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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 MARCH 31, 2004 COMMISSION FILE NUMBER 0-19771
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DATA SYSTEMS & SOFTWARE INC.
(Exact name of registrant as specified in charter)
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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
May 12, 2004: 7,921,691
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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, 2003 and March 31, 2004.................................................. 1
Consolidated Statements of Operations and Comprehensive Loss
for the three month periods ended March 31, 2003 and 2004................................... 2
Consolidated Statement of Changes in Shareholders' Equity
for the three month period ended March 31, 2004............................................ 3
Consolidated Statements of Cash Flows
for the three month periods ended March 31, 2003 and 2004................................... 4
Notes to Consolidated Financial Statements......................................................... 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................................................. 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk................................. 13
Controls and Procedures.................................................................... 13
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K............................................................ 14
SIGNATURES ............................................................................................ 15
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
(in thousands, except share and per share data)
AS OF
AS OF DECEMBER MARCH 31,
ASSETS 31, 2003 2004
---------------- ---------------
Current assets: (unaudited)
Cash and cash equivalents .................................................... $ 1,213 $ 1,101
Restricted cash .............................................................. 241 241
Accounts receivable, net ..................................................... 7,053 6,013
Inventory .................................................................... 88 42
Other current assets ......................................................... 661 655
------------ ------------
Total current assets ..................................................... 9,256 8,052
------------ ------------
Investment in Comverge, net ....................................................... 68 --
Property and equipment, net ....................................................... 814 727
Other assets ...................................................................... 613 661
Funds in respect of employee termination benefits ................................. 2,379 2,497
Goodwill .......................................................................... 4,430 4,269
Other intangible assets, net ...................................................... 114 101
------------ ------------
Total assets ............................................................. $ 17,674 $ 16,307
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term bank credit and current maturities of long-term debt .............. $ 1,517 $ 1,533
Trade accounts payable ....................................................... 2,586 1,902
Accrued payroll, payroll taxes and social benefits ........................... 1,451 1,405
Other current liabilities .................................................... 2,973 2,833
------------ ------------
Total current liabilities ................................................ 8,527 7,673
------------ ------------
Investment in Comverge, net ....................................................... -- 285
------------ ------------
Long-term liabilities:
Long-term debt ............................................................... 632 451
Other liabilities ............................................................ 227 215
Liability for employee termination benefits .................................. 3,721 3,857
------------ ------------
Total long-term liabilities ........................................... 4,580 4,523
------------ ------------
Minority interests ................................................................ 1,367 1,382
------------ ------------
Shareholders' equity:
Common stock - $0.01 par value per share:
Authorized - 20,000,000 shares;
Issued - 8,740,729 and 8,742,395 shares as of
December 31, 2003 and March 31, 2004, respectively .................... 87 87
Additional paid-in capital ................................................... 39,595 39,547
Warrants ..................................................................... 461 461
Accumulated deficit .......................................................... (33,069) (33,664)
Treasury stock, at cost - 838,704 and 820,704 shares at December 31, 2003 and March
31, 2004, respectively ................................................... (3,874) (3,791)
Accumulated other comprehensive loss ........................................ -- (196)
------------ ------------
Total shareholders' equity ............................................... 3,200 2,444
------------ ------------
Total liabilities and shareholders' equity ............................... $ 17,674 $ 16,307
============ ============
The accompanying notes are an integral part of these consolidated
financial statements.
