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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 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.
| | Yes |X| 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 November
10, 2003: 7,902,025
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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 September 30, 2003.............................................. 2
Consolidated Statements of Operations
for the nine and three month periods ended September 30, 2002 and 2003...................... 3
Consolidated Statement of Changes in Shareholders' Equity
for the nine month period ended September 30, 2003......................................... 4
Consolidated Statements of Cash Flows
for the nine month periods ended September 30, 2002 and 2003................................ 5
Notes to Consolidated Financial Statements......................................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............... 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk......................................... 21
Item 4. Controls and Procedures............................................................................ 22
PART II. Other Information
Item 2. Changes in Securities and Use of Proceeds.......................................................... 23
Item 6. Exhibits and Reports on Form 8-K................................................................... 24
Signatures ............................................................................................ 25
Certain statements contained in this report are forward-looking in nature. These
statements are generally identified by the inclusion of phrases such as "we
expect", "we anticipate", "we believe", "we estimate" and other phrases of
similar meaning. Whether such statements ultimately prove to be accurate depends
upon a variety of factors that may affect our business and operations. Many of
these factors are described in our most recent Annual Report on Form 10-K as
filed with Securities and Exchange Commission.
PART I. Financial Information
Item 1. Unaudited Consolidated Financial Statements
On October 9, 2003, KPMG LLP ("KPMG") notified the Company that as of that
date it had resigned as the Company's independent accountant.
The audit reports of KPMG on the Company's consolidated financial
statements for the past two fiscal years did not contain an adverse opinion or
disclaimer of opinion, and were not qualified or modified as to uncertainty,
audit scope or accounting principles, except for references to the Company's
adoption of certain recent accounting pronouncements.
During the two most recent fiscal years and through October 9, 2003, there
were no disagreements between the Company and KPMG as to any matter of
accounting principles or practices, financial statement disclosure, or audit
scope or procedure, which disagreement, if not resolved to the satisfaction of
KPMG, would have caused KPMG to make reference to the subject matter of the
disagreement in its reports on the financial statements for such periods within
the meaning of Item 304(a)(1)(iv) of Regulation S-K.
The Company has not yet retained new auditors and therefore, did not obtain
a review of the attached interim financial statements, for the three and
nine-month periods ending September 30, 2003, by an independent accountant using
professional review standards and procedures.
Upon retaining an auditor and completion of their review, the interim
financial statements, for the three and nine month periods ending September 30,
2003, will be filed with the SEC, making the filing current.
-1-
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except per share data)
As of As of
December 31, September 30,
ASSETS 2002 2003
--------------- ---------------
(unaudited)
Current assets:
Cash and cash equivalents.................................................. $1,150 $707
Restricted cash............................................................ 241 1,741
Trade accounts receivable, net............................................. 12,267 5,656
Inventory.................................................................. 2,217 55
Other current assets....................................................... 1,401 693
-------------- ------------
Total current assets................................................... 17,276 8,852
Investment in affiliated company................................................ - 2,575
Property and equipment, net..................................................... 1,972 790
Goodwill 4,929 4,430
Other intangible assets, net.................................................... 404 131
Long-term deposits - restricted................................................. 5,700 -
Other assets.................................................................... 669 859
Prepaid employee termination benefits........................................... 2,355 2,313
-------------- ------------
Total assets........................................................... $33,305 $19,950
============== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term debt and current maturities of long-term debt, net............. $3,755 $1,681
Trade accounts payable.................................................... 5,185 2,118
Accrued payroll, payroll taxes and social benefits......................... 2,098 1,290
Other current liabilities.................................................. 3,411 2,717
-------------- ------------
Total current liabilities.............................................. 14,449 7,806
-------------- ------------
Long-term liabilities:
Long-term debt............................................................. 6,278 529
Other liabilities.......................................................... 477 279
Liability for employee termination benefits................................ 3,364 3,247
-------------- ------------
Total long-term liabilities......................................... 10,119 4,055
-------------- ------------
Minority interests.............................................................. 1,609 1,492
-------------- ------------
Shareholders' equity:
Common stock - $.01 par value per share:
Authorized - 20,000 shares;
Issued - 8,162 and 8,750 shares
as of December 31, 2002 and September 30, 2003, respectively......... 82 87
Additional paid-in capital................................................ 37,687 42,906
Warrants.................................................................. 364 461
Deferred compensation..................................................... (7) (2)
Accumulated deficit....................................................... (26,787) (32,940)
Treasury stock, at cost - 846 and 848 shares as of
December 31, 2002 and September 30, 2003, respectively......... (3,913) (3,915)
Stockholder's note...................................................... (298) -
-------------- ------------
Total shareholders' equity............................................ 7,128 6,597
-------------- ------------
Total liabilities and shareholders' equity............................ $33,305 $19,950
============== ============
The accompanying notes are an integral part of these consolidated
financial statements.
