SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005 COMMISSION FILE NUMBER 0-19771
DATA SYSTEMS & SOFTWARE INC.
(Exact name of registrant as specified in charter)
Delaware | | 22-2786081 |
(State or other jurisdiction of | | (I.R.S. employer |
incorporation or organization) | | identification no.) |
| | |
200 Route 17, Mahwah, New Jersey | | 07430 |
(Address of principal executive offices) | | (Zip code) |
| | |
(201) 529-2026
Registrant’s telephone number, including area code
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x Yes oNo
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
o Yes x No
Number of shares outstanding of the registrant’s common stock, as of August 10, 2005: 8,116,691
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, 2004 and June 30, 2005 | 1 |
| | |
| Consolidated Statements of Operations and Comprehensive Loss | |
| for the six and three month periods ended June 30, 2004 and 2005 | 2 |
| | |
| Consolidated Statement of Changes in Shareholders’ Equity | |
| for the six month period ended June 30, 2005 | 3 |
| | |
| Consolidated Statements of Cash Flows | |
| for the six month periods ended June 30, 2004 and 2005 | 4 |
| | |
| Notes to Consolidated Financial Statements | 6 |
| | |
Item 2. | Management’s Discussion and Analysis of Financial Condition | |
| and Results of Operations | 11 |
| | |
Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 15 |
| | |
Item 4. | Controls and Procedures | 15 |
| | |
PART II. Other Information | |
| | |
Item 1. | Legal Proceedings | 16 |
| | |
Item 6. | Exhibits | 16 |
| |
Signatures | 17 |
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)
ASSETS | | | As of December 31, 2004 | | | As of June 30, 2005 | |
Current assets: | | | | | | (unaudited) | |
Cash and cash equivalents | | $ | 685 | | $ | 265 | |
Short-term bank deposits | | | 72 | | | -- | |
Restricted cash | | | 354 | | | 352 | |
Accounts receivable, net | | | 6,069 | | | 6,021 | |
Unbilled work-in-process | | | 533 | | | 588 | |
Inventory | | | 61 | | | 63 | |
Other current assets | | | 540 | | | 610 | |
Total current assets | | | 8,314 | | | 7,899 | |
Property and equipment, net | | | 649 | | | 598 | |
Other assets | | | 737 | | | 730 | |
Funds in respect of employee termination benefits | | | 2,836 | | | 2,748 | |
Goodwill | | | 4,408 | | | 4,151 | |
Other intangible assets, net | | | 81 | | | 61 | |
Total assets | | $ | 17,025 | | $ | 16,187 | |
LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | | | |
Current liabilities: | | | | | | | |
Short-term bank credit | | $ | 729 | | $ | 858 | |
Current maturities of long-term debt | | | 466 | | | 401 | |
Related Party - Note payable | | | -- | | | 100 | |
Trade accounts payable | | | 2,283 | | | 2,147 | |
Accrued payroll, payroll taxes and social benefits | | | 1,735 | | | 1,715 | |
Other current liabilities | | | 2,227 | | | 2,326 | |
Total current liabilities | | | 7,440 | | | 7,547 | |
Long-term liabilities: | | | | | | | |
Investment in Comverge, net | | | 1,444 | | | 1,824 | |
Long-term debt | | | 201 | | | 166 | |
Liability for employee termination benefits | | | 4,279 | | | 4,270 | |
Other liabilities | | | 65 | | | 21 | |
Total long-term liabilities | | | 5,989 | | | 6,281 | |
Minority interests | | | 1,471 | | | 1,437 | |
Shareholders’ equity: | | | | | | | |
Common stock - $0.01 par value per share: | | | | | | | |
Authorized - 20,000,000 shares; Issued - 8,937,395 shares at December 31, 2004 and June 30, 2005 | | | 88 | | | 88 | |
Additional paid-in capital | | | 39,733 | | | 39,733 | |
Warrants | | | 461 | | | 461 | |
Deferred compensation | | | (59 | ) | | (47 | ) |
Accumulated deficit | | | (34,290 | ) | | (35,303 | ) |
Treasury stock, at cost -820,704 shares at December 31, 2004 and June 30, 2005 | | | (3,791 | ) | | (3,791 | ) |
Accumulated other comprehensive loss | | | (17 | ) | | (219 | ) |
Total shareholders’ equity | | | 2,125 | | | 922 | |
Total liabilities and shareholders’ equity | | $ | 17,025 | | $ | 16,187 | |
The accompanying notes are an integral part of these consolidated financial statements.
