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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999 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
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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
Number of shares outstanding of the registrant's common stock, as of
October 31, 1999: 7,433,278
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DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets
as of December 31, 1998 and September 30, 1999..............1
Consolidated Statements of Operations
for the three month and nine month periods ended
September 30, 1998 and September 30, 1999...................2
Consolidated Statement of Changes in Shareholders' Equity
for the nine month period ended
September 30, 1999..........................................3
Consolidated Statements of Cash Flows
for the nine month periods ended
September 30, 1998 and September 30, 1999...................4
Notes to Consolidated Financial Statements.......................6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations......................9
PART II. Other Information
Item 2. Changes in Securities and Use of Proceeds...........................13
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 "the
Company expects," "the Company anticipates," "the Company believes," "the
Company estimates," and other phrases of similar meaning. Whether such
statements ultimately prove to be accurate depends upon a variety of factors
that may affect the business and operations of the Registrant.
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(dollars in thousands, except share data)
As of As of
December 31, September 30,
ASSETS 1998 1999
------------ -------------
(unaudited)
Current assets:
Cash and cash equivalents $ 1,003 $ 467
Short-term interest bearing bank deposits 1,252 243
Marketable equity securities, available for sale 1,383 --
Restricted cash 752 209
Trade accounts receivable, net 7,244 8,614
Inventory 704 2,399
Other current assets 960 941
-------- --------
Total current assets 13,298 12,873
-------- --------
Investments 56,490 48,700
-------- --------
Property and equipment, net 1,738 3,121
-------- --------
Other assets:
Goodwill, net 190 2,635
License, net 471 412
Other 1,057 946
-------- --------
1,718 3,993
-------- --------
Total assets $ 73,244 $ 68,687
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term debt $ 470 $ 7,699
Current maturities of long-term debt 504 90
Trade accounts payable 2,105 4,653
Accrued payroll, payroll taxes and social benefits 2,561 1,661
Other current liabilities 1,939 1,968
-------- --------
Total current liabilities 7,579 16,071
-------- --------
Long-term liabilities:
Long-term debt, net of current maturities 102 30
Other 585 609
-------- --------
Total long term liabilities 687 639
-------- --------
Commitments and contingencies
Minority interests 25,560 21,298
-------- --------
Shareholders' equity:
Common stock - $.01 par value per share:
Authorized, 20,000,000 shares;
Issued, 7,923,540 shares 79 79
Additional paid-in capital 34,979 35,051
Deferred compensation expense (327) (136)
Retained earnings 6,942 (1,950)
-------- --------
41,673 33,044
Treasury stock, at cost - 490,262 shares (2,365) (2,365)
Accumulated other comprehensive income 110 --
-------- --------
Total shareholders' equity 39,418 30,679
-------- --------
Total liabilities and shareholders' equity $ 73,244 $ 68,687
======== ========
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 per share data)
Nine months ended Three months ended
September 30, September 30,
----------------------- -----------------------
1998 1999 1998 1999
-------- -------- -------- --------
Sales:
Products $ 15,029 $ 10,632 $ 3,205 $ 4,315
Services 14,573 14,526 4,946 4,902
-------- -------- -------- --------
29,602 25,158 8,151 9,217
-------- -------- -------- --------
Cost of sales:
Products 11,865 9,007 2,587 4,022
Services 11,192 10,937 3,864 3,460
-------- -------- -------- --------
23,057 19,944 6,451 7,482
-------- -------- -------- --------
Gross profit 6,545 5,214 1,700 1,735
Research and development
expenses, net 1,254 777 496 196
Selling, general and
administrative expenses 10,581 8,842 2,825 3,180
-------- -------- -------- --------
Operating loss (5,290) (4,405) (1,621) (1,641)
Interest income 144 293 19 4
Interest expense (215) (275) (49) (160)
Gain on sale of division 5,998 -- -- --
Other expense, net (2,126) (263) (1,744) (242)
-------- -------- -------- --------
Loss before income taxes (1,489) (4,650) (3,395) (2,039)
Provision for income taxes 32 32 (41) 20
-------- -------- -------- --------
Loss after income taxes (1,521) (4,682) (3,354) (2,059)
Minority interests 579 204 184 95
Loss in affiliates, net of minority
interests (2,932) (4,414) (1,336) (1,140)