-2-
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Consolidated Statements of Operations (unaudited)
(in thousands, except per share data)
Nine months ended Three months ended
September 30, September 30,
---------------------------- ----------------------------
2002 2003 2002 2003
------------- ------------- ------------ -------------
Sales:
Products........................................... $24,868 .$16,900 $7,207 $3,779
Services........................................... 11,992 9,937 4,062 2,905
----------- ----------- ----------- -----------
36,860 26,837 11,269 6,684
----------- ----------- ----------- -----------
Cost of sales:
Products........................................... 19,749 13,951 5,698 3,202
Services........................................... 9,178 7,323 3,208 2,279
----------- ----------- ----------- -----------
28,927 21,274 8,906 5,481
----------- ----------- ----------- -----------
Gross profit....................................... 7,933 5,563 2,363 1,203
Research and development expenses....................... 1,266 153 256 -
Selling, general and administrative expenses............ 12,675 8,394 3,923 1,984
Impairment of goodwill.................................. 2,760 - 2,760 -
----------- ----------- ----------- -----------
Operating loss..................................... (8,768) (2,984) (4,576) (781)
Interest income......................................... 203 42 57 15
Interest expense........................................ (743) (721) (450) (71)
Other income (expense), net............................. 148 (510) 56 (345)
Minority interests...................................... 852 139 649 35
Equity loss in unconsolidated subsidiary................ - (2,112) - (611)
----------- ----------- ----------- -----------
Loss before provision for income taxes............. (8,308) (6,146) (4,264) (1,758)
Provision (benefit) for income taxes.................... 64 7 7 (27)
----------- ----------- ----------- -----------
Net loss........................................... $(8,372) $(6,153) $(4,271) $(1,731)
=========== =========== =========== ===========
Basic and diluted net loss per share:
Net loss per share................................. $(1.14) $(0.80) $(0.58) $(0.22)
=========== =========== =========== ===========
Weighted average number of shares
outstanding - basic and diluted.................... 7,353 7,680 7,353 7,894
=========== =========== =========== ===========
The accompanying notes are an integral part of these consolidated
financial statements.
- 3 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Shareholders' Equity (unaudited)
Nine months ended September 30, 2003
(in thousands)
Additional
Number Common Paid-In Deferred Treasury Stockholder's Accumulated Total
of Shares Stock Capital Compensation Warrants Stock Note Deficit
--------- ------ ---------- ------------ -------- -------- ------------- ----------- -----
Balances as of
December 31, 2002 8,162 $ 82 $37,687 $ (7) $ 364 $(3,913) $(298) $(26,787) $7,128
Amortization of
deferred
compensation - - - 5 - - - - 5
Issuance of shares
as compensation 50 - 50 - - - - - 50
Exercise of options 11 - 17 - - - - - 17
Issuance of shares
in lieu of debt
repayment 527 5 798 - - - - - 803
Warrants issued for
professional
services - - - - 97 - - - 97
Purchase of treasury
shares - - - - - (2) - - (2)
Write of off
stockholder's note - - - - - - 298 - 298
Equity from issuance
of shares by
Comverge Inc. - - 4,354 - - - - - 4,354
Net loss - - - - - - - (6,153) (6,153)
--------- ------ ---------- ------------ -------- -------- ------------- ----------- -----
Balances as of
September 30, 2003 8,750 $ 87 $42,906 $ (2) $ 461 $(3,915) $ - $(32,940) $6,597
========= ====== ========== ============ ======== ======== ============= =========== ======
The accompanying notes are an integral part of these consolidated
financial statements.
- 4 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited)
(in thousands)
Nine months ended September 30,
---------------------------------
2002 2003
----------- ------------
Cash flows provided by (used in) operating activities:
Net loss.......................................................................... $(8,372) $(6,153)
Adjustments to reconcile net loss to net cash used in operating
activities - Appendix: 2,996 5,966
----------- ------------
Net cash used in operating activities......................................... (5,376) (187)
----------- ------------
Cash flows (used in) provided by investing activities:
Restricted cash................................................................... - 4,200
Proceeds from sale and maturity of debt securities................................ 1,519 -
Proceeds from sale of property and equipment...................................... - 15
Investment in debt securities..................................................... (154) -
Acquisitions of property and equipment............................................ (344) (193)
Funding of termination benefits................................................... 425 (243)
Acquisition of intangible assets.................................................. (8) -
Other............................................................................. - (204)
Investment in equity method investee.............................................. - (3,327)
----------- ------------
Net cash provided by investing activities..................................... 1,438 248
----------- ------------
Cash flows (used in) provided by financing activities:
Short-term debt, net.............................................................. (863) (503)
Proceeds from issuance of convertible note........................................ 2,000 -
Borrowings of long-term debt...................................................... 646 441
Repayments of long-term debt...................................................... (69) (479)
Convertible note issuance costs................................................... (167) -
Investment in subsidiary by minority interest..................................... - 22
Exercise of options............................................................... - 17
Purchase of treasury stock........................................................ - (2)
----------- ------------
Net cash provided by (used in) financing activities........................... 1,547 (504)
----------- ------------
Net decrease in cash and cash equivalents.............................................. (2,391) (443)
Cash and cash equivalents at beginning of period....................................... 4,025 1,150
----------- ------------
Cash and cash equivalents at end of period............................................. $1,634 $707
=========== ============
Supplemental cash flow information:
Cash paid during period for interest.............................................. $332 $308
=========== ============
Cash paid during period for income taxes.......................................... $92 $106
=========== ============
Non-cash investing and financing activities:
Issuance of common stock in lieu of debt repayment............................... - $803
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.............................. - $17
Accounts payable incurred in acquisition of fixed assets......................... $50 -
Value of beneficial conversion feature and related warrants on
issuance of convertible note.................................................. $692 -
Adjustment of goodwill and intangible assets..................................... $48 -
Increase in deferred tax liability associated with adjustment of
intangible assets............................................................. $17 -
The accompanying notes are an integral part of these consolidated
financial statements.