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Loss (unaudited)
(in thousands, except net loss per share data)
| | Six months ended June 30, | | Three months ended June 30, | |
| | 2004 | | 2005 | | 2004 | | 2005 | |
Sales: | | | | | | | | | |
Products | | $ | 8,156 | | $ | 9,053 | | $ | 4,123 | | $ | 3,925 | |
Services | | | 4,927 | | | 4,947 | | | 2,467 | | | 2,359 | |
Projects | | | 1,472 | | | 1,657 | | | 710 | | | 814 | |
Total sales | | | 14,555 | | | 15,657 | | | 7,300 | | | 7,098 | |
Cost of sales: | | | | | | | | | | | | | |
Products | | | 6,914 | | | 7,422 | | | 3,549 | | | 3,237 | |
Services | | | 3,379 | | | 3,855 | | | 1,684 | | | 1,871 | |
Projects | | | 1,186 | | | 1,143 | | | 541 | | | 603 | |
Total cost of sales | | | 11,479 | | | 12,420 | | | 5,774 | | | 5,711 | |
Gross profit | | | 3,076 | | | 3,237 | | | 1,526 | | | 1,387 | |
Operating expenses: | | | | | | | | | | | | | |
Research and development expenses | | | -- | | | 26 | | | -- | | | 17 | |
Selling, marketing, general and administrative expenses | | | 3,328 | | | 3,614 | | | 1,498 | | | 1,722 | |
Total operating expenses | | | 3,328 | | | 3,640 | | | 1,498 | | | 1,739 | |
Operating income (loss) | | | (252 | ) | | (403 | ) | | 28 | | | (352 | ) |
Interest income | | | 77 | | | 4 | | | 75 | | | 2 | |
Interest expense | | | (86 | ) | | (98 | ) | | (29 | ) | | (43 | ) |
Other income, net | | | 237 | | | 60 | | | 136 | | | 55 | |
Income (loss) before taxes on income | | | (24 | ) | | (437 | ) | | 210 | | | (338 | ) |
Taxes on income | | | (20 | ) | | 137 | | | (13 | ) | | 40 | |
Income (loss) from operations of the Company and its consolidated subsidiaries | | | (4 | ) | | (574 | ) | | 223 | | | (378 | ) |
Share of losses in Comverge | | | (684 | ) | | (380 | ) | | (331 | ) | | (179 | ) |
Minority interests | | | (48 | ) | | (59 | ) | | (33 | ) | | (17 | ) |
Net loss from continuing operations | | | (736 | ) | | (1,013 | ) | | (141 | ) | | (574 | ) |
Net income from discontinued operations, net of tax | | | 348 | | | -- | | | 348 | | | -- | |
Net income (loss) | | | (388 | ) | | (1,013 | ) | | 207 | | | (574 | ) |
Other comprehensive income (loss), net of tax: | | | | | | | | | | | | | |
Differences from translation of financial statements of subsidiaries | | | (170 | ) | | (202 | ) | | 26 | | | (161 | ) |
Comprehensive income (loss) | | $ | (558 | ) | $ | (1,215 | ) | $ | 233 | | $ | (735 | ) |
Basic and diluted net income (loss) per share: | | | | | | | | | | | | | |
Loss per share from continuing operations | | $ | (0.09 | ) | $ | (0.12 | ) | $ | (0.01 | ) | $ | (0.07 | ) |
Discontinued operations | | | 0.04 | | | -- | | | 0.04 | | | -- | |
Basic and diluted net income (loss) per share | | $ | (0.05 | ) | $ | (0.12 | ) | $ | 0.03 | | $ | (0.07 | ) |
Weighted average number of shares outstanding: | | | | | | | | | | | | | |
Basic and diluted | | | 7,918 | | | 8,117 | | | 7,922 | | | 8,117 | |
The accompanying notes are an integral part of these consolidated financial statements.
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIESConsolidated Statement of Changes in Shareholders’ Equity (unaudited)
Six months ended June 30, 2005
(in thousands)
| Number of Shares | | Common Stock | | Additional Paid-In Capital | | Warrants | | Stock-Based Deferred Compensation | | Accumulated Deficit | | Treasury Stock | | Accumulated Other Comprehensive Loss | | Total |
| | | | | | | | | | | | | | | | | |
Balances as of December 31, 2004 (audited) | 8,937 | | $ 88 | | $39,733 | | $ 461 | | $(59) | | $(34,290) | | $(3,791) | | $ (17) | | $2,125 |
| | | | | | | | | | | | | | | | | |
Amortization of stock-based deferred compensation | | - | - | | - | | - | | 12 | | - | | - | | - | | 12 |
| | | | | | | | | | | | | | | | | |
Net loss | - | | - | | - | | - | | - | | (1,013) | | - | | - | | (1,013) |
| | | | | | | | | | | | | | | | | |
Differences from translation of financial statements of subsidiaries | - | | - | | - | | - | | - | | - | | - | | (202) | | (202) |
| | | | | | | | | | | | | | | | | |
Balances as of June 30, 2005 | 8,937 | | $ 88 | | $39,733 | | $ 461 | | $(47) | | $(35,303) | | $(3,791) | | $(219) | | $922 |
The accompanying notes are an integral part of these consolidated financial statements.