- 1 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (unaudited)
(in thousands, except net loss per share data)
THREE MONTHS ENDED MARCH 31,
----------------------------
2003 2004
----------- -----------
Sales:
Products .......................................................... $ 8,976 $ 4,033
Services .......................................................... 2,881 2,460
Projects .......................................................... 1,101 762
----------- -----------
Total sales ................................................. 12,868 7,255
----------- -----------
Cost of sales:
Products .......................................................... 7,300 3,365
Services .......................................................... 1,781 1,695
Projects .......................................................... 718 645
----------- -----------
Total cost of sales ......................................... 9,799 5,705
----------- -----------
Gross profit ...................................................... 3,069 1,550
----------- -----------
Operating expenses:
Research and development expenses ................................... 153 --
Selling, general and administrative expenses ........................ 4,302 1,830
----------- -----------
Total operating expenses .................................... 4,455 1,830
----------- -----------
Operating loss ......................................................... (1,386) (280)
Interest income ........................................................ 22 2
Interest expense ....................................................... (354) (57)
Other income (loss), net ............................................... (14) 101
----------- -----------
Loss before taxes on income ....................................... (1,732) (234)
Taxes on income ........................................................ (12) 7
----------- -----------
Loss from operations of the Company and its consolidated subsidiaries .. (1,744) (227)
Share in losses of Comverge ............................................ -- (353)
Minority interests ..................................................... (17) (15)
----------- -----------
Net loss .......................................................... $ (1,761) $ (595)
=========== ===========
Other comprehensive loss, net of tax:
Differences from translation of financial statements of subsidiaries ... -- (196)
Comprehensive loss .............................................. $ (1,761) $ (791)
=========== ===========
Basic and diluted loss per share:
Net loss per share - basic and diluted ............................ $ (0.24) $ (0.08)
=========== ===========
Weighted average number of shares outstanding - basic and diluted 7,345 7,920
=========== ===========
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)
(in thousands)
Accumulated
Additional other
Number of Common Paid-In Accumulated Treasury comprehensive
Shares Stock Capital Warrants Deficit Stock loss Total
----------- ----------- ----------- ----------------------- ----------- ----------------- ---------
Balances as of
December 31, 2003 8,741 $ 87 $39,595 $ 461 $(33,069) $(3,874) $ - $3,200
Exercise of options 1 * (48) - - 83 - 35
Net loss - - - - (595) - - (595)
Differences from translation
of financial statements of
subsidiaries - - - - - - (196) (196)
----------- ----------- ----------- ----------------------- ----------- ----------------- ---------
Balances as of
March 31, 2004 8,742 $ 87 $39,547 $ 461 $(33,664) $(3,791) $ (196) $2,444
=========== =========== =========== ======================= =========== ================= =========
* Less than $1
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)
THREE MONTHS ENDED MARCH 31,
-------------------------------------
2003 2004
--------------- --------------
Cash flows used in operating activities:
Net loss................................................................. $(1,761) $(595)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization........................................ 262 62
Minority interests................................................ 17 15
Share in losses of Comverge....................................... -- 353
Change in allowance for doubtful accounts......................... 29 (1)
Deferred taxes.................................................... -- 24
Increase (decrease) in liability for employee termination benefits... (23) 136
Loss (gain) on disposition of property and equipment................. 1 (5)
Stock and stock option compensation............................... 52 --
Accretion of discount on convertible note and amortization
of related costs and warrants................................. 169 --
Other............................................................. 3 (40)
Change in operating assets and liabilities:
Decrease in accounts receivable and other current and 2,705
non-current assets....................................... 972
Decrease in inventory.............................................. 267 46
Decrease in accounts payable and other liabilities................. (1,539) (879)
--------------- --------------
Net cash provided by operating activities.......................... 182 88
--------------- --------------
Cash flows provided by (used in) investing activities:
Withdrawal of long-term deposit........................................ 3,200 --
Amounts funded for employee termination benefits...................... (117) (106)
Utilization of employee termination benefits.......................... 102 (12)
Acquisitions of property and equipment................................. (94) (22)
Proceeds from sale of property and equipment........................... 14 30
--------------- --------------
Net cash provided by (used in) investing activities................ 3,105 (110)
--------------- --------------
Cash flows used in financing activities:
Short-term debt borrowings (repayments), net........................... (232) 39
Repayments of long-term debt........................................... (3,258) (164)
Exercise of options.................................................... -- 35
Purchase of treasury stock............................................. (2) --
--------------- --------------
Net cash used in financing activities.............................. (3,492) (90)
--------------- --------------
Net decrease in cash and cash equivalents.................................. (205) (112)
Cash and cash equivalents at beginning of period........................... 1,150 1,213
--------------- --------------
Cash and cash equivalents at end of period................................. $945 $1,101
=============== ==============
Supplemental cash flow information: Cash paid during the period for:
Interest........................................................... $169 $48
=============== ==============
Income taxes.......................................................... $41 $8
=============== ==============
Non-cash investing and financing activities:
Issuance of warrants for professional services............................ $97
===============
Adjustment of treasury stock and additional paid-in-capital with respect to
options exercised...................................................... $83
==============
The accompanying notes are an integral part of these consolidated
financial statements.