- 5 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows - Appendix (unaudited)
(dollars in thousands)
Nine months ended September 30,
-------------------------------
2002 2003
----------- ----------
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization..................................................... $ 938 $ 447
Allowance for doubtful accounts................................................... - 54
Stock and stock option compensation............................................... 22 55
Accretion of discount on convertible note and amortization of
related costs and warrants............................................. 355 493
Minority interest and write-off of minority interest balance...................... (892) (139)
Equity loss....................................................................... - 2,112
Unrealized gain on debt securities................................................ (10) -
Impairment of goodwill and acquired software...................................... 3,000 -
Settlement of payable to contract settlement...................................... (189) -
Loss on dilution of investment in Comverge........................................ - 102
Loss on write-off of stockholder's note........................................... - 298
Restricted cash................................................................... (842) -
(Decrease) increase in liability for employee termination benefits................ (416) 283
Exchange adjustment on long-term debt............................................. (29) 49
Loss on disposition of property and equipment..................................... 15 3
Deferred taxes.................................................................... 7 (166)
Change in operating assets and liabilities:
Decrease in accounts receivable and other current assets...................... 2,542 4,379
(Decrease) increase in inventory.............................................. (2,567) 326
Increase (decrease) in other assets........................................... 105 (101)
Increase (decrease) in accounts payable and other liabilities................. 957 (2,229)
----------- ----------
Total......................................................................... $ 2,996 $ 5,966
----------- ----------
The accompanying notes are an integral part of these consolidated
financial statements.
- 6 -
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 nine-month
period ended September 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 September 30, 2003, the Company had working capital of $1,046,
including $707 in unrestricted cash and cash equivalents. Net cash used in
operating activities in the first nine months of 2003 was $187. The net loss for
the period of $6,153 included a non-cash equity loss in Comverge of $2,112
(primarily in the second quarter), and other non-cash expenses and losses of
$1,359. The primary source of the Company's cash provided by operating
activities during the first nine months of 2003 was collections of trade
accounts receivables and other current assets in excess of reductions in
accounts payable and other liabilities of $2,150, net. Net cash provided by
investing activities was $248, primarily from the release of previously
restricted cash of $4,200, of which $3,327 was invested in Comverge. Net cash
used in financing activities of $504 was primarily due to net payments of debt
of $541.
The working capital of $1,046 at September 30, 2003, included negative
working capital of $82 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, positive working capital and cash flows from dsIT's
operations in past periods were not readily available to finance U.S.
activities.
dsIT is utilizing approximately $1,213 of its $1,576 lines of credit as of
September 30, 2003. dsIT's lines of credit are denominated in NIS and bear an
average interest rate of the Israeli prime rate plus 0.9% per annum. The Israeli
prime rate fluctuates and on September 30, 2003 was 7.9%. 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.
Since April 2003, the Company's formerly consolidated subsidiary,
Comverge, Inc. (Comverge), completed private equity financings totaling
approximately $18,600 (see Note 3). As a result of the financing, Comverge no
longer requires additional funding from the Company. As part of the agreements
related to 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. Comverge is obligated to prepay the term loan and facilitate
the release of the Company's $1,500 deposit over the six 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.
As of October 31, 2003 the Company's wholly-owned US operations (i.e.,
excluding dsIT and Comverge) had an aggregate of $740 in unrestricted cash and
cash equivalents, reflecting a $292 decrease from the balance as of December 31,
2002.
- 7 -
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,
including the freeing up of the restricted deposit pledged to secure Comverge's
term loan, and operating cash flows.
Note 3: Comverge equity financing transactions
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 $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 to common stock in
Comverge the balance of the intercompany loans of $12,673 .