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIESConsolidated Statements of Cash Flows (unaudited)
(dollars in thousands)
| | Six months ended June 30, | |
| | 2004 | | 2005 | |
| | | | | |
Cash flows used in operating activities: | | | | | |
Net loss | | $ | (388 | ) | $ | (1,013 | ) |
Adjustments to reconcile net loss to net cash provided by (used in) operating activities - Appendix A: | | | 251 | | | 364 | |
Net cash used in operating activities | | | (137 | ) | | (649 | ) |
Cash flows provided by (used in) investing activities: | | | | | | | |
Restricted cash | | | 6 | | | 2 | |
Utilization of employee termination benefits | | | 122 | | | 157 | |
Amounts funded for employee termination benefits | | | (324 | ) | | (69 | ) |
Maturity of short-term deposits | | | -- | | | 72 | |
Proceeds from sale of property and equipment | | | 30 | | | 23 | |
Acquisitions of property and equipment | | | (54 | ) | | (117 | ) |
Net cash provided by (used in) investing activities | | | (220 | ) | | 68 | |
Cash flows provided by (used in) financing activities: | | | | | | | |
Short-term debt borrowings (repayments), net | | | (71 | ) | | 129 | |
Proceeds from note payable to a related party | | | -- | | | 350 | |
Repayment of note payable to a related party | | | -- | | | (250 | ) |
Proceeds from long-term debt | | | -- | | | 90 | |
Repayments of long-term debt | | | (323 | ) | | (158 | ) |
Exercise of options | | | 35 | | | -- | |
Net cash provided by (used in) financing activities | | | (359 | ) | | 161 | |
Net (decrease) increase in cash and cash equivalents | | | (716 | ) | | (420 | ) |
Cash and cash equivalents at beginning of period | | | 1,213 | | | 685 | |
Cash and cash equivalents at end of period | | $ | 497 | | $ | 265 | |
Supplemental cash flow information: | | | | | | | |
Cash paid during period for interest | | $ | 78 | | $ | 64 | |
Cash paid during period for income taxes | | $ | 23 | | $ | 17 | |
Non-cash investing and financing activities: | | | | | | | |
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.
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows - Appendix A (unaudited)
(dollars in thousands)
| | Six months ended June 30, | |
| | 2004 | | 2005 | |
| | | | | |
Adjustments to reconcile net loss to net cash (used in) provided by operating activities: | | | | | |
Depreciation and amortization | | | 122 | | | 128 | |
Minority interests | | | 48 | | | 59 | |
Share in losses of Comverge | | | 684 | | | 380 | |
Deferred taxes | | | (38 | ) | | 7 | |
Increase (decrease) in liability for employee termination benefits | | | 335 | | | (9 | ) |
Gain on disposition of property and equipment | | | (4 | ) | | (2 | ) |
Amortization of deferred compensation | | | -- | | | 12 | |
Other | | | (34 | ) | | (31 | ) |
Change in operating assets and liabilities: | | | | | | | |
Decrease (increase) in accounts receivable, unbilled work-in-process and other current and other assets | | | 674 | | | (77 | ) |
(Decrease) increase in inventory | | | (42 | ) | | (2 | ) |
Decrease in accounts payable and other liabilities | | | (1,494 | ) | | (101 | ) |
Total | | $ | 251 | | $ | 364 | |
The accompanying notes are an integral part of these consolidated financial statements.
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 and six month periods ended June 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. 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, 2004. Certain reclassifications have been made to the Company’s consolidated financial statements for prior periods to conform to the consolidated financial statement presentation for the current period.
Note 2: Financing of Operations
As of June 30, 2005, the Company had working capital of $352, including $265 in non-restricted cash and cash equivalents. Net cash used in the first six months of 2005 was $420. Net cash of $649 was used in operating activities during the first six months of 2005. The net loss for the six-month period ended June 30, 2005 of $1,013 was primarily due to the Company’s share of unconsolidated losses of Comverge of $380 and corporate expenses of $797. The Company's use of cash in operating activities during the first six months of 2005 was primarily due to increases in accounts receivables, unbilled work-in-process and other current assets in as well as reductions in accounts payable and other liabilities of $178, net. Net cash of $161 provided by financing activities was primarily from the net proceeds of a note payable to a related party of $100.