- 4 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(dollars in thousands)
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
three-month period ended March 31, 2004 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2004. 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, 2003.
Certain reclassifications have been made to the Company's prior period's
consolidated financial statements to conform with the current period's
consolidated financial statement presentation.
NOTE 2: FINANCING OF OPERATIONS
As of March 31, 2004, the Company had working capital of $379,
including $1,101 in non-restricted cash and cash equivalents. Net cash used in
the first quarter of 2004 was $112. Net cash of $88 was provided by operating
activities during the first quarter of 2004. The net loss for the three-month
period ended March 31, 2004 of $595 was primarily due to non-cash expenses,
primarily the Company's share of unconsolidated losses of Comverge of $353. The
primary source of the Company's cash provided by operating activities during the
first quarter of 2004 was collections of trade accounts receivables and other
current and non-current assets in excess of reductions in accounts payable and
other liabilities of $93, net. Net cash of $110 used in investing activities,
was used primarily to fund employee termination benefits of $106. Net cash of
$90 used in financing activities was primarily utilized for payment of debt of
$125.
Of the total working capital at March 31, 2004, approximately $246 was
in the Company's majority owned dsIT subsidiary. 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 $897 of its $1,100 lines of credit as
of March 31, 2004. dsIT's lines of credit are denominated in NIS and bear an
average interest rate of the Israeli prime rate plus 1.4% per annum. The Israeli
prime rate fluctuates and as of March 31, 2004 is 5.8%.
As of April 30, 2004 the Company's wholly owned US operations (i.e.,
excluding dsIT) had an aggregate of $1,097 in unrestricted cash and cash
equivalents, reflecting a $98 decrease from the balance as of December 31, 2003.
- 5 -
NOTE 3: INVESTMENT IN COMVERGE
Comverge's summary results of operations for the three-months ended
March 31, 2004 is as follows:
Three months
ended
RESULTS OF OPERATIONS March 31, 2004
------------------
Sales $4,892
Gross profit $1,854
Net loss $(2,084)
The change in the Company's Comverge investment, during the three
months ended March 31, 2004 is as follows:
Comverge Comverge Net investment
common stock preferred stock in Comverge
--------------- ---------------- ------------------
Balances as of December 31, 2003 $ (1,824) $ 1,892 $ 68
Equity loss in Comverge - (353) (353)
--------------- ---------------- ------------------
Balances as of March 31, 2004 $ (1,824) $ 1,539 $ (285)
=============== ================ ==================
In March 2004, Comverge signed and closed on an additional agreement
for private equity financing in the amount of $3.0 million. This round of
financing further diluted the Company's preferred equity holdings to
approximately 15% and its total equity investment in Comverge to approximately
37%.
NOTE 4--GOODWILL AND OTHER INTANGIBLE ASSETS
The entire balance of goodwill was in the Software Consulting and
Development segment. There were no acquisitions or impairments of goodwill
recorded during the three-month period ended March 31, 2004.
The Company's amortizable intangible assets consisted of software
licenses, with a gross carrying amount of $260, accumulated amortization of $106
and $114 and net balances of $154 and $146, as of March 31, 2004 and December
31, 2003, respectively. All intangibles assets are being amortized over their
estimated useful lives, which averaged 5 years and the amortization expense for
the three months ended March 31, 2003 and 2004 amounted to $26 and $8,
respectively. Amortization expense of the remaining balance of these assets, is
estimated at; $32, $32, $28 and $14 for each of the years ended March 31, 2005,
2006, 2007 and 2008, respectively.