-------- -------- -------- --------
Net loss $ (3,874) $ (8,892) $ (4,506) $ (3,104)
======== ======== ======== ========
Basic and diluted net loss per share $ (0.53) $ (1.20) $ (0.62) $ (0.42)
======== ======== ======== ========
Weighted average number of shares
outstanding 7,359 7,433 7,310 7,433
======== ======== ======== ========
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
(in thousands)
Accumulated
Additional Deferred other
Common paid-in comp- Treasury Retained comprehensive
Shares stock capital ensation stock earnings income Total
--------- --------- --------- ---------- --------- -------- ------ -----
Balances as of
January 1, 1999 7,924 $ 79 $ 34,979 $ (327) $ (2,365) $ 6,942 $ 110 $ 39,418
Amortization of warrants 27 27
Amortization of restricted
stock award compensation
and warrants 45 191 236
Unrealized gain on securities
available for sale (110) (110)
Net loss (8,892) (8,892)
--------- --------- --------- --------- --------- ---------- -------- ---------
Balances as of
September 30, 1999
(unaudited) 7,924 $ 79 $ 35,051 $ (136) $ (2,365) $ (1,950) $ -- $ 30,679
========= ========= ========= ========== ========== ========== ======== ========
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)
Nine months ended
September 30,
---------------------
1998 1999
------- -------
Cash flows used in operating activities:
Net loss $(3,874) $(8,892)
Adjustments to reconcile net loss to net cash used
in operating activities - see Schedule A (79) 3,208
------- -------
Net cash used in operating activities (3,953) (5,685)
------- -------
Cash flows provided by (used in) investing activities:
Short-term and long-term bank deposits, net (1,965) 1,009
Restricted cash 1,134 543
Investment in marketable securities (5,898) --
Proceeds from realization of marketable securities 6,528 1,520
Net proceeds from sale of division-see Schedule B 6,595 --
Acquisitions of property and equipment (821) (2,139)
Proceeds from sale of property and equipment 135 117
Acquisition of intangible assets (474) (2,692)
------- -------
Net cash provided by (used in) investing activities 5,234 (1,642)
------- -------
Cash flows provided by (used in) financing activities:
Proceeds from issuance of common stock, net 55 46
Purchase of treasury stock (495) --
Proceeds from sale of shares received in partial
conversion of note receivable 1,871 --
Short-term debt, net (2,303) 7,229
Proceeds of long-term debt 102 39
Repayments of long-term debt (880) (523)
------- -------
Net cash provided by (used in) financing activities (1,650) 6,791
------- -------
Net decrease in cash and cash equivalents (369) (536)
Cash and cash equivalents at beginning of period 1,424 1,003
------- -------
Cash and cash equivalents at end of period $ 1,055 $ 467
======= =======
Supplemental cash flow information:
Cash paid during the period for:
Interest $ 172 $ 188
======= =======
Income taxes $ 151 $ 44
======= =======
The accompanying notes are an integral part
of these consolidated financial statements.
-4-
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Schedules To Consolidated Statements of Cash Flows (unaudited)
(dollars in thousands)
Nine months ended September 30,
-------------------------------
1998 1999
------- -------
A. Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization $ 822 $ 906
Minority interests (2,591) (3,928)
Allowance for writeoff against note receivable 610 --
Allowance for bank guarantees for affiliate 1,135 --
Writeoff of investment in affiliate and related receivables 256 --
Earnings on marketable debt securities (30) --
Deferred interest -- 27
Increase in liability for severance pay 195 24
Loss in affiliates 4,954 7,454
Gain on sale of division - See Schedule B (5,998) --
Gain on sale of securities (192) (247)
(Gain) loss on sale of property, plant and equipment, net (38) 38
Amortization of restricted stock award compensation 147 191
Other (4) --
Decrease (increase) in accounts receivable and other current assets 1,355 (1,351)
Increase in inventory (490) (1,695)
Decrease in long-term receivables 97 111
Increase (decrease) in accounts payable and other current liabilities (372) 1,677
Increase (decrease) in liability in respect of customer advances, net 65 --
------- -------
$ (79) $ 3,207
======= =======
B. Assets/liabilities transferred upon sale of division:
Trade accounts receivable, net $ 754
Property and equipment, net 405
Accrued payroll, payroll taxes and social benefits (111)
Other current liabilities (452)
-------
$ 596
=======
C. Non-cash activities:
Issuance of 250,000 warrants to lender in connection with loan received $ 318
=======
Receipt of capital stock in partial conversion of note receivable $ 1,871
=======
The accompanying notes are an integral part
of these consolidated financial statements.