Of the total working capital at June 30, 2005, approximately $510 was in the Company’s majority owned dsIT Technologies Ltd. subsidiary (dsIT). Due to Israeli tax and company law constraints, as well as the significant minority interest in dsIT, such working capital and cash flows from dsIT’s operations are not readily available to finance U.S. activities.
dsIT is utilizing approximately $858 of its $1,100 lines of credit as of June 30, 2005. dsIT's lines of credit are denominated in NIS and bear an average interest rate of the Israeli prime rate plus 2.8% per annum. The Israeli prime rate fluctuates and as of June 30, 2005 is 3.5%.
On July 27, 2005, the Company and the other shareholders of dsIT entered into a definitive agreement for the sale of dsIT's outsourcing consulting business to Taldor Computer Systems (1986) Ltd. (TASE: TALD) (“Taldor”) for approximately $6 million in cash. The price is subject to adjustment under the terms set forth in the agreement. DSSI’s net share of the purchase price is expected to be approximately $3.5 million. The closing of the transaction is subject to consents and approvals, including approval of various Israeli government authorities, dsIT's banks and certain other parties.
The Company requires the proceeds from this transaction to finance its activities. Should the Company be unsuccessful in completing a transaction providing the necessary liquidity, it may not have sufficient funds to finance its activities for the 12 months following the date of this report. However, management believes that the proceeds from the expected closing together with cash available and anticipated profits from operations will provide more than sufficient liquidity to finance DSSI's activities for the foreseeable future and for the next 12 months in particular.
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (unaudited)
(in thousands, except per share data)
Note 3: Investment in Comverge
Comverge’s summary results of operations for the three and six month periods ended June 30, 2005 is as follows:
Results of Operations | | Six months ended June 30, 2005 | | Three months ended June 30, 2005 | |
| | | | | | | |
Sales | | $ | 7,834 | | $ | 3,933 | |
Gross profit | | | 3,309 | | | 1,673 | |
Net loss | | | (6,115 | ) | | (3,134 | ) |
The change in the Company’s Comverge investment, during the six months ended June 30, 2005 is as follows:
| | Comverge common stock | | Comverge preferred stock | | Net investment in Comverge | |
| | | | | | | | | | |
Balances as of December 31, 2004 | | $ | (1,824 | ) | $ | 380 | | $ | (1,444 | ) |
Equity loss in Comverge | | | -- | | | (380 | ) | | (380 | ) |
Balances as of June 30, 2005 | | $ | (1,824 | ) | $ | -- | | $ | (1,824 | ) |
As the Company’s share of losses attributable to its Comverge preferred stock has equaled its investment in Comverge’s preferred stock, the Company ceased recording equity losses in Comverge. In the future, equity income will be recorded to the Company’s preferred stock investment (the Company currently owns approximately 7% of Comverge’s preferred stock), only once Comverge’s equity reaches the level it was when the Company ceased recording equity losses. Equity income from the Company’s preferred investment may be recorded up to the Company’s original $3,644 preferred share investment in Comverge, and thereafter to its investment in Comverge’s common shares, of which the Company currently owns approximately 76%.
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 six-month period ended June 30, 2005.
The Company’s amortizable intangible assets consisted of software licenses, with a gross carrying amount of $260 and accumulated amortization of $179 and $195, as of December 31, 2004 and June 30, 2005, respectively. All intangibles assets are being amortized over their estimated useful lives, which averaged five years and the amortization expense for each of the six months ended June 30, 2004 and 2005 amounted to $16. Amortization expense of the remaining balance of these assets, for the years ending June 30, 2006, and 2007, is estimated to be $32, and $33, 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.
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIESNotes to Consolidated Financial Statements (unaudited)
(in thousands, except per share data)
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:
| | Six months ended June 30, | | Three months ended June 30, | |
| | 2004 | | 2005 | | 2004 | | 2005 | |
Net income (loss) as reported | | $ | (388 | ) | $ | (1,013 | ) | $ | 207 | | $ | (574 | ) |
Plus: Stock-based employee and director compensation expense included in reported net loss | | | - | | | 12 | | | - | | | 6 | |
Less: Total stock-based employee compensation expense determined under fair value based method for all awards | | | 61 | | | 162 | | | 46 | | | 81 | |
Pro forma net income (loss) | | $ | (449 | ) | $ | (1,163 | ) | $ | 161 | | $ | (649 | ) |
Net income (loss) per share: | | | | | | | | | | | | | |
Basic and diluted – as reported | | $ | (0.05 | ) | $ | (0.12 | ) | $ | 0.03 | | $ | (0.07 | ) |
Basic and diluted – pro forma | | $ | (0.06 | ) | $ | (0.14 | ) | $ | 0.02 | | $ | (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.
