee termination benefits .................... 3,364 3,285
-------- --------
Total long-term liabilities ............................. 10,119 4,218
-------- --------
Minority interests .................................................. 1,609 1,505
-------- --------
Shareholders' equity:
Common stock - $.01 par value per share:
Authorized - 20,000,000 shares;
Issued - 8,161,867 and 8,714,063 shares
as of December 31, 2002 and June 30, 2003, respectively ... 82 87
Additional paid-in capital ..................................... 37,687 42,850
Warrants ....................................................... 364 461
Deferred compensation .......................................... (7) (4)
Accumulated deficit ............................................ (26,787) (31,209)
Treasury stock, at cost - 845,704 and 847,704 shares
as of December 31, 2002 and June 30, 2003, respectively ... (3,913) (3,915)
Stockholder's note ........................................... (298) (298)
-------- --------
Total shareholders' equity ................................. 7,128 7,972
-------- --------
Total liabilities and shareholders' equity ................. $33,305 $22,170
======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
- 1 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Consolidated Statements of Operations (unaudited)
(in thousands, except per share data)
Six months ended Three months ended
June 30, June 30,
---------------------- ----------------------
2002 2003 2002 2003
--------- --------- --------- ---------
Sales:
Products ................................... $17,661 $13,121 $8,960 $4,145
Services ................................... 7,930 7,032 3,823 3,140
--------- --------- --------- ---------
25,591 20,153 12,783 7,285
--------- --------- --------- ---------
Cost of sales:
Products ................................... 14,051 10,749 7,230 3,449
Services ................................... 5,970 5,044 2,961 2,545
--------- --------- --------- ---------
20,021 15,793 10,191 5,994
--------- --------- --------- ---------
Gross profit ............................... 5,570 4,360 2,592 1,291
Research and development expenses ............... 1,010 153 550 -
Selling, general and administrative expenses .... 8,752 6,410 4,452 2,108
--------- --------- --------- ---------
Operating loss ............................. (4,192) (2,203) (2,410) (817)
Interest income ................................. 146 27 53 5
Interest expense ................................ (293) (650) (199) (296)
Other income (expense), net ..................... 92 (165) 66 (151)
Minority interests .............................. 203 104 207 121
Equity loss in unconsolidated subsidiary ........ - (1,501) - (1,501)
--------- --------- --------- ---------
Loss before provision for income taxes ..... (4,044) (4,388) (2,283) (2,639)
Provision for income taxes ...................... 57 34 15 22
--------- --------- --------- ---------
Net loss ................................... $(4,101) $(4,422) $(2,298) $(2,661)
========= ========= ========= =========
Basic and diluted net loss per share:
Net loss per share ......................... $(0.56) $(0.58) $(0.31) $(0.34)
========= ========= ========= =========
Weighted average number of shares
outstanding - basic and diluted ........ 7,353 7,570 7,353 7,792
========= ========= ========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
- 2 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Shareholders' Equity (unaudited)
Six months ended June 30, 2003
(in thousands)
Additional
Number Common Paid-In Deferred Treasury Stockholder's Accumulated
of Shares Stock Capital Compensation Warrants Stock Note Deficit Total
--------- ------ ---------- ------------ -------- -------- ------------- ----------- -----
Balances as of
December 31, 2002 8,162 $82 $37,687 $(7) $364 $(3,913) $(298) $(26,787) $7,128
Amortization of
deferred
compensation - - - 3 - - - - 3
Issuance of shares
as compensation 50 - 50 - - - - - 50
Issuance of shares
in lieu of debt
repayment 502 5 759 - - - - - 764
Warrants issued for
professional
services - - - - 97 - - - 97
Purchase of
treasury shares - - - - - (2) - - (2)
Equity from
issuance of preferred
shares by
Comverge Inc. - - 3,669 - - - - - 3,669
Equity from issuance
of common shares by
Converge Inc. - - 685 - - - - - 685
Net loss - - - - - - - (4,422) (4,422)
-------- -------- -------- -------- -------- -------- -------- -------- --------
Balances as of
June 30, 2003 8,714 $87 $42,850 $(4) $461 $(3,915) $(298) $(31,209) $ 7,972
======== ======== ======== ======== ======== ======== ======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
- 3 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited)
(dollars in thousands)
Six months ended June 30,
-------------------------
2002 2003
-------- --------
Cash flows (used in) provided by operating activities:
Net loss ........................................................................ $(4,101) $(4,422)
Adjustments to reconcile net loss to net cash provided by
operating activities - Appendix A: .......................................... 1,484 5,149
-------- --------
Net cash (used in) provided by operating activities ......................... (2,617) 727
-------- --------
Cash flows (used in) provided by investing activities:
Restricted cash ................................................................. (28) 4,200
Proceeds from sale and maturity of debt securities .............................. 411 -
Proceeds from sale of property and equipment .................................... - 15
Investment in debt securities ................................................... (468) -
Acquisitions of property and equipment .......................................... (201) (131)
Funding of termination benefits ................................................. 64 (249)
Acquisition of intangible assets ................................................ (2) -
Other ........................................................................... - (160)
Investment in equity method investee ............................................ - (3,327)
-------- --------
Net cash provided by (used in) investing activities ......................... (224) 348
-------- --------
Cash flows (used in) provided by financing activities:
Short-term debt, net ............................................................ (572) (393)
Proceeds from issuance of convertible note ...................................... 2,000 -
Borrowings of long-term debt .................................................... 646 441
Repayments of long-term debt .................................................... (37) (403)
Convertible note issuance costs ................................................. (167) -
Purchase of treasury stock ...................................................... - (2)
-------- --------
Net cash provided by (used in) financing activities ......................... 1,870 (357)
-------- --------
Net (decrease) increase in cash and cash equivalents ................................. (971) 718
Cash and cash equivalents at beginning of period ..................................... 4,025 1,150
-------- --------
Cash and cash equivalents at end of period ........................................... $3,054 $1,868
======== ========
Supplemental cash flow information:
Cash paid during period for interest ............................................ $192 $247
======== ========
Cash paid during period for income taxes ........................................ $67 $91
======== ========
Non-cash investing and financing activities:
Issuance of common stock in lieu of debt repayment ............................. - $764
Increase in investment in Comverge from issuance of preferred and common stock
credited to additional paid in capital ....................................... - $4,354
Accounts payable incurred in investment of Comverge ............................ - $43
Accounts payable incurred in acquisition of fixed assets ....................... $100 -
Value of beneficial conversion feature and related warrants on
issuance of convertible note ................................................ $692 -
Adjustment of goodwill and intangible assets ................................... $48 -
Increase in deferred tax liability associated with adjustment of
intangible assets ........................................................... $17 -
The accompanying notes are an integral part of these
consolidated financial statements.