-5-
DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (unaudited)
(dollars in thousands)
Note 1: Basis of Presentation
In the opinion of the Company, all adjustments necessary for a fair
presentation have been reflected herein. Certain financial information, which is
normally included in financial statements prepared in accordance with generally
accepted accounting principles but which is not required for interim reporting
purposes, has been omitted. The accompanying consolidated financial statements
should be read in conjunction with the financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 1998. Certain amounts included in the consolidated statements of operations
for the three and nine month periods ended September 30, 1998 have been
reclassified to conform with current presentation. The results of operations for
the nine months ended September 30, 1999 are not necessarily indicative of the
results to be expected for the full year.
Note 2: Investment in Tower
Although the Company maintains the effective control of Tower Semiconductor
Ltd. ("Tower"), the Company does not have voting control of Tower and therefore
consolidates Tower's operations on an equity basis.
Summarized statement of operations information of Tower is as follows:
Nine months ended September 30, Three months ended September 30,
------------------------------ -------------------------------
1998 1999 1998 1999
---- ---- ---- ----
Sales $ 52,926 $ 47,332 $ 15,167 $ 18,190
Gross loss (4,939) (8,500) (2,691) (624)
Research and development expenses 6,104 6,956 1,894 2,131
Sales, general and administrative 6,292 6,371 2,254 2,339
Operating loss (17,335) (21,827) (6,839) (5,094)
Note 3: Effects of Recently Issued Accounting Standards
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities." SFAS 133 establishes accounting and
reporting standards for derivative instruments and for hedging activities,
requiring the recognition of all derivatives as either assets or liabilities and
the measurement of those instruments at fair value, as well as the
identification of the conditions for which a derivative may be specifically
designed as a hedge. SFAS 133 is effective for fiscal years beginning after June
15, 2000. Management is currently addressing the financial reporting measures
that will be needed in order to comply with this disclosure requirement.
Note 4: Acquisition
In the third quarter of 1999, the Company has acquired the assets of the
Control Systems division of Scientific-Atlanta, Inc., making it an integral part
of the Company's data communications solutions for utilities segment. The
purchase price for the acquisition, including cash paid, contingent payments and
fees related to the transaction, was $4,181, of which, $1,862 was allocated to
inventory, $1,810 to property and equipment and $509 to patents and patents
pending. The patents and patents pending are being amortized over the remaining
life of the patent, 15 years from patent approval. The acquisition has been
accounted for by the purchase method of accounting and accordingly, the purchase
price has been allocated to the assets acquired based on their estimated fair
value at the date of the acquisition. The valuation of these acquired assets is
preliminary and as a result, the allocation among the different assets may
change. In addition, the purchase price is subject to certain adjustments a year
after the closing in the third quarter of 2000.
The Company financed the acquisition with a short term bank loan, bearing
interest of prime +1% per annum payable monthly, with the principal payable in
August 2000. In addition, the Company issued to the lender 250,000 warrants to
purchase Common Stock of the Company, with an exercise price of $3.31 per share,
the fair market value of the Company's Common Stock on the date of the grant,
expiring on August 30, 2002. The Company recorded $318 of deferred interest
expense related to the issuance of the warrants, using the Black Scholes option
pricing model to determine the fair value of the warrants. The Company amortizes
the deferred interest expense over the life of the short term bank loan. The
loan is secured by substantially all the Company's assets.
-6-
Pro Forma Operations Data. The following pro forma statements of operations
information gives effect to this acquisition, assuming it had been consummated
at the beginning of the earliest period presented:
Nine months ended September 30,
1998 1999
-------- ---------
Revenues $ 39,667 $ 29,985
Net loss (9,114) (10,873)
Net loss per share $ (1.24) $ (1.46)
The pro forma information is not necessarily indicative of the results that
would actually have occurred had the transactions been consummated on the dates
indicated, nor are they necessarily indicative of future operating results of
the Company.
Note 5: Segment Information
Computer VAR Data Multimedia
consulting computer communication Help desk entertainment
services hardware for utilities software software Other* Total
-------- -------- ------------- -------- -------- ------ -----
Nine months ended September 30, 1999:
Revenues from external customers .............. $ 13,753 $ 9,218 $ 1,360 -- $ 38 $ 519 $ 24,888
Intersegment revenues ......................... 113 26 331 -- -- -- 470
Segment profit (loss) ......................... (21) 74 (2,688) -- 22 (305) (2,918)
Nine months ended September 30, 1998:
Revenues from external customers .............. $ 13,967 $ 13,502 $ 175 $ 785 $ 123 $ 780 $ 29,332
Intersegment revenues ......................... 103 18 -- -- 158 -- 279
Segment profit (loss) ......................... 5,898 1,466 (2,573) (1,330) (651) (251) 2,559
Three months ended September 30, 1999:
Revenues from external customers .............. $ 4,123 $ 4,072 $ 718 -- $ -- $ 214 $ 9,127
Intersegment revenues ......................... 27 10 (15) -- -- -- 22
Segment profit (loss) ......................... (289) 151 (1,326) -- 1 31 (1,432)
Three months ended September 30, 1998:
Revenues from external customers .............. $ 4,750 $ 3,079 $ -- -- $ 30 $ 151 $ 8,010
Intersegment revenues ......................... 42 7 -- -- -- -- 49
Segment profit (loss) ......................... -- 241 (1,060) -- (55) (24) (898)
- ----------
* Represents two operating segments below the quantitative thresholds of FAS
131, a VAR software operation in Israel and an Internet database venture.