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (unaudited)
(in thousands except per share data)
Note 7: Segment Information
| | Software Consulting and Development | | Computer Hardware | | Other (*) | | Total | |
Six months ended June 30, 2005: | | | | | | | | | |
Revenues from external customers | | $ | 6,490 | | $ | 9,146 | | $ | 21 | | $ | 15,657 | |
Intersegment revenues | | | - | | | 15 | | | - | | | 15 | |
Segment gross profit | | | 1,540 | | | 1,676 | | | 21 | | | 3,237 | |
Segment income | | | 63 | | | 85 | | | 16 | | | 164 | |
Six months ended June 30, 2004: | | | | | | | | | | | | | |
Revenues from external customers | | $ | 5,764 | | $ | 8,766 | | $ | 25 | | $ | 14,555 | |
Intersegment revenues | | | - | | | - | | | - | | | - | |
Segment gross profit | | | 1,258 | | | 1,793 | | | 25 | | | 3,076 | |
Segment income | | | 185 | | | 291 | | | 7 | | | 483 | |
Three months ended June 30, 2005: | | | | | | | | | | | | | |
Revenues from external customers | | $ | 3,116 | | $ | 3,965 | | $ | 17 | | $ | 7,098 | |
Intersegment revenues | | | - | | | 5 | | | - | | | 5 | |
Segment gross profit | | | 667 | | | 703 | | | 17 | | | 1,387 | |
Segment income (loss) | | | (4 | ) | | (53 | ) | | 14 | | | (43 | ) |
Three months ended June 30, 2004: | | | | | | | | | | | | | |
Revenues from external customers | | $ | 2,854 | | $ | 4,427 | | $ | 19 | | $ | 7,300 | |
Intersegment revenues | | | - | | | - | | | - | | | - | |
Segment gross profit | | | 664 | | | 843 | | | 19 | | | 1,526 | |
Segment income | | | 122 | | | 93 | | | 10 | | | 225 | |
___________
(*) 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
| | Six months ended June 30, | | Three months ended June 30, | |
| | | 2004 | | | 2005 | | | 2004 | | | 2005 | |
Total income (loss) for reportable segments | | $ | 476 | | $ | 148 | | $ | 215 | | $ | (57 | ) |
Other operational segment income | | | 7 | | | 16 | | | 10 | | | 14 | |
Total operating income (loss) | | | 483 | | | 164 | | | 225 | | | (43 | ) |
Net loss of corporate headquarters | | | (535 | ) | | (797 | ) | | (35 | ) | | (352 | ) |
Share of losses in Comverge | | | (684 | ) | | (380 | ) | | (331 | ) | | (179 | ) |
Discontinued operations income | | | 348 | | | - | | | 348 | | | - | |
Total consolidated net income (loss) | | $ | (388 | ) | $ | (1,013 | ) | $ | 207 | | $ | (574 | ) |
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (unaudited)
(in thousands except per share data)
Note 8: Subsequent Event
On July 27, 2005 the Company entered into a definitive agreement for the sale of dsIT's outsourcing consulting business to Taldor for approximately $6 million in cash. The operations to be sold under that agreement are comprised of dsIT's business of providing computer software and systems professionals on an outsourcing basis to clients in Israel. Pursuant to the agreement, Taldor will pay $6 million for all of the dsIT shares. The price is subject to adjustment under the terms set forth in the agreement. The Company’s net share of the purchase price is expected to be approximately $3.5 million.
Prior to the consummation of the sale, dsIT will complete a spin-off and a reorganization of its project development services and solutions activities, subsequent to which the Company will own 80% of the entity which will continue to conduct these activities. Under the terms of the definitive agreement, at the closing Taldor will receive a warrant to purchase 10% of this entity.
The closing of the transaction is subject to consents and approvals, including approval of various Israeli government authorities, dsIT’s banks and certain other parties.
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 in this report 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, 2004.
Overview and Trend Information
During the periods included in this report, we operated in two reportable segments: software consulting and development 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
On July 27, 2005 we entered into a definitive agreement for the sale of dsIT's outsourcing consulting business. These operations accounted for approximately two thirds of this segment’s revenues during recent quarters. Subsequent to the sale, segment revenues will be from dsIT’s project development services and solutions activities. dsIT provides both defense and commercial solutions. Its defense solutions focus particularly on sonar technology and include:
- | Diver Detection Sonar (DDS); |
- | Mobile Acoustic Range (MAR); |
- | Harbor Surveillance System (HSS); and |
- | Generic sonar simulator solutions, sonar system upgrades and underwater navigation systems. |
dsIT’s commercial IT solutions include:
- | OncoPro™, a cutting edge solution that integrating patient data with medical knowledge bases, and enabling simplified management of daily ward functions and creation of complex protocols, and; |
- | EasyBill, a customer care and billing system for small and midsize companies. |
The closing of the transaction is subject to consents and approvals, including approval of various Israeli government authorities, dsIT’s banks and certain other parties.