- 4 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows - Appendices (unaudited)
(dollars in thousands)
Appendix A Six months ended June 30,
-------------------------
2002 2003
-------- --------
Adjustments to reconcile net loss to net cash (used in) provided by operating
activities:
Depreciation and amortization .................................................... $ 676 $ 357
Allowance for doubtful accounts .................................................. (87) 61
Stock and stock option compensation .............................................. 20 53
Accretion of discount on convertible note and amortization of
related costs and warrants .................................................. 54 493
Minority interest and write-off of minority interest balance ..................... (243) (104)
Equity loss ...................................................................... - 1,501
Unrealized gain on debt securities ............................................... (13) -
(Decrease) increase in liability for employee termination benefits ............... (65) 321
Exchange adjustment on long-term debt ............................................ (27) 82
Loss on disposition of property and equipment .................................... 14 4
Deferred taxes ................................................................... - (96)
Change in operating assets and liabilities:
Decrease in accounts receivable and other current assets ..................... 1,473 3,988
(Decrease) increase in inventory ............................................. (1,642) 314
Increase (decrease) in other assets .......................................... 91 (102)
Increase (decrease) in accounts payable and other liabilities ................ 1,233 (1,723)
-------- --------
Total ........................................................................ $1,484 $5,149
-------- --------
The accompanying notes are an integral part of
these consolidated financial statements.
- 5 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except per share data)
Note 1: Basis of Presentation
The accompanying unaudited consolidated financial statements of Data
Systems & Software Inc. ("DSSI") and subsidiaries (the "Company") have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by accounting principles generally
accepted in the United States of America for complete consolidated financial
statements. In the opinion of management, all adjustments considered necessary
for a fair presentation have been included. Operating results for the six-month
period ended June 30, 2003 are not necessarily indicative of the results that
may be expected for the year ending December 31, 2003. These unaudited
consolidated financial statements should be read in conjunction with the
consolidated financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2002.
Certain reclassifications have been made to the Company's prior period's
consolidated financial statements to conform to the current period's
consolidated financial statement presentation.
Note 2: Financing of Operations
As of June 30, 2003, the Company had working capital of $1,481, including
$1,868 in unrestricted cash and cash equivalents. Net cash provided by operating
activities in the first six months of 2003 was $727. The primary sources of the
Company's cash provided by operating activities during the first six months of
2003 were collections of trade accounts receivables in excess of reductions in
accounts payable ($2,265, net), the Company's non-cash equity loss in Comverge
($1,501) and other non-cash expenses included in net loss ($964). These sources
of cash were partially offset by the Company's loss ($4,422), (primarily first
quarter consolidated losses in Comverge ($1,125) and corporate expenses
($1,171). Net cash provided by investing activities was $348. The primary source
of cash provided by investing activities was the release of previously
restricted cash ($4,200) of which $3,327 was invested in Comverge. Net cash used
in financing activities was $357, which was comprised primarily of net payments
of debt ($355).
Of the total working capital at June 30, 2003, approximately $215 was in
the Company's majority owned Israeli subsidiary, dsIT. Due to Israeli tax and
company law constraints, as well as the significant minority interest in dsIT,
such working capital and cash flows from dsIT's operations are not readily
available to finance U.S. activities.
dsIT is utilizing approximately $1,100 of its $1,700 lines of credit as of
June 30, 2003. dsIT's lines of credit are denominated in NIS and bearing an
average interest rate of the Israeli prime rate plus 0.9% per annum. The Israeli
prime rate fluctuates and on June 30, 2003 was 9.4%. The Company believes that
dsIT will have sufficient liquidity to finance its activities from cash flow
from its own operations and available lines of credit over the next 12 months.
On April 7, 2003 the Company's formerly consolidated subsidiary, Comverge,
Inc. (Comverge) signed and closed on an agreement for private equity financing
(see Note 3). As a result, the Company is no longer required to fund Comverge's
operations. As part of the agreement for the private equity financing, Comverge
received a new $6,500 credit facility, which included a $1,500 term loan secured
by a $1,500 restricted deposit of DSSI at Comverge's new lender. Comverge has
agreed to prepay the term loan in and permit release of DSSI's $1,500 deposit
over the 12 months commencing December 31, 2003, subject to certain conditions
(see Note 3). The Company believes that the proceeds of the financing and new
credit arrangements provide sufficient financing for Comverge to independently
fund its activities, and has no obligation to fund any of Comverge's losses
subsequent to April 1, 2003.
As of July 31, 2003 the Company's wholly owned US operations (i.e.,
excluding dsIT) had an aggregate of $1,854 in unrestricted cash and cash
equivalents, reflecting a $722 increase from the balance as of December 31,
2002.
- 6 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except per share data)
The Company believes it has more than sufficient liquidity to finance its
US-based operating activities and its corporate activities for at least the next
12 months. The Company intends to finance these activities from cash on hand and
operating cash flows.
Note 3: Comverge equity financing transaction
On April 7, 2003, the Company and its formerly consolidated subsidiary,
Comverge, signed and closed on a definitive agreement with a syndicate of
venture capital firms raising an aggregate of $13,000 in capital funding. The
Company purchased $3,250 of Series A Convertible Preferred Stock issued by
Comverge in the equity financing and incurred transaction costs of an additional
$77. A syndicate of venture capital firms purchased the remaining $7,750 of
Series A Convertible Preferred Stock issued by Comverge, and one member of the
syndicate also purchased $2,000 of Series A-1 Convertible Preferred Stock of
Comverge. In connection with the transaction, the Company converted $12,673 of
intercompany balances with Comverge to equity.
The venture capital firm which purchased the Series A-1 Preferred Stock
entered into an agreement with Comverge pursuant to which Comverge granted to
the venture capital firm an option to put its shares of Series A-1 Preferred
Stock to Comverge for $2,000. The put is exercisable from April 8, 2004 to April
18, 2004. This agreement also grants to Comverge a right to call all the Series
A-1 Preferred Stock for $2,000, at anytime on or before April 18, 2004.
The Series A and Series A-1 Convertible Preferred Stock (collectively the
"Preferred Stock") have priority over Comverge common stock for dividends and
liquidations (which includes a sale of Comverge). Additionally, the Preferred
Stock has anti-dilution protection for stock issuances by Comverge below the per
share purchase price of the Series A Preferred Stock (subject to customary
exceptions such as employee stock options) as well as approval rights for major
corporate transactions, stock issuances, declaration or payment of dividends,
changing corporate governance documents, liquidation or dissolution of Comverge
and other corporate matters. Each share of the Preferred Stock is convertible
into one share of Comverge common stock at any time at the holder's option, or
upon an initial public offering with gross proceeds of at least $30,000 and an
offering price of at least $10.40 per share. The Preferred Stock votes on an "as
converted" basis with the common stock. The Comverge articles of incorporation
provide for an initial board of directors with five members, of which the
Preferred Stock holders elect three members and the common stock holders elect
two.