Reconciliation of Segment Profit to Consolidated Net Loss Nine months ended
September 30, 1999:
Total loss for reportable segments $(2,613)
Other operational segment loss (305)
Unallocated amounts: Net loss of corporate headquarters* (5,974)
-------
Total consolidated net loss $(8,892)
=======
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* Includes equity in losses of Tower (net of minority interest) of
$4,342.
Nine months ended September 30, 1998:
Total income for reportable segments $ 2,810
Other operational segment loss (251)
Unallocated amounts: net loss of corporate headquarters* (6,433)
-------
Total consolidated net income $(3,874)
=======
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* Includes equity in losses of Tower (net of minority interest) of
$2,821.
-7-
Three months ended September 30, 1999:
Total loss for reportable segments $(1,463)
Other operational segment profit 31
Unallocated amounts: Net loss of corporate headquarters* (1,672)
-------
Total consolidated net loss $(3,104)
=======
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* Includes equity in losses of Tower (net of minority interest) of
$1,115.
Three months ended September 30, 1998:
Total loss for reportable segments $ (874)
Other operational segment loss (24)
Unallocated amounts: Net loss of corporate headquarters* (3,608)
-------
Total consolidated net loss $(4,506)
=======
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* Includes equity in losses of Tower (net of minority interest) of
$1,299.
Note 6: Contingencies
Tower has been approached separately by two parties alleging that Tower is
infringing on certain semiconductor production patents owned by such parties and
requesting that Tower enter into negotiations for a royalty-bearing license for
the use of the technology covered by such patents.
Tower has successfully obtained, without royalty or other payments, a
license to use such technology from one of the parties and is engaged in
discussions with the other party to determine the merits of its claims. Tower
and the Company are unable to determine at this time with any certainty the
ultimate outcome of these discussions or the possible effect, if any, of this
matter on Tower's and the Company's financial condition, operating results and
business.
Note 7: Purchase of Outstanding Minority Interest in Subsidiary
In April 1999, the Company completed successfully a tender offer for all of
the publicly-held shares of a foreign subsidiary. The Company recorded goodwill
resulting from the purchase of the outstanding minority interest in the
subsidiary of approximately $2,200, which is being amortized over seven years.
The cost of the tender offer was approximately $2,700. The Company financed the
offer primarily by short-term bank credit and cash.
Note 8: Subsequent Event
In October 1999, the Company completed a private placement of $2,000 of 0%
Convertible Subordinated Debentures (the "Debentures") and 100,000 warrants to
purchase Common Stock of the Company. The Company also issued 20,000 warrants as
compensation to a finder in connection with the placement. The Debentures, which
are payable in October 2001, do not bear interest. Interest will be imputed on
the debentures and will be amortized over the life of the Debentures. The
Debentures are convertible into Common Stock of the Company at a conversion
price equal to the lower of (i) $3.06625 and (ii) 85% of the average of the
closing bid prices for the Common Stock for the five trading days preceding
delivery of a notice of conversion. The Company intends to record deferred
interest expense related to the issuance of the warrants using the Black Scholes
option pricing model to determine the fair value of the warrants, amortizing the
deferred interest over the life of the Debenture. A charge related to the
discount on conversion feature of the Debentures will be recorded and amortized
as interest expense over the life of the Debentures. The warrants are
exercisable at a price of $3.06625 per share and expire in October 2002.
-8-
Management's Discussion and Analysis of
Financial Condition and Results of Operations
General
Data Systems & Software Inc. through its subsidiaries in the United States
and in Israel (collectively, the "Company"), (i) provides consulting and
development services for computer software and systems, (ii) is an authorized
dealer and a value-added-reseller ("VAR") of computer hardware, and (iii) is a
provider of data communications solutions for utilities. Through its equity
investment in Tower Semiconductor Ltd. ("Tower"), the Company also engages in
the manufacture of semiconductor products. Although the Company has retained
effective control of Tower, the Company does not control more than 50% of
Tower's voting shares, and accordingly accounts for its interest in Tower's
results under the equity investment method.