NOTE 5: WARRANTY PROVISION
The Company grants its customers one-year product warranty. No
provision was made in respect of warranties based on the Company's previous
history.
NOTE 6: STOCK-BASED COMPENSATION
The Company applies Accounting Principles Board Opinion ("APB") No. 25,
"Accounting for Stock Issued to Employees" and the related interpretations in
accounting for its stock option grants to employees and directors, with the
disclosure provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation". Under APB No. 25, compensation expense is computed under the
intrinsic value method of accounting to the extent that the fair value of the
underlying shares on the date of the grant exceed the exercise price of the
share option, and thereafter amortized on a straight-line basis against income
over the expected service period.
Had compensation cost for the Company's option plans been determined
based on the fair value at the grant dates of awards, consistent with the method
prescribed in SFAS No. 123, the Company's net loss and loss per share would have
been changed to the pro forma amounts indicated below:
- 6 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(dollars in thousands)
Three Months Ended March 31,
2003 2004
---- ----
Net loss as reported.................................................... $(1,761) $(595)
Plus: Stock-based employee and director compensation expense included 52
in reported net loss............................................. --
Less: Total stock-based employee compensation expense determined under 109
fair value based method for all awards........................... 15
------------- -------------
Pro forma net loss...................................................... $(1,818) $(610)
============= =============
Net loss per share:
Basic and diluted - as reported................................... $(0.24) $(0.08)
============= =============
Basic and diluted - pro forma..................................... $(0.25) $(0.08)
============= =============
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 Company accounts for stock-based compensation issued to
non-employees on a fair value basis in accordance with SFAS No. 123 and EITF
Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other
Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services"
and related interpretations.
NOTE 7: SEGMENT INFORMATION
SOFTWARE
CONSULTING ENERGY
AND INTELLIGENCE COMPUTER
DEVELOPMENT SOLUTIONS(*) HARDWARE OTHER (**) TOTAL
----------- ------------ -------- ------ -----
Three months ended March 31, 2004:
Revenues from external customers $2,910 $-- $4,339 $6 $7,255
Intersegment revenues -- -- -- -- --
Segment gross profit 594 -- 950 6 1,550
Segment income (loss) 63 (353) 198 (3) (95)
Three months ended March 31, 2003:
Revenues from external customers $3,230 $4,700 $4,930 $8 $12,868
Intersegment revenues - 284 20 - 304
Segment gross profit 863 1,313 885 8 3,069
Segment income (loss) (21) (1,125) 50 (6) (1,102)
- ---------------
(*) Operating results of Comverge (the Energy Intelligence Solutions segment)
are no longer consolidated beginning the second quarter of 2003. Segment
loss for the three months ended March 31, 2004 represents the Company's
share of Comverge's losses during that period.
(**) Represents VAR software operations in Israel that did not meet the
quantitative thresholds of SFAS No. 131.
RECONCILIATION OF SEGMENT LOSS TO CONSOLIDATED NET LOSS
Three months ended March 31,
------------------------------------
2003 2004
--------------- --------------
Total loss for reportable segments $(1,096) $ (92)
Other operational segment income (loss) (6) (3)
--------------- --------------
Total operating loss (1,102) (95)
Net loss of corporate headquarters (659) (500)
--------------- --------------
Total consolidated net loss $(1,761) $(595)
=============== ==============
- 7 -
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(dollars in thousands)
NOTE 8: SUBSEQUENT EVENT
On April 19, 2004, the Company signed an agreement in principle with
Kardan Communications Ltd. ("Kardan"), a subsidiary of Kardan N.V., for a
strategic transaction with Kardan or an affiliate thereof. The transaction
contemplates the purchase by the Company of certain interests in a portfolio of
communication and technologies companies owned by Kardan in exchange for the
issuance by the Company of approximately 3.7 million shares of its common stock.