In connection with the equity financing transaction, Comverge secured a
$6,500 credit facility with a leading financial institution. In connection with
the private equity financing and this new credit facility, Comverge paid off its
bank term loan outstanding and its $2,000 secured line of credit, which line was
also terminated. As a result of the repayment of the term loan, $1,000 of DSSI's
long-term deposit, which had been pledged to Comverge's bank as security for
Comverge's loan, became unrestricted.
Comverge's new credit facility includes a $1,500 term loan secured by a
Company pledge of a $1,500 restricted deposit at Comverge's new lender, and a
revolving line of credit of up to $5,000 secured by the assets of Comverge.
Comverge agreed to make certain prepayments of the $1,500 term loan and the new
lender agreed to the release of amounts equal to such payments from the pledge
account, subject to Comverge's compliance with certain financial and other
covenants in its agreement with the lender, if (i) Comverge raises at least $2
million in additional equity in subsequent transactions and (ii) Comverge
exercises its right to call the Series A-1 Preferred Stock or the holder's right
to put such stock expires without being exercised.
The prepayments by Comverge and release of the pledge account, if any, are
to be made in three payments of $500 each on December 31, 2003, June 30, 2004
and December 31, 2004; the first payment will be deferred to April 28, 2004 if
the Series A-1 Preferred Stock is not redeemed. The prepayments and release of
the pledge will be accelerated to two payments of $750 each if, in addition to
satisfying the other conditions referred to above, Comverge raises at least
$3,000 (rather than $2,000 as mentioned above) of additional equity. If none of
the above conditions have been satisfied, then the Company will not be entitled
to the release of the $1,500 until April 1, 2006, although Comverge is obligated
to use commercially reasonable efforts to cause the release of the money to the
Company before that date.
- 7 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except per share data)
Until December 31, 2003, the Company has the option to purchase from
Comverge up to $1,500 of Series A-2 Convertible Preferred Stock. The amount of
Series A-2 Preferred Stock that the Company may purchase from Comverge will be
limited to the number of shares that could be purchased by the principal balance
of the $1,500 term loan as of the date the Company gives notice of exercising
the Series A-2 option. The Series A-2 Preferred Stock has the same purchase
price as the Series A-1 Preferred Stock. The Series A-2 Preferred Stock has the
same rights as the Series A and the Series A-1 Preferred Stock, except the
Series A-2 Preferred Stock is junior in priority in liquidation (which includes
the sale of Comverge) to both the Series A and Series A-1 Preferred Stock.
The Company entered into various agreements with Comverge and the syndicate
of venture capital investors. These agreements provide for, among other things,
restrictions on the transfer of the Company's shares of Series A Preferred Stock
and Comverge common stock, the voting of the Company's Series A Preferred Stock
and Comverge common stock, the Company's right to receive quarterly and annual
financial reports from Comverge and registration rights for the Company's Series
A Preferred Stock and Comverge common stock. Under Comverge's Amended and
Restated Certificate of Incorporation, the holders of Comverge common stock have
the right to elect two of the five directors on Comverge's Board. Certain
preferred shareholders other than the Company have the right to elect the other
three directors. Pursuant to a voting agreement, one of the directors elected by
the holders of the Comverge common stock must be the Chief Executive Officer
(CEO) of Comverge. The Company's chairman and CEO and Comverge's CEO were
elected as the initial directors by the Comverge common stockholders.
In connection with Comverge's equity financing transactions, Comverge
acquired Sixth Dimension, Inc. ("6D") in a purchase business combination, valued
at approximately $1,052, in exchange for 877,000 of Comverge's common shares.
Some of the venture capital participants in Comverge's equity financing
transaction were the principal owners in 6D prior to the acquisition. 6D is an
early stage Internet-based software company, whose iNET product enables a broad
range of energy services including: upstream facility metering, monitoring, and
control; performance-based operations and proactive maintenance; economic demand
response and active load curtailment; aggregated distributed generation; power
reliability and quality monitoring; and other real-time capital equipment
analysis using a low-cost, robust, software for service delivery. The
acquisition adds to Comverge's product offering technology for upstream
monitoring & control of capital assets, by combining 6D's real-time,
internet-based, data warehousing iNET software with the analytical and metering
capabilities of Comverge's PowerCAMP software applications.
Comverge is in the process of obtaining third party valuations of the
assets acquired, thus the preliminary allocation of the purchase price may
change and effect the Company's equity loss from its investment in Comverge.
Based on the preliminary price allocation, Comverge has estimated goodwill to be
$596.
At June 30, 2003, the Company remains Comverge's largest shareholder,
owning approximately 50.6% of the outstanding capital voting stock of Comverge
(42.6% if outstanding options and warrants of Comverge are exercised). The
Company holds approximately 26% of the Preferred Stock issued by Comverge in the
private equity financing, in addition to owning approximately 76% of Comverge's
common stock. The Company's investment in Preferred Stock was primarily financed
by the release of $3,000 of previously restricted cash. The issuance of
preferred and common stock in Comverge resulted in increases in the value of the
Company's interest in Comverge. These increases were treated as a increase to
the Company's additional paid in capital.
-8-
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except per share data)
Note 4: Equity investment in Comverge
As a result of the private equity financing transaction and other
agreements described in Note 3, the Company can elect at most two directors of
Comverge, one of whom must be the CEO of Comverge (who is selected by the
Comverge Board which is not controlled by the Company); the Company is unable to
determine the selection of the remaining three directors. Therefore, although
the Company currently owns 50.6% of Comverge's voting stock, Comverge is no
longer a controlled subsidiary of the Company. Thus, effective April 1, 2003,
the Company no longer consolidates Comverge's balance sheet and results of
operations and accounts for its investment in Comverge on the equity method.