The Company's future operating results are subject to various risks and
uncertainties. See "Item 1. Business - Factors Which May Affect Future Results"
in the Company's Annual Report on Form 10-K for the year ended December 31, 1998
(the "1998 10-K").
Results of Operations
The following table sets forth certain information with respect to the
results of operations of the Company for the nine months and three months ended
September 30, 1998 and 1999, including the percentage of total revenues during
each period attributable to selected components of operations statement data,
and for the period to period percentage changes in such components.
Nine months ended September 30, Three months ended September 30,
----------------------------------- Change ----------------------------------------- Change
from from
1998 1999 1998 1998 1999 1998
--------------- --------------- ---- ----------------- -------------------- ----
% of % of % of % of % of % of
($,000) sales ($,000) sales 1998 ($,000) sales ($,000) sales 1998
------- ----- ------- ----- ---- ------- ----- ------- ----- ----
Sales $ 29,602 100% $ 25,158 100% (15)% $ 8,151 100% $ 9,217 100% 13%
Cost of sales 23,057 78 19,944 79 (14) 6,451 79 7,482 81 16
-------- --- -------- --- -------- --- -------- ---
Gross profit 6,545 22 5,214 21 (20) 1,700 21 1,735 19 2
R&D expenses, net 1,254 4 777 3 (38) 496 6 196 2 (60)
SG&A expenses 10,581 36 8,842 35 (16) 2,825 35 3,180 35 13
-------- --- -------- --- -------- --- -------- ---
Operating loss (5,290) (18) (4,405) (17) (17) (1,621) (20) (1,641) (18) 1
Interest income (expense),
net (71) (--) 18 -- 125 (30) -- (156) (2) (420)
Gain on sale of division 5,998 20 -- -- (100) -- -- -- --
Other expense, net (2,126) (7) (263) (1) 88 (1,744) (21) (242) (3) 86
-------- --- -------- --- -------- --- -------- ---
Loss before income taxes (1,489) (5) (4,650) (18) (212) (3,395) (41) (2,039) (23) 40
Income tax expense 32 -- 32 -- -- (41) -- 20 -- (149)
-------- --- -------- --- -------- --- -------- ---
Loss after income taxes (1,521) (5) (4,682) (18) (208) (3,354) (41) (2,059) (23) 39
Minority interests 579 2 204 1 (65) 184 2 95 1 (48)
Loss in affiliates,
net of minority
interests (2,932) (10) (4,414) (18) (51) (1,336) (16) (1,140) (12) 15
-------- --- -------- --- -------- --- -------- ---
Net loss $ (3,874) (13)% $ (8,892) (35)% (130)% $ (4,506) (55)% $ (3,104) (34)% 32%
======== === ======== === ======== === ======== ===
SALES. The increase in sales in the third quarter of 1999 as compared to
the same period in 1998, was primarily due to increased sales in the data
communication solutions for utilities segment, as well as increased VAR computer
hardware segment sales. These improvements were partially offset by a decrease
in sales from computer consulting in Israel. The decrease in sales in the nine
months ended September 30, 1999, as compared to the same periods in 1998, was
primarily due to decreased VAR computer hardware segment sales, the sale of the
former help desk segment and decreased sales from computer consulting in Israel.
This decrease was partially offset by increased sales in the data communication
solutions for utilities segment. Data communication solutions for utilities
sales were up more than 29% and computer hardware VAR sales were up 42% in the
third quarter of 1999 as compared to the immediately preceding quarter.
-9-
GROSS PROFIT. The increase in gross profits in the third quarter of 1999 as
compared to the same period in 1998, was due to increased gross profit in all
areas of activity except for consulting activities in Israel which had lower
gross profits due to the aforementioned decrease in sales. The decrease in gross
profit in the nine months ended September 30, 1999 as compared to the same
period in 1998, was primarily due to the aforementioned decrease in VAR computer
hardware segment sales and decreased consulting services sales in Israel. The
decrease in the gross profit margin in these periods as compared to the
comparable periods in 1998 was primarily the result of decreased gross profit
margins from consulting services provided in Israel and from the VAR computer
hardware segment.