Computer Hardware Sales
Computer hardware sales and gross profit margins in the second quarter of 2005 were lower than those in previous quarters, however we believe they will increase in the third quarter of this year.
To offset the concentration and volatility in the hardware resale market, we continue to seek to diversify our revenue base and have initiated efforts to augment with more value added software products and services. We currently expect the increase in the coming quarters of 2005, to come also from new VAR activity in the area of integrated hardware/software security solutions for computer LAN and WAN networks and related services, leveraging our existing VAR customer base.
Energy Intelligence Solutions
Although we no longer control Comverge, we have invested in it significantly and it continues to have a material effect on our consolidated results.
Comverge has recently partnered with Tampa Electric to launch a price responsive load control pilot, utilizing Comverge’s MaingateTM Home system. This system will seek to examine the impacts of critical peak pricing on reducing Tampa Electric’s winter and summer peaks. In addition, over the next year and a half, Progress Energy Florida will be installing 6,000 of Comverge’s Service Reconnect/Disconnect Devices (SARD TM).
Due to the structure of its largest VPC contract, Comverge’s results continue to suffer from revenue recognition constraints. Due to the conditions of that contract, recognition of revenues is dependent on the results of certain tests, which can only be performed in the summer months. Accordingly Comverge’s revenues from this contract are expected to be seasonal, with the third quarter providing most of the increase in sales.
Comverge’s continued marketing, installation and development of product require significant financial resources. To the extent required, it intends to utilize and further increase it’s bank credit lines and seek additional investor financing.
Corporate
Over the past year we have been in the process of evaluating and exploring different restructuring, acquisitions or mergers and/or other strategic alternatives. This process has required the devotion of significant time and resources by our management as well as by our legal and accounting advisors. As mentioned above, this process has culminated with the signing of a definitive agreement for the sale of dsIT’s outsourcing consulting business. After we’ve obtained the consents and approvals required for closing this sale, management will consider the alternatives then available for DSSI’s continued growth.
Results of Operations
The following table sets forth certain information with respect to the consolidated results of operations of the Company for the three and six months ended June 30, 2004 and 2005, 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.
| | Six months ended June 30, | | Three months ended June 30, | |
| | 2004 | | 2005 | | Change | | 2004 | | 2005 | | Change | |
| | | ($,000) | | | % of sales | | | ($,000) | | | % of sales | | | % of 2004 | | | ($,000) | | | % of sales | | | ($,000) | | | % of sales | | | % of 2004 | |
Sales | | $ | 14,555 | | | 100 | % | $ | 15,657 | | | 100 | % | | 8 | % | $ | 7,300 | | | 100 | % | $ | 7,098 | | | 100 | % | | (3 | )% |
Cost of sales | | | 11,479 | | | 79 | | | 12,420 | | | 79 | | | 8 | | | 5,774 | | | 79 | | | 5,711 | | | 80 | | | (1 | ) |
Gross profit | | | 3,076 | | | 21 | | | 3,237 | | | 21 | | | 5 | | | 1,526 | | | 21 | | | 1,387 | | | 20 | | | (9 | ) |
R&D expenses | | | - | | | 0 | | | 26 | | | 0 | | | | | | - | | | 0 | | | 17 | | | 0 | | | | |
SMG&A expenses | | | 3,328 | | | 23 | | | 3,614 | | | 23 | | | 9 | | | 1,498 | | | 21 | | | 1,722 | | | 24 | | | 15 | |
Operating income (loss) | | | (252 | ) | | (2 | ) | | (403 | ) | | (3 | ) | | 60 | | | 28 | | | 1 | | | (352 | ) | | (5 | ) | | (1,357 | ) |
Interest expense, net | | | (9 | ) | | 0 | | | (94 | ) | | (1 | ) | | 944 | | | 46 | | | 1 | | | (41 | ) | | (1 | ) | | (189 | ) |
Other income, net | | | 237 | | | 2 | | | 60 | | | 0 | | | (75 | ) | | 136 | | | 2 | | | 55 | | | 1 | | | (60 | ) |
Income (loss) before taxes on income | | | (24 | ) | | 0 | | | (437 | ) | | (3 | ) | | 1,721 | | | 210 | | | 3 | | | (338 | ) | | (5 | ) | | (261 | ) |
Taxes on income | | | (20 | ) | | 0 | | | 137 | | | 1 | | | (785 | ) | | (13 | ) | | 0 | | | 40 | | | 1 | | | (408 | ) |
Income (loss) from operations of the Company and its consolidated subsidiaries | | | (4 | ) | | 0 | | | (574 | ) | | (4 | ) | | | | | 223 | | | 3 | | | (378 | ) | | (5 | ) | | (270 | ) |