The purchaser of the Series A-1 Preferred Stock was granted a put option
exercisable in April 2004 and Comverge received a right to call all the Series
A-1 Preferred Stock for $2,000, at anytime on or before April 18, 2004. In
September 2003, Comverge completed an agreement raising an additional $2,000 in
capital funding in exchange for additional Series A Convertible Preferred Stock
issued by Comverge. Comverge utilized these funds to repurchase the Series A-1
Convertible Preferred Stock previously issued by Comverge.
Subsequent to the third quarter, in October 2003, Comverge, completed an
agreement raising an additional $5,600 in capital funding in exchange for
additional Series A Convertible Preferred Stock issued by Comverge.
The Series A Convertible Preferred Stock has 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, at Comverge's option, 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 in April, Comverge secured a
$6,500 credit facility with a leading financial institution. 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 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. Such covenants have been subsequently either
fulfilled or waived.
- 8 -
Based on the total capital raised (some of which occurred after September
30, 2003), and the redemption of the put, the prepayments by Comverge and
release of the pledge account, are to be made in two payments of $750 each on
December 31, 2003 and June 30, 2004
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 September 30, 2003, following Comverge's second equity transaction of
the year, the Company owned approximately 49.6% of the outstanding capital
voting stock of Comverge, comprised of approximately 25% of the Preferred Stock
and approximately 76% of Comverge's common stock. As a result of the last equity
transaction in October 2003, the Company remained Comverge's largest
shareholder, owning approximately 40.9% of the outstanding capital voting stock
of Comverge, comprised of approximately 17% of the Preferred Stock and
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 an increase to the Company's additional paid in capital.
- 9 -
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 transactions and other
agreements described in Note 3, 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 September 30,
2003 and for the period from April 1 to September 30, 2003 is as follows:
As at September
30, 2003
-------------------
FINANCIAL POSITION
Current assets $10,862
Property, plant, and equipment, net 1,831
Intangible and other assets, net 1,624
-------------------
Total assets $14,317
===================
Current liabilities $3,346
Long-term debt 3,918
Other non-current liabilities 191
-------------------
Total liabilities 7,455
Shareholders' equity 6,862
-------------------
Total liabilities and shareholder's equity $14,317
===================
Period from April
1, 2003 to
September 30, 2003
-------------------
RESULTS OF OPERATIONS
Sales $7,319
Operating loss $(4,134)
Net loss $(4,468)
The activity in the Company's investment in Comverge during the six
months ended September 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 95
Adjustment of the Company's Comverge investment
from sale of preferred shares and issuance
of common stock 4,354
Adjustment of the Company's Comverge investment
from dilution of preferred shares (102)
-------------------
Investment balance prior to equity loss 4,687
Equity loss in Comverge - April 1 to September 30,
2003 (2,112)
-------------------
Investment balance at September 30, 2003 $2,575
===================
As a result of Comverge's net loss during the six months ended September
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 $668, against its
Preferred Stock investment.
- 10 -
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, September 30,
2002 2003
---- ----
Raw materials, spare parts and supplies $1,396 $23
Work-in-process 161 -
Finished goods and merchandise 660 32
------ ---
$2,217 $55
====== ===
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
nine-month period ended September 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 September 30, 2003 $4,430 $ - $4,430
================ ================ ===============
The following table presents certain information regarding the Company's
amortizable intangible assets as of September 30, 2003 and December 31, 2002.
All intangibles assets are being amortized over their estimated useful lives,
with no estimated residual values.
As of September 30, 2003
----------------------------------------------------
Gross
Weighted average carrying Accumulated Net carrying
amortization period amount amortization amount
---------------------- ------------- ----------------- --------------
Amortizing intangible assets:
Software licenses 4.5 yrs $260 $129 $131
==== ==== ====
As of December 31, 2002
----------------------------------------------------
Gross
Weighted average carrying Accumulated Net carrying
amortization 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
============= ================= ==============
- 11 -
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
intangible amounted to $304 and $59 for the nine months ended September 30, 2002
and 2003, respectively (2002 includes amortization of $108 with respect to
acquired backlog which was fully amortized in 2002).
Estimated amortization expense for the remainder of 2003 is $17 and as
follows with respect to intangible assets for each of the next five years:
Year ended September 30,
2004 $41
2005 32
2006 32
2007 22
2008 4
-----------
$131
===========
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 nine-month periods ended September 30, 2002 and 2003:
Nine months ended September
30,
------------------------------
2002 2003
------------- -------------
Warranty provision at beginning of the period $302 $52
Accruals for warranties issued during the period 85 23
Warranty settlements made during the period (300) (23)
Other - deconsolidation of Comverge (see Notes 3 and 4) - (52)
------------- -------------
Warranty provision at the end of the period $87 $-
============= =============
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.