RESEARCH AND DEVELOPMENT ("R&D"). The decrease in R&D in the nine months
and three months ended September 30, 1999, as compared to the same periods in
1998, is due to lower development costs in the Company's data communication for
utilities segment as it shifts the focus of its activities from product
development to the marketing of its products.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A"). The increase in SG&A
in the third quarter of 1999 as compared to the same period in 1998, was
primarily due to increased marketing expenses in the data communication for
utilities segment and the VAR computer hardware segments. The decrease in SG&A
in the nine months ended September 30, 1999, as compared to the same period in
1998, was primarily due to the sale of the former help desk segment and the
suspension of operations of the multimedia entertainment software segment, as
well as reduced corporate SG&A.
OPERATING LOSS. Operating loss in the third quarter of 1999 was relatively
unchanged as compared with the third quarter of 1998, reflecting an increase in
gross profits and reduction in R&D expenses, which were offset by increased SG&A
expenses as described above. The decrease in the operating loss in the nine
months ended September 30, 1999, as compared to the same period in 1998, was
primarily attributable to the decrease in SG&A and R&D, partially offset by the
decrease in gross profit for this period.
OTHER EXPENSE. In 1998 other expense was primarily due to the accrual of
loss contingencies in connection with guarantees by the Company of the debt of
an affiliate and the writeoff of the Company's investment in such affiliate, as
well as to the settlement of certain litigation. In 1999 other expense was
primarily due to writing down of inventories to market value.
SHARE OF AFFILIATED COMPANY'S NET LOSS. The decrease in the equity loss,
net of minority interests, in the third quarter of 1999 as compared to the same
period in 1998, was due to decreased operating losses at Tower, as a result of
increased sales and capacity utilization. The increase in the equity loss in the
nine months ended September 30, 1999 as compared to the same period in 1998,
resulted from increased losses at Tower, primarily attributable to a decrease in
Tower sales and capacity utilization in the first six months of 1999.
NET LOSS. The decrease in net loss in the third quarter of 1999 as compared
to the same period in 1998, was primarily due to other expenses recorded in the
third quarter of 1998. The increased net loss in the nine months ended September
30, 1999 as compared with net loss in the comparable period in 1998 was almost
entirely due to a nonrecurring gain from the sale of the former help desk
segment in the second quarter of 1998 as well as to the aforementioned increase
in equity losses from Tower.
FINANCIAL CONDITION
Liquidity and Capital Resources
As of September 30, 1999, the Company had negative working capital of $3.2
million, including cash, cash equivalents and short term deposits of $710,000.
The Company also had restricted cash of approximately $459,000. DSSI has a
credit line from a bank of up to $2.2 million, which is secured by accounts
receivable and inventory of its US subsidiaries, of which $1.4 million was being
utilized at September 30, 1999.
The negative working capital was primarily due to the Company financing its
recent acquisitions with short term bank loans as described below. The Company
intends to continue financing its operating activities and the service on its
debt for the remainder of 1999 from cash on hand and credit lines, to the extent
available. The Company is also seeking alternative and additional long term
financing for its data communications solutions for utilities segment. The
Company is considering various avenues for financing its ongoing activities,
including the selling of certain assets and obtaining additional financing. To
the extent that these resources are unavailable or insufficient, the Company may
have to curtail and/or discontinue certain of its activities.
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In the second quarter of 1999, the Company completed successfully a tender
offer for all of the publicly-held shares of a foreign subsidiary, approximately
77% of the shares of which it had owned up to the date of the tender offer. The
cost of the tender offer was approximately $2.7 million and was financed
primarily by short-term bank credit and also by cash that resulted in part from
the sale of the balance of the Company's marketable securities for $1.6 million.
In the third quarter of 1999, the Company acquired the assets of the
Control Systems division of Scientific-Atlanta, Inc., making it an integral part
of the Company's data communications solutions for utilities segment. The
purchase price for the acquisition, including cash paid, contingent payments and
fees related to the transaction, was $4.18 million, of which $1.86 million was
allocated to inventory, $1.81 million to property and equipment, and $509,000 to
patents and patents pending. The patents and patents pending are being amortized
over the remaining life of the patent, 15 years from patent approval. The
acquisition has been accounted for by the purchase method of accounting and
accordingly, the purchase price has been allocated to the assets acquired based
on their estimated fair value at the date of the acquisition. The valuation of
these acquired assets is preliminary and as a result, the allocation among the
different assets may change. In addition, the purchase price is subject to
certain adjustments a year after the closing in the third quarter of 2000.