The agreement in principle also contemplates the issuance by the Company of an
additional approximately 881,000 shares of its common stock to Kardan and
another minority shareholder of the Company's dsIT Technologies Ltd. subsidiary
("dsIT") in exchange for the approximately 32% of dsIT not currently owned by
the Company. It is contemplated that upon consummation of the transaction, a
majority of the current members of the Company's Board of Directors will resign
and be replaced by nominees of Kardan.
As part of the transaction, Kardan would invest $2 million in the
Company in exchange for approximately 631,000 shares of common stock of the
Company and warrants, exercisable for two years from the closing of the
transaction, to purchase an additional 500,000 shares of common stock at 120% of
the purchase price of the common stock purchased at closing. Kardan would also
be obligated to invest up to an additional $1 million in exchange for additional
shares of common stock in the event that the Company's cash on hand falls below
a certain level. In addition, the agreement in principle contemplates put and
call options for an additional 631,000 of the Company's shares in exchange for
increased equity in one of the portfolio companies.
The agreement in principle contains an exclusivity provision pursuant
to which neither DSSI nor Kardan may solicit or engage in discussions with
respect to any third party alternative transaction for a period of 60 days from
the date of the letter agreement, except with respect to DSSI in the event and
to the extent that its fiduciary duties otherwise require.
The agreement in principle and consummation of the transactions are
subject to completion of due diligence, negotiation and execution of definitive
agreements, and various other agreements, conditions and terms.
- 8 -
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,
2003 (the "2003 10-K").
OVERVIEW AND TREND INFORMATION
During the periods included in this report, we operated in three
reportable segments: software consulting and development, energy intelligence
solutions, and computer hardware. The following analysis should be read together
with the segment information provided in Note 7 to the interim unaudited
consolidated financial statements included in this quarterly report, which
information is hereby incorporated by reference into this Item 2.
Software Consulting and Development
Segment revenues continued to decrease in the first quarter of 2004,
primarily as a result of the decreasing backlog of fixed price development
projects. This decrease was partially offset by an increase in the number of
consultants and revenues on a cost-plus basis, although this segment's revenues
are still below the revenue level in the first quarter of 2003. There are
certain signs of a positive turn in the high-tech market, but we are unable to
project how and when this will affect us in this segment.
Energy Intelligence Solutions
In March 2004, Comverge closed on an additional agreement for private
equity financing in the amount of $3.0 million, bringing the aggregate amount of
financing raised since April 2003 to $21.6 million, including $3.35 million
invested by DSSI. This last round of financing further diluted our preferred
equity investment holdings in Comverge to approximately 15% and our total equity
investment holdings in Comverge to approximately 37%.
Comverge recently secured its third Virtual Peaking CapacityTM ("VPC")
program. These programs, while requiring significant upfront cash investments in
marketing and installation, are expected to bring revenues starting the third
quarter of this year.
Computer Hardware
Although sales in the first quarter of 2004 were below those of the
previous quarter and those of the first quarter of 2003, gross profits were
higher due to the high profit margins on the defense projects bid jointly with
dsIT. We currently expect additional projects in this area but as of yet we have
not received any new similar contracts and we cannot be certain that in fact we
will.
Corporate
Starting the beginning of this year, our Chief Executive Officer
retired from full-time employment, although at the Board's request he continues
to act as CEO as a consultant, under the terms prescribed by his employment
agreement. In the context of our continuing evaluation of corporate strategic
alternatives, on April 19, 2004, we signed an agreement in principle with Kardan
Communications Ltd. ("Kardan"), a subsidiary of Kardan N.V., for a strategic
transaction with Kardan or an affiliate thereof. The transaction contemplates us
purchasing certain interests in a portfolio of communication and technologies
companies owned by Kardan in exchange for our issuing approximately 3.7 million
shares of common stock.
- 9 -
The agreement in principle also contemplates our issuing an additional
approximately 881,000 shares of common stock to Kardan and another minority
shareholder of dsIT in exchange for the approximately 32% of dsIT not currently
owned by us. It is contemplated that upon consummation of the transaction, a
majority of the current members of our Board of Directors will resign and be
replaced by nominees of Kardan.