- 12 -
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 September 30, Nine months ended September 30,
2002 2003 2002 2003
---- ---- ---- ----
Net loss as reported.............................. $(4,271) $(1,731) $(8,372) $(6,153)
Plus: Stock-based employee and director
compensation expense included in
reported net loss.......................... 2 2 5 55
Less: Total stock-based employee compensation
expense determined under fair value
based method for all awards................. 394 - 1,089 186
------- ------- ------- -------
Pro forma net loss................................. $(4,663) $(1,729) $(9,456) $(6,284)
======= ======= ======= =======
Net loss per share:
Basic and diluted - as reported.............. $(0.58) $(0.22) $(0.95) $(0.80)
======= ======= ======= =======
Basic and diluted - pro forma................ $(0.63) $(0.22) $(1.36) $(0.82)
======= ======= ======= =======
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 only for the nine month period ended September 30, 2002 and the first
three months of 2003 until the Company's deconsolidation of its interest in
Comverge - see Notes 3 and 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 pays 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 approximately $97, which has been
charged to selling, general and administrative expense.
- 13 -
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
Nine months ended September 30, 2003:
Revenues from external customers $9,138 $4,700 $12,974 $25 $26,837
Intersegment revenues 0 284 20 0 304
Segment gross profit 1,949 1,313 2,276 25 5,563
Segment loss (493) (3,535) (247) (17) (4,292)
Nine months ended September 30, 2002:
Revenues from external customers $10,636 $12,683 $13,415 $126 $36,860
Intersegment revenues 72 870 73 - 1,015
Segment gross profit 1,704 3,918 2,260 51 7,933
Segment income (loss)*** (3,553) (2,465) 36 (2) (5,984)
Three months ended September 30, 2003:
Revenues from external customers $2,827 - $3,856 $1 $6,684
Intersegment revenues - - - - -
Segment gross profit 549 - 653 1 1,203
Segment loss (28) (909) (156) (11) (1,104)
Three months ended September 30, 2002:
Revenues from external customers $3,339 $3,259 $4,638 $33 $11,269
Intersegment revenues 53 391 27 - 471
Segment gross profit 412 1,144 801 6 2,363
Segment income (loss)*** (2,862) (597) 61 (7) (3,405)
_______________
(*) 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 (the Energy Intelligence Solutions
segment) are no longer consolidated beginning the second quarter of
2003 - see Note 4. Segment loss for the nine and three months ended
September 30, 2003 includes other expense of $298, relating to the
write-off of a stockholder's note from segment CEO.
(***) Segment loss for the nine and three month periods ended September 30,
2002 in the software consulting and development segment include a
charge of $3,000 for impairment of goodwill and acquired software,
reduced by $528 for minority interests.
RECONCILIATION OF SEGMENT LOSS TO CONSOLIDATED NET LOSS
Nine months ended Three months ended
September 30, September 30,
--------------------------- --------------------------
2002 2003 2002 2003
---- ---- ---- ----
Total loss for reportable segments $(5,982) $(4,275) $(3,398) $(1,093)
Other operational segment loss (2) (17) (7) (11)
----------- ----------- ----------- ----------
Total operating loss (5,984) (4,292) (3,405) (1,104)
Net loss of corporate headquarters* (2,388) (1,861) (866) (627)
----------- ----------- ----------- ----------
Total consolidated net loss $(8,372) $(6,153) $(4,271) $(1,731)
=========== =========== =========== ==========
* Net loss of corporate headquarters for the nine and three months ended
September 30, 2002 includes $311 and $256 of interest expense related
to the amortization of the fair value of the beneficial conversion
feature and related warrants at the issuance of the convertible note
in June of 2002.
- 14 -
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. 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 third quarter of 2003. 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.
In June 2003 Clalit Health Services, Israel's largest HMO and one of the
largest HMOs 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 a one-year period 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.
Revenues from this contract are expected to begin in the fourth quarter of 2003.
In addition, dsIT has been successful in bidding together with Databit
(from our Computer Hardware segment) 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 to
our unaudited financial statements) for private equity financing in the amount
of $13.0 million. We invested $3.25 million, and $9.75 million was invested by a
group of leading energy venture capital investors, in exchange for Series A
Convertible Preferred Stock of Comverge. In September 2003, Comverge signed and
closed another agreement with two other venture capital firms raising an
additional $2.0 million in capital funding in exchange for additional Series A
Convertible Preferred Stock issued by Comverge, utilizing these funds to
repurchase the Series A-1 Convertible Preferred Stock previously issued by
Comverge. Subsequent to the third quarter, in October 2003, Comverge signed and
closed on its last agreement with two other venture capital firms raising an
additional $5.6 million in capital funding in exchange for additional Series A
Convertible Preferred Stock issued by Comverge, completing this round of equity
investment, totaling $18.6 million.
- 15 -
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 September 30, 2003 (effective April 1, 2003) comprises the
equity loss in unconsolidated subsidiary in our consolidated statements of
operations.