The Company financed the acquisition with a short term bank loan, bearing
interest of Prime +1% per annum, principle payable in August 2000 and interest
paid on a current basis. In addition, the Company issued to the lender 250,000
warrants to purchase Common Stock of the Company. The warrants are exercisable
at an exercise price of $3.31 per share, the fair market value of the Company's
Common Stock on the date of the grant, and expire on August 30, 2002. The
Company recorded $318 of deferred interest expense related to the issuance of
the warrants, using the Black Scholes option pricing model to determine the fair
value of the warrants. The Company amortizes the deferred interest expense over
the life of the short term bank loan. The loan is secured by substantially all
the Company's assets.
The increase in trade accounts receivable during the third quarter of 1999
reflected primarily a higher level of hardware sales during the quarter as well
as sales in the recently expanded data communication segment. The increase in
short term debt was attributable to utilization of the credit line to fund, in
part, the purchase by the Company of the publicly held shares of DSI Israel as
well as short term loans and to finance the aforementioned acquisition of the
Scientific-Atlanta Control Systems division.
In October 1999, the Company completed a private placement of $2 million of
0% Convertible Subordinated Debentures (the "Debentures") and 100,000 warrants
to purchase Common Stock of the Company. The Company also issued 20,000 warrants
as compensation to a finder in connection with the placement. The Debentures,
which are payable in October 2001, do not bear interest. The Debentures are
convertible into Common Stock of the Company at a conversion price equal to the
lower of (i) $3.06625 and (ii) 85% of the average of the closing bid prices for
the Common Stock for the five trading days preceding delivery of a notice of
conversion. The warrants are exercisable at an exercise price of $3.06625 per
share and expire in October 2002. Conversion of the Debentures could result in
significant dilution of the interests of shareholders of the Company.
Year 2000 Disclosure
The Company has conducted a review of its computer systems and operations,
both those for internal use and those developed for customers, to identify and
determine the extent to which any systems may be vulnerable to potential errors
and failures as a result of the "Year 2000 problem." Any of these programs that
have sensitive software could experience system failures or miscalculations and
result in disruption of operations.
The Company has completed a comprehensive review of these computer systems
to ensure that all such systems are Year 2000 compliant prior to the
commencement of the year 2000. The Company's plan for its Year 2000
compatibility effort includes the following: (i) conducting a comprehensive
inventory of the Company's internal systems, including non-information
technology systems (e.g. switching, billing and other platforms and electrical
systems) and any systems intended to be acquired by the Company, (ii) conducting
a comprehensive review of the systems developed by or licensed to the Company
for customers either under development or within their warranty period, (iii)
assessing and prioritizing any required remediation, and (iv) remedying any
problems by modifying, or replacing where appropriate, non-compliant systems.
In connection with its Year 2000 remediation efforts, the Company has not
and does not expect to incur any significant costs. Any such efforts are
expected to be handled by Company personnel as part of their regular duties. In
respect of Tower's remediation efforts, Tower expects to incur staff costs well
as consulting and other expenses incremental to current spending levels. Tower
anticipates that such costs will not be material. Tower estimates that the total
cost associated with the Year 2000 projects will be $1.5 million, of which
approximately $1.1 million has been expended to date. Tower has financed its
Year 2000 related costs from its working capital and has expensed them as
incurred.
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Both the Company and Tower do not believe that any of its products have any
direct material Year 2000 compliance problems.
In addition to assessing its own internal or externally supplied systems,
the Company has made efforts to identify and remedy potential implications to
the Company as a result of its suppliers' vulnerability to Year 2000 problems.
There can be no assurance that the Company has or will be able to identify all
aspects of its business that are subject to Year 2000 problems of customers or
suppliers that affect the Company's business. There can also be no assurance
that the Company's software suppliers are correct in their assertions that the
software is Year 2000 compliant. Should either the Company's internal systems or
the internal systems of any of its more significant suppliers or customers fail
to achieve Year 2000 compliance, the Company's business and its results of
operations could be adversely affected. The Company has reviewed all of its key
systems and has satisfied itself that it has identified substantially all
systems with potential problems and has either corrected or is in the process of
replacing them. As of September 30, 1999, the Company's Year 2000 remediation
efforts were almost completed. The Company expects to complete the remediation
by December 1999.
Tower believes that it has or will have addressed all Year 2000 issues
before the end of 1999, except with respect to certain embedded fab machinery as
a result of no response on the part of certain vendors; however, there can be no
assurance that Tower will achieve Year 2000 compliance as scheduled.