As part of the transaction, Kardan would invest in DSSI $2 million in
exchange for approximately 631,000 shares of our common stock and warrants,
exercisable for two years from the closing of the transaction, to purchase an
additional 500,000 shares of common stock at 120% of the purchase price of the
common stock purchased at closing. Kardan would also be obligated to invest up
to an additional $1 million in exchange for additional shares of common stock in
the event that our cash on hand falls below a certain level. In addition, the
agreement in principle contemplates put and call options for an additional
631,000 of our shares in exchange for increased equity in one of the portfolio
companies.
The agreement in principle contains an exclusivity provision pursuant
to which neither DSSI nor Kardan may solicit or engage in discussions with
respect to any third party alternative transaction for a period of 60 days from
the date of the letter agreement, except, with respect to DSSI, in the event and
to the extent that its fiduciary duties otherwise require.
The agreement in principle and consummation of the transactions are
subject to completion of due diligence, negotiation and execution of definitive
agreements, and various other agreements, conditions and terms.
RESULTS OF OPERATIONS
The following table sets forth certain information with respect to the
consolidated results of operations of the Company for the three months ended
March 31, 2003 and 2004, including the percentage of total revenues during each
period attributable to selected components of the operations statement data and
for the period to period percentage changes in such components. Since commencing
with the second quarter of 2003, we do not fully consolidate Comverge's results
of operations, but rather include them on an equity basis, the results of the
periods presented are not fully comparable.
Three months ended March 31,
------------------------------------------------------ Change from
2003 2004 2003 to
2004
--------------------------- ------------------------- -------------
($,000) % of sales ($,000) % of sales % of 2003
------------ -------------- ------------ ------------ -------------
Sales $12,868 100% $ 7,255 100% (44)%
Cost of sales 9,799 76 5,705 79 (42)
------------ -------------- ------------ ------------
Gross profit 3,069 24 1,550 21 (49)
R&D expenses 153 1 - - (100)
SG&A expenses 4,302 33 1,830 25 (57)
------------ -------------- ------------ ------------
Operating loss (1,386) (11) (280) (4) (80)
Interest expense, net (332) (3) (55) (1) (83)
Other income (expense), net (14) 0 101 1 (821)
------------ -------------- ------------ ------------
Loss before taxes on income (1,732) (13) (234) (3) (86)
Taxes on income (12) 0 7 0 (158)
------------ -------------- ------------ ------------
Loss from operations of the Company and its
consolidated subsidiaries (1,744) (14) (227) (3) (87)
Share in losses of Comverge -- -- (353) (5) --
Minority interest (17) 0 (15) 0 (12)
------------ -------------- ------------ ------------
Net loss $(1,761) (14)% $(595) (8) (66)%
============ ============== ============ ============
- 10 -
Sales. Of the $5.6 million decrease in sales in the first quarter of
2004 compared to the first quarter of 2003, $4.7 million was due to Comverge,
which since the second quarter of 2003, is no longer fully consolidated. Sales
decreased in the computer hardware sales segment by $0.6 million, primarily due
to a weak hardware market. In the software consulting and development segment,
sales decreased by $0.3 million. This decrease is primarily attributable to the
decrease in fixed price project development backlog as a result of the prolonged
downturn in the high-tech market in general and the software consulting and
development market in particular.
Gross profit. The decrease in gross profit and gross profit margin in
2004 as compared to 2003 was also primarily due to us no longer fully
consolidating Comverge's operations since the second quarter of 2003. This
accounted for $1.3 million of the $1.5 million decrease. In addition, as
Comverge's gross profit margin was higher than the average in the group, ceasing
to consolidate its operations caused a decrease in our consolidated gross profit
margin. Gross profit in the computer hardware segment increased in the first
quarter of 2004 by $0.1 million, primarily due to the higher margins with
respect to Israeli defense sales marketed jointly with dsIT. In the software
consulting and development segment, as we expected an increase in fixed price
project sales, the decrease in such sales in the past quarter was not followed
with a commensurate decrease in engineers and labor expenses, and as a result,
the gross profit margin decreased in this segment from 27% in the first quarter
of 2003 to 21% in the first quarter of 2004.