Summary unaudited financial information for Comverge as of June 30, 2003
and for the period from April 1 to June 30, 2003 is as follows:
As at June 30,
2003
--------
Financial Position
Current assets $12,830
Property, plant, and equipment, net 1,435
Intangible and other assets, net 1,695
--------
Total assets $15,960
========
Current liabilities (excluding current maturities of long-term debt) $ 2,433
Current maturities of long-term debt 2,700
Long-term debt 1,500
Other non-current liabilities 225
--------
Total liabilities 6,858
Shareholders' equity 9,102
--------
Total liabilities and shareholder's equity $15,960
========
Period from
April 1, 2003
to June 30,
2003
-------------
Results of Operations
Sales $4,008
Operating loss $(1,984)
Net loss $(2,211)
The activity in the Company's investment in Comverge during the three
months ended June 30, 2003 is as follows:
Conversion of inter-company balances to equity $ 12,673
Accumulated deficit at March 31, 2003 (15,583)
Cash paid for preferred stock of Comverge 3,250
Transaction costs paid 77
--------
Company's Comverge investment at March 31, 2003 $417
Adjustment of the Company's Comverge investment from sale of preferred shares
and issuance of common stock 4,354
--------
Investment balance prior to equity loss 4,771
Equity loss in Comverge - April 1 to June 30, 2003 (1,501)
--------
Investment balance at June 30, 2003 $3,270
========
As a result of Comverge's net loss during the quarter ended June 30, 2003,
the Company reduced its investment in Comverge's common stock to zero and
recognized a charge of 26% of the excess net losses of $57, against its
Preferred Stock investment.
- 9 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except per share data)
Note 5: Inventory
Inventory consists of the following:
As of As of
December 31, June 30,
2002 2003
------------ --------
Raw materials, spare parts and supplies $1,396 $55
Work-in-process 161 -
Finished goods and merchandise 660 12
-------- --------
$2,217 $67
======== ========
Note 6--Goodwill and Other Intangible Assets
The table below presents the carrying amount of goodwill, by segment. There
were no acquisitions or impairments of goodwill recorded during the six-month
period ended June 30, 2003.
Software Energy
Consulting and Intelligence
Development Solutions Total
------------- ------------- -------------
Segment balances as of December 31, 2002 $4,430 $499 $4,929
Deconsolidation of Comverge investment (See Notes 3 and 4) - (499) (499)
------------- ------------- -------------
Segment balances as of June 30, 2003 $4,430 $ - $4,430
============= ============= =============
The following table presents certain information regarding the Company's
amortizable intangible assets as of June 30, 2003 and December 31, 2002.
Intangible assets are amortized over their estimated useful lives, with no
estimated residual values.
As of June 30, 2003
-----------------------------------------------
Weighted average Gross Net
amortization carrying Accumulated carrying
period amount amortization amount
---------------- ------------- ------------ ----------
Amortizing intangible assets:
Software licenses 4.5 yrs $260 $112 $148
As of December 31, 2002
-----------------------------------------------
Weighted average Gross Net
amortization carrying Accumulated carrying
period amount amortization amount
---------------- ------------- ------------ ----------
Amortizing intangible assets:
Licenses 5.0 yrs $568 $563 $ 5
Patents 15.0 yrs 288 70 218
Software licenses 4.5 yrs 260 79 181
------------- ------------ ----------
Total $1,116 $712 $404
============= ============ ==========
- 10 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except per share data)
Amortization in respect of license, patents and software licenses amounted
to $42 and $250 for the six months ended June 30, 2002 and 2003, respectively
(2002 includes amortization of $84 with respect to acquired backlog which was
fully amortized in 2002).
Estimated amortization expense for the remainder of 2003 is $25 and as
follows with respect to intangible assets for each of the next five years:
Year ended June 30,
-------------------
2004 $50
2005 32
2006 32
2007 25
2008 9
-------
$148
=======
Note 7: Warranty Provision
The Company generally warrants its products against certain manufacturing
and other defects. These product warranties are provided for specific periods of
time and/or usage of the product depending on the nature of the product, the
geographic location of its sale and other factors. The accrued product warranty
costs are based primarily on historical experience of actual warranty claims as
well as current information on repair costs.
The following table provides the changes in the Company's provision for
product warranties for the six-month periods ended June 30, 2002 and 2003:
Six months ended June 30,
-------------------------
2002 2003
--------- -------
Warranty provision at beginning of the period $79 $52
Accruals for warranties issued during the period 61 3
Warranty settlements made during the period - (3)
Other - deconsolidation of Comverge (see Note 4) - (52)
--------- -------
Warranty provision at the end of the period $140 $ -
========= =======
The Company's dsIT subsidiary defers a portion of its revenues on projects
and recognizes them over the warranty period so as to cover any costs related to
these warranties. To date the Company has not incurred material costs related to
warranty obligations in excess of the revenues deferred.
The Company's product license and services agreements include a limited
indemnification provision for claims from third parties relating to the
Company's intellectual property included in the Company's products and projects.
Such indemnification provisions are accounted for when amounts of liabilities
are probable and estimable. The indemnification is generally limited to the
amount paid by the customer and to date there have not been material claims
under such indemnification provisions. At this time, the Company cannot
reasonably estimate future potential indemnifications, if any.
-11-
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except per share data)
Note 8: Stock-Based Compensation
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting
for Stock Based Compensation", permits companies to (i) recognize as expense the
fair value of stock-based awards, or (ii) continue to apply the provisions of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" and related interpretations ("APB 25"), and provide pro forma net
income and earnings per share disclosures for employee stock option grants as if
the fair-value-based method defined in SFAS No. 123 had been applied. The
Company continues to apply the provisions of APB 25 and provide the pro forma
disclosures in accordance with the provisions of SFAS No. 123, as amended, to
its Stock Option and Incentive Plan. Under APB 25, the Company has recorded
minimal stock-based employee and director compensation cost associated with its
stock option plan, as all options granted under the plan had an exercise price
equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net loss and net loss per
share as if the Company had applied the fair value recognition provisions of
SFAS No. 123 to its stock option plan:
Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
2002 2003 2002 2003
-------- -------- -------- --------
Net loss as reported ........................... $(2,298) $(2,661) $(4,101) $(4,422)
Plus: Stock-based employee and director
compensation expense included in
reported net loss ....................... 1 1 3 53
Less: Total stock-based employee compensation
expense determined under fair value
based method for all awards ............. 187 77 695 186
-------- -------- -------- --------
Pro forma net loss ............................. $(2,484) $(2,737) $(4,793) $(4,555)
======== ======== ======== ========
Net loss per share:
Basic and diluted - as reported
$(0.31) $(0.34) $(0.56) $(0.58)
======== ======== ======== ========
Basic and diluted - pro forma ............ $(0.34) $(0.35) $(0.65) $(0.60)
======== ======== ======== ========
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 (the application of SFAS No 123 with respect to Comverge is
included for the six month period ended June 30, 2002 and the period in 2003
until the Company's deconsolidation of its interest in Comverge - see Note 4).