Towards the end of the first quarter and through the third quarter of 2003,
Comverge devoted significant attention to the capital raising process mentioned
above. In addition, during this period, Comverge signed its first major,
long-term Virtual Peaking Capacity(TM) contract to provide significant peak load
reduction to PacifiCorp, a subsidiary of Scottish Power. Although little revenue
was recognized with respect to this contract, 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 this project's profitability, due to product
improvements and reductions in component costs.
COMPUTER HARDWARE
Sales in the third quarter of 2003 continued to be 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 and are beginning to
see signs of such improvement. 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 over the last few
months, we do not need to fund Comverge and no longer have control over its
activities. Mr. George Morgenstern, has informed our 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 and has agreed within
this construct to make himself available to fill any position the Board may
desire. 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 continue to evaluate 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, completing it
before year-end.
- 16 -
Results of Operations
The following table sets forth certain information with respect to our
consolidated results of operations for the three and nine months ended September
30, 2002 and 2003, including the percentage of total revenues during each period
attributable to selected components of the operations statement data and 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, but rather include them on an equity basis, the results of the
periods presented are not fully comparable.
Nine months ended September 30, Three months ended September 30,
------------------------------------------------ -----------------------------------------------
2002 2003 Change 2002 2003 Change
----------------- ----------------- ------- ----------------- ----------------- ------
% of % of % of % of % of % of
($,000) sales ($,000) sales 2002 ($,000) sales ($,000) sales 2002
-------- ------ -------- ----- ------ ------- ----- ------- ----- ------
Sales $ 36,860 100% $ 26,837 100% (27)% $ 11,269 100% $ 6,684 100% (41)%
Cost of sales 28,927 78 21,274 79 (26) 8,906 79 5,481 82 (38)
-------- --- -------- --- -------- --- ------- ---
Gross profit 7,933 22 5,563 21 (30) 2,363 21 1,203 18 (49)
R&D expenses 1,266 3 153 1 (88) 256 2 -- -- (100)
SG&A expenses 12,675 34 8,394 31 (34) 3,923 35 1,984 30 (49)
Impairment of goodwill 2,760 7 -- -- (100) 2,760 24 -- -- (100)
-------- --- -------- --- -------- --- ------- ---
Operating loss (8,768) (24) (2,984) (11) (66) (4,576) (41) (781) (12) (82)
Interest expense, net (540) (1) (679) (3) 26 (393) (3) (56) (1) (86)
Other income (loss), net 148 0 (510) (2) (444) 56 0 (345) (5) (714)
Minority interests 852 2 139 1 (84) 649 6 35 1 (95)
Equity loss in
unconsolidated subsidiary -- -- (2,112) (8) -- -- -- (611) (9) --
-------- --- -------- --- -------- --- ------- ---
Loss before provision
for income taxes (8,308) (23) (6,146) (23) (26) (4,264) (38) (1,758) (26) (59)
Provision (benefit) for
income taxes 64 0 7 0 (92) 7 0 (27) (0) (514)
-------- --- -------- --- -------- --- ------- ---
Net loss $ (8,372) (23)% $ (6,153) (23)% (26)% $ (4,271) (38)% $(1,731) (26)% (59)%
======== === ======== === ======== === ======= ===
SALES. Sales in the third quarter and first nine months of 2003 were $6.7
million and $26.8 million, compared to $11.3 million and $36.9 million in the
same periods of 2002, respectively. The decreases were primarily attributable to
not consolidating Comverge sales starting the second quarter of 2003.
Comverge sales in the first quarter of 2003, third quarter of 2002 and
first nine months of 2002 were $4.7 million, $3.3 million and $12.7 million,
respectively.
Sales in the computer hardware segment in the third quarter and first nine
months of 2003 were $3.9 million and $13.0 million, decreasing by 17% and 3%,
from sales of $4.6 million and $13.4 million, in the same periods of 2002,
respectively. The decrease was attributable to the increased competition and the
continued decline in the hardware market during the second and third quarters of
2003.
Software consulting and development sales were $2.8 million and $9.1
million in the third quarter and first nine months of 2003, respectively,
compared to $3.3 million and $10.6 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 third quarter and the first nine months
of 2003 was $1.2 million and $5.6 million, respectively, compared to $2.4
million and $7.9 million in the same periods of 2002. The decreases were almost
entirely attributable to not consolidating Comverge's gross profit starting the
second quarter of 2003. The gross profit margin in the computer hardware
segment, slightly increased to 18% in the first nine-months of 2003, compared to
17% in the same period of 2002. However, in the third quarters of both 2003 and
2002, the gross profit margin was stable at 17%. As a result of our continued
effort to improve the cost structure of the software consulting and development
segment, gross profit margins increased to 21% and 19%, in the first nine months
and third quarter of 2003, respectively, compared to 16% and 12% in the same
periods of 2002. In addition, in the third quarter of 2002, we had a
non-recurring expense of $240,000 for the write down of acquired software.