Research and development expenses ("R&D"). The decrease in R&D expenses
was due to our no longer consolidating Comverge's operations since the second
quarter of 2003.
Selling, general and administrative expenses ("SG&A"). The
discontinuation of full consolidation of Comverge's operations since the second
quarter of 2003 accounted for $2.2 million of the $2.5 million decrease in SG&A
expenses in the first quarter of 2004 as compared to the first quarter of 2003.
However, corporate SG&A and SG&A in our software consulting and development
segment decreased as well. In the software consulting and development segment,
SG&A decreased by $0.2 million, or 15%, as a result of cost cutting measures
continuously being implemented. Corporate SG&A also decreased primarily due to
reduced compensation expenses resulting from our Chief Executive Officer's
retirement from full-time employment. The change in auditors, increased
correspondence with regulatory authorities and expenses related to the
exploration of strategic alternatives have caused an increase in professional
fee expenditures, this is expected to continue to negatively impact the next two
quarters.
Interest income (expense). The decrease in net finance expenses is
attributable to completing the accretion of discounts and the amortization of
related costs in connection with convertible debt and warrants in the first few
months of 2003, which accounted for a significant portion of these expenses in
the first quarter of 2003.
Equity loss in unconsolidated subsidiary. The equity loss in the first
quarter of 2004 was attributable to Comverge, whose results we account for on an
equity basis as of the second quarter of 2003. Our share of Comverge's $2.1
million of net losses during this quarter was $0.4 million. Comverge's increased
losses in the first quarter of 2004 was primarily due to increased SG&A
expenses, primarily attributable to the marketing expenses associated with its
new VPC programs as well as severance and vacation expenses associated with
staff reductions.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2004, we had working capital of $0.4 million, including
$1.1 million in non-restricted cash and cash equivalents. Net cash used in the
first quarter of 2004 was $0.1 million. Net cash of $0.1 million was provided
from operating activities during the first quarter of 2004. The net loss for the
three-month period ended March 31, 2004 of $0.6 million included non-cash
expenses primarily including our share of unconsolidated losses of Comverge of
$0.4 million. The primary source of cash provided by operating activities during
2003 was our collections of trade accounts receivables and other current and
non-current assets in excess of reductions in accounts payable and other
liabilities of $0.1 million, net. Net cash of $0.1 million used in investing
activities was primarily for funding employee termination benefits. Net cash of
$0.1 million used in financing activities was primarily due to net payments of
debt.
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Of the total working capital at March 31, 2004, $0.2 million was in our
majority owned dsIT subsidiary. 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.
As of April 30, 2004 the Company's wholly owned US operations (i.e.,
excluding dsIT and Comverge) had an aggregate of $1.1 million in unrestricted
cash and cash equivalents, reflecting a $0.1 million decrease from the balance
as of December 31, 2003.
We believe we have 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, utilizing the cash on hand of $0.8 million as
of May 10, 2004 and operating cash flow from expected profitable operations of
the computer hardware segment. However, due to our liquidity, successful
implementation of our plan to fund our activities is subject to risk and
uncertainties, including those associated with (i) increasing the level of
computer hardware segment revenues from the level achieved in the first quarter
of 2004, and (ii) effective and timely implementation of cost reductions already
begun. Our long-term liquidity is contingent on our ability to increase our
revenue and profit base, become cash flow neutral in our US-based activities and
attract equity investments to the extent required.
For further detail, see Notes 2 and 8 to the interim unaudited
consolidated financial statements included in this quarterly report.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
Our contractual obligations and commitments at March 31, 2004,
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, and are as set forth in the
table below.