Note 9: Warrants
On February 25, 2003, the Company engaged a third-party for the purposes of
providing investor awareness and business advisory services for a period of one
year. The Company is to pay a monthly advisory fee, totaling $90 over the period
of the agreement. In addition, the Company granted the third-party common stock
purchase warrants for the purchase of 120,000 shares of the Company's common
stock (60,000 at $2.00 per share and 60,000 at $2.50 per share). The warrants
became fully vested on May 26, 2003 and expire on February 25, 2005. The Company
used the Black-Scholes valuation method to estimate the fair value of the
warrants, using a risk free interest rate of 1.75%, their contractual life of
two years, an annual volatility of 88% and no expected dividends. The Company
estimated the fair value of the warrants to be $97, which has been charged to
selling, general and administrative expense.
-12-
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (unaudited)
(in thousands except per share data)
Note 10: Segment Information
Software
Consulting Energy
and Intelligence Computer
Development Solutions(**) Hardware Other (*) Total
Six months ended June 30, 2003:
Revenues from external customers** $6,311 $4,700 $9,118 $24 $20,153
Intersegment revenues - 284 20 - 304
Segment gross profit 1,400 1,313 1,623 24 4,360
Segment loss (465) (2,626) (91) (6) (3,188)
Six months ended June 30, 2002:
Revenues from external customers $7,297 $9,424 $8,777 $93 $25,591
Intersegment revenues 19 479 46 - 544
Segment gross profit 1,292 2,774 1,459 45 5,570
Segment income (loss) (894) (1,868) (25) 5 (2,782)
Three months ended June 30, 2003:
Revenues from external customers $3,081 $ - $4,188 $16 $7,285
Intersegment revenues - - - - -
Segment gross profit 537 - 738 16 1,291
Segment loss (444) (1,501) (141) - (2,086)
Three months ended June 30, 2002:
Revenues from external customers $3,462 $4,770 $4,521 $30 $12,783
Intersegment revenues - 208 29 - 237
Segment gross profit 503 1,334 745 10 2,592
Segment income (loss) (720) (1,017) 1 (15) (1,751)
- ----------
(*) Represents the operations of a VAR software operation in Israel that did
not meet the quantitative thresholds of SFAS No. 131.
(**) Operating results of Comverge (in the Energy Intelligence Solutions
segment) are no longer consolidated beginning the second quarter of 2003 -
see Note 4.
Reconciliation of Segment Loss to Consolidated Net Loss
Six months ended Three months ended
June 30, June 30,
---------------------- ----------------------
2002 2003 2002 2003
--------- --------- --------- ---------
Total loss for reportable segments $(2,787) $(3,182) $(1,736) $(2,086)
Other operational segment income (loss) 5 (6) (15) -
--------- --------- --------- ---------
Total operating loss (2,782) (3,188) (1,751) (2,086)
Net loss of corporate headquarters (1,319) (1,234) (547) (575)
--------- --------- --------- ---------
Total consolidated net loss $(4,101) $(4,422) $(2,298) $(2,661)
========= ========= ========= =========
- 13 -
Data Systems & Software Inc.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
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 below under "Factors That May Influence Future Results"
and in "Item 1. Description of Business - Factors That May Influence Future
Results" in our Annual Report on Form 10-K for the year ended December 31, 2002
(the "2002 10-K").
Overview and Trend Information
We operate in three reportable segments: software consulting and
development, energy intelligence solutions, and computer hardware. As we no
longer have control over Comverge (see Notes 3 and 4 to the Financial
Statements), effective the second quarter of 2003 we account for our investment
in Comverge on the equity method and no longer consolidate Comverge's balances
and operating activity into our consolidated balance sheet and statement of
operations. Therefore, beginning with the second quarter of 2003, our energy
inteligence solution segment consists solely of our equity method investment of
Comverge. The following analysis should be read together with the segment
information provided in Note 10 to our unaudited financial statements included
in this report.
Software Consulting and Development
Segment revenues continued to decrease in the second quarter of 2003,
compared to the immediately preceding quarter. The decrease resulted primarily
from the continued general weakness in the global hi-tech markets and in the
software consulting and development market in particular. We currently do not
see the market improving and, while increasing our marketing efforts, we are
constantly implementing cost cutting measures so as to prevent this activity
from incurring losses, until the market improves. These measures are what caused
the segment's gross profit and segment loss in 2003 periods to improve on those
of the 2002 periods. This improvement was partially offset by foreign exchange
losses included in other expenses of $153,000 due to the revaluation of the
Israeli Shekel against the US dollar during this quarter. The exchange rate of
the Israeli Shekel continues to fluctuate and there is no assurance it will not
have a negative effect on results in future periods.
In June 2003 Clalit Health Services, Israel's largest HMO and one of the
largest in the world, awarded our dsIT subsidiary, together with Yael Software,
a $4 million contract, of which dsIT's portion is approximately 50%. The
contract includes the development and implementation of a new Customer Care and
Billing system, based entirely on dsIT's e-asyBillTM billing system. The system
is to be implemented over one year and includes a seven-year maintenance
contract. In the future, we expect that this product, our OncoProTM product and
sonar technology systems will have increased impact on our results, offsetting
the continued deterioration in the software consulting market.
In addition, dsIT has been successful in bidding together with Databit for
certain Israeli Ministry of Defense (MoD) contracts and we expect this
cooperation to produce increased revenues in the future.
Energy Intelligence Solutions
On April 7, 2003 Comverge signed and closed on an agreement (see Note 3)
for private equity financing in the amount of $13,000. We invested $3,250, and
$9,750 was invested by a group of leading energy venture capital investors.
- 14 -
Comverge's operating results for the period from January 1, 2003 to March
31, 2003 have been consolidated and are included in our consolidated statements
of operations. Our share of Comverge's operating results for the period from
April 1, 2003 to June 30, 2003 have been included in equity loss in
unconsolidated subsidiary in the our consolidated statements of operations.
Towards the end of the first quarter and beginning of second quarter of
2003, Comverge devoted significant attention to the capital raising process
mentioned above. In addition, during this quarter Comverge signed a major,
long-term Virtual Peaking Capacity(TM) contract to provide significant peak load
reduction to PacifiCorp, a subsidiary of Scottish Power. Although no revenue was
recognized with respect to this contract in the second quarter, we expect it to
have a positive effect on revenues in future periods. Comverge and Gulf Power
have agreed in principle to modify their long term agreement for the deployment
of Maingate gateway systems, temporarily delaying shipments. This will
significantly reduce revenues from this contract in the short term, but is not
expected to negatively impact operating results at Comverge. Over the longer
term, the modifications are expected to improve the Gulf Power project's
profitability, due to product improvements and reductions in component costs.