- 17 -
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 starting 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 third quarter
and first nine months of 2003, SG&A decreased to $2.0 million and $8.4 million,
respectively, from $3.9 million and $12.7 million in the same periods of 2002.
The decrease was primarily attributable to not consolidating Comverge's SG&A,
which was $2.9 million and $1.6 million in the second and third quarters of
2002, respectively. However, corporate SG&A and SG&A in the software consulting
and development segment continued to decrease as well, as we continued to reduce
our overhead.
IMPAIRMENT OF GOODWILL. With the acquisition of Endan by our dsIT
subsidiary in December 2001, we recognized goodwill and acquired software valued
at a total of $6.4 million. This value was supported by third party valuations
prepared at the time of the acquisition, based on sales and business projections
made at that time. Since then, the hi-tech market in general and that of
software consulting in particular continued to deteriorate. We have made
concerted efforts to offset this negative trend with cost cutting measures
already implemented. As we looked forward in September 2002 to the coming year,
the expense recorded reflected our reassessment of the values then recorded with
respect to the entire software consulting and development segment to reflecting
our sales projections then, based on the same valuation models then employed. We
are confident that the cost cutting measures already implemented will provide
for breakeven and even positive performance in the coming quarters, justifying
the remaining goodwill and value attached to this segment.
INTEREST EXPENSE, 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, the amortization
expenses are expected to decrease over the coming quarters. Of the $721,000 of
interest expense incurred during the first nine months of 2003, $396,000 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 we account 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 $2.3 million and
$4.5 million of net losses, during the third quarter of 2003 and period from
April 1, 2003 to September 30, 2003, was $0.6 million and $2.1 million,
respectively. Comverge's increased losses in the third quarter of 2003 of $2.2
million compared to $0.6 million in the third quarter of 2002, was primarily
attributable to a decrease in sales, particularly those related to Comverge's
Gulf Power contract, where shipments have been suspended. In addition, SG&A in
Comverge has increased primarily due to increased advertising and marketing
expenses, particularly those related to marketing and advertising its new Utah -
PacifiCorp program.
OTHER INCOME (EXPENSE), NET. We had previously entered into a restricted
stock purchase agreement with the CEO of our energy intelligence solutions
segment subsidiary. Pursuant to this agreement, we issued to the segment CEO
50,000 shares of our common stock. The common stock was paid for by assigning
and endorsing to us a 6% subordinated note, due April 15, 2010, in the principal
amount of $297,500. The note was issued by Philip Services Corp. (NasdaqNM:
PSCD) in favor of the segment CEO under a trust indenture with Wilmington Trust
Company. PSCD has recently filed for bankruptcy and we therefore wrote-off this
note to other loss in the third quarter of 2003.
- 18 -
Liquidity and Capital Resources
As of September 30, 2003, we had working capital of $1.0 million, including
$707,000 in unrestricted cash and cash equivalents. Net cash used in operating
activities in the first nine months of 2003 was $187,000. The net loss for the
period of $6.2 million included a non-cash equity loss in Comverge of $2.1
million (primarily in the second quarter), and other non-cash expenses and
losses included in net loss of $1.4 million. The primary source of our cash
provided by operating activities during the first nine months of 2003 was
collections of trade accounts receivables and other current assets in excess of
reductions in accounts payable and other liabilities, of $2.2 million, net. Net
cash provided by investing activities was $248,000, primarily from the release
of previously restricted cash of $4.2 million, of which $3.3 million was
invested in Comverge. Net cash used in financing activities of $504,000 was
primarily due to net payments of debt of $541,000.
The working capital of $1.0 million at September 30, 2003, included
negative working capital of $82,000 in our majority owned Israeli subsidiary,
dsIT. Due to Israeli tax and company law constraints, as well as the significant
minority interest in dsIT, positive working capital and cash flows from dsIT's
operations are not readily available to finance U.S. activities.
dsIT is utilizing approximately $1.2 million of its $1.6 million lines of
credit as of September 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 September 30, 2003 was 7.9%. We
believe 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.
Since April 2003, our formerly consolidated subsidiary, Comverge,
signed and closed a number of private equity financing transactions raising
approximately $18.6 million (see Note 3 of our unaudited Consolidated Financial
Statements). As a result, Comverge no longer requires additional funding from
us. As part of the agreement for the private equity financing, Comverge received
a new $6.5 million credit facility, which included a $1.5 million term loan
secured by a $1.5 million restricted deposit of DSSI at Comverge's new lender.
Comverge has agreed to prepay the term loan and permit release our $1.5 million
deposit over the 12 months commencing December 31, 2003, subject to certain
conditions (see Note 3 of our unaudited Consolidated Financial Statements). We
believe that the proceeds of the financing and new credit arrangements provide
sufficient financing for Comverge to independently fund its activities.