Cash Payments Due During Year Ending March 31,
----------------------------------------------------------
(amounts in thousands)
Contractual Obligations Total 2005 2006 2007 After 2007
----------------------- ----- ---- ---- ---- ----------
Long-term debt related to Israeli operations $1,087 $636 $305 $146 $--
Guarantees 558 558 -- -- --
Operating leases 2,515 1,238 671 280 326
Consulting agreement with CEO 1,304 -- 1,304 -- --
------ ------ ------ ---- ----
Total contractual cash obligations $5,464 $2,432 $2,280 $426 $326
====== ====== ====== ==== ====
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
March 31 2004. We have collateralized a portion of these guarantees by means of
a deposit of $0.2 million as of March 31, 2004. 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 March 31, 2004, we had a total of $3.9 million in potential
severance obligations, of which approximately $2.5 million was funded with cash
to insurance companies and approximately $1.4 million was unfunded. The entire
$3.9 million was accrued for as of March 31, 2004.
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Under the terms of his employment agreement with us, we have an
obligation to pay our Chief Executive Officer consulting fees over a seven-year
period starting January 1, 2004. During the first four years of the consulting
period, we have to pay our CEO $237,000 per year, equal to 50% of his salary in
effect as of December 31, 2003. During the last three years of the consulting
period, we must pay $119,000 per year, equal to 25% of that salary. In addition,
we must make contributions to a non-qualified defined contribution retirement
plan equal to 25% of the consulting fee. Under the terms of the employment
agreement, we are obliged to fund the amounts payable for the term of the
consulting period by the purchase of an annuity or similar investment product at
the beginning of the consulting period. The CEO has agreed to forgo the
commitment of immediate funding for the next twelve months or until we acquire
additional funding. When and if we successfully conclude the negotiations with
Kardan, including their equity investment of $2 million, a portion of this sum
would be utilized to fund our obligation under this agreement.
We also have obligations under various agreements and other
arrangements with officers and other employees with respect to severance
arrangements and multiyear employment agreements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of business, we are exposed to fluctuations in
interest rates on lines-of-credit and long-term debt incurred to finance our
operations in Israel, currently $897,000 and $1,087,000, respectively.
Additionally, our monetary assets and liabilities (net liability of
approximately $930,000) in Israel are exposed to fluctuations in exchange rates.
We do not employ specific strategies, such as the use of derivative instruments
or hedging, to manage our interest rate or foreign currency exchange rate
exposures.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we completed an
evaluation, under the supervision and with the participation of our management,
including the Chief Executive Officer and the Chief Financial Officer, of the
design and operation of our disclosure controls and procedures. Based on this
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures are effective for gathering,
analyzing and disclosing the information we are required to disclose in the
reports we file under the Securities Exchange Act of 1934, within the time
periods specified in the SEC's rules and forms.
CHANGES IN CONTROLS AND PROCEDURES
There have been no significant changes in our internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation.
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PART II - OTHER INFORMATION
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
99.1 Certification of Chief Executive Officer pursuant to Section 906 of
Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer pursuant to Section 906 of
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
(i) Report on Form 8-K, dated January 14, 2004, filed on January 15, 2004,
changing DSSI's certifying accountant and engaging Kesselman & Kesselman,
a member of PricewaterhouseCoopers International Limited.
(ii) Report on Form 8-K, dated February 26, 2004, filed on March 5, 2004,
changing our symbol to "DSSCE" pursuant to a decision of a Nasdaq Listing
Qualification Panel.
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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: May 12, 2004
By: /s/ YACOV KAUFMAN
------------------------------------------
Yacov Kaufman
Vice President and Chief Financial Officer
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I, George Morgenstern, the Chief Executive Officer of Data Systems &
Software Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Data Systems &
Software Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and to the
audit committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Dated: May 12, 2004 By: \s\ GEORGE MORGENSTERN
------------------------
George Morgenstern
Chief Executive Officer
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I, Yacov Kaufman, the Chief Financial Officer of Data Systems &
Software Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Data Systems &
Software Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and to the
audit committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Dated: May 12, 2004 By: \s\ YACOV KAUFMAN
-----------------------
Yacov Kaufman
Chief Financial Officer
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