Computer Hardware
Sales in the second quarter of 2003 were below expectations and below the
level of sales achieved in the first quarter of this year. We expect computer
hardware sales to improve in the coming quarters. To offset the weakness in this
market, and diversify our revenue base, we have initiated efforts towards adding
more value added software products and services, which we hope to leverage off
the expertise of our existing sales force and customer base. These activities,
together with continuing joint marketing efforts with dsIT for Israeli Ministry
of Defense projects, are intended to reduce Databit's dependency on the computer
hardware markets in the future.
Corporate
With the completion of Comverge's venture financing in April 2003, Comverge
has sufficient independent finance and we no longer have control over its
activities. Our CEO, Mr. George Morgenstern, has informed the DSSI Board that he
intends to retire from full-time employment as of December 31, 2003 and to
remain as a consultant to us as called for in his employment agreement. In light
of our reduced involvement at Comverge, the capable independent management in
place at our dsIT and Databit subsidiaries and our CEO's retirement, we have
begun an evaluation of our corporate activities and structure. This evaluation
includes exploration of restructuring and/or acquisitions or mergers. We expect
to continue this process during the next few months.
- 15 -
Results of Operations
The following table sets forth certain information with respect to our
consolidated results of operations for the three and six months ended June 30,
2002 and 2003, including the percentage of total revenues during each period
attributable to selected components of the operations statement data and for the
period to period percentage changes in such components. Being that starting the
second quarter of 2003 we do not fully consolidate Comverge's results of
operations; rather include them on an equity basis, the results of the periods
presented are not fully comparable.
Six months ended June 30, Three months ended June 30,
-------------------------------------------------- -------------------------------------------------
2002 2003 Change 2002 2003 Change
------------------ ------------------ -------- ------------------ ------------------ --------
% of % of % of % of % of % of
($,000) sales ($,000) sales 2002 ($,000) sales ($,000) sales 2002
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Sales $25,591 100% $20,153 100% (21)% $12,783 100% $ 7,285 100% (43)%
Cost of sales 20,021 78 15,793 78 (21) 10,191 80 5,994 82 (41)
-------- -------- -------- -------- -------- -------- -------- --------
Gross profit 5,570 22 4,360 22 (22) 2,592 20 1,291 18 (50)
R&D expenses 1,010 4 153 1 (85) 550 4 - - (100)
SG&A expenses 8,752 34 6,410 32 (27) 4,452 34 2,108 29 (53)
-------- -------- -------- -------- -------- -------- -------- --------
Operating loss (4,192) (16) (2,203) (11) (47) (2,410) (18) (817) (11) (66)
Interest expense, net (147) (1) (623) (3) 324 (146) (1) (291) (4) 99
Other income (loss), net 92 0 (165) (1) (279) 66 1 (151) (2) (329)
Minority interests 203 1 104 - (49) 207 2 (21) 2 (42)
Equity loss in
unconsolidated subsidiary - - (1,501) (7) - (1,501) (21) -
-------- -------- -------- -------- -------- -------- -------- --------
Loss before provision (4,044) (16) (4,388) (22) (1) (2,283) (16) (2,639) (37) (1)
for income taxes
Provision for income taxes 57 0 34 0 (40) 15 0 22 0 47
-------- -------- -------- -------- -------- -------- -------- --------
Net loss $(4,101) (16)% $(4,422) (22)% (2)% $(2,298) (16)% $(2,661) (37)% (1)%
======== ======== ======== ======== ======== ======== ======== ========
Sales. Sales in the second quarter and first six months of 2003 were $7.3
million and $20.2 million, respectively, compared to $12.8 million and $25.6
million in the same periods of 2002, respectively. The decreases were primarily
attributable to not consolidating Comverge sales in the second quarter of 2003.
Sales in Comverge, in the first quarter of 2003, second quarter of 2002 and
first six months of 2002 were $4.7 million, $4.8 million and $9.4 million,
respectively.
Sales in the computer hardware segment in the second quarter of 2003 were
$4.2 million, decreasing by 7% from sales of $4.5 million in the second quarter
of 2002. The decrease in sales in the second quarter of 2003 was attributable to
the softer and more competitive hardware market. Computer hardware sales in the
first six months of 2003 were $9.1 million, increasing by 4%, from sales of $8.8
million in the first six months of 2002, due to increased non-recurring sales in
the first quarter of 2003.
Software consulting and development sales were $3.1 million and $6.3
million in the second quarter and first six months of 2003, respectively,
compared to $3.5 million and $7.3 million in the same periods of 2002. This
decrease was primarily attributable to the decrease in consulting revenues
resulting from the continued general weakness in the global hi-tech markets and
in the software consulting and development market in particular.
Gross profit. Gross profit in the second quarter and the first six months
of 2003 was $1.3 million and $4.4 million, respectively, compared to $2.6
million and $5.6 million in the same periods of 2002. The decreases were
entirely attributable to not consolidating Comverge's gross profit in the second
quarter of 2003. The gross profit margin in the computer hardware segment,
increased to 18% in the 2003 periods, from 16% for the second quarter of 2002
and 17% for the first six months of 2002. As a result of our continued effort to
improve the cost structure of the software development and consulting segment,
gross profit margins increased to 22% for the first six months of 2003 compared
to 18% for the first six months of 2002 and 17% in the second quarter of 2003,
compared to 15% in the second quarter of 2002.
- 16 -
Research and development expenses ("R&D"). The decrease in R&D expenses in
each 2003 period, as compared to the comparable periods in 2002, was primarily
attributable to not consolidating Comverge's R&D in the second quarter of 2003,
although R&D in our software consulting and development segment has ceased as
well.
Selling, general and administrative expenses ("SG&A"). In the second
quarter and first six months of 2003, SG&A decreased to $2.1 million and $6.4
million, respectively, from $4.5 million and $8.8 million in the same periods of
2002. The decrease was primarily attributable to not consolidating Comverge's
SG&A, which was $2.9 million in the second quarter of 2002. However, corporate
SG&A and SG&A in the software development and consulting segment continued to
decrease as well, as we continued to reduce our overhead.
Interest expense, net. Prior to the investment recently secured for our
energy intelligence solution segment, we raised capital through issuing
convertible debentures and utilized lines of credit to finance our activities.
We incurred finance expenses in connection with the capital raised including
interest and amortization of non-cash costs associated with the convertible debt
and warrants issued. Although the interest associated with the utilization of
lines of credit is expected to continue at the current level, amortization of
non-cash costs has been completed and will no longer effect the coming quarters.