As of October 31, 2003 our wholly owned US operations (i.e., excluding dsIT
and Comverge) had an aggregate of $740,000 in unrestricted cash and cash
equivalents, reflecting a $780,000 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 corporate activities for at least the next 12 months.
We intend to finance these activities from cash on hand and operating cash
flows.
- 19 -
Contractual Obligations and Commitments
Our contractual obligations and commitments at September 30, 2003,
excluding certain severance arrangements described below, principally including
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 September 30,
---------------------------------------------------------
(amounts in thousands)
----------------------
Total 2004 2005 2006 After 2006
----- ---- ---- ---- ----------
Long-term debt related to Israeli operations $ 997 $ 468 $ 285 $181 $ 63
Guarantees 558 558 -- -- --
Operating leases 3,362 1,206 1,027 353 776
Consulting agreement with CEO 1,572 1,572 -- -- --
------ ------ ------ ---- ----
Total contractual cash obligations $6,489 $3,804 $1,312 $534 $839
====== ====== ====== ==== ====
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
September 30 2003. We have collateralized a portion of these guarantees by means
of a deposit of $0.2 million as of September 30, 2003. The obligation is
presented as a current liability, though it is uncertain as to when actual
payment will 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
September 30, 2003, we had a total of $3.2 million in potential severance
obligations, of which approximately $2.3 million was funded with cash held by
insurance companies and approximately $0.9 million was unfunded. The entire $3.2
million was accrued for as of September 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. It is currently
contemplated those payments will begin on January 1, 2004. During the first four
years of the consulting period, we will be obligated 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 and
benefits similar to those received as an employee. 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 has
agreed to forgo this funding for as long as there is no change in control in
DSSI, as defined in his employment agreement. The CEO`s base salary for 2003
(including cost of living adjustments through the beginning of 2003) 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.
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 September 30, 2003, the
unfunded portion of such severance obligation was $36,000.
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We also have 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 company for reasons other
than for cause, we must pay him 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 September 30, 2003, the unfunded portion of such
severance obligation was approximately $33,000.
Payments to Related Parties
We paid an individual as a vice-president (and director in 2002), who is
the son of our Chief Executive Officer, approximately $188,000 and $212,000 for
the nine months ended September 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 included fees and expenses of special counsel hired on our
behalf) of approximately $580,000 and $306,000 for the nine months ended
September 30, 2002 and 2003, respectively. We also previously engaged an asset
management firm controlled by one of our directors (who resigned in April 2003).
This firm provided discretionary asset management services to us, and in the
nine months ended September 30, 2002, we paid it fees of $12,000 for asset
management. 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, originally made by a company that subsidiary acquired in 2001. The
loan balance and accrued interest at December 31, 2002 and at September 30, 2003
was $48,000 and $52,000, 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 increase in the loan balance over the nine month period is entirely due to
the linkage and interest accrual.
The Company's Comverge subsidiary has made loans of $10,000 each to both
our Chief Executive Officer 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
balance of each of the loans and accrued interest at December 31, 2002 and
September 30, 2003 was $12,500 and $13,000, respectively.
Recently Issued Accounting Pronouncement
In May 2003, the Financial Accounting 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 statement 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 September 15, 2003. Adoption of the standard is not
expected to have an impact on the Company's consolidated financial position or
results of operations.
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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 amounts outstanding on our line of credit and under a term
loan used to finance our Israeli operations. As of September 30, 2003, $1.2
million was outstanding on our line of credit and we had $1.0 million
outstanding under the term loan. Of our $1.0 million term loan (which is from a
bank located in Israel and is denominated in NIS), $130,000 is linked to the
Israeli consumer price index and $0.9 million is unlinked.
Additionally, our monetary assets and liabilities (net liability of
approximately $1.3 million) in Israel are exposed to fluctuations in foreign
currency exchange rates. During the second quarter, we recorded exchange gains
of $53,000 due to a 3.0% appreciation of the NIS in relation to the dollar
during the period. Since the end of the third quarter until October 31, 2003,
the dollar has strengthened in relation to the NIS by 1.1%.
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 nine months of
2003 the appreciation of the NIS against the dollar was 6.2%, whereas during the
first nine months of 2002 the devaluation of the NIS against the dollar was
7.9%. During the period from October 1 to October 31, 2003, there was a
devaluation of the NIS against the dollar of 1.1%. In the first nine months of
2003, the rate of deflation in Israel was 1.5% whereas in the first nine months
of 2002, the rate of inflation was 7.0%.
As of September 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
that are reasonably likely to materially affect, our internal controls over
financial reporting.
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PART II - Other Information
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
Report on Form 8-K, dated August 18, 2003, filed on August 19,
2003, relating to the announcement of our results for the second
quarter and six months ended June 30, 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: November 14, 2003
By: /s/ YACOV KAUFMAN
--------------------------------------
Yacov Kaufman
Vice President and Chief Financial Officer
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