Quantitative and Qualitative Disclosures About Market Risk
General
The Company is required to make certain disclosures with respect to its
financial instruments, including derivatives, if any. A financial instrument is
defined as cash, evidence of an ownership interest in an entity, or a contract
that imposes on one entity a contractual obligation either to deliver or receive
cash or another financial instrument to or from a second entity. Examples of
financial instruments include cash and cash equivalents, trade accounts
receivable, loans, investments, trade accounts payable, accrued expenses,
options and forward contracts. The disclosures below include, among other
matters, the nature and terms of derivative transactions, information about
significant concentrations of credit risk, and the fair value of financial
assets and liabilities.
Forward Exchange Agreements
The Company, through Tower, has entered into forward exchange agreements to
manage exposure to equipment purchase commitments denominated in Japanese yen.
These transactions qualified for hedge accounting in accordance with generally
accepted accounting principles and, accordingly, the results of such
transactions have been recorded concurrently with the realization of the related
items (i.e., receipt of the equipment and payment of the related liability).
Although the Company has retained effective control of Tower, the Company no
longer maintains voting control of Tower. The Company does not hold or issue
derivative financial instruments for trading purposes.
Foreign Exchange Transactions
No such transactions are reflected for the nine-month and three-month
periods ended September 30, 1998 and 1999.
Fair Value of Financial Instruments
Fair values are estimated for financial instruments included in current
assets and current liabilities at book value, due to the short maturity of such
instruments. Fair value for long-term debt is estimated based on the current
rates offered to the Company for debt with the same remaining maturities. Fair
value of long-term equity marketable investments is estimated based on market
value. The estimation of fair value for non-marketable long-term equity
investments (book value of $286,000 as of September 30, 1999) was not
practicable, although the Company believes that the estimated fair value of such
financial instruments was not materially different from their book value.
The market value of the Company's investment in Tower as of September 30,
1999 was approximately $29.7 million, above the carrying value of the equity
investment (after minority interest) as of September 30, 1999 of $27.5 million.
Concentrations of Credit Risk
The Company is subject to credit risk through its trade receivables. As of
September 30, 1999, approximately 9% of the trade accounts receivable were due
from a major Israel government-owned company which, despite experiencing
financial difficulties, continues to pay its trade receivables over extended
credit periods. Approximately 17% of the trade accounts receivable were due from
a U.S. customer that continues to pay its trade receivables over usual credit
periods. The remaining balance consists primarily of receivables from various
customers.
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DATA SYSTEMS & SOFTWARE INC. AND SUBSIDIARIES
PART II - Other Information
Item 2. Changes in Securities and Use of Proceeds
(c) Sales of Unregistered Securities
Set forth below is certain information concerning sales by the Company
of unregistered securities during the third quarter of 1999. The
issuance by the Company of the securities sold in the transaction
referenced below were not registered under the Securities Act of 1933,
pursuant to the exemption contemplated by Section 4(2) thereof for
transactions not involving a public offering.
In August 1999, the Company issued, in connection with a credit
agreement between the Company and Bank Leumi U.S.A., warrants to
purchase an aggregate of 250,000 shares of Common Stock of the Company
to Bank Leumi USA and Bank Leumi le-Israel. The warrants may be
exercised at any time on or before August 30, 2002 at an exercise
price of $3.31 per share. The warrant agreement and the form of
warrant are included as Exhibit 4.1 to this Quarterly Report. Pursuant
to the terms of the warrants, the Company is required to file, make
effective and maintain the effectiveness of a registration statement
covering the resale of the shares of Common Stock underlying the
warrants. The Company has filed the registration statement which is
awaiting review by the Securities and Exchange Commission.
The proceeds from the exercise of the warrants, if any, will be used
for working capital and general corporate purposes.
Item 6: Exhibits and Reports on Form 8-K
(a) Exhibits
4.1 Warrant Agreement dated August 30, 1999 between Bank Leumi USA
and the Registrant, including form of warrant annexed thereto.
10.1 Amended and Restated Credit Agreement dated August 30, 1999
between Bank Leumi USA and the Registrant.
10.2 Term Note dated August 30, 1999 of the Registrant payable to Bank
Leumi USA for the principal sum of $5,947,482 due August 1, 2000.
27.1 Financial Data Schedule
(b) Reports on Form 8-K
Report of the Company on Form 8-K dated September 9, 1999, as amended
by Amendment No. 1 on Form 8-K/A dated November 12, 1999.
Report of the Company on Form 8-K dated October 5, 1999.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by its
Principal Financial Officer thereunto duly authorized.
DATA SYSTEMS & SOFTWARE INC.
Dated: November 15, 1999
By: /s/ Yacov Kaufman
Yacov Kaufman
Chief Financial Officer
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