Of the $296,000 and $650,000 of interest expense incurred during the second
quarter and the first six months of 2003, $252,000 and $396,000, respectively,
was related to the accretion of discounts and the amortization of related costs
in connection with convertible debt and warrants.
Equity loss in unconsolidated subsidiary. The equity loss in 2003 was from
our formerly consolidated subsidiary, Comverge, whose results are accounted for
on an equity basis starting the second quarter of 2003 (see Note 4 of our
unaudited consolidated Financial Statements). Our share of Comverge's $2.2
million of net losses during the second quarter of 2003 was $1.5 million.
Comverge's increased losses in the second in the second quarter of 2003 of $2.2
million compared to $1.1 million in the second quarter of 2002, was primarily
attributable to the increase in SG&A expenses. In addition, sales decreased from
$4.8 million in the second quarter of 2002 to $4.0 million in the second quarter
of 2003, reducing gross profits by approximately $300,000.
Liquidity and Capital Resources
As of June 30, 2003, we had working capital of $1.5 million, including $1.9
million in unrestricted cash and cash equivalents. Net cash provided by
operating activities in the first six months of 2003 was $0.7 million. Our
primary sources cash provided by operating activities during the first six
months of 2003 were collections of trade accounts receivables in excess of
reductions in accounts payable ($2.3 million, net), our non-cash equity loss in
Comverge ($1.5 million) and other non-cash expenses included in net loss ($1.0
million). These sources of cash were partially offset by our loss ($4.4 million)
(primarily first quarter consolidated losses in Comverge ($1.1 million) and
corporate expenses ($1.2 million). Net cash provided by investing activities was
$0.3 million. The primary source of cash provided by investing activities was
the release of previously restricted cash ($4.2 million) of which $3.4 million
was invested in Comverge. Net cash used in financing activities was $0.4
million, which was comprised primarily of net payments of debt.
Of the total working capital at June 30, 2003, $0.2 million was in our
majority owned Israeli subsidiary, dsIT. dsIT is utilizing approximately $1.1
million of its $1.7 million lines of credit as of June 30, 2003. Due to Israeli
tax and company law constraints as well as the significant minority interest in
dsIT, such working capital, cash flows and borrowing capacity from dsIT's
operations are not readily available to finance U.S. activities. We believe that
dsIT will have sufficient liquidity to finance its activities from cash flow
from its own operations and available lines of credit over the next 12 months.
As of July 31, 2003 our wholly owned US operations (i.e., excluding dsIT
and Comverge) had an aggregate of $1.9 million in unrestricted cash and cash
equivalents, reflecting a $722,000 increase from the balance as of December 31,
2002. We believe we have more than sufficient liquidity to finance our US-based
operating activities and our corporate activities for at least the 12 months
following the date of this report. We intend to finance these activities
primarily from cash on-hand and from operating cash flows. We are currently
engaged in an evaluation of our corporate activities and structure, including
possible restructuring and/or acquisitions or mergers. Possible changes from
resulting from this process could have a material effect on our financing
requirements and resources.
- 17 -
Contractual Obligations and Commitments
Our contractual obligations and commitments at June 30, 2003, excluding
certain severance arrangements described below, 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 June 30,
--------------------------------------------------
(amounts in thousands)
----------------------
Contractual Obligations Total 2004 2005 2006 After 2006
----------------------- ------- ------- ------- ------- ----------
Long-term debt related to US operations 200 $ 200 -- -- --
Long-term debt related to Israeli operations 1,156 512 $ 342 $ 195 $ 107
Guarantees 558 558 -- -- --
Operating leases 3,872 1,259 1,126 565 922
Consulting agreement with CEO 1,572 1,572 -- -- --
------- ------- ------- ------- -------
Total contractual cash obligations $7,358 $4,101 $1,468 $ 760 $1,029
======= ======= ======= ======= =======
We expect to finance these contractual commitments from cash on hand and
cash generated from operations.
Previously, we accrued a loss for contingent performance of bank
guarantees. Our remaining commitment under these guarantees is $0.6 million at
June 30, 2003. We have collateralized a portion of these guarantees by means of
a deposit of $0.2 million as of June 30, 2003. The obligation is presented as a
current liability, though it is uncertain as to when actual payment may be made.
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
June 30, 2003, we had a total of $3.3 million in potential severance
obligations, of which approximately $2.3 million was funded with cash held by
insurance companies and approximately $1.0 million was unfunded. The entire $3.3
million was accrued for as of June 30, 2003.
We are obligated to pay our Chief Executive Officer consulting fees over a
seven-year period upon his retirement on December 31, 2003. Although it is
currently contemplated those payments will begin on January 1, 2004, the CEO has
the option to terminate his employment agreement and begin his consulting period
prior to December 31, 2003. During the first four years of the consulting
period, we would have to pay the 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,
which is expected to begin on January 31, 2004, we are also required to fund
amounts payable to the CEO for the term of the consulting period, by the
purchase of an annuity or similar investment product. The CEO`s base salary for
2003 (including cost of living adjustments) is $474,000. We also have
obligations under various agreements and other arrangements with officers and
other employees with respect to severance arrangements and multiyear employment
agreements as described below.
- 18 -
Under an employment agreement with the Chief Financial Officer, we also
have obligations to pay severance, upon termination of his employment for any
reason other than for cause. Under this agreement, 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 six times his last month's salary. The 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 June 30, 2003, the unfunded
portion of such severance obligation was $40,000.
We also have severance arrangements under an employment agreement with the
Chief Executive Officer of dsIT to pay severance under certain circumstances. If
his employment agreement is terminated by him or by our selves for reasons other
than for cause, we must pay him (i) an amount equal to his last month's salary
multiplied by the number of years (including partial years) that he worked for
Endan and dsIT. Our severance obligation would be reduced by the amounts
contributed by us to certain Israeli pension and severance funds pursuant to his
employment agreement. As of June 30, 2003, the unfunded portion of such
severance obligation was approximately $43,000.
Payments to Related Parties
We paid an individual as a director and vice president, who is the son of
our Chief Executive Officer, approximately $134,000 and $155,000 for the six
months ending June 30, 2002 and 2003, respectively. We also have engaged certain
of our directors and former directors to render professional services to us. One
of our former directors, who is also the son-in-law of our Chief Executive
Officer, 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 $377,000 and $224,000 for the six months ended June 30, 2002 and
2003, respectively. We also engaged an asset management firm that is controlled
by one of our directors. This firm provided discretionary asset management
services to us. In the six months ended June 30, 2002, we paid fees of $8,000 to
this asset management firm. The engagement with the asset management firm was
terminated in September 2002. The chief executive officer of the Company's
Israeli subsidiary has a loan from the subsidiary that was acquired in 2001. The
loan balance and accrued interest at December 31, 2002 and at June 30, 2003 was
$48,000 and $54,000, respectively. The loan has no defined maturity date, is
denominated in NIS, is linked to the Index and bears interest at 4% per annum.