Share in losses of Comverge | | | (684 | ) | | (5 | ) | | (380 | ) | | (2 | ) | | (44 | ) | | (331 | ) | | (5 | ) | | (179 | ) | | (3 | ) | | (46 | ) |
Minority interests | | | (48 | ) | | 0 | | | (59 | ) | | 0 | | | 23 | | | (33 | ) | | 0 | | | (17 | ) | | 0 | | | (48 | ) |
Net loss from continuing operations | | | (736 | ) | | (5 | ) | | (1,013 | ) | | (6 | ) | | 38 | | | (141 | ) | | (2 | ) | | (574 | ) | | (8 | ) | | 307 | |
Net income from discontinued operations, net of tax | | | 348 | | | 2 | | | - | | | - | | | (100 | ) | | 348 | | | 5 | | | - | | | - | | | (100 | ) |
Net income (loss) | | $ | (388 | ) | | (3 | ) | $ | (1,013 | ) | | (6 | ) | | 161 | | $ | 207 | | | 3 | % | $ | (574 | ) | | (8 | ) | | (377 | ) |
Sales. Sales in the first six months of 2005 increased by $1.1 million, from $14.6 million in the first six months of 2004, to $15.7 million in 2005. This increase was due to increased sales in both segments, particularly in the first quarter of this year. Sales in the second quarter of 2005 decreased in comparison to those in the second quarter of 2004. The decrease in sales was due to a $0.5 million decrease in computer hardware sales, partially offset by a $0.3 million increase in software consulting and development sales.
Gross profit. Gross profit in the first six months of 2005 increased by $0.2 million, compared to the first six months of 2004, due to increased gross profit in both segments, in the first quarter of this year. Gross profit in the second quarter of 2005 decreased by $0.1 million, in comparison to the second quarter of 2004, due a decrease in gross profit in our computer hardware segment.
Selling, marketing, general and administrative expenses (“SMG&A”). SMG&A in the first six months and second quarter of 2005 increased by $0.3 million and $0.2 million, respectively, as compared to the same periods in 2004. The increase was due to increased compensation expenses and professional fees. Although we expect this increased level of expense to continue in the third quarter, they are expected to decrease significantly in the fourth quarter of this year with the closing of the transaction for the sale of dsIT’s outsourcing consulting business.
Share of losses in Comverge. Our share of Comverge's $6.1 million and $3.0 million of net losses in the first six months and second quarter of 2005, was $0.4 million and $0.2 million, respectively. As the carrying value of our investment in Comverge's common stock and preferred stock has been reduced to zero, we will no longer be recording equity losses in Comverge. In the future, when Comverge begins to show profit, after it has reached the level of equity whence we ceased recording equity losses, we will record 7% of that income as equity income to our preferred investment up to our original $3.6 million preferred share investment in Comverge, and thereafter to our investment in Comverge’s common shares, of which we currently own approximately 76%.
Other income. Other income in the first six months and second quarter of 2004 was primarily due to our then receiving a decision from the Israeli Supreme Court in our dispute with an Israeli bank. In its decision, the Court reversed the district court’s award for costs in favor of the bank for which we had had previously accrued. The court also remanded to the district court our claims against the bank for a determination as to the amount of damages.
Liquidity and Capital Resources
As of June 30, 2005, we had working capital of $0.4 million, including $0.3 million in non-restricted cash and cash equivalents. Net cash used in the first six months of 2005 was $0.4 million. Net cash of $0.6 million was used in operating activities during the first six months of 2005. The net loss for the six-month period ended June 30, 2005 of $1.0 million was primarily due to our share of unconsolidated losses of Comverge of $0.4 million and corporate expenses of $0.8 million. Our use of cash in operating activities during the first six months of 2005 was primarily due to increases in accounts receivables, unbilled work-in-process and other current assets as well as reductions in accounts payable and other liabilities of $0.2 million, net. Net cash of $0.2 million provided by financing activities was primarily from the proceeds of a note payable to a related party of $0.1 million.
Of the total working capital at June 30, 2005, approximately $0.5 million was in our majority owned dsIT Technologies Ltd. subsidiary (dsIT). Due to Israeli tax and company law constraints, as well as the significant minority interest in dsIT, such working capital and cash flows from dsIT’s operations are not readily available to finance U.S. activities.