The Company's Comverge subsidiary has made loans of $10,000 each to both our
Chief Executive Office and Chief Financial Officer. The loans had an initial
maturity date of January 3, 2002 and were extended at that time to mature on
January 3, 2004. The loans bear interest at 4.25% per annum. The balances of the
loans and accrued interest at December 31, 2002 and June 30, 2003 were $25,000
and $26,000, respectively. The Comverge subsidiary also extended a loan of
$14,000 to Comverge's Executive Vice-President in 2001. This loan bears interest
at 6.5% per annum and is to mature in July 2004. The balance of the loan and
accrued interest at December 31, 2002 and at June 30, 2003 was $16,000 and
$17,000, respectively.
- 19 -
Recently Issued Accounting Pronouncement
In May 2003, the Financial Accouting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 150, "Accounting for
Certain Instruments with Characteristics of Both Liabilities and Equity" (SFAS
150). The standard establishes standards on the classification and measurement
of certain financial instruments with characteristics of both liabilities and
equity and requires that such instruments be classified as liabilities. The
standard is effective for financial instruments entered into or modified after
May 31, 2003, and is otherwise effective at the beginning of the first interim
period beginning after June 15, 2003. Adoption of the standard is not expected
to have an impact on the Company's consolidated financial position or results of
operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
In the normal course of business, we are exposed to fluctuations in Israeli
interest rates on the $1.1 million outstanding on our line of credit and our
long-term debt of $1.2 million as of June 30, 2003, respectively, to finance our
Israeli operations. Of our $1.2 million of long-term debt in Israel (which is
denominated in NIS), $150,000 is linked to the Israeli consumer price index and
$1.0 million is unlinked.
Additionally, our monetary assets and liabilities (net liability of
approximately $1.0 million) in Israel are exposed to fluctuations in foreign
currency exchange rates. During the second quarter, we incurred exchange losses
of $153,000 due to an 8% appreciation of the NIS in relation to the dollar
during the period. Since the end of the second quarter until July 31, 2003, the
dollar has strengthened in relation to the NIS by 3%.
We do not employ specific strategies, such as the use of derivative
instruments or hedging, to manage our interest rate or foreign currency exchange
rate exposures.
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 the first six months of
2003 the appreciation of the NIS against the dollar was 9.0%, whereas during the
first six months of 2002 the devaluation of the NIS against the dollar was 8.0%.
During the period from July 1 to July 31, 2003, there was a devaluation of the
NIS against the dollar of 3.0%. In the first six months of 2003, the rate of
deflation in Israel was 0.5% whereas in the first six months of 2002, the rate
of inflation was 6.3%.
As of June 30, 2003, 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.
Item 4. Controls and Procedures
Evaluation of Controls and Procedures
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including the Chief Executive Officer and the Chief Financial Officer, of the
design and operation of our disclosure controls and procedures. Based on this
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures are effective for gathering,
analyzing and disclosing the information we are required to disclose in the
reports we file under the Securities Exchange Act of 1934, within the time
periods specified in the SEC's rules and forms.
Changes in Controls and Procedures
During the period covered by this report, we did not have any changes to
our internal controls over financial reporting that have materially affected, or
is reasonably likely to materially affect, our internal controls over financial
reporting.
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PART II - Other information
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) Unregistered Sales of Securities.
(i) On May 5, 2003, we issued 102,196 shares of our common stock to Laurus
in lieu of payment of interest and a $200,000 monthly installment of principal
due under a 10% convertible note issued by us to Laurus in June 2002. Laurus may
resell the shares we issued as payments under the 10% convertible note under an
effective registration statement.
We relied on Section 4(2) of the Securities Act of 1933 as our exemption
from registration for the issuance of the common stock to Laurus in payment of
amounts due under the 10% convertible note.
(ii) As previously reported in our Annual Report on Form 10-K, in March
2003, we received a notice of conversion from Laurus, as the lender under
Comverge's line of credit obtained in December 2002, for the conversion into
shares of our common stock of $600,000 principal amount of the debt outstanding
under the line at a conversion price of $1.50 per share. In April 2003,
following the repayment in full of all amounts outstanding under the line, we,
in lieu of the conversion, issued 400,000 shares of our common stock to Laurus
under the same terms as the conversion and at an amount equal to the aggregate
conversion price of $600,000. Additionally, prior to June 5, 2003, Laurus could
sell the 400,000 shares of our common stock subject to a volume limitation equal
to 25% of the average daily trading volume of the calendar month in which the
sale is to be made (as determined on a rolling basis).
We relied on Section 4(2) of the Securities Act of 1933 as our exemption
from registration for the sale and issuance of the common stock to Laurus.
(iii) On February 25, 2003, we engaged J.P. Turner & Company, L.L.C. for
the purposes of providing investor awareness and business advisory services for
a period of one year. In connection with this engagement, we granted J.P. Turner
common stock purchase warrants for the purchase of 120,000 shares of our common
stock, of which 60,000 shares are exercisable at $2.00 per share and 60,000
shares are exercisable at $2.50 per share. The warrants became fully vested on
May 26, 2003 and expires on February 25, 2005. We granted J.P. Turner the right
to have the shares of our common stock included in a registration statement that
we file (commonly referred to as piggyback registration rights), subject to
contractual restrictions that limit our ability to include shares in a
registration statement.
We relied on Section 4(2) of the Securities Act of 1933 as our exemption
from registration for the sale and issuance of the warrants to J.P. Turner.
Item 6: Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Certification of Chief Executive Officer pursuant to Section
302 of Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section
302 of Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to Section
906 of Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to Section
906 of Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
(i) Report on Form 8-K, dated April 12, 2003, filed on April 3,
2003, relating to the announcement of our results for the
fourth quarter and year ended December 31, of 2002.
(ii) Report on Form 8-K, dated April 29, 2003, filed on May 2,
2003, relating to changes in membership of our Board of
Directors.
(iii) Report on Form 8-K, dated May 15, 2003, filed on May 19,
2003, relating to the announcement of our results for the
first quarter ended March 31, of 2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by its
Principal Financial Officer thereunto duly authorized.
DATA SYSTEMS & SOFTWARE INC.
Dated: August 14, 2003
By: /s/ YACOV KAUFMAN
--------------------------
Yacov Kaufman
Vice President and Chief
Financial Officer
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