As of July 31, 2005 our wholly owned US operations (i.e., excluding dsIT and Comverge) had an aggregate of $0.3 million in unrestricted cash and cash equivalents, reflecting a $0.4 million decrease from the balance as of December 31, 2004.
On July 27, 2005, we and the other shareholders in dsIT entered into a definitive agreement for the sale of dsIT's outsourcing consulting business to Taldor Computer Systems (1986) Ltd. (TASE: TALD) for approximately $6 million in cash. The price is subject to adjustment under the terms set forth in the agreement. Our net share of the purchase price is expected to be approximately $3.5 million. We intend to fund our activities with the cash from this sale as well as with the cash available and anticipated profits from operations. The closing of the transaction is subject to consents and approvals, including approval of various Israeli government authorities, dsIT’s banks and certain other parties.
To finance our activities we require the proceeds from this transaction. The proceeds from the expected closing will provide more than sufficient liquidity for our activities for the forseeable future and the next 12 months in particular.
Contractual Obligations and Commitments
Our contractual obligations and commitments at June 30, 2005, excluding certain severance arrangements described below, principally include obligations associated with our outstanding indebtedness, future minimum operating lease obligations and contractual obligations to our CEO for payments for his post-retirement consulting services to us, are as set forth in the table below.
| | Cash Payments Due During Year Ending June 30, | |
| | (amounts in thousands) | |
Contractual Obligations | | Total | | 2006 | | 2007-2008 | | 2009-2010 | | 2011 and thereafter | |
Long-term debt | | $ | 567 | | $ | 401 | | $ | 138 | | $ | 28 | | $ | -- | |
Contingent performance of bank guarantees (1) | | | 410 | | | 410 | | | -- | | | -- | | | -- | |
Operating leases | | | 2,999 | | | 1,130 | | | 1,471 | | | 398 | | | -- | |
Potential severance obligations to Israeli employees (2) | | | 4,270 | | | 2 | | | 70 | | | 29 | | | 4,169 | |
Consulting agreement with CEO (3) | | | 1,500 | | | 300 | | | 600 | | | 375 | | | 225 | |
Purchase commitments | | | -- | | | -- | | | -- | | | -- | | | -- | |
Other long-term liabilities reflected on the balance sheet in accordance with GAAP | | | -- | | | -- | | | -- | | | -- | | | -- | |
Total contractual cash obligations | | $ | 9,746 | | $ | 2,243 | | $ | 2,279 | | $ | 830 | | $ | 4,394 | |
We expect to finance these contractual commitments from cash on hand, cash from the pending sale of dsIT's outsourcing consulting business and cash generated from operations.
(1) Previously, we accrued a loss for contingent performance of bank guarantees. Our remaining commitment under these guarantees is $0.4 million at June 30, 2005. We have collateralized a portion of these guarantees by means of a deposit of $0.2 million as of June 30, 2005. The obligation is presented as a current liability, though it is uncertain as to when actual payment may be made.
(2) Under Israeli law and labor agreements, dsIT is required to make severance payments to dismissed employees and to employees leaving employment under certain other circumstances. The obligation for severance pay benefits, as determined by the Israeli Severance Pay Law, is based upon length of service and last salary. These obligations are substantially covered by regular deposits with recognized severance pay and pension funds and by the purchase of insurance policies. As of June 30, 2005, we accrued a total of $4.3 million for potential severance obligations which is included in long term liabilities, of which approximately $2.7 million was funded with cash to insurance companies.
(3) Under the terms of his employment agreement with us, as amended, we have an obligation to continue to pay our Chief Executive Officer consulting fees over a seven-year period starting January 1, 2005. As a result, during the coming four years, through 2008, we have to pay our CEO $240,000 per year, equal to 50% of his salary in effect as of December 31, 2003. From 2009 through 2011, we must pay $120,000 per year, equal to 25% of that salary. In addition, we must pay contributions to a non-qualified defined contribution retirement plan equal to 25% of the consulting fee. In accordance with the employment contract, we are obliged to fund 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 allow us not to so fund such amounts until the earlier of (i) June 30, 2006, (ii) his termination as CEO, or (iii) the closing of a transaction with gross proceeds to us of at least $1.5 million.
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 incurred to finance our operations in Israel, currently $0.9 million. Additionally, our monetary assets and liabilities (net liability of approximately $0.6 million) 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
Within 90 days prior to the date of filing of 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
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.
PART II - Other information
Item 1. Legal Proceedings
None
Item 6. Exhibits
| 31.1 | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2 | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 99.1 | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 99.2 | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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.
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| DATA SYSTEMS & SOFTWARE INC. |
| | |
Date: August 15, 2005 | By: | /s/ Yacov Kaufman |
| Yacov Kaufman |
| Vice President and Chief Financial